Dood issues new seven point plan to reform financial markets

Debt on our Doorstep has today called for the Treasury to place more emphasis on protecting consumers in its strategy to deal with the financial crisis and to increase financial stability. In particular, Government should now legislate to allow the FSA and OFT to cap the cost of credit where it is apparent that these are reflective of high risks or where there is a failure of competition.

The paper also argues that Government cash used to bail out the banks must be diverted to those that need it most including homeowners with little or no equity, rather than to the wealthy who are the only ones currently benefitting from historically low bank base rates.

And noting that many people will now be defaulting on credit agreements and facing insolvency through no fault of their own, Debt on our Doorstep has also called for an immediate review of insolvency legislation and credit scoring mechanisms to ensure that people affected by the recession are rehabilitated back into mainstream financial services as soon as possible.

The full paper is available here

OFT consults on Financial Sector Strategy

The OFT has launched a consultation on its proposed financial services strategy which sets out its approach to the sector in response to the current economic crisis, and also announced a review of the unsecured consumer credit market.

The OFT is asking interested parties to comment on its proposal to focus on two inter-related themes:

• The prioritisation, in the short term, of promoting fairness and responsibility between the credit industry and consumers, and

• advocating choice and competition to ensure that public decisions made to deal with the current crisis do not harm competition in the long term to the detriment of consumers.

The consultation will run until 12 June 2009, and the consultation document can be downloaded here.

A review of the unsecured credit market is also being scoped out, with details available from:

www.oft.gov.uk/oft_at_work/markets/services/credit-sector/.

Comments are currently being invited concerning this until 8th May, with the full review expected to start in the summer.

Global Coalition for Responsible Credit calls on G20 leaders to create a financial system ‘worth saving’

Debt on our Doorstep, with support in the UK from the trade unions UNITE and PCS, the New Economics Foundation, Church Action on Poverty, the National Housing Federation, and former Cabinet Minister and Chair of the Labour Party Ian McCartney M.P, and with the support of a Global Coalition for Responsible Credit comprising the European Coalition for Responsible Credit, the U.S National Community Reinvestment Coalition, and partners in twenty other countries, today issued a call for the forthcoming meeting of the G20 to commit itself to the creation of a financial system that is worth saving by:

Agreeing to place financial services providers under a ‘duty to exercise responsibility in financial services’. Financial services providers need to be required to sign up to clear principles of responsibility and to have transparent mechanisms in place to ensure that these principles guide their behaviour in practice. Remuneration policies need to be reassessed in the light of this ambition. The responsibility should include a requirement for financial services providers to properly consider the needs of all households, including those on low incomes, when designing financial products

Ensuring taxpayer investment in the banking system is turned into real help for people in financial difficulties, by agreeing actions to force lenders to offer to reschedule the liabilities of households in debt over the long term at affordable rates

Committing to take further action to stop home repossessions and ensure lenders offer affordable mortgages to people in negative equity and/or mortgage arrears, and to work to stabilise housing costs in the longer term by increasing the supply of affordable housing.

Chair of Debt on our Doorstep, Damon Gibbons, commented:

“Financial services providers have engaged in irresponsible and usurious lending, causing households to become increasingly vulnerable to economic shocks and saddling them with unsustainable levels of debt. We call on the G20 to signal a decisive break with the short termism, greed, and irresponsibility that have caused the current crisis and to take action to ensure that taxpayer investment in the banking system is now used to create a system that benefits people.”

Supporting the work of the Global Coalition, Andy Case, a National Secretary for Unite, the UK’s largest trade union with 2 million members, including 178,000 working in the Finance Sector, said:

“The current situation provides an opportunity to re-build a financial system that supports a long-term outlook and is consistent with democratic aims, financial stability and social justice."

Why cutting VAT could now be on the agenda

With the rise in unemployment figures released yesterday, and continuing long term downturn in consumer confidence affecting retail spending and small business, it may be that the time has come to consider cutting one of the most regressive tax schemes currently in place - VAT.

Calls have already been made this year for government to cut VAT on maintenance and home improvement work as a means to encourage homeowners to carry out energy efficiency measures and contribute to carbon reduction - see http://www.fmb.org.uk/cutthevat/(e4xgrh55hgjfox45er31qiq1)/default.aspx for details.

In his last speech as Chancellor, Gordon Brown also called on the EU to cut VAT on 'green goods' to 5%.

But a wider VAT cut may have advantages over tax rebate strategy that has been put in place by the Bush administation and which was echoed in comments made by the TUC's Brendan Barber in an interview with Channel 4 news last night.

As we highlighted earlier this year on this blog, one of the key theoretical advances made by the monetarist economist Milton Friedman was his exposition of the 'permanent income hypothesis' which dictates that households will not be encouraged to spend by income tax cuts whilst they are fearful for their jobs and long term position. As a consequence, VAT cuts have a distinct advantage - the benefits of them are only realised in the act of spending. To get the benefit of lower prices, you have to buy. They also have a real advantage in redistributing income to the poorest who spend a greater proportion of their income on VAT than higher income households, especially if the VAT regime is rebalanced in order to provide the largest cuts in the VAT rate on those goods which the poorest need and buy most.

If government is seeking to boost the economy and consumer spending then the measures we set out in our post earlier this week - an income based mortgage interest credit, central bank control over new long term mortgage and consumer lending rates, compulsion for banks to lend, discretion for courts to reschedule mortgages that are in arrears, and a cut in the VAT rate could form the basis of a solution.

Banking on Change - Can we build a sane future?

The action of governments and central banks across Europe and in the U.S to save the financial system from complete collapse is without a doubt one of the most significant economic and political events since the second world war. But it would be foolish to think that this crisis is anywhere near over. In fact, we may simply be entering a third phase in which we witness the impacts start to spill over into the real economy - resulting in more lost homes and rising unemployment.

The primary reason for continuing alarm? The causes of the credit crisis have not been addressed. We perhaps need to remind ourselves that neither the mass movement of bank deposits or the loss of liquidity in the banking system was the initial cause. Both of these were second order problems. They only arose because of falling values in the U.S - and by extension uncertainty in other national - housing markets. This 'trigger' remains in place, creating a prisoner's dilemma for banks.

Simply put the prisoner's dilemma is this - with so many people now in need of remortgaging at cheaper rates in the U.S, which one of the banks will be the first to take the risk on by offering them loans? The answer, clearly is none will do so for fear of attracting the most risky customers - after all just as the market knows that those banks accepting loans from government are in the worst problems, the banks know that those customers most desperate to reschedule home loans are likely to have the most problem repaying. This 'adverse selection' in credit markets was recognised long ago.

Two immediate actions need to be taken to resolve this. Firstly, households in the most difficulties need helping and fast. Secondly, central banks have to break the prisoner's dilemma by placing 'strings' on their assistance.

How can households be helped? - Debt on our Doorstep calls on government to consider introducing a 'housing interest credit' for low income families, which provides interest relief at source on mortgages and is paid on a sliding scale according to income. That will provide instant assistance to households struggling with increased fuel prices, and rising inflation but will ensure that it reaches mortgage repayments and reduces the risk of arrears. The Obama campaign has something similar in its economic proposals in the U.S at the moment.

Government should also legislate to amend S.36 of the Administration of Justice Act 1970 and S.8 of the Administration of Justice Act 1970 - the legislation which currently provides court's with powers to help borrowers facing repossession proceedings. The current law does not allow judges to reschedule mortgage agreements to ensure that people can retain their homes. They should be provided with the discretion to do so. Again, these measures are being supported by Democrats and community groups in the U.S.

But fundamentally the prisoner's dilemma in banking needs to be broken. To do this, banks must be forced to put out greater amounts of capital on loan to support mortgage and consumer credit restructuring for households over the next five years. Long term loans need to be made available to the banking industry from central banks to support this but banks must pass on this funding at fixed rates and terms established by the central banks to consumers. In effect the central bank will be setting the terms on which loans are to be provided to consumers, with banks simply acting as the intermediaries. Such is the lack of trust which can be afforded to Britain's banks.

Over time, such a direct mechanism can be relaxed provided the regulatory framework under which credit is provided in future is revamped and ensures that incentives are in place for responsible lending to take place and long term, ethical, relationships between consumers and lenders fostered.

That regulatory framework now needs to be constructed with the active participation of consumer agencies and representatives in partnership with banks and government. Our conference, which will take place on 13th and 14th November in London provides a seminal opportunity to begin those discussions. Further details can be found at

http://www.cesi.org.uk/events/current_events/responsible_credit_conference.htm

Please note that we have also secured up to 50 half price places for not for profit agencies to attend these discussions.

Why aren't Americans spending? What would Friedman say now?

The Bush administration's plan to get Americans to spend their way out of the economic doldrums appears to have hit problems, according to a survey of US householders conducted for CNN/ Opinion research Corp.

Only last month, the U.S congress voted through a $170 billion package to boost the economy, with $120 billion of this set to be put straight into consumers pockets in the form of tax rebates, with payments of $600 to most individual taxpayers who earn less than $75,000, and $1,200 for married taxpayers filing joint returns who together earn less than $150,000. There is also a $300-per-child tax credit.

But a survey pulished today reveals that only one in five U.S consumers are planning to spend the money. Instead 41% of those surveyed plan to use their rebates to pay off bills, and 32% will put the money in savings. A further 3% said they will donate the extra money to charity.

The survey indicates that only $24 billion of the $120 billion being handed out will actually contribute to stimulating the U.S economy.

The results are ironic, given the long standing commitment of the U.S to monetarist economics. Monetarism's rise dates back to the 1970's when nations were grappling with the failure of Keynesian economics to stimulate domestic demand in the face of the oil crisis, and inflation and unemployment were both rising.

One of the key theoretical explanations for Keynesian economics failure was contained in Milton Friedman's 'Permanent Income Hypothesis' first published in the 1950's. This stated that, rather than modify their consumption patterns in line with temporary increases or decreases in income, people would use credit to smooth out these fluctuations over their lifetime and attempt to maintain a constant level of consumption. Short term attempts to boost the economy - for example increased welfare payments or tax rebates - Friedman argued, would be largely ineffectual. Only changes in household's long term expectations would have an impact.

For neo-liberal administrations like those of Thatcher and Reagan, Friedman's theory - and other life cycle theories of credit that followed it in the 1960's - provided the theoretical justification for policies that deregulated credit markets, promoted home ownership, and boosted demand. Expanding credit markets meant not having to resort to the old Keynesian mechanisms of state spending, but instead relying on individual households to borrow and spend. The consequent surge in house values shifted household expectations sufficiently to encourage a cycle of increasing indebtedness and, for limited periods, economic growth.

It also provided a good basis on which to reduce traditional welfare provision throughout this period under slogans of "self-reliance", and "individual responsibility". In this sense, credit was the tool of choice for those administrations looking for a mechanism to undermine the welfare state.

But this cannot last forever. Just as this process resulted in mass repossessions in the UK in the late 1980's, so it must come to an end this time around also. At some point, as the economists Godley & Izurieta pointed out in 2003, (Coasting on the Lending Bubble Both in the U.K and U.S. Paper presented at the Annual Meeting of the Society of Business Economists, London, June 25th, 2003) household expectations begin to flatten out - they balance their debt burdens against a prognosis for the economy more broadly. Once this happens, spending slows and the cycle begins to reverse. Consumers repay debts or save rather than spend, demand slows, and asset values including house prices fall.

The evidence from the US survey indicates that consumer expectations have now been firmly realigned downwards. According to Friedman's theory, tax breaks are not going to be enough to save the US economy now.

What might help? Firstly, if Friedman's theory is right then measures must be taken that will help manage household expectations for the longer term. Short term measures are unlikely to be successful. Instead, emphasis should be placed on preventing house prices from collapsing further - putting in solid protections against repossession would be a good start.

Secondly, there has to be both liquidity of credit, and responsibility in its provision - this means ways must be found to continue to lend to households that require re-financing, but that this must be done in ways that help households in the longer term rather than simply seek to profiteer on their desperate positions. Rescue loan funds, that genuinely work with consumers to provide sustainable long term solutions would be useful. Given that so much central bank funding is now flowing into private banks, some insistence that this be used to assist households in difficulty doesn't appear to be too much to ask.

For the longer term, there needs to be a reassessment of the regulatory framework governing credit provision and a debate involving government, consumers, and the industry to determine accepted principles of responsible lending and the required rules to ensure this.

UK Government confirms 'Greed & Fear' as causes of credit crunch:

Writing in 1998, Professor Susan Strange wrote that:

"“Greed and fear are the two human emotions most evident in the day-to-day behaviour of the international financial system today….Either dealers are drawn by greed to take too big risks with their own or, more often, with other peoples’ money; or they are overcome by fear that the risks they have taken will catch them out. In their rush to escape the consequences of greed, they may start…an avalanche of panic that carries away the innocent along with the guilty.” (Mad Money, pg. 139)

10 years later, the Treasury have confirmed this assessment - although they use less obvious language. Their current consultation on proposals to increase stability in the world of banking highlights the two causal factors of greed and fear in the language of the marketplace: with 'search for yield' as greed, and 'uncertainty' as fear.

The Treasury's current consultation on proposed measures to stabilise the financial services sector notes that:

"...the disruption in global financial markets in the second half of 2007 followed a prolonged period of macroeconomic and financial stability and low interest rates in the UK and globally. Historically low interest rates encouraged investors to ‘search for yield’ by investing in increasingly risky financial products without being fully compensated for the additional risks, leading to a general under-pricing of risk. Benign macroeconomic conditions and the search for yield also encouraged an erosion of credit risk assessment standards in some markets, most notably US sub-prime mortgages." (para 2.2)

and then at para 2.4:

"Although the US sub-prime mortgage market is small in relation to the global financial system, difficulties in valuing many of the residential mortgage-backed securities (RMBS) and uncertainty about where the risks associated with sub-prime mortgages had been distributed led to significant uncertainties about the losses and their impact on banks’ balance sheets."

However, rather than focusing on ensuring that lenders act responsibily in the first place, the proposals concentrate on allowing the Government, Bank of England and FSA to prop up banks that get into difficulty. Banks, it would appear, are now too big to fail - with the consequent moral hazard that means they will invariably take greater risks with other peoples' money in the future.

This is the wrong approach - act now to tighten the rules on responsibility in lending, and link the huge level of assistance currently being given to banks with additional requirements that they meet the needs of all communities in the U.K for affordable credit.

Northern Rock Nationalised

The decision to nationalise Northern Rock represents the ultimate failure of the private sector to sort out its own problems arising from the credit crunch. Heavily reliant upon public investment in the entire banking sector (and increasingly upon the use of sovereign funds from overseas governments) the financial sector is no longer capable of raising funds to rescue those banks in the biggest trouble.

This is bad news. Not least because it also means that many other projects reliant upon raising large amounts of capital will also find it more difficult to proceed. Look around any UK city, and you will find a skyline of cranes putting up retail developments, swanky city living apartments, theatres and cinemas. But already many of these projects are in jeopardy. As last weekend's Guardian reported from Manchester, many of those city apartments have already come down sharply in value. There is every likelihood that new developments will stand empty for some considerable time as consumers lack the confidence to buy and mortgages are harder to find.

Equally, many commercial developments are likely to be stopped. The commercial property market started to squeal loudly in pain last month with many share prices tumbling. It's hard to see the financial sector wanting to invest in new developments for commercial property even if it had the ability to get it's hands on the levels of cash that this would require. But the reality is, cash and liquidity is now of vital importance to the banks themselves so less likely to be available for investment. That supply side crunch feeds through as both inflationary pressure (demand remains high) and as a threat to growth (by removing the funds for investment), which poses such problems for monetary policy in the UK.

So no surprise that the Northern Rock fiasco has resulted in nationalisation. But what next? Northern Rock has been actively repossessing customers in arrears in recent months. Will the Government want to take responsibility for evicting families from their homes, or will they now take an active role in leading mortgage lenders to adopt better ways of dealing with debt. Today's call by union leaders to preserve jobs at Northern Rock needs supporting, but further demands to review debt management, arrears and repossession policies also need to be urgently raised with new boss Ron Sandler.