Two years after the crunch, are we any wiser?

In London, the sun was shining, the banks were lending, the shops were busy. The first week of August 2007 was going swimmingly well, or so it seemed. The mild euphoria that accompanied the long holidays fed into the mood of the nation. There was quiet optimism that house prices would continue rising, though perhaps more slowly, and many dared to believe in new British Prime Minister Gordon Brown, who confidently declared that the boom-to-bust economic cycles that had devastated economic life in the 1970s and 1980s were a thing of the past.

On Aug. 9, however, French bank BNP Paribas revealed it was struggling to value some of its mortgage-backed assets, sparking panic in the financial markets. The credit crunch had begun, with banks refusing to lend to each other, or to businesses and consumers. On the same day, the European Central Bank (ECB) and the US Federal Reserve injected US$90 billion into the system to allow institutions to meet their short-term credit commitments and bolster confidence. Former Northern Rock bank boss Adam Applegarth said it was 24 hours when “the world changed.”

What happened two years ago was to lead to a chain of events that involved the nationalization of about half the major banks in the UK and the US. It was also to lead to the collapse of emerging markets from Latvia to Pakistan and the biggest-ever globally coordinated government rescue package, involving trillions of pounds. The world is now an uglier place, with mass unemployment, widespread business failures and dramatic falls in world trade. A swift political response may have staved off the horror of another 1930s-style Depression, but the data suggests that this is the worst slump for the past 80 years.

Richard Snook, senior economist at the Centre for Economic and Business Research, said: “This is a saxophone-shaped recession. The long neck represents the sharp fall in output over the last year, then a gentle recovery that falls far short from where we started.”

Others are even more wary. Gerard Lyons, chief economist at Standard Chartered, fears that there could be another leg to the financial crisis as “many official bodies have inferred that there is a big shortfall in what the banks have written off so far, and what the losses really are.” For evidence of more pain, look no further than this week’s interim figures due from the Royal Bank of Scotland (RBS), Barclays and HSBC, all of which are expected to disclose additional, sizable write-offs.

However, if British residential property prices start to edge up consistently and confidence returns to the banking industry, it may be possible to conclude that government — which is pump-priming the economy via expanding the money supply — has saved the day. What should not be forgotten, however, is that the authorities have largely transferred losses from privately run, domestic financial institutions to the public balance sheet.

That stores up potentially explosive problems for the future as national debt levels rocket and the country finds itself with humongous borrowings that will take years to repay.

Most commentators agree that the upshot will be cuts in public expenditure and tax rises; they only differ in the timing and scope of future policy action, which is expected to lead to significant public sector job losses this year.