A Tale of Two Banking Crises

For the past few months I've been trying to explain why looking at the past is so important for understanding the future. Here is a practical example of why this is so important, and how practical the outcomes can be if you do it properly.

You may have noticed that the world has recently been through an economic downturn, and that the UK has been particularly badly hit. Recently week the Bank of England (the Central Bank of the UK) revealed that it had given secret loans to HBOS and RBS, totalling £61.6 billion at the height of the crisis last year. This comes at the same time that Lloyds - a reasonably healthy bank that was basically forced by Gordon Brown to merge with a very sick bank, HBOS, is trying to raise £13.5 billion from investors. It has had to offer a significant portion of this at a 60% discount. This is because the market just doesn't trust the banks. We don't trust that the bad news is all finished, that the balance sheets are real, or that the banks are safe yet.

To try and ease the crisis, the Bank of England has been printing money (they call it euphemistically, "quantitative easing"), guaranteeing loans to banks, and otherwise sounding pretty toothless in their dealing with the country's banks. And worse still, the government continues to overspend (by an estimated £10 billion per month!), living under the illusion that future growth will fix all current problems.

All of this sounds scarily familiar. So, let me tell you the tale of two banking crises.

A long time ago, in the land of 1980s-ville, there lived a tribe of bankers. They had spread throughout the world, and were feeling pretty pleased with themselves. They had resided over a long period of sustained growth, and their efforts to create a global trading system were beginning to bear fruit. In 1989, they even saw the collapse of communism and the opening up of entire new markets.

The Japanese banker tribe went wild with excitement. Their greatest moment of folly was probably the 1989 purchase of the Rockefeller Center, which just added to mounting debts based on the expectation of unlimited growth in property prices. In 1991, it all came crashing down for Japan (and many other countries too).

And so began a long period of "zombie banking" in Japan - something they haven't yet escaped. They refused to do a full assessment of the crisis, preferring to just not look at the scale of the problem. The Japanese government applied almost the identical remedies that the UK government is currently applying.

And, so it came to pass that when the world economy began to recover in the mid-1990s, the Japanese banks were once again exposed. You see, they hadn't fixed anything.

Their economic recovery was unsustainable, and Japan limped along, wounded, for more than a decade, while the rest of the world saw stellar growth and recovery.

But there is another story from 1980s-ville. And that is the story of the bankers of Scandinavia.

At the same time as Japan's banks were hit in the early 1990s, the Scandinavian banks experienced a similar collapse. Sweden and Finland had allowed their banks to also run up a huge property bubble - and when the bust came it was as big as the UK's bank losses last year.

But the Scandinavians were not going to create untenable banks and wreak long-term havoc in their financial system. They brought in hundreds of external experts and auditors, and forced every bank to be fully exposed. It was horrific - and not a little embarrassing. But then it was done. There were no more surprises, and nothing hidden.

So investors were confident, money returned and the banking system started doing what it is supposed to do. Health had returned, and growth followed. If you had invested in Scandinavian banks in the mid-1990s, you would have had a 400% return on your investment. And you'd be fairly confident of your investment at the moment.

Oh, and the Scandinavian taxpayers, who helped bankroll some of the recovery, got all of their money back. I don't know any British taxpayer who dares to hope that could happen here.

So, that is the tale of two banking crises, and two very different responses. Britain is in danger of almost perfectly copying the very worst banking story of the last 20 years. Japan has only recently recovered - if, in fact, it has. The UK could be destroying everything it created in the 1970s and '80s, and turning itself into a zombie nation.

To stop this happening, they need to stop being Japanese, and start being Scandinavian. They should force banks to confess. Full disclosure, and nothing less. Then, they should calculate the amount of money they need to fix the crisis - how much capital do the banks really need? It's going to be a huge number, but surely it's better to know it, than pretend it doesn't exist? Then, they should force the banks to find that capital themselves. There are plenty of investors who would bet on the UK's future, as long as they were sure they weren't going to be hamstrung by its past.

And that, my friends, is the moral of the story. Look ahead by understanding what has gone before.