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What to do when there is money…

The rows between No 10 and No 11 Downing Street are almost part of the constitution. And now they’re back.

In The Sunday Times this weekend, Tim Shipman lays bear the current episode; ‘”As the Chancellor recipes with the gargantuan bill for Covid” runs the stand-pull, “Boris Johnson has grown evermore addicted to making grandiose spending promises.”

But what does a government do when, as the phrase goes, ‘there is no money’? In this lovely little book by NIESR I set out the way we approached the Great Financial Crisis in 2009-10 (I’ve extracted my essay below).

It is the Treasury’s job to make sure the nation lives within its means. Hence the old tradition of private living notes from one team to the next, lamenting the lack of cash. It’s a tradition that goes back to Winston Churchill.

In the final years of the last Labour government it was my job, together with Alistair Darling, to try and put the budget back on an even keel after the Great Financial Crisis.

Pity the poor fiscal policy maker trying to steer the ship of state between the Symplegades of certainty and flexibility. On the one hand, voters – and bond markets – like the comfort of a plan for balanced budgets. On the other, politicians like to get re-elected. As I we used to say in 2010, ‘we know what to do, we just don’t know how to get re-elected once we’ve done it.’

After months of work, I had in fact negotiated across government a detailed blue print as part of Alistair’s plan to halve the deficit in four years and put debt on a the decline by 2016 – a better trajectory than George Osborne in the event managed to achieve.

Summarised in what was known as ‘The Sum’ our approach entailed a mix of underpinning economic growth (which helped bring down unemployment and out up tax yields), raise taxes by around £19 billion, and moving spending down by £38 billion, carefully protecting as we did it, frontline services, an approach set out at length in the Smarter Government White Paper that I wrote alongside No 10 colleagues. It was a balanced approach. Radically different to the Osborne plan that involved trying to go much faster and shifting over 90% of on the consolidation on spending cuts, an approach that triggered the double dip recession we were desperate to avoid – and pushing out his own self declared target for deficit reduction.

I got used to telling my colleagues in the long hours of patient negotiation as I sought to reduce their budgets, ‘I’m sorry, there is no money’…But the plan that emerged was far better than the Tories. We were obsessed about avoiding a double dip recession (like Japan) or seeing inequality rise. So we chose not to go to fast, to carefully weigh the right mix between spending cuts and tax rises and to take incredible care about reform of social security (to the great credit of both Yvette Cooper, who was Secretary of State for DWP at the time and Alistair).

But of course, we were conflicted about how to explain this to the public (investment vs cuts?) and in 2010, in the wake of my infamous note, we simply abandoned the field of argument, failed to set out the detailed alternative in the 2010 budget as a better plan (along with much defence of our achievements in office), and lost trust as a result.

Our challenge was different to the challenge today. Back on 2009 the world economy was basically having a heart attack as the financial system went into cardiac arrest.

There has always been such a strong link between financial globalisation and financial crises. While many nations have graduated from a troubled past repaying national debts, as Rogoff and Reinhart elegantly put it ‘so far graduation from banking crisis has proven elusive.’ In their masterful study of sixty-six countries since the Napelonic War, the pair point out that the world’s great finance hubs – the US, the UK and France have experienced some forty banking crises since 1800 and just four of the nations they studied avoided a banking crisis between 1945 and 2007. In eighteen of the twenty-six banking crisis since 1970, the financial sector was liberalised in the preceding five years sparking faster international capital mobility.

2009 was no different, as we watched some very familiar patterns repeat; financial liberalisation, faster international capital flows, and an asset price bubble. But the scale was staggering.

At the beginning of the 21st century the world was awash with huge cash piles building in countries running significant export surpluses like China and Germany and this abundance helped fuel an extraordinary asset price boom. As early as 2005, the Economist was warning of ‘the biggest bubble in history’.

Financial sector deregulation in the United States (especially President Clinton’s repeal of the Glass-Steagal Act) multiplied the risk as loans were offered to those who could ill afford them, creating a vast ‘sub-prime market’ which the Federal Reserve failed to stem. The US Financial Crisis Enquiry Commission later castigated this pervasive permissiveness as ‘the Federal Reserve’s pivotal failure to stem the flow of toxic mortgages’. As a result, ‘trillions of dollars in risky mortgages had become embedded throughout the financial system as mortgage related securities were packaged, repackaged, and sold to investors around the world’. When the housing bubble collapsed, noted the US investigators, ‘a string of events…led to a full blown crisis.”

But when sub-prime lenders began going bust many were simply bought by bigger banks, concentrating the risk in the arms of fewer and fewer banks. And these arms were not strong because the Basel II safeguards had been relaxed after 2004 allowing banks to reduce minimum regulatory capital by around $220 billion. “Banks could [now] either expand their portfolios and take on more risk’ says Adam Blundell Wignall and Paul Atkinson, ‘or return the money to shareholders via dividends and buy-backs”. Worse, the relaxation of regulation on investment banks allow them to operate with capital ratios that were half the level of commercial banks – yet many were building funds composed of sub-prime problems.

The costs of any financial crisis are severe because they trigger secondary crises. The US financial crisis enquiry commission concluded “nearly $11 trillion in household wealth has vanished”. In the UK, one million jobs, and £400 billion of UK net wealth – most of it household wealth – would be destroyed.

‘The sentries [ie the Federal Reserve] concluded the US Financial Crisis Enquiry Commission, ‘were not at their posts, in no small part due to the widely accepted faith in the self-correcting nature of the markets and the ability of financial institutions to effectively police themselves’.

Today, I feel right in saying Boris Johnson knows far less about economics than Gordon Brown. And Alistair Darling had a hell of a lot more experience of running Whitehall departments than Rishi Sunak. It’s going to be a bumpy ride.


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