Economic insight

This is a huge crisis. The roots of the problem are in the way banks have shifted their emphasis away from their traditional business of serving their customers towards trading in their own right and transacting between themselves. This shift has generated huge income for bankers, but the end result has been a complete loss of trust between financial institutions.

Having said that, I think 1929 is the wrong comparison. Not all banks have been affected to the same extent – Bank of America is still able to buy Merrill Lynch, for example.
Additionally, there are strong emerging economies like China where banks have not taken the same level of risk. Factor in sovereign funds in the Gulf and elsewhere, and there’s still plenty of liquidity in the world system.

However, the impact on the British economy will be deep. For ten to 15 years the UK has been driven by banks, and especially by the City. We’ve had ten good years – low interest, low inflation – and that’s created excess. So it will take a bit longer to recover than some people think.

Now that banks have problems with their balance sheets, they will cut lending to companies, especially small and medium-sized ones. To make matters worse, entrepreneurs, who tend to use property as collateral, are seeing the value of that collateral fall, reducing their ability to borrow.

In the long term, we need to lower our expectations about how much return we expect from financial investments so that banks don’t have to invest in riskier and riskier assets.