Not Learning From Our Mistakes

Over the last few years on this blog, I have often talked of the importance of understanding the problem. That is you can’t properly solve a problem unless you understand what’s causing it.

For example, what caused the financial crisis? If you want to prevent a reoccurrence, you need to understand what caused it and make sure you put something in place to prevent the same mistakes being made in the future.

The government pedals the story that the financial crisis that affected the whole world was caused by the irresponsible spending of the previous Labour government. I’ve written in detail about why that’s a fallacy here but I’ll summarise it briefly:

The banks started lending higher and higher loan-to-value mortgages to people wanting to buy houses. In older times the banks would have worried about house prices going down but house prices had not gone down for so long that banks forgot about those risks. Borrowers were able to take on bigger and bigger mortgages relative to their wealth, which in turn led to a huge increase in house prices. The huge increase in house prices led banks to lend even more irresponsibly in order to provide the now even more unaffordable mortgages to borrowers. That led to further increases in house prices. Etc. etc.

By the time the banks realised they’d made a bubble and that bubble was about to burst it was too late. Lots of people couldn’t make their mortgage repayments all at once. The banks had started by lending the money they held in savings but as the bubble took off, the money that they held in deposits wasn’t enough to finance the mortgages they wanted to give so they borrowed more and more in order to lend it out again. When the homeowners were unable to make their repayments to the banks, the banks were unable to make their repayments to each other. Like a house of cards everyone became insolvent and the governments of the world had to take on a lot of debt to bail them out. The financial crisis was upon us.

This is how house prices in the UK have compared with the median wage since 1997:

UK house prices vs median wage

In the ten years running up to the financial crisis the average house price in the UK almost trebled and wages were not going up anything like that amount. This was the result of irresponsible lending and it was happening all over Europe and the US.

But now forget this for a moment and suppose that you didn’t understand what caused the financial crisis. Put yourself in the shoes of a government minister who has spent the last five years marketing the argument that the crisis had nothing to do with the banks’ private lending. Suppose instead you had put a huge amount of marketing effort into perpetuating the falsehood that the financial crisis was all down to the public spending of the previous government.

I don’t think I’m asking you to make a huge leap of faith by accepting that you that if you’d put everything behind that wrong assertion it’s quite possible you’d have come up with the wrong solutions to the problem.

Throughout his time in government, George Osborne has frequently appeared with a brand new, broken lightbulb taped to his forehead. The latest example is called his “Help to Buy” scheme. In this scheme, the government will encourage banks to offer high loan-to-value mortgages by providing guarantees for them in the case that the borrower defaults.

Yes. Read that last sentence again. That is really what they want to do.

When the financial crisis hit, the banks quickly changed their policy from lending high loan-to-value mortgages to not lending high loan-to-value mortgages, ‘cleverly’ spotting that these had directly caused their insolvency. Our government now wants to bring back this bubble-inflating, crisis-causing system and so much so that it is prepared to offer a tax-payer funded subsidy to the banks to get it going again.

Using public money to subsidise high loan-to-value private mortgage lending is really not a good idea. It is a policy that directly encourages banks to make all of the same mistakes that caused the financial crisis but (and get this) this time the banks won’t be liable and have to ask to be bailed out! This time the taxpayer will just fund the defaults directly! Ace!

When I’ve talked about bad government policy in the past, I’ve often pondered on whether the motivation has been government incompetence or something more sinister. For example, did they cut public spending in an economy suffering from a lack of demand because they didn’t understand that my spending is your income or was it because they saw a chance to evilly create a smaller public sector in order to align it with their own idealisms? Well, who knows?

In the case of the “Help to Buy” scheme though, I can really see no possible motivation, good or evil, for pursuing such a terrible strategy. In the past we could have argued that they were being clever and devious but not any more.

“Help to Buy” simply shows that they have no idea what they’re doing.

RedEaredRabbit