The crisis has been a ‘perfect storm’ i.e. a catastrophe resulting from the coming together of a number of negative factors all driving in the same direction. I am usually TC’s historian so my first point is to remind you that this is the fourth time in 100 years that the US government has had to step in to save Wall Street (and the rest of the world) from financial meltdown. In the 1930’s the Federal Reconstruction Company took on bad debts which in today’s money would amount to more than $1trillion. In the 1980’s there were ‘Brady Bonds’ issued  by the US Treasury to banks to bail them out of their Latin American debts. In the 1990’s there was the Savings and Loans crisis when hundreds of billions of bad debts were taken on by the state-sponsored Resolution Trust.

So, government intervention has worked before, the economy has survived and the financial system has, after a while, picked up where it left off, including all the old bad habits plus some new ones.

The prime mover this time was injudicious mortgage lending on the part of some banks - a failure of the financial economy. The dangers were pointed out by Peter Warbuton in Debt and Delusion a few years back

 To this has been added the use of derivatives, particularly bundles of mortgage debt used as securities to be traded – a failure of the casino economy.

The consequent balance sheet weaknesses have been probed and exposed by short sellers, but were not spotted by the rating agencies.

In the background, a number of changes over the last twenty or so years have contributed to the growing fragility of the system. These include the growth of 24 hour trading, the deregulation of markets, the increasing complexity of financial instruments, the growth of private contracts (so called ' over the counter' trades), and the growth of intermediaries in the investment chain.

The huge complexity of derivatives makes it virtually impossible for even the most sophisticated investors to evaluate the risks involved in trading them. In many cases the complexity reflects ingenious ways invented by traders to enable their companies to avoid regulations.  Probably the best known of all the financial debacles due to the use of derivatives is that of Long Term Capital Management (LTCM). Banks that were selling complex derivatives to their clients began to pay LTCM to take on the more esoteric risks. By 1997 the fund had about $4.7 billion of equity which it used to borrow $125 billion and enter into $1.25 trillion of derivatives. In August 1998 Russia defaulted on some of its debts, triggering a crisis in the markets as financial institutions that had borrowed to buy Russian bonds were forced to sell other investments to raise cash. In particular they were dumping stocks and bonds in emerging markets in Latin America, Eastern Europe and Asia. LTCM's computer models had assumed that losses in some investments would be compensated by gains in others. At this time, however, almost every market went down and LTCM's position began to unwind rapidly. Faced with the prospect of the worst financial crisis the world had experienced in half a century, fourteen major banks agreed to contribute $13 billion in return for a 90 per cent stake in the company. (Small beer by the standards of last week). A crisis was avoided, but the downside was that others drew from the events the lesson that if you failed on a large enough scale either the government or the other players in the system would bail you out. That lesson has now been greatly reinforced.

In this historical context I have identified some implications for policy:

·         If government is now acting as guarantor for all the major financial institutions it will surely require greater transparency, greater accountability and more regulation. But will government risk the unpopularity that would follow greater restrictions on lending, particularly lending for house purchasing? The system needs to go back to a sensible multiple of salary – which would wipe out the aspirations of many first time buyers. Also it is the case that effective regulation is very elusive and attempts to regulate lead to unintended consequences.

·         Short selling didn’t cause the banks to collapse but it did precipitate collapse by drawing attention to structural weaknesses. The answer is not to ban the  practice, but for institutional investors to question whether stock lending is in their interests. Hermes has announced that it will no longer lend shares in 20 financial companies world wide and Calpers has taken similar steps. TC should add its voice to those bodies like the Investment Management Association which are urging institutional investors to refrain from stock lending. It is, however, very likely that hedge funds will be subject to greater regulation, such as being required to put up the same high levels of regulatory capital as other financial institutions.

·         The prediction is that hedge funds, being left with very unfavourable short positions will incur huge losses. No-one seems to be asking what the knock on effects of these losses will be for the rest of the system.

·         The crisis has shown the weakness of corporations with dispersed shareholdings in respect of the actions of speculators. European financial institutions with dominant shareholders are immune from short selling as are mutuals and co-operatives.

·         It is widely predicted that the main short sellers will now turn their guns on corporations in the real economy – retail is tipped as a favourite, also property. This links to our project proposal on financialisation and its impact on companies in the real economy.

·         UK banks are also more exposed to default on personal debt than in the case of any other country. This issue is lurking in the background but will become live if the financial  crisis has a knock on effect on the real economy and unemployment grows significantly. Will the banks now stop spraying credit cards around like confetti?