Free Storm, The by Vincent Cable Page A

and Congress, between them, contrived a massive
     ‘Keynesian’ budget deficit – turning a budget surplus of 4 per cent of GDP in 2000, and an expected surplus of 4.5 per cent
     in 2005 in the absence of any policy change, into an expected deficit of 14 per cent of GDP in 2009 (that is, Federal government
     borrowing). The only developed country with comparable deficit financing is the UK, where, as we saw in the last chapter,
     the government has also made the case for ‘reflationary’ policy in order to stave off the expected contraction in demand,
     production and employment that could result from financial institutions retreating too rapidly from their function of providing
     credit to the real economy. There are those who worry that governments risk creating even bigger problems in the future.
    These reservations expose a deep dividing line in policy. In fact, the financial crisis has thrown up two major, related sets
     of controversies which expose fundamental fault lines in economic and political thinking. One is how far governments should
     intervene to stop panics and financial crises, by acting as lender of last resort, rather than letting them run their course.
     The second is whether, in the aftermath of the excesses of the financial crisis, there should be a reversion to tighter regulation
     of markets, and, if so, in what form.

    The first issue – whether the authorities should intervene in a financial crisis – is one that has preoccupied policy makers
     eversince what Kindleberger calls ‘speculative manias’ have been recorded. These go back to the bubble in tulips, Dutch East India
     Company shares and other financial excesses of Holland in the 1630s, or the
Kipper- und Wipperzeit
wave of speculation in coinage among the German princely states a little earlier. From the outset, but particularly with
     the emergence of economic theory in eighteenth-century Britain and France, there has been a gulf between those who worried
     about moral hazard – the rewarding of imprudence, greed and folly – and those who worried that financial panics would spread
     and infect the real economy. The former view was most succinctly summed up by Herbert Spencer: ‘The ultimate result of shielding
     man from the effects of folly is to people the world with fools.’ This approach was influential in the years of the Great
     Crash, and it helped inform the advice given to President Hoover by his Treasury Secretary, Andrew Mellon: to do nothing.
     ‘[Panic] will purge the rottenness out of the system… People will work harder and live a more moral life… enterprising people
     will pick up the wrecks from less competent people.’ Since Hoover and Mellon emerged as the fools who precipitated the Great
     Depression, their abstemiousness became seriously unfashionable.
    The theory of moral hazard has been invoked more recently by the Governor of the Bank of England, Mervyn King, in initially
     resisting a bail-out of Northern Rock. His has been a more sophisticated version of the argument than Mellon’s, based less
     on self-righteousness and a desire to punish the imprudent than a practical concern that free insurance or underwriting from
     the government would encourage further excessive risk-taking. The experience of the Greenspan years was that, if the US Federal
     Reserve intervened quickly to cut interest rates drastically at any sign of a potential financial crisis, it would lead to
     a new wave of imprudent investment behaviour when the economy recovered. Financiers came to accept such intervention as normal,
     and as a duty of government.
    This view was put, in parody form, by a leading US hedge-fundmanager, Jim Cramer, who lost his temper on CNBC television when the financial storm broke in August 2007, accusing the Federal
     Reserve of being ‘asleep’ and Mr Bernanke of ‘behaving like an academic’, and demanding help for ‘my people’ (that is to say,
     Wall Street). Much more abuse of the same