ARTICLE ORIGINALLY PUBLISHED JULY 5TH 2017
In 2008, financial institutions across the globe were engulfed by waves emanating from an over-extended US property sector. The problems surfaced in the ‘shadow’ banking sector, where much of the exposure to the US sub-prime housing market then resided. Britain endured a precursor to the sub-prime crisis in 1973-75, albeit on a smaller scale, when a number of ‘secondary’ banks failed as the 1968-73 property boom turned to bust. The 1973-75 crisis has been explored by Margaret Reid, Charles Gordon and Forrest Capie, and it forms the backdrop of a contemporary novel by Margaret Drabble.1 Nonetheless, the episode remains relatively understudied – perhaps because it coincided with momentous events such as the first oil shock, the second three-day week, and the fall of the Heath government; perhaps also because the Bank of England has destroyed most of the archival material.2
Origins of the crisis
Many of the institutions at the heart of the 1970s secondary banking crisis had their origins in the consumer boom of the 1950s. As financial markets sloughed off wartime controls, finance houses such as London and County Securities and Cedar Holdings found it profitable to borrow in the wholesale markets and lend to consumers, initially for hire purchase but increasingly in the mortgage markets then eschewed by the clearing banks. As Reid explains, this was often with little regard for one of the principles that had guided British banking for centuries – matching. This is the notion that short-term liabilities, such as wholesale deposits, should be matched with liquid short-term assets, such as Treasury bills, and not with less-liquid, longer-term property lending.
The secondary banks were competing against the more prestigious, and more heavily regulated, clearing banks that were increasingly subject to government-imposed ‘ceilings’ on their lending. These controls formed part of the government’s attempts to restrain consumer demand, and protect the balance of payments in an era of full employment and consequent high aggregate demand. The clearing banks lost market share to the secondary banks during the 1960s and this was one of the motivations for the overhaul of monetary policy in 1971 when the ‘competition and credit control’ monetary policy removed quantitative controls on bank lending, hopefully levelling the playing field for the better-capitalised clearing banks to out-compete the secondary banks.
Setting the stage
The Conservatives returned to power in June 1970, committed to injecting competition into the economy, partly as a prelude to membership of the European Economic Community. Three specific measures breathed oxygen into a property boom that had been underway since 1968. First, the Heath government abolished the Land Commission, set up by the predecessor Labour government. The Conservatives argued that the Commission, with its powers of compulsory purchase and levies on development, ‘had no place in a free society’.3 Second, and in accordance with another manifesto pledge, Chancellor Anthony Barber made interest payments above £35 tax-deductible for individuals. Senior Treasury officials warned against this in the strongest terms, predicting a large increase in bank lending for consumer spending, particularly for the highest rate taxpayers for whom the cost of servicing a loan was immediately reduced by 90%. The third, and most important, factor was Heath’s ‘dash for growth’.
Heath’s dash for growth
In December 1971, with the economy stalling and unemployment about to pass through the politically sensitive one-million mark for the first time since the 1930s, the Prime Minister called a meeting of ministers, civil servants and businessmen. At this meeting, Heath warmed to the Head of the Civil Service’s suggestion that ‘we should think big, and try to build up our industry onto a Japanese scale. This would mean more public spending. We should ask companies what they needed in the way of financial and other help, and give it to them’.4 The result was the dash for growth, launched in the March 1972 Budget when the Chancellor injected an estimated 2% of GDP into the economy with tax cuts and higher public spending. The aim was to achieve GDP growth of 5% per annum over the next two years – roughly double Britain’s long-term average.
Heath was hoping that loose fiscal and monetary policy would stimulate industrial investment, increase output, and generate productivity growth. But as Treasury economist Michael Posner pointed out, the British economy was characterised by ‘consumer horses which could not be reined in by high interest rates, and… investment horses which could be led to water but not made to drink’.5 Heath wanted sustainable industrial growth; he ended up with an unsustainable consumer and property boom.
Unintended consequences
Lending to the property sector increased more than eight-fold from 1970 to 1974, with the secondary banks overtaking the clearing banks as the principal lenders. Residential prices doubled and commercial prices trebled. In 1971 the ‘competition and credit control’ policy had taken the shackles off the large clearing banks, but it was the secondary banks that thrived most under the more liberal regime. Cedar Holdings, for instance, saw pre-tax profits rise from £87,000 in 1967-8 to £1.9 million in 1972-73, with deposits increasing more than twenty-fold.
Heath had been aiming for 5% GDP growth in 1972-73; he ended up with 7.2%. With the economy overheating and inflation accelerating towards its 1975 peak of 25% the government called time on its boom with a stringent mini-Budget in December 1973, raised the benchmark interest rate to 13% (it had been just 5% when the dash for growth was launched), and re-imposed curbs on lending. With higher financing costs bursting the property bubble, a number of developers and their secondary bank lenders found themselves embarrassed.
The Bank of England’s lifeboat operation
The Bank of England first instructed the banks to curb their property lending in August 1972, and commercial rents were frozen three months later with the introduction of statutory prices and incomes policy. These measures had little immediate impact with property lending rising significantly more in the year after the guidance than it had the year before. But with finance increasingly hard to obtain after a further request for restraint from the Governor of the Bank in September 1973, even at the higher rates, and property prices falling precipitously, the secondary banks found their liquidity drying up.
The first to receive Bank-led assistance was London and Country Securities in November 1973, followed by Cedar Holdings a month later. By Christmas it was evident that the problem was widespread and the Bank launched a ‘lifeboat’ skippered by Deputy Governor Jasper Hollom. Eighteen institutions were rescued, largely by recycling the deposits that had fled the secondary banks for safe harbour at the better-capitalised clearing banks. If an institution was insolvent, or if there was any suggestion of fraud, that institution was allowed to fail. The lifeboat remained afloat for several years, with the Bank also extending unilateral support to three institutions, including Slater Walker, the bank run by Jim Slater who had helped persuade Heath at the December 1971 meeting mentioned above to launch the dash for growth in the first place. At its peak, the lifeboat extended £1.3 billion in financial assistance (about 1% of GDP) at an estimated final cost to the taxpayer of £55 million.6
Lessons for today
A key lesson from the 1973-75 secondary banking crisis is that financial crises usually bubble up in a secondary, less-regulated sector. This is why the Bank of England is currently so focused on ‘policing the perimeter’ of the financial system. A second lesson is that well-meaning policies often have unintended consequences. Heath was desperately keen to see industrial investment rise, and created the conditions for this to happen. He ended up fuelling an unsustainable consumer and property boom that crashed in 1973-4, bringing down a number of secondary banks with it.
But the principal lesson, and one of the first lessons this writer was taught as a junior understrapper in the City in the 1990s, is that matching is still important. We teach our undergraduates that ‘maturity transformation’ is the job of the banks, that it is perfectly legitimate for them to take, or more accurately create, short-term deposits, and transform these into longer-term lending. And if anything goes wrong, there are deposit insurance and lender-of-last resort facilities to protect against bank runs. These safeguards offered little comfort to the Northern Rock depositors who queued up outside the Golders Green branch in September 2007. Another feature of today’s financial sector that would have had Victorian bankers reaching for the smelling salts is the amount of mortgage exposure on the balance sheets of the deposit taking banks that operate the payments system. But that is a topic in itself, and one for another article!
Notes
1. M.I. Reid, The secondary banking crisis, 1973-75: its causes and course (London, 1982); C. Gordon, The Cedar story: the night the City was saved (London, 1993); F.H. Capie, The Bank of England: 1950s to 1979 (Cambridge, 2010); M. Drabble, The Ice Age (London, 1977).
2. Capie, 2010, p. 525.
3. A better tomorrow, 1970 Conservative Party election manifesto (London, 1970).
4. E.E. Dell, The Chancellors: a history of the Chancellors of the Exchequer, 1945-90 (London, 1997), p. 384.
5. ‘Credit control – Sir Frank Figgures meeting on Monday 8 March’, R.G. Smethurst, 8 March 1971, TNA, T326/1261.
6. Capie, 2010, p. 583.
Image (c) iStockphoto
