Part of the debate – in the House of Lords at 3:15 pm on 3rd November 2008.

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Photo of Lord Myners Lord Myners Parliamentary Secretary, HM Treasury 3:15 pm, 3rd November 2008

My Lords, we are living in extremely challenging times for the global economy and financial architecture. I welcome this debate as an opportunity for this House to have an open, constructive discussion on the issues that face us. The twin global shocks of the credit crunch and the surge in energy and food prices have hit every country in the world, including here in the UK. As we are all aware, families have been hit by a big hike in world oil and food prices, while companies have seen associated rises in their costs. At the same time, as we have seen so vividly, the global credit crunch, which affected America, has now spread across the world affecting businesses and households, especially home owners. Many of the recent events in the banking system were unimaginable less than a year ago. Few predicted that by now the five largest Wall Street investment banks would have merged, sought government help or collapsed.

Before considering the effects of the developments we have seen unfold over the recent past and what the Government are doing in response, it is useful to clarify the many forces that came together over the past 15 years to set the stage for these unprecedented events. First, we saw increasingly integrated global financial markets, with enormous amounts of capital flowing across borders every day. Secondly, improved policy frameworks played a major role in delivering low inflation and low interest rates across the developed world. Thirdly, the massive build-up of emerging markets' foreign exchange reserves, invested mainly in US assets, pulled long-term interest rates down to historic lows.

As returns on conventional investments were low and borrowing was cheap, financial institutions searched for higher yields. Complex products were devised to repackage securities into new investment opportunities. Advances in technology and processes made possible the repackaging and global distribution of these securities, and banks borrowed heavily from global capital markets to fund their investments and leverage up returns.

Investors were overpaying for risky assets, obtaining inadequate returns for the risks involved. In other words, a global credit bubble had formed with a belief that repackaged assets could be worth more than the sum of their parts. As American sub-prime mortgages defaulted—around one in five is currently behind on its payments—that belief was shown to be false. In a highly leveraged, interconnected and complex financial system, shocks like these are profoundly felt and quickly transmitted across countries. That is how, last summer, we had a catalyst: the trouble in the American sub-prime mortgage market. Last week, the Bank of England's Financial Stability Report estimated sub-prime and related losses at almost $3 trillion. Since the global financial system was so highly leveraged, this shock is having a profound effect. Having paid too much for the assets, financial institutions are now having to revalue them, booking losses in the process, with consequent damage to their capital and, importantly, to confidence in and among banks.

The Government are taking decisive action to deal with these challenges and have repeatedly made clear that they will do whatever is necessary to maintain financial stability.

Later this month, world leaders and Finance Ministers will meet in Washington to discuss these global economic problems. These global shocks are unprecedented in their scope, scale and confluence, and we fully recognise that they are affecting the daily lives of families and businesses. As the IMF stated last month:

"The world economy is now entering a major downturn in the face of the most dangerous shock in mature financial markets since the 1930s".

It also noted:

"The major advanced economies are already in or close to recession".

Why does the global environment have such an important influence on Britain? Britain is a trading nation. Openness is one of our great strengths, providing new opportunities for growth and jobs, so shocks in global markets affect us all at home. We trade around a third of our output as exports and imports with the rest of the world, receive over £100 billion of inward investment a year and over £200 billion of investment in bonds, stocks and shares from abroad.

Millions of people and millions of jobs are influenced by our overseas links, and the UK is home to a significant number of the world's best companies. Our financial services industry—the industry at the centre of the turmoil we have witnessed—is of course a world leader, and very important to our economy.

Although the world economy is clearly experiencing huge challenges at present, we should not lose sight of the fact that openness and globalisation, and being a key part of the global economy, has increased our national prosperity significantly. Openness will remain the approach of the Government, making the most of the opportunities available to the UK in the global economy. Indeed, it is imperative that the global problems we face are addressed by comprehensive global solutions.

Let me say a few words regarding the present economic environment, which noble Lords know is very difficult. No Government can prevent a downturn in the face of the unprecedented shocks we and others are facing. It is going to be challenging. We have already seen output decline by 0.5 per cent in the third quarter of 2008. As my right honourable friends the Prime Minister and the Chancellor have made clear, it looks as though our economy—like all other major economies around the world—is moving into recession.

The latest economic data show very clearly the task we are facing. The preliminary estimate of GDP growth recorded the first quarter of negative GDP growth for the third quarter of this year since the second quarter of 1992 and the weakest since the final quarter of 1990. Data suggest that individuals are reigning in spending on discretionary and big-ticket items as disposable incomes have been squeezed by high energy prices, alongside growing uncertainties arising from the global financial situation. Consistent with consumers acting more cautiously in this challenging environment, retail sales fell in September.

Forecasters have continued to revise down their projections. Last week, the esteemed National Institute of Economic and Social Research predicted that UK growth next year will be minus 0.9 per cent, compared with its forecast only this summer of plus 1.4 per cent—a true indication of the shock of global developments on the UK economy. The Treasury will update its own forecasts in the Pre-Budget Report as usual.

Underlining the global nature of these problems, we have seen a similar pattern in other G7 economies. GDP in the euro area fell in the second quarter by 0.2 per cent—falling a quarter earlier than in the UK. Confidence in the euro area fell back sharply in data reported last week to its lowest for over a decade. In the US, unemployment has risen significantly and just last week we saw it reported that GDP growth declined in the third quarter. Indeed, over the recent past, GDP has declined in Germany, France, the US, Italy, Canada, Japan and now the UK, so the whole G7 has seen declining output. But we should also recognise that the nature of this downturn is fundamentally different from the past. In the late 1980s, UK GDP growth was allowed to rise to more than 6 per cent, which was well above the economy's growth potential.

As a result, inflation rose into double digits and interest rates, in an effort to control rampant domestic inflation, followed suit. As a result of these domestic policy mistakes, the economy entered recession in 1990 and unemployment rose to more than 3 million for the second time in only 10 years. Today, things are very different, so the policy conclusions we draw from these experiences are likely to be different too.

We should make no mistake: this Government are fully aware of the difficulties and problems faced by the most vulnerable. That is why we have taken decisive action to help the economy as a whole and those most vulnerable to the effects of this global slowdown. The Government are determined to help families and businesses affected by the global economic difficulties. We will do whatever we can to support those who need it most.

Let me outline the action which the Government have taken. Their priority is financial stability and this focus on financial stability has been critical for small businesses and families. Financial stability means small businesses having access to credit and home owners having access to mortgages. Supporting the banking system in this way is essential, not only for financial institutions, but also for the businesses and individuals who rely on them.

Our action to stabilise the banking system is also vital for hard-working families. A sound banking system is an essential part of the everyday lives of every family in the country and an essential precondition for the long-term health of the economy. Because today's problems are global, the solutions will also be global and will require global co-operation.

Today, Governments all over the world are using approaches that until recently could not have been considered. It is right that the conduct of policy should evolve. Just as markets change, so should policy. On 8 October, after consultation with the Bank of England and the Financial Services Authority, the Government announced specific and comprehensive measures to ensure stability in the financial system, and to protect the depositors and businesses which rely on the system.

This comprehensive programme addresses three vital issues. First, it addresses the provision of sufficient short-term liquidity by increasing the amounts available to the Bank of England to lend through the special liquidity scheme. Secondly, new capital will be made available for UK banks and building societies so that they can deal with the current events in global financial markets while continuing their role of lending to individuals and businesses, thus supporting the economy. Thirdly, it will ensure that banks are willing to lend to each other with confidence—which will free up inter-bank lending—by offering an innovative, temporary government guarantee for eligible new debt issued by banks.

We are also working to tackle the causes of the problems in the banking system and in global financial markets.