First, the government must make it clear that the UK taxpayer will not be put at risk. If Germany or France are stupid enough to agree to underwrite a rescue, so be it; but there should be no British guarantees or assistance. As the Bank of England’s downgrade to its growth forecasts yesterday (to 1.3 per cent in 2010 and around three per cent in 2011) testifies, we have enough problems of our own without needing to incur yet more liabilities.
Second, the government should ask the Financial Services Authority to produce an urgent report assessing how any Eurozone sovereign default or downgrade would affect London’s financial services industry. This report should be published within the next week or so and should not pull any punches. When the US financial crisis broke out in earnest in 2008, it was impossible for outsiders to judge the degree of exposure of the large international players to sub-prime debt, either directly or indirectly via credit default swaps. It was also impossible to judge accurately how one failure would affect other firms, which is why even pro-market commentators often felt obliged (at the time at least) to endorse the rescue of the likes of Merrill Lynch and AIG.
This time around, it is clearly in the public interest that we find out in advance who would lose out and by how much if Greece were to default, what would happen to those who have written insurance against those risks as well as the exposure of institutional investors, pension funds and insurance companies to dodgy debt.
On closer inspection, it turns out that the US system may well have been able to cope with AIG’s failure; very few firms had truly substantial exposures to it and many – such as Goldman Sachs – were hedged. But outsiders did not have access to such information at the time and the lack of hard data helped to fuel the panic. Greater transparency would have meant better decision-making. My strong hunch is that a proper assessment of London's exposure to a Eurozone default would show that while there would be a lot of pain, it would be manageable without any more handouts.
In truth, Greece will probably be bailed-out, for the time being at least, so it won’t come to that. But that doesn’t negate the desperate need for more clarity.
IT is always a joy to read the latest issue of the Credit Suisse Global Investment Returns yearbook. Its long-term perspective is a breath of fresh air. The latest edition reveals that – over the last 110 years – the real value of UK equities, with income reinvested, grew by a factor of 286.9, compared to 4.3 for bonds and 3.1 for bills. Since 1900, the real return on UK equities has been an annualised 5.3 per cent, compared to 1.3 per cent for bonds and 1 per cent on bills, adjusting for inflation.
The UK’s long-term returns are surprisingly similar to the overall world index, which saw annual real growth of 5.4 per cent for equities and 1.7 per cent per year for bonds. The lesson is clear: over very long periods of time, shares remain better than bonds. Just don’t expect double-digit returns year in, year out.