An expensive lesson

It’s easy to be wise with the benefit of hindsight. After all, wisdom comes partly from experience.
Nottingham City Council has clearly had a bad experience with Icelandic banks. Wisdom – and hindsight – therefore suggest there are 42 million reasons why it won’t go there again.
But why did it choose to invest £42 million of Nottingham taxpayers’ money in a Nordic island in the first place?
Why, having signed up with banks paying above average rates of interest, did it not consider whether higher reward might mean higher risk?
And why, if it did think higher reward meant higher risk, did it not manage the investment with a higher degree of vigilance?
We don’t know the answers to all those questions. All we’ve had so far is the council repeating that its investments – like those of all the other councils caught out by the Icelandic banking collapse – were made in line with Government guidelines.
That’s true, and when a range of apparently sober organisations across the country fall into the same trap you wonder if this was a problem that could not have been foreseen.
What we do know is that there was a rising tide of evidence to suggest that the model on which the Icelandic banks were operating was inherently weak.
Much of their money came from wholesale money markets – the same markets that began to dry up more than a year ago, dragging Northern Rock down with them.
We know that the credit ratings agencies on which the Government and the council based its assessment of the Icelandic banks’ strength had been criticised for the methods behind their judgements.
We know that the Icelandic economy of which the banks were such a central part had been deteriorating for months.
On a more fundamental level, it was pretty obvious some time ago that the wheels were coming off the global economy in a big way.
So, while the credit ratings might have suggested the banks were OK right up until the point they collapsed (though not all of them did), there was a developing bigger picture which naturally raised questions about the ability of high-interest investments to continue delivering.
There is another bigger picture, one becoming more obvious by the day. We’ve been living through an era where normally prudent and conservative institutions apparently began to think that decades-old rules of economics had somehow changed.
We’ve had building societies – mutually-owned organisations never meant to chase profits – investing in loans to people with poor credit histories. It’s a practice that brought the Derbyshire Building Society to its knees.
With 100% (or more) mortgages we’ve had banks allowing people to buy property without putting any of their own money in. They even handed out loans – self-certified mortgages – in a manner that was almost no-questions-asked. Was this responsible lending or responsible borrowing?
Worst of all, it is now blindingly obvious that people in very senior positions in major High Street banks did not fully understand what the obscure parts of their investment wings were up to. Was this responsible management?
There is no evidence that Nottingham City Council has been financially reckless. But it may have fallen into the same trap as scores of other institutions and allowed either the herd instinct or ambition to over-rule well-established principles of economic history.
An economist put it to me like this: There is nothing new to learn from the era we have just been through, it’s simply the first time some people have learned it.
And this time it has been a ruinously expensive lesson.