Anguished of Edinburgh

The BBC’ Business Editor Robert Peston offered a rapid fire tutorial in the credit crunch in his address to the Edinburgh Book Festival today. Some people have perhaps unfairly labelled him as “Pessimistic Peston”, the man who first revealed the state of the liquidity crisis at the Northern Rock in early September 2007. But he delivered an engaging and witty talk to a large group of the well heeled of Edinburgh who clearly have weighty financial issues on their minds.

The audiences at the Literary Fest are a different breed from those who attend the fringe - I calculated that (at 44) I was giving at least a decade to the vast majority of those there - many of whom continue to steam and spit blood over the multi-million losses made by the Royal Bank of Scotland and the apparent inequity of the CEO Sir Fred Goodwin taking his £4 million bonus.

Indeed there was a tangible sense in the question and answer session of incredulity and anger that the Treasury naivety, the regulatory failures of the FSA and the lacklustre performance of the Bank of England had allowed the credit bubble to have grown to such astounding proportions over the last couple of years. And a deepening realisation that most of those involved actually took few of the real risks - they continue to ‘trouser the money’ whilst the pain - for mortgage holders, shareholders, property businesses and taxpayers - is more widely spread and felt.

Here are some of the key points from the Peston presentation that I jotted down:

Are the staggering rewards to the figureheads of the Private Equity and Hedge Fund sectors fair? The gap between the returns to those at the apex of the financial system is astronomical. Philip Green - effectively a one man private equity business paid himself a dividend of £1.2 billion a short while ago - a figure equivalent to the average annual wages of 54,000 workers in the UK. 0.1% of the highest income earners take home more than 4% of total income. The gini coefficient continues to rise both in measuring income and wealth inequality.

Peston argues that we are seeing the age of New Victorians but with less philanthropy (yet). When markets bust, all of us pay the price

Leverage provides the key to understanding what has gone on - the willingness of financiers across the spectrum to borrow (speculate) with huge amounts and tap into the global surplus of cheap money. Simple maths tells a story - if you borrow £900m to buy a company for £1bn and then a couple of years later you sell it for £1.1bn then you have doubled your £100m investment - not a bad return in an age when interest rates on alternative assets are low.

The Gilt Road has replaced the Silk Road as a driver of global financial excess - surplus global savings have been sent over from emerging markets in the East to the West along the global superhighway. And now that the credit crunch has occurred and borrowing is falling in the West, the surplus cash of countries such as China, Russia and India can be channelled through sovereign wealth funds into buying up some of the assets of western businesses that are desperate to recapitalise their balance sheets. Eastern countries have the cash - we have the debts - but the scale of these toxic bad debts remains far from clear - it will take at least another couple of years for the banks to own-up fully to just how exposed they are to fragile finance.

For the moment - most of the losses such as those made by the Northern Rock - are being nationalised. The government remains in a state of shock about what has happened and it may take a change of government to have the credibility and mandate to bring in new rules for lending - e.g. counter-cyclical rules about how much banks and others can borrow relative to their capital base.

For the moment the shrinkage in the supply of credit plus the acceleration in prices from the global commodity and energy price shock represents a lethal combination.

In the last decade the UK, the USA and many other advanced economies have allowed disconnect between risk and reward - the fall out from the credit crunch may bring about a reconnection and perhaps a more sober understanding of the balance that needs to be struck between growth and fairness.

Robert Peston’s new book is available here from Amazon