Understanding the crash
There’s certainly too much to say on the financial crises blowing through Wall Street and billowing around Canary Wharf, but from a futures perspective what is perhaps most striking is that the people who have been shrewdest in their judgments – and often among the earliest as well – have been financial and economic outsiders, usually writing from the perspective of political economy rather than economics or finance. Their comments and critiques, of course, had been drowned out by the noise of received wisdom.
Ann Pettifor, one of the co-founders of the Jubilee 2000 campaign, was the first to observe the seriousness of the crisis, on what she called ‘Debtonation Day’ in August last year, in an article headlined “How globalisation dies“. Fortune, of course, favours the prepared mind, and Pettifor’s background in debt campaigning had led her to see that one of the fundamentals of the deregulated finance system was that it had “drowned the world in debt” – effectively a global Ponzi scheme which (like all Ponzi shemes) fell apart when there it ran out of new people to enrol. Pettifor and the New Economics Foundation had sketched out the shape such a debt crisis might take five years previously – but in finance, of course, timing is everything, and ‘confidence’ can take the system a long way, whatever the economic ‘fundamentals’ such as savings ratios or income-to-debt levels might say.
The Marxist critic Robin Blackburn cast a forensic eye over the state of the global financial economy earlier this year in a long article in New Left Review (subscription required). Like Pettifor, he pointed to the earlier analyses of financial turbulence, by writers such as Robert Brenner, Andrew Glyn (a group that includes Blackburn as well). There’s much in Blackburn’s piece, but an important part of the argument is that deregulation allowed the banking sector to convert consumer debt into tradeable securities – which were then traded, disappearing into the world of a “shadow banking system”. This was all part of a wider process of ‘financialisation’, in which
the logic of finance becomes ubiquitous, feeding on a commodification of every aspect of life and the life-course—student loans, baby bonds, mortgages, home equity release, credit-card debt, health insurance, individualized pension funds.
Good for profits, but paradoxically, says Blackburn, “a bankers’ nightmare in which key assets could not be valued.” Nor could risk be assessed, since there was so much of it:
The complexity of the CDOs and CDSs—credit default swaps, the financial instruments which insure bond holders—generates new risks: documentation risk, operational risk, ratings risk, counter-party risk, liquidity risk and linkage risk among them.
To some extent, this explains why it has taken so long – more than thirteen months since ‘debtonation day’ – for the crisis finally to overwhelm Lehman Brothers and Merrill Lynch, or to catch up with HBOS. As William Goldman famously said of Hollywood, ‘no-one knows anything’. But it also suggests that we just don’t know whether there are further bad debt positions yet to unravel, but that it seems a lot more likely than less.
The suggestions from finance’s apologists that regulation would damage the sector’s capacity for innovation and economic development can only be regarded as chutzpah. There will be re-regulation: the question is how much. But what is striking about the present moment is the way in which we are – at last – hearing alternative stories, and not kind ones, about the role of financial capital.
There are a couple of notable things about the moment that we’re in. The first is that the story about the reasons for the growth of global finance is being heard as a story about political decisions abut deregulation, and not the reified effect of changes in technology. In her 2003 article, Ann Pettifor suggests that deregulation was an attempt by Presidents Nixon and Reagan to escape the economic consequences of the debts incurred fighting the Vietnam war. In the UK, in the 1980s, Thatcher had her own narrow domestic reasons for joining in.
The second is greater scepticism about the value that the activities of investment banks contribute to the wider economy. Most mergers and acquisitions reduce economic value rather than increase it. And the effects of investment bankers’ incomes (and especially their bonuses) have fostered the surge in inequality we have seen over the last two decades.
And the third is that relatively radical ideas about finance can start to be heard for the first time in a generation (which also tells us something about the failure of mainstream politics in that time to articulate dissenting views).
As Joseph Stiglitz – another critic of the global market finance model – observed this week, the banks failed at the only two things they’re supposed to be good at: managing risk and allocating capital. And where they did innovate, it was a toxic form of innovation which destroyed social value but enriched banks and bankers.
This all raises the interesting question of where the value represented in the financial sector has come from. The answer seems to be: from turning into markets processes which earlier in the 20th century were a social exchange (the ‘financialisation’ model described above, seen for example in pushing the poor into taking on mortgages), or asset-stripping funds held in trust for the future (such as pension funds), or by re-pricing risk and then profiting from this (for example in PFI funding of what were once public sector assets), or by creating more transactions and then taking a turn on them (in promoting the mergers and acquisitions boom).
In addition, the impact first of deregulated investment banks, and later of hedge funds and private equity funds (both driven largely by complex financial engineering techniques such as derivatives) had the effect of aligning the behaviour of corporate managers with the interests of the financial markets, effectively turning the corporate sector into an extension of the financial sector.
But one of the most insidious aspects of the way in which the rest of us have subsidised the financial sector is almost completely hidden from view, even in the economics literature. James Robertson (and others) have noted for some years now that almost all new currency in the British economy, and others, is created not by the state but by commercial banks, not by printing money but by creating credit. This is a complex argument which needs more space, but in his articles (e.g. in Soundings) Robertson estimates that this represents a direct benefit (or subsidy) to the banking system of £20 billion a year – just in interest payments – while the public exchequer would benefit to the tune of £45 billion a year in the UK – that’s around 3% of the economy – if the central bank took back the monopoly it once enjoyed on creating currency. Robertson argues that this – like so much else to do with the financial system we now have – represents a form of private enclosure of a public commons.
Banks clearly do have a purpose. Banking functions can be seen in societies going back to the ancient Greeks and beyond. One of the puzzles of the present moment is how a set of institutions which has been so damaging to the public good have managed to enrol politicians, regulators, journalists and other opinion-formers as supporters and promoters even as they engaged consistently in visibly destructive behaviour. (Most people who referred to themselves as ‘masters of the universe‘ in public would most likely be certified).
The last great wave of globalisation stumbled to a close in the 1890s when Australia’s banks collapsed under a wave of land mortgage speculation. On that occasion, British bankers thought their Australian colleagues had been reckless. As Edmund Rogers writes in an article in History & Policy,
They regarded the holding of property as security in the expectation of it rising in value as mere risk-laden speculation. George Rae’s celebrated banking textbook, originally published in the 1880s, informed readers that doing business on ‘building-land’, and holding on ‘for better times and a higher price,’ was ‘virtually to speculate in it.’
The triumph of the UK’s ‘Big Bang‘ deregulation in the 1980s was to remove from the mix such cautious voices – which could still be heard, if ever quieter, when I worked as a financial journalist in the early 1980s. Like all such apparent successes, the triumph looks now to have been short-lived.
Update: See also my later post on ‘St Francis and the Wolf of Gubbio‘ as a metaphor for the Paulson bail-out proposal.