Ann Pettifor | ukwatch.net

The week that changed everything

tim — Mon, 22 Sep 2008 20:57:49 +0000

The last week has changed everything. A series of extraordinary events in the United States – from the collapse of Lehman Brothers to the forced sale of Merrill Lynch, from the state takeover of insurance giant AIG to the Federal Reserve’s emergency bailout plan – has transformed the crisis in the financial markets into an argument about the very foundations of the model of economic governance that rules the world.

For three decades the ship of global finance has been steered by the economics of globalisation – the flawed neo-liberal economics of the Chicago school. Their navigational charts for deregulation and liberalisation have led the global economy into a financial hurricane of unprecedented intensity. This crisis will prove immensely destructive – of the value of assets like property, of jobs, of pensions and investments, and of the hard-earned achievements of companies small and large, everywhere. Above all, the crisis will damage the lives and the futures of millions of blameless citizens, most of them poor.

Orthodox economists did not see the crisis coming, even as the financial hurricane hit land on what I have called “debtonation day”, 9 August 2007. They still do not understand it. They failed to warn their paymasters or the captains, crew and passengers of the finance-sector’s ships. Even now, their intellectual and policy maps offer no way forward.

This is because orthodox, neo-liberal economic theory pays little regard to the role of finance in the economy. Systemic insolvency is not permitted in the assumed world of orthodox economics. Very few members of the Chicago school have read Irving Fisher’s Booms and Depressions (1932); and if they have read John Maynard Keynes on the theory of money and interest, it was only to malign or marginalise his rationale for the regulation of finance. Instead, they lionised free-marketeer Milton Friedman, trenchant enemy of “big government”.

But in the single week of 14-20 September 2008, the public and even much of the media began to register the scale of the finance sector’s and governments’ intellectual and policy failure. No one – it seems – is fooled anymore. Free-marketers now embrace big government with a fervour that embarrasses socialists. Even more conservative voices in the establishment media have begun to challenge the flawed economics that they have for so long championed.

The world may be moving on its axis, but the change has not yet gone nearly far enough: for neo-liberal economists remain at the helm of the global economy, and continue to disseminate potent mis-diagnoses of what is happening. These economists include the world’s major central bankers and finance ministers. It is vital that their economics and their three principal delusions are challenged if the global economy is to be steered safely out of this all-consuming storm.

Three delusions

The first and most important of these delusions is the belief that banks and financial institutions are illiquid, when in fact they are insolvent. Systematic insolvency is, again, categorically excluded from world of orthodox economics. It was the failure of central-bank governors and finance ministers like Alistair Darling and Hank Paulson to acknowledge insolvency in the summer and autumn of 2007 that has prolonged and deepened the crisis. It is the failure to recognise insolvency now that lies behind the apparently endless, and ineffective flow of taxpayer-backed liquidity from central banks.

Second, central bankers are – thanks to their reverence for orthodox economic theory – allowing illusory inflationary pressures to justify keeping interest-rates high, and refusing to relax monetary policy. Despite a spike in oil and food prices, inflation is now falling. The deleveraging of asset prices (think of the fall in property prices) will force down a whole range of prices and if not checked, could lead to deflation. Deflation will be far more devastating to the population as a whole than mild inflation. The 1930s and Japan since 1990 are sobering precedents here. Central bankers must escape from the gridlock of orthodox economic theory and act now to check the downward, debt-deleveraging, deflationary spiral.

Third and most urgently, central bankers and finance ministers have to escape the constraints of orthodoxy – and think system-wide fixes not quick fixes. To ban a few short-selling speculators is but tinkering with a system that needs comprehensive overhaul.

Four solutions

What then should be done? Here are four steps.

First, a good place to start would be where Franklin D Roosevelt did in 1933 – by declaring a week-long bank holiday. The Federal Reserve, the Financial Services Authority (FSA) and the Bank of England could then take time and check the books of banks for well-hidden “toxic waste” – their massive undeclared liabilities, including more than $60 trillion of so-called “credit default swaps” (CDS). Only when regulators have a proper sense of the scale of the mess, can they take decisive and appropriate action. Right now they are sloshing buckets of our money about, unsure as to the whereabouts of the financial “weapons of mass destruction” that banks have concealed.

Second, there must be an end to “inflation targeting” – which is just a cover for keeping interest-rates high. High interest-rates are great for lenders/creditors, but a killer for debtors, and there are far more debtors in the economy than savers. If this financial crisis – and the planetary threat of climate change – are to be faced, there is a need for cheap (but not easy) money to help finance investment in energy security (for more on this theme, see the report I co-authored, A Green New Deal [new economics foundation, 2008]).

Third the Bank of England and the Fed should regain control over interest- rates – all rates. The interbank lending rate (the so-called Libor rate) should no longer be set by a closed committee of private bankers meeting daily at the British Bankers’ Association. Rates must be set by a committee accountable to society; and, when setting rates, it must consider the interests of all who make the economy work – labour and industry as well as finance.

Fourth, in order to again exercise control over all rates, the Bank of England will have to reintroduce capital controls. That might require a new international agreement, along the lines agreed at Bretton Woods in 1947.

All of this is doable as well as necessary. These are the initial system-wide fixes needed to deal with systemic threats; the public have every right to expect the guardians of the nation’s finances to implement them promptly.

If they are to do so, these guardians will need a new moral compass, new navigators and new helmsmen and women. But one thing that is not needed is a new navigation chart. That was provided by John Maynard Keynes in his The General Theory of Employment, Interest and Money (1936). Its ideas will today do just as well to restore the world to a period of stability as after the great depression of the 1930s. This was a period that Barry Eichengreen and Peter H Lindert (in The International Debt Crisis in Historical Perspective, MIT Press, 1991) described as “a golden era of tranquillity in international capital markets”.

To return to such a golden era, the money-lenders, speculators, and orthodox economists responsible for the gross failures exposed by the week that changed everything must stand aside – so that everything indeed can change, and for the better.

The global financial mess: blaming the victims

tim — Mon, 11 Aug 2008 21:52:30 +0000

We now know that on 9 August 2007 – which I called “debtonation day” – central bankers and regulators finally woke up to the scale of bad debts on the balance-sheets of banks and other financial institutions. On that day blindfolds were removed and scales fell from the eyes – of at least some of the key players in the finance sector. The “guardians of the nation’s and the world’s finances” finally began to emerge from a long period of stupid and unforgivable denial of the havoc wrought on the international economy by the privatised, deregulated and globally integrated finance sector.

But it has taken more than a year for the wider public to realise that “debtonation day” was but the prelude to a terrifying prospect: large-scale and prolonged economic failure of a globalised, highly integrated economy, built on a financial house of cards.

The floating world

In creating huge burdens of debt, particularly in the Anglo-American economies, private financiers have defrauded and deceived tax collectors, investors and regulators – a level of deception partially exposed on “debtonation day”. Worse, they have burdened the productive sectors of the economy – the companies that you and I work for – with unpayable debts, which have already begun to hurt consumers, bankrupt key sectors of the economy in the United States and Britain, and to weaken the economies of (among others) Germany and Japan. Now the private-finance sector – represented for example by the management and shareholders of Fannie Mae and Freddie Mac and Northern Rock – are holding a gun to the heads of regulators and politicians. The demand is that losses be socialised or nationalised. The alternative, they warn, is global financial armageddon.

Until recently the vast bubble of debt these private institutions created was regarded by orthodox economists, regulators, politicians and investors as representing real, and possibly eternal wealth. Their delusions fed on the economic mantra that asset prices (such as property, commodities, works of art, racehorses, or commercial brands) were rising because of a shortage of supply and an excess of demand for assets: not because they were being powered upwards by the availability of “easy money” or credit.

By finally admitting to the unpayability of debts on their books, and by making write-downs and write-offs, banks were and are in effect admitting to extensive deception of their fellow-bankers, regulators and investors. Each day brings fresh news of the destruction of wealth – and fresh allegations, such as the revelation that Merrill Lynch wrote off $9.4 billion in July 2008 (see Jeremy Lerner, “Citigroup results set to lift US stocks”, Financial Times, 18 July 2008). This brings the company’s losses over the last year to $19 billion – losses largely suffered by investors, including pension- funds.

It is reported that the Massachusetts secretary of state promptly charged Merrill with “fraud” and “dishonest and unethical” conduct “for creating and implementing a sales and marketing scheme, which significantly misstated the nature and stability of the auction-rate market. As a result, thousands of investors were abandoned with illiquid investments…....” (see “Massachusetts sues Merrill over auction securities”, Reuters, 31 July, 2008).

These losses and alleged deceptions have generated deep distrust in the whole sector, which stopped making credit available in the week running up to 9 August 2007, and thereafter tightened up on lending to all borrowers. This shortage of credit led in turn to the bursting of housing and other asset bubbles in the Anglo-American economies, and in economies like that of Spain.

Central bankers and elected politicians acted swiftly to refinance heavily indebted banks, and bail out incompetent managers and shareholders. However nothing has been done to remove the debt burden from borrowers in either the domestic or the corporate sectors. It was announced on 5 August 2008 that the British government is offering Northern Rock, a failed private bank now nationalised, a further £3.4 billion of taxpayer-backed funds. But the current Labour government in Britain has little consolation for their debtors. Northern Rock’s notorious “Together” loans were offered to a market of desperate people anxious to buy a roof over their heads in a rising market. These were set at 125% of the value of a property and six times the borrower’s salary. Now, the number of house repossessions by this government-owned bank has risen from 2,215 to 3,710 in 2007-08, an increase of 67%; more than two-thirds of 70% of these repossessions related to “Together” loans.

So while the British government is using taxpayer funds to socialise the losses of a bank whose gains were largely privatised, it is simultaneously punishing the Rock’s borrowers by evicting them from their homes. Herein lie the seeds of social upheaval and discontent.

The house of cards

The stupidity, poor economic analysis and sheer ignorance of those – central bankers, politicians, auditors – that have a duty to act as guardians of the nation’s and the world’s finances has had and will continue to have very grave consequences for the whole of the global economy, but also for millions of individual and corporate borrowers.

Their conduct stems in part from a failure of economic analysis. More precisely, the economics profession has failed to correctly analyse and alert policy makers to the impact of the finance sector – and of privatised credit creation – on the global economy. Indeed the economics profession has had a (not accidental?) blindspot for the role of haute finance in the economy, while at the same time encouraging its deregulation.

Now, just as the curtain is being raised on the house of cards built by the finance sector, so a cabal of economists is working to pull it down.

Their main concern is – of course – to protect the sector from governmental or democratic oversight and regulation, and to transfer private losses to taxpayers. To do so, they need to distract attention from the sector, limit debate, prevent a coherent analysis of the causes of the crisis emerging, and blind citizens to the “science” of finance.

The first tactic in the campaign to divert attention is to blame the victims. The most hapless of these are sub-prime borrowers – people in low-paid work earning $7 an hour in the poorest districts of Ohio (for example) who were persuaded by dodgy mortgage-floggers that they could take on a adjustable rate mortgage at “teaser rates”, go to the ball and have a roof over their heads.

The game of blaming the victim is conducted of course, in more elevated terms by the high priests of finance, and by the economics profession. One of these is Josef Ackermann, chairman of the board of directors of the Institute of International Finance, and chairman of the management board and group executive committee of Deutsche Bank.

Ackermann has explained the current financial crisis thus: “for the first time in history, a crisis triggered by US housing finance problems is having global ramifications” (see “How the banks can win back confidence”, Financial Times, 31 July 2008). No mention here of sub-prime borrowers, but the inference is clear: this crisis originated with those borrowers and with the property market, not with reckless credit creation by the private finance sector.

Others prefer just to blame “the bursting of the housing bubble” – which they would have us believe occurred simply as a result of spontaneous combustion. Alan Greenspan now argues that the “financial crisis is heralded, in fact defined, by sharp discontinuities of asset prices” (see “The world must repel calls to contain competitive markets”, Financial Times, 4 August 2008) In other words, it’s the spontaneous combustion of property and other asset prices, he suggests, that caused the financial crisis. We beg to differ and contend that it was the dramatic contraction of credit in August, 2007 that precipitated the collapse in asset prices.

The arguments put forward by Greenspan and mainstream economists has as its main goal the maintenance of the system of financial globalisation. To do so, they insist in effect that the crisis “is nothing to do with us, guv.” That way analysis of the role of the finance sector, and excessive credit creation can be avoided.

Yet another frequently repeated analysis is that the crisis was caused by the decision of the Federal Reserve to cut interest rates after 2001, in order to lessen the impact of an earlier crisis – the bursting of the dot.com bubble. So Chris Giles argues that “there is little doubt that the immediate cause of both the commodities price boom and the credit crisis has been low global interest rates” (see “Shifting down the gears…”, Financial Times, 5 August 2008).

Alan Greenspan, governor of the Federal Reserve, was indeed obliged to cut interest rates in 2001 as a reaction to the financial crisis of that time, tackling one of the increasingly frequent crises of international financial capitalism over the decades since deregulation began in the 1970s. The 2001 crisis was caused by easy, if costly credit (offered at high real rates of interest to corporates) blowing up and then bursting the dot.com bubble. It’s true too that Greenspan’s actions eased the crisis, and encouraged banks and other lenders to go on yet another spree, and lend even more recklessly. But if he had not acted, then the credit-crunch of 2007 would have occurred much, much sooner.

The fact is that while official rates of interest were low for a period after 2001, they had been much higher before. And even while official rates were low, few companies embarking on risky investment were able to borrow at these low official rates. But the credit-crunch occurred precisely because the scale and cost of debt was too high, so debtors began to fall into arrears and default.

The exit strategy

There is a frequently heard and self-justifying argument – expressed especially at times of crisis – that bankers have no responsibility for the amount of credit in the economy; they are mere intermediaries (like restaurateurs, one has said, “struck down by a sudden drying up of a food supply for which they have no responsibility”).

This argument is more than a little ingenuous. Bankers create their own “food supply” for serving borrowers: credit. Credit is not created by an outside body, like the Bank of England or the Federal Reserve. Thanks to the outsourcing of credit creation by central bankers and politicians, the provision of credit is overwhelmingly an activity undertaken by private banks, few of which have been, or are adequately regulated. The fact that credit (or “the food supply”) has dried up is entirely a function of the incompetence of bank managers like Adam Applegarth of Northern Rock, and of the loss of trust that he and others created between banks and other financial institutions. It has nothing whatsoever to do with governments.

The public – the borrowers, and therefore ultimately the victims of this vast private debt-creation machine – must not be fooled. Credit creation is a remarkable power, granted to banks and other financial institutions. By entering a number into a ledger, and guaranteeing the sum against an asset (like a property) a private financial institution can leverage very large sums of credit. The private sector has used these powers like a magic wand – to inflate a vast bubble of credit, or debt, which in turn inflated the housing and other bubbles.

Since JM Keynes and FD Roosevelt first argued that finance must be regulated – must be servant, not master of the economy – the finance sector and its apologists in the economics profession have lobbied, deceived, bullied and bribed regulators and politicians to prevent all effective regulation over its activities. They have also demanded the removal of all controls over the movement of capital and effectively removed central-bank control over the setting of interest rates.

On 9 August 2008, the anniversary of “debtonation day” it is incumbent on citizens to hold haute finance’s feet to the fire, and to demand strict regulation, transparency and oversight of the sector’s activities. But on this anniversary it is also important to begin to promote solutions.

I suggest that there are only two solutions to the credit-crunch. The first is a grand jubilee – the cancellation of all unpayable debts, the clearing up of balance-sheets, and the restoration of stability to the financial system. If this solution is unacceptable there is a second: to raise the incomes of the indebted, to enable them to repay debts, and to drastically lower interest-rates to enable companies to reschedule and repay debts.

If neither of these solutions are applied, the outcome will be the accelerated destruction of the financial system.