Archive for August, 2010

Why the financial crisis is worse than you think

August 3, 2010

Now that banks are beginning to declare big profits again, and stock markets are in reasonably good shape, there is the possibility of thinking that the financial crisis is in some way over. But it really, really isn’t.

For a start, we seem to have learned very little in terms of re-regulating the banks that nearly brought the entire Western economy down two years ago. This week the Basle group published proposed changes to regulative structures that are so mild, and so limited, that they will make very little difference to bank behaviour. We are told that, within the Bank of England, briefing papers are being prepared to show that the economy, if the banks remain unregulated, is as vulnerable as it was in 2007/8. And yet we don’t do anything about it. This is really scary.

One of the reasons we don’t do anything about the banks is that re-regulating them would be, in the short term, a hugely deflationary act. Banks remain massively over-leveraged, with their profits coming from speculative activity and lending to individuals, mostly the form of mortgages. There is very little lending to business. This should come as no surprise – banks in the UK don’t lend to business as it’s far to messy and unreliable for them when they can instead be making highly leveraged bets on esoteric financial instruments instead. Banking likes to present itself as being a great friend to small and medium-sized business when only a tiny proportion of bank activity goes in that direction.

If we were to apply even moderate banking regulation, forcing that banks deleverage down to, say, a ratio of eight to one, that would result in massive amounts of financial assets having to be sold and a possibly even greater reduction in the paltry amount of lending to business that banks presently offer. But it would make the financial system far more stable down the line. A great deal of pain now, but at the avoidance of future crises.

One thing we ought to have learnt is that the boom times of the 2000s were largely illusory – the profits upon which public services were expanded and banks could claim to be masters of the Universe, were almost entirely the result of accounting illusion and increased amounts of leveraged debt. We are going to have to contract the system back down to a sensible level at some point, or face another crisis down the line when we haven’t paid for the last one yet.

Several accounts of the crisis suggest that what we need is to find a new ‘long wave’ of economic activity that will save us. So, as the post-war boom was based on something called Fordism which entailed mass production and a huge expansion of consumer goods, we now need a new wave of economic activity to take us forward. But this is hugely mistaken – if we expand world production on a massive scale again, can you imagine what the environmental consequences would be? Some accounts suggest the environmentalism can provide us with a new world boom, but that is surely to miss the whole point of environmentalism in the first place – it is not about ever-expanding economic activity but about making do better with what we have and making a sustainable future.

So unless we are really going to buy into the idea that free markets can save us (because that worked so well in the 2000s), we are facing a future where we have to deleverage banks, reduce our own holdings of debt, and work within a lower level of GDP. The alternative is to be forever looking for a new bubble to invest our debt into in the hope it will somehow put off the moment when we have to face up to the mess we are in.

Instead it is time to grasp the moment and realise that economic growth is not the be-all and end-all. We know that our well-being doesn’t actually improve above a certain level of GDP which most industrial nations are now well beyond. We know that the planet needs us to adopt a more sustainable future. We know that we can’t go on with the levels of debt that we have. All this adds up to us looking to a different future, and having to take the pain of the consequences in the present.

Government needs to be far harder with the banks, forcing them to deleverage, but also demanding that they go back to their old role of lending to businesses again. I’d even go with Minsky and suggest that government could become the retail banker of the nation – let the existing banks continue to engage in highly risky speculative activity and see how many people choose to leave their money with them. We need new visions of what the future might look like – not to keep repeating the errors of the last twenty years.

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