John Lanchester on the financial crisis

John Lanchester

The financial crash of 2008 was worldwide, and the failure of governments to address the causes of the crash also was worldwide.  Because the same thing happened in different countries under different leaders, the reasons for failure are systemic, not just the personal failings of particular leaders.  The solution must be systemic.  A mere change in leaders is not enough.

John Lanchester, writing in the London Review of Books, wrote an excellent article about the crash and its aftermath.  I hoped to call attention to it in my previous post, but, as of this writing, there has been only one click on the link.

I know people are busy and have many claims on their attention.  If you don’t want to bother reading the full LRB article, here are some highlights.  If you’re an American, bear in mind that, even though so much of what he wrote applies to the USA,  his focus is on British policy.

The immediate economic consequence was the bailout of the banks.  I’m not sure if it’s philosophically possible for an action to be both necessary and a disaster, but that in essence is what the bailouts were. 

They were necessary, I thought at the time and still think, because this really was a moment of existential crisis for the financial system, and we don’t know what the consequences would have been for our societies if everything had imploded.  But they turned into a disaster we are still living through.

The first and probably most consequential result of the bailouts was that governments across the developed world decided for political reasons that the only way to restore order to their finances was to resort to austerity measures.  The financial crisis led to a contraction of credit, which in turn led to economic shrinkage, which in turn led to declining tax receipts for governments, which were suddenly looking at sharply increasing annual deficits and dramatically increasing levels of overall government debt.

So now we had austerity, which meant that life got harder for a lot of people, but – this is where the negative consequences of the bailout start to be really apparent – life did not get harder for banks and for the financial system. In the popular imagination, the people who caused the crisis got away with it scot-free, and, as what scientists call a first-order approximation, that’s about right.

In addition, there were no successful prosecutions of anyone at the higher levels of the financial system.  Contrast that with the savings and loan scandal of the 1980s, basically a gigantic bust of the US equivalent of mortgage companies, in which 1100 executives were prosecuted.  What had changed since then was the increasing hegemony of finance in the political system, which brought the ability quite simply to rewrite the rules of what is and isn’t legal.

Ten years after the financial crisis

Canary Wharf financial district in London. Source: Quartz.

Ten years after the financial crisis of 2008, the U.S. government has failed to do anything necessary to avoid a new crisis.   I just read an article in the London Review of Books that says that the U.K. government’s policies are just as bad.

Like the U.S.-based banks, the British banks engaged in financial engineering that was supposed to create high profit on completely safe investments—which, as experience proved, couldn’t be done.

The British government had to bail out the banking system in order to save the economy.  There probably was no alternative to that.  But it then proceeded to put things back just the way they were before.

John Lanchester, the LRB writer, said there was no attempt at “ring fencing”—what we Americans call firewalls—to split up investment banks, which speculated on the financial markets, and retail banks, which granted small business loans, home mortgages and other services to the real economy.

The UK, like the US, engaged in “quantitative easing”—injection of money into the banking system through buying bonds.  The basic idea was that if banks and corporations had more money to invest, they would invest more, and the economy would grow.

This didn’t happen.  Instead banks and corporations bid up the prices of existing financial assets and real estate, which added to the wealth of the already rich.

Ordinary Britons faced austerity.  Their government cut back on the social safety net and public services.  British life expectancy, like American life expectancy, has actually fallen.

The British, like us Americans, had 10 years to fix their financial system.  Like us, they wasted the opportunity.  Now it may be too late to avert the next crash—even if the UK and US governments wanted to act.

LINK

After the Fall: Ten Years After the Crash by John Lanchester for the London Review of Books.  Well worth reading in detail.  Hat tip to Steve B.

An SF writer’s diagnosis and cure for capitalism

In the opening of Kim Stanley Robinson’s new SF novel, New York 2140, two unemployed financial software engineers known as Mutt and Jeff—unemployed because they refuse to design a possibly illegal program for high-speed trading—contemplate a flooded lower Manhattan from atop the former Metropolitan Life building.

One of them says he has figured out what’s wrong with capitalism.

The basic problem with capitalism, he says, is that the forces of the market forces producers to sell products below cost.

How can you sell below cost and survive?  By offloading your costs onto someone else—onto customers, onto neighbors, onto taxpayers, onto the wider community and onto future generations.

This enables an individual enterprise to survive (sometimes), but, in the long run, leads human society into bankruptcy.

In the novel, global warming has taken place, sea levels have risen and lower Manhattan is under water.  Skyscrapers such as the Met Life building are still survive amid a kind of new Venice.  Uptown Manhattan is 50 feet higher in elevation, and is dry.  In the middle is a tidal zone, where the poor and homeless congregate.

Some environmental problems have been solved, or at least are being coped with.  Gasoline, jet fuel and other fossil fuels no longer exist.  Air travel is by dirigible, ocean travel is by sailing ship and land vehicles are electric.   But the financial structure and distribution of income are more or less like they are now.

New skyscrapers—”superscrapers”—in uptown are owned by the world’s wealthy elite, as investments or as one of multiple homes, and are often vacant.

A hurricane late in the novel leaves many homeless.  They try to storm the vacant uptown towers, and are turned back by private security forces, who outgun the New York Police Department.

Rather than attempt a violent revolutionary overthrow, the common people attempt a political and economic jujitsu.

They join in a nationwide debt strike.  On a given day, they stop paying their mortgages, student loans and credit card balances.  The financial system is go highly leveraged with debt upon debt that it comes crashing down, just as in 2008.   So the financiers go to Washington for another bailout, just as they did then.

But this time, the President and Federal Reserve Chairman, who are in on the plan, act differently.  They tell the banks and investment companies that they would be bailed out only on one condition—that the government be given stock of equal value to the bailout, as was done in the bailout of General Motors.   Those who refuse this deal are allowed to fail.

Now the federal government has the authority to force the banks to act as public utilities.  And the huge profits that once flowed to the financial elite now flow to Washington, which makes it possible to adequately fund public education, infrastructure improvement, scientific research and all the other things the country needs.

And so the American people live happily—not ever after and not completely, but for a while.

Mark Blyth on ending the creditor’s paradise

An American economist, Mark Blyth, author of Austerity: the History of a Dangerous Idea, gave a talk to members of the German Social Democratic Party on why so-called austerity is a bad idea.

I write “so-called” because the dictionary meaning of austerity is doing without things you don’t really need.  Food rationing in the UK and USA during World War Two is an example of austerity.  It doesn’t mean prioritizing the requirements of holders of financial assets over the needs of everybody else.

Here’s why Blyth had to say.

Back in the 1970s, a period that now seems quite benign, corporate profits were very low, labor’s share of income was very high, and inflation was rising.  We were told that this was unsustainable, and new institutions and policies were constructed to make sure that this particular mix of outcomes would never happen again.

In this regard we were singularly successful.  Today, corporate profits have never been higher, labor’s share of national income has almost never been lower, and inflation has given way to deflation.  So are we happier for this change?

What we have done over the past thirty years is to build a creditor’s paradise of positive real interest rates, low inflation, open markets, beaten-down unions, and a retreating state — all policed by unelected economic officials in central banks and other unelected institutions that have only one target: to keep such a creditor’s paradise going.

In such a world, why would you, the average worker, ever get a pay rise?

David Graeber on debt as a false religion

If debt through compound interest is an obligation with no upper limit, and if it is in law an obligation which transcends all other obligation, then the idea of debt is like a religion—the sacrifice of all other values to Mammon.  Or so it has long seemed to me.

People today world are still sold into slavery to pay their debts.  Nations are required by international organizations to sacrifice the welfare of their people in order to pay debts to international banks, even debts incurred by previous rulers to acquire the means to keep their people down.  Overhanging debt holds back our economy, yet a write-down of debt seems unthinkable.

David Graeber is an American who teaches anthropology at Goldsmiths, University of London; he also is an anarchist who was one of the originators of the Occupy Wall Street protest.   In his book, Debt: the First 5,000 Years, he attempted to explain the origins of the moral, religious and social meaning of debt.

Debt: the First 5,000 Years is profound, interesting, difficult and, at times, sometimes questionable.  Graeber clarified and expanded my own insight about the nature of debt.  He made me see world history in a new light.  I wonder about some of his assertions, but do not have the knowledge to refute.  I would willingly take a semester course with this as a textbook.

You can click on the title above to get Graeber’s outline of his idea for the book.   In what follows I’ll try to explain what I got out of it.

How the global elite escape taxation and the law

Offshore tax havens are a bigger factor in the world economy that I ever dreamed.  Financial assets held offshore, beyond the reach of effective taxation, are about one-third of the world’s total financial wealth.  Over half of all world trade passes through tax havens.  Without tax havens, there might not be a world financial crisis.

Such are the conclusions of a new report completed last month for an organization called the Tax Justice Network by a team of researchers headed by James S. Henry, former chief economist for McKinsey & Co., a respected business consulting firm.  Among the facts and figures in the report:

• An estimated $21 trillion to $32 trillion were held in secret “offshore” tax havens in 2010.  To give an idea of how much that is, the value of the entire U.S. output of goods and services (gross domestic product) in that year was $15 trillion.
• Some 139 non-rich countries have a combined debt of $4.1 trillion.  But if their citizens’ foreign reserves and secret bank accounts where brought home, those countries would have net assets of $10.1 trillion to $13.1 trillion.
• If assets held in tax havens, beyond the reach of effective taxation, generated investment income at a 3 percent rate, and if that income were taxed at a 30 percent rate, it would generate $190 billion to $280 billion in tax revenue—about twice as much as the world’s wealthy countries contribute in foreign development aid.

Click to enlarge.

This chart shows where the world’s billionaires put their money.  More than 43 percent of their wealth is hidden in tax havens.  Among the small elite group with more than $30 billion each, nearly 60 percent is invisible.

Click to enlarge.

The above chart shows the 20 countries with the greatest capital outflows.  These 20 countries account for more than 80 percent of the money flowing out of the 139 non-rich countries.  Where does the money go?  A lot of it comes to the United States, where our laws exempt non-resident aliens from U.S. taxes and permit them to hide their income from their home governments.

Some of the people who use tax havens may be honest business owners who fear that their hard-earned wealth will be confiscated by a corrupt dictator.  But James S. Henry thinks most of the money in tax havens comes from the corrupt dictators themselves, along with criminals, money launderers and ultra-rich people who are allergic to paying taxes.  Mitt Romney’s Bain Capital made extensive use of offshore tax havens.  It would be interesting to know the names of the investors in Bain Capital’s various deals.

In the Real News Network interview shown at the top of this post, James S. Henry told interviewer Paul Jay that Treasury Secretary Timothy Geithner provided information to the Canadian government on U.S. bank accounts of Canadian citizens.  When the Mexican government asked for the same information, Geithner ignored them.   Our government supposedly is waging a War on Drugs, but our laws enable drug lords in Mexico and other countries to stash invisible wealth in U.S. banks.

The “offshore” tax havens are not just small and obscure nations such as Panama, Liechtenstein and the Cayman Islands.  The biggest tax havens are the United States (not for our own citizens, of course), the United Kingdom and Switzerland.  We are part of the problem, not part of the solution.

Click on The Price of Offshore Revisited press release PDF for the Tax Justice Network’s press release and summary of the report.

Click on The Price of Offshore Revisited: New Estimates of “Missing” Global Private Wealth, Income, Inequality and Lost Taxes PDF for the full report.

Click on Tax Justice Network for that organization’s home page.

Paul vs. Paul on banking and debt

Last week Bloomberg News hosted this interesting debate between libertarian Rep. Ron Paul of Texas, currently seeking the Republican nomination for President, and liberal Paul Krugman, the Nobel Prize-winning economist and New York Times columnist, on central banking, deficit spending and inflation.  You could watch two important public figures, both independent thinkers who are beholden to nobody, debate what they honestly think about an important public issue.  That is something I fear will be a rarity in this Presidential election year.

Ron Paul wants to phase out the Federal Reserve System.   He correctly pointed out that without the existence of a semi-government agency with authority to buy government bonds and create money, it would be very difficult and maybe impossible for the government to finance either the current endless wars or the welfare state, which he is equally against.

The problem is that without a Federal Reserve, decisions about interest rates and money supply would be made not by an impersonal mechanism, but by powerful individuals such as J. Pierpont Morgan, who would not be accountable to the public.  Or you would have a chaotic system, like that which existed in the United States during the decades leading up to the Civil War, when wave of bank failures were frequent, and depositors lost their money.   Ron Paul would like to go back to that era or, alternatively, to return to the gold standard.  The problem is that impersonal mechanisms are just as fallible as individual people.   There is no magic of the market, or magic anything else–just a choice among imperfect systems.

While Ron Paul focused on deficit spending, debt and inflation, Paul Krugman focused on employment and economic growth.  I think Krugman had the right priority.  The U.S. government dealt with the enormous debt left over from World War Two, not by paying down the debt but by generating strong economic growth so that the debt became proportionately less in relation to the overall economy.

Krugman is a Keynesian, which means that while he favors a balanced budget and tight money in normal times, he thinks that deficit spending and easy money are warranted in a serious recession, as a means of getting money into circulation so that people will start spending and investing again.   The problem with that is that it doesn’t seem to be working.  I think the reason is that the current recession is more than part of the normal economic cycle.  It is a crisis resulting from decades of running the U.S. economy on debt rather than production.  When people have more money in their pockets, they don’t necessarily spend it, they use it to pay off their mortgages, installment loans and credit card balances.  And the big banks, as Ron Paul said, are content to borrow money from the Federal Reserve at 1 percent interest and lend it back to the government at 3 percent interest.   That does nothing to help the real economy.

I don’t believe in spending money for the sake of getting money into circulation, but I think the government should refrain from cutting back on basic services and that this is a good time to invest in infrastructure repairs, scientific research, job training and other measures to maintain our country’s productivity.  Ron Paul said, perhaps in jest, that it would have been better for the Federal Reserve to give relief to mortgage-holders (perhaps by refinancing their loans?) than to relieve the banks.  Certaintly this would have done more for economic recovery.

Click on Economics Throw-Down! Krugman vs. Ron Paul on Bloomberg TV — Helicopters, Gold and More for highlights.

Click on David Henderson on Paul vs. Paul for a conservative economist’s summary of the debate.

Click on Ron Paul Flunks History for comment on David Frum’s Daily Beast web log.

Click on Ron Paul vs. Paul Krugman: the Bloody Aftermath for discussion of the issues by Reason magazine’s Brian Doherty.

Click on Krugman Says Fed ‘Reckless’ to Allow High Jobless Rate for a Bloomberg News followup to the debate.

Hat tip to Joshua Chacon.