President Obama is determined to do something, Gordon Brown is ‘appalled’ but no one has seemed to have gotten the real message of what is happening in the newly invigorated financial system.
More intelligent people than me, such as Joseph Stiglitz, the Nobel Laureate in Economics, have pointed out that the bank bailout has effectively wiped the slate clean for banks and they can now resume their high risk activities with new, cheap, even free money. In fact, Stiglitz presents the argument I put forward yesterday with real credibility – that now banks have been written a blank cheque they can gamble more freely and with less conscience as they now know that the Governments will never let them fail. With the odd exception as we celebrate Lehmans Day.
Stiglitz asserts that Obama’s failure to rein in Wall Street will lead to further disasters and we hear only talk of potential curbs on bonuses and tighter regulations but not one single country is prepared to take the lead as they don’t want to be the loner that effectively rings the bell on their financial centres by spoiling the party unilaterally. All the big leaders are talking up the importance of the forthcoming Pittsburgh G20 meeting but the chances of getting any consensus for concerted action is slim. Someone, somewhere will sense an opportunity to win on this and it will only take one to not toe the line.
In a snippet in the Guardian yesterday, Bethany McLean who authored the book ‘Enron: The smartest guys in the room’, argues that far from financiers losing too much, they in fact lost too little. Meaning, on a personal and even company level, we bailed them out to an extent that it did not hurt – not one iota. In fact, like Stiglitz, she argues, with the exception of Lehmans, the lack of loss has embolden banks to be more aggressive in their ‘talent acquisition’ activities, salaries and bonus schemes as now the stakes are much higher and the potential rewards much greater as we exit the financial crisis and experience the inevitable bounce back.
Both of these observers claim that there should have been wider losses than Lehmans and in the UK there should have been at least one, if not more of the financial institutions we so gleefully bailed out that should have been left to fold. Only then, they claim, could the banks have really been convinced of the folly of their system. In the real world, bondholders, shareholders and those involved in the derivative contracts should have been left to face the consequences of their mistakes as most of the casualties in the business have done during this recession. By allowing these special cases we have given an unfair business advantage to companies who already have business by the short and curlies. The same people who would have no qualms about shutting down companies who default on their loans to them. However, that opportunity as been missed and now all we can talk of is curbing bonuses when everyone knows that banks will find a way to pay the high rewards for the high risks, somehow.
It means that banks are more than ever gearing their strategies and reward schemes to short term profits. This newly fine-tuned mindset is based on the simple maxim that if there are incredible short term rewards to be gained for taking huge risks which ultimately makes the rest of us pay for them in the long term, then unless there is an obvious barrier placed, they will take them. Banks are now working in the secure knowledge that we cannot let them fail and that they will get their free rein as Governments are so dependent on them to sustain economic growth. In short, the Governments want the rewards of the high risks too and are prepared to stake our taxes as collateral should the bets not come off. It is a highly dangerous joint strategy and, while the growth figures may look fine in the short term, in the long term it means that we are all progressively worse off. Amid burgeoning deficits and borrowing, there will be ever greater cuts in public spending and higher taxes in order to pay for all this, while the business world will be a great deal more uncertain with much higher unemployment.
Some argue that as early as 2010 could see the next financial crash, we can only hope that is too early as Britain will not have peaked in terms of unemployment by then and the effects of cuts in public spending to reduce the budget deficit will have not even kicked in. There could only be one course of action – the ‘TUC way’ which is to raise taxes, and then some as the need for cuts would be immediate and huge. While the TUC has a point about the super rich avoiding paying tax, to the tune of perhaps £1bn, it is still a drop in the ocean and it will mean higher tax for all above average earners under any such new scheme. One can only hope that we can get a few years in of decent recovery before the next crisis hits but it surely will.
The only effective way to stop these high risk bets from being placed would be to go to the source of the issue which is the free flow of money based around derivative products which are effectively a work of fiction. Only when we take away such products from the system will we get some stability in it which can be sustained. It will inevitably mean a slowdown or stagnation in growth but you cannot have it all ways – if the system has no real growth in it, you cannot just create it based on no good principles. It is better we find a way to grow our economies based on sensible risk than to get ourselves repeatedly into the same mess while just a small number of people reap incredible rewards for which we have to pay over the long term.
The wide consensus of opinion is that political leaders have learnt few lessons from this economic crisis and that their collective inaction has allowed banks to gear themselves for even more risk. On the anniversary of the Lehmans crash, we have the bizarre sight of the restructuring adviser for Lehmans, Alvarez & Marsal, putting the remaining Lehmans funds back ‘in play’ and they have hired many former Lehmans traders to do so. It is not just a high risk strategy, it is totally counter intuitive to the role of liquidators whose sole purpose is to maximise the remaining assets to make some return to creditors, shareholders and the like. It is as if people view the remaining monies as lost anyway, so they may as well buy a bunch of lottery tickets or back a horse at the 5.30 at Kempton Park. It is that stupid but it is precisely indicative of the new era we have created. Far from learning from their mistakes, the banks think they now have the secret formula to beat the casino. Only there is no formula but there is an unlimited benefactor who will supply all the money they need should they incur incredible loses – the taxpayers. They are now, in their own eyes, unbeatable.
The other obvious learning point from the Lehmans crash that has not been heeded at all is that banks build up their structure like an intertwined morass of interdependencies which makes any kind of proper accounting and scrutiny almost impossible. Lehmans had a web of over 3,000 companies which owed each other enormous sums of money and we have the idiotic situation of British subsidiaries suing American ones for hundreds of billions of dollars while liquidators try to unravel the ball of string that was Lehmans structure. It is a feature of the whole financial industry to build such impenetrable webs and makes the nirvana of banks having some kind of ‘Living Will’ a complete pipe dream. There is a strong case that the situation has got over complicated and is designed to keep prying eyes out and to shield the fact that banks are not really making any profits at all but playing some over elaborate game of ‘fantasy trading’ in order to generate virtual profits. It all looks great on the computer screens and spreadsheets but does not have the same credence in the real world.
As I sat on the plane at an unearthly hour, the music over the tannoy was ‘Road to Hell’ and there was prophetic line in there about credit being just bits of paper which I forget but it seems very apt – it goes on to say ‘This ain’t no technological freeway, this is the road to hell.’ I’m sure it wasn’t written with all this in mind but it might just apply.
It will take a bold politician to break this Mexican stand off as the G20 leaders all look at one another to get a nod of synchronisation before they all move together in perfect harmony. It will be like herding cats. Even then, I think we will barely have paper over the cracks rather concoct real remedies to the ills of the financial world but I believe that’s because they believe they cannot afford to change it and sacrifice growth.
In this foolish and unholy alliance, the bankers know they have the upper hand and a blank cheque. We have created the conditions for catastrophic failure for the future.
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