The people who try to run finance capital find hindsight a lot easier than foresight…
The Turner Review – capitalism indicts itself
WORKERS, OCTOBER 2009 ISSUE
LORD Turner’s Review – “A regulatory response to the global banking crisis” – makes interesting reading for those who take the trouble to go through its 126 pages. Turner, Chairman of the Financial Services Authority, starts by saying that “the world’s financial system has gone through the greatest crisis for at least a century, indeed arguably the greatest crisis in the history of finance capitalism”. He continues that past assumptions about the self-correcting nature of efficient and rational financial markets have been challenged.
The last decade has seen an explosion of world macroeconomic imbalances, Turner points out. Oil exporting countries, Japan, China and some other East Asian nations have accumulated large current account surpluses, while large current account deficits have emerged in the USA, Britain, Ireland, Spain and other countries. The resultant central bank reserves in countries like China were typically invested in what were considered risk-free or close to risk-free government bonds or government-guaranteed bonds. This in turn drove a reduction in real risk-free rates to historically low levels. So there was a rapid growth of credit extension in some developed countries, particularly the USA and Britain, especially for residential mortgages, together with a lowering of credit standards and a huge property price boom which for a time made those lower credit standards appear costless.
In Britain total mortgage debt soared from 50 per cent of GDP to over 80 per cent in the decade up to 2007. Governments and banks assumed that debt burdens were likely to fall with continuous property price appreciation and that there would always be a supply of new remortgage offers to allow refinancing.
Hunt for profit
The low interest rates have also driven among investors a ferocious search for profit. This demand was met by a wave of “financial innovation”, focused on the origination, packaging, trading and distribution of “securitised credit instruments” (SCIs – otherwise known as toxic debt). This was founded on the belief that by slicing, structuring and hedging it was possible to create value. The whole development was lauded as a way of cutting banking system risks and reducing the need for “unnecessary” and expensive bank capital. The IMF Global Financial Stability Report of April 2006 confidently stated:
“There is growing recognition that the dispersion of credit risk by banks to a broader and more diverse group of investors, rather than warehousing such risk on their balance sheets, has helped make the banking and overall financial system more resilient. The improved resilience may be seen in fewer bank failures and more consistent credit provision. Consequently the commercial banks may be less vulnerable today to credit or economic shocks.”
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| Wealth and need: the banking centre of Canary Wharf – seen through a run-down estate in London’s East End |
Were the banks being encouraged to build up capital buffers in the good times before 2007, ahead of potential future problems? Far from it. The pressure of the market was for them to return capital in order to reduce capital ratios from what were perceived as inefficiently high levels. Then when the crisis broke, the banks did not have enough capital to absorb their losses and were helped out by being handed massive freebies by the taxpayer to bring those capital ratios back up again.
The evolution of SCIs and toxic debt was accompanied by a remarkable growth in the relative size of wholesale financial services within the overall economy. Activities internal to the banking system grew far more rapidly than end services to the real economy. It stimulated a self-reinforcing cycle of risky behaviour and irrational optimism that made it look as though assets were worth far more than they really were. But hey, the profits were massive. But this couldn’t go on. The crash was waiting.
Most of these profits proved to be illusory but they were used as the basis for bonus decisions, creating incentives for traders and management to take further risk. The fact that many of the bonuses were invested in their firms’ own equities did not seem to result in any greater awareness or concerns about the risks the firms were running.
Explosion of claims
There was an explosion of claims within the financial system, between banks and investment banks and hedge funds with the growth of the relative size of the financial sector increasing the potential danger of instability in the financial system bringing down the real economy.
There had been warnings from the past. In 1986 the economist Hyman Minsky argued that financial markets and systems are inherently susceptible to speculative booms, which – if long lasting – will inevitably end in crisis. In mid 2007 things went sharply into reverse with growing evidence that excessive credit extension and weak credit standards had resulted in rapidly rising credit losses.
Several of Britain’s largest banks were deeply involved in the growing and intricate web of intra-financial system assets and liabilities. They were just as exposed as US banks and investment banks to the loss of confidence, disappearance of liquidity and fall of asset prices – reality, in other words – which gradually gathered pace from summer 2007. This became catastrophic after the collapse of Lehmans in September 2008. The bubble burst.
In Britain there had been the rapid growth of a number of specific banks – mainly former building societies such as Northern Rock, Bradford & Bingley, and Alliance and Leicester, plus HBOS – that were increasingly reliant on the permanent availability of large-scale interbank funding.
The shock to the banking system has been so great that its impaired ability to extend credit to the real economy is still playing a major role in exacerbating the economic downturn. The role of offshore centres was not central in the origins of the crisis – it was inadequate regulation of the trading activities of banks operating legally in major financial centres such as London or New York.
After such a clear and comprehensive analysis Turner goes on to suggest a series of regulatory measures to prevent another crisis. But can the system be fixed? Marx showed over 100 years ago that such crises are endemic to capitalism and a previous issue of Workers carried an account of the South Sea Bubble, with its many similarities to the present situation, which occurred at the very beginning of capitalism.
Former Federal Reserve chief Alan Greenspan has warned that the world will suffer another financial crisis, adding, “The problem is you cannot have free global trade with highly restrictive, regulated domestic markets.” Wall Street is fiercely resisting the modest reforms being proposed by the Obama administration.