It’s said that the New York banker, J P Morgan, finally realised the Great Crash was coming when his shoeshine boy started offering him share tips. Well I had my own low rent version of this financial epiphany eighteen months ago when the waiter in my local Indian restaurant offered to get me a mortgage. I’d casually remarked that I didn’t know how people afforded the colossal mortgages on pokey city flats, and he assured me that, as a freelance broker, he could get me a mortgage of seven times my earnings. No bother, man.
The wonder of this current financial holocaust is that anyone is surprised by it. This has been the most predictable financial crisis in history, even more so than the Wall St Crash. Believing that house prices could rise forever is the economic equivalent of believing in fairies, and yet that’s apparently what most of us believed. My curry house capitalist, our politicians, bankers, buy-to-letters, home buyers decided, as an act of collective will, to suspend reason and believe that the laws of economic gravity could be abolished - “an end to boom and bust” as Gordon Brown put it in a phrase that will be carved on his political tombstone.
And make no mistake: this is about house prices, the Daily Mail wasn’t all wrong. The reason that mighty Wall St institutions have been falling like dominoes is because they had created an industry out of buying and selling bits of paper based largely on residential mortgage debt, which they postulated had a secure value that could never fall. The infamous collateralised debt obligations (CDOs) were mortgage-backed bonds which traded as if they were as good as gold. In fact they were based on inflated valuations of houses held by people with mortgages they had no hope of repaying if house prices fell, which of course they eventually did. Reality had to intrude into this crazy pyramid scheme.
Why did banks allow freelance brokers to do engage in this mortgage lending insanity? Well, because clever people like the former Chairman of the US Federal Reserve, Alan Greenspan, told them that, since house prices always rose over time, the bank’s money would be recoverable, and then some, even if the “nninja” homeowner with no job and no assets was repossessed. And anyway, thanks to the miracle of “securitization” the mortgage debt would have been passed on to other investors. Yes, banks actually turned debts into assets, and got other people to buy them.
Then they used leverage to lend out even more money sometimes on a debt to asset ratio of thirty to one as was the case with the now defunct Lehman Brothers. That’s a bit like taking out a mortgage on thirty times your actual salary. It was financial madness. The unwinding of this debt - called “deleveraging” in the business - has turned into a financial contagion, which is spreading through the highest institutions of the global capitalist world. Governments have been reduced to arranging shotgun marriages for staggering financial behemoths like HBoS. Merrill Lynch, Bear Sterns. Global investment banks like Lehman Brothers are simply ceasing to be, going to meet their maker, pushing up the daisies. The very bankers who used to condemn government intervention in the market are now begging to be saved by the public institutions they decried as inefficient, bureaucratic and a drag on the wealth creation.
It is the end of the neoliberal era; the twilight of Thatcherism. Karl Marx must be laughing himself hoarse in Highgate Cemetery. Here are the capitalists destroying themselves, without any need for proletarian revolution. Last week, Alex Salmond hit out at the “spivs and speculators” the short sellers who’ve been consuming the great capitalist institutions in their death throes, like a dying man devouring his own legs. Short selling is the apotheosis of pure greed, a completely amoral form of financial manipulation which destroys the system from within. But it is a practice none of the banks could resist, even HBoS.
The BBC’s Business Editor, Robert Peston, revealed in July that the two banks who handled HBoS’s rights issue in July, JP Morgan and Dresdener, were allowed to take out huge short positions on HBoS stock worth hundreds of millions, even though they possessed insider information about the likely movements of HBoS stock prices. That’s right - the very people who were supposed to be getting the best price from the sale of HBoS shares were actually betting that they would fall. And made a lot of money when they did. Such is the honour among thieves. The government has now put a temporary hold on short-selling, but it will be back.
There is no morality when it comes to financial affairs today, only naked self interest. Modern banking is about pure and unmitigated greed. What’s new is that it is mathematical greed engineered by some of the finest minds of their generation, the so-called ‘rocket scientists’ and ‘quants’, who dedicated their intellects to inventing ever more obscure and complex financial instruments the better to promote personal enrichment. Trouble is, they were too clever by half as the banks have discovered.
The great irony of the 2008 Crunch is that the result of all this individual greed has been a kind of collectivism by default. The commanding heights of the capitalist world are now being taken into public ownership: Northern Rock, Fannie and Freddie, AIG. Most of the rest of the banking system is on life support from central banks who have been pumping hundreds of billions of public money into the system to prevent even more banks from collapsing. The US government is even planning now to buy up all the bad mortgage-related debts of the banks using taxpayers money. This will cost hundreds of billions, perhaps trillions of dollars, and would amount to an unprecedented nationalisation of Wall Street’s losses. The stock market bounced on the news on Friday. Hardly surprising since this means the American taxpayer will effectively be paying Wall Street’s debts, leaving the banksters free to start another cycle of financial excess. Mind you, no one in the real world believes that this new scheme will end the crisis. Indeed, it could sink the entire US government by increasing public debt to unsustainable levels.
So far, this has all been a spectator sport for the vast majority of us, who shake our heads and suck our teeth and feel a certain moral superiority over those venal banksters who are now scurrying to the state for help. But last week the crisis suddenly came home as the oldest bank in Scotland, HBoS collapsed and had to be merged into LLoyds TSB. Almost every family in Scotland has some connection or other to this institution, which employs 17,000 directly in Scotland. The Edinburgh financial community is shattered, and preparing for the worst as jobs are rationalised throughout the new super-bank.
This is when it get real. Britain is now heading rapidly into recession as house prices fall 2% a month and businesses lay off workers. Finance is a vital part of the real economy, and if there is a shortage of funds for lending, then economic activity slows very rapidly. Fear takes over and everyone stops spending. Business lose sales and banks become even more reluctant to lend to them. A vicious spiral can set in leading to an economic depression. We’re not there yet, but we could be.
It’s often said that what makes capitalism such a successful system is this balance between greed and fear. Greed is good, according to economists, because it encourages capitalists to start businesses, employ people and generate profits from making commodities. Fear of losing their capital initially stops them making too many bad investments. Crashes are inevitable because after a while as risk gets out of hand, people get too greedy and too many commodities are produced for the market to absorb. The collapse of asset values as the rubbish is cleared away is what the economist Joseph Schumpeter called “creative destruction”.
What is distinctive about this current crisis, however, is that it is all about global companies who haven’t made anything at all, except debt. They have been manufacturing money out of money, other peoples’ money. Banks have been playing high-risk financial games using other peoples’ capital held in pension funds, bank deposits, investment funds. The giant US insurer, AIG, which was nationalised last week, had been using the funds that it should have been keeping safe to pay out on insurance claims to gamble on the derivatives market.
In Wall Street the greed-fear dialectic disintegrated because the individuals who were playing the game were not subject to risk. Risk is quantified fear, costed fear, and it is supposed to act as a brake on what John Maynard Keynes called the “animal spirits” of businessmen and what the rest of us call plain greed. Not one of the CEOs who have recently destroyed their companies have lost out personally, though their stock options might have taken a paper battering. Dick Fuld of Lehmans, Jimmy Cayne of Bear Sterns, even Adam Applegarth of Northern Rock got out with huge severance payments and a lavish pensions. And we’re talking millions here. Andy Hornby, of HBoS hasn’t even lost his job. They awarded themselves vast bonuses when things went right and golden parachutes when things went wrong.
As long as unrestrained greed is lavishly rewarded, then this cycle of uncreative destruction is likely to continue and get worse. The entire regulatory system needs to change to impose prudence on the animal spirits, but this requires concerted and confident action by government - the kind of action taken by Franklin D. Roosevelt in the Great Depression. But the actions of the central banks and governments this time round do not inspire confidence. Obsessed by headlines, they seem more concerned to bury the scandal under public funds rather than hold the perpetrators to account for their predatory lending, their financial mismanagement and outright fraud.
Why were mortgages given to people who couldn’t pay them? Six months after Northern Rock collapsed it was still selling 125% “suicide” mortgages. How could it be legal to package up toxic sub-prime mortgages with sound assets and then sell them on to unwary investors? The accounting practices of the giant US mortgage companies, Fannie Mae and Freddie Mac. were designed to disguise epic losses, so why is no one being prosecuted?
Why were banks allowed to create an entire shadow banking system, devoid of regulation, in which they traded obscure and potentially fraudulent financial derivatives which they didn’t really understand? How is it that company bosses can lose billions of pounds of shareholder value without any personal loss, except to their egos? These are huge questions which no one seems to want to answer. When Gordon Brown says he is going to “clean up the financial system”, I’m afraid that what he really means is find more ingenious ways to use taxpayer’s money to bail the system out.
A large part of the problem is that state has effectively merged with the banking industry to create a new kind of government: financial corporatism. Over the last twenty five years, investment banks like JP Morgan and Goldman Sachs have been welcomed into the centres of political power to help with PFI, health service reform and many other functions of government. There is a revolving door between government and the banks at all levels of the civil service. Number Ten staff , like Shriti Vadera, formerly of UBS, Jeremy Heywood from Morgan Stanley come and go between the City and Gordon Brown’s private office. Jonathan Powell, Tony Blair’s chief of staff left to work for Morgan Stanley. His boss walked into JP Morgan on a reported $im salary for a part time job.
Given this degree of intermarriage between finance and government it is hardly surprising that there hasn’t been tighter regulation. The world-view of the financier has permeated public life, with disastrous consequences. This is going to have to change, and government is going to have to start disentangling itself from finance, if the present crisis is to be resolved.
But it isn’t just the bankers and the government that’s to blame. In true Dickensian fashion we are all implicated, one way or another in the financialisation of everyday life. Many of us became intoxicated with house price inflation, believing that paper gain amounted to an increase in real wealth. People who held out against the house price madness were treated as slightly slow - old dears living in the past. Why bother saving, when you could make hundreds of thousands by taking out bigger debts for bigger houses? Why build a business when you could make a million sitting back and watching the value of bricks and mortar accumulate. The property porn that has dominated prime time broadcasting for the last decade was a symptom of collective greed as we turned into a nation of property speculators. It is time to put aside these puerile fantasies and start rebuilding the real economy.