Finance at the Threshold (Transformation and Innovation)

Finance at the Threshold

This book is dedicated to the late Freya von Moltke.

Finance at the Threshold Rethinking the Real and Financial Economies

Christopher Houghton Budd

© Christopher Houghton Budd 2011 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise without the prior permission of the publisher. Published by Gower Publishing Limited Wey Court East Union Road Farnham Surrey GU9 7PT England Gower Publishing Company Suite 420 101 Cherry Street Burlington VT 05401-4405 USA www.gowerpublishing.com Christopher Houghton Budd has asserted his moral right under the Copyright, Designs and Patents Act, 1988, to be identified as the author of this work. British Library Cataloguing in Publication Data Budd, Christopher Houghton. Finance at the threshold : rethinking the real and financial economies. -- (Transformation and innovation) 1. Global Financial Crisis, 2008-2009. 2. International finance. 3. Interbank market. 4. Economic policy. 5. Economics--History. I. Title II. Series 338.5'43-dc22

ISBN: 978-0-566-09211-4 (hbk) 978-0-566-09212-1 (ebk) I

Library of Congress Control Number: 2010940026

Contents

List of Figures Acknowledgements Foreword Prologue PART I ��

vii ix xi xiii 1 3

1

Why Nobody Saw It Coming

2

When the Banks Stopped Lending to One Another

25

3

2007 – A Threshold in Financial Evolution

67

4

It’s the Epistemology, Stupid

91

PART II ���

�� 117

5

Rudolf Steiner’s Conception of Society

119

6

Rudolf Steiner’s Monetary Analysis

139

PART III ����

�� 151

7

The Twentieth Century

153

8

Keynes vs. Friedman – A False Debate

163

9

The Flattened Economy

177

PART IV ���

�� 183

10

Beyond Banking

185

11

Deep Accounting

195

12

Banking on Youth and Trade

219

13

From Threshold to Bridge

225

Bibliography Index

227 231

Transformation and Innovation Series Series Editors: Ronnie Lessem, University of Buckingham, UK Alexander Schieffer, University of St. Gallen, Switzerland

This series on business transformation and social innovation comprises a range of books informing practitioners, consultants, organization developers, and academics how businesses and other organizations set in the context of whole economies and societies can and will have to be transformed into viable 21st Century enterprises. A new kind of R&D, involving social, as well as technological innovation, needs to be supported by integrated, active and participative research in the social sciences. Focusing on new, emerging kinds of public, social and sustainable entrepreneurship originating from all corners of the world and from different cultures, books in this series will help those operating in the area of interface between business and society to mediate between the two in the way that business schools once did until, as is now argued, they lost their way and business leaders came, in many cases, to be seen as at best incompetent and at worst venal and untrustworthy. Published and Forthcoming Titles in this Series: Transformation Management Ronnie Lessem and Alexander Schieffer Integral Research and Innovation Ronnie Lessem and Alexander Schieffer Integral Economics Ronnie Lessem and Alexander Schieffer Finance and Society in 21st Century China Junie Therese Tong African Economic Humanism Mfuniselwa J. Bhengu Spiritual Capital and Economic Transformation Samuel D. Rima Culture and Economics in the Global Community Kensei Hiwaki Islamic Values and Management Practices Maqbouleh M. Hammoudeh Transforming Trade Policy in an Arab State Mohammad Al-Zoubi

List of Figures

Figure 2.1 Figure 2.2 Sketch 6.1 Sketch 6.2 Sketch 6.3 Chart 8.1 Sketch 10.1 Sketch 10.2 Sketch 10.3 Sketch 10.4 Sketch 11.1 Sketch 11.2 Sketch 11.3 Sketch 11.4 Sketch 11.5 Sketch 11.6 Sketch 11.7 Sketch 11.8 Sketch 11.9 Sketch 11.10 Sketch 11.11 Sketch 11.12 Sketch 11.13 Sketch 11.14

An Aristotelian taxonomy Two aspects of money Gold standard Bretton Woods Federally co-ordinated economies Monetary aggregates Credit as a sub-set of cash Cash as a sub-set of credit Cash and credit in reflexive relationship Cash and credit as a resolved polarity Two different logics From ‘me’ to ‘we’ Two orders; two lower modalities Keynes’s thesis – I Keynes’s thesis – II Modern central banking (and the global financial architecture) Functions of money Kinds of money Deep accounting The structure of accounting Counterpart accounts Cross-sectoral accounting Profit and capital as flow The nature of exchange

29 29 149 150 150 171 189 189 189 190 196 197 197 199 200 201 202 203 204 212 212 215 216 217

This page has been left blank intentionally

Acknowledgements I have to thank Ronnie Lessem for asking me to write this book and Martin West for guiding me through the production processes. Many others have provided crucial stimulation, though they may not be aware of this. The result is something of a synthesis, bringing together a diverse range of views and experience, including life-long ideals and reactions to recent events. Thanks are due, too, to Anita Isherwood Murphy for faithfully converting page upon page of faxed scribblings sent from far-flung corners of the world into intelligible copy then promptly emailing it back to me. And to my wife, Tessa, who continues to be the supportive wife of an often intemperate author. But I have dedicated this book to Freya von Moltke because of her unswerving conviction that the fate of mankind depends on its future generations. This is not a tautology or a platitude. In economic life, especially as regards the thinking on which it is based, very much depends on the experiences, notions and habits of thought one develops in one’s formative years, most of which, economics today being what it is, are reinforced by practical life. If there is anything awry in economic life, and it would be unwise to suggest otherwise, the starting point for lasting change must be with young people, and with the subtlety of thought they bring to bear on economic events, their own lives in particular. Throughout my life, I have been certain that what matters is that young people develop a sense of their purpose in life, and that this depends to no small degree on the acquisition of financial literacy, along with being provided with the finance that can give credence to this sense. Rather than indebting students, for example, I believe they should be capitalised in ways appropriate to their life paths but so that the funding they receive puts air beneath their wings. In ancient Samothrace the statue of Nike once adorned the prow of a ship in a specially created lake. It is usually said that this represented a naval victory, but I am not convinced. For me, the ‘clue’ to understanding Western civilisation, which owes so much to Aristotle who sojourned on Samothrace, is that, however down-to-earth, our thinking does not spring from there. It knows itself to be self-supporting. The initiative of youth, if it is not hopelessly overlain by a culture that does not, at bottom, believe in it, and if it is not directed away from a sense of itself by the many distractions on offer today, needs to spread its wings, Nike-style, and prevail victorious over the circumstances of existence. In this, especially in the future, the financing of youth has the most important part to play. Christopher Houghton Budd Centre for Associative Economics, Canterbury, England

This page has been left blank intentionally

Foreword When I first met Christopher Houghton Budd he was writing a PhD at Cass Business School. I followed his work closely, for though his views on monetary economics were unconventional they were also both interesting and, it seemed to me, of possible practical importance. Further, even if I had thought everything he said or wrote was wrong, he was invariably stimulating and concerned to advance understanding – so under any circumstances I would have been interested in his work. The high regard I had of him from early in our acquaintance has been reinforced by this book. The world has been through a major financial crisis. Indeed, it is through it only in the sense that the acute phase is past. Many economic and political struggles lie ahead before the world will once again be fully restored to financial stability. Why did this crisis occur, and what can we do to diminish the likelihood of such events occurring again? In Chapter 2 Christopher gives a good and very fair summary of the conventional account of the crisis. Banks stopped lending to one another because each bank realised that it had on its books many debts that were unlikely to be repaid, and feared – indeed, realised – that other banks were in the same situation. This suddenly halted bank lending not just among the banks themselves but to non-banks also. In effect there was a sudden monetary squeeze, the world was plunged into recession, and many banks were at risk of failure. This conventional account neglects a great deal. It treats the crisis as an event that can be studied in isolation, and looks entirely at the event itself. That is of course perverse. No physician would treat a patient’s heart attack without knowledge of how other heart attacks had been treated in the past, and if advice were to be given on how to prevent the patient having another one then it would be manifestly necessary to look at the known causes of these past attacks, and perhaps to consider seldom used preventative measures and remedies. It should not be forgotten that every previous banking crisis, whatever its particular circumstances, had two features in common with every other financial crisis, including the most recent one. Every crisis has been preceded by a period of excessive monetary ease, and by ill-thought-out regulatory changes. To these points, which should be made by any careful economist, this book adds several insights. Economists’ modelling their subject on the physical sciences is misleading – of economists as well as others – for it ignores the changing interactions among individuals, the complex nature of expectations, and not least the in general rather poorer quality of the data. Christopher emphasises, too, that money is a social construct, and that different kinds of societies may well require therefore different kinds of money. In developing this argument and its implications the book builds on the work of Rudolf Steiner. Steiner is well known for his ideas on education. Very much less well known are his ideas on the economy and on money. On the basis of these most interesting ideas Christopher Houghton Budd argues that many of the differences between Keynesians and Monetarists, even those few differences that now remain, are based on misconceptions about the nature of the world. We would gain, he suggests, by changes

xii

Finance at the Threshold

in the nature of banking systems, by a depoliticisation of money and indeed perhaps its internationalisation, and by changing accounting, so that it ‘ceases to afford hiding places for uncertain transactions’. This well-written and thought-provoking book will prompt its readers to reconsider their ideas on money, on credit, on banking, and on the role of government. Even if it does not change the mind of a single reader, all readers will go away with a deeper understanding of why they hold the ideas they do. Geoffrey Wood Professor of Economics, Cass Business School, London

Prologue How integral is this book? It is not easy for an English economic historian, writing from an English perspective, to accept an approach that does not place Anglo-Saxonism centre stage. I do not mean it is not easy for me personally because, as I point out in the beginning of the book, I have always ‘gone native’ when outside England and have spent my life studying all manner of economic philosophies and indeed being active in their terms. Whether it be Marxism or green economics, being in business on my own account (thus learning that most crucial but least known skill of all economics, surviving a negative cash flow) or participating in Local Exchange Trading; whether it be serving in school finance and governance, becoming an academic among City and central banking economists, working in the ‘less developed world’ (as we so unfairly and inaccurately call it), consulting in a slum one day and interviewing investment bankers the next; whether it be researching the economics of Rudolf Steiner, who was no Anglo-Saxon, or learning about accounting, a schooling in numbers far more real and effective, both practically and theoretically, than the usual numbers of mathematics and econometrics – I have spent a lifetime studying economics from all angles. Because I never subscribed to the idea of shouting louder if not understood in a foreign country, I have also worked in several languages and various cultures. As a result, I do not in fact regard myself as an example of unintegrated economics. Yet I am Anglo-Saxon! Or at least English. One of the those Englishmen, moreover, who thinks that Jeremy Paxman, in his book, The English, pretty much got it right when describing who we are. I have been to many parts of the world and spent little time in ivory towers. Having always been self-employed, I have also had to live from what I say, teach or advise, and thus been entirely dependent on my wits, as the English language understatingly puts it. Much of what I do outside England begins or is prefaced by deconstructing the role of narrow-mindedness, whether in economics or on the part of the English generally, in order to find the way to the essence of the country I find myself in. This is not always easy as many cultures are overlain, even enthusiastically so, with an Anglo-Saxonism of their own devising. How often, when visiting another country or culture and feeling the need to lessen Anglo-Saxon hegemony, one meets people going the other way! They are wanting to get to the US or the UK, not merely as economic migrants, but because for them ‘the west’ or the American Dream has genuine allure. Indeed, there are places in the supposedly Anglo-Saxon world, like the Bay Area of California, or the US as a whole, and even England, that are like melting pots for all the world’s cultures. There is also English, which is one of the most mongrel of languages imaginable, and for that very reason all the more easy to acquire. The Anglo-Saxon may have a special relationship to it, but it is hardly ‘his’ any more. Yes, there has been a history of domination, often negative, unkind and ill-intended. And, yes, there is a dangerous reliance on mathematics. That, in point of fact, is why I studied economic history rather than economics per se. I am a ‘plot’ person, needing to know the place of what I am doing in the larger picture, both in space and over time. Those who rely on mathematical models do not need to do this; in fact they part company

xiv

Finance at the Threshold

with ‘plot’. Plotting is more what they do, be it sales graphs, marketing strategies or even interference in sovereign states, which is what such policies as ‘structural adjustment’ often amount to in my mind. The English have a special relationship to Anglo-Saxonism and to how to overcome its narrowness. By definition, our part in achieving an integral economics cannot be that of critiquing ourselves from another point of view. It can only be changing our own view of how we are and how we behave. I call this being english with a small ‘e’. Where we have a history and even a psychological tendency to lead or dominate we need to become hosts, facilitators, accompaniers instead. Where we have laid down the law or dragged whole peoples overnight into a stage of development that took us centuries to develop, we have to know the moral responsibility this brings, and discharge that responsibility properly, not walk away from it. It does not bother us that in 1947 we gave a man three weeks to demarcate the western boundary of the imminent Indian republic, to cite but one example of the way we let go the Empire. Or that we ascribe so many of today’s problems to the ‘immature cultures’ we left behind, when the real immaturity lies in our continual interference in the affairs of sovereign nations that often passes as foreign policy. Similarly, we think any and every person and culture on the planet has to be like us – ‘blessed’ with parliamentary democracy, an industrial revolution and abstract finance. We never stop to think that, for example, bi-party, first-past-the-post, adversarial governance may not be the height of parliamentary evolution, but its caricature. Or rather we do think about such things but then insist that all is as it should be. How, then, does an Englishman make the ‘e’ a small one? The answer is not easy and not obvious. At least, not to my mind. If, rather than by being shoved there by others, we are to move ourselves from centre stage to a point on its edge, to join hands, as it were, with the rest of humanity – I call this going from imperialism to partnership – then our task is of a subtler, more transformative kind than adopting outwardly imposed changes. Like all real transformation, it has to be self-willed and directed by the one who would be changed or needs to change. If the Anglo-Saxon-dominated world is to not be such, the challenges we face are not those that confront non-Anglo-Saxons. They anyway also have in their own way to resist such things as market philosophy, Darwinist explanations of behaviour, the plausibility of supply and demand thinking, and any number of other concepts that trip as readily off the lips of non-Anglo-Saxons as Anglo-Saxons, and often with greater fervour and less criticism. An Englishman may revere or be steeped in Newton, but he does not necessarily admit him to his heart. We also have to manage a problem that non-Anglo-Saxons do not. There are many in the Anglo-Saxon world and especially in finance who believe very genuinely in what they call ‘the white man’s burden’. This dangerous notion underlies much behaviour – from past colonisations, to hemispheric pacts, to Bilderberg gatherings and similar. Even, perhaps especially to global finance. This is a huge and fraught topic, which I am only touching on to signal the fact of its presence. Finding a way past such a reality – better still, enabling us to let go such dangerous predilections – is by no means easy. Career and funding prospects can be affected. Connections can simply not happen or be ‘unhappened’. It is not just a fascination with and dependence on mathematics that bedevils modern economic life and the way it is understood. In one sense, that is precisely the means that Anglo-Saxon dominance took up when outer domination had been achieved or run its

Prologue

xv

course by the late nineteenth century. Our true economic identity does not consist in manufacture or, in Napoleon’s quaint image, being a nation of shopkeepers. It is to be tracked in matters financial, above all finance as conceived in and centred on London. The very nature of modern economic orthodoxy has two consequences that, for me as an Englishman, are quite clear. One is that Anglo-Saxon dominance causes an external antagonism: people want to supplant or at least pluralise the prevailing paradigm. But that can really only be the position of a non-Anglo-Saxon. For an Anglo-Saxon it is a matter of seeing through illusions, overcoming myopia in thinking, refining one’s concepts so that one gets beyond what, in this book I call the propensity to divide, so as to arrive at the propensity to unite which can readily follow on but needs a degree of will and interest in one’s fellow men that dividing does not. We, the English at least, are lamed by this incompleteness on our part. Our task cannot be simply to give way to other points of view, even if we are inclined to do so. We cannot just share the stage but have first to make it sharable. But that means we have ourselves to overcome the dead end that mere market economics can entail. Whether we break through the wall at the end of the cul-de-sac, or back up and find a path in the maze of human history that leads us further, time will tell. But the key to doing so will be to revisit cherished assumptions, redesign policies, take up different habits. What do I mean by that? In the book I give details, but examples would be to study Islamic finance in order to see there arrangements that we could as easily arrive at, but out of the anarchy of individual freedom and responsibility, rather than in compliance with an external code of behaviour. Or we could overcome our fascination with real estate as an asset to be kept permanently in play and whose value is to be constantly increased – a practice that does not come out of any real economics, however, for an asset is by definition a means of production and is thus always being used up and never for sale (unless it is inventory). It comes rather from the Englishman’s deep need to be connected to the earth, to things material. This is not unique to us but we are its ‘best’ exemplars. The English, perhaps the Anglo-Saxons more widely, have a need to find their identity through what they evidently achieve. They cannot depend on an idea, but need to be pragmatic. From this simple piece of inner fact, call it psychology if one resists anything deeper, derives much else. To begin with, our fascination with and even authorship of the materialist philosophies that underpin modern economics. Then there is the idea, as false as any idea could be, that economics starts with Adam Smith rather than Aristotle (at least as far as ‘the west’ is concerned). Next, those things that go to the essence of the Anglo-Saxon psyche – for example, the need to see one’s home as one’s castle. Or that an important person is said to be ‘somebody’, as if the deepest aspect of a human being is the skin and bones that clothe him. If the Anglo-Saxons are to let go their hegemony, without which act there can be no integral economics, no sharing of the stage with other points of view, this is the problem that has to be addressed and addressed somewhat urgently. That, if it is not too pompous a thing to say, is what this book attempts. To lead the Anglo-Saxon mind out of its imprisonment. Out of the labyrinth of solitude, to remind us of Octavio Paz; back from the slain minotaur (thanks to Ariadne’s string) but without forgetting to raise the white sail; beyond the confines of ‘the box’ (for which read brain) within which we have learned to think but outside of which lies the next step in intellectual development; to lift our gaze from its fascination with the ground, as if transfixed by the stare of a snake,

xvi

Finance at the Threshold

towards the blue sky and even beyond – to the world of blue birds also. To look up at a rainbow, as Dorothy did, or to fly up to it as the Wizard of Oz may well have done, is not an unimportant thought. But how about going to the other side, then turning to look down into the rainbow and to the earth beneath? Of course, such poetical whimsy has no place in economics, or so we assume. But maybe that is the problem. We make the mistake that science has no link to poetry, to intuition. Yet whence comes a research question? What is a hypothesis if not a form of poetry, a formulation of something that initially no one else can see, but that one hopes can be gradually brought to others’ awareness and recognition. The syntax and the articulation may become more prosaic in the process, but real prose never loses its link to poetry. Prose is not the antithesis of poetry so much as its generalisation, the transposition of leading thoughts from lofty heights to accessible foothills, the filling out and grounding of what first appears as sketch and intuition. In short, the pathway to integral economics for an Englishman, who in a sense is also the epitome of an Anglo-Saxon, is to pass through what others would come up alongside. To release from his capture things which have in fact a universal quality and belong to humanity generally, not to any one group in particular, least of all his own. This is why all eyes for me are on accounting and on how one capitalises initiative. For whether it be the ‘voice of the people’ one is listening to, the deeper intent of an entrepreneur whose balance sheet currently belies the opportunity he has in mind, the health of the economy (which is what central bankers attune their ears to), or the as-yet-unformulated goal of an otherwise behooded hooligan whose chances in life, above all his chance to see himself as someone who matters, have been close to nil – everything depends on how a person or a nation expresses its deepest destiny and sense of itself. In a globalised economy, moreover, such things are necessarily affected very directly by whether, at that moment, the capital implied by an initiative is made available on the terms of the borrower rather than the lender. In the first place, outwardly, structurally nothing, but nothing needs to change in such a situation. But paradigmatically everything changes. It is not easy, but not impossible, for a provider of capital to realise that it is not his possession of it that makes it grow, but the use made of it by the person he lends it to. At that point, however, is he in fact lending it or transferring it? Capitalism could overnight become what I have for many years called ‘capital economy’ if we would just see through the illusion of the idea that capital ownership brings capital growth. What matters is the circulation of the means of production, the circulation of capital. Not who possesses capital, but who is using it. And not even that. What matters is whether the use is fruitful in a wide sense and whether, above all, the distinction can be made between what part of the fruits of capital belong to the various ‘stakeholders’ party to its use. Above all, can each of those parties further discern when more is allocated to their account than should be? For in this is the clue: can the lone, self-interested individual know by his own divining when he has taken to his balance sheet, as it were, an amount that does not belong there. Of course, if he were awake and financially literate he would be able to see this very precisely in the balance sheet itself, for a balance sheet cannot in fact be over-capitalised. But where is this sense to come from in a world steeped in or saturated by AngloSaxonism, by too close a fascination with one’s earthly existence? For my money, the answer is simple and universal, though boring and anti-climactic. It is to be found in looking directly into one’s accounts (which exist irrespective of the currency one uses and

Prologue

xvii

whether or not one is in a monetised or ‘cashless’ economy), for these in their essence are but a mirror of one’s actions and therefore of the ideas and motivations, conscious or otherwise, that underlie one’s actions. In a global economy, if allowed to unfold its inherent nature, accounting necessarily takes on this character. For all mankind there can be nothing else that does this. Accounting therefore has the power to bring Anglo-Saxon dominance to its Waterloo. But what enables a human being to see this in accounting? It is one’s deep, hidden, even long forgotten and seldom used but nevertheless existent, sense of right. This shines as a beacon across the last two millennia, despite the whole of modern history culminating in non-integral economics; a light lit or a tone sounded by Aristotle when he spoke of the need to know the mean in life. To paraphrase his eloquent words from the Ethics: a liberal man is the man who knows how to give the right amount of money to the right person in the right way at the right time. Neo-liberalism, which seems to forget that it takes its cue from the towering presence of Aristotle, would do well to give thought to its own etymology. How, if it does, does neoliberalism relate to this sense of right, of knowing when excess arises and how to ensure one does not privatise it? How does it square its belief in the importance of individual freedom with the need to include the context of that freedom, namely, all the other individuals on the planet? On the other hand, is it compatible for the Anglo-Saxon to conform to external codes? The Koran, for example, can be explicit in terms of riba, and one can create all manner of government regulations, but the Anglo-Saxon can never go this path. He has to find within himself what he has in fact banished from his vocabulary and code of conduct. Despite himself, he has to make clear what is new about Aristotle’s dictum. The new thing, in my view, is that what has for ages been there as the insight of a genius, as a guiding light, has now to become the basis of everyday conduct in monetary affairs. When that happens, when the Anglo-Saxon, now the possessor of all the world’s capital, realises how he can give it away to humanity as a whole, himself included, in the right way at the right time and to the right amount, then, but not until then, can the Anglo-Saxon of his own volition, and therefore with all the future forces at his command, take a place on the edge of the stage rather than occupy its centre. (This is by no means easy, however, because he knows well enough how to be at the centre even if he seems to be at the periphery. The British, for example, have no need to be part of the euro or the European Central Bank in order for both to serve British interests. They just need to have been in on their design.) In fact, the biggest challenge for Anglo-Saxonism, whether on the part of the English or anyone else, is not initially an outer event at all. It is to still one’s egoism, to know its bounds, the limits of its social legitimacy. Obfuscatory? Lacking in external drama? Sheer nonsense? Maybe. But I think not. To be Anglo-Saxon is not in the end to be of a particular ethnic or cultural provenance; it is to have one’s mind focused on a particular destination, a particular mode of consciousness, the consciousness that comes with being self-aware. For then it becomes crucial not only to know why one is trying to do something and that one can achieve it, but also that one has access to the credit on which, in a globalised, monetised, self-conscious world, the fulfilment of any and every sense of one’s purpose in life depends. It is as if the role of Anglo-Saxon culture is to kill off all cultures (itself included!), so that they might create themselves anew, giving life to their latent but yet-to-emerge

xviii F i n a n c e a t t h e T h r e s h o l d

potential, unfolding their re-discovered genius. It is to subject all cultural development to date to self-consciousness so that each culture can give bold expression to its future instead of merely reinventing or reiterating its past. New Africa is what we should be scanning the horizon for, New China, New Arabia, New Brazil, New Columbia (with apologies to Vespucci). And, of course, New England. These are the single members of what I call the choir of cultures. The challenge they face, the challenge we all face, is to pass from cacophony to unison. But that is something we will never be able to do if we continue to take our cue from the dirge-like drone of Anglo-Saxon economics as it has become to date. We could do worse than to heed the words of Alfred Tennyson when he wrote: Unfaith in aught is want of faith in all, It is the little rift within the lute, That by-and-by will make the music mute, And ever widening, slowly silence all.

At its ‘height’, Anglo-Saxon economics epitomises this thought, because, for all its bombastic certainty about itself, it risks separating human beings from economic reality, for which fact today’s rift between the real and financial economies surely gives warning.

part

I Loose funds may sweep the world disorganising all steady business … – J.M. Keynes

This page has been left blank intentionally

chapter

1 Why Nobody Saw It Coming

This book offers a radical view of the global financial crisis. After describing its methodology, including its reasons for using Rudolf Steiner as a main reference, it provides first a chronology of the global financial crisis and, second, various explanations of it, before proceeding, third, to its technical details. It then identifies its own, one hopes unique, guiding intuitions, prompted in part by Steiner’s socio-economic analysis, in order to present its own theses. Their ‘political impossibility’ apart, the book culminates in outline policies capable of practical implementation. Its aim is to lead the reader into a new landscape – the world we in fact occupy but not as we currently conceive it. Spanning the wide gamut of current thinking, the book argues that we need above all to overcome the Left–Right divide, so much taken for granted today, and to promote financial literacy on the part of young people.

1.1  Themes This introduction serves a number of purposes. The first is to introduce the main themes with which this book is concerned and which will serve as its base narrative. The second is to outline its methodology. Third, to provide a preliminary reference to associative economics, as the perspective adopted here is known. Fourth, to contextualise the use of Rudolf Steiner as a main reference. Fifth, a word is needed to explain what is meant by ‘innately English’, which is what the author claims to represent. Last, because it is a feature of associative economics to use plain English and avoid jargon and mystification as much as possible, certain terms will be new or have meanings other than are usual. Where these terms are deemed fundamental to the book’s treatment of the global financial crisis they are made clear at the outset. Less crucial terms are dealt with as they arise. In the course of writing this book a number of themes kept presenting themselves, either in the research material or in the author’s mind. Although they are reiterated and elaborated as the book unfolds, it feels right to draw attention to them at the outset.

1.1.1  ‘Crisis, What Crisis?’ The first of these is ‘Crisis, what crisis?’ Writing in the second half of 2009 on the topic of the global financial crisis did not prove easy. Was the crisis still happening? Or was it over? Indeed, had it ever existed? When in the spring and early summer of 2009, Goldman Sachs and other Wall Street firms posted their highest ever profits, what, one



See 2.3.5: Goldman Sachs, p. 41.



Finance at the Threshold

wondered, was the US government’s September 2008 $700 billion bank bailout all about? And if what one writes in late 2009 is not to be published until some time in 2010, would it be worth the paper it was printed on? Presumably not if the crisis had passed, or if one’s analysis of it proved defective. But definitely if the crisis, as this book contends, was not really financial so much as epistemological; not really of a moment, but ongoing. Chronic rather than acute.

1.1.2  An Epistemological Challenge If colossal government intervention to prop up the balance sheets of banks and car makers (and in Australia, more intriguingly, school buildings) in fact did nothing to address the epistemological challenge, would it not therefore be reasonable to expect the ‘crisis’ to continue, albeit in metamorphosed form? Of course, ‘crisis’ is not a word one rushes to use in the world of finance, lest it exhibits that most typical of financial characteristics – recursive causality – and indeed makes critical what might, if less dramatically described, have remained only a ‘blip’. Great care has been taken in the literature to define the term. There is, for example, a distinction made between a banking crisis, which is about a loss of liquidity and often prompts government intervention (though conventionally this ought not be for a single bank unless it threatens to bring the system into collapse), and a financial crisis, which entails a breakdown of the payments system. In Anna Schwartz’s well-known definition (1986: 11), ‘a financial crisis is fuelled by fears that the means of payment will be unobtainable at any price … [Its essence] is that it is short-lived ….’ By this definition, however, it is not clear that the global financial crisis is properly named on either count, since it has more to do with banks’ fear of non-return of loans. One of the reasons for the careful definition is to ensure that such an event can be quarantined in the country of its origin. In a study made at the end of the 1990s, topical then because of the collapse of the Thai Baht, the demise of Asian ‘tigers’ and so on, Williamson and Mahar (1998) surveyed 33 countries which had experienced crises since they had been financially liberalised. Two-thirds of these crises were attributed by the authors to financial liberalisation. In these terms, Long Term Capital Management (LTCM) in 1998 was not a crisis, but Argentina in 2001 was. Neither, however, was global in scale or scope. To speak of a ‘global financial crisis’, therefore, marks something of a threshold in our understanding of economic and monetary evolution. If it does warrant the title, matters are immediately made more complex because one has also to ask whether such an event can happen more than once. In October 2008, Bank of England deputy governor, Charlie Bean, warned that the pain is just beginning, calling the situation the ‘largest financial crisis of its kind in human history’. Whatever its ‘status’ in the annals of human experience, one certainly needs to ask whether it will, indeed can, be a historically ‘overnight’ affair or ought to be seen more realistically as a protracted occurrence both beginning before and continuing after its more obvious expression.

 In this book, whether the billion references are US or UK is a function of the citation since the quantities are arguably so great as to make the difference between the two immaterial to the discussion presented here.

Why Nobody Saw It Coming



1.1.3  The Future of Finance Accordingly, the book has been written for those who are concerned where the future of finance might lie. Professionally, the readers held in mind when writing it were those in such policy and practical areas as are covered by the wide-ranging categories of finance, investment and accountancy, business transformation, sustainability and social responsibility. Especially included were academics linked to financial districts (e.g. The City, Wall Street), policy analysts and central bankers and their advisors. But there is another group of readers, those, namely younger people, who are seeking fresh perspectives and wanting a less bewildering sense of history and thus of the forward prospects of global finance than many economists seem able currently to provide. The book’s main thesis is that current developments – not only the so-called global financial crisis – are far more readily understandable and even predictable than many commentators would have one believe. When Queen Elizabeth asked on her November 2008 visit to London School of Economics, ‘Why did nobody see it coming?’, she may have been being polite to her hosts or even exercising extreme constitutional caution. For there are many who were not in the least surprised – witness Dirk Bezemer’s 8 September 2009 letter to The Financial Times (see 2.3.8: Dirk Bezemer).

1.1.4 Predictability Predictability is the bedrock of economics. It cannot be treated lightly therefore. Either we can or we cannot foresee economic events. It is not just a matter of the psychology of addiction, the well-known difficulty of leaving the gaming table when ‘on a roll’, herdism in markets and any other number of relatively banal explanations of human behaviour. Nor does it help much to remind ourselves that mortgages issued at more than three times income entail well-known risks. Or that real estate values bid up by speculation beyond their cash-rentability would normally be discounted by the prudent. If we know this but ignore it, was greed the reason for dispensing with conventional practice, as many claim, or has some event of a fundamental nature taken place in our times, and maybe still is taking place? The prospect should at least be entertained, because, if so, getting the genie back in the bottle by returning to time-tested prudent practice may not be so easy.

1.1.5  A Single World Economy Simply stated, this book’s thesis is that humanity has crossed a threshold into a single world economy but one comprising more than one polity and to be shared rather than fought over or ‘colonised’ by the most powerful. A single global economy that we simply have to learn to conceive and conduct as if it were a global commonwealth. As Keynes (1919: 11) famously said at Versailles: The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world, and share, without exertion or even trouble, in their prospective fruits and advantages; or he could decide



Finance at the Threshold to couple the security of his fortunes with the good faith of the townspeople of any substantial municipality in any continent that fancy or information might recommend …

1.1.6  Choir of Cultures Such an economy entails a severalty of all the world’s peoples* now brought together in one economy such that no one of them can control, ransom or fight over it. It will be (already is?) an economy that depends on each people identifying its global comparative advantage, meaning what it can especially, even uniquely, bring to humanity’s table. More than this, the huge diversity of the world’s peoples will act, as does individual diversity, as a kind of perpetually functioning difference in levels on which forward movement of economic life depends (or will come to depend). Put poetically, the concomitant of a single global economy will be a choir of cultures, each able to sound its own note but able also to include the tones of all the others. The case is made that this circumstance has obtained ever since World War 1 and that overlooking (or avoiding) it has been the cardinal feature of humanity’s economic affairs ever since. We have overlain this basic fact with all manner of theoretical and geopolitical constructs that would have us continue to believe that economic life is not all-of-a-piece and so can continue to be understood by ideas that are essentially atomistic. A part can never become the whole, however. It can only ask what is its contribution to the entirety. One cannot speak any longer of a national or a nation’s economy (e.g. the British economy). One can only ask what is the role of Britain (or any country) in the world economy. Nor can the answer be to take it over, reign supreme or beggar one’s neighbours. In a world economy we are our own neighbours.

1.1.7 Denationalised Economic Life Unexpectedly, perhaps, the globalisation of finance has itself brought us to this point. While it may have been thought of as a way to give preference to an essentially AngloSaxon* economic modality over all others, its real effect is to denationalise economic life, emphasising the one-worldness of modern economic history. The global financial crisis is in principle not that at all, therefore. It is primarily an epistemological crisis. Once we understand that, overcoming it is immediately in our gift. It is no longer unpredictable or undoable. Indeed, it moves from being a crisis to an event, one moreover that entails conceiving modern economic life as a partnership, not a quest for supremacy. This shift in our mindset, but also in our behaviour – learning to walk a different talk – is where we should put our focus. Then we will step into a vital, if to-date little-credited stream of history; one that issues from the future, where in reality we already are, rather than from the past, where we fancy economic events always have their origin. Then, instead of looking perplexedly at economic history as if it were a fait accompli of which we are the victims, we will regard it as something ever-becoming of which we are the authors.



For the meaning of starred (*) words see 1.5: (Re)defining Terms, p. 19.

Why Nobody Saw It Coming



1.1.8  Associative Economics and Rudolf Steiner The thesis of a single global economy as represented here belongs to the nomenclature of associative economics and is borrowed from Rudolf Steiner, but its elaboration is the author’s own. Moreover, it is one that pretends to be quintessentially English. A particular eye has been put to a particular lens. While this will entail divergence from conventional perspectives, there is no intention to diverge from the events they seek to explain. On the contrary, the aim is a convergence of phenomena and explanation of them.

1.1.9  Innately English Written in an accessible style and designed to treat the global financial crisis in a manner that will continue to be of relevance and interest even after its current intense topicality has evaporated, the book takes an approach that aims to be innately English – that is to say, not English-speaking generally and not American, but standing in the stream of English economic history with its central concern being, to quote Hartley Withers (1909: 294), to act as the City of London’s ‘monetary physician [whose patient] cannot afford, under any circumstances, to be sick’.

1.1.10  The City of London Citing the City of London is a metaphor for standing at the centre of both the British economy and that of the earth as a whole. Here two important worlds coincide. For it is fanciful to equate Britain’s economy with manufacturing, important as that has been and in certain respects still is. Britain was far more, and far more consistently, the entrepôt port of the world than its workshop. Especially the entrepôt of finance. ‘Greenwich Meantime’ says it all. London is located midway between the beginning and end of the world’s day. The most crucial policies will continue to be those that maintain London – in the eyes of the world – as the deepest, broadest and most effective pool of world liquidity. Losing that status is the greatest risk run by advocates of abandoning sterling in favour of either the euro or the US dollar. Not for nothing, perhaps, is the former ‘pool of London’ now the locus of global financial markets. Indeed, if, as suggested by Elisabeth Gilbert in her novel, Eat, Pray, Love (2006), important cities can be summed up in one evocative word, such as ‘success’ for Los Angeles and ‘achieve’ for New York, then perhaps London’s synonym is ‘liquidity’.

1.1.11  At the Threshold – Between the Real and the Financial Economies Maintaining the patient’s health remains paramount, but this means that the monetary well-being of the world is a function of Britain’s. And vice versa. In the realm of finance, Britain and the global economy live in a symbiotic, even osmotic, relationship. Quite where the one stops and the other begins is not easy to tell. Likewise, how can one tell where the ‘real economy’* stops and the ‘financial economy’* begins? It is by no means easy to occupy that most crucial of all monetary places – the threshold between two distinguishable yet not actually separable realities. This is the problem that this book explores.



Finance at the Threshold

1.1.12 New Financial Instruments At least, it is written from that place. It considers the global financial crisis as something paradigmatic, arguing that global finance has brought us to the limits of what mechanistic economic explanations can capture. New ideas and above all new instruments are needed, so that financial innovation can turn its attention to new, more fertile ground. We have become accustomed to linking such innovation with its dexterous (to date!) exploitation of the inefficiencies consequent on the discrepant relationship between state and economy and between national and global economics. But it is in the nature of such activities to cause the world to shrink, resulting in a reduced field of endeavour for innovation. Innovation thus turns to the invention of what one might call surreal products, such as high-frequency trading and the like. Once the condition of a single global economy has been achieved, however, such innovation necessarily rebounds on itself, at which point we need to give thought to the one place that new value can really come from – not from capital doing business on its own account, as it were, but from the uncollateralised capitalisation of fresh initiative, especially on the part of young people.

1.1.13  Investing in Youth This culminating focus on young people has three grounds: (a) that today’s youth needs the orientation of a clear financial paradigm, (b) that they are less hide-bound and more able to grasp new thinking, and (c) that the time and energy needed to adjust to the new circumstances humanity now faces are generational. We need to be brought up differently, both as to the way we think about finance and the way we behave in regard to it. In short, we need to equip future generations with an understanding of finance, both technically and in its deeper aspect, that previous generations lacked.

1.2 Methodology In finance, methodology – that is to say, the way one organises one’s thinking, orders one’s thoughts and ideas – is especially crucial because in finance thoughts are as things. Finance occupies an invisible realm in which what we ‘see’ are the ideas by which we comprehend (or try to comprehend) processes and events that have no ‘hard’, that is, physical existence. In fact, we do not so much see as imagine or make an image to ourselves. From this point we then have to choose between two paths. We can either deepen our imagination to ensure that our images correspond with reality, or we can assume our initial images are correct and force reality to comply with them by means of policies from which in turn practice derives.

 Soros once said of his ‘attack’ on sterling in 1992, for example, that he did so because it was refusing to lose itself in the wider concept of the euro, thus going against the trend to reduce the number of currencies in the world.  It is not only young people. At any age, one knows that if one is capitalised in recognition of the intuition behind what one wants to do, and in support of the initiative one has to give it effect, not against some real assets provided as collateral, this can make the difference between succeeding and failing, between making something youthful, along with the entrepreneur representing it, and making it feel old, already at inception.

Why Nobody Saw It Coming



For some, the global financial crisis is a straightforward problem of the banks having stopped lending to one another. The solution, therefore, is to find out why so that one can convince, prompt or, at worst, cajole them to start again. All will then be well. But if that is all the global financial crisis amounts to there is little point writing a book such as this one. Its existence therefore presupposes that the global financial crisis is a more complex, less readily resolved matter than mere bank lending. In fact, much of today’s preoccupations entail technical matters that for most are difficult to comprehend and for many border on the unethical. This, of course, has long been the fate of finance. Because it is often outside our normal understanding it is assumed to be a questionable world inhabited by questionable people with questionable motives. ‘Why did the banks stop lending to one another?’ is a question readily formulated but by no means as readily answered. The facts of the matter will often be muddled up in one’s mind with one’s opinion about them, and this will often be tinged with moral indignation, political or ideological persuasion, envy and much else. Sifting the facts out from these other aspects is no easy task.

1.2.1  The Nature of Proof As a point of method, the more precisely one can describe both events and the thinking, or at least theory, that underpins them, the closer one comes to their exact nature. However, one has always to bear in mind that in economic affairs event and related idea are not readily separated, unlike in the ‘hard’ sciences,* where the facts of the matter are discernible apart from one’s reaction to them. Because in economics thoughts are as things, so one needs to include one’s reactions, as also one’s biases, in the data – something that takes special effort and requires stringent methodology. If successful, however, one’s research can go ‘one level up’ to where both the thing observed and the thoughts of the observer come within the researcher’s purview. Here intuition can play its part. Thoughts can occur to one that, though initially not proven, can become guiding intuitions. The genesis of such thoughts is not unimportant. Of course, the subjective needs to be rendered objective, not left unspoken; but not banished absolutely either. To this end, one’s intuitions need to be in link with data, both of which in regard to one another can occur either ex ante or ex post. They have then to be verified. In matters financial, however, proof cannot be of a hard science kind. Instead, it takes more the form that ‘correct’ intuitions will lead to policy formulations that, vested interests of all kinds notwithstanding, are capable of displacing discredited or outmoded policies, along with their associated theories. Such policies are suggested in Part 4 of this book.

1.2.2 Data and the Owning of Bias Seen from a physical point of view, the data in this book are ephemeral, soft.* But such is the nature of all financial data. To talk of ‘hard facts’, meaning statistics or balance sheet information, is fair enough at the level of colloquial English, but it is epistemologically imprecise. A ‘hard’ fact is a physical phenomenon perceptible to one of the five senses. There are no such phenomena in finance, or in economics for that matter. Who has ever touched a financial instrument or product, a market, or the relationship between finance

10

Finance at the Threshold

and the state? Who has ever seen a price or smelled a level of inflation? Such terms are but pointers to something invisible. For this reason, the data in regard to the global financial crisis are only ever ‘soft’ – but they are of two kinds. There is the information that comes from ‘outside’, such as news that a company is insolvent. And the data that come from ‘inside’, such as the reaction one has to such news, the picture that arises in one’s mind because of it, even the decision one then takes in regard to it. Thus, the just-mentioned link between external data and intuitions, and vice versa, is crucial. An important part of the methodology of this book, therefore, concerns the owning of its author’s biases. It is an illusion to think one can be without bias. Even the claim to be bias-free expresses a bias. Objectivity does not come from excluding human beings but from asking everyone to be conscious of his biases – to declare, describe and even defend them, so that they can be gone beyond.

1.2.3  Englishness In this book, two main biases are present. (There may, of course, be others the author is not aware of.) The first is the Englishness of the author. Even if one is much travelled since an early age and for that reason conscious of being English, one cannot escape deep embeddedness in one’s own culture, with its myriad daily references to histories, philosophies, events and so on that mean nothing to those brought up in other cultures. This is true of all cultures, of course. The particular problem for an Englishman is that English is the primary language of economics. Most of the philosophical underpinnings of economics come from the likes of Hume, Smith, Ricardo and Mill, not to mention Jevons, Marshall and Keynes. This is further supported by Britain’s central role in bringing about a world economy (a development that had both positive and negative aspects), her continuing presence in world affairs, be it through foreign policy or the working and effects of The City, and the unspoken assumption that to think in mainstream economic terms is to accept (consciously or otherwise) the paradigm that underlies it – one that gives to the English a certain primacy in economic affairs. It is especially difficult for an Englishman to remember, for example, that the axioms of modern economics have an Anglo-Saxon bent. They are ‘natural’ to an Englishman, but people from other cultures have, in some sense, to adopt this perspective. For the most part, in doing so, one does not see that one has adopted a way of looking at economic life, not the way. Yet we, the English, allow the unspoken thought to exist that our view is universal. In the course of this book the endeavour has constantly been made to maintain awareness of this particular bias. One cannot, of course, use a style which continually qualifies everything with the phrase ‘bearing in mind these are the ideas of an Englishman’, or some such; but this consideration does need to be kept in the forefront of both the reader’s and the author’s mind. When it comes to economics and economic affairs, those who are innately English have a comparative advantage of a higher order than usual.

1.2.4  Rudolf Steiner The second bias, which is made as explicit as possible, concerns the author’s reference to the work of Rudolf Steiner as regards economics. Steiner (1861–1925) is well-known

Why Nobody Saw It Coming

11

as a ‘Renaissance man’ and as the inspiration in many practical areas of life including education, special needs care, farming and medicine, but hardly at all for his contribution to economics. Steiner was a Central European who was active at the time of World War I. As such, his ideas, though not unknown, were no more admitted into the future scheme of things – as determined by the Treaties of Versailles – than those of anybody else whose lineage was not part of the Anglo-American heritage. Germany had lost the war (for which at that time it was held culpable), France was intent on avenging the earlier events in Versailles in 1870/71, America had now embarked on its world role, and Britain continued as ever quietly to secure its place through participation in the arranging of future economic affairs. Though not a German (he was born in Kraljevic and brought up in then Austria), Steiner belonged to a recently vanquished world, Central Europe, from which nothing was to be countenanced or heeded (hence the need for the Battenburgs to change or ‘anglicise’ their name to Mountbatten). His ideas about economic life have received scant attention, therefore, and when mention is made of them it is all too easy to categorise them as ‘Central European’, which contains the subtle message: ‘Therefore, not English. Therefore, not part of economic evolution.’ This is unfortunate in that, whether Central European or not, Steiner’s ideas have a universal quality. To that extent they challenge the unspoken, though very definite, hegemony of Anglo-Saxon, Newtonian thought habits, with their subtle claim to be also universal. Anyone, therefore, who represents Steiner’s views, especially perhaps an Englishman, has to reckon with this fact and consider how to treat it. In this case, the treatment is deliberate. It is a simple matter of autobiographical fact that the author has long concerned himself with Steiner’s contribution to economics, although not in any blinkered sense, but because of its (in the author’s view) explanatory power. Whether or not one is comfortable with any explanation, or has any intention of following up its implicit policy recommendations, ought not prevent one from considering it. This is true also of Steiner’s view of things. They are not presented in this book other than to make a bias clear; namely, the influence they have had on the author’s view of events, especially of the global financial crisis. It would be churlish and dishonest, not to mention plagiarist, not to share this fact. One is aware that for Steiner’s views, at least as represented here, to get a hearing, let alone influence policy in financial circles, is a very big ‘ask’. But that is not the intent. The intent is very deliberately simply to introduce them into the debate about the future of finance, from which, for whatever reason, they have to date been absent. They are not advanced in any zealous mood, however, but in the spirit of the following comment Steiner made in an essay published in 1898: In my view everyone should stand up wholeheartedly for his own convictions with all their implications and consequences. There is nothing to lose, for should they turn out to be wrong then another one is bound to win anyway. The question on whether [one’s] views will win the day we must leave to the future to decide. (Steiner 2003: 38–9)

There is no proselytising intended here, therefore, only clear exposition. It is indeed for larger history to decide our fates!  There have been isolated instances, such as the work of Guido Preparata at Washington University, but these often have a left of centre approach that does not necessarily do Steiner justice.

12

Finance at the Threshold

1.2.5  (Mis)description and Imagination A further methodological dimension is that much of economics is animated by a wish to know in order to control, rather than the aim of perceiving in order to know. As a result, in its tenor and practice economics often tends to be more prescriptive than descriptive of economic events and processes. This fact underlies the mood and effect of many key concepts, concepts that would benefit from some fresh scrutiny. This is not to say that our normal concepts or modern economic life for that matter are unreal (though many think they might be). But one needs to be aware that the reflexive nature of financial and even economic causation means that almost any idea can be given formal expression and made the basis of policy and thus practice. In economics we do what we think. That does not mean, however, that our actions prove the objectivity or veracity of our ideas. This leads to three essential epistemological considerations that affect economics generally, and characterise associative economics in particular: 1. 2. 3.

the need for description rather than definition, for good or ill, the vital part played by imagination, the possibility of misdescription, of a ‘wrong’ image giving rise to a fictitious, but nonetheless socially real, circumstance. At its worst, this leads to forcing reality to comply with a picture of events known to be false.

1.3  Associative Economics and Rudolf Steiner This exposition approaches the global financial crisis from the point of view of associative economics. While the fuller meaning of associative economics will become apparent as the book unfolds, a preliminary reference is warranted at this stage. Deriving mainly from lectures given by Rudolf Steiner in 1922, associative economics is an approach that is little known in general economic history. In consequence, its propositions are scarcely known, let alone tested.

1.3.1  Introducing Associative Economics Fundamental to associative economics is that it seeks an understanding of modern economic life that is true to economic, as distinct from political reality. This entails significant challenges, given the normal tenor of twentieth-century economic thinking and its generally accepted ground of an intermingling between state and economy. One readily admits that in the general way of today’s world such a distinction is usually greeted with scepticism and may have little prospect of realising itself; but that does not invalidate and should not deter one from the analytical exercise. After all, to paraphrase the British economist, Tim Congdon, whose work is featured later in this book, it is  While these lectures have as their wider background the world view known as ‘anthroposophy’ (from the Greek, ‘wisdom of man’), suitably edited they can be taken as a stand-alone discourse that is capable of being considered in everyday terms. Indeed, their significance can only perhaps be fully grasped if one enters into their content strictly on that basis. That is to say, not treating them as representative of a world view (although of course they are), let alone with the intent of proselytising, but as a basis for examining the ability (or otherwise) of modern consciousness to grasp the deeper nature of economic life, not only in its technical aspects (how it ‘works’) but why it is ‘there’ in the first place.

Why Nobody Saw It Coming

13

neither the number of people who believe in an idea nor the length of time they cling to it that makes it true. Indeed, one can take heart from Geoffrey Wood’s words in the September 2009 edition of the Institute of Economic Affairs journal: ‘Some of [one’s] proposals may appear politically impossible. But as the history of the UK alone shows, few sensible proposals remain politically impossible for ever’ (Wood 2009: 4). Though Wood was not referring to the thesis of this book, the point still stands. One can further characterise associative economics by mentioning three of its key elements not generally found in other perspectives: the deliberate endeavour to enter into the thinking of as many schools of thought as possible in order both to appreciate their differences and to identify common ground, 2. the inclusion of the work of Rudolf Steiner qua economist (see below), 3. the strong link to accounting in terms of its inner logic, rather than convenient use (or abuse) – see Chapter 11. 1.

The novelty of its perspective notwithstanding, this book treats associative economics as a formal discipline. It does so for three reasons. Firstly, to throw a light on the global financial crisis from a new angle. Secondly, thereby to conduct an examination that is also expository as regards the associative economic approach. Thirdly, to ask the questions: does associative economics have a link to current developments? And is now the time to give it serious consideration? It should be added that one is not looking for a ‘yes’ or ‘no’ answer to this question. One is not craving recognition, nor wanting to be à la mode. In economics there is no merit in ideas that do not accord with reality. Our only question is whether the book’s conclusions contribute in any way to improving our understanding of global finance, not only at this currently critical stage, but also in a more stable, enduring sense. If they do, and if, in fact, this is because of the associative economic approach, any influence they have will be found in their nuancing of the quiet ongoing march of economic development, not displayed in flashing lights above history.

1.3.2  Rudolf Steiner qua Economist Concerning the book’s substantial reference to Rudolf Steiner, it is part and parcel of economics that it is a domain in which we all find ourselves and need all to be able to take ‘ownership’ of. In such a world what matters is not the who of economics, but the what, and whether a person’s contribution serves our overall understanding. Modern economic life is characterised by people lining up behind Milton Friedman or John Maynard Keynes, for example, usually in expression of a bias. Yet what matters is whether an individual economist bequeaths ideas we can all recognise. It is of set purpose in this book that Friedman and Keynes are not systematically opposed because in respect to monetary economics, at least, their ideas coalesce, making it a matter of political contrivance or intellectual laziness if one builds separate universes around the individuals concerned. In similar vein, Rudolf Steiner’s reputation varies depending on how one relates to the extensive range of material he covered. It is not usual for one person to be knowledgeable in the many fields in which Steiner was versed, ranging from medicine to architecture, agriculture to pedagogy. Few if any seers, for that is a significant aspect of Steiner’s

14

Finance at the Threshold

biography, also taught double-entry bookkeeping. One should be wary, however, of regarding Steiner as a dilettante, a jack-of-all-trades but master of none. Many a critic has come to grief on the supposition that Steiner’s knowledge was hearsay! Here the reference is not to Rudolf Steiner as a person, however, nor to his wide field of activity, but to Steiner the economist and in particular to his economic and monetary analysis, with such contextual sociological commentary as seems warranted.

1.3.3  Six Problems Therein lie difficulties enough, because to the English mind Steiner’s economic analysis presents a number of problems. One is its absence from general economic discourse, hardly figuring even among ‘alternative economics’, where some – but not this author – would locate it. Even those banks that claim their lineage in Steiner’s oeuvre seldom make overt reference to his analysis to the full extent and depth they could, in part perhaps because it implicitly refers to a world beyond banking as we know it. A second problem is that Steiner stands outside the Anglo-Saxon tradition, to which, thirdly, certain of his key ideas – e.g. that money is not a commodity – present too direct a challenge. If money is not a commodity, how can there be a market in it? (To which question Steiner would reply that what we call a money market may in fact be something else; not that it does not exist, but that it masks some deeper economic meaning and possibility.) Fourthly, there is Steiner’s explicit questioning of Newtonian thinking. Building on the work of the German poet, statesman and scientist, Wolfgang Johannes Goethe, Steiner’s approach has greater affinity with German idealism, and thus, in the British tradition, with the likes of Samuel Taylor Coleridge. In all these respects, however, one should guard against the premature conclusion that Steiner’s ideas are foreign to modern economic life, least of all on the grounds that Steiner was an esotericist. Later in the book, attention will be drawn to the fact that Newton was also an esotericist, and that many today think economics, and especially financial economics, needs to find a link to Romanticism, precisely because the global financial crisis has shown its epistemological foundations to be weak. A fifth problem is that many advocates of Steiner’s economic ideas interpret and represent them as finance-averse and with an NGO, third-sector or left-of-centre bias. Yet, many of his ideas overlap with neo-liberalism in fact (see 1.3.6: Steiner and The Austrians), a thought that is difficult to accept for many people familiar with Steiner’s work – even though ‘liberal’ is an allusion to Aristotelian economics, a genesis Steiner would in no way disavow. Sixth, there is the awkwardness that Steiner’s ‘spiritual scientific’ (a combination of terms usually kept far apart in the Anglo-Saxon mind) view flatly contradicts positivism, though such a stark opposition could perhaps only occur to what Owen Barfield, an early proponent of associative economics and one of the original translators of Steiner’s economic texts into English, called a ‘naughty materialist’. Barfield (1944) distinguished between true materialists, for whom the non-material world does not not exist, but is all that is left over, all that, while we might experience it, cannot be explained materially.  Most well-known are Triodos Bank, based in Holland, the GLS Bank in Germany, RSF Social Finance in San Francisco and Prometheus Finance in New Zealand.

Why Nobody Saw It Coming

15

[English philosophy] seeks the material everywhere; it deals with the material, with the physical, in which it feels itself at home. That is one side of the picture. On the other side we have – what is left! If you laid your finger on everything that is material, wherever it is to be found, it follows that whatever is left is non-material. You have detached the material from the immaterial, and the immaterial that is left rejoices, as it were, in its freedom. And such is indeed the gift of English philosophy to Europe – the license for free speculation in the realms of pure thought, unhampered by disguised forms of materialism. One cannot of course say that the English philosophers had any such purpose in view; but there are other purposes besides conscious ones. In the light of the whole history of western consciousness it is very clear that English philosophy proper … was engaged on a definite task. It sought for matter everywhere – in order not to confuse it with Spirit. And by doing so it detached ‘what is left’ from the cosmos and made it free. (90–91)

Untrue materialists, ‘the ‘naughty’ ones, are those who, being amateur or inconsistent in their thinking, argue that because matter cannot explain the non-material, the latter does not exist.

1.3.4  And a Seventh … This brings one to the last of the problems that Steiner presents to modern economics: the fact that his manner of expression is seldom hypothetical. To an English mind this can amount to a sin against science and rational thought – a ‘sin’ that has to be atoned for if Steiner’s ideas are to be given serious consideration. This last point is perhaps the most crucial. By way of atonement on his behalf (but not disavowal), where in this book Steiner’s economic and monetary analysis is treated it is done so in a hypothetical, even counterfactual spirit. That is to say, it invites consideration of his views divorced from one’s opinion of them or any changes in behaviour they might imply. It is not about proselytising or peddling his perspective, but asking for a fair hearing. In Steiner’s words, ‘One does not by any means wish to agitate that this or that must be done ... [Economic] science, after all, has only to indicate the conditions under which things are connected’ (1996b: Lecture 6: 83). It is in this spirit that Steiner is taken as a reference; because, in short, he has some interesting insights to share. It is in this spirit, too, however, that this book neither intends nor pretends to offer a systematic presentation, let alone defence, of Steiner’s ideas. References to them appear as and when they are pertinent to the author’s exposition of his own lines of thought or enquiry, and where in the author’s own experience they have served as valuable (and usually valid) propositions for understanding events, good servants in a life-long endeavour to understand the deeper trends of modern economic life.

1.3.5  Rudolf Steiner and Geo-politics To these difficulties needs to be added another, the somewhat delicate matter that Steiner’s analysis entails the end – or at least, conscious recognition – of geo-politics. He considered, for example, that the main effect of the Treaty of Versailles was that global economic affairs after World War I would fall under the dominion of the Anglo-American peoples, who would in consequence have to bear the responsibility ‘going forwards’. Here is not

16

Finance at the Threshold

the place to go into this matter in any detail, but awareness of it is necessary, otherwise one would be perceived as historically naïve. It is for this reason that Philip Bobbitt’s image of the future is included in this book (5.3: The Market State), a future based on market states because we face a period of generalised terrorism. Its self-confessed lauding of Anglo-American concert and its sad and pessimistic view of humanity’s potential notwithstanding, Bobbitt’s book nonetheless provides an important foil for sensing the importance and salience of Steiner’s views for the simple reason that part of the global financial crisis entails the question: where to after the US dollar? Is the world’s future currency really to be the yuan, or the yuan-euro-dollar, or even some mix of yuan-rupeereal? Or should it not become something above and beyond all nations and all parts of the world economy, a single world currency in fact (see 5.4: A Single Global Economy), belonging to a civilisation that knows how to share the world’s economy because it also knows how to celebrate its diversity? Does it have to be about terror, in other words? This, at any rate, is a central image of this book – a single global economy shared and mutually governed by a choir of the world’s peoples. This gesture is expressed in the wellknown Hymn for the Russian Earth albeit of uncertain provenance: If the people lived their lives As if it were a song For singing out of light Providing music for the stars To be dancing circles in the night.

Intriguingly, a similar gesture seems to inform Milton Friedman’s famous dictum (from which Keynes would not distance himself) concerning monetary policy: Flexible exchange rates are a means of combining interdependence among countries through trade with a maximum of internal monetary independence; they are a means of permitting each country to seek for monetary stability according to its own lights, without either imposing its mistakes on its neighbours or having their mistakes imposed on it. If all countries succeeded, the result would be a system of reasonably stable exchange rates; the substance of effective harmonisation would be attained without the risks of formal but ineffective harmonisation. (1966: 200)

Naïvely perhaps, the thought thus occurs that precisely where Keynes and Friedman are of one mind associative economics finds its interface with current conventions.

1.3.6  Steiner and The Austrians Though his formative years and early twenties were spent in Austria-Hungary and Vienna, Steiner cannot be described as an ‘Austrian’ in the sense that has in the history of economic thought. Although the economic philosophies of both Steiner and the Austrian school esteem the free, creative individual, this can also obscure the differences between them. Owen Barfield’s characterisation of Steiner’s general philosophy as ‘romanticism  For this section, a debt is owed to Mark Arnold, lecturer in economics and philosophy at Oxford and Cherwell Valley College, England, who provided the ‘ghost’ text.

Why Nobody Saw It Coming

17

come of age’ (see later discussion) indicates a very different orientation compared to the Austrian school. The holistic traditions of the German Historical School with its roots in Hegel were formative for Steiner, whose cosmology is framed in terms of evolutionary consciousness, a social philosophy which speaks of the ‘souls of nations’ and society characterised as organic, described later. These and other themes such as ‘historical stages’ and notions of ‘social wholes’ are alien to Austrian metaphysics, witness the Austrians’ three main arguments: Ludwig Von Mises argues that socialism, which would abolish such institutions as money and private property, will find it impossible to carry out economic calculations with the consequence that it simply defaults into planned chaos. 2. For Friedrich von Hayek (1945), socialism’s problem lies in the fact that knowledge of particular circumstances exists only as the widely dispersed, personal possession of a multitude of different individuals, and consequently it is ‘practically impossible’ to assemble and process all the actual existing knowledge within the mind of a single central planner. Decentralisation of the use of knowledge is capitalism’s strength. 3. Murray Rothbard advocates a natural rights theory which justifies the ownership of private property attaching to the first appropriation of unused resources. It is the duty of government to protect such private property rights. 1.

In contrast, the focus for Steiner is on recognising and gradually improving the working of and between society’s three autonomous yet interdependent economic, political and spiritual sub-systems (see Chapter 5, Rudolf Steiner’s Conception of Society). He is also averse to dressing up in complex abstractions what is in fact aggregated human behaviour, if that is a fair description of ‘Austrian’ economics. And he is less concerned with who owns capital than that it finds itself in the ‘hands’ of people with appropriate capacities to use it and make it good in service to their fellows. Austrian and (some) associative economists recognise the importance of utilising accounting models in decision-making; however, financial information needs to be supplemented by discursive space within the wider economic sphere. Steiner himself proposed institutional arrangements (‘associations’, hence associative economics) which bring together producers, traders and consumers whose task is to co-ordinate economic life. Von Mises would be critical of such institutional arrangements, arguing that it is unlikely that consensus will emerge between economic actors and that the state will have to intervene in order to sort out the mess. Von Mises also cautions that no one should be allowed, especially in a globalised economy, to represent the consumer except oneself. Effectively, therefore, Steiner challenges the Austrian notion of ‘the market’ as the ultimate arbiter of how economic values are to be allocated. Firstly, ‘the market’ is to be contained by limits given by the environment, rights, and traditional ways of life. Secondly, it is to evolve into a confluence of individuals acting in conscious association with one another, rather than, as now, in relative alienation. In saying this, aspects of Steiner’s approach to economic life are touched on that will not in fact be elaborated. Our attention will be confined to such of Steiner’s ideas as strike the author as directly related to the global financial crisis in its more ‘practical’ aspects. The aim, as already stated, is not to provide a comprehensive exposition of Steiner’s work directly, but to include it in general financial discourse

18

Finance at the Threshold

1.4  Innately English The Englishness of the writer of this book has already been referred to. Biographically, that simply means he was born and brought up in England and that his mother tongue is English. However, when learning languages, as also when travelling from a young age, he found an affinity with the non-English cultures he visited, which, while contributing in his view to the development of a cosmopolitan outlook, also meant that he found himself looking in on his Englishness. By ‘going native’, trying to speak the local language rather than merely shouting more loudly in English, he began to appreciate his Englishness rather than take it for granted. This led early on to his awareness that English is the language of navigation, both sea and air – even ‘Mayday’ is an Anglicised version of m’aider – but also of business and economics. And thus the experience that people the world over are happy to speak English in these areas at least, not to mention popular music. The challenge is not to take advantage of this fact, but to ask why it should be. To be sure, Adam Smith was a Scot, as has been many an important economist ever since, but the medium used is Englishness – not only linguistically, but institutionally, historically and geo-politically. The formative effects on world historical and economic development of the Bank of England, the Industrial Revolution and the British Empire are so well known as not to warrant further comment here. But these influences are ongoing through the relationship of London to the rest of the world. Not just the docks of the entrepôt port that was, but its replacement by London’s financial district down river from its original locus in The City. Midway between the start of the world’s day ‘across’ the dateline in New Zealand and its end, Greenwich Meantime continues to have an effect, as does the provision of worldwide liquidity. ‘Big Bang’ originated in London in the 1980s, along with the introduction, initially as domestic policy, but then taken up worldwide, of the many policies and practices originally associated with right-wing groups but now, for better or worse, generalised and not easily described as on one side or other of the political divide. Few today, for example, question the merits of price stability or central bank independence. It is in this sense that one points to England, rather than Britain. But rather than the United States also. Even though the two countries share a language and enjoy a ‘special relationship’, this does not make the US innately English. Its population is decidedly not so, with an increasingly greater number being from other cultures, notably Hispanic. But nor is its constitution. It is a quirk of history that Thomas Paine, an Englishman, did not prevail in his own country, that the US has a written bill of rights but that Britain, more specifically England, does not.

1.4.1  From Empire to Partnership One can make of these facts what one will, and have views about what ought to happen. For example, that the UK ‘should’ have a written constitution. But that is not the point. By ‘innate’ we do not mean that a feature of history could not be replicated elsewhere or got rid of, but that different peoples have different sensibilities and that these play an important part in the way the peoples of the world conduct themselves and, in this instance, relate themselves to economic affairs.

Why Nobody Saw It Coming

19

The thought here is that somehow the English way of being plays a crucial part in economic development in terms of the way economic life is both understood and conducted. The liberalisation of the 1980s is a case in point. But where to go next, now that that enterprise has achieved its goal of opening up national economies to the world? In many ways, the global financial crisis is a child of the 1980s. What should be the next ‘big idea’ and where should it arise and enter into economic evolution, if not in England and in London specifically? But no longer as an instrument of world domination (or major market share, if one prefers the euphemism), but as the instrument of partnership between former rivals, as the means to give expression to the inherent dynamic of a single global economy, rather than exploit it to one’s own ends. In a word, to promote a new dimension of that very English idea, commonwealth.

1.4.2 Of Newton and Coleridge To be precise to the epistemological theme on which this book turns, can we nuance ourselves away from Newtonian to Coleridgean thinking? More precisely still, can the propensity to divide, discussed later, which entails separating opposites so that they compete with one another, give way to understanding the polarities or contrasts in economic life in such a way that they speak to one another instead, giving rise to a mutual but higher synthesis? It is this quality that is suggested as being innately English, but also innate to the exigencies of a single world economy.

1.5  (Re)defining Terms It goes without saying that in any discussion the meaning given to the words used cannot be left uncertain. Also, the author’s meanings may differ from those of the readers. The problem is compounded by the fact that although certain meanings may be deemed generally agreed, that does not mean they are clear or precise. Because the argument of this book places great emphasis on epistemology, where terms are used that are in general parlance but not, in the author’s view, clear or precise, those terms are here (re)defined. It is all too easy to use insufficient precision, in the field of finance especially. The effect, however, is like throwing the points on train tracks, so that the locomotion of consciousness is sent on a detour or, worse, into a siding or, worst of all, put in reverse. Meanwhile, life moves ahead along quite other lines. It goes without saying that ‘(re)defined’ means no more than ‘as meant here’. While one has a duty to be clear as to what one means by the words one uses, one does not thereby claim them to be ‘correct’ or aim to impose those terms on others (except for the duration of the exposition).

1.5.1 People By ‘people’ is meant something close to a nation in cultural rather than political terms: for example the Welsh or the Basques. That is to say, an identifiable group that enjoys or expresses or seeks a degree of autonomy from the nation-state it is otherwise supposed to be part of. The point is that, since the Treaty of Versailles (see later discussion) nations can have an arbitrary status. Red lines in the desert delineate sheikdoms, for example. Many boundaries have been created or moved, as have whole peoples. If there is to be a choir

20

Finance at the Threshold

of cultures, the point at which a people feels itself to be one needs to be identified, but not in strident, political terms. Deeper yet, recent history has seen peoples lost beneath all manner of ideological overlays or, on first release from oppression, referring to some ancient image of themselves. What is meant here, however, is the raw people, especially as defined by the future they see for themselves.

1.5.2  Rights Life A term that embraces all matters political and legal provided they are not used to force into being any particular spiritual or cultural modality or to interfere with or conduct economic life. The sphere in which human relationships are cultivated and ordered, but not cultural or economic pursuits.

1.5.3  Local, Global These can be imprecise terms, often in reaction to globalisation and therefore asserting some protection from it. However, if one assumes humanity has entered a cosmopolitan era, or achieved some degree of cosmopolitanism, this would manifest in two ways. Firstly, as an assertion of the individual. Secondly, as a need to find and meet the rest of the world. Or a degree of self-centredness, matched by a sense of being a world citizen. Or a looking out from oneself onto the world and a looking in at oneself (at one’s effects and motives) from the world’s point of view. In this sense, ‘local’ is the individual’s sense of and relationship to his own identity; ‘global’ is his belonging to the rest of the world and to humanity as a whole. The two terms represent a twin experience, the double condition of modern existence, not conflicting aspects of it.

1.5.4  Taxpayer The term ‘taxpayer’, especially as used in ‘taxpayers’ funds’, is slippery. On the face of it, it simply describes the funds that taxpayers have provided and that are administered by the state on their behalf. In reality this is not so. First of all, if they were owned by the taxpayers, the state’s role would be no more than that of a fund manager. It would have no right to override or supersede the taxpayer’s wishes anymore than a fund manager can do beyond the exercise of his professional judgement and duty. Second, if they belonged to the taxpayers they would not be tax! That they are tax means they belong to the state. It is, therefore, disingenuous and even fraudulent to refer to such money as taxpayers’ funds, for they are not. Like it or not, the state is charged to carry out various functions which we agree to fund via taxation. The reason for the term, especially in its more recent usage, is to take into the state’s remit something that in fact does not need to be taken over by the state – charitable work, collective endeavours that serve a cause or purpose other than ‘private interest’. If a community jointly funds a village hall by way of a tax exempt entity (tax exempt because it is fulfilling a task that the state does not need to do, as also funding it), there is no reason to describe these people as agents of the state or, worse, civil servants, or to refer to the assets thus funded as state assets.

Why Nobody Saw It Coming

21

1.5.5  Anglo-Saxon The word is perhaps imprecise in ethnic terms. What is meant is a penchant for rationalism; in Keynes’s language ‘cold, untinctured reason’. This means also a bias towards material explanations of the world and therefore economic life, and a shortcircuiting of inquiry because one accepts plausible though only partial explanations of phenomena rather than waiting for the phenomena to speak for themselves, as it were. Newton’s light theory looks at the ray of light; Goethe observes the light in the context of darkness. It is not a question of right or wrong, but partial or complete understanding. This can be naïve; there are many non-Anglo-Saxons who think in this way. But it can become consciously crafted so that no one any longer sees the problem. Two examples: the language of economics pretends to be scientific, when in fact it is attempting to be so. It allows an aura of universality, when in fact it has definite biases – to positivism, for example. It suggests that ‘value free’ is not a value-laden concept. The gold standard of the nineteenth century was, and still is, described as if it were a scientific technique and therefore apolitical and objective, which can only be partly true since the background to the creation and use of the gold standard was the clear intent to promote the interests of Britain and even to marginalise bimetallism. In the bigger picture of history these may prove to have been right things to do. One does not mean to impute nefarious or negative intent. But we would understand history very differently if, when looking at something like the gold standard, we described it as foreign policy dressed up in scientific-sounding economics. A case in point is Newton’s 1717 calculation that gold should be at 20s 8d, but parliament’s deliberate adjustment of that to 21s. The difference of £1 2s 11d per 22 carat gold was a conscious one, the effect of which was that science took a back seat to politics.

1.5.6 Hard/Soft Science ‘Hard’ and ‘soft’ are ways of avoiding an issue, namely that the human being has two modalities – a relationship to the world accessible to or perceptible by his senses, and a world, equally real to him, that is known other than through the senses. We can see a chair, for example, and even sit on it. But who has ever seen, let alone sat upon, a value or a price, or anything that economics is concerned with? Modern science grew up in link with intense observation of the physical world and thus has become associated only with the modality of that world. But the scientific method exists independently of its subject matter. One needs to distinguish between the scientific method used to understand physical phenomena (natural science) and the same method when used to comprehend supra- or non-physical phenomena, such as inflation. In Steiner’s nomenclature this is the difference between sensible and super-sensible science. Whereas the German language is upfront and calls such science Geistenwissenschaft, (spiritual science), the English typically do not like to be so direct, which does not mean they do not recognise or know about such things. Rather, they prefer their expression to be poetic rather than scientific, implicit rather than explicit, thereby hiding the problem in such euphemisms (or poetry) as ‘hard’ and ‘soft’. That is fair enough as long as we do not delude ourselves into thinking that ‘soft’ is a lesser version of ‘hard’. But it would be clearer, for example, to say ‘physical’ and ‘ephemeral’. Better yet – though admittedly too direct – ‘sensible’ and ‘super-sensible’.

22

Finance at the Threshold

In its wish to emulate physical science, economics has become ever more mathematical, the more so as it endeavours to capture the complexity of its subject matter, essentially an economic life that has gone global, outgrowing the nationalistic concepts of economics by which we usually try to apprehend such phenomena. But if aping the physical sciences is not the way forward, what is? What models are we to use? Should they be based on theoretical propositions about equilibrium, for example, or on analogies to engineering systems? Moreover, when we use the term ‘system’ to which world are we referring − a mechanical world or one that is dynamic? A central heating system is clearly mechanical but hardly so an ecological system, and debatably so the human being. Indeed, for some the nature of economic life is autopoietic (self-organising), an ontological implication that many economists find too challenging. Originating in the early 1970s with the Chilean biologists Maturana and Varela (1980), the term refers to ‘organisations that live [and whose] main purpose is to self-reproduce and to survive.’ In this sense, can we even be sure that ‘system’ is the best term? ‘Organism’ or even ‘being’ might be more apt.

1.5.7  Real and Financial (see also Hard and Soft Science) Finance is perhaps one of the most abstract fields we can experience. Any serious study of finance, especially in regard to its ‘plot’ aspect rather than just its techniques (why finance is the way it is and does what it does) necessarily involves ontological and epistemological considerations. Indeed, one could argue that they are crucial for the very important reason that when one comes into finance the possibility arises of separating the abstract from the real, so that what is not real is somehow suspect. Conversely, we try and make finance fit the way of thinking peculiar to the real world. How different things would be if we could accept that something abstract may yet be real but in quite other terms and according to a logic that we have perhaps yet to discover. This problem is basic to economics and to understanding the global financial crisis, regarding to which many people convey a sense of preferring the first and disparaging the second, much like Aristotle and many since. Because people are not comfortable with twin realities, let alone different in kind, they prefer the easier option of describing the physical as real, while casting the other, at best, as derivative, at worst inimical. Thus, by ‘real economy’ most lay people and not a few experts mean physical; chairs not options. By ‘financial’ they mean speculative; not necessary, even parasitic. A trade in the derivative markets cannot be real. Real is buying and selling things; better yet, making them, manufacture. But any trade is real in economic terms, only it also has its monetary reflection, unavoidably so in today’s highly monetised world. The problem is that once one has a monetary expression for something the thing it stands proxy for disappears from view and money can begin to be seen as existing unto itself, autonomously, as it were, in regard to what it represents. There may be a good historical reason for this. Before insurance, a farmer had no option but to rebuild his neighbour’s barn when it burned down. One was socially obliged to do so. By monetising the relationship, division of labour enters in and one becomes free to do something else when a neighbour’s barn burns down because one has already paid for that task to be done by others, firemen. All monetisation, and by extension all finance, has this twin character. It arises because of the emancipation of the individual who is then free to follow a calling born, one could

Why Nobody Saw It Coming

23

say, of the future not the past. But it brings with it the danger that, in the hiatus between the two, one forgets this larger story and simply ‘does one’s own thing’, thinking only of oneself and acting accordingly. Real and financial should never be opposed, therefore. The true contrast is between the economics of the sensible world – the transformation of resources into things – and the economics of the super-sensible – the fact that the simplest of ideas can have huge consequences. Neither is more real than the other and both have a financial aspect or reflection. In this book, therefore, ‘physical economy’ is often used where others might have real economy.

1.5.8  Western One frequently refers to ‘western finance’ and ‘western economics’. But where is the West to which western refers? The term is imprecise since it really means Anglo-Saxon (see above), if not indeed Anglo-American. Much of the economics used in Germany, for example, Japan, Latin America, Africa and even in Islamic contexts is western, meaning derived from Adam Smith, Ricardo, Mill, Marshall, Keynes, Friedman, and so on. If one were to differentiate between Anglo-Saxon and the narrower term, Anglo-American, one would need to see that the latter is western economics admixed with Anglo-American interests, as implied, for example, in the idea of ‘a special relationship’. Throughout this book the word is used without quotation marks, but should be read in the sense qualified here.

This page has been left blank intentionally

chapter

2 When the Banks Stopped Lending to One Another

In the course of 2007 the banks stopped lending to one another. Why was this? Usually a technical answer is given to the effect that the banks began to realise that the counterpart of much of their lending was unsure or unidentifiable. The sub-prime market, especially in the USA, plays a large part. Loans had been made to people who by traditional measures could illafford to borrow on houses that were speculatively rising in value. However, that was but one example of credit being provided without constraint. Credit cards were being issued liberally with 0 per cent transfers giving everyone the chance to ‘kick the can down the street’, to use a typically glib financial colloquialism for delayed debt settlement. The risks of such lending are obvious, as is the response that we should return to prudent practice. But is this explanation really convincing?

2.1 Preamble Whereas many argue that it is time to get ‘back to basics’, these may no longer obtain. To paraphrase an old Turkish proverb, a more apt thought might be to return to the fork in the road where one took the wrong turning and take the ‘right’ one this time. Some would have us identify culpability and apportion blame, but this may well be impossible in the glass house that is the global financial system. For who is to throw the first stone in so fragile an edifice – founded as it largely is on the dangerous and, from any normal financial point of view, extraordinary idea of ‘risk-free’ returns – the financial institutions that earn their shareholders profits thereby, the governments that enjoy the tax revenues, or the millions of people who directly or through their agents seek to avail themselves of the gains such products bring? Who today does not ‘work’ the housing market, or ‘play’ the stock exchange, or rely on a pension fund? The purpose of this chapter is to look close up at the world of finance in order to get a sense of what, should it prove not to be mere a hiccough in monetary history, the global financial crisis might entail. To understand the global financial crisis, one needs to begin by describing it phenomenologically, in order (a) to avoid or overcome moral indignation and (b) to intuit what, if anything, ‘should’ have happened or, more crucially, could yet happen. The three sections of this chapter look at the global financial crisis in terms of its chronology, the way it has been described by key commentators, and the technical details these

 Although not the earliest event, the start of the phenomenon has been pinpointed as 9 August 2007 when bad news from the French bank BNP Paribas triggered sharp rise in the cost of credit and made the financial world realise how serious the situation was. 

Other such terms include ‘haircut’, ‘the pain trade’, ‘liar loan’, etc.

26

Finance at the Threshold

accounts yield. Insofar as the chosen commentators are for the most part also important players in the financial community, these sections also serve as a literature review, but of a particular kind, in that it is deliberately random, even to the extent that the views featured were not sought out by the author but came to his desk unsolicited and by persons unknown to one another. Moreover, the views expressed are not theoretical in any ivory tower sense, but born of their authors’ experience and, most crucially, of how they interpret and articulate that experience. This experience, moreover, combines, in most cases, both ‘real world’ postings and academic qualifications. Information gleaned in this way stands independently of its sources, providing data that serve as an objective point of investigative departure, as also for pointing up vital considerations for our later epistemological discussion.

2.2  Chronology The aim of the following chronology is to present the historical data without bias or opinion, simply as incontestable fact – information free of normative comment. Though it may not be as detailed or comprehensive as some might like, the endeavour has been made to provide as complete a picture as possible so that the orientation given to the reader is neutral. The presentation is deliberately both long- and short-run because the global financial crisis is seen to be not only of recent genesis, but rooted in a long evolution. Without the context of a serious span of time, one is likely to understand the global financial crisis as a technical hitch rather than as something more deeply seated and even pivotal to economic history. The chronology of the global financial crisis could have many starting points. For our purpose, we begin at the end of the Napoleonic wars with, in Rudolf Steiner’s words (1920), ‘the emancipation of the money-market from the goods-market, dating roughly from the period 1810 to 1815. It was then for the first time that the earlier, purely economic, conditions governing public life, gave place to control by the money-market; the time when the banking system first really became the dominant factor in economic life’ (1996a: 74). Until then the capital aspect of economic life had taken its cue, as it were, from the goods aspect. Capital was invested in order to finance production, not for the sake of a return only. The financial economy was in service to the real economy, as one would say today, not in opposition, as some aver it has now become.

2.2.1  Individuation, Emancipation and Financial Liberalisation For Steiner this is simply a reflection of humanity’s increasingly abstract relationship to life, a deepening of individuation and the continuation of our emancipation from deism and pre-rational forms of consciousness. This gives the context to the beginning of the spike that has culminated (or so it seems) in the global financial crisis. To this development other authors contemporaneous to Steiner but better known than him have also borne witness, notably Hartley Withers (1909), with The Meaning of Money, and Ellis Powell (1915), with The Evolution of the Money Market, 1385–1915. With the dawning of the nineteenth century, therefore, capital became a category independent of labour, challenging the, till then, predominance of the labour theory of value. Thus arose marginal utility theory, which is capital preferring. What the market

When the Banks Stopped Lending to One Another

27

will bear became the wiser approach to pricing than cost-plus. Margin not mark-up. Marginal utility theory is in effect a capital theory of value. Importantly, too, it looks at economic life from outside, as it were, from the consumer’s point of view. It is therefore the opposite of an economics based on physical or labour theory of value, which stands within and looks out. With this development, the financial economy having been for long ages held in check by moral injunctions, broke its bonds (pun not intended!), a process that has culminated in the recent ascendance of financial liberalisation. For many this has gone beyond our normal awareness and ought to be put back in its traditional, pre-fractional reserve banking, place. This is epistemological Luddism, however. The clock cannot be set back. What is needed is a leap, even a quantum leap, in our understanding. We need to enlarge our consciousness in order to embrace the new development; not demand that it remain within the confines of old habits of thought. In the sense of associative economics, for example, capital, especially in our time, refers to human ingenuity, ideation, hunches, intuition, even initiative. All these aspects of the human condition appear in economic life as capital. When someone asks the bank for a loan, the lender ‘banks’ on the borrower’s idea and his ability to realise it – both ephemeral, non-physical categories. Of course, the entrepreneur uses the capital to buy means of production or even pay himself in order to realise his scheme, but strictly speaking ‘capital’ is an economic reference to the borrower’s aims and capacities.

2.2.2  Aristotle This long historical process has clear milestones beginning far back with Aristotle, who first cautioned us against money on account of its ‘improper, secondary’ nature. In A History of Economic Thought (1992), the late Eric Roll – one of Britain’s foremost economic historians who in turn relies on two other eminent researchers, A. Monroe (1924) and R.H. Tawney (1929), so that his account is in fact highly synthetic and representative of more views than his own – describes Aristotle as ‘the first analytical economist … It was he who laid the foundations of science and who first posed the economic problems with which all later thinkers have been concerned’ (20). For Roll, Aristotle’s main analytical ideas were the scope of economics, an analysis of exchange, and a theory of money: According to Aristotle, economy is divided into two parts: economy proper, which was the science of household management; and the science of supply, which was concerned with the art of acquisition … In discussing the science of supply Aristotle is soon led to analyse the art of exchange through which the needs of the household are increasingly met. Here he distinguishes between a natural and an unnatural form of exchange. The former is merely an extension of the economy of the household designed for the satisfaction of men’s natural wants; it arises from the existence of varying stocks of goods and the enlargement of the association of men beyond the confines of the household. It is from this simple form of exchange that a more complicated and unnatural practice arises. (21, referring to Aristotle’s Politics (Jowett’s translation), Book I, 9) 

Aspects of this discussion are taken from Houghton Budd (2006).

 The author is also mindful of the work of the Association of Social Economists, who have a special affinity with the works of Aristotle and Aquinas.

28

Finance at the Threshold

Roll is worth citing further on this point, partly because of his authority in this field and the representativeness of his views, partly because of the exposition his commentary affords of his own understanding of the subject: ‘Of everything which we possess there are two uses: both belong to the thing as such, but not in the same manner, for one is the proper, and the other the improper or secondary use of it. For example, a shoe is used for wear, and is [also] used for exchange …’ He continues: Aristotle seems to say that the secondary value of an article − as a means of exchange − is not necessarily ‘unnatural’. Men may exchange without being engaged in the unnatural form of supply, the art of money-making. They would in that case exchange only until they had enough; but barter does not stop there. Men become more and more depen­dent upon exchange for the supply of their needs and they develop a medium of exchange. They make a convention to use an article useful in itself, such as iron or silver, for the purpose of facilitating exchange. Thus Aristotle carries a little further Plato’s definition of money as a symbol for the sake of exchange. He shows how the inconveniences of barter lead to the development of indirect exchange, how measure­ment by size and weight is replaced by coinage, and how trade for its own sake, the pursuit of money-making, arises. The natural purpose of exchange, the more abundant satisfaction of wants, is lost sight of; the accumulation of money becomes an end in itself. The worst form of money-making is that which uses money itself as the source of accumulation: usury. Money is intended to be used in exchange, but not to increase at interest; it is by nature barren; through usury it breeds, and this must be the most unnatural of all the ways of making money. (22)

One needs to proceed with great caution at this point. Many a modern mind would understandably bridle at this line of reasoning. Usury is a comprehensible response on a moral level, but technically it is not good enough. One needs to ask where does the increase in value come from? Clearly not from not trading; then from somewhere else. In that event, even though it ‘reads’ as an increase in the money lent, interest is but a method for allocating that increase to the provider of credit rather than, for example, the creator of the increase, namely, the borrower. In this sense, one can see that Aristotle seems not to grasp or give credence to the deeper reality that lies behind exchange, namely, the release of capital. It is as if this aspect is behind a veil that he cannot quite penetrate. As if he is aware of it, but cannot discern it clearly and, therefore, does not accord it the positive status he gives to physical human needs. He alludes to it in the idea of accumulation, but does not seem to sense that this can mean more than wealth acquisition. Moreover, this hidden dimension is regarded as suspect in some way, as not worthy of man, even though Aristotle seems to recognise the value to society of accumulation giving way to public works. In this respect, Aristotle reminds one of those who, because they either do not have or do not understand wealth, tend to disparage it and those connected to it. But also of Adam Smith and others who refer to anything other than self-interest as somehow of a ‘public kind’. In neither case, does the analysis penetrate or expand to include what individuals may collectively do for the common wealth. That, it seems, cannot begin until the process of individuation has eclipsed all forms of togetherness, of society. That is to say, until more or less ‘now’.

When the Banks Stopped Lending to One Another

29

Figure 2.1 lists the main features of Aristotle’s taxonomy, contrasting needs and exchange, but not mentioning capital.

Needs

Exchange

Proper Household Natural Satisfaction of wants Use Value Primary Fruitful

Improper Acquisition Unnatural Money making Exchange Value Secondary Barren (Usurious)

Capital

|

Figure 2.1 An Aristotelian taxonomy How different it would have been, and would still be today, if this hidden dimension had been understood as connected to capital in the sense of capacities (Figure 2.2), an economic category that is equally real, but of a different nature and order? In that case, money would have been seen, and could yet be seen, as having two aspects − material needs and the goods produced to satisfy them, and capacities and the capital that is or enables their expression − and it would not have been necessary, or even possible, to explain money by reference to only one of them. The lopsidedness of Aristotle’s analysis (as of all subsequent theory reliant upon it) would then not have arisen, or could now be overcome. We would also think very differently, as the arrows in the figures illustrate. Instead of thinking from needs to exchange and seeing some uncertain reality on the other side of trade, we would look towards exchange from two distinct points if view, with each one secondary to the other:

Needs Needs/Goods

Exchange Goods-money

|

Capital-money

Capital Capital/Capacities

|

Figure 2.2 Two aspects of money

2.2.3  Thomas Aquinas Long ages passed before any serious restatement of Western* economic thought took place through the work of Thomas Aquinas. However, according to Roll, the economic theory of Thomas Aquinas is not original, nor does it add anything new. It is essentially a reiteration of Aristotle’s ideas and their accommodation to Church doctrine as it was

30

Finance at the Threshold

at that time (the thirteenth century). Aquinas accepted Aristotle’s proposition that trade is unnatural, while adding that those who engaged in it risked falling from Grace (Roll 1992: 34). It could only be justified if the profit from it were ‘just’, implying that it not be ‘privatised’ to the individual but devoted in some way to public benefit. Aquinas accepted, too, that the price of something was inherent to that thing; an assumption linked directly to Aristotle’s cost of production theory of value, to use a modern term (though in doing so it shows how modern Aristotle was or, conversely, how little economic understanding has advanced beyond his seminal notions). Aquinas’s opposition to usury also relied on Aristotle’s earlier described theory of money, namely that, while goods were fruitful, being the means of satisfying human (material) needs, money (understood as proxy for goods) was barren (Roll 1992: 36). It produced nothing. ‘Making money’ − the characteristic of trade − was therefore usurious. By the same token, Aquinas regarded money as consumptible but not fungible, not usable as a substitute. The reason for Aquinas’s lack of addition to economic theory was in part due to the fact that so little had changed in the way of economic life prior to his time. But change was on its way. An incipient mercantilism was making its presence felt, which Church doctrine sought to resist. ‘Just price’, for example, itself derived from Aristotle’s concept of the ‘mean’, was part of an attempt to prevent trade becoming respectable because trade implied an individualism that directly challenged Church (i.e. papal) authority. Indeed, the defence of ‘just price’ entailed a degree of complex argumentation that puts one in mind of the difficulty Islamic economists have even today in achieving any interface with western economics that does not in fact amount to an abandonment of Koranic principles. The fact is that Aquinas – along with the Scholastics generally − stood at the threshold of a new age, the modality of which was to be very different. In Roll’s words, his positivist bias notwithstanding, ‘Canonist thought was essentially an ideology, in economic matters it was an illusory representation of reality [that was destined to give way to] a secular science of society’ (40–41)

2.2.4  English Experience In direct English experience, this threshold is later clearly represented by Shakespeare in The Merchant of Venice as a whole and in the cautionary remark he places in the mouth of Polonius in Hamlet, Act I, Scene III: … Neither a borrower nor a lender be; For loan oft loses both itself and friend, And borrowing dulls the edge of husbandry. This above all: to thine own self be true, And it must follow, as the night the day, Thou canst not then be false to any man…



The more accurate term would be ‘releasing surplus value’, see discussion in 11.5.

 In economics, an example of fungibility is a bank note that can be swapped for coins. Fungibility, that is, is not synonymous with tradability, where the bank note is swapped for a good. In this sense, by extension one can also say that something is fungible if it can change its character. 

Witness, ‘Allah has permitted trade and forbidden interest’ (II.275). See Houghton Budd (2002).

When the Banks Stopped Lending to One Another

31

Such commentaries show how perennial is the notion that money is somehow a problem, a challenge – if not anathema – to our moral natures. The Enlightenment, needless to say, represents a wholesale moving on from such strictures of yore. Similar can be said of the loss of guilds. All solidarity is swept away before the process that Galbraith (1987) called ‘the separate personality of money’, Polanyi (1944) referred to as ‘dissassociation’, and many others have identified as some kind of culmination. Only that is not certain. During the twentieth century the onward march of what today would be called financial liberalisation was resisted and obviated by statist economics of various shades. Against this resistance, however, there grew the arguments of the likes of Keith Joseph and Ralph Harris, who, while biding their time, honed the arguments and crafted the policies that found their moment in history in the period that will probably be forever associated with Margaret Thatcher. In this way, a crucial British component of modern economic history became the basis of worldwide changes in economic life. Financial liberalisation then moved centre stage as the driving concept of all economic policy, both domestic and foreign. Markets were opened up, unions ‘tamed’, socialist governments marginalised and central banks made independent. The stage was now set for the 1990s, when hardly any constraints were left on finance. If limits were to return (although there is no historical necessity entailed in such a sentiment) they would have to be those that finance itself gave rise to.

2.2.5 Beyond Central Bank Independence There will be those who say this is not a neutral description of events; that it favours the outcome and the prevailing arguments that made it possible. It is, however, possible to describe such developments clearly without thereby endorsing them. The point of the description is not to tilt against the history of finance, but to ask if, once liberated, it will be able to continue in the manner it had developed when struggling to become free. With the field left to itself a different dynamic than antithesis or even antagonism will need to operate. It is one thing to advocate price stability in a world not used to it, but once price stability becomes generalised, once every central bank has become or been made independent after the example of the New Zealand Reserve Bank – once, that is, one loses the marked variations in inflation rates that result in external pressure to compete while at the same time serving as the crucial driver of the foreign exchange market on which many markets in turn depend – the landscape goes flat. Other things then have to happen if the discrepancies and opportunities on which financial trade (whether one likes the idea or not) depends cease to arise. For the paradigm to continue, trade in finance needs to continue. And so one arrives at May 1997, by which time finance had become extensively deregulated, along with much else in economic life. Credit was readily available, most people had their houses ‘in play’ (even if they were living in them) and the idea had established itself in the public mind that real estate and share prices could go ever upwards, no matter how often reminders were given to the contrary, and whether in small print or large. At that moment in history, Britain’s Labour Party gave immediate effect to a plan long previously prepared. Responsibility for financial regulation was transferred from the Bank

32

Finance at the Threshold

of England to the Financial Services Authority (although the people in it were largely exBank), creating a tripartite arrangement with the Treasury. For better or worse, general financial behaviour in the decade following owed much to this regime (and others like it). During that period credit became increasingly issued against rising real-estate values, Britain’s 1988 negative equity experience having quickly faded from active memory. While it is important not to moralise or pontificate about the practice, the fact remains that borrowing against rising real-estate values can result in unaffordable rents and/or unaffordable interest levels. This fact of life can readily be lost from view, however, when such transactions become at a remove. When Abbey National in the winter of 2006 offered mortgages at five times income to ‘only carefully selected customers’ and when mortgages became ‘liar loans’, traditional caution was overridden by the seemingly healthy information. In this context sub-prime mortgages are a wholly understandable, even predictable development, though this does not mean they are prudent, necessary or beyond question.

2.2.6  The Global Financial Crisis Begins But by April 2007 sub-prime defaults in the US had reached 13 per cent. A limit, seemingly, had been reached and, the world of finance having become a global affair, the effect was to send a signal far and wide. Any financial institution with funds collateralised, whether directly or, as often, indirectly, in sub-prime markets drew the obvious conclusion. Interbank lending and, more crucially, wholesale money markets began to freeze up, all the more quickly because uncertain counterparts had become part of normal business. Northern Rock, in the UK, became the event it did because of the reliance of its business model on money markets rather than members’ savings. But Northern Rock served only to amplify the signal. It was only a matter of time before one part or another of the global financial system could not substantiate its balance sheet. In mid-March 2008, the Bear Stearns hedge fund collapsed (into the Fed-orchestrated arms of J.P. Morgan Chase) and on 4 April Halifax-Bank of Scotland (HBOS) ran out of road. Five months later, on 11 September 2008, Lehman Brothers collapsed and the western financial system froze. Overnight the LIBOR went from 2.15 per cent to 6.44 per cent. The UK’s Financial Services Authority (FSA) issued a temporary ban on short selling (see 2.4: Technical Details) on the grounds that this technique was thought to have at least exacerbated if not caused the crisis. The US Treasury under Hank Paulsen then created the Troubled Asset Relief Program (TARP) which would provide the banking system with an unprecedented $700 billion. Then on 14 September the world’s largest insurance company, American International Group (AIG), failed and was bailed out by the Fed to an amount of $180 billion (see 2.3.4: American International Group). At the same time, Merril Lynch came to the rescue of Bank of America, whose bailout had been advised against by Chris Flowers, an influential voice in the private equity sector. From then on, events gathered pace. On 8 October the UK government provided the banking system with £50 billion capital, £200 billion short-term funds and £250 billion  Self-assessed mortgages where the borrowers were charged extra for lending against undocumented (or falsified) income information. 

It is to be doubted how even-handed this arrangement was. (See 2.3.5: Goldman Sachs.)

When the Banks Stopped Lending to One Another

33

in guarantees. A watershed of sorts was thought to have been reached with the £37 billion provided to Royal Bank of Scotland and HBOS, except that in November Citibank was in a ‘death spiral’ and many big names were in trouble. On 16 January 2009 British bank shares plummeted (shortly after the lifting of the earlier-mentioned FSA curbs on short selling) and on 19 January the UK government promised to insure bank losses (estimated at £585 billion) combined with a new £50 billion initiative designed to prompt reissuance of credit. By March, the financial crisis had become an economic crisis. Recession was in process, possibly of the ‘double dip’ variety; governments were effectively giving citizens grants to go out and buy new cars (later, household boilers); consolidation was widespread, as was home repossession; and the Bank of England had introduced ‘quantitative easing’,10 a term that fools few people, being little more than a volte face on the part of ‘the authorities’. The ‘hands-off’ arrangements achieved under central bank independence (operational independence and ‘signalling’, to use Friedman’s (1999) term) are overridden by open market operations whereby the central bank, not the markets, becomes the source of essential capital. ‘Quantitative easing’ is meant to say ‘a temporary step backwards before the onward march of financial liberalisation can be resumed.’ And, indeed, by April 2009, thanks no doubt to massive state intervention, calm had returned, and word went out that ‘bonuses are back’. In June Goldman Sachs reported its biggest profits ever, and in August 2009, Barclays Bank quietly announced first half profits of £4.2 billion, an average of £191,780 for each of its 21,900 employees. Much more detail could of course be added, but sufficient has been recounted to justify the question, ‘Crisis? What crisis?’ By the autumn of 2009, the storm was thought or said to have passed and everywhere, in officialdom and on the lips of ordinary citizens, one could hear the hope expressed that conditions would return to those before the crash, so that real-estate and stock values could continue their ever-upward journey, albeit at a reduced pace. To know how ‘real’ all this, however, it would be prudent to watch a place like Dubai.

2.3  Commentaries Where is the best place to begin discussion of the global financial crisis? At its centre? At its height? It is not easy to locate a global financial crisis. Where exactly is it? And where is one in relation to it? For some, those who have not been caught short in their real-estate gambles or who in regard to their pensions, incomes and wealth levels were not trading on margin, as it were, it is but another storm to weather, the time not to sell, panic or take one’s eye off the long term. For others, both in regard to their circumstances and their reactions to them, events are simply now taking place outside their comprehension. A frequent explanation is that banks stopped lending to one another in the course of 2007, causing a generalised contraction of credit which in turn precipitated the failure 10 The term ‘quantitative easing’ describes an extreme form of monetary policy used to stimulate an economy where interest rates are either at, or close to, zero. Normally, a central bank stimulates the economy indirectly by lowering interest rates but when it cannot lower them any further it can attempt to seed the financial system with new money through quantitative easing. In practical terms, the central bank purchases financial assets (mostly short term), including government paper and corporate bonds, from financial institutions (such as banks) using money it has created ex nihilo (out of nothing). This process is called ‘open market operations’.

34

Finance at the Threshold

of several substantial financial institutions. As a further consequence, the non-financial economy has been severely impacted implying the (real or imaginary) prospect of recession. In an endeavour ‘to get the economy going again’, inter alia, governments have provided huge tranches of capital to banks, but also to certain manufacturers, notably car makers, although, as observed by Simon Jenkins, ‘Quite why cars were considered good for demand but other forms of consumption bad was never explained’ (‘We are Paying an Enormous Price for the Myth that Banks are Too Big to fail,’ Guardian, 16 October 2009). The hope is that these are medium-term measures, the general thought being to return to business as usual, meaning (a) banks lending to one another again, albeit on less risky grounds, and (b) real-estate values returning to summer 2007 levels, from whence they can continue their ‘upward-only’ trajectory (albeit less spectacularly than prior to 2007). In other words, the hiatus in inter-bank lending is thought to be but a blip. Enormous in size and global in scope, but a blip nonetheless. The question asked here, however, is not only why did the banks stop lending to one another, but why at this moment in history? Is the problem merely a matter of over-loose credit due to the relaxation of traditional prudence? Or did global finance find itself at its limits, both technically and epistemologically? Have government bailouts saved the day, therefore, or merely ‘kicked the can down the street’? Finance being often considered as ‘unreal’ – even by academic minds – the best place to begin a review of both chronology and technique is arguably with what one might call primary players – central bankers, regulators and those most closely in touch with financial institutions. But also financial commentators because their utterances have huge influence on the way people generally not only understand economic events, but above all on how they behave in regard to them. In the autumn of 2008, for example, the BBC’s Robert Peston was held by some to have been responsible for grave circumstances because he leaked information about Northern Rock’s situation. Likewise, public opinion and whether or not to join a deposit withdrawal queue are heavily influenced by the press’s view of events, but also by whoever it was that converted so complex and vulnerable an event as a global financial crisis into the simple sound-bite of ‘credit crunch’, in antithesis to which, to be consistent, ‘credit binge’ ought to have been in coinage during the ten or so years prior. In this section a range of commentaries, chosen at random, is rehearsed in order to guard against the author’s own biases. The initial survey begins at the relatively superficial level of commentary, because that is where many people begin and end their understanding of finance. Trusting that its intricacies are appreciated and managed by experts, they do not go deeper. Although Chapter 3 considers the ideas that underpin modern finance and is thus more academic, less anecdotal, no apology is offered for this approach because its aim is to replicate the way we generally think about financial phenomena. The commentaries have been kept as brief as possible but endeavour to be faithful to their authors’ intents. To a certain degree, the overall story the accounts tell from their various perspectives is corroborated and also statistically supported by the work of Norman Gall of the Fernand Braudel11 Institute in Sao Paulo, Brazil, on whose work a certain reliance has been placed, in particular, Millions, Billions, Trillions (2009). Gall’s writings tend to be highly researched 11 Fernand Braudel (1902–85) was the foremost French historian of the post-war era, and a leader of the Annales School.

When the Banks Stopped Lending to One Another

35

and even-handed, albeit an at times odd mixture of representing at the same time as being critical of mainstream views. Thus, they have a certain objectivity and provide a valuable overall perspective. Though it does not affect their content, the commentaries are presented in chronological order, beginning with a seminar held at London School of Economics by its Financial Markets Group in October 2007. Next is Will Hutton’s account, included because it is not untypical of many whose position as regards finance tends to be left of centre, even though they may not be averse to ‘working the housing market’ at the same time as criticising it.12 Hutton is followed by the autobiographical experience of Edmund Andrews, whose experience is probably not unique. It is worth recounting because he was both a commentator and a player. He knew – or supposed he did – what he was doing. That means, if ever it was a question, that he knew what was possible, if, not probable, indeed inevitable, and therefore predictable. This makes claims of ignorance on the part of financial experts difficult to credit. If they were to admit they were deliberately running high risks that would be fair enough, but to claim they did not know what was at risk is at best disingenuous. The next vignette concerns American Insurance Group, a case in point as regards Andrews’s explanation of events. Though a journalistic account, Tim Rayment’s description of the AIG situation should not be regarded as merely anecdotal. Rather it is a close-hand description of what happened. It should be pointed out, however, that sections of the article that focused on who, if anyone in particular, was to blame, and what, if any, remedy in that respect is needed going forwards, have been ignored in order not to be distracted from what seems to be a crucial characteristic of the global financial crisis, namely, the techniques used and the meta-economic assumptions they presupposed (see 4.1.6: Meta-economics). It is not part of this book to consider the role of greed, for example, or to voice any moral concerns. Not because such considerations are not, in a general sense, unimportant, but because few people if any are without financial sin and thus entitled to throw stones. Better to spend the energy one would use moralising on devising new instruments that presuppose, prompt and reinforce human virtues rather than human vices. It is for the individual to discipline his conduct. The economist’s task is to help this by conceiving economic and financial processes more clearly. Goldman Sachs is next considered, perhaps the most contestable, not to mention contentious, aspect of the global financial crisis on account of the evident proximity (to say the least!) of Wall Street to the US government (but not only).13 Whatever one’s opinion of Goldman Sachs, the relationship of fox to henhouse is crucial here. The view of Alistair Milne provides a typical banker’s apologia, meaning that in a neutral sense. It is important to articulate the view from within banking, as it were, notwithstanding the possibility (discussed later in Chapter 10) that banking per se, and therefore any apologia of it, may have become anachronistic and thus be part of the problem.

12 This is not a comment on Will Hutton, of course, but on the now generalised ownership of property that, ideologically speaking, ought to be outside the pale of socialist-minded people but which, thanks to such schemes as Wider Share Ownership in the 1980s, by no means is. 13

The British government and doubtless others are not without links to Goldman Sachs.

36

Finance at the Threshold

Next is something of a composite perspective provided by the September 2009 edition of Prospect, which featured a discussion involving Adair Turner, chair of the FSA, John Gieve, former deputy governor of the Bank of England, Gillian Tett of the Financial Times and Paul Woolley, a senior fellow at London School of Economics, concerned with capital markets, who were quizzed by Reuters’s Jonathan Ford. Again, the reason for including this element is the critical feature of modern finance – the fact that it is ‘managed’ by people who combine academic credentials with direct proximity to ‘real world’ events, with real here meant to include financial! Alongside the generally mainstream views there runs the continual and consistent critique of economists such as Dirk Bezemer. His ‘creditary’ view warrants rehearsal here because it shows that the global financial crisis has not arisen for want of rethinking the foundations of economics but to a certain extent because of its focus on (some would say capture by) the too-narrow, so-called ‘orthodox’ point of view. Of pithier tone was the noted spat between Paul Krugman and John Cochrane in September 2009, in which the former sought to unseat the supremacy of the efficient markets hypothesis, while the latter cried ‘foul!’. The final sub-section concerns alternative perspectives, the chief ones being Islamic economics and monetary reformism. The latter is a catch-all term for those who essentially argue against private credit creation and so-called debt-based money issue and for stateengendered finance instead. If we deal somewhat summarily with these perspectives it is because our concern here is to focus on how capitalism and western finance ought to and could transform themselves in ways that would overcome the argument made by their critics that they have become morally and technically bankrupt and have therefore forfeited any claim they might make to being ethical.

2.3.1  London School of Economics Early on in the global financial crisis, the Financial Markets Group of LSE held a seminar (1 October 2007) at which several of its ‘interdisciplinary and intercollegiate group of experts specialising in financial regulation’ sought to characterise events. In his introduction, Charles Goodhart drew attention to the fact that, with the real liquid assets of financial institutions having fallen from 25 per cent in the 1960s to 1 per cent nowadays, there is too great a reliance on wholesale markets, short-term interest rates and the ‘put’ of central banks. In such a situation, when the inter-bank market ‘dries up’ there is little central banks can do except exercise their lender of last resort role but so massively that they risk contradicting their price stability responsibilities. LSE-based economist Wilhem Buiter pointed to the presence of excess global liquidity which ‘gobbles up’ the official bank interest rate, the focus of its monetary policy mandate. Financial Times journalist Brandon Davies was very clear that banks did not believe the credit rating agencies. He also expressed the view that in August 2007 someone (at Barclays Bank?) chose not to provide liquidity. Another LSE economist, Jon Danielson, highlighted the dangers of model dependency (e.g. Basel II) and of regulation that is too narrow and over complicated. The last is to question the 1997 tripartite arrangement. Gillian Tett sounded an interesting note, such as only a financial journalist rather than market participant might sound, when she wondered if transparency did not inhibit profitability so that, perversely, the financial sector ‘needed’ obscure instruments.

When the Banks Stopped Lending to One Another

37

Ross Altmann, a pensions expert, was emphatic. ‘Our once great savings culture has been decimated.’ Because, since 1997, of a government bias in favour of borrowing not saving, it is not in the banks’ interests to increase savings, thus reliance becomes placed on money markets. Northern Rock, which failed so spectacularly, was money-market dependent; Britannia building society, by contrast, had 100 per cent retail deposits. This, of course, points also to demutualisation, the release of ‘suppressed assets’, Big Bang, securitisation and all the many related developments of the mid 1980s, both intellectual and practical. Finally, Matt King, credit products strategist at Citigroup, pointed to the role of the ‘carry trade’ which can readily go in reverse.

2.3.2  Will Hutton According to Hutton’s commentary in his Dispatches programme for Britain’s Channel 4, ‘Crash – How the Banks went Bust’, China’s colossal US dollar holdings, consequent on its trade surplus, were invested in Wall Street, which then reinvested them in the so-called ‘subprime’ mortgage market, taking US house values to a 60-year high. This rise, significantly, has been continuous; giving life to the idea that ‘ever upwards’ is both healthy and sustainable. This process has been accompanied by the appearance of all manner of exotic financial instruments, such as collateral debt obligations (CDOs), which, originating in the very late 1980s, were sold to insurance companies, resulting in a 1:40 pyramid centred on London. Claiming to be without risk (causing practitioners to feel silly if they wondered how) they were fostered by the tripartite regulatory framework introduced in May 1997. A ‘party’ then got into full swing, underpinned by the assumptions of free market ideology (which could do no wrong), but by April 2007 the situation had begun to unravel. In the US, sub-prime defaults (quaintly, euphemistically, and even clinically, called ‘delinquency’) reached 13 per cent, with a consequent falling in house prices. Matters were compounded by several other problems. Firstly, although there is in effect only one (international) financial system, it is regulated in London and New York as if there were two. Secondly, Gordon Brown’s light touch regulatory approach preferred the financial over the real economy. As a consequence of the events of spring 2008 (the collapse of Bear Stearns hedge fund, etc.) cash became king, causing an inter-bank lending freeze. The party14 having got out of hand, the state stepped back in, only too welcome on the part of some failing banks. As Alistair Darling put it at the time: ‘There are moments when financial stability trumps anti-competition.’ In other words, in extremis the positivism of competitive economies cannot be relied upon.

2.3.3  Edmund Andrews Writing in the Guardian on 11 July 2009, New York Times journalist Edmund L. Andrews spoke for many when, referencing his book Life inside the Great Meltdown, he summed up his experience in the manner of the following extracts: I wrote several early-warning stories in 2004 about the spike in high-risk mortgages. Yet in the same year, I joined millions of otherwise sane Americans in what we now know was a catastrophic binge on overpriced property and reckless mortgages … 14 An allusion to William McChesney Martin’s famous quote when chairman of the Federal Reserve that the job of the Federal Reserve is ‘to take away the punch bowl just as the party gets going’.

38

Finance at the Threshold Nobody duped me, hypnotised me, or lulled me with drugs. Like so many others, I thought I could beat the odds. Everybody had a reason for getting into trouble. The brokers and the dealmakers were scoring huge commissions. The ordinary homebuyers wanted to own their first houses, or bigger houses, or holiday homes. Some were greedy. Some desperate, some deceived ... American Home Mortgage had become one of the fastest growing mortgage lenders in the country. Its speciality was people like me: borrowers with good credit scores who wanted to stretch their finances far beyond what traditional banks would allow, and who were prepared to pay slightly higher rates for the privilege of concealing our financial weaknesses. [For such companies] if I wanted to buy a house, it was my job to decide whether I could afford it. [Their] job as to make it happen … They were betting that a default would be much more painful to [the borrower] than to them … What mattered more than anything was a person’s credit record? Investors had become steadily less interested in the details of a person’s financial position. If you had always paid your debts on time before, the theory went, you’d probably do so in the future … [Moreover, as AHM’s agent, Bob Andrews, put it]: ‘… don’t worry, the value of your house will be higher in five years. You’ll be able to refinance.’… I take some pride in the fact that I outlasted two of my three mortgage lenders. One was shut down by federal regulators in early 2007. Its loans were so bad that it became a catalyst for the panic that kicked off the broader financial crisis that August. Another collapsed overnight… It will take years to make up for the costs of our15 misadventure. I have no idea when I might be able to get credit again, much less retire … [but] we are not victims, because we knew we were taking a huge gamble. My hunch is that a large share of the people who are now in trouble knew in their gut they were taking unreasonable risks, too. But our misjudgements, however egregious they have been, pale in comparison with the self-enriching recklessness of those at the top of the financial ladder. They knew their loans were absurd. They knew, they knew, they knew.

2.3.4  AIG16 AIG is the world’s largest insurance company. In March 2009, it reported a quarter(!) loss of $61.7 billion, the biggest in corporate history, and was rescued by the US government using resources that exceeded the value of the gold reserves in Fort Knox, making it one of the greatest bailouts in history. On the day after Lehman declared bankruptcy, the U.S. authorities virtually nationalized the American International Group (AIG), the world’s biggest insurance company founded in Shanghai in 1919, with 116,000 employees in subsidiaries operating in 130 countries. The government initially made available $85 billion to AIG, at a punitive 14 per cent annual 15

Referring to himself and his wife.

16 These paragraphs are largely based on two sources: the earlier-cited article by Norman Gall (2009) and Tim Rayment’s (2009) article. All main quotations are from Gall.

When the Banks Stopped Lending to One Another

39

interest, to pay its creditors in complex derivatives deals and took 80 per cent ownership of the company, the first stage of a federal commitment that since has grown to $182 billion. It was the price of terror. An even greater bankruptcy, only days after Lehman’s collapse, simply could not be absorbed by financial markets. Fortune magazine reported that ‘the government realized by Tuesday that it had erred grievously by letting Lehman go down and knew that it could not compound the error by allowing AIG to fail a day later.’ Terror arrived with the Black Swan. In the now-fashionable lingo of financial markets, a Black Swan is an event that was not supposed to happen. In his book, The Black Swan: The Impact of the Improbable (2007), Nassim Nicholas Taleb, a trader and professor of risk engineering at New York University, called it a rare event ‘nobody talks about, since they escape models – those that you would feel ashamed discussing in public because they do not seem plausible.’ In this vein, some mathematicians at Financial Products, an AIG subsidiary, concocted a model that showed a 99.85 per cent probability that AIG never would have to pay anything on the debts it insured with CDSs. So AIG charged a tiny fraction of a penny ($0.0002) annually for each dollar of credit protection on its first big CDS deal proposed by J.P. Morgan to insure some of the bank’s loans. If $0.0002 is multiplied by hundreds of billions of dollars, a CDS could produce a large yearly cash flow over several decades. Because AIG was an insurance company, not a bank, and enjoyed a AAA credit rating, its Financial Products subsidiary escaped government regulation and was not required to set aside capital reserves to support the CDS risk it was assuming. Tom Savage, former president of AIGFP, said that the U.S. economy would have to disintegrate into a major depression to trigger events requiring AIG to cover defaults. ‘The models suggested that the risk was so remote that the fees were almost free money,’ Savage said. ‘Just put it on your books and enjoy the money.’ (Gall 2009: 13)

AIG was a hedge fund on top of an insurance company, selling derivative products to banks all around the world. One such product was a type of derivative called a creditdefault swap (CDS), ‘which allowed banks to buy risky debt without attracting the attention of regulators. AIG took the fees, but did not have the money to pay up if the loans went bad. By the time the music stopped, European banks had protected more than $300 billion of debt with this bogus “insurance”. And that is just one corner of a web of risk extending to over 1,500 big corporations, banks and hedge funds’ (Rayment 2009: 47). One of the causes of what some (using a derogatory image) call today’s ‘Frankenfinance’ is the predicating of economics on physics, only it is a faux physics. By showing in the 17th century that the universe conforms to natural laws, Isaac Newton encouraged our age to see money as a branch of physics. Starting in 1952, two generations of economists worked to show that people are like molecules, whose behaviour can be predicted in ways that are stable over time. Science then infected everything, from how much capital banks need to protect themselves against insolvency, to the risk in credit-default swaps. But there was a flaw: the City’s faux physicists never go back far enough in their analysis, because the data on the Bloomberg terminal cover a tiny period of history. ‘Real scientists tend to be much more sceptical about their data and their models,’ says William Janeway, an MD of the privateequity firm Warburg Pincus and a Cambridge University lecturer. ‘They had all of the maths, but none of the instincts of (real) scientists.’ (Rayment 2009: 49)

40

Finance at the Threshold

The starting point of such things is as innocuous as that of a water-spout. It begins as a whisk on the sea’s surface that is suddenly pulled up to the cloud level, then, spinning at a great rate, races uncontrollably across the ocean. The image is deliberate: does the tower of water push itself upwards, or is it sucked up? Faux finance similarly begins innocently enough. In AIG’s case, a trader, Howard Sosin, had the idea to buy financial risk from people who did not want it, then sell the risk to others in a series of ‘hedges’ so that AIG kept the fees but not the risk. Risk transfer, the counterpart to which is liquidity transfer, is always the characteristic of a futures market. Great care needs to be exercised in judging such a thing. If a farmer, in need of liquidity until his crop matures, can be harvested and then sold, forward sells his crop to someone who has liquidity (cash) which earns him nothing, where is the untowardness? Both take a gamble on the price, discounting it, but they do so with their eye to the future. (Hence the name.) A future crop of potatoes gives such a transaction some semblance of normality, but one needs to observe the process, not the form of the collateral. Because the one holding the right to the crop then sells it forward (the right to the crop now being the equivalent to the crop itself). And so on. The AIG case also raises the issue of light-touch regulation, in this instance of a degree that defies belief. America has an Office of Risk Assessment, set up in 2004 to co-ordinate risk management for the main regulator, the Securities and Exchange Commission (SEC). Jonathan Sokobin, its director, says it is charged with ‘understanding how financial markets are changing, to identify potential and existing risks at regulated and unregulated entities’ (Rayment 2009: 49). According to its website, it also helps to ‘anticipate, identify and manage risks, focusing on early identification of new or resurgent forms of fraud and illegal or questionable activities … across the corporate and financial sector’. By early 2008, the office was reduced to a staff of one. ‘When that gentleman would go home at night,’ says Lynn Turner, the SEC’s former chief accountant, ‘he could turn the lights out. We had gotten down to just one person at the SEC responsible for identifying the risk at all the institutions’ (Rayment 2009: 49). The $596-trillion market in unregulated derivatives, including $58 trillion in credit-default swaps, was being watched by one person’ (Rayment 2009: 49). As a result, ‘any bank that thought it was protected by credit-default swaps with AIG would have been exposed from the start, putting taxpayers at risk. The banks’ credit traders would – or should – have realised that AIG was never likely to pay out. ‘The key point that neither the public, the Fed nor the Treasury seems to understand,’ says Whalen, ‘is that the CDS contracts written by AIG were shams, with no correlation between fees paid and the risk assumed. These were not valid contracts but acts to manipulate the capital positions and earnings of financial companies around the world’ (Rayment 2009: 53). Clearly in evidence in the AIG case, but also more widely of course, is, on the one hand, the intellectual capture of the Establishment, so that everyone – politicians such as Gordon Brown, regulators such as the SEC and the FSA, and academic and media commentators – is persuaded that ‘a new way of thinking is in the public interest.’ On the other, there is exploitation of this circumstance (Rayment 2009: 53). It cannot be said that no one saw it coming, however. Charles Bowsher, for instance, head of the US government’s General Accounting Office, testified as long ago as 1994 that ‘the sudden failure or abrupt withdrawal from trading’ of large dealers in derivatives ‘could cause liquidity problems in the markets and could also pose risks to others, including

When the Banks Stopped Lending to One Another

41

… the financial system as a whole’. It took another 13 years, but that is exactly what happened (Rayment 2009: 49). ‘From 1973 to 1985,’ says Simon Johnson, a former chief economist at the IMF, ‘the financial sector never earned more than 16% of [US] corporate profits. In the 1990s, it oscillated between 21% and 30%, higher than it had ever been in the post-war period. This decade, it reached 41%.’ The whole point of financial companies is to allocate your savings to those who can use the money best. If they are taking 41% of the profit in an economy, something is out of balance. These figures reveal an enormous transfer of wealth. (Rayment 2009: 53)

Although such analogies cannot be spread too thinly, the problem with water-spouts is that they can spend their energy as quickly as they accumulate it. In the case of AIG, more specifically its London financial products division under Joseph Cassano, as house prices fell, credit ratings were cut and bankers began to panic. At this point other problems set in. AIG was then bailed out by the US Treasury under Hank Paulson, an ex-CEO of Goldman Sachs. He received tax benefits of about $200 million (£133 million) for taking on a government role. When the US decided to bail out AIG, the chief beneficiary of the rescue was Goldman Sachs, which received $12.9 billion of public funds via the insurer. The new CEO, Edward Liddy, whose task is to wind down the company and to close $1.6 trillion in trades that are still outstanding from the Cassano era, is ex-Goldman Sachs. He even has $3.2 million in the bank’s shares. One could go on, except that it begins to sound like a litany of woe. Important, however, is the observation of Simon Johnson that ‘all the technical details – light regulation, cheap money, the promotion of home-ownership – have something in common: they all benefit the financial sector’ (Rayment 2009: 53).

2.3.5 Goldman Sachs Norman Gall (2009) sets the stage for consideration of Goldman Sachs: These troubles threatened losses for Goldman Sachs, AIG’s biggest trading partner, whose success as Wall Street’s premier investment bank inspired in rivals what is known as ‘Goldman envy.’ In 2007 Goldman made $11.6 billion in profits, unprecedented among investment banks, with its 30,522 employees, including secretaries, averaging $600,000 in pay, including $69 million for its boss, Lloyd Blankfein, the Bronx-born son of a postal clerk who drove Goldman’s trading strategy. Despite its $20 billion exposure to AIG in derivatives, Goldman claimed ‘no material exposure to AIG’ at the time of the federal bailout, having already received $7.5 billion from AIG in collateral against the declining value of securities that Goldman marked down as the crisis deepened. But early in 2009 the New York Fed’s Maiden Lane III vehicle, created to absorb AIG’s bad debts, bought $14 billion of Goldman’s $20 billion in outstanding derivatives contracts with AIG at face value. ‘This was a sweet deal for Goldman and the other counterparties, a deal only available from the government,’ The Wall Street Journal observed. Goldman acquired other privileges as the crisis developed. These included investment banks’ access to cheap money from the Fed’s discount window after Bear Stearns’ failure in March 2008 and to deposit insurance and federal guarantees as a result of their being granted commercial bank charters as part of their flight into protective custody during the convulsions that followed the collapse of Lehman and AIG in September. Without this

42

Finance at the Threshold protection, Goldman may not have survived instead of announcing $3 billion in profits for the first quarter of 2009. (Gall 2009: 14) Talent and success turned Goldman into a political heavyweight. Two of its bosses, Robert Rubin and Henry M. Paulson, served as Treasury Secretary since 1995. Paulson was recruited for the job in July 2006, just as the credit boom was peaking, by President George W. Bush’s chief of staff, Joshua B. Bolten, a former Goldman executive. Several former Goldman executives occupy other key posts at Treasury. When AIG was bailed out in September 2008, Paulson chose a Goldman board member, Edward M. Liddy, to run it. Geithner was chosen as president of the New York Fed by a board headed by Stephen Friedman, a former Goldman chairman. The Wall Street Journal remarked: ‘Half of the financial world already thinks Goldman runs the U.S. Treasury and Fed, however unfairly. The American public is furious about the bailouts of AIG and the banks, engineered by the Fed and the Treasury, that have helped the likes of Goldman Sachs. And guess who Mr Friedman’s search committee picked as Mr Geithner’s successor when he left to run the Treasury? Another Goldman alum, William Dudley.’ At Treasury, Geithner named a former Goldman lobbyist, Mark Patterson, as his chief of staff. (Gall 2009: 14)

This credible mainstream account is important because it makes more ‘palatable’ the challenging commentary by Matt Taibbi (2009), a contributing editor to Rolling Stone, who marshalled the following facts. While not everyone’s choice of words, his account reflects well-known facts and expresses the views of many ordinary citizens, that is to say taxpayers. He points to the changes that took place at the end of the 1990s, a decade in which finance had begun to act untrue to type. [The banks] changed the rules of the game … by setting up what was, in reality, a two-tiered investment system – one for the insiders who knew the real numbers, and another for the lay investor who was invited to chase soaring prices the banks themselves knew were irrational ... [With] the housing bubble [came] a decline in underwriting standards, although in this case the standards weren’t in IPOs but in mortgages. By now almost everyone knows that for decades mortgage dealers insisted that home buyers be able to produce a down payment of 10 percent or more, show a steady income and good credit rating, and possess a real first and last name. Then, at the dawn of the new millennium, they suddenly threw all that out the window ...

This sounds all very neutral, as if financial evolution proceeds as an event of nature, which, indeed, is how most economists do understand things. Regarding human beings as noisy disturbers of otherwise neatly balanced equations, they do not hold them culpable for events. The close-knitted nature of the financial community can therefore be seen either as normal, if one is part of the specialist profession, or untoward, which is more Taibbi’s view. The history of the recent financial crisis [reads] like a Who’s Who of Goldman Sachs graduates. As George Bush’s last Treasury secretary, former Goldman CEO Henry Paulson was the architect of the bailout, a suspiciously self-serving plan to funnel trillions of Your Dollars to a handful of his old friends on Wall Street. Robert Rubin, Bill Clinton’s former Treasury secretary, spent 26 years at Goldman before becoming chairman of Citigroup – which in turn got a $300 billion taxpayer bailout from Paulson. There’s John Thain, the ... chief of Merrill Lynch, a

When the Banks Stopped Lending to One Another

43

former Goldman banker, Thain enjoyed a multibillion-dollar handout from Paulson, who used billions in taxpayer funds to help Bank of America rescue Thain’s sorry company. And Robert Steel, the former Goldmanite head of Wachovia, scored himself and his fellow executives $225 million in golden-parachute payments as his bank was self-destructing. There’s Joshua Bolten, Bush’s chief of staff during the bailout, and Mark Patterson, the current Treasury chief of staff, who was a Goldman lobbyist just a year ago, and Ed Liddy, the former Goldman director whom Paulson put in charge of bailed-out insurance giant AIG, which forked over $13 billion to Goldman after Liddy came on board. The heads of the Canadian and Italian national banks are Goldman alums, as is the head of the World Bank, the head of the New York Stock Exchange, the last two heads of the Federal Reserve Bank of New York – which, incidentally, is now in charge of overseeing Goldman.

It is indeed difficult not to wonder at such circumstances. One understands, as Paul Volcker once opined that finance is a technical matter that has first to be explained to one’s inquisitors, for example at a Congressional hearing, but even so the strong links that characterize the financial relations between Wall Street and Washington seem designed to bewilder and anger the ‘man in the street’. What they then do smacks all too easily of the worst cronyism and disregard bordering on contempt of many outside their world. [In September 2008], although he had already engineered a rescue of Bear Stearns … and helped bail out … Fannie Mae and Freddie Mac, Paulson elected to let Lehman Brothers – one of Goldman’s last real competitors – collapse without intervention... The very next day, Paulsen greenlighted a massive, $85 billion bailout of AIG, which promptly turned around and repaid $13 billion it owed to Goldman. Thanks to the rescue effort, the bank ended up getting paid in full for its bad bets: By contrast, retired auto workers awaiting the Chrysler bailout will be lucky to receive 50 cents for every dollar they are owed.

But that was small beer compared to one of Paulsen’s last acts under the outgoing Bush administration: Immediately after the AIG bailout, Paulson announced his federal bailout for the financial industry, a $700 billion plan called the Troubled Asset Relief Program, and put a heretofore unknown 35-year-old Goldman banker named Neel Kashkari in charge of administering the funds... [Moreover] immediately after the AIG bailout, Paulson announced his federal bail-out for the financial industry, a $700 billion plan called the Troubled Asset Relief Program, and put a heretofore unknown 35-year-old Goldman banker named Neel Kashkari in charge of administering the funds. [Then], in order to qualify for bailout monies, Goldman announced that it would convert from an investment bank to a bank-holding company, a move that allows it access not only to $10 billion in TARP funds, but to a whole galaxy of less conspicuous, publicly backed funding – most notably, lending from the discount window of the Federal Reserve.

Who knows? Many moons hence, when history has run its course, perhaps so much interconnectedness and self-interest will be thought benign. Perhaps there is a rightness to the ‘banks are too big to fail’ argument, on which such behaviour relies. Even so, one understands the incredulity of Taibbi, who is but one of many such critics.

44

Finance at the Threshold

2.3.6  Alistair Milne To the question, ‘How and why did all this happen and what needs to be done to prevent a new Great Depression?’, Alistair Milne, author of The Fall of the House of Credit (2009b), writing in Cass Business School’s InBusiness (Milne 2009a), answers as follows: The ‘how’ is the easiest question to answer. From the initial slowdown in the US housing market in late 2006 until the global banking run of late 2008, economies around the world have been struggling to adapt to the growing global current-account imbalances, with savings from China, Japan, Germany and other surplus countries recycled to finance the consumer credit and housing boom in the United States, the United Kingdom and other deficit countries. The business context was the rise of a system of parallel banking, with credit intermediated not through traditional retail deposits but using new, innovative credit instruments, held by banks and financed through short-term wholesale money markets. The ‘why’ and ‘what’ are more difficult. The unsustainable boom of credit and house prices that preceded the crisis had its roots in psychology and culture and what has been aptly called the madness of crowds. Many others have written about the role of euphoria and of self-reinforcing beliefs when the banks were building up their large exposures to household and risky corporate debt. The controversial argument is that psychology, culture and crowd madness are playing an equally important, if not bigger, role in the crisis itself. What has been pushing many banks to the wall is not poor lending decisions but a blind panic, an overreaction to mistakes made during the boom – a panic made possible by the reliance on highly unstable short-term funding, in which professional investors are fleeing from any form of bank exposure. (2009a: 21)

Milne concludes that ‘Consumers and governments, especially in the English-speaking world, have borrowed far too much. There is nothing else to be done except cut back on our spending and sell off all our assets to reduce borrowing. Banks’ assets are worth far less than the banks pretend and they may be hiding even worse problems. They must reveal the full extent of their holdings of toxic assets and revert to being cautious, riskless utilities.’ Then he asks the question many ask: ‘Should government and the financial authorities stand aside and let private businesses and individuals suffer the consequences of their own actions? Or should public funds be used to protect borrowers and investors from the consequences of their decisions?’ (22). His answer, which surely ranks high on the scale of moral hazard, is that it is ‘The duty of government … to provide that leadership, to demonstrate that, even if right now no one else does, they still support the banks. Money, if necessary extraordinarily large sums of taxpayers’ money, must be made available to support banks and enable them to start lending again. [Furthermore,] ‘central banks, government and, ultimately, the taxpayer will have to take responsibility for economy-wide disasters, providing insurance against extreme systemic risks’ (23).

2.3.7  Adair Turner and Colleagues The September 2009 issue of Prospect featured an edited transcript of a conversation between Adair Turner, Paul Woolley, Gillian Tett and John Gieve. The title of the article was ‘How to Tame Global Finance’, an image also used by Rudolf Steiner in regard to

When the Banks Stopped Lending to One Another

45

modern finance.17 It covered many topics, which have here been regrouped according to subject area rather than the sequence of the discussion. The first, and one of the most crucial, concerns epistemology – the challenge the global financial crisis represents to our understanding of finance to date and from now on. For Adair Turner, The more fundamental thing, especially for regulators like me, is to realise that what has occurred has imposed huge economic harm throughout the world and so we really do have to work out how to stop it happening again in five or ten years’ time. And that requires a very major reconstruct of the global financial regulatory system, and I don’t mean a minor adjustment. (Prospect 2009: 34) [We need a major adjustment because there has been] a fairly complete train wreck of a predominant theory of economics and finance. For the regulators of the world, once you’ve accepted that you don’t have an intellectual framework of ‘more market is always better,’ you’re in a much more worrying space, because you don’t have an intellectual system to refer each of your decisions, and that requires more judgement and therefore confidence. (Prospect 2009: 36) The wreck is very specific, namely the reliance of macro policy and indeed macro economics on ‘light touch’ regulation considered viable because of the efficient markets hypothesis. There are two particular areas where we know the direction of travel but turning it into concrete analysis is tough. First of all, this whole area of macro-prudential policy, the importance of seeing the big picture and having the right levers to pull – we all recognise that we need levers other than micro-prudential ones or other than interest rates alone. There’s something that resides in the middle there, economy-wide capital or liquidity measures which make the system more stable. But one issue here is do we try to hardwire things into the system so that when you go into a boom an automatic formula demands of banks, for example, that they squirrel away more capital? Or should such decisions reside within a body of wise people, some financial stability committee? Second, we have had a very fundamental shock to the ‘efficient market hypothesis’ which has been in the DNA of the FSA and securities and banking regulators throughout the world. The idea that more complete markets and more liquid markets are definitionally good and the more of them we have the more stable the system will be, that was asserted with great confidence up to three years ago. But what precisely we do as a result of the collapse of that approach is unclear. Does that mean that we as regulators have to sometimes ban new products and say, ‘I’m going to ban that unless you can prove to me that it is socially useful’? The whole burden of proof in the past has been the other way round – an organisation like the FSA has worked on the assumption that it has to define that there is some specific market failure, or else our intervention is not legitimate. We have not felt it sufficient to say, ‘Well, there’s not a market failure here, but the management of this bank is completely out of control, and therefore we’re going to tell them to slow down.’ We have not felt the ability to act against market volatility

17 ‘Think how long a horse has to be tamed before it can be used. Think what would happen if we did not tame our animals, but used them wild. Yet we let money circulate quite wildly in the economic process’ (1996b: Lecture 12: 150).

46

Finance at the Threshold for reasons of financial stability; we’ve only felt that we can act on it for reasons of market abuse. (Prospect 2009: 36)

A related theme, again both conceptual and practical – the unity between idea and action seems particular to finance – is the further reliance placed on agents, with its attendant problem of the opportunity this provides for self-serving behaviour. In the view of Paul Woolley: The crisis, as you say, has served to discredit mainstream finance theory, and especially its key idea, that capital markets are efficient. The idea that prices are always right and that capital markets exert their own self-discipline – the so called efficient markets hypothesis – has received a deadly challenge. Some commentators now argue that if markets are inefficient that must be because investors are irrational. The way forward, they argue, is to understand finance based on psychological biases and irrational urges, the so called behavioural model, to better explain the erratic performance of asset prices and capital markets. But people in the financial markets are not all acting irrationally. The real key lies in understanding a crucial mistake that economists have been making. Their theories are based on the assumption that there is an army of private investors who invest directly in stock, bond and derivative markets. They have ignored the real world complication that investors delegate responsibility for financial matters to banks, fund manager, brokers and so on, and it is these intermediaries who determine asset prices. Delegation creates an ‘agency’ problem in that the agents have better information than their customers and, moreover, the interest of the two are rarely aligned. Bringing agents into the analysis helps us to understand how bubbles form, why equities are so volatile and the forces behind these ‘momentum’ surges and collapses in so many markets. (Prospect 2009: 36) There are some products which should be offered but aren’t because although they are very attractive to long-term investors they are bad for ‘agent’ business because they are buy and hold investments with low price volatility – I’m thinking of, for example, GDP bonds, bonds that give a return equal to the increase in nominal GDP each year, thereby capturing the three things that many investors want: some growth, inflation protection and price stability. (Prospect 2009: 40)

Central to the experience of the global financial crisis has been the part played by the tripartite arrangements set up under Gordon Brown’s chancellorship immediately when Labour came into power in May 1997 whereby the financial supervision role of the Bank of England alongside the Treasury was hived off to the FSA. In Adair Turner’s view, The way that the tripartite system worked post 1997, and especially the relationship between the Bank of England and the FSA reflected a particular philosophy of the time, and in retrospect, I think everyone recognises that a different approach would have been better. The Bank was focused on its monetary policy mandate. The FSA focussed on micro-prudential supervision on an institution by institution basis, and on an interpretation of that which was fairly legalistic and focused on systems and processes. Somewhere between the big picture got lost; the overall trends in credit extension across the economy and in assets prices were not put together with certain business developments to sound a warning. To be more concrete: back in 2005, there was not a process between the Bank and the FSA of saying look we have a large current account

When the Banks Stopped Lending to One Another

47

balance of payments deficit requiring the outflow of capital, rapid credit growth, rapid growth of securitised lending to mortgage markets, rapid development of some go-getting mortgage banks – HBOS, Alliance & Leicester, Northern Rock and so on – which were heavily reliant on both the ability to sell mortgage securities through to US mutual funds and the ability to borrow money wholesale in the inter-bank market… there was a failure to put all of that together and say, ‘faced with this, we want to be imposing levers on the liquidity or the capital policy of HBOS or Northern Rock.’ There wasn’t the philosophy that this was really part of either institution’s job. There was no definition of the levers to pull if you decided there were problems – no concept of counter-cyclical capital and so on. (Prospect 2009: 35)18

But if the tripartite system is to be replaced, by what? John Gieve, now out of the Bank and in the City, asks: do we need a different sort of regulation for finance? When we regulate the electricity or the telecoms industry what we’re talking about is economic regulation, which looks at industrial structure, pricing and market power – but apart from occasional forays by the OFT we don’t do that in finance. Perhaps we should take that sort of economic regulation into finance – and the Conservative proposal, which has had less attention than the breakup of the FSA, is to bring the OFT and the consumer bits of the FSA together which might give you something which could be the basis of a new form of economic regulation. (Prospect 2009: 37)

For Adair Turner, however, [Concerning] the size and profitability of the financial sector you must separate out the retail activity and the wholesale. On the retail side there is no evidence that it is too large in terms of employees or in terms of margins – the margin between what you get on a deposit and what you pay on a loan hasn’t gone up over the last 30 years. And the CEOs of the major retail banks are paid what the CEOs of the major retailers are paid. What is surprising is when you go to the wholesale side, and you see the enormous amounts of money that are made out of the provision of liquidity or the provision of complicated products or bits of the asset management industry or the hedge fund industry – those are activities that have ballooned in size, appear to be making hugely more money than 20 years ago, and where you end up with levels of personal remuneration which are just stunning. And the trouble is that the sort of economic regulation that John is talking about is hardest to do where it is needed most, on the wholesale side. Why? Partly because prices are opaque so that there’s nothing you can actually get your arms around and regulate. Secondly, it is truly global, and unless you can get a rigorous global agreement, there’s a problem. (Prospect 2009: 37)

A chief case in point is banking, concerning which Paul Woolley raises a crucial question, the answer to which goes to the heart of the global financial crisis and beyond. Banking and finance has become by far and away the largest global industry in terms of revenue, long-term profitability and share of GDP. It is strange that an industry whose function is the quite utilitarian one of converting savings into real investment should have become so 18

For a consideration of the idea of cycles see 11.2: Beyond Cycles.

48

Finance at the Threshold dominant. We need to ask how it has come about that this intermediary role is being performed at such high cost to society, with such complexity and capacity for systemic collapse. There are several explanations. One is the so-called ‘agency problem’ which I just mentioned and which confers on banks, fund managers and so on, the power to capture a disproportionate share of the returns from the productive economy. (Prospect 2009: 36)

In recognising that the banking and finance system is ‘larger than is socially optimal’, Adair Turner adds: Now, unless you’ve got a theory that explains why financial intermediation suddenly needs all this extra resource, there is something of a conundrum. Is it really the case that financial intermediation today is a more complex thing than a decade or two back? At a pinch you could argue that as people get richer, they recycle more money from one bit of their life to another bit of their life … But you still have to say that a lot of the increase of the balance sheets of the banks was derived from activities internal to the banking system. And you have a financial system that creates products which at one level help you to hedge volatility but which can also be used in ways that create more volatility. It is hard to distinguish between valuable financial innovation and non-valuable. Clearly, not all innovation should be treated in the same category as the innovation of either a new pharmaceutical drug or a new retail format. I think that some of it is socially useless activity. On the other hand, I don’t know whether that means the world would have been better off without any credit default swaps, or simply some credit default swaps. I just think it’s difficult to work out where one can draw the line with this. And that leads me away from the idea that regulators should be saying: product X bad, product Y good, and more towards a set of mechanisms such as high capital requirements which create hurdles19 for new products, but do not stop those that are of obvious value. (Prospect 2009: 37)

Then there is the vital [practical] question of the role of London as a financial centre. According to Adair Turner, Moreover, there are many good economists, for example, who work for investment banks yet none of them are likely to write papers that suggest the financial sector has got too large. And also the fact that in Britain the financial system is very big and was a large source of taxation revenue – both through corporation tax and income tax – was bound to reinforce the political idea that a relatively light-touch regulatory regime must be a good thing, and therefore we should not just be regulating for the competitiveness of London as a financial centre. (Prospect 2009: 40) I think London will continue to be a major financial centre and I say that despite agreeing that the whole financial system has grown bigger than is socially optimal. There will still be the process of researching, distributing and trading equities, there will still be Lloyds of London doing wholesale insurance, there will still be ship-brokers and so on, and I think the

19 A Swiss colleague, and fellow author, Marc Desaules (2004), suggests a different picture. Imagine one is walking across a room with a tray of water. Any movement will set up a surge, which will easily get out of control. One can mitigate this problem by placing bulwarks (rather than hurdles), as in ships that carry liquid cargos.

When the Banks Stopped Lending to One Another

49

concentration effects in financial services are very strong – London is a classic cluster and it will remain the dominant time zone centre in Europe. From the point of view of Britain as a whole we have over-relied on the City and we need other dynamic sectors, but in 20 or 30 years London is not going to have shrunk to the equivalent of Rome. There will remain four or five global financial centres, and it is almost certain that one will be London. (Prospect 2009: 40)

Finally, in response to Gillian Tett’s question: ‘If you look back has securitisation been a good thing for the financial system or not?’, Adair Turner said, ‘That’s a good question, and the answer is that I don’t know. The complex form of securitisation which grew in the past ten years was a bad thing. I think it is possible that the original developments of it were a good thing, but we just don’t know what is the optimal form of credit intermediation. The basic arguments for it are sound ones [but] the problem was that it became over complicated, we had securitisation and re-securitisation, we had the over development of the credit-derivatives swaps market – somehow we just created this empire of activity. We need to create a stable and sensible form of securitisation rather than the monster of the past five years’ (Prospect 2009: 39).

2.3.8 Dirk Bezemer One who claims the global financial crisis was not a surprise is Dirk Bezemer. In a letter entitled, ‘Why Some Economists Could See It Coming’, published in the Financial Times on 8 September 2009 (Bezemer 2009a), he claimed that ‘many had seen it coming for years. They were ignored by an establishment that [relied on] a model world where debt does not exist.’ Referring to a study he had made (Bezemer 2009b), he cited Kurt Richebächer, an investment newsletter writer, Wynne Godley of the Levy Economics Institute, and Michael Hudson of the University of Missouri to support his argument that, given that ‘the economy’s assets and liabilities must balance, growing financial asset markets find their counterpart in a growing debt burden … [users of] flow-of-funds models [can] foresee when finance’s relation to the real economy turns from supportive to extractive, and when a breaking point will be reached. [Yet] such calculations are conspicuous by their absence in official forecasters’ models in the US, the UK and the Organisation for Economic Cooperation and Development.’ He ended by observing that since ‘the financial sector is just as real as the real economy … policymakers, and the analysts they rely on, ignore balance sheets and the flow of funds at their peril – and ours.’

2.3.9 Krugman vs. Cochrane In September 2009, two well-known American economists – Paul Krugman of Princeton University and John Cochrane of Chicago’s Booth School of Business –locked horns on the question of ‘how did economists get it so wrong?’ In a New York Times piece, ‘How Did Economists Get it So Wrong?’, dated 6 September 2009, Krugman (2009) commented as follows: Macroeconomics has divided into two great factions: ‘saltwater’ economists (mainly in coastal U.S. universities), who have a more or less Keynesian vision of what recessions are all about; and ‘freshwater’ economists (mainly at inland schools), who consider that vision nonsense. Freshwater economists are, essentially, neoclassical purists. They believe that all worthwhile

50

Finance at the Threshold economic analysis starts from the premise that people are rational and markets work, ... saltwater economists [are] pragmatists. In the saltwater view, active policy to fight recessions remained desirable and economics, as a field, got in trouble because economists were seduced by the vision of a perfect, frictionless market system. In the 1930s, financial markets, for obvious reasons, didn’t get much respect … [but by] 1970 or so, however, the study of financial markets seemed to have been taken over by Voltaire’s Dr. Pangloss, who insisted that we live in the best of all possible worlds. Discussion of investor irrationality, of bubbles, of destructive speculation had virtually disappeared from academic discourse. The field was dominated by the ‘efficient-market hypothesis,’ which claims that financial markets price assets precisely at their intrinsic worth given all publicly available information … And by the 1980s, finance economists were arguing that because financial markets always get prices right, the best thing corporate chieftains can do, not just for themselves but for the sake of the economy, is to maximize their stock prices … The theoretical model that finance economists developed by assuming that every investor rationally balances risk against reward is wonderfully elegant. And if you accept its premises it’s also extremely useful. [But] finance economists rarely asked the seemingly obvious (though not easily answered) question of whether asset prices made sense given real-world fundamentals like earnings. Instead, they asked only whether asset prices made sense given other asset prices.

To this Cochrane (2009) provided the following riposte: Krugman’s attack has two goals. First, he thinks financial markets are ‘inefficient,’ fundamentally due to ‘irrational’ investors, and thus prey to excessive volatility which needs government control. Second, he likes the huge ‘fiscal stimulus’ provided by multi-trillion dollar deficits. It’s fun to say we didn’t see the crisis coming, but the central empirical prediction of the efficient markets hypothesis is precisely that nobody can tell where markets are going – neither benevolent government bureaucrats, nor crafty hedge-fund managers, nor ivory-tower academics. This is probably the best-tested proposition in all the social sciences. Krugman knows this, so all he can do is huff and puff about his dislike for a theory whose central prediction is that nobody can be a reliable soothsayer. Krugman writes as if the volatility of stock prices alone disproves market efficiency, and efficient marketers just ignored it all these years. This is a canard that Paul knows better than to pass on, no matter how rhetorically convenient. (I can overlook his mixing up the CAPM and Black-Scholes model, but not this.) There is nothing about ‘efficiency’ that promises ‘stability.’ ‘Stable’ growth would in fact be a major violation of efficiency. Efficient markets did not need to wait for ‘the memory of 1929 … gradually receding,’ nor did we fail to read the newspapers in 1987. Data from the great depression has been included in practically all the tests. In fact, the great ‘equity premium puzzle’ is that if efficient, stock markets don’t seem risky enough to deter more people from investing! Gene Fama’s PhD thesis was on ‘fat tails’ in stock returns. It is true and very well documented that asset prices move more than reasonable expectations of future cashflows. This might be because people are prey to bursts of irrational optimism and pessimism. It might also be because people’s willingness to take on risk varies over time,

When the Banks Stopped Lending to One Another and is sharply lower in bad economic times. As Gene Fama pointed out in 1972, these are observationally equivalent explanations at the superficial level of staring at prices and writing magazine articles and opeds. Unless you are willing to elaborate your theory to the point that it can quantitatively describe how much and when risk premiums, or waves of ‘optimism’ and ‘pessimism,’ can vary, you know nothing. No theory is particularly good at that right now. Crying ‘bubble’ is no good unless you have an operational procedure for identifying bubbles, distinguishing them from rationally low risk premiums, and not crying wolf too many years in a row. But this difficulty is really no surprise. It’s also the central prediction of free-market economics, as crystallized by Hayek, that no academic, bureaucrat or regulator will ever be able to fully explain market price movements. Nobody knows what ‘fundamental’ or ‘hold to maturity value’ is. If anyone could tell what the price of tomatoes should be, let alone the price of Microsoft stock, communism would have worked. More deeply, the economist’s job is not to ‘explain’ market fluctuations after the fact, to give a pleasant story on the evening news about why markets went up or down. Markets up? ‘A wave of positive sentiment.’ Markets went down? ‘Irrational pessimism.’ (And ‘the risk premium must have increased’ is just as empty.) Our ancestors could do that. Really, is that an improvement on ‘Zeus had a fight with Apollo?’ Good serious behavioral economists know this, and they are circumspect in their explanatory claims so far. But this argument takes us away from the main point. The case for free markets never was that markets are perfect. The case for free markets is that government control of markets, especially asset markets, has always been much worse. Free markets are the worst system ever devised – except for all of the others. Krugman at bottom is arguing that the government should massively intervene in financial markets, and take charge of the allocation of capital. He can’t quite come out and say this, but he does say ‘Keynes considered it a very bad idea to let such markets … dictate important business decisions,’ and ‘finance economists believed that we should put the capital development of the nation in the hands of what Keynes had called a `casino.’’ Well, if markets can’t be trusted to allocate capital, we don’t have to connect too many dots to imagine who Paul has in mind. To reach this conclusion, you need theory, evidence, experience, or any realistic hope that the alternative will be better. Remember, the SEC couldn’t even find Bernie Madoff when he was handed to them on a silver platter. Think of the great job Fannie, Freddie, and Congress did in the mortgage market. Is this system going to regulate Citigroup, guide financial markets to the right price, replace the stock market, and tell our society which new products are worth investment? As David Wessel’s excellent In Fed We Trust makes perfectly clear, government regulators failed just as abysmally as private investors and economists to see the storm coming. And not from any lack of smarts. In fact, the behavioral view gives us a new and stronger argument against regulation and control. Regulators are just as human and irrational as market participants. If bankers are, in Krugman’s words, ‘idiots,’ then so must be the typical treasury secretary, fed chairman, and regulatory staff. They act alone or in committees, where behavioral biases are much better

51

52

Finance at the Threshold documented than in market settings. They are still easily captured by industries, and face horrendously distorted incentives. Careful behavioralists know this, and do not quickly run from ‘the market got it wrong’ to ‘the government can put it all right.’ Even my most behavioral colleagues Richard Thaler and Cass Sunstein in their book ‘Nudge’ go only so far as a light libertarian paternalism, suggesting good default options on our 401(k) accounts. (And even here they’re not very clear on how the Federal Nudging Agency is going to steer clear of industry capture.) They don’t even think of jumping from irrational markets, which they believe in deeply, to Federal control of stock and house prices and allocation of capital.

2.3.10  Alternative Perspectives The global financial crisis is an occasion for other paradigms to argue their case, each of them in their own way claiming to represent a path away from or beyond capitalism’s supposed impasse. Often their approach is self-described as ‘ethical’ or ‘social’, a tag that more than implies a view that ‘normal’ finance is both unethical and unsocial. To be sure, one can distinguish between a financial and a social profit, for example, but these do not necessarily mean different things. They could be two ways of looking at the same thing. It would be more useful and accurate to distinguish between embedded and emancipated or abstract finance, than to assume that what is abstract is also unethical and unsocial. It may simply refer to leaving behind one version of ethics and social before another is discovered. It is in the nature of abstraction that it repudiates or eclipses the matrix (or matrices) from which it has abstracted itself. This is what adolescents do when they deem themselves more important than their parents or teachers. But once one has put oneself on the map, claiming to be the centre of the universe, the question arises: how is one, with all one’s uniqueness, to serve humanity? Few people are paid just for being unique: they are paid because their uniqueness enables them to bring something to the table that the rest of us need. Modern capitalism, along with abstract financialism, can be seen as an adolescent phase of development. Its purpose is to eclipse all other value systems in order to bring the whole of humanity to a spiritually neutral place in which no one version of spirituality holds sway over any other, but in which everyone mutually recognises everyone else. One needs to ask, therefore, when a form of finance or economics claims to be ethical or social, exactly what is the value system it refers to and could that not also be achieved by a metamorphosis of capitalism. Indeed, at the end of the day, if one makes a list of all the criticisms that non-capitalist perspectives proffer one has the equivalent of a photographic negative of what capitalism has yet to address. Opposing shareholders to stakeholders, for example, is too simplistic. In a global economy, a business that ignores the profits it makes because it has been able to socialise costs would be unwise to bank on such profits permanently. It is similarly old hat to oppose the long term to the short term. Many do, of course, and yet in September 2009 an important BBC Radio 4 broadcast featured many people from finance saying it was almost amateur to think in such terms. Better is to think of both, not to prefer one over the other.

When the Banks Stopped Lending to One Another

53

Admittedly, on the road to abstraction finance does prefer the short term to the long term. Unlike classic German banking, British banking does prefer to stay ‘out’ of the enterprises it lends to. But once abstraction is complete, re-embeddedness becomes a necessity. The concern is mainly that it should not entail a walking backwards in history, a return to unconsciousness. But the problem with many alternatives is just that, namely, they require us to accept an ideology or religion or given set of values, rather than discover any universal value within finance. Thus, monetary reformists rely on statism, especially state-issued credit; Japanese, Korean and Chinese economics rely on forms of corporatism (as does the American business model); Islamic economics relies in fact on Shari’a law. Islamic economics in particular has long been critical of western finance and sees the global financial crisis as an opportunity to argue its case. In this author’s opinion, however, the issue is whether the claimed discrepancy between ideals and behaviour is overcome by adherence to an external moral standard (in Islam’s case the Koran and Shari’a law) or by recourse to state subsidies of one kind or another, ranging from deposit insurance to fullfledged bail outs. Or whether we may yet arrive at universal precepts, albeit anarchically or, better put, autopoietically, achieved, which is what western economics is presumably counting on. And it is worth pointing out that Islamic economics nevertheless looks to England and London. To quote Mushtak Parker, writing in a special issue of The Times on 27 November 2008: ‘Most Islamic bankers would agree that London and English law is their preferred jurisdiction when structuring international deals. British financial expertise … is arguably the best in the world.’ It is only capitalism that risks all on the individual, that looks to the individual as its essential ‘motor’. The problem therefore is almost as simple as figuring out how one goes from ‘me’ to ‘we’ (to use John Davis’s (2004) formulation) in the way we behave economically and financially, from asserting oneself above the community, to being recognised by the community. In this regard, a further dimension needs to be reckoned with, namely the technical basis of economic life. Whatever one’s philosophy or uniqueness, it cannot today entail its imposition on or required acceptance by anyone else. When a loaf of bread is exchanged for some money the parties to the trade cannot be required to be of one religion. Trade necessarily entails a moral no-man’s land. That does not mean it is immoral or even amoral. In fact, it calls on all moral perspectives to enhance themselves by including rather than negating the others. The fact of financial history is that the more cultural diversity is to thrive, the more must the technicality of economic life become the same. And it is far from clear or certain that ‘ethical’ or ‘social’ financial systems are technically so different to ‘unethical’ and ‘unsocial’ systems. The responsibilities of a fiduciary agent, for example, do not operate in the one but not the other. ‘Creative’ accounting is not a phenomenon only to be found in western finance. To focus alternative economics on food and localisation is understandable enough, but one needs also to explain how the world’s airlines are to be organised, or global car production. It is also quietly insulting, if not arrogant, to claim the moral high ground in finance. There are many people in finance and much in its techniques that is of a high moral order, or presupposes such. Central bankers, for example, see themselves as ‘enlightened princes’ in matters of price stability, possessing, or at least representing, a state of awareness in advance of the population generally. Such has always been the responsibility of an elite

54

Finance at the Threshold

in the strict sense of the word. An elite is required to bring ‘the rest’ of a population up to its level, not ‘privatise’ the information they have. ‘Elitism’ is a reference to the latter. The term is not a description of the nature of a true elite, but of a failed elite. Furthermore, nowadays citizens generally ought to be able to match the consciousness of the elites of old, demonstrating ‘enlightened’ behaviour born of their own literacy and sense of social responsibility. That is why, in this book at least, the emphasis is on the adult phase of capitalism, the awakening of every individual to his effects in economic life so that he can become aware also of his motives. For the most part we remain just actors, using the economy without consciousness of doing so. But if we can take this step we will discover in our own behaviour the well-springs of all those aspects of life, so-called ethical and social, that immature, adolescent capitalism leaves out of account. If one becomes a Buddhist and so practises Buddhist economics, for example, it comes down to compassionate behaviour, suffering with the others, not just letting the devil take the hindmost because ‘world prices’ have moved against the coffee market. Similarly, just as Islamic economics does not hold an individual entrepreneur responsible if the conjuncture is the cause of a problem, so western finance does not have to foreclose on a business at a moment of weak balance sheet. It chooses to do so because of a narrow mindset. And yet, what is the rationale of saving a bank if it threatens systemic collapse, except a sense that some businesses are crucial to the wider economy? Is it such a huge leap to see that every business is in fact linked to the wider economy in this way. Moreover, what, economically, is achieved by selling someone’s house out from under him when he cannot meet his mortgage payments? The individual is ‘punished’, but at what waste? What costs are unnecessarily incurred? What opportunities thwarted? If it is going to do anything with taxpayers’ money, why could a government not simply provide mortgage relief to the individual against a pay-back scheme where he ‘learns’ the lesson (if that be the point) of playing loose with credit and real estate. It does not always do us justice to cry ‘moral hazard’, to default to negative scenarios just because in the back of our minds we have a low opinion of human nature. We could equally invent ‘moral literacy’, or some such term, and devise schemes that encourage alertness rather than sleep. If in this book we have not given serious space to the alternatives to capitalism and financialism, the reason is specific. In their different ways, they suppose western finance is unable, out of itself, to engender ethical conduct. This is not an assumption we make. Indeed, if the many things capitalism is accused of leaving out of account are to be addressed they will require a going through modern finance, not a going round it. Others have extensively and eloquently argued the case for non-capitalist perspectives, so the focus of this book is elsewhere. It is not that one is unaware of or unsympathetic towards the many critiques of capitalism. The point is that they arise because capitalism is failing to undertake its own further development, to include what it has necessarily to date excluded. To internalise what it has externalised. But a single global economy will not allow this to continue. Rather, therefore, than look to other economic paradigms, preferring, for example, Islamic economics (to mention the most powerful), why not ask how can capitalism on its own terms address the problems its critics point out? Clearly if it cannot or will not then we have a serious problem on our hands. But this judgement cannot yet be made because the debate is still framed in terms of preserving or replacing capitalism rather than guiding it through a metamorphosis, a metamorphosis

When the Banks Stopped Lending to One Another

55

that, if it is to be truly grounded, has to pass through the individual’s own awareness and behaviour. In this regard, it is telling that in an age when the individual could and should become the locus of economic and financial evolution, one so often refers (and defers) to ‘the authorities’, instead of seeing one’s own behaviour as capable of being authoritative. Authoritative in both senses – that we can be the authors of more conscious finance, and that were we to become so our behaviour would evince inherent morality. It would be moral by dint of consciously directed behaviour, not because it conformed to some external religious or political edict.

2.4  Technical Details The sequence of events and the myriad processes that culminated in the global financial crisis, along with practitioners’ explanations of them, is one aspect of the story. Another is what one might call the ‘technical details’, of which the following list, while not claiming to be exhaustive, is very representative of today’s financial system.

2.4.1  List of Technical Details Epistemology Faux physics Modelling Computer modelling Model dependency Interdependence via IT Human Weaknesses Greed re. fees Liar loans Dishonesty Conflict of interest Fraud Cronyism Ephemera Confidence Moral hazard Obscurity Reversed Causation From savings to money markets Consumer over-borrowing followed by government rescue Consumer debt Precarious information Asset price funding returns liquidity to financial sector

56

Finance at the Threshold

Theory Efficient markets failure? Intellectual capture Free market ideology Macro Policies Central bank independence Role of London Regulation Regulatory avoidance Over-complex regulation Light touch Split regulation Financial deregulation Repeal of GS Act Tripartite Rules and Practices Ignored high risk mortgages Changed rules (IPOs and mortgages) Sub-prime Ignored warnings Products Derivatives CDSs CODs Techniques Short selling Presounding Leverage Hedge funding (Re)securitisation Future markets Agencies Agencies Credit rating agencies Carry trade Single individuals Threshold Economics Excess liquidity Ever-rising real-estate values Global chasing of real-estate markets

When the Banks Stopped Lending to One Another

57

Banking Parallel (shadow) banking Short-termism Beyond banking

2.4.2 More on Methodology The list was initially derived from the commentaries presented in the previous section. It was then organised firstly so that each detail is only mentioned once (even though it may have been identified more than once, e.g. conflict of interest), and secondly to introduce some degree of categorisation. The categories are those that the data themselves seemed to suggest. Doubtless such triage could be undertaken differently, but the point here is not to define what is or should be in the world of finance, but to describe and characterise that world in a way that is reasonable. That said, whether the categories used here, the way they have been sequenced and the story they purport to tell are convincing to the reader is for him or her to decide. The purpose of the list is to do no more than provide (a) an overview of the complexity of finance and (b) a sense for what seems to be its obvious gesture, namely a strong degree of abstraction. Again, before one says life should not be so abstract and begins to pine, and even opine, for a return to earlier times, the question needs to be asked: ‘Maybe we have extricated ourselves from the mores of yore in order to enter into a new reality, one we consciously author rather than inherit from the gods or monarchs in exercise of their divine right?’ In this sense, the list and the brief descriptions that accompany it are like the unfamiliar language of an equally unfamiliar world as it comes towards us from out of the future. We are inclined, of course, to explain this new landscape and its terminology in the terms to which we are accustomed. But the challenge is to still this inclination in order that a more refined sense of finance may appear, both in our minds and in our behaviour. So that finance may speak to us, rather than we to it. As with the chronology, the list aims at neutral exposition. By ‘technical details’ one means a range of topics: how the banking system works, the role of monetary policy, the concept of financial stability, the nature of financial ‘products’, the place of agents, the psychology of investing, and so on. Of these, however, as well as for the reasons given earlier, the last shall be excluded as outside our province, partly on the grounds of lacking competences but also because one wonders if behaviour would have been as it was had there been more awareness of the fuller nature of financial techniques. The list is deliberately random, even arbitrary, except that the all-of-a-piece nature of global finance hardly allows one the luxury of separate elements. While one may wish to pick and choose, attributing culpability to one aspect or another, the likelihood is that this is a technical impossibility. The underlying question has to be: which came first, the techniques or the ballooning of finance? Again, the answer is likely to exhibit reflexive causation. Finance is more membrane or organism than machine. To a certain extent, therefore, one can begin the list anywhere and reshuffle it as one’s fancy takes one. The question to ask is: ‘Could any one of these techniques be given up without deflating the balloon, bursting the bubble or collapsing the system?’ More to the point, despite intense scrutiny and critique, what part, if any, of the global financial

58

Finance at the Threshold

system has in fact been got rid of? Since such technical details are an integral part of modern finance, their continued presence presumably means the global financial crisis has gone quiet rather than gone away.

2.4.3  A Story (of Abstraction) Emerges The chosen triage does of course reflect the author’s sense of things. Since bias is often better expressed than suppressed, made conscious rather than hidden, the following story of emerging abstraction is what the details seem to illustrate. It is for the reader to decide how real or convincing is the linking narrative.

Epistemology Faux physics  An essential and rational starting point for understanding modern finance is the thoughts we have about it and whether these thoughts comport with or distort reality. Economics by and large models itself on the ‘hard’ sciences, because it imagines it can approximate normal physics, even though nothing in its purview is sense-perceptible. One could therefore begin with epistemology and faux physics in particular.

Modelling Computer modelling/Model dependency/Interdependence via IT  From this it follows, as night does day, that one has then to model the economy as if it were something real, so that this model, albeit an approximation of reality, is assumed to be reality. Now one is at a remove, for we are not in the world of testing against external givens, such as the speed of an apple when falling to the ground. We are testing against assumptions and using computers and mathematics to do so. Mathematics, notably, operates independently of external sense data. A model might not fully represent reality and in that sense not be ‘good’, but it must exhibit internal logical consistency if it is not to be ‘bad’. The problem is clear already, we begin our reasoning at a remove and at that point what we think has no less reality than what we are trying to approximate. We run two important risks here, that our models are not a match for reality (though a reliance on mathematics may obscure this) and that, adrift in the realm of reason, we become dependent on our models. We prefer them over reality and go on, in fact, to change reality to match our model. Economics has the power, in other words, to make its equivalent to apples (i.e. values) fall faster or slower.

Human weaknesses Greed regarding fee /Liar loans/Dishonesty/Conflict of interest/Fraud/Cronyism  In such a world, once the Pandora box of finance is opened all manner of problems put in an appearance – of a kind which would have the ancients saying ‘we told you so’. The most important thing here is that once the ages-long constraints on human behaviour fall away, we become exposed to predictable human weaknesses that it takes considerable personal maturity and discipline to master.

When the Banks Stopped Lending to One Another

59

Ephemera Confidence/Moral hazard/Obscurity  Another is that ephemeral (or subjective) factors come into play that physical economics does not admit because it does not need to. The laws of physics pass outside the human being. Not so, those of finance.

Reversed causation From savings to money markets/Consumer over-borrowing followed by government rescue/ Consumer debt/Precarious information/Asset price funding returns liquidity to financial sector  With finance come all the problems associated with reflexive causation (discussed in detail later), problems that cannot be understood, let alone remedied, if we insist on normal causation.

Theory Failure of efficient markets hypothesis?/Intellectual capture/Free market ideology  The greatest risk is that we will lose our bearings and find ourselves all at sea. In such a situation, try as we might, it is not easy to capture in our mind’s eye all the factors at work, let alone devise a cogent explanation of them. Much then depends on the theories with which we underwrite our ideas and even policies. Chief among these has to be the efficient markets hypothesis and its cousins or supporting cast, such as rational expectations, BlackScholes, and so on. One might not like or agree with such theories but when it comes to modern finance who can better them? Who, also, can avoid becoming spellbound by their explanatory power, especially when advanced in the wider context of free market ideology?

Macro policies Central bank independence/Role of London  If it were only a question of contemplating the economy, such things might not matter. But the economy has to be managed and so no theory can exist except that it is at the same time the justification of policy, especially macro policy. In particular, the global financial crisis can in no wise be disassociated from the global financial architecture, and also the global financial geography with London at its centre.

Controlling regulation Over-complex regulation/Split regulation/Tripartite  All-pervading, the global financial architecture is an admix of regulation and free markets (which is a form of regulation itself, of course). The way in which regulation is conceived, organised and applied is thus crucial to the way human beings behave both individually and in aggregate (markets).

60

Finance at the Threshold

Enabling regulation Regulatory avoidance/Light touch/Financial deregulation/Repeal of GS Act/Ignored high risk mortgages/Changed rules (IPOs and mortgages)/Sub-prime/Ignored warnings  But regulation should not be thought of only in terms of external imposition or control. It can as easily be enabling or prompting. That is to say, just as it can constrain behaviour, so it can set it free by, for example, relaxing, ignoring and even contradicting the norms of traditional prudence.

Products and techniques Derivatives/CDSs/CODs/Benefits to the financial sector benefits us all/Short selling/Presounding/ Leverage/Hedge funding/(Re)securitisation/Future markets  Whether deliberately or accidentally, once regulation is relaxed the constraints of yore no longer operate and – seen from the ancient past – our ever more abstract way of being and behaving becomes reflected in products and techniques that are all at a remove from a physical/real economic point of view.

Agencies Agencies/Credit rating agencies/Carry trade/Single individuals  Such remoteness from ‘normal’ reality is further reflected in the use of agencies – the dangerous split between being responsible for something, detailed knowledge of which one depends on others for. More dangerous still, information gaps can open up and be exploited. Worse, global-scale events can become vested in the actions (or inactions) of single individuals.

Threshold economics Excess liquidity/Ever-rising real-estate values/Global chasing of real-estate markets  Finally, our alienation undermines our ability to observe the true nature of processes that are central to modern economic life and which in many ways give rise to its financial aspect. Two deserve special mention because they are also key to how one can go, not backwards from abstraction to earlier forms of stability, but forwards beyond abstraction, to a stability that appears to be inherent rather than created from outside. (See Chapter 11: Deep Accounting.) They are the fact that the individuation and emancipation of humanity yields ever-greater amounts of surplus capital, excess liquidity. This is a source of great value that cannot be stopped up. But nor, to mention the second example, can it be rerented back into the physical economy (and real estate in particular) beyond a certain amount? To use an image from Steiner, every wheat harvest of, say, 100 sacks of corn only needs one sack to be held back in order to produce the next 100. The other 99 must be used up. This is the nature of economics at the interface between the real and financial economies, the nature of threshold economics.

Banking Parallel (shadow) banking/Short-termism/Money markets/Beyond banking  Very finally, the entire nature of banking becomes transformed by the onward march of financial

When the Banks Stopped Lending to One Another

61

history from being embedded in and dependent upon the physical economy, to being an autonomous, shadow or parallel operation. At this point the cry goes up to distinguish between retail and wholesale, for example, which is understandable enough. But it will be of no avail to try and make wholesale behave as if it were retail. At best, the banking system, to the extent that it continues to exist in its conventional sense, can be confined to retail banking; but the wholesale needs to be conceived as part of a process rather than a system. Then it will not be described as a shadow, but as belonging to a different order of things. At which point an intractable problem begins to become tractable, because the ideas we form about it will become a fit for what lies behind it, not a straitjacket we would impose upon it.

2.4.4 Products and Techniques The list of technical details included a number of products and techniques, some of which merit, if only briefly, further focus in order to underline the abstract nature of modern finance that is being stressed in this account. Our purpose, to repeat, is to acquaint one with this abstraction before one reacts to it. Moral indignation seldom advances objective inquiry. The examples below are baldly stated on purpose. The examples are baldly stated on purpose. Others could be mentioned, but those cited serve the purpose here, of illustrating abstraction.

CDOs Collateral debt obligations (CDOs), for example, were sold to insurance companies, resulting in a 1:40 pyramid centred on London. Claiming to be without risk (causing practitioners to feel silly if they wondered how), they allowed the normally tenacious link between the two sides of a balance sheet to become tenuous. Not unconnected, but reliant on an element outside normal view. For example, McKinsey’s accounting of global financial assets excludes derivatives.

Derivatives Derivatives are agreements to shift risk among market participants in exchange for a fee. This feature of making the real basis of transactions remote is worth noting.

Computer modelling Financial firms have come to rely heavily on ‘value at risk’ computer programs using past experience to anticipate possible losses. These methods provided reassurance to investors following the 1987 stock market crash and the rescue in 1998 of Long-Term Capital Management (LTCM), a big hedge fund guided by Nobel prize economists. In a pattern repeated in the 2007–2008 sub-prime/derivatives crisis, LTCM employed portfolio theory in using $2.2 billion in investors’ funds as collateral to buy $125 billion in securities and then pyramid this paper as collateral in exotic transactions worth $1.25 trillion. The methodology gained prestige during the decade October 1998 to June 2007, when banks’ share prices rose by nearly 60 per cent and their business volume tripled.

62

Finance at the Threshold

The consequence, according to Andrew Haldane (2009), Executive Director, Financial Stability, Bank of England, was that ‘many risk management models developed within the private sector during the Golden Decade were, in effect, pre-programmed to induce disaster myopia.’

Short selling (source: Investopedia) Short selling means going long on an investment because one buys a stock believing its price will rise in the future. Conversely, to go short is to anticipate a decrease in share price. But ‘short selling’ refers to the selling of a stock that the seller does not in fact own directly but has promised to deliver. When you short sell a stock, your broker will lend it to you. The stock will come from the broker’s own inventory, from another one of the firm’s customers, or from another brokerage firm. The shares are sold and the proceeds credited to your account. Sooner or later you must ‘close’ the short by buying back the same number of shares (called covering) and returning them to your broker. If the price drops, you can buy back the stock at the lower price and make a profit on the difference. If the price of the stock rises, you have to buy it back at the higher price, and you lose money. Here again remoteness (or super-abstraction) is a feature. As is the danger of [exponential] events if the practice of an individual becomes that of a ‘herd’, let alone of the system as a whole.

Presounding (source: Financial News) The ‘presounding’ of deals in the bond market is legal and involves an investment bank approaching an investor with basic and often vague details of a potential transaction to gauge demand. In and of itself and in ‘normal’ conditions it can be seen as benign, notwithstanding the potential it affords for unscrupulous trading. But when turmoil occurs in credit markets the number of deals involving presounding is likely to escalate.

Agencies It is part and parcel of modern finance to use and become reliant on agencies; that is to say, to share awareness of a transaction. This can be as dangerous as sharing a car when it comes to knowing if there is oil in the engine. The one hand may not know what the other is doing. Moreover, agents have their own interests in mind. They may not downgrade credit ratings, for example, if their own turnover and/or reputation will be adversely affected. They may not be able to keep apart auditing and consulting roles. Their appointment to or away from government posts, even after a due period, may not break the link between their now-public, now-private allegiances. Principal-agent concepts may theoretically address such problems, but people are, after all, only people.

Repeal of Glass-Steagall in 19­­­98 The 193­3 Glass-Steagall Act was introduced because at the time financial regulation was a nascent science and the financial community seemed unable to distinguish between wholesale and retail banking. Nowadays it is thought that both the science of finance and

When the Banks Stopped Lending to One Another

63

the behaviour of players have matured and that open, competitive environments keep everything in view. It is to be wondered, however, if we are, collectively, as grown-up and disciplined as we might like to be.

Central bank independence The general acceptance and therefore reinforced ascendance of operational central bank independence, more technically, ­­­ operational independence, has been a feature of the 1990s. The argument ran that central banks should be freed from the political imperatives of governments on the grounds that financial market competition is both a better allocator and a better regulator. People needed to be free of nanny state economics and the risk had to be run that, when left to their own devices, they would not dare behave imprudently.

Confidence One might not normally think of confidence as a technique. But techne refers to action and action in finance is ephemeral. Confidence extends maturity; loss of confidence extinguishes it. Confidence, however, is a form of financial doing, as can also be talking the market up or down. Meta-confidence, if you will.

Moral hazard The concept is a classic of monetary theory. Instances of the potential for it are equally well known. To name a few: bank deposit insurance, known governmental willingness to rescue a bank, taxpayer funding of what would otherwise be shareholder losses, the idea (even if disowned in small print) that house values can go ever upwards, the notion of ‘super-profits’ as if they were legitimate economic events rather than warning signals, etc. (Under this heading one should also include conscious and therefore deliberate imprudence, such as self-certified mortgage applications being known in the trade as ‘liar loans’.)

Leverage This is a crucial concept. Borrowed from physics, it has the ‘reputation’ of requiring mass in order to have effect and in the physical world, of course, one can only move the fulcrum so far towards the mass or downward pressure before no further upward movement becomes possible. However, finance is not physical and it is recursive. While we imagine some kind of downward pressure is applied in order to leverage a product, it may well be that the product, so to speak, lifts itself off the ground, thus exerting downward pressure on whatever it is linked to. This is or should be par for the course in our abstract stage of economic and financial evolution, only it seems not to be understood as such. As a result, many practices today exhibit a behaviour which is not truly explained by physical leverage and therefore in themselves constitute a danger if other realities are at work, such as in particular the credo that financial liberalisation is tantamount to, and even a proxy for, human freedom. The point is not made negatively, but it is deliberate because many financial conceptscum-techniques can arguably be understood to belong to such a world. To name some:

64

Finance at the Threshold

Hedge funding – the borrowing of money to multiply positions (more unkindly, ‘bets’). (Re)securitisation – the selling away of repackaged debt for a fee. Future markets – discounting for projected risk.

Excess liquidity Last but by no means least in this glossary of potential untowardness is the concept of excess liquidity and the knowledge that it (a) exists and (b) is increasing. It surely should set bells ringing when, rather than inhibit or in some way lessen the presence of excess liquidity, one tries to invest it for a fee if not a return. Liquidity, by definition is inactive, non-productive money normally known as cash to gamer to income. If one derives an income from it, let alone a full livelihood, let alone a substantial Christmas bonus, should one not wonder what is going on (even as one spends the money)? Is there not some contradiction of financial principle involved? The question is not a moral one. It is technical. If the apogee of humanity’s long journey of emancipation is worldwide excess liquidity is there not a message to be heard here? Liquidity might exist in excess while emancipation has yet to be achieved. But afterwards? In other words, is ‘excess liquidity’ the right name for the phenomenon, or is it masking some other reality?

High-frequency trading Definitions differ, but at its most basic, high-frequency trading implies speed: using supercomputers, firms make trades in a matter of microseconds, or one-millionth of a second. Goals vary. Some trading firms try to catch fleeting moves in everything from stocks to currencies to commodities. They hunt for ‘signals’, such as the movement of interest rates, that indicate which way parts of the market may move in short periods. Some try to find ways to take advantage of subtle quirks in the infrastructure of trading. Other firms are ‘market makers’, providing securities on each side of a buy and sell order. Some firms trade on signals and make markets.

Off-balance sheet Buckle and Thompson (1992) define off-balance sheet business as that which ‘guarantees a contingent commitment and generally an income to the bank without … being captured on the balance sheet under conventional accounting practices’ (73). Typical examples are: non–activated loan commitments, guarantees, swaps and hedges, securities underwriting, and foreign exchange dealings. Such business is accompanied by ‘[a] desire to escape capital adequacy controls,’ (78) which, especially since 1988, has in turn invited ongoing efforts to harmonise capital controls. Off–balance sheet business is characteristically fee-generating, enabling those concerned ‘to earn income without having to source funds or set aside capital or reserves.’ (Khoury 1990: 195). Swary and Topf (1992) attribute the rise in off-balance sheet business

When the Banks Stopped Lending to One Another

65

to ‘the development of [the derivatives] markets since the late 1970s … Financial futures … exist for a wide variety of instruments – debt, equity, currencies, and even indices … They have revolutionised risk, for example, by vastly increasing the importance of off–balance sheet assets as opposed to traditional assets’ (276). They point out, however, that ‘off-balance sheet activity, by its very nature, is difficult to capture accurately in traditional financial statements … greatly complicat[ing] the task of financial reporting …’ (344). Khoury addresses this in the following way: At issue here is the definition of what constitutes adequate capital because no capital ratio is adequate if the decisions on the asset side are substandard or if a bank run hits … The other issue is the definition of capital. Today it includes perpetual bonds, perpetual FRNs and perpetual preferred stock. This most liberal of definitions is troubling indeed because it creates an ‘equity illusion’ and increases the probability that creditors can force banks into liquidation … What should be considered is some form of netting schemes in which the natural hedges that off–balance sheet items provide for on–balance sheet items is accounted for. (1990: 228)

This page has been left blank intentionally

chapter

3 2007 – A Threshold in Financial Evolution

Was 2007 just one year among others? Or does it have deeper economic historical significance? Could the problem have happened earlier? Will it be repeated? Or is it a one-off in monetary evolution? The background was widespread financial liberalisation, a movement that culminated inevitably in the creation of a seamless, single world financial circumstance. Previously, financial crises were quarantined. What then changed? Traditionally, the extent of credit is governed by ability to repay, affordable rents in real estate, interest rates that stay well away from zero per cent, and all manner of regulation. With the financial liberalisation of the 1980s came the removal of many such constraints, largely on the grounds that economic life should be conducted by and between individuals, not their governments. Was this merely the ascendance of right-wing politics, or did it portend a new kind of economic consciousness?

3.1 Preamble The thesis of this chapter is that at some point in its history humanity was bound to arrive at the threshold of a new kind of economic reality. In short, the global financial crisis is a defining moment in human history, if not evolution. Humanity finds itself at the threshold of its future, at the brink of an abyss, at the edge of a precipice, confronted by a yawning gap, a break in continuity, beyond which lies the future. It has been brought to this pass by recent financial developments, the nature of which are highly abstract. Many recoil in moral indignation at this circumstance for which they hold nefarious groups and bankers generally accountable. Others see it as the ultimate pain before the ultimate gain. At last, the shackles of deism have been thrown off and even thrown away. It is time to see what the market will reveal to us. What is certain is that few people take it lightly. And yet, whatever their persuasion, whether of the Left or the Right and most points in between, most people see the global financial crisis as a quasi-natural event, a problem to be fixed. Unpredictable, perhaps, but ultimately manageable. One would like to think so and much is riding on that being the case. But it can be seen in quite another light – as a break from the past into a future that may not, in the fullness of time, allow persistence in the ways of thinking and behaving that have been valid until now. To wonder in this way is not to make a mountain out of a molehill. It is to share a question which, if subsequently found to have been useful, it would have been irresponsible not to articulate. This chapter therefore looks at the global financial crisis not in order to explain it, to say what it is (or was), but only to describe what it might represent.

68

Finance at the Threshold

‘What ifs’ are the stuff of economic and financial planning. This chapter is a ‘what if?’ that no one else may have contemplated. No insistence is made on the hypothesis it puts forward; nevertheless, one hopes that it will provide some aid to understanding and indeed navigating future economic life. Having profiled, hopefully faithfully, the global financial crisis in outer terms – its chronology, technical details and the way it is generally understood by financial professionals of various kinds and of various schools of thought – it is clear that, whatever their differences in regard to it, everything turns on whether the efficient markets hypothesis (and all that lies behind it) has had its day. In this chapter we change tack and consider the global financial crisis in the light of one of Rudolf Steiner’s key ideas, namely, that human history to date has been marked by the emancipation of the individual from all manner of previous social matrices – tribe, family, nation, etc. We have trodden this long road out of deism because we are on an even longer journey towards freedom (a term which, for Steiner, should never be spoken without its concomitant, responsibility).

3.2  The Long Road to a Single Global Economy This basic process informs many details – freedom of expression, democracy and property rights being obvious candidates. It also has a very evident counterpart in economic history, namely that initially local economies have been compelled to open up to and coalesce with their ‘surroundings’. Thus one can see that local economies melded into regional and countrywide economies, that these eventually took the form of national economies (several of which behaved as empires) until, towards the end of the nineteenth century, they were bound to coalesce yet further into a single global economy. This, the underlying fact and presence of a one-world economy, has been the cardinal feature of economic life ever since, despite the persistence of economic nationalism and even economic imperialism throughout that time. Such a condition, however, entails a fundamental problem that is both epistemological and geo-political: a single, world economy cannot be severally explained or severally operated. That means it needs to be understood in its own terms, that is to say, economically, and not in terms of how it might be used to serve other purposes – principally ideological or political. But what are those terms and can they be identified in and among the current, albeit competing explanations that otherwise prevail?

3.2.1  Two Strands in History This problem will not be noticed, let alone resolved, however, unless two strands of history, mistakenly now entwined with the economy, are discerned and given their proper status. One is the implication of the state at the moment that national economies arose – the idea that the state should have macro-economic responsibilities rather than private individuals collectively (not using the term in any soviet sense). This will not be resolved unless and until the rightful jurisdiction of the state is seen to be what Steiner calls the rights life* which for him moreover should remain nation-based. An example is property rights, on the clear enunciation and upholding of which economic activity depends.

2007 – A Threshold in Financial Evolution

69

The second is the transposition of freedom and responsibility from a spiritual or cultural key to an economic one. Individuation presupposes, even begets, the division of labour, the overarching fact that all economic life is ultimately the joint undertaking of humanity as a whole, with every individual included because of his comparative advantage, what he can contribute to society that no one else can. Understood in the first place not as economic concepts, but as images of mutual sovereignty, their true meaning is deeply historical, not merely technical. There can be nothing dismal about an economics that celebrates the entire family of man by celebrating the individuality of each member of it. This is where division of labour is leading us, to a world in which every human being recognises and hallows every other human being.

3.2.2  The Shell of a Nut For such a history to make sense, however, one needs to have a feeling for how economic life is at bottom a spiritual event; it is whatever it is because of the image we have of ourselves. For Steiner (1996a) the matter was clear: The economic life of a particular time, and the spiritual life of a particular time (the times are not quite identical), hold the same relation as a nut to its shell; the economic life is invariably the shell which the spiritual life has thrown out. It takes its cast from the spiritual life. Today’s abstract economic life is, therefore, the product of an abstract spiritual life. That is why today we are in an age of abstract thinking, of life-remoteness – unreal conjunctures and such things.

Individuation brings abstraction, and in an abstract civilisation, finance follows suit. It reflects back the way we have become. If we would that finance were otherwise than it is, we need to envisage ourselves differently, not hold the mirror to account. This we will not be able to do, however, unless economic life and rights life are allowed their distinct, but interwoven jurisdictions. Nowadays and even more so in the future, just as a nation cannot go global except that it becomes megalomaniacal, so the economic life can no longer remain in the confines of nations, not even nations in cohort. Once this is understood the economy as a whole and its abstract representative, ‘the market’, will be seen to be the place in which the enormous diversity of mankind becomes conscious of itself but needs to do so on a global, universal scale. Diversity becomes in fact the ‘driver’ of economic life, in lieu of inter-nation trade. As a concept, diversity, of all kinds, ought to have a place in the economic heavens as exalted as division of labour and comparative advantage.

3.2.3  Excess Liquidity Now – the period of the global financial crisis – is not the time to be financially Luddist. But nor is it appropriate to press on regardless as if finance were the new deism. Finance is both hiatus and awareness, a yawning gap and the bridge across it, the vestige of outmoded meanings and the dawn of new ones. Like its little brother, arithmetic, it can link us back to Abraham, the father of arithmetic, as surely, presumably, as it can cast our minds equidistant forwards! It is for this reason that, in terms of Steiner’s analysis, one can expect, as the crucial mark of our times, the phenomenon of burgeoning surplus capital. In that perspective,

70

Finance at the Threshold

a moment is bound to arise in history when there will simply be too much capital in the world for its (capital’s) own good. If one accepts Steiner’s thesis, or at least a clear implication of it, this is a foreseeable, predictable event. It belongs to the logic of economic history. The question that needs to be asked, therefore, is whether this is what is behind the presence in today’s world of ‘excess liquidity’, that being the other main phenomenon to which our various commentators drew attention. The excess liquidity of today is not a phenomenon in the abstract. It is the crown or flower of processes that have been long in train, culminating in the financial liberalisation of recent times. Much of modern economic life is the way it is because it is predicated on the concept of free markets and free competition, above all competition in finance. The idea of financial liberalisation is to open, by financial force if necessary, all the markets of the world so that the cold wind of price-driven efficiency may blow freely through them. This is the last stage in a long process intended to rid humanity of its ancient constraints, rigidities and inefficiencies. That is the logic of ‘outgrowing’ guilds, of enclosures, of undermining the power of unions, of lifting restraints in the movement of capital, and so many other aspects of Anglo-Saxon economic history. Like it or not, right or wrong, progressive or socially reprehensible, reformist or ruinous, once this has been achieved, so the argument runs, humanity will find itself in a brand new landscape in which the wisdom of the market will lead us forwards to our future. What that future is, none can, or should, tell. It will be revealed to us once we let go our preconceptions of or pretentions about it. It is part of this philosophy and outlook to break down, remove or subvert all boundaries until the economic life of the world is fully open. But open to what in the end? Trade with non-terrestrial partners? If not, and the prospect seems slim or at least remote enough not to be relied upon for immediate cash flow purposes, then the worry is that the opening up of markets will lead to there being no boundaries, save those of the world as a whole. This is why the global financial crisis is an epistemological event: it leads us to an unbounded world, the match for which, presumably, has to be unbounded thinking. But what does that mean in fact?

3.2.4  From Competition to Competition Not unsurprisingly, the literature on financial liberalisation, central bank independence, et al. is characterised by frequent recognition that supranational finance implies coordination and co-operation, rather than endless competition. The more central banking operates apolitically, for example, the more it acts in the best interests of the economy it represents. This does not necessarily mean acting in competitive mode, so much as out of a sense of global economic partnership, or, to put it in more usual language, in the spirit of internationally co-ordinated monetary policy. Although it was some 30 years ago, Gordon Richardson, when Governor of the Bank of England, gave a lecture in which he spoke clearly of this important dimension, using words that have lost none of their relevance. ‘It is, I think, difficult to believe that over the longer term so large a proportion of the world’s currency reserves will be willingly held in one national currency … There are two possible ultimate destinations of such a development. Either we move to a world in which there is a single reserve asset, but in place of a national currency we have a man-made multinational ‘outside asset’; or we move to a world in which there are several major reserve currencies …’ (1979: 13).

2007 – A Threshold in Financial Evolution

71

This is still the situation, only it is not clear what should play the role of ‘outside asset’. The idea harks back to Keynes’s ‘bancor’, but still the discussion remains predicated on a replacement national currency, such as the yuan instead of the dollar. In a phrase reminiscent of Friedman’s earlier quoted paragraph, Richardson went on to say: We live in a world … [in which] each individual nation will continually be attempting to carry out more or less specific monetary or exchange rate policies and is likely to have … a specific balance of payments objective. These aims and policies will not automatically be mutually consistent. At the same time there exists neither the safety valve of the asymmetric accommodation of the dominant single reserve centre; nor an agreed set of rules of the game, nor a general willingness to abandon one of the policy objectives, namely any management of the exchange rate. It does not require