Bailing Out Financial Capitalism

Here’s a statement from the Secretariat of the Trade Union Advisory Committee to the OECD (TUAC)

http://www.tuac.org/en/public/e-docs/00/00/03/13/document_news.phtml

The dramatic events on the US and global financial markets in the past days – the collapse of Lehman Brothers, the takeover of Merrill Lynch by Bank of America and not least, the government bailing out of AIG, the largest insurer in the US – have changed the nature of the financial crisis. The crisis proves to be a far more serious threat to the integrity of the global financial system than OECD governments and financial authorities anticipated a year ago when the crisis erupted. Financial authorities are not equipped with the needed regulatory tools to handle this crisis. The emergency action to support financial institutions that are too big to be allowed to go bankrupt is necessary. But it is unacceptable that governments nationalise the losses of financial capital and privatise the profits. The quid pro quo must be properly regulated financial institutions. International cooperation should go far beyond what is currently under consideration – ie. reviewing prudential rules for banks and “encouraging” more transparency on the market place. It is the national and global regulatory architecture that needs to be restored so that financial markets return to their primary function: to ensure stable and cost-effective financing of the real economy.

The continuing uncertainty about where credit risks and losses are located as a result of the collapse of the US mortgage market and the incapacity of central banks and other supervisory authorities to re-establish minimum levels of market confidence have triggered reactions in chain in the global financial system. The inter-bank lending market has ceased to function despite repetitive liquidity injections by central banks. A year after the deepening of the crisis, banks, insurance groups and other regulated institutions continue to disclose new write downs to their balance sheets, while credit ratings are downgraded.

If it were not for the impact on the real economy and on working families, there would irony in witnessing the past two decades of frantic financial de-regulation reforms that swept throughout the OECD ending with the largest nationalisation programme in modern history of the financial sector. In less than two weeks in September, the US authorities have gained effective control of the entire mortgage lending industry (the $200bn bailing out of Fannie Mae and Freddie Mac on 7 Sep.) and of the dominant player on the insurance market (control of AIG against a $85bn funding). They have agreed to a partial transfer onto taxpayers of the credit risks that was created by the subprime crisis by way of broadening the range of collaterals accepted for the liquidities injected by the Federal Reserve Bank. They have also exposed government money in the on-going restructuring of the investment banking sector with the takeover of Bear Stern by JP Morgan in March. The scale of the US government’s interventionism contrasts with the weak response by the financial private sector that was supposed to apply “self-corrective measures” to the crisis. The long awaited announcement earlier this week of ten large US financial institutions to pool together a $70bn liquidity fund comes too little and too late in the crisis.

The immediate consequences of the brutal deepening of the crisis have been a fall in global stock market indices, and a continuing tightening of lending standards. One can only expect further downward revisions of economic outlook forecasts. The US government debt has doubled instantly as the result of the recent bail outs, which should put further pressure on the US budget deficit, and hence on the Dollar exchange rate in the face of persistent structural imbalances within the OECD, with China and other emerging economies. For now, the direct exposure of financial markets in Europe and in Japan appears to be measured.

OECD governments are at a turning point. Central banks, treasuries and exchange authorities are not equipped with the needed regulatory tools to handle the current insolvency crisis. The monetary reaction operated by OECD central banks since the beginning of the crisis – easing access to short term government loans and/or reducing lead interest rates – were necessary to manage liquidity dry ups but insufficient to re-establish market confidence. The light regulatory approach that has prevailed in the past decade has nurtured a culture of excessive leveraging among financial institutions. This was favoured by lightly regulated entities such as hedge funds and private equity, but also by main street investment banking groups which are not subject to the same prudential rules than deposit banks. The toxic effect of leveraging was amplified by the financial “innovation” of the originate-and-distribute model of securitisation of debt: bad debt was traded under the guise of “structured products”.

The task of regulators has become impossible: not only do these “alternative” products and investment entities escape from their oversight, overseeing the activities of main street financial groups have also become a complication for them. Rather than increasing competition among institutions, the dis-intermediation of the financial system has given birth to global conglomerates that cumulate different lines of businesses – deposit banking, investment banking, trading – which are subject to different regulations and hence different supervisory authorities. The collapse of the US giant AIG was precipitated not by its core activities in the highly regulated life insurance business, but by “AIG Financial Products”, the derivative trading subsidiary that the parent company of AIG had set up in the late 1980s.

This year, the G8 Summit in Hokkaido Japan expressed strong support for the recommendations of the Financial Stability Forum in its report “Enhancing Market and Institutional Resilience” in April. The FSF calls among others for the strengthening of banks’ capital requirement for structured credit product and off-balance sheet exposures, of banks’ own risk management procedures, for new accounting valuation of structured products, stronger oversight of rating agencies and more broadly for international cooperation to “encourage financial institutions to improve the quality of disclosures” about “complex and other illiquid instruments”. As welcome as these recommendations may be – many of which relying on private sector voluntary cooperation – they seem seriously inadequate.

In its annual statement to the G8, the Global Unions denounced “a growing divergence between unregulated and unmanageable financial markets on one hand and the financing needs of the real economy to provide decent work on the other”. According to the OECD, the international financial architecture should be judged upon its capacity to “maintain financial stability by ensuring solvency of market participants”, to “protect investors” against failures and frauds, and “to ensure efficient and effective financial markets”. This week, the system failed to deliver on all three objectives. International cooperation, including the OECD and the IMF, must aim at a concerted return to ensuring that all sources of financial capital are effectively regulated and public confidence in the system is established.

The regulatory implications of the crisis will be addressed at a meeting of TUAC affiliates senior economists on 29-31 October at the OECD in Paris, in partnership with the Global Unions and the ETUC. They will be discussing the launching of a trade union blueprint on effective financial regulation

8 comments

  • This is a useful article on the situation Andrew, thank you.

    I’m not entirely sure, however, we can let the central banks off the hook by echoing their line that they do not have the regulatory tools to deal with the situation.

    They have used this line for over a year now, while they have been gathering in innumerable conferences under various auspices and have come out with only the most flimsy of recommendations, as you and others on this blog have noted.

    Even if they, theoretically, couldn’t have creatively interpreted existing parameters in the public interest, they didn’t even make recommendations towards the kind of regulation which would actually deal with the root problems.

    The more likely answer is that they don’t really want regulations in the public interest. Understandable, as the boards of these institutions in most countries are made up of the cronies of many venerable casino operators who prefer to leave decisions and benefits to themselves. Even now they can quietly shift around in the background, doing God knows what, while everyone else is left in the dark.

    It is good that unions and others are gathering, again, to prescribe some stronger rules, because I don’t think we’re honestly going to get any substantial solutions otherwise.

    thanks again,
    Leigh

  • François-Marie Michel

    Can savvy economists comment on this?
    Instead of bailing out the big Institution directly, what would be wrong in the reverse solution that would consist in PARTIALLY bailing out the demand side according to portions of obligations it would or would not be able to meet?
    In my opinion, the big institution would thus recover enough liquidity to favor investments, while the previous contracts or mortgages could be repaid?
    A win-win situation.
    Please debate the subject, and let me know about what is said.

  • The problems lay in income distribution and the materialism in our culture of dreams, aka consumer society.

    If you have a bunch of workers who are paid appropriately, then much of the credit within this buy now, pay later economy works fine.

    Regardless of the political stripe, fluid and robust credit is one of the pillars of a well functioning modernity based economy.

    Workers dream and the wealthy lend. It goes back to profits and wages. You cannot have the imbalance of profits only, especially within this side show, casino economy that does eventually have linkages to the real economy.

    It is ironic when you think about what happened today.

    THe American government just announced that they will provide the safety net to these bankers and investors. The question is what does the public get in return.

    Potentially they should all now have their mortgages paid! In a round about way this could effectively been the case, where all these sub- prime mortgages could have effectively been heavily subsidized. Funny how capitalism of the American variety really works in the end.

    Of course the sub-prime mortgage appilcants would never receive such a housing subsidy within a non-socialist system, they needed the financiers to have their profits and be paid off before any notion of socialism makes its way into the process.

    Systematically, at the end of the day, it really does seems to be one of the biggest failures in financial history ever! The neo cons have got to step up to the plate and start taking their whacks. Of course they never will, but at least the public should be offered a real chance to understand what just went before them. It is up to progressives to unwind, and unpack the spin.

    I am sure without billions of dollars and ideological control over the cultural mechanisms that the public will ever understand clearly what happened here.

    In fact I worry even about whether history will actually record what happened here. At least the stink will linger for some time and the longer it lingers the more the public is forced to at least sense something is wrong with the neo con way.

    If only we could just understand that paying workers a decent wage is key to a well functioning economy. A job is not a job, it is the quality of the job that is imperative. The polarizing forces of the wal-mart economy must seriously be reinvented. Or we will continue to face this economic war between classes.

    Alas that is what this financial crisis is, a war between the classes and determining who is going to pay for what and how much each is going to get.

    Paul

  • yes, the left should be demanding socialized housing as a first step, and better wages, unions, and blaming the normal workings of capitalism — instead of focusing solely on financial regulation.

    here is david mcnally’s backgrounder on the crisis.
    http://www.newsocialist.org/index.php?id=1636

    i hope more members of this blog start posting on this issue.

  • Exactly. The quid pro quo should be the socialization of the bottom third of the mortgage market. The US gov buys 2 trillion of toxic sub prime for say 40 cents on the dollar and flips that into new mortgages at 50 cents on the original dollar. The tax payers get a 20% return, the bottom third get their houses for half the original price and the investors have ponied up 50% of the cost of the housing program.

  • That should have read: “the taxpayer get a 25 % return.”

    Buy for 800 billion sell at 1,000 billion = 25%.

  • After listening too Mr. Paulson tday, it would seem this whole package toted at $700 billion, still just may be a hope and a prayer that it will right side the wrong sidedness of finance capitalism and what has become of it. It could theoretically takes trillions to fend off an collapse.

    The fear being that all the policy is so rushed and hurredly put together and just before an election that could see the dems take power. I find the timing a bit suspect. Could the meltdown not held off for another few weeks? Could not some of the major policy decisions.

    Hard to say but I would envision with a democratic regime in the white house potentially a much different solution to this mess would have come to the surface. Maybe I am being conspiatorial, but hopefully some of these decisions will be thought out bit more down the road, i.e. after the election.

    Mr. Bush and his regime will sure go down in history with a quite large footnote.

    From Paulson’s talk this morning, it still leaves one a bit leary about how out of the loop the government is within the heart of the financial circles in the US.

    Some quite loud voices still need to be heard over this mess. I have a feeling the snow ball is only small yet compared to what we will see in the next months to come. I hope not, but I have a feeling that the 700 billion is still chump change compared to what it is going to take to purge the system of the ill effects of all that has been swept under the carpet.

    A new form of socialism has made its appearance. I am not exactly sure what to call it, but it is definitely totalitarian in nature. The financial system seems to have acted in a manner that had total disregard for the outcomes and consequences. It seems to be above the law and institutions. The gathering storm I am hoping wil put them into a box and put on a lid so tight that eveytime they bang on the bars to be released this period will not soon be forgotten and contained they will remain.

    Will that happen, early market driven deregulation 1900’s-> 1929 market crash-> economic collapse-> WWII -> post war renewal and regulation of capital-> post war neo cons and deregulation- market crash-> ???

    I could have went back to the 1870’s and that crash.

    I would have thought the whole WWII lesson would have been enough to keep our regulatory stance in place, but of course the cultural memory fades.

    We need to refocus this debate into wider political and economic debates.

    I have never heard the word regulation in such a positive discourse setting in all my 40 odd years. Being from this specific generation, it really is a tune that is foreign to my ears. I am just walled over by the swiftness in the discourse change. It really is something to be admired within our culture, for as much as we think change is hard to come by, it sure can happen suddenly and in such a swirling dervish of a force that I personally am blown away.

    paul

  • Strange to think of America as having too much housing, but I guess an efficent housing strategy would’ve been to have most bubble-funded new homes built smaller or as apartments/townhomes.
    A long-term solution to derivative bubbles is to institute a flexible lever controlling outstanding derivatives to hard asset ratios. When more derivatives flood the markets, they have to be backed by more hard capital. And vice versa if derivatives threaten to dieoff.
    American have too large a consumer goods sector. A luxury tax with subsidies for electronics and medical ergonomic devices would help.

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