Tag Archives: Financial Crisis of 2008

Bankers the unruly and uncontrollable children in the family

Politicians seem to think that as they can manage their own family budgets, they have all the knowledge necessary to manage the economy. This results in statements such as the government needs to balance its books or that the country has maxed out its credit cards. Such statements demonstrate an appalling ignorance of the economy and how it works. However there is a competence that is lacking at the most elementary of levels,  as too many MPs are appalling at managing their own finances. Disraeli one of the greatest leaders of the conservative party was always on the verge of bankruptcy because of his extravagant lifestyle. Fortunately he had a rich wife and friends ready to bail him out. Politicians are as likely to follow his example as they are that of his prudent rival Gladstone. The recent expenses scandal when it was demonstrated that most MPs used their expense account to finance their comfortable lifestyle. People still remember the MP who used his expense account to pay for a duck house. If financial rectitude is not characteristic of many MPs This should give pause to any claim that they are capable of managing the economy.

If the analogy of family finances is to be made it should be said that the government resembles the nominal head of an unruly family, whose views are largely disregarded by the family members. The unruly children in the family take little notice of the head of the family, only listening to them and accepting their authority when they get into trouble. The banks are the obvious example as they pay minimal heed to the authority of the government except in times of crisis such as during the financial crisis of 2008.Once the crisis passed the banks forgot their need for government support and showed a lack of gratitude to the governments actions for bailing them out during the crisis. They successfully prevented the government from introducing a reform which would have separated their retail banking activities from those of investment banking. If a bank fails  in future the government is still on the hook, as it can’t protect the individual customers of the bank without bailing it out for the much larger losses incurred by its speculative investment banking arm.

This is no small matter as the combined assets of the banks are in total ten times the value of our national GDP.    Our national GDP is the country’s national income. There are four large banks in the UK and it is not unreasonable to suggest that the assets of each is in total a sum near to, equal to our GDP or greater than it. In the event of a failure of one of the large banks the government could be called on to raise a sum equivalent to our national income to bail them out. At one time during the crisis of 2008/9 the government of Gordon Brown had to pledge a similar figure to our banks creditors to prevent a run on their finances. Fortunately the banks creditors did not call on our government to make good this pledge, they were satisfied with the the pledge alone. When the next crisis occurs the country may be less fortunate.

When I describe the banks as unruly children over whose actions their parent has little control, there are numerous examples I can cite of such behaviour. Britains biggest bank is HSBC and Standard Chartered is its branch in the US. This bank almost lost its licence to conduct banking in the USA because of its money laundering activities. Only the pleas of the British Chancellor of the Exchequer prevented the American financial authorities from withdrawing its banking licence. It had lost its licence to bank in the USA, its parent bank HSBC would have been in serious financial trouble and it would have had to ask the British government for financial support to enable it to cope with the crisis.

The family finance analogy of which so many politicians are so fond of using describes so well the activities of the banks. The banks are the prodigal children who can behave as badly and irresponsibly as they wish as they know that their parent the British government will always come to their aid no matter how badly they behave.

In Britain as in most countries the politicians are content to remain in ignorance of these unpleasant truths. They believe that their homespun economics all they need, or they are ideologues who believe that the great prophets of economics Hayek, Friedman and Rand said all there is to be said about economics and the managing of the economy. This last group believes that all the answers to matters economic are to be found in books such as ‘The Road to Serfdom” (Hayek) or ‘Atlas Unchained’ (Rand).

There are a small group of politicians who understand the problems of which I have written, but they are only too willing to pretend that all is well in return for government office or employment as well paid lobbyists for the financial sector. Money is incredibly effective balm for soothing fear.

I am not the first person to express concern about the appalling ignorance of our politicians. Leo Amery looking around at his fellow politicians in the 1920’s said that the country would be better served, if there was  separate parliament consisting of industrialist and trade unionists to manage the economy and industrial policy.

Alice in Wonderland Economics

The book that I would recommend to anybody wishing to understand the economy is Lewis Carroll’s ‘Alice in Wonderland’. Not as a book to replace all the books that can be found in the economics section of any library, but as a first text which to give a good grounding in all things economic. What any budding economist needs to know about the economy is that things are not as they appear.  Alice is able to get through a door for which she is to tall by drinking from a bottle labelled ‘drink me’. After drinking that she shrinks in size to such an extent she is now able to walk through the door. She can be both giant and of normal stature in Wonderland. Later in the book she meets the Cheshire cat, who not only can become invisible but is able to become visible in place other than that in which he first appeared.  What the good economist should do is to be prepared to surrender their belief in a world of common sense. Just as for Alice the rabbit hole is a portal to another world, so a public corporation can equally be a portal to a world in which strange behaviours predominate.

One good example of this strange new world of economics is the strange behaviour of Starbucks. I was puzzled when I read that Costa Coffee a British coffee shop chain was more profitable than Starbucks. Starbucks seemed to be everywhere and I could see no evidence from what I observed that the business was doing badly. Then on reading more I realised that is was yet another example of a company not wanting to earn profits. Yet all the textbooks state that all businesses are profit maximisers. Profits earned are subject to corporation tax, so companies will do all they can to minimise their profits and tax bills. This is usually done by having a head office located in a low tax country such as Eire and that head office then imposes such a high level of charges on the business (for services provided) that the profits are reduced to such  a low level that the company is either ceases to be liable for tax or it only has to pay a minimal amount.

However the process becomes stranger and stranger the more it is examined. Usually the ‘charges’ that are paid to the Head Office are through a chain of offshore companies remitted to the multinationals homeland. Yet the profits declared then are only small part of the companies income. Such companies sit on vast cash piles which are located in various tax havens. This cash pile increases the companies wealth and the price of its shares. Shareholders are in many cases happy to have a reduced dividend but a reduction more than balanced by an increase in the value of their shareholding. Banks recognise that the shares held in such as Starbucks, Apple. Google etc. are extremely valuable assets. They will then lend large sums of money to these people against the security offered by there shares. These loans which are rolled over from year to year and which can be increased in line with the increase in the value of these shares. Loans have the advantage of not being income and are therefore exempt from tax. Many shareholders are content to enjoy their income in this way. Although there are a significant number who would still want to enjoy a cash return from their investment.

There is a passage in ‘Alice in Wonderland’ where Alice comes across a group of the Red Queen’s servants painting white rose red. This because the Queen wanted red roses and they mistakenly planted white roses. They hope that the Queen won’t notice the red paint. Similarly there is the many thousands of financial advisers who role in life is to paint earned income as anything but earned income. Anything that is either not liable for tax or which is taxed lightly. Unlike the Red Queens gardeners they are very successful in that the tax authorities never see through the disguise.

Apple is described as the world’s largest business. Although they are  the company with the largest sales revenue are not necessarily the most profitable. Much of the profit earned is changed into something quite different, such as a charge to Head Office at least in all the European countries. What profit Apple declares is largely resting in some offshore tax haven beyond the reach of the US tax inspector.

What any economist needs to realise is that to understand the behaviour of multi-national companies,is that the economics textbook is of little use. The book describes the behaviour of an ideal and imagined company, not a real one.

I could go further and relate other features of the book to the real economy. There are frequent examples in the book of nonsense verse, such as the song of the Walrus and the Carpenter. What the economist needs to know is that in the real world economy there are plenty such similar examples. All too often when a company goes bankrupt it is usually one that has received a successful audit. The auditors seem unable to notice those gaping black holes in the company accounts. This is because they use a set of industry agreed accounting conventions when analysing the companies accounts, conventions that serve to conceal rather than reveal mismanagement and a shortage of funds. While company accounts are not nonsense verse, they are often intended to deceive as often as they are intended to reveal the true state of a company’s affairs.

Politicians come the nearest to uttering nonsense verse on the economy. They are found of uttering what seem to be profound mantras on matters of the economy, but which are in fact meaningless phrases. Phrases such as the country has ‘maxed out its credit card’ a phrase uttered by a politician, when his government was doing all it could to encourage a borrowing binge to kick start the economy back to life.

Why I recommend Lewis Carroll’s book for any budding economist is that it reveals to the reader a strange world that is and is not ours. It prepares for them recognising the unfamiliar and strange amongst the familiar and it is often the strange and unfamiliar that make seemingly inexplicable behaviour explicable. Conventional or bad economists are unable to see beyond the fog that is the received economic wisdom. This is why these economists were unable to see the financial crash of 2008 looming in front of them, when all the danger signals were showing red.

Scapegoating the dominant economic policy of our times

images

There is a difference between the economics practised by politicians and the economics taught in the universities. One commentator has called the former macromedia (Professor Wren-Lewis) meaning that politicians have developed their own unique understanding of economics. The politician’s economics is a mish mash of economics, common sense and prejudice. While the economy is doing well this misunderstanding of economics matters little, however the problems occur when this misguided economics is the basis of policy making in the time of crisis. This is seen in the various crisis that have afflicted Europe since the crash of 2008/9. Greece is perhaps the most notable policy failure, although even the one self proclaimed success story the UK, if far less successful than claimed by its leaders. The Central Bank interest rate remains at crisis level of 0.5% as even a modest increase will derail the recovery.

The consequence of this misguided economic practice is that all governments can now do is hope that the next crisis will not occur on their watch, as they have little clue as to how to tackle it. Political economics is informed by prejudice as with many a primitive religion and always looks for scape goats to blame for provoking the anger of the Gods. If they can identify those who have angered the Gods, they can deflect blame from themselves. This policy means the government won’t have to undertake of those difficult policy measures that would mean taking on those powerful interests that would oppose change. In Europe a convenient scape goat has been found in the people, much as in many a fundamentalist religion it is the misdeeds of the people that has brought suffering on them. God punished the people of Sodom and Gomorrah by turning their cities into salt, while the God of the market punishes the people by making them poor. In the case of Sodom and Gomorrah it was the sexual licence that brought down on them the punishment by God. In Europe it was the greed of the people. They were not content with the modest income the market allocated them, they wanted more. More generous wages, sick pay, benefits of all kinds, the greed of the people know no bounds and forced the governments into borrowing more and more and forcing the government into greater and greater debt. The God of the market punished the people with the great crash of 2008/9 and his angr could only be appeased through an act of penance. This penance was to intended to get the people to reject their greedy lifestyle by embracing austerity. Since the people would not willing do this themselves government would have to act to compel them to do  penance. Penance was enforced through cutting people’s incomes, such as by welfare cuts, wage cuts or wage freezes Once people had learnt the error of their ways after a period of suffering, prosperity would return.

(Using ‘The Old Testament’ to explain the practices of contemporary politicians might seem strange. However once it is realised that the sophistication of policy making by the political leaders has advanced little since the time of ‘The Old Testament’; this use of ‘The Old Testament’ stories as a metaphor to explain contemporary political behaviour is  valid.)
One consequence of this is that it is hard to make a reasoned defence what is an irrational policy so the opponents of the austerity programme must be labelled as deviants, to prevent their policies being given a hearing. Politics can be divided into the sensibles and the foolish. The upholders of the agreed of consensus of policies are the sensibles and their opponents are as but foolish children, who know no better. One notable sensible is Christine Lagarde of the IMF who described the Greek politicians who opposed austerity as children. In Britain since the Labour party members elected a leader opposed to austerity he has been subject to a constant stream of abuse by the media and the austerians of his own party. This last group have pledged that they will do all in their power to prevent a move away from the agreed policy consensus. In terms of ‘The Old Testament” metaphor the guilty people are asking to practice again those bad habits that got them into trouble in the first place. Only the superior people that is the austerians in parliament understand what is best for the people.

When the next crash occurs the austerians will tell the people it is because they did not willingly embrace poverty. They again are at fault and the only solution is to subject more of the people to increasing poverty so they learn the error of their ways. Only in that way can the God of the market be persuaded to relent and ease the suffering of the people. How long this policy approach will work is unknown. It will at some stage be challenged by an equally irrational ideology or belief system that cannot be discredited by upholders of the dominant austerian ideology. Perhaps the ideology of the Neo Fascist Golden Dawn in Greece will be that of the group that successfully challenges the dominant irrational belief system with that of a more compelling narrative, but one that is equally irrational.