Daylight Robbery

The financial crisis of 2007/2008, aka the credit crunch, brought about some shocking events in the world banking industry. As I am sure you know, the housing bubble, inflated with the easy credit and the fashionable casino banking of the 21st century, burst spectacularly in 2007 resulting in plummeting values of real estate securities, a lack of liquidity for financial institutions, widespread evictions and foreclosures in the housing market, the collapse of huge financial institutions and, consequently, global economic recession. But we are still feeling these effects today. The banks still haven’t managed to shake off the bad debt and get back to doing healthy business. Why is that?

As you must have heard on the news, one of the main actions taken by the government was the bailout. The first companies to go under were those sufficiently invested in the housing market or leveraged with mortgage lending. In the UK, we all remember seeing the huge queues outside Northern Rock in late 2007 as people rushed to withdraw their savings after the bank’s cry of help to the Bank of England hit the news. Soon the investor panic was felt by financial institutions all across the western world and the crisis peaked in September/October 2008. Some of the victims of the financial meltdown such as Bear Stearns, Merrill Lynch, Wachovia and in part Washington Mutual in the US were bought by other companies and now form part of the balance sheets of other larger banks that successfully weathered the storm. Lehman Brothers was left to crumble. Other casualties such as the US mortgage institutions Fannie Mae and Freddie Mac, multinational insurer AIG, Northern Rock, Royal Bank of Scotland and Lloyds TSB were either nationalised or propped up by the governments’ rescue packages of short term loans, liquidity funds and recapitalisation schemes. In other words, we bailed them out (emphasis on the we). 

In the last quarter of 2008 alone, the US Federal Reserve, the Bank of England and other European Central Banks together purchased a total of $2.5 trillion of government debt and private assets of failing banks. Yes, 2.5 trillion dollars, this can be written as: $2’500’000’000’000. This was the largest liquidity injection in world history. And we were the ones that paid for it. Theoretically there may be the possibility of the British government paying us a dividend from the bank shares that it nationalised but the chances of us getting any direct benefit from these purchases is slim. Although it didn’t seem like we paid for it, we did, or at least we will. The huge amounts of money that the government uses for bailouts are not just lying around in the treasury, they have to be borrowed; and the money that the government borrows is paid through our taxes. You may be thinking that borrowing money is an odd kind of response to a debt crisis. Well, get used to it, this is policy now – bailout and borrow.

So, financial meltdown, calamity, one might say, tragedy, destruction etc. But no-one actually died. It’s wasn’t a real tragedy like a plane crash, or an earthquake or starvation. It’s just a bunch of numbers on computer screens disappearing or changing erratically. Well, this bunch of numbers in computer systems is the backbone of our capitalist society. Our whole way of life is underpinned by the functionality of banking. We require the facility of lending and borrowing so that we can accumulate and invest capital, so that we can gain private wealth and property, expand business, employ more people, produce more things, spend more money and consume. Some say that the financial crisis, and indeed the past financial crises, was an example of fundamental failure in the free market system; that capitalism has gone out of control.

Some economists disagree and argue that the free market system would in fact function harmoniously if there was no government intervention altogether, that the very root cause of the credit boom in the first place, is government intervention itself. The control of paper currency by national governments, instead of maintaining a gold standard, has allowed them to print money whenever they wish and expand the money supply exponentially, causing the rate of growth of credit and wealth to soar far above what the world is producing... but this is an argument for another day.

So was the financial crisis a failure of the free market system, or is failure just a natural occurrence within a free market system? As with any business, you take on a certain amount of risk for a certain amount of potential reward. If your business idea fails, then you must bear the consequences. Thus is the inherent nature of the free market. Imagine a scale spanning from a low risk/low reward to high risk/high reward. Many bankers in this case were playing at the top end of this scale, and they knew it. Many investors with assets in these banks were therefore also playing at the top end of this scale, but were perhaps only somewhat aware of how high they were on the scale. And finally many ordinary folk with savings in these banks were certainly not aware that their savings were being risked for another person's gains.

One could say therefore, that the decision to bail out these institutions has both a moral justification and an immoral side effect. The people who were fooled into investing their money in risky assets deserve to be compensated for their losses. The bankers who knew fully well what risks they faced, do not. But it is difficult to just sit and watch these banks slip into the brink when large numbers of honest hard-working people are going to lose their savings as a result. Government intervention definitely seemed the right thing to do. One thing is for sure, something must be done in the future to protect individual savers from their exposure to risky trading floor activity.

However, in the future, this undesirable side effect, of compensating the losses of those that don’t deserve it, can only get worse. When companies can determine with reasonable certainty that ‘bailout and borrow’ is policy, then they have no real restraint or diligence in their risk management, because they know that if all goes wrong, and the people affected is a significantly large group that the government cares about, they will always be bailed out. In effect, it further encourages more speculative behaviour, the very same actions that got us into this mess in the first place. One bailout begets the next.

As the US and European governments buy up lots of junk debt and borrow money from other governments (and the taxpayer) to do so, they too have found themselves in a similar situation. The banking crisis has moved on to become a sovereign debt crisis. First we were bailing out banks, now we are bailing out whole countries in the likes of Greece, Ireland and Portugal. Yet still we borrow more. Money is robbed from the ordinary taxpayer in order to bail out the organisations that cannot balance their books. Through what democratic function did the taxpayer agree to collectively bailing out people that spend too much money? Not only is it sending out the message that becoming indebted is not a problem anymore, but it is trying to solve a debt crisis with more debt. Recently there has been talk of a new super bailout for the whole European banking sector, a boost of the EFSF (the Euro bailout fund) to a sum of 440 billion euros to be leveraged in the debt markets to the give an overall firepower of 2 trillion euros, yet another unimaginable sum of money. This is supposed to be backed by the European Central Bank, the same bank which has been buying junk bonds from the Italian and Spanish governments and is now, by definition, a ‘bad’ bank. So who is it that is able and willing to lend us this money in these times of indebtedness and austerity? Who is going to guarantee these debts? - Our children, and our children's children.