Bash the Bankers or the State?

I don't much go in for the sport of 'banker bashing', as I see the responsibility for the failures in the banking system sitting at the feet of politicians and other policy makers. Notwithstanding this, I have noted two articles, both of which could be said to be of the bashing variety, but which nevertheless capture some of the problems and the ongoing ludicrous situation of the banks being immune from their own failures. The first comes from Matt Taibbi in the 'improbable' Rolling Stone magazine. Matt has been railing against the excesses of the banks for a long time. His writing is polemical, includes ad hominems, and a list of other 'sins', but he nevertheless makes some very good points. Somebody needs to. This is in his introduction:

It was all a lie – one of the biggest and most elaborate falsehoods ever sold to the American people. We were told that the taxpayer was stepping in – only temporarily, mind you – to prop up the economy and save the world from financial catastrophe. What we actually ended up doing was the exact opposite: committing American taxpayers to permanent, blind support of an ungovernable, unregulatable, hyperconcentrated new financial system that exacerbates the greed and inequality that caused the crash, and forces Wall Street banks like Goldman Sachs and Citigroup to increase risk rather than reduce it. The result is one of those deals where one wrong decision early on blossoms into a lush nightmare of unintended consequences. We thought we were just letting a friend crash at the house for a few days; we ended up with a family of hillbillies who moved in forever, sleeping nine to a bed and building a meth lab on the front lawn.

I will not quote endlessly from the article but his introduction sums up the situation, in his unique style, rather well. Regular readers will know that I was firmly opposed to any bailouts at the time of the financial crisis blowing up, and have been firmly against ever since. Of course, the massive scale of the bailouts in the US only became apparent a long time later, thanks to Bloomberg's persistence in pursuing the detail of the Federal Reserve's support for the banks, at a grand total of over $7 trillion in guarantees and lending limits. The interesting thing about the Taibbi article is that it puts some of the details of the kind of shenanigans that were taking place, such as how bank executives benefited from the support. Again, I will not detail the article here, but my interest is that Matt seeks to foment outrage, and he is right to do so. The reason I mention Matt's article is that I had it in mind when I read this:

At the behest of its former chief executive, Maurice Greenberg, AIG (AIG) is considering joining a lawsuit filed by its shareholders against the government. On Wednesday, according to the New York Times, Greenberg, 87, will try to persuade the AIG board that the terms of the company’s $182 billion government bailout were too onerous, the interest rates were too high, and ultimately, that AIG shareholders got a raw deal. What’s that about biting the hand that feeds you?

Since this article, AIG have rapidly retreated from the lawsuit in the face of general public outrage.  The first reason I write this post is that the initial action of AIG is beyond belief, and indicates that they are entirely incompetent.The second reason is a more fundamental concern; they actually must have thought that they could use the law to achieve their ends. This suggests that financial institutions really believe that the law in the US is putty to be toyed with. No sense of a functioning judicial system would give even the slightest inkling that AIG could win, but AIG nevertheless believed they might do so. Such an impression can only come from experience, and this returns to the many points made in Matt's article. The situation is one in which the US government and the federal reserve, and the judicial system seem completely under the influence of the major banks and financial institutions.

Matt is seeking to foment outrage and I am guessing that, when surveying the world around him, he must be baffled that there is so little outrage. And there is so little. The nearest thing to popular outrage were the sit-in protests whose name I cannot even remember (I did visit one of the sit-in sites, and found that the protesters had nothing coherent to say). Other than this, there seems to be little popular outrage, and I find this odd. It seems that key institutions of state have been, and continue to be, corrupted by these major financial institutions. My belief is that part of the problem has been the focus on the ills on the banks, or 'banker bashing', when the ills are actually to be found in the state institutions that are supporting them. I will even go as far as to say the banks are not to blame. Why, when they have every reason to play the game as they can do, would they do otherwise?

Yes, there might be some personal ethics that might prevent the banks acting to use the system as they do but that is not the point. Banks, by their nature, are institutions aimed at making money and they will therefore seek to further this interest. There should never have been a state system that allowed their rampant corruption in the first place, and that system is and can only be the responsibility of the state. In summary, just as Matt must look around him with bafflement, I find myself doing the same. Where is the outrage, and demand for reform?

King Canute and the Banking Crisis

I very rarely post this often, but it is an unusual point in time. I have long predicted this crisis (for new visitors to the site see the links to the left and browse the posts in the archive), knew what would happen but, somehow, now that it is here, there is a sense of unreality about it. I predicted this crisis but now we are in the situation, it seems less real than it did in my imagination and thoughts. In my imagination I did not have a sense of the panic that would ensue, but imagined the world looking on with the same dispassionate perspective that I take in considering these matters. A strange point of view with hindsight.

The reason for this quick post is that I have just browsed onto the Times website and found the following news:

'The Bank of England today joined forces with five of the world's most powerful central banks to inject up to $180 billion (£100 billion) into the world's financial system in a concerted bid to ease the funding pressure on international markets.'

From the title of this post, it is probably fairly obvious what I think of this action. More to the point, how much money are governments going to keep pumping into the markets before they realise that there is no stopping the crisis. They may delay it, but nothing can alter the fact that the fundamental problems that have caused the crisis will still be there.

The reasons that the banks are not lending to each other is that they all know that they are all holding toxic debt. This is not just CDOs etc. but also fast deteriorating commercial debt, unsecured consumer debt, and old fashioned mortgage debt (held on devaluing assets with people with ever more insecure job prospects). Furthermore, the sources of liquidity from the East are drying up as confidence in the 'rich world' banking system is evaporating.

The trouble is that, government balance sheets were already looking ugly and were getting uglier by the day as revenues will have been falling like a sone. Government are now piling more toxic debt onto the balance sheets, hastening the day when governments start to default. Had they accepted the reality of the situation, then there was a real possibility that they could have cut back on expenditure, reformed structurally, and perhaps have scraped through (just). Instead they are pouring money into black holes, and daily raising the likelihood of default.

Of all of the actions that governments could take, I can not think of a worse solution. There is going to be a very, very painful period of adjustment. Governments need to hold whatever resources they can for when their economies go through restructuring. It will not be possible to reform the cost bases of the world economy overnight, and that means that there is a need for as much of a breathing space as possible. Every $ that is poured into the black hole of the banking system shortens that breathing space. Furthermore, as I have said in my previous posts, it will eventually be repaid from the healthy sectors of the economy.

I am starting to find myself repeating myself, but it also needs to be said that the current crisis is not the real crisis but the symptom of the imbalances in the world economy. The only way to address these imbalances is to actually address the structure of the Western economies such that they are once again able to compete.

As I suggested at the start of the post, what we are witnessing is blind panic - and an irrational belief that something can be done. The trouble is that what is being done will be both ineffective and costly, and can (at best) delay the adjustments. It is a tragic waste of resource just at the time when those resources will be needed most.

Note:

The Telegraph also has article on the rescue package here, and the FT offers the best summary here...

Note 2:

We are currently undergoing an experiment in seeing whether governments can hold back economic reality. It is, when you think of this, very much like Canute holding back the tide. However, in the case of Canute, he knew that he could not really do it, and that was the point. Do the central bankers think they can really hold back the economic tide?

Note 3: In my last post I answered a question on what was a safe investment, and suggested that gold was a reasonable bet (I had mentioned a similar sentiment in an earlier post). I have just noticed that gold had already been posting record gains (not surprising under the circumstances). I have never looked closely at the gold market, so have no sense of how these gains can be measured, but perhaps it is too late to buy into gold. As such I would strongly recommend a long look at the history of gold prices before jumping into the market. However, as I mentioned before, gold prices are driven by sentiment, and any positive sentiment on the latest bailout is not likely to last that long.

The Banking Crisis is as Much a Symptom as a Cause

It seems that my post on reform regulation will have to wait a little longer, so I apologise to regular readers who may have been waiting for the post. It seems that the news of the moment is worth further comment.

A good starting point is to refer you to some commentary in the Telegraph newspaper:

'In a year's time, consumers may look back on the past 48 hours as a bit like the first few minutes after the Titanic struck the iceberg, when high-spirited passengers played snowballs unaware of the danger they were in. '

It seems that people are finally waking up to the reality of the dire situation that we are in. The current banking crisis has arrived a little sooner than I expected (about one or two months earlier than I thought), and is actually just the start of the carnage. In a related story The Times today reports that unemployment has now reached a 9 year high, and with the highest increase since 1992. Once again, it is very much as predicted. The return home of Central Europen workers has acted as a dampener, but it could only slow the growth in unemployment so long. There is also a growing recognition that house prices have a long way to fall yet.

Following the Northern Rock fiasco, the first of the second tranche of UK banking problems is HBOS, with the government scrabbling around for a rescue package. I have not looked at individual banks closely, so I will not give a long list of those at risk. However, a good way of looking at the question of which bank is at risk is simply to ask which banks have seen massive growth in profits and expansion over the last ten years. Banks such as Royal Bank of Scotland come to mind, but I emphasise that I have not looked closely at individual institutions.

As if the fiasco were not bad enough, there are calls for the prevention of short selling of stocks (see here for a good description of what this means). This makes me think of the analogy of a person saying that they want to ban the use of thermometers for patients with a fever. It reveals the ignorance of those in power. The short selling is just an indirect indication of the underlying problems.

As for the whole idea of bailing out the financial system, I have suggested that government bailouts are not the solution. I am now ever more confident in that view. The reality is that the governments are just taking on liabilities from a stricken sector, and will then have to use the remaining healthy sectors of the economy to pay back the debt that they accept. Taking on such liabilities will also add to the coming crisis of government finances, as governments find that confidence in their ability to repay debt wanes, or collapses. They are, in other words, spreading the 'sickness' into other parts of the economy. Furthermore, where will governments stop, and how much can they bail out? The following makes the point:

'Fears that America's central bank – the Federal Reserve – may have over-stretched itself in agreeing to bail out AIG were underlined after the US Treasury announced plans to raise $40bn to allow the Fed to "better manage their balance sheet."'

Incidentally, the Economist reported a long time ago about the potential risks in insuring credit, but I am afraid that I do not have a reference for this (despite a quick search of the Economist site). We can expect more problems to emerge amongst the insurer and reinsurance companies.

The bail outs, I'm afraid, amount to a philosophy of 'something must be done', whether the something makes any sense or not.

In amongst the emerging realisation that the crisis is not going away, and the realisation that it will get much worse, there is no sign yet that anyone has yet realised that the banking crisis is not the problem. The mainstream economists, governments, and bankers still do not understand what is happening. The foolishness of the credit bubble has just been a mechanism of delay in the rebalancing of the world economy, putting off the inevitable restructuring of the world economy. There is no doubt that the credit bubble will have made what was always going to be a painful adjustment much worse. But it is not the cause of the problem.

For those who are new to the blog, I would suggest that you take a look at the recommended reading at the top left of the blog for an explanation of why the world economy needs to rebalance. The reasons are pretty straightforward, and blindingly obvious once you read them. The shocking thing is that none of the 'experts' seem to have grasped the nature of the problem.

The purpose of this post is, as much as anything else, to re-empahise that the banking crisis is not the real crisis. It is as much a symptom as a cause. It has taken such a long time to wake up to the fact that the economies of the OECD have been built upon foundations of sand, it makes me wonder how long it will take for everyone to wake up to what is the real cause of the problems. No doubt, for a long time yet, the symptoms will be confused for the cause.

Without understanding what the root cause of the problems might be, the solutions provided to solve the crisis will continue to be misguided. The UK, and other Western economies, can not afford to continue to try to navigate whilst blind.

What of New Zealand?

I had a comment from someone asking the prospects for the New Zealand economy. My apologies for the belated reply, and that I do not have time to find the original comment.

The answer is that, like the rest of the 'rich world' New Zealand will suffer in the current crisis, but there will be some countries that will feel the pain more than others. I do not know the New Zealand economy that well, (due to the size of the economy, it is not well reported on) but will hazard an opinion nevertheless (so treat what I suggest with caution). As a second apology I am rather pushed for time, so can only go on memory rather than checking facts and figures (so I reemphasise treating my comment with caution).

New Zealand has strengths and weaknesses. The first weakness is that, as the world globalises, scale of businesses will increasingly matter. New Zealand is just too small an economy, and lacks the large companies that will increasingly be dominant in the world economy. Another problem is that the New Zealand economy has a large tourism sector, and that this will be hurt by the current financial turmoil. However, this can be ameliorated by finding ways to appeal to new markets, such as China and India. The question is whether New Zealand can find an appeal that will resonate with these markets, and that is a question of marketing. At the moment New Zealand is very good at promoting itself as a 'clean green' location. The trouble is that the environmentalism that New Zealand loves may hobble other sectors of the economy, in particular agriculture and forestry.

As for the rest of the OECD, New Zealand has had a housing and credit bubble, but the size of the bubble is not as large as, for example, the UK. I have not looked in a long while, but I believe that the government debt is very high. and overall external debt, allowing for population and size of economy, is at a similar level to a country such as Germany (based upon a quick back of a cigarette packet estimation - please do not take this too seriously).

On the positive side of the balance, New Zealand has a large commodity sector, and this is a good thing in the world economy now, and in the future. Whilst commodities will have a bumpy ride, as the world economy swings wildly, the demand for commodities is, on balance, going to increase. Of particular note is the New Zealand agricultural sector, which has more potential than is currently realised. In particular, New Zealand has potential to develop a stronger food industry, and move up the value chain. If New Zealand is to realise this potential, they need to start to switch their added value food products to products that will service the Asian market. This will need a shift in the thinking of the people who run the large New Zealand food companies. The current milk scandal in China will not help matters much, but hopefully that is just a blip.

Overall, I think that New Zealand has the potential to fare relatively well, but I would like to reemphasise again that I speak from a position of relative ignorance.

Note for Lemming (a regular commentator on the blog):

Anatole Kaletsky still seems to have retained his job as a columnist, despite getting it all so wrong. He is still opining with complete confidence, and still seems to think he knows the answers. I wonder whether he reflects on his previous errors and suffers doubt? See his latest article here.

Note For Tin Hat:

Tin Hat, thanks for your question which I have edited and added below:

What are your views on how bad will it get. Lots are suggesting another Great Depression, that bad? Is there anything that can be done to protect your savings. On the basis of your assessment government bonds do not even sound appealing and gold buried in your back garden seems extreme! Your thoughts would be appreciated

Right now, I am afraid that I would be a very foolish person I were to be giving firm advice on where to invest. The trouble is that, in the short term there is no place of safety. The reason for this is that world economy is going to become more and more chaotic in the coming year. Much will depend on the actions of governments and politicians, and they are individuals who carry all of the faults of people anywhere. How will they react? So far, not very well. However, as the situation worsens, and the demands for action multiply, they will likely act upon their economies in increasingly irrational ways.

The other problem, at least in my mind, is what the instability will do to China. I have discussed this in another post, and the problem is that, if China's economy is pulled down enough by the turmoil, it is quite possible that the country will see civil unrest. The real question is whether China can sustain itself through the current turmoil, and I confess that I do not know the answer to that question. It is too opaque an economy to have any certainty. However, if the current crisis tips China into recession, then the world really will be in for a period of chaos, including civil unrest in China and the possibility of war as well.

As a general point I would suggest commodities, as they are likely in the medium term to gain in price, but holding commodities is not easy. I do not know enough about futures to know the maximum length of contracts, but suspect that they would not meet your needs, and would any case be too complex for most people. However, as the world economy absorbs the current blows, it will shrink back, lowering commodity demand in the short to medium term. I do not know what your time scales are.

As for putting gold in the garden, that seems as good a bet as any (just don't tell your neighbours). But seriously, as mindless as it is, gold does do well in periods of turmoil. The danger with gold is the very fact that it is a safe haven, and that means sentiment is the real driver of value. However, in the current climate, I can not see sentiment turning positive (on aggregate at least) for some time yet. However, I have to reiterate that, in the current situation, there really is no safe investment (there never has been, but I speak in relative terms). It seems that your instinct appears to be in accord with mine. Maybe you need to get out and buy that shovel (or spade if you are from Yorkshire).