Stupid money - Page 6
From Griffith REVIEW Edition 25: After the Crisis
© Copyright Griffith University & the author.
Written by Gideon Haigh
AUSTRALIA HAS BEEN fortunate in its banks. Unlike the fragmented and dispersed American banking sector, the ‘four pillars' were able to spread their risks around markets and geographies; they have run high capital ratios, enjoy low-cost retail funds and, after heavy losses there in the 1980s, have gradually disinvested overseas. Casualties have accumulated in the realm of asset-backed securities, whether property or infrastructure, and the days when Macquarie Bank was referred to as the ‘millionaires' factory' suddenly seem the stuff of nostalgia. But the regulatory system, chiefly the Reserve Bank of Australia, the Australian Prudential Regulation Authority and the Australian Securities and Investment Commission, seems largely to have avoided the phenomenon, famously delineated by the economist George Stigler, of ‘regulatory capture', where market participants coerce regulators into serving primarily their own interests.
America offers a demonstration of what Australia avoided. Simon Johnson, former chief economist at the IMF, has argued persuasively in The Atlantic that the crisis in the US is ‘shockingly reminiscent' of crises of crony capitalism in Russia and Argentina. In the US, as in emerging markets, Johnson contends, ‘elite business interests...played a central role in creating the crisis, making ever larger gambles, with the implicit backing of the government, until the inevitable collapse.' In their deliberations on the crisis, regulators ended up speaking to people exactly like themselves, often old friends too senior to have a sophisticated sense of market conditions and credit quality, but willing participants in mutual disorientation; between them, they then did everything possible to protect their industry's interests, staving off insurrectionary talk of nationalisation. Ironically, American financiers and economists have scourged developing nations for just such coalitions of interests. In the aftermath of the Asian crisis a decade ago, for example, the much-admired economist Rudi Dornbusch deplored the mentality of ‘Dial 1-800-BAILOUT for reckless businessmen, greedy bankers and corrupt politicians'. He told the Davos World Economic Forum: ‘It's important that some people lose a lot of money, important that they be punished for their stupidity and greed.' But nobody enjoys the taste of medicine, least of all their own.
Bankers, regulators and politicians alike have resolved instead to gamble that theirs is a crisis of liquidity rather than of solvency, like those hostages in mass kidnappings who insist that if everyone just sits tight and keeps calm then no one need get hurt. Bankers have rediscovered how important they are to the ‘real economy', reminding whoever will listen that credit creation is integral to all industry; regulators and legislators have taken them at their word, trusting that stability will rekindle optimism. The agreed solution has been to perpetuate the banking system with repeated infusions of taxpayers' money, and indeed to take certain parts of it over: British taxpayers are already majority owners of Royal Bank of Scotland and Lloyds Banking Group; American taxpayers will soon own the largest stake in Citigroup; German taxpayers look like controlling Hypo Real Estate. This has been done, so far at least, without actual formal representation, or the setting of limits and targets, thanks partly to a dread of the repeat of the panic glimpsed last September, but mainly because of an engrained ideological antipathy to such state controls. Barack Obama's modest regulatory proposals of June came with a resigned sigh about ‘the speed, scope and sophistication of a twenty-first-century global economy' – a formulation that could have come directly from the pitch documents of the banking industry lobbyists who have besieged the Beltway these last six months. One area of risk management in which American financial institutions have continued to excel is the area involving risk to their own freedom of opportunity. If asset and securities repricings since last year reflect fundamentals rather than a temporary discount for illiquidity, however, those lobbyists have a great deal more work in front of them.
IF THERE WAS A POINT at which this crisis metastasised from one of finance into what is sometimes euphemised as ‘the real economy', it was with the demolition of Lehman Brothers, which had had the misfortune to seek regulatory clemency at the same time as AIG and after Bear Stearns. Lehman had a concentrated version of what would soon be identified as a widespread problem: a balance sheet fat with assets that weren't worth their ascribed values, and that were therefore too injurious to sell.
Unlike at Bear Stearns, where investors had some warning, nobody had seen it coming, and there was fright at the tyranny of mark-to-market accounting, which requires more or less instant recognition of fluctuation in asset values, thereby seeming to bankers the acme of common sense in boom times and a diabolical imposition in busts. A colossal broad-based liquidity crisis ensued: banks doubled the reserves they held at the Fed, interbank lending ceased almost altogether, and the market for short-term and asset-backed commercial paper froze as if flooded by liquid nitrogen. The panic was so pervasive and paralysing that you half-expected tales of ATMs refusing to disgorge depositors' cash.
In the preceding years, the relationship between finance and business had appeared an increasingly distant one, reflected in the media's topsy-turvy preferences, reporting the fluctuations of stocks, commodities and currencies as news, while treating the manufacture of physical goods as something arcane and esoteric. Market turmoil after Lehmans' collapse threw everyone into turmoil together, credit creation being next to impossible in an environment where nobody quite knows what anything is worth.
Corporates singed by recession in the early 1990s, and by periodic reckonings in the equity and property markets since, have actually only been averagely wasteful in recent years. Some leveraged buyout funds and venture capitalists have tended their reputations for daredevilry – in KKR's $26 billion acquisition of First Data in April 2007, interest payments were set to absorb the target's entire cash flow – but business conditions had not been so buoyant as to cajole companies into over-borrowing. General Motors perished of pre-existing wounds, decades in the seeping.
The calamity in private consumption, however, reverberated. Flush with credit, American consumers have accounted for more than two-thirds of the country's economic growth since 2000, and more than a third of worldwide growth in private consumption since 1990. Now, like a deep-sea diver hurriedly yanked to the surface, they were decompressing dangerously, and in intensifying anguish. Certainly they were too busy dealing with existing borrowings to incur more, which hurt the economy at every level: retail sales, corporate profitability, capital investment, dividends and distributions, consumption and personal-tax revenues.
Goldman Sachs' balance sheet stress test is famously known as ‘the WOW', standing for ‘worst of the worst'. The WOW is designed to interrogate whether the bank could survive the worst conditions encountered in the preceding decade in each market simultaneously, worsened by a further 30 per cent – and it was here made to appear optimistic. As American consumption slackened month by month, cruelling worldwide demand, forecasts became unremittingly bleak, whether it was the International Labour Organisation estimating that fifty million jobs would be lost, or the World Bank's prophecy that between 200,000 and 400,000 more children will die annually between now and 2015 than had earlier been predicted. Of course, there is something deeply ironic about trusting the prophecies of many of the same economists whose predictions were so rosy so recently.
The coping mechanisms agreed on are risky, involving the continuance of institutions of dubious solvency. The crisis has already been marked by several intemperate acquisitions, such as Wachovia's of Golden West and Lloyds TSB's of HBOS: governments are placing themselves in similar positions. The burden of salvage on the state almost beggars belief. In renaissance Florence, keepers of the exchequer distinguished between the Monte Vecchio (Old Mountain), debt sustained in fighting Genoa, and the Monte Nuovo (New Mountain), debt sustained in fighting the Turks. The American economy now bears similar twin burdens: the toll of the initial damage and the cost of the repair. Barack Obama's budget digest, ironically entitled A New Era of Responsibility (Office of Management and Budget, 2009), forecasts his government taking on more than US$9 trillion in new debt in the decade to come, and deficits averaging almost 5 per cent in each of the five years after the recession's forecast end. An auction of British government debt failed in March; the Australian budget in May was a sobering reflection of the layers of cost lying ahead. With levels of risk aversity as pusillanimously high as they were casually low two and a half years ago, the state's capacity to spend will be severely constrained.
In other words, crisis is again worth the name, rather than being the stuff of passing headlines, short-term corrections and token recalibrations; indeed, it has embedded itself with a vengeance. For even after its economic impacts have faded, the collapse of credit and the end of stupid money will leave a social and cultural imprint, in the form of fears, taboos, superstitions, cautionary tales, diminished expectations – indeed, in some respects, perhaps this is to be hoped for, lest it be repeated sooner rather than later. Last time I was in Sydney, I happened to pass through the foyer of the same tower in which I'd worked a decade ago, although the bank itself is no longer there, swallowed by another, franchise destroyed, personnel scattered. The intents, the expressions, the atmosphere – all brought back old memories. But experientially, the people could not have been other than different. ♦