In the five years since the Global Financial Crisis, no policies have been developed to effectively ensure against another systemic failure of banking and insurance systems.
It has now been five years since the beginnings of the Global Financial Crisis (GFC). What has been learned – if anything – by international agencies about the nature of the crisis and how to manage macroeconomic policy? In the wake of the crisis, ongoing problems of the Eurozone, slow and fragile growth in the United States and a slowdown of emerging economies, governments around the world have been reviewing the risks to insure economies against the systematic failure of banking and insurance systems.
The GFC drew attention to market volatility, to knock-on effects of “too big to fail” entities, the dangers of high levels of public debt and the risks associated with the massive growth and expansiveness of the finance sector vis-a-vis the real productive economy. Suddenly the role of the state and other extra-state agencies is back on the policy agenda as governments explore the scope of new regulatory tools designed to restructure banks, introduce new capital reserve levels and monitor professional standards. Greater thought has been given to the threats that the finance sector pose to the economy as a whole, and European governments in particular have sought to deal with these problems by pursuing austerity measures designed to cut levels of unsustainable public debt.
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The systematic collapse of global financial institutions is in part a result of a number of interrelated problems that indicate the many dimensions of the crisis of finance capitalism and the exhaustion of the neoliberal model of development:
- The failure, and subsequent recapitalization, nationalization or bailout of major banks leading to an era of “austerity politics” in Europe;
- The massive growth of the world derivatives market and consequent over-expansion of national banking systems in relation to the “productive economy”;
- The growth of unsustainable sovereign and national debt levels resulting in sequestration and quantitative easing policies in the United States;
- The attempted regulation of tax evasion strategies by multinational companies;
- The tax evasion by wealthy individuals in a system of international tax-havens and trusts;
- The excessive bonuses and preferential shares given to CEOs even in the face of poor performance;
- The way that the EU (acting with the CEB and IMF) has exercised considerable fiscal and economic pressure on democratically elected governments to change policies;
- The rapid growth of new information technologies that produces a new global complexity of high-frequency trading (HFT) at a speed that eludes national and regional agencies to effectively track or regulate;
- The decline of trust and misalignment of incentives at the very heart of the financial culture of equity markets;
- The fraudulent and criminal culture at the highest levels of the finance industry including the deliberate manipulation of the Libor exchange rate, with few criminal convictions except for ponzi-schemers and insider-traders.
The heart of Anglophone finance capitalism is built on the twin pillars of Wall Street and the City of London, and the globalization of finance markets has increased this connectivity. In both these poles, the culture of the finance sector has come under increasing scrutiny.
The final report of the “Kay Review of Equity Markets and Long-Term Decision-Making” (July 2012) concluded that “short-termism is a problem in UK equity markets and that the principal causes are the decline of trust and the misalignment of incentives throughout the equity investment chain” (p. 9). The Kay Review identifies “the systematic nature of the problems” and aims to restore trust and confidence in the investment chain through a variety of measures including “the application of fiduciary standards of care” and “diminish[ing] the current role of trading and transactional cultures.” Overall, the review focuses on defeating the short-termism of equity market traders and to reintroduce a concept of good stewardship of financial resources based on transparent and trustworthy financial intermediation. The review is damning of the change in culture that has occurred since the 1970s that has benefitted traders at the expense of users.
The financial system has been transformed since the 1970s by globalisation, deregulation, and reregulation. These developments changed the culture of UK financial institutions and the identity and behaviour of the leading participants. A culture which had emphasised trust relationships was replaced by one which gave primacy to trading. The trading culture has influenced the behaviour of market users – companies and savers – as well as market intermediaries. In the long run, the outcome has benefitted market participants more than market users (p. 88).
John Kay has been a longtime critic of investment banking, which has been ruthless in dumping risk on hapless consumers. He suggests – as one commentator summarizes it in an interview with Kay – “there is an endemic culture in financial services that makes it incapable of learning from other disciplines,” particularly from the study of complex systems that provides sophisticated analysis and understanding of how systems work and the damage that monocultures can inflict on the whole ecosystem. Kay is an advocate of what he calls “narrow banking,”the purpose of which is to protect the nonfinancial economy from financial instability:
A much needed restructuring of the financial services industry would establish a retail sector focused on the needs of consumers, rather than on the promotion of products and the remuneration of producers. We could look forward to an industry in which new technologies are used, not just to reduce costs, but to deliver better services. We should establish a market in which customer satisfaction is the measure of success. That would be an outcome very different from our recent experience. But it is an outcome we can – and must – achieve (p. 5).
Perhaps even more significant is Kay’s (2009) comment, quoting Simon Johnson’s (2009) The Quiet Coup. “The financial services industry is now the most powerful political force in Britain and the US.” He goes on to say:
If anyone doubted that, the last two years have demonstrated it. The industry has extracted subsidies and guarantees of extraordinary magnitude from the taxpayer without substantial conditions or significant reform. But the central problems that give rise to the crisis have not been addressed, far less resolved. It is therefore inevitable that crisis will recur (p. 94).
Johnson’s (2009) critique is even more devastating and plain. He begins his article with the following paragraph:
The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government – a state of affairs that more typically describes emerging markets and is at the center of many emerging-market crises. If the IMF’s staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reform. And if we are to prevent a true depression, we’re running out of time.
Sir Mervyn King, the outgoing governor of the Bank of England, in his last public appearance before the Parliament’s treasury select committee complained that top banking officials were interfering with regulatory authority to make banks safer by putting pressure on politicians and government officials to water down new rules to “force lenders to comply with a higher leverage ratio of 3 percent of capital as a proportion of total assets, years ahead of the Basel III global requirements.”
The culture of banking is endemically fraudulent, and it has bought off all political opposition. The fact is that fraudulent activity has been at the heart of international banking activities as demonstrated by the systematic manipulation of the Libor rate controlled by a small group of banks. The Libor also underpins world derivatives markets worth hundreds of trillions.
The Libor scandal involved the manipulation of interest rates based on submissions by selected major banks in London. Banks either inflated or deflated submissions – profiting hugely from such manipulation. The Libor rate is used as the major standard reference for a range of financial products including many derivatives, mortgages and student loans. Some reports indicate that this fraudulent practice has been ongoing since the early 1990s. Given the huge trades of trillions of dollars, manipulated adjusted submissions of less than 1 percent offered easy and sometimes huge returns – up to over a trillion dollars. Despite coverup reviews by major banking authorities, including the IMF and the Bank of International Settlements, the story broke in 2008 and was covered by The Wall Street Journal regulatory investigations in 2011, implicating some of the world’s largest banks including Barclays, Citibank, JP Morgan, Royal Bank of Scotland (RBS), HSBC, Deutsche Bank and nine others spread over three continents, some of which were later fined for their fraudulent behavior.
The accusation of knowledge of the rate-fixing has been leveled at the highest authorities including Treasury Secretary Tim Geitner. It is becoming apparent that the practice has existed for quite some time, that it was pervasive, involving the world’s major banks, and that Libor fixing operated as a cartel. This interest rate fixing fraud is being pursued currently by the US Department of Justice, the Commodity Futures Trading Commission (CFTC) and the UK Financial Service Authority among other national regulatory and prosecuting agencies.
Part of the story can be judged by the CFTC (2013) case against the Royal Bank of Scotland:
The London Interbank Offered Rate (“Libor”) is a leading global benchmark interest rate, critical to international financial markets. Libor is determined each day based on rates submitted by a select panel of banks. The rates contributed by the panel banks are supposed to reflect each bank’s honest assessment of the costs of borrowing unsecured funds in the London interbank market, not the profit motives of traders. Over a period of more than four years, RBS violated this fundamental precept and undermined the integrity of Libor for Yen and Swiss Franc (p. 2).
It is alleged that beginning in 2006 the RBS made hundreds of manipulations “to manipulate Yen and Swiss Franc Libor and, on numerous occasions, made false Libor submissions to benefit its derivatives and money market trading positions. At times, RBS also aided and abetted other panel banks’ attempts to manipulate those same rates” (ibid.). The true gravity of the situation can be gauged by the following paragraph:
Libor is the most widely used benchmark interest rate in the world. Approximately $350 trillion of notional swaps and $10 trillion of loans are indexed to Libor. It is the basis for settlement of interest rate futures and options contracts on many of the world’s major futures and options exchanges and is used as a barometer to measure strain in money markets and is often a gauge of the market’s expectation of future central bank interest rates. To be sure, Libor is fundamentally critical to financial markets and has an enormously widespread impact on global markets and consumers (p. 4).
The RBS was ordered to desist from the Libor manipulation practices and to pay a fine of $350 million. Other measures were introduced to ensure the integrity of the benchmarking process.
The Parliamentary Commission on Banking Standards was set up in July 2012 in the wake of the Libor scandal to investigate the culture of UK banking and its professional standards. The final report was released in June 2013. The chairman, Andrew Tyrie, confirmed that banking malpractice was widespread and that both taxpayers and customers had lost out and the economy had suffered.
The report “Changing Banking for Good” attempts to make bankers personally responsible, to reform bank governance and strengthen the powers of regulators. Some think that if the report’s recommendations are implemented, it will destroy London as a global financial center. Others believe that the report does not go far enough and are skeptical whether the recommendations can or will be implemented. While proposing new rules and legislation and practical changes to the way in which banks are regulated in the UK is designed to enhance individual accountability and standards of governance, the report, rather than taking the opportunity to fully nationalize the RBS, makes practical recommendations of how to return partly state-owned banks to private ownership, naively believing that its recommendations can change banking culture and regulate it, despite banking’s global and increasingly technological nature.
This problem-set concerns an essentially fraudulent culture that is a symptom only of a larger transformation that some commentators call “financialization,” where the finance sector overshadows the real productive economy and takes control of it. It is naïve in the extreme to think that a new set of prudential standards can change the finance culture when politicians themselves created it, starting with deregulation policies in the Reagan years, and when financiers hold the highest public office. In one sense, the real power and influence is anchored in a set of beliefs about markets and finance, especially given its demonstrated immense profits in the 2000s with the invention of new financial products and the new information technologies exploiting the speed of transactions. Under these circumstances the financial moguls hardly needed to buy favors or to exercise pressure: It was done for them by politicians and policy-makers. Banks use the latest mathematical modeling to demonstrate risk profiles that popularized the belief that unregulated markets are virtually foolproof. These attitudes still persist today, despite the crisis and the dangers of further crashes, constituting the greatest single stumbling block to genuine reform.
In the five years since the outbreak of the GFC, what progress has been made – especially in rethinking economic policy? This was the theme of the IMF conference “Rethinking Macro Policy II: First Steps and Early Lessons” held April 16–17, 2013. The results are not encouraging. In the panel discussion following the conference, Joseph Stiglitz addressed the issue directly:
The approximately 100 crises that have occurred during the last 30 years – as liberalization policies became dominant – have given us a wealth of experience and mountains of data . . . The big lesson that this crisis forcibly brought home – one we should have long known – is that economies are not necessarily efficient, stable or self-correcting.
Stiglitz draws attention to the need for structural transformation suggesting we may not return to high levels of employment and that reforms have been largely tinkering at the edges. Much of his consideration is devoted to the need for stronger regulation of the global finance industry. The other panel experts were equally pessimistic. George A. Ackerloff reflecting on the two-day conference proceedings used the image of a cat up a tree: “My view of the cat is the poor thing is there in the tree; it’s going to fall, and we don’t know what to do.” Olivier Blanchard, IMF chief economist, suggested that there is no consensus on the future global financial architecture:
Rethinking and reforms are both taking place. But we still do not know the final destination, be it for the redefinition of monetary policy, or the contours of financial regulation or the role of macroprudential tools. We have a general sense of direction, but we are largely navigating by sight.
David Romer’s remarks are perhaps the most sobering. He asks, “Where do we stand in terms of averting another financial and macroeconomic disaster?” and provides the answer:
My reading of the evidence is that the events of the past few years are not an aberration, but just the most extreme manifestation of a broader pattern. And the relatively modest changes of the type discussed at the conference, and that in some cases policymakers are putting into place, are helpful but unlikely to be enough to prevent future financial shocks from inflicting large economic harms.
After five years of catastrophic macroeconomic performance, “first steps and early lessons” – to quote the conference title – is not what we should be aiming for. Rather, we should be looking for solutions to the ongoing current crisis and strong measures to minimize the chances of anything similar happening again. I worry that the reforms we are focusing on are too small to do that and that what is needed is a more fundamental rethinking of the design of our financial system and of our frameworks for macroeconomic policy (bold in original).
The consensus is that what is required is fundamental transformation of finance capitalism and that the current neoliberal model is exhausted but there is no new thinking being generated about what alternatives we might pursue or how countries can regain control of their own destinies.
The sophisticated analytics of massive data-sets, latest mathematical tools and rigorous modeling may provide an increasing measure of understanding of what went wrong or what the present dangers are, but these methods and tools of measurement do not provide either imagination or values: the imagination of a new system, a more stable architecture; the values of a system truly redistributive and less damaging to culture, environment and people. For this possibility to occur, I suspect we will need either another crash deeper than the previous one or global revolution: The former seems a lot more likely.