photo credit: hitthatswitch

In yesterday’s Guardian, Simon Jenkins complained that none of the major UK parties are attacking the Chancellor Alistair Darling’s decision to bail out the banks in 2008. After watching Tuesday’s Chancellors debate, Jenkins was left wishing for some “good old Labour blood and guts”, someone who could say to the would-be Chancellors:

“You blew it! When those petrified, knock-kneed smoothies from the City came pleading for help, you caved in and gave them the people’s money. You panicked, you bunch of creeps.”

Now I’m all for a bit of bank-hating, and I agree it’s important to stand up to any ”petrified, knock-kneed smoothies” that come your way (has there ever been a better description of bankers in the credit crunch?) and I definitely agree with Jenkins when he says that the better option would have been to nationalise the banks, not bail them out, but the idea that a better option would also have been to let the banks fail isn’t left wing, it’s just wrong. And it’s particularly wrong to say this:

Of course we shall never know what the world would be like today had Darling reacted differently in 2008. It could hardly have been worse. Some scenarios, such as just letting the banks fail, are undeniably hairy, though the global market in finance is astonishingly resilient and would, by now, probably be picking up the pieces and getting back to normal. America still eats and breathes, despite the failure of Lehman Brothers.

Wow. Saying that America still eats and breathes despite the failure of Lehman Brothers is like saying that Dick Cheney still lives and breathes after his heart attack. Technically true, but avoiding the minor detail of the triple-heart bypass in between. The crash of investment bank Lehman Brothers started the credit crunch proper and almost brought the world’s financial markets to their knees. Its collapse sent waves of panic through the markets, causing investors to try and dump all their dodgy financial products, which simply made the crisis worse. The mistake of the US government was to assume that the financial markets could cope with the failure of Lehman Brothers, and it learnt its lesson by bailing out all the other massive banks that needed help, and in doing so (narrowly) averted the complete collapse of America’s banking system

If Darling had let banks like RBS fail instead of bailing them out, then Britain might have had its own mini Lehman Brothers crisis. Jenkins says “it could have hardly have been worse”, but it really could have. At least we still have a functioning banking system. Obviously this doesn’t mean we shouldn’t still be angry about the respective parties’ current approach to the banks - no-one seems to be willing to make the banks pay for the mess they created, and no-one is taking the steps necessary to stop it happening again - but venting this anger by wishing that we’d just told the bankers to, uh, go collapse themselves instead of bailing them out is not admirably Old Labour, it’s just silly.

photo credit: fabbriciuse

David Davis, ex Conservative MP, was on the Andrew Marr Show this morning and had this to say about the Tories’ chances at the upcoming general election:

“If we’re coming up to the election and we don’t show a clear lead, the financial markets are going to respond. The pound will fall, people will talk about our credit rating… The biggest financial wake up call to the electorate you’re ever  likely to see.

The markets hate indecision. And it is said… I’m not in a position to judge… but it is said that they’ve already allowed for a tory victory in our credit rating. We wouldn’t have our credit rating if the markets didn’t think there was going to be a tory victory.”

Now, just like David Davis, I’m not in a position to judge the calculations of the bond markets, though I will say that this  idea that the people investing in our debt are a group of all-knowing political sages  ready to punish us if we commit to anything other than Tory-style severe  cuts is getting a little wearisome.

But it seems to me pretty obvious that this kind of thing is pretty offensive and not the kind of theory that you’d want to parade around too much. I mean, think about it. What Davis is essentially saying is that the public should base their vote not on the unemployment rate or the state of the economy or the respective parties’ manifestos but on the beliefs of a group of people  effectively holding a gun to the UK’s head. And let’s not forget that these are the same people (hedge funds etc) who until recently were busy helping to flush the global economy down the toilet.

When you’re being held hostage, it’s probably best not to gloat about it.

photo credit: thefost

It’s now been a whole week since the G20 met (an event which, if it was a Friends episode, would surely be called The One Where The Canadian Prime Minister Missed The Group Photo Because He Was In the Toilet) and yet commentators are still very much divided on the deceptively simple question: Was the summit a success? This isn’t really surprising, since the answer depends on how you define success. For example, if you were looking for a demonstration that in the midst of global recession the world’s leaders are able to get together, put aside their differences and promise to sort stuff out then the summit was very successful indeed. Alternatively, if you were looking for a solid commitment to prevent a global crisis like this from ever happening again, then you must have come away very happy with the result. And if what you were after was a bunch of vague commitments that will probably/maybe be ratified in the future but more importantly look very good in the present, then you’re probably still doing triple backflips of joy.

But if you were hoping for a substantive commitment to lifting the global economy out of recession – and doing it now, rather than later – then it’s hard not to see the G20 summit as a bit of a let-down, albeit a very glamorous and show-stopping one. It’s true that restoring growth and getting people back to work was never the sole aim of the summit- in the final communique it’s merely listed as an equal pledge amongst eight others -  but lifting the world out of recession is nevertheless the first thing you’d expect someone to say if you asked them what the summit’s main goal was. And with good reason – the current numbers coming out of America alone suggest that we might have to soon start switching out terminology from talk of global recession to the use of the dreaded “d” word (“depression” that is, though doom and devastation work quite well too).

To prove my point, let’s examine what have been touted as the main substantive achievements of the summit – the clampdown on tax havens, the new regulatory framework and the headline-grabbing sum of $1.1 trillion.

The publishing of a blacklist for tax havens is obviously a really welcome development, but tax havens had little to nothing to do with the current crisis. Tackling them was very much an example of “we’re never going to have so much capital to get stuff done, so let’s sort out the havens while we’re here”. Moving on to the ambitious new international regulatory framework, this is – assuming it’s actually followed through and enforced effectively – a spectacularly impressive achievement.  Indeed, the proposed reforms that will be the responsibility of the new, international “Financial Stability Board” read like a checklist of what should have been done to prevent the current recession: controls on leveraging,  stricter capital reserve requirements, regulation of derivatives like credit default swaps, better analysis of systemic risk, etc. But let’s be clear: the progress on regulation is all about preventing another global recession. Welcome as these reforms are, they’re of no use for the one we’re in now.

Which brings us to that eye-catching $1.1. trillion pledge. If you break it down, it comes to an extra $500 billion in funding for the International Monetary fund, a $250 billion increase in the IMF’s “special drawing rights” (sort of like a cheap overdraft facility for IMF members), $250 billion in trade finance and $100 for multi-lateral development banks like the World Bank. At first glance, this is an impressive haul. But, just like Bernie Madoff’s company accounts, the more you scrutinise the numbers the more they fall apart.  Mark Lander in the New York Times has undertaken a rather damning analysis of the figures; suffice to say it turns out that much of the $1.1 trillion is a mixture of money that’s already been pledged, hasn’t yet been pledged, isn’t really money or has been pledged but needs to face an unlikely approval by a country’s legislature (hello, American Congress!). As Felix Salmon has pointed out, at best you can say that there is around $400 billion of new money.  Others have been more brutal and pegged it at $100 billion. But even putting aside questions about the exact amount of new money pledged, there still remains the fact that the majority of it is aimed at preventing the poorest countries from financial collapse. A crucial concern, no doubt, but it doesn’t really help us with the recession we’re already in – it’s merely preventing it from deteriorating too badly. In other words it’s staunching the wound but it’s hardly sowing our fingers back on…

So, as the steak-lover said to the vegetarian chef, where is the beef? Leading economists have warned that we need more Keynesian, deficit-spending, stimulus packages in order to reduce the growing output gap between what the world should be producing and what it is producing. But there were no commitments to increase the size of international stimulus packages to be found in the final communique, merely vague promises and disingenuously boastful references to the inadequate stimulus packages that have already been passed. This was not at all surprising given that the Franco-German anti-stimulus crowd had won the argument against the Anglo-Americans weeks before, but it was nevertheless very dispiriting to see the advice of most leading economists trumped by misguided European concerns over the demerits of more stimulus.  Of equal concern is the fact that another piece in the recovery puzzle – dealing with the toxic assets of banks and confronting the current insolvency of many leading financial institutions – was also shied away from; more vague language was all we got on that front.

This leaves us with the alarming realisation that a summit convened in response to a global recession has failed to come up with any substantive responses to it. It’s true that the leaders of the free world put on the convincing show that everyone needed to see. And it’s also true that a lot was achieved to prevent another recession like this one. In that sense, good work was done. But when it came to fixing the economy in the here and now, the G20 members put on their magician’s hats, bestrode the stage and gave us nothing but grandiose statements and awe-inspiring illusions; except unlike most good conjurers we can now see how their tricks were done. And, frankly, I want my money back.

photo credit: srqpix

Last month Britain was swept up in a maelstrom of rage after it was revealed that Fred Goodwin, the chief executive of the Royal Bank of Scotland, was due to receive a generous pension to the tune of a staggering £703,000 a year. The problem? The Royal Bank of Scotland is now 70% owned by the British taxpayer. Cue outrage from all sides: while the tabloids and broadsheets alike foamed at the mouth, government ministers went a bit mental and promised to suspend the rule of law. The controversy over Goodwin’s pension wasn’t just a matter of one man’s greed, however; it was a focal point for the public feeling of  helplessness, disbelief and disgust brought on by the realisation that the mighty, all-knowing financial powers we entrusted with our money are actually just a load of out-of-their-depth greedy idiots who’ve gone and squandered the lot.

Well, now the United States is having their “Goodwin” moment – and who knows where the chips will fall?

The controversy centres around American International Group, the behemoth insurance giant who has so far been bailed out to the tune of $170 billion – $30 billion of that under Obama’s watch. It turns out that AIG intends to pay its employees $165 million in bonuses. Yes, you heard that right: AIG, one of the companies directly responsible for the financial meltdown, wants to reward its employees to the tune of one hundred and sixty five million dollars. Cue outrage across America: congressmen foaming at the mouths, TV pundits having aneurysms before our eyes, etc.

AIG Chief Executive Edward M Liddy (who is testifying before Congress today which should be, uh, interesting…), defended the bonuses by claiming they were necessary so that AIG could keep their “best and brightest talent”, though quite what the talent were doing while the economy went to hell in a handcart he neglected to explain. An arguably better defense of the bonuses has been made in the New York Times: essentially, they are necessary to stop the departures from AIG of the only people who know how to defuse the complex financial instruments that they helped put together. This is all very well, but perhaps we should first remind ourselves how AIG got into this mess, and then judge for ourselves whether we give a damn if there’s anyone left in their offices by the end of the month…

Basically, AIG dragged themselves into this hole – taking part of the economy with it – by engorging themselves on the devastatingly stupid credit default swap market. Say what now? Allow me to explain. A credit default swap is essentially an insurance contract, in that an insurance company – like AIG – says to a bank: I bet you that your subprime mortgages won’t fail. You pay me an annual premium, and, in the event of the subprimes being defaulted upon, I’ll pay you their value! Sounds alright, except for two things: the subprime mortgages turned out to be pretty rubbish. And by pretty rubbish I mean economy-ruining awful. Even more damning, AIG took on so many contracts that they didn’t have enough money to pay out in the event of all the subprimes defaulting. Which is obviously what happened – which in turn is partly the reason why you don’t have a job, the bailiff is taking your sofa and there’s an angry mob off to burn down the banks.

AIG, however, are not the only ones facing tough questions. Treasury secretary Tim Geithner, and his accomplice National Economic Council head Larry Summers, are under close scrutiny over their roles in this clusterf***. Specifically, why were strict rules on bonuses not ironed out when AIG was given a further $30 billion last month? Were Geithner and Sumners aware of the bonuses at that point? If not, why not? If so, then can we have your resignations, please? There is a growing feeling, as there has been ever since Geithner and Summers were appointed to their respective roles, that Obama’s economic gurus are, to repeat a cliche, more interested in protecting Wall Street than they are Main Street. Their original reaction to the news of the bonuses didn’t  exactly squash this suspicion: Larry Summers basically said “they have ironclad contracts… there’s nothing we can do!” Nothing we can do, eh? I suppose that’s why Congress is right now planning to impose a 100% surtax charge on the bonuses, right?

If anything, this mess is another reminder that the Treasury seems to be trapped in what Paul Krugman has called the “Big Dither” when it comes to fixing the banks. Geithner is obviously reluctant to go down the path of bank nationalisation, even though – as increasing numbers of economists are pointing out – it’s the most efficient, tax-payer friendly way out of this mess.  Indeed, as I pointed out a few weeks ago in my post “Nationalising Banks – In America?” a path to nationalisation was slipped into last month’s still-not-enacted Treasury plan. But Obama’s team seem unwilling to bite the bullet and take over the troubled banks. Instead, Geithner gets the worst of both worlds: no concrete action on the banks and a lack of confidence caused by the Treasury’s unwillingness to do anything. In this way, the AIG scandal only serves to highlight the perils of the current strategy: on the one hand using taxpayer money to bail out the banks but on the other hand not having any control over what happens to our cash. Given all this, it’s hard not to agree with Ex-Labour secretary Robert Reich’s conclusion:

Oh, and by the way, Mr. President. You may not want to hear this, but your Treasury Secretary is making things worse. His dithering on what to do about Wall Street, and his incapacity to speak clearly to the Street and to the public about what needs to be done, is spooking everyone. Why doesn’t he just put the irrevocably insolvent banks into receivership under the FDIC, sell off their assets, protect depositors, and reimburse taxpayers with whatever remains? Let the rest of the banks fend for themselves — working out their bad loans with their creditors. As to AIG, well, that’s a complete basketcase. Put it out of its suffering. Take it over, sell its assets, protect policy holders (you’ll need to create a big co-insurance plan with every other major insurer in the world), then get out.

I should add that had the government allowed AIG to go bankrupt then the problem would be solved: in bankruptcy proceedings bonuses would be right at the back of the queue behind dozens of more important creditors. This makes AIG protests all the more ridiculous. Of course, if the government owned them, then this wouldn’t be a problem:  you don’t have to honour a contract if the other party doesn’t exist anymore.  Given this, I think the argument for nationalisation of companies like AIG goes from “pretty rock solid” to “more unbreakable than diamond”.

Right now, Obama’s worst enemy is his Treasury department. The AIG mess and the unprecedented public rage that has followed it is not just another example that capitalism as we know it has failed – though it is that -  but also an urgent warning to the President: If he doesn’t do something about the banks soon, then he can kiss the rest of his agenda goodbye. It really is that simple.

Update: Chris Bowers identifies the four main questions that need answering about Geithner and Summers’ involvement in the mess.

Well you can imagine my surprise at hearing this, given that I was under the impression that the deficit-spending, government-stimulus strategy being adopted by leaders like Obama was meant to stop another Great Depression, not start one. If I’d been drinking coffee, you can be sure that I’d still be wiping it off the TV instead of writing this. But I thought I’d see what Rogers had to say before coming to judgement on the man. Big mistake!

Analysis and conclusions come over the fold.

Let’s start with this Rogers quote:

The idea that you can solve a problem of too much debt and too much consumption and too much borrowing by more borrowing and more consumption and more debt to my mind is ludicrous and insane.

This is a pretty crazy thing for Jim Rogers to say. The “more borrowing” he’s referring to is that of the government – say, the US government – used to fund, for example, Obama’s stimulus package . The theory behind such a strategy is the following:  in a deep recession, the only way to stimulate the economy is to get the government to pump lots of money into it, piling up national deficits in the process. Any government spending by definition creates jobs and this helps to get the economy going again. The government has to do this because the private sector can’t: when no-one else is able to spend to get the economy going again it’s left to the government to step in as a spender of last resort. Crucially, the government’s borrowing is not, as Jim Rogers is suggesting, the same as the borrowing of the private sector. The government can afford to rack up deficits in the short term to fund anti-recessionary borrowing,  indeed they have to: if private credit is frozen, who else is going to step in?

This isn’t just one of many opinions: it’s the theory of legendary macro-economist John Maynard Keynes, whose work on the solutions to recession are accepted by the vast majority of economists. Now it’s true that you could probably find a few who disagreed, but it’s pretty evident from the interview that Rogers’  response was not that of a man who wanted to point out the defects in Keynes and respond with his own argument. Oh no. Instead it’s the kind of response you’d give if, having never seen a car before, you drove one to the petrol station and then some stranger came up and jabbed a hose in your bodywork . You’d think he was pretty mad, wouldn’t you?

Having said all that, let’s give Jim Rogers another chance, shall we?

Unfortunately everybody’s making the same mistakes we made in the 30s… the 30s started out as a typical stock market bubble – pop – and then a recession, but then the politicians got together and made mistake after mistake after mistake and it led to the great depression… I’m afraid it’s happening again.

This time it’s not just economists who might be puzzled at Rogers’ words, it’s historians too. The mistakes he is referring to must be the alleged ones of President Franklin D. Roosevelt, since it’s Roosevelt’s deficit spending which is being mimicked today by politicians. (He could of course be referring to Herbert Hoover’s mistakes, but then that would completely destroy his argument, so let’s give the man some benefit of the doubt.) This, then, is a bizarre thing to say by any standards. While it’s true that FDR’s reign was not without its economic blunders, it’s generally accepted by economists that his deficit spending helped to relieve the depression of the early to mid 30s. Indeed, if anything, modern Keynesians think that he should have piled up more deficits. In fact, the real blunder of FDR’s presidency came not when he was spending deficits but when he decided, in 1938, to reign in spending and balance the budget. This is generally assumed to have caused the second main recession of the 30s, and is universally regarded as maybe the biggest economic blunder of the 20th century. That recession, in fact, was only ended by the ultimate example of Keynesian Economics: the enormous deficit spending of World War II, which finally ended the Great Depression for good.

Again, Rogers isn’t articulating another economic viewpoint of the 30s here. He’s just being ignorant.

I could go on, but I think I’ve made my point (although I should give a shout-out to Rogers’ interesting assertion that the stockbrokers of London will soon be handing over their lambourghinis to the presumably rather non-plussed farmers of China).  As the interview drew to a close I reflected that it was sad to see Channel 4 news present this guy in the same way you would a well-respected economist. He’s not. He’s a well respected financier.

The kind of garbled, faux-economic mumbo-jumbo spouted by Rogers is, sadly, not an isolated case. Across the media spectrum, financial commentators and cable news Wall Street reporters are queuing up to offer their outraged opinions on what they see as Obama’s economic stupidity. For example, CNBC’s Jim Cramer claimed recently that Obama’s budget was “the greatest wealth destruction I’ve ever seen by a president”. I can only  assume the words “by a president” were inserted there to distinguish it from “the greatest wealth destruction I’ve ever seen” which is presumably the description Cramer’s saving in case  Obama follows his advice and does nothing to help the economy.

There’s an obvious conclusion to be drawn from all of this: finance is not the same as economics.

I can’t stress how important a point this is, because it’s one of the main reasons why the public debate about the actions of world leaders such as Barack Obama in combatting the global recession is fundamentally flawed. Instead of having a genuine argument on the economic merits of the various plans, the soapbox is instead often being left in the hands of people who show no interest in even the basic points of macro-economics – and this includes illustrious and important members of the world of finance.

Just as a Harvard macro-economist is likely to know know very little on the subject of  collateral debt obligations, credit default swaps and other bizarre financial contraptions, so too a Wall Street financier cannot be assumed to know his output gap from his liquidity trap. And if you’re expecting a basic knowledge of  Keynesian theory, then I’ve got news for you: the money men don’t care. Ask them how to invest your money and you’ll get a fairly solid reply (though you might come to regret it later). But ask them to defend their opposition to anti-recessionary government spending on solid economic grounds, and it’s like entering Alice in Wonderland. If, that is, Alice had  sweetened her rabbit hole experience further by indulging in a bit of LSD.

Once again: finance is not the same as economics. A lifetime of trying not to get caught when the bubble bursts is not equivalent to a degree in macro-economics. Just saying!