The Mess We're In

Chris Waller 2009
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Author's note: I began this piece in early October of last year, 2008, and then 'put it aside', as they say.

In 1995, Will Hutton, then Economics Editor of the Guardian, wrote a book entitled, 'The State We're In', a socio-economic critique of Britain at that time. In light of current events, I feel 'The Mess We're in' is now an appropriate title for this piece. Events in the world of global finance are currently moving so quickly that it is impossible to form any cogent opinion which will not probably be rendered manifestly false twenty-four hours later.

To put it in perspective, the $700 billion bail-out package offered by the Bush administration is equal to the entire GDP of the Netherlands; in the last few days, a total of $2,700 billion has been wiped off the value of world stock-markets, a sum equal to the entire GDP of Germany.

It is barely three weeks since Lehman Brothers' bank failed and its assets bought by JP Morgan for a mere $1.9 billion. (In their world $1.9 billion is 'mere'.) Washington Mutual, America's biggest bank, has gone to the wall, as has Wachovia, the US's fourth biggest commercial bank. Citigroup and Wells Fargo are currently squabbling over the remains of Wachovia. Morgan Stanley, another Wall Street veteran, is currently courting Japan's Mitsubishi bank in the hope of securing an injection of $9 billion, for which Mitsubishi is asking for over 20 percent of Morgan Stanley. President Bush's last public announcement on the crisis was reminiscent of Dad's Army's Private Jones rushing around shouting, "Don't panic", and seems to have been just about as effective in preventing panic. Comparisons with the Wall St. Crash of 1929 have been made, though so far I have heard of no-one leaping from a sixth floor window.

The aftershocks of Lehman Bros' collapse are now beginning to hit the markets as their credit default swaps unravel. A credit default swap (CDS) is, in essence, an insurance policy against the prospects of a company defaulting on its loan repayments. Lehman Bros' CDSs are valued at somewhere between $200 billion and $440 billion - but nobody is quite sure. Barclays and Royal Bank of Scotland (RBS) are involved in the credit default derivative market and thus may be forced to make write-downs if they are unable to recover all of their money. The recent collapse of several Icelandic banks is expected to throw a further demand for $200 billion of payouts into the credit default derivatives market. In anticipation of this, banks around the world are holding on to cash, further exacerbating the credit shortage. Another consequence is that the value of CDSs being traded on world markets is falling, in some cases to 25% of their original value.

Here in Britain, Northern Rock has been nationalised and the Bradford and Bingley has been partially nationalised, while Lloyds TSB has taken over Halifax/Bank of Scotland (HBOS).

Even Germany, a country usually noted for its financial conservatism and economic robustness, has its problem: Hypo Real Estate, the country's second largest mortgage lender, is on the brink of collapse.

In all of this one has to question the validity of the audits performed on these companies' accounts. There were manifest failures of audit in the collapse of Maxwell, the Bank of Credit and Commerce International, Enron, Tyco, WorldCom and others, and one would have thought that the alarm bells would have started ringing somewhere in the corridors of power. Clearly they didn't and thus one component of this current financial maelstrom is that no one knows the full extent of the problem. Only the other week, the Deputy Governor of the Bank of England, speaking at a meeting at Jackson Hole, Wyoming, said: "... every time the financial markets began to look better another grenade exploded." He speaks as one surprised by events: he should not be - he is the Deputy Governor of the Bank of England and should know what is happening. What his statement does tell us is that national governments are no longer in control of their finances. Over the past twenty-odd years, governments have contracted out various of their functions to private interests; computer systems for the administration of government departments is one example and the failure of the contractors to provide adequately functioning systems is evident in over 85 percent of cases. In more recent times the laxity of security in these systems has also been revealed.

It seems perverse therefore that a state should relinquish stewardship of the currency to private interests, and yet this is exactly what it has done. The financial institutions promised to deliver prosperity if left to their own devices; the government entered into a Faustian pact whereby they agreed to let the banks do as they will, expecting to bask in the warm glow of that promised prosperity and garner votes at the next election. Sadly, it hasn't worked out that way.

The banks offered to work some kind of magic through which money would be conjured out of money: a new kind of alchemy in which the bankers claimed to have possession of the financial equivalent of the philosophers' stone which would transmute the base metal of deposits into unlimited gold.

We might bear in mind that Isaac Newton, one of the world's greatest scientists of his day, actually retained a belief in alchemy and the possibility that base metals could be turned to gold. We now know that alchemy was nonsense and thus we should have known that the promises by the banks that they could work some arcane sorcery on money would fail. But governments are no more immune to seduction than the gullible fool setting foot in a new and exotic land where he believes anything possible.

Boris Johnson, speaking on 23rd September, condemned criticism of the banks as 'neo-socialist claptrap', but what is happening at present is socialism of an order which would have warmed the heart of Lenin; this is failing private institutions being bailed out by government and passing into the hands of the people - who didn't agree to becoming shareholders, but will be, whether they like it or not.

The more sanguine of the Austrian school of economics have said that this crisis should be allowed to work itself out in a frenzy of that 'creative destruction', recommended by Joseph Schumpeter, as the economic purgative. It may well come to that as the scale of the problem builds to the point where it exceeds the power of national governments to avert the deluge. What will emerge from this crisis is as yet unclear but it has served to demonstrate that governments worldwide had relinquished control of their currencies to an extent that would have alarmed a medieval king as a dereliction of one of the states most fundamental functions. We had been led to believe by both bankers and politicians that economic wisdom was their stock-in trade and yet that wisdom has nor been forthcoming; on the contrary, they have revealed themselves as charlatans and fools.

I suspect that one effect of this crisis will be that politicians will assert a much tighter control over the financial institutions if only to protect themselves from future embarrassment. I expect also that there will be a resurgence of their interest in Keynes and Galbraith, with a move away from the doctrines of Hayek and Friedman.

What is ironic in all of this is that China, principal purchasers of American debt, have stubbornly eschewed all the financial nostrums offered by the Western banking system and refused to respond to all exhortations by the International Monetary Fund to restructure their banking system, yet it looks as if they will emerge relatively unscathed, and so much stronger economically and politically.

The Chinese have a saying, "May you live in interesting times." It sounds like a generous sentiment but is in fact intended as a curse. At the moment we are living in very interesting times.

One Year Later ...

The financial phase of the crisis seems to have worked itself out, though there are still, I fear, further failures in prospect. The ripples from the financial tsunami are now damaging the real economy. The government has not, in my opinion, asserted its authority over the financial institutions to anything like the extent needed. They seem to be hoping that 'business as usual' will instil confidence and foster a recovery, but it was 'business as usual' that got us into this mess in the first place. It was once said that the Governor of the Bank of England could express his alarm to an errant banker by the raising of his eyebrow. Mervyn King is currently using both eyebrows, furiously inflecting them as if trying to send semaphore messages to the government, but the government has seemingly put its telescope to its blind eye and refused to take the necessary action.

As the rest of the world begins tentatively to move forward again, if all the figures are to be believed, Britain remains mired in recession. The government is injecting more cash - your cash - to alleviate the situation, but all will be in vain unless Britain reshapes its economy and gets back to real wealth creation rather than dallying in the casino of global derivative markets.

Chris Waller - Permission granted to freely distribute this article for non-commercial purposes if attributed to Chris Waller, unedited and copied in full, including this notice.

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