Gold9472
07-15-2007, 09:12 PM
Danger signals on road to global prosperity
Our financial leaders need to be brought down from their Olympian heights
http://business.guardian.co.uk/story/0,,2127113,00.html
Larry Elliott, economics editor
Monday July 16, 2007
The Guardian
The stand-off between Britain and France over the top job at the International Monetary Fund lifts the lid on how these things work. Alistair Darling was done up like a kipper by Nicolas Sarkozy, who united every EU country bar Britain behind the former French finance minister, Dominique Strauss-Kahn.
It goes without saying that Darling had right on his side. The idea that the Fund is a European fiefdom, with the MD chosen not through an open and transparent process but as a result of a deal cut in Brussels is indefensible. But there is a bigger issue at stake.
Whoever is chosen to run the IMF will join a select band of men wielding enormous power beyond the scope of the democratic process. If DSK (as he's known in France) eventually starts laying down the financial law to poor countries in Africa, it will be without the approval of a single voter anywhere in the world. The same goes for Robert Zoellick at the World Bank, Pascal Lamy at the World Trade Organisation, for Jean-Claude Trichet at the European Central Bank and a host of lesser immortals who sit at the feet of the gods in the new Olympus.
In theory, these guys are tribunes of the people. They are put there after horse-trading by national governments to pursue policies that will ensure global peace and prosperity.
Together, they embody a distinct world view; growth is good, inflation is bad, free trade is good, protection is bad; free movement of money is good; capital controls are bad; the market is good, the public sector is bad.
Not entirely coincidentally, this also happens to be the world view of the rich and powerful around the world. It is the agenda of the multi-national corporation and the City of London; it is the agenda of the media mogul and the hedge fund. There would be a problem with this arrangement even if it could be proved that privatisation, tax breaks for the rich and financial market liberalisation had made the global economy so much more efficient that everybody was benefiting. Why? Because the idea that all of the important decisions are taken beyond the scope of the democratic process leads to political apathy and disengagement - precisely what we are seeing, in fact.
Things get a lot more interesting though, when it starts to dawn on voters that this model is not working, and to the extent that it does deliver it does so for the billionaire rather than the ordinary Joe. Take financial liberalisation. The case for removing all the shackles from capital was that the constraints imposed after the second world war not only led to inefficiency but were also an intolerable attack on freedom. Everything would move a bit faster and a bit more smoothly if these constraints were removed.
All sounds entirely sensible, doesn't it? By the same token, though, it is an intolerable attack on liberty to force a teenager to pass a driving test before being allowed out on to a public road. What's more, traffic would move more smoothly if we abolished speed limits. Get right down to it, and government has no part in this process at all. We should let people sit behind the wheel of a car whenever they want. We should leave it to the self-regulation of the motor manufacturers to restrict the speed of the vehicles put on the road. And we should rely on the common sense of motorists to know just how safe it is to drive.
Well, there might be some libertarian ultras who would support such an idea, but most of us can tell the difference between freedom to drive and licence to kill. Any period of self-restraint would be short-lived and before long we would all be driving like Mr Toad. There would be an almighty car crash, after which there would be urgent calls for the old controls to be brought back.
Now take a look at the financial system. It is easier than ever to get credit. People who really should not be allowed to borrow are being bombarded with offers of loans. Mortgage providers offer unheard multiples of income to first-time buyers because the speculation unleashed by too much easy money has made it impossible to get on the property ladder any other way. Free movement of capital internationally means speculators can borrow money where interest rates are low and invest in riskier assets somewhere else in the world.
So what do you think? A more efficient system for apportioning capital? A system that has removed all the pettifogging restrictions on liberty? A car crash waiting to happen? Or, in the case of the sub-prime crisis in the United States, a car crash that is already happening, albeit in slow motion?
What's happened in the US is an example of how the economy has been pulled out of shape to suit one particular interest group. Over the past few decades the New Deal constraints that were put on big finance after the Wall Street crash of 1929 were systematically dismantled. As a result, when after 9/11 the Federal Reserve flooded the American financial system with cheap money the banks went wild.
Interest-free periods
Once they had lent all they could to those who were good risks, attention switched to the more financially vulnerable. It was obvious many of these people would have trouble paying back their loans, but they were hooked by interest-free periods, teaser rates, no-deposit loans and mortgages where no verification of income was required.
The argument was that this was philanthropy on the part of the banks; they were allowing the poor to get on the property ladder. That's right, said Robert Kuttner, editor of the American Prospect, but only in the sense that the mafia makes loans available to America's small business community.
Loans were extended to millions of people who were never going to pay them back, but the assumption was that this was not really all that risky because house prices would continue to rise. If the borrower couldn't keep up the monthly repayments, they could sell their property at a profit.
So confident was Wall Street that it was on to a winner that it looked for another way of making money out of the sub-prime sector. It took thousands of these loans, bundled them up and sold them as bonds. These bonds were then sliced up into tranches of varying degrees of risk of default, which were then traded on the derivatives market. Hedge funds picked up the riskier portions of the mortgage-based securities because the profits were potentially bigger. As, of course, were the losses.
As interest rates have risen, this get-rich-quick scheme looks a lot less clever. Dodgy mortgage providers have collapsed, the cost of credit has risen, putting a brake on the economy, and Wall Street's rocket scientists have discovered that the market value of their derivatives is a heck of a lot lower than it should be according to their mathematical models.
All the ingredients are in place for a full-scale financial economic crisis in the US. Should that occur, there would not only be a thumping great recession but a backlash against Wall Street of the kind not seen for 70 years. That would provide a fascinating backdrop to next year's presidential election, with the Democrats, in particular, having to decide between populism or rule by elites (or unpopulism). In those circumstances, the excesses of big finance, trade policy and income inequality would all become live issues.
The New Olympians may need to watch their backs.
Our financial leaders need to be brought down from their Olympian heights
http://business.guardian.co.uk/story/0,,2127113,00.html
Larry Elliott, economics editor
Monday July 16, 2007
The Guardian
The stand-off between Britain and France over the top job at the International Monetary Fund lifts the lid on how these things work. Alistair Darling was done up like a kipper by Nicolas Sarkozy, who united every EU country bar Britain behind the former French finance minister, Dominique Strauss-Kahn.
It goes without saying that Darling had right on his side. The idea that the Fund is a European fiefdom, with the MD chosen not through an open and transparent process but as a result of a deal cut in Brussels is indefensible. But there is a bigger issue at stake.
Whoever is chosen to run the IMF will join a select band of men wielding enormous power beyond the scope of the democratic process. If DSK (as he's known in France) eventually starts laying down the financial law to poor countries in Africa, it will be without the approval of a single voter anywhere in the world. The same goes for Robert Zoellick at the World Bank, Pascal Lamy at the World Trade Organisation, for Jean-Claude Trichet at the European Central Bank and a host of lesser immortals who sit at the feet of the gods in the new Olympus.
In theory, these guys are tribunes of the people. They are put there after horse-trading by national governments to pursue policies that will ensure global peace and prosperity.
Together, they embody a distinct world view; growth is good, inflation is bad, free trade is good, protection is bad; free movement of money is good; capital controls are bad; the market is good, the public sector is bad.
Not entirely coincidentally, this also happens to be the world view of the rich and powerful around the world. It is the agenda of the multi-national corporation and the City of London; it is the agenda of the media mogul and the hedge fund. There would be a problem with this arrangement even if it could be proved that privatisation, tax breaks for the rich and financial market liberalisation had made the global economy so much more efficient that everybody was benefiting. Why? Because the idea that all of the important decisions are taken beyond the scope of the democratic process leads to political apathy and disengagement - precisely what we are seeing, in fact.
Things get a lot more interesting though, when it starts to dawn on voters that this model is not working, and to the extent that it does deliver it does so for the billionaire rather than the ordinary Joe. Take financial liberalisation. The case for removing all the shackles from capital was that the constraints imposed after the second world war not only led to inefficiency but were also an intolerable attack on freedom. Everything would move a bit faster and a bit more smoothly if these constraints were removed.
All sounds entirely sensible, doesn't it? By the same token, though, it is an intolerable attack on liberty to force a teenager to pass a driving test before being allowed out on to a public road. What's more, traffic would move more smoothly if we abolished speed limits. Get right down to it, and government has no part in this process at all. We should let people sit behind the wheel of a car whenever they want. We should leave it to the self-regulation of the motor manufacturers to restrict the speed of the vehicles put on the road. And we should rely on the common sense of motorists to know just how safe it is to drive.
Well, there might be some libertarian ultras who would support such an idea, but most of us can tell the difference between freedom to drive and licence to kill. Any period of self-restraint would be short-lived and before long we would all be driving like Mr Toad. There would be an almighty car crash, after which there would be urgent calls for the old controls to be brought back.
Now take a look at the financial system. It is easier than ever to get credit. People who really should not be allowed to borrow are being bombarded with offers of loans. Mortgage providers offer unheard multiples of income to first-time buyers because the speculation unleashed by too much easy money has made it impossible to get on the property ladder any other way. Free movement of capital internationally means speculators can borrow money where interest rates are low and invest in riskier assets somewhere else in the world.
So what do you think? A more efficient system for apportioning capital? A system that has removed all the pettifogging restrictions on liberty? A car crash waiting to happen? Or, in the case of the sub-prime crisis in the United States, a car crash that is already happening, albeit in slow motion?
What's happened in the US is an example of how the economy has been pulled out of shape to suit one particular interest group. Over the past few decades the New Deal constraints that were put on big finance after the Wall Street crash of 1929 were systematically dismantled. As a result, when after 9/11 the Federal Reserve flooded the American financial system with cheap money the banks went wild.
Interest-free periods
Once they had lent all they could to those who were good risks, attention switched to the more financially vulnerable. It was obvious many of these people would have trouble paying back their loans, but they were hooked by interest-free periods, teaser rates, no-deposit loans and mortgages where no verification of income was required.
The argument was that this was philanthropy on the part of the banks; they were allowing the poor to get on the property ladder. That's right, said Robert Kuttner, editor of the American Prospect, but only in the sense that the mafia makes loans available to America's small business community.
Loans were extended to millions of people who were never going to pay them back, but the assumption was that this was not really all that risky because house prices would continue to rise. If the borrower couldn't keep up the monthly repayments, they could sell their property at a profit.
So confident was Wall Street that it was on to a winner that it looked for another way of making money out of the sub-prime sector. It took thousands of these loans, bundled them up and sold them as bonds. These bonds were then sliced up into tranches of varying degrees of risk of default, which were then traded on the derivatives market. Hedge funds picked up the riskier portions of the mortgage-based securities because the profits were potentially bigger. As, of course, were the losses.
As interest rates have risen, this get-rich-quick scheme looks a lot less clever. Dodgy mortgage providers have collapsed, the cost of credit has risen, putting a brake on the economy, and Wall Street's rocket scientists have discovered that the market value of their derivatives is a heck of a lot lower than it should be according to their mathematical models.
All the ingredients are in place for a full-scale financial economic crisis in the US. Should that occur, there would not only be a thumping great recession but a backlash against Wall Street of the kind not seen for 70 years. That would provide a fascinating backdrop to next year's presidential election, with the Democrats, in particular, having to decide between populism or rule by elites (or unpopulism). In those circumstances, the excesses of big finance, trade policy and income inequality would all become live issues.
The New Olympians may need to watch their backs.