Guest post: Avoiding a Lehman 2 and a Second Great Depression – David Lilley

September 8, 2011 10 comments

I’m afraid a second Great Depression is a possibility.

The only doctor that can cure the problem is the G20.

The debt situation is far bigger than 1929 when many US citizens jumped on the stock bubble with credit. But many would be less than 10% unlike the many that jumped on the worldwide property bubble.

We cannot unilaterally change our interest rate without consequences affecting FOREX, capital movements and balance of trade. The US can.

The US is like the sun and the rest of us are like planets. If the US gets hot or cold the rest of us get hot or cold.

We have just witnessed a bubble busting, the tech bubble of 2001. We couldn’t possibly walk right into another, but we did.

The tech bubble burst thanks to tiny calculations showing that the emperor had no clothes and 90% of the new Internet companies disappeared overnight. It cost the US 2m jobs and Alan Greenspan took advantage of the US’s reserve currency status to reduce interest rates every 6 weeks 11 times in a row.

I’m not looking at any references. This is all from memory. I follow these things like a hawk.

Easy money put on 7m new US jobs.

When the US reduces interest rates we, and others, can follow and we did. We went down to 3.5% and it occurred to me that that was ¼ of the base rate when I bought here. Therefore, another person could get 4 times his mortgage for the same cost as his 1991 mortgage and that is what happened here and across the world.

The UK house price rose to 9.3 times average income when the norm is 3. US house prices went to 6.

We first heard the term sub-prime mortgagee in 2007. But the fact is that since Carter the NINJAs basically had to be given a mortgage and if he didn’t get one he could get legal assistance from Barack Obama, the solicitor, to get his right to a mortgage. The banks found a way of selling on sub-prime mortgages as securitized bonds (mortgages are securitized loans as the lender has his name on the title and can reposess the asset and sell it if the mortgagee fails to pay). The rip-roaring Northern Rock was giving 125% loans but it was selling them on and was outstanding in the building society market with a great business model for many years.

Securitized bonds paid as much as 18% and there was massive appetite for them. The more sub-prime the better the bond paid and house prices just went up and up and up (as bubbles do). US banks were actively seeking NINJAs and Northern Rock was reaping them in with its 125% deals. In the US you got a three-year easy start to draw you in. These bonds were triple A and when you think that interest rates in Japan were 0% for seven years you can see where the appetite came from. Foreigners held 80% of US treasuries. They were AAA and paid 4% when your bank paid 0%. Buyers of Mortgaged Backed Securities (MBS) looked no further than the 18% and the word “securitized”.

So my point is that the US, with its reserve currency status, had a licence to reduce interest rates and it paid them well, putting on 7m extra jobs and expanding GDP. The cost of Medicare and Medicaid increased 10 fold in twenty years and Bush signed the cheques. The cost of Iraq was small fry by comparison. The US debt ceiling was increased with a nod some twenty times and no one was bothered.

That is what was happening to the world economy. The sun was getting hot and we all benefited from the low interest rates.

But back home we were wanting in parliamentary debate and scrutiny. This is what parliament does. The massive Labour majority of 1997 led to a situation where it was not necessary for Labour MPs to attend debate but only to attend for the vote. Typically few or no Labour backbenchers attended a Finance Bill debate. Try keeping Ken Clarke, John Redwood or Peter Lilley away when money was on the table. But Labour MPs, who actually thought that Gordon Brown was a super economist (when he only studied modern history), never received or contributed to debate and scrutiny.

Labour (when we talk about labour we are only talking about the handful of middle class privately educated politics, philosophy and economics graduates, PPEs, who traditionally take all the top jobs) (prior to 1965 every member of a conservative cabinet had a PPE from Oxford, you need a PPE to govern) jumped on the easy money decade. They borrowed £30-£40bn every year since 2003, grabbed £15bn pa from pension funds (forcing employers to scrap their defined benefit schemes or fund the missing £15bn from profits which in turn takes £15bn from investment in UK wealth creation), drove people into property as the FTSE suffered the loss of £15bn pa, ran up an off-balance sheet debt of £300bn in PFI, allowed mortgage debt to sky-rocket to £1.2tr, allowed £400bn of home equity release and allowed banks to multiply their lending reserve by as much as 30 times deposits.

The result is that today we have personal debt of 1.06 x GDP, corporate debt of 1.26 x GDP and sovereign debt of 89% of GDP. All affordable when interest rates are low but all having to be paid back.

Debt is where you go when you cannot make ends meet. It is bringing forward future earnings. It is like earning £100 per week and taking a one-week sub and telling everyone you are on £200 per week.

GDP is measured in three ways that all give the same answer. It is basically the summation of all transactions. It peaked at £1.5tr in 2007, as did personal debt (£1.2tr of which was mortgages).

Nevermind Gordon Brown’s claim of 53 quarters of growth and the best chancellor ever. Just looking at a simple model; personal debt rising from 0 to equal to GDP between 1997 and 2007, and assuming it is linear, it takes real GDP from +3% to –7%. We were spending money and providing jobs that derived from home equity release, PFI, mortgages and personal, corporate and sovereign loans.

30,000 extra doctors, 90,000 extra nurses, 80,000 teaching assistants and 118 brand new schools in 2007. It all sounded great. A doubling in the spend on pupils pa and a tripling of NHS spend but all based on borrowing and not what we can afford but passed off as the latter.

The illusion was first broken when the Daily Mail ran the story that 90% of all the new jobs that Labour boasted about went to migrants who came here from 2004 onwards to get paid 6 times what they could get back home for the same work. The £ fell and the Zloty rose and many went home but we still have 1.35m doing work that Brits will not do because they are much better off on benefits. Then it transpires that many of the 5.2m Brits on benefits are basically unemployable and industry will always choose a migrant over a Brit because the Brit is less educated, less presentable and has a lower work ethic.

I broke the story that to halve the deficit in four years also meant to increase the national debt in five years. I put it on lots of financial sites prior to the election. Obama first used the phrase and I thought it was good news until I realised that he would be halving the deficit and not the debt. Labour picked up on it and even made it law and I knew it was a persuasive mantra.

You only had to add a few numbers together to understand that halving the deficit in four years meant doubling the debt in five. Debt was £700bn. Add £178bn, £130bn, £110bn, £89bn and a further year and you doubled the debt. I posted it on Jeff Randall’s Telegraph column and the following day was budget day. He never mentioned the budget on his Sky news show when every other channel was budget, budget, and budget. He just repeated that debt was different to deficit and the debt would double in five years. The Treasury Secretary, Steven Timms, was a guest and Jeff asked him what would happen to debt and Steve didn’t know. Jeff pointed out that it would double and that it was in the budget document that Steven had just written.

We are paying £43bn pa in debt service charges and this will grow to £63bn at the end of the coalition term. But we will miss this target, as it is so difficult to get the structural deficit down to 0 in a five year term.

Please ask yourself what you think about halving the deficit in four years? It does mean paying £120b pa in debt servicing in four years time, equal to the cost of the NHS.

The NHS costs £120b pa out of a total government spend of £700b pa of which £400b goes on benefits and pensions. Does any one really think that paying the cost of the NHS in debt service charges is a good idea?

The numbers are the key to understanding the problem and understanding a problem is the key to solving it.

Management is what we need.

Spending money on the most vulnerable in society was hard to control and ended up multiplying the poor and diverting money from the most vulnerable in society.

We introduced IB (incapacity benefit) for a target audience of 175,000 but soon there were 20 times that number claiming that they couldn’t work a day in their lives due to incapacity. Including 200,000 teenagers.

We went easy on single mums and their numbers grew by three fold in the last twenty years. Often due to LAT’s (live apparts). Those who choose to recover the lost income of the female when a child occurs by claiming to live apart and get everything funded by the state (or as I put it, by their neighbour).

We have to swallow some facts about Labour’s Britain that are not well aired by the media.

-The BBC delighted in telling us that the kids would go back to 118 brand new schools in September 2007 but omitted to tell us that even the primary school children would have to pay the PFI (generally 17% pa over 20 years) as it would load their council tax in years to come.

-600,000 LAT’s all getting all their home bills paid by the taxpayer.

-a career choice for 3.5m, less 175,000, was to graduate from JSA (job seeker’s allowance) to IB for the extra money and to save Labour the embarrassment of high unemployment figures. The most common illness being depression.

-1.35m guest workers doing the work we refuse to do.

-14,000 children excluded from school who will never learn to read and write.

-the average cost of a truant was £2m some 15 years ago. Yet we have more truancy today than ever
-15% leave school with no qualifications despite a doubling of the spend on schooling.

-public sector workers get 43% greater remuneration than private sector workers doing the same work when their 7% extra wages, lower hours, longer holidays, earlier retirement and better pensions are accounted for. The reason being that for 13 years the union (Labour) has sat in the employer’s chair.

-only 64% of working age men work, one in four children live in a home without a father (2m children), 5.2 m of working age do not work, one in four households of working age has no worker.

This list is endless.

I have not mentioned all the assaults on employers. We are beginning to realise that we quite like employers as they provide employment. That is what it says on the can. If you kill an employer you lose the tax they provide and the rest of us have to pick up the tab for benefits necessary to fund the workers that he funded before you hit him with CGL (climate change levy), NMW (national minimum wage) and increased employer NI and UBR (uniform business rates).

None of the Labour stimulus went to employers.

Going forward.

Before going forward let us please get the problem properly identified. There is no point in trying to solve the wrong problem.

Do we all agree that the above is the correct characterisation of the problem?


Banks: victims or perpetrators?

On this morning’s Today Programme (Radio 4) there was a spokesperson for one of the UK banks (Stephen Hester of RBS), discussing the current economic turmoil in Europe and the US.

Essentially the message from the contributor was that the banks are just innocent victims in all this! The gist of the claim is that “Our economic problems have been created by Government excesses, and so it is Governments that need to show resolve to address fiscal difficulties in order for the financial crisis to be averted”.

In other words he was stating that the Government and the people created the problem, and so the Government and the people need to pay for it through austerity.

What is most troublesome is that this is the popular narrative being conveyed to the public, and most people seem to be buying it. It is little more than the UK’s equivalent of the US anti-state Tea Party movement, yet the logic is a complete contortion of the facts.

Firstly, this assertion completely evades any consideration of how the banks contributed to high levels of sovereign debt. The Gvts borrowed the money from the banks in the first place! If the banks didn’t think that Gvts would be credit worthy, then why in the world did they lend to them. Only a partially sighted amnesiac could make an honest declaration that there has been absolutely no Irresponsible and Incompetent lending by the banks! See Irresponsible borrowing and irresponsible lending.

Secondly, if you want to understand the source of Gvt income woes then look no further than the offshore banking system where the super wealthy squirrel away their assets out of the reach of scrutiny, regulation, or taxation! Nicholas Shaxson’s “Treasure Islands” demonstrates how an ideologically lax approach to taxation has been implemented by the UK, US and others (and not just in far way Caribbean Islands, but actually within the City of London and Wall St). Profits and income gain are booked in low tax, semi-secretive havens, whilst liabilities sit with us full exposed and law abiding tax paying chumps who are lumbered with underwriting losses through austerity and inflation.

Finally, it shows a complete ignorance of historical facts! Banking crises precede sovereign crises. Not the other way round. This is the conclusion of Reinert & Rogoff in “This time is different” where they study 800 years of financial crises.

Credit liberalisation (born from excessive bank lobbying) leads to asset speculation which leads to excessive banking leverage which then embroils Gvt / sovereign balance sheets.

Does Mr Hester not recall that following a pure “banking” crisis in 2007-2008 the UK Gvt stepped in and has underwritten large private sector losses? Not only that but they have lowered Gvt spending and commenced the debauching of the pound.

In sum, the banks are not the passive victims of financial instability, but the very perpetrators of it! The humble UK tax payer and the enviable public services are the real victims of this crisis.

To be told otherwise is a complete insult to everyone’s intelligence.

Categories: Finance and money

A new Banana Republic?

Imagine a country where the police can’t be trusted to enforce the law, politicians can’t be trusted to represent the best interests of society, and the press can’t be trusted to impartially and fully inform the public.

This isn’t the description of a third world Banana Republic, but unfortunately the worrying trend in the UK. The heroic efforts of a handful of journalists and MPs to uncover the truth behind the recent phone hacking scandal should not be allowed to rest there. The accusations of police bribery and corruption are paramount in this story as it reveals not just police failings or bad decision making, but potential complicity with the unpleasant activities of the media.

Unsavoury conduct in the police is likely to reveal that they were often the press’ source of personal details (such as names and contact details of victims and suspects) thus facilitating phone hacking in the first place (see notes from the Metropolitan Police Authority meeting in 2009 in link below).

The extent of bribery, corruption and coercion by some in the media could also explain why earlier police investigations seemingly found no major issues, and may even reveal how senior executives in the media organisations must have been aware of, or even sanctioned unscrupulous behaviour, through authorising payments.

I wonder if the amount of corruption identified so far is only small because of a lack of looking under enough rocks by truly independent investigators.

Potentially corrupt police officers cannot investigate allegations of their own corruption!

Perhaps we all need to support London Mayoral candidate and MPA member Jenny Jones in her request that we get a formal declaration from all officers involved in the MET Investigations (Operations Weeting & Elveden) that they have never and are not receiving any inappropriate payments or are under any undue pressure or influence from outside sources:

Jones quizzing MET commisioner

Without a trusted police force, it is frightening to think what is now possible. A non-elected corporation which has files on the private lives of politicians, the police, celebritries and members of the public. Information is acquired illegally either by phone hacking (which is akin to tapping is it not?) or by bribing the police. This intel is then used to apply undue influence on anyone who dares to stand up against the firm.

The media’s duty is to acquire (through legal and legitimate means) information to inform the public of illegal behaviour. Instead they have engaged in illegal conduct to acquire information on various peoples’ perfectly legal (if salacious) behaviours.

The police’s duty is to uncover and pursue illegal conduct. Instead they have monumentally failed to pursue this illegal conduct, and what is more, all but covered it up.

We have a history in this country of distrusting politicians, the press and powerful businessmen, but to begin to severely distrust the police is a very worrying consequence of this whole episode.

Categories: General

Irresponsible borrowing and irresponsible lending

Tensions in Greece are reaching melting point. And the debate is a clear and straightforward one. What we are witnessing is a propaganda battle between the forces calling for Austerity and those (perhaps indirectly) proposing Default.

Those calling for Austerity claim lazy workers, socialism and corrupt politicians created a dire fiscal problem that Greece must now pay up for. The sins of the past must be repented through public sector belt tightening (a squeezing of living standards) and large-scale land and infrastructure privatisations (i.e. asset sales).

Those calling for default state that the very Sovereignty of Greece is being challenged by external enforcement of debt peonage. Debt that was foisted on them without due care or consent.

The justification for Austerity is that Greece must own up to its responsibilities and pay back these debts. It is the honourable thing to do, we are constantly told. This mantra is voiced by many economists, politicians, the Prime Minister of Greece himself and would no doubt be the de facto position of the majority of citizens in Europe. Default is treated with emotive disdain, and the spectre of financial Armageddon is wielded around with fear-mongering fanaticism to scare any wavering spirits into submission.

The suggestion being is that default would reward the feckless and punish the prudent. However, this conclusion misses out some more profound behaviour re-enforcement which could be demonstrably more harmful.

Here are at least six very sound reasons why the implementation of Austerity would be morally, socially and legally reprehensible:

1) Shared responsibility

If a bank made a stupid loan to me or my business, who is the greater fool?

Surely, in cases of poor lending circumstances, an irresponsible lender should be just as much to blame as an irresponsible borrower. To enforce total accountability on the borrower is tantamount to supporting loan shark type tactics. In a civilised world, the lender of money has a duty of care to ensure the standard of lending, and this should manifest through the acknowledgement of accountability in times of poor judgement.

2) The symmetry of risk & reward

The voices calling for Austerity also seem to be the most vocal ones with a conservative / libertarian bent. Yet they don’t even realise the sheer hypocrisy of demanding such asymmetric punishment when the very mantra of the true Laissez-Faire Capitalist is the cure of poor investment stakes through default!

Hence the very principle of Equity Investment which correctly balances risk & reward. Debt peonage is not the symmetrical solution as defined under Libertarian principles. One has to be either deluded or an ignoramus to accept the blatant contradiction of extracting all reward (interest AND principal repayment) for no risk.

3) Incompetent lending

In addition to the concept of shared / symmetrical responsibility, it should be clear that in all respects a lender should be more accountable for bad investment decisions, as after all they are deemed to be specialists at lending. I am not a professional borrower of money, but my bank manager is a professional lender. They are deemed to be competent, qualified and professional stewards of investment capital.

So let’s review the performance of these lending professionals.

Taking the historical track record of Greek sovereign debt; it has spent 50.6% of years since 1824 in default or re-scheduling. It suffered a severe banking crisis between 1991 and 1995. This is not an auspicious start point, is it? The banking “professionals” may well proclaim that they relied on elaborate and professional risk assessment criteria using the very latest in sophisticated statistics. But a cursory examination of the situation using the techniques of one Rev’d Thomas Bayes would reveal that the Prior Probability of Greek default was in the order of 50%! And in fact, the course of events is no doubt going to support the accuracy of risk assessment by the humble Bayesian probability over the wildly naïve Gaussian statistics of high finance.

Therefore, it’s not just irresponsible lending that has happened, but incompetent lending!

Bear in mind that bankers justify very high salaries and bonuses because they claim to be very good at their job and that they perform socially beneficial activities. Clearly they are not using reliable tools for assessing levels of risk, and nor have they conducted appropriate due diligence on the country’s ability to pay. Not only this but their self-proclamations of societal benefactors is crumbling before our eyes.

4) Odious debt

So we have seen how the lender has to accept an element of responsibility, but now to turn to the borrower. What many voices seem to declare is that each of the people within Greece have been personally complicit in this excessive borrowing. But this is to accept the idea that all nationals are fully accountable for the conduct of their “representative” leaders. It is the notion of “borrowing by proxy”.

In a way our Gvt in the UK has also done this covertly. It has taken private sector debt problems and soaked up the responsibility onto the nation’s balance sheet. How many people in this country are aware that our banks have liabilities 5 times our national GDP? Was I consulted on this? Did I vote for this? Did I sign a declaration of acceptance of these terms? No, I did not.

There is a term for this situation and one which may become more prominent in months to come. It is that of “odious debt”. Debt which was incurred for purposes that do not serve the best interests of the nation, and therefore should not be enforceable:

Zerohedge – Odious debt

Iceland serves as an example of this principle in action. The people of Iceland have refused to underwrite the extraordinary liabilities of private banking institutions. They understand all too well the morally unjust nature of letting a few wealthy people prosper during the good times, and the scarper when it goes bad (in fact they are charging their Prime Minister for financial negligence for tolerating such leveraged liabilities).

5) Debt for foreclosure

Returning to the national stereotypes mentioned above, then why in the world would anyone invest money in such a country and then expect to get it back? One can’t turn around and forcefully demand the repayment of debt from a nation, whilst at the same time claim that those peoples were never really good for it in the first place. This is an overt admission of not doing one’s homework, but then still demanding full and fair entitlement. It is nothing less than a deliberate intention to ensnare.

Economist Michael Hudson tells an intriguing story of this very strategy in action more than 200 years ago in the US:

“[In] colonial times, when British speculators eyed rich New York farmland. Their ploy was to extend loans to farmers, and then call in the loans when the farmer’s ability to pay was low, before the crop was harvested. This was indeed a liquidity problem – which financial opportunists turned into an asset grab. Some lenders, to be sure, created a genuine insolvency problem by making loans beyond the ability of the farmers to pay, and then would foreclose on their land.”

“They sued under the fraudulent conveyance law, which says that if a creditor makes a loan without knowing how the debtor can pay in the normal course of business, the loan is assumed to have been made with the intent of foreclosing on property, and is deemed fraudulent.”

In other words, it is a pre-planned strategy on the part of the lender to push the borrower into such a corner that they have to sell up at firesale prices. But, clearly this strategy needs some form of social compliance and legitimacy, otherwise it would / should be deemed legally fraudulent!

To socially and legally tolerate it is to explicitly legitimise loan sharking:

“high finance is seeking to turn public infrastructure into rent-extracting tollbooths to extract economic rent (the “free lunch economy”), while replacing labour unions with non-union labour so as to work it more intensively. This new road to neoserfdom is an asset grab.”

Michael Hudson: How Bankers are using the Debt Crisis to welcome in the Financial Road to Serfdom

6) And finally, but what if the devil turns on you?

There is a scene in the play “A man for all seasons” in which the young Roper is debating with Thomas More:

More: What would you do? Cut a great road through the law to get after the Devil?
Roper: I’d cut down every law in England to do that!
More: Oh? And when the last law was down, and the Devil turned ’round on you, where would you hide, Roper, the laws all being flat?

There is a stark warning for us all in the events in Greece. If you are happy to play along with the Neoliberal asset stripping and cheer the Austerity along in other countries – then don’t complain when they turn their sights on us. As highlighted above, the UK’s implicit sovereign liabilities are 5 times our GDP (and therefore more than twice our whole country’s national wealth).

Hudson’s article later extends the actions happening in Greece to the wider western world. He situates this as a general rolling back of progressive principles which were enacted primarily Post WWII:

”The asset stripping that Europe’s bankers are demanding of Greece looks like a dress rehearsal to prevent the “I won’t pay” movement from spreading to “Indignant Citizens” movements against financial austerity in Spain, Portugal and Italy. Bankers are trying to block governments from writing down debts, stretching out loans and reducing interest rates. “

Also from Zerohedge again:

“The war between liberals and conservatives is a false divide-and-conquer dog-and-pony show created by the powers that be to keep the American people divided and distracted. So before assuming that privatization is a good thing, read on.”

America is being raped just like Greece

Certainly anyone for whom their personal interest will be clearly served through the enactment of Austerity will never even raise these points or acknowledge their legitimate discussion. But if we are to hope for an enlightened resolution to the mounting debt woes of the world, we must at least confront each one of these points with the full force of conviction. To have no debate on these points is to unconditionally surrender ourselves to economic genocide.



This post is now available in Spanish, courtesy of!

Potemkin Firewalls

In today’s news we are hearing that George Osborne is endorsing the UK’s Independent Commission on Banking (ICB) interim recommendations for ring-fencing Retail & Investment Banking. This is being couched as a tentative step towards the re-instatement of Glass-Steagal type separation of banking practices. On Radio 4’s Today programme Robert Peston declared the move one of the most fundamental aspects of financial sector reform in recent decades. However, this conclusion might be a little hasty on his part, for in reality the reforms do not tackle the fundamantal operating structure of modern banking, and instead mask more profound issues.

Deregulation of the banking sector since the 1990s has led to the feasibility of banks selling-on loans, known as the “originate and distribute model”. This has led to a fundamentally different market structure whereby an increasing proportion of loans are packaged up and traded as securities on a secondary market (e.g. Asset Backed Securities such as Collateralised Debt Obligations – CDOs).

The importance of securitisation to the ICB was clearly outlined in their opening position paper:

“It was argued and widely accepted during the pre-crisis period that diversifying exposure to credit risk through securitisation made the financial system more stable…the events of the financial crisis showed the opposite.” (ICB Calls for Evidence Paper 2010, Section 2.9)

Yet they seem to have glossed over this issue in their interim report. The important shift in modern banking is not the emergence of the universal banks per se, but the fragmentation of the loan process, i.e. the principle of Securitisation itself.

Under this regime, tasks that would normally be the integrated responsibility of banks become dissected, with one of the most critical aspects, the pricing of risk and the supervision of borrower behaviour, being placed within the hands of secondary markets. However, with credit risk assessment (by the Originating bank) becoming separated from credit risk responsibility (resting with the Holding institution) it seems highly unlikely that the quality of loan evaluation would improve. Indeed evidence collected and published on the cusp of the crisis in 2008 demonstrates that securitised loans severely underperformed!

The very structure of securitisation could be facilitating the exploitation of moral hazard and asymmetric information concerns that have dogged banking for centuries. Borrowers themselves may be making inferior loan judgements (with easy credit enabling an “extend and pretend” lifestyle which they can’t realistically sustain), and/or loan originating firms could develop a tendency to ignore weak borrower circumstances (such as the spate of “self certification” mortgages).

The Independent Commission on Banking may well conclude that firewalls should be erected between Retail and Investment banks. However, the role of securitisation both maintains a mutually interdependent link between the two types of institution, plus places the overall system at higher risk by creating perverse incentives for lower quality lending within the economy. This is no longer a closed system, but instead an open system where risk ownership and responsibility can become complex and obfuscated.

At the time of the crisis in 2007/2008 both Northern Rock & Lehman Bros already sat either side of the notional banking firewall. This argument has been used to dismiss the potential effectiveness of such a compulsory demarcation. Such a split would indeed be little more than a Potemkin firewall; a flimsy masquerade that would provide no genuine safeguards at all. But this should not be concluded at the expense of ignoring a more fundamental point. These two fragile institutions shared in common a heavy reliance on Securitisation. Much of the debate about the market structure of banking seems to ignore this crucial issue, yet it seems certain that this was the underlying cause of their financial distress.

We mustn’t forget that the practice of Originate and Distribute is still new territory, and currently one with a very patchy record. Given that the vertical fragmentation preserves an umbilical link between two distinct systems (one required to be totally watertight, the other free to be more risky), it seems that we can’t yet declare that the future of banking is as safe as houses, until we confront this specific issue head-on.

Categories: Finance and money

Wall of illusions

I have just finished reading Karl Polanyi’s “Great Transformation”, and it is poignant to see the parallels between our current situation and the early part of the 20th Century.

Polanyi’s view is that the free-market should be a servant to Society, not its master. The economic and political tensions throughout the nineteenth and twentieth century are viewed as responses by society to tame and limit un-abandoned free-market policies.

Polanyi was referring to “market-economy” as the market for land, labour and money, whereby these “fictitious commodities” are traded (and therefore priced / valued), as if they were real commodities:

“A market economy is a self-regulating system where everyone is assumed to behave in a way that maximizes money gains. It assumes that in the market supply price will equal demand price. Money is assumed to exist, and the market sets prices. There are markets for everything from goods and services to labor, land, and money. In this ideal system there is not external regulation of prices, demand, or supply.”

Source: Polanyi – Great Transformation

The two key concepts in defining a market economy are firstly that people should be incentivised to act in self-interest (as the assumption is this then benefits society) and secondly that to achieve the utopian vision all aspects of control or regulation of land, labour and money should be abandoned. The true free-marketeer craves de-regulation of the three “fictitious commodities” in order that the market can then price them purely through the mechanism of exchange. Therefore, every man has his price! Society is then a conglomeration of mercenary exchanges by mercenary actors.

It is easy to forget that the relentless pursuit of international trade and liberal Capitalism as defined above was heavily embedded throughout the nineteenth century. Far from a very modern invention, the world had embarked on a grand experiment throughout the Victorian era. So how did it fare back then?

Polanyi describes an era where relative peace in international terms was held together thorugh the Gold Standard, and the military notion of the Standard of Power (whereby Britain could defend against an alliance of the next two most powerful nations). At the national level a liberal state was doing its utmost to implement the utopian self-regulating market. To outside appearances a relative calm existed, but to Polanyi this because inherent tensions were pushed under the surface:

“A hundred years peace [1815-1914] had created an insurmountable wall of illusions which hid the facts.
No people could forget that unless they owned their food and raw material sources themselves, or were certain of military access to them, neither sound currency nor unassailable credit would rescue them from helplessness.”
p198 (my emphasis)

“Within the single nations the tension remained latent as long as world economy continued to function” p228

But towards the end of the nineteenth century the world economy started to fracture. National resistance against the liberal state’s free-market methods was coupled with a breakdown of international finance.

The first world war failed to address the inherent problems as many nations tried to kick start the Laissez-Faire agenda, culminating in the boom and bust of the late 1920s. In his view protectionist policies emerged in the 1930s as a reaction to the failure of un-fettered Capitalism. In their own different ways the New Deal, Communism and Fascism were the social responses to the collapse of International Capitalism; a way for society to re-assert it’s primacy over the market.

The second world war all but eliminated Fascism, and instead left the two models of Communism and the social Democratic approach. The mixed economy of the West saw it through its heyday of the 50s/60s but started to wobble in the 70s. Since the 80s, however, the liberal economic model crept back in to the frame. In a way it was the resurgence of this utopian free-market that crushed Communism in the East, whilst covertly mutuating the semi-protectionist mixed economies of the West.

In its current guise of Globalisation, the free-market has reigned supreme; with Russia, China, Asia etc. adopting this model from the 1990s onwards. The twin pillars of self-interest and de-regulation as the Modus Operandi of Laissez-Faire. But at what price? Perhaps latent tensions exist today, much as they did as the world entered the twentieth century. Polanyi lists the sources of friction as follows:

– Unemployment
– Class divides
– Currency pressures / exchange rates
– Imperialist rivalries

As we take stock of the recent financial crisis, it is important to keep track of these potential flash-points. Unemployment is rising in many countries yet the wealth / income gap widens. The cost of living is increasing yet wages are stagnating. And the contest for dwindling resource supplies in and around the middle-East could provoke tensions between the imperial giants of China and America.

The friction between the market system and society is growing day by day; whether in North Africa, the middle-east or Southern Europe. The Wall of Illusions is starting to crack and crumble, and we dare not wish to peek beyond it.

Does the world have the stomach for another revolt against the global Laissez-Faire pillage? And if so, what kind of form will it take this time?

——- Update 9/9/2013

Summary of Polanyi’s work is found here:

“Land, labour and money are crucial to the efficient functioning of a market economy. Appropriating the functions of these alters and harms central social mechanisms governing human relations.”

Is economics a real science?

If economics would like to consider itself a “science”, then it should be willing to be subjected to genuine scientific scrutiny.

The next 10-20 years will offer us perhaps the most damning expose of the fallacy of modern economics. The true test of a scientific theory is its ability to make testable predictions. Therefore we should compare the expectations laid out by mainstream economics with those from less orthodox origins.

Relentless (linear) growth is assumed to be possible, as long as mankind adopts the bureaucratic / technocratic prescriptions of the economic preisthood. This is the Solow growth model embeded in neoclassical economics.

By contrast in 1972 predictions of global economic growth, population and resources were made by the Club of Rome team’s “Limits to Growth”. The predictions made by this report are consistent with the field of Ecological Economics which places the human economy WITHIN the worlds natural resources. So far, their predictions are worryingly accurate:

(Chart Courtesy of Charles Hall’s Revisiting the Limits to Growth)

The Club of Rome’s model offers a considerably more plausible representation of the world economy than that postulated by traditional economics. The model relies on stocks and flows of various inputs and outputs, the rate at which is dictated by certain rules and feedback loops. Key aspects of the model are:
1) the world has a finite set of resources
2) industrial production requires resource inputs
3) the rate at which these resource draw downs are occuring are not underestimated
4) the consequence of resource extraction & consumption yields pollution

Therefore, the model does not disobey basic laws of physics, such as thermo-dynamics. So from a theoretical point of view it is superior to any Neoclassical model no matter how elaborate their mathematical prowess. Mathematics should represent reality, not replace it; and the Club of Rome model achieves this.

From a practical view, the model predicts world food per capita peaking in about 2010. Real world events are bearing this out. The model also predicts peak resource extraction (steepest decline of the blue line) between 2010 and 2020. Many in the “Peak Oil” community share this synopsis. Peak Industrial Output per capita, and Peak Services per Capita are also predicted to be on the cusp of steep declines.

If the next 5-10 years follow these trends then it will become even more untenable for the traditional economists to hold sway over the population and politicians.

But even more foreboding is that it is just as plausible for many in positions of power and influence to try and distract and deny these problems publicly, whilst privately understanding this dynamic. Instead of informing, educating and preparing the nation for the unsettling future, many in power may simply resort to hoarding wealth, influence and access to these dwindling resources.

Portentous times, indeed.


“From a physics perspective it seems natural to suppose that economic wealth is an abstract representation of a capacity to do something. If so, then economic value, adjusted for things like inflation, should be directly proportional to the rate ( in Watts) at which civilization consumes energy (e.g. coal, oil, uranium, etc.). Nothing in the universe happens without energy being transformed from one form to another. The global economy should be no exception.”

Thermodynamics of civilization growth


A more indepth discussion of the LTG book and the academic assualt against it see:,club_of_rome_revisted.pdf

Categories: Economics, Energy