Over the past week, we - the rich-world voter and taxpayer - have bailed out the hedge-funds, their bankers and their counterparts caught in the global squeeze on credit. Again. It happened in 2001 and in 1998. The financial system has once more fallen into the soft, bouncy, but ultimately comfortable safety-net (trampoline?) that we - all of us together, through our central banks and the losses we are prepared to underwrite as taxpayers - extend to troubled financiers.
Are we right to keep bailing out the bankers, offering them a safety-net that turns their business nto a risk-less, one-way bet? There was an innocent time when we - as voters and taxpayers - were right to always be there as "lenders of last resort". But finance has become self-servingly postmodern too: the banking system knows how to take advantage of the social-security we have extended, and we are only storing up trouble by keeping them afloat. We should resist the temptation to "hug a hedgy''. Now is the time for some tough love for the newly stressed and bedraggled hedge-fund managers. Only this will allow the emergence of a fair and stable financial order.
But, the fund manager might retort, why endure the pain that a wholesale financial restructuring now would entail? Can't we - that is, you - give in just one more time, and hope that our binge of bad investment is pardoned in the dilutive (and real) forces of technological and global-south catch-up growth?
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“Corporate liability and social interest” (25 July 20This is an offer the rest of us should refuse, for it resembles nothing so much as the argument for repeated concessions to the welfare-Keynesianism of the 1960s and 1970s. The crisis of that model, and the lack of principled, intellectual and political, resolve among the policy-makers of that era in response to it, eventually undermined the modern dream of fair, full and fruitful employment. So today, the continuation of healthy global growth in the world economy is threatened by institutional blockages, this time from systematically malfunctioning financial agencies that seem at every step too powerful to cross. We live in a moment when technology and trade offer great hope for the development of good lives. This generation must not allow itself to squander through cowardice, as did its predecessor, the opportunity for sustainable economic betterment.
The lineaments of crisis are plain. Financial markets have fallen sharply. Central banks have acted in concert as "lenders of last resort'' to troubled funds. Bond dealers show from their trading behaviour that they are no longer expecting interest rates, which had been rising, to rise any further in 2007. The consensus is that the United States federal reserve and the central banks of Europe and Japan have been right to intervene, to offer cash when none others will, in order to avoid a system-wide crisis. The world's finances rely on a basic assumption that markets will continue to exist. If I need to make a cash payment, I will be able to select which of my assets to sell and will actually be able to sell them at some price.
In a system-wide crisis, no one wants to trade. There is no price at which anyone can be convinced to hold a contract, because no one knows what its value is. In this circumstance, a fund manager is a helmsman in a storm: aware of every danger of his position but powerless as wind, then waves, batter him here, then there. But unlike the helmsman, the storm is made worse if another ship in the vicinity goes down. If a bank actually faces bankruptcy, all the contracts and obligations held by that institution will be bad, thus infecting trust in every part of the financial system.
The central banks bail out the funds in order to stop anyone seeing a ship go down, as a way of stemming contagion. That is the defence. This is why we, as citizens and voters the owners of the central banks, lend money in conditions in which no banker would lend. And the argument is strong: contagion and system-wide crisis will have a real impact that will cause hardship: when firms and households find borrowing is hard, demand drops, jobs go ... recession. There is a real case here for us to bail the hedge-funds.
But the metaphor of the storm is misleading. Meteorology is not caused - at least not predictably - by the decisions of the helmsmen it affects. Financial crises are. It is because we can be counted on to be lenders of last resort that traders and managers can discount the risks of system-failure and therefore behave imprudently with increasing ease and frequency. The pattern is familiar from the libertarian critique of welfarism: while a safety-net for the deserving poor is good, the existence of the safety-net will create a class of idle, undeserving scroungers. It is hard to be good without encouraging others to be vicious.
Fund managers have been enjoying a one-way bet for six years or more. A credit-worthy institution could borrow very cheaply and lend on without any concern about becoming systematically over-stretched. In the extreme case, the Japanese central bank has been lending money almost for free. Those with access to free money could lend it on to those without such privilege and pocket not just the difference, but, through gambles, multiples of the difference. This is the magic of the "carry-trade".
The skill of the game - if you listen to its practitioners - is to make sure that the risk is properly packaged. The near-zero cost of borrowing is available to the credit-worthy banks; the fact that money costs most of us 7% or more arises because each of us individually might default: if I lose my job, I might miss a few mortgage-payments. The credit-worthy bank, on the other hand, will not default ...even in the face of catastrophe. The incentive to find punters who can be convinced to take on a loan is very clear: their monthly interest-payments are pure profit to the credit-worthy institution which has paid nothing for the money. If that is a hedge-fund, then one in every three dollars, pounds or yen repaid goes into the personal wealth of the masters of the universe at the helm.
Anyone looking down from an aeroplane window-seat onto a mid-western American city in the past few years will have seen the outgrowths of the hunt for the loan-hungry. The plane approaches Denver airport. The mile-high plain, a mixture of ranch scrubland and oil-pumping jackdaws - here, they look like an artisanal industry, an accessory of ranching accessory - is cut out by jigsaw-puzzle-pieces of curlicued driveways, tendrils into the emptiness. The street-lighting is there, the houses not yet. A few seconds closer to landing, the wooden frames of the semi-built appear. And now the new suburb, complete with SUV or pick-up. The trees will come later to Linden Avenue. All over America, telephone-mortgage salespeople turned individuals' dreams of owning a piece of ex-scrubland into a commitment to monthly repayments into profit contributions for the funds and eventually into 142-foot yachts like John Devaney's Positive Carry.
The carry-trade has been turned into a one-way bet by the financial system's equivalent of welfare-Keynesianism. The credit-worthy lender knows that if there is no system-wide turbulence, individual defaults will be weathered through the predictable statistics of the game; but the lender knows also that when everyone has some chance of defaulting together, we will all - as taxpayers - come to the rescue. Each carry-trader faces this tough choice: either I make a packet, or I survive. Compare this to the tough choice faced by Keith Talent, Martin Amis's archetypal wheeler-dealing welfare-scrounger, textbook baddy of neo-liberals set in Thatcherite London: either I hawk these stolen pornographic videos and make a nice profit, or I just wait around for the welfare cheque. In either case, life is pretty good, and certainly presents no strong incentive to develop my capabilities to be productive and useful.
We extend social security to bankers because of the appalling consequences of a financial-system failure; we thereby increase the likelihood and frequency of having to bail out the bankers. It is all too reminiscent of late-1970s labour disputes, when the threat or reality of concerted industrial action was all too often met by consent to trade-union demands for pay increases and improved entitlements unrelated to productivity. The result was to worsen the climate of industrial production and increase confrontations between labour and capital. In Britain and America, the denouement of this model was devastating to its political champions and social beneficiaries: the election of Margaret Thatcher (1979) and Ronald Reagan (1980), and the deep recessions of the early 1980s, and the drastic readjustment of labour expectations.
But is there anything actually wrong with bailing out the bankers? Why not live with more frequent crises? Just as we once bribed organised labour for an easy life, can we not just view what we do here as bribing the bankers to keep the world economy oiled with the cash it needs to generate the goods and jobs we want?
There was an innocent time when this deal may have worked. Bankers did their job of assessing risks and allocating savings to worthy investments. When panic threatened, the social-security of last-resort lending was effective. Think of it as the classic Keynesian welfare state or the context for the great successes of the New Deal: honourable behaviour all round, with the edge taken off misfortune. But self-awareness of this mechanism has undermined it, just as welfarism has led to unsustainable levels of abuse. Today, bankers are principally looking for any source of commitment to pay interest, irrespective of its credit-worthiness. A firm desire to have a substantial asset in your name - the house or the SUV - is the soft target at the end of the carry-trade chain.
But the real job of the banker should be to judge the realism of the desire, not just its strength or existence. The structural role of finance in the home, the company, or the world economy is as a sort of super-ego, a reality principle. Social insurance for bankers has undermined the traditional virtues of banking: prudence, scepticism, an eye for opportunity, understanding, and has replaced them by the sharp tactics we know from Keith Talent - opportunism, carelessness, foolhardiness.
The result of losing the reality principle that finance should incarnate will be felt for years to come: instead of careful investment in useful projects, we will have spent years and billions over-indulging fantasies of ownership. Just as when the personal ego is allowed to run riot, the hangover and depression may be painful. So why should we go through the pain?
Out of the end of innocence in welfarism and trade-unionism came the tough love - and also destructiveness - of neo-liberalism. But thence also comes the political opportunity for a new social democracy - which the better aspects of New Labour in Britain, of Gerhard Schröder in Germany and Clintonite policies in the United States moved towards: attempts to create a new social contract that allows the best of fairness-based justice to re-emerge. The same pattern should be sought for banking: a financial order based on the virtues of the gentleman-capitalist is brought under repeated strain when those virtues no longer constrain behaviour (the degenerate Keynesian phase). A period of tough but destructive reorganisation is needed (where we are today) before a financial order based on recognised roles and shared responsibilities can emerge (the new social contract we should seek to establish).
Much as nostalgics and conservatives might bemoan the old order, and much as libertarians might like to see here an opportunity for the end of social contracts in finance altogether, neither is a real alternative. We want insurance from panic-attacks, so we will need some form of welfarism in financial markets; we have lost forever - and do not want to recreate - the ways of life that made the old order of gentlemanly capitalism effective. The financial crises and asset bubbles we see today are the symptom of a broken system. To borrow a tune from Thatcher, "there is no alternative'' - to the painful path of renewal for our financial system that the other parts of the old order have seen over the last thirty years.