One of the things that happens in economic good times – a very clear lesson from history which is repeatedly ignored – is that money gets too cheap. Too much credit enters the system and there is too much money looking for investment opportunities. […] it is an iron law of investment that risks are correlated with returns. The only way you can earn more is by risking more. But ‘this time it’s different.’
I spoke to bankers at the time who said that what happened was supposed to be impossible, it was like the tide going out everywhere on Earth simultaneously. People had lived through crises before – the sudden crash of October 1987, the emerging markets crises and the Russian crisis of the 1990s, the dotcom bubble – but what happened in those cases was that capital fled from one place to another. No one had ever lived through, and no one thought possible, a situation where all the credit simultaneously disappeared from everywhere and the entire system teetered on the brink.
[…]The immediate economic consequence was the bailout of the banks. I’m not sure if it’s philosophically possible for an action to be both necessary and a disaster, but that in essence is what the bailouts were. They were necessary, I thought at the time and still think, because this really was a moment of existential crisis for the financial system, and we don’t know what the consequences would have been for our societies if everything had imploded. But they turned into a disaster we are still living through. The first and probably most consequential result of the bailouts was that governments across the developed world decided for political reasons that the only way to restore order to their finances was to resort to austerity measures. The financial crisis led to a contraction of credit, which in turn led to economic shrinkage, which in turn led to declining tax receipts for governments, which were suddenly looking at sharply increasing annual deficits and dramatically increasing levels of overall government debt. So now we had austerity, which meant that life got harder for a lot of people, but – this is where the negative consequences of the bailout start to be really apparent – life did not get harder for banks and for the financial system. In the popular imagination, the people who caused the crisis got away with it scot-free, and, as what scientists call a first-order approximation, that’s about right.
[…]That impunity, the sense that these things had consequences for us but not for the people who caused the crisis, has been central to the story of the last ten years. It has also been central to the public anger generated by the crash and the Great Recession.
[…]By now we’re eight years into that public anger. Remember that remark made by Robert Lucas, the macroeconomist, that the central problem of depression prevention had been solved? How’s that been working out? How it’s been working out here in the UK is the longest period of declining real incomes in recorded economic history. ‘Recorded economic history’ means as far back as current techniques can reach, which is back to the end of the Napoleonic Wars. Worse than the decades that followed the Napoleonic Wars, worse than the crises that followed them, worse than the financial crises that inspired Marx, worse than the Depression, worse than both world wars. That is a truly stupendous statistic and if you knew nothing about the economy, sociology or politics of a country, and were told that single fact about it – that real incomes had been falling for the longest period ever – you would expect serious convulsions in its national life.
[…]…in the United States […] the income of the typical worker, the real median hourly income, is about the same as it was in 1971. Anyone time-travelling back to the early 1970s would have great difficulty explaining why the richest and most powerful country in the history of the world had four and a half decades without pandemic, countrywide disaster or world war, accompanied by unprecedented growth in corporate profits, and yet ordinary people’s pay remained the same. I think people would react with amazement and want to know why. Things have been getting consistently better for the ordinary worker, they would say, so why is that process about to stop?
[…]Bonuses were a tremendous flashpoint in the aftermath of the crash, because it was so clear that a) bankers were insanely overpaid; and b) they had incentives for taking risks that paid them huge bonuses when the bets succeeded, but in the event they went wrong, all the losses were paid for by us. Privatised gains, socialised losses. The bonus system has been addressed legally, with new legislation enforcing delays before bonuses can be paid out, and allowing them to be clawed back if things go wrong. But overall remuneration in finance has not gone down. It’s an example of a change that isn’t really a change.
[…]…a very clear lesson from history is that complexity allows opportunities to game the rules and exploit loopholes. One way of describing modern finance is that it’s a mechanism for enabling very clever, very well paid, very highly incentivised people to spend all day every day thinking of ways to get around rules. Complexity works to their advantage. As for the question of whether ring-fencing makes the financial system safer, the answer again is that we don’t really know. As the financial historian David Marsh observed, the only way you can properly test a firewall is by having a fire.
[…]The plan for increased equity has been most rigorously advocated by the Stanford economist Anat Admati, and the banks absolutely hate the idea. It would make them less profitable, which in turn means bankers would be paid much less, and the system would with absolute certainty be much safer for the public. But that is not the direction we’ve taken, especially in the US…
In some cases, it’s not so much a case of non-change change as of good old-fashioned no change. Take the notorious problem of banks that are too big to fail. That issue is unambiguously more serious than it was before the last crash. The failing banks were eaten by surviving banks, with the result that the surviving banks are now bigger, and the too big to fail problem is worse.
[…]In other areas, we’re in the territory that Donald Rumsfeld called known unknowns. The main example is shadow banking. Shadow banking is all the stuff banks do – such as lending money, taking deposits, transferring money, executing payments, extending credit – except done by institutions that don’t have a formal banking licence. Think of credit card companies, insurance companies, companies that let you send money overseas, PayPal. There are also huge institutions inside finance that lend money back and forwards to keep banks solvent, in a process known as the repo market. All these activities taken together make up the shadow banking system. The thing about this system is that it’s much less regulated than formal banks, and nobody is certain how big it is. The latest report from the Financial Stability Board, an international body responsible for doing what it says on the tin, estimates the size of the shadow system at $160 trillion. That’s twice the GDP of Earth. It’s bigger than the entire commercial banking sector. Shadow banking was one of the main routes for spreading and magnifying the crash ten years ago, and it is at least as big and as opaque as it was then.
[…]The mental image of a market is misleading: the metaphor implies a single place where people meet to trade and where the transactions are open and transparent and under the aegis of a central authority. […] Financial markets today are not like that. They aren’t gathered together in one place. […] In many areas, the overwhelming majority of transactions are over the counter (OTC), meaning that they are directly executed between interested parties, and not only is there no grown-up supervision, in the sense of an agency overseeing the transaction, but it is actually the case that nobody else knows what has been transacted. The OTC market in financial derivatives, for instance, is another known unknown: we can guess at its size but nobody really knows. The Bank for International Settlements, the Basel-based central bank of central banks, gives a twice yearly estimate of the OTC market. The most recent number is $532 trillion.
So that’s where we are with markets. Non-change change, in the form of bonus regulation and ring-fencing; no change or change for the worse in the case of complexity and shadow banking and too big to fail; and no overall reduction in the level of risk present in the system.
We are back with the issue of impunity. For the people inside the system that caused a decade of misery, no change. For everyone else, a decade of misery, magnified by austerity policies. Note that austerity policies were not recommended by mainstream macroeconomists, who predicted that they would lead to flat or shrinking GDP, as indeed they did. Instead politicians took the crisis as a political inflection point – a phrase used to me in private by a Tory in 2009, before the public realised what was about to hit them – and seized the opportunity to contract government spending and shrink the state.
[…]We thus arrive at the topic that more than any other sums up the decade since the crash: inequality. For students of the subject there is something a little crude about referring to inequality as if it were only one thing. Inequality of income is not the same thing as inequality of wealth, which is not the same as inequality of opportunity, which is not the same as inequality of outcome, which is not the same as inequality of health or inequality of access to power. In a way, though, the popular use of inequality, although it may not be accurate in philosophical or political science terms, is the most relevant when we think about the last ten years, because when people complain about inequality they are complaining about all the above: all the different subtypes of inequality compacted together.
[…]A third driver of increased inequality, alongside austerity and impunity for financial elites, has been monetary policy in the form of Quantitative Easing. QE, as it’s known, is the government buying back its own debt with newly minted electronic money. It’s as if you could log into your online bank account and type in a new balance and then use that to pay off your credit card bill. Governments have used this technique to buy back their own bonds. The idea was that the previous bondholders would suddenly have all this cash on their balance sheets, and would feel obliged to put it to work, so they would spend it and then someone else would have the cash and they would spend it. As Merryn Somerset Webb recently wrote in the Financial Times, the cash is like a hot potato that is passed back and forwards between rich individuals and institutions, generating economic activity in the process.
The problem concerns what people do with that hot potato cash. What they tend to do is buy assets. They buy houses and equities and sometimes they buy shiny toys like yachts and paintings. What happens when people buy things? Prices go up. So the prices of houses and equities have been sustained, kept aloft, by quantitative easing, which is great news for people who own things like houses and equities, but less good news for people who don’t, because from their point of view, these things will become ever more unaffordable. […] We’re back to that question of whether something could be necessary and a disaster at the same time, because QE may well have played an important role in keeping the economy out of a more severe depression, but it has also been a direct driver of inequality,
[…]Napoleon said something interesting: that to understand a person, you must understand what the world looked like when he was twenty.
[…]Thatcher was a philosophical conservative for whom the ideas of Hayek and Friedman were paramount: capitalism was practically superior to the alternatives, but that was intimately tied to the fact that it was morally better.
[…]In recent decades, elites seem to have moved from defending capitalism on moral grounds to defending it on the grounds of realism. They say: this is just the way the world works. This is the reality of modern markets. We have to have a competitive economy. We are competing with China, we are competing with India, we have hungry rivals and we have to be realistic about how hard we have to work, how well we can pay ourselves, how lavish we can afford our welfare states to be, and face facts about what’s going to happen to the jobs that are currently done by a local workforce but could be outsourced to a cheaper international one. These are not moral justifications. The ethical defence of capitalism is an important thing to have inadvertently conceded. The moral basis of a society, its sense of its own ethical identity, can’t just be: ‘This is the way the world is, deal with it.’
I notice, talking to younger people, people who hit that Napoleonic moment of turning twenty since the crisis, that the idea of capitalism being thought of as morally superior elicits something between an eye roll and a hollow laugh. Their view of capitalism has been formed by austerity, increasing inequality, the impunity and imperviousness of finance and big technology companies, and the widespread spectacle of increasing corporate profits and a rocketing stock market combined with declining real pay and a huge growth in the new phenomenon of in-work poverty. That last is very important. For decades, the basic promise was that if you didn’t work the state would support you, but you would be poor. If you worked, you wouldn’t be. That’s no longer true: most people on benefits are in work too, it’s just that the work doesn’t pay enough to live on. That’s a fundamental breach of what used to be the social contract. So is the fact that the living standards of young people are likely not to be as high as they are for their parents. That idea stings just as much for parents as it does for their children.
This sense of a system gone wrong has led to political crises all across the developed world.
[…]Sociology would have been a better social science than economics for understanding the last ten years. Three dominos fell. The initial event was economic. The meaning of it was experienced in ways best interpreted by sociology. The consequences were acted out through politics. From a sociological point of view, the crisis exacerbated faultlines running through contemporary societies, faultlines of city and country, old and young, cosmopolitan and nationalist, insider and outsider. As a direct result we have seen a sharp rise in populism across the developed world and a marked collapse in support for established parties, in particular those of the centre-left.
[…]In conclusion, it’s all doom and gloom. But wait! From another perspective, the story of the last ten years has been one of huge success. At the time of the crash, 19 per cent of the world’s population were living in what the UN defines as absolute poverty, meaning on less than $1.90 a day. Today, that number is below 9 per cent. In other words, the number of people living in absolute poverty has more than halved, while rich-world living standards have flatlined or declined. A defender of capitalism could point to that statistic and say it provides a full answer to the question of whether capitalism can still make moral claims. The last decade has seen hundreds of millions of people raised out of absolute poverty, continuing the global improvement for the very poor which, both as a proportion and as an absolute number, is an unprecedented economic achievement.
The economist who has done more in this field than anyone else, Branko Milanović at Harvard, has a wonderful graph that illustrates the point about the relative outcomes for life in the developing and developed world. The graph is the centrepiece of his brilliant book Global Inequality: A New Approach for the Age of Globalisation. It’s called the ‘elephant curve’ because it looks like an elephant, going up from left to right like the elephant’s back, then sloping down as it gets towards its face, then going sharply upwards again when it reaches the end of its trunk. Most of the people between points A and B are the working classes and middle classes of the developed world. In other words, the global poor have been getting consistently better off over the last decades whereas the previous global middle class, most of whom are in the developed world, have seen relative decline. The elite at the top have of course been doing better than ever.
[…]I mentioned earlier that assets and liabilities always balance – that’s the way they are designed, as accounting equalities. But when we come to global wealth, this isn’t true. Studies of the global balance sheet consistently show more liabilities than assets. The only way that would make sense is if the world were in debt to some external agency, such as Venusians or the Emperor Palpatine. Since it isn’t, a simple question arises: where’s all the fucking money? Piketty’s student Gabriel Zucman wrote a powerful book, The Hidden Wealth of Nations (2015), which supplies the answer: it’s hidden by rich people in tax havens. According to calculations that Zucman himself says are conservative, the missing money amounts to $8.7 trillion, a significant fraction of all planetary wealth. It is as if, when it comes to the question of paying their taxes, the rich have seceded from the rest of humanity.
Source: London Review of Books (July 5, 2018)
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