Category Archives: Business and Society

‘Chasing Goldman Sachs’ by Suzanne McGee – A Review

A Review of ‘Chasing Goldman Sachs: How the Masters of the Universe Melted Wall Street Down…and Why They’ll Take Us to the Brink Again’  by Suzanne McGee (2010, Crown Business)

'Chasing Goldman Sachs'  by Suzanne McGee
‘Chasing Goldman Sachs’ by Suzanne McGee

This book is an excellent complement to the academic stuff I’ve read on the causes of the financial crisis. These latter accounts are very detailed in terms of ‘what’ happened but tend to be light on the ‘why’. ‘Chasing Goldman Sachs’ goes a long way to filling that gap.

The academic consensus view seems to be that driven by an increase in demand for safe places to save there was a huge increase in deposits held by financial institutions and collateralised by Asset-Backed Commercial Paper (ABCP). A significant proportion of this paper was comprised of securitised mortgages – many packaged in such a way that their quality was opaque. The toxicity of these was enhanced by dodgy ratings and shuffling to off-balance-sheet vehicles. When problems with some of these mortgages arose it took a while for holders of these ‘shadow-banking’ deposits to sort out whether or not their deposits were collateralised by bad assets or good ones. There was a panic and large-scale dumping of these deposits which led to loss of liquidity in the market for short-term interbank loans. Without these loans banks find it very difficult to balance their books at the end of each day as they are obliged to. (A good guide to all this from the academic point of view and to further more technical reading is at http://www.nber.org/papers/w17778.)

So the ‘why’ questions become:

  1.     Why was there so much additional demand for large chunks of saving that required collateralisation?
  2.      Why were poor-quality mortgage assets allowed to find their way into supposedly high-quality collateral?
  3.    Why was the nature of these poor-quality assets hidden by the approach of the financial institutions and the rating agencies?

Englebert Stockhammer of Kingston University, UK, has argued that the answer to Q1 can be found in a combination of rising inequality and international financial deregulation. McGee’s book does a good job in answering Qs 2 and 3. There were opportunity and motive to make enormous short-term gains from the huge wave of money flowing around looking for a home – much more than could be recycled into productive investment. The potential gains going to individuals were so large that the long-term fate of their institutions, let alone the financial system as a whole, was of no consequence even if they ever thought about these.

Deregulation of banks allowed them increasingly to use assets on their own balance sheets to leverage large, risky and profitable transactions. Their operations were increasingly about maximising the returns on transactions in which their own capital was at risk, rather than fees earned for safely managing the capital of others. Thus it is hardly surprising that their diligence in looking after the interests of their clients/counterparties dramatically decreased. ‘Chasing Goldman Sachs’ documents well the pressures brought to bear on any individuals who were less happy about these developments!

My own main research interest is in the real (rather than the theoretical) working of the monetary system and its relationship to economic processes that involve real people, goods and services. According to my reading of the way bank lending works, the existence of large quantities of savings looking for a profitable home is actually the result of a dysfunctional economy; one in which banks are creating money in excess of genuine consumption or investment needs. Why should banks do this – since a failed loan results (eventually) in a hit to their equity capital via the profit and loss account? One semi-rational reason is that loans are riding on the back of speculative bubbles, and every lender is hoping they will be repaid before the bubble bursts. Less rational (from the institutional point of view) is reckless fee and bonus-generation activity by managers and employees. Third I guess is just stupidity. All of these appear in Suzanne McGee’s account!

One might predict (hope, anyway) that the stupidity would have been flushed out of the system by the financial crisis, but there is of course no reason to suppose that the incentives driving the first two reasons for excess loans and money creation have changed much.

As this book rightly and repeatedly emphasises, the financial system is a utility primarily for allocating purchasing power where it generates most welfare. Bank loans create that purchasing power for the purpose of allowing production, consumption time-shifting (especially of housing services) and asset re-allocation. That purchasing power actually disappears when the loan is repaid, which allows the quantity of money in the economy to fluctuate in line with the quantity of goods and services being produced and additional value being created. Inevitably, because mistakes are made and because individuals want to save despite the paradox of thrift in the aggregate, not all money created finds its way back to the banks as anticipated. In which case institutions can ‘intermediate’ between these savers and firms needing money to repay loans (or, in practice, other immediate purposes) and reduce the inefficiency resulting from the lending mistakes and saving desire. Because money mainly exists as bank deposits the mechanisms of payment between individuals, firms and the government also take place through the banking system. Any other activities banks get involved in are essentially secondary to these primary purposes.

Thus it is essential and appropriate that banks are prevented from doing anything that puts these primary roles at risk. But how to do so without limiting their ability to provide purchasing power where and when needed, or their ability to intermediate efficiently? McGee describes the regulations aimed at doing this as well as several instances of individuals trying to run their (small) institutions in this way. I think she is quite correct in her views of the limitations of all this.

My view is that the best way to tackle this is to internalise the externalities, by changing the governance of banks to a much more social model by ensuring employee, customer and community representation in their governance. In some ways this model recalls George Bailey’s institution in ‘A Wonderful Life’ but modern versions actually exist in Europe and no doubt elsewhere. The German Sparkasse system was remarkably resilient during and after the financial crisis – maintaining its loan issuance much better than the big German banks. On the other hand similar institutions in Spain apparently made quite a lot of local property and construction loans that went bad – governance has to be competent whoever is doing it.

Understanding Money

Understanding Money – a non-technical account of the essential role money and its creation plays in a modern economy. This article was previously available as a pdf, but I have now posted it as a blog in its own right. Since it was originally written in 2010, I have made a few revisions and additions.

 

Introduction

The genius of Lehman
The genius of Lehman

Most of us have little idea of what money is and where it comes from. When we think of money, we think of bank-notes and coins. We know that most money is held in bank accounts, but even then we have an image (although most of us are probably aware that it isn’t quite an accurate image) of these notes and coins being held for us by the bank or lent out by the bank to make money for them (and hopefully us, if the money is held in an interest-bearing account). In fact the reality is about as far away from this as it is possible to imagine.

Of the total amount of money (adding together bank-notes and coin held by the general public and the value of all bank accounts in the UK), the bank-notes and coin make up only around 3% ! The reality is that the vast majority of all money exists only as a record held in someone’s name by some bank or other. How can this be? Where does this money come from? Where does it go? In this article I will attempt to answer these questions, and in doing so explain the benefits and the potential downside to our monetary system. Continue reading

Modern Thinking: Atomism and Communication

‘Modern Thinking: Atomism and Communication’ – Although written four years ago for an essay competition, I still think this piece encapsulates as well as anything my approach to economics, politics and social institutions.

Atomised and helpless
Atomised and helpless
Bertrand Russell, the great British mathematician and philosopher, believed that to be ‘modern-minded’ was to make the error of thinking with the fashion rather than ahead of it. When he wrote about this in 1937 he believed that with God’s role as arbiter of truth and beauty having been usurped, ‘detachment and objectivity, both in thought and feeling’ had also been thrown overboard. Russell, as a rationalist and a non-believer, believed it was ‘possible and important’ to preserve them without recourse to a Creator. To do so, he believed, required ‘solitude’ and ‘a certain degree of isolation both in space and time’. While he may have been right when it comes to studying the physical world and creating great art, his advice is less helpful when it comes to human nature and society. Even if we wanted to, as human beings ourselves, we cannot stand apart from other humans and society as a whole. Unfortunately when this recognition came it was in part responsible for a critical wrong turning in our approach to social phenomena. This wrong turning came about because modern thinking, having dispensed with God guiding from above, had already turned to look for causes and drivers of events at the level below that at which they are observed. The properties of substances had to be derived from the properties of their molecules; the properties of the forces that change the world about us from day to day are derived from the waves and particles into which they can be decomposed. Continue reading

Unemployment – Morality, Money and Increasing Returns

Returns to Scale in Frankfurt's business district
Returns to Scale in Frankfurt’s business district ©DWP

The causes of unemployment make it a moral issue. Radical solutions are required.

In an earlier post I noted some features of unemployment from a UK perspective. The main thrust was that a fairly constant proportion of the population in employment (around 72% of those of working-age) hides a serious decline in the availability of adequate work, due mainly to the increase in women in the workforce and the fall in the ratio of full-time to part-time work. In a paper I wrote and referenced here on welfare I hinted at a moral dimension to the issue of unemployment in a capitalist economy (by which I simply mean an economy where physical means of production tend to belong in more or less concentrated hands).

I have now written a rather more formal paper (pdf 198kb) which I presented to the Post-Keynesian Study Group annual workshop in May this year in which I expanded on why we have a persistent problem with unemployment, and why this has a significant moral implications in our attitude to the unemployed. In this light of this I review the inadequacy of current policy and look at some of the more radical solutions proffered. The following is a non-technical summary of the paper. Continue reading

The Real Wealth of Fizz

Coca Cola bottle and CashAmol Rajan, whom I have had cause to praise previously, wrote last week about Coca-Cola’s self-serving ‘anti-obesity campaign’. While much of what he writes is refreshingly scathing, I would take issue with the following statement:

[Coke] is a massive corporation that exists to make huge profits. This is fine by me, because I like big corporations: they create wealth, tax revenues and jobs.

Clearly the first part is mostly true. Mostly in the sense that a company also exists to expand the empires, wealth and reputations of its executives – which is generally also tied up with making ‘huge profits’. The problem I have is with the idea that big corporations necessarily ‘create wealth, tax revenues and jobs.’ Whether they create real wealth is often doubtful.

In the case of Coca-Cola what it mostly creates is sweet fizzy drinks and the additional pleasure that comes from drinking their drinks rather than those of any competing suppliers. If we wanted to monetise that real ‘wealth’ it would be in terms of the additional price we are willing to pay for Coca-Cola products over other similar drinks. Note that we have to pay that surplus freely – if we are forced to pay it because of local monopolies or persuaded by misleading advertising than it represents not a social gain but a loss. Continue reading

Better Press Regulation should be Liberating

This article is on 3 pages, and you can go to the next page you want by clicking on the relevant  number at the bottom of each page.

papersThe report of the Leveson inquiry into the Culture, Practice and Ethics of the Press is expected to be delivered next week. I am publishing here a fuller version of my article that was previously published on LabourList. I was interested to note a report on the BBC News this evening on the Danish Press Council, which operates on a statutory basis and in a way not dissimilar to my suggestions here.

Introduction – The Press: Free for Whom and Free from What?

Press regulation as self-regulation is no longer, if it ever was, acceptable. It has utterly failed to prevent harm, to deal with the consequences of harm, and most importantly, failed to give us the high quality information and varied interpretation of current events and processes for which a ‘free press’ is valued. There is strong evidence for this in observing some extraordinary misapprehension of facts about our society.

As reported by a Cabinet Office briefing in 2000, when questioned people estimated on average that 26% of the population belonged to an ethnic minority. The real figure then was 7.1%. They thought on average that 20% of the population were immigrants. The figure at that time was just 4%, although it has now increased following EU expansion. A recent YouGov survey conducted for the Fabian Society found that people systematically overestimate government spending on unemployment benefit and the police by a factor of eight, housing benefit and child benefit by a factor of three, and sickness and disability benefits and defence by a factor of two. Yet when it comes to those parts of public expenditure where direct experience is common, such as the NHS, education and state pensions, the average estimate is reasonably close to the reality. Whatever our preferences, if we aren’t getting accurate information we cannot collectively make good decisions on important matters. As Lord Judge, the Lord Chief Justice, has pointed out

‘[T]he liberty of the press…is the right of the community as a whole. It is…our right, the right of every citizen.’ Continue reading

Equality of Voice and ‘Devo-localism’

Dependent Smurf
Don’t I get a say?

 

That’s where the real constitutional debate needs to be – around a radical constitutional option that puts Scotland back into the hands of its people: devo-local, if you like. Trevor Davies, The Scotsman 10/5/2012

 [Politicians] see themselves as propping up something which is tottering rather than letting citizens build anew something that is soundly based. Charles Moore, Daily Telegraph 13/7/2012

 

Power wielded from the centre is slow to react, inflexible and discriminates poorly. Yet political power at all levels has been steadily eroded as a consequence of the economic demands of global corporations and the economic strain on central government to provide for these corporations and mop up the damage they cause. No redistribution of political power from centre to periphery can be sustainable without addressing the centralisation of economic power. The willingness to address the latter is surely what will separate the left ‘devo-localist’ from the right. Continue reading

Leveson Heat Rises for the Press

Since my post Leveson, the Press and Labour there have been further developments. The Prince Harry photos episode was hardly edifying for the press or the Royal Family. That the Sun editor could claim that publishing these photos of a silly over-privileged young man was somehow ‘about the freedom of the press’ should re-inforce my main point. The primary freedoms most of the current press industry are ultimately interested in are the freedom to make money and the freedom to promote their owners’ interests.

That News International in particular are an organisation whose values are seriously removed from human concerns was re-inforced today by the publication of a seriously awful picture of Cheryl Cole. She had been photographed through a car windscreen bleeding from the nose after an accident. For all the photographer knew at the time this image was taken, this woman had a basal skull fracture and was minutes from death. The fact that she is well known for her celebrity career gives only public prurience rather than public interest to this photograph.

The tendency for the press to close ranks in denial at the overall damage done by a press with skewed ambitions was emphasised yesterday in the Independent editor Chris Blackhurst’s BBC Radio 4 interview on the ‘Section 13′ letter he has received from the Leveson Inquiry outlining the criticisms likely to be made. Continue reading

Leveson, the Press and Labour

This post was published on LabourList on 16th August 2012, under the title ‘Labour must free the Press’.

The first instalment of Lord Leveson’s inquiry report into the Culture, Practice and Ethics of the Press is due in the autumn. It’s vital that Labour are ready to argue for a truly free press. We should be well aware that the political right and the press industry itself have major combined interests in adhering as closely to the status quo as possible. Although the issue of privacy was the final trigger for the inquiry, the most important failure of our press is to provide high quality information about current events and a true variety of interpretations of their causes. We need these if we are to make good collective decisions on important matters. The truth-distorting bile that issues from some outlets has had a measurable effect in false impressions left on the public. Continue reading

The Riots of August 2011

The riots that engulfed London and other cities in England began one year ago today. Just to hark back to my piece ‘Riots: Looking Deeper’ on this topic last year, written one week after they started. I think it’s fair to say that it was a reasonable analysis. In particular the Independent Panel set up to investigate their causes stated

Clearly the importance of those attributes becomes even more pronouncedwhen young people are faced with growing up in a time of austerity, a struggling job market and pervasive messaging telling them that criminality provides a fast track to achieving status among their peers. For example, while we know that most convicted rioters were not gang members, we also know that gangs operate in a large number of areas where the riots occurred. Some young people are exposed to imagery and attitudes associated with gang culture from an early age, which glamorise a life of criminality outside the system and which eschews any empathy for the victims of crime.

An article by Richard Wilkinson and Kate Pickett (of ‘The Spirit Level’ fame) on today’s Guardian CiF specifically blames inequality. You might care to look here at my general response to that thesis.

As Laura Wilkes, Policy Manager at the Local Government Information Unit, points out today on LabourList

…with local authority cuts set to continue the environment will become more challenging than ever before – if we are to avoid a repeat of 2011 councils need to have the funding to invest in key intervention programmes, community development and economic growth; all things that could help to prevent future riots. As things currently stand, government policy could threaten this.