Sunday, August 19, 2007

Capitalism, with a subsidy

The end of gentlemanly capitalism
Tony Curzon Price
The global financial panic triggered by uncertainties in the United States home-loans market is much more than an institutional wobble, says Tony Curzon Price:
it is a system-crisis that requires a radical solution.
13 - 08 - 2007

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?
Tony Curzon Price is the editor-in-chief of openDemocracy. He worked as a consultant economist for more than ten years. Since 1997, he has lectured on economics and energy policy to postgraduates at Imperial College, London, and at the École Polytechnique Fédérale de Lausanne (EPFL)

Among Tony Curzon Price’s recent articles in openDemocracy:

This 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 masters of go
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".
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