>It’s Finished

>by John Lanchester

London Review of Books (May 28 2009)

It’s a moment of confusion and loathing that most of us have experienced. You’re in a shop. It’s time to pay. You reach for your purse or wallet and take out your last note. Something about it doesn’t feel quite right. It’s the wrong shape or the wrong colour and the design is odd too and the note just doesn’t seem right and … By now you’ve realised: oh shit! It’s the dreaded Scottish banknote! Tentatively, shyly – or briskly, brazenly, according to character – you proffer the note. One of three things then happens. If you’re lucky, the tradesperson takes the note without demur. Unusual, but it does sometimes happen. If you’re less lucky, he or she takes the note with all the good grace of someone accepting delivery of a four-week-dead haddock. If you’re less lucky still, he or she will flatly refuse your money. And here’s the really annoying part: he or she would be well within his or her rights, because Scottish banknotes are not legal tender. ‘Legal tender’ is defined as any financial instrument which cannot be refused in settlement of a debt. Bank of England notes are legal tender in England and Wales, and Bank of England coins are legal tender throughout the UK, but no paper currency is. The bizarre fact of the matter is that Scottish banknotes are promissory notes, with the same legal status as cheques and debit cards.

These feared and despised instruments, whose history has long been of interest to economists, come in three varieties from three issuing banks: the Bank of Scotland, the Royal Bank of Scotland and the Clydesdale Bank. Small countries with big ambitions but few natural resources need ingenious banking systems. The history of the Netherlands, Venice, Florence and Scotland show this – and so does the tragic recent story of Iceland. ‘In the 17th century, when English and European commerce was expanding by leaps and bounds’, James Buchan wrote in Frozen Desire (2001), ‘the best Scots minds felt acutely the shortage of … what we’d now call working capital; and Scots promoters were at the forefront of banking schemes in both London and Edinburgh, culminating in the foundation of the Bank of England in 1694 and the Bank of Scotland in 1695’. The powers down south, however, came to think – or pretended to think – that the Bank of Scotland was too close to the Jacobites, and so in 1727 friends of prime minister Walpole set up the Royal Bank of Scotland.

There was more to the new bank than Whiggish manoeuvring. During the 17th century, Scottish investors had noticed with envy the gigantic profits being made in trade with Asia and Africa by the English charter companies, especially the East India Company. They decided that they wanted a piece of the action and in 1694 set up the Company of Scotland, which in 1695 was granted a monopoly of Scottish trade with Africa, Asia and the Americas. The Company then bet its shirt on a new colony in Darien – that’s Panama to us – and lost. {1} The resulting crash is estimated to have wiped out a quarter of the liquid assets in the country, and was a powerful force in impelling Scotland towards the 1707 Act of Union with its larger and better capitalised neighbour to the south. The Act of Union offered compensation to shareholders who had been cleaned out by the collapse of the Company; a body called the Equivalent Society was set up to look after their interests. It was the Equivalent Society, renamed the Equivalent Company, which a couple of decades later decided to move into banking, and was incorporated as the Royal Bank of Scotland. In other words, RBS had its origins in a failed speculation, a bail-out, and a financial crash so big it helped destroy Scotland’s status as a separate nation.

Fast-forward 300 years, and RBS is today, by the size of its assets, not just a big bank, and not just one of the biggest companies in Europe. The Royal Bank of Scotland, by asset size, is the biggest company in the world. If I had to pick a single fact which summed up the cultural gap between the City of London and the rest of the country, it would be that one. I have yet to meet a single person not employed in financial services who was aware of it; I wasn’t aware of it myself. I think if I had been, there are two questions I would have wanted answered: how did that happen? And is it a good thing?

Unfortunately, the second one is easy to answer. During the weekend of 11-12 October last year, the point when the British banking system teetered on the edge of collapse (‘the only time in my career’, a senior banker told me, ‘when I’ve felt genuinely frightened’), RBS was in receipt of an emergency injection of government cash, to the tune of GBP 20 billion. This left us, the taxpayers, owning about sixty per cent of the collapsing bank. On 26 February this year, RBS gave a preliminary announcement of its annual results. The bank had lost GBP 24 billion, the largest loss in British corporate history, and required yet more government money to stay solvent. The new government money, GBP 25.5 billion, took the taxpayer’s share of the bank to around 95 per cent. In addition, RBS put GBP 302 billion of its assets into the government’s Asset Protection Scheme, a sort of insurance plan under which the government, in return for a fee, promises to underwrite future losses from the toxic assets (these assets used to be worth GBP 325 billion but their value has already been written down).

A figure of GBP 50 billion has been widely touted as the eventual cost of this scheme to the government – not the overall cost of it, just the part of it belonging to RBS. That figure is guesswork, since the whole problem is that nobody knows what these assets are worth. In the same week that news came out, it emerged that the former chief executive of RBS, Sir Fred Goodwin, had, at the time of the October bail-out, asked for and received a doubling of his pension pot before he would agree to leave the bank. This took his pension pot to GBP 16 million, which will pay out GBP 693,000 annually for life. Why did the government go to such lengths to secure Sir Fred’s acceptance of his own departure, rather than just sacking him? Why did they agree to the doubling of his pension pot? We don’t know, but it’s almost certainly because, when the deal was done, everyone was so preoccupied by the question of whether the British banks would stay solvent that Sir Fred’s pension was the last thing on anybody’s mind. Anybody’s, that is, except Sir Fred’s.

He’s an easy man to dislike. Even his face, pinched and complacent, is easy to dislike. In a wider perspective, however, the pension question is something of a non-story. We are exposed to such gigantic losses through the financial crisis that it doesn’t really matter if Sir Fred spends the rest of his life bathing in Cristal at our expense. The question of his pension has become a synecdoche for the more general issue of City bonuses, which to the City are a normal fact of life but to outsiders are the emblem of the City’s greed and amoral exceptionalism. It’s interesting to observe how completely the banking industry fails to hear its own tone of voice on this subject. By City standards, Sir Fred’s pension is not outlandishly large; bonuses are so much a part of City culture – on average, they make up sixty per cent of an investment banker’s pay – that they are often guaranteed by contract, and even when they aren’t they are part of an employee’s ‘reasonable expectation’ in terms of pay, and are therefore protected by law. To outsiders, it doesn’t make sense to have a ‘guaranteed bonus’: if your bonus is guaranteed, it isn’t a bonus, it’s a salary. In the interests of preserving their trade’s reputation, it’s bankers who should be leading the attack on Sir Fred’s clearly indefensible pension; instead, they’re chirruping about the evils of ‘banker bashing’.

To sum up: so far taxpayers have spent GBP 45.5 billion in directly bailing out RBS (for wonks, that’s GBP 15 billion in equity and GBP 5 billion in preference shares last October, followed by GBP 25.5 billion in capital instruments this February), plus another GBP 50 billion for the toxic assets in the protection scheme (though as I’ve said, that’s a plucked-out figure which could go as high as GBP 302 billion if the assets are worthless). Call it GBP 95.5 billion. Oh, and another GBP 16 million to keep the person responsible in Dom Perignon and Charvet shirts for the rest of his life. Still, let’s look on the bright side: at least we have an unequivocal answer to our question about whether it was a good thing that RBS got to be the biggest company in the world.

The question of how it got to that point is easy to answer at the macro level. RBS grew through takeovers. These are commonplace in the financial service industries, though it should be noticed that takeovers and mergers often have the effect, in the long term, of destroying value. Company A, worth GBP 10 billion, takes over company B, worth GBP 5 billion, some time passes, and you end up with a new company worth not A + B = GBP 15 billion, but A + B = GBP 12 billion. You have magically made GBP 3 billion go away. That’s destroying value, and many takeovers and mergers in time end up doing exactly that. Perhaps the definitive example was that of the car companies Daimler-Benz and Chrysler. The German company took over the American firm in 1998 at a cost of $36 billion, promising all sorts of exciting synergies and possibilities for growth. These turned out not to exist, and Daimler-Benz ended up selling Chrysler in 2007 in a complicated deal which involved a net cash outflow of 500 million Euros – an amazing turnaround and a heroically effective destruction of value. In fact, when you look into the question, you soon conclude that non-capitalists and anti-capitalists should throw street parties every time the words ‘merger’ or ‘takeover’ are used. Why do they go on happening? Mainly because it is the mission of most companies to grow, and takeovers are one of the quickest and most spectacular ways of doing that.

This is partly a question of accounting. In the stock market, all money is not created equal. The price of a share is determined by what people think it’s worth – obviously. But what people think it’s worth is in turn decided by what they think the company’s prospects are. Take the example of companies A and B mentioned above. Both of them make widgets. Company A is a fast-growing internet-based firm, eWidget, which is promising to take over the world market in widgets by riding the new trend for firms and customers to order their widgets online. Last year its earnings were GBP 200 million. The company’s pitch to the stock market runs something like this: the global market for widgets is GBP 1 trillion. In time, say ten years, it is clear that thirty per cent of widgets will be ordered over the internet. Our ambition is to win ten per cent of that market. (The trick is to keep these projected and made-up figures sounding sensible and achievable: don’t claim that the net will be all the market, and that you’ll get all of that business. State a huge number for the total market, and claim to be after a sensible fraction of it.) So your sensible and achievable goal is for eWidget to have ten per cent of thirty per cent of GBP 1 trillion, in other words GBP 30 billion a year. Wow! It’s clear that eWidget has a big, big future, and if you get in on it now by buying a piece of the company – that is by buying shares – you will, in time, make out like a bandit. As a result, eWidget’s shares trade at a high price in relation to the company’s present earnings: at the already mentioned market capitalisation of GBP 10 billion, that means the shares cost fifty times the company’s earnings. The P/E ratio, as it’s called, is 50/1. That is high, and it can only be justified by steeply rising future growth.

Company B is Goodwidget Ltd. This is a well-run old firm with members of the original founding family still in charge. It has grown at ten per cent a year for decades, and its business model is the same one it had during those years, one of steady incremental growth through the old-fashioned method of making a better widget than its competitors. The stock market takes one look at its figures and reacts with a colossal, neck-ricking yawn. There is no glamorous upside here and no reason to believe in any growth beyond the kind that Goodwidget has proved it can achieve. Thus, although Goodwidget actually sells more widgets and makes more money than eWidget – it made GBP 500 million last year – because it seems to have less potential for growth, its shares are, in terms of their earnings, cheaper. The shares are priced at ten times their earnings, giving the company a market capitalisation of GBP 5 billion. Goodwidget, despite earning more than twice as much as eWidget, is worth only half as much on the stock market. All money is not created equal. The money earned by Goodwidget is worth much less than the money earned by eWidget. This is one of those points of stock-market logic which seems surreal, nonsensical and wholly counterintuitive to civilians, but which to market participants is as familiar as beans on toast. (An example: when AOL took over Time Warner, the old media company supplied seventy per cent of the profit-stream, but ended up with 45 per cent of the merged firm, because AOL’s market cap was so much bigger. How successfully did that play out? Well, at the time of the merger, the new combined company’s market capitalisation was $350 billion. Today it’s $28.8 billion. That’s $321.2 billion in value gone with the wind. I say again, for anti-capitalists, merger = fiesta.)

Now let’s consider what happens if eWidget takes over Goodwidget. They bid GBP 5 billion for the old-school company, and their offer is accepted. (In practice, by the way, they would offer more than that, since the whole point of takeovers is that the buyer sees more value in the target company than the market does: he sees a way of making more money than is already being made. But let’s keep this example simple.) The new company is worth GBP 10 billion plus GBP 5 billion, yes? No – and this, from the stock market’s point of view, is the beautiful part. Goodwidget’s GBP 500 million of earnings are now added to the total revenue of eWidget, so the merged firm is earning GBP 700 million a year. Remember that eWidget is valued at fifty times its earnings (so that GBP 700 million of earnings implies a market capitalisation of GBP 35 billion), which means that eWidget shares are about to more than treble in price. That in turn completely justifies the confidence of the shareholders who bought a piece of this exciting, sexy, go-go 21st-century widget-maker. The successful takeover has magically sent the share-price rocketing; the company has grown. It isn’t what’s known as ‘organic’ growth, of course, the kind which comes from selling more of your stuff to more people, but so what? Although most takeovers and mergers end by destroying value, the market loves them anyway.

Back to RBS. The bank fought off three takeover/mergers in the 1970s and 1980s – one each from Lloyds, Standard Chartered and HSBC – before growing stronger and launching takeovers of its own. The first was of Citizens Financial Group, which has grown (through the takeover of Charter One Bank) to be the eighth largest bank in America. The biggie, however, was the battle to take over the high street behemoth NatWest in 1999. RBS’s opponent in that battle was its old enemy, the Bank of Scotland; the older bank’s plan had been to part-fund their acquisition by selling off various components of NatWest such as Coutts and the Ulster Bank. (Coutts is the posh bank, concentrating exclusively on high net-worth customers, which only recently began issuing cheque cards. Before that, any shop or service provider who didn’t understand what a Coutts account meant was demonstrably too lower-class to deserve patronage from Coutts clients such as the queen and Wayne Rooney.) RBS by contrast planned to keep the subsidiaries together as part of a new company, the Royal Bank of Scotland Group. RBS won the fight, and became the second biggest UK bank after HSBC. Fred Goodwin was something of a hero in the banking world. Philip Delves Broughton, a former Telegraph journalist who went to Harvard to do an MBA and wrote a funny, depressing book about it, What They Teach You at Harvard Business School (2008), reports that in 2003 the school made RBS the subject of one of its famous case studies. The study was called ‘The Royal Bank of Scotland: Masters of Integration’ and began with a quote from the man we now know as Fred the Shred or the World’s Worst Banker: ‘Hard work, focus, discipline and concentrating on what our customers need. It’s quite a simple formula really, but we’ve just been very, very consistent with it.’ Right. By now RBS, or the RBS Group, was a truly huge company, embracing the banking interests already mentioned plus a large range of insurance products, known to the UK consumer under various brand names such as Direct Line, Churchill and Privilege.

From this springboard – which included a ten per cent share in the Bank of China, the world’s fifth biggest bank – RBS launched yet another takeover bid, this time for the Dutch bank ABN Amro. The French philosopher Rene Girard talks about something called ‘mimetic desire’, which basically means copying our idea of what we want from someone else who wanted it first. We’re all familiar with the phenomenon in everyday life, but RBS seems to have had a corporate version of mimetic desire. Barclays had launched a high-profile takeover bid for ABN Amro, a long-established bank whose earnings and share price had recently stagnated. (ABN stands for Algemene Bank Nederland, the inheritors of a business which had originally been one of the Dutch charter companies, the Nederlandsche Handel-Maatschappij or Dutch Trading Company – not so different from RBS’s legacy as the Company of Scotland.) RBS, seeing Barclays putting the moves on ABN Amro, decided to make some moves of its own, and after a complicated fight, ended up winning ABN Amro, as part of a consortium of bidders with the Belgo-Dutch bank Fortis and the Spanish Banco Santander. The consortium bid 71 billion Euros, as opposed to Barclays’s 66 billion Euros – and this notwithstanding the fact that ABN had sold off its American subsidiary LaSalle, which was one of RBS’s reasons for being interested in the deal in the first place. (The action of selling off LaSalle was part of what’s known in the city as a ‘poison pill’ defence, undertaking an action intended to make you toxic to a potential predator.)

The consortium’s plan was to split ABN Amro up, with RBS getting the Anglo-American and wholesale parts of the business, Fortis the Belgo-Dutch, and Banco Santander the South American. It wasn’t in principle a ridiculous scheme, but the problem was the price. Most of what has been written about the financial crisis is pure hindsight, but not this: many observers thought that the winning consortium had overpaid. The consortium won their takeover on 10 October 2007; by April 2008, RBS was going to the markets to raise more capital, to cover losses from the deal; by July 2008, Fortis had lost two-thirds of its value and its CEO, Jean-Paul Votron, had resigned; on 28 September, Fortis was part-nationalised by the Dutch, Belgian and Luxembourgeois governments. We’ve already read what happened to RBS. So within months, the ABN Amro takeover destroyed RBS and Fortis and what was left of ABN Amro itself. Along with the AOL-Time Warner merger and the Daimler-Chrysler merger, the ABN Amro takeover is one of the biggest flops in corporate history.

All of this makes RBS’s corporate report for 2007, published just weeks before the bank had to go back to the markets for more capital, a document of unusual interest. Northrop Frye somewhere defines ‘irony’ as involving a state of affairs in which words have a different meaning from their apparent sense. This can be achieved by the audience’s knowing something the speaker doesn’t: so the speaker is saying one thing but we are understanding another. The RBS corporate report is like that. (So are their slogans: ‘Make it happen’. Make what happen? A GBP 100 billion tab for the taxpayer?) The section on corporate citizenship at the beginning is particularly good value. The firm is involved in plans to increase general levels of financial education. ‘When people have been educated about money and how to work with financial services firms they are more likely to make the right decisions and to avoid difficulties’. That’s true, but you can also just rob post offices. ‘RBS is a responsible company. We carry out rigorous research so that we can be confident we know the issues that are most important to our stakeholders and we take practical steps to respond to what they tell us. Then occasionally, we blow all that shit off, fire up some crystal meth, and throw money around with such crazed abandon that it helps destroy the public finances of the world’s fifth biggest economy.’ See if you can guess which of those sentences is not in the report.

Joking apart, the RBS Group corporate report is a document of historic importance. This was the last bulletin from the bank before it blew up: a process that began within days of its publication – the accounts were signed on 27 February 2008, and on 22 April RBS announced that it was attempting to raise GBP 12 billion of capital in the form of newly issued shares, to cover its losses from the acquisition of ABN Amro. The consequences of the bank’s unravelling will be with us for a long time, in the most basic way: we will be paying for it. Not metaphorically, but literally: instead of schools and medicines and roads and libraries, huge chunks of public money will go to RBS’s balance sheet. So it’s worth taking a close look at that balance sheet, and before we do so, it’s worth thinking for a moment about what a balance sheet actually is. If the Titanic is the most abused metaphor in the world – in the words of the Onion parody headline for 1912, ‘World’s Largest Metaphor Hits Iceberg’ – the balance sheet runs it a close second.

We don’t know who invented balance sheets; they seem to have been in use in Venice as early as the 13th century. But we do know who noted down the method behind them, and in the process invented modern accounting, which relies on four financial statements to provide a full picture of any given business: the balance sheet, the income statement, the cash-flow statement, and the statement of retained earnings. The man who noted down the method for gathering and recording the relevant information was Luca Pacioli, a Franciscan monk and friend of both Piero della Francesca and Leonardo da Vinci, whose assistant he was for many years. Pacioli wrote Summa de Arithmetica, the book which laid out the method of double-entry bookkeeping which is still in use in more or less every business in the world. (He also wrote about magic, in the sense of conjuring. I’d like to think he would have enjoyed the old joke about accountants: ‘What’s two plus two?’ ‘What would you like it to be?’) There’s something amazing about the fact that a method used in Venice in the 13th century and written down by a Tuscan in the 15th should still be in daily use in every financial enterprise in the developed world.

Of the four financial statements, the balance sheet is the one which provides a glimpse into a moment in time. The others show processes, flows of money; the balance sheet is a snapshot. A balance sheet is divided into assets and liabilities. Assets are things which belong to you, liabilities are things which belong to other people. Here’s what an individual’s balance sheet might look like:

Assets (GDP)
70,000 Share of house owned by me
10,000 Deposits in bank
10,000 Car
15,000 Stuff I own
05,000 Money people owe me
40,000 Pension
150,000 Total

Liabilities (GDP)
130,000 Share of house owned by bank
02,000 Credit card debt
02,000 Car loan
06,000 Unpaid debt on stuff I own
140,000 Total
10,000 Equity

150,000 Total Liabilities and Equity (GBP)

You’ll notice there is something mysterious on there called ‘equity’. This is the magic ingredient which means that a balance sheet always balances: it is added to your liabilities so that they match your assets. The fact that it appears with the liabilities might make equity seem sinister, but it isn’t: it’s a good thing. It’s the amount by which you are in the clear; it’s the amount by which your assets exceed your liabilities. Your equity is your safety margin; it is your net worth, it is the thing which keeps you in business.

Now imagine for a moment that you are a business. Instead of just being plain you, you are now You Ltd. You set out to sell shares in yourself. The part of you that you sell shares in is the equity. The buyer isn’t taking over the assets and liabilities, but the equity. Say I bought ten per cent of your equity, as set out in the balance sheet above, at a price of GBP 1000 (an accurate price, since that’s exactly what it’s worth today). In a year’s time, say you’ve paid back GBP 10,000 of your mortgage, your house price has gone up by half, you’re being paid better at work and so you’ve another GBP 10,000 in the bank – golly, your assets are now GBP 270,000, your liabilities are GBP 130,000 and your equity is now GBP 140,000. My one-tenth share of your equity is now worth GBP 14,000. Cool. I could sell my share in your equity and make a nice profit, or I could just sit on it, betting that you would do even better in the future. On the other, scarier hand, you could have had a lousy year: your house price might have crashed (in fact, using UK average figures, your house price has crashed, by GBP 50,000), you have been put on part-time work so your salary has halved and wiped out your savings, your debtors have gone bankrupt and your car has lost fifty per cent of its value, so your assets have gone down by GBP 70,000. Your liabilities, on the other hand, are the same. There’s a problem: your liabilities now exceed your assets, by a cool GBP 60,000. In plain English, you’re broke. In the language of accountancy, you are insolvent. You have met one of the two criteria for insolvency: your liabilities are greater than your assets. The other criterion is inability to meet your debts as they fall due. In British law, meeting either criterion makes you insolvent. It is a criminal offence to trade while insolvent.

There may be a get-out, however. Are you really insolvent? I’ve made things clear-cut for the purposes of this example, but you could argue – and in comparable cases people do argue – that your problem is not so much insolvency as illiquidity. Liquidity is the ability to turn assets into something that can be bought or sold. With a depressed housing market, the problem with your house could easily be not so much its value, as the fact that you can’t sell it, because nobody is buying property at the moment. Or rather you can sell it, but you have to do so for an artificially depressed, crazy-cheap price: a ‘fire sale’ price. When the market returns to normal functioning, you will be able to sell your house for its true value; so you aren’t really insolvent, you’re just caught in a ‘liquidity trap’. In practice, all you would do, in the above example – as long as you weren’t really You Ltd, in which case you might well be under a legal obligation to go into receivership – would be to simply ignore the question and keep going. You’d hope to be able to pay bills as they fell due, and hang on for grim life until your house price recovered. As we speak, hundreds of thousands of people across the UK – across the world – are doing precisely that.

The same principles apply to company balance sheets. They look a lot more complicated, but the underlying factors are the same. At business schools, they play a game – sorry, ‘undertake an exercise’ – in which students are given balance sheets and asked to determine what type of business the company is in. Sums are in millions of pounds. So what’s the business whose balance sheet is shown here?

See table at http://www.lrb.co.uk/v31/n10/lanc01_.html

There are clues in the fact that ‘Deposits by banks’ and ‘Customer accounts’ are listed in the column for liabilities. ‘Loans and advances’ are a main category of asset. Our hypothetical business student would be able to work out in pretty short order that this business is a bank. Which one? A clue is the figure for ‘Total assets’: GBP 1,900,519,000,000 – GBP 1.9 trillion. Since the entire GDP of the United Kingdom is GBP 1.762 trillion, this is a freakishly large bank – oh, all right, I’ll stop being coy, it’s our old friend the Royal Bank of Scotland, aka the biggest company in the world. It seems weird at first glance, and indeed at second glance, that bank balance sheets list customer deposits as liabilities, but it makes sense if you think about it, since a liability is at heart something that belongs to somebody else, and the customers’ deposits belong to the customers. This was something that my father, who worked for a bank, used often to say to me: don’t forget that if you have money in a bank account, you’re lending the bank money.

Banks themselves certainly don’t forget it. Actually, that’s not true. They forget it all the time in their actual dealings with their customer/creditors – us. They act as if it’s their money and they are doing us a favour by letting it sit in their bank earning interest. Take a look at the balance sheet, however, and at the page after page of corporate reports and footnotes which accompany it, and it’s a different story. High levels of deposits mean high levels of liabilities; and high levels of liabilities oblige a bank to have high levels of assets. Since banks are mainly in the business of lending money, high levels of assets mean high levels of loans. That means that a bank’s main assets are other people’s debts. This is another distinctive feature of bank balance sheets, the fact that its principal assets are other people’s debts to it.

The balance sheets of other businesses look very different. They’re smaller, for a start: only banks are this bloated with assets and liabilities. That’s natural, since the business model of banking, involving lots of money coming in and sitting in accounts, balanced by lots of lending, is always going to involve lots of money on the balance sheet and relatively small amounts of equity. A company with a quicker turnover will look very different. Apple Computer, for instance, in 2008 had $39.6 billion in assets, $18.5 billion in liabilities and $21.1 billion in equity; compare that to RBS’s GBP 1900 billion, GBP 1809 billion and GBP 91 billion. Apple’s assets are a fiftieth the size of RBS’s, but its equity is only a sixth the size. In that sense, Apple is a safer business than RBS; it has a larger safety cushion, a proportionately bigger margin for error. {2} Of course, it might be that it has a bigger margin for error because it is an inherently riskier business. Banking should be much more solid than computers/gadgets/music, but the fact that banks will always have elephantine balance sheets, in proportion to their equity, means they have a tendency to be a little less secure than they look at first glance. That’s one of the many reasons banks are, in their corporate body-language, so keen to look as imposing and rock-like as they possibly can.

Apple’s accounts are all about how many computers and phones and songs the company will sell, since its financial health depends on that. (I say ‘songs’ – Apple’s iTunes is the biggest music retailer in both the UK and US.) RBS’s accounts are all about its loans, since the financial health of the company depends on the quality of those loans. It follows from that that RBS’s accounts are all about loan risk, since the profitability of the loans depends on how likely they are to be repaid. For that reason the nature of the assets – the loans – are all important; and risk is not some marginal factor but the core of a bank’s business. Risk is always an important issue for any company, but for a bank, it isn’t just important, it’s their whole business. Banking does not just involve the management of risk; banking is the management of risk.

The RBS accounts were signed on 27 February 2008. On 22 April, the bank went back to the markets to seek GBP 12 billion in new capital, to repair its balance sheet. The later unravelling of this very balance sheet, as I’ve already said, has us on the hook to the tune of GBP 100 billion and maybe more. By rights, by logic, and by everything that’s holy, it should therefore be possible to see, somewhere in the accounts and the balance sheet, some clue to what went wrong – especially given that whatever went wrong must have already gone wrong, to hit the company so hard less than two months later. The reader who thinks that is quickly disillusioned. Instead we get this: ‘It is the Group’s policy to maintain a strong capital base, to expand it as appropriate and to utilise it efficiently throughout its activities to optimise the return to shareholders while maintaining a prudent relationship between the capital base and the underlying risks of the business’.

Where on the balance sheet are the gigantic bets that went bad? Where are all the toxic assets? The losses were so huge that one shouldn’t have to look for them in this way – in fact it’s bizarre to be doing so, minutely parsing the accounts for evidence of a gigantic disaster. It’s a little like being Sherlock Holmes, crouched over and peering through his magnifying glass, looking for a smoking crater the size of Birmingham. Eventually you come across this glimmer of a clue: ‘Derivatives, assets and liabilities increased reflecting the acquisition of ABN Amro, growth in trading volumes and the effects of interest and exchange rate movements amidst current market conditions’. Looking at the balance sheet, we see that derivatives have indeed become a much, much bigger part of it, to the tune of GBP 337 billion of assets, as opposed to GBP 116 billion the year before. Is that where it all went wrong? When you read the report’s words about derivatives, it makes them sound as if they were used to hedge risks: ‘Companies in the Group transact derivatives as principal either as a trading activity or to manage balance sheet foreign exchange, interest rate and credit risk’. Nothing there about the famous sub-prime mortgage derivatives which have blown up the global banking system. When we go looking for sub-prime elsewhere in the report, we find this:

The Group has a leading position in structuring, distributing and trading asset-backed securities (ABS). These activities include buying mortgage-backed securities, including securities backed by US sub-prime mortgages, and repackaging them into collateralised debt obligations (CDOs) for subsequent sale to investors. The Group retains exposure to some of the super senior tranches of these CDOs which are all carried at fair value.

At 31 December 2007 the Group’s exposure to these super senior tranches, net of hedges and write-downs, totalled GBP 2.6 billion to high grade CDOs, which include commercial loan collateral as well as prime and sub-prime mortgage collateral, and GBP 1.3 billion to mezzanine CDOs, which are based primarily on residential mortgage collateral. Both categories of CDO have high attachment points. {3} There was also GBP 1.2 billion of exposure to sub-prime mortgages through a trading inventory of mortgage-backed securities and CDOs and GBP 100 million through securitisation residuals.

Right. So they have a ‘leading position’ in this stuff. It consists of GBP 2.6 billion in allegedly high grade CDOs, GBP 1.3 billion in the next grade down, and another GBP 1.2 billion of diverse exposure to sub-prime, for a total of GBP 5.1 billion. Granted, GBP 5.1 billion will buy you quite a few Mars bars; but again, how did we get from there to a GBP 100 billion black hole? Might the weasel word be ‘include’ – meaning, there’s more of this stuff but we’re not discussing it here?

According to the Daily Telegraph, the answer is simple: the bank had much bigger exposure to the sub-prime market than it admitted:

During a board meeting in the summer of 2006, Sir Fred was asked by fellow directors whether the bank had any plans to move into the sub-prime market. He told the board that the bank would not move into sub-prime and that, as a result, ‘RBS is better placed than our competitors’. In the foreword to RBS’s 2006 annual report, published in April 2007, Sir Fred wrote: ‘Sound control of risk is fundamental to the Group’s business … Central to this is our long-standing aversion to sub-prime lending, wherever we do business’.

On the principle that people deny something only when there’s something to deny, this remark might be the biggest single clue anywhere in the RBS accounts as to the risks the bank was running. RBS turned out to have quite a lot of exposure to sub-prime risk, and to be steadily acquiring more. On the 2007 balance sheet, it appears to be under ‘Debt securities’. When we look at the relevant footnote, we find that this category includes GBP 68.302 billion of mortgage-backed securities, up from GBP 32.19 billion the previous year. Aha! Already in 2006 some analysts were citing the firm as the world’s third biggest player in sub-prime mortgages. In her new book, Fool’s Gold (2009), Gillian Tett, the heroine who covered capital markets for the Financial Times and who predicted the crisis, has RBS ‘aggressively’ growing its exposure to Collateralised Debt Obligations during this period {4}. In 2007, its American subsidiary Greenwich Capital bought a chunk of sub-prime mortgages from New Century Financial, one of the biggest players in the market, which was, not coincidentally, facing bankruptcy; RBS lent another sub-prime player, Fremont General, $1 billion; yet another American subsidiary of RBS, the aforementioned Citizens Bank, was buying up US sub-prime risk, ‘allegedly without seeking approval from the RBS board’. The Telegraph goes on to say: ‘It is claimed that it was not until the summer of 2007, as Northern Rock was facing meltdown, that Sir Fred told the board that RBS had, in fact, built up a substantial sub-prime exposure’. A spokesman for RBS said:

The reality is that, like many others, RBS was heavily exposed to problems in sub-prime markets via its own operations and those inherited from ABN Amro. This is despite the fact that we did not engage directly in sub-prime issuing. The Board was in possession of full information and the details provided to the market in all financial reporting reflected the Group’s honestly held opinion at the time.

The experience of reading a publicly held company’s accounts is not supposed to resemble a first encounter with late Mallarme. But unfortunately, it all too often does – particularly in the case of the banks. I defy anyone to study RBS’s reports and accounts and to acquire from them a full sense of the risks the bank was taking. It is exactly as Warren Buffett wrote in 2004: ‘No matter how financially sophisticated you are, you can’t possibly learn from reading the disclosure documents of a derivatives-intensive company what risks lurk in its positions. Indeed, the more you know about derivatives, the less you will feel you can learn from the disclosures normally proffered you.’

I’m not claiming that the accounts are deliberately obfuscatory, but I am saying that there is no way one can acquire a full understanding of what was going on from reading them. The lack of transparency is severe. And this was just RBS, whose arrangements weren’t especially baroque by the standards of the City and Wall Street. RBS had no involvement in the Structured Investment Vehicles – SIVs – whose main purpose is to keep things off the balance sheet. SIVs involved borrowing short in order to lend long, the same dazzlingly successful financial model that underpinned Northern Rock; I use the past tense in reference to SIVs because none of them is still in business. They have all blown up – they were hugely involved in lending to and investing in the sub-prime market – and as a result have had to be taken onto the balance sheet of their parent banks. SIVs were invented by Citibank in 1988. Citibank’s SIVs were all taken back onto the balance sheet of Citigroup, the holding company, last year, and partly as a result Citigroup, by revenue the biggest bank in the world, lost $32 billion dollars. On 23 November 2008 the bank received $20 billion from the US government, with an agreement that it would stand as guarantor for another $306 billion of the bank’s loans. On 27 February this year the US government announced that it was swapping its $25 billion in emergency aid for a 36 per cent share in the bank. So the people who brought us the SIV have now been the subject of two of the biggest bail-outs in history. Now consider the Lehman Brothers’ balance sheet. In their 2007 accounts, under the heading ‘off balance sheet arrangements’, they had derivative contracts with a face value of $738 billion. According to them, this represented an actual value of $36.8 billion. Pocket change by comparison, but still, as it turned out, big enough to destroy the bank.

RBS, I repeat, had no involvement in SIVs or off balance sheet investments. Its accounts are models of clarity and translucency compared with some of its competitors. And yet you still can’t tell from them what the hell was going on. A big part of the assets listed on their balance sheet turned out not to be worth anything. We have to conclude from this that with the banks in their current condition, it isn’t possible to tell from their public accounts what the real condition of their business is. Call that problem one. There is another problem, however, and it is this which compounds the difficulty with banking accounts and makes it a critical one for the British economy. That problem is the sheer size of the big banks. They are, by near universal consent, too big to fail. The one time a big bank has been allowed to go under – Lehman’s, in September last year – it almost destroyed the global banking system, with consequences that are still being felt, and will continue to be felt for a long time. Without confident lending from banks to banks and from banks to businesses and individuals – without the proper functioning of the credit system – the global economy comes to an abrupt screeching halt. When a bank goes under, it destroys that confidence. So a big bank can’t be allowed to go under. Call that problem two. Put problem one and problem two together, and we have the current situation, in which the big banks are completely untransparent but also too big to fail. That is a catastrophic formula. We (the taxpaying we) have no choice but to keep them in business, and yet no real idea what’s going on inside them.

Sometimes, when you eat chilli-hot food, the first few mouthfuls tell you nothing other than that the food contains chilli. It takes a moment or two to detect the presence of other flavours. Bank bail-outs and collapses are a bit like that. At first you think they’re all the same – that’s the chilli – then you notice that the spicing is in fact subtly different. RBS might be considered a complex dish like the Mexican mole, a chilli-and-chocolate stew with a huge variety of textures and flavours that leaves you uncertain what you’re eating. The failure of HBOS is more straightforward, more like a bog-standard high-street curry. The Halifax was a former mutual society which became Britain’s biggest mortgage lender. In 2001, it merged with the Bank of Scotland to form HBOS, a new bank to rival the ‘Big Four’ on the British high street. The company set out to dominate the mortgage market in the UK, and did so. And that’s the problem: not fancy derivatives and sub-prime loans from the US, not indecipherable off balance sheet SIVs, just plain old mortgages which customers can’t afford to repay. Only seven per cent of HBOS’s troubled assets are the fancy-pants imported sub-prime variety. The rest are all home-grown, created during the UK housing bubble. In 2007, HBOS had GBP 28 million of mortgage arrears and repossessions on its books. In 2008, that figure became GBP 1.13 billion. HBOS says it is making allowance for eighteen per cent of its mortgage loans to go into default. These weren’t for the most part the super-risky 125 per cent loans which helped destroy Northern Rock, just ordinary mortgages on ordinary, wildly overvalued British homes, which have at the time of writing fallen in value by about twenty per cent, and have an unquantified amount still to fall. (My evidence-free personal view is that they won’t stop before they’ve fallen thirty per cent, and because markets tend to overshoot in both directions, may well fall further.) HBOS’s share price began to drop last summer when the City became nervous about its reliance on UK mortgages. There were denials that the firm was in crisis, which is always a terrible sign. In September 2008, the Big Four bank Lloyds bought HBOS, after its boss, Victor Blank – this is the part you couldn’t make up – bumped into Gordon Brown at a drinks party and got him to give an assurance that a takeover would not be referred to the monopolies commission.

Most of us have had a few drinks at a party and done something embarrassing, usually along the lines of “I’ve always fancied you isn’t it time we did something about it”, but let’s take comfort in the following truth: none of us has ever done anything as embarrassing as buying HBOS. The idea was to make Lloyds-HBOS into a giant, dominating the British high street. The reality? Well, on 1 September 2008, a couple of weeks before the news of the HBOS takeover, Lloyds was a much admired bank with a strong capital base (everybody thought) trading at 303p a share; today, 14 May, it trades at 88p a share and is around 65 per cent owned by the British taxpayer, following a bail-out in October 2008 (GBP 17 billion) and then another bail-out in March this year (cost as yet unknown), after it became clear just how badly the HBOS merger had affected Lloyds’s balance sheet. So the failure of HBOS has dragged Lloyds down and in turn dragged down the taxpayer, and is another thing we will be paying for for years and perhaps decades to come. HBOS was TBTF – Too Big To Fail – and Lloyds, which was bigger, was also obviously TBTF. The combined Lloyds-HBOS is TBTF in spades.

The alert reader will have noticed that I haven’t been precise about exactly how much of RBS and Lloyds-HBOS we-the-taxpayer now own. That’s because we don’t yet know. This overlaps with the question of what is meant by the all-encompassing word ‘bail-out’. The term is a portmanteau one, and it involves several different kinds of cash injection from the government to the afflicted banks. (‘Afflicted’ probably isn’t the right word. ‘Self-afflicted’?) The government’s money has been given in return for various different kinds of shareholding and stake, involving distinctions between ‘ordinary’ and ‘preference’ shares, exquisitely boring distinctions which I don’t propose to explore in detail. Because RBS doesn’t yet know how much of the available capital it’s going to need, we don’t yet know how much of the bank we are going to end up owning. The amount could go as high as 95 per cent. In addition, the government has created the aforementioned Asset Protection Scheme, as a sort of dump for the assets that are causing all the trouble. The way it works is that banks can put assets into the scheme, and the government will insure them against a crash in their value. The scheme has one of those ‘attachment points’, in that the first chunk of the loss is borne by the bank: in the case of RBS, the first GBP 19.5 billion of losses is borne by the bank. Then the Asset Protection Scheme kicks in, and the government bears ninety per cent of the rest of the losses. RBS has put GBP 302 billion of assets into the scheme. In return for this service, the government is charging a fee of GBP 6.5 billion. In addition, RBS has to promise not to use tax credits from its losses to weasel out of paying tax; it also has to promise to keep up lending to UK homeowners and businesses, to the tune of GBP 25 billion over the next twelve months. The equivalent numbers for Lloyds are GBP 260 billion in the Asset Protection Scheme, with an attachment point of GBP 25 billion before the scheme kicks in. The fee is GBP 15.6 billion, and the bank promises to lend GBP 14 billion over the next year to the great British public. How much of the bank we end up owning depends on a complicated arrangement which swaps kinds of share for other kinds of share, and is capped at 65 per cent.

Put simply, this is an insurance scheme. The government is insuring the banks against losses on their assets. There’s nothing unusual about such schemes: they’re a standard feature of the banking world. In fact, they are one of the sources of the current crisis. In the commercial world, a deal in which one financial institution insures another against defaults, in return for a fee, is called a credit default swap, or CDS. In effect, the UK government has undertaken a CDS with our imploded banks.

As chance would have it, it was CDSs that destroyed the third of our chilli-hot financial companies, the American insurance group AIG. That feeling you get when you’ve eaten something, and a few minutes later you think, oh-oh, I think that my dinner just said that was a case not of adieu but au revoir? That would be AIG. This is a gigantic insurance company, worth $200 billion at its peak and definitively TBTF. Entertainingly for fans of financial acronyms, AIG was done in by CDSs on CDOs. That’s to say, it took part in credit default swaps on collateralised debt obligations, the pools of sub-prime mortgages whose dramatic collapse in value last year was the proximate cause of the financial crisis. When Lehman’s imploded last September, done in by its exposure to CDOs, there was a panicked scramble to see who else was carrying similar risk. When it turned out that AIG was, and, worse, that it was valuing those assets at much higher prices than Lehman’s had, investors freaked and the company’s credit rating collapsed. That meant that it had to post more collateral to cover its share of risks; because credit markets had tightened up, it couldn’t borrow the money it needed; and because it was TBTF, the US government stepped in with a bail-out on 16 September, worth $85 billion, in return for 79.9 per cent of the company. (The bail-out – I’ve said they come in different varieties – was in the form of a 24-month credit facility. To adopt an analogy with personal finances, this meant AIG could draw on the government’s bank account.) On 8 October, AIG was given another $37.8 billion in credit. Enough, already? No. On 10 November the US Treasury pumped another $40 billion into the company by buying freshly issued stock created for the purpose (this being yet another variety of bail-out – somebody should write a Bankster Bail-out Cookbook). Finally enough, already? Don’t be stupid. On 1 March 2009 the Treasury gave the company another $30 billion and restructured the terms of its loan to make repayments of government money less arduous. The next day the company announced a loss for the quarter – not the year, the quarter – of $62 billion, the worst corporate results in history. Finally enough, already already? Not necessarily. According to the US Treasury statement accompanying the fourth bail-out: ‘Given the systemic risk AIG continues to pose and the fragility of markets today, the potential cost to the economy and the taxpayer of government inaction would be extremely high’. To stabilise AIG would ‘take time and possibly further government support’. That’s what Too Big To Fail means. Cost of US government assistance to AIG thus far: $173 billion. You could put it like this: AIG + CDS + CDO + TBTF = $173,000,000,000.

We had our entertaining but essentially distracting row over Sir Fred ‘Knighted for Services to Banking’ Goodwin’s pension; in the US they had their equivalent row over bonuses paid to senior AIG executives after the bail-outs. The bonuses totalled $165 million and it doesn’t take a PR professional to see that March 2009, after the fourth AIG bail-out, wasn’t the ideal time to have announced them. Everyone on both sides of American politics from Obama downwards joined in the storm of outrage, which was followed by predictable bleating from the banksters. A Republican senator invited the AIG executives to follow the ‘Japanese example’ and either apologise or commit suicide. (More authentic to do both, surely?) A Democratic senator threatened to tax the bonuses at 100 per cent. The New York Times published an AIG executive’s open letter to his boss, which said he was resigning because he hadn’t been a derivatives trader and his feelings were hurt. He seemed to be expecting applause because he was giving away his own bonus of $742,006.40. Good fun all round.

The story was a distraction from the real scandal about AIG, which is what was happening to the other 99.9 per cent of the money the government was pumping into the company. Since AIG wrote CDSs, which are effectively insurance against losses, and since those losses had occurred, why then the cash was going to companies that had lost money in the credit crunch: companies such as Societe Generale, which received $11.9 billion; Goldman Sachs, $12.9 billion; Merrill Lynch, $6.8 billion; Deutsche Bank, $11.8 billion; Barclays, $8.5 billion; BNP Paribas, $4.9 billion. Nothing could better illustrate the way in which this has be- come a systemic international crisis than the fact that the US Treasury is transferring these gigantic sums to foreign banks, because they feel they have no choice if they’re to keep the financial system functioning. But it’s a hell of a pill for the US taxpayer to have to swallow, a much bigger and more bitter pill than the one about the bonuses. AIG is broke, essentially because it got its sums wrong about the level of risk represented by CDSs. So it can’t pay its counterparties (that’s the other side of the insurance deal, the insurees). But the counterparties made the same mistake, since they took out insurance with an insurer who, in the event of a structural crisis, wouldn’t be able to afford to pay them. So why are the insurees walking away whistling with pockets full of US Treasury cash, while the US taxpayer sits on a gigantic loss? Note that AIG’s market capitalisation – the total value of all its shares – was at its lowest less than a billion dollars. Saving the company has cost many, many times more than buying it would have. Why therefore has the Treasury saved it? Because AIG is Too Big To Fail.

What links all these companies – and all the other companies and institutions around the world which have been felled by the credit crunch, from the Icelandic banks Glitnir and Landsbanki, the Belgian bank Fortis, the Irish bank Anglo Irish, Northern Rock which started it all, and all the other institutions that are currently in trouble – is that gigantic holes have appeared on the left-hand side of their balance sheets, where assets are listed. Those assets are for the most part linked in one way or another to the collapse in property prices in the US and elsewhere. They are often described as ‘toxic assets’, or more euphemistically as troubled assets, and in fact that’s how they’re named in the US scheme to buy them from the banks, by way of rebuilding the banks’ balance sheets: the Troubled Asset Relief Programme, TARP. This is different from the British plan to insure toxic assets, which makes the UK into a gigantic issuer of CDSs, in favour of its troubled banks. But the term ‘toxic assets’ is misleading. It makes me think of Superman intercepting a rocket-powered canister of vileness unleashed by some villain and deflecting it into space. Toxicity, however, is not some inherent property of these assets. The assets in question don’t contain some magic property of poisonous money-juice. What’s poisonous about them are their prices. As Stephanie Flanders has said, it would be more accurate to call them ‘toxic prices’ – it would at least be an aid to clearer thinking.

The definition is usually stated as follows: these are assets which can’t be accurately priced, and which therefore spread uncertainty and insecurity throughout the financial system. But that isn’t quite right. It’s true that some of the assets at the moment have no price because there is no market for them, and it’s a moot point whether or not there ever will be a market again. But many of these assets do have prices – there are buyers out there willing to acquire them. That makes sense. Consider Lloyds-HBOS: it’s obviously not true that every mortgage sold in recent years by Halifax is a dud, spreading poison through the company’s balance sheet. That defies common sense. It’s probably the case that the bulk of the company’s mortgages, perhaps the overwhelming bulk of them, perhaps including the worrisome recent loans, are viable. People’s houses might not be worth what they paid for them, but in most cases their owners are going to continue paying the mortgages anyway. There must be many comparable examples out there, of highly out-of-fashion mortgage-based investments which aren’t as deeply in trouble as the markets currently think. It might make sense, if you were an experienced investor in those markets, to investigate the possibility of buying some of these investments at a bargain price. The problem is that these prices are, from the banks’ point of view, too low. The buyers are willing to acquire them at, say, twenty or thirty cents to the dollar, so that an asset whose notional worth is $10 million – a derivative tracing its value from sub-prime mortgages, for example – might have someone willing to buy it for $2 or $3 million. For the bank, that price is too low. It isn’t too low in the sense that they quite fancy the idea of a higher price; it’s too low in the sense that, if they accept the valuation, they have a gigantic hole on the left-hand side of the balance sheet. Their assets aren’t worth what they’re supposed to be, and the bank is no longer solvent.

I guarantee that at this very moment, somewhere in the world, somebody at one of the big banks is sitting with his head in his hands, looking at the company’s balance sheet and sweating over this very problem. If the global economic crisis can be reduced to one single phenomenon, it is this: the fact that nobody knows which banks are solvent. Because banks are crucial to the creation and operation of credit, a bank crisis leads directly to a credit crunch. It’s also the reason the huge amounts of money being pumped into the banking sector by governments are tending not to do the thing they are supposed to do, that is, restart lending to businesses and consumers. That’s because – and here we can have that very rare thing, a brief moment of sympathy for the banksters – the banks are being given two totally incompatible goals. One is to rebuild their balance sheet and recapitalise themselves so they’re no longer at risk of going broke. The second is to keep lending money. They’re being told to save and to keep spending at the same time. It’s not possible, and in the circumstances it’s no mystery why banks are using every penny they can get, and calling in every loan they can: they’re doing it in order to ‘deleverage’ and rebuild their capital as fast as possible.

What the banks want to be able to do is what most of us would do in comparable circumstances. Indeed, it’s what a good few of us, myself included, have done in the past, during previous busts in the property market. You just wait. Those who are in the dreaded position of having ‘negative equity’ – that’s 900,000 people in the UK, with many more due to join them in the coming months – can sell and take a loss, if they can afford to, or they can just wait. Carry on living, and wait for prices to recover, and even if they don’t, you still have somewhere to live. That’s what the banks would like to do about their toxic prices: wait for them to become non-toxic. If they were forced to value their assets today, for the price they could get today – a practice known as ‘mark to market’, which is supposedly enforced on most kinds of asset – some of them would be insolvent. Since the current valuations would irretrievably trash their balance sheets, they would prefer not to accept them.

The trouble is that banks are not households. If banks sit on their hands and wait for valuations to recover, the economy grinds to a halt. The flow of money would stop and the recession would be even more severe than it is already certain to be. That’s because a situation in which banks are insolvent but stay in business means that you have ‘zombie banks’. A zombie bank is a bank which is dead – insolvent – but has a horrible pseudo-life because it is being allowed to keep trading by (usually) an overindulgent government. Zombie banks are not hypothetical: it was zombie banks, created by a too-cosy relationship between banks and the state, which after 1989 turned the Japanese economy from a wonder of the world to a comatose onlooker on global growth. The economy can’t recover until the zombies are killed.

It isn’t hard to know how to slay the zombies. The only way to do it is to hold a gun to the head of the various bankers – those various guys sitting with their heads in their hands staring at balance sheets with holes in them – and force them to admit what their assets are worth, right now. Many of the banks will turn out to be insolvent. In that case the bank is nationalised, or at the very least goes into administration and receivership. Then, a number of options become available, one of the principal ones being to break the bank up into the viable part of the business, which will eventually be refloated back onto the market, and a ‘bad bank’ of dodgy assets which must be sold off (or arguably held until the values recover) in whatever way makes the most possible money for the taxpayer.

Nobody in power wants to do that. Nobody with power in the banking system, and nobody with power in government. Both the British and the American plans to help the banks are very, very, very expensive variations on the theme of sticking their fingers in their ears and loudly singing ‘La la la, I’m not listening’. This is what’s happened so far. In Britain, on 8 October 2008, the government announced a GBP 500 billion rescue package. This had various components. One was GBP 200 billion for the Special Liquidity Scheme. This scheme had begun in April 2008 and the new announcement increased its size. It allows banks to swap assets which can’t be sold – pretty much the definition of a toxic asset – in return for much more sellable (in other words, liquid) nine-month government bonds. At the time of writing, this scheme has been taken up by banks to a value of GBP 185 billion. The government also created the Bank Recapitalisation Fund, to keep the banks in business by buying their shares. An initial GBP 25 billion went into the scheme, with another GBP 25 billion available if needed. It’s this money which has been used to bail out RBS and HBOS, as above. In addition, the government offered up to GBP 250 billion in loan guarantees between the banks. These were designed to take away the uncertainty in interbank lending, the uncertainty whose cause was the existence of toxic assets on each others’ balance sheets. The government was offering to insure these loans – in other words, the government was offering to become a one-stop shop for credit default swaps.

The distinctive feature of the UK scheme is the way the government took stakes in the banks as a way of recapitalising them and helping them to stay in business. In the US it was different. There, on 1 October 2008, the Senate passed the Emergency Economic Stabilisation Act, based on the plan floated by the then treasury secretary, Henry Paulson. This created the Troubled Asset Relief Programme I’ve already mentioned, a $700 billion fund designed to buy the toxic assets from the banks. The government would then be free to sit on them until they recovered some value, and in the meantime could enjoy the income from the various underlying streams of mortgage revenue – since these assets were of course mortgage-backed securities based on the famous sub-prime mortgages. This scheme varies from the British one in that it doesn’t have the government pumping cash into the banks to keep them solvent, but instead has it taking the toxic assets away – deflecting them into space a la Superman – and hoping that this will in and of itself cause normality to break out in the banking sector. There was a not-so-subtle difficulty with the plan, however: what price is the government to pay for the toxic assets? How are the banks to be prevented from gouging horribly unfair sums of money from the taxpayer? After all, the market has broken down because the gap between what sellers are willing to accept and buyers are willing to pay is so great that the two parties can’t do deals. So the government waltzes in and agrees to be the patsy, overpaying for assets which the bank knows far more about than the government does? It’s not just buying a pig in a poke: it’s buying a pig in a poke at a price determined by the seller, at a time when there is no market in pigs.

That problem proved unfixable. The banks and the government couldn’t agree prices for the assets to go into TARP. Instead, the government found itself putting money directly into the banks in return for shareholdings, in a less structured version of the British approach. So far $250 billion has gone into the banks in this way; it’s this money which has underpinned the bail-outs to date, plus the extra $40 billion into AIG. The current cost to the US taxpayer of TARP so far is estimated at $356 billion. That got through about half the $700 billion Congress had allocated to the bail-out. In February, the new treasury secretary, Tim Geithner, announced the outline of his plan for the rest of the money, and then on 23 March the detail of the plan came out. It has three different components, all of which involve the creation of public-private partnerships between the government and private investors. One part of the plan matches private money with government money, while also offering to lend up to 85 per cent of the private stake. (We decide to buy something for GBP 100. I lend you GBP 92.50, GBP 85 of it on loan, and you pay GBP 7.50.) Another part has the government putting up a chunk of money to buy toxic assets, and offers a line of credit to buy more assets, provided that private money goes in too. This part of the plan is called the Term Asset-Backed Securities Loan Facility or TALF (presumably TABSLF was viewed as unpronounceable – but I can’t be the only person to find in TALF a faint, embarrassing shadow of the porny acronym MILF). This additional government money comes in the form of a ‘non-recourse loan’ – that’s to say, the government can’t ask for its money back, if the investment goes wrong. The non-recourse loans can constitute up to 85 per cent of the total investment. The private investors get all the upside if the price goes up. This is a truly amazing sweetener to persuade private money – in practice, if the plan works, that will be made up of hedge funds, sovereign wealth funds and private equity groups – to get involved in buying up the toxic assets. The idea, the hope, the longing, is that this will create a market in the assets; and once a functioning market is created, the thinking goes, the market will realise that these assets are in fact undervalued, and the prices will recover, and bank balance sheets will recover, and peace and order will break out and the financial sector will be restored to health. It’ll be like the last act of Fidelio, except the people emerging from the cellars blinking with joy will be bankers.

To the relevant bigshots of the financial sector – people Tim Geithner knows well from his time as head of the New York Federal Reserve – this plan represents a bold, sane, ingenious attempt to create a space for the so-called assets to return to their rightful values. To many other observers, it’s not so different from dressing up in a costume and dancing in a circle praying for the intervention of the Market Gods. The plan embodies a desperate yearning for this to be a crisis of liquidity rather than one of solvency, and hopes that by acting on that belief, it will make it come true.

About twenty years ago I bumped into Alan Hollinghurst at a party at the Poetry Society. He greeted me with the words, ‘Hello. I’m going to tremendous, Basil Fawltyish lengths to avoid being introduced to Sir Stephen Spender’, whose collected poems he had just given an unglowing review. ‘Tremendous, Basil Fawltyish lengths’: that phrase stuck with me. It comes to mind when I look at Anglo-Saxon attempts to address the crises in their respective financial sectors. The UK and US plans are different, as I’ve said, but at their heart they both show the governments going to tremendous, Basil Fawltyish lengths in order to avoid taking the troubled banks into public ownership. Our governments are prepared to pay for them, but not to take them over.

There are four reasons for the reluctance to take over the banks, of which the first isn’t a real reason but a piece of political bullshit.

1. Because the government would be bad at it. This is the only reason governments are willing to give in public, and it fails the most elementary test of all: only a professional politician can say it with a straight face. Bad at running the banks, compared to the bankers who broke capitalism? Please. But this is the closest they can get to admitting the first real reason, which is:

2. Because if the banks were taken over, then every decision they take would come at a potential political cost to the government. Your state-owned mortgage lender is threatening to repossess your house, after you fell behind on the payments? Blame the government. Your firm is laying off half its workforce because the bank won’t roll over its loan? Blame the government. This, of course, is in addition to all the other economic things for which people are already blaming the government. People are grumbling now, but to nothing like the extent they would if the banks were directly owned by the state. Politicians simply aren’t willing to take on the responsibility for the banks’ actions.

3. They also don’t want to admit the extent to which we are all now liable for the losses made by the banks. Guess what, though: it’s too late. The thirty per cent collapse in the value of sterling over the last months is something which is only just beginning to be noticed by the public at large; but it is unlikely to go away as quickly as it arrived. The reason sterling has crashed is simple: the markets are pricing in the fact that we the taxpayer are on the hook for the losses made by our banks. The markets assume that we can’t or won’t default on our government debts – that would mean we simply can’t afford to pay back the amount we’re currently borrowing. They’re probably right about that. But Alistair Darling’s desperately grim Budget made it clear just how deep in the mire we are. As for how bad it is, and how quickly it’s gone bad, well: in March last year, at the time of the Budget, the projected deficit for 2009-2010 was GBP 38 billion. By 24 November, the projected deficit was GBP 118 billion. In the Budget on 22 April, Darling admitted that the real figure is going to be GBP 175 billion. The total projected borrowing for the next four years is GBP 606 billion. National debt will hit 79 per cent of GDP – the highest peacetime figure ever. The economy is going to have its worst year since 1945. The debt is going to cost in the range of GBP 35 to GBP 47 billion a year to service. That’s just the debt alone; we’re going to be spending more on debt than we are on the entire transport budget. Perhaps New Labour might consider changing its motto from ‘Education, education, education’ to ‘Debt, debt, debt’.

That means tax rises, a near total freeze on government spending, swingeing public-sector job cuts, companies laying off every worker they can to save costs, and a dramatic upward spike in unemployment. The one easy thing the government will be able to do to help itself is to make inflation go up – that helps, because it decreases the real cost of the debt. An inflation rate of five per cent means that the debt goes down in cost by five per cent every year, magically and just by itself. From the point of view of a heavily indebted government, that’s good news; for other parts of the economy, for borrowers and for anyone holding sterling, it’s less good. To compound this already desperate picture, we also have huge levels of personal debt, directly arising from our credit bubble. The average British household owes 160 per cent of its annual income. That makes us, individually and collectively, a lot like the cartoon character who’s run off the end of a cliff and hasn’t realised it yet. None of this is secret, and investors looking at the prospects for sterling are making up their minds and bailing out. The investor-pundit Jim Rogers, colleague of George Soros, is advising anyone who will listen to ‘sell any sterling you might have. It’s finished. I hate to say it, but I would not put any money in the UK.’ This isn’t nice or polite, but it puts into the public domain what a lot of international money men are saying in private. More to the point, it’s a policy on which they have already acted. This is the reason an auction of government debt held in March failed. The debt was for forty-year bonds paying out at a rate of 4.25 per cent, and the reason it failed to sell everything on offer – the last time that happened was in 2002 – is that the markets thought inflation likely to rise, making the bonds a bad bet.

And the reason for that is that we in Britain are, to use a technical economic term, screwed. Economies across the whole world are struggling. Because nobody is spending money, even relatively blameless countries such as Germany, with low levels of debt and workforces who actually make things, are having a difficult time. Germany’s economy is predicted to contract by 5.4 per cent this year. A banker explained it like this: ‘When your country’s economy depends on people buying a car every three years, and they decide that they’ll only buy a car every five years, you’re fucked. Off a cliff.’ So the German economy is fucked off a cliff. But it will recover, when people start buying cars again, and when it does, at least their underlying levels of debt are manageable. Something similar goes for Spain, where the ending of the property boom has caused a spike in unemployment to 17.4 per cent, almost doubling in a year, or Ireland, which has contracted by a truly horrendous eight per cent and where people have gone from owning private helicopters to losing their homes in six months flat. All of these countries are in deep trouble. But there are four things you don’t want to have, going into the current crisis. 1. You don’t want to have had a boom based on a property bubble. 2. You don’t want to have a consumer credit bubble. 3. You don’t want to have an economy based on financial services. 4. You don’t want your government to have just gone on a massive spending spree. We have all four of those things that you don’t want.

It is possible that we are on course for the worst-case scenario. That would involve all our big, TBTF banks turning out to be insolvent, with the result that their balance sheets go onto the public debt. If that were to happen, Britain itself could become insolvent. Countries do go broke. A famous-to-economists example was Newfoundland, which in 1934 effectively went into administration and opted for direct rule from Britain because it was broke – becoming in the process one of the only colonies anywhere in the world ever to have voluntarily given up independence. A modern-day equivalent is having to go to the IMF and ask for money. It happened in 1976 and could happen again. The trigger would be a general view in the markets that the government’s tax receipts weren’t sufficient to meet its debt payments. That would cause a ‘buyer’s strike’ in the bond market: nobody would want to buy UK government bonds, so the government could no longer keep going back to the markets for cash to pay its liabilities. That would leave the government facing an immediate need for cash with no means of raising it – and it’s that which would send us prostrate to the IMF. Sterling would be more or less worthless. Travel would be next to impossible, imports would be unaffordable, interest rates would zoom up and stay up, there would be cuts in all aspects of public sector spending, especially employment. It would be brutal. Nobody thinks this scenario is likely, but quite a few people are willing to admit that it is possible. In 1976, Britain went broke running an annual deficit – the gap between tax revenues and government spending – of six per cent of GDP. Next year that figure is going to hit 12.4 per cent. A bad omen.

Even if we fall short of the IMF option in favour of a run-of-the-mill severe recession, the consequences for Britain are going to be horrific. Roads and schools and hospitals will go unbuilt and unrepaired, medical treatments will go unbought, nurses and policemen and council workers will be laid off. Six hundred thousand jobs have been created in local government in the last few years. Most of them will have to go. And then the really gigantic argument will have to be had, over the public service pensions which are paid for out of current tax receipts. I don’t know anyone who has studied this problem who thinks the government will be able to afford them. Can you imagine the fights that are going to happen? The political polarisation between public and private sector employees, the savagery of the cuts, the bitterness of the arguments, the furious sense of righteousness on both sides? It’ll be Thatcher all over again, and the current period of managerial non-politics will seem as distant as the Butskellite consensus did in the 1980s.

All of this leads us to the fourth and deepest reason why the government won’t nationalise the banks. The deepest reason is:

4. Because it would be so embarrassing. Some of the embarrassment is superficial: on the “not remembering somebody’s name at a social occasion” level. The Anglo-Saxon economies have had decades of boom mixed with what now seem, in retrospect, smallish periods of downturn. During that they/we have shamelessly lectured the rest of the world on how they should be running their economies. We’ve gloated at the French fear of debt, laughed at the Germans’ 19th-century emphasis on manufacturing, told the Japanese that they can’t expect to get over their ‘lost decade’ until they kill their zombie banks, and so on. It’s embarrassing to be in a worse condition than all of them.

There is, however, a deeper embarrassment, one which verges on a form of psychological or ideological crisis. To nationalise major financial institutions would mean that the Anglo-Saxon model of capitalism had failed. The level of state intervention in the US and UK at this moment is comparable to that of wartime. We have in effect had to declare war to get us out of the hole created by our economic system. There is no model or precedent for this, and no way to argue that it’s all right really, because under such-and-such a model of capitalism … there is no such model. It just isn’t supposed to work like this, and there is no road-map for what’s happened.

It’s for this reason that the thing the governments least want to do – take over the banks – is something that needs to happen, not just for economic reasons, but for ethical ones too. There needs to be a general acceptance that the current model has failed. The brakes-off, deregulate or die, privatise or stagnate, lunch is for wimps, greed is good, what’s good for the financial sector is good for the economy model; the sack the bottom ten per cent, bonus-driven, if you can’t measure it, it isn’t real model; the model that spread from the City to government and from there through the whole culture, in which the idea of value has gradually faded to be replaced by the idea of price. Thatcher began, and Labour continued, the switch towards an economy which was reliant on financial services at the expense of other areas of society. What was equally damaging for Britain was the hegemony of economic, or quasi-economic, thinking. The economic metaphor came to be applied to every aspect of modern life, especially the areas where it simply didn’t belong. In fields such as education, equality of opportunity, health, employees’ rights, the social contract and culture, the first conversation to happen should be about values; then you have the conversation about costs. In Britain in the last twenty to thirty years that has all been the wrong way round. There was a reverse takeover, in which City values came to dominate the whole of British life.

It’s becoming traditional at this point to argue that perhaps the financial crisis will be good for us, because it will cause people to rediscover other sources of value. I suspect this is wishful thinking, or thinking about something which is quite a long way away, because it doesn’t consider just how angry people are going to get when they realise the extent of the costs we are going to carry for the next few decades. I think we will end up nationalising at least some of our big banks because the electorate will be too angry to do anything that looks in the smallest degree like letting them get away with it. Banks can’t change their behaviour, so we have to do it for them, and the only way to do it is to take them over. We can’t afford any more TBTF.

I get the strong impression, talking to people, that the penny hasn’t fully dropped. As the ultra-bleak condition of our finances becomes more and more apparent people are going to ask increasingly angry questions about how we got into this predicament. The drop in sterling, for instance, means that prices for all sorts of goods will go up just as oil and gas prices have spiked downwards. Combined with job losses – a million people are forecast to lose their jobs this year, taking unemployment back to Thatcherite levels – and tax rises, and inflation, and the increasing realisation that the cost of the financial crisis is going to be paid not over a few years but over a generation, we have a perfect formula for a deep and growing anger. Expectations have risen a lot, over the last three decades; that’s going to have a big impact on how furious people feel about the hard years ahead. The level of future public spending cuts implied in Darling’s recent budget – which included the laughably optimistic idea that the economy will grow by 1.25 per cent next year – is greater than the level of cuts implemented by Thatcher. Remember, that’s the optimistic version. If we’re lucky, it won’t be any worse than Thatcherism.


1 Neal Ascherson wrote about the Darien Scheme in the LRB of 3 January 2008: http://www.lrb.co.uk/v30/n01/asch01_.html

2 They go to some lengths to make sure it’s that way, since Apple is, in financial circles, notorious for sitting on huge amounts of cash. In the balance sheet we’re looking at, Apple had $24.49 billion in cash. That’s a colossal amount, as much as RBS, a company fifty times its size. This cash, obviously, stays on the asset side of the balance sheet. You might think that having lots of cash is a good thing, but in investment circles it isn’t loved: the logic is that if you have cash, you should give that cash back to its ultimate owners, the shareholders. They might have other things they want to do with it.

3 My footnote, not RBS’s: an ‘attachment point’ is the same thing as the excess in an insurance policy. It means the point at which the insurer shells out. I quite like it as a corporate euphemism, embodying as it does an image of the insured person desperately trying to attach himself to the insurer, while implying that the insurer is keen for this not to happen. Translated, ‘high attachment points’ means ‘these crappy mortgage-borrowers need to have lost a lot of money before they become our problem’.

4 Fool’s Gold will be reviewed in the LRB by Donald MacKenzie.


John Lanchester’s book about the financial crisis, Whoops, will be published by the Penguin Press, once he’s finished writing it.

Other articles by this contributor:

Cityphobia · The Crash

Warmer, Warmer · Global Warming, Global Hot Air

A Month on the Sofa · My Sporting Life

See you in court, pal · The Microsoft Trial

Bravo l’artiste · What is Murdoch after?

Unbelievable Blair · John Lanchester falls out with New Labour

Diary · Blogswarms

Other People’s Capital · Conrad and Barbara Black

ISSN 0260-9592 Copyright (c) LRB Ltd, 1997-2009


Bill Totten http://www.ashisuto.co.jp/english/index.html

>A Guide for the Perplexed

>The Archdruid Report (May 27 2009)

by John Michael Greer

Druid perspectives on nature, culture, and the future of industrial society

An irony endured, and occasionally relished, by those of us whose concerns about peak oil have found their way into print is the awkward fact that it’s difficult to talk publicly about using less fossil fuel energy without using more of it. The networks of transportation and communication left to us by the collective decisions of the recent past demand a great deal of energy input, and social habits evolved during the heyday of cheap energy amplify that, making long-distance trips a practical necessity for the working writer. These days, that usually means air travel.

A passage in Theodore Roszak’s Where the Wasteland Ends (1972) explores the chasm between the old romantic dreams of human flight and the utterly unromantic reality that replaced them. More than once, after a few hours packed like sardines in a metal can breathing the same stale air a hundred times over, it’s occurred to me that the crabby oldsters who insisted that humanity was not meant to fly may have had more of a point than most of us suspect. The one consolation I’ve found is that the hours of enforced inactivity on planes and in airports provide some of the few chances an increasingly busy schedule allows me for sustained reading. And that, dear reader, is how I ended up sitting in a tacky restaurant in the even more tacky Dallas-Fort Worth airport a few weeks back, killing time between one flight and the next, with a copy of E F Schumacher’s book Small Is Beautiful (1973) in my hands.

This was by no means my first encounter with Schumacher. Back in the 1970s, when I first began studying the ways that energy, ecology, and history were weaving our future, his name was one to conjure with throughout the environmental and appropriate-tech movements; you could expect to see Small is Beautiful on any bookshelf that also held The Whole Earth Catalog (1968-1998), say, or The Book of the New Alchemists (1977). Still, by the time I stuffed a copy in my carry-on bag and headed to the airport, close to thirty years had passed since the last time I’d opened it. I suspect many other people have neglected it to at least the same degree.

This is unfortunate, because Schumacher’s insights have not lost any of their force with the passing years. Quite the contrary; he was decades ahead of his time in recognizing the imminence of peak oil and sketching the outlines of an economics that could make sense of a world facing the twilight of the age of cheap abundant energy. It’s fair to say that in many ways, the peak oil scene has not yet caught up with him. For this reason among others, a review of the man and his ideas may be timely just now.

Ernst Friedrich Schumacher was born in Bonn in 1911 and attended universities there and in Berlin before going to Oxford in 1930 as a Rhodes Scholar, and then to Columbia University in New York, where he graduated with a doctorate in economics. When the Second World War broke out he was living in Britain, and was interned for a time as an enemy alien, until fellow economist John Maynard Keynes arranged for his release. After the war, he worked for the British Control Commission, helping to rebuild the West German economy, and then began a twenty-year stint as chief economist and head of planning for the British National Coal Board, at the time one of the world’s largest energy firms.

He also served as an economic adviser to the governments of India, Burma, and Zambia, and these experiences turned his attention to the economic challenges of development in the Third World. Recognizing that attempts to import the industrial model into nonindustrial countries usually failed due to shortages of infrastructure and resources, he pioneered the concept of intermediate technology – an approach to development that focuses on finding and using the technology best suited to the resources available – and founded the Intermediate Technology Development Group in 1966. His interest in resource issues also led to an involvement in the organic agriculture movement, and he served for many years as a director of the Soil Association, Britain’s largest organic farming group.

I suspect it was precisely these practical involvements that predisposed him to see past the haze of unrecognized ideology that makes so much contemporary economic thought so useless when applied to the real world. Economics as an academic field is notoriously forgiving of even the most embarrassingly inaccurate predictions, and a professor of economics can still count on being taken seriously even when every public statement he has made about future economic conditions has been flatly disconfirmed by events. This is much less true in the business world, where predictions can have results measured in quarterly profits or losses. Working in a setting where consistently failed predictions would have cost him his job, Schumacher was not at liberty to put ideology ahead of evidence, and the conflict between what standard economic theory said, then as now, and the realities Schumacher observed all around him must have had a role in making him the foremost economic heretic of his time.

His economic ideas cover a great deal of ground, not all of it relevant to the project of this blog; readers interested in the overall shape of his ideas should certainly pick up a copy of Small Is Beautiful and find them there. Four of his propositions, however, struck me as core assets in any attempt to make sense of the economic dimensions of the end of the industrial age.

First, Schumacher drew a hard distinction between primary goods and secondary goods. The latter of these includes everything dealt with by conventional economics: the goods and services produced by human labor and exchanged among human beings. The former includes all those things necessary for human life and economic activity that are produced not by human beings, but by nature. Schumacher pointed out that primary goods, as the phrase implies, need to come first in any economic analysis because they supply the preconditions for the production of secondary goods. Renewable resources, he proposed, form the equivalent of income in the primary economy, while nonrenewable resources are the equivalent of capital; to insist that an economic system is sound when it is burning through nonrenewable resources at a rate that will lead to rapid depletion is thus as silly as claiming that a business is breaking even if it’s covering up huge losses by drawing down its bank accounts.

Second, Schumacher stressed the central role of energy among primary goods. He argued that energy cannot be treated as one commodity among many; rather, it is the gateway resource that allows all other resources to be accessed. Given enough energy, shortages of any other resource can be made good one way or another; if energy runs short, though, abundant supplies of other resources won’t make up the difference, because energy is needed to bring those resources into the realm of secondary goods and make them available for human needs. Thus the amount of energy available per person puts an upper limit on the level of economic development possible in a society, though other forms of development – social, intellectual, spiritual – can still be pursued in a setting where hard limits on energy restrict economic life.

Third, Schumacher stressed the importance of a variable left out of most economic analyses – the cost per worker of establishing and maintaining a workplace. Only the abundant capital, ample energy supplies, and established infrastructure of the world’s industrial nations, he argued, made it functional for businesses in those nations to concentrate on replacing human labor with technology. In the nonindustrial world, where the most urgent economic task was not the production of specialty goods for global markets but the provision of paid employment and basic necessities to the local population, attempts at industrialization far more often than not proved to be costly mistakes. Schumacher’s involvement in intermediate technology unfolded from this realization; he pointed out that in a great many situations, a relatively simple technology that relied on human hands and minds to meet local needs with local resources was the most viable response to the economic needs of nonindustrial nations. Since the end of the age of cheap abundant energy bids fair to place the world’s industrial nations on something like a par with today’s Third World, struggling to feed large populations with sharply limited resources and disintegrating infrastructures, the same logic will much more likely than not apply to our own future as well.

Finally, and most centrally, Schumacher pointed out that the failures of contemporary economics could not be solved by improved mathematical models or more detailed statistics, because they were hardwired into the assumptions underlying economics itself. Every way of thinking about the world rests ultimately on presuppositions that are, strictly speaking, metaphysical in nature: that is, they deal with fundamental questions about what exists and what has value. Trying to ignore the metaphysical dimension does not make it go away, but rather simply insures that those who make this attempt will be blindsided whenever the real world fails to behave according to their unexamined assumptions. Contemporary economics fails so consistently to predict the behavior of the economy because it has lost the capacity, or the willingness, to criticize its own underlying metaphysics, and thus a hard look at those basic assumptions is an unavoidable part of straightening out the mess into which current economic ideas have helped land us.

All of these four points deserve more development than Schumacher, in the course of a busy and active life, was able to give them. All four also can be applied constructively to the specific economic questions surrounding the end of the age of cheap energy and the coming of deindustrial society. Over the weeks and months to come, subject to the usual interruptions, I want to explore this latter task in some detail, and propose a few potential lines of approach toward the former. As last week’s post pointed out, the economic dimension is perhaps the least understood aspect of the crisis of industrial civilization, and a good part of that lack of understanding can be traced to the chasm that has opened up between current ideas and economic reality. Anything that can help bridge that gap could be crucial in navigating the challenging future ahead of us.


John Michael Greer has been active in the alternative spirituality movement for more than 25 years, and is the author of a dozen books, including The Druidry Handbook (2006) and The Long Descent (2008). He lives in Ashland, Oregon.


Bill Totten http://www.ashisuto.co.jp/english/index.html

>Banksters Playing Both Sides

>Banks Aiming to Play Both Sides of Coin

Industry Lobbies FDIC to Let Some [banks] Buy Toxic Assets With Taypayer Aid From Own Loan Books

by David Enrich, Liz Rappaport and Jenny Strasburg

Wall Street Journal (May 27 2009)

Some banks are prodding the government to let them use public money to help buy troubled assets from the banks themselves.

Banking trade groups are lobbying the Federal Deposit Insurance Corp. for permission to bid on the same assets that the banks would put up for sale as part of the government’s Public Private Investment Program [PPIP].

PPIP was hatched by the Obama administration as a way for banks to sell hard-to-value loans and securities to private investors, who would get financial aid as an enticement to help them unclog bank balance sheets. The program, expected to start this summer, will get as much as $100 billion in taxpayer-funded capital. That could increase to more than $500 billion in purchasing power with participation from private investors and FDIC financing.

The lobbying push is aimed at the Legacy Loans Program, which will use about half of the government’s overall PPIP infusion to facilitate the sale of whole loans such as residential and commercial mortgages.

Federal officials haven’t specified whether banks will be allowed to both buy and sell loans, but a list released by the FDIC and Treasury Department of the types of financial firms likely to be buyers made no mention of banks.

Allowing banks to have it both ways would give them added incentive to sell assets at low prices, even at a loss, the banks contend. They claim it also would free up capital by moving the assets off balance sheets, spurring more lending.

“Banks may be more willing to accept a lower initial price if they and their shareholders have a meaningful opportunity to share in the upside”, Norman R Nelson, general counsel of the Clearing House Association LLC, wrote in a letter to the FDIC last month.

The New York trade group represents ten of the world’s largest banks, including Bank of America Corporation, Citigroup Incorporated and Wells Fargo & Company. Those banks are seen as likely sellers of assets using PPIP. Officials at the banks declined to comment.

“It’s an issue that’s been raised and an issue we’re aware will need specific guidelines”, said an FDIC spokesman, adding that the agency still is working on the final structure of its program and plans to launch a $1 billion pilot program this summer, which likely won’t include an infusion from the Treasury.

Some critics see the proposal as an example of banks trying to profit through financial engineering at taxpayer expense, because the government would subsidize the asset purchases.

“To allow the government to finance an off-balance-sheet maneuver that claims to shift risk off the parent firm’s books but really doesn’t offload it is highly problematic”, said Arthur Levitt, a former Securities and Exchange Commission chairman who is an adviser to private-equity firm Carlyle Group LLC.

“The notion of banks doing this is incongruent with the original purpose of the PPIP and wrought with major conflicts”, said Thomas Priore, president of ICP Capital, a New York fixed-income investment firm overseeing about $16 billion in assets.

One risk is that certain hard-to-value assets might not be fairly priced if banks are essentially negotiating with themselves. Inflated prices could result in the government overpaying. Recipients of taxpayer-funded capital infusions under the Troubled Asset Relief Program also could use those funds to buy their own loans.

“Sensible restrictions should be placed on banks, especially those that have received government capital, from investing their own balance sheets in a backdoor effort to reacquire what could be their own assets with an enormous amount of federally guaranteed leverage”, said Daniel Alpert, managing director at Westwood Capital LLC, an investment bank.

Even supporters of letting banks buy their own loans said it could be a tough sell.

“A bank bidding on its own assets really has the potential to look awful in the public’s mind”, said Mark J Tenhundfeld, an American Bankers Association lobbyist. Some bankers said the concerns can be addressed through strong oversight by the government and outsiders.

The banking industry’s lobbying is meant to overcome a hurdle facing PPIP: unwillingness by banks to sell assets at steep discounts.

Banks generally would rather hold on to assets they believe have more inherent value, avoiding selling them at a low point in the market. Many mortgage securities are valued at less than half their original price.

“Bankers see it as a win-win”, said Tanya Wheeless, chief executive of the Arizona Bankers Association, which has urged the FDIC to let banks buy their own assets through PPIP.

US banks held about $4.7 trillion in commercial and residential mortgages of the type that banks are lobbying to buy as of the end of the third quarter of 2008, according to Federal Reserve data. PPIP is designed in part to mitigate $600 billion of potential losses through the end of 2010 tied to toxic assets at the nation’s nineteen largest banks, according to the Fed’s stress tests.

Mr Nelson proposed to the FDIC that banks be allowed to control as much as half the capital in a buyers’ group. In some cases, he wrote, “the selling bank should be able to participate as the only private-sector equity investor.”

The California Bankers Association said in a letter that the FDIC’s supervision of the asset-pricing process “should alleviate concerns about the inability to effect arm’s length transactions between a bank and its affiliate that purchases through a public-private investment fund.”

Irene Esteves, the chief financial officer at Regions Financial Corporation, which has been lobbying to buy assets through PPIP, included a reference to gobbling up loans under the heading “Conflict of Interest” in a letter to the FDIC. A spokesman for the Birmingham, Alabama, bank declined to comment.

Towne Bank of Arizona plans to sell some of its soured real-estate loans into PPIP and wants to profit from the program. “We think it would be attractive to our shareholders to be able to share in whatever profits there are from the venture”, said CEO Patrick Patrick.


Damian Paletta contributed to this article.


Bill Totten http://www.ashisuto.co.jp/english/index.html

>Making Climate Consciousness Personal, and Acting


by Jan Lundberg

Culture Change (May 03 2009)

The amount of urgent news on the unravelling climate, or the perception and weight of it, does not drive many of us to take action. We know how bad things are getting, but we don’t change society’s or our own patterns. This remains true until we come up against the direct threats or consequences of climate change.

This has already begun for millions of climate-chaos victims. But at this point social and individual change look like they will mostly be involuntary. Significantly, whether our change is deliberate or not, we can find that climate change is personal and therefore quite activating.

Perhaps a key to overcoming the abstract threat of climate change is this personalizing, such that we feel our entire beings affected. This has to result in our lives changing outwardly too. Until this happens, when we’re just on the intellectual level – as consumers of news and facts – we don’t intimately sense our own lives’ impact from climate change.

Fortunately, we don’t have to all have a specific influence that’s direct, such as our homes being inundated by sea level rise, for example, to graduate to climate consciousness. Such consciousness is not the destination; rather, it’s a beginning for action that is immeasurable.

Not only is there the impact from climate change, there is our impact on climate change. For we reflect back into society and nature what is going on inside us. This can be powerful.

To illustrate my point that climate consciousness must flow from the personal, I will follow up on my recent climate-fast experience and share further findings that amount to more than my own fast. The mainly US protest started on April 20. My short fast of 3 1/2 days does not compare impressively with the still-going fast by nine persons now entering their third week of no eating (some taking only water).

I’m sure they would agree that even a short fast is one way to become directly involved with climate change, if that is our intent. Our impact from this unique kind of act could be significant. If it is not, for all practical purposes, soon enough to tell we had an impact on society, we have still learned a lot which will be useful until this fight for a livable planet is won or lost.

One thing we’re learning is that “this fight” is a narrow way to characterize our dreams and goals. We revere life, and invite everyone to share the good feeling – for it seems some do not appreciate life in its diversity and mystery.

That’s a good segue to say such folk might do well to learn about fasting. They may have to do it suddenly due to the intensifying Depression and ensuing deprivation. This implies stress instead of contemplating life’s glory and wonder. Which way would most choose, if they were already somehow aware that our hopes are mostly pinned on “Fred Astaire in the White House” or a bogus techno-fix? Fortunately, many choices are going the way of common sense for economic survival, to creatively assure subsistence in the destructive wake of economic growth. Boom and bust never went away.

My inclusion of fasting in last week’s Culture Change report, “Legally Drugged Populace: Handy Tool?” disappointed or scared some readers, but probably a low proportion. On an email list, someone commented on my report thusly:

“Fasting for more than two days is probably as controversial as over-consumption of calories, and not advisable for everyone! Certainly not a solution for much, except as an exigency measure.”

I responded with this clarification and defense:

Fasting is a most ancient healing method that works consistently unless done without regard to proper rest or proper breaking of the fast. Western medicine doesn’t profit off it, so fasting is discouraged and is therefore controversial. Not in all cultures, though.

In our culture we retain residual knowledge: English word “breakfast” = break the fast. Same as in Spanish. We all fast, in the night time: try eating really late or waking up in the middle of the night and eat a meal, and see what rest you can then get.

In my 56 years I’ve not found any condition or person for whom fasting is not advisable. Except, when I encounter those heavily ensnared in the medical cult and they’re on various drugs and treatments that are compromising their health (and sending them to the poorhouse) – they cannot be approached and changed easily. Many modern persons have theoretical disagreements, as do credentialed health professionals, about fasting – but never have I known the disagreements, fear, objections, or confusion to be based on evidence or actual experience.

The elimination of toxins – symptoms – is unpleasant and confused with disease, hence interfered with by conventional medical practice. The result is usually more advanced diseases and weakened states. In a polluted world and sedentary lifestyle this can mean doom for one’s survival.

Detoxification through fasting = quickest healing or the enabling of healing. Doing and seeing is believing. It’s all empirical, giving rise to simple, common-sense principles. Stopping pain and ending addictions are no small accomplishments.

When healing has been put off or stifled (by failing to detoxify and change life-style), at some point it becomes too late to do anything but amputate or whatever.

My treatise on fasting is at culturechange.org

Good health to all,


If we don’t all have the same ways in approaching climate change, that’s okay. But the sooner people experience it directly, ideally voluntarily with willingness to share the knowledge, the sooner climate consciousness will take precedence over obsessing about the collapse of the old guard’s outmoded control-tripping of humanity and nature.

* * * * *

“Legally Drugged Populace: Handy Tool?” by Jan Lundberg:

“Fred Astaire in the White House” by Michael Brownstein:

Fasting for the climate: official website, blog, et cetera:


Bill Totten http://www.ashisuto.co.jp/english/index.html

>The Latest in Junk Economics

>Marginalist Panaceas to Today’s Structural Problems

by Michael Hudson

Personal correspondence (May 21 2009)

It looks like bookstores are about to be swamped this summer and fall by a forest of advice for which publishers gave respectable advances a year ago as the economy was going off the rails. Seeking to minimize the risk of cognitive dissonance, the marketing strategy seems to be to offer advice by well-placed or celebrity insiders on how to recover the kind of free lunch that American pension plans – and popular hopes for easy wealth – have long assumed to be part of the natural law of economic growth, if only it can be better managed. The fantasy people want to buy is that the happy 1981-2007 era of debt-leveraged price gains for real estate, stocks and bonds can be brought back. But the Bubble Economy was so debt-leveraged that it cannot reasonably be restored. This means that publishers have achieved the marketer’s dream of planned obsolescence: Readers a year or so from now will have to buy a new slew of books as they feel hungry again from the lack of intellectual protein.

For the time being we are supposed to be satisfied Wall Street defenses of the Bush-Obama (Paulson-Geithner) attempt to re-inflate the Bubble by a bailout giveaway that has tripled America’s national debt in the hope of getting bank credit (that is, more debt) growing again. The problem is that debt leveraging is what caused the economic collapse. A third of US real estate is now estimated to be in negative equity, with foreclosure rates still rising. So publishers have only a short window of opportunity to sell the current spate of books before people wake up to the fact that attempts to renew the Bubble Economy will make our financial overhead heavier.

In the face of this stultifying financial trend, the book-buying public is being fed appetizers pretending that economic recovery simply requires more “incentives” (a euphemism for special tax breaks for the rich) to encourage more “saving”, as if savings automatically finance new capital investment and hiring rather than what really happens: Money is being lent out to create yet more debt owed by the bottom ninety percent to the economy’s top ten percent. Publishers evidently believe that the way to attract readers – and certainly to get reviews in the major media – is to propose easy solutions. The theme of most of this year’s Bubble books therefore is how we could have avoided the Bubble “if only …” If only there had been better regulation, for instance.

But to what aim? After blaming Alan Greenspan for playing the role of “useful idiot” by promoting deregulation and blocking prosecution of financial fraud, most writers trot out the approved panaceas: federal regulation of derivatives (or even banning them altogether), a Tobin tax on securities transactions, closure of offshore banking centers and ending their tax-avoidance stratagems. But no one is going so far as to suggest attacking the root of the financial problem by removing the general tax deductibility of interest that has subsidized debt leveraging, taxing “capital” gains at the same rate as wages and profits, or closing the notorious tax loopholes for the finance, insurance and real estate (FIRE) sectors.

Right-wing publishers are re-warming their articles of faith such as giving more tax incentives to “savers” (another euphemism for more giveaways to the rich) and a re-balanced federal budget to avoid “crowding out” private investment. One of Wall Street’s dreams is to privatize Social Security to create yet another Bubble to feed off of. (Fortunately, such proposals failed during the Republican-controlled Bush administration as a result of taxpayer outrage after the dot.com bubble burst in 2000.)

What is not heard is a call to finance Social Security and Medicare out of the general budget instead of keeping their funding as a special regressive tax on labor and its employers, available for plunder by Congress to finance tax cuts for the upper wealth brackets. Yet how can America achieve competitiveness in global markets with its pre-saving retirement tax (Social Security) and privatized health insurance, debt-leveraged housing costs and related personal and corporate debt overhead? The rest of the world provides much lower-cost housing, health care and related employee costs – or simply keeps labor near subsistence levels. Our lack of affordability is a major problem for continued dreams of a renewed Bubble Economy, yet the international dimension is ignored.

The latest panacea being offered to jump-start the economy is to rebuild America’s depleted infrastructure. Alas, Wall Street plans to do this Tony Blair-style, by public-private partnerships that incorporate enormous flows of interest payments into the price structure while providing underwriting and management fees to Wall Street. Falling employment and property prices have squeezed public finances so that new infrastructure investment will take the form of installing privatized tollbooths over the economy’s most critical access points such as roads and other hitherto public transportation, communications and clean water.

Surprisingly, one does not hear even an echo of calls to restore state and local property taxes to their Progressive Era levels so as to collect the “free lunch” of rising land prices and harness its gains over time as the main fiscal base. This would hold down land prices (and hence, mortgage debt) by preventing rising location values from being capitalized into new mortgage loans against “capital” gains and paid out as interest to the banks. Restoring Progressive Era tax philosophy (and pre-1930 property tax levels) would have the additional advantage of shifting the fiscal burden off income and sales – a policy that would make labor, goods and services more affordable. Instead, most reforms today call for further cutting property taxes to promote more “wealth creation” in the form of higher debt-leveraged property price inflation. Instead of housing prices falling and income and sales taxes being reduced, rising site values merely will be recycled to the banks for ever larger mortgages, not taxed to benefit local government. In this scenario, local governments are forced to shift the fiscal burden onto consumers and business, impoverishing the community.

The new books advocate merely marginal changes to deep structural problems. They include the usual pro forma calls to re-industrialize America, but not to address the financial debt dynamic that has undercut industrial capitalism in this country and abroad. How will these timid “reforms” look in retrospect a decade from now? The Bush-Obama bailout pretends that banks “too-big-to-fail” only face a liquidity problem, not the growing bad-debt problem we now face along with the economy’s widening inability to pay. The reason why past Bubbles cannot be re-inflated is that they have reached their debt limit, not only domestically, but also the international political limit of global Dollar Hegemony.

What needs to be written about is what the marginalists leave out of account and what academic jargon calls “exogenous” considerations, which turn out to be what economics really is all about: the debt overhead; financial fraud and crime in general (one of the economy’s highest-paying sectors); military spending (a key to the US balance-of-payments deficit and hence to the buildup of central bank dollar reserves throughout the world); the proliferation of unearned income and insider political dealing. These are the core phenomena that “free market” idea strippers have relegated to the “institutionalist” basement of the academic economics curriculum.

For example, the press keeps on parroting the Washington mantra that Asians “save” too much, causing them to lend their money to America. But the “Asians” saving these dollars are the central banks. Individuals and companies save in yuan and yen, not dollars. It is not these domestic savings that China and Japan have placed in US Treasury securities to the tune of $3 trillion. It is America’s own spending – the trillions of dollars its payments deficit is pumping abroad, in excess of foreign demand for US exports and purchases of US companies, stocks and real estate. This payments deficit is not the result of US consumers maxing out on their credit cards. What is being downplayed is that military spending in most years since the Korean War (1951) that has underlain the US balance-of-payments deficit. Now that foreign countries are starting to push back, this trend cannot continue much longer.

Inasmuch as China’s central bank is now the largest holder of US Government and other dollar securities, it has become the main subsidizer of the US balance-of-payments deficit – and also the domestic US federal budget deficit. Half of the federal budget’s discretionary spending is military in character. This places China in the uncomfortable position of being the largest financier of US military adventurism, including US attempts to encircle China and Russia militarily to block their development as economic rivals during the past fifty years. That is not what China intended, but it is the effect of global dollar hegemony.

Another trend that cannot continue is “the miracle of compound interest”. It is called a “miracle” because it seems too good to be true, and it is – it cannot really go on for long. Heavily leveraged debts go bad in the end, because they accrue interest charges faster than an economy’s ability to pay. Basing national policy on dreams of paying the interest by borrowing money against steadily inflating asset prices has been a nightmare for homebuyers and consumers, as well as for companies targeted by financial raiders who use debt leverage to strip assets for themselves. This policy is now being applied to public infrastructure into the hands of absentee owners, who will themselves buy these assets on credit and build the resulting interest charges into the new service prices they collect, in addition to being allowed to treat these charges as a tax-deductible expense. This is how banking lobbyists have shaped the tax system in a way that steers new absentee investment into debt rather than equity financing.

The irresponsible cheerleaders applauding a Bubble Economy as “wealth creation” (to use one of Alan Greenspan’s favorite phrases) would like us, their audience, to believe that they knew that there was a problem all along, but simply could not restrain the economy’s “irrational exuberance” and “animal spirits”. The idea is to blame the victims – homeowners forced into debt to afford access to housing, pension-fund savers forced to consign their wage set-asides to money managers at the large Wall Street firms, and companies seeking to stave off corporate raiders by taking “poison pills” in the form of debts large enough to block their being taken over. One looks in vain for an honest acknowledgement of how the financial sector has turned into a Mafia-style gang more akin to post-Soviet kleptocrat insiders than to Schumpeterian innovators.

The cursorily reformist gaggle of post-Bubble tomes assumes that we have reached “the end of history” as far as financial problems are concerned. What is missing is a critique of the big picture – how Wall Street’s collaboration in financializing the public domain has inaugurated a neo-feudal tollbooth economy while privatizing the government itself, headed by the Treasury and Federal Reserve. Left untouched is the story how industrial capitalism has succumbed to an insatiable and unsustainable finance capitalism, whose newest “final stage” seems to be a zero-sum game of casino capitalism based on derivative swaps and kindred hedge fund gambling innovations.

What has been lost are the Progressive Era’s two great reforms. First, minimization of the economy’s free lunch of unearned income (for example, monopolistic privilege and privatization of the public domain in contrast to one’s own labor and enterprise) by taxing absentee property rent and asset-price (“capital”) gains, keeping natural monopolies in the public domain, and anti-trust regulation. The aim of progressive economic justice was to prevent exploitation – for example, charging more than the technologically necessary costs of production and reasonable profits warranted. Progressive Era reforms had a fortuitous byproduct: Minimization of the free lunch enabled economies such as the United States to out-compete others that didn’t embrace progressive fiscal and financial policy, creating a Leviathan that has now fallen to its knees.

The second Progressive Era reform was to steer the financial sector so as to fund capital formation. Industrial credit was best achieved in Germany and Central Europe in the decades prior to World War One. But the Allied victory led to the dominance of Anglo-American banking practice based on loans against property or income streams already in place. Because of this, today’s bank credit has become decoupled from capital formation, taking the form mainly of mortgage credit (eighty percent), and loans secured by corporate stock (for mergers, acquisitions and corporate raids) as well as for speculation. The effect is to spur asset-price inflation on credit, in ways that benefit the few at the expense of the economy at large.

The consequences of debt-leveraged asset-price inflation are clearest in the post-Soviet “Baltic syndrome”, to which Britain’s economy is now succumbing. Debts are run up in foreign currency (real estate mortgages, tax-avoidance funds and flight capital), without exports having any prospect of covering their carrying charges as far as the eye can see. The result is a debt trap – chronic austerity for the domestic market, causing lower capital investment and living standards without hope of recovery.

These problems illustrate the extent to which the world economy as a whole has pursued the wrong course since World War One. This long detour has been facilitated by the failure of socialism to provide a viable alternative. Although Russia’s bureaucratic Stalinism got rid of the post-feudal free lunch of land rent, monopoly rent, interest and financial or property-price gains, its bureaucratic overhead overpowered the economy in the end and Russia fell. Ideology aside, the question is whether the Anglo-American brand of finance capitalism will follow suit from its own internal contradictions.

The flaws in the US economy are tragic because they are so intractable, embedded as they are in the very core of post-feudal Western economies. This is what Greek tragedy is all about: A tragic flaw that dooms the hero from the outset. The main flaw embedded in our own economy is rising debt in excess of the ability to pay, which is part of a larger flaw – the financial free lunch that property and financial claims extract in excess of corresponding costs as measured in labor effort and an equitably shared tax burden (the classical theory of economic rent). Like land seizure and insider privatization deals, such wealth increasingly is inherited, stolen or obtained through political corruption. Adding insult to injury, wealth and revenue extracted via today’s finance capitalism avoids taxation, thereby receiving an actual fiscal subsidy as compared to tangible industrial investment and operating profit. Yet academics and the popular media treat these core flaws as “exogenous”, that is, outside the realm of economic analysis.

Unfortunately for us – and for reformers trying to rescue our post-Bubble economy – the history of economic thought has been suppressed to give the impression that today’s stripped-down, largely trivialized junk economics is the apex of Western social history. One would not realize from the present discussion that for the past few centuries a different canon of logic existed. Classical economists distinguished between earned income (wages and profits) and unearned income (land rent, monopoly rent and interest). The effect was to distinguish between wealth earned through capital and enterprise that reflects labor effort, and unearned wealth from appropriation of land and other natural resources, monopoly privileges (including banking and money management) and inflationary asset-price “capital” gains. But even the Progressive Era did not go much beyond seeking to purify industrial capitalism from the carry-overs of feudalism: land rent and monopoly rent stemming from military conquest, and financial exploitation by banks and (in America) Wall Street as the “mother of trusts”.

What makes today’s Bubble different from previous ones is that instead of being organized by governments as a stratagem to dispose of their public debt by creating or privatizing monopolies to sell off for payment in government bonds, the United States and other nations today are going deeply into debt simply to pay bankers for bad loans. The economy is being sacrificed to reward finance instead of remaining viable by subordinating and channeling finance to promote economic growth via an affordable economy-wide cost structure. Interest-bearing debt weighs down the economy, causing debt deflation by diverting saving into debt payments instead of capital investment. Under this condition “saving” is not the solution to today’s economic shrinkage; it is part of the problem. In contrast to the personal hoarding of Keynes’s day, the problem is that the financial sector is now using its extractive power as creditor instead of wiping out the economy’s bad-debt overhang in the historically normal way, by a wave of bankruptcies.

Today, the financial sector is translating its affluence (at taxpayer expense), into the political power that threatens to pry yet more public infrastructure away from state and local communities and from the public domain at the national level, Thatcher- and Blair-style. It will be sold off to absentee rentier buyers-on-credit to pay off public debt (while cutting taxes on wealth yet further). No one remembers the cry for what Keynes called “euthanasia of the rentier”. We have entered the most oppressive rentier epoch since feudal European times. Instead of providing basic infrastructure services at cost or subsidized rates to lower the national cost structure and thus make it more affordable – and internationally competitive – the economy is being turned into a collection of tollbooths.

How disheartening that this year’s transitory wave of post-Bubble books fails to place the financialization of the US and global economies in this long-term context.


Bill Totten http://www.ashisuto.co.jp/english/index.html

>The 21st century’s bleak harvest

>by Asif Mehdi, development practitioner

Al Jazeera (May 19 2009)

As the world staggers from one economic crisis to another, it seems easy to forget the global food crisis that occupied centre stage in 2008.

World prices for essential grains more than doubled between 2006 and 2008.

Rice, the staple food of most of Asia, doubled in price in just seven months. And, despite their commitments to trade liberalisation, a few significant grain-exporting developing countries rushed to protect domestic grain stocks by banning exports.

The poor, who typically spend between fifty and seventy per cent of their meagre incomes on food, were most affected by the crisis.

According to the United Nations Food and Agriculture Organisation, the food crisis raised the number of undernourished people from 923 million to more than one billion by this year.

In late 2007 and 2008, the crisis caused food riots in at least fifteen countries across the world, from Brazil to Bangladesh, and international media and forums spoke of little else.

Then, as suddenly as it struck, declining prices relegated the food crisis to collective global amnesia.

Causes not addressed

However, while prices for grains and foods have declined in 2009, they are still higher than pre-crisis levels and the fundamental causes of their volatility have not disappeared.

The international economic system has witnessed a dramatic disbanding of trade and investment barriers.

However, the international market for agricultural commodities, the nature of industrial agriculture, changing consumption patterns and international finance all threaten to make food price volatility and food insecurity a recurrent feature of the early 21st century.

Agriculture offers a textbook case of international market distortion. And in this case, the market distortion is created by precisely the developed countries that extol the virtues of free markets.

Double standards

The developed world protects its domestic agriculture with any number of subsidies and technical barriers to trade.

In 2006, for example, the Organisation for Economic Co-operation and Development (OECD) estimated that agricultural subsidies in OECD member countries were about $230 billion.

In contrast to the magnitude of those subsidies, Official Development Assistance from OECD member states amounted to $120 billion (the US alone had a military budget of $600 billion in 2007).

The agricultural subsidies cover a host of measures – from domestic price support, to compensation to farmers for maintaining fallow land, to export price subsidies to dumping, some of which is disguised as food aid.

Paradoxically, international trade negotiations and, more importantly, International Monetary Fund (IMF) lending conditions expect developing countries to remove agricultural subsidies and liberalise domestic markets to imported foods.

While these measures allow for the increased availability of food, they have also eroded domestic agriculture and impoverished the rural economy, often in the most economically fragile states.

It was not surprising that the most impoverished countries were unable to meet the international price surge with increased domestic production, or the release of buffer stocks of staple food commodities.

In fact, those countries became ever more aid dependent as governments struggled to find the resources to pay the bills for imported food (and fuel), in the face of sharpened threats of hunger and undernourishment.

Industry domination

The opening of developing country markets does not benefit the average farmer in the developed world.

The international agricultural industry is dominated by a few grain, seed, chemicals and oil companies.

Such is their market power that three companies control the global grain trade and one company controls sixty per cent of seed production.

The grain trading conglomerates have unchecked market power to hoard and influence world prices.

Seed companies have employed breakthroughs in biotechnology to produce seeds that are compatible only with certain brands of pesticide or supply patented terminator seeds which germinate just once, and therefore the seed from a harvest cannot be used to grow a second crop.

This last feature of the seed business ensures a seed serfdom for the farmer, who cannot set aside part of the harvest for replanting.

It is no wonder, then, that the profits of the grain traders soared to astronomical heights in 2007, in one case up by sixty per cent over the previous year.

And it is no wonder that small farmers are bankrupted by one crop failure because of their inability to afford to buy or finance the procurement of seed for a new crop.

Industrialised agriculture

The other facet of industrialised agriculture is its energy intensity and reliance on hydrocarbon resources, whether as fertiliser or as fuel.

During the heyday of the Green Revolution, one study noted that between 1945 and 1994 US energy input for agriculture increased four-fold while crop yields only increased three-fold.

Since then, energy input has continued to increase without a corresponding increase in crop yield.

Barring a breakthrough in seed technology, industrial agriculture has reached a point of diminishing marginal returns from energy usage.

In addition, the fact that oil resource availability has peaked suggests that oil prices will be on a long-term increase, thereby increasing the costs of food production.

Given the nature of the financial crisis in developed countries, it is highly doubtful that governments will have the fiscal resources to increase subsidies to the agricultural sector, in order to contain the increase in prices.

For the developing world, fiscal constraints on governments and the likely drying up of development assistance will have the same impact.

Food to fuel

The recent movement in the developed world to produce bio-fuels is yet another factor propelling the price of grains.

A World Bank study, prepared in April 2008, pointed out that a third of US corn production goes to produce ethanol and half the vegetable oils produced in the EU to the production of biodiesel.

This diversion from food to fuel is subsidised extensively, while imports from Brazil (which has had the longest standing and most extensive bio ethanol production) are subjected to tariff barriers that effectively prohibit imports of Brazilian ethanol into these markets.

Commodity speculators, seeing the potential from increased demand for grains in these subsidised programmes, drove up futures commodity prices which in turn raised current prices in grain markets.

The same World Bank study contends that 75 per cent of the food price increase was due to bio-fuels, a figure hotly contested by the Bush administration at the time.

An International Food Policy Research Institute study asserts that the effect was somewhat less, at thirty per cent of the food price increase.

Ideology of the rich

The financial crisis in itself was a cause for the food price hike.

While prices rose steadily through 2006 and 2007, the latter half of 2008 saw a sharp increase in prices, in a so-called price spike.

However, little had changed in the fundamental conditions of supply or demand to cause such dramatic market adjustments.

By now it is clearly evident that as the unregulated and complex financial sector of the US was facing the unfolding effects of the real estate bubble, trillions of dollars moved across sectors and spaces and invested in food and primary commodities, causing another price bubble, this time of an altogether more serious consequence.

The simultaneous inflation of oil and food futures caused cost increases in the production of food while inflating its trading prices at the same time.

It seems that finance had run out of opportunities for profit, so it turned to the earth as a means of generating speculative profit, whether through real estate or primary commodities and food.

As the more recent financial crisis has shown, there is no regulatory capacity to stop such profiteering from reoccurring.

These are the difficult prospects and consequences of a world run by the ideology of the rich and powerful.

Development lessons

There are development lessons to be learned here.

First, food security is an issue requiring long-term international effort and food security demands that local agriculture be able to supply domestic needs wherever possible and that reserve stocks are garnered for difficult times.

Second, the developing nations are justified in holding out in the Doha Round of trade negotiations until real and tangible concessions are made with regard to trade in agricultural products.

Third, national development efforts need to be replenished with such ‘old fashioned’ endeavours as investing in rural production, water availability and the empowerment of the small farmer.

Economic history shows us that industrialisation was preceded by agricultural transformations, with the state playing a heavy role.

And economic history is a better guide to policy than the theorising of free marketers serving powerful corporate interests.


Asif Mehdi works in international development with an international intergovernmental organisation and has worked extensively in Asia and Africa during his 29-year career as a development practitioner.

The views expressed by the author are not necessarily those of Al Jazeera.


Bill Totten http://www.ashisuto.co.jp/english/index.html

>Key Points About Hyperinflation

>by Eric deCarbonnel

marketskeptics.com (April 21 2009)

The encyclopedia (Farlex) explains hyperinflation:

My comments are in square brackets [ … ]


Rapid and uncontrolled inflation, or increases in prices, usually associated with political and/or social instability, as in Germany in the 1920s.

Inflation during World War One

The hyperinflation that blighted Germany between 1920 and 1923 had its roots in World War One. Prices rose by 240% between 1914 and 1919. This figure was equivalent to price rises in France and the UK, but masked more serious problems in Germany. The Germans had borrowed vast sums to fund the war. When supplies of funds proved inadequate, the German central bank, the Reichsbank, simply lent itself money and printed new banknotes. The currency was not backed by gold after 1914, so there was no limit on the amount of money that could be printed. The amount of marks in circulation rose by 300% between 1914 and 1919. This resulted in limited inflation at the end of the war, but the seeds of later problems were sown.

Post-war expenditure

The new Social Democratic government of the Weimar Republic had great plans to improve the conditions of the poor in Germany. Improved education, welfare, and more jobs were promised. These were expensive programmes to deliver, more expensive than the government could really afford in 1919. To finance them the government borrowed more money and printed more currency. Prices rose by 400% between 1919 and 1920, yet the German government did little to try to stop the rise. Prices did actually stabilize after 1920, partly due to improved exchange rates. Import prices fell by fifty percent. However, the government did not act to stop future price rises. In fact they simply carried on printing more money to pay for the price rises. Between 1920 and 1921 the supply of money increased by fifty percent. At this stage a loaf of bread cost two marks.

The burden of reparations

The shadow of Germany’s defeat in World War One and the reparations demanded by the Allies hung over Germany throughout this period. Under the terms of the Treaty of Versailles (1919) following the end of World War One, Germany was forced to sign a ‘War Guilt clause’ and pay reparations (compensation) for the damage Germany had done to the economies and infrastructure (buildings, communication networks, and utilities) of the Allies. In 1921 the Allies presented the Germans with their demands for payment, a sum of GBP 6.6 billion (132 billion gold marks). Germany was already in financial trouble, and the only way its government could see to pay the reparations was through the printing of more money. Without this bill, the German government may have been able to adopt a more sensible policy and avoid some of the worst effects of the hyperinflation that followed. As the defeated nation, however, the Germans had no way to avoid paying the Allied demands.

Attempts to control inflation in 1922

The impact of reparations on the German economy was catastrophic at a time when social and political upheaval was widespread under Germany’s new democratic constitution. Prices were already rising fast by the start of 1923. The number of items in the shops stayed the same, but there was suddenly more money around to spend on them, so prices started to rise. When the government printed more money to meet the new prices, the price rises began to become astronomical. In the twelve months before January 1923 prices rose to more than 75 times their January 1922 levels. A loaf of bread now cost 450 marks. The German government seemed powerless to stop the inflation. In fact they were making it worse. They tried to support the value of the mark against foreign currencies by buying German marks from abroad. By raising the demand for marks they hoped they would become more valuable and reduce inflation. This was a total failure, and merely led to the Germans spending much of their precious gold and foreign currency reserves to buy worthless German marks. The German government also carried on printing more and more money to meet the demand, which just led to higher price rises. The German government also refused to raise the interest rate for borrowing, which encouraged business people to take out ever larger loans, secure in the knowledge that they would be able to pay them back with worthless currency. This further increased the demand for money and meant more had to be printed. However, at this stage price rises were nowhere near the levels to be seen in 1923.

Franco-Belgian invasion

With rising debts and an increasingly worthless currency, the Germans stopped paying the reparation payments demanded by the Allies. The response of the French and Belgians was to occupy the German industrial region of the Ruhr in January 1923. They intended to get their reparations from the German factories and mines in the form of goods and raw materials. The impact on the German economy was devastating. With the loss of so much industrial production and income the German economy faltered. This alone would have led to higher inflation, but the response of the German government made the situation worse. They organized strikes in the Ruhr, and paid the striking workers’ wages out of government funds. Of course the government had no money, so simply printed more cash to pay the workers. The government employed 300 paper mills 24 hours a day to turn out the currency. As prices rose the denomination of marks on notes was changed. Notes bearing one figure were recalled to have a new figure printed on them. The government believed it had to supply the demands for more cash or the economy would grind to a halt. By October 1923 the government was printing 120,000 trillion marks a day, yet the demand was eight times the production. The response of the government was to further increase production to 500,000 trillion marks. As money became worthless so people stopped using it and began to barter for goods. The economy of Germany seemed to be collapsing, and the government was simply making the problem worse rather than solving it.

Effects on the German people

In 1920 a loaf of bread in Germany cost two marks. By June 1923 when the hyperinflation was in full flow, a loaf of bread in Germany cost 430,000,000,000 marks. Prices rose by the hour. People sitting in bars or coffee shops found that their second drink could cost twice as much as their first. Images of the era include children using piles of banknotes as building blocks or toys, and Germans wallpapering their houses with banknotes [Anyone dying for a room wallpapered with 100 dollar bills? Give it a year, and you might just be in luck.] Workers were paid up to three times a day. The wages would be collected in a wheelbarrow and taken down to the shops to be spent as quickly as possible, before prices rose any further.

Shopkeepers found it almost impossible to make money. Unless they could spend their takings on new supplies immediately, they would be unable to restock their shops with goods. Many shopkeepers simply closed their doors, or opened as little as possible. Goods became hard to come by. Farmers refused to bring their produce to the towns as the money they received was worthless by the time they came to spend it. There were riots in Berlin and other German cities, and some workers organized parties to go to the countryside and steal the farmers’ produce out of the ground. Trade unions bargained with employers for regular wage increases, but these failed to keep pace with rising prices. At first workers believed they were doing well, but this feeling soon disappeared as they struggled to support their families. Those who were reliant on pensions from the government fared very badly. The government failed to raise benefits fast enough to keep up with price rises and pensioners struggled to survive. People with investments in bank accounts saw their value vanish overnight. Any income generated was worthless. Tax receipts for the government stopped, as people realized that they could reduce their taxes to virtually nothing to pay if they waited a few months to pay. With money increasingly worthless, the government lacked the incentive to collect taxes. By October 1923 just one percent of government expenditure was covered by taxes. To make up the shortfall the government simply printed new notes to cover the remaining 99% of expenditure.

Many Germans gained from the hyperinflation. People with property were able to ride out the storm, while those with debts or mortgages saw their value disappear and their debt payments effectively end. Businesses were able to borrow money, spend it on new machinery, and then pay back virtually nothing to the banks. Bankruptcies became almost unknown. In 1913 around 10,000 German firms went out of business due to their debts. In 1923 the figure was less than 200. The speed with which Germans had to spend their money meant that demand in the shops was actually higher than before the period of hyperinflation. In response to this companies employed more workers, and unemployment effectively ended by 1923. Banking jobs, for example, rose from 100,000 in 1913 to 375,000 in 1923. Companies opened new factories to supply the high demands of Germans desperate to part with their cash. The German government also benefited in at least one way. During World War One the government had borrowed vast sums to finance the war effort. As the hyperinflation rose, the government saw its debts being wiped out.

The solution

With Germany on its knees, the government finally acted. A new centre-right government had been established in August 1923 led by Gustav Stresemann, a renowned politician of the liberal right-wing German People’s Party. The German government realized eventually that it would be unable to defeat the French and Belgian invasion, and would have to accept the agreed reparations. Resistance to the French and Belgian forces was abandoned. Reparation payments were restarted, and economic stability was re-established. In November 1923 the government called a halt to new currency issues of marks. A new currency, the Rentenmark, backed by land and property was created. The new government led by Stresemann realized the mistakes made in the past and tried to solve them. Each Rentenmark was exchangeable for one trillion old marks with a limit of 2.4 billion Rentenmarks to be issued. The government also cut its expenditure, partly by sacking around 700,000 employees. However, reparations remained a problem.

In April 1924 the US government brokered a deal with Streseman known as the Dawes Plan, a scheme initiated by US republican politician Charles Dawes to help Germany pay off its enormous war debts. This reduced Germany’s annual payments to more manageable levels, and arranged for the Germans to receive loans of 800 million gold marks from banks and businesses in the USA and Europe. In August 1924 the Rentenmark was replaced with a new Reichsmark of equal value. The new currency had backing from gold so inspired confidence. Taxes were raised and by 1925 the German government actually had a surplus. The Pact of Locarno (1925) settled the frontiers between Germany, France, and Belgium.

Long-term impact on Germany

The hyperinflation of the early 1920s had a negative impact on the democratic stability of the Weimar Republic. Although there was economic recovery from 1924 to 1929 with the assistance of US loans, confidence in the democratic politicians who led Germany was shattered [This will be seen again here in the US]. When the USA demanded its loans back after the Wall Street Crash of 1929, the German economy collapsed again. Much of the middle class, many of whom lost everything in the early 1920s, supported the Nazis after 1929 as they had lost all confidence in the democratic politicians handling of the German economy. The workers of Germany also abandoned the democrats, moving their support to German communism. This collapse of support for democracy was not simply the result of the hyperinflation crisis of the early 1920s, but it had a major impact on the German people. With the second economic collapse after 1929 Germans no longer believed that the politicians who had led them to two economic disasters in the space of ten years were capable of running Germany. The opportunity for extreme political forces to gain power was great, with both communist and fascist parties threatening rebellion. Within four years of the Wall Street crash the destruction of the democratic dream of 1919 was complete and Adolf Hitler’s Nazi state was in place.


My reaction: This well written article summarizes some key points about hyperinflation.

1) Hyperinflation begins, always, with budget deficits. Governments promise more than they can afford, racking up debt. When this accumulation of debt reaches the breaking point, a loss of confidence and currency collapse begins.

2) Instead of keeping budget steady in the face of rising prices, most governments adjust spending upwards to compensate for inflation. This increasing government spending, paid for with printed currency, is what makes price rises become astronomical during hyperinflation.

3) In a currency collapse, the government’s initial reaction is usually to support their currencies. For example, the US is supporting the dollar using currency swaps. These efforts always prove useless, worsening the eventual collapse by squandering resources and racking up foreign debt.

4) During currency collapse, governments also refuse to raise interest rates (because this would make financial system insolvent). These low interest rates are used to speculate against the currency, making hyperinflation worse.

5) Shopkeepers/retailers find it almost impossible to make money during hyperinflation. Rising costs make it impossible to restock shops with goods. With the US’s economy so dependent on retail sector, this is a nightmare waiting to happen.

6) Many people end up gaining from the hyperinflation:

(a) Those with debts or mortgages see their value disappear and their debt payments effectively end.

(b) Businesses were able to borrow money, spend it on new machinery, and then pay back virtually nothing to the banks.

(c) The government’s debts are wiped out.

7) Once the government finally finds the resolve needed to stop the hyperinflation, the steps to stabilize prices are:

(a) Stop printing money and introduce a new currency

(b) Cut expenditure (by laying off hundreds of thousands of government employees)

(c) Renegotiate (or default on) national debt

(d) Raise taxes

8) Hyperinflation shatters confidence in the politicians and political institutions. Even more, hyperinflation undermines faith in democracy itself, which can lead to extremist forms of government (such as facism, et cetera)

Conclusion: Hyperinflation happens because of irresponsibility at the national level. Politicians spend more than the nation can afford, and, when prices start rising, they don’t have the political will to take the steps necessary to stop it.

It will be interesting to see what the long term effects of the dollar’s collapse will have on the US political system. Right now it is too early to tell what those effects will be.

Here are some past entries on hyperinflation:

What life looks like during hyperinflation

What Is Hyperinflation?

Models of Hyperinflation

How Deflation Creates Hyperinflation

The Dynamics of Inflation and Hyperinflation

The Nightmare German Inflation


Bill Totten http://www.ashisuto.co.jp/english/index.html