The media has been giving a lot of attention in the last week to the 10-year anniversary of the Lehman Brothers crash which occurred on September 15, 2008 and marked the realisation, after months of denial, that there was a financial crisis underway. Lots of articles have been published recently about what we have learned from this historical episode. I thought that the Rolling Stone article by Matt Taibbi (September 13, 2018) – Ten Years After the Crash, We’ve Learned Nothing – pretty much summed it up. We have learned very little. Commentators still construct the crisis as a sovereign debt problem and demand that governments reduce fiscal deficits to give them ‘space’ to defend the economy in the next crisis. They are also noting that the balance sheets of the non-government sector components – households and firms – are looking rather precarious. They also tie that in with flat wages growth and a run down in household saving. But the link between the fiscal data and the non-government borrowing data is never made. So we are moving headlong into the next crisis with very little understanding of the relationship between government and non-government. And we are increasingly relying on private sector debt buildup to fund growth as governments retreat. Everything about that is wrong.
The recently published book – Financial Exposure: Carl Levin’s Senate Investigations into Finance and Tax Abuse (Palgrave Macmillan) by Elise J. Bean is worth reading. Elise Bean was an investigative lawyer for the US Senate Permanent Subcommittee on Investigations (PSI).
The book recounts the workings of the PSI.
We read that the PSI has:
… faced down corrupt bankers, arrogant executives, and sleazy lawyers. We’d confronted tax dodgers of all stripes, from billionaires to multinationals. We’d interviewed crooks in prison, North Korean representatives, and tax have operatives. We’d protected whistleblowers, championed victims, and defended honest government employees battling abuses. We’d stood up to dirty tricks, assaults on PSI’s bipartisanship, and attacks on our bosses.
Never was this environment more loaded than when they started looking into the financial services sector.
The chapter on “Deconstructing the Financial Crisis” is particularly interesting, given the current attention the decade-anniversary is receiving.
Elise Bean writes that the investigation was “the longest, toughest inquiry” the PSI under Carl Levin had ever undertaken.
The “facts were tangled, the players powerful, and the stakes huge”.
She credits the legislative action that led to the “Dodd-Frank Act, the most extensive set of U.S. financial reforms in a generation” as the results of their investigation.
The book leaves no doubt as to what caused the GFC – and the train wreck of Lehmans and others had been gathering pace for a few decades as a result of the neoliberal-inspired deregulation and reduced oversight (mostly due to regulative capture).
The crisis saw governments offer trillions to the otherwise failed big banks and related institutions to keep them alive. Those bailouts have had long-term consequences that Matt Taibbi documents.
1. “a radical transformation of the economy”.
2. “Previously, small banks traditionally enjoyed a lending advantage because of their on-the-ground relationships with local businesses. But the effective merger of the state with giant, too-big-to-fail banks has tilted the advantage far in the other direction.”
3. “Big banks post-2008 could now borrow much more cheaply than smaller ones, because lenders no longer worried about them going out of business.”
4. “How much of the record $171.3 billion in profits earned by banks in 2017 was owed to the implicit guarantee?”
5. “The bank-state merger brokered 10 years ago this week socialized the risks of the financial sector, and essentially converted Wall Street into a vehicle for annually privatizing a big chunk of America’s GDP into the hands of a few executives.”
And so on.
But if we thought there might be a change in behaviour afterwards (for example, because of Dodd-Frank) we would be wrong.
The scandals have keep coming.
1. The 2010 “flash crash” of the New York Stock Exchange as a result of some rogue traders on Chicago’s derivatives exchange – see The 2010 ‘flash crash’: how it unfolded.
2. The LIBOR scandal – see Libor scandal: the bankers who fixed the world’s most important number rigging HSBC’s $850 million drug money-laundering fiasco
3. HSBC getting caught laundering drug money from Mexico, among other criminal acts – see – HSBC to pay $1.9 billion U.S. fine in money-laundering case
4. Australian readers who have been following the Royal Commission into the financial services sector will be able to catalogue a sequence of criminal acts by bankers, insurance companies etc. Charging fees for no service, cheating customers, etc.
I saw a Tweet last week listing the top 10 financial market players who had gone to prison for their criminal conduct.
The list looked like this (first three only):
In other words, no-one went to prison for their criminal behaviour.
In the recent German TV series, Bad Banks, the major character tells her boss who is about to go down for criminal behaviour that no-one at his level goes to prison.
Matt Taibbi lists other legacy issues arising from the lax way governments dealt with the crisis.
1. “we made Too Big To Fail worse by making the companies even bigger and more dangerous”.
2. “The people responsible for the crisis weren’t just saved, but made beneficiaries of another decade of massive unearned profits”.
I was reading Elise Bean’s book around the same time I was alerted to an Irish Times article (September 13, 2018) – Trader blows €100m hole in Nasdaq’s Nordic power market – which reported that one of the highest earning Norwegian financial market trader had just severely compromised the “stability fund that ensures the safety of derivatives trading in European electricity markets.”
This character was betting on “European power markets” and:
… saw his positions collapse on Monday after extreme market moves in German and Nordic energy markets … [he] … had defaulted on Tuesday after they were unable to meet margin calls at its clearing house on loss-making trades … [he] … blew through several layers of safeguards designed to protect it from such losses …
The size of the loss also ate up about two-thirds of a separate €166 million mutual default fund members must contribute to …
And “some of the biggest banks and energy traders such as Morgan Stanley, UBS and Equinor, Norway’s state oil company” will have to make up the losses to the clearing house.
Power is an essential service to communities. Yet, we still allow the financial market casino to bet on it and compromise the stability of the financial system as a consequence.
Enron went bankrupt in 2001.
Australia had power cuts in 2017 because the financial arms of the privatised (previously state-owned) energy companies arranged for generating capacity to be turned off so they could profit on the spikes in the energy prices.
And so it goes.
And one of the most powerful narrative that still remains is somehow that governments have to pursue fiscal surpluses to safeguard our financial system – to give them the ammunition to defend the economy from meltdown.
Just this week, economists are coming out claiming there is no government capacity ‘left’ to prevent another crisis.
Remember Martin Feldstein’s appearance in the investigative movie – Inside Job – which the Director Charles Ferguson said was about “the systemic corruption of the United States by the financial services industry and the consequences of that systemic corruption.”
As a reminder, I considered his qualification to comment on macroeconomics in this blog post – Martin Feldstein should be ignored (May 3, 2011).
Feldstein, a Harvard economics professor, was a board member of AIG, which was paying massive fees in that role. He was also a board member of the subsidiary company that made all the credit default swaps that bankrupted AIG.
His appearance on the Inside Job was a classic example of the disgraceful hubris that the mainstream of my profession exuded then, and now.
He recently wrote a Wall Street Journal article (June 10, 2018) – The Fed Can’t Save Jobs From AI and Robots – which ran the line that Artificial Intelligence and Robots will create mass unemployment in the US (millions will become unemployed as a consequence) but the central bank should not deviate from maintaining low inflation.
His solution is that government should further deregulate the labour market (cut wages) rather than try to engage in demand stimulus to generate higher labour demand.
In an article published today (September 17, 2018) in the UK Daily Telegraph (but syndicated to Fairfax) – ‘We don’t have any strategy to deal with it’: experts warn next recession could rival the Great Depression – Feldstein is quoted as saying:
We have no ability to turn the economy around … When the next recession comes, it is going to be deeper and last longer than in the past. We don’t have any strategy to deal with it … Fiscal deficits are heading for $US1 trillion dollars and the debt ratio is already twice as high as a decade ago, so there is little room for fiscal expansion.
Of course, none of this Feldstein nonsense is remotely correct.
As I explained in these blog posts – There is no financial crisis so deep that cannot be dealt with by public spending – still! (October 11, 2010) and The government has all the tools it needs, anytime, to resist recession (August 20, 2016) – a currency-issuing government can always attenuate the impacts of a financial crisis that has its origins in a non-government spending collapse.
This capacity is independent of what policy positions the same government has run prior to the crisis. Any notion that a running a deficit now (of any scale) in some way reduces the capacity to run a similar scale deficit in the future is plain wrong.
There is not even a nuance that we can bring to that proposition – a conditionality. Plain wrong is plain wrong.
When Feldstein is saying that “there is little room for fiscal expansion” he is just rehearsing the fake knowledge of the mainstream economists who define fiscal space in circular terms.
Sort of like this:
1. Fiscal expansion can only occur if deficits and debt ratios are low.
2. Currently deficits and debt ratios are higher than they were at some point in the past.
3. Therefore we have run out of fiscal space.
A circular, self-referencing proposition. Which begins wrongly and thus concludes wrongly.
If there is a new crisis, then there will be massive fiscal space which will be defined by the idle resources in the non-government sector that have become unemployed because non-government spending collapses.
That is the only way in which we can talk about ‘fiscal space’. If there are productive resources that are idle and available to be brought back into productive use, then there is fiscal space.
The fact is that there is no crisis large enough that the government through appropriate fiscal policy implementation cannot respond to.
There is no non-government spending collapse big enough that the government cannot maintain full employment through appropriate fiscal policy implementation.
A currency-issuing government can always use that capacity to buy whatever idle resources there are for sale in the currency it issues, and that includes all idle labour.
A currency-issuing government always chooses what the unemployment rate will be in their nation.
If there is mass unemployment (higher than frictional – what you would expect as people move between jobs in any week), then the government’s net spending (its deficit is too low or surplus too high).
I explain the so-called helicopter money option in this blog (also cited above) – Keep the helicopters on their pads and just spend (December 20, 2012).
By way of summary (although I urge you to read that blog post if you are uncertain):
1. Introducing new spending capacity into the economy will always stimulate demand and real output and, as long as there is excess productive capacity, will not constitute an inflation threat.
2. When there is weak non-government spending, relative to total productive capacity (and unemployment) then that spending capacity has to come from government.
3. The government can always put the brakes on when the economy approaches the inflation threshold.
4. A currency-issuing governments does not have to issue debt to match any spending in excess of its tax receipts (that is, to match its deficit) with debt-issuance. That is a hangover from the fixed-exchange rate, convertible currency era that collapsed in August 1971.
5. Quantitative easing where the central bank exchanges bank reserves for a government bond – is just a financial asset swap – between the government and non-government sector. The only way it can impact positively on aggregate demand is if the lower interest rates it brings in the maturity range of the bond being bought stimulates private borrowing and spending.
6. But non-government borrowing is a function of aggregate demand itself (and expectations of where demand is heading). When elevated levels of unemployment persist and there are widespread firm failures, borrowers will be scarce, irrespective of lower interest rates.
7. Moreover, bank lending is not constrained by available reserves. QE was based on the false belief that banks would lend if they had more reserves.
8. Governments always spend in the same way – by issuing cheques or crediting relevant bank accounts. There is no such thing as spending by ‘printing money’ as opposed to spending ‘by raising tax receipts or issuing debt’. Irrespective of these other operations, spending occurs in the same way every day.
9. A sovereign government is never revenue constrained because it is the monopoly issuer of the currency.
10. If the government didn’t issue debt to match their deficit, then like all government spending, the Treasury would credit the reserve accounts held by the commercial bank at the central bank. The commercial bank in question would be where the target of the spending had an account. So the commercial bank’s assets rise and its liabilities also increase because a deposit would be made.
11. Taxation does the opposite – commercial bank assets fall and liabilities also fall because deposits are reduced. Further, the payee of the tax has decreased financial assets (bank deposit) and declining net worth (a liability/equity entry on their balance sheet).
12. A central bank can always credit bank accounts on behalf of the treasury department and facilitate government spending. This is the so-called ‘central bank financing’ option in textbooks (that is, ‘helicopter money’). It is a misnomer.
And the point is that all this talk of sovereign debt crises and the central bank running out of firepower is actually raising the probability of a renewed financial crisis emanating from the non-government sector, which is clearly, despite all the myths that have been told, was the source of the GFC.
Household debt at elevated levels in Australia
In recent weeks, there has been more discussion about the elevated levels of household debt in Australia.
Last week (September 10, 2018), the Assistant Governor of the Reserve Bank of Australia gave a speech to a business group – The Evolution of Household Sector Risks – where she noted that with low interest rates and lax lending conditions household debt-to-income ratios have risen in many developed nations over the last 3 decades.
Australia is now in the “top quarter of the sample” of developed countries.
She said there were two vulnerabilities as a result:
1. “any difficulties in the residential mortgage market could translate to credit quality issues for banks … the Australian banking system is potentially very exposed to a decline in credit quality of outstanding mortgages.”
2. “if there were an adverse shock to the economy, households could find themselves struggling to meet the repayments on these high levels of debt … If they have little savings, they might need to reduce consumption in order to meet loan repayments or, more extreme, sell their houses or default on their loans.”
Both of these are obvious and get forgotten in the mad rush to borrow.
I considered this issue, in part, in this recent blog post – Reliance on household debt and a lazy corporate sector – a recipe for disaster (September 6, 2018).
That blog post noted that corporate profits are booming, private capital formation is flat, wages growth is flat and consumption expenditure is being driven by a falling saving ratio and rising household debt levels.
The ratio of household debt in Australia to annualised household disposable income is now at record levels – each month a new record is established.
The following graph shows the ratio from 1988 (the beginning of the series) to the March-quarter 2018 (latest).
In June 1988, the ratio was 63.2 per cent. It peaked at 171 per cent in the June-quarter 2007, just before the GFC emerged.
It stabilised for a while as the fear of unemployment and the economic slowdown curbed credit growth for a while. But that didn’t last.
Over the last two years it has accelerated considerably and now stands at 190 per cent. The housing component of that total debt position has also been rising and now stands at 140 per cent of disposable income. At the turn of the century (March-quarter 2000), the ration was 66.8 per cent.
The shaded area denotes the period the federal government ran fiscal surpluses (10 out of 11 years) and during that period the financial sector ran amok with the lack of supervisory oversight, courtesy of the dominant neoliberal ideology.
The position of Australian households, carrying record levels of debt, is made more precarious by the record low wages growth and the conduct of the private banks.
Please read my blog post – Australia’s household debt problem is not new – it is a neo-liberal product – for more discussion on this point.
The problem, now, is that the real estate market is starting to cool, fairly quickly in Australia.
The Australian Bureau of Statistics published the latest data for – Housing Finance, Australia, July 2018 – recently (September 7, 2018), which showed that both owner-occupied financing and investment dwelling financing has fallen away quite sharply in recent months.
Indeed, total housing finance growth (net of refinancing of owner-occupied housing) has been negative in all months bar one since December 2017.
Most of the decline is in the investment dwelling financing as the Australian Prudential Regulation Authority forced tighter lending standards onto financial institutions.
This Press Release (April 26, 2018) – APRA announces plans to remove investor lending benchmark and embed better practices – explains how the regulator sought to tighten lending in the speculative section of the housing market.
It illustrates that governments can modify speculative housing bubbles if they want to.
And the next graph indicates why the conversation about household debt is finally ramping up. It shows the annual growth in residential property prices (weighted average of the eight capital cities) from the September-quarter 2004 to the March-quarter 2018.
Housing prices are falling towards zero and it is expected they will cross that line in the June-quarter.
With the recent national accounts data showing the household saving ratio is now down to 1 per cent and heading back to pre-GFC negative territory and flat wages growth, the vulnerability of households to changes in economic conditions is massive.
Add into that the decline in housing prices, which underpin the record levels of debt and you have a recipe for a disaster.
All of this is in the context of a federal government that is projecting a return to fiscal surplus in the not too distant future, which is further squeezing households.
That is the part of this discussion that is lost in the mainstream media.
A government surplus is exactly equal to the non-government deficit.
Taking more out of the expenditure and income generating stream (via taxation) than is being put in (by government spending) forces the non-government sector into a state of liquidity squeeze.
It can maintain expenditure growth for a time by running down saving (as it is) and increasing borrowing (as it is).
But that cannot last, especially as the growth in asset values that have driven the debt start to taper off.
But as long as the financial press doesn’t make the link between what is going in the fiscal space with what is going on with respect to non-government debt and asset prices we will see this dichotomised discussion.
The right-wingers will rave on about public debt and the evils of deficits.
The others will rave on about the dangers of household debt.
Neither will realise or articulate the idea that to provide some security to the non-government sector, it is likely that the government sector will have to run continuous fiscal deficits.
That is enough for today!
(c) Copyright 2018 William Mitchell. All Rights Reserved.