Austin Mitchell and Prem Sikka spot a way out of the economic crisis and suggest some measures to ensure it never happens again
BEFORE we can clear up the mess, we need to assess what went wrong. Greed and gambling in the inflated financial sector did the damage, but the lack of effective regulation allowed it to spread out from the badlands of shadow banking. There, the new cowboys – the hedge funds, the private equity capital and the liquidity factories – played with new toys: derivatives. Collateralised debt obligations, “structured investment” vehicles and securitisation meant they prospered enormously.
The practitioners called this a new paradigm. In fact, it was gambling. Former building societies tried to be super banks, lending irresponsibly. They shifted off the balance sheet things they weren’t supposed to do as banks. Executives, paid by profit-related incentives, and chief executives holding jobs for a four-year average, enriched themselves by taking ever-bigger risks with clients’ money. They then sold on the risks in bundles in order to produce even more revenue to take more risks. While regulators dozed, derivatives mushroomed to $1.14 trillion and banks fiddled $5,000 billion off their balance sheets and top salaries rocketed, outstripping the pathetic ability of regulators to keep up and leaving financiers at a loss to put numbers on the extent and scale of their risks.
As long as the funny money-go-round rolled on, all was well. But only on three conditions: weak regulation, government collusion and rising house prices underpinned everything.
Labour’s Financial Services Authority had been devised by Mo Mowlam, but the leadership of Tony Blair and Gordon Brown deserted the party’s old base, manufacturing (which lost a million jobs and declined from 20 per cent to l4 per cent of the economy) and fell in love with finance (which grew to 24 per cent of the economy). What had been seen as a powerful regulator maintaining effective accountancy was emasculated. Labour didn’t want to frighten its new chums.
Credit poured out unchecked. Asset prices rocketed. Consumers spent. It was all a great bubble, leaving rising inequalities and an economy weighed down with debt. Consumer debt, taken on because real earnings weren’t rising in the belief that house prices would go up for ever, leveraged debt for companies and financial debt for banks and institutions (some of which borrowed $60 for every $1 of equity). Everyone was leveraging their own particular opportunities to speculate. Banks exceeded prudential limits, hid things in tax havens and shifted transactions off the balance sheet – just like the Government. Cowboy institutions created candyfloss credit, former building societies dredged ever deeper into the sub-prime market. Credit cards encouraged endless debt shuffling to postpone nemesis.
With the American sub-prime crisis, the bubble burst. British house prices stopped rising. The special purpose vehicles proved unsellable and over-extended institutions dried up credit. Everything swung into reverse as negative equity, repossessions, borrowing famine, share shorting and bank and insurance company collapses replaced euphoria.
Clearly a major part of the answer (Peter Mandelson permitting) must be effective regulation. That means a strengthened FSA with the ability to change and control auditors and require banks and shadow banks to lodge their business plans every year to be vetted and approved. Since all the failed banks had received clean bills of health from their auditors, the FSA will also have to audit financial institutions on a real time basis.
To be fully effective, regulation needs to be international, curbing offshore boltholes, exchanging information and imposing a Tobin tax on derivative and currency transactions – say a tenth of 1 per cent. But the slowness of getting an international agreement can’t be made an excuse for delaying national measures. The crisis is here and now. And we can accomplish what we need on a national basis, if we stand up to finance.
First, we need to boost liquidity with a massive reduction in interest rates, down to America’s 2 per cent level, secured either by Government fiat or by requiring the Bank of England to maximise employment. Next, we must require the Bank to pump out liquidity, not by buying toxic debt, but by providing capital to banks and getting shares and powers in return. Then these must be used to boost manufacturing and production.
Openness and information are essential. So banks must reveal their total assets and liabilities. They must be forced to act as banks, not casinos. Derivative trading is gambling. Gambling tax may not apply, but we can require that all derivatives are registered for a fee and that all new products are tested.
As for the hedge funds, whose greedy gaderine rushes (usually in the same direction) have boosted oil prices and brought down building societies, they must be required not only to register, but also to report regularly on their major investments. Pension funds and similar institutions must be prohibited from facilitating their gains by lending out shares for short-term speculative purposes. Then we can encourage the funds to build schools and hospitals instead of fattening the banks and other middlemen by lush Private Financial Initiative projects.
To stop the gross excesses in executive rewards, top management remuneration (including bonuses and share options) should not be more than 10 times the mean wages of employees in their company. Share options should be held for a minimum period of, say, eight years and golden goodbyes should be proportionate to length of service and no more than double mean redundancy pay in that company. Payments for failure should end and performance bonuses should not be cashable until the outcome of any deals made is on the books and any profits banked.
Levies on corporations making excessive profits, as the banks did in the bonanza and the oil, gas, electricity and water companies are now, is a matter of political will. If Gordon Brown avoids these levies, he should put a ceiling on the profits of utilities whose prices are regulated. These are monopoly profits and low risk. So the Prime Minister should ensure that they are only marginally higher than the yield on Treasury bills.
The Conservatives propose establishing an authority to rule on Government spending and borrowing. That’s irrelevant when inflation requires us to borrow and spend to stimulate the economy. If the state doesn’t borrow, the people must borrow more on worse terms. Government borrowing should be used to compensate the hardest hit with tax cuts and pension increases – say a 10 per cent increase in the state pension (currently 10 per cent of earnings against Europe’s 57 per cent) costing £9 billion. A 10 per cent increase in personal allowances would cost £4.5 billion. That could be paid for by raising the ceiling on National Insurance to bring in £9 billion and introducing a 50 per cent income tax rate on earnings above £100,000. The Government should add in an aggressive attack on the tax avoidance industry, which costs the country more than £100 billion a year. All this would mean more revenue to spend, redistribute and put in the pockets of ordinary people.
In the 1930s, a big house-building programme boosted the economy. Labour now is stymied by the financial difficulties of private builders and the credit squeeze on housing associations. The Government’s obsession with private ownership is partly responsible for the housing disaster. When public housing for rent is not available, prices are driven up and vulnerable groups are forced to buy, leading to sub-prime problems. Compare the experience of Germany, where more housing is for rent, with Britain, where local councils have been stopped from building. The difference is clear. We had a bubble and the Germans didn’t.
Our council housing estates became ghettos of the needy, not the mixed communities they used to be and need to be. Unless these estates are revived, refurbished and expanded, there can be no answer to the problems of child poverty.
As our already low building rate falls, a big boost to building public housing for rent is essential. The Government must end the long squeeze on councils to force them into large-scale voluntary transfers. Instead it must provide proper management and maintenance grants, along with development grants to get councils back to building. Ministers can put private builders back to work building the homes we actually need, rather than speculative housing that won’t sell.
This immediate programme would enjoy mass support, but would be categorised by Conservatives as a shift to the left and a threat to the private sector. However, most of it is what Labour should have done years ago, but didn’t because it loved markets too much. Now the Government is lagging behind in the opinion polls, it must implement this programme quickly and effectively. With only 20 months until the next general election, the alternative is drift and defeat, leading to the destruction of so many of the good things Labour has done.
Austin Mitchell is Labour MP for Great Grimsby and Prem Sikka is professor of accounting at Essex University
