More shocks on the way

The disarray – and fear – in ruling class circles over the future prospects for the financial system is growing apace. Far from rescuing the banks, unprecedented levels of state intervention have, according to Mervyn King, Governor of the Bank of England, and others, reinforced existing weaknesses.

King has put himself at odds with the New Labour government, which has poured billions of pounds of taxpayers’ cash down the throats of the banks to no avail. Not only have they failed to resume previous levels of lending, bankers are paying themselves huge sums in bonuses, which for 2009 are up 50% on last year.

So King told Scottish business organisations last night: “The sheer scale of support to the banking sector is breathtaking. In the UK… it is not far short of a trillion (that is, one thousand billion) pounds, close to two-thirds of the annual output of the entire economy. To paraphrase a great wartime leader, never in the field of financial endeavour has so much money been owed by so few to so many. And, one might add, so far with little real reform.”

He went on: “It is hard to see how the existence of institutions that are ‘too important to fail’ is consistent with their being in the private sector.” King has a point, of course. In effect he is saying that the private sector can only function through the capitalist state and that this is not a genuine kind of private enterprise capitalism. He is right there!

Just over two years ago the financial system went critical, highlighted by the panic withdrawal of funds by Northern Rock’s depositors. The combination of the worst financial crisis since the Great Depression and now the longest recession since the Second World War was triggered by a rising rate of defaults on sub-prime mortgages in the US, the weakest point in a worldwide explosion of credit secured against overpriced property.

The world’s governments and central banks were forced into drastic action. They’ve taken some bankrupt institutions into public ownership, provided guarantees against loss for others, and cast trillions into the credit markets. They’ve reduced interest rates to historic lows, effectively entering negative territory. And they’ve created new money to inflate their own balance sheets.

In a wide-ranging comment on King’s speech, Martin Wolf, the Financial Times’ senior columnist accurately assessed the effect of this intervention, and all the half-hearted attempts at regulation. He concludes: “Trying to make financial systems safer has made them more perilous. Today, as a result, neither market discipline nor regulation is effective. There is a danger, therefore, that this rescue will lead to still greater risk-taking and an even worse crisis at some point in the not too distant future.”

King is proposing something different to regulation however. It puts him at odds with the rest of the establishment. His proposal for a separation of traditional banking from investment, high-risk activities is an echo of the American Glass-Steagall Act of 1933. This was a rapid reaction to the banking crisis that swept America after the 1929 stock market crash, in which investment banks played a key role. Glass-Steagall’s restrictions were steadily eroded in the 1980s to allow globalisation to proceed and the law was finally abandoned by the US in 1999.

Both King’s proposals for a return to the pre-globalisation era and Wolf’s assessment show that the crisis is far from over. More shocks are on the way. For example, soaring stock market prices contain little of substance and are essentially a new bubble just waiting to burst while house prices remain artificially high.

The IMF is warning that the global recession is having an adverse effect on commercial property prices and defaults are soaring. Increasing unemployment is also accelerating the rate of repossessions in America and Britain. The conditions for a second wave of the global financial crisis are already present. It wouldn’t take much to touch it off.

Watch this space.

Gerry Gold
Economics editor