The collapse of Bear Stearns into the arms of the JP Morgan Chase was a seminal moment in economic history. It was not only indicative of how deeply the present “credit crunch” has affected long-time bastions of Wall Street, it was also an indicator of how far and wide the spectre of mistrust has affected the infrastructure of global finance.
Bear Stearns tried to keep the wolf at the door by bluffing; Chief Executive Alan Schwartz said on March 1that “We don’t see any pressure on our liquidity, let alone a liquidity crisis.” However, less than 48 hours later, he was going cap in hand to anyone who could help him.
It is a cliche, however, it is accurate to say that they only have themselves to blame; Bear Stearns heavily invested in financial instruments based on complex mortgage assets. Hence, they had problems approaching fellow banks in obtaining credit; other institutions understandably didn’t trust Bear, as they had no idea how valuable their assets were, given their potential exposure to problems in the sub-prime market.
This ignorance is widespread. One of the most pernicious elements of the sub-prime crisis was how inordinate risk was dispersed and hidden amongst other assets thus making it maddening difficult to untangle the good assets from the bad. Every bit of lending between institutions is done in a context where people are waiting for the other shoe to drop. Trust is a becoming commodity even rarer than credit.
This is a disaster for the titans of finance, for trust is the very foundation of banking, its reason for existence. Banks were founded in the first place as a safer, more trustworthy repository of gold than under one’s mattress. When bank notes were first issued, there was trust that a slip of paper had a particular value backed by precious metal. When loans were issued, there was trust that they would be paid back. When investments were made, there was trust that these funds would be used towards improving businesses.
Without trust, there is no finance. Without finance, there is no modern capitalism. The former “Masters of the Universe” of Tom Wolfe’s parlance are wandering around, blinking in the daylight of realisation, and unsure about what to do next. What will happen in a world that is devoid of the necessary confidence to keep the wheels turning?
Like most economic crises, the present situation has its roots in the extremes of human behaviour. There is something in the human mind that cannot cope with the idea of muddling along: rather, investors clung to the idea that prosperity was forever. The pendulum has since swung back to everything being cast in gloom. The truth has generally been somewhere in between.
These extremes have a consequence, however. In this instance, it has quietly murdered the neo-liberal capitalist order. We are not living in one now: the Federal Reserve and other central banks have been given ultimate responsibility for the economy, not the “invisible hand”. It is the central banks which are expected to prick the bubble of expectation when they become too inflated, and to pick up the pieces when illusions of eternal growth finally shatter. The people who pay the ultimate price are those who carry the weight of bailing out the folly. These are generally not the rich, who have access to accountants and tax lawyers who help them to (quite legally) avoid tax.
Rather, the burden falls on the middle class and the poor to fund these continual bail outs. What makes the present situation even more precarious is that the economy is under pressure from another direction: the ever increasing price of energy is having a knock on effect. In haste, the governments of both the United States and European nations have proclaimed bio-fuel as being the answer to the problem of diminished oil supplies. European regulations on leaving land fallow in order to recover have been ripped up to get as much of this valuable resource as possible. However, there are insufficient amounts of arable land to supply the demand for both fuel and food; the Brazilian answer of hacking down the rainforest to grow more sugarcane is an unappealing and environmentally costly solution.
The rise of inflation, and the absence of cheap food and fuel again hits the middle class and poor most strongly. In Britain alone, it is predicted that a family that had an average shopping bill of £100 per week last year, will see that annual bill rise by £570 in 2008. This is in an era in which supposedly the central banks have defeated inflation and achieved solid, year on year growth.
It gets worse: while in the West, there is a standard of living that would be incomprehensible to generations past, we find that at the same time, countries in the developing world cannot follow the same path. Their achievement the same level of consumption would only exacerbate the steep rise in
prices, and secondly, increase carbon emissions required to achieve the necessary economic output.
All in all, the picture is a very bleak one. We might wonder at the results of our cycles of extravagance and penury, trust and deceit. And again, it all leads back to the question: where do we go from here?
Where we go from here has to begin with a realistic assessment of how the world presently runs. First and foremost, with certain exceptions, there is very little appreciation for the long term. The requirements of shareholder capitalism and releasing of quarterly results mean that few firms are interested in six months down the road, let alone years from now. The incentives are structured in such a manner that one is inclined to grab as much as possible as quickly as possible, and leave the long term planning to someone else, even in a scenario where there is no someone else to make such decisions.
Second, there is no understanding of limitations. Massive economic growth cannot be maintained forever in circumstances where resources are finite. Even if a way is found out of the present commodities impasse, there is no way to get something for nothing: sooner or later, humanity will run into the obstacle that we inhabit one planet, and there is a limit to what can be extracted from it.
Third, we have to accept that democratic nations find it extremely difficult to make painful decisions. Politicians try to please the electorate rather than confront them with hard choices; for far too long, the electorate has been kept apart from the process, swaddled in the cotton wool of idle promises. In order to stave off pain, politicians borrow and divert resources, in the belief that they will be long gone once the final cheque comes due.
However, it looks as if the world is teetering on the edge of a reckoning. For example, the lack of preparation, the ignorance of limitations, and an inability to make painful decisions is particularly acute in Britain: the present Labour government did not use years of robust economic growth to shore up its financial position, it believed it could continue to operate in a scenario of limitless prosperity, and it has avoided making painful choices about where resources are best applied and how. The middle class and poor are paying the price, and getting no return on this investment.
Perhaps this is where the answer to the present scenario begins: the central banks are proposing and enacting massive bailouts of leading financial institutions. However, those who are actually paying for it are not receiving a share in the enterprises which have been rescued. Responsibility without power is the predicament of a eunuch.
The public should no longer be emasculated; at the very least, the governments and central banks should be giving shareholder certificates in any company that is rescued to the taxpayers. The amount of certificates received should be in direct proportion to percentage of income received by the state; thus those who specialise in tax avoidance should not disproportionally benefit merely because their contribution is more in absolute monetary terms. These shares should enable the taxpayers to have a voice in the decision making of these firms, and get a return on the investment made.
This alteration in the economic order should be augmented by a new kind of politics: “participatory democracy” naturally follows “participatory economics”. If politicians are not brave enough to set out the difficult choices because of their desire to maintain power, then decision making will need to be devolved to the most basic level. Hitherto, because of the somewhat tedious and arcane nature of politics, the public has been content to allow decision making to rest at the apex of a hierarchical pyramid. However, the present atmosphere of mistrust of politicians creates ideal conditions for pushing decision making to as close as the individual citizen as possible.
An emphasis on locality and pro-active citizenship could have the beneficial effect of framing debates in a way that shows that hard choices are inevitable, and that limits will have to be observed. These boundaries will have to be observed anyway: as Ayn Rand put it, “one can ignore the consequences of reality, but one cannot ignore the consequences of ignoring reality.”
As for the developing world, this is their chance to observe that if they continue to follow in the same path of development as the West, they will eventually reach the same impasse. While a certain level of scepticism has to be attached to the idea of others learning from history, the limitations on commodities necessary for further development will act as a spur towards this awakening.
Overall, however, the answer can be summarised in two rather dull words: thrift and accountability. Thrift and its synonyms frugality and parsimoniousness are neither pleasant nor fun words. The thought of being answerable for one’s actions tends to make one cringe. The idea of parcelling out resources intelligently, being cautious and responsible has very little appeal to people who want to buy an SUV, fly off to Ibiza for the weekend or “need” to buy several new pairs of shoes every two months. It is more akin to the grey necessities of rationing during wartime. However, if we are to maintain a decent standard of living, and if others are to achieve it, our lives need to be conducted within the confines of what we know will not lead to disaster in the medium to long term. It’s time to stop living just for today and to stop rising and falling with each tick of the stock market. It’s time to step up from the world as it is, to the world as it should be, not in a utopian sense, but in an anti-utopian sense, whereby a belief in uninterrupted prosperity is ditched, as such a belief always ends in tears. The question is, are we adult enough as a species to understand this? Can we conquer our own need to believe in illusions? If this present crisis doesn’t achieve this, perhaps nothing will.