Economic deja vu

UK Chancellor of the Exchequer, George Osborne, claimed this week that austerity is working and that emergent signs of recovery validate the government's economic policies. Contrast this claim with the reality for the majority of the population and the continuing distortions in the global financial system. Inflation for most people is very different from the headline Consumer Price Index (CPI) and Retail Price Index (RPI). For many, the price of food has doubled in the last two and a half years while energy costs have soared.

Last month Daily Pickings referred to the Plutonomy, a term coined by Citibank in three research papers a few years ago. Essentially, averages are meaningless in some economies (like the US and UK) - a shrinking minority are getting richer while a growing number are getting poorer and suffering greater hardship.

Meanwhile, all the distortions in global finance which led to the "credit crunch" in 2008 not only still persist but in many respects have got worse, as reported by Gillian Tett in the Financial Times this week.

Insane financial system lives post-Lehman By Gillian Tett

There are at least six peculiar features that might make Alice blink

Five years ago, the markets plunged into an Alice-in-Wonderland world. For when Lehman Brothers collapsed, the repercussions were so violent investors were faced with confronting “six impossible things before breakfast” each day, to paraphrase Lewis Carroll.

So, as markets mark the anniversary of that Lehman collapse, is the system any safer or saner? The answer is both Yes and No. The good news is that the chance of another full-blown banking crisis has receded: some of the crazier innovations have been reined in, banks are better capitalised and financiers more cautious.

But the bad news is that the system is just as insane – perhaps more so. There are a host of developments that are at best counterintuitive, and at worst dangerously bizarre. Investors may no longer face six new banking shocks before breakfast, but there are at least six peculiar features of the post-Lehman world that might make Alice blink.

● The big banks are bigger – not smaller. When Lehman collapsed, there was outrage over the fact that many western banks had become so enormous they were “too big to fail”, creating concentrations of risk. Reformers called for banks to be broken up, to make them smaller and create badly needed diversity. Some financial officials, such as Richard Fisher of the Dallas Fed, continue to demand this sensible step. But, as the investor Henry Kaufman points out, the banking world, especially in the US, has become more concentrated than ever. That is unnerving, particularly since no one knows how regulators would ever shut down a really big bank.

● The shadow banking world is taking over more activity, not less. When Lehman failed, regulators suddenly realised they had been ignoring the non-bank sphere, enabling egregious behaviour to flourish. Given that, you might have expected those shadows to shrink. But think again: it has expanded since 2008 from $59tn in size to $67tn, according to the Financial Stability Board. And it is likely to swell further, because tighter bank regulations are pushing more and more activity into the non-bank world. The FSB insists it has become better at monitoring these shadows; we had all better hope it is right.

● The system depends more than ever on investor faith in central banks. One issue that caused the last credit bubble was excessive investor trust in the abilities of central bankers, both to keep inflation low and understand how financial innovation worked. Logic might suggest this blind faith should have wilted after Lehman Brothers failed. Not so; these days all manner of asset prices are now being propped up by a sunny investor belief that central bankers know what they are doing with quantitative easing; even though nobody has tried it on this scale before, or knows how to exit.

● The rich have become richer. The Lehman Brothers crisis triggered a surge of popular anger against wealthy elites; hence the rise of the Tea Party, Occupy Wall Street and other protest groups. But that has not caused elites to lose wealth. On the contrary, one (largely unacknowledged) consequence of QE is that this has raised asset prices and thus benefited the asset-rich wealthy elite, widening inequalities. The Bank of England, for example, calculates that 40 per cent of the QE benefit has gone to the top 5 per cent, including those bankers.

● Financiers have been prosecuted – but not for the credit bubble. After the Lehman collapse, politicians demanded banker prosecutions, and initially this seemed likely to occur. After all, almost 2,000 financial professionals were convicted following the 1990s savings and loans crisis in the US. But while senior financiers have been hauled off in handcuffs since 2008, this has generally not been due to credit bubble issues (think, for example, about Bernie Madoff, Alan Stanford, Raj Rajaratnam, Rajat Gupta and so on).

● Fannie and Freddie are alive and well. Back in 2008, it seemed self-evident that the rotten entities of Fannie Mae and Freddie Mac were overdue for reform; indeed, it was a crisis in those state-backed housing finance agencies in August 2008 that started the chain of events leading to the Lehman shock. But five years later, Fannie and Freddie are more entrenched than ever, accounting for more than 90 per cent of the US mortgage market, up from 60 per cent before.

An optimist might argue these six factors are just temporary distortions; some observers might insist they were inevitable. Housing would have suffered badly without Fannie and Freddie underwriting the mortgage market, for example. But if nothing else, these issues are a potent illustration of the law of unintended consequences, and a powerful reminder of the vast amount of work still to be done before we have a financial world that looks both sane and safe. 

Hat tip to Tom for this


Fuel is being poured on to global bond markets. Toby Birch uses the analogy of the game "Buckaroo" to describe how artificially low interest rates and market manipulation by central banks will end in tears.

Bond Market Buckaroo by Toby Birch

Many leaders are tentatively declaring the end of the recession but readers should be wary of the pitfalls ahead. Just as endless credit creation by the banking system pumped up the property market in the past, so the vast issuance of government debt has fostered a superficial aura of prosperity in the present.


And if you thought anything was learned from the sub-prime mortgage crisis which led to $trillions in bank bailouts, bank support and bank losses, the architects of the last crisis are back in business:

Subprime lending execs back in business five years after crash By Daniel Wagner

After the Meltdown: Part two in our series looking at the impact of the financial crisis of 2008

Hat tip to Maggie for this

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