After the Northern Rock crumble, neo-liberal agenda begins to unravel
The really big question about Northern Rock is still not being asked. It’s not just about £25bn loans and £30bn guarantees from the taxpayer and how they can be redeemed, nor even about whether temporary public ownership at the outset would have been a better solution. It’s about what caused this systemic failure in international financial markets, and how it must now be put right.
Northern Rock’s specialty had been its use of well-stocked wholesale markets to fund its huge expansion in mortgage lending, and then using the same markets to offload dodgy loans which had been worryingly granted to borrowers even at a 6:1 debt-to-income ratio. The mortgage loans were sold off in exchange for a lump sum via complex financial investments such as structured investment vehicles (SIVs) and collateralised debt obligations (CDOs) – a process known as securitisation. The scale and intensity with which Northern Rock pursued this strategy turned it from being less a conventional bank than an SIV itself, selling its loans forward through its Granite offshore operation. The plan failed when the commercial markets on which it depended for its funds dried up in the credit crunch induced by the US sub-prime housing market collapse.
There are several aspects of this saga which show how systematic the breakdown of financial market operations has now become. First, the new exotic securities in bonds and derivatives were generated because they offered the prospect of turning property lending, previously seen as a long-term business, into a short-term business with instant profits. Instead of waiting 20-25 years to recoup the loans, SIVs enabled banks to regain their funds straightaway so that they could lend them out again and make even more money. This process was repeated endlessly, with hedge funds, pension funds and insurance companies joining in frenzied rounds of buying and selling re-bundled mortgages, and thus widening the repercussions of the crisis when it finally broke.
Second, SIVs and the labyrinthine CDO pooling structures which contained them were not understood even by those who dealt in them, and perhaps were devised precisely with that intent. Repeated repackagings left what were always complex instruments bearing little or no value comparable with the original asset taken as collateral. Moreover many SIVs have been set in offshore havens with a reputation for secrecy and light controls. Yet no regulatory agency demanded transparency and no auditor condemned the securitisation process on the grounds that it confounded the valuation of risk.
The crisis has also exposed the financial industry’s relentless drive for quick profits, irrespective of long-term security, in an environment woefully lacking in public accountability. Speculation has been carried to new heights without apparently any thought as to how newfangled complex instruments might fail. The present dominant enterprise culture locks remuneration for chief executives, directors, markets and investors to short-term gains and creates perverse incentives for reckless behaviour. The rewards of Northern Rock’s directors over the last five years are a case in point: the £30 millions they made in salaries, share incentives and bonuses were profit-driven, though the losses are now accruing to the taxpayer.
This crisis is not, as some have sought to make out, a temporary glitch which can be got over as soon as a satisfactory buyer can be found for Northern Rock. The monumental scale of the losses, present and future, belies that. Bernanke, the chairman of the US Fed, has already estimated the losses from bad mortgage loans at $150bn, and that may grow given that a staggering $1.3 trillions of sub-prime loans were set up in the two years to 2006, of which nearly half may be unrecoverable. In the UK, HSBC has already announced losses from its sub-prime business of nearly £1bn, and other British banks have yet to make clear their write-downs which must foretell a tightening of credit. When the British economy has long been kept afloat by easy credit – mortgage and credit card debt now amounting to some £1.35 trillions, greater than the country’s entire GNP – the knock-on effects of this crisis will stretch far beyond the perpetrators in the financial sector.
Finally, as the enumeration of actual and potential losses reveals, the de-regulatory, light-touch, unfettered markets regime that underpins the neo-liberal ideology that has dominated the international economy since the 1980s has sustained a severe reverse from which it will take long to recover, if ever. It may be seen as a repetition, writ even larger, of the secondary banking crisis of 1974. The lessons of that have clearly not been learnt, and have now returned with a vengeance – lack of prudential controls, regulatory capture, obscure accounting, absence of auditor independence, and an economic elite driven by reckless short-term profit-making at the expense of the taxpayers who have to bail them out.
No doubt intense lobbying from the City, the dominant arm of today’s financial capitalism, will exert every sinew to minimise reform. But the risk downsides of unregulated markets have now been shown to be far too great, and it is clear the market cannot of itself establish the necessary supervision. Investors in loan-backed securities have not sought tougher monitoring because they were captured by the allure of the yields on offer, which Alan Greenspan has compared to cocaine abuse. Auditors have been only too happy to offer a clean bill of health to companies in which they may have an interest. The Financial Services Authority, it has emerged, does not have inspectors dedicated to the regulation of banks or to monitor potentially worrying investments or to test financial products against risk of serious public detriment.
In view of this systemic failure in the financial sector and its kickback across the whole economy, what is now needed is a Committee of Inquiry into the governance, accounting and auditing of the banks. This should investigate offshore structures, complex derivatives, the lack of accounting transparency, and the overriding need to align commercial incentives with public accountability. Otherwise the same problems will recur again, only with the adverse consequences ratcheted up still further.
This article appeared in The Tribune on 29 February 2008.