Michael Meacher - Labour's Future

THE biggest question about Northern Rock is still not being asked. It’s not just about billions in loans and in guarantees from British taxpayers and how they can be redeemed. It’s not 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 cam now be put right.

The breakdown of financial market operations has become systematic. 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 one with instant profits. Instead of waiting up to 25 years to recoup the loans, “structured investment vehicles” 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. SIVs and the labyrinthine “collateralised debt obligations” – the pooling structures which contained them – were not understood even by those who dealt in them. 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 financial havens with a reputation for secrecy and light controls. In fact, 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. 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 past five years are a case in point: the £30 million they made in salaries, share incentives and bonuses were profit-driven, although the losses are now accruing to the taxpayer. This crisis is not a temporary glitch which can be got over as soon as a satisfactory buyer for Northern Rock can be found. The monumental scale of the losses – present and future – belies that.

Ben Bernanke, the chairman of the United States Federal Reserve, has already estimated the losses from bad mortgage loans at $150 billion. And that may grow, given that a staggering $1.3 trillion of sub-prime loans were set up in the two years to 2006 – of which nearly half may be unrecoverable.

In Britain, HSBC has already announced losses from its sub-prime business of nearly £1 billion, while 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 trillion, which is greater than the country’s entire gross national product – the knock-on effects of this crisis will stretch far beyond the perpetrators in the financial sector.

As the enumeration of actual and potential losses reveals, the deregulatory, light-touch markets regime underpinning the neo-liberal ideology that has dominated the international economy since the 1980s has sustained a severe reverse from which it will take a very long time to recover – if it ever does. This may be seen as a repetition of the secondary banking crisis of 1974. The lessons of that time have clearly not been learned and an economic crisis has 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.

The risks of unregulated markets have now been shown to be far too great and it is clear the market on its own cannot 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, the former chairman of the US Federal Reserve, 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 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 worse.