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Banking: Crisis v2.0

A senior UN economist urges action to save the economy.


Little has been done to fix the problems that triggered meltdown in the global economy in 2007-08. That’s the view of Andrew Mold, a senior development economist with the United Nations. Writing exclusively for the Strategist, he urges governments to make banks serve the economy, not control it.

World AffairsOPINION: It has been more than seven years since the onset of the global financial crisis. Lest it be forgotten, it was the worst such crisis since the Great Depression of the 1930s and threatened to bring down the global economic system. For those who are complacent and believe that the world’s financial crisis has in some way been ‘fixed’, it hasn’t according to a new report.

The 16th Geneva Report on the World Economy reveals some stark facts that have been largely ignored by policymakers. Contrary to widely held beliefs, the world has not yet begun to de-leverage its debt exposure. In fact, global debt to GDP is still growing, breaking new highs. The total burden of world debt, both private and public, rose from 160 per cent of national income in 2001 to almost 200 per cent in 2009. In 2013, the figure had risen again, to 215 per cent.

Whereas the growth of global debt was spearheaded by developed economies until 2008, since then it has been led by emerging economies. In particular, Chinese debt has been increasing at a worrying rate, driven by increases in private household borrowing.

In the same week as the release of the Geneva report, the International Monetary Fund lowered its forecast for global growth, on the back of weak global performance in the first half of 2014. There are particular concerns over growth in the euro area.

What this means

Andrew Mold, economist

Andrew Mold, senior development economist at the United Nations.

The inexorable rise of debt, combined with the slow pace of global growth, is a potential recipe for disaster: it is precisely what causes a lack of confidence in the financial system and in the capacity of countries to pay off their debts.

Such trends should make policymakers everywhere pause and reflect. Arguably, the West’s financial services sector – on which the UK is overly dependent – remains a problem. Reforms to the sector since the crisis broke have been little more than token and it continues many of the bad practices that led to the crisis in the first place.

Banks are still making exorbitant profits and paying out excessive salaries to their kingpins. Moreover, the underlying detonator of the global financial crisis – the proliferation of opaque financial instruments – has not been tackled at all. Under Basel III regulations, banks have been required to improve their capital requirement ratios – something they dislike, but ultimately it has had little impact on high-risk speculative practices.

There is a political dimension to these problems too. Right-of-centre parties worldwide have conflated high debt with reckless public spending, particularly on welfare. In reality, it was the financial crisis itself, caused by systemic failures within banks, that caused debt to explode. We are now living with a combination of constrained public spending, low growth, and still excessive risk-taking by the financial sector: all the ingredients for renewed economic turmoil.

A correct diagnosis of the problem is therefore essential if we are to find the right solutions.

A different mindset

As documented in a report issued by a group of prestigious developmental economists – Be Outraged: There Are Alternatives – the real objective of policymakers should be to transform the financial sector from a bad master to a good servant of the global economic system.

In principle, the financial sector should have two main functions. First, it should serve the needs of the real economy in terms of efficiently providing funds for investment. Second, it should help manage and mitigate risk. Over the last two decades it has done neither.

As a direct result, the global economy is locked in a pattern where economic crises threaten to become more and more frequent as the financial sector becomes further detached from its proper economic function and increasingly tied up with high-risk speculation. [See the Strategist report The Shadow System for more on this.]

The problem is fundamentally political. The financial sector needs to be discouraged from speculative activities where the social risks outweigh possible benefits to the real economy. Banking activities should be regulated so as to separate retail banking from investment banking, as was done in the US in the 1930s with the Glass-Steagall Act.

Through the looking Glass

The 1998 repeal of the Glass-Steagall act sowed the seeds of excessive risk-taking. It allowed the investment banking arms of major national and international banks to take risks with the funds accumulated by its high-street depositors – secure in the knowledge that, should problems arise, governments would be obliged to take action to avoid the collapse of the economy.

On the latter point they were right, as evidenced by the $700 billion bailout rushed through Congress after the collapse of Lehman Brothers. Similar measures were adopted in the UK and elsewhere. This perhaps represented one of the worst examples of moral hazard in human history.

So the banks’ strategy worked, and in a sense it is still working. The quantitative easing that was implemented post-crisis to avoid the collapse of the financial system has profited the banking sector well. With negligible and even negative real interest rates, raising capital has never been cheaper. In a very real sense, parts of the financial sector have become hooked on cheap credit – and the economy cannot survive indefinitely on that. Ultimately, it undermines incentives to accrue savings.

The real question is whether political leaders will have the courage to confront the financial sector with some home truths, or if they will prefer the easier option of allowing business to carry on as usual, with its concomitant risk of a second economic meltdown – one which, this time, they may not be able to forestall. TS

Andrew Mold is Chief of the Sub-Regional Data Centre and Senior Economic Affairs Officer of the Sub-regional Office for Eastern Africa (SRO-EA) of the United Nations Economic Commission for Africa (ECA).



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