The Troika, the US Hedge Funds and the Diversion of Taxpayers' Money

A guest post by Stephan Lindner

Do you remember John Paulson? In 2007 he became famous for having the highest income of all hedge fund managers on Wall Street, because he bet against the US housing market. Not all of his deals were fair, to say it politely. Later the SEC investigated a deal called ABACUS 2007-AC1, for which Paulson told Goldman Sachs to create a CDO with bad subprime mortgages, so that he could bet against it. Goldman Sachs agreed 2010 to pay $550 million to settle with the SEC and a former vice president of Goldman Sachs, who was responsible for the deal inside of Goldman Sachs was found liable for fraud in front of a jury. With that single deal Paulson earned around $1 billion and never had to justify himself in front of a court. And now he tells the whole world, that he owns shares in two Greek banks, Piraeus Bank and Alpha bank. Reuters cites from a statement: ‘They have good management and we think the Greek economy is improving, which should benefit the banking sector.'


What does this management looks like? In Greece after the haircut the banks are more or less bankrupt and need to be recapitalized. Officially they are solvent thanks to the $50bn. they received from the troika, but most experts still estimate that the non-performing loans are still higher than the injected capital. Normally nobody would like to give capital to such banks. Here is the explanation the owner of Piraeus bank found for this situation: Reuters reported in summer 2012, that he used credit in his own bank to buy shares of his bank (read the full story here). In this New York Times article from June you can read even more of what the president of Piraeus bank did to make his bank grow during the crisis to become the biggest bank in Greece:


If you think you get into trouble if someone finds out about such business practices, you are wrong. Mr Salinas is still the President of Piraeus bank and the Greek Central Bank, which investigated all allegations, could find no evidence of wrongdoing. And they have the ideal informant: the president of the Greek central bank is a former vice president of Piraeus bank. So what happens to people who report about such practices in Greece? It isn’t pretty.

We might also ask how the troika did everything possible to make the buying shares of Greek banks as lucrative as possible? For each Euro someone invests in banks like Piraeus the troika pays an additional nine Euros, and if the share price aises to a certain level, the investor gets the right to buy this additional 90 per cent of shares, not for the then actual much higher price, but for the low price at which they made their first investment. Hurrah for the troika for making such lucrative deals with taxpayers’ money. Read the full explanation of the Paulson deal in todays blogpost of Yanis Varoufakis.

Tweet

Irrational Expectations

For years leading up to the financial crisis it was obvious that the money within the economy was being misallocated. A tiny elite were managing to control most of the finance and were constantly and rapidly reinvesting it in ways that could make the largest and fastest returns for them. This led to inequality within and between nations and had devastating consequences for our health and our social well-being.

But the misallocation of capital has also destroyed the ability of the economy itself to function. Although I resist cultural explanations for the financial crisis, whose origin was political, the attitude towards money amongst those who consider themselves entrepreneurs is a significant part of the explanation for the continuation of the banking and financial crisis. The whole notion of money being used as a facilitator of economic activity has evaporated as 'investors' have come to understand their role as only one of accumulating profits for no effort. The irrational expectation of vast returns for no risk is now preventing the normal mechanisms of a capitalist economy from operating.

At the level of firms this is being demonstrated by the unprecedented hoarding of cash by corporations. During the good years companies learned how to make large profits but they did not learn how to spend them: the process of globalisation and weak power by labour unions enabled companies to achieve unfeasibly high margin. Now that times have changed they are refusing to reduce these margins but they are nervous about investing the cash. More importantly, their expectations about the sorts of returns they might expect for their investments are what economists would call 'sticky'--they have not changed in line with the vast changes in the economic environment. This has led to a situation where British businesses were holding as much as £750bn in deposits, around two-thirds of it in cash. The Reuters graphic shows the situation in the US, where this issue is the subject of considerably more debate than in Europe.

There is, of course, a simple expedient to resolve this problem. Just as the government should use the power it has through owning two of our largest banks to ensure that they lend into the productive economy, so the Treasury should create incentives for companies to spend rather than hoard cash. A new capital tax proportional to reserves held should do the trick. It would encourage companies to spend their own money, but allow the government to spend it in the interests of the citizenry if they refuse to.

For long years the problem of our economy has not been that there is not enough cash around but rather than it is in the wrong hands. As the political authority governments have the power to address this, but their decade-long ideology of impotence is preventing them from doing so. Meanwhile the politics of austerity grinds on, punishing the poor and crushing life out of the economy. On the private and public side those in power, wedded to an anachronistic understanding, are sucking money out of the economy and ensuring that the slump continues.
. Tweet

Not Waiving but Drowning

'There's not much to a bank except its licence, its computer system and its reputation.' Thus spake Martin Taylor on this morning's Today programme, the same programme that, with its recent behaviour as lackey of the elites, invited Bob Diamond to give its inaugural lecture in 2011. A member of the 'independent' commission on banking, Martin Taylor was Chief Executive of Barclays between 1994 and 1998. The extraordinary breakdown of retail banking services at RBS and its subsidiaries this week - the result, it appears, of offshoring vital services to under-qualified and under-priced programmers who could not be properly monitored - has seriously eroded confidence in one of those pillars. The fraud revealed by the IFS yesterday further undermines the reputation of Barclays, with other banks set to follow the same route to opporobrium. It only remains for the government to take from Barclays the licence of which bank executives have proved themselves utterly unworthy.

Although the Barclays scandal has pushed the Eurozone crisis off the front pages this morning, the two are intimately related. As the previous post on this blog indicated, the sovereign debt crises have also arisen as a result of banks bidding up the rates of interest paid by nations on the money they borrow from those banks, increasing bank profits while bankrupting countries and destroying their societies. As in their mainpulation of the LIBOR rate they have controlled what is supposed to be a free market to benefit their narrow interests, and the whole economy and wider society have suffered as a result.

What has not been mentioned in this recent round of scandals is that, in a capitalist economy, the banks' most important function is to provide the liquidity that brings into play the factors of production that enable economies to be productive. For years, our banks have failed to do that effectively, preferring to suck money out of productive sectors and local economies to feed it into speculative circuits and lucrative rewards to bank employees.

This situation has gone beyond discussion about regulation, of whatever degree of touch, and into the realms of serious political action. The government already holds controlling stakes in RBS and Lloyds on behalf of the citizenry. The withdrawal of Barclays' banking licence would leave the vast majority of UK banking in public hands. The government therefore has the active power to operate a proportion as public interest banking, keeping the value of money creation to invest in public projects, while the remainder are broken up and made available to be operated as a system of locally based community banks.

Please sign the e-petition calling on the government to withdraw Barclays banking licence.
. Tweet

Banking Mad

Holmes and Watson pursue an errant banker

So the Vickers Commission has reported and made its bland recommendations. In view of the apocalyptic views expressed about the behaviour of the banking sector by Bank of England Governer Mervyn King earlier this year the proposals seem mild indeed. More telling is the eight years that the banks have been given to wheedle, wangle, and reorganise their business to avoid the legislative changes that are proposed having any potential to curb their room for manoeuvre.

Given the devastating consequences of the banks' nefarious practices over the past 30 years the only conceivable response is one of rage. But while rage seems to me quite appropriate, and proposals along the lines of a national audit committee to repudiate much of the debt that is presently destroying our society may be a way of channelling this rage, there is also a need to engage in the debate about the future shape of the banking sector in the UK.

My Green House colleague Thomas Lines has done this with admirable grace and restraint (not to mention some wit) in his recent report The Dog that Didn't Bark. As its subtitle indicates it provides useful historical background to the present limited debate by analysing 'when banking crises did not occur and what we can learn from that'.

Lines reaches some rather unexpected conclusions. If I may risk mixing his extended metaphor (over which he himself is quite scrupulous) he finds that the focus on competition between banks is a red herring. During the nearly three decades following the end of the Second World War when there were no significant banking crises, British banks were not very competitive and operated more like an informal cartel. This was elitist and resulted in the rationing of credit, but it did achieve stable banking.

Interbank lending was also rare during this period. It was the interconnectedness of banks, as much as their size, Lines argues, that left them so vulnerable in the period leading up to the 2008 crash. Its origin lay in the laziness of bankers, who sought easy profits without effort:

'An uncharitable way to describe inter-bank lending would be as lazy banking, since the wholesale markets make it possible to build up a bank's assets without the hard work of developing a customer deposit base.'

The report recommends that banks return to their function within a stable economy: that of unglamorous utility banking, providing a haven for savings and a source of reasonably priced loans. A key recommendation is one that finds a comfortable home on a blog on the theme of Gaian Economics:

'Ecological theory suggests that a system will be most resilient when it is divided into compartments to protect it from external dangers. The banking system should be set up in this modular way too, without financial interconnectedness between banks. For this reason we proposed severe restrictions on interbank lending and derivatives trading, and a reintroduction of exchange controls designed, among other things, to sharply reduce international flows of money between banks.'
. Tweet

Chancellor Fails to Separate Retail and Commercial Banking

The loudest call for reform following the failure of the banking system in 2008 was that the risky activities undertaken by investment banks should not, in future, be able to threaten the deposits of ordinary working people. Osborne's speech at the Mansion House last night indicated that he is not going to separate these two very different aspects of UK banking activity.

The newspapers this morning draw attention to the proposal, adopted by the far-from-independent banking commission, to 'ring-fence' the savings and deposit side of banking from the global casino. Like the stock-market itself, this tired metaphor is drawn from the agricultural sector. But the beasts of the City are far more powerful than the politician's fence. Admissions that negotiations are still ongoing makes it clear who will decide the outcome. Needless to say, the citizens who have paid for the banking fiasco are not represented in these discussions.

If retail banking remains within the same company structure as its more glamorous, more profitable and more powerful investment-banking sibling, the efforts of all the most creative and Machiavellian minds within each global conglomerate will surely be bent towards finding ways through the barrier. Only a clear separation into separate companies, with separate boards pursuing different agendas can remove the threat of another crisis in future. The banks will refuse to settle until they have made this clear separation impossible, until they are sure that the ring fence is full of holes.

But this whole discussion addresses only half of the problem. Even if your own savings are safe, if the massive investment banks run into problems as a result of their absurd and irresponsible activity then, while they are large enough to provoke a systemic crisis, the risk that we will all have to carry the costs and take over their debts onto the public balance-sheet will remain. Another policy proposals is, if anything, even more important than the separation of retail and venture banking: to limit the overall share of the market held by any individual institution.

I would anticipate that most readers of this blog keep their own money far away from the commercial banking system, in a mutual organisation such as a building society or with the Co-operative Bank. However, we are still vulnerable to the threat that the uberbanks make to the credit system on which our national economy depends. Never was there a clearer example of when finding your own small-scale solution is not enough: we must rather find a way of turning public anger into a significant political challenge to the banking sector.
. Tweet

Higher Education Accountability

As the debates over student fees have ebbed and flowed I have missed once again the skills of the accountant. What nobody has explained adequately to me is how the government's plan will ensure that money flows in in these straightened times, and exactly how it will also flow out.

Will Hutton has assisted on the second point, by offering some figures in his report on 'fair pay' in the public sector. Two points leap immediately to the critical mind: since national bankruptcy has resulted from the behaviour of the private sector, perhaps we should start our pay policy there; and how can any person reasonably accept Hutton's conclusion that a differential of 20-to-1 within organisations can be fair. Time for a new dictionary, not to mention a new moral code.

For myself and my colleagues in the universities there is no surprise that the differentials are highest in our sector. We have long been scandalised by the salaries and the expenses-paid trips enjoyed by our bosses. Hutton found that the average salary for a vice-chancellor is £200,000 and the median salary is some 15 times that of the lowest paid academic salary. Of course that is far from the lowest salary in a university, which also has a huge number of cleaners, caterers and other support staff on poverty wages.

The fattests of gowned cats are found, unsurprisingly, in the self-selected elite who call themselves the Russell Group, where the differential is 19 to one. These very same professors and administrators who are calling for students to pay three times as much to enjoy their skills are part of the reason why a university education is no longer affordable. Universities pay their managers more than all other sectors, with vice-chancellors earning more than four-star generals.

In these 'times of austerity' these salaries will be hard to afford, but how will raising student fees help? Since the increase will only affect the 2012 freshers, no money will flow back to the Treasury until 2016. Here is where accountants could be so useful. The details are decidedly murky at present, and when they are published no doubt we will all be looking elsewhere, but it appears that this money will be marked as an asset rather than a liability, thus reducing the deficit by actually shifting it onto the individual debts of young people.

With the additional help of some financial wizardry, the government may also be able to bring money into the public coffers sooner than 2016 by making the debt of our young people available for sale. This method of using securitization of our children's futures to help pay for support to the banking sector is the story that was missed while we watched the enraged students attempting to smash their way into the Treasury.
. Tweet

Ooh aah!

You might think that footballers would know a thing or two about money. Not only are they paid absurd amounts of the stuff, but they have also seen their game destroyed in a process of rapacious financialisation so that nothing beautiful remains. Well, ok that winning goal that Spurs scored against Arsenal on Saturday is an honourable exception.

So we can be delighted to hear from Eric Cantona that it is not complicated to sort out the global financial crisis. All we have to do is nip to the bank on December 7th and take all our cash out. This will precipitate a banking collapse: banks are the problem, so problem over.

The advantage of being French is that you can make such prognostications sound really cool and when you say 'C'est pas complique' you sound irresistible. But Eric could not be more wrong about this providing a solution to the problem. Just like in 1968, destroying an existing system is not the complicated part: it is putting something better in its place that takes the thought and effort.

I'm intrigued to see whether this money withdrawal ploy will take off like the Rage Against the Machine mass buy-in did last Christmas. Perhaps it is something about the festive season that lures us to act in a communal fashion. If it works, then Cantona may finally get himself onto a Philosophy Football t-shirt, although there will no means of buying it.
. Tweet