Mortgaging our future; stealing our assets

Financial engineering is a phrase that has become part of our normal vocabulary when thinking about the 2008 crash and its aftermath. Like genetic engineering, which implies that the botchery of implanting crocus genes into rice is akin to building the Clifton Suspension Bridge, the phrase is unduly respectful towards the City whizz-kids. Financial fraud is obviously closer to the truth.

It is worrying, therefore, that so many of the cabinet have a background in the financial world and owe their exalted status to its riches. And more worrying that the techniques they learned there are creeping into policy-making at local and national levels. The offending item of policy is what is being called 'tax increment financing' - a piece of misleading spin typical of the 'financial engineers' who brought us credit-default swaps and leverage.

At the Lib Dem conference Clegg claimed that tax increment financing was ‘the first step to breathing life back into our greatest cities’. It is hard to see how shifting debt from central to local government is breathing life. At a time where debts are in the process of destroying what we have come to think of as civilisation it seems more like the kiss of death.

The theory is that public infrastructure can be funded through borrowing, which will be repaid as a result of extra taxes that will be generated because this infrastructure, say a road, will encourage the development of more property, say another supermarket. This is using financial engineering to engineer economic growth and forcing the pace of development. It is also putting local taxpayers at the mercy of developers, since infrastructure (like roads) that would serve their interests will find funding, whereas infrastructure that will not (say, a care home for elderly people) will not.

The word from the Treasury is that tax increment financing would operate within a ‘carefully designed framework of rules, which the Government will work closely with local authorities to design’. The nature of liabilities and the assignment of collateral will be key here. Depending on what the detail says, this could be a way of allowing developers and financiers to take control of local infrastructure and the most important local asset: land. Tweet

If it is all Greek to you, read on

I'm convinced that much of the discussion about finance, global and corporate, is deliberately obfuscatory. Simple activities that could be described using words like 'gamble' or 'risky investment' are concealed in arcane phrases such as 'taking a position' or 'creating a collateralised debt obligation'.This certainly worked - even the CEOs could not understand what was going on.

But I know a woman who does. Mary Mellor has helped me find my way around the mysteries the financialised global economy, and she has also had the good sense to publish a book on what when wrong, and what we should do to put it right. It's called The Future of Money: From Financial Crisis to Public Resource. As a taster, here is her take on the mysterious drama being played out in Greece:

'The Greek situation demonstrates the problem of an interconnected global financial system. When the new socialist government took over in October 2009 it revealed that the previous government had hidden deficits in its accounts (with the help of Goldman Sachs). This was a ‘Bear Stearns’ moment. Early action at this point could have stablilised the European monetary system pro tem (but not in the longer term without reform) but the leading European economies dithered, particularly Germany where the government was facing regional elections. Bear Stearns became Lehman Brothers. Greece is a small economy within the EU (around 3% of GDP) and around 0.5% of the world economy. Its total debt was around 300 bn euros. Its immediate needs were around 8 billion euros. By the time rescue was at hand it was facing short term interest rates of up to 38% and an immediate need of a hundred billion euros. What was needed in the early stages was an injection of euros which could have been issued by the ECB. Why did this not happen?

'Because of the ideology of money issue as a private commercial matter. The ECB is not empowered to lend to governments only to the financial system as a private entity. This makes the assumption that governments and financial systems are separate, but this is not the case. As demonstrated by the 2007-8 financial crisis the financial problems of the private sector, particularly its debt crisis became a debt crisis for states. As states poured money into the sector they were forced through their ideology of privatised money to borrow from the ‘financial market’. Who were the financial market? The banks whose debt they had just rescued. Banks made money lending to states through the front door who had just rescued them through the back door. The Greek situation is even more ludicrous. Banks have lent to the Greek government. Other governments will not provide support, so banks are facing billions in bad debt. It is rumoured some banks in France, Germany or Switzerland may be threatened. They will need to be rescued by the very same governments who would not support the Greeks in the first place.'

In the mean time, of course, huge profits have been made by the financial intermediaries - money that will be paid by the Greek workers. Tweet

When is a risk not a risk?

Today the the talk is all of the additional money we are now required to find in the future to pay for the past mistakes of banks. This time the discourse has shifted subtly. Rather than bailouts this is, apparently, insurance.

Let's spend a while to ponder that concept of insurance. The original insurance companies were mutuals, which meant that it was a way of genuinely sharing risk. The risk was that something would happen that you couldn't afford to pay for. Perhaps you would die and there would be nobody to earn money to feed your children; or your house would burn down and you would need money to rebuild.

Once you privatise insurance the risk becomes the sort of risk a gambler enjoys. Now we have a whole new profession - the actuary - whose job is to do the complicated statistics that enables a company to charge each person enough so that the small number of catastrophic events that befall the minority of policy-holders will cost less than the premiums taken from all - thereby generating profits for the company.

In this situation we are still dealing with sharing of risks between people whose chance of facing disaster is more or less the same. But the sort of insurance we are talking about in the financial world - when it comes to AIG, for example - is of a different order entirely.

Companies that ensure 'financial products' that they don't understand and can't investigate closely are gambling on something over which they have no control. The financial companies that create and sell the products are simply passing the risk down the line. In the good times the insurers are raking in premiums and making money for old rope. When the bubble bursts they are going to be the first to go bust, since they are at the bottom of the pile.

Apart from us, of course. Because under the pyramid of bad debt sits Joe Public. Today we are being asked to 'insure' the losses of Lloyds and RBS. The problem with the use of the word 'insurance' to describe the £600bn. we are going to oblige our children to pay is that the disaster has already happened. We know that the loans made by the banks will not be paid back. This must represent another creative move by the financial engineers: a move into ex-post-facto insurance. Tweet

Frenetic engineering

There's nothing I love as much as a critical accountant - just thinking about the juxtaposition of those two words is delightful. It is a subversive job title. I recently attended a seminar by Jean Shaoul, Professor of Public Accountability (there's another subversive job title) at Manchester Business School and one of the UK's leading critical accountants.

Jean explained how 'financial engineering' developed as a tactic for squeezing profits out of economic sectors that had already been squeezed dry. She has made her name by analysing the waste of cash that results from privatising public industries. Her simple account of corporate accounts made it clear that if you make profits where once there was only a service either the service users (us) or the service providers (public-sector employees) will lose.

Since the deregulation of financial markets in the 1980s companies have focused on using their money to make money rather than investing in tiresome productive capacity and persuading people to buy things. It is in this setting that 'financial engineering' has flourished. Its predominance is indicated by the gulf between falls in sales and falls in profits. In the case M&S sales have fallen by 6% but profits by 50% in the past year. This gives an indication of how much of their profit was actually related to sales of stuff and how much was about financial fiddling the could engage in balanced on top of the stuff they were selling.

She had some other rather challenging statistics - such as that 67% of corporation tax is paid by three sectors: banking, insurance and oil & gas. And that in 1977, 70% of public expenditure went towards wages, whereas now the percentage is only 45%.

Talk about intelligent design. I sometimes wonder whether the whole financial crisis isn't a sort of cosmic joke. I like the idea of God(dess) as some form of comedian - probably not the stand-up sort; probably more like Alan Bennett - especially as I've noticed that since I've been putting more energy into spirtual practice I've lost my sense of humour.

Subversive job titles is one thing, but what about the potential for double entendres offered by a fiscal bailout that is made up of bonds which are also called gilts. Images of snouts in troughs and prisoners longing to break free abound. But it was the divine being who made Bernard Madoff into a fraudster that takes the prize - the crook that launched a thousand puns. Tweet