Friday, 10 October 2008

Financial Chaos

It seems like an age ago, but it is really only just over a year ago that the financial world seemed to be fairly stable. Since then we have all been watching the news with our jaws hitting the ground. For some reason Sunday evenings seem to be the preferred time for amazing stories to break, each one coming out of the blue and topping the one before.

There doesn't seem to be much doubt that we are heading into rising unemployment, increasing homelessness and its attendant rising crime. The general level of misery is likely to be increasing.

But strangely, I feel okay about all this. I am not naive: I remember previous recessions and I know that they are not a walk in the park. And even then, this one is shaping up to be the worst of my life. The situation is already being compared to the Great Depression. In fact if you look at the numbers it might well be worse statistically. If you buy the idea that it was the depression that led to World War II then there is every reason to be alarmed. I am not positively looking forward to all this - and there are going to be some grim times ahead.

So why am I so calm?

I think that what are now seeing is reality coming back into focus. For a long time now, certainly since I was a teenager in the seventies, credit has grown and grown. The flow of money from banks has been steady and we have filled our boots. Many people owe tens of thousands on their credit cards. Many people owe hundreds of thousands on their mortgages. Most of us have done it to some extent or other. There are very few of us who genuinely have no debts. Even if we don't have debts ourselves, our customers do. Or we work for companies that have debts and sell to others who have debts. The government borrows money on our behalf too. We have been in the red since we beat Napoleon.

Of course we all know this. You can't miss it. Many people spend their whole working lives in the debt business: selling it, counting it, moving it around. Some of our top mathematicians work out complicated deals with weird acronyms for businesses in the city. You can bet money you don't have on the future of a business in which you have no direct interest. Get it right and you can make more money than you can imagine.

Where will it all end, I used to wonder. But nothing seemed to happen. Years came and went and we all seemed to be getting richer. And there was a philosophy behind it. The market was king. Capitalism had triumphed over the Soviet Union and was now unstoppable. Economists concluded that the optimum distribution of resources was only obtainable from the free play of the market, so people should be left to get on with whatever they wanted. Bankers and hedge fund managers trousering millions? Just the free play of the market. Don't dare to interfere. Leave things be and it will all be alright.

This manner of thinking became all pervasive. Even the nominally socialist Labour Party bought into it. Tony Blair got rid of Clause 4 and embraced business. Social justice from now on was an afterthought.

I found all this to be profoundly dis-empowering. What was to be done? Nothing it seemed. Just let the market do its magic and we would all get rich together. Some of us richer than others, but that is just the way it is. In fact, it is the rich people to whom we should be grateful. They were the risk takers, the entrepreneurs, the ones who made it all happen. We just needed to let them get on with it and enjoy all the goodies they came up with.

But now the whole world has changed. Has the free operation of the market worked? Hardly. Look around the world. Chaos and confusion reign. Stock markets tumble wherever they are open. In many places they are closed. Assets, including the houses which many people have huge mortgages against, are losing their value at an astonishing rate. Banks are only prevented from collapsing by the injection of funds on a scale barely imaginable from central governments. And the traders and financiers look on stunned. Many are fearful. None of them know what is going to happen next and how this edifice that they have constructed is going work.

So by rights I should be fearful and worried. And in the sense that I see bad things coming I am. My job is perhaps a bit safer than most, but still highly precarious. And given my age and how specialised my skills are I am quite certain that if I were to lose it the chances are very slim of finding another one. But I don't feel any anxiety. What will happen will happen. But I do now feel for the first time since I was a teenager, that what I do really matters. We are in a dreadful state, but it is a state we can get out of. We know now that the financial masters of the universe have been owner operators of feet of clay for some time. They are bankrupt figuratively. Some of them are bankrupt literally. Most of them would be bankrupt without state intervention. And for the first time in years things seem clear to me. Yes the market works well for distributing oranges and fridges. But let the market to work on the very financial system itself and disaster ensues. One great depression can be put down to bad luck, but two smacks of a philosophy that just doesn't work. And what is more, there are things we can do to solve this problem. It is an easy problem to understand. Banks have too much power in a free market. And they use that power to promote that which is most profitable to themselves - debt. In a period when the banks are competing with one another, people and companies who take on that debt to acquire assets do well. As the assets rise in value these 'risk takers' see their risk taking rewarded. The more prudent who build businesses by creating value get left behind. A self reinforcing cycle is built up. The entrepreneurs bestride the world. Their enormous red bank balances are invisible - the tangible things that they have spent the money on dazzle us all. They become the heroes of the age. And ordinary people who own their own homes get to participate. Your house increases in value as the credit supply expands. You are richer. Until of course, it goes too far. Eventually the value of assets gets out of all proportion to the income you can derive from them. When you can earn millions simply by buying a few hundred houses and waiting for their value to appreciate whilst doing nothing of value to society, you know it is nearly over.

And now it is over. The credit bubble is not just deflating: it has popped. We have had all the fun, now we just have the debts. And debts are the problem. We live in a sea of debts. Many people owe a huge proportion of their likely future income. Significant numbers of people owe more money than they will ever be able to pay back. These are not just problems for the individuals. They are huge problems for all of us. The person who defaults on their debt takes a big chunk of spending power out of the economy. The bust company that does the same thing does it on a larger scale. A bank defaulting on its debt takes out a huge lump. In the end, we all pay. And boy are we going to pay.

But at least we can see the way forward. There are clear messages for how we should behave as individuals. how companies should behave and what the government should do.

We all need to look at our own financial affairs. We need to pay back what we owe. If you want something - save for it. Getting into debt is antisocial. It harms people around you and it undermines society. There are times when you have to, but take a deep breath and get out of it as quickly as you can. Remember Mr Micawber. If your net income is greater than your net expenditure the result is misery. When you are looking where to put your savings, it must be safety first. Don't look where you get the best return, look at where your money will be looked after. The ideal place is the local mutual building society - if there are any of these left anywhere. We need institutions like these to be recreated and we should praise the people who do, even if they don't get to appear on the Dragon's Den. And we should vote for parties that take a long term view and put prudence first. The retail banks need to be nationalised. They are simply too key to the economy to be left in the hands of unaccountable investors. Banking should be as boring as plumbing.

But for me the biggest thing to come out of this crisis is simply that what we do matters. If we want things to change, we need first to change our own individual behaviour. We need to think through the consequences of our actions. And if we want to be wealthy, we need to offer something of value. There are no quick easy ways to make money any more. And for that, if for nothing else, we should be pleased for the lesson the financial chaos has taught us. It has been an expensive lesson but maybe that was the price we had to pay.

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