The economic crisis of 2009




One of the clearest messages to emerge from the current economic crisis is that the world is still addicted to economic growth. Although the current crisis is undoubtedly very serious and has resulted in the shrinkage of many economies, it has done no more than to take them back to their GDP levels of only a few years ago. There have been and will continue to be severe social consequences in terms of unemployment and indebtedness, but the world as a whole, and the developed world in particular seems to be unwilling to face up to the fact that continuous growth is not sustainable in the long term. All governments in various ways have sought to get the bandwagon of growth moving again, and in the case of the United States and of the United Kingdom sought to use the expedient of printing money (or rather its financial equivalent) to galvanise consumers into continuing to buy and borrow as they did before. The problem which precipitated the current economic crisis – cheap money and easy credit leading to asset price inflation, is now deemed to be the solution. Sadly, it can equally be said that the (temporary) solution to any spendthrift’s problem is the ability to find a new source of credit.



There have been a number of signs of economic recovery during the autumn of 2009, at least in terms of growth re-appearing in a number of major economies. Whether this is a permanent trend or a temporary phenomenon resulting from government stimulus packages such as car scrappage schemes, and re-stocking remains to be seen. In any event the cost to governments of providing liquidity and credit to the financial markets has been enormous in both small economies such as Iceland and Ireland and large such as the United Kingdom and the United States.



The most seriously affected and systemically important financial institutions have been nationalised. In the United States not only was the government obliged to take over AIG, the largest US insurance company, but also to render explicit what had only been implicit previously; a government guarantee of Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Mortgage Association). Ironically Fannie Mae was a creature of the New Deal, having been founded in 1938 to provide housing credit, and was owned by the US government until 1968 when it was privatised, and became a ‘Government Sponsored Enterprise’ with special privileges, such as exemption from tax and from oversight of the SEC. Freddie Mac was created in 1970 to provide it with some competition. These institutions play an absolutely fundamental role in the provision of mortgage finance in the US, and their failure would be catastrophic.



In the United Kingdom Royal Bank of Scotland and HBOS were also deemed too big to fail and were nationalised when their losses became unsustainable. It was the collapse of Lehman Brothers in the United States that triggered a crisis of confidence in the already febrile financial markets and underlined the fact that some institutions were, from a systemic point of view, too important not to save, thereby implying an implicit government guarantee, if not for their shareholders at least for their creditors.



In the past few decades banks have transformed themselves from the stuffy and conservative institutions of earlier generations to swashbuckling financial buccaneers, creating new financial products with high tech wizardry. After the stock market crash of 1929 the US congress had passed the Glass-Steagall Act in 1933 which enforced a rigorous separation of investment banks and commercial banks. This was finally repealed in 1999. In the UK, the barriers between merchant banks, stockbrokers, and commercial banks had been taken away by the ‘Big Bang’ in 1986. Increasingly financial institutions became so-called ‘universal banks’ able to do all kinds of financial business. But the most rewarding (because the most risky) was investment banking. Banks became less risk averse and more profit driven, and had far larger balance sheets available to them than the old investment banks. Linked with the globalisation and de-regulation of the world’s capital markets, the scope and scale for profit (and the incentive for risk) was greater than ever before. As mentioned elsewhere in the book, Alan Greenspan , Bernanke’s predecessor as Chairman of the US Federal Reserve remarked in 2002, a couple of years after the dotcom crash ‘It is not that humans have become any more greedy than in generations past. It is that the avenues to express greed had grown so enormously’. In an interview in September 2009 Greenspan also repeated his view of the importance of human nature as a causative factor, saying that the fundamental source of the crisis was “the unquenchable capability of human beings when confronted with long periods of prosperity to presume that it will continue”.



The immediate source of the crisis was the collapse of Lehman Brothers. Its importance to the US financial system should have been better understood, as well as its history. It is not as if it had not happened before. Lehman Brothers had been deeply troubled in 1973, revived and then sold to American Express in 1984, after major management problems. In his book ‘Greed and Glory on Wall Street. The Fall of the House of Lehman.’, Ken Auletta described the events of 1983/4 leading to the collapse of Lehman as ‘..a story of greed for money, power and glory. It is a reminder that human folly and foibles, not the bottom line of profits, not business acumen, not “scientific management or the perfect marketing plans or execution – often determine the success or failure of an organization.” It would not become independent again for another decade. Lehman, as they say, had form.



Yet as the consequences of allowing Lehman go to the wall have become increasing apparent, the understanding that central banks will bail out systemically important financial institutions has grown ever stronger. In order to protect the more staid side of banking, such as money transmission, ordinary commercial and residential loans central banks are implicitly providing a guarantee for all the activities of these large financial institutions, including the more risky activities driven by the sentiments referred to above. As Mervyn King, Governor of the Bank of England has remarked “It isn’t sensible to allow large banks to combine high street retail banking with risky investment banking strategies, and then provide an implicit state guarantee”



In effect governments across the world have not only nationalised some financial institutions they have nationalised the problems and the risk profile of their financial sector as well. The long term consequences of this are exceptionally difficult to predict, but the track record of Japan since its own, domestically created, asset price bubble peaked at the end of the 1980’s is a salutary reminder of the difficulty in dealing with the aftermath of easy money and excessive asset price inflation. The Japanese stock market, even after 20 years still languishes at about a quarter of its peak, its property market has yet to recover to its previous levels, and its growth rate over the past 20 years has been anaemic at best, despite a huge amount of government stimulus, resulting in a substantial increase in government debt, which is heading towards 200% of GDP according to some accounts.



The current situation of the world economy is that it is clearly malfunctioning, and the consequences of that malfunction have spread into the political sphere. Some argue that this is just a temporary, albeit severe, aberration, others that it is more fundamental, a crisis for capitalism, and an indication that there are systemic problems in the way in which the modern economic system operates. The crisis has raised a profound degree of unease, and governments worldwide, faced with an economic framework that is not working properly have sought to allay concern by trying to remedy the situation, through the infusion of vast quantities of taxpayers’ money; their efforts focused on how to get the current system working better, and increasing growth and consumption. Dealing with the fundamental problems of an unsustainable system has taken a back seat, and echoes of the policy equivalent of St. Augustine’s prayer, ‘Lord, make me chaste, but not yet’ resound in the corridors of power.



However there is equally a feeling of profound impotence in the face of recent trends, and current policy is as much to do with breathing a huge sigh of relief that the worst has been averted, at least for now, as it is with having a coherent strategy for dealing with the underlying problems. While it is clear that the superficial cause of the recent crisis lies in the financial markets, inadequate regulation an globalised trading imbalances the more fundamental issues that allowed the asset bubble and easy money to build up are more pervasive and widespread. More than a change in banking regulation is required to deal with two of the key drivers of modern society – greed and growth. International discussions in respect of limiting the bonuses paid to bankers, perhaps owe as much to a desire for retribution and playing to the public gallery as to a coherent regulatory strategy. In any event they miss the larger picture, which is that the corporate structure enhances certain attributes, such as greed and the need for growth and concentrates the their effect and impact at the expense of other considerations, such as the social and environmental consequences . The actions of the major financial institutions before the banking crisis are just an extreme and systemically highly sensitive example of a wider malaise.



The recent financial and economic crisis is not only a huge problem in itself, requiring massive government intervention after the failure of a major part of the economic system, but a reminder and an analogy about the unsustainability of current economic and corporate practices generally. Just as the latest boom was built unsustainably on the supply of cheap money, habituating people to a life-style that could not be maintained long-term, so in a wider context has the pattern of modern industrial growth been fuelled by the supply of cheap energy. Central banks around the world chose to stave off the worst of the effects of the crisis by the creation of cheap money. Governments are at least in a position to lower interest rates and to print new money, and this can work, at least as a temporary expedient, in alleviating the most immediate consequences of living beyond one’s means. But the creation of new energy is a rather more difficult trick to pull off, and requires conjuring skills of a completely different order from those that governments have recently demonstrated.



Given the finite resources of the world, the fact that much of the economic growth depends on cheap energy the availability of which is increasingly in doubt, and issues of climate change, of pollution, and environmental exhaustion, as well as a spiralling increase in the human population there can be little doubt that current trends cannot continue. The natural limitation of trends was neatly encapsulated by the economist Herbert Stein (economic adviser to both Presidents Ford and Nixon) who stated that ‘If something cannot go on forever, it will stop’. However in the absence of intervention and a planned change in strategy any changes in worldwide economic trends may well be abrupt and extreme, rather like the financial crisis. The situation becomes more and more unstable and liable to be disrupted by even very minor events like the proverbial beating of a butterfly’s wings in chaos theory.



Stein’s remarks were in the context that the US balance of payments would ultimately correct itself since they could not worsen indefinitely. It makes no reference to the consequences of allowing events to run their course and of non-intervention. In the oft used analogy of pulling on a brick with a rubber band, it is not necessarily wise to wait until the tensile energy of the rubber band overcomes the inertia of the brick.



The current economic crisis is a clear warning of the consequences of not taking action early enough, and of the importance of the breadth of areas where intervention may be required. After all, central banks and governments intervene frequently in the financial markets through the adjustment of interest rates to try to ensure steady non-inflationary growth, but they failed to recognise the importance of over-rapid asset price growth and the pent-up damage it was able to inflict, despite the previous experience of Japan.



The problem with both asset price inflation and indeed with environmental depletion is that their consequences can continue for a number of years without there appearing to be any irremediable damage caused. As with a sky-diver whose parachute remains unopened, all appears to be well, even exhilarating, until the moment of impact. Better to open too soon than too late. The consequences of not opening the parachute on a timely basis are only apparent some time later, and as the diver reaches maximum velocity there may even be the sense of stability. But a parachute, like a mind, is of little use unless it is open.



In a global context, mankind is engaged in little more than slash and burn exploitation of the planet’s resources on a world-wide industrial scale; we are using resources up at a rapid rate and then moving on to the next site. Some theories suggest that the over-exploitation of Easter Island’s resources caused the collapse of its population, and that this is a harbinger for the earth as a whole. It appears to be the case that the Polynesian population of Easter Island created a political/religious system which favoured the short term over the long term and the rapid exploitation of the island’s natural resources, and there was a subsequent collapse of the population to one tenth of its previous size as the depletion and destruction of resources meant that fewer and fewer people could be supported. It has been suggested that the Easter Island experience is one that is now being repeated on a global scale.



Democratically elected governments are less and less setting the agenda. The agenda in many parts of the world is that of companies. Whatever the truth of the collapse of the habitat and environment on Easter Island this explanation has a strong resonance for the predicament in which we find ourselves today. The vital importance of economic growth is the mantra of our age, and the greater the growth the more successful the economy. Although the importance of the ‘green’ vote is growing in many countries, there are few politicians who are brave enough to campaign on a platform of low growth or no growth, much less negative growth. Yet concern is undoubtedly rising in many countries that we cannot continue as we are, that there are consequences to our current life-style. While everyone agrees that it cannot continue forever there is no mechanism in place for managing the transition. How have we reached this situation, where it seems increasingly likely that the juggernaut of growth is hurtling towards an environmental cliff-edge, but the driver thinks it is still too far away to start changing direction, and indeed that others will be in the driving seat by the time anything too drastic needs to be done?



Part of the problem is that the driver of the juggernaut is the corporate world, incentivised to drive as fast and as furiously as he can, and to beat all the other drivers on the road, regardless of the consequences. It is true that he has to meet the rules of the highways code, but there are few speed cameras, and the policemen can sometimes be persuaded to turn a blind eye, and some roads are rather less well monitored than others.



As companies become larger and more powerful they are increasingly in a position to set their own agenda, which is increased growth, and also shape public opinion as to the importance of that agenda. The wealth of the developed world prior to the recent financial crisis was greater than it has ever been, although not necessarily equitably shared, yet there is no concept of what might constitute enough. The benchmark for success is always ‘more’. At a time of increasing disquiet about the sustainability of our current economic approach the institutional framework we have in place seems incapable of mounting an effective counter agenda to that of the corporate world. Governments have increasingly seen themselves as effective deliverers of economic growth, rather than setting the balance between competing commercial, social and environmental interests, although perhaps governments in Anglo-Saxon countries have been rather more prone to this approach.



The key to solving the problem lies in the very legal structure of corporations and their sole responsibility to make money for their shareholders. The legal form of a limited company is not synonymous with business, nor are companies either good or evil. The actions of their directors and shareholders are however are, however, a rational response to their constitutional framework. That framework is the very narrow one of making money and getting larger – in effect greed and growth – and one that has few checks and balances. The very attributes which can be deemed virtuous in a small enterprise rooted in its community can become vicious and uncaring when replicated impersonally on a global basis. The modern company has few of the concerns and caveats that a modern democratically elected government has; this makes it a powerful and effective agent in its task of making money, but largely blind to its own excesses (and largely impotent to do anything about them if this conflicts with its primary goal), and being answerable to money means oftentimes being answerable to no-one.



The financial crisis which started in 2008 is not only a warning about the fragility of our financial system. It is a warning about the way in which risk taking and social responsibility are not dealt with adequately within the current corporate structure. The consequences of this wider problem have not been thrown into the spotlight in the same way as the delinquency of management in the financial sector, but failure to tackle this fundamental flaw in the way in which we conduct business will just as surely lead to dire consequences for the world.



This book explains the way in which companies and modern democratic government have developed, and how their model for decision making has diverged. These two models of corporate governance have become increasingly incompatible as modern democracy has developed and as corporations have become larger they exert an increasing sway over the governments of many countries. The financial crisis of 2008 and the ensuing economic problems is just one manifestation of the impact that the unbridled ambition and risk taking enabled by the corporate structure can have not just on the economy of particular countries, but on the world as a whole. As the economic imperatives of large corporations diverge from the social and environmental requirements of the customers they claim to serve a way must be found to encapsulate these latter concerns within the corporate constitutional structure. A recent article in the Times written by Charlie Mayfield, the chairman of the John Lewis Partnership, an employee owned organisation, was entitled “Is the plc a bankrupt model for business?” The current corporate constitutional architecture is not unlike the description of the Russian constitution reported by Georg Herbert, Count Münster in the nineteenth century “An intelligent Russian once remarked to us, ‘Every country has its own constitution; ours is absolutism moderated by assassination.’”. Modern democratic governance has moved on from such picaresque arrangements, corporate governance should follow suit.