LAST week, the most free-market administration in the West nationalized America’s two giant mortgage banks, Fannie Mae and Freddie Mac, in the world’s biggest ever bank bailout. Shareholders saw $20 billion of their wealth eliminated but the American government’s concern was not them. America’s private financial system, like ours, has seized up. Without the bailout the US mortgage and housing market would have collapsed.
It is a landmark event as Hank Poulson, US Treasury secretary, acknowledged — underlined by the emergency talks in which he is now locked this weekend to save another casualty of the credit crunch, the US investment bank, Lehman Brothers. For 30 years the financial system in Britain and America has been the battering ram for the free-market revolution. The theory has been that markets are so efficient that regulation and state intervention must be as minimal as possible — allowing a very particular conception of finance, exemplified by hedge funds and private equity, to become the most dominant influence in our economies. Now the theory and its practice have exploded.
This is an intellectual and political bombshell. Thatcher would never have been such a radical free marketer without continual succor from the now dead American example; Blair and New Labour would never have made so many concessions, especially to the City, without the continuing intellectual, economic and political pressure from the US to keep the state out of finance. The result has not just been the house price boom and incredible levels of personal debt, now unwinding in our very own British credit crunch. It has been that government and business alike have been in thrall to hegemonic deregulated financial markets and their sole interest — to maximize immediate short-term profits.
All this can now change. Britain has a massively unbalanced economy. Financial services are overblown; industry undernourished. Every chief executive I have spoken to over the last few years has had mounting concern that the financial markets and uncommitted shareholders do not value what business values: Research, innovation, motivated people, brand, loyalty, trust, independence. What the markets value instead is the takeover, so many of which go wrong. There is equal concern about how extravagant City pay has become a benchmark for corporate salaries, crippling internal norms of fairness. Nor they do agree with the City ideology that the state necessarily bungles everything because it is the state, while free markets never make mistakes. Serious chief executives know how crucial the state is to fund research, education, skills and the national infrastructure — and that it can be adaptive and intelligent.
The first battle that has to be won is over the mortgage market. Britain has swung from mortgage glut to mortgage famine. British banks and building societies have supplemented their own deposits to fund lending by bundling up mortgages as collateral for new, tradable mortgage-backed bonds. But investors have suffered a crisis of confidence and the market is now shut. Former chief executive of HBOS, Sir James Crosby, in his review for the Treasury, says it will stay shut for the next three years. Thus the mortgage famine. Nobody knows where house prices, now falling at 2 percent a month, will settle. What we do know is that if they carry on falling at this rate for another year the financial system will be crippled, risking a very deep recession.
One option to reopen the market is for the government temporarily to guarantee investors that in return for an insurance premium they will get their money back in full — a far less radical move than America’s. The markets now need someone in the control room to remedy malfunctions. The proposition is not to prop up house prices; rather it is to address a system failure and get mortgage finance moving again so that the housing market can start to function. In any case, the economic and political, like bank bailouts, have been going hand in hand for centuries. To inflict suffering on millions to pursue an impossible ideal of a market economy without active public institutions and intervention is irrational and unfair.
The temporary guarantee should only be the first step in a new progressive politics. First and foremost we need the markets to value what business values. Shareholders should only win rights to dividends and votes in British-quoted companies by signing a newly initiated declaration of the firm’s purpose which they are legally obliged to uphold. All mergers and takeovers should meet both this purpose and public interest safeguards. The banks should partner the government in establishing a new Long Term Investment Bank to provide patient, committed long-term finance. The Financial Services Authority should regulate bank operating margins as if they were utilities, and investment and commercial banking should be separated. One percent of bank assets should be directed to community and social projects. We need to limit the potential for speculative frenzy. All financial securities should be traded in licensed exchanges by organizations whose accounts are subject to regular inspection and where bargains are routed through a central clearing house. Anonymous trading should be outlawed. And financial pay must come back to earth. The higher the pay, the more the regulator should ask banks to strengthen their balance sheets.
