THE RETURN OF THE STATE

By Jorg Huffschmid

[This article published in: Blatter fur deutsche und internationale Politik, 11/2008 is translated from the German on the World Wide Web, www-user.uni-bremen.de/~huffschm/docs2009/Rueckkehr_des_Staates-Blaetter_11-08-v2.pdf.]

In the beginning of 2007, a bank reform called “Basel II” was carried out in the EU, which was praised everywhere for restraining direct governmental bank oversight and releasing banks for more “personal responsibility” and “market discipline.” The alternative would have been legal regulations as security against problematic developments. Since then, banks have assessed risks of credits given them through internal risk models and put aside their own capital resources as reserve for the case of credit failure. This partial privatization of bank oversight reduced the obstacles of banks and lent wings to their credit-awards to financial investors and all kinds of speculations. At the same time, banks increasingly made speculative deals. The results should now be probed. The speculators committed fraud, the banks are in trouble and the crash is at the door.

In this distress, the state is welcome again. The brazenness with which those who caused the crisis now demand state subsidies to “bail out the financial system” is just as breathtaking as the state readiness to fulfill this demand. Guarantees conjured out of a hat are suddenly available for this rescue. 50 billion euro was given to the Hypo bank. The state guarantees awarded since then were ten times as great. This happened after citizens were told for years there was no money for pensions, education and jobs programs.

The cudgel with which this impudent demand is pushed through against the general public is that the whole financial system would collapse without these subsidies damaging the whole economy and the “little people.” This extortionate kidnapping of the whole society in the interest of private banks producing fear, a feeling of lack of alternatives and submissiveness toward the government has largely succeeded.

In reality, a bluff of adventurers is involved who see their pillar swimming away. Even in the worst case, the collapse of the financial system is not imminent. Firstly, banks for their part have the funds to stabilize the system at their own expense. But if they refuse in an attack of self-destructive adventurism, the state secondly has sufficient possibilities to guarantee the functioning of the financial sector. The state only needs to communicate unmistakably its readiness to immediately nationalize the leading private banks and put them under state control to guarantee the three central functions of the financial system together with the central banks: smooth monetary transactions, supplying credit to the economy and ensuring the security of savings deposits. The more resolutely the state demonstrates its determination not to become the plaything of the financial markets, the more the trust of customers and – paradoxically – the banks in the reliability of the system returns. From such a position of demonstrative strength, the necessary short- and medium-term new order of the financial sector can be tackled – with threatened or actual nationalization.

THE NECESSARY NEW ORDER OF THE FINANCIAL SECTOR

In the short-term, those practices that afflicted the most damage in the last two years and acutely destabilized the whole system should be ended.

Firstly, guaranteeing and trading credit packages should be prohibited on principle. These practices involve bypassing regu9lations on banks’ capital holding resources and an incalculable increase of risks in the financial sector. Exceptions from this prohibition need the explicit approval and constant oversight by the monitoring boards.

Secondly, awarding credit to financial investors for financing partnerships or takeovers should be prohibited or raised in price through a much higher capital resources requirement so these credits become attractive again for banks and financial investors. In the past, transactions carried out with a massive credit lever led to dramatic speculative excesses. Financial investors of all kinds should only finance their investments with their own capital.

Thirdly, false salary incentives and stock options should be removed. These false incentives seduce business leaders to focus their attention mainly at the fast rise of stock prices instead of a long –term strategic development and strengthening their businesses.

Fourthly, the largely unsupervised activity of hedge funds contributed to the turbulences on the financial markets and crises. Therefore hedge funds should be allowed any more.

Further lessons can be learned from the financial crises beside these emergency measures or intermediate steps. A thorough reorganization of the financial sector involving banks, the credit sector, the capital market and the securities sector is imperative. Separating the two spheres is necessary because uncontrolled teamwork led to a speculative overheating.

Banks should be brought back to their two essential functions, providing the economy with credits and safeguarding deposits. The business model of the universal bank where credit- and securities-businesses are united in one institution did not stand the test despite all solemn declarations. Credit-financed speculation was encouraged after the US Congress revoked the separation of credit- and securities businesses authorized in 1933 with the Glass-Steagall Act. Trading with securities and especially derivatives should not be part of the business model of private and public banks.

DE-ACCELERATION OF THE CAPITAL MARKETS

De-acceleration should be the most important orientation in the necessary reorganization of the capital markets. The extent and speed of the securities trade assumed dimensions that had nothing to do with overall economic rationality. The largest part of trading with stocks and shares is secondary trading, trading with past securities. Trading is necessary for keeping the markets liquid, that is guaranteeing willing buyers will always meet willing sellers. However the extent and speed far exceeded this necessity, were increasingly speculation-driven and did not prevent markets drying up in the crisis.

As a rule, trading with securities should not be financed with credits so that no credit guarantees will be needed. Substantial taxes on financial transactions would make fast speculation unattractive. One lesson from the crisis is that the great number and complexity of certificates, the “structured products” of the “financial innovations,” were incomprehensible for buyers and most sellers and only provided the latter with additional profits. Therefore the investment possibilities offered on the capital markets should be radically reduced and standardized so they become understandable for everyone. The economically sensible goal of security against fluctuations of prices and exchange rates does not require complex constructions and can be fulfilled through simple futures and forwards. What goes beyond this is functionless speculation and should have no place in orderly financial markets.

In this connection, there is a special need for reorganizing rating agencies, which send misleading signals on the markets out of opportunism toward their firms and thus contribute to the severity of the collapse. Like notaries, they should be subject to public approval, monitoring and fee structures and as rating agencies may not carry out any business consultation. They could be paid out of pool that finances the institutions and commissions the evaluations. In addition to the existing private agencies, public rating agencies should be established. These public agencies could recruit from the employees of European national banks that have had little to do since the founding of the currency union.

As a result of such a radical reorganization, the extent and the profitability of the financial sector and its two pillars, banks and securities trading, could be clearly scaled back. This is very desirable given the real economic development, the turbo-growth and excessive profits of this sector. The threatening job losses here could be avoided if the banks properly develop and improve their customers’ responsibility.

The governments of the massive financial centers should reach agreements on reforms in a global consensus. However this cannot be expected since the parties responsible in the United States – and elsewhere – are hardly ready for agreements despite the continuing crisis.

NEW PROFIT SOURCES AND RISKY STRATEGIES

Therefore the second-best way is a European Initiative for Reorganizing Financial Markets that could have stimulating effects on other world regions. Large countries like Germany and France could take independent initiatives and play independent pioneering roles in single-handedly implementing several measures.

To safeguard a European reform and protect it from spectacular attacks and inflows and outflows of capital, the EU must drop the dogma of the absolute freedom of capital transactions. This is less revolutionary than it sounds to neoliberal ears. In the EU treaty, a series of political and economic exceptions from the freedom of capital transactions are provided. These include the “extraordinary circumstances” in Article 59 in which “capital movements toward or from third countries seriously disturb or threaten to disturb the functioning of the economic and currency union.” In such extraordinary circumstances, the EU can take the necessary protective measures for six months “if this is absolutely required.”

With all necessary political concentration on the immediate steps and far-reaching reforms for the stabilization and reorganization of the financial markets, the limits of such a policy should not be ignored. The driving forces for finance market-driven capitalism are neither in the insatiable greed and speculative mania of people nor in the excessive awarding of credits of banks. Rather they lie firstly in the redistribution of incomes and assets over decades from bottom to the top. This redistribution created a constantly growing accumulation of financial assets at the top of society that was not channeled back in the reproductive cycle since those at the bottom lacked purchasing power.

Secondly, this accumulation is speeded up by the privatization of pension systems. Pension insurance contributions paid out directly to pensioners in the solidarity transfer system shifted in the long-term as a result of the change to capital-covered systems in private pension funds on the capital markets.

These two-mega trends create pressure that drives financial investors to seek new sources of profit for the wealthy and to trust increasingly risky strategies. A reversal of these two mega-trends is necessary to reduce the pressure and thus give a stable long-term foundation to the new structure of the financial sector: a clearly more equal and just distribution of incomes and assets and building a solidarity financing of old-age security. Both go far beyond financial market policy. Essential pillars of a democratic macro-, distribution- and social policy are involved. In their framework, the reorganized financial markets could then play their important and useful role.