contribution by Riz Din

How should the left respond to the financial crisis? Here are some issues to think about.

Clarity and Transparency
The complete hotch-potch of initiatives earlier in the year pointed to a government scrambling about in the dark. Now, at least, policy measures seem centered on the key prongs of fiscal stimulus, a gigantic asset protection scheme and quantitative easing. However, significant uncertainties remain and the lack of transparency suggests the public may be being hoodwinked at a very basic level.

Let’s take the example of the government’s asset protection scheme, an insurance programme that has so far agreed to underwrite losses on over £600 billion of toxic debt from RBS and Lloyds alone. If the economy stages a sudden recovery the solution could cost the taxpayer almost nothing, but if things go completely belly up it could well be ‘game over’ for the public finances.

Either way, the government surely has a figure for expected losses in mind that it is not revealing, or has it just written hundreds of billions of insurance without understanding the risks involved (can you hear the scary ringing echoes of AIG?). Is the outlook not foggy enough that we must add our own smoke to the mix with unnecessary obfuscation?

Facing the Consequences of Your Actions
History is littered with examples of players in the financial sector reaping abnormal profits year upon year, only to shift the losses on to the taxpayer when it all inevitably blows up. This type of self-reinforcing looting of the system does not make for an effective free market and represents a woefully inefficient allocation of resources.

A core part of the solution to this problem involves addressing the problem of the global financial system’s interconnectedness, which can be almost thought of as almost a kind of ‘shadow keiretsu’.

Solutions to prevent the system holding the taxpayer hostage by threatening a cascade of blow-ups could involve limiting the size of firms and capping cross-holdings and other dependencies (through insurances and bond holdings) to reduce the level of interconnectedness that produced the type of systemic risk we face today.

Also framework of longer term solutions needs to be kept firmly in front of policy makers to prevent the kind of decision making and side stepping of competition policy that led to the Lloyds-HBOS merger, which will surely have ramifications in the years ahead.

Related to the above is the principle of holding people responsible to their actions. Equity holders of financial companies have rightly been wiped out in many instances, but bond holders could yet be give a ‘get out of jail free’ card by the government to avoid systemic collapse.

This just makes the situation worse by rewarding failure, transferring the loss to the tax payer, and creating an incentive for similarly bad behaviour in future years. Can it be avoided? Perhaps. On his Maverecon blog, Willem Buiter offers a ‘good bank’ solution that would punish bond holders accordingly. Whether this solution is workable or not, surely repeated failures through history are a signal that we need to err on the side of favouring the taxpayer and breaking the cycle of looting.

Protectionism
In times of crises, it is in our nature to put up the barricades and protect local interests. The G20 seems to be headed in the right direction, with China and others making positive sounds, but I think we need to put more effort keeping protectionism on the back foot.

In Europe we have heard the UK being accused of engineering a weaker pound to help exports – it is pure drivel, but these types of stories could lead to political calls for retaliation. More seriously, Switzerland’s decision on earlier this year to intervene in the foreign exchange market to “prevent any further appreciation of the Swiss franc against the euro” was a very worrying development.

As a small player in the global economy, the logic for a devaluation may be sound but it will only be effective if it isn’t met with retaliatory devaluations. Indeed, could Japan, once a serial intervener, use the Swiss action to green light devaluation of the yen, which is also trading very strong? It doesn’t take a wild imagination to envisage a round of devaluations followed by direct protectionism. This ‘everybody loses’ scenario can not be allowed to happen.

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The TUC is holding a free one-day conference on 16th November 2009: Beyond The Crisis, on the subject.

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