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The Credit Crunchand the Green New Deal. BByy AAnnnn PPeettttiiffoorr October 2008

“Since the 1970s we have been subjectedby our politicians to the ‘liberalisation’ ofthe economy. Under pressure from thefinance sector, politicians and centralbankers once again de-regulated finance,and celebrated their ‘light touch’ overprivate credit creation, and the setting ofinterest rates.”

Compass publications are intended to create realdebate and discussion around the key issues facing thedemocratic left - however the views expressed in thispublication are not a statement of Compass policy.

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The Credit Crunch aanndd tthhee GGrreeeenn NNeeww DDeeaallBByy AAnnnn PPeettttiiffoorr

The Credit Crunchaanndd tthhee GGrreeeenn NNeeww DDeeaallBByy AAnnnn PPeettttiiffoorr

‘Finance must be the servant, and the

intelligent servant, of the community

and productive industry; not their

stupid master”.

National Executive Committee of theBritish Labour Party (June 1944), FullEmployment and Financial Policy.

he world is now faced by aterrifying prospect: large scale,systemic and long-term economic

failure of a liberalised, highly integratedeconomy, popularly defined as‘globalisation’. This crisis was caused by thebursting of a massive bubble of privately-created credit, issued at high real rates ofinterest; rates which have now made thesedebts un-repayable.

The credit bubble was and is the productof actions of policy-makers, from the1970s onwards. It is the creation of centralbankers and political de-regulators, fromNixon through Reagan, Thatcher, Heath,Blair and Brown - not innocent home-buyers and borrowers. De-regulation,liberalisation, globalisation was cheered onby both Conservative and Labourpoliticians, and it was these frameworksthat enabled and encouraged financialinstitutions to inflate the biggest creditbubble in history.

Excessive ‘easy’ credit at high real rates ofinterest, inflated asset bubbles. In otherwords, easy money blew up bubbles inproperty, stocks and shares, brands, worksof art, vintage cars, and commodities likeoil, grains and gold. (The finance sector,engaged in special pleading, would have usbelieve that the housing bubble is a root

cause of the Credit Crunch. That is self-serving nonsense, and must be challenged.)

Assets are on the whole owned by therich, and so ‘easy money’s’ inflation of thevalue of assets explains why the rich grewso much richer over the last threedecades. Why those who owned aproperty, e.g. could borrow/leverage farmore than those who did not.

As we all know, the owners of assets donot need to engage in productive activity,and instead can live by collecting rent ontheir assets – whether in the form of rentsand returns on property, dividends fromstocks and shares, rent from theintellectual property on brands, or capitalgains from the sale of works of art etc.These are all effortless ways of becomingricher.

Those engaged in productive activity – theowners of small businesses, farms orcompanies, the waged and middle-incomeworking classes - have not enjoyed aparallel inflation of prices for their goodsand services, or of their wages or salaries.Indeed compensation as a share of thenational cake that is the economy hasshrunk over the last decades. To make upfor that, wage- and salary- earners andsmall businessmen and women have hadto borrow and get into debt, just to investin their businesses, or to pay for a roofover their heads, or to send their childrento university, or to stay afloat. They arenow burdened by debts, which becomeunpayable because of rocketing interestrates, or because of the shock ofbankruptcy or unemployment.

The first to fall victim to this process on alarge scale were the ‘sub-prime’ debtors ofthe United States – hit by a hike in rates,and a rise in job losses. But the UK has abigger debt problem than the US, and sodebt dominoes are falling all over theAnglo-American economies, and incountries like Spain.

Defaults and arrears on debts damagedthe balance sheets of highly leveragedbanks (who had used their mortgage

assets to borrow up to 35 times more)and precipitated the Credit Crunch ofAugust, 2007. Their leveraged borrowingand liabilities were hidden behind financialproducts deliberately obscured and madecomplex. As banks began to be damagedby defaults on debts that had become tooexpensive to repay, their complexity,secrecy, deception and often outrightfraud led to an evaporation of trustbetween banks. Inter-bank lending froze,which in turn threatened to freeze thewhole financial system. It was this crisis –which hit the headlines on 9th August,2007, a day we have dubbed ‘debtonationday’, that forced central banks to pump$150 billion - into the financial system tokeep it functioning. However this did nothelp.

More defaults led to major bank failuresand losses; notably the collapse ofNorthern Rock in the UK and BearStearns in the United States, and to thewrite-off of hundreds of billions of dollarsdebt. This in turn caused banks to cut backon new lending, and to raise interest rateson loans, worsening the crisis.

A bank is a place where they lend

you an umbrella in fair weather and

ask for it back when it begins to rain.

Mark Twain (1835 - 1910)

Despite this financial crisis, the Anglo-American economies have not yet, a yearlater, technically fallen into recession.Unemployment is still relatively low,although it rose each month for the lastseven months in the United States, andhas started to rise in the UK.

Unemployment is a key determinant ofthe ability to repay debts. People don’t, byand large, pay their debts by e.g. sellingtheir houses or businesses. They pay theirdebts out of income or revenue. Whenthis is cut, or dries up, debts are invariablydefaulted upon.

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With rises in bankruptcies and job losses,we can expect another wave of defaults,leading to deeper, more systemic bankingcrises. It is this negative feedback loop –between the real economy and theimploding finance sector – that poses thebiggest threat to the global economy. Bycontrast a positive feedback loop is whatis accelerating climate change – and posinga parallel threat to national andinternational security. The one – easycredit – has fuelled the other. That is, easymoney has fuelled easy shopping(consumption) which in turn has fuelledthe growth in fossil fuel emissions by e.g.the coal-fired factories of China, producinggoods for consumption, paid for oncredit cards, i.e. debt.

This Thinkpiece considers thefinancial crisis in the context of aproposal by a group of ‘neweconomists’, of which I am one, for aGreen New Deal (new economicsfoundation).

How did we get here? By ignoringthe lessons of history.

The massive deflation/de-leveraging ofcredit and debt that is now cascadingthrough the banking system and rapidlydeflating the value of housing and otherassets in the Anglo-American economieswill precipitate large-scale, globaleconomic failure, for years to come. Thetragedy is that our predicament is theresult of ignoring, denying and evenconcealing lessons known to ourpredecessors, especially those that dealtwith the Credit Crunch of the 1920s and30s. The most important of these lessonsis that the interests of the private financialsector are opposed to the interests ofsociety as a whole, and therefore have tobe carefully regulated by bodiesaccountable to the public.

Central bankers and elected politicianshave, since the 1970s gradually transferredto the private finance sector powers tocreate credit effectively out of thin air. Inaddition the private sector, notably theBritish Bankers Association enjoys the

extraordinary power of being able to fixthe price of this credit – the rate ofinterest, in this case the LIBOR rate (theLondon Inter Bank Offer Rate). Becausepowers to create credit and fix interestrates are such an extraordinary power,they have almost always been strictlyregulated and governed by central banksand governments. The periods duringwhich credit creation and control overinterest rates escaped regulation haveinvariably ended in disaster, most notablythe Great Depression of the 1930s. Thatcatastrophe led Keynes and Roosevelt toapply system-wide regulation that lastedfor three decades after the war – a period

now often defined as ‘the golden age’ offinancial stability.

Since the 1970s we have been subjectedby our politicians to the ‘liberalisation’ ofthe economy. Under pressure from thefinance sector, politicians and centralbankers once again de-regulated finance,and celebrated their ‘light touch’ overprivate credit creation, and the setting ofinterest rates.

The dangers of de-regulation

Because the creation of unregulated creditis almost costless; because the gains are soextraordinary; and because the privatesector believed for too long thatunregulated credit was without risk, theylent without limit or caution. Their massive,effectively unearned gains were then usedto gamble recklessly.

In order to make gains on lending, many inthe finance sector deceived fellow bankersabout the creditworthiness of their

borrowers and about the value of assetson their books. They used false accountingto borrow more on international capitalmarkets; paid large fees to rating agenciesfor inaccurate ratings on some veryquestionable assets; paid even larger feesto organisations like AIG to insure theseassets, and mis-named them CreditDefault Swaps. (They’re not swaps at all,just a form of un-regulated insurance, forwhich there appears to be very little‘collateral’ with which to meet claims.)They then used these dodgy ratings andthis ‘insurance’ to entice investors likepension funds into buying their financial‘assets’.

Market players, earnest centralbankers and commentators call thismisleading and fraudulent activity‘mispricing risk’. In fact it is simplyunethical behaviour. Outrightintentional deception was employedto deceive bankers, investors(including pension funds) andregulators as to the true state of afinancial institution’s liabilities. Onlywhen this deception ‘debtonated’ on

9th August, 2007 did a more accurateassessment of liabilities become possible.Today, in September, 2008, central bankscontinue to scramble to make sense ofthe scale of outstanding liabilities. It is clearthat even now, they do not know what isowed, and to whom.

Because of their ignorance of the scale ofthe debts, and therefore the scale ofinsolvency within the financial system,central bankers have rushed to pour‘liquidity’, or new loans, into the bankingsystem. However, more liquidity, we havelearned, does not address the root causeof this crisis.

The root cause is a build-up of a bubbleof excessive and unpayable credit/debtswhich have led to widespread insolvency.This includes the insolvency of banks andother shadow financial institutions; theinsolvency of companies and theinsolvency of individuals and households.Insolvency – as all civilised westernbankruptcy law accepts - can only be

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‘We have to put a stop to

this financial system

which is out of its mind

and which has lost sight

of its purpose.’

President Sarkozy quoted byReuters, 26th January, 2008.

addressed by writing off, or re-structuringdebts. This clears the slate, enables thedebtor to start again, and by doing so,restores the economy’s overall health.

How to restore stability to the economy.

In order to salvage the global financialsystem it will be vital to recognise thisreality and declare a Grand Jubilee of debtcancellation, to enable debtors to write offunpayable debts, and to allow banks torestore their balance sheets to health. Thatway the economy could get started againtoo.

However, such a proposal might wellprove unpalatable to financial institutions.The only alternative then, if we are tosalvage the financial system, is to raise theincomes of those that must repay debts.Indeed, the UK Labour government’spolicy of holding down incomes as thedebt crisis accelerates is counter-intuitive,and poses a fundamental threat to theinterests of the City of London. MervynKing, the governor of the Bank of England,in his June 2008 Mansion House speechwarned that mean average real take-homepay will stagnate this year and the squeezeon real income growth is likely to meanthat both house prices and consumerspending weaken together. But it will alsomean an increase in debt defaults.

The situation is already becoming urgentin the United States, where thephenomenon of ‘jingle post’ has emerged.The implicit social contract that ensuresthat debtors have sufficient income torepay debts has broken down, and sodebtors are taking matters into their ownhands. Unable to repay their mortgages,increase their incomes or secure theirjobs, they simply pop the keys of theirproperty into the post, return it to thebank, and walk away from their debts. Asthe scale of these defaults rise, so theauthorities lose control over theenforcement of debt payments, and overthe financial system as a whole. Only untila new social contract is established, eitherthrough debt cancellation or throughhigher incomes for debtors, can we expect

the financial system to be restored tostability.

A system-wide transformation.

The Green New Deal goes further andproposes the re-regulation of the financesector, in particular careful, system-wideregulation of the finance sector’s powersto create credit, move capital abroad, andcontrol the rate of interest.

To achieve this we we must end thegovernment’s and the Bank of England’spolicy of ‘inflation targeting’ – just acover for keeping interest rates high, andwages low. High interest rates are greatfor lenders/creditors, but a killer fordebtors, and there are far more debtors inthe economy than savers. And if we areto face both this financial crisis, and thethreat of climate change, we need cheap,but not easy, money to help financeinvestment in energy security.

Next the Bank of England and the Fedshould regain control over interest rates –all rates. The interbank lending rate(LIBOR) should no longer be set by aclosed committee of private bankersmeeting daily at the British BankersAssociation. They must be set by acommittee accountable to society, and,when setting rates, must consider theinterests of all who make the economywork – labour and industry – not justfinance.

To once again exercise control over allrates, the Bank of England will have to re-introduce capital controls. That mightrequire a new international agreement,along the lines agreed at Bretton Woodsin 1947.

Such changes are vital if we are to dealwith this crisis. But they are vital too if weare to do with two other major ‘crunches’.The coming oil crunch, and the comingclimate change crunch.

How to create jobs

To create jobs it is vital that central banksbuild a framework of sustained, low ratesof interest to enable affordable public andprivate investment in the Green NewDeal’s proposals for “a massive £50 billiona year public and private spendingprogramme to slash fossil fuel use anddramatically increase energy efficiency andrenewables’ use in every building in thecountry. This programme, focusing initiallyon the goal of ‘every building a powerstation’ will involve traditional energy-saving measures such as insulation throughto large-scale combined heat and powerand a greatly accelerated uptake ofrenewable technology. The Green New Deal will generate highskilled jobs in energy analysis, design andproduction of hi-tech renewablealternatives, and large-scale engineeringprojects such as combined heat andpower and offshore wind. Lower skilledwork will include loft lagging, draughtstripping and fitting more efficient energysystems in all the UK’s homes, offices andfactories.”

New political alliances

In proposing such a strategy, we hope tocorrect a number of critical oversights.These include the ways in whichenvironmentalists have tended to neglectthe role of the finance sector andeconomic policy; how those involved inindustry, broadly defined, have failed tograsp the malign effects of the financesector on the overall economy; and howtrade unionists have for too longdownplayed, or under-estimated the roleof the finance sector and the threat ofclimate change.

We hope that the publication of theGreen New Deal pamphlet by the neweconomics foundation will help bringthese diverse social and industrial forcestogether, leading to a new progressivemovement. An alliance between thelabour movement and the greenmovement, between those engaged inmanufacturing and the public sector,

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between civil society and academia,industry, agriculture and those workingproductively in the service industries.

Such a political alliance is vital if we are tochallenge the dominance of the financesector in the economy, its threat to theproductive sectors of the economy, itscorruption of the political system and itscorrosion of social and environmentalvalues.

All of this is do-able. Indeed urgently do-able. They are the system-wide fixesneeded to deal with systemic threats, andthe public expect the guardians of thenation’s finances and of the nation’ssecurity to implement these system-widefixes promptly.

Download a copy of A Green New Dealfrom the New Economics Foundation at http://www.neweconomics.org

The full length version of this Thinkpiecewill appear in Soundings journal issue 40,out in November

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