The last week has been interesting in the world of finance.
Greensill Capital collapsed. The provider of what might best be described as unusual forms of supply chain financing to what seem to have been vulnerable companies unable to offer what seem like conventional security for loans, the model ran out of steam despite the support of former Prime Minister David Cameron.
Significant numbers of companies are left vulnerable as a result, from the UK's third-largest steel manufacturer to banks that had provided Greensill with its funding. They bet that they could fund a reward from financial engineering failed, as is so often true, and the edifice has collapsed.
Some of the same banks that will lose on Greensill, and most especially Credit Suisse, seem to also be exposed as a result of the collapse of the private hedge fund, Archegos Capital. That this was predestined to failure seems to have almost been assumed by its name, but still the banks funded it.
And as, once again, has happened before, providing funding for stock gambling has proved to be very expensive for those involved. Eventually the egos on display in these environments overrule sense. The cost is always significant. It will be many billions in this case.
Neither of these failures is the least bit surprising. Each relied on a punt that continual funding of leveraged financial positions would by itself provide the security required to make repayment. In effect, the size of the punts would, it was presumed, create growth that would yield the return to justify the risk within the differing, and yet similar in the sense that they were financially engineered, positions taken.
There is nothing new about this. The whole 2008 crisis was based on false assumptions of similar sort that by forever extrapolating a position no breakpoint would be found. Before that there was the failure of Long Term Capital Management in the 1990s. And there are ample others. The fool, whether they be technically described as a banker or not, and their money seems always to be willing to part with their money when offered returns that can only be realised if a market can continually grow.
We could, at one level, shrug this off. Both failures will be costly. David Cameron looks dodgier than ever. Some banks have been bruised. C'est la vie, it could be said. But that would be unwise.
I noted an article on inflation risk in the FT by someone called Andrew Parlin. To describe him as an inflation fetishist would be fair, but at least he had the honesty to lay bare his fear. He said:
[A]n entrenched inflation such as we have not known in decades and the need to slam on the brakes through aggressive rate tightening [is the risk that exists]. Given how inflated asset prices are, the bust that would follow would probably be unusually severe and protracted.
What he is suggesting is that there aren't just isolated examples of excessive risk-taking on the basis of asymmetric betting right now, but that the entire financial market is currently built in it. Asset values are, as he is honest enough to admit, utterly distorted. The distortion has been created by low interest rate policy, linked to low inflation.
There is an inverse relationship between both low interest rates and inflation and financial asset prices. If financial assets pay broadly steady returns but interest rates fall asset prices rise to approximately equate the two. If inflation is also low then there is an extra boost for asset prices as lower risk discounts need not be applied. Both situations have existed for so long now asset prices are seriously over-inflated.
Parlin's naked fear is that this situation might reverse if there was to be inflation, and that to prevent that asset price crash then the real economy must be sacrificed, in his view. Unemployment, austerity, and small-town corporate failures must all become the norm to maintain orderly asset pricing, even when it is recognised that those prices are seriously over-inflated.
Leaving aside questions of desirability (because it is patently undesirable to do this) and necessity (which is doubtful, as the inflation paranoia on display is not based on real-world risk, but on textbook ones instead, and the textbooks are wrong) what Parlin is saying is that financial markets are one entire asymmetric risky bet, all premised on the idea that interest rates will stay low in perpetuity. That may be true. But, when everything else in the economy has to be sacrificed to making good on that bet it is clear that the risk has moved from being routine to asymmetric. In other words, it can only continue to be justified by the perpetuation of the bet itself. That is the logic of the Ponzi, or pyramid selling scheme, of course. And that is where the whole of financial markets are.
Parlin wants effort to be directed to maintain this edifice. I rather suspect some self-interest in that desire. That self-interest might taint the views of many. But it should not stop us from realising that once a bet reaches this stage it is always, eventually, going to fail. It is only time before financial markets must adjust to the very obviously absurd valuations implicit in them.
That is not because interest rates need change, because I doubt there will. There is, in my opinion, almost no inflation incentive for that to happen. It is instead because the risk evaluation within markets is wrong. Most assets are being valued as if they offer near-guaranteed returns. But that is not true.
In finance, returns will fail because the bets are all wrong.
In energy, returns will fail because we have to reduce oil dependency.
In raw materials, returns will adjust to declining consumption.
In retailing, returns will fall as the shop beings increasingly irrelevant.
The same will be true in commercial property.
And the transport sector has not yet priced the adaptation to alternative energy, sufficiently.
Whilst tech has not priced changing tax rules.
Markets are going to decline because they gave mispriced risk. Oddly, inflation is not one of those risks. But that will not prevent a fall. The fall has simply been deferred by low inflation and low interest rates which have disguised the real risk of fundamental economic change.
Greensill and Archegos have failed because of mispricing risk, believing financial engineering can offset the real underlying economic factors that they chose to ignore. The signal that they provide is that the whole market is doing the same thing. But that does not mean we crash the real economy to maintain the financial edifice. We do instead invest in the real economy to create new worth.
We have to consign the era of financial engineering to history. But will we? It's an absolutely fundamental question.
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“…. we crash the real economy to maintain the financial edifice.”
A very perceptive phrasing of the problem, if I may say; and a neat summation of the solution found to fix the 2007-8 Financial Crash; and of the Neoliberal economic consensus for the last forty years of boom and bust.
I would say there is next to no hope this financial engineering will stop,the gaps always occur.Regarding the affair regarding Archegos Capital the same happened with my own bank,the Cooperative bank, a few years back . When a huge hole appeared in their accounts it turned it that the FCA nor anyone else had been watching the bank and the incredible excuse given was that as its parent company was “non finance” and so escaped the need for financial supervision!. You really have to wonder how many of these “gaps” exist, my bet is there are way too many.
Fundamentally though I think that as long as the day to day payments system is safe we can largely ignore such blow ups. There will be huge losses time to time,seems you just you can’t top cyclical events, but as long as regular peoples'(non financial) payments and deposits are unaffected the economy will carry on regardless. This requires a safe payment system, the longer we have banks linked to risky bets and also being responsible for our payments system, we will be continually looking over our shoulder at the next financial crash.
This is a very peceptive, but frightening, analysis. Low interest rates have driven over-leveraged debt-financing and this has driven asset prices to unsustainable heights. We’re now at the point where the financial system is like Wile E Coyote over-running the cliff edge and is, momentarily, suspended in mid-air – before crashing to the ground.
I can’t see how an orderly re-balancing of portfolios can be effected. If central banks try to get a grip it’ll make the “taper tantrum” of a while back look like a parish bun-fight. It genuinely is a frightening prospect. And, as usual, it’ll be those at the bottom of the economic pile who’ll suffer most.
Correct
[…] By Richard Murphy, a chartered accountant and a political economist. He has been described by the Guardian newspaper as an “anti-poverty campaigner and tax expert”. He is Professor of Practice in International Political Economy at City University, London and Director of Tax Research UK. He is a non-executive director of Cambridge Econometrics. He is a member of the Progressive Economy Forum. Originally published at Tax Research UK […]
Does this mean that the ” authorities ” haven’t learned from the 2008 crash ?
And are we going to crowdfund an appeal to help out ” Dodgy Dave ” in his hour of need ?
I read the article you cite and was moved to comment “below the line”, something I rarely do in the FT. I am sure you can imagine the gist of what I said!
To be frank, I don’t think financial engineering here is the problem. Both failures are remarkably straightforward and have occurred countless times. So, what are the reasons for failure at Greensill and Archegos (or Arch Egos as someone quiped!)?
The boss of Archegos is well known as a massive punter and a crook (insider trading). Greedy investors saw the returns he was generating and wanted a slice of the action and have had their comeuppance. Greedy bankers lent him too much money against too little collateral on the promise of fat margins and large trading commissions. As the value of the collateral fell, Archegos could not make the margin payments so the collateral was liquidated….. with Goldman Sachs and Morgan Stanley at the front with Nomura and Credit Suisse left trailing behind and nursing losses. Lots of people looking stupid and feeling poorer but NO systemic issues. Frankly, this sort of thing happens quite often…. but very rarely at this scale (excluding 2008, LTCM in 1998 was the last biggie and that time the Fed intervened) and with much better capitalised banks, the losses are not significant in the grand scheme of things. So, I am not sure that the Authorities should care about this…. although there should be some examination of the paper trail between compliance/risk and the business units. Where risk/compliance were overruled these bosses should be declared not fit and proper to be in the business. Compliance/risk MUST be respected and a few sackings are required “pour encourager les autres”.
It would be rather nice if these people spent their time more productively but “it’s a free country and their money to lose” or “being stupid is not against the law”.
Greensil is different. There appears to be fraud/corruption (as well as the standard stupidity and hubris) and quite a few bystanders got hurt in the fall out. It illustrates one of the problems of banking regulation – we can tighten up on “proper” banks but the business leaks away into the shadow banking system. One approach is to draw a line and say once you go away from “proper” banks it is caveat emptor….. it makes intellectual sense but in practice it is not so simple for lots of reasons (too many to enumerate here). In short, the fraud perpetrated here is as old as the hills and I really don’t know what the answer is.
To the BIG question – how do we get out of this situation? The key is that the banks are now vastly better capitalised than before – eg. a Brexit stress test found that a 40% drop in house prices could be handled by the systemically important banks. So, I would gradually tighten credit conditions by raising margin lending requirements and limiting bank lending in certain sectors. I would keep real short rates negative and allow long rates to be roughly zero (1% and 2% in nominal terms at present) and do this by QE/bond sales as required. This would put the cat among the pigeons but that is fine as long as government stands ready to deliver real financial support to real people and businesses. I would also encourage a bit of inflation to cushion asset owners (and I am thinking home owners) from too larger nominal falls in price.
Much to agree on
An interesting comment, but unfortunately it doesn’t take us very far. ‘Caveat emptor’ is over-rated as a serious check on very much at all in the modern, digital globalised (in scale and reach) world of surveillance capitalism.
“Where risk/compliance were overruled these bosses should be declared not fit and proper to be in the business. Compliance/risk MUST be respected and a few sackings are required ‘pour encourager les autres'”.
We do regulations badly and under resource it (in terms of both scale and effectiveness; we are not serious about it – it is designed to fail). Regulation that is always and invariably ex-post the horse having bolted, and lacking adequate retribution in any case is in ‘chocolate teapot’ territory. I hear this kind of appeal every time, and we all know it is mere hand-wringing. It will happen again next time. And again. And again …. (on a larger and larger scale); and we know that too is inevitable.
“One approach is to draw a line and say once you go away from ‘proper’ banks it is caveat emptor….. it makes intellectual sense but in practice it is not so simple for lots of reasons (too many to enumerate here). ….. I really don’t know what the answer is.”
A fair summation, but what this unfortunately shows is that you are defending an intellectual framework that you know does not work. If it worked you would not be arguing “I really don’t know what the answer is”. We are going round in circles. Perhaps the essence of your position is ‘this is the best we can do – and this deeply flawed, dysfunctional system is the best we can do’?
I have great respect for your knowledge and insights in this specialist area, Mr Parry; but this is your argument, and I merely draw these conclusions from the logic of your position. I am not convinced.
You are right, I have not taken us very far! I wish I could do better. The problem is human greed so I am sure you will forgive me for failing to find an answer.
You may have noticed that I failed to deliver “the answer” in my reply; my objection is that we are not trying hard enough to re-think the fundamentals. I don’t think the standard shrug of the shoulders at human greed is quite enough; there is more to the insidiousness of the problem than greed alone.
Forgive me if I return to this, but ‘caveat emptor’ is one of the longest established first principles of business. It is appealed to be government an business frequently, and it often enough , when they should have actedallows both to sit on their hands; but that is ‘small beer’, after all there is an obligation on the buyer to take some responsibility for decisions made (at least that is the argument).
It does not work in the digital economy. The key principle of this 21st century, instant consumer-commercial market, is a concept first established by Schumpeter, but only in the last decade or so, taken up wholesale by the big global internet players. This principle, following Schumpeter is termed “permissionless innovation” (see Zuboff, for example who discusses this). The important point about permissionless innovation is that it has vested the digital economy with enormous legal authority; this is the crucial ingredient, and it has real consequences. Consumers are now just pawns being moved around a board over which they have no control and know nothing. They have surrendered their power, and rights for the advantage of convenience and instant gratification.
The real consequences of this are yet to play out, but the awareness of it, at the political level is – frankly – abysmal.
That should read: “Forgive me if I return to this, but ‘caveat emptor’ is one of the longest established first principles of business. It is appealed to by government and business frequently, and it often enough allows both to sit on their hands, when they should have acted to prevent harm;”
What can I say of the garbled version? – I am a hopeless editor of my own comments. Apologies.
Where human greed’s the problem the solution would seem to be not to create
greedy humans. The Indians (early American variety) and the Inuit seem to have managed, where are we going wrong? This is why I voted Corbyn, incidentally, as he had Attlee’s policy of doing away with the public school system which would have stopped the creation of damaged ‘elites’ like Osborne, Cameron and Boris all unable to see beyond their own advancement, to the detriment of society as a whole. I’m not keen on the family as a social unit either – what happened to tribes?
‘But will we?’
Maybe – but not quickly enough.
You have Snyder’s model of ‘inevitability politics’ and the Neo-liberal reliance on ‘ignorance’ (as identified by Mirowski) and its ability to infiltrate and re-purpose Government.
And then, just as something like 2008 comes along and people begin to question everything, there is a life extension programme for Neo-liberalism called ‘Facism’ and authoritarianism (another trait of Neo-liberalism that both Snyder and Mirowski mention) – where everyone but the bastards who caused it are blamed and you defeat dissent.
There you go. I have no problems with anything you have said. It’s the means of the ending of financial engineering that is the problem. And it has to start I feel with the politicians first.
With high level corruption like this apparently happening, there’s not much chance of seeing the necessary regulation https://threadreaderapp.com/thread/1376834906957955073.html
Meanwhile the FCA appear determined to look the other way in order to protect financial predators
https://financefeeds.com/85-year-old-woman-behind-fake-london-binary-options-firm-addresses-exposed/
This is about financial matters that are beyond me but what bothers me is that the magnitude of the ecological and climate emergencies has not been factored in.
The Covid epidemic has forced governments to listen to medical scientists but they are still not listening to the ecological and climate scientists.
Sir David Attenborough has illustrated the enormity of the loss of biodiversity. (https://www.bbc.co.uk/news/science-environment-54329813)
Sir David King was a senior scientific advisor to the governments of Blair, Brown, Cameron and May. At the end of Mark Carney’s recent Reith Lectures, King said “SCIENTISTS BELIEVE THAT THE MELTING OF THE POLES HAS PASSED A TIPPING POINT … [By] 2050, countries like Vietnam will be so frequently flooded that they will be effectively unable to sustain a population.” (https://www.bbc.co.uk/sounds/play/m000qkms).
Ministers often refer to ‘net zero 2050’ but none speak of the cataclysm we are heading into. Nor is there government support Caroline Lucas’s Climate and Ecological Emergency Bill.
For millions of years, there was a balance: heat was kept in by the carbon dioxide ‘blanket’… while white ice reflected out about the same quantity of heat. There is grudging acceptance that the increase in carbon dioxide concentration has caused the planet to heat up [Though the acceleration of the process is ignored by governments and those with fossil fuel interests]. A few know that this extra heat has melted snow and ice — but not of the catastrophic consequences.
In simple terms:
1 The increased concentration of CO2 has caused millions of square miles of ice to melt in the Arctic, Greenland, the Antarctic and from mountain glaciers.
2 90% of the sun’s heat that hits white ice, bounces back into space. For the dark land and sea that was beneath the ice, it is the other way round; these absorb 80% of the sun’s heat.
3 The land-and-sea that has been warmed, now warms the air. Warm sea and air together melt more ice. With an even smaller area of ice, even less heat is bounced back into space … so more ice melts … creating more heat … and even more melting.
4 There is no longer a balance: MORE heat is kept in – and – LESS heat is reflected out.
5 Temperatures are now rising more rapidly.
6 They will continue to rise and rise … unless there are large scale interventions.
7 The melt-water raises sea-levels relentlessly. When water freezes, it expands — which is why it floats. When it melts, it shrinks to the same volume as the sea that was displaced by the ice. The Arctic has floating ice, so when it melts, it does not contribute to sea-level rise. However, the loss of whiteness, helps to melt land-based ice — which does cause sea-levels to rise.
8 When land-based ice melts, the melt water raises the sea level and the loss of white causes more melting.] (https://www.bbc.co.uk/news/av/science-environment-50701438)
9 Water expands when heated — which adds more to the sea-level rise — but slowly.
10 Melt-water plus thermal expansion will go on raising sea levels for centuries (https://www.nature.com/scitable/knowledge/library/modeling-sea-level-rise-25857988/)
11 Places threatened include cities with large populations: Shanghai; Hong Kong; Mumbai; Calcutta; Jakarta; Ho Chi Minh City; Osaka; Chittagong & London. And, local to me in Dorset, smaller populations in Bournemouth, Poole, Wareham, Weymouth, West Bay and Lyme Regis.
According to Sir David King, governments need to:
A HALT ALL EMISSIONS as rapidly as possible.
B EXTRACT CO2 from atmosphere every year by a range of biological and other methods. Many peat-bogs which have been destroyed, and forests, could be restored to help absorb millions of tons of carbon using natural ecosystems. If done correctly, this would also reverse the ecocidal destruction of wildlife populations. (https://www.iucn.org/resources/issues-briefs/peatlands-and-climate-change.)
Immediately, the government could:
i. Urge the public to use as little energy as is safe – electricity (yes, we need to be frugal with electricity), gas, petrol, diesel etc.
ii. Discourage air travel with a heavy flying levy; and a doubling of the levy for each extra return journey.
iii. Act as if human lives and COMING GENERATIONS matter more than economic growth, luxury, sport and entertainment.
According to award-winning climate change communicator, Professor Katharine Hayhoe, ‘burning fossil fuels not only produces visible pollution and smog, but leads to nearly 9 million premature deaths each year, three times as many as Covid’. An option, she says is ‘clean energy that means you may have to see some white towers on your horizon’.
Professor Kevin Anderson of Manchester University: “Globally the wealthiest 10% are responsible for half of all emissions, the wealthiest 20% for 70% of emissions. If regulations forced the top 10% to cut their emissions to the level of the average EU citizen, and the other 90% made no change in their lifestyles, that would still cut total emissions by a third.
If we were serious about this crisis we could do this in a year — if we were really serious we could do it in a month, but we are not and our emissions just keep rising.” https://www.theguardian.com/environment/2020/jun/26/leading-scientist-criticises-uk-over-its-climate-record
Thank you
This is why I also do sustainable cost accounting
I wonder whether the driving force for the asset bubble is more prosaic? There was a flurry of articles some years ago about the so called shadow banking system, not a system at all, but a euphemism for the trillions of cash swashing around the globe as the various corporate owners seek speculative returns on their respective monetary oceans. Add to this the trillions of liquidity gushing into the banking system itself via QE that states refuse to inject directly into infrastructure and surely everything is in place to guarantee global asset bubbles? Is there any theory, misplaced or otherwise, necessary to explain this? Create cash oceans without the need or incentive to invest in the real economy and the consequence, by definition, is an unregulated global casino. Money is plentiful, but in the wrong place and controlled by the wrong people.
There is an uncanny match between the corrupt, and their business cards, that I can’t get out of my head.
Seems that the USA does it “bigger and brasher” but the uncanny match tells us a lot.
Felix Sater, Russian/American mobster, sported a card saying “Senior Adviser to Donald Trump”
Lex Greensill is now reported as having a very similar “Senior Adviser” card.
[…] Cross-posted from Tax Research UK […]