COMMENT: MONEY MATTERS

Articles on this blog are intended to introduce the reader to the nature and shortcomings of our financial system and ways to change it to free us from debt slavery

Banking time bombs

Samah El-Shahat, Al Jazeera's resident economist, will be writing a regular column analysing key elements that have contributed to the global financial downturn and its impact across the world.

The trickle-down effect don't work
As a development economist, I have seen many economics theories or so called 'magic bullets' for the world's ills come and go.
No, I am not that old, but economics, like fashion, has many theories that come and go and then make a come back retro style.

The problem is some of them have been largely discredited but they still make a return becaue they serve the interests of those with influence and power. So it has always been politically convenient to dress up self interest in intimidating and opaque economics jargon.

During the 1980s and 1990s, the World Bank and the IMF believed that something called the 'trickle down effect' could save the world's poor.
In rough terms, 'trickle down' means if you give the rich tax breaks and support their industries, the wealth they create will ultimately benefit poorer people.
That is, money, just like rain, will start trickling down to us all. A theory that never worked, and African and South American countries that were made to pursue it got poorer not richer, and the poorer of those countries ended up paying a very high price

John Kenneth Galbraith, another economist, calls this the horse and sparrow theory: "If you feed the horse enough oats, some will pass through to the road for the sparrows."

So how does this apply to today's banking crisis?

Well, it is very relevant because governments across the world, but particularly the US and British administrations, are solving the financial crisis with a top-down approach.
They are hoping if they shower rich bankers with money and use taxpayers' cash to underwrite their banks then, ultimately, some money will flow down to us.
Over optimistic William Cohan, a well-known American journalist, questioned this recently in the New York Times.
"Why is so much effort being put into propping up those at the top of the economic pyramid — the money-centre banks, the insurance companies, the hedge funds and so forth — when, during a period of deflation like the one we are in, any recovery will come only by restoring the confidence of the people down at the bottom of the pyramid."

But given that a lot of these banks are ZOMBIES - and by this I mean they are dead, but are walking among the living thanks to taxpayers' money.

I believe resting our economic futures on their resurrection is taking optimism a step too far. Look how much bad debt they have on their balance sheets.
Economists such as Ann Pettifor and John Kenneth Galbraith believe that the banks will use all the taxpayer money that comes their way to recapitalise themselves.
The banks will try to cover huge holes in their balance sheets due to the toxic debt they have. They should, instead, be using this money to start lending to us again - you know the real economy. This is what the banks are supposed to be doing.


Unemployment in the US is rising, fuelling fears more homes will be repossessed [AFP]

The 'trickle down' has been captured by the banks and this will continue slowing down our recovery, and I find that very frightening.

So how could this happen?

Governments are trying to find solutions to this problem that are dictated by the interests of the banking and financial sectors.

But when did the interests of the financial sector become the interest of the country?

Particularly when unemployment in America is estimated to go over ten per cent. Has anyone asked a person who is losing their home how they feel about this?

Simon Johnson, a former IMF chief economist, recently said: "Throughout the crisis, the government has taken extreme care not to upset the interests of the the financial institutions or to question the basic outlines of the system that got us here.

"In September 2008, Henry Paulson asked Congress for $700 billion to buy toxic assets from banks with no strings attached and no judicial review for his purchase decision.

"Many observers suspected that the purpose was to overpay for those assets and thereby take the problem off the banks’ hands, indeed that is the only way that buying toxic assets would have helped anything.

"Perhaps because there was no way to make such a blatant subsidy politically acceptable, that plan was shelved."

'Business as usual'

So I am still astonished that that governments are still hell-bent on maintaining the status quo, the business as usual approach that got us into this mess in the first place.

Has a single bank management been made to change despite being the source of the mess? Has a single bank been truly nationalised in the real sense of the word? Has any real clean audit of a bank happened? And please let's not bring up stress tests that were made to make sure everyone passes...

For every one of those questions the answer is a loud and resounding NO.

Some of the banks are now being allowed to payback some bailout money - banks such State Street and JP Morgan Chase. But they are being allowed to do so without revealing the extent of the toxic assets on their balance sheets.

"I fear these banks are walking time bombs... freed from any noose or hold the government had over them because they have paid back their bailout"

We are none the wiser than we were at the start of this crisis as to how truly 'insolvent' they are.

Yes, I hate to bring up that word but just because they are paying back some Treasury Asset Relief Program money doesn't make them healthy. Remember, they are using taxpayer money to pay the taxpayer back.

The Obama administration had a plan to get rid of these toxic assets called the Public Private Partnership Investment Partnership - the PPIP.

And even though the PPIP gave investors and Wall Street incredible inducements, and huge taxpayer subsidies to buy and sell these toxic assets, the banks did not play ball.

The plan was laid to rest last week, which is extraordinary because it was the central plank of the Obama administration's plan to rescue the banks.

I think this is disastrous. Not because I liked the PPIP, I thought it was grossly unfair and I agree with the economists Paul Krugman and Joseph Stiglitz when they said it transferred taxpayers money to the banks.

But at least the PPIP tried to deal with the toxic assets that got us into this mess in the first place.

Now I fear that these banks are walking time bombs, which are now walking away, freed from any noose or hold the government had over them because they have paid back their bailout.

And if we do not get an economic recovery soon, the toxic assets on the banks' balance sheets will detonate and bring us all down with them.

The banks are gambling on the green shoots of a miraculous economic recovery, which I think is delusional and shame on those in power for allowing them yet another chance to gamble with our economic futures.

Samah El-Shahat also presents Al Jazeera's People & Power programme.
The views expressed in this column are the author's own and do not necessarily reflect Al Jazeera editorial policy.

Source: Al Jazeera