Before our eyes the financial crisis is accelerating into a downward spiral of nightmarish proportions. Today it was confirmed for the first time that the UK is officially in recession, as the effects begin to hit the real economy in earnest. Nobody expects things to get better before they get a lot, lot worse.
‘Decisive action’, we are told, is being taken to deal with the banks. The latest £50 billion guarantee package comes hard on the heels of the untold billions to ‘recapitalize’, or to provide ‘liquidity’, or just to keep the lights on a little longer in the hope that something turns up.
The government resembles a grimly optimistic hot air balloonist, spat out of a storm and crashing to earth while frantically pumping more and more hot air into the balloon, only to see it flow out of huge holes rent in the fabric of his craft. The pilot, lets call him Darling, will certainly delay the crash a little bit, but only at the cost of using up all of his gas. Once the basket hits the ground – in whatever battered shape – it will surely stay there.
Step 1: fix the holes
The balloon’s predicament mirrors our own. For the basket read the UK economy. For the balloon read the UK banking sector. For the gas read the supply of money, which the government can produce either by borrowing or by printing. Both are finite in the end. We can only borrow what others are prepared to lend, and there is even talk of the government having to turn to the IMF when the resources or patience of private creditors is exhausted. We can only print money to the extent that it holds its worth: ultimately runaway inflation lies at the end of that road, where we would struggle to print the stuff fast enough to keep pace with its plummeting value.
Policy must first fix the ‘holes’ and make sure that our money is used properly and effectively. The government is throwing money at the banks and exhorting them to lend, but they are using it to stave off insolvency and hold the excesses of the past at bay. Given their business models, this is the only thing they can do – it is not a matter of ‘bad’ bankers (although there are undoubtedly plenty of those) but ‘bad’ and discredited business models. This is what has to be fixed before anything else can happen.
We should stop messing about and move to full nationalisation of the major UK banks without further delay. In all probability this will happen anyway. The government already owns all of Northern Rock and most of RBS, but all the other banks followed the same business model, if less aggressively. All are laden down with ‘toxic assets’ that no amount of creative accounting can hide forever.
They need cash, and lots of it, and will almost certainly have to turn to the state for this sooner or later – their other options are either unpalatable or non-existent.
The government has said from the start that it would be a ‘passive investor’. It would provide cash for equity, but not insist on the control this equity would normally bring. The only possible logic for this is that the banks, uniquely, have the ability to turn things around and function in the public interest to support the real economy. This was never particularly plausible and now looks close to absurd.
The state should invest to take the banks into full public ownership now before any more money is frittered away. Given current share prices, this would cost little or nothing – the fact that the government is standing behind the banks is the only thing that has kept their valuation in positive territory anyway. It could then separate out and pool the toxic assets into a separate legal entity: a so-called ‘bad bank’. These assets can either be sold if conditions improve, or just held to maturity if not. This would just be a reflection of reality in many ways: the state has already underwritten these risks; we should make this explicit.
The holes in our balloon would thus be patched, and the remaining ‘good’ banks potentially ready to fly again. By not injecting new money until this was done, we would also have preserved the supply of gas to power this flight. The question then is what next?
Step 2: rebuilding the craft
Even the growing numbers of commentators that now argue for full nationalisation assume that, with a few tweaks, we can continue much as before. The assumption is that we should stabilise the banks under public ownership, get lending going again, improve the regulatory framework a bit, and then move the banks back into private ownership in much the same form.
If we get the regulation right this might avoid recreating the worst excesses we have seen, but it misses a broader point. The banking structure in the UK has long failed to serve large swathes of the real economy – particularly smaller enterprises, and many of our communities – particularly the most disadvantaged.
Headlines usually focus on the problems facing large corporations, but it is small and medium enterprises (SMEs) that are the real foundation of the economy. SMEs account for 59% of all private sector jobs, and generate more than half of private sector turnover – they are the incubators of our future prosperity, yet have long been ill-served by the high street banks.
The banks have withdrawn from disadvantaged areas, leaving widespread financial exclusion in their wake. For many poor people, financial services are either unavailable from the banks, or can only be accessed from loan-sharks on such exploitative terms that unsustainable debt become inevitable, with all the personal and social consequences that this entails.
This has not happened by accident. It is a product of a financial system driven to maximise returns for shareholders, and free to range in the outer reaches of the esoteric financial universe in search of these. Far from abolishing boom and bust, we have seen a boom of staggering proportions in the financial world: the returns available from serving the needs of local businesses and local people have looked very small beer in comparison to what could be gained in the global casino that has been international finance.
Just as this was no accident, neither is anything about it inevitable. One positive feature of the meltdown we are witnessing is that it should finally lay to rest the idea that if we just let financiers and business leaders get on with it, the best of all possible worlds will be the result.
Finance has been solely geared to maximising returns, usually over the shorter term. Even considered on these terms, however, it is difficult to say that it has done a particularly good job. But we also have other objectives – for example, in terms of social justice or the environment – which are not always the same as maximising returns, and may even run counter to them in some circumstances. As a society, we therefore have a variety of objectives – economic, social, environmental – and so need a financial infrastructure that is able to value outcomes in these areas, and channel funds to the organisations best able to achieve them.
Just as there is nothing inevitable about the financial system we have today, so there is no reason why we could not seize the opportunity offered by impending public ownership of the banking system to demerge, restructure and put in place a diverse financial infrastructure that reflects the diverse needs of society and is designed to serve these.
What actually are the services we needed from the financial sector? For individuals and families, these are: a safe place to save and access their money; a means of transferring cash to receive or settle payments; some flexibility with credit to smooth earnings; the ability to borrow and save for the longer-term for things like mortgages and a pension, and access to wider financial products such as insurance and investments, ideally accompanied by free and impartial advice.
These are very different services, and there is no reason to assume that they will be best supplied through the set of institutions we have grown used to.
Private businesses – large and small – need many of the same things as individuals, but also access to capital on fair commercial terms when it is needed so that they can invest for the long-term. They will also benefit greatly from the establishment of a durable local relationship so that flexibility of support can be given when needed.
Again, given the very different focus and size of the business sector – from multinational to local social enterprise – there is no reason to think our financial structure is well set-up to serve these diverse needs. Experience would very much suggest that it is not.
It is clear that we do not only wish to see investment in those things that can generate a competitive commercial return. There are other forms of ‘value’ that are of equal if not more importance. Many social enterprises now seek to generate ‘social value’ in terms of their impact upon society, while the environmental challenges we face are such that generating positive environmental ‘value’ is not so much an option as a necessity.
We need to invest in different forms of value for a more balanced society, but a financial sector organised to focus on maximising financial returns alone will not do this. We need to put diversity back into finance, with different institutions focusing on different goals and the creation of different forms of value. In some cases these will be mutually supportive goals, in others not. Many things that we should invest in as a society may not, necessarily, yield the highest financial returns, particularly in the short term. This does not mean we shouldn’t do them, but if our only criteria for allocating financial investments is relative returns over the short term, that is what will (and does) happen.
As we need and value different things, we should build a network of financial institutions in local communities to reflect this diversity and to invest in it for the long-term. These need to focus upon serving these communities, not chasing the latest bandwagon in the international derivatives markets – the best way to ensure this, is by giving local people a real stake, as owners, members, customers and employees. Some of this infrastructure already exists: credit unions and community development finance institutions (CDFIs) work to provide personal and business finance to local communities, for example. We can build upon these strong foundations.
There is also a strong case for combining private, mutual and employee-owned models with a permanent public presence. It is clear that we cannot rely on the market as the only coordinating mechanism – we need to retain a publicly-owned element to do this. The best and easiest way would be through the existing Post Office network, where we could create a ‘Post Bank’ – as exists in many other countries – to provide fair financial services and act as a ‘hub’ for the local infrastructure sketched out above.
Returning to our balloon, its fabric should be used to create many balloons of different sizes supporting the single basket of the real economy. Diversification – as every good banker used to know – is key to reducing risk. An economy supported by a small number of monolithic banks is inherently fragile, particularly when they are all herding into the same activities. When one fails, all fail.
A variety of different types of institutions serving different sectors in a variety of ways is far more resilient: the system can cope with failures in some areas, as it retains the support of others. If one balloon bursts, the basket does not fall.
Being close to the communities in which a bank invests is important. There is no substitute for local knowledge and the building of long-term relationships. Community level institutions have long known this, but need to be able to access finance to channel into the things that work.
This is not to say that all banks need to be small or all located in just one area. Diversity applies to scale as well as to ownership. Just as we need a local infrastructure with a variety of ownership models – private, public, mutuals, co-operatives and employee owned – so we need diversity of scale. Larger, national level institutions are also indispensable, to act as wholesalers and to ensure finance can flow between different parts of the economy, particularly from richer to poorer areas and into strategically important sectors, such as a clean energy infrastructure, for example.
People seeking to build social and environmental value are clearly not trying to maximise financial profits – their success or failure, and ability to access investment funds, should therefore not be judged on this basis. The government has been exploring the idea of creating a Social Investment Bank to act as a wholesaler, channelling funds to local financial institutions and socially-focused businesses. It is possible to see how such a bank could fit into a diverse financial infrastructure, performing specific functions at the national level, and linking with community-level institutions to achieve positive outcomes.
Although a social investment bank could, in principle, be set up as an independent social enterprise, there is also a real case for keeping a publicly-owned presence at the national level in some form. The challenges we face – whether dealing with pressing environmental or social issues – require a far more coordinated approach to economic development than we have seen. Expecting our economy to make the transition to a low or zero carbon trajectory, while addressing endemic poverty and inequality, in an uncoordinated way is, to say the very least, rather optimistic. We will need to put in place something akin to a green ‘industrial policy’, where investments can be channelled in a strategic manner as part of a coherent strategy.
There is no reason why such investments should not also be guided towards less affluent areas, thus addressing environmental and social goals simultaneously.
The key point is that diversity leads to resilience, but is also vital to reflect different needs and aspirations. It is these that the financial system should serve, and we have a unique opportunity to put in place a financial infrastructure to achieve this. We have called this an ‘ecology of finance’.
Step 3: chart a course?
Where then does this leave our balloon? Well, we have fixed the holes and have used the material to make a plurality of balloons of different shapes and sizes to support our diverse economy and society. The basket is more stable and resilient to shocks. Having stopped wasting our fuel, there is gas left to power our flight.
The question now is in what direction should we travel? We could stay close to our previous path and brave the storm again, or we could change direction entirely. We face urgent challenges, some new, some far older than they should be: climate change, ecosystem collapse, endemic poverty and inequality, low and unequal well-being. We also have vast assets to build upon to overcome these, many of them untapped, all of them under-utilised.
None of this will be easy of course. But if we can imagine a different type of financial system we can also build one. An ‘ecology of finance’ that serves the diverse needs and aspirations of individuals, communities and society could supply some of the vital tools we need, and set us on a journey to a sustainable future.