THE LIFEWORTH REVIEW OF 2008

From bail-outs to better capitalism

People began to realise just how bad the situation with the financial industry was when governments began bailing out major banks and insurers. They started in the US, in March 2008, with investment bank Bear Stearns. Then, in the space of ten days in September 2008, the two mortgage giants Fannie Mae and Freddie Mac were taken over by the federal government as was one of the world’s biggest insurers, American International Group (AIG). During the same period the four remaining large independent banks disappeared. Lehman Brothers was allowed to fail, Bank of America acquired Merrill Lynch at a discounted price while Goldman Sachs and Morgan Stanley turned themselves into regulated banks.

The Federal Reserve System (Fed)’s lax monetary policy, leading to abundant liquidity in the system, and loosening lending practices combined to cause a crisis in sub-prime mortgages in the US. What transformed this into a global financial crisis was the complex and opaque securitisation process and the shadow banking system made of off-balance-sheet vehicles, special-purpose vehicles and the like. Yet, as the crisis developed, it became clear that the whole system of highly leveraged banking had become unstable and unsustainable.

In a first plan to rescue the financial system, the US Treasury Secretary Hank Paulson and the Chairman of the Board of Governors of the Fed, Ben Bernanke, had Congress pass a vast bail-out of US financial institutions whereby the Treasury Department can buy up to $700 billion in toxic mortgage-backed securities or recapitalise the banks.5 This dramatic turn of events raised many questions and was widely commented upon. Were these bail-outs necessary? Should taxpayers’ money be used to bail out private companies that failed because of their excessive risk taking? What should regulators and government demand in return? In other words, who should pay the price for yesterday’s recklessness?

Robert Borosage: it would be obscene to help the predators and not those that they preyed on

Robert Borosage: it would be obscene to help the predators and not those that they preyed on

That bankers were going to be bailed out, while homeowners still struggled, was galling to many. Robert Borosage, president of the Institute for America’s Future, said, ‘many homeowners were misled by predatory lenders to taking mortgages that they didn’t understand and couldn’t afford. It would be simply obscene to help the predators and not those that they preyed on.’6 Some also questioned the revolving door between bankers and regulators, and whether people such as Paulson, who became super-rich from working in one of the firms whose practices had helped create the crisis, should be deciding how to hand out billions to the same sector.7 They could point to investment firms scrambling for the oversight of all the assets that the Treasury planned to buy, so they could receive hundreds of millions of dollars in fees.8 News that the bankruptcy courts had released $2.5 billion to secure Lehman Brothers bonus payments, at a time when savers were still losing out, was just one example of a situation that seemed to many like a systemic abuse of power by a professional elite of regulators, judiciary and bankers.9

The bail-outs were defended by the fact that these financial institutions were ‘too big’ or ‘too interconnected’ to fail and that failure would have caused a systemic risk. If governments and regulators have let financial institutions become so big that they cannot be allowed to collapse, shouldn’t they be encouraging more competition and more diversity? This is at least the view of trade unions. UNI Finance Global Union, the global trade union for finance workers, has repeatedly called for a diverse finance market that includes not only private banks and insurance companies but also public banks, savings banks and insurances, cooperative banks, mutual insurance companies and foundations.10 However, this does not seem to be the view of governments and regulators who were pushing failing institutions into the arms of healthier ones (for example, the acquisition of Merrill Lynch by Bank of America in the United States or the takeover of HBOS by Lloyds TSB in the United Kingdom). As Lina Saigol, a Financial Times columnist, argued, this ‘new generation of gargantuan institutions [will have] the power to dictate the next financial boom and bust’.11 With the new injection of funds from governments, many banks turned their attention to attempts at buying each other out, and thus compounding the problems associated with market domination by too few players, rather than getting back to the business of lending money to people in the business of making things for others.

Another issue raised by the bail-outs was that of moral hazard. Many commentators, including Financial Times columnist John Gapper, argued that the rescue of AIG ‘encourages the idea that institutions can run amok in markets and will be bailed out. Indeed, the bigger they are and the worse they have behaved, the more likely it is to happen.’12 Other critics called these events ‘a perfect demonstration of Wall Street socialism’13 and the ‘socialisation of finance’.14 It is true that the financial industry seems to have understood better than any other how to privatise gains but socialise losses. After all, in 2007, Daniel Mudd, the CEO of Fannie Mae, reaped a 7% pay increase to $13.4 million while his company was losing $2.1 billion and its shares fell 33%.15

In many cases the bail-outs became part-nationalisations of the banks involved. This gave governments some additional influence over their practices, yet most politicians were cautious about what influence they would exert, and merely spoke about future executive pay. This timidity is an issue we return to in the following section, when discussing the broader implications of the financial crisis.

The irony of increasing government ownership of the banks is that taxpayers may face a double whammy of their own. Not only have they bought up bad debts, but they have bought into potentially massive legal liabilities. In a comment in The Guardian, Nick Leeson, the trader who brought down Barings Bank in 1995, said, ‘For my role in the collapse of Barings I was pursued around the world, and ended up being sentenced to six and half years in a Singaporean jail. Who is going to go after the reckless individuals responsible for the financial catastrophe? Apparently no one.’16 However, as time passed there appeared to be growing pressure to hold companies as well as individuals responsible for the global financial crisis. On 24 September 2008, regulators announced the broadening of the investigations into the collapse of the sub-prime mortgage market to include Fannie Mae, Freddie Mac, Lehman Brothers and AIG.17 In addition, many observers expected a sharp rise in shareholder lawsuits against investment banks and other financial institutions following the millions of dollars of losses they made by gambling money in asset-backed securities and the like.18 Lawsuits were emerging from Hong Kong to Paris to Reykjavik.

These actions slam the legal door after the capital horse has bolted. Rather than punishing the individuals who profited from using other people’s money to buy derivatives they did not fully understand, but knew could turn a profit in time for their next bonus, this legal action will cost the companies’ new owners, including the taxpayer. First the bankers, then the lawyers, will have bled the collective purse. As this situation becomes visible to the general public, calls for the people who made millions from speculating with their money to replenish their depleted pension funds may grow. There could be investigation into whether there was abuse of fiduciary duty by those who received large bonuses through creating, investing, rating or trading in mortgage-backed securities or credit-default swaps since the deregulation of those markets in 1999. Given the mobility of capital, such processes would require international cooperation, to freeze assets of those being investigated. If this happened, it would remind us of the words of Interface CEO Ray Anderson, who said that people like him would in future be regarded as criminals for doing things that at the time they considered normal business. Letting bankers live as millionaires, some as billionaires, from creating a crisis that has emptied the pensions funds and now the coffers of government, would sadly stand as a testament to systemic injustices of contemporary societies. However, it is unlikely that governments will want to see such a wave of litigation. As such, there may be growing calls for some form of ‘financial truth and reconciliation’ commission, to explore how this crisis developed, where fault lies, and how to repatriate some savings.

» The end of financial triumphalism

(The references are available in the pdf download and hard copy versions of this annual review, available from Lifeworth’s bookstore.)

This section can be referenced as:

Bendell, J., and N. Alam, S. Lin, C. Ng, L. Rimando, C. Veuthey, B. Wettstein (2009) The Eastern Turn in Responsible Enterprise: A Yearly Review of Corporate Responsibility from Lifeworth, Lifeworth: Manila, Philippines. (Page numbers for this section are available in the pdf download and hardcopy.)

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