Turbulence and Trends

A trend is a trend is a trend.

But the question is, will it bend?

Will it alter its course

through some unforeseen force

and come to a premature end?

-- Sir Alec Cairncross

I’ve had a lot of meetings this week, and very little time to reflect on fast moving events. This entry may be light on cites and hyperlinks as I’m in a bit of a rush today. It will also lack much in the way of perspective or insight as I find it impossible to distance myself just now from the swirling turbulence around me.

Here in Britain, several banks were offered partial nationalisation as an alternative to private recapitalisation. Strangely, this seems to have encouraged them to more strenuous efforts to recapitalise. The plan is now being held up as a model as it seems to force managements to confront their undercapitalisation as a problem that they can solve to their advantage or that will be solved for them to their heavy personal cost.

Iceland collapsed. It was more of a hedge fund than a country, with it’s 200,000 population supporting a massive leveraged position in financial markets via risk loving bankers and financiers. There were approximately 200,000 British depositors in accounts offered by Icelandic banks. Local authorities (municipalities) and charities were also big investors, exposed for more than £700 million. As a result, the government has frozen Icelandic-owned assets in the United Kingdom – using terrorism legislation, naturally – to provide the basis for a partial recovery of the losses likely to be incurred. This is causing more stress between the two island nations than they have known since the Cod Wars of the 1980s. Also causing tension is a rumour that Russia might bailout Iceland with $4.5 billion of credit, leading to speculation that the Russians may be eying the vacant airbase formerly used by Americans. This is problematic as Iceland is a member of NATO, and so has spurred efforts toward finding European alternatives.

Europe continues to call for collaboration while each country unilaterally defines and acts on its self-interest. That is the way it should be, and I approve heartily. I would rather not have the European Union making hasty decisions or holding such concentrated powers that it can force a uniform resolution across all member states. Either the EU builds consensus for action in the common interest, or it remains impotent. Either is preferable to too much concentration of power in Brussels.

In an attempt to shut just one stable door in a barn full of bolting horses, the Treasury has laid legislation before Parliament to reform the treatment of UK bank insolvencies and deposit insurance arrangements. Roughly described, the Financial Services Authority will decide if a bank is bust, the Bank of England will be responsible for overseeing its resolution and ensuring financial stability of the system, and the Treasury will oversee a new deposit insurance scheme that no one can currently describe but will make permanent the rise in protection to £50,000 per depositor. Despite the massive failure of Lehman, and the huge losses incurred by investors and hedge fund prime brokerage clients in London, the legislation is completely silent on the insolvencies of investment banks and broker-dealers and other institutions of systemic importance to financial markets. My fear is that the failure to address the systemic issues as a whole will be a vulnerability exploited by US banks and authorities as they try to undermine London as a financial centre, gaming the fragile global markets.

There is still a touching confidence among many in the City that the US authorities will provide the “leadership” to reinforce collapsing markets. As John Plender of the Financial Times quipped, “Gaul votes for Rome to take the strain.” This seems to me to display a total incomprehension of the way US authorities operate to externalise pain and loss to the greatest extent possible in times of crisis. Gaul, after all, was an occupied state that was militarily and economically exploited to Rome’s advantage for centuries before Rome’s collapse. Saving Gaul was never a high priority once Rome was threatened.

Elsewhere in the world, bureaucrats continue to show up at the office in the morning and check to make sure all boxes are ticked, all forms are correctly ordered, and all initiatives in progress continue their stately way forward unimpeded by global chaos. I find this comforting, although much of their efforts will ultimately prove futile and failed.

Finally, an optimistic note. I was reminded yesterday that the vast bulk of “wealth” created during the Greenspan/Bernanke bubble years accrued to the very top percentiles of population – with many in the OECD middle class and lower class either stagnating or getting poorer as they mired themselves in unsustainable debt. While opportunity and employment grew strongly in emerging countries, there too the elites gained disproportionately as income inequalities surged. The crash of global financial markets therefore will have disproportionate effect on the elites, impoverishing them to a far greater extent, although it will be felt throughout society as employment, pensions, investments and public services contract.

Once we hit bottom of this downturn, some years hence in all probability, we may experience a democratisation of wealth and opportunity like none seen since the end of World War II when education reforms and unionisation laid the groundwork for the rise of the American and OECD middle classes. Those who have lost economic and political power during the boom years, are likely to organise and retake authority within economic and political systems during the bust years. The collapse of concentrated wealth in Wall Street will spur more collaborative capital formation and investment throughout the economy. This could provide reorientation of economic progress toward more equitable, sustainable and democratic outcomes in coming generations. I hope so, it’s the only bright spot of the week.