The financial sector must be reconnected to the real economy and support productive activities that benefit working families. Only then can another crash be avoided.
Cosmetic repairs fail to fix a broken banking system
The third anniversary yesterday of the collapse of the US investment bank Lehman Brothers, the event that triggered the global financial crisis, reminded us that history may be repeating itself. With Greece teetering on the brink of default, the euro zone faces meltdown and European banks stare into an abyss. Is this another "Lehman moment"?
As the West slides towards a second downturn in less than three years, the recovery is fast mutating into a relapse. The latest wave of the "Great Contraction" that started in 2008 threatens to engulf both the US and Europe. That would have serious knock-on effects for emerging markets as diverse as China and GCC countries.
Since February, global stock markets have seen hundreds of billions wiped off shares. Euro-zone banks have lost more than 55 per cent of their value, collapsing to levels not seen since the dark days of Lehman's demise. Once again some French banks need urgent recapitalisation.
Amid the turmoil, however, the differences from 2008 are considerable. Banks hold more capital and fewer toxic assets. These changes have improved liquidity and solvency, reducing the threat of imminent bankruptcy.
Following the recommendations by the Sir John Vickers banking commission, the UK government is considering steps to separate economically essential retail banking from the reckless gambling of investment banking. All this aims to reduce systemic risk and taxpayer exposure.
But as the predicament of Europe's banking sector illustrates, the fundamental problem of debt still besets much of global finance. Undercapitalised banks buy the bonds of over-indebted states, with each bailing out the other at the expense of taxpayer money and at the risk of systemic contagion.
For the past 30 years or so, sovereign states and banking conglomerates have colluded to the detriment of society and the real economy. In exchange for state-guaranteed capital mobility and financial opportunities, banks created a worldwide market for national bonds that enticed countries to run budget deficits and accumulate public debt.
Moreover, banking and other financial institutions made bumper profits by borrowing cheaply from central banks and lending to corporations or countries at usurious rates. The investment arms of retail banks turned everything into tradable commodities, including labour, land and life. A debt-fuelled spending spree turned the conventional business cycle of moderate expansion and contraction into a speculative boom bound for a bust.
But the structural problems are not confined to Wall Street or euro-zone banks. The system in place continues to privatise profits, nationalise losses and socialise risk.
Profits accrue mostly to corporations, with small and medium-sized businesses struggling to survive. That is not helped by a lack of lending, with banks preferring short-term speculative profits over long-term productive investment. Nor is there sufficient demand from consumers, who feel the income squeeze as a result of lower private spending and draconian cuts to public expenditure.
Following bank bailouts and rescue programmes for heavily indebted countries such as Greece, western taxpayers have been saddled with levels of debt not seen since the end of the Second World War.
Neither national measures like the Dodd-Frank financial reform bill in the US nor the international regulations of the Basel III agreement have addressed the fundamental problem - making money out of money and separating profit from risk.
What is required are proper risk- and profit-sharing arrangements. In concrete terms, that involves converting some debt into equity. For example, the maturity of existing mortgages could be lengthened and interest rates fixed at low levels to minimise foreclosures that depress the value of assets and hit households hard.
New mortgages could involve the transfer of equity in exchange for a monthly rental fee linked to the local market for rented properties. This would contribute to the localisation of credit. In addition, a periodic payment would transfer part of the equity in the property to the tenant.
All this would put a floor under asset prices and stabilise key sectors such as housing in which most private wealth is invested.
Risk- and profit-sharing arrangements also involve more employee-ownership in the private and the public sector. In this way, workers not only earn a wage but also get a share in the company's capital and profit or in the management of public budgets.
By strengthening simultaneously individual initiative and reciprocal responsibility, these more mutualist structures promote innovation and labour productivity.
Moreover, regulators need to link bonuses to longer-term performance and also to some measure of social purpose. Only in the short-term does pure self-interest pay. In the medium-term, it is economically inefficient and socially corrosive because it feeds mutual mistrust and therefore requires ever more costly control.
Like all businesses, banks and other financial institutions are part of society - as their bailout with taxpayers' money underscores. But in an age of global finance, corporate profits do not trickle down to the masses.
The financial sector must be reconnected to the real economy and support productive activities that benefit working families. Only then can the world economy avoid another crash and become more sustainable.
Adrian Pabst is lecturer in politics at Britain's University of Kent and visiting professor at the Institut d'Etudes Politiques de Lille in France