The Far Eastern economies went through a similar crisis. Their banks also fell apart and their economies and their currencies and everything was shattered. And in fact the prescription given to them at the time was that you must follow the model of the Washington consensus. Liberalise, downsize and shut anything which doesn’t work. All of them followed this prescription except for Malaysia. The then Prime Minister did exactly what the USA and Europe are doing today: bailed out his banks and worked out the bad debts. As a result Malaysia had a much smaller downturn, a much less dramatic experience than Indonesia which was more or less shattered.
When Saeed phoned me I was really taken by surprise there is no way I can say ‘no to him. So I said let us look at the whole idea of the end of history. Many of you know this was floated by a Professor in the USA called Francis Fukayama.
His basic argument in 1992 was that mankind had reached the end of its development: social, political, economic and military in the realisation of the new liberal establishment which was at that time represented in its full sense by the USA political and economic dispensation.
There followed many other consequences. One of them was that everybody in the world should aim for that and if they didn’t we would beat them up if the do not aim for that. It was not like we will leave them to their fate – no we will beat them.
And if anybody comes in our way we will also beat them up. This was like hyper power triumphalism. But behind that there was another twenty years of historic development which I want to briefly refer to.
This started with the advent of the election of President Reagan in the USA after President Carter and Margaret Thatcher. And we had what we call the birth of market fundamentalism. The theory was that markets are supreme. They are like demi-gods self correcting and they are the best way to allocate resources.
This became like a theology and if you objected to it you were ridiculed and regarded as militant Labour in the UK or old fuddy duddy or all kinds of socialist, communist or obscurantist in the USA. The force of the media and overall intellectual pressure was such that you could not argue against it.
There was a man, he is still there. I will trace his history because this will show you where these things can lead. He was a Catholic professor of theology. His name was Michael Novak. He was quite a progressive of economics and had written a book which epitomises the spirit of the era of that time. It was called The Spirit of Democratic Capitalism. He argued that the requirement of present day progressive Christianity could be embodied in the market model which was epitomised by Reagan and Thatcher. And so he advocated wholesale privatisation and the de-unionisation and so on.
In the middle of this I was invited to York and the bishops were having a conference on economics. At that time I was with the World Bank NGO committee and I was one of the leading critics of the structural adjustment programmes which were imposed on most of the developing countries.
So they said why don’t you come. This man Michael Novak is coming. We don’t know how to fact this man. You have some experience and you can probably face him. So we went to York and we dissected privatisation at that time. We were looking at British Telecom, British Gas, the first wave of privatisation and the closing down of national services.
We could see that if you privatised the Post Office all services to remote villages and locations would cease because they do not make sense to any private operator. Similarly for having a single rate of postage across the country. This is not an economic decision – it is a national social decision because then you say okay if you pay a 34p stamp your letter can reach anywhere in the country.
There were many questions at this time which were in the realm of social justice and equity rather than pure economics. And therefore they were carried by society. All the railways, all the public transport and so on.
So at that time I gave a lecture and I analysed that as far as I could see even at that time privatisation amounted to monopolisation of gain and socialisation of any losses. It is very clear now. We said that we are going to privatise the management of London underground. After four years these companies came back and said sorry we cannot manage it and we leave it in your hands. We find that we are landed with a two billion hole in the budget. Just before the last elections the mayor took over Metronet and now it is no longer private. It is owned by the tax payer. Those guys have run away with profits. And this is constantly the case with that kind of stuff.
So we were able to argue against Michael Novak at that time. And we said this is no way in congruence with Christianity yet alone with any religion. Religions cannot validate this kind of monopolisation of gain. The bishops said you have laid the scene very well because we see in our parishes people suffering and we don’t know how to conceptualise that in the whole scheme of things. We see that this is what is happening.
We saw the whole structure of the country, both here and in the United States, ravaged during those twenty years. There were some good things but there was a lot of ideologically driven stuff which created a culture of greed. They said that greed is not bad, greed is what we should aim at. So the good things were submerged by the creation of this culture.
At the end of her reign, Margaret Thatcher even said that two-thirds of the people are doing very well. To hell with the third which is going down the shoots. We don’t care. So in the United States, after the Reagan era when Clinton was campaigning for his term, his main slogan was very very interesting and all over the United States it was saying nothing grows from the top down. One of the arguments of this line of thought was that if you make a few people very rich this wealth will trickle down and everybody will benefit. So there is no need to criticise greed, wealth, opulence etc everything will trickle down.
So Clinton’s message went down very well because he said nothing grows from the top down and even ordinary people could understand that everything has to go from the bottom up rather than the other way. And of course power passed away from the Republicans at that time for one term until Clinton got distracted by his own problems.
So the main upshot of that time was the sanitization of greed. Acceptance of a culture of greed. The late Professor John Kenneth Galbraith who passed a year ago, was still writing at the age of 90. An amazing man. He is one of the most eloquent economists and theoreticians of development. One of his last books was called innocent fraud. I think it is about 70 pages. In it he has taken about ten things which have been sanitized.
The first thing he takes on is the idea of capitalism. He says this word capitalism has got too much baggage. People think of them as crooks as rapacious profiteers and so on and so forth. It has baggage from Marxism, it has baggage from poverty people it has baggage from all kinds of problems.
So he says over the last 30 years an attempt has been made to change the terminology from capitalism to market mechanism. Market mechanism is a very neutral term. It has no baggage. If you say I am working for establishing the market mechanism nobody is going to shout at you. If you say I am going to establish a capitalist economy, half the room can potentially stand up and say you are going to look at trouble.
The government says that this era has also been accompanied by change of language and sentiment saying what it wrong if somebody benefits from the market mechanism. He is contributing to the overall good, he gets his share and so there should be no problem.
So you can see now that bringing religious scholars like Michael Novak. Margaret Thatcher gave him an award for creating thought in market leadership, or something like that.
So even before Fukayama’s book on the triumph and the end of history the whole scene was set by these twenty years. We had a number of upheavals during this time. These were not as big events in Europe and the United States and therefore they do not go into the public conscience.
Let me outline one or two of them. The first big one was what we call the Third World debt crisis. After the increase in the oil prices in the early 70s you had a very similar surplus to what you have today. Now the same investment banks which we are becoming more and more familiar with took the surpluses and re-cycled them into lending to Third World countries.
Most of it was siphoned back into the accounts of the same banks through capital flight. In fact if you do the sums you will see that whatever money went it all of it came back illegally as holding of various elites in the developing countries. Unfortunately this money did not contribute to the projects, and the enrichment of the projects, for which it was intended. When that happened those things could not be paid back and so you had the crisis.
Now I will give you a small example. At the end of that process a country like Indonesia. At the time of the 1996 Asian crisis, Indonesia has an overseas debt of $96bn. These numbers look very small today because we are looking at some telephone numbers now. At that time it was a big sum.
Out of that $76bn was private debt i.e. debt which was taken on by private companies, not government entities and not guaranteed. Because it was debt from banks here and financial institutions mostly in the United States and Europe any default on that could create problems so one of the conditions for a country like Indonesia to get any assistance from the IMF was that the private debt would have to be nationalised and paid back by the country so it would become sovereign debt.
What is the difference between private debt and sovereign debt? In sovereign debt even if it is accumulated by Saddam Hussein or Mabutu or whoever the country has to pay it because it is sovereign debt. It is not an individuals debt. In this way they managed to shift the burden of adjustment to the poor rather than suffer a loss on the debt. Because the debt was lent badly the money was siphoned back and that money is still sitting in bank accounts here.
So before now it was possible to shift the burden of adjustment to someone else. But after the Clinton era we again had the advent of some of his market fundamentalists in the States and here unfortunately New Labour broke away from its original Labour roots and started to talk a very similar language to Thacherite economics with a few nuances here and there.
But somebody like Mandelson for example who has just come back into the cabinet said what is wrong with being filthy rich? We can life with that! No problem. So when these Bush people came back during Clinton’s time one of the things that happened was that the US deficit had been reduced to a very small amount and had become manageable as there was a sense of fiscal responsibility. Now that was reversed and we had tax cuts, huge military expenditure and so on.
So after the first term the annual US external deficit had become something like $400bn it is now running at $600bn plus per year. Obviously this has to be funded from somewhere. And whilst you can see that somebody like Fukayama is talking about this as the top model the underpinning of that economy is becoming a totally indebted structure where you are borrowing $400bn or $500bn a year.
Fortunately for the US at that time but in the final analysis very problematically it coincided with the time when China was taking off and increasing its exports. So most of the Chinese exports started to go to the US and China was in a very difficult position. Here you had a big buyer of your goods but a bankrupt buyer of your goods. So if you are a big supplier you have a choice. Either you lend your buyer the money to buy the goods or you decrease production. So year after year Japan and China started to lend this money – $300bn, $200bn.
The investment banks saw this and they said this is the golden goose. We are going to make a very serious effort to get as much as we can. So they started to encourage customers. Here the UK is not very far behind the USA and then Europe follows. It is not because Europe doesn’t like to follow. Europe takes time to follow as we can see with the crisis, it takes time to come through the crisis. They started to devise ways in which to encourage Americans, and we started here to follow and not think of sales.
So if you look at a profile of a particular household, for example, the take home salary is £2,000 and I can save a little bit of it and then save for year and buy a car for £5000 if I save £500. If a banker comes along and says what kind of silly medieval existence you are living, waiting for one year to buy a simple car. Why don’t you just take out a loan and buy it.
And slowly you start buying and before you know it all your salary is just going back in repayment rather than any saving or any building of equity. Under a small impact on your income stream you are going to default and you have a problem
So you can see that if you look at the figures now overall the people of the United States and the United Kingdom have borrowed 120 to 150 percent of the overall GDP. There is net negative savings. There are no savings at all. So they are indebted right up to the hilt. Nothing can go wrong. If something goes wrong they have a problem.
So on the one hand we have all these Chinese, Japanese and Singaporean, Taiwanese money coming in, buying US government securities and then the same US government facilitating the lending of money to the US customer and also the same fear.
Now the investment banks are thinking of some clever ways to make sure they can push larger amounts of debt. So you go the Chinese and say if we give you securities in our housing corporations like Fedimac which are underwriters of the US mortgage industry and we give you a slightly higher rate of return than US bonds isn’t it better you get a better rate of return on your money. And in the end it is US government guaranteed so nothing will go wrong anyway.
So they start piling in their effect to big institutions to be bailed because they found that half of their bonds were owned by the Chinese and the Japanese. Even with this profile, even when are in debt someone who is working can service part of the debt. But that is not enough for some of these bankers. They want to look at someone who is not working.
The US has some very interesting vocabulary for these things. They call these structures ninjah mortgages. Ninjah mortgages means no income and no job. You want to give a mortgage to someone who has no income and no job how do you do it? They go to a person who is living in the back of a trailer and they say look man how would like to own a house? This is now the American dream. You have to own a house. He says I can’t, I have no job and no income. They say no you don’t have to anything. Just sign this paper and I will fill in the figures and so on and then we can give you a loan and then for two years we will give you a very low rate which I will pay and then after two years the property prices are going up so after two years your property will double so we will take out and then we will rebalance the mortgage and then you are a property owner and you go on your way.
And so on and it spreads. That is step one. Step two. How do you sell this to the investors. So you package them. And this is how what we now call this toxic element in the loans comes. You package them and you go to the rating agencies and you say if I package this like this can you rate the whole package as triple A or investment grade rating.
If you put the best minds on doing something, they will come up with something. If you put the best minds to create fraud they will create the best fraud. In Pakistan, for example, we put the best minds on corruption and we have a corrupt president. Its very simple. There is no magic or logic about it. And we see that because of the money you can earn the best graduates are going into investment banking.
You have the best minds now and this creates the structure – and the create what I call asset backed securities on these ninja mortgages and sell those across the world to European banks, British banks, Japanese banks. Now you can see world wide people are saying we don’t know what the value of these things is. Underlying that is an asset but we don’t know what is the price.
As long as you continue pumping money into it you can see that house prices can go up because obviously the more demand the more prices go up and people can benefit. And this is the classic case of what is known as a ponsey scheme. The ponsey scheme is I come to you and you say to me Dr Amin give me a thousand pounds, I will give you 50percent return in six months. He gives me a thousand pounds. If I have enough customers coming in I can pay you from new deposits instead of earning. And as long as I keep getting customers in I keep a very confident posture and say I am the cleverest banker in the world and so on. You are fine, you get two or three times your money back and your money with 50 percent. You tell him join, this is very good, shut up, don’t worry about your bank it doesn’t pay you anything. And it spreads and then the whole thing comes crashing down.
If you thing that these ponsey schemes don’t work let me give you an example. In Dubai now if you go and they say we are now building the tallest building in the world. If you put five percent down we can reserve an apartment for you. So you put your $100,000 down and they reserve the apartment. After a month you to do somebody else and say the price of this tallest building has gone up twice. So I made my $100,000 I sell it. And before the building is complete that five percent has become a million.
This can continue as long as the music goes on. What happened one developer said: I can’t build this. So he goes back to the original buyer and says here is your $100,000 and five percent on top for the year when I have used your money. That man has old it on. The man who bought it for a million says eh man I bought it for a million, where is my money. I have nothing to do with your million, I sold it to this person. You go to him.
That million has been borrowed from the bank on the security of this. It is some depositors money. When this happens the whole thing can come smashing and crashing down. In the middle four or five people have made their money. I sold it for $200,000. I made by $100,000 but the whole system is in a mess. But where the trick is, is that the broker who does the sales has got six sales down and is enjoying himself. He is only unhappy if the music stops because he cannot sell anymore. Otherwise has pocketed the money and gone away. And this what the investment bank is. It wants to create deal flow, sell and buy as many times as possible so they make intermediary commission. And if you incentivise this smart people that your salary packet depends on how much commission you make, they will create as many ponsey schemes as you want.
Just today the Chairman of Lehman Brothers was giving evidence to the congressional committee and the congressional person asked: ‘So I believe you have made $£300million in the last five years’. He said: ‘Yes your honour but $250m was in shares’. ‘But you have still made $50m while your company has gone bankrupt. Twenty-five thousand people have lost their jobs’. That’s how life is.
So it is not going to be easy. In this process of creating ponsey schemes. We do have time to go into what banking is about. Banking is a confidence matter at the moment. There is no solid gold lying at the bottom of the money. It is all confidence. Normally is you in the UK for example, in our experience, if you manage your deposits to loans ration at a leverage of about one to eight times you should be able to manage. If you have £1 of deposit you can create £8 of loans. That is where banking profit comes from. You can manage that in a stable economy.
Investment banks took that leverage to between one to twenty times and some of them to 50 times. So on every dollar or pound they made £50 or loans or derivatives or structures on top. So you can see the effect upwards and downwards of commissions you can generate. And some of the hedge funds took it to one to hundred times. So LTCM (Long Term Capital Management) which collapsed ten years ago took it to 102 times. It cost us $5m to rescue that. It was a single event and everybody put in money and it was rescued.
The thing is now that normal regulators are looking at one to eight one to ten, if you go just over one to ten the FSA will come to you and say what are you doing? This is not prudent and it is not safe and so on and so forth. So how do you go to 20, 30, 40 in that circumstance?
What happens is that you create off balance sheet vehicles – risk which is not on your balance sheet so there is nothing which they can see. And this as the scheme which was practised and perfected by companies like Enron, just as the Bush people were coming in. Mr Bush friends.
And when Enron and Worldcom collapsed they collapsed because they shifted risk to off balance sheet vehicles which had really not been reflected in their risk profiles and then when things went wrong they went belly up. Huge corporations were gone.
So similarly now we find there are so many off balance sheet vehicles which are at taking that kind of risk. All these ninja mortgages and all kinds of risk packages and we don’t know how much the leverage is.
So at the end of the day now we find that the music has stopped and these over-leveraged borrowers have to come down. But if I am a ninja borrower (the Americans also have another term ‘jingle bells’) which refers to the idea that if I am at all careful or sensible I will drop my keys back into the borrowers post box. I don’t care because I don’t have any stake in the house – they take it. And you do what you want to do with it. And you see lines and lines of empty houses to be bought. And the more you have the more the value of the other property goes down and the property market begins to wind down.
You have leverage up and leverage down. It is not a one way process. It is not like 20 percent of the people lose their money. It is going to be compounded by the effects of the whole thing. And therefore I think this downturn is going to be harsh.
The other part of this process is that despite pretensions that it is creating wealth and growth for everybody there has been a constant concentration of wealth. You can look at World Bank and IMF figures over the last 40 years. The amount of wealth owned by 10percent of the world population is increasing all the time.
So even for example yesterday they were looking at this deposit guarantee of £50thousand. And the chancellor said 96percent of the depositors will be protected if you raise the limit from £35th to £50th. And 45percent of UK deposits are with only four percent of the depositors. So those four percent who are not protected actually have half of the deposits. So see the concentration in the structure. This is evident even here where you have a better spread than many other countries. So in that structure a few can manipulate large numbers.
Now the last bit. Why were the regulators not able to pick up off balance sheet de-regulation exercises. If you look at politics in the USA and increasingly so here it is composed of paid lobbyists. They say we will do this and that.
If you look at the bail out packages there are features there which just do not make sense. You want to reward the people who created the mess all over again. So the political process is corrupted. Not corrupted in a very direct sense but corrupted because that is how politics works.
If you at the debate in the House of Representatives on this bail out package. The package was 700bn and now it has been 820bn. And the other 120bn has been given to this man to import his rum and to this man to liberalise his ranch etc all kinds of handouts to all kinds of small backwoods men representatives from Middle America. $120bn is not a small amount.
At one time we used to look at these sums as huge amounts of money. Now finally we have a whole other issue relating to market economics. Money fundamentalism is based on growth at any cost is good. There are no limits to growth and we have limitless resources.
The first person to look at that systematically in the 70s was a man called Herman Delli. He and his group which was called the Club of Rome published a report which was called The Limits to Growth.
At the moment for example each US citizen consumes 80times the resources of a Chinese citizen. If the Chinese limits himself to that level and starts consuming 80 times what he or she does now, Herman Delli argued that there is no carrying capacity in the earth for that kind of resource consumption.
So we then have to think of how to limit our resource consumption, how to change our life styles how to reform this idea of taking the waiting out of the wanting, how to create purchases from savings rather than credit.
All those things which at the end of the day resulted in this whole climate change crisis and so on because of the unsustainable use of resources. It was laughed out of court. For thirty years they were saying the market is creative and we will just invent new technologies, better technology and there is no need for all this nonsense talk of limiting our resources. The two problems are now compounded. We have climate change which is at the top of the agenda and we have a credit crisis which can no longer fuel that kind of credit.
The third component of Fukayama’s idea was military superiority. We can see that throughout the whole crisis the only thing that has remained constant in the US and increased has been military spending. Last year it was of the order of $600bn. That is $2bn a working day. It is a staggering sum.
The idea was that anybody who does not behave can be beaten back into place by military might. The problem with military might is that it is very good until it is used because when it is used and it fails there is no comeback.
And now we see in Iraq and Afghanistan and elsewhere what do we do next. Even this Taliban who can hardly afford to wear shoes are creating havoc. Over the last two weeks we have heard talk that we need to talk with these guys we can’t defeat them. They are in their own country. But we are spending $600bn we can’t defeat these guys? We can’t. Seven years has gone. Psychologically this is a big set back. If you start talking the other side has some demands as well which you need to concede. That is the beginning of the problem for a hubristic world.
So I would suggest that the structure that has developed of creating debt at any cost is unsustainable and is going to create problems. Unfortunately in the short term as the leverage goes into reverse its going to impact on the poor much more badly than on the wealthy – as always.
For governments it is a choice of this evil or worse. Its not a bail out or worst for the poor people. Secondly one can see that if the imbalances like the Chinese surplus and the US deficits are balanced than both sides will have to change their lifestyles. The US cannot borrow as much as it does. It has to live within its means which means a complete a re-adjustment of the structure.
If we cannot borrow or live within our means than the whole financial sector whicih is about 40 percent of our economy will have to be downsized considerably. We have already destroyed the manufacturing base here so in order to get that back or get other parts of the economy running we have to think hard and long.
These clever people can do other things. Three of four of the top chairmen of leading investment banks who have retired are now in China and Hong Kong working for other institutions. This is the growing middle class which has a lot of savings. And you can create debt for them and push them up the debt scale and have the whole cycle working again. And this can happen because this is survival for them.
We have to be careful not to count the end of this system prematurely. It has the capacity to survive and it can survive on the blood of everybody. Alternatively it can also give birth to new ideas. In fact crisis of this kind have given rise to new ideas, how to manage human affairs better in the future. In this climate this may take root.
This is not new. I want to read a couplet from Iqbal which was written in 1916. It is called Lenin in the presence of God. In the one or two couplets which I want to read. It ways that the buildings of banks are much more massive and eloquent than the buildings of churches. And the business of banks is gambling pure and simple because in their business there is untold profits for one and pecuniary and destitution for millions. And in their shadow the knowledge, governance the hubris preaches equality of man but sucks the blood of everybody.
*Mr Iqbal is a trained Economist and Accountant. He has worked as an Investment Analyst in the City of London for several years. He has been involved in consultancy on financial product structuring and niche marketing services to faith and ethnic communities in the UK . He has advised many banks in the UK on their launch of Islamic financial services. He is also consultant to a number of institutions on structuring and marketing Islamic financial products in the UK . Iqbal is a member of the Islamic Finance sub-committee of the City’s Financial Markets Law Committee (FMLC). He is also an associate of the Islamic Banking and Finance Institute of Malaysia (IBFIM). He was awarded the CBE in 2005 Queen’s Honours List for services to international development.
