ECONOMY: Government Failures Feeding Next Financial Bubble

  • Analysis by Julio Godoy (berlin)
  • Tuesday, November 24, 2009
  • Inter Press Service

The failures go from central banks’ overshooting the easing of monetary and interest policy, which has led to a substantial increase in the world’s money supply, to the incapacity of governments to agree on coordinated global regulation for the operation of investment banks and hedge funds.

Since early 2007, the joint monetary base of the U.S. and the European Union has increased by 70 percent, from 1,400 billion to 2,500 billion Euros. The monetary base comprises coins, paper money and the commercial banks’ reserves at the central bank.

Yet another mistake by governments and central banks is the lack of proper controls over the use of the billions of dollars in state funds allocated during the last 18 months to rescue - from insolvency - the private banks involved in highly risky investment in and trade of toxic financial derivates.

Thanks to these rescue packages and the low interest policy practiced in practically all industrialised countries, private banks can cheaply borrow money from central banks. But, instead of using this money to grant credit to industries and fuel real economic growth, banks are investing it in the stock markets; are speculating in natural resources, such as oil, copper, and food; and in risky hedge businesses.

In Germany, Dieter Hundt, head of the local confederation of employers’ associations, said in a press conference that despite such government policies private companies find it ever more difficult to obtain credits.

'We do not have to discuss whether there is a credit crunch or not,' Hundt told the press. 'The fact is, it is ever more difficult and expensive to obtain credit.'

The latitude in the commercial banking business - which under the fragile current conditions should be unthinkable - has led again to a swift growth in stock exchange markets all over the world. On Nov. 23, the U.S. Dow Jones index reached its highest value this year - 10,451 points, up from 6,626 last March.

The same day, the main German industrial index, the DAX, reached 5,800 points, up 3,800 since last February. Similar growth has been registered in all stock exchange markets across the world. At the same time, recession is still felt in the European Union, Japan, and the U.S.A.

Oil and copper prices have more than doubled since last January. The price of sugar has increased by 80 percent in the same period, indicating a high degree of speculation in the markets.

'Prices for practically all kinds of assets have skyrocketed in the last three or four months,' Thomas Meyer, head economist for Europe of the largest German private bank, the Deutsche Bank, told IPS. 'The only explanation for this inflation is the very low interest policies of central banks,' he explained.

At the same time, private investment banks and hedge funds have restarted their financial engineering, creating new financial derivates to sell the old toxic assets they still posses - assets they created during the early 2000 real estate bubble. These derivates go under the name of re-remic - short for 're-securitisation of real estate mortgage investment conduit.'

Wall Street bankers and analysts have been quoted as saying that the vast majority of these re-remics are aimed to help 'create buyers for orphan securities that otherwise would have languished.'

'I am really shocked to realise how little has changed since the outburst of the crisis,' Ed Yardeni, former head of investment strategy at the Deutsche Bank, told IPS.

Some investment banks are also applying practices that are downright illegal - such as front running. Using highly performing software, banks buy or sell a company’s shares a fraction of a second in advance of other investors, who are the bank’s own customers. By so doing, the bank profits from prior knowledge they have obtained from pending orders from the investors, its own customers.

Such businesses practices - re-remics and front running - explain the high profits investment banks such Goldman Sachs, Stanley Morgan, and the Deutsche Bank, have reached this year.

'Actually, the rescue packages for banks and the easy money policy were put in practice not only to stop the bankruptcy of private financial institutions, but also to avoid a credit crunch, and to stimulate the production and consumption of goods and services,' Gerhard Leithaeuser, professor of financial economics at the university of Bremen, some 300 kilometres of from Berlin, told IPS.

These policies were aimed at offsetting the global recession provoked by the collapse of the real estate and financial bubble in the U.S. and Britain in 2007.

'Instead, these policies have helped to recreate the situation that provoked the financial crisis in the first place,' Leithaeuser added. 'Banks and hedge funds are misusing the enormous amounts of cheap money provided by governments and central banks to invest and trade in new financial derivates and in the stock exchange market, leading to the inflation of equity and real estate.'

The substantial growth in the stock markets alongside the recession in the real economy in most industrialised countries reveals this again - the financial economy has decoupled from the production and consumption of goods and services, Leithaeuser said.

At the same time, the policies have raised state deficit and indebtedness to historical levels, putting public finances across the industrialised world in a critical state of disarray. To finance their deficits, states are likely to increase indirect taxes, such as the valued added tax, and to reduce social services.

The lack of coordination of interest rate policies is also allowing speculators to make profits with simple arbitrages - by borrowing money in a lower interest rate country, such as the U.S. and lending in another, where the rate is higher.

This arbitrage has reinforced the devaluation trend of the U.S. dollar, which is at the same time affecting emerging countries - such as Brazil and South Korea - which practice a flexible exchange rate policy. In both countries, the local currency has suffered a revaluation of some 40 percent since last March.

Bank executives do not appear to have learnt from the crisis. Only last week, Josef Ackermann, CEO of the Deutsche Bank, repeated his promise that the Deutsche Bank aims at a pre tax return of equity of 25 percent. Such a rate of return is generally considered impossible without engaging in highly risk investments.

In spite of Ackermann’s promise, during a conference on banking and business on Nov. 18 in the German capital Berlin, he called for a state bail out of banks in case of new crisis.

'Many critics have the unrealistic assumption that a systemic banking crisis can be solved without deploying state resources,' Ackermann said during the conference. At the same time, Ackerman rejected new regulations for the financial sector.

German Chancellor Angela Merkel, who also participated at the conference, warned banks of such thinking. 'Banks are risking getting beaten again,' Merkel complained, referring to their risky investments. Merkel also rejected Ackermann’s calls for a permanent state bail out fund, but failed to announce new regulations to avoid such big risks. Instead, Merkel only urged banks 'to be judicious - without renouncing to making profits.'

© Inter Press Service (2009) — All Rights ReservedOriginal source: Inter Press Service

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