Rip it up and start again

19th September, 2008: My comment for the Guardian’s site, part of a debate on the Credit Crunch organised by the new economics foundation, of which I am a fellow…

Bankers have gone to great lengths to damage our confidence in the banking sector. And loss of confidence and trust on this scale can’t be fixed by banning a few short-selling speculators or by nationalising a bank here, an insurance company there. Nor is confidence restored when ministers meet up with bankers on the quiet, and grant them monopoly powers (as with Lloyds).

Or when central bankers flood banks with new loans (liquidity) backed by taxpayers. We assume bankers will abuse their monopoly power, and taxpayer-backed loans will not be repaid. That makes us nervous.

Above all, we can have little confidence if interest rates remain so high. Banks are cracking under huge debts and liabilities (like the outstanding $60 trillion-plus Credit Default insurance claims hidden away from regulators as “swaps”). How can they honour claims and debts if interest rates remain so high?

Oh and by the way, it is really difficult to retain confidence in the system if politicians assure us that interest rates are very low – contrary to what our own bank statements tell us. Or indeed that low interest rates caused the crisis. It is the deregulation of credit creation in the 1970s that is at the root of this crisis, and it was high, not low interest rates that made today’s vast bubble of debt unpayable. Our politicians should catch up.

So how to fix this catastrophic mess and restore confidence?

First we have to think system-wide fixes, not quick fixes. We have to ignore the bleatings of the City, and subordinate all financiers to their proper role as servants of the economy, not masters.

Where do we start? We could begin where Roosevelt did in 1933, and declare a three-day bank holiday. The Fed, the FSA and the Bank of England could then take time and check the books of banks for well-hidden toxic waste – undeclared liabilities. Only when regulators have a proper sense of the scale of the mess can they take decisive and appropriate action. Right now they are sloshing buckets of our money about, unsure as to the whereabouts of the financial “weapons of mass destruction” banks have hidden away.

Next we must end “inflation targeting” – just a cover for keeping interest rates high. Inflation is falling, not rising, and there is a grave risk of deflation. Think the 1930s, or Japan since 1990. High interest rates are great for lenders/creditors, but a killer for debtors, and there are far more debtors in the economy than savers. And if we are to face the threat of climate change, we need cheap, but not easy, money to help finance a Green New Deal.

Third the Bank of England should regain control over interest rates – all rates. The interbank lending rate (Libor) should no longer be set by a committee of private bankers meeting daily at the British Bankers Association. They must be set by a committee accountable to society, and, when setting rates, must consider the interests of all who make the economy work – labour and industry – not just finance.

These are the fixes needed to deal with systemic threats. We could expect them to restore and retain confidence for as long as they did after Keynes introduced system-wide fixes in the 1930s. That was a golden age of 40 years.

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