The governor of the Bank of England, Mervyn King, last week admitted that the regulatory mechanisms of the world’s financial systems “all failed to some degree to prevent the accumulation of risks that finally produced the crisis”.
Bank bailouts and “economic stimulus packages” have not stemmed the economic turmoil. So world leaders are forced to look for new solutions – and the latest one is better regulation of the markets.
This may seem to make sense. After all, deregulation of financial markets and in the wider economy has caused havoc.
The deregulation of the US mortgage market allowed lenders to target their loans at people with low credit ratings – the so-called “subprime” market.
The fact that people were ultimately unable to repay the debts, combined with a new market spreading the bad debts across the system, was the trigger for the “credit crunch” and the current crisis.
So could this have been averted with better regulation?
The collapse of the subprime market may have started the chaos, but it reflected deeper problems within capitalism. Subprime mortgages were developed in response to the tendency of the rate of profit to fall.
This means that, over time, the bosses get a lower return on their investments. They have to constantly seek out new ways of making money and cutting costs.
Bosses try to cut the amount of money they spend on workers, but they are caught in a trap. On the one hand, each individual boss wants to pay their workers the bare minimum to stop wages eating into their profits.
Yet if workers have little spare cash to spend, the things that companies are producing will go unsold, hitting profits.
Debt and credit were ways to deal with this conundrum. Giving workers easy access to credit meant that they could still buy goods but bosses could hold their wages down, which is a win-win situation for them.
The problem comes when the debts can no longer be repaid.
So the crisis is rooted in the way capitalism operates. But capitalism doesn’t undergo constant crisis. It can, and does, recover.
Many people ask if more regulation can be part of this recovery, or at least limit the impact of crises in the future.
This ignores the fact that there are already regulations in place, which the bosses do their best to evade.
Take insider dealing for instance. The buying and selling of shares based on “insider knowledge” of a company is illegal.
This ban on this form of trading is meant to prevent wild fluctuations in the markets by stopping those who know that bad news is coming selling up and creating a spiral of panic.
Yet insider dealing is commonplace. One study of 172 mergers on the
US stock exchange found that insider trading took place in every single case.
Bosses will tolerate regulation at certain times. But when they need to they push to dismantle such controls – called cutting “red tape” – just as they did in the 1980s. And governments will go along with them.
What kind of “regulation” is on the table at the moment?
Lord Turner, the chair of the Financial Services Authority, is suggesting measures that the government could impose on the financial system.
These include forcing banks to build up capital reserves when the system is expanding so that they have enough capital to survive future slumps.
That’s all well and good, but the reason banks won’t lend now isn’t because they don’t have the money – it’s because they don’t have confidence that they’ll be repaid.
And even if they were willing to lend, firms won’t borrow to invest if there are no profits to be made.
Many of Lord Turner other suggestions are also focused around ensuring the liquidity of the banks.
None of these proposals deal with falling profit rates or take into account the fact that the economy is already deep in recession.
In Britain the car industry is facing big problems – not because of a lack of regulation but because too many cars have been produced.
The competition at the heart of capitalism leads to overproduction as firms compete with each other to grab the biggest share of the market.
Each firm produces cars to try to grab as much demand as possible – which means we have too many cars.
When the crisis hits, car workers are put on short-time working or are made redundant. This has a knock-on effect on other groups of workers – those who produce steel and rubber components for the cars, workers who transport those components, and so on.
More people are laid off. More people are unable to buy the commodities that are being produced. Bosses pull back further from production because they know they can’t sell their goods. More people are laid off. And so it goes on.
Introducing tighter “regulation” of the financial markets cannot resolve this problem of overproduction.
The financial system is key to keeping the system moving. It gives the bosses an outlet for their profits and new ways of making money – through gambling on stocks and shares.
But the health of financial markets depends on the health of the real economy. The value of shares may be exaggerated and fluctuate wildly depending on the activities of investors and speculators.
But the actual value of shares is related to the level of dividends – the amount of profits distributed to shareholders – that the company pays out. These dividends are related to its profits.
If profits are falling, the company pays less out in dividends, and the share price falls. Though share prices can be pushed up by things other than profits, this only creates a speculative bubble that at some point will burst.
The problems reflected in the financial sector are linked to the state of the wider economy.
Talk of increasing regulation focuses on the wrong target.