Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday 28 January 2016

Sanders, Corbyn and the financial crisis

Shortly after the full extent of the financial crisis had become clear, I remember saying in a meeting that at least now the position of those who took an extreme neoliberal position (markets are always right, the state just gets in the way of progress) would no longer be taken seriously. I could not have been more wrong. But in a way I think that the ‘surprising’ strength of the radical left (by which I mean those who are not the established centre left) in the US, UK and perhaps some European countries reflects exactly this contradiction.

We need only to consider the position of the financial sector to understand this contradiction. That sector was by far the major cause of the largest recession since WWII, and yet it is now in essentially the same position as it was before the crisis. There are no purely economic reasons why this has to be so: economists know that it is perfectly possible to make fundamental changes to this sector that could significantly reduce the chance of another crisis at little cost, but such possibilities are just not on the political agenda. For example, Admati and Helwig have convincingly argued that the problem with banks is very low capital requirements, but actual reforms have been marginal.

The reason is straightforward: the financial sector has political power. Many on the centre left seem too timid or too ignorant to talk about this power publicly,  and are therefore unwilling to challenge it. The political right and it's media machine help divert those who have little interest in politics and economics into believing that their problems are really due to too many migrants or too generous welfare payments. Those who are members or supporters of left wing political parties tend to have a better understanding of what is going on. To put it simply, a sector that caused a great deal of harm and cost us all a great deal has got away largely unscathed such that it could easily do it all again.

But it gets much worse. The right has succeeded in morphing the financial crisis into an imagined crisis in financing government debt (or, in the Eurozone with the ECB’s help, into an actual crisis) which required a reduction in the size of the state that neoliberals dream about. The financial crisis, far from exposing neoliberal flaws, has led to its triumph. Confronted with this extraordinary turn of events, many of those on the centre left want to concede defeat and accept austerity!

That is all scandalous, and if the left’s established leaders will not recognise this, it is not surprising that party members and supporters will look elsewhere to those who do. Now wise heads may warn that the radical left has in many cases not grasped the nature of the problem and are simply repeating old slogans, and worse still that voting for radical leaders may deny the left the chance for power, but inevitably this can sound just like the appeasement of many on the centre left. What Corbyn’s victory shows Democrats in the US is the power of the contradiction between the global financial crisis and where we are now.


  1. This Robert Reich column is interesting.

    I kept bumping into people who told me they were trying to make up their minds in the upcoming election between Sanders and Trump.

    At first I was dumbfounded. The two are at opposite ends of the political divide. But as I talked with these people, I kept hearing the same refrains. They wanted to end “crony capitalism.” They detested “corporate welfare,” such as the Wall Street bailout. They wanted to prevent the big banks from extorting us ever again. Close tax loopholes for hedge-fund partners. Stop the drug companies and health insurers from ripping off American consumers. End trade treaties that sell out American workers. Get big money out of politics.

    President Hillary Clinton wouldn't even try to do much (if any) of that. (Neither would Trump, for that matter, but that's another discussion.)

  2. Well, here in the UK it was the 'left' in the form of the Labour Party that was responsible for the situation that resulted in the Financial Crisis, and the immediate response to it. Whether the 'right' would have done anything differently is a point for discussion, but irrelevant: it was the 'left' what done it.
    Since Financial Crisis here and the resulting support of the finance sector was a product of the 'left' it is no surprise that the 'right' is now in the ascendancy (and the reverse is true in the US). A fact underlined by Blair, Darling and Brown now all being in the pocket of the financiers.

    1. That's absolutely true. And the Government pretty much reflected the views of the economic orthodoxy during the Great Moderation - free labour, capital good flows leads to an 'efficient' allocation of resources - comparative advantage, credibility, incentives, etc etc - all EC 101. Also you cannot blame globalisation (which they thought was an unambiguously good thing anyway); academics outside mainstream economics have warned about the dangers of leaving a country overly exposed to globalisation since - well the beginning, but most people studying economics would have been unaware of the arguments and the richness of this literature (and still largely are).

      On migration, the tragedy of us not being able to let in desperate Syrians is a result of huge immigration (largely of cheap labour) under the Labour government which has not delivered tangible net positive results for most people and left them fatigued. Now we find we politically cannot let in the people that we have a moral responsibility to let in.

      Since the failures happened under Labour, they had to take responsibility, and in the end it played to the Conservatives and we got something worse.

      The start of the solution is to get more pluralism and critical thinking into economics and make it look more like other social sciences. Then hopefully we do not get a repeat of the hubris and Great Moderation Era mistakes.

    2. The financial crisis couldn't have happened without Thatcher's Big Bang which is no doubt why she was and continues to be feted in death by the City. If you're trying to blame the worldwide financial problems on Labour overspending, where's your evidence to support this (never mind the then Tories were critical of Labour spending on the grounds it was insufficient)? Are you trying to suggest Osborne And Cameron, for example, aren't in the pocket of the financiers? Where's your evidence? :-)

    3. SimonP: I wrote a couple of comments under Simon's post "The dead hand of austerity; left and right" that relate to yours. In those comments I made the point that it is, and probably always has been, plain to everyone that the centre-left position of New Labour is a right-wing ideology with an identity crisis.

      The 2008 crash hit the UK hard because New Labour was a right-wing party that carried on the Conservative’s policy of under-regulating our financial systems; a decision that those of us on the genuine left of politics would have done our best to avoid. New Labour’s abandonment of a genuine left-wing outlook, along with its analogues in the US and Europe, has led us to the current financial crisis and its ongoing austerity con.

      Unfortunately though, it appears that people such as yourself, and even Simon Wren-Lewis with his disappointing assertion that Corbyn is on the “radical left” rather than just the plain left, want to keep up the pretence that you think that New Labour was somehow a left-wing party.

      As I’ve said before, and I’m sure I’ll have to keep saying again and again:

      The centre is on the right.

    4. I have no idea why you would post such drivel on the blog of an academic macroeconomist. When both parties agreed on the direction of travel there is no left or right on finance and the City of London.

    5. How was New Labour "left" or anything but Thatcher-lite? And how were New Labour any more responsible for 2008 than the decades of Tory rule setting up the groundwork for underregulated markets?

    6. You've completely missed the point of Simon's post. A party that furthers the interests of finance captal is by definition not of the "left". The rise of Corbyn, whatever else it may presage, is clearly driven by an appetite for a genuinely left position. Ditto Sanders in the US.

    7. The UK Labour Party in the GFC was neo-liberal light rather than a believer in improving regulation.
      The GFC was caused by very poor prudential behaviour by all financial institutions.
      Ogden Nash was quoted at the start of Chapter 15 of Paul Samuelson's text;
      " rule which woe betides the banker who fails to heed it.. never lend money to anyone unless they don't need it."

    8. Hence the 'quotation marks'.

    9. `@Big Bill Critics of Labour and New Labour here are not directing blame at 'overspending' by Labour for the problems that led to Britain's exposure to the Financial crisis and the elevation of the Conservatives. They are blaming things like financial deregulation and over-liberal and naive policies towards trade, capital and labour flows, Labour also ignored growing inequality. Mainstream economists did not take seriously arguments made by historians, sociologists, social workers and many others about dangerous inequalities, imbalances and social problems that were becoming clearly evident. Mainstream economists, almost unanimously said that industrialisation was not a problem , almost natural, and the City was where Britain's 'comparative advantage' lay. Too much confidence in their theories and seeing things through abstraction to the extent you can just ignore what others are actually seeing, not through abstraction, but actual engagement with reality. Take economic immigration, or trade with an assertive China, again, naive neo-classical arguments were prominent.

    10. This whole derail is just pointless 'whatabouttery'. Who cares if it was the right or the left. By playing into this partisan 'not me sir, i just got here' cheapens the argument and stymies true academic debate.

      In summary:- whenever someone says 'It was the left/right which started this' you should ignore it - the problem is now.

  3. Simon,

    I agree with everything you say and this might be nitpicking, but some economists -- Dean Baker in particular -- think it was the real estate crisis, and not the finanical crisis, that created our current woes:

  4. Not sure I agree. The problem is there is no rational *bankruptcy* procedure in place at the moment. Here is my view, it is not quite the same as Positive Money put it but similar:

    The lending banks we need are the ones that can lend development capital effectively and stick to doing just that. If we are to have private lending banks, then they need to be able to make a decent profit doing development capital lending.

    The way I would narrow banks is to offer them an incentive - an unlimited cost free overdraft at the Bank of England. 0% funding costs. In return they must drop all the side businesses and just do capital development lending on an uncollateralised basis - probably in the form of simple overdrafts. In other words they become an agency businesses delivering state money to those that require it.

    A capital buffer probably ISN'T required here. Losing your lending licence if your underwriting isn't that good should be sufficient incentive to run a tight ship. Backing off the entire thing to the central bank reduces the barriers to entry in lending - making self-employed, highly dispersed and, importantly, locally focussed underwriters a possibility.

    Any lending businesses that doesn't want to take the oath, then has to fully fund their lending on a maturity matched basis Zopa style. No deposit insurance, no access to the Bank of England, and losses absorbed by those doing the lending. This then becomes the fate of the shadow banking system - the building societies and money funds.

    What we need is asset side regulation.

    You proscribe a list of valid purposes for a loan. Anything outside that list becomes unenforceable in court.

    That leaves the courts to decide what fits and what doesn’t fit the list. If they decide it doesn’t fit, then it becomes a gift of shareholders funds.

    Operate like that and I guarantee you that banks will become very keen on their due diligence – because the client just has to argue in court that the loan was ‘ultra vires’ to get a freebie.

    It’s really easy to regulate for the government banks if you want to.

  5. (continued)

    There is another issue:

    The transaction system is clearly also being used as a hostage by the banks to get whatever they want out of the government and the central bank. Do as we say or we shoot the transaction system!

    There are lots of ways of designing a mutual transaction system. But at its core is one concept – transactions operate on the balance sheet of the central bank, not the individual banks. So you would have a Transaction Department at the Bank of England (alongside the Issue and Banking Departments) and current and savings account ultimately represent liabilities on that balance sheet.

    The functional aspects are less important – existing bank accounts could be held in trust by the current banks, run as separate subsidiaries companies and a myriad of different other options. But the key point is that the operational entity is acting as agent and the legal ownership and responsibility is always at the central bank. That makes anything recorded in the transaction system exactly the same as holding cash. You have a receipt for liabilities at the central bank.

    However that makes the individual banks short of deposits and balancing liabilites. The replacement on the individual bank’s balance sheets is of course an overdraft from the central bank. Existing banks would then have to get the match funding to free themselves from the central bank lending restrictions, conform to requirements or just enter run-off, as I mentioned earlier.

    The transaction system is like the road or rail infrastructure and is a common good required by all.

    Inevitably the state will have to fund its existence – because there is no money in running it. I see the state providing a ‘white box’ system that anybody authorised can put a marketing veneer on. Done correctly it would mean that you can literally operate your bank accounts through any of the competing front ends. Account numbers would stay the same whoever you are notionally with.

    The other important thing about cutting down on bank lending is it free ups a *huge* amount of space for government spending. I can see this as a good way for ‘funding’ a basic income – certainly better than raising the basic rate of tax to 45%.

    That way also the public have an *incentive* to support narrowing banks. Basic Income allows you to narrow banks without a depression.

  6. This is roughly the same as my own thinking; that Corbyn's victory comes on the back of a membership angry that they lost the last election having to take the 'austerity-lite' approach for responsibility reasons and Sanders rise has come on the back of Democrats angry that more significant reforms were not put in place after the crash.

  7. There is a very simple explanation for all these circumstances but you won't see it if you keep thinking in outdated ways about political influence.

    It's no longer about Left and Right but about Up and Down.

  8. The U.S. Presidential primaries are starting this week and Sanders could win the first two in a large upset. Hillary and her supporters have been attacking Bernie much more lately. Econobloggers Krugman, DeLong, Thoma have all come out for Hillary, arguing that the danger of a Republican victory is too much.

    Sanders has criticized the Fed while Hillary has not. Sanders has a substantial financial transaction tax. I agree with Dean Baker who is still for Sanders.

    I would bet money that Trump doesn't win. He wont' get enough votes. He turns off Latinos and women, etc. He may motivate more people to vote. What Trump shows is that the Republican establishment is in tatters and the base no longer trusts them.

  9. I do wish you'd remove your moderating policy statement. It' quite redundant and it appears as if it's the main theme of any post of yours shared on Facebook! Grrr...

  10. At PMQs this week (with due apologies to Henry Fielding's 'Shamela') Shameron, crimson faced, shouted that Blair, Brown and Darling are all being paid by large financial companies so don't talk to him about Google paying 3% corporation tax.

    If you are an anti-Thatcherite, this is the sort of 'argument' that really turns the stomach. Quite what it would have taken for Labour to have got City and Murdoch support in 2010 does not bear thinking about.

    1. Is it not true that Blair, Brown and Darling are all being handsomely paid by large financial companies?
      Why do you think these companies are doing it?

  11. From the first sentence to the last, everything you have written here describes the way I think and feel about this. Like you were reading my mind (but written much better and more coherently).

    Sanders offers the chance that challenging that power of the financial sector would even be considered. Clinton, not so much.

    1. Mr. Brown, my thoughts as well. Living in the US feels live living on the sharp edge of a knife.

  12. If only it was as simple as Left and Right, but it is bigger and worse than that. today I asked the question who rules the world?

  13. Excellent post! And finally a break with Paul Krugman.

    1. Thank you for the first comment, but I think the second reflects what you think I wrote rather than what I actually said. While Paul is undoubtedly a wise head, I did not say these warnings were wrong, but said they might be ignored. Paul and I have differed about issues in the past, like the microfoundations of macro, or the political solidity of the Eurozone.

    2. Well, I can read too and Madhyamak is right, this column does constitute a break with Krugman's recent posts and as Peter earlier noted, other leftish leaning econ bloggers.

      Maybe it was not your intent, but the actual post you wrote displays a deep understanding of, and approval for, the motives and desires of Sanders supporters. And a definite criticism of the center-left. Furthermore, it extends hope that it is not all a foolish dream when you compare it to the Corbyn victory.

      And it is an excellent post.

  14. "For example, Admati and Helwig have convincingly argued that the problem with banks is very low capital requirements,"

    Then I wonder at that. Banks always have 100% loss capital on their balance sheets. Deposits are essentially capital. After all why else would you need a depositor's protections scheme if they are not subject to loss?

    Having a system where people 'bail-in' ahead of time rather than behind time sounds like the same faulty control thinking as the sovereign money idea.

    Banks can essentially create their own capital via the lending process as Professor Werner has already described in his seminal papers on how the banking system actually works.

    So there can be no effective control point on the liabilities side of a bank's balance sheet. All you can do there is alter the price, which just feeds through to the price of loans. And we already saw how well price adjustment controls banks in 2008.

    The job of the financial sector is to create money for appropriate projects in the non-financial sector. Their use of the power to create money, delegated to them by the state, should be limited to that purpose and that purpose alone - restrict financial sector asset creation only to those assets that fund the non-financial sector. No more borrowed-into-existence casino money. If the finance sector wants to do anything amongst itself it should be force to raise equity to do it, which would then have to come from existing savings.

    The place to discipline banks is on the asset side of the balance sheet. By removing the financial sector's ability to borrow money from banks you shrink the size of the financial sector and stop it creating bubbles within itself.

    The financial sector size is determined by how much it can expand its balance sheet, and the expansion is driven on the asset side - where the result of its sales efforts end up.

    1. I do not understand why you think equity capital is just like deposits.

  15. "Many on the centre left seem too timid or too ignorant to talk about this power publicly, and are therefore unwilling to challenge it."

    The other one is that the left has severe loss aversion issues.

    To shrink the financial sector requires putting people out of work.

    Allowing capitalism to work requires businesses to fail, which puts people out of work.

    Unfortunately capitalism without loss and failure is like Catholicism without hellfire. It doesn't work as a concept. Things have to be allowed to fail - banks included.

    Importantly failed expansion leads to permanent loss which has to be allocated. If you were earning good money on a bubble project, or in a declining business area that fails, and your skills are unneeded anywhere else, then your income will decline - possibly right down to the living wage.

    So the first task is working out how to take losses with good grace.


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