Every year at Birmingham Book Festival, I experience something that brings my outlook on life into sharp relief. In my first year, Mark Thomas tackled the issues that the Coca-Cola Company prefers to brush under the rug: appalling workers’ rights; environmental damage; and a general disinclination to put corporate social responsibility anywhere near on a par with profit-making (plus ça change). A year later, Tristram Stuart showed the true extent of the Western world’s profligacy, and what we can gain by producing and using food in a wiser, more sustainable and less wasteful fashion. This year was the turn of John Lanchester, giving us a terrifying insight into the out-of-control world of the global banking sector.

The markets haven’t exactly been strangers to trauma in the last 30 years, although given the terminology and measurements attached to such events, you would be hard-pushed to know it. Those who count themselves part of the global banking sector call them Black Swans: “high-impact, hard to predict, and rare events that are beyond the realm of normal expectations.” But how rare, and how predictable? And how common do these Black Swans have to be before we start questioning the system that labels them so?

John Lanchester first uses the example of Black Monday – a 10-standard deviation (or 10σ) event:

“...on the basis of the market’s historical volatility, had the markets been open every day since the creation of the Universe, the odds would have still been against it falling that much on a single day. In fact, had the life of the Universe been repeated one billion times, such a crash would still have been theoretically “unlikely”.”

That was followed by the Russian bond default of 1998, a  7σ event – rather more likely, albeit something that should only occur once every three billion years. Indeed, the last few decades have been peppered with five, six and seven sigma events. But this is nothing compared to what the markets have been through in recent years. In 2007, Goldman Sachs CFO David Viniar famously remarked that recent movements in the tumultuous market “were 25-standard deviation [25σ] events, several days in a row”.

Blimey. So how large a number is 25σ, Mr Lanchester?

“It is almost impossible to put into words how big a number 25-sigma is, expressed as odds-to-one. Twenty sigma is ten times the number of all the particles in the known universe; twenty-five sigma is the same but with the decimal point moved 52 places to the right. It’s the equivalent to winning the UK National Lottery twenty-one times in a row.”

So David Viniar, CFO of one of the world’s most successful financial institutions, feels that the likelihood of a drop in house prices leading to the most vulnerable homeowners defaulting on their mortgages is one in…um, that.

It’s not wrong for people to want to own their own home, to strive for security for themselves and their family. But not everyone in is the position to do so, and many people simply do not have the disposable income available to make repayments on a mortgage. But these people were the target market for lenders in the days of the housing bubble, when risk had been “eradicated” by the exotic (but ultimately toxic) mix of collateralised debt obligations (CDOs) and credit default swaps (CDSs). If the process has supposedly eliminated risk, the quality of the underlying asset becomes less important. And it became utterly unimportant. Which as we all know, was catastrophic, and we live with the consequences today.

Not that the banks have shown even a modicum of humility, mind. Bonuses are already back to normal, even though we bailed them out and insured their actions. They are in our debt, but we are paying for it…with our jobs, with the quality of our public services, and the quality of our lives. If you’ll pardon my language, it fucking sucks.

As I type, the Independent Commission on Banking are examining whether the risks posed by banks of “different size, scale and function” require investment and retail operations to separated. Back in June, Chancellor George Osborne quite rightly (gasp) said that “we need a proper debate about the future structure of banks, the relationship between retail and investment banking, and the question of how to ensure greater competition in the banking industry.” For his part, Business Secretary Vince Cable, felt the “direction of travel” is towards a split. How the coalition government acts when the recommendations are made to the Cabinet Committee in September 2011 will be very interesting.

I don’t see how anything BUT a split could be recommended – and if the direction of travel is as Cable says, then Labour must support that. The banks will wail – but they are yet to earn the right to be trusted with quality of life of a whole nation.

The way that the global financial sector created (and lost) so much wealth is no alchemy, and we owe it to ourselves an the people we love to try to understand what happened, and why (and how) it must change. If we don’t, it’ll happen again – and this time, we can’t afford a bailout.

Incidentally, you should really read ‘Whoops!’.

Categories: Economics, Sustainable Lives

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Please watch Hannah Nicklin‘s excellent video, visit the site, and circulate:

The coalition has painted their way as the only way. It’s not, and a great deal hangs on winning that argument.

Categories: Economics, Screaming Howlers
Tags: coalition, cuts, economics, recession

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No-one is (or should be) particularly thrilled that the UK is still in recession, regardless of their political affiliation.

Looking at the figures, I am still hopeful of recovery in the final quarter – the decline of 0.4 percent is less than the 0.6 percent decline seen in Q2 2009, business confidence is on the increase…and it’s Christmas, which certainly won’t hurt, although that certainly won’t be enough to drive growth in Q1 2010. But things are looking good in the global market – initial public offerings are occurring once more, and the private equity and venture capital industry has been shaken out of its blue funk by taking new approaches to investing – less leverage for private equity, more mature investments for venture capitalists. This will have an effect – after all, if we have learnt anything from the financial crisis, it is that we are more interconnected than anyone realised. We still have a problem though, and clearly, the three main political parties have very different ideas on how we will ultimately pull ourselves out of recession – Labour by spending now, cutting later, Conservatives by cutting now and Lib Dems by “progressive austerity” – the most poetic of the three plans, to be sure.

But throughout this crisis, it has become worryingly clear that the label “recession” and the economic concept to which it refers have become divorced – otherwise we wouldn’t be having this increasingly circular argument about whether you can spend out of a recession. You can only spend out of a recession. Consequently, when Roger Bootle, an economist who writes for the Telegraph wrote this simple, but excellent piece, I breathed a sigh of relief. “A recession is a situation in which output, spending and income are all below normal or below potential. If output and income are to go up then someone must spend more. There is simply no other way. As a matter of logic. The only sensible debate is about who should spend more, on what, and how they can be persuaded to do so.”

So, are those who propose cutting ignorant of what a recession actually is? Or are they pretending to for the sake of presenting a different slant to those they wish to distinguish themselves from? I don’t know – frankly, it gives me no pleasure to think that a potential Chancellor does not understand what a recession is, just as it gave me no pleasure when Gordon Brown said that we had eliminated boom and bust. I don’t like people with power making bad decisions – even if I get to say “I told you so”.

Mr Bootle outlines four groups of “spenders” in his article – consumers, companies, foreign visitors and the government. Considering the weak pound, it was widely thought that tourists would do a lot of our spending – but considering the declines in the services sector, this clearly did not happen to the anticipated extent. Of course, financial services are more of an issue than the health of the hospitality sector – our reliance on them is probably the single most important reason that we are still in recession.

I am not saying that there is one way out of recession and into growth. Ultimately though, we have to be reading from the same economics textbook, or, as Mr Bootle says, we will have to learn to love the recession.

This blog was originally posted on House of Twits, with graph from the BBC.

Categories: Economics
Tags: economics, financial crisis, private equity, recession, venture capital

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