Financial crisis or financial sting ...

Right now the world is going through financial turmoil, if not a financial meltdown. Billions of dollars have been wiped off the share markets, banks are going broke or being “rescued”, super funds have taken an enormous knock and there is now serious disruption to the supply of finance, severely affecting businesses of all kinds.

The problem is worldwide, and while almost the entire Western world is in recession it is not yet openly admitted by our elected representatives. Also, what isn't spoken of a great deal is just how we came to be in this mess. The emphasis seems to be on how quickly it can be corrected and while that of course is absolutely necessary, if we are to find an enduring solution we have to know the cause of the problem.

It would appear the problem has been in the making for at least 10 years and even then would never have been possible but for changes to our financial systems made over many decades before that. In short, what has happened is that there has been an inordinate increase in the supply of cash readily made available to the market place; a level of cash that the economics of the community could simply not support.

In 2006 the United States Reserve Bank ceased publishing the figures relating to the available money supply, signifying there was at least some awareness, at that level, that there was an overheating. This excess in available cash materialised in the level of consumer and government spending; significantly by way of credit card debt, mortgages, re-mortgages and reverse mortgages.

In order to facilitate a continuing supply of all this debt much of it was bundled and packaged up and sold all over the world as things such as structured investment vehicles (SIV's), credit default swaps and Collateralised Debt Obligations (CDO's) to mention only some of the most common.

All these financial vehicles would have been sound if the communities’ capacity to pay the debt had been adequate. But many of the bundled mortgages were what we now know as “sub-prime” loans, where the lenders should have been aware, with due diligence, the loans would never be repaid. We can all remember the description of these loans when they were being drawn e.g. “Low Doc”, “No Doc” and worst of all the NINJNA loans: “No Income, No Job and No Assets.”

Even at the time of their issuance, these loans were known to be questionable debts that should not have been created in the first place. So, it is not hard to conclude that there was little regulation and no effective oversight at all over the issuance of these loans. Having them bundled would not likely have improved their quality, but somehow ratings agencies were able to rate them as suitable for an unsuspecting investment market, whatever that particular rating was.

In addition, there was the sheer size of the volume of these mortgages. It would appear as though everyone who put his or her hand up was given a loan. Now of course it has all come to grief, the suppliers of the money have lost their equity, those who brought the bundled packages of SIV's are out of pocket, and the home “owners” are out on the street.

A similar thing has happened with credit cards. Obtaining a credit card is less than a matter of making an application as free applications turn up in the letter box each week. Credit card debt is at frightening levels and while this may be tolerable, if not desirable in good times, it is a disaster in bad times when employment gets tighter and jobs are lost.

The consequence of all this is that the banks and other financial institutions, having both bought and sold these bad debts, are now in trouble themselves. Banks throughout the Western world are falling like ninepins despite substantial propping up by Governments. Credit is becoming short to the point where businesses of all sorts are suffering even from a shortage of “carry on” money, wages bills, inventory and the like.

The situation has reached the stage where serious inconvenience, to say the least, is being caused. At this point it is interesting to note that it is only the Western European and US banking systems that are in trouble. The Islamic banking system remains sound, which tends to indicate that the fault in the West lies in the banking system.

So, the question arises as to just who it was that allowed all this to happen, and there is no doubt that the ball falls squarely in the court of the credit and bank regulators. There is no other place for it to go; it was their responsibility and they dropped (or threw) the ball. What’s more, the regulators seem to have done it in unison and on a worldwide scale.

So the time has come to inquire as to who exactly these regulators are?

This question is not difficult to answer. The Reserve Banks throughout the Western world are the regulators. In all Western countries they not only control the production and flow of money but also the price of it; they set the interest rates on that money. With the last decrease in the interest rate by the Australian Reserve Bank it was embarrassing to hear both our Prime Minister and Treasurer “begging” the retail banks to do the right thing and pass on the full reduction in rates.

This should not be the case.

It now appears as though there will be a series of inquiries into the financial situation, but these will merely serve as a form of entertainment until the industry is about to move on.

Alan Greenspan, the ex Chairman of the Federal Reserve Bank, has now admitted before the US Congress that he was wrong to believe the banking industry in America would self-regulate, although he did claim that the system had worked successfully for 40 years. So the lack of oversight is well and truly admitted.

So to whom do we turn for recourse? Clearly we cannot avoid the question as to why there was no regulation or oversight from the Reserve Banks. The serious power resides with the Reserve Banks and if they are negligent in their duty then they set the standard for the rest of the industry.

As to how we prevent this from happening again, the suggestions are already coming out of Europe with the Prime Minister of Great Britain, Gordon Brown, stating words to the effect that in order to prevent this happening again there needs to be more global supervision of the banking industry.

Many won't agree and say all that Gordon Brown's proposal will do is cause greater centralisation of the banking systems of the various countries. If Gordon Brown's “solution” goes through then any hope of recovery will be lost forever, or given its best spin, made infinitely more difficult.

This present crisis is not yet over and in the near future we can expect to read about severe damage being done to hedge funds, even more so than today. To date the accumulated losses by investors and taxpayers is in the trillions of dollars. So it is a matter of urgency that a genuine solution is found.

Perhaps Ben Chifley had it right when he passed the Commonwealth Banking Act of 1945 and the Banking Act of 1945. It's just a great pity that this legislation never came to be effective. If it had we wouldn't be in the position that we are today and without doubt we would live in a far more stable and robust democracy than we presently do.

I believe it is timely to reflect on the words of Thomas Jefferson, President of the United States (1801-1809), who said (1802):

I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around the banks will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered.

These very words are not only relevant in the United States today, but also in our great nation, but will our Federal Government bite the bullet and enact legislation that returns the control of “currency” to the Parliament, and removes the unfettered ability to issue “currency” by private banks and other financial institutions with the stroke of a pen.