The Legacy of the 2008 Financial Crisis and a Decaying System
It's been business as usual since the financial crash of 2008...
The financial crisis of 2008 created a massive black hole that will inexorably suck in the decaying system bit by bit. But that black hole has been building for some time and will continue to build.
In this article I'll examine just how the big banks have and will continue to erode the very fabric of our society and ultimately the planet. From tax havens to climate change, our financial institutions have pervaded and corrupted and will threaten our very existence through the extensive links that draw the global neoliberal system together.
Move your money UK campaign
Move Your Money UK was a national campaign that launched in 2013 in conjunction with a major investigation by Ethical Consumer into the big banks behaviour. The campaign ran for nearly 5 years before winding up. The aim was to persuade people to change their bank accounts away from the big banks responsible for the current economic malaise. The campaign followed on from a successful movement launched in the US.
It has become evident that the big banks have been avoiding tax, paying huge bonuses, investing unethically and providing poor customer service. The vested interests mentioned above include major corporations and politicians. Neither are likely to change the system anytime soon and the regulatory framework is designed to facilitate the current system.
There are alternatives to the big banks. And it’s relatively straight forward to change over. As well as individuals, groups and organisations are also supported and advised. Other supporters of the campaign were UK Uncut, the New Economics Foundation (NEF) and Co-operatives UK among others.
Co-operatives UK produced an informative booklet called The Little Book of Money, which offers advice on changing accounts and some historical facts about banks:
‘mis-selling of financial products has led to the loss or transfer of an astounding £32bn from ordinary customers to executives and shareholders in the last five years alone.
‘The big banks gambled with our money, then demanded a stunningly large bailout. Their sheer size threatens the entire global economic system, but since we bailed them out they’ve only got bigger.
‘There is nothing wrong with banks making a profit, like any other business. But if a bank is owned by external shareholders, as a plc, it may struggle to balance the interests of those shareholders and its customers. In a mutual bank or credit union, the shareholders are the customers. They’re unlikely to invest their money unwisely — or to encourage mis-selling of financial products that customers don’t need or can’t afford’.
Of the 100 biggest groups listed on the London Stock Exchange, 98 use tax havens:
The banking sector makes heaviest use of tax havens, with a total of 1,649 tax haven companies between the ‘big four’ banks. They are by far the biggest users of the Cayman Islands, where Barclays alone has 174 companies.
These are the findings of research into tax havens by ActionAid. At a meeting of G20 leaders in London in April 2009, it was identified that the catalyst of the Global financial crisis was a toxic mix of complex financial products routed through tax havens.
HSBC is the biggest financial sector user of tax havens in the FTSE 100, with a grand total of 556:
UK law compels companies to report all of their subsidiary companies, together with their country of registration. When we [ActionAid] looked for this information in early 2011, we discovered that more than half of the FTSE 100 were not complying with this legal obligation.
Another attraction to companies using tax havens is the veil of secrecy surrounding operations:
Secrecy helps to undermine the regulations of other jurisdictions, while providing an effective shield against investigations into tax avoidance and evasion. The Tax Justice Network recently updated its authoritative ranking of secrecy jurisdictions.
In some tax havens, secrecy and minimal reporting requirements are more important than the tax rates on offer.
Is anything being done to close these loopholes? Previous UK Chancellor George Osborne stated: ‘We will also target tax evasion and off-shore tax havens… Everyone must pay their share’. This followed action by the Treasury to shut down two schemes that Barclays used to avoid at least £500m of tax.
The changes that have taken place revolve round a set of rules called the Controlled Foreign Company (CFC) rules, which are designed to deter British multinational companies from exploiting the low tax rates offered by tax havens. Under the CFC rules, if a multinational shifts its profits into a tax haven in order to lower its bills anywhere in the world, the UK tops up its tax bill at home, bringing it into line with the standard UK rate. This covers companies who are based in the UK. How this works is explained in the ActionAid report Collateral Damage (PDF), which details how tax avoidance affects developing countries:
The next infographic shows the situation after the changes:
The overall result? Lost revenue for the UK and developing countries where the companies are based. Such tax contributions in developing countries can help provide funds to expand infrastructure. This helps provide the basic building blocks for economic growth and can help to avoid dependency on foreign aid.
Barclays in the spotlight
In March 2009, a whistleblower leaked internal Barclays memos to Liberal Democrat MP Vince Cable. They described how a 2007 scheme called Project Knight proposed to save tax by manipulating loans totaling more than $16bn (£9.8bn), through a web of firms in the Cayman Islands, Luxembourg and the United States. The documents, which were leaked to the Guardian disclosed seven tax avoidance schemes operated by Barclays. Many of them were devised by structured capital markets boss Michael Keeley. They involved more than £20bn of loans typically shuttled between entities in Luxembourg and the Cayman’s, designed to generate hundreds of millions of pounds of tax reliefs, the proceeds frequently shared with US banks.
Barclays took out a gagging order against the Guardian to prevent publication of the documents. But they were already in the public domain and were picked up by ActionAid:
In January 2011, Barclays was forced by the UK parliament’s treasury committee to disclose the value of its UK corporation tax payments. Testifying in front of the committee, Barclays’ CEO Bob Diamond stated that the company paid £2 billion in taxes in 2009. The committee was incensed when Diamond admitted that this figure included payroll taxes incurred by Barclays’ employees, not by the bank itself. When Diamond was not able to disclose a breakdown, one committee member retorted: “then we don’t know what, as a corporate entity, you’re paying.” Coming at a time of distrust in the banking industry, the misleading disclosure became a story in itself. This was compounded when Barclays eventually divulged that its UK corporation tax payment was just £113 million of the £2 billion originally cited. The Guardian newspaper calculated an effective tax rate of just 1%. The confusion had arisen because Barclays had disclosed only the UK tax figure that had been required by the committee, and this had been compared with its global profits.
In fact, the company “paid over £1 billion in corporation taxes worldwide,” according to group finance director Chris Lucas, writing in response to the Guardian article. Had Barclays given a breakdown of its profits and tax payments by country, this mistake would not have arisen, those following its disclosure would have gained an accurate impression of its tax contribution, and the company would have inspired much greater trust.
Barclay’s was also one of the key banks involved in the LIBOR scandal, which broke in 2012, following a transatlantic investigation involving the US Commodity Futures Trading Commission (CFTC), the Department of Justice (DOJ) and the UK Financial Services Authority (FSA). A paper published in the Journal Economy and Society, On arbitration, arbitrage and arbitrariness in financial markets and their governance: unpacking LIBOR and the LIBOR scandal goes into the details of the scandal. The scandal involved the manipulation of the London Inter-bank Offered Rate by Barclay’s traders, who attempted to either raise or lower interest rates that would benefit financial transactions. But such activities weren’t restricted within the bank. As the paper outlines:
Barclays traders’ attempt[ed] to influence the rate submissions of other banks (by making requests to those banks’ traders, with a view to such traders passing on the requests to their own submitters); and Barclays traders’ requests to Barclays submitters based on the requests of traders (often ex-Barclays employees) working at other banks. Exploiting membership on a LIBOR panel, it appears from the evidence produced through the investigations, was a common mode of financial rent-seeking undertaken by Barclays and other banks during the latter part of the 2000s.
In total, Barclay’s was fined over £1.5Billion by US and UK regulators over the scandal.
The Tax Justice Network
The Tax Justice Network (TJN) focuses on the issue of tax havens or ‘secrecy jurisdictions ‘ as they are referred to. In 2009, it developed the Financial Secrecy Index (FSI) in order to highlight the level of secrecy and transparency prevalent in tax havens. The current index at the time of writing was set up in February 2020. It serves to rank ‘jurisdictions according to their secrecy and the scale of their offshore financial activities.’ The following list shows the top 50 current rankings (full details on how index works here):
In 2012, TJN published the report The Price of Offshore, Revisited. It has been estimated that up to $32trillion could be located in offshore jurisdictions. ‘Offshore’ can mean locations that are either physical or virtual. And these locations can be in a state of flux. Most of this wealth is concentrated in the hands of just a few people. This is illustrated in the following wealth pyramid graphic:
These people can rest in comfort in the knowledge that their wealth is securely hidden from prying eyes. As the report puts it:
It is these core capabilities, secrecy, tax minimization, access, asset management, and security — that our modern “offshore” system offers. In the last 30 years a sophisticated transnational private infrastructure of service providers has grown up to deliver these services on an unprecedented scale. This “pirate banking” system now launders, shelters, manages and if necessary re-domiciles the riches of many of the worlds worst villains, as well as the tangible and intangible assets and liabilities of many of our wealthiest individuals, alongside our most successful mainstream banks, corporations, shipping companies, insurance companies, accounting firms and law firms.
Despite increased public awareness of this issue in recent years, decisive action to deal with the problem has been limited. Most of the offshore capital is held in various shell companies that acts as a front for investors. But the real core investments are held in countries such as Switzerland and Luxembourg.
A clear and important conclusion from this report is that the offshore financial ‘black hole’ is generating extreme inequality. This stems from a ‘Tax base erosion’ across the board that affects funding for essential public services and investment. In particular the report highlights climate change mitigation as a future casualty of such investments. The report notes that all the major banks are complicit. This doesn’t just involve tax avoidance. They are also engaged in illicit money laundering operations. What is particularly galling is the fact that the top 10 major institutions in the market ‘received substantial injections of government loans and capital during the 2008-2012 period’:
In effect, ordinary taxpayers have been subsidizing the world’s largest banks to keep them afloat, even as they help their wealthiest clients slash taxes.
In May 2019, research by TJN detailed the breakdown of the global corporate tax system, caused mainly through UK controlled networks of satellite jurisdictions. As a result this has:
aggressively undermined the ability of governments across the world to meaningfully tax multinational corporations.’ This has sparked what TJN describes as a ‘World Tax War’ leading to a ‘‘race to the bottom’ across the globe that will further deplete tax revenues as countries desperate to claw back foreign investment engage in the false economy of ‘tax competitiveness’ and increase their complicity in corporate tax havenry.
Poor nations end up being adversely affected, as tax revenues are siphoned from their economies. The Corporate Tax Haven Index ranks the world’s most important tax havens for multinational corporations.
But its not only poor nations that have suffered. The UK itself has been impacted by a highly inflated financial sector. This is explored in the 2018 book, The Finance Curse.
The book was authored by Nicholas Shaxson, who has previously written about the ‘Resource Curse’ and tax havens, and John Christensen, who is currently the director of the Tax Justice Network, a member of the OECD Task Force on Tax and Development, and a board member of Washington, D.C.-based New Rules for Global Finance. This report (PDF), based on the book goes into the salient details of the issues covered in the book.
The report discusses similarities between the so-called resource curse and the finance curse, pointing out that countries with abundant resources such as oil and minerals tend to stagnate in terms of economic growth, particularly in developing countries where there is already poor governance. The results are high unemployment and greater inequality as the focus switches from other economic outputs and production to mineral exploitation. This results in increased dependence on the resource.
The inevitable consequence of this is that wealth flows to elites and actors connected to the resource industry. As the report notes:
The easy economic ‘rents’ that flow from minerals extraction are particularly prone to corruption and looting by political élites. Research has shown that more corrupt countries tend to have more natural resources, particularly in non-‐democratic societies.
Along with cost of living increases where the industry is predominately centred and a movement of people away from other areas of the economy, this sends other sectors into free-fall. This over-dependency on extractive industries can cause serious economic problems if prices fluctuate. Its a case of overindulgence during boom times with blowback during bust — a never ending cycle of economic malaise. That doesn’t bother speculative vultures moving in for the kill and making sure they get their piece of the pie. Not surprisingly, this fosters corruption and authoritarianism which can lead to conflict and instability.
It boils down to resource wealth flowing directly to the elites and then filtering down to those who prop up the system. This creates a bubble in which society as a whole are excluded. With enough wealth pouring in from the ‘gold mines’ everything else is excluded. Complete dependency on the resource ensures, whereas in a ‘normal’ economy:
a diverse array of economic actors in manufacturing, agriculture, tourism, teaching, healthcare and other productive sectors add genuine value at the ‘bottom’ or grass roots level. They interact through many ‘horizontal’ and co-‐operative relationships, which can reinforce the social fabric and create more distributed sources of power.
The exception to the rule is Norway, which had the integrity and insight to install buffers that would counter the effects of the resource curse. Its oil reserve fund has been the mainstay of this process, emerging from a strong and stable political economic base.
The report then goes into detail about the finance curse, which has many similarities to the resource curse. Basically the political and economic establishment of a country is ‘captured’ by the financial institutions that become dominant. The sector defends its position by framing a discourse around issues such as tax contribution, job creation and positive impact on GDP.
In the UK, finance is dominated by the City of London Corporation. Fronting the City is the ‘not for profit’ lobbying organisation TheCityUK, which claims:
In the UK, across Europe and internationally, we promote policies that drive competitiveness, support job creation and ensure long-term economic growth. The industry contributes over 10% of the UK’s total economic output and employs 2.3 million people, with two thirds of these jobs outside London. It is the largest tax payer, the biggest exporting industry and generates a trade surplus almost equivalent to all other net exporting industries combined.
TheCityUK provides data and claims regarding the performance of the City. But the report debunks many of the claims put forward by CityUK, suggesting they are ‘a form of benefits fraud’. The data presented by CityUK is vague and incomplete and difficult to understand and the claims made don’t appear to fit the evidence. The report observes that the financial sector has ‘massively outgrown its ‘utility’ role’ serving the wider economy. Using Apple as an example of financial engineering, from an article by the Financial Times, it illustrates how companies use the market and its instruments to manufacture profit:
When Apple borrowed, it did so not to raise funds for its business but to return to its shareholders cash secured from operations. Capital markets are no longer mechanisms for putting money into companies, but mechanisms for getting money out.
Here’s a definition of financial engineering:
Financial engineering is the use of mathematical techniques to solve financial problems. Financial engineering uses tools and knowledge from the fields of computer science, statistics, economics, and applied mathematics to address current financial issues as well as to devise new and innovative financial products.
Financial engineering is sometimes referred to as quantitative analysis and is used by regular commercial banks, investment banks, insurance agencies, and hedge funds.
The City of London Corporation, also known as the square mile, is a gravy train for financial speculators. Its lobbyists have privileged access to politicians, particularly the UK Treasury, according to an investigation by The Bureau of Investigative Journalism.
As part of the PR offensive, wining and dinning of VIP's is part and parcel of the City agenda. The Sunday Times sums up how the Corporation is run, by an:
exclusive coterie of men who rule the City of London according to conventions laid down in medieval times… at least 21 of the 25 aldermen attended top public schools including Eton, Harrow, Charterhouse, Radley, Haileybury, Rugby and Stowe. They are drawn from some of the most prestigious City names, including Rothschilds and Linklaters & Paines… The City was the only local authority allowed to keep its aldermen when they were abolished elsewhere in 1972. Aldermen wine and dine regularly at the Mansion House, home of the lord mayor of London, and at Guildhall, the official headquarters. They rub shoulders with prime ministers and ministers, not only from Britain, but from abroad. Each alderman gets a turn as lord mayor, for which he is given the use of two Rolls-Royces, travel expenses and the right to live in the Mansion House. There are 230 lunches, dinners and banquets each year at the Mansion House, which has extensive wine cellars and 37 staff.
An alderman is a 'member of the legislative body of a municipal corporation in England and the United States. In Anglo-Saxon England, ealdormen, or aldermen, were high-ranking officials of the crown who exercised judicial, administrative, or military functions. Earls, the governors of shires (counties), and other persons of distinction were among those who received the title of alderman.'
The Finance Curse report compares the City to a spiders web, rings of influence, with the neighboring Crown Dependencies of Jersey, Guernsey and the Isle of Man feeding UK banks over $300billion. The report notes that:
Much… of the City’s financing involves tax-evading and criminal funds from around the world. Jersey Finance, the lobbying arm of Jersey’s finance industry, notes that: ‘Jersey represents an extension of the City of London’.
Then there is Britain’s 14 Overseas satellite Territories, which are well established tax havens.
To sum up:
This British web provides the City with two main things. First, the tax havens scattered across the world capture passing foreign business and channel it (often via structures that involve a variety of other jurisdictions) to London, just as a spider’s web catches insects. Second, it lets the City get involved at arm’s length in ‘dirty’ business, but with enough distance to maintain plausible deniability.
Tax contributions and jobs created within the sector are overstated. People working in the sector tend be highly paid and highly talented, causing a ‘brain drain’ from other sectors. Many of the jobs (at least 25%) consist of overseas workers. Countries are also offering tax breaks to corporations to set up shop. This would effectively contribute to GDP. But in reality, the companies involved transfer their profits out of the country, so the actual GDP figure is inflated. The result of all this is money and talent being siphoned from the rest of the country into London and the south east:
The expansion of finance consumes scarce resources (such as the country’s brightest, best educated people) that could be deployed productively elsewhere. Shrinking the financial sector to appropriate levels could reap large savings, improving economic efficiency.
A key focus on the industry is between the ‘utility’ element of the sector, which is the various services that people use and the ‘casino’ element, which as the name suggests, involves speculation and betting, the very issues that caused the financial crisis in the first place. A Financial Times article (noted in the report) summed up the ‘casino’ sector:
A couple of years ago, it occurred to me that the 21st century financial system had come to resemble a huge ball of candy floss (or cotton candy, as Americans might say). For bankers had become so adept at slicing and dicing debt instruments, and then re-using these in numerous deals, they had in effect spun a great web of leverage and trading activity — in much the same way that sugar is spun in a bowl to create candy floss.
From a distance, that activity looked impressive. But the underlying asset base was surprisingly small. Thus the key question that has hung over the system — and is doubly relevant now — is whether that cloud of trading activity could crumble back into itself? And what might the impact of that be?
One of the major revelations of Shaxson’s book is that the big banks drain not just the local economy but the global economy. The financial crisis exposed this. This is initially reflected in the performance of the financial sector. An IMF working paper (noted in the report) from 2012 considers ‘peak finance’.
It notes that when the financial sector grows to a certain point relative to GDP, it causes the economy to decline:
The positive effect of financial depth is no longer statistically significant when credit to the private sector reaches 42% of GDP, it becomes negative [at] 90% GDP, and negative and statistically significant when financial depth reaches 113% of GDP…
And concludes that:
Our result show that the marginal effect of financial depth on economic growth becomes negative when credit to the private sector reaches 80–100% of GDP. This result is surprisingly consistent across different types of estimators.
All this incorporates a degree of instability, with the big banks taking inordinate risks, leading to the familiar boom-bust cycle. But the big banks contribution to the economy was considerably less, even taking account of the major gambles that eventually led the the crash. Estimates indicate that in the decade before the crash, the amount of tax paid by the banks were much less that the value of the bailouts that were handed out after the crash. Indeed it goes back further than that:
We are talking about the bailouts easily wiping out all the corporation tax revenues from the relevant part of the financial sector since the UK corporation tax was introduced in 1965.
In addition the banks were subsidised due to their ‘to big to fail’ status:
The Bank of England estimated in January 2011 that the implicit subsidy to UK banks amounted to about £100 billion in 2009 alone… Andrew Haldane of the Bank of England added that globally, the implicit subsidy was worth “several hundreds of billions of dollars” per year.
What this effectively means is that the banks were let off the hook. In addition to the above, banks can also defer tax:
The European Banking Authority in 2012 estimated that Barclays, Royal Bank of Scotland and Lloyds would have “deferred tax assets” worth €4bn, €5bn and €7.3 in 2012 between just these three banks.
Not to mention that tax havens are used extensively by the banks as well as ‘aggressively assist[ing]other corporations to escape tax.’
An implication of an overbearing financial sector is the nudging out of other sectors. There are two dramatic examples the report refers to.
One of the more infamous tax havens linked to the UK is the Island of Jersey. A former tourist hotspot, 'finance now makes up over 50% of GDP', causing a proportional decline in tourism. Cyprus is another example as it shows how academic orientation by nearly 50% of all students are driven towards studying 'Business Administration', a course directly linked to the tax haven industry.
This trend appears in other jurisdictions. There's a danger that this could herald the educational future of larger economies dependent on finance and everything that that could entail. Ultimately that means a shift away from just about anything, with the focus on short-term financial gain instead of long term planning. And it has become a global phenomenon. As the report notes:
In modern times, the financialisation of the US and UK economies has been accompanied by tepid economic growth, soaring inequality and stagnant middle class incomes.
Inequality has been a key factor. According to the report:
the top 10% of the population had 97 times the wealth of the bottom 10%; inside London itself the figure was 273 to 1. Income inequalities were also high, with a 90:10 ratio of 12.4.
There can be little doubt that the corporate actors that control the financial sector have the political establishment in their pockets. With finance's complexities, it can be easy for 'experts' to portray that everything is running smoothly. Whilst one of the great ironies of financial centres such as Switzerland and London is the perception of stability, strong rule of law and trustworthiness, yet:
at the very same time these centres serve as the world’s largest repositories for criminal and other forms of ‘dirty’ money, typically hidden behind layers of secrecy?
And to answer the question:
We will not steal your money - but we won't kick up a fuss if you steal other peoples money.
In short, Finance has effectively become a criminal enterprise. This has been highlighted by major scandals such as Libor (see above) and Eurobor and other major money laundering scandals involving the big banks.
This article from Rolling Stone outlines the absurdity of untouchable financial elites. Don’t bother feeling outraged as you read it, because there’s nothing you can do about it. Even the regulators are helpless. Criminal impunity is now the norm rather than the exception.
The article highlights how HSBC ended up to its neck in widespread money laundering, effectively engaging openly in activities that once would have been done on the black market. The bank ‘helped to wash hundreds of millions of dollars for drug mobs’ and ‘also moved money for organizations linked to Al Qaeda and Hezbollah, and for Russian gangsters’.
“They violated every goddamn law in the book,” says Jack Blum, an attorney and former Senate investigator who headed a major bribery investigation against Lockheed in the 1970s that led to the passage of the Foreign Corrupt Practices Act. “They took every imaginable form of illegal and illicit business.”
The authorities were completely impotent:
“Had the U.S. authorities decided to press criminal charges,” said Assistant Attorney General Lanny Breuer at a press conference to announce the settlement, “HSBC would almost certainly have lost its banking license in the U.S., the future of the institution would have been under threat and the entire banking system would have been destabilized.”
In other words, not only are the banks too big to fail, they’re also too big to jail.
One of the consequences of these excesses in the financial system is widespread inequality. This in itself exasperates corrosion within the wider economic system. How equality affects society was studied in the landmark book The Spirit Level: Why More Equal Societies Almost Always Do Better. The Equality Trust provides a range of resources that are based on the books research.
The Shadow Banking System (SBS) is the entity that pervades throughout the financial sector. It exists in a sort of twilight zone behind the conventional banks, holding the lynch pin between boom and bust. As such it manages to avoid the regulatory system that the conventional banks come under.
Much of the activities done within the SBS was conducted by the investment banking sector. This allowed them to conduct many of their transactions in ways that don’t show up on their conventional balance sheet accounting and so are not visible to regulators or unsophisticated investors. For example, prior to the financial crisis, investment banks financed mortgages through off-balance sheet securitisations and hedged risk through off-balance sheet credit default swaps.
The volume of transactions in the SBS grew dramatically after the year 2000 — as a report from the Financial Stability Board points out. By late 2007 the size of the SBS in the U.S. exceeded $10 trillion. Globally this amounted to about $50,000bn in 2007, fell to $47,000bn in 2008 but by late 2011 had climbed to $51,000bn, just over its estimated size before the crisis. Overall, the world wide SBS totaled to about $60 trillion as of late 2011.
The SBS — set up by the G20 group of nations to reform the banking sector — works by relying on short-term funding in which borrowers offer collateral as security against a cash loan and then sell the security to a lender and agree to repurchase it at an agreed time in the future for an agreed price. They are often based in tax havens, invest in long-term loans like mortgages, providing credit across the financial system by matching investors and borrowers individually or by becoming part of a chain involving numerous entities, some of which may be mainstream banks.
The shadow bank function is very important for a market economy because by providing funding to traditional banks they facilitate the credit availability to businesses. In fact, without their funding, traditional banks would not be able to lend money, which would then slow growth in the wider economy. Given their specialised nature, shadow banks often can provide credit more cost-efficiently than traditional banks. The shadow banking system also offers credit and provides liquidity and funding in addition to that provided by the mainstream banking system.
Shadow banking institutions like hedge funds often take on risks that mainstream banks are either unwilling or not allowed to take. This means shadow banks can provide credit to people or entities who might not otherwise have such access.
Unregulated shadow institutions can be used to circumvent the strictly regulated mainstream banking system and therefore avoid rules designed to prevent financial crises. As the Financial Times noted (paywall):
Regulators fear it remains a major threat to long term stability, particularly as more activities move out of the traditional banking sector to escape tighter regulation there.
Shadow banks can also cause a buildup of systemic risk indirectly because they are interrelated with the traditional banking system via credit intermediation chains, meaning that problems in this unregulated system can easily spread to the traditional banking system. As shadow banks use a lot of short-term deposit-like funding but do not have deposit insurance like mainstream banks, a loss of confidence can lead to “runs” on these unregulated institutions. Shadow banks’ collateralised funding is also considered a risk because it can lead to high levels of financial leverage. By transforming the maturity of credit — such as from long-term to short term — shadow banks fueled real estate bubbles in the mid 2000s that helped cause the global financial crisis when they burst.
An article in the New York Times has highlighted the problems and the impacts on the Eurozone in particular:
In the euro zone, these problems have plagued banks and entire countries, like Greece and Portugal. The “country as bank” is a new and not entirely reassuring catch phrase, and it shows that the problem goes beyond the private sector.
If a central bank is deft enough, it can avoid deflation by using loans and monetary policy to guarantee the liabilities of run-prone institutions. That worked reasonably well in 2008, but in the long term such a policy sets up the system for even more danger, by subsidizing bank risk-taking and precarious financial structures.
Another problem is that ending those central bank guarantees isn’t always easy. The European Central Bank has stemmed a financial collapse for now, but only by lending large amounts to banks at 1 percent for a three-year window. And yet the euro zone has entered a recession, so it’s unclear when troubled European banks can return to private capital markets. The arrangement also assumes that economic growth will pick up fairly quickly in the euro zone — hardly a certainty… . So the system remains extremely vulnerable.
The article concludes with the ominous comment that there’s:
no promising financial path before us. It’s good that the American economy seems to be recovering, and this may shove some problems into the future. But banking and finance remain a mess at their core.
So it remains to be seen whether the new regulatory climate will change the weather of the financial crisis.
In the US the Dodd-Frank Act was passed into law in order to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end “too big to fail”, to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices.
The only problem here is that US banks can circumvent Dodd-Frank by funneling their activities through UK subsidiaries based in the City of London.
Indeed most of the scams committed by huge US financial institutions used the City as a cover up. JP Morgan Chase is one institution that has built up a reputation for corruption and wrong doing.
To summarise, since the financial collapse, nothing has really changed. The big banks have got bigger and the event horizon of the SBS is expanding, along with the whole sorry mess of the entire financial sector.
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