Thursday, August 02, 2007

The US, Germany, and the privatisation of gains

Details are emerging of a German government plan to rescue a domestic lender that has suffered heavy losses on investments in U.S. "subprime" mortgage markets. At the end of the day German taxpayers will foot the bill for this part of the risk-taking, it seems. This is part of a broader problem with global capitalism: too often private-sector operators reap the full rewards from their risk-taking, and when losses happen, they can pass them on to taxpayers. This is especially problematic in a world where returns to capital relative to labour, and therefore inequality, are rising. Government regulators have a role to play here: as another excellent FT editorial said recently:

Regulators have to ensure that excessive risk-taking is not going on, with the gains once again privatised and the losses shifted on to taxpayers.

The German woes are just the latest example of this fundamental problem of how risks and rewards can be divided between the public and private sectors. A mighty example of this problem was the Latin American debt crisis, as described in James Henry's book The Blood Bankers. In short, what happened was this. Western banks lent Latin American governments money. Wealthy and well-connected Latin American private citizens appropriated much of this money, then recycled it offshore - notably into the giant tax haven that is called the United States of America. The Latin American governments, prevented by the U.S. government from knowing about their citizens' holdings, could not tax this offshore privatised money. Yet they still had to repay the foreign loans, even after the money had been privatised and sucked offshore. So they went bankrupt, and had to be bailed out by the IMF.

Who shouldered the resulting pain? It was, of course, ordinary Latin American taxpayers and workers, along with ordinary western taxpayers who paid for the IMF bailouts. Meanwhile, the wealthy private citizens, using offshore secrecy, had held onto their gains.

Now global credit markets are turning sour, as the woes from U.S. "subprime" markets ripple outwards. Is this just a wobble, which will eventually stabilise? Or is it the start of something nastier? Desmond Lachman, a fellow at the American Enterprise Institute, has written an article comparing the unravelling of credit markets with the nasty Savings & Loans debacle of the 1980s. We would agree with his conclusions.

At the heart of today’s subprime crisis is the unfortunate interaction of financial innovation gone awry, inept market regulation and a failure of the rating agencies to exercise their fiduciary responsibility to protect the average investor. . . now that the bottom is falling out of this market, it is important that the financial institutions, which stood most to gain from that lending, rather than the taxpayer, foot the bill.


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