‘Those who do not learn history are doomed to repeat it’ – Are you ready for the next crash?

Ten years on from the financial crisis of 2007, not a lot has changed.

It is now ten years since the banking crash and despite a lot of rhetoric and posturing, there has been little substantive change. Are you ready for next crash?

The seeds of the 2007 crash were sown by neoliberal ideologies which promoted light touch regulation, control by markets, self- interest and unbridled competition. Banks designed clever financial products which even they themselves did not fully understand and for good measure also indulged in tax dodging, money laundering and interest rate rigging. Has anything changed?

People bailed out banks and accepted a large dose of austerity and loss of hard-won social rights whilst corporate executives collected large pay packets. In 1976, workers’ share of GDP in the form of salaries and wages stood at 65.per cent, but by 2016 it shrank to 49.5 per cent (see Table D of the UK Quarterly National Accounts). Between 2007 and 2015, the real wages of UK employees fell by over 10 per cent, almost the largest fall among major industrialised nations. 40 per cent of the working-age population have less than £100 in savings. Personal debt now stands at record £1.529 trillion. None of this has forced new thinking as neoliberal ideologies remain in ascendancy.

Banks and major companies continue to pile into derivatives. These are essentially clever bets on the movement of interest rates, price of commodities, exchange rates and everything else. Well, we know that all financial horses can’t win all of the time and someone will sooner or later have a great fall. 25 major banks have total assets of around $1.8 trillion, but their exposure to derivatives is about $222 trillion. To put this in perspective, global gross domestic product (GDP), or the total market value of all final goods and services produced in all countries, is about $78 trillion. This rush for speculative profits won’t have a happy ending.

Red flags have continued to be raised. In 2011 the Vickers Commission recommended that to contain future banking crises and protect savers and taxpayers, there should be a forced statutory separation of retail banking and speculative banking. The government has failed to follow the advice and instead in 2019 we may or may not have some kind of a weak ring fencing of the two banking operations. The government remains ambivalent towards derivatives.

The UK had a secondary banking crash in the mid-1970s and a banking crisis in each decade ever since. Bank of England (BoE) failed miserably as a financial regulator. For more than half a century, financial businesses have mis-sold mortgages, endowment policies, insurances and much more. BoE did little as regulators were too closely connected with the City. In 1991, the fraud-infested Bank of Credit and Commerce International (BCCI) was forcibly closed. It was the biggest banking fraud of the twentieth century but to this day there has been no independent investigation. Successive governments have gone out of their way to suppress information about the frauds. Is it possible to strengthen regulation without independent investigation of failures?

The 1997 Labour administration of Tony Blair replaced the BoE with Financial Services Authority, but all under the control of banking grandees who were too close to the industry. Light touch regulation continued. After the 2007 banking crash, the Conservative government handed the responsibility for policing the finance industry to the Financial Conduct Authority and prudential regulation of financial firms to the Prudential Regulation Authority, all under the umbrella of the BoE. The regulatory deck chairs have been rearranged, but banking grandees remain in control.

The 2007 crash revealed that bank auditors were asleep on the job. Accounting regulators looked the other way. HBOS ran into difficulties in 2007 and it is in June 2016, after considerable parliamentary pressure, that the Financial Reporting Council (FRC) announced that it will look into audit failures at the bank. The FRC is still a regulator.

Rather than directly auditing the banks, regulators continue to rely on auditors to alert them of any financial problems ahead. In the era of instantaneous movement of money, reliance on ex-post audits is highly questionable. Annual corporate accounts are supposed to inform shareholders of corporate wealth accumulation and cannot tell the regulators a great deal about the health and risks of the financial system as a whole. Yet they remain a central feature of the regulatory approach.

The 2013 report of the Parliamentary Banking Standards Commission concluded that “shareholders failed to control risk-taking in banks, and indeed were criticising some for excessive conservatism”. The Commission urged the government to consult with a view to changing the company law and “remove shareholder primacy in respect of banks, requiring directors of banks to ensure the financial safety and soundness of the company ahead of the interests of its members”. Yet there has been no change to the shareholder centric model of corporate governance.

George Santayana once said that “Those who do not learn history are doomed to repeat it”. The difficulty here is that the price of indulging the financial sector will continue to be paid by innocent people.

Prem Sikka is Emeritus Professor of Accounting at the University of Essex. He tweets here.

9 Responses to “‘Those who do not learn history are doomed to repeat it’ – Are you ready for the next crash?”

  1. Michael

    Karl Marx wrote that all great events and personages in History occur twice: the first time as tragedy, the second time as farce.

  2. Blade Runner

    I’m sure a big capitalist crash is on the cards…probably before the nuclear holocaust

  3. Will

    As long as we remember that there is no money in the world, just bits of paper with “I promise to pay the bearer the sum of”.
    In other words, lots of “I Owe Yous” but nothing to back it all up with as there is nothing out there except false promises.
    Of course the whole system will crash, there is nothing to hold it all together.

  4. Sanjay Mittal

    Will,

    So you object to paper money and want to go back to the gold standard or something? Very out of date I’m afraid. Only about 1% of economists favour the gold standard.

    Bank instability results from the fact that private banks are allowed to create or “print” money. Milton Friedman and several other Nobel laureate economists opposed private money printing. Positive Money continues the fight for the abolition of privately issued money.

  5. Douglas Andrew Town

    Just as we are not allowed to gamble by purchasing life insurance on the lives of strangers, so options, futures and other derivatives should be more tightly controlled . For example, unless we are physically able to sell and distribute commodities, we should not be allowed to buy derivatives based on them.

    I often wonder where the derivatives market ends and the bucket shop begins.

    As defined by the U.S. Supreme Court, a bucket shop is “[a]n establishment, nominally for the transaction of a stock exchange business, or business of similar character, but really for the registration of bets, or wagers, usually for small amounts, on the rise or fall of the prices of stocks, grain, oil, etc., there being no transfer or delivery of the stock or commodities nominally dealt in.”[Wikipedia – Bucket shop]

    The difference between the two seems to have more to do with the volume of the betting and the social class of the gamblers than the nature of the business itself.

  6. Chester Draws

    George Santayana once said that “Those who do not learn history are doomed to repeat it”.

    People have learned from history. We now know that our current economic system runs in cycles and that it will dip.

    But each dip is less severe than previous dips. The “austerity” of the 2007 crash wasn’t in the same league as the Great Depression. Unemployment went up, but not like to the 1970’s. Capitalism may have crashes, but it also recovers better than any other system.

    The problem with more control is that it does not prevent the economy running in cycles. If the auditors and regulators were “asleep” in 2007, as you yourself admit, then why will they be any more awake next time?

    The Soviets had 100% control of their economy and it ran in cycles — they didn’t avoid economic crises (and in the end it was their system that crashed completely not the capitalist one). In fact no economy anywhere that is producing any amount of wealth at all has ever avoided the issue. It’s not a feature of Capitalism, it is a feature of complex economies of any sort.

    So if the Left is to find a system that is better, it needs to advance somewhat from the position that “Capitalism has crashes”.

  7. Dave Roberts

    Some of the above prescient, some just plain silly. Before it was banking, now it is property. After the banking scandals and associated quasi frauds people who had money left and those coming up the ladder moved into property.

    There are a number of key indicators why the next ” crash” although as has been pointed out above they become less and less severe, will be property based. If a number of factors happen there will be a property crash as opposed to the leveling out in certain areas that is taking place at the moment.

    The Buy to Let market is particularly vulnerable because of a number of factors. Many portfolios are in negative equality because of the narrow margins. Investors saw 8 to 10 per cent and looked at what they could get in a bank and went for property on the lowest possible deposit. They didn’t take heed of warnings about things like building repairs, voids, increases in tax and the ever changing legislation that imposes penalties on them in terms of the condition of the property especially with regard to energy rating. Take into account the fact that courts take forever to carry out repossessions because of the backlog of cases and the general anti landlord attitude of said courts could mean that there might be, and if interest rates rise a per cent or so will be, a rash of repossessions by lenders or keys back and walk away situations that we saw after the last big one starting in 1989.

    That could throw thousands of properties onto the market which would depress the prices at the auctions which then starts a panic at the lower end of the market. Even though rates are still low confidence isn’t there, buyers are wary and lenders are reluctant to lend.

    At the top end there is a glut of unsold flats built with offshore money, mostly Chinese and Russian, which aren’t selling. The property market papers and sites are full of similar types of flats that aren’t moving and on which there isn’t much wriggle room in terms of price. London within the M25 is a separate country in terms of industry, wealth and many other things and it is also, in property terms, where the next big thing is going to happen.

  8. James.R.Green

    Yep: that’s a fact. As it is that our jails are swollen with people who had originated elsewhere, socialist are still to be heard calling for yet more immigrants to be allowed to settle even here, though they are already settled in a cultivated modern country such as France!

  9. Robert Jinkens

    i lost a significant amount of money in 2007/2008. Subsequently I investigated what happened very carefully. First, I had a stock broker employed by Morgan Stanley who REFUSED to sell my holding in 2007. Regardless, of his refusal. The stock market crashed because of FANNIE MAE and FREDDY MACK buying bad loans. Yes the banks originated the loans, but the banks would not have done so if they could not have sold these bad loans to FANNIE MAE and FREDDY MACK.
    Robert C. Jinkens, PhD, CPA

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