Greedy bankers not to blame for crisis

The following comment by me appeared in the latest Fund Strategy (4 May).

As time goes by, more sophisticated explanations for the economic crisis emerge. Working out which is correct is crucial to finding solutions. Clearly there are many elements involved in any comprehensive explanation of the downturn. But it is necessary to distinguish between those that are central to explaining the crisis and those that are contingent.

Will Hutton gave the most straightforward explanation for the crisis in his recent Channel 4 Dispatches documentary. For Hutton, as for many others, it was the fault of greedy bankers.

This argument at least has the virtue of simplicity. Dispatches featured many financial types confessing their responsibility, or at least that of their institutions, for the crisis. Not so much out of the horse’s mouth but, at least in Hutton’s view, the devil’s mouth.

But just because many people perceive something to be the case it does not make it true. From a common sense perspective it appears that the Earth is the ­centre of the universe and the sun revolves around it. Yet as far back as the 16th century scientists realised the sun is the centre of the solar system.

Just as with natural science, it is necessary for social science to go beyond superficial appearances. For example, it may appear to observers and even participants that aggressive risk-taking characterised the financial markets.

But the reality is much more paradoxical than such impressions suggest. Complex financial instruments developed in response to a demand to manage risk rather than to take big risks. Mortgage-backed securities, for instance, had the advantage of taking risk off the balance sheet of mortgage lenders. Yet the desire to manage risk simply meant that it reappeared in a new form.

The overproduction explanation for the crisis favoured by Michael Howell, the managing director of CrossBorderCapital, has more merit. He argues that there is a mismatch between the sharp rise in production – particularly from Asian producers – and the much slower increase in consumption. Therefore Howell characterises the downturn as one of overproduction while others have referred to its obverse, underconsumption.

The problem with this is that underconsumption itself has to be explained. It is not sufficient to describe it as a natural phenomenon, with production growing inherently faster than consumption. If people had the resources to consume more they no doubt would. The problem is identifying what it is about the market mechanism that creates this imbalance.

It appears there is a long-term trend towards falling profitability, particularly in the developed nations. This should not be taken to mean that the West is ­facing imminent collapse. But it does mean there is a constant drive for the market to try to find ways of overcoming its tendency towards breakdown.