Pettifor: “Private authority can’t fully be trusted to uphold contracts.”

Trust and compliance with regulation are not familiar virtues in the world of global finance according to Ann Pettifor. She explains for The Mint how that could plunge the world into crises beyond the merely financial.

Money is confusing says an economist.

The same economist says the private sector can’t be trusted, because “what we’ve seen happen is our monetary system is effectively controlled and, at times, looted by private interests.” And this is this is born out of politicians’ “extreme timidity” and “deep ignorance”. Meanwhile little has changed since the 2007 financial crash to rein in cavalier lending by the banks, s. So “we’re bound to have another crisis.”

Ann Pettifor is the economist. And she takes few prisoners when arguing her case. As The Mint is writing, the former economic advisor to Jeremy Corbin is on air at the BBC tearing a strip off Institute of Fiscal Studies’ director, Paul Johnson’s “utter nonsense” in not seeing that a revenue spur from public sector jobs was needed, not more austerity.

“the monetary system is confusing the populace and politicians alike”

Pettifor tells The Mint that the monetary system is confusing the populace and politicians alike and she has a “mission to explain.” And a fundamental premise that she says is not grasped, is that money is all about trust and that trust is being abused.

“The joy and the great strength of the monetary system is that, with it, there should never ever be a shortage of money. Because money is essentially credit and credit is based on a simple thing, which is trust,” she asserts.

“Money is a promise to pay. It’s nothing more than a promise to pay. Now, the promise to pay has to be underpinned by a contract that has to be upheld by what I regard as public authority. Private authority can’t fully be trusted to uphold contracts,” she adds.

Pettifor posits that the original design of our monetary system was to “enable society to undertake transactions, to do work, to meet social needs.

“Now it no longer fulfils that function. And part of the reason that it’s being usurped and that power over the system is now exercised by a very small financial elite, is the public, more widely, don’t understand the system and therefore it’s been very easy to capture. And so my mission is to help the public understand how the monetary system operates and how money works, where money comes from.”

Her explanation of how, in her view, “this great, public civilisation advance that is our monetary system” has been hijacked begins with the move from a controlled rate of interest under the dominant Keynsian economic thinking, post 1930, to one governed by competition in the early 1970s.

She said the invisible hand – the market – “was going to decide the rate of interest on an individual loan.” She continues: “The rate of interest is also a social contract. It’s an assessment of risk and that assessment can be very subjective. If it’s done in the interest of a particular group, it can be highly exploitative. So after 1930 the central bank had some oversight over managing the rate of interest across the spectrum of lending, short-term, long-term, safe, and risky.”

Sub prime: when makers lose out to takers
The capital gains made from speculation are much higher than the profits made from investment in (say) manufacturing. People attracted to risky speculation are most likely to be willing to pay the high rates of interest. And this is why the banks poured into subprime mortgages – loans made available to people with poor credit records. For the banks, the risk associated with the loans was offset because in the event of a default they had recourse to a potentially valuable asset – the property.

So in the short-term, investors could make massive capital gains on that investment. Banks bundled the sub prime mortgage with more conventional mortgages to create mortgage bonds of varying degrees of complexity which were then resold. Rolling up arrangements in this way arguably masked the risk associated with the sub prime lending involved. The banks made their 15% interest and then they profited on the asset, when they resold.
Investors made huge gains on ????

The crash came when escalating credit card and other debt among the sub prime borrowers and a slump in property values led to their default on payments in overwhelming numbers. So the basis of the high interest rates offered to sub prime borrowers – the high risk that they might default – came home to roost in 2007.

Possibly the best illustration of the allure of the sub prime boom was the fate of US-based engineering giant General Electric. , Jack Welsh the man who, during his time at the helm of GE, increased its capitalisation by 4,000%, moved it away from its engineering and manufacturing roots with the creation of GE Capital which then dived into the sub prime trough. The financial crisis came and Welch’s successor, Jeffrey Immelt, was forced to go cap in hand to investment maestro Warren Buffet for a US$3 bn loan to bail out GE. Buffet provided the loan on the condition that Immelt folded GE Capital and returned GE to its manufacturing core.

The impact on GE was not as high profile in the litany of disasters that made up the crash. But it does illustrate the situation that Pettifor deftly summarises as: “The sound-investing makers sector, has been neglected and the takers sector has become bloated.”

Keynes, she says, argued that interest rates should not outstrip the rates of return made by investors in projects which were on average, over time, about 3%. Where interest rates do go beyond 3%, then debts would become un-repayable so there would be little point in investing. “In 1973 the Bank of England, under pressure from the City of London, introduced something called competition in credit control, which economists describe as all competition and no control. And after 1973, it was left to individual bankers to decide the rate of interest on the loan.”

“Pettifor says the exposure of lending rates to market forces has spawned criminal cover- ups of legally questionable and economically hazardous activity.”

Under that new regime, those who could pay the highest price were likely to get a loan. But those lenders, Pettifor says, tend to be the riskiest borrowers. “The sound borrower who wants to make a proper return is probably not going to pay this very high rate of interest,” she says.

Consequently, according to Pettifor, banks lent at very high real rates of interest. “In our view, and it’s not a widely held view, it was those very high rates, real rates of interest, on lending that ultimately led to the financial crisis that punctured the massive bubble of credit.”

An outcome of this preference by banks for high-risk, high-interest investments has been a shift by banks away from land and labour and towards speculative ventures such as property says Pettifor. “Today the banking system lends overwhelmingly for property speculation. Funds now, big funds, prefer to issue bonds to raise capital. But SMEs can’t do that so since the crisis, SMEs have really suffered.

“And far from the banks lending into the small funds, or innovative, exciting, risk-taking small funds, they have been investing in the banks. So we’ve had a reversal, if you like, of the system, whereby banks were created to lend into the economy. We now find that the economy is lending to banks, basically, there are more deposits being made in banks than there is lending by, or there has been a period where deposits in banks exceeded lending to SMEs.”

“Absolutely nothing has changed.”

Pettifor says the exposure of lending rates to market forces has spawned criminal cover- ups of legally questionable and economically hazardous activity. “There was this huge amount of fraud and, I think, theft actually, that took place because, by liberating the system from oversight by regulatory democracy, you allowed the private vested interests to decide how they were going to manage risks and how they were going to hide it.

“The reason they hid the risk was precisely because it was systemically dangerous. And that’s precisely why we need public authority to assert regulatory management of the system. These individual institutions can create systemic failure and everyone can be punished for that failure. What’s really scary is that all this happened in 2007-9 and nothing has changed.

“Absolutely nothing has changed.”

She concedes that there has been minor amendments post the Crash: “There’s been some tinkering at the edges.” But she asserts that the banks remain unfettered in the kind of risks they’re taking. “Actually the share of debt, relative to global GDP, is higher than it was before the last financial crisis. So we’re bound to have another crisis, the question is only timing.

So it seems that whenever we try to regulate the financial sector, a load of very smart people go into a room and work out the loopholes and then it’s business as usual. Sometimes the people in the room even help in writing the regulations and know where all the loopholes are. The Mint put it to Pettifor: how do you regulate that? Is it perhaps impossible?

Pettifor rapped that as a “very defeatist approach.” But she concedes it is the approach of many and “it’s certainly the approach of the City of London.” She says it has become the argument for not managing the system. But the consequences of neglecting to curb the risk taking, could take us back to one of the darkest periods in world history she warns.

“So we’re bound to have another crisis, the question is only timing.”

“I think those arguments, unfortunately, will hold until the next systemic failure and only then will we begin to see. But by that time, we will have had political and social upheaval and we will probably have a form of, nationalism, protectionism, and even fascism if we’re not careful.”

Pettifor warns that we are on a trajectory that bears a strong resemblance to that when the financial sector argued after the 1929 crash that nothing could be done and the banks had to be free to act as they saw fit.

“All that carried on until Keynes – until in 1933 Roosevelt says to the banks, ‘we are going to manage you and we are going to impose regulations and we are going to stabilise the global financial system’. And between 1933 and 1971, they did.”

Pettifor’s call for greater regulatory control of the banks does not, she says, amount to advocating state control. Neither does it rule it out. Where she does draw the line is at state control of the supply of money. On this issue she has had a public spat with not- for- profit, Positive Money.

It is campaigning for “the power to create money to be used in the public interest, in a democratic, transparent and accountable way, rather than by the same banks that caused the financial crisis.” It and Pettifor have exchanged lengthy arguments in the media in which she has castigated Positive Money’s declared mission to “remove the power to create money away from banks and give it to a transparent, accountable public body that will work for the public interest,”

What’s wrong with that? Pettifor says it’s “irrational beyond belief.”

“I’m not opposed to nationalising the banks,” says Pettifor. “I don’t really think it’s necessary, but I wouldn’t fight against it. But the idea of nationalising the money supply is like saying there’s going to be a committee of men sitting at the top of the world deciding whether or not you can have a mortgage for your flat in Hackney or whether you can have an overdraft, Mr Corner Shop, because you’ve got to pay wages before your suppliers have paid their bills. So I find it an almost totalitarian, authoritarian position. And that, for me, is quite extraordinary coming from an NGO.”

“I’m not opposed to nationalising the banks,” says Pettifor. “I don’t really think it’s necessary, but I wouldn’t fight against it.”

The irrationality, as Pettifor sees it, is in the assumption that the private banks are creating the money supply. “Actually the central bank is probably responsible for 1%, at the most 5% of the money supply. The money supply is created by you and me. It is created every time we apply for a loan. And what Positive Money failed to include in their analysis is the role that we play in creating the money supply,” says Pettifor.

She illustrates her point by highlighting that when we lack confidence in the economy, we are wary about applying for loans. When the economy is weak, she says, small businesses back off and the money supply shrinks.

“However powerful the banks may be, they can’t create any money. They require a partner. Every credit requires a debt. Every creditor requires a borrower. So the central banks, while they are powerful, are not that powerful that they can create a money supply. When the money supply is created, it’s created not by the central bank but by the private banking system. But I repeat, they can only do so when we, the people, apply for a loan, for a credit. And when we don’t, if we don’t go shopping, if we don’t use our credit cards, the money supply shrinks, you know, regardless of the power of the banks.”

And she is clearly filled with dread at the prospect of the central banks at the tiller when they c“Clearly didn’t fully understand how the system worked. “The Federal Reserve’s committee that governs the monetary system in the US, and the committee of bankers that governs the British banking system, made huge mistakes in the run up to the financial crisis,” says Pettifor. “The idea of putting these unelectable, unaccountable people in charge of the nation’s money supply seems to me to be quite horrific and very anti-democratic.”

So what are the options for regulation? The Mint raised the idea known as Eethical Business Rregulation developed at Oxford University by Professor Christopher Hodges who summarised the basic notion as “a collaborative approach between businesses, their stakeholders and public officials, based on a shared ethical approach.” One of its core tenets is that regulatory systems need to be designed to provide evidence of business commitment to ethical behaviour, on which trust can be based.

Does this have legs, given that a shared commitment to comply in a system based on trust would be a cultural volte face for the financial sector? Pettifor thinks notis not so sure: “It’s terribly important that there should be an ethical basis to all our regulation and one of our problems is that this notion of ethics and values has evaporated. Our society has been corrupted by the money and the managers of our monetary system. So I think that’s really important, but I don’t buy the story that you need widespread compliance.”

She emphasises her view that we have massive leverage over the financial sector that we fail to use. “We’re going to let them continue to behave as they behaved in the past. There will be no terms and conditions for all this public largess,” she says. Yet without rock bottom interest rates and without taxpayers guaranteeing deposits, the banks would all be “completely bust” Pettifor says.

“The money supply is created by you and me.’

“None of them, in my view, are solvent,” she concludes. She says the reason the banks have been rescued and not called to account despite reaping havoc and inflicting pain and misery on millions of people is again a reflection of her earlier assertion that the public does not understand what has happened.

“It’s not just giving them a public subsidy on the scale that the National Health Service cannot even dream of. Because we don’t understand it, we don’t challenge it.

“When the government bailed out RBS and said, ‘we don’t want for a moment to challenge your competence or ensure that you made losses or shared some of the burden.’ That’s extreme timidity on the part of politicians based, in my view, on deep ignorance of how the system works.”

She says politicians’ claims that the crisis in 2008 was down to market forces and beyond their control has angered the public and the fury is manifest in the election of Donald Trump in the US, France’s attraction to Marine Le Pen and the UK’s Brexit vote. “And that kind of reaction was the reaction we got in the 1930s and it turned very ugly. You simply have to withdraw government guarantees from the banks. Just say, ‘sorry we’re not going to guarantee your deposits anymore unless you do this that and the other.’ ”

Isn’t that the nuclear option? “Why don’t we try it?” Pettifor responds. “Why don’t we say there’s no more quantitative easing (QE)? Or command ‘thou shalt lend to small enterprises or no more QE for you’?”


“We have made no effort whatsoever to manage the banks. And we believe, as a society, that market forces, the invisible hand, will do it for us and the public authorities, don’t have to do that. Hence, the disillusion with public authority and with the political class. And when you get that kind of disillusion, the social and political consequences are scary, very frightening.”

Pettifor foresees a time, in the wake of Trump’s administration, after he has “betrayed the populism that brought him into power.” She forecasts “anger against that betrayal” that will be “far worse than what we’ve seen so far.

“And so what the financial system is bringing down upon us as well as itself is protectionism, nationalism, and ultimately Fascism,” she says.

Pettifor’s words could easily be tucked away as overreaction but for her track record as a positive force in real global economics. This is the woman whose campaigning tenacity helped to free some of the poorest nations from the yoke of borrowings when the programme that she led in the late 1990s succeeded in writing off US$100 billion of their debt. And she was among the few who foresaw the crisis in 2007.

So when such a positive-thinking, insightful person looks forward to a time of probably “extraordinarily destructive” politics when “war will be the least of it,” there is cause to be disturbed.

She says disruption created by the financial sector is creating a platform for “strong men who are promising to stabilise the system. “Whether its Putin in Russia, Erdogan in Turkey, or Modi in India they’re all trying to find ways of taking control. And this is all reaction against the absolute refusal of the finance sector to be managed and stabilised in the interest of wider society.”

The finance sector is, she believes, sewing the seeds of its own destruction. “I think there are some enlightened financial sector leaders who are beginning to see that this is very dangerous for the financial system. But they’re few and far between and they don’t have, and haven’t had any real impact. We don’t see any attempt yet at managing this totally out-of-control financial system, which is now well beyond the reach of regulatory democracy.”

If the financial sector’s actions are, as Pettifor suggests, spawning populist demagogues who will probably put a stop to the gravy train, a rational, self-preserving response for the sector to take would arguably be to accept the ethical model advocated by Hodges. But – and this is a potentially tragic irony – the empirical basis evidence from behavioural and institutional economics underpinning pluralist economics issuggests that rational behaviour is generally not a sound assumption. Which could mean that a behaviourist premise anticipates that the neoclassical economics-guided banks are not likely to deviate from their current trajectory.

Ann Pettifor

Ann is a political economist, author and public speaker. She is Director of Policy Research in Macroeconomics (PRIME), and an Honorary Research Fellow at the Political Economy Research Centre of …

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