The Biblical invocation against usury, making loans for interest, has been discarded by the two older Abrahamic religions, the Jews and the Christians, though it persists in Islam. I used to think the prohibition was another obsolete idea, based on a misunderstanding of the usefulness of finance. But as time goes by, the more I come to see that the biblical fathers, or God if you prefer, were on to something. The dysfunctional nature of financial markets is one of the modern world’s most pressing problems.
This reflection comes on the fifth anniversary of the collapse of Lehman Brothers, which was the point at which the current financial crisis broke out into the open. This has lead to a flurry of newspaper comment. I was most drawn to an article by Gillian Tett in the FT, covering a talk given by Adair Turner, the former head of Britain’s financial regulator, the FSA. Unfortunately this behind the FT paywall, and I cannot find coverage anywhere else. Lord Turner produced a blog, but this only covers part of the subject matter, and not the most interesting bit reported by Ms Tett. Lord Turner says that we have not really come to grips with the failure of financial markets that became evident with the Lehman episode.
The most eye-catching thing about financial markets, which is the main point made in the blog, is the explosion of private sector debt. In 1960, according to Lord Turner, household debt in the UK was just 15% of total income; by 2008 it has risen to 200%. If you start to add up loans made by financial institutions to each other, then even that figure looks pretty tame (837% according to this rather good Economist School’s Brief on the subject – though this suggests a little confusion in Lord Turner’s numbers on household debt). But the statistic that hit me most forcibly was the claim that only 15% of the money that flows into financial products actually gets invested in proper wealth-creating projects.
Macroeconomists have long been dismissive of the significance of debt and financial markets in their imperious declarations about the state of national and global economies. These are just means to an end, and they all cancel out – one person’s debt is another’s asset; what matters is the real world of what is produced and consumed. Economists are reluctantly having to rethink this, though most would still rather divert the discussion into conventional subjects about austerity and money supply. Lord Turner’s 15% statistic, however, should translate the issue into one which even an old-fashioned macroeconomist can understand. There is a massive gap between what people set aside to save, and what is actually invested. Financial markets are meant to be the channel by which savings are turned into investments – but instead they are simply a smokescreen hiding a black hole, as it were.
Let’s pause for breath, and look at the problem from another angle. One of the critical points of economics, too often forgotten, is that money and financial assets have no intrinsic value. They are simply useful tools by which we can coordinate the process of producing work and consuming its output. You can think of it as being a bit like electricity. You cannot store it. If people want work now, and consume later at leisure, the simple act of putting aside money won’t do the trick. You have to persuade other people to be around to do the work for you when you want to do your consumption. The wider purpose behind financial products is to help us to do this, to balance our over-production now (i.e. saving) with over-consumption later, or vice versa. Theses activities depend on coordination with people who want to do the opposite, and that is what financial markets are meant to do. How? Through investment. Investment is work that is done now to produce things that can be consumed later. This allows production without consumption in money terms to be balanced by a real world equivalent. Maynard Keynes’s great breakthrough was understanding that the failure of the money and real worlds to match was the main cause of recessions.
So if 85% of savings are not actually invested, there is a problem. Where does the money go? There seem to be two main places. Firstly a lot of it consumed by intermediaries – those fat-cat salaries included – to no real purpose. Secondly a lot of it goes into inflating the prices of assets, real estate or financial assets, that exist already. In other words it is a colossal waste of time which simply serves to make a lucky few rich. And meanwhile huge volumes of debt are being created, much of which can never be repaid. Or, to put it another way, we have manufactured vast banks of financial assets which are not worth anything like what we think.
This spells trouble ahead, as this situation will only resolve itself through, one way or another, debt being forgiven and assets written down. The owners of those assets show no sign that they understand this; or if they do, they simply assume that it is somebody else that will pay. Meanwhile the best we can do is not to make things worse. Amongst other things that means continuing to make life miserable for the banks and the financial sector, and hope that, as they shrink, they concentrate on the more socially useful aspects of it work.
What those old Jewish and Christian fathers understood, and Islamic scholars still understand, is that debt creates moral problems by dehumanising the relationship between debtor and creditor. Financial assets are in fact human relationships between real people, which we are attempting to abdicate responsibility for. Alas though, it is unthinkable that our current economic system, with its manifold benefits, can be created or sustained without them. But we would all be better off if we understood the moral and personal implications, and consequent limitations, of financial assets and the markets through which we acquire them.