US banks emerge stronger from crisis, says Bernanke
Factory output likely fell 0.7 percent in February: Poll

Economy Apr 9, 2013

What have we done, Maggie what have we done?

By Vivek Kaul

John Maynard Keynes, the greatest economist of the twentieth century, had a line for most occasions. In his magnum opus The General Theory of Employment, Interest and Money, published in 1936, Keynes wrote: "The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist."

Margaret Thatcher, more popularly known as "Maggie", the longest serving British Prime Minister of the twentieth century, who died of a stroke yesterday, was no different on this front. As an obituary in The New York Times points out "Mrs Thatcher's prescription for change was based on the ideas of the conservative economists Friedrich von Hayek and Milton Friedman. Hayek believed that political and economic freedom were inseparable; Friedman argued that economic productivity and inflation were determined by the amount of money the government put into the economy, and that the heavy government spending advocated by Keynesian economics distorted the natural strength of the marketplace."

Former British PM Margaret Thatcher. AFP

Former British PM Margaret Thatcher. AFP

When Thatcher first took over as the Prime Minister in 1979, Great Britain had become the sick man of Europe (a tag which was usually used for Turkey). To revive the moribund economy Thatcher fell back on the ideas of von Hayek and Friedman. Thatcher went after the trade unions which had a stranglehold on the British industry. She sold off government firms, cut subsidies to the the firms which were piling on losses (in the process many of them went bankrupt) and resisted suggestions that the government should carry out more social spending and create jobs. She introduced both tax and spending cuts.

Like her intellectual gurus Hayek and Friedman, Thatcher was a firm believer in the "free market", over and above everything else. As The Economist writes in an obituary of her: "Mrs Thatcher believed that societies have to encourage and reward the risk-takers, the entrepreneurs, who alone create the wealth without which governments cannot do anything, let alone help the weak."

Thatcher was not the only politician at that point of time who believed in the primacy of the market. Ronald Reagan, who was the President of the United States at almost the same point of time, also shared her belief.

And this unleashed an era of market triumphalism. As Michael Sandel, one of the greatest living philosophers, who works at the Harvard University, writes in What Money Can't Buy - The Moral Limits of Markets "The era (of market triumphalism) began in the early 1980s, when Ronald Reagan and Margaret Thatcher proclaimed their conviction that markets, not government, held the key to prosperity and freedom. And it continued in the 1990s, with the market-friendly liberalism of Bill Clinton and Tony Blair, who moderated but consolidated the faith that markets are the primary means for achieving public good."

And this belief in the markets led to the proliferation of market values into spheres of life where they don't belong, feels Sandel. As he writes in a piece in The Atlantic "We live in a time when almost everything can be bought and sold. Over the past three decades, markets-and market values-have come to govern our lives as never before. We did not arrive at this condition through any deliberate choice. It is almost as if it came upon us."

This led to 'market values' playing a bigger role in social life. As Sandel writes "Economics was becoming an imperial domain. Today, the logic of buying and selling no longer applies to material goods alone. It increasingly governs the whole of life."

Sandel provides many examples of the same. There were more private contractors fighting the war in Afghanistan and Iraq, than American military troops. In fact, an individual can fight in Afghanistan or Somalia for as much as $1,000 a day. "The pay varies according to qualifications, experience, and nationality," points out Sandal. At $2,50,000 you can shoot an endangered black rhino in South Africa. Western couples can pay as little as $8000 to hire the service of an Indian surrogate mother. You can sell space to display advertising on your forehead for $10,000. Becoming a guinea pig for the big pharma companies in their drug trials can pay as much as $7,500. "The pay can be higher or lower, depending on the invasiveness of the procedure used to test the drug's effect and the discomfort involved," writes Sandal.

In the Great Britain and United States public safety has been taken over by private security firms. The number of private guards is nearly double the number of police officers. When Pope Benedict XVI, who recently retired, first visited America, tickets for his stadium masses were distributed for free. Soon they were selling on the internet for more than $200. Even religious goods have been turned into instruments of profits (On a different note this has been a great business model for all the babas and gurus who have popped up all over India).

As the above examples show profits could be made on almost anything, including death. And in her death even Margaret Thatcher became a part of the market triumphalism that she helped unleash.

Death pool is a popular game on the internet where people bet on celebrities they think will die by the end of the year. "Serious players do not make their picks lightly; they scour entertainment magazines and tabloids for news and ailing stars...popular pool choices are Kirk Douglas, Margaret Thatcher, Nancy Reagan, Muhammed Ali...Stephen Hawking, Aretha Franklin, and Ariel Sharon," writes Sandel in What Money Can't Buy. People who would have bet on Thatcher dying before the end of 2013, would have won some money by now.

While market values have grown into the western society steadily over the last three decades, they have grown much more faster in the financial sector where a price tag has been put on almost everything. Two particular concepts that were widely used to do this were securitisation and credit default swaps.

Around 2002, American banks (and even banks in Europe) started giving out subprime home loans. The best customers of the bank were prime customers. Those who did not fall into the category and were seen as not good enough to be lend to, were known as subprime customers.

Those were days that anybody and everybody got a home loan including subprime customers. This was primarily because banks did not keep loans on their books. They securitised them away. They bundled these loans together and sold bonds against them. The interest paid on these bonds was lower than the interest the bank was charging on the home loan. The difference in interest was the money made by the bank. This process was referred to as securitisation.

This process worked not only on home loans but it also worked on auto loans, consumer loans, credit card receivables, student loans, and what not.

The bonds were bought by investors of various kinds. When the borrowers of loans paid interest on their loans that interest was pooled together and used to pay interest to those investors who had bought these bonds. The same thing happened with the principal on the loan that was repaid by the borrowers. It was pooled together and used to pay off the investors who had bought these bonds.

By doing this banks no longer carried the risk of the borrower defaulting. It was passed onto the investor buying the bonds. Also the bank securitising the loan got back its money immediately and could thus give out fresh loans. And the more fresh loans banks made, the more bonds they could securitise. And they more bonds they securitised, the more bonds they could sell and charge commissions on that. Given this the banks were more interested in giving out more and more loans, securitising them and making commission on selling them, instead of checking the credibility of the borrower and whether he would be in a position to repay the loan.

Investors were not borrowed about the quality of the borrowers because the rating agencies had given AAA or the best ratings to these bonds. More than that they had also managed to buy insurance on these bonds. In 1997, JP Morgan had developed a financial instrument known as the credit default swap (CDS).

Investors who bought securitised bonds also bought a CDS against those bonds. They paid an insurance premium to the firm selling the CDS. And in case the underlying borrowers of the bonds that investors had bought defaulted, the investors got compensated for the losses by the firm selling the CDS. It worked like any other insurance contract would.

But over a period of time investors could buy a CDS even on a bond they did not own. In simple English this is what it meant. I can go and buy a life insurance on my life or for my car. If I die then my nominee gets paid by the life insurance company. If my car is damaged then the insurance company pays me the cost of getting the car repaired.

The CDS version of the same would be that anyone could go and buy life insurance on me or an insurance on my car for that matter. And as long as they paid their premiums if I died or my car was damaged they would be compensated.

The primarily player in the CDS market was the financial products divisions of the insurance major AIG, which was based out of London. So everybody thought they would live happily ever after because they had paid a 'market price' for being adequately protected. But that was not to be.

The borrowers started defaulting and this finally led to the financial crisis, the aftermaths of which are still on. All this could have been avoided if a 'market price' had not been put on everything and banks would have checked the credibility of the borrower before lending them money. But that was not to be as good old fashioned banking had been destroyed. And it all started with Ronald Reagan and Margaret Thatcher believing that markets were over everything else.

Let me conclude with some lines Roger Waters, that other Great British, once wrote:

What have we done, Maggie what have we done?
What have we done to England?
Should we shout, should we scream
"What happened to the post war dream?"
Oh Maggie, Maggie what have we done?
- The Post War Dream - Pink Floyd.

(Vivek Kaul is a writer. He tweets @kaul_vivek)

by Vivek Kaul

Related Stories.