Blogging the Zombies: Expansionary Austerity – Reanimation

by John Quiggin on December 19, 2011

<h3>Expansionary Austerity – Reanimation</h3>

 

The idea of expansionary austerity first emerged in the early 1990s, in the context of the formation of the eurozone. The creation of a monetary union between countries with no capacity to undertake a co-ordinated fiscal policy was seen as requiring convergence on a more conservative fiscal stance than had been possible during the chaos of the 1970s and 1980s. The agreements made at Maastricht in 1992 , and later formalised at the Growth and Stability pact required countries wishing to join the eurozone to hold deficits below 3 per cent of GDP and public debt below 60 per cent Check

With unemployment still high in many European countries, there was some reluctance to implement the austerity measures required by the Maastricht criteria. So, there was a lot of interest in analyses claiming to show that austerity could, in fact, be expansionary.  A series of such analyses were produced by Albert Alesina and a series of co-authors, most notably Silvia Ardagna.

Some of these papers provided econometric analyses, which tried to show that reducing government expenditure and budget deficits would lead to stronger economic growth. Statistical analysis is rarely as convincing as a good story, however, and the most influential work in this literature was a series of stories about individual countries, entitled ‘Tales of Fiscal Adjustment’ by Alesina and Ardagna.

Although this work had only a modest impact at the time it appeared, it but it become part of the thinking of many anti-Keynesians, particularly in Europe So, when European governments found themselves struggling with apparently unsustainable levels of public debt in the aftermath of the global financial crisis, advocates of austerity measures could argue that the policies they proposed would accelerate economic recovery.

This claim led to a re-examination of the econometric work undertaken by the advocates of expansionary austerity. Some of the most important work was done by the IMF and by one of Alesina’s former co-authors, Roberto Perotti.  The conclusions reinforced the common-sense Keynesian view that contractionary fiscal policy (that is, austerity) is contractionary in macroeconomic terms.

The IMF critiques convinced most professional economists, at least those open to empirical evidence. But what about the success stories told by Alesina and Ardagna. Such stories can’t be refuted by statistical analysis. Rather it’s necessary to examine the historical accuracy of the account that is offered. I decided to look at the story told by Alesina and Ardagna about my own country Australia. I expected to find points of disagreement, but I was surprised to find much more. The section on Australia is full of glaring factual errors, even though Alesina had spent time there as a guest of the central bank.

To mention just a few of the most glaring errors

* Alesina and Ardagna attribute the policy of austerity to a leftwing government elected in 1985. In fact, the government was elected in early 1983 at the depths of a severe recession. It implemented an expansionary policy. The recovery was well under way when the government took measures, beginning in 1984 to wind back the budget deficit

* Alesina and Ardagna assert that the main budget savings came from  “cuts in transfer programmes .. mainly concentrated on unemployment insurance.” Spending on unemployment benefits fell, but not because of cuts. The unemployment rate was falling and expenditure fell as a result. This is the standard Keynesian “automatic stabilisers” at work

* Most strikingly of all the write ‘Australia is a clear case of an‘expansionary fiscal contraction’. GDP grew faster during and in the aftermath of the adjustment, both in absolute terms and relative to the G7 countries. A private investment boom was associated with profits and easier access to credit following the financial deregulation process that took place in 1985–6.”

This is like the story of the man who jumps off a tall building and says, as he passes the 25th floor “All good so far”. Writing in 1998, Alesina and Ardagna must surely have been aware that, almost immediately after their story ends, Australia entered the worst recession in its postwar history. 

Australia’s recession was triggered by contractionary monetary policy, but its severity was largely due to the collapse of the investment boom, which was dominated by speculative investment projects undertaken by so-called ‘entrepreneurs’ who took advantage of financial deregulation to build conglomerate empires that failed in the crisis, almost taking down the banking system with them.  The Australian experience of the 1980s was a preview of what would happen in the US and Europe in the 2000s.

To sum up, the tale told by Alesina and Ardagna bears zero relation to the actual history of Australia in the 1980s. The most revealing point about their account is their eagerness to shift the burden of adjustment to a crisis onto its most vulnerable victims – the unemployed. The 1990s literature on expansionary austerity was a warning of what was to come after the global financial crisis.

The crisis and its aftermath

For a brief period after the eruption of the crisis in 2008, it seemed that everyone was a Keynesian.  With interest rates already at or near zero in most countries, the fear of disaster led governments of all political persuasions to engage in large-scale fiscal stimulus

The only exceptions to this trend were countries such as Iceland and Ireland where the financial crisis had resulted in the rapid collapse of an over-expanded financial sector.  Decisions to guarantee the debts of failing institutions, while perhaps inevitable, were disastrous for the fiscal position of the governments concerned. Public debt  increased massively and suddenly, leaving governments with with no room to stimulate the real economy through higher public expenditure and lower taxes.

Unsurprisingly, the combination of financial collapse and enforced fiscal austerity produced severe recessions, made more dramatic by the fact that the countries most affected were precisely those which had enjoyed unprecedented prosperity as a result of the financial sector boom. Conversely, Australia, where the domestic banking system remained stable, and a large-scale fiscal stimulus was introduced before the effects of the global crisis were felt, avoided recession altogether.

The experience of the crisis was entirely in line with the Keynesian analysis. Nonetheless, with the immediate danger of global economic collapse in the past, there was a substantial push to restore the status quo ante, in which fiscal policy played a marginal role. The key players here were central banks, for whom the era of inflation targeting had meant an immense increase in power and prestige. Despite having presided over the near-collapse of the financial system they were supposed to manage, and despite continuing double-digit inflation, central banks were keen to treat the crisis as a temporary aberration, with no lessons for the future.

Emblematic of this view is the widely-publicised statement of outgoing ECB President Jean-Claude Trichet at a press conference in September 2011 

⁠1I will say the following: first, we were called to deliver price stability! We were called on by all the democracies of Europe to deliver price stability and, in particular, of course by the 17 democracies that asked us to issue the currency in their 17 countries. We have delivered price stability over the first 12-13 years of the euro! Impeccably! Impeccably!  I would like very much to hear some congratulations for this institution, which has delivered price stability in Germany over almost 13 years at approximately 1.55% – as the yearly average of inflation – we will recalculate the figure to the second decimal. This figure is better than any ever obtained in this country over a period of 13 years in the past 50 years. So, my first remark is this: we have a mandate and we deliver on our mandate! And we deliver in a way that is not only numerically convincing, but which is better than anything achieved in the past.

 

http://www.ecb.int/press/pressconf/2011/html/is110908.en.html

Bad as the return to inflation targeting was, it did not imply a resurrection of the austerity policies that had failed so disastrously in the Great Depression. Although proposals for further discretionary stimulus met with increasing resistance, governments initially maintained a neutral or expansionary policy

All of that changed in early 2010 with the emergence of the Greek sovereign debt crisis. In … the major ratings agencies downgraded Greek government debt, beginning a downward spiral so steep that default became virtually inevitable. As of October 2011, the market prices of Greek bonds and credit default swaps implied a default probability close to 100 per cent, with likely losses of 60 per cent.

For many years, Greek governments had used a wide range of expedients to increase borrowing while appearing to remain within, or close enough to, the limits on debt and deficits set by the ‘Stability and Growth’ Pact under which the eurozone was established. A notable , and well-publicized, instance was a bogus currency swap set up with the assistance of Goldman Sachs.

http://www.spiegel.de/international/europe/0,1518,676634,00.html

The real story however, involved the big French and German banks. Under the Basel II system of financial regulation, they had been freed from prescriptive controls on the assets they were required to hold. Instead, they were required to maintain a low-risk portfolio, where risk was assessed by credit ratings agencies.  

This system encouraged banks  to hold AAA-rated assets, since these were considered as virtually riskless. Unfortunately, low risk usually means low return and banks were hungry for profits. So, there was a massive potential gain to anyone who could find a way of making risk invisible, producing a AAA-rated asset with the high return that risky borrowers were willing to pay.It was for this reason that European banks piled into the subprime derivatives created on a massive scale in the US, often raising the money to do so on the US wholesale market. 

Within Europe, the creation of the euro provided another way of adding risk while staying within the Basel II guidelines.  Bonds issued by eurozone countries with high public debt, such as Greece and Italy, carried a small but significant risk premium. On the other hand, for regulatory purposes, such debt was effectively treated as risk-free.

The role of the banks, and of the Basel II system was not immediately apparent (even now, the idea that European investments in subprime assets reflected ‘dumb bankers in Dusselsorp’ has a fair bit of currency. Instead, attention was focused almost entirely on the profligacy of Greek governments, … in the civil service and rampant tax evasion.

The real problems came when this analysis was extended to the rest of the heavily indebted periphery – commonly referred to in such accounts as the PIGS (Portugal, Italy, Greece and Spain) group, sometimes with Ireland thrown in as a second ‘I’. This was unfair and inaccurate, particularly as regards Spain and Ireland, which had been running budget surpluses in the years leading up to the crisis. Even Italy was reducing its ratio of debt to GDP, and adopting measures aimed at a gradual return to fiscal sustainability.

The fiscal crisis in these countries was driven by the need to bail out the financial sector, and by the collapse in revenues that resulted from the bursting of financial bubbles. In Ireland, for example, under pressure from the ECB, the government agreed to guarantee all the debts of the major banks, pledging  as collateral $20 billion euros from the National Pension Reserve Fund (the equivalent of the Social Security Trust Fund  in the US). Most of this money, and tens of billions more from other sources, appears to have been lost.

The injustice of making hospital workers, policy and old age pensioners pay for the crisis, while the bankers who caused it are receiving even bigger bonuses than before, is glaringly obvious. So, just as with trickle down economics, it was necessary to claim that everyone would be better off in the long run.

It was here that the zombie idea of expansionary austerity emerged from the grave. Alesina and Ardagna, citing their dubious work from the 1990s, argued … They attracted the support of central bankers, ratings agencies and financial markets, all of whom wanted to disclaim responsibility for the crisis they had created and get back to a system where they ruled the roost, and profited handsomely as a result.

The shift to austerity was politically convenient for market liberals. Despite the fact that it was their own policies of financial deregulation that had produced the crisis, they used the pretext of austerity to push these policies even further. The Conservative government of David Cameron in the UK [formally a coalition with the Liberal Democrats led by Nick Clegg, but Clegg has proved utterly ineffectual in all respects].

Although the term ‘expansionary austerity’ was not much used in the US, the swing to austerity policies began even earlier than in the US and Europe. After introducing a substantial, but still inadequate fiscal stimulus early in 2009, the Obama Administration withdrew from the economic policy debate, preferring to focus on health policy and wait for the economy to recover.

Meanwhile the Republican party, and particularly the Tea Party faction that emerged in 2009, embraced the idea, though not the terminology, of expansionary austerity and in particular the claim that reducing government spending is the way to prosperity. In the absence of any effective pushback from the Obama Administration, the Tea Party was successful in discrediting Keynesian economic ideas.⁠2 

Following Republican victories in the 2010 Congressional elections, the Administration accepted the case for austerity and sought a ‘grand bargain’ with the Republicans. It was only after the Republicans brought the US to the brink of default on its debt in mid-2011 that Obama returned to the economic debate with his proposed American Jobs Act. While rhetorically effective, Obama’s proposals were, predictably, rejected by the Republicans in Congress.

At the state and local government level, austerity policies were in force from the beginning of the crisis. Since they are subject to balanced-budget requirements, state and local governments were forced to respond to declining tax revenues with cuts in expenditure. Initially, they received some support from the stimulus package but, as this source of funding ran out, they were forced to make cuts across the board, including scaling back vital services such as police, schools and social welfare.

The theory of expansionary austerity has faced the test of experience, and failed. Wherever austerity policies have been applied, recovery from the crisis has been halted. At the end of 2012, the unemployment rate was above 8 per cent in the US, the UK and the eurozone. In the UK, where the switch from stimulus to austerity began with the election of the Conservative-Liberal Democratic coalition government in 2010, unemployment rose rapidly to its highest rate in 17 years. In Europe, the risk of a new recession, or worse, remains severe at the time of writing (December 2011).

Although the US economy shows some superficial signs of recovery, the underlying reality is arguably even worse than in Europe. Although unemployment rates have fallen somewhat, this mainly reflects the fact that millions of workers have given up the search for work altogether. The most important measure of labor market performance, the employment-population ratio (that is, the proportion of the adult population who have jobs) fell sharply at the beginning of the crisis and has never recovered (Graphs to come here).

 The reanimation of expansionary austerity represents zombie economics at its worst. Having failed utterly to deliver the promised benefits, the financial and political elite, raised to power by market liberalism has pushed ahead with even greater intensity. In the wake of a crisis caused entirely by financial markets and the central banks and regulators that were supposed to control them, the burden of fixing the problem has been placed on ordinary workers, public services, the old, and the sick.

With their main theoretical claims, such as the Efficient Markets Hypothesis and Real Business Cycle in ruins, the advocates of market liberalism have fallen back on long-exploded claims, backed by shoddy research. Yet, in the absence of a coherent alternative, their policy program is being implemented, with disastrous results.

 

 

 

1 The question referred to German concerns about the limited ‘quantitative easing’ undertaken by the ECB. It is striking that, three years into the deepest recession since the 1930s, Trichet is most concerned to defend himself against charges that he is not hawkish enough!

2 It’s worth observing that, although the Tea Party now claims to have been motivated by anger at the bailout of the banks, which took place under the Bush Administration, it did not begin to organize until after the inauguaration of Barack Obama. The precipitating event was a widely publicised rant by a Chicago commodities trader, Rick Santelli. Mr Santelli whose job would have disappeared if the financial system had not been bailed out was not, of course, complaining about the trillions of dollars spent to rescue Wall Street and its offshoots in Chicago and elsewhere. Rather, he was objecting to the much more modest help given to families who had taken out mortgages they could no longer afford to buy houses that had collapsed in value.

{ 44 comments }

1

Stephen Kinsella 12.19.11 at 10:22 pm

Hi John,
Great post, one quibble: I don’t think the expansionary austerity idea is a product of the 1990s. The idea of cutting your way to growth (at least in an Irish case) can be found in Auerbach, and Kotlikoff’s 1987 book on Dynamic Fiscal Policy and references therein heading back to the 70s. I think it was Giavazzi and Pagano’s 1990 NBER Annual everybody seems to look to for the first explanation of the issue (they used Ireland and Denmark as case studies, both well debunked by now), and that’s where the 90s tag comes from. But I’m open to being corrected on this.

2

Watson Ladd 12.19.11 at 10:26 pm

Not all states in the US have balanced budget amendments, but they do face borrowing costs that prevent them from being Keynesian stabilizers.

3

bob mcmanus 12.19.11 at 10:30 pm

Is this partly for proofreading?

“Despite having presided over the near-collapse of the financial system they were supposed to manage, and despite continuing double-digit inflation, central banks were keen to treat the crisis as a temporary aberration, with no lessons for the future.”

Did you mean “inflation” or “unemployment”

Loved this piece a lot. This is great.

4

Ryan 12.19.11 at 10:42 pm

There are definitely some needed clarifications or expansions throughout; one being:

“The shift to austerity was politically convenient for market liberals. Despite the fact that it was their own policies of financial deregulation that had produced the crisis, they used the pretext of austerity to push these policies even further. The Conservative government of David Cameron in the UK [formally a coalition with the Liberal Democrats led by Nick Clegg, but Clegg has proved utterly ineffectual in all respects].'”

The Conservative government… what? I look forward to the finished product.

5

James Wimberley 12.19.11 at 11:13 pm

¨Dusselsorp¨? Obscure joke or typo for Düsseldorf?
¨.. the Tea Party was successful in discrediting Keynesian economic ideas.¨
Not alone. Surely it needed the ⁠freshwater economists given a platform by the WSJ for remarkably ignorant commentary, and the conservative network of think tanks and paid bloggers to turn their story into Beltway CW by sheer force of repetition.

6

john c. halasz 12.20.11 at 12:51 am

You might focus a bit of attention on the case of Germany here, since that government is the prime exponent of “expansionary austerity” in the Eurozone. Germany (BRD) reunified with the East (DDR) at one-to-one currency parity (when 1/4 might have been the real rate), and expended enormous sums to redevelop the East, so it was like a boa that had swallowed an elephant in the 1990’s, subject to sclerotic growth, even as the Maastrich rules and the preparations for the Euro, (also an especially German-led project), were being locked in. The Hartz labor market reforms were presenting as the key to restoring economic growth in the early 2000’s by reducing unit labor costs and thus expanding domestic employment. And, indeed, they half-way worked, with respect to unit labor costs, at least, resulting in growing German CA surpluses with the rest of the Eurozone: thus a supposedly successful case of “expansionary austerity”, except for, er,…

This is explained in this video clip by a former deputy of Oskar Lafontaine, the SPD finance minister who walked out of the Schroeder government in protest, in an account that significantly contradicts Trichet’s triumphalism:

http://www.nakedcapitalism.com/2011/12/class-war-low-wages-and-beggar-thy-neighbor.html

7

Jeffrey Davis 12.20.11 at 2:25 am

I don’t understand the impetus to continue economic policies that simply don’t work.

There are rich ideologues who believe in free markets etc. and all the Randian/Hayekian palaver, but first, second, third, and fourth they believe in being rich. There must be a long term goal here that involves impoverishing the West. Maybe there’s no real difference between $10 billion and $100 million and what the rich ideologues want is imperial sway.

Or maybe the Red Chinese have bought up obviously pliant right wing economists and have asked them to drive the West into bankruptcy.

Or maybe I’m dead and in Hell and don’t know it.

8

heckblazer 12.20.11 at 3:23 am

My impression is that the main reason for Republican calls for austerity is that it’s a handy excuse for dismantling the social safety net, a goal they’ve had since the New Deal. It certainly fits the pattern of the deficit only being a problem when a Democrat is president. The Republicans also have a stated goal of ensuring Obama is a one term president, and having a bad economy usually hurts the incumbent. From where I sit the fact that this zombie idea makes things worse is somewhere between irrelevant to a plus for its most vocal American proponents.

9

keikobad 12.20.11 at 5:34 am

Re Footnote 2: Rick Santelli works for CNBC, although Wikipedia says he was a trader years ago. Unfortunately, neither commodities floor trading nor CNBC would have ceased to exist without TARP.

10

dsquared 12.20.11 at 8:36 am

John – Basel 2 actually tightened the rules on sovereign bonds. Under Basel 1, all sovereign debt of OECD countries was zero weighted (as long as the country hadn’t rescheduled in the previous ten years, a provision brought in when Mexico joined the OECD). Basel 2 changed this to a ratings-based system, under which the capital charge for Greek debt went up to a 20% weighting.

Also, the low regulatory capital requirement on subprime CDOs wasn’t really driven by the AAA rating so much as the actually very low historical default experience – the B2 regulatory system can be seen as a massive assertion that the future would look like the past. The US banks never implemented B2, and they also owned massive amounts of the same securities – the trouble here was the branding and the moral hazard, rather than any specific regulatory distortion. (This is true of the banking industry – insurance was quite a lot different).

11

Guido Nius 12.20.11 at 8:58 am

I’m still not convinced although this is already more convincing. I don’t think anybody in Europe is defending the zombie that is depicted in the above. ‘Reculer pour mieux sauter’ is probably a better way to put it. Austerity is not seen as a direct way to expansion but as a necessary reaction to the facts. As far as I can see even the unions support tightening, if it is done by increasing taxes (and diverting them away from labour).

In fine, everybody agrees to some extent that the model needs to a big overhaul because the society has changed and keeping things as is will exacerbate the need for financing (& a net need of financing by developed countries is, after all, a perverse idea).

It also seems that, except for the UK and the populist right/doctrinarian left, there is a consensus that one of the elements of the overhaul is ensuring the primacy of politics over finance by increasing the leverage of politics through scale. This is certainly true of the European Parliament where people disagree on what to do once increased scale is realized but seem to be 80% in favor of increasing scale and convergence.

I know all of this is meant well but it seems simplistic.

12

David Woodruff 12.20.11 at 9:58 am

The first time I remember encountering expansionary austerity was in this from Stanley Fischer on Argentina: see page 6. I’m pretty sure the IMF site will have a transcript. Argentina is in a lot of ways a good analog to the Eurozone.

13

Shay Begorrah 12.20.11 at 12:18 pm

The fiscal crisis in these countries was driven by the need to bail out the financial sector, and by the collapse in revenues that resulted from the bursting of financial bubbles. In Ireland, for example, under pressure from the ECB, the government agreed to guarantee all the debts of the major banks, pledging as collateral $20 billion euros from the National Pension Reserve Fund (the equivalent of the Social Security Trust Fund in the US). Most of this money, and tens of billions more from other sources, appears to have been lost.

The accepted narrative in Ireland now is that the unconditional bank guarantee was initially undertaken by the Irish government without ECB or EU encouragement as the general impression (provided from the banks themselves) was that the banks merely had severe liquidity problems. Subsequently when the scale of the bank’s finance problems became apparent and the government wanted to unwind and restrict the terms of the guarantee the ECB lobbied strongly to prevent any losses for bondholders and then, as a party to the national bailout that Ireland was forced to enter as a result of the scale of the bank bailout, made funding of Ireland (which now had a budget deficit even without the bank bailout costs as a result of a collapse in tax receipts) conditional on a “No bondholder being left behind” policy.

Your line about “The key players here were central banks, for whom the era of inflation targeting had meant an immense increase in power and prestige.” might be an area ripe for further analysis. The ECB (famous for its secret minutes policy – did you mention that in ZE already?) was independent of popular democratic control or accountability but it was certainly not free of a guiding political ideology or stakeholders very much beholden to the financial sector.

14

roger 12.20.11 at 12:25 pm

I don’t think “‘Reculer pour mieux sauter’ is probably a better way to put it.our ” It is rather a case of economists and Eurocrats urging mieux sauter by sawing off one of your legs. The simplistic view is precisely the austerity expansion view, which takes all too literally the neo-classical myth that there is some competition in a mythically limited space between government and private investment. This space, magically, becomes boundless when it is a matter of competition between investors in the private sphere. It is almost like economists are working for those who want to make immense profits and will argue in any way to make them…

Which is I think the main point I’d disagree with in this article – the lack of any mention of class interest. Because class interest is the only thing that makes the policies of the Eurocrats and the follies of the austerians comprehensible. Even if – especially if – the austerians were convinced that expansionary policies would raise the wages and employment of the wage class, they’d oppose it because it is what they fear: militant labor. They’ve feared it for 150 years, and have always resented the compromises of what Polanyi calls the double movement – the great compromise between capitalism and socialism (or social democracy). This has struck them as an imperfection in the system, and neo-liberalism has always been about solving that imperfection by extruding contemporary state welfare functions – education, healthcare, public health, retirement, support for the countervailing power of organized labor – into the private sphere. Now that this project has evidently failed, it is on to phase 2, where the state welfare functions are now considered too expensive to continue, full stop.

15

Shay Begorrah 12.20.11 at 12:48 pm

@Guido Nuis

Austerity is not seen as a direct way to expansion but as a necessary reaction to the facts.

It seems that in many countries that more austerity is now the necessary reaction to the facts austerity necessarily creates and it can not be escaped that the policy up to now has benefited significantly the power, political base and influence of those promoting it (the ECB, the most conservative parts of the German/North European establishment) rather than those implementing it.

I would say that in Europe at least expansionary austerity as is more used as a plausible alternate explanation for a type of economic imperialism than a sincerely held belief about the long terms benefits of austerity to its current subjects.

16

Barry 12.20.11 at 1:13 pm

Seconding heckblazer, here. I’ve not encountered a single case in the USA where a major program beloved of the elites was cut or eliminated by the alleged ‘fiscal conservatives’.

17

dsquared 12.20.11 at 1:23 pm

Actually two other gremlins, John:

The precipitating event was a widely publicised rant by a Chicago commodities trader, Rick Santelli. Mr Santelli whose job would have disappeared if the financial system had not been bailed out

Santelli had been a trader in the past, but at the time of the rant, he was a CNBC presenter. His job probably would have disappeared if, &c but not in that straightforward way.

Also,

The injustice of making hospital workers, policy and old age pensioners pay for the crisis, while the bankers who caused it are receiving even bigger bonuses than before, is glaringly obvious.

I’ll restate my objection in the specific Irish case (to the effect that it was a choice of the Irish government to reduce the deficit by cutting spending rather than raising the lowest tax rates in Europe – although the austerity was mandated by the crisis, its specific incidence was a conscious choice on the part of the Irish government; the idea that an austerity budget has to be all spending cuts is a bit of a zombie itself). But just on a factual point, bankers aren’t “receiving bigger bonuses than before” anywhere and certainly not in Ireland.

18

roger 12.20.11 at 1:39 pm

dsquared, I think this is wrong: But just on a factual point, bankers aren’t “receiving bigger bonuses than before” anywhere…
Take the Royal Bank of Scotland. The Bank received 541 billion dollars worth of 1 percent and below loans from the Fed in the three years of the Fed’s Big Bank Bonanza attempt to help the rest of us by larding the financial sector with 16 trillion dollars in various ’emergency loan’ programs (the stat comes from table 8 in the GAO report on the Federal Reserve loan programs released this June). Now, according to this story in the Guardian (http://www.guardian.co.uk/business/2011/mar/08/rbs-executives-handed-28m-shares-disgrace), the Royal Bank of Scotland certainly did think its upper management crewe was worthy of bonuses that were bigger than before.

Here’s the key grafs:
“Hester – whose £2m bonus for 2010 was announced last month and will be paid in shares – is receiving an extra £4.5m in stock through the long-term incentive plan on top of his annual bonus and £1.2m salary. This puts him on track for a pay deal of around £7.7m. For 2009 he did not take a bonus but received just over £4m through the long-term share plan.

Finance director Bruce van Saun is receiving £1.3m in shares for his 2010 bonus and a further £2.8m through the long-term incentive plan.

The largest bonus awarded in shares is the £2.5m handed to John Hourican, head of the investment bank. Next week it is likely to emerge that Hourican has received more than that because he is also being paid in the bank’s debt – although he is not expected to top the £7.7m that Hester could be handed if he meets all his performance criteria.

American-based Ellen Alemany also emerges as a top earner with a £1.1m bonus in shares and £2.5m of stock awarded through the long-term plan. Nathan Bostock, who runs the parts of the bank being shut down or sold off, gets £637,000 in shares for his 2010 bonus and £2m through the long-term plan. Brian Hartzer, who runs the retail bank, had £600,000 awarded in shares for 2010 and £1.9m in the long-term plan.”

Sounds to me like you could dicker by extending “before” to mean – all the past. But these bonuses look big and obscene to me, ample evidence that the upper management at banks is not only incompetent but rewarded enormously for that incompetence. Notice, for instance, the American, Ellen Alemany. I have a little analysis of her career at the Citizens Financial Group, Inc, here: http://limitedinc.blogspot.com/2011/08/looting-in-plutocene.html, containing further links to the operations of Citizens Financial during the boom years.

19

dsquared 12.20.11 at 1:54 pm

Roger: the top management of RBS were all sacked in 2008 (and some of them were banned from the industry for life). The people getting bonuses now are being paid under the agreement with the government that they struck in 2008-9, and most of them (except Hourican and Alemany iirc) weren’t working for RBS before the crisis.

More generally, individual bonuses go up and down, but the aggregate amount has fallen precipitously.

20

bert 12.20.11 at 3:53 pm

Lots to like here.
Towards the end of the post your discussion of UK party politics seems a little off, though. I think the problem is partly that you’re discussing two separate issues, financial deregulation and fiscal retrenchment.
On the first there was a broad consensus at the top of British politics during the boom. You rightly mention that the Tories were full-on market liberals. The killer example here would be the Economic Competitiveness Policy Group, which Cameron gave to starey-eyed europhobe John Redwood as a way of stopping him from causing trouble. His 2007 report to the Shadow Cabinet shows the strength of the financial deregulation lobby on the Tory right. But the leadership faction of the LibDems, dominated by “Orange Book” liberals, also embraced the consensus. As of course did the Labour governments of the time (“light touch regulation” and “Ed Balls” would be useful search terms here).
On the second issue, fiscal retrenchment, again, the LibDem leadership is fully signed up to deficit cutting: http://news.bbc.co.uk/1/hi/programmes/newsnight/9652072.stm.
So, the idea that the LibDems have been utterly ineffectual on these issues doesn’t seem right to me. They’ve signed the coalition agreement in blood.
What’s more, there is a reregulation effort currently underway under the banner of the Vickers report. In recent days, LibDem ministers have been permitted to trail the coming legislation on this in front of the media.

Where there does seem to be a party political difference is on austerity, and it’s a difference between the coalition and the Labour opposition. The Labour line is a good deal more Keynesian. But it’s being pursued cautiously, with a nervous eye on the focus groups.

21

bert 12.20.11 at 3:57 pm

Also, “… the swing to austerity policies began even earlier than in the UK and Europe.”

22

Barry 12.20.11 at 7:11 pm

“But just on a factual point, bankers aren’t “receiving bigger bonuses than before” anywhere and certainly not in Ireland.”

Frankly, I’d count them not being gibbeted in chains as a pretty big bonus.

23

mds 12.21.11 at 3:02 pm

Barry, I love you like an internet brother, but the talk of gibbets isn’t very helpful. What we need to work out is a better shorthand than “bankers,” “banksters,” etc. to describe those in the financial services industry who, according to serious economists, really did play a major role in the severity of the crash. Ideally, it would include Jamie Dimon and others who are grabbing enormous rewards from a till brimming over with taxpayer money, even as they form groups to push back against the “imbeciles” who want them to pay even slightly higher taxes in a time of austerity hysteria. The problem with “bankers” is that it is such a broad term; I don’t loathe the loan officers at my local mutual savings bank, and they certainly aren’t receiving large bonuses. So we need a more precise term for those who (1) worsened the economic crisis through incompetence, malice, or failure of oversight; (2) are still being amply compensated, especially on Wall Street and in the City; and (3) are supposedly exempt from even the level of blame heaped upon an elderly pensioner in Corinth, who should have known better than to authorize his government to borrow abroad so lavishly. “Lords of Finance” is a bit arch, and already taken. Suggestions?

24

Alex 12.22.11 at 2:11 am

Austerity is not seen as a direct way to expansion but as a necessary reaction to the facts.

Well David Cameron has for example:

“Today, British businesses are rebuilding their balance sheets because they have relatively strong profit and loss accounts. In the first six months of this year, they ran a financial surplus worth almost five percent of GDP. If we are to get back to strong growth, these profits need to turn into productive investment – and my message to you today is that we are providing the stability for that investment. In five years’ time, we will have balanced the books. The sharp tax rises and huge interest rates you feared, the uncertainty you felt – these are things you no longer need to worry about”

Pure Ricardian equivalence.

Of course, this is just what he says to the business leaders and wonks to make them feel smart. To the rank-and-file and the plebs though, he dons the hair-shirt, saying things like:

“Back in May, we inherited public finances that can only be described as catastrophic. This year, we will borrow more money than we spend on the NHS. Just think about that. Every doctor’s salary. Every operation. Every heating bill in every hospital. Every appointment. Every MRI scan. Every drug. Every new stethoscope, scalpel, hospital gown. Everything in our hospitals and surgeries – paid for with borrowed money, much of it from abroad. And then think about the interest. This year, we’re going to spend £43bn on debt interest payments alone. £43bn – not to pay off the debt – just to stand still. Do you know what we could do with that sort of money? We could take 11 million people out of paying income tax. We could take every business in the country out of corporation tax. That’s why we have acted decisively – to stop pouring so much of your hard-earned money down the drain.”

25

Watson Ladd 12.22.11 at 2:57 am

Barry, banks didn’t make the crisis. It was a failure of governments to adequately close the demand gap in response to the fiscal crisis after a massive overexpansion that did it. Yes, the precipitating shock was a bank run. But even sans bank run people were going to lose a lot on the mortgage bubble, which would have existed even without banks driven as it was by systemic imbalances that created lots of capital looking for a safe haven. We might as well blame congress for not passing a 2.1 billion dollar stimulus or Bernanke for not sending agents from the Treasury with C-notes to put them on red at Vegas.

26

Andrew C 12.22.11 at 9:09 am

Most strikingly of all the write

Should be “they write”

27

Tim Wilkinson 12.22.11 at 9:39 am

Watson Ladd – I’m sure that’s what you right wingers tell each other on your own blogs and threads, but I did note that a crisis caused entirely by financial markets and the central banks and regulators that were supposed to control them didn’t make it onto dsquared’s list of gremlin-plagued assertions.

JQ – happened to notice that Russia Today is now included in the UK freeview package (which provides some welcome balance), and caught today’s Keiser Report, which featured your colleague(?)/competitor Steve Keen (of whom I know nothing of but I imagine you must do) plugging his own econ debunking book, also some extravagant-sounding figures for the ratio of UK private debt to GDP.

(Also fwiw, I think ‘glaring errors’ is used twice in your text.)

28

bert 12.22.11 at 2:01 pm

Russia Today is the Putin channel, you chump.

29

Tim Wilkinson 12.22.11 at 2:10 pm

No shit, Sherlock.

30

bert 12.22.11 at 3:03 pm

So, by “welcome balance” you actually mean “countervailing propaganda”.
Whatever they think they’re doing here, it’s not irony.

31

dsquared 12.22.11 at 3:05 pm

crisis caused entirely by financial markets

um no. There were houses involved. And Greece.

32

Tim Wilkinson 12.22.11 at 7:10 pm

bert So, by “welcome balance” you actually mean “countervailing propaganda”.

Well kind of, yeah (‘you chump’) – a different set of stories, reportedby journos who approx. correctly don’t consider themselves any more corrupt than those of the BBC or CBS or whatever, and to be assessed just as critically. RT covered, e.g. the fake Libya rape/porn mockup business, which is a whole can of worms, but certainly of interest and equally certainly not covered in the West. Press TV goes in the mix too.

dsquared, JQ – far be it from me to sow discord, but this seems to require resolution…

33

john c. halasz 12.22.11 at 7:27 pm

Actually, from the bits of it that I’ve seen, RT is pretty good, certainly no worse than Al Jazeera. This show is their econ/business broadcast, featuring a nice California gal, which is a cut above the usual such fare: http://rt.com/programs/capital-account/ . And here is an interview with Varoufakis: http://yanisvaroufakis.eu/2011/12/10/interview-on-capital-account-9th-dec-2012-on-the-indispensability-of-the-political-dimension/

34

bert 12.22.11 at 7:32 pm

You need a reason to call someone a chump.
Otherwise you might be thought offensive.
I’m away on holiday so this is the last from me on this thread.
Let’s have no more nonsense from you now.
Merry Christmas.

35

Tim Wilkinson 12.22.11 at 7:53 pm

jch – indeed.

bert – you were indeed thought offensive, hence the quote.

36

BenP 12.22.11 at 8:37 pm

http://www.newbottomline.com/report_big_bank_bonuses_in_2011 says bank bonuses will be higher than last year, in the US at least. Though as Vince Cable has noted “even if bonuses are cut, salaries have risen significantly to compensate, by up to 40% in some cases”.

37

Watson Ladd 12.22.11 at 9:31 pm

Tim, past financial crises were contained with no harm to the larger economy (1980’s savings and loan, mexican peso crisis, Russian bond default). Why wasn’t this one? The recession started December 2007. The financial crisis reached its peak in September 2008 with Lehman weekend. Lehman clearly could not cause a recession that preceded it: far more likely is that the collapse of the housing bubble caused losses in the finance sector along with the rest of the economy. The financial crisis must have been anticipated ungodly well to cause a recession nine months earlier.

38

john c. halasz 12.22.11 at 9:48 pm

I know it’s not worthwhile to respond to the gibberish Watson Ladd types, but the financial crisis started in the U.S. in Aug. 2007. Here’s a link to the TED spread:

http://www.bloomberg.com/apps/quote?ticker=.TEDSP:IND

39

john c. halasz 12.22.11 at 9:49 pm

Oops! The link didn’t quite take. Click on 5 years.

40

Watson Ladd 12.22.11 at 10:04 pm

And then it settles back down, only to rise again in December 2007. So despite an initial round of effective containment more was required as the economy weakened. Furthermore, even if there was no banking crisis a drop in the housing market of 30% would have impacted household spending due to wealth effects. The argument for the banker caused crisis seems to be that the contraction of lending caused by the fiscal shock pushed the economy over the edge, but government could have stepped in to lend instead if the markets had frozen to that extent, and lending to financials was impared while loans to nonfinancials were not as impaired. As for right-wing, blaming the banks seems far more right wing then blaming the system of global capital under which capital overextension then collapse has been the rule for as long as it has existed.

41

Bruce Wilder 12.22.11 at 10:38 pm

I wouldn’t concede that the Savings & Loan crisis of the 1980s was concluded “with no harm to the larger economy”. On the contrary, I tend to think it was early among a series of wounds to sound institutional structures. Destroying the Savings and Loans was a step down the path of transforming banking and finance into a predatory casino.

Without banks to write bad loans, you don’t get a housing bubble, and without a housing bubble, you don’t get a fall in housing prices, and bad loans sinking mortgage-backed securities, or a wave of foreclosures, debt-deflation, etc. Institutional control matters, and government regulation failed to regulate effectively, at a number of key points in the system.

It’s a system. The only reason to privilege one factor as a “cause” over others is because you believe it is amenable to strategic intervention. Bankers, left to their own devices, will predate. That’s what they do. It is part of the general pattern of capitalism. Capitalism is a system, which, left unregulated, will sweeten children’s toothpaste with antifreeze. I suppose you can see that as just another indication that humans are a lousy species. Or, you can see as an argument for rational, republican (by law) government. Unconstrained, banking and finance is just a volatility machine, from which some will make ungodly sums out of antisocial behaviors. Constrain it. Duh.

42

Watson Ladd 12.23.11 at 2:03 am

Bruce, the Savings and Loans had turned themselves into a casino with very little help from predatory wall street banks. In fact, if we had eliminated the savings and loans and the thrifts, creating a consolidated financial services regulator (why have two legal forms for the same business?) some of the worse regulatory problems that lead to the financial crisis would have been avoided. Also I doubt regulators would have been able to prevent the crisis. I don’t think there is a single rule that would actually have stopped a world awash in savings from loaning them to people hungry to consume. Capitalism seems to go into crisis regardless of the modes of regulation that exist at the time.

43

Tim Wilkinson 12.23.11 at 1:52 pm

blaming the banks seems far more right wing then blaming the system of global capital

This only has even surface plausibility if one assumes that blaming the banks excludes blaming the systym. But as has been thrashed out on CT before, it is quite possible – and indeed correct – to blame both, jointly, severally and as an organic unity.

What does sound right-wing (so far as I can make sense of it) is blaming a failure of governments to adequately close the demand gap in response to the fiscal crisis after a massive overexpansion

There’s good reason to argue that some criticisms of finance capitalism don’t go far enough. But occasionally intoning formulaic remarks about capitalism and crisis isn’t very useful – particularly against a background of consistently adopting a proprietarian, market-fundamentalist approach to specific issues.

44

Walt 12.23.11 at 1:57 pm

People make many puzzling comments in favor of austerity. I wonder if the explanation is that they don’t realize that investment is counted in GDP, and that GDP is just consumer goods. If we have dug ourselves a big hole, then the act of filling up that hole would show up in GDP. But in a recession, we both less consumption, and less investment. We get a whole lot more ass-sitting, though.

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