Joanne Knight

February 18, 2009

Business Out, Government In

For too many of us the political equality we once had won was meaningless in the face of economic inequality. Franklin D. Roosevelt, 1935

As the Federal Opposition snarl and gnash their teeth and ardent neoliberals sigh and shake their heads, it seems that the Rudd government is willing to reclaim the role of government as the provider of social investment. The Federal Government’s stimulus package provides long overdue funding to schools and housing, social infrastructure long neglected during the Howard years. As business is unable or unwilling to sustain its social investment with the global economic crisis, in the style of ABC Learning and Rio Tinto, it becomes clear that government has an important role to play in providing this. But not only during crises. Government’s investment in social infrastructure must be ongoing and significant and if business cannot sustain its input during bad economic times then they need to be forced to provide in the good times.

Despite pleas from the government to maintain employment, Rio Tinto abruptly closed its WA mining operations and sacked 2000 workers in spite of WA government money put into the project. Until recently the orthodoxy has been to reduce the size of government to a far smaller percentage of GDP. One argument is that governance functions can be performed by other institutions such as corporations, non-government organizations, and communities. The collapse of ABC childcare and the current Connex debacle seems to demonstrate quite clearly that the private sector has a limited role to play in the provision of public services. This is clearly the role of government. The government is finally showing some leadership in this direction but they must go further.

This package reverses the trend of the last 10 years of transferring government debt to personal debt. The government instead of expecting individuals to carry the burdens of the State is shouldering these responsibilities and ultimately the government has greater resources, particularly if it requires business to make a fair contribution. In 2005 the Senate Economics Committee found that the large current account deficit in 2004-5, which exceeded 7% for the first time, was primarily driven by household debt in housing finance. The household sector made a dramatic move between 2000 and 2005 from saving to borrowing, resulting in a large rise in household debt. In the same period, credit card debt also increased by a similar order of magnitude.

According to associate professor Steve Keen from the University of Western Sydney, Australia’s debt has grown rapidly from less than 80% of gross domestic product (GDP) in the early 1990s to now stand at almost 170% of GDP. Forecasts of rising unemployment and a slowing economy mean an increasing number of Australians will come under pressure due to problems repaying debt. And to top it off, a recent Dun & Bradstreet survey showed that many people expect to increase their level of indebtedness over coming months.

And while Australia’s level of household debt continues to increase, in common with many other nations, Australia has been running down its stock of public assets. The public investment share of GDP has declined quite dramatically from just less than 8 percent in the 1960s to under 4 percent in the 2000s. This reflects the diminishing priority given to government investment into electricity, gas, communications, infrastructure, education and health over recent decades. Numerous empirical studies have demonstrated the shift from productive to unproductive government spending negatively impacting on productive private investment. Productive government spending tends to crowd-in private investment, while unproductive provision of transfer payments for subsides and handouts crowd-out private investment. Thus, Australia-along with the US, UK and others- has insufficiently built a public regime of accumulation for long-term investment.

Government spending in Australia is the third lowest of the 30 OECD countries and our tax collection, as a per centage of GDP, is the eighth lowest in the OECD. Dr Richard Denniss argues if Australian tax rates were equal to the OECD average, tax receipts would increase by about $50 billion dollars per year. We could use that to pay for the government’s stimulus package.

The corporate tax rate has been reduced from 49 per cent in 1987 to 30 per cent in 2001. In 2008, the corporate tax rate was 21st lowest among OECD countries. While lowering the corporate tax rate may not impact on tax revenues, they do little to bolster social infrastructure. For every $1 billion spent on reducing the corporate tax rate, three quarters of it is captured by the wealthiest 20% of citizens.

Speculation and private investment have failed to deliver solid sources of revenue for public investment. As the tide turns in the coming years, we would do well to move away from the ‘masters of the universe’ mentality. It is time to repair the damage of the past years of madness and the government’s stimulus package takes a few small steps in that direction.

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February 15, 2009

Shorting the Regulation

Filed under: economic crisis,Uncategorized — joanneknight @ 12:23 am
Tags: , , , ,

Innovation is the salient energy; Conservatism the pause on the last movement.
Ralph Waldo Emerson The Conservative (1842)

Biblical images of people scrabbling through the dirt for food in Colorado seem to capture the essence of this economic downturn. Lines stretching down the street for charity food parcels certainly remind one of images of soup kitchens during the Great Depression. But unfortunately Western leaders look more like Nero than FDR. The best they can come up with is more interest rate cuts to encourage people to borrow more and spend more; more tax cuts so once again people have more money to spend. It’s time to introduce the ‘R’ word: Regulation on financial markets. If banks cannot decide what is in their own best interest (as was pointed out by the guru of the free market, Alan Greenspan), let alone the broader public interest, it is time for the government to step in and tell them what is.

None of the $US700 billion ($1 trillion) financial rescue package provided to US banks will be used to assist homeowners facing foreclosure or business even though the legislation authorises it. US Treasury Secretary Hank Paulson, who has made about half a billion dollars from the deregulated system, has clashed with Congress, telling them it was designed to stabilise the financial markets, not as a panacea for economic difficulties or to help beleaguered homeowners and automakers.

Deregulation means that we have wildly fluctuating markets operating on rumour and sentiment rather than hard data. Michael Heffernan, senior client adviser at Austock argues that the sharemarket drops have ‘a lot more substance to them that we thought 6 months ago.’ Many commentators claim that the market is suffering from a loss of confidence as if there were no structural reasons like deregulation, speculation and over-leveraging causing instability in the market.

The G-20 Study Group on Global Credit Market Disruption concluded in their report last year that regulatory gaps encouraged the increased use of securitisation and the spread of the ‘originate and distribute’ mortgage model that resulted in insufficient attention being paid to credit quality. Weaknesses in risk management systems and regulatory oversight saw these lending practices continue even as credit quality continued to decline and risk exposures increased. The spread of these losses was caused largely by high levels of leverage in the system, including insufficient capital held against loans. This in turn was partly a product of failings in the regulatory system to apply adequate risk capital to the off-balance sheet entities that securitise loans on behalf of the banks. The complex nature of structured finance products also resulted in some investors having an over-reliance on credit ratings instead of undertaking adequate due diligence. This complexity also meant that exposures to subprime lending were difficult to determine, which contributed to difficulties in assessing risks. Weaknesses in accounting rules meant that off-balance sheet entities did not require clear and transparent disclosure. It seems a significant part of this problem is a lack of regulation.

The main reforms being offered are patently inadequate. The G20 countries advocated greater oversight of ratings agencies and stronger regulation of hedge funds. Consumer protection is to be bolstered and international financial institutions should be reformed. In addition, there should be clearer accounting standards and a review of the way managers are paid.

Many observers believe that Obama will be more open-minded about regulations that strengthen international institutions or that put an end to tax havens. But the incoming president will likely resist ambitious plans for a global financial regulator. ‘Even under a President Obama, the US government would not accept any kind of global supervisory authority for the financial markets,’ said Brad Setser of the Council on Foreign Relations. It seems America remains committed to free trade and deregulated markets.

Proposed changes to financial regulation require brokers to ask their clients whether an order was a covered short sale, and market operators to publicly disclose short-selling data they received from brokers. David Enke, Associate Professor of Finance at the University of Tulsa, argues that by making short data public, others might be tempted to increase their short positions, and so too the selling pressure on the shorted security. In the end, this may do nothing to decrease market manipulation, while still allowing the funds to profit from the falling prices.

According to AEF Rofe, Chairman of the Australian Shareholders’ Association, the new regime fails to address the past failure by the market operator and the regulator to effectively monitor and enforce the disclosure requirements. Advisers at DLA Phillips Fox also seem doubtful about the veracity of these changes. Traders have been selective about disclosure laws for years so asking them to disclose more appears rather pointless. At bottom financial institutions have shown themselves to be exercising reckless judgment when they think there are easy dollars to be made.

It is clear that short selling is a problem and needs to be regulated, but focusing on extreme speculation practices fails to take account of the myriad other causes of the financial meltdown. Companies which collapse due to high leveraging, such as Rubicon, have nothing to do with short selling. Deregulated lending resulting in shoddy lending practices and the inclusion of these bad mortgages as part of investment packages, which was not disclosed, has not even made it onto the agenda. The markets have run away and are now causing the economy to collapse, throwing thousands of people out of work, destroying local businesses, forcing people to seek charity. Markets need to be controlled by governments, not the other way around.

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