Enron style collapse for US banks?

Apparently a number of US banks have been engaging in shady practices similar to what caused the collapse of Enron. Some of America’s investment banks are at the edge of insolvency after creating a special type of fund, filling it with cheaply borrowed money and using the difference between the cash interest rate and the mortgage interest rates to make a quick buck. The banks then guaranteed these funds, called SIVs (Structured Investment Vehicles), in order to convince investors that they were a relatively risk free investment.

What has happened is that the banks who guaranteed their SIVs didn’t put them down on the balance sheet and the banks’ accounting procedures were then unable to account for the liabilities that the guarantees were. This is eerily reminiscent of Enron’s “Mark to Market” accounting technique which allowed accounting departments to write projected future income as current income. When a number of Enron’s investments went bad, they continually searched for new investments to avoid the financial reality of gaining no return on their investment. Continuously writing projected future income as current income gave Enron the ability to hide the true state of their finances. Eventually, it all came undone and Enron is now a household word that symbolises greed, a lack of ethics, bad practice and ultimate bankruptcy.

The US government didn’t bail Enron out but a lame duck, pro-business President might just do the deed when it comes to these major banks. For all the talk these companies (and politician) generate about how the market is the ultimate tool for distributing resources, these corporate collapses and bail-outs represent an amazing market failure. The bailing out of these banks may be necessary to stop Americans losing their homes (purchased on cheap credit) and avoid a recession.

Cheap credit is plentiful in the USA and many homes have credit cards with which they purchase either a lifestyle they can not afford or their day to day essentials with the hope that they can pay the money back later. America has long had problems with predatory lending and the reduction in the availability of cheap credit may yet put an end to this. Unfortunately, the economy does not exist apart from society and the removal of cheap credit will bring with it increased hardships for Americans. Many households reliant on cheap credit for their groceries and home loans will find life a lot tougher. A number of banks are suggesting an interest rate freeze on home loans for those who will not be able to make their payments should the Reserve Bank’s interest rates jump.

What has happened to the business world is deregulation and capitalism gone mad. As we seek to unleash the power of markets, those with money are able to provide much false hope to those without. Should a customer become unable to make payments, it’s not the business of the bank or other financial institution to worry about the social side of the repossession; their obligations are to their shareholders. Would an ethical finance system take care of these problems? Would government financial assistance for bankrupt consumers alleviate the problems or only further encourage people to be reckless with their money?

The clear culprit here is the notion of the free market being the solution to every problem. Operating only in terms of money, a completely free market fails to take care of things like poverty and other social and environmental ills. When a large company responsible for the purchase of many homes goes under, it goes under spectacularly. Many in business whose talk advocates free markets do not accept that a free market means no government bail-outs for businesses, no intellectual property law to protect their work and a world of cut-throat competition leading to slashed costs across the board such as wages for workers and health and safety measures.

When politicians talk about moving towards free markets they are advocating protections for businesses but not consumers. Time and again we hear of weakening of environmental legislation (such as fuel efficiency standards and pollution levels) and removing workers’ rights in the name of “flexibility” and the government is ever ready to hand out taxpayers’ money to businesses to help them meet compensation agreements when the company goes broke. The lack of corporate accountability means that for too long it has been the rich dictating the distribution of wealth in our economy.

I’m not advocating a return to a centrally planned economy nor the nationalisation of the finance industry such as Chifley proposed in the 1940s. We do need to rethink the way we let big business (particularly Big Money) behave if their recklessness in the pursuit of the quick profit is going to leave in their wake a trail of broke citizens whose homes have been repossessed. Cheap credit has led to an increase in the amount of material possessions we own and an increase in the size of our houses. It’s also led to environmental damage in the mad dash for a better standard of living through carbon emissions from cars and land clearing for domestic housing and international crop farming. The way the world does business is going to need some close scrutiny and rethinking.