The Ethics of Banking: Conclusions from the Financial Crisis (Issues ...

156 10 Disturbance of the Invisible Hand
even if interest rates are low. This will pose difficulties for the individual, who has
become accustomed to present consumption but now has to start saving twice as
hard. Downward corrections of disposable income will have to be made. If the individual
is unable to keep up repayments, and if many others find themselves in the
same position, house prices will fall, and the falling house prices will drive more and
more loans into default. A downward spiral sets in. The banks have to write down
asset values. Capital is destroyed. Consumption has to be reined in. Stagnation and
deflation follow.
The policy of easy money and easy credit enabled an unprecedented expansion
of consumption, and of the banking and finance sector that brokered the consumer
credit. But it also enabled the emergence of special finance and investment institutions
on the investment side, such as private equity firms and hedge funds. The
private equity firms and hedge funds owe their extra profits and indeed their very
existence to easy credit. Thanks to the low interest rates, they were able to borrow
money cheaply for leveraged corporate acquisitions and “corporate raiding”, and
are still able to do so today. Private equity firms not only accepted private equity
from private investors, but also borrowed themselves, taking loans amounting to
billions of dollars at 3% interest from the banks. The banks, for their part, were
equally over-leveraged because, thanks to imaginatively structured products like
CDOs, they were lending money far beyond the regulatory capitalization limits.
The private equity firms bought corporations on the never-never, put management
under pressure, improved corporate governance – or not, and then resold the corporations
on the stock exchange after a year with a premium, an agio, of 10–20% on
the capital deployed for the purchase, and made between 7 and 17% profit on the
borrowed billions used to make the investment. When private equity firms sold firms
after owning them perhaps for just 1 year, at a profit of only 6% on the acquisition
price which they had financed by borrowing billions at 3%, the profit was huge.
This is where low interest rates facilitated greed, as evidenced in the pursuit of
mere agiotage, the practice already described whereby a premium is levied although
no value has been added. If lending rates are between 7 and 10%, and the resale
of the firm acquired with borrowed capital is delayed for several years by a weak
stock market, and the firm has gained little or no value in the intervening years,
this business plan starts to look very different. In some cases this leads to losses
amounting to billions, which these firms cannot absorb and dump on their banks,
who are also unable to absorb them and therefore become insolvent, and seek a
reprieve from the state. For an imprudent speculation, the state has to stump up
billions from funds that belong to taxpayers – who ultimately take the loss. When
the conditions that favored easy money no longer apply, easy profits are no longer a
prospect whereas huge losses certainly are.
Mention must also be made here of the unfairness of the situation created by
those who engaged in financial wagers, who amassed huge debts when these failed,
and who then put an equal share of the burden of paying their wager debts upon
those who detest wagers and might even think the state should not allow them. The
elements of the population who oppose wagers find themselves having to accept that