The current financial crisis is unprecedented and threatens to destroy economies and bankrupt nation states. Governments are pouring vast sums of money to rescue the faltering financial system with no end in sight.

Prior to the recently launched second phase of the rescue, the US had committed around $8.5 trillion to support ailing financial institutions. A further package of between $800 billion and $2 trillion is being unveiled. The UK has committed around £500 billion, and rising. Other European countries are also pouring vast monies into the bottomless hole. Auto makers are now looking for bailouts and high street chains, such as MFI and Woolworths, have vanished. The economy is in decline and any recovery is a long way off, maybe at least 5-10 years away.

Future generations will bear the burden of the greed of financial wheeler-dealers, poor regulation, vast expansion of credit and faith in unregulated markets. Yet governments seem to have no coherent plan for reviving the economy. They have not explained the risks that are being foisted on taxpayers. They seem to be writing a blank cheque to rescue financial institutions.

Consider the case of so-called toxic assets i.e. the debts that banks have shown in their balance sheets as good but maybe relatively worthless. Two proposals are doing the rounds. One is that the government should buy them and put some in some giant ‘Bad Bank’. The second is that government offers some kind of
insurance so that when these debts turn out to be worthless banks can recover the amounts from the taxpayer. The difficulty is that no figures have been specified. No one has explained how these toxic assets are to be valued. Since the final recovery is likely to be less than the face value there is no way the taxpayer should buy them at the face value. Many of the bank shares and assets only have a value because the taxpayer is bailing them out. So valuing them at market prices is also problematic. Government has not explained what the upper limit of any burden on the taxpayer will be.

The difficulty of working out the toxicity of bad assets is shown by the experience of Bank of America. It was persuaded to buy Merrill Lynch in a $50 billion deal believing that all toxic assets had been identified. But that has not been the case. Recently Merrill reported a $15.3 billion loss for the fourth quarter and there is probably more to come. Bank of America itself now had to be rescued through $138 billion government loans and guarantees. Toxic assets have been diced, sliced and repackaged many times over and that makes it difficult to know what exactly the exposure of any institution is.

Banks and insurance companies have been placing clever bets on movements on interest rates, commodity prices, exchange rates and almost anything that moves. These are known as derivatives and come in a variety of forms. At the end of 2007, the face value of derivatives sloshing around is estimated to be around $1,140 trillion, which includes $55 trillion of credit default swaps. Just five banks have derivatives with a face value of some $170 trillion. J.P. Morgan has $2.251 trillion of assets and $91.339 trillion face value of derivatives. Citibank has $2.050 trillion of assets and $38.186 trillion of derivatives. Barclays Bank is party to derivatives with a face value of nearly £29 trillion. Even a small fraction of these becoming toxic can blow away economies. The US gross domestic product (GDP) is about $14 trillion and the UK GDP is about $2.7 trillion. Global GDP is around $60 trillion.

Unlike the previous recessions the governments cannot ensure that benefits of any bailout mainly accrue to the local economy. In a globalize world, finance is footloose. Probably over 50% of the assets of the banks being rescued by the taxpayer are outside the UK. The UK taxpayer is also rescuing banking operations in tax havens. These places enabled banks and their rich clients to avoid taxes and shrink the UK base. RBS, Lloyds TSB and Barclays and HSBC alone have over 1200 subsidiaries in tax havens. Toxic debts built by them are also being bailed out through insurance, guarantees, loans and financial support provided by the taxpayer. To date, no bank has published any information about its UK specific assets, liability, derivatives, profits, losses, exposure or anything else. We are being taken for a global ride. Some want banks to be nationalized so that credit can once again begin to lubricate the economy, but what exactly is it that the taxpayer will be taking over?

Governments need to be selective about what they are going to bail out. It does not make any sense to bailout speculators. The banking system needs to be analyzed under two headings. The first is primarily retail finance which covers bank deposits, mortgages and commercial lending and is central to the functioning of the economy. The second ‘merchant banking’ is primarily about clever bets and speculation. Governments will have to think about letting the latter sink. There is simply not enough money around to rescue the lot. In due course, the bailed out banks should be restructured as co-ops and mutual so that the corporate world is democratized and the quick buck mentality is checked.

The above needs to be accompanied by a new institutional architecture. Credit rating agencies made their money from banks and conveniently could not distinguish AAA securities from a shack on Brighton beach. Credit rating business should be handed over to a not-for-profit foundation. All its records and methods should be publicly available.

Company auditors have been asleep on the job. Last year, all distressed banks received a clean bill of health. Within days, many were bailed out. In every case, auditors acted as consultants and advisers to the banks that they audited. They collected fat fees for worthless audit opinions. Bank audits should be conducted by the statutory regulators on a real-time basis themselves. This could be Bank of England or a newly created regulator. This way the banking regulators will have eyes and ears for monitoring banks.

The UK government has not shown a lot of foresight in reviving the economy. The temporary 2.5% cut in VAT, adding up to a tax cut of some £14 billion, may have helped some but is unlikely to have created many jobs. Successive governments had shown no concern about the demise of manufacturing and paid too much attention to the expansion of financial services. That is now a busted flush. Government needs to rebuild the economy by investing in science, technology, manufacturing and education. Houses, hospitals, schools and transport infrastructure should be built. It also needs to rebalance the economy and put money in the pockets of ordinary people. Compared to rich individuals, the average citizen spends money on everyday things and that has a much higher multiplier effect on the economy.

Panic stricken governments are sending out confusing messages to people. They want people to spend so that the economy keeps ticking over. At the same time, they want people to save so that we generate funds for investment and also save for our pensions. These cannot be reconciled without drastic changes to the distribution of income and wealth.

Successive governments have weakened workers’ rights and destroyed their share of the GDP. Skilled jobs have been replaced by a shelf-stacking economy. The share of the GDP going to workers in the form of wages and salaries declined from its peak of 65.1% in 1975 to 52.6% in 1996. By the third quarter in 2008, and after the introduction of the national minimum wage, it stood at just over 53.1%. This is a decline of 12% and even then this cake has been sliced unevenly with fat cats taking the largest share. The biggest beneficiary has been capital as it increased its returns.

After excluding the value of their dwellings, 50% of the population owns just 1% of the wealth. Even with the value of their dwellings, 50% of the population only owns 7% of the wealth. In 2006/07, original income, before taxes and benefits, of the top fifth of households in the UK was 15 times greater than that for the bottom fifth (£72,900 per household per year compared with £4,900). After redistribution through taxes and benefits, the ratio between the top and bottom fifths is reduced to four-to-one (average final income of £52,400 compared with £14,400). The median income of UK workers is around £24,000 a year before taxes. Nearly 13.2 million people, including 2.1 million pensioners and 3.9 million children, are living in poverty, defined as those with less than 60% of median income.

The average citizen is also hit hard by taxes whilst the rich enjoy low taxes. The poorest 20% of the population pay nearly 40% of their total income in direct and indirect taxes, compared to 34.8% for the richest 20%. An estimated 36% of people have cash savings of less that £500 which would run out after just 11 days. A typical adult has savings of £2,474 which will run out after 52 days. With personal debt exceeding £1.4 trillion, the UK is the debt capital of Europe. Whichever way you look at it people don’t have a lot of capacity to save or spend. Governments must address this through progressive taxation and redistribution of wealth.

Since poverty is defined as 60% of median wage, it follows that no income tax should be levied on that income. Personal tax allowances should be raised. At the very least, no one on the national minimum wage should pay any income tax. Since the rich would also benefit from the raising of such allowances, that portion should be clawed back by levying 50% marginal rate of tax on income above £100,000 and by removing the artificial ceiling on the national insurance contributions. These two measures would raise tax revenues of around £7 billion and £8.5 billion respectively.

The UK state pension is about the lowest in Europe. The single person’s pension is around 17% of average earnings compared to 57% for the EU. An immediate 25% increase would cost around £9 billion. A Doubling of the £250 winter fuel allowance would cost around £2bn. Scrapping all prescription charges would put £1 billion in people’s pockets. This could be funded by scrapping ID cards project, which would save around £9 billion. Confining tax relief on pension contributions to basic rate of income tax only will provide another £5 billion.

Companies and rich individuals have been busy avoiding taxes. Each year, the government is estimated to be losing around £100 billion of tax revenues. Yet it has done little to prosecute banks, accountants and lawyers peddling these schemes. A concerted effort to check this leakage can provide lots of resources for social development.

Government should broaden the tax base. We already tax gambling and insurance and charge extra taxes on so-called harmful products (alcohol, cigarettes). Speculation and gambling by banks has brought us to the edge of disaster and should also be taxed. If derivatives were taxed at a modest rate of 1% that would globally raise around $11 trillion each year. A significant part of that would also accrue to the UK. The tax might also help to dampen excessive risk taking.

We also need to end fat-cattery, which is at the root of the current financial crisis and income and wealth inequalities that have dogged us. There should be a national maximum wage. No company executive should be able to collect more than 10 times the average remuneration of workers in the same company. So if they want more they will have to pay workers more. Wealth generation has always been a collective effort and it stands to reason that all those who have invested skills, brains, brawn, muscle and pain should all receive equitable share. If a company violates this norm then it should be penalized by having its entire wage bill disallowed for tax purposes, i.e. it will have to pay more in tax.

None of these changes are likely to come to fruition unless we change the structure of our political institutions too. After all, they have presided over the present mess. A necessary start would be to elect all members of parliament (House of Lords). Corporations and rich individuals are able to hire politicians to get favorable laws. So we need to need to license all lobbyists and all their correspondence should be on the public record. There should be no private donations to any political party. Legislators should not be allowed to act as paid consultants to companies. Instead, all donations should go to a newly created Foundation for Democracy. Any consultancy fees should also go to the same. The sums should then be divided amongst political parties according to a formula that takes account of their membership and performance at recent polls. So if parties produce popularity ideas they would get more funding and with a bit of luck might listen to ordinary people and their concerns.

The above reforms are indicative of what needs to be done. These reforms are necessary to rebuild society to provide justice, equity and opportunity. No doubt there would be much opposition from corporations and wealthy individuals. Hopefully, they will realize that a good society is also in their long term interest.