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Preliminary,pleasedonotquote–commentswelcome-30thSeptember2009THEFINANCIALCRISIS,PRIVATEANDPUBLICDEBT-Contrastingtheapproachesofeconomicsandtheology-PaperpreparedfortheEvangelicalAllianceStudyGroupon“LifeAfterDebt”by1EPhilipDavisPemburyBaptistChurch,NIESR,BrunelUniversity1AssociatePastoratPemburyBaptistChurch,Kent,VisitingFellowattheNationalInstituteofEconomicandSocialResearch,andProfessorAssociateatBrunelUniversity.Email:e_philip_davis@msn.com.IthankPhilipBooth,PaulMillsandmembersoftheadvisorygroupforhelpfulsuggestions. 2IntroductionThecurrentfinancialcrisisiswidelyseenasthemostseriousandfar-reachingeconomiceventsincetheGreatDepressionofthe1930s.AndyetthevolumeofanalysisfromaChristian,asopposedtoaneconomicorfinancialperspective,hasbeenrelativelysmallto2date.Thereisariskthatthechurchwilllackacriticalvoiceincurrentdebates,andhencebeseenasirrelevant.Thiswouldbeatravesty,sinceinfacttheBiblicalpointofviewhasagreatdealofdistinctiveanalysistocontribute,especiallywhensetalongsidetherulingparadigmoftoday,thatofeconomics.Inthiscontext,thispaperhasthreeaims.First,itseekstoprovidedistinctiveChristian-Economicsanalyses,derivingpolicyimplicationsfromabiblicalpointofview,informedbyeconomicthought–givingthechurchadistinctivevoiceinatimeofeconomiccrisis.Second,itaimstoprovidematerialforministersseekingtounderstandandinterpretthecrisistotheircongregations.Andthird,itseekstohighlightinapropheticmannerradicalChristiansolutionstosomeofthecurrentdifficulties,whiletherearestillopenearsandbeforevestedinterestsreassertthemselves.Thepaperfocusesonthreekeyaspectsofthecrisis,understandingtheroleandincentivesofthebankers,theplightofhouseholdswithindebtedness,andthemassiveriseinpublicdebt.Thepaperisstructuredasfollows:Inafirstsectionweoutlinetheeventsofthefinancialcrisisfromadescriptivestance,albeitinformedbyfinancialeconomics.ThisiscomplementedbyasecondsectionthatcontraststheviewsofhumanitygivenbyeconomicsandChristiantheology.Withtheseasbackground,weproceedtothreemainsectionsontheroleofbanks,householddebtandpublicdebt.Ineachcasewepresentconsiderationsfromeconomicsandtheologyseparately,andthenseektoidentifytensionsandcomplementaritiesbetweenthem,seekingtoarriveinturnatpolicyorotherprescriptivesuggestions.Inafinalconcludingsection,weseektobringtogetherthesesuggestionsandsketchanoverallChristianresponsetocurrentevents.1EventsofthefinancialcrisisItisimportanttonotethatthecrisisinagenericsensewasnotanunusualevent(see3Appendix1).Ashasbeenthecaseformanyothercrisesofrecentdecades,itwasprecededbygrowingvulnerabilityoftheeconomyandfinancialsystemtoshocksintheformofacreditboom,financialinnovations,increasingindebtednessoffinancialinstitutions,risktaking,andtheformationofanassetpricebubble.Thismakesitsurprisingthatitwasnot4betterforecast.Thatsaid,thereweresomeidiosyncraticfeatures.SincethebubbleandtheriskiestlendingwasinUShousing,sub-primerelateddebtwasitsproximatecause.Thesize,globalintegration,andthecomplexityoftheUSfinancialmarketsmadeitinevitablethecrisiswouldbecomeglobal.AndhighhouseholddebtintheUKandanevenbiggerbubbleinhousingmadetheUKeconomyhighlyvulnerable.Anoutlineofkeyfeaturesofthecrisis5follows–thosealreadyfamiliarshouldproceedtoSection2:Globalinterestratesover2000-7werelow.Onereasonfortheboomthatprecededthecrisiswashighlevelsof“globalliquidity”.CountriessuchasChina,JapanandKorea,whichweresavingmorethantheyinvestedathome,builtupcurrentaccountsurplusesandforeign2OneexceptionisBooth(2009).3SeeDavis(1995)andDavisandKarim(2009).4SeeDavisandKarim(2008)foranassessmentofthedegreetowhichthecrisiswasforecastbymajorUKandinternationalfinancialorganisations.5SeeBarrellandDavis(2008)andDavis(2009)formoredetail. 3exchangereserves.Ineffect,suchcountrieslentmoneyonamassivescaletodeficitcountriesliketheUKandUS.Asaresultofsuchafloodofgloballiquidity,globalreal(inflationadjusted)interestratesfellafter2001andlongtermrealrateswereprobably1percentagepointbelowtheirlevelofthepreviousdecade.TherewerealsolowshorttermrealinterestratesarisingfromtheeasymonetarypolicyincountriessuchastheUS.Theselowinterestrateswerenaturallyreflectedinlowinterestratesforloans,makingthemattractivetoborrowers.Alendingandassetpriceboomtookplaceover2000-7.Inthisenvironmentofcheapcredit,lendinggrewatunprecedentedrates,especiallyincountriesliketheUS,theUKandSpain,wherehousepricesalsoroserapidly.Thelendingwasoftentotypesofborrower(suchassub-primeandbuy-to-letborrowers)whohadbeenpreviouslyexcludedorrationedinaccesstomortgagecredit,duetothehighlevelofdefaultrisktheyposetothelender.Theywereofferedlargeamountsofcredit,especiallyintheUS,andtoalesserextentintheUK.Someborrowersfalsifiedtheirincomestogetmorecredit.Morecreditworthyborrowersalsoincreasedtheirdebtsmarkedly,sometimestobuynewhomesbutoftenalsotoreleaseequityfromtheirhomesforconsumptionpurposes.Nodoubtpartlydrivenbyreleaseofcreditconstraints,realhousepricesintheUKandtheUSrosefarabovetheirlonger-termtrend.HousepricesbecamesimilarlyovervaluedincountriessuchasSpain.Policyerrorswerecommitted.LowshortterminterestratesintheUSwereinitiallyaresponsetotheequitypricecollapseof2000-3,whosefeareddeflationaryimpacttheysoughttocounteract.Butitcanbearguedthattheequitypricefallwassoonmorethanoffsetbytheabove-mentioneddebt-financedhousingboom,whichgatheredstrengthasequitypricesrecoveredin2003-4.Thecreditandhousingboomwashencenotcounteractedbymonetarypolicythatstayed“tooloosefortoolong”especiallyintheUS.Althoughtherewerewarningsbycentralbanksandinternationalorganisationsofrisksofafinancialcrisisresultingfromthedebtandassetpriceboom,verylittlewasdonebeyondcautionaryspeechesbyCentralBankGovernors(so-called“moralsuasion”)tocountertheboom.Monetarypolicywasnottightenedtilltheboomwasfaradvanced,andbankregulationdidnotcounteractthegrowingrisksbankswererunning.Fiscalpolicywasalsoloose,asdiscussedfurtherinSection5.Therewaswidespreadfinancialinnovation,speculationandeasylendingbybanks.Lowinterestratesinturnprompteda“huntforyield”onthepartofbanksandinstitutionalinvestors,asboththeythemselvesandtheirsaverssoughtareasonablereturnontheirassets.6Inthiscontext,high-yieldingfinancialinnovationssuchasassetbackedsecurities(ABSs)becamepopularasasourceofprofitforbanks.ABSarebasicallymeanswherebybanksmakingloanscanpackagethemandsellthemtoinvestorsasbonds,aprocessknownassecuritisation.InissuingABS,lenderbankswouldprofitfromup-frontfeesforloans(suchasthosetosub-primeborrowers)withouthavingtoholdtheloanonthebalancesheet.Anytypeofloanseemedtobesuitableforsecuritisationinthe2000-7period,andespeciallysubprimeloans,i.e.toborrowersoflowcreditquality.TheABSthatweremostcentraltothecrisishavetheinterestingpropertythatabunchofpoorqualityloanscanbemade(orseemtobemade)intomostlytopqualitysecurities.It’sasifleadcanbemadeinto80%goldand20%plutonium-nuclearwaste.Themathsseemedtobecorrect….6WeusethetermABSalsotorefertocollateraliseddebtobligations(CDOs),whicharebasicallysecuritiesformedfromindividualABSs.TherewerealsoCDO-squaredwhichwereCDOsmadeofotherCDOs.Themorecomplextheproduct,themoreimpossibleitwastofindoutwhatassetswereactuallybackingthem. 4Thereisafurther“twist”inthatsecuritisationreducestheincentiveofsuchlenderbankstoassesssuchloansforcreditquality,sincetheABSholderwouldtaketheriskofdefault.Thishelpsexplaintheriskyloanstosubprime,buytoletetc.borrowersthatweremadeduringtheboom–thelenderbankdidnotbeartherisk.Somesuchloanswereactuallyknownas“liarloans”becausethebanklendingofficerwouldinducetheclienttoexaggeratetheirincomesoastogetalargerloan.Banksalsomadetheirownbalancesheetsmoreriskyinthesearchforprofit(seeAppendix2).Theyreducedtheirliquidassets,givenlowinterestratesthatcouldbeearnedonthem,leavingthemwithlesscoverforanyemergencyneedsforfinance.Theygrewtheirbalancesheetsviaaggressivewholesaleliabilitymanagement(i.e.borrowingfromotherbanksandmoneymarketsratherthanretaildepositors).Furthermore,theybothinvestedinABSthemselvesandshiftedsuchsecuritisedassetstooff-balance-sheetvehiclescalledconduitsandspecialinvestmentvehicles(SIVs),inordertoavoidcapitalrequirements(seeAppendix2forfurtherclarification).Soparadoxically,whiletheyknewthattheirownloansbackingABSweresubstandard,theywerewillingtogivethebenefitofthedoubttoloansbackingotherbanks’ABSs.Andofcoursetheywerealsosubstandard–typically20%goldand80%plutonium-nuclearwaste.Itisclearthatbankstookonmorecreditriskthantheyotherwisewould,particularlyviaABSsalbeitalsoinmoreusualbalancesheetlending.Reasonsmayincludethescopeforsecuritisationandtheimpressionofliquidityitgave,highcreditratingsandyieldsonABS,andtheseemingprecisionofriskmodelsbasedoninadequatedata.AllthisdespitethefacttheABSwereextremelydifficulttounderstandandhadnotbeentestedinadownturn–likedrugswhosesideeffectsareunknownbutwhicharemarketedanyway.ThecrisisinfactshowedthattheriskmodelsfortheABSwereflawed,anddidnotallowforthepossibilityofUShousepricesfallingastheydid.Italsoshowedthegrosserrorsinassessmentsbytheratingagencies,whichstatedthatthe“gold”ABSbondswerealmostriskfree.Numeroustakeoversoccurredinbankingandfinance.Theboominlending,assetpricesandinnovationwasaccompaniedbyapeakinmergersandacquisitionsinthefinancialsector,withthetakeoveroftheDutchbankABN-AMRObyRBSbeingakeyexample.Suchtakeoverswerelatertoensnarethebuyers,giventhedebttheyhadincurredforthetransaction,aswasalsothecaseforLehmanBrothers’purchaseofthepropertycompanyArchstonein2007.Therewasacollapseinconfidenceandassetprices,leadingtolossesforbanks.2007sawgrowingrealisationofpotentiallossesonsub-primemortgagesasUShousepricesfellanddefaultsincreased.ByOctober2008theIMF(2008)estimatedsuchlossesas$1.4trillion.Theselosses,alongwithuncertaintyandsuddenrealisationthatbanksdidnotunderstandthepropertiesoftheABS,combinedtogeneratesalesofABS.Salesledinturnnotjusttopricefallsbutalsomarketliquidityfailure.InotherwordstheABSbondscouldnotbesoldatanyprice.Sincebanksholdsecuritiesatso-calledmark-to-marketpricing,theymadeimmediate7lossesaspricesofABSwentintofreefallwhiletheassetsthemselvescouldnotbedisposedof.EffectswerefeltnotonlybyUSbanksandalsobyEuropeanbanksthathadboughtABSofsub-primeloans.BankconduitsandSIVscouldmeanwhilenolongerobtainfinancingwhichmeantsponsoringbankshadtotaketheoften-“toxic”ABSassetstheyheldbackontheirbalancesheets,thusaggravatingthesituationforthebanks.7Thiswasunlikebankingcrisesinthepastwhereloanshavetypicallybeenheldonbalancesheetathistoriccostwithnospecificprice.Bankswerehitfarquicker. 5Freezingofsecuritisationandinterbankfundingensued.Bylate2007,bankswereunabletosecuritisethemortgagesandotherloanstheywereissuingowingtoliquiditycollapseoftheABSmarket.TheyalsoexperiencedcallsonbackuplinesofcreditforconduitsandSIVs.Accordingly,thebanks“hoardedliquidity”inordertoprovidesufficientfundingfortheirongoingbusiness.ThishoardingwasalsomotivatedbyfearofthatotherbankstheymightlendtoontheinterbankmarketmightbearundisclosedlossesonABS.So,interbankfundingbegantobewithdrawn–anunprecedentedeventinthedomesticmarketsoftheadvancedindustrialcountries.Otherformsofwholesalecreditalsobecamehardtoobtain.Banksingeneralwerevulnerabletoeffectsofreducedsuchwholesaleandinterbankfundingduetotheirlowholdingsofliquidassets,growthinrelianceonshorttermwholesalefundinganddependenceonsecuritisation.Banksinthewakeofthissoughttoreducebalancesheetlending,atthesametimethatborrowerswererenderedcautiousbyhousepricefalls,leadingtounprecedentedfallsinmortgagelending.Theongoingprocessunleashedbythecrisiscanbereferredtoasdeleveraging(IMF2008),asbanksandotherinstitutionssoughttoreduceexposuretohighrisksectors,sellingassetsorreducingassetgrowth,aswellasreducingdependenceonunstablewholesalefundingandrebuildingcapitaladequacy.Theprocesswasacceleratedbytheongoingfallinassetpricesandriseinprivatesectordefaultsonloans,aswellasbyclosureofsecuritisationmarkets.Centralbanksofferedmassivevolumesofliquiditytosupplybanksandseekinvaintorestarttheinterbankfundingmarkets.Bankfailurestookplace.AnearlyconsequenceofthecollapseofwholesalefundingmarketswasthefailureofthesolventUKmortgagebankNorthernRock,whichhadanaggressivewholesalefundingratioandhadbeenrelyingonsecuritisingassets,whichwasnolongerfeasible(TreasuryCommittee2008).Itsuffered“runs”inbothwholesaleandretailmarkets(seeAppendix2foradiscussionof“bankruns”andthefragilityofbanksinperiodsofcrisis).BeyondNorthernRock,failuresin2007includedmainlytwosmallGermanbanks.Thecasualtiesofthisongoingpatternin2008weremuchmoreimportant.UptoSeptember,theyincludedtheUSfirmsBearStearns(takenoverwithgovernmentguarantees),IndyMac(failed)andFannyMaeandFreddyMac(effectivelynationalised).BySeptember2008itseemedthatthecrisiswasongoing,butnotworsening.ButfollowingthebankruptcyofthemajorUSinvestmentbankLehmanBrothers(unsupportedbytheauthorities)inmidSeptembertherewasasharpworseningofmarketconditions.Theprocessofdeleveragingbecamedisorderlyascounterpartyriskperceptionsballooned.Theequitymarket,whichhadbeensurprisinglylittleaffectedbythecrisisuptothatpoint,begantofallsharply.Thisparticularlyreflectedlowconfidenceinbanksthatweredependentonwholesalefunding,becausemarketsforsuchfunds,thathadpreviouslybeencostlyandrestrictive,provedtobetotallyclosedtosuchinstitutionsafterLehmans’failure.Crossborderlendingwasevenmoresharplycurtailedthandomestic.Therewerefiscalinjectionsand“lenderoflastresort”assistancetosavefailingbanks.Theauthoritiesactedinthewakeoftheworseningofmarketconditions.Provisionofliquiditytothemarketsincreasedfurther.TheUSauthoritiessuggestedandpassedthePaulsonplanwhichwasdesignedtorestoreliquiditytothemarketsbyusing$700billiontobuyupABS.However,thisplandidnotaddressthesolvencyofthebanksdirectly,andleftmanyexposed.TheAmericanInsuranceGroup(AIG)hadmadeamajorforayintoinsuringcomplexproducts,andhadlostmostofitscapitalbasewhendefaultratesrosetotentimesthoseonwhichpolicieswerebased.It,alongwithBradfordandBingleyintheUKhadtobenationalizedinsuccession.MerrillLynchandWachoviaweretakenover.WashingtonMutualwasclosedbyregulatorsandsoldtoJPMorganChase.TheremainingUSinvestmentbanks 6hadtobecomebankholdingcompanies.Banksdependentoncrossborderfinancingwerehardesthit.Forexample,thetwomajorBelgianbankshavehadtobenationalizedandallthreeIcelandicbanks,inwhichmanyUKsavershadbeeninducedtoinvestwithhighdepositrates,failedinOctober.Significantpublicsectorstakestotaling£37billionweretakeninthreemajorlendersintheUK,HBOS,RBSandLloydsinordertoensuretheirsolvency.GuaranteeswereofferedfortheirliabilitiesandtheBankofEnglandexpandeditsswapfacilityforilliquidassets.HBOSinparticularseemedclosetofailure,owingtoahugeriseinloandefaultsandarelianceonwholesalefunding,untilitwasannouncedthatatakeoverbyLloydswouldoccur.TheeffectivenationalizationofalargepartoftheUKbankingsectorensuredthatthissystemwouldremainsolvent,andanumberofEuropeancountriesannouncedthattheywouldalsostrengthentheequitybaseofbanksbytakingapublicshare.ThePaulsonplanwasredirectedtothesamepurpose,andinmidOctober$250billionwasmadeavailabletoUSbankstoincreasetheircapitaladequacyratioswiththegovernmentbuyingsharesinthem.Effectsontherealeconomyweresevere.Inensuingmonths,therealeconomiesofmostcountrieswerebadlyaffected,withdeeprecessions,fallinghousepricesandrisingunemployment.Atthetimeofwritingthereisevidencethattherecessionsarebottomingout,butprospectsfordurablerecovery,letalonereturntopreviouspeaklevelsofGDP,seemremote.Oneparticularconcernisthattherewillbemoredefaultsontheheavymortgagedebtthathouseholdshaveincurred.Eveniftheydonotdefault(forexampleduetounemployment)theirconsumptioncannotgrowattheratesseeninthepastfewyears,giventheburdenofinterestpaymentsandthelackofavailabilityofloansto“extractequity”.Anotherconcernrelatestotheenormousvolumeofpublicdebtbeingincurred,notonlyduetothebankrescuesbutbecauseasharprecessionreducestaxrevenuewhileincreasingneedforbenefitpayments,andgovernmentshavealsocarriedoutdiscretionaryfiscalloosening.Meanwhile,emergingmarkets,thathadhithertobeenrelativelyunscathed,begantobebadlyaffected(IMF2008)astradefinanceandexternalfinancebecamemuchhardertoobtain.Policyissuesnowfacingtheauthoritiesarehowlongtomaintainloosefiscalandmonetarypolicies,andhowtotightenbankregulationsothecrisisdoesnotrecur(seeFSA(2009)forexample).2ComparingtheviewofmankindfromeconomicsandtheologyHavingoutlinedinsomedetailtheeventsofthecrisis,wenowexaminekeyissuesraisedbythecrisisinthelightofeconomicsandtheology.Wecontendthatsinceeconomicsistherulingparadigminsocietyandgovernment,itisinappropriatetosolelyfocusonatheologicalcritique.Forexample,Hobsbawm(1994)states“economics,thoughsubjecttotherequirementsoflogicandconsistency,hasflourishedasaformoftheology–probablyintheWesternworld,themostinfluentialbranchofseculartheology”,whileNelson(1991)statesthatit“offersasetofprinciplesandunderstandingsthatgivemeaningto,defineapurposeforandsignificantlyframetheperceptionofhumanexistence”.BrittonandSedgwick(2003)pointoutthatthereis“notmuchineconomicsthatcanbedemonstratedbeyondreasonabledoubt”eventhoughitisan“impressivebodyofreasoning,extremelyinfluentialincontemporaryculture,providingonetypeofinsightintothewaymodernsocietyworks”.Certainly,economics’influenceextendswellbeyondacademia,becauseitiswidelytaughttothoseactiveinbusinessandmanagement,andalsopervadespoliticaldebatesoneconomicpolicy.Thereareeven“missionaries”takingtheideasoffreemarketeconomicstothedevelopingworld.Indeed,Collier(1992)attacks“economism”,thetendencytogiveprimacy 7toeconomicsoverothersourcesofmeaningandvalue.Accordingly,wesetoutinthenextsectionabasicunderstandingofthenatureofeconomicthinking,inrelationtohumanityperse.ForadeeperanalysisseeHay(1989)andBrittonandSedgwick(2003).Notethatwefocusontheprincipalapproachtoeconomicsknownasthe“neo-classical”paradigm.2.1Economics–today’srulingparadigmEconomics,likeothersocialsciences,differsfromthephysicalsciencesinthattheunitofobservationisthebehaviourofthehumanbeing.Hence,asnotedbyHay(1989)economistsdonotmerelyanalyseusingdetachedobservation(thusdeducingcauseandeffect)butcanuseintrospection(howwouldIactinthesecircumstances?)Weighingupalternativesandmakingadecisioniscore(Iboughtthishousebecausepricesarerising;Iborrowedagreatdealbecauseinterestratesarelowatpresent).Accordingly,humanactionsareunderstoodintermsofreasons,preferencesandmotivesandnotsimplycauseandeffect.Indeed,oftenthemethodologyisnotoneofscientificexperimenttotestahypothesisbutassumptionsaboutbehaviourandmotivationwhicharenotsubjecttoempiricaltest.Wecancontrastthepositiveeconomicdomain(analysisofwhatdoeshappen)withthenormative(whatshouldhappen)dealingwithpositivefirst.AsnotedbyBrittonandSedgwick(2003),economicsisinevitablynormativeaswellaspositivebecausevaluescannotbereadilyseparatedfromfactswhenhumannatureisthesubjectmatter.Positiveeconomicstypicallyusesasimplifiedconceptofmankindoftencalled“rationaleconomicman”.Itisassumedtobequitegeneralacrossthehumanraceandnotculturespecific.Atabasiclevel,individualsoperateinanenvironmentofscarcityandcompetition.Theyareassumedtohavepreferencesoverthesetofconsequencesofalltheirpossibleactions,betheyconsumption,laboursupplyorinvestment.Thesepreferencesarerationalinthreesenses.First,theyare“complete”inthatforallpairsofchoices,thepersoneitherprefersoneorisindifferentbetweenthem.Andpreferencesare“transitive”,ifwepreferAtoBandBtoC,wepreferAtoCalso.Individuals(onaverage)actrationallyinaccordancewiththesepreferences,inthesensethatgivenasetofavailableactions,thereisnoactionavailabletothemsuperiorinconsequencestotheactiontheyhavechosen.Oftenthereisaddedtheideaof“nonsatiation”,somoreofagoodisalwayspreferredtoless.AsnotedbyBrittonandSedgwick(2003)theveracityoftheseformsofrationalityarearticlesoffaith,notlogicallynecessary,selfevidentorobvious.Avariantonthetheoryofpreferenceis“revealedpreference”theorywhichappliesthisapproachtoanalysisofactualchoicesbetweenasetofgoods,services,assets,employment,useoftime,etc.thusavoidingtheneedtoconsiderwhatpeople’sdecisionprocessesare(albeitusuallyassumingtheyareasdescribedabove).8ThebasisofthisapproachistheutilitarianismofBenthamandMillwhosawexperiencesasgeneratingpleasureorpain,desirableorundesirablefeelings.So,individualsrationallyseektoincreasedesirablefeelingsandreduceundesirableones.AsnotedbyHay(1989),thegoalofautilitarianisto“promotehisowninterests,preservehisownlife,increasehisownpleasuresanddiminishhispains”.Then,thecalculationcouldbesimplysummarisedasasinglemeasureofutilitywhichhumanbeingsseekrationallytomaximise.NineteenthcenturyeconomistssuchasEdgeworthtookthisapproachtomeanthatindividualsaremotivated“onlybyselfinterest”.Themaindevelopmentsincethenhasbeenafocusonorderingofpreferencesratherthanabsolutelevelsofutilitythatcouldbemeasuredbyanoutsideobserver.Corollariesarethatonlyconsequencescount,nottheactionsthemselves;actionsareevaluatedfortheireffectswithoutreferencetorulesofconduct.8SeeforexampleMill(1836). 8Meanwhile,everythingexceptself-interestistypicallyexcludedasamotiveineconomicbehaviour.Thisisnotanecessaryfeatureofthesubject.Economistscouldincludeothermotivesbesidesself-interestinanalysinghumanbehaviourintermsof“utility”.Forexample,others’consumptionaswellasone’sowncouldenterpreferences.Buttheytypicallydonotdosoexceptincertainspecialisedarticles.Economistsassumepursuitofself-interestisa“usefulsimplification”whichisbroadlycorrectonaverage.Thishasconsequenceswhichgowiderthaneconomictheory,andintopoliticsandwidersociety.Maximisingone’sownconsumptionlessdisutilityoflabour,orasanentrepreneurmaximisingprofits,isquitewidelyseenasthe“onlyrationalapproach”tolife,particularlyincountrieswherereligiousconvictionshavefadedandsincetheReagan/Thatcheryearsofderegulationofthe1980s.Byviewingindividualsasindividualisticallyselfishintheirbehaviour,economicstendstoruleoutintrinsicvaluetocommunitylife,beyondthebenefittheindividualmayobtainfromit.Relationships,beyondthosepursuedforself-interestedmotives,alsohavelittleroletoplay.Economicsrulesoutethicalgoalssuchaspovertyreliefbeyondtheirimpactonone’sownwell-being.Byassumingindividualself-interest,economicscouldbeseenasrecognisingtheubiquityoffallenbehaviour.Indeed,someeconomistssuchasBeckerhavearguedfromevolutionarybiologythatevolutionwilleliminatethosegeneticcharacteristicsinconsistentwithselfinterestandsurvival.Orequally,afirmthatdoesnotmaximiseprofitswillbeeliminatedfromthemarketbycompetitors.Sincetheindividualisusuallyassumedtobeselfishratherthanaltruistic,charitablegivingishardforeconomicstounderstand.Whereasthepossibilityofperfectaltruismisconceded(i.e.theindividualcaresonlyaboutthebenefittotherecipient),economistsfeelthereismoreevidenceforexplanationshighlightinga“warmglow”(i.e.someadditionalinnersatisfactionfromgiving)or“prestige”(i.e.valuingrecognitionbyothersforgiving,asMatthew6:2).Thetestofthesecondandthirdisthatprivategivingdoesnotdeclineone-for-onewithgovernmentgivingtothesamerecipient–whichisempiricallyverified.Naturally,therehavebeenanumberofcriticismsofthe“rationaleconomicman”paradigmfroma“commonsense”pointofview,evenabstractingfromatheologicalcritique.First,followingrulesofconductmayhavevalueinitself,bothtotheindividualandwidersociety,implyingavaluetoactionsandnotjustconsequences.Moralnormsthathaveamajoreffectonhumanbehaviourshouldnotbeomittedorjustincludedas“tastes”.Second,apurehedonistmightmakenoprovisionforthefuture,onlythepresent,andthisisthoughttobeunrealistic.Third,the“rationaleconomicman”paradigmomitstheconceptof“commitment”,wherepeoplechoosetoactinacertainwayregardlessoftheeffectontheirutility.Examplesareagreeingtoprovisionofgoodstothecommunitythatonebenefitslittlefrom,repayingadebt,orcontinuinginamarriage.Fourth,itisevidentthatcommunitylinksarevaluedbyhumanity.Wenote,however,thattheseobjectionshaveweakenedsincethe1960sasrulesandcommitmenthavebeenseenasobstructionstoself-fulfilmentandhedonismhasbeencelebrated.Communitylinkshaveweakenedalso.Theparadigm,onthisbasis,maybecomingclosertothetruth.Amoretechnicalobjectionisthatindividualsdonothavetheinformationtomakerationaldecisionsinthewaydescribed.Advertisinginfluencesindividualswellbeyondprovisionofinformation–itshapespreferencesthemselvesandgeneratespeergrouppressure.Furthermore,itcanbearguedthatpeoplemighttrytogettoasatisfactorylevelofutility,perhapsrepeatingorcopyingearlierdecisionsratherthanmaximising,notleastduetolackofcompleteinformationordesiretokeepoptionsopen.Buteconomiststypicallycontinuetousethestandardfull-informationrationalparadigm. 9Thenormativeapproachineconomicstracestheconsequencesoffreechoicebyrationalindividualsforsociety.Itdoesnottypicallymakeprescriptionsaboutindividualethics,butgivesadvicetopolicymakersonpublicchoices.Itisalsopervadedbyutilitarianism,inthatittypicallystatesthatasocialsituationissuperiorifindividualwell-beingisgreater,andthelatterissomethingtheindividualseekstomaximise.Thenatraditionalapproachistosaythatthebestchoiceforsocietyisonethatmaximisesthesumofsuchhappiness.Inprinciple,suchwellbeingorhappinessisnotjustmaterialpleasureorpainbutalsocouldincludenonmaterialorspiritualelementsinlife.Butthisisusuallynottakentobethecase.Again,therecanbeincludedpreferencesforequalityinsocietysothatindividualswithlesswell-beinghaveagreaterweight.However,suchadditiveorcardinalutilityiswidelycriticised,andinsteadeconomistsprefertoconsiderrelativeutility.ThekeyconceptisParetoOptimality,statingthatsocialwelfareisincreasedifsomeonecouldbemadebetteroffwithoutanotherbeingworseoff.Thisonlyrequiresarankingofindividualoutcomes.Usingthistool,asdiscussedinDavis(2007),economicsassumesthatthepursuitofself-interestwillleadtoanoptimaloutcomeforall(the“competitiveequilibrium”)acrosstheeconomyasawhole.Thisisachievedbyeveryoneactinginaselfinterestedmanner,asnotedbyAdamSmith(1828)“Itisnotfromthebenevolenceofthebutcher,thebrewer,orthebakerthatweexpectourdinner,butfromtheirregardtotheirowninterest.”TheprocessofreachinganoptimumviamarketsisoftencalledtheoperationofAdamSmith’s“invisible9hand”.Inmoredetail,thestandard“neo-classical”economicparadigmisthe“competitiveequilibrium”.Itstartswithaninitialsetofasset-endowmentsforindividuals(talents,skills,capital),whopursuetheirownselfinterest.Itthenstatesthatfinancial,labourandproductmarketswilloperatetosetpricessothatallsuppliesanddemandsbalance,andnoonecouldbemadebetteroffwithoutanotherbeingworseoff(“Paretooptimality”).Thiswillbethecaseifcertainconditionsarefulfilled,notably,thattherearenomonopolisticproducersortraderswhocancontrolpricesindependentlyofthemarket.Theseassumptionsandthe“optimal”outcometheygeneratenaturallyleadtolaissez-fairepolicies,whichopposeanygovernmentinterventiontoredistributewealth,theso-calledminimalstatethatjustensurestheruleoflawanddefence,andpossiblyinfrastructure.Individualsfollowingthislineofargumenttendtoseeamoreactivestateasathreattofreedomaswellastoprosperity.Theymayarguethatthepoorwillbenefitfrom“trickledown”effectsofgrowthwithoutanypositivemeasurestohelpthem.Theyarealsosuspiciousofregulationofmarkets,otherthanthatagainstmonopolies,urgingthatthesystemisselfcorrecting.Themostlaissez-faireeconomistsviewindividualrightsandjusticewithsuspicion,astheymayviolatethecompetitiveequilibriumandaretypicallyomittedfromcalculationsofutilitymaximisation.Butrightsandjusticecomeclosertothe“commonsense”viewthatapersonhasdignityandindividualvalue,andshouldbetreatedasasubjectandnotanobject.Forexample,asocialcontractmayspecifythatgovernmentsshouldensureallcitizenshavesufficienttocovertheirbasicneeds(nutrition,shelter,sanitation,healthcare),basiceducation,andalsopoliticallibertywhichinturnempowersthepoortoparticipateinwealthcreationinaself-directedmanner.9Thisisthedominantapproachforbothacademicsandeconomicpolicymakers;thereexistalternativessuchasMarxianeconomicsthattalksforexampleofpovertyasarisingfromtheexploitativealienationofworkersfromtheproductoftheirlabour;seeGriffinandGurley(1985). 10Rawlsforexampletalksaboutjusticeasrequiringontheonehandpoliticalandcivilliberty,butontheotheralsothatsocialandeconomicinequalitiesshouldbetothegreatestbenefitofthemostdisadvantaged.Thisisabasisformandatingredistributionorwelfarestatepoliciesaswellasequalopportunitiesineducationandhealth.Theimplicationisthatwemayneedtoimportnon-utilitarianpoliticaltheoryintoeconomicstojustifygovernmentscorrectingtheselfishbiasofindividualchoicesandamendingthe“initialendowment”inthecompetitiveequilibrium,ifitleavessomecitizensvulnerable.SuchanapproachtypicallyalsosuggeststhatregulationssuchasthoseoutlinedinAppendix2shouldbeundertakentocorrectforarangeof“marketfailures”.Economicscanstillgiveusefulpolicyadvice(“ausefulhandmaidenbutabadmaster”).Forexample,welfareeconomicstellsusthattherevisedendowmentafterredistributioncouldstillgenerateaPareto-Optimalcompetitiveequilibrium.Italsohasanawarenessof“marketfailures”,whichleadtodifficultiesforthemarketsystem.Thefirstoftheseisexternality,wheretheactionofoneagenthasanunpricedinfluenceonanother’swelfare.Arunononebankmayforexampleleadtorunsonothers.Thesecondisproblemsduetoinformationasymmetrysuchasmoralhazardwhereasetofmarketprices(orapolicy)stimulateindividualstoactdifferentlyfromtheirunderlyingneedsandpreferencestothedetrimentofthesellerorpolicymaker.Thethirdismonopolywhichasnotedabovemayrenderacompetitiveequilibriumimpossibletoachieve.Overall,itcanbesuggestedthateconomicsanditsviewofhumanityoffersagooddiagnosticanalysisofissues,andapplicationofittotherunningofeconomieshasprovidedmajorbenefitsintermsofeconomicdevelopment.However,itisweaknormatively(unlessweimport“rights”frompoliticaltheory)–thereisaclearfocusonefficiencyandnotmorality(Griffiths1984).Economicsisoftenpresented(forexamplebyFriedman,HayekandBecker)inamannerthatrejectstranscendentandabsolutemoralstandards(Griffiths2001).Indeed,thereisnoawarenessofsinorhumanevilineconomics;asnoted,noprescriptionsaremadeforindividualbehaviour,althougheconomistsacknowledgethatvirtuesliketrustworthinessandhonestyarevitalforthesmoothrunningoftheeconomy.Irresponsibilityandimmoralbehaviourcanonlybecondemnedbyeconomicsiftheyarecontrarytoindividualutilitymaximisation.Individualismasisassumedineconomicscannaturallybesaidtopromoteprideandselfsufficiency.ThisistheoppositeoftheChristianviewofhumanityasappropriatelybasedonrelationshipwithGod,eveninitseconomicbehaviour.Wenowturntoasummaryofrelevantaspects.2.2AbiblicalviewofhumankindLikeeconomics,theologylooksbothathowthingsare(positive)andhowthingsoughttobe(normative).Lookingatbiblicalviewsofmankind,inapositivesense,humanityisseenasbeingmadeintheimageofGod.Mankindhasamandatetoorderandcareforcreation(the“stewardshipmandate”,Genesis2:15-20)andobtainfromittheirfoodandshelter.Workisthewayinwhichpeoplecarryouttheirstewardshipandexpressesthemselvesaspersons;craftsmensuchasBezalel(Exodus31)arecelebratedintheBible.Furthermore,likeGod,10humansarepersonalbeings,abletomakechoices,andalsoabletocomeintorelationshipwithotherlivingbeings.Butmankindisalsofallen,havingdisobeyedGodinEden.Assuch,choicesandactionscanbedeterminedbyself-interest,relationshipscanbespoiltbypowerandfear,humanitymayexploitratherthancaringfornature,andworkcanbecometoil(the“curseofEden”,Genesis10Griffiths(1980)notesthat“thecreatorisrevealedtousasarational,moral,feelingpersoncapableofmakingchoices,andGod’simageinmanimpliesthatheis[thesame]”. 113:14-19).PeoplearewidelyshownintheBibleto“doastheyseefit”(Judges21:25),generallyfollowingtheirownselfishinterests.Accordingly,thereisamixtureinwhatweobserveofhumanbehaviour,alsointheeconomicfield,ofthedivineandthefallen.Theeconomicanalysisdescribedaboveisperhapsanapproximationtofallen,self-interestedbehaviour.Workisseenasadisutility,actionsaredirectedtomaximisepersonalutilityonaselfishbasis,whilemediationoftransactionsviaimpersonalmarketsmayallowustoignorepowerrelationsbetweenindividuals.Buttheeconomicapproachcanstillbecriticisedforignoringtherealityofpowerrelationsandnegativespiritualinfluencesthattheologyacknowledges.Furthermore,therearealsoaspectsofthedivineinhumanbehaviourstill,suchasaltruism.PeoplecanbeseenasendsvaluedbyGodforthemselvesandnotjustasmeans(toproductivework,toutilitygeneration)asisoftenthecaseintheworldviewofeconomics.Workiswidelyvaluedinitselforasapartofhumandignitynot“disutility”.Relationshipsmaybeaffectedbycommitmentandnotjustpersonalutility.Thedegreetowhichthefallenanddivinerelatewilldependonindividualsbutalsoonculture.Theology,unlikeeconomics,takesnoteofstructuralaspectsthatmayoverlayindividual11behaviour.Structuralsinisaparticularfocusof“liberationtheologians”,wholinkittoviolationofhumanrights,disempowermentofthepoorandalsoeconomicinjustice,12“favouringgreed[oftherich]attheexpenseofthelifeanddignity[ofthepoor]”,andwhichmaybemanifestinthemarketeconomyitself.The“sinoftheworld”(John1:29)makesithardforthosewhobenefittodiscernsystemicevilanditssources.LiberationtheologyarguesthattheNewTestamentencouragesChristianstooppose‘structuralinjustice’inpoliticsandeconomicsleadingtopoverty,whichinturnreflectstheinfluenceofthedevilon‘theworld’(Ephesians2:1-2).Theyarguethatowingtoimbalanceofpowerandinfluence,marketsthemselvesmaybevulnerabletobindingandoppressingthepoor,asituationfromwhichtheyneedtoberedeemed.OntheotherhanditisimportanttoaddthattheBibledoesnotassertthatmarketsperseareanegativething.ThroughouttheBibleindividualsspecialiseandbuyandsellproductsfortheirwiderneedsasinthemoderneconomy,beitbybarterorcashtransactions,aswellasinsubsistence.Theviewofmanfromtheologyismoreroundedandcompletethanthatofeconomics.Asnoted,communitylifeiscrucialandnotjustindividualfulfilmentortheimpersonalityoftransactionsinamarket.Indeed,Israel–andlaterJesushimself-areseenasrepresentativeofhumanityandabletostandbeforeGodonbehalfoftherestofhumanity,agroupidentificationthatgoeswellbeyondtheindividualismofeconomics.Christiansarecalledtobetogetherincommunityasthechurch.HumanityisessentiallyrelationalasinAdambeingsaidtobeincompletewithoutEve,aswellasneedingarelationwithGodhimself.Indeed,sinceGodisrelationalintheTrinity,humanityinhisimageisrelationalalso.Accordingly,emotionssuchasloveandhatredwhichareinterpersonalareofrelevancetobehaviour.AsnotedbyBrittonandSedgwick(2003)“economicscannotcomprehendlovebecauseofitspriorcommitmenttorationalcalculation,butalsobecauseofitspriorcommitmenttoindividualism”.Trustisnotfeasibleinapureeconomicsenvironment,aparadoxsincetrustbetweenpeople-whichChristianswouldarguecouldonlyarisebetweenindividualstrustingalovingGod-isessentialtotheefficientworkingofmarkets.AlthoughwealthiscelebratedattimesintheBibleasindicatingGod’sblessingandcomingfromthebenevolentcreator,itistherelationshipwithGodthataChristianseesascentraltowell-being.Indeed,Jesusstatesfirmlythatweareblessedifwearepoor,oridentifywiththe11WhiteandTiongco(1997).12Fitzgerald,(1999). 12poor.RichescanblindustotheneedsofothersandtheneedforarelationshipwithGod.AndPaulseeschurchatitsbestasalovingfellowship,willingtosharewiththeneedyamongthem,beinggeneroustoimitatetheoverwhelminggenerosityofGodhimself(2Corinthians8:9).Wealthisaresponsibility,somethingwemuststewardforthebenefitofothers,evenasmankindiscalledtostewardcreationitself.Acorollaryisseeingworkasaformofservicetoblessothers.Andbeyondthat,well-beingincorporatesthepromiseofeternallifewithChristinheaven.Allthesearenottobegainedbyselfishlymaximisingbutbyshowinglovetoall.InotherwordsthecoreofChristianityisnotabout“doinggood”whichcouldbeintegratedineconomicsviaasuitableutilityfunction,itistodowitharelationshipwithGodhimself.Consequently,themostimportantchoicesarethoseofsalvationitself,entailingrepentancefromsins,goingwellbeyondsimplechoiceofconsumptionandlaboursupply.OpennesstoGod’sloveandfulfillingthedestinyhehasgivenistheessenceofhumanity.FulfilmentisfoundinservingGod,notgoingourownway.Rationalityisplacedinawidercontextofspiritualrealitywhererationalchoiceisnotaboutweighingpreferencesbutattemptingtoembodyaparticularstyleoflife,followingJesus.Thechoicetofollowhimistruefreedominrelationship,asfortheTrinity,contrarytothepopularviewthatbecomingChristianinvolvesasacrificeoffreedom.Normatively,theBiblesuggestsanethicalfocustothetheologicalviewofmankindwithjusticeasacore.Thereislessfearofvaluejudgementsand“blaming”thanforeconomics.Individualbehaviouraswellassocialsituationsaresubjecttocritique.For,beingmadeintheimageofGod,manhasfreechoicebutalsoheisresponsiblemorallyforthechoiceshemakes.TheBiblenotestheriskthatmoneybecomesanidol,andtheeconomicsystemaformofstructuralinjustice–althoughtheologyalsohighlightstheneedforprivatepropertyunderGodtoprotectagainstpoverty.InthelightofChrist’ssacrificeonthecross,Christiansarecalledtobe“redeemersoffallencreation”inadvanceoftheNewHeavenandNewEarth(Romans8:18-25).ThisimpliesbeingstewardsinthewayGodintended–soitisessentialforChristianstofocusoncurrenteconomicissues.AChristiancritiqueofthenormativeapproachofeconomicscouldinclude,first,theideaof“thegood”(Hay1989).AChristianapproachwouldgomuchwiderthantheeconomicviewofmaximisingpersonalsatisfactioninpursuitofindividualpreferences,usuallyintermsofhedonism.JesustaughtustoloveGodandourneighbour,goingmuchwiderthantheindividualandhisfamily.Second,aChristianwouldcareaboutactionsandnotmerelyconsequences.God’sjudgementisintermsofwhatherequiresofmankindindailylife,suchasrighteousmotives(notpurelyforselfaggrandisementattheexpenseofothers),righteousactions(e.g.notlying),maintenanceofsocialinstitutionsthatGodhasordained(suchasmarriageandthesanctityofhumanlife),andsensitivitytojustice(asinglobalpoverty).So,concernbytheeconomistforefficiency,growthand(insomecases)equality,isreplaced,oratleastsupplemented,byaconcernforstewardship,usefulwork,protectionofthevulnerableandthepreservationofmarriageandfamilylife.Furthermore,aChristianwouldseeabenefittocommunity,goingbeyondsimpleaggregationofindividuals.Rather,itcanbeseenasgoodinitselfbothfortheindividualconcernedaswellasintermsofthedutytohelptheneighbour.Sogoalsoftheindividualshouldberelatedtothoseofthecommunityandnotbesolelyindividualistic.Again,thisisbasednotonlyonthewayGoddesignedhumanity(Genesis2:18)butalsothefactthatGodhimselfisarelationalbeinginthecontextoftheTrinity.Theviewtakenofthestatediffers.Asnoted,economistscanseethestateasathreattoeconomicoutcomesaslaissezfairewouldmaintain,orasneedingonlyabenevolentdictator 13imposingthesocialoptimumonareluctantsociety.AChristianviewisthatthestateisordainedbyGodtokeepthepeaceandadministerjustice,preventingevilthatwouldarisefromanarchy.Arealisticviewistakenofthefall,inotherwords.Sothereisadutytoobeythestate,butequallyrulersareseenasunderGodandhenceresponsibletohim.Christianswouldstandalongsideeconomistsinopposingadictatorialstatethreateningfreedom.Anditisnotablethatregimesthatseektosuppressmarketshaveoftenbeenthosethatdenyhumanrights,includingfreeexerciseofreligiousfaith(Griffiths2001).Tosummarisethissection,wenotethesuggestionsbyHay(1989)forextensionsoftheeconomic“good”beyondconsumption,leisureandeconomicefficiencyifaChristianviewpointisadopted.Thesefocusonresponsibilitiesaswellasrights:•Manmustusetheresourcesofcreationtoprovideforhimselfbutnotdestroythecreatedorder(asinthestewardshipmandateofGenesis1:26-30).•Eachpersonhasacallingtoexercisestewardshipoftalentsandresources(asintheparableofthetalents,Luke19:11-27)•Stewardshipimpliesaresponsibilitytodeterminethedispositionofresources.EachpersonisaccountabletoGodforhisstewardship(asinLeviticus25,thelandultimatelybelongstoGod).•Manhasarightandanobligationtowork(asinEdenwheremanissettoworkitandtakecareofit,Genesis2:15)•Workisameansofexercisingstewardship.Inwork,manshouldhaveaccesstoandcontroloverresources(asinprovisionsintheJubileeforlandtoalwaysreturntothefamily,Leviticus25)•Workisasocialactivityinwhichmencooperateasstewardsoftheirindividualtalentsandasjointstewardsofresources(asinthechurchasabodytowhichallcontribute,1Corinthians12)•EachpersonhasarighttoshareinGod’sprovisionformankind,forbasicneedsoffood,clothingandshelter,andtheseshouldbeprovidedbyproductivework(asinprovisionforthepoortoshareintheharvest,Deuteronomy24:19-22)•Personalstewardshipofresourcesdoesnotimplytherighttoconsumetheentireproductofthoseresources.Therichhaveanobligationtohelpthepoorwhocannotprovideforthemselvesbywork(asintherichmanandLazarus,Luke16:19-31).Consideringthesesectionstogether,wedonotdenythateconomicsandthemarketbasedeconomyandfinancialsystemhasprovidedhugebenefitsintermsofwealthgenerationthathaveassistedthewholeofsociety.Butthereremainsanuneasewiththelackofmoralfoundationsofeconomicsatitsmostbasiclevel,astaughttomillions.Thisneedstobesupplemented,attheveryleast,byvaluesfromhumanisticpoliticaltheory,butbetterbytheteachingoftheChristianchurchasoutlinedabove.Withthiscomparisonandcontrastasbackground,wenowturntoanexaminationoftheteachingsofeconomicsandtheologyrelevanttothreekeyelementsofthefinancialcrisis,thebehaviourofbankers,theriseinhouseholddebt,andtheexplosionofpublicdebt.Byconfrontingineachcasethedistinctiveapproaches,weseektodevelopadistinctiveviewofpersonalbehaviourandpolicyrecommendations.3Thefinancialsector–incentivestounderestimaterisks3.1TheissuefromaneconomicsperspectiveGiventhecentralroleofbanksandbankersinthecrisisasoutlinedinSection1above,wefocusfirstonissuesinbankingthatcouldhaveledtothecatastrophicunderestimationofrisksthatprecededthecrisis.Theeconomicroleoffinancialinstitutionssuchasbanksinthe 14moderneconomyisacrucialone.Itcanbesummarisedinsixfunctionsofthefinancialsystem(MertonandBodie1995).Theseare:(1)Theprovisionofmeansforclearingandsettlingpaymentstofacilitateexchangeofgoods,servicesandassets.Anexampleischequeclearingandotherformsofpaymentforgoodsandservicesthatbanksprovide.(2)Theprovisionofamechanismforpoolingoffundsfromindividualhouseholdssoastofacilitatelarge-scaleindivisibleundertakings,andthesubdivisionofsharesinenterprisestofacilitatediversification.So,forexample,bankdepositsarepooledtomakeloanstomortgageholders,whilebanksareenterprisesissuingsharesforgrowthoftheirbusiness.(3)Theprovisionofmeanstotransfereconomicresourcesovertime,acrossgeographicregions,countriesorindustries.Bankloansagainenableshorttermsavingstobetransformedintolongtermlendingthatcantakeplacecross-borderaswellastodifferentplaceswithinacountry.(4)Theprovisionofmeanstomanageuncertaintyandcontrolrisk.Banksseektocarryout“duediligence”creditanalysisinlendingtoensurethattheborrowerhascapacitytorepayloans.(5)Providingpriceinformation,thushelpingtoco-ordinatedecentraliseddecisionmakinginvarioussectorsoftheeconomy.Thisisthefunctionofthestockandbondmarketsthatsetpricesforfinancialassets,butinwhichbanksarehighlyactive.(6)Providingmeanstodealwithincentiveproblemswhenonepartytoafinancialtransactionhasinformationtheotherdoesnot,orwhenoneisanagentoftheother,andwhencontrolandenforcementofcontractsiscostly.Sobanksdevisecontractsthatseektoprovideincentivesforloanstoberepaid,overcomingthedifficultiesthateconomistscalladverseselection(suchasthetendencyforthoseaskingforfinancefromabanktobeoflowcreditqualityifitchargeshighinterestrates–sincetheydon’tintendtorepay)andmoralhazard(suchasthetendencyofborrowerswhoarenotmonitoredproperlybythebanktomisusethemoneytheyarelent).Afirstremarkisthatitisself-evidentthatwidespreadbankfailure,threateningprovisionofthesefunctions,isextremelydamagingtotheeconomy.Thisexplainsboththeamplitudeofthedownturnandalsotheeffortsbygovernmentstosupportbanks,asdiscussedinSection1above.Asecondremarkisthattheperformanceofthesefunctionsrequiresintegrityandprudenceonthepartofbankersinperformingtheirfunctions–aswaslackinginrecentyears.Notably,theyneedtoavoidthetemptationtoprovidecredittooreadilytoindividuals,firmsandgovernmentsinawaythatentailsexcessiverisktotheirinstitution.Onceunderpricedloanshadbeenmade,banksarevulnerabletotheconsequencesofdefault,directlyandviasecuritisedclaims,whenborrowers’financialsituationworsens.Equallytheyneedtoensure13theirinstitutionshadaccesstoreliablesourcesofliquidity,toavoidtheriskof“runs”.Andfurthermore,theyneedtoensuretheirinstitutionhadadequatecapitaltocoverexpectedlosses(seeAppendix2).Failuretocarryoutsuchdiligence–aswasthecaseinthecrisisasdescribedinSection1-threatenstheeconomyasawholeandnotjustthebankconcerned,ifitissufficientlywidespread.Inthiscontext,adangerouspatternmayhavebeencreatedbyacombinationofthebonuscultureofbanksandthe“safetynet”providedbythegovernment.Bonusschemesinbanks,whichmayaccountforasmuchas50%ofremuneration,oftenrewardtheshort–termperformanceofanindividualtraderorlendingofficerandthiscanleadthemtofocusonraisingshort–termreturns,withthepotentialofriskinggreaterlossesinthefuture.Meansof13SeealsothediscussioninAppendix2. 15obtaininghighreturnswouldinclude,first,lendinglargevolumesathighrisk,saytosubprimeborrowersorbuy-to-letinvestors(withhighinterestratesandalsofeesattached)withoutconcernforlongtermrisk.Second,itwouldincludepurchaseoflargevolumesofhighyieldingsecurities(suchassubprimeABS)withouttakingaviewoftheirlong-termvaluation.Besidesindividualbankemployeesandtheirbonuses,incentivesrelatedtobonusesandalsoCEOstockoptionsandshareownershipmayalsohaveunderlaystrategicerrorsbymanagers.Theseincludeseekinggrowthoftheinstitutionbeyondwhatwasfeasiblewithretaildepositsviauseofriskywholesaledeposits;andallowingcapitalandliquidassetcovertobereducedandthusboostingprofitabilityatacostofenhancedriskofinsolvency(seeAppendix2).Italsoentailedaggressivetakeoversofbanksatthepeakoftheboom,whichleftsomeofthebuyinginstitutions(suchasRBSandLehmans)highlyvulnerabletofailure.Thebackgroundtothis,notablyforthestrategicdecisionsofCEOs,wasknowledgethattheauthoritiessimplycouldnotletmajorbanksfail,andwouldhavetosupporttheminitiallyvialenderoflastresortliquiditysupportandlaterviarecapitalisationandguaranteesattaxpayers’expense.Thebankers,ineffect,hadanincentivetounderpricerisk,partlybecauseofasymmetricpayoffs-theprofitswouldaccrueinbonusesandoptionrevaluation,thelossesintheendtothetaxpayersifthebankis“toobigtofail”soissupportedbythecentralbankandgovernment.Thisisanotherformofmoralhazard,aguaranteewhichgeneratesbehaviour(bybankers)adversetotheproviderofthatguarantee(thestate).Notethattheseincentivesarenotsofavourableforshareholders,whomayloseoutinagovernment“rescue”.Indeed,pensionfundsofindividualemployeeshavelostoutgreatlyowingtothedevaluationofbankingshares.Theshareholder’svoiceinalimitedliabilitycompanysuchasabankisnotastrongone,evenformajorinstitutionalinvestors,exceptinthecaseofmajorfailuresof“corporategovernance”(DavisandSteil2001).Thisispartlyduetolackofsufficientlydetailedinformationonthefirm,aswellaslackofsanctionsapartfromsellingtoatakeoverraider.Shareholderswereaccordinglyunabletorestraintherushforprofitabilitybytakinghighlevelsofriskthatbanksundertookintheperiodupto2007.Suchanexplanationofbanker’sbehaviourasthatsetoutabovesuggestsdirectculpability,withactionstakeninfullknowledgeoftherelatedrisks,whichisconsistentwiththeeconomicmodelofmanaspursuingself-interest.Theremayalsobeindirectchannels.Notably,theremayhavebeen“disastermyopia”,thatlendersforgottherecouldbebadtimesagain.Asinpastcrises,peoplestarttobelieve“it’sdifferentthistime”(e.g.duetothefactclaimsweresecuritised)andforgetthelessonsofthepastthatacreditandassetpriceboomoftenendsinafinancialcrisis(seeAppendix1).Thispatternofindividualandinstitutionalforgetfulnessmaybeprovokedbythesameasymmetryofoutcomesforemployees/managersandthestate/shareholders,makingbankersfocusontheshorttermonly.Butitisclearlycontrarytothemainstreameconomicassumptionof“rationality”.Whereashistoricallybankshaveoftenbeenvulnerabletopatternsoflossesfromloansheldonthebalancesheet(e.g.inthe1973crisisoftheUKsecondarybanks,theLatinAmericandebtcrisisof1982,andtheJapanese,SwedishandFinnishbankingcrisesof1991),itcanbearguedthatthesecuritisedproductssuchasABSthataboundedintherunuptothecrisiswereparticularlyvulnerabletoabuseintermsofunderplayingofriskand/ordisastermyopia.Asinnovations,theirbehaviourunderstresswasnotyetknown-likeanewdrugwhosefullrangeofsideeffectshasnotbeentested.Alsothereareawiderangeof“informationgaps”wherethosetakingdecisionsdidnotbeartheconsequencesofpooroutcomes,whilethosewhodidsuffertheconsequencesdidnotunderstandtherisk,duetocomplexityandpoor 16information.Forexample,thosemakingsubprimeloansintheUSwouldsellthemasbonds,sopassingtherisktoothers.Andthird,the“ratingagencies”whoaresupposedtomakeindependentassessmentsofcreditriskactuallymadeexcessivelyoptimisticassessmentsofsuchriskfortheseinstruments,followingtheirownself-interestingeneratingfeesfromtheissuers.Thesituationwasworsenedbytheprincipal-agentproblemwhichisendemicinbanking.The“principal”ownstheassetsbuthegetssomeoneelse,his“agent”tolookafterthem.Forexample,theshareholdersofabanklikeRBS(theprincipal)mandatethemanagersofthebanktobetheagentandrunthecompanyontheirbehalf.Buttheproblemis,theagentmayeasilyactinhisorherowninterestandnotthatoftheowner,iftheyarenottrustworthy,beingdrivenbygreed.SirFredGoodwinofRBSmadedisastrousoverpricedtakeoverswhichledhisbanktoruin.MoneymanagerslikeMadoffandStanforddefraudedpeopledirectlywhohadentrustedmoneytothem.Therearethreewaysineconomicstodealwithprincipalagentproblems,whichisineffectthewaythesubjectdealswithbusinessethics.Itisassumedthataself-interestedpersonwillbehaveethicallyiftherearesufficientincentives,only.Thefirstresolutionistodrawupacompletecontractthatspecifiestheagent’sbehaviourineverycircumstance,oratleasttoalignperfectlytheinterestsoftheagentandprincipal.Butthisisgenerallyseenasimpossible,aswitnessthedifficultybankshavehadwithannualbonuses.Whiletheyareassumedtogiverisetoappropriateincentivestomaximiseprofits,theyactuallyledtorisk-takingthatwreckedsomeinstitutions.Asecondistorelyonreputation.Iftheagentseeshisreputationforhonestyasanasset,hewillbetrustworthybecauseit’sinhisowninterests.Peoplecanafterallbefired,andinstitutionscanfailorbetakenover.Spoilyourreputationonce,andnoonewilltrustyouagain–atleastforafewyears.Butthisismoreeffectiveforasingleindividualorinstitutionthatbehavesdifferentlyfromtherest.Inthecreditboom,bankerswerecomfortedbythefactthatalltheircounterpartswereactinginthesameway,andhenceexceptforthemostegregiouscasestherisktoreputationfromrisktakingwassmall.Andthethirdisongoingrelationships.Ineconomics,peoplearesupposedtoactinatrustworthymannerinanongoingrelationship,suchasanemploymentrelationshiporalinkwithaclient,soastokeepthebenefitsofthatrelationship,thatwouldotherwisebespoilt.Buteconomicsseesmankindastotallyselfishsotherelationshipwillbespoiltifthepersonconsidersittobeintheirinterest.Wenotedearlierthattheideaofcommitment(loyalty,love)isabsentfromthebulkofeconomicanalysis.Furthermore,theformofbankingthatdevelopedinthe2000s,withloansbeingsecuritisedandsoldpiecewisetoinvestorsroundtheworld,isinimicaltotheformofbankingrelationshipstypicaloftraditionalbanking,wherethemanagerwouldknowhisownclientsanddealwiththemonaregularbasis.Soagainthesanctionwasweak.Sinceprotectionfromdepositinsuranceandthelenderoflastresort(thegovernment“safetynet”)offerbanksanincentivetotakerisks,theneconomicsstressesaneedforprudentialregulationasaformofprotectionforthe“safetynet”andthegovernmentthatprovidesit,as14wellasfordepositors,againstbanks’risktaking(seeAppendix2).Banksmustbeobliged14Therearevariousregulationsonloans(suchason“largeexposures”)topreventthebankbecominginsufficientlydiversifiedandthusincreasingtheriskofinsolvency.Prudentialregulationalsofocusesonmanagementandearningsasimportanttoriskmanagementandabilitytogrowcapital,respectively.Overarchingthesemaybe“structuralregulations”thatlimitcompetitionbetweenbanksandhencelimitthedegreeofriskontheassetside(sincecompetitiontypicallyinducesbankstoseekhigherreturnsathigherrisk). 17toholdsufficientcapital,whileliquidityshouldalsobeheldinspiteofthebankers’incentivestominimiseit.Theremightalsobesupervisionoftheincentiveschemesinbanksperse.Butinfactitwouldappearthattheauthoritieshadallowedliquidityregulationtobeexcessivelylax;thebonusculturewasrarelyinvestigatedandcapitaladequacywasnotmaintainedonarisk-adjustedbasis.Theregulators,too,weresubjectto“disastermyopia”(Davis2009).Hencethecallsatpresentformuchtighterregulation,notablyofthebonuscultureandofbanks’capital(FSA2009).Tosumup,whileeconomicsoffersanunderstandingontheimportanceofbanksandtheincentivesandmotivationsforbankers’behaviour,thereremainpuzzlesfromthepointofviewof“rationaleconomicman”paradigm.Forexample,whyistheretheirrationalityimplicitin“disastermyopia”,whichisahugedeparturefromtheparadigmsdiscussedinSection2?Whydidfirmsinvestmassivelyinsecuritieswhosepropertiestheydidnotunderstand?Whyweretakeoversundertakenatexcessiveprices,whichthreatenedthebiddingfirm’ssolvency?Equally,economicsissilentontheissuesofprudence,trustandhonestywhichareessentialtothefunctioningoffinancialmarketsinthelongterm.WenowturntoaChristianviewtoseewhatadditionalinsightsareavailable.3.2TheissuefromatheologicalperspectiveWhilethesophisticationofthemodernfinancialsystemisabsentfromscripture,theunderlyingissuesarenot,andnotablytheissueofbusinessethics.ItarisesalreadyintheFallofGenesis,asproposedbyHigginson(1993).Oneaspectwasthatofhubris,assetoutinGenesis3:5.AdamandEveweretemptedbytheserpentto“belikeGod”knowinggoodfromevil.Therecanbecorruptionbypowerandsuccessandarrogantbehaviour,whichcanentaildisastermyopiawithrisktakingattheindividuallevel(suchasexcessivepurchaseofriskysecurities)orthefirmstrategiclevel(suchasinappropriatetakeovers).Prideitselfleadsindividualstooverlookrisks,aswellasseekingfinancialgain.Similarly,theaccountofBabelinGenesis11:4describesindividualsseekingtobelikeGod,buildingempiresfortheirownglorylikethebankconglomeratesbuiltduringtheboom.James4:13-17showsindividualsboastingaboutthefutureprofitstheywouldmake.DesiretomakeanameforthemselvesandtheunderlyinginsecurityagainmayunderliethedominanceofbanksbyempirebuilderssuchasDickFuldofLehmans,whooverreachedthemselvesandbroughtdowntheirinstitutions.Theyreportedlyrefusedtohearnewscontrarytotheirownviews.Wesawabovethatdesiretoprotectreputationisoneprotectionagainstprincipal-agentproblems,butScriptureshowsitslimitations.Second,thereisabreakdownoftherelationshipofcooperationbetweenhumanbeingsthatcamewiththefall.Thespecificexampleisthatofmenandwomen,whereGodsaystoEveinGenesis3:16“yourdesirewillbeforyourhusband,andhewillruleoveryou.”Corruptioninhumanrelationshipsagainisrelevanttobankingethics,wherecompetitionratherthancooperationwithinfirmshelpedtobuilduprisk,traderscompetingwithoneanothertomaximisetheirprofitsandhencetheirbonuses.Equally,leadershipinfirmsthatshouldbebenignandforthebenefitofallcanbecomedictatorialasatLehmans,inthesamewaythatmaritalrelationshipscansour.Wesawabovethatongoingrelationshipsisoneprotectionagainstprincipal-agentproblems,butScriptureagainshowsitslimitations.Third,therecanbetheblamegameasinGenesis3:12-3,whereAdamandEveaccusedoneanotherandtheserpentofbeingtheguiltyparty–andAdamimplicitlyalsoblamesGod(“thewomanyougaveme”).Peopleseektoavoidresponsibilitybecauseofitseffectonfuturereputationandemployment,althoughthatisdishonest.Andwhennooneiswillingtotake 18responsibilityforafirm’sactions,thentheoutcomemaywellbeadverse,asmanyfirmsfoundoutinthebankingcrisis.Thereisabiblicalissueofqualityofwork,whichappliestobankers,andmayalsounderlietheirriskyactions.Withthefallthereisacurseonwork,(Genesis3:17-19),whileEcclesiastes2:22-23says“Whatdoesamangetforallthetoilandanxiousstrivingwithwhichhelaboursunderthesun?Allhisdayshisworkispainandgrief;evenatnighthisminddoesnotrest”.ThiscouldcertainlyapplytooverstressedCitybankersandmayhelpexplainwhytheywerewillingtoputtheirjobsatriskforpecuniaryreward,iftheworkitselfwasseenasunrewarding.Furthermorethebibleisrepletewithexamplesofirrationalbehaviour,suchastheIsraelitesworshippinggodswhoaremereblocksofwood(Isaiah44:12-20)asin“Theyknownothing,theyunderstandnothing;theireyesareplasteredoversotheycannotsee,andtheirmindsclosedsotheycannotunderstand.”Hencetheirrationalbehaviourforbankersishardlyasurprise.AmoreexplicitexampleofmyopiaisshowninIsaiah56:12“Come,”eachonecries,“letmegetwine!Letusdrinkourfillofbeer!Andtomorrowwillbeliketoday,orevenfarbetter.””Noprecautionaryprovisionforhardtimes,inotherwords.Despitethefall,thereremainsaBiblicalvalueplacedonqualityofwork,theconceptofsecularvocation(Green1988).Thisisevident,forexample,intheskilledworkofBezalelonthetabernacle,whichiscelebratedinExodus31:2-5,andwhichwasaccompaniedbyhisbeing“filledwiththeSpiritofGod”.Thisworkwasnotjustfortheself,healsotaughtothers(Exodus35:34).InProverbs22:29theskilledmanispraisedasservingbeforekings.Jesus’parableofthetalents(Matthew25:14-30)encourageshardworkinthecontextoftheskillsGodhasgivenus,whileLuke10:7saysworkersdeservetheirwages.ThisimpliesitisnotwrongBiblicallytostriveforbettersalariesandpromotion.Indeed,PaulsaysinColossians3:23weshouldworkwithalloutheart,asworkingfortheLordandnotformen.Barth(1969)suggeststhatwearecalledtobeservantsofGodandourfellowhumanbeings;ourworkinthislightisthensustaininganddirectingandcaringfortheworldandaboutthewelfareofcreation.Griffiths(2001)arguesthatworkgenerally,andmarketenterprisemorespecificallycanbeseentohavealegitimacybasedonthecreationmandate,toordercreationformankind’sneeds.Thesetextsencouragehardworkbutthebiblealsoenjoinsintegrity.Virtuessuchashonesty(Leviticus19:11),andputtingothers’interestsbeforeone’sown(Philippians2:4)wereabsentinmanyfirmsinthebankingcrisis,asshownabove.Awordoftenusedforhardworkinthebibleis“diligence”asinEzra5:8whichhasadeepermeaninginbanking–duediligencemeansassessingcorrectlyalltherisksbeforeundertakingatransaction,avirtuesadlylackingintherunupto2007.Turningmorespecificallytobiblicalmaterialrelevanttobanking,diversificationofportfoliosisenjoinedbyEcclesiastes11:1-6,“Castyourbreaduponthewaters,foraftermanydaysyouwillfinditagain.Giveportionstoseven,yestoeight,foryoudonotknowwhatdisastermaycomeupontheland.”ItwasevidentthatbanksholdingsubprimeABSdidnotdiversifysufficientlytheunderlyingliquidityandcreditrisk.Andalthoughbanksmayhaveusedavarietyofwholesalefundingsourcesandinstruments,theydidnotallowsufficientlyforacompletecollapseofthemarket.TheBible’swarningsaboutfalseweightsandmeasures(Proverbs20:23)canbeseenaslinkedtotheinaccurateratingsofthecreditratingagenciesforthestructuredproductsaswellasthemisleadingofclients.WediscussinSection4belowthecontroversyregardinginterestandusury,whichhasimplicationsforbanks.SufficetonoteherethattraditionalChristianteachingregardedall 19lending(exceptthatfreelyundertakenatzerointerest)withsuspicion.Calvinsaidthatunderthelawoflove,therecouldbenoobjectionofloansonreasonabletermsbetweenpartieswithgoodbusinessreasonstolendandborrow,hencelegitimisingbanking.ButthelawofloveandstewardshipthatCalvinadvocateswouldnotpermitmanyoftheexploitativepracticesundertakenintheboom,notablylendingtosubprimeborrowerswithoutadequatewarningoftheriskofhomelessness,andthesharpfuturerisesininterestratesonceinitiallow“teaser”interestratesfinished.Jesus’viewofthetradeoffinanceisseeminglyambivalent.HewasopposedtotheintrusionoffinanceinrelationshipswithGodasinthedrivingoutthemoneychangers(Matthew21:12).ButheseemstoacceptthetradeoffinanceintheinjunctionintheParableoftheTalentstoputmoneywiththebankers(Matthew25:27).Moresubtly,itcanbearguedthatthecoreofJesus’teaching,thekingdomofheavenisalongtermdevelopment,comingtofruitiongraduallylikeaplantgrowing(Mark4:30-33),incontrasttothepracticesofbankerstofocusonshorttermgaintothedetrimentoftheirfirms’viability.AndtheideaoftheservantthatJesusadoptedashisparadigm(Philippians2,Matthew20:28)impliesbankersputtingthecustomer’sinterestsfirst,whichwasclearlynotthecaseforsellersof“toxicdebt”.Paulwarnsthat“Peoplewhowanttogetrichfallintotemptationandatrap”(1Timothy6:9)asmanybankersdid,namelythetemptationtocutcornersinprudence,diligenceandriskassessment.Ontheotherhand,Jesuscommendsadvanceriskassessmentinthecaseofthebuildingofthetowerandthepreparationforwar(Luke14).Heisnotagainstrisktakingasintheparableofthetalents,wheretherisk-averseindividualiscondemned(Hoare2006).Thequestionisforwhatobjectivetherisksaretaken–theyareappropriateforsalvationbutnotforfinancialgain.SomeofJesus’parablesarerelevanttobankers’behaviour.Intheparableoftheshrewdmanager(Luke16:1-15)Jesuscommendsthemanagerforbeingalertandgenerous(albeitwithanother’smoney)buthighlightsthathisproblemwasthathewasnottrustworthy.Noteinthiscontextthatbeingtrustworthygoesbeyondobeyingrules.Itimpliesbeinghonestandprudent,tobereliedupontomakeanappropriatejudgementintheinterestsoftheprincipalorclientinvaryingsituations.Trustisessentialforfinancialmarkets,therootoftheword“credit”being“credere”–trust.InJesus’parable,themanagerwasn’ttrustworthybeforehand,forhe’dbeenwastingtherichman’sassets,withrecklessirresponsibility–justlikesomedidinthefinancialsectorupto2007.Andhewasn’ttrustworthyduringtheparableashegaveawaythemaster’sassets.That’swhyJesuscallshimdishonestevenastherichmancommendshim.Andthisisclearlyrelevanttobankingethicsintermsoftheprincipal-agentproblemofeconomicsasidentifiedinSection3.1above.Jesusissayingthatourtrustworthinessisdependentonloveandloyalty,andwheretheyaredirected.Themanagerwasloyalonlytohimself–heshowednoloyaltytotherichmanandsotheirrelationshipwasruptured.Jesusissaying–don’tbelikehim!Wecanonlybeloyaltoonemaster.Butthemanager’sbehaviourwasaspredictedbyeconomictheory,whereloveandloyaltyhavenoroletoplay.Thisintroducesakeyverse(Luke16:13)“Noservantcanservetwomasters.Eitherhewillhatetheoneandlovetheother,orhewillbedevotedtotheoneanddespisetheother.YoucannotservebothGodandMoney.”Orinotherwords,youcannotserveGodifyourattitudetomoneyistoseeitasagoalinlife,anendinitself,ultimatelyanidolthatisworshipped.Asimilarissuearosefortherichyoungmanwhohadkeptthelawbutwasobsessedwithhiswealth(Mark10:17-23).Wealthenticesusintoselfsatisfaction,selfishness,greed,andallthe 20humanmotivationsthatmainstreameconomicssadlyfindsbothaccurateandpredictive.Godhasnopartintheseattitudes.Withthemisuseofmoneywebecomeonlyfriendswithourselves,aslavetrappedinspiritualpovertytowardsGodandothers,alonelikeKingMidasamidhisgold.Ifwetrustinthe“godofmoney”wewillspendourlifeingreedandfear.Wehaveseenthatthecrisiswasduetogreedofbankersandborrowers;butwhenfeartakesovernoonelends,asinthecrisisitself.Itishardtoseegreedinourselves–acrisisisinthissensegoodasfearishardertohidefrom–Godchallengesusfortrustinginthewronggod.Jesusknewthatonecouldneverhaveasatisfactorylifebeinginlovewithmoney.Hencethedissatisfactionofmanybankersdespitetheirvastbonuses.Indeed,evenforpeoplewhoareveryhighlypaid,happinessandsatisfactionareoftenabsentasEcclesiastes5:11“Whoeverlovesmoneyneverhasmoneyenough;whoeverloveswealthisneversatisfiedwithhisincome.Thistooismeaningless.”Instead,JesuscallsforpeopletoloveGodandneighbour(Matthew22:37-40),liveincommunityandseekhiskingdom–objectivescontrarytothebasicprinciplesofeconomics.Inthecontextofthebonuscultureandhighremunerationofbankers,Jesus’warningsofthe15dangersofgreedareappropriate,suchasintheparableoftherichfool(Luke12:16-21),andparableofLazarusandtherichman(Luke16:19-31).Therichfool,asintheclassiceconomicparadigm,hadonlyhisselfinterestinmindandwasalsofocusingsolelyonthislifeandnotthelifetocomeinhisgreed.Meanwhile,therichmanwascompletelyobliviousofthebeggarLazarusoutsidehisgates,inthesamewaythatindividualswhooperateinimpersonalmarketscanbeblindtotheindividualconsequencesoftheiractions(bankruptcy,repossession,lostsavingsandpensions).ScripturecallsmankindtobetrustworthytoGod,andwegethistrustbybeinghonestwithmoney.Godjudgesusonsmallthingsandtheycanhaveahugeeffectonourdestiny(Matthew16:10)“Whoevercanbetrustedwithverylittlecanalsobetrustedwithmuch,andwhoeverisdishonestwithverylittlewillalsobedishonestwithmuch.Soifyouhavenotbeentrustworthyinhandlingworldlywealth,whowilltrustyouwithtrueriches?”OnemistakethatevenChristiansinbankingcanmakeistocompartmentaliselives,tobehonestonSundaybutlesstrustworthyonMonday,perhapstherebyperhapsgainingagoodreputationatworkasawheelerdealer.HonestyandintegritybeforeGodcanbechallengedinacommercialenvironmentevenforChristians,whocanendupthinkingGodcan’tseeusatalltimes.LiketheagentssellingsubprimeloanstopoorpeopleintheUS,knowingintheirheartstheycouldn’trepay.Theywerewellrewardedatthetime,buttheirbehaviourwasnotmorallyacceptable.ThehubrisofbankerscanalsobeviewedinthelightofRevelation18,whichcanbeseenasdepictingafinancialcrisis,withthebankerstakingtheplaceofthemerchantsandBabylonbeingtheglobalfinancialsector,inwhichallsoughttoworkandwhichseemedmorepowerfulandinfluentialthangovernments.ThefallofBabylonaffectsnotonlythekingsoftheworldbutalso“themerchantsoftheearthgrewrichfromherexcessiveluxuries”(Revelation18:3),implyingopulentconsumerismasintherecentboom.Themerchants“willweepandmournoverherbecausenoonebuystheircargoesanymore”(Revelation18:11)asdidthosedismissedfromfailingfirmssuchasLehmanBrothers.Theideathat“inonehoursuchgreatwealthhasbeenbroughttoruin!”(Revelation18:17)isagainreminiscentoftheabruptaggravationofthecrisisatthefailureofLehmans.ThesucceedingrecessioniscapturedinRevelation18:22“noworkmanofanytradewilleverbefoundinyouagain”15"Thesevendeadlysinsofbankingincludegreedyloangrowth,gluttonyofrealestate,lustforhighyields,sloth-likeriskmanagement,prideoflowcapital,envyofexoticfees,andangerofregulators,"MikeMayo–CLSA,April6th2009(thankstoPaulMillsforsendingthisquote). 21whilethe“masteroftheuniverse”prideofthetopbankersisshownin18:23“yourmerchantsweretheworld’sgreatmen.Byyourmagicspellallthenationswereledastray.”Higginson(1993)notesthreereasonswhyBabylon(Rome)hadtofall,whichwereexploitingpeople(withareferencetoslavesasoneofthe“luxurycargoes”);ostentation,withallthegoodsbeingluxuryonesratherthanbeingofhelptothepoor,andprideinparalleltotheOldTestamenttextsproclaimingjudgementonTyreandBabylon(“awidowIshallneverbe”).Inasimilarmannerthefinancialsectorasawholeisvulnerabletothechargeofexploitingindividuals’lackofinformationandunderstandingaboutrisks.Italsoraisestheissueofdebtsofthethirdworld;wealthandprideofbankers,seenas“mastersoftheuniverse”till2007havealsobeennoteworthy.Inpassagessuchasthis,Biblicalfaithgivesawarningandachallengetothevaluesoftheworldthat(atleasttill2007)seemedtovaluefinancialsectoremploymentaboveotherformsofwork.Integrityiswhatthebiblecallsfor,asstatedinProverbs10:9,“Themanofintegritywalkssecurely,buthewhotakescrookedpathswillbefoundout”.This,besidesbeingageneralcalltointegrityinbanking,canrefertothewayfinancialcrisestendtoexposefraudandsharppracticesthataremissedintheboombut,asforStanfordandMadoff,areexposedbythedownturn.3.3ConfrontationandreconciliationItisimportantattheoutsettonotethatweconsiderbanksandmodernfinancialmarketsessentialtothemoderneconomy,andtheissue,ratherthantheirabolition,iswhethertheycanbemadetoworkbetter,andtheirexcessessomehowcurbed.Wecontendthatthecrisis,followingtheanalysisabove,resultsfromindividualandstructuralcauses,andbothneedtobeaddressed.Wehaveseenthattheresponsetothebankingdifficultieshasbeenacallfortighteningofregulation.This,togetherwithtakeoversand(forindividuals)thethreatofdismissalarethemeanswhicheconomicsenvisagestopreventarecurrenceofthecurrentfinancialcrisis.Regulationistypicallyseenintermsofcapitaladequacy,anappropriateremunerationsystem,liquidityandinternalproceduresofbanks.Afirstpointiswhiletheseelementsareessential,formsofregulationmaybetootechnical.Theyshouldarguablybecomplementedbyregulationencouragingmorebasic“values”asbenchmarksforbehaviourtobemeasuredagainst.Forexample,effortstoavoidregulationbyfinancialinnovation,socalledregulatoryarbitragecouldbereducedbyaformofregulationforbiddingactionsagainsttheirspiritandnotmerelytheirletter.Featherby(2009)suggestsaseriesofveryappropriatevaluesthathavebeenneglectedinfinanceinrecentyears,suchasservicebeforeself,honestyandnotconformity,competitionandnotaggression,rewardalignedwithrisk.Theologyanditsrealisticviewoffallenbehaviourneverthelessraisestheissueofwhethereventhisissufficient.Regulation(andfirmculture)promoting“values”mayendupwithpiousliststowriteonthewallandignore,orseektocircumvent.Inourviewacrucialcomplementare“virtues”,whichVincent(2008)definesas“personalcapacityforaction,thefruitofaseriesofgoodactions,apowerofprogressandperfection”.Examplesofsuchvirtuesarehonesty,prudence,courage,justice,trustworthiness,diligence-theinternalconvictionofwhatisrightbehaviouranddeterminationtofollowitthrough.Gregg(2009)suggeststhatthemostimportantoftheseisprudence“theperfectedabilityofindividuals 22possessingrightfreedomandfreewilltomakemorallycorrectpracticaldecisions”e.g.using16experience,data,andjudgementinthegrantingofcredit.Hencethequestionariseswhetherbankerscanbemotivatedtofollowprudence,integrityandbusinessethics.Howcanweinstilbiblicalvirtues(seeGreen1988)?Howcanbankingstructuresbedevelopedtoencouragegoodpeopletodothegoodtheywanttodo?Firmscouldbeencouragedtorewardsuchvirtuesfinanciallywherevertheyarefound.Churchescanpointoutthatmoralbehaviourisasinequanonforthemoderneconomytofunction,withallthebenefitsitprovides.Christiansinfinancecanactasexamples,especiallyiftheyareleaders.Forvirtuedependsoncharacterandcharacterislearntbyexampleratherthanprecept.ItisnotablethatthebankGreenleads,HSBC,hasemergedrelativelyunscathedfromthecrisis.ItisclearthatChristiansarenotcalledtoleavethefinancialsectorbutmustbecome“saltandlight”bythevirtuestheydisplay,intheplacewhereGodhascalledthemtohisservice.Theforceofexampleandcarefulevangelismcanpaydividendsforthefirm.Butperhapsfundamentaltoreestablishmentofethicalbehaviourmaybetheresolutionofthequestionofwhoistheultimatemaster,you,theemployerorGod?Weacceptthatvirtuescannotbereliedonalone–somepeoplewillalwayslackvirtueandneedregulationsandvaluestobemeasuredagainst.Valuesareenforceablewhilevirtuesarenot–sotheyareneededasabackup.Butwecontendthatasystemthatneitherpromotesnorrewardssuchvirtuehastheseedsofitsowndestruction.Fromasecularviewpoint,anotherwaytolimitlossesviadisastermyopiaistoretaintheolderbankerswithexperienceofpastcrises–otherwisethesamemistakestendtobemadeagain.ThebiblecouldbequotedinfavourofthisintermsofthegoodadviceRehoboamsonofSolomongotfromhiselderlyadvisors(1Kings12:1-24),toreconcilehimselfwithhisrestlesssubjectsbyeasingtheirburdenoftaxandforcedlabour.Insteadhetookhisyoungfriendsbadadvice,to“acttough”,andpromptedthebreak-upofthekingdom.Afurtherpolicytopursueistoreducemoralhazardfromthe“safetynet”whichgeneratesincentivestoactimprudently,asdiscussedinSection5.3.Itisclearthatsomethinghasgonebadlywrongforbankstoineffectcreatethedeepestrecessionsincethe1930s.Thisraisesthequestionwhetherbanks,whichweredevisedforthegoodofthecommunity,havebecomeself-seekinganddestructive.Abiblicalanalysiscouldsupportanenforceddeclineintheimportanceandinfluenceofthefinancialsector.Forexample,inthewordsofArchbishopWilliams(2008),itiseasytopersonifythemarketandcapital“asiftheywereindividuals,withpurposesandstrategies,makingchoices,deliberatingreasonablyabouthowtoachieveaims.Welosesightofthefactthattheyarethingsthatwemake.Theyaresetsofpractices,habits,agreementswhichhavearisenthroughamixtureofchoiceandchance.”Andso“weexpectanabstractioncalled'themarket'toproducethecommongoodortoregulateitspotentialexcessesbyasortofnaturalinnateprudence,likeaphysicalorganismorecosystem.Weappealto'business'toacquirepublicresponsibilityandmoralvision.”Indeed,thisiswhattheBiblecallsidolatry,attributingagencytosomethingwehavemadeourselves–andhencethereisaneedfordiscernmenttoavoidtheriskofstructuralevilthatsuchabstractioncanleadusto.Itcanleadtofoolishanddestructiveerrorsaboutthe17self-stabilisingnatureoftheeconomyorfinancialsystem,forexample.Suchidolatryisalso16Gregg(2009)goesontoseethepartsofprudenceas“understandingoffirstprinciples(e.g.,‘don’tsteal’),open-mindedness,humility,caution,thewillingnesstoresearchalternativepossibilities,foresight,shrewdness,andthecapacitytoformanaccuratesenseoftherealityofsituations”.17Suchbeliefs,commonamongeconomists,areinfactcontrarytotheteachingsofthegreatesteconomistsofthepast,suchasKeynes(1936),whosaid“Speculationmaydonoharmasbubblesonasteadystreamofenterprise.Thepositionisseriouswhenenterprisebecomesabubbleonthewhirlpoolofspeculation.Whenthe 23awayforindividualstoseektoavoidresponsibilitybyblamingthesystemortheinstitutionwhentherewerealternativechoicesthattheindividualcouldhavemade.Thesizeofthefinancialsectorcouldalsobequestioned.WehavenotedthatCalvinsuggestedthatbankingtransactionsbetweenequalpartieswereunexceptionable,underJesus’lawoflovethatsupersedesOldTestamentrules.IngeneralwecanagreewithCalvinthatmuchlendingisbeneficialtosociety.Ifalltransactionswereequity-basedthentherewouldbeacollapseineconomicactivity.Buttherecouldremainquestionsonthevalueaddedbybankingandfinance(isitallbeneficialorpartly“parasitic”ontherealeconomy?)Forexampletherecouldbequestionsaboutthevalueofthemyriadofderivativetransactions,someofwhichmaybeforhedgingbutformanyarepurelyspeculative,suchascreditdefaultsswapsonstructuredproducts.ItisintriguingthattheheadoftheFSA,LordTurner,hasraisedtheissueofatransactionstaxonfinancialtradingthatwouldreducethescopeofsuchspeculation,andwouldlikelyreducetheoverallsizeofthefinancialsector.Othershavearguedtobreakupthemonopolypoweroflargebanks,whichalsothreatensfinancialstability.Calvinmightwellagreewithsuchpolicies,quiteapartfromcondemningascontrarytothe“lawoflove”themorepredatorylendingtosubprimeborrowers,manyofwhomhavelosttheirhousesduetorepossession.Indeed,theimpersonalityofthemarket,andespeciallywhenstructuredproductsbreakthelender/borrowerlinksuggestsaneedtomakefinanceagainmoreaquestionofpersonalrelationships–inlinewithscripture.Moralhazardisreducedincloserelationships,asinthehouseholdofbiblicaltimes.Afterthecrisisoftheearly1990s,banksinSwedenwereheldto“gowrongwhentheystoppedlendingonlytothosetheycouldseefromthechurchtower”.Thedownsideislackofdiversification.Toensurealevelplayingfieldthereisalsoaneedforenhancingtheunderstandingoffinancialproductsbyindividuals,whichmayrequireregulationofcomplexity.4Thehouseholdsector–privatedebt4.1TheissuefromaneconomicsperspectiveAlthoughwehighlightinSection1andAppendix1thattherearecommonfeatureslinkingthiscrisistothoseofthepast,theimportanceofpersonalsectordebthasbeenanoutstandingfeaturewhichwaslessmarkedincrisesofthepast.This,andthesocialissuesraisedbypersonaldebt,makeitessentialtoassessthistopicindetail.Itisself-evidentthatalthoughbankersbearsomeoftheresponsibilityforthecrisis,thehouseholdsectorwasnotobligedtotakeonmassivedebtburdens.Inotherwords,they–we-werecomplicitintheprocessofoverlending,indeedcelebratingthehousepriceandconsumerboom.Hence,wenowgoontoanalysethefinancialbehaviourofhouseholdsincountriessuchastheUK.Itisnoteworthyinthiscontextthat1/3ofEUconsumerdebtisintheUK.Everyindividualbearsonaverage£1000inconsumerdebtand£21000inconsumerplusmortgagedebt,farabovetheEUaverageineachcase.Thereseemstobeadifferenceinbehaviourmorewidelybetween“AngloSaxon”countriessuchastheUK,USandAustralia,andtheContinentofEurope.Householdsintheformeraremuchmorewillingtoincurdebt–andthebankstolendtothem.Asnoted,fromaneconomicviewpoint,individualsareassumedtowishtomaximisetheirownconsumptionasanoverallobjective,andminimiseworkasopposedtoleisure.Overaeconomicdevelopmentofacountryisabyproductoftheactivitiesofacasino(i.e.thefinancialmarkets)thejobislikelytobeilldone” 24lifetime,thereareperiodswhenincomeislow(whenstudying,earlyincareerandinretirement)andotherswhenincomeishigh(inmiddleage).Theaimofrationalindividualsisassumedtobetomaximiseconsumptionoverthelifecycleandalsopreventvolatilityinconsumption(e.g.collapseofconsumptioninoldage,lowconsumptioninyoungadulthood).Stabilityimprovesutilityoverallif,asiscommonlyassumed,thereisdiminishingmarginalutilityofconsumption(anextraunitofconsumptionwhenitisalreadyhighisworthlesstoanindividualthananextraunitatlowlevelsofconsumption).Then,theso-called“lifecycle”paradigmmostcommonlyadoptedbyeconomistsstatesthat,theconsumerdoes(andshould)rationallycarryout‘intertemporaloptimisation’toboostconsumptionwhenitislow.Givenanormalincomeprofile,i.e.risingovertime,withheavyexpenditureonhouseholdformationinyoungadulthood,thisislikelytomeanheavyborrowingearlyinthelifecycleandcorrespondingrepaymentslater.Suchborrowingmaybeagainstthesecurityofhumanwealth(consumerlendingagainstfuturewageincome)ornon-humanwealth(suchasmortgagesonproperty).Correspondingly,asregardspurpose,theborrowingmaybedirectlyforconsumptionorindirectlyforthepurchaseofinvestmentgoodsordurables(house,car,whitegoods)thatprovideastreamofconsumptionservices.Savinginmiddleageisthendecumulatedasapensionwhenthepersonisinretirementandincomeislow.Growthinincomeandassetpricesmayraisetheamountofborrowinginanoptimallifecyclepatternofincome,consumptionandsaving.Agrowingrealincomeincreasestheresidualpartofincomeoverandabovenecessitiesthatcanbedevotedtointerestpayments,whilegrowingwealthincreasescollateralfordebt.Notethatthereisnoreferenceineconomicanalysisofthelifecycletothewiderimplicationsofaccumulatingwealth,whicharelinkedtoindependence,security,statusandpower.Nordoesitrefertotheriskofdebt.Constraintsonborrowingmayalsoaffecttheamountofborrowingrelativetoanoptimallifecyclepattern.Inthiscase,consumersaresaidtobe“liquidityconstrained”andtheirconsumptionwillbecloselytiedtoreceiptsofincome,thoughassetswillalsobeavailabletodecumulateforconsumption.Suchliquidityconstraintstypicallyimplythathouseholdscannotconsumeattheleveldefinedbytheirlifetimeconsumptionplan,atthepointswhereheavyborrowingwouldberequiredearlyinthelifespan.Thisisseenbyeconomistsasundesirable,assuchliquidityconstraintsimplythatconstrainedconsumersincurwelfarelosses,owingtoforcedintertemporalrearrangementofconsumption,eventhoughconsumptioncanbemadeuplaterinthelifecycle.Anylooseningoflendingconstraintswillnaturallybemarkedbyasharplyrisingdebt/incomeand(toalesserdegree)debt/wealthratio,andfallingsaving,asobservedintheUKsincethe1980s.IntheUK,financialliberalisationinthe1980swasonestepineasingofsuchliquidityconstraints,notablybyincreasingcompetitioninthemortgagemarket.Butafurtherstepmorerecentlywassecuritisationanddevelopmentofglobalwholesalefinancialmarketswhichenabledbankstoraisefarlargervolumesoffundsformortgagelendingthanhitherto,withlessrestrictions(forexampleNorthernRockofferedloansof125%ofpropertyvalues).Noteagainthatsuchareleaseofconstraintsisgenerallyseenaspositivedevelopmenteconomically,sinceitenablesconsumerstoapproachtheiroptimumconsumptionpath.AnimportantaspectoverlayingthelifecycleintheUKisthebehaviourofthehousingmarket.Itmayitselfimposedynamicsonthepatternofdemandforborrowing.Inparticular,researcherssuchasHendry(1984)andMuellbauerandMurphy(1991)havefoundevidenceof‘frenzies’whererisinghousepricesenteraspiralwithdemandformortgages,partlydrivenbyfearonthepartoffirst-timebuyersofbeingleftbehind.Thisimpliesthatattimesrisingpricesmayinducepurchasespurelyintendedforprofitbyresale.Therehasclearlybeenan 25elementofspeculationinsomehousepurchasesintherecentboom,notablybuy-to-let,furtherboostingindebtedness.Thecounterpartmaybesharpreductionsinpricesfollowingsuchfrenzies,asseeninthecurrentcrisis.Goingbeyondthis,itisacknowledgedbyeconomiststhatindividualshavesometendencytopreferconsumptiontodaytothatinthefuture(calledpuretimepreference).Thismaybeduetomyopia,withpeoplebeingunabletoenvisagethefuture;finitehumanlives;riskstoanyformofsavingsuchasinflationorastockmarketcrash;andtheexpectationtobenefitfromthegrowthoftheeconomyasawhole.Thistendencymayoffsettheseemingrationalityofthelifecycle,leadingtotendenciestogointodebtbeyondthelevelneededforconstantconsumptionoveralifetime,sothatpeople“enjoytodayandsuffertomorrow”.Ontheotherhandacountervailingfactorshouldbetheinterestrateondeposits(orreturnonothersassets)thatencouragessavingtodayoverconsumption.ThecurrentworkinggenerationintheUKappearstobeunusuallyaffectedbythetendencytoconsumemorethanisconsistentwithlifetimeoptimisation.Indeed,economistsBarrellandWeale(2009)characterisea“profligatecohort”whichcloselyresemblesthisbehaviour.Theyhaveborrowedmassivelyforconsumption,bothviaconsumercredititselfandbymortgagelendingthatisactuallyusedforconsumption(“equityextraction”).Theydonotappeartobesavingsufficientforacomfortableretirement.ThisisofcoursefacilitatedbythefreeaccesstocreditintheUKfinancialsystem.ThispatternisnotobservedincountriessuchasGermany,FranceandItaly,wheresavingismuchhigherandborrowingmuchless–andwhereborrowingperseismuchmorerestrictedbythebanks.PossiblythisgenerationintheUKexpectsthatrisinghousepriceswillbailthemout,orthatthenextgenerationwillmakegenerouspensiontransferstothem.Buthousepricesmaywellcomeunderdownwardpressureincomingdecadeswhenthecurrentlarge“babyboom”generationretires,whileasdiscussedinSection5,thestateofpublicfinancesleaveslittleroomforanexpandedsocialsecuritypensionscheme,evenabstractingfromthe“ageingofthepopulation”.Ifthesepointsarecorrect,thenlowconsumptioninretirementwillbethelongtermdownsideofhighdebt.Theshortertermdownsideoffreeavailabilityofdebtisofcoursedefaultrisk,orevenifconsumersareableandwillingtorepaydebt,periodswhenshockstoincomeorinterestratesactuallyleadtomuchlowerconsumptionthanisdesired.Defaultriskisdependentnotmerelyondebtorincomebutalsoontheotherassetsinthebalancesheetoftheborrowers,andmacroeconomicvariablessuchasinterestratesandtheeconomiccycle.Giventhelinkofdebttoassetpricesandthepossibilityofbubblesthereisariskofoverborrowing,especiallywhenpeoplemisperceivelikelyfutureincomegrowth,ortheiremploymentsecurity.Economicanalysisofdefaultisassumedtobebasedonsimplecostandbenefitanalysisbyindividuals;costsofdefaultmayincludefinancialpenaltiesandalsorestrictedaccesstocreditinthefuture.Itisnotseenasamatterofmoraljudgement.Lendersmayrationallybeexpectedtochargehigherinterestratesonloanswithhighercreditrisk,orrationcredit,forexamplebyrequiringlowerloan-to-valueratios,toallowforthepossibilityofdefault.Therearealsodisincentivestodefaultsuchaslossofreputationandhenceabilitytoaccesscreditinthefuture,aswellasformortgageloansthepossibilityofrepossession.Ontheotherhand,competitionbetweenlendersisassumedtoensurethatinterestratesarenotexcessive.Intherecentboom,lenderstobuytolet,subprimeandevenconventionalmortgagesappeartohavebeencarelessaboutborrowerrisk,focusingonlyoninitialreturnsratherthanlongtermabilitytorepay.Asnotedabove,thismaylinktothefactloanswereoftensecuritised. 26Thereareofcoursedifferencesbetweenconsumercreditandmortgagecreditintermsofrisk.Collateralforhousepurchaseisimmediatelyavailableintheformofthetitle-deedstotheproperty.Comparedwithconsumercredit,therisktothelenderrelatestotheriskthat,owingtoregionalornationaldepression,thevalueofthecollateralwillhavefallenbelowtheoutstandingprincipaloftheloan,inwhichcasetheborrowermayhaveanincentivetodefault.Thereareobviouslyalsotransactionscoststoforeclosure.Accordingly,theriskofadefaultleadingtoalossforalendinginstitutionisgreater,thegreatertheproportionofahousehold’sdebtthatisconstitutedbyunsecuredconsumerlending.Butthisisreflectedinhighinterestratesoncreditcardlending.Inpractice,greaterquantitativelosseshavebeenmadeonmortgagecredit,perhapsbecausethelowerdefaultratemakeslenderscomplacentaboutabsoluteriskstobalancesheetsarisingfromcreditriskinrealestateloans.Tosumup,whileeconomicsoffersanunderstandingofthebehaviourofhouseholdsintherecentcrisis,thereremainpuzzlesfromthepointofviewof“rationaleconomicman”paradigm.Forexample,whyistheretheirrationalityofborrowinginexcessofthelifecycleoptimum,threateningloandefaultandrepossessionintheshortrun,andapoorpensioninthelongrun?Whywassuchavalueplacedonconsumption“now”thatsavingwasneglected?Wenowturntoatheologicalpointofviewtoseekfurtherinsights.4.2TheissuefromatheologicalperspectiveThestartingpointinassessingabiblicalviewofhouseholddebtistoconsideritsobjective,namelyconsumption(includingofhousingservices).WenotedinSection2.2abovethatwealthandconsumptionshouldnotbecoretohumanlife,ratherrelationshipswithothersandwithGod.Furthermore,thebibleisrepletewithwarningsagainstexcessinconsumption.Jesuswarnsagainstgreed(Luke12:15)asdoesPaul,whowarnsagainsttemptationsfrommoneyleadingtoruinanddestruction(1Timothy6:9-10).Thereisaneedtofocusonmoderationinconsumption,beingcontentwithwhatyouhave(seealsoBeaudoin2003),asforexampleisshownbyProverbs23:4“Donotwearyourselfouttogetrich;havethewisdomtoshowrestraint”and25:16“Ifyoufindhoney,eatjustenough—toomuchofit,andyouwillvomit”.Thewisepersoniswarnedtogetincomefirstbeforeconsumingas24:27“Finishyouroutdoorworkandgetyourfieldsready;afterthat,buildyourhouse.”Sider(1997),arguingsimilarlyforasimplerlifestyle,endorsesJohnWesley,whoarguedthatthesolutionforarichChristianistogiveawayallincomeexceptwhatisneededfor“theplainnecessariesoflife”,whilenonethelessmaintainingcapital,andaccumulatingitfurtherasnecessary.Thebasisisthecommandin2Corinthians8:13-15thatweshouldgiveenoughforeveryonetohaveadecentliving“Ourdesireisnotthatothersmightberelievedwhileyouarehardpressed,butthattheremightbeequality….”.ForSider,thebarrieristhe“unprecedentedmaterialluxuries”ofWesternsocietiesthattooquicklybecomesnecessities.Thismayentailwhatiscalled“spiritualpoverty”basedonaddictiontoconsumption.HouseholdsintheUKandUSevidentlydisregardedsuchadvice,borrowingheavilytoconsumeinexcessoftheirincome.Accordingly,biblicallyaswellaseconomically,theblameforcurrentdebtproblemscannotbelaidsolelywithbankers;allneedtoconsiderthesayingofJesus“donotjudgeoryoutoowillbejudged”(Matthew7:1).Borrowersfreelytookoutlargeloanswithaviewtoprofitingfromhigherhouseprices,extractingequityforconsumptionorlivinginhomesbeyondtheirmeans.Theseloanshaveoftennowbecomeamillstoneformany,ashousepriceshavefallenbelowthevalueofmortgages(“negativeequity”)orincomeisinsufficienttopayinterestonthedebt.Overthelong-term,heavydebt 27repaymentswillhinderabilitytosaveforretirement,anactivitythatmanyhouseholdsappearinanycasetohaveabandoned.Wenotethatexcessiveconsumptionanddebtisnotonlyofconcernfortheriskitgivestohouseholds’futurewell-beingbutalsoforitsside-effectsontheenvironmentandonthepoor.ThereisalsotheissuewhetherconsumptionandGDParegoodmeasuresofhappiness,healthandwellbeing(seeSDC(2009)).Wedonotfocusontheseissuesinthecurrentpaper.Theirrationalityofrecentconsumerbehaviourisperhapslessofasurprisetoscripturethantoeconomics,inthesensethatagenerationthatdisownsitscreator,followingonfromthefall,isnotlikelytoactinitsowninterestseither(Psalm53:1“Thefoolsaysinhisheart,“ThereisnoGod.”Theyarecorrupt,andtheirwaysarevile;thereisnoonewhodoesgood.”)Thelinkofatheism-orlukewarmfaith-tomaterialismisclearinProverbs30:8,whichsays“Keepfalsehoodandliesfarfromme;givemeneitherpovertynorriches,butgivemeonlymydailybread.Otherwise,Imayhavetoomuchanddisownyouandsay,‘WhoistheLord?’…”Thebibleisrepletewithwarningsaboutdebt.Akeyaspectisof“bindingthefuture”,inthesensethatdebtlimitstheflexibilitywehaveinlife,andcanultimatelyleadtoaformofslavery,aswasthecasefortheEgyptianfarmersduringthefaminewhohadtogiveuptheirlandtoPharaohinexchangeforfood(Genesis47:21).EquallyinNehemiah5:3-4,theIsraeliteswereforcedtogointodebt,orsellingtheirchildrenintoslaverytoobtainfoodfromtherichortopaytaxestotheking.Thereisabiblicalparallelofdebttosin,giventhatbothareenslavinganddestructiveifnotcoveredandeliminated(comparetheLord’sprayerinMatthew6:12andLuke11:4).Selby(1997)arguesthatdebtclosesdownthepossibilityofthefutureinbothOldandNewTestaments,andhencethepotentialoftheChristianlife.TheBiblealsowarnsgettingintodebtvoluntarily,pointingouthowtheborrowerisservanttothelender(Pr22:7).Hab2:6-7giveswarningsaboutspeculationanduseofborrowedfundstoenhancestandardsofliving,asitstates“Woetohimwhopilesupstolengoodsandmakeshimselfwealthybyextortion!Howlongmustthisgoon?’Willnotyourdebtorssuddenlyarise?Willtheynotwakeupandmakeyoutremble?Thenyouwillbecometheirvictim.”Thismightariseforexampleiftheassetsboughtwithborrowedfundsfallinvalueasinthecaseofhighlyleveragedhousingloans.Therearealsowidespreadwarningsaboutguaranteeingdebtsforothers,asinProverbs22:26-27and11:15).Thisisnotonlyduetotheriskoffinanciallossbutbecausetheborrowerislikelytobeborrowingbeyondtheirmeansifsuchanarrangementisneeded.Furthermore,therelationshipoftheborrowertotheco-signerisatriskinthiscase.TherearewidespreadprovisionsforwritingoffdebtintheBible,althoughtheytypicallyassumetheborrowerispoorandtheloanavirtualobligationowingtoadversefinancialcircumstancesratherthan,asinrecentyears,avoluntarytransactionmotivatedbyspeculationordesireforahigherlivingstandard.Anditisnotcleartheywereeverinstituted.TheJubilee(Leviticus25:23-28)everyfortynineyearswastoallowforperiodicreturnoflandtothefamilythatoriginallyownedit,thatmayhavehadtosellitduetodebt.TheSabbathyear(Deuteronomy15:1)everysevenyearsentailedreleaseofdebts,freedomofHebrewslaves,andlandleftfallowsothepoorcouldeat;leavingthecornerofafieldunharvested.Therewastobenotakingofamillstoneduetodebt,whichwouldthreatenafamily’slivelihood.Deuteronomy6:15urgesIsraelitestocancelanydebtotherthanonetoforeigners.IntheseprovisionsGodoverridesunlimitedpropertyrightsfortherichwithhisownhigherjustice,sinceheisthemakerofallthings(Ecclesiastes11:5). 28Morebroadly,Godcreatesamechanismof‘structuraljustice’,givingrisetoentitlementsforthepoor,tooffsetthetendencyoffallenhumankindtoexploitothers’misfortunes.Asnoted,Matthew’sversionoftheLord’sprayertalksaboutforgivingdebts,asweforgivedebtors(Matthew6:12).PaulurgestheChristiansinRomans13:8toletnodebtremainoutstandingamongthem.Selby(1997)arguesthatthe“NuncDimittis”ofSimeoninLuke2isrelatedtoreleasingaslavefromthepast,akintoreleasingadebtor,inthecontextofthebroadthemeofredemption.Similarly,banksmayneedtoofferdebtforgivenesstothoseinconsumerdebtbeyondtheirabilitytorepay,oratleastofferinterestholidaysorextendedrepaymentperiodsformortgageborrowers.AwiderobligationrestsonChristianstocarefortheneedy,whocannotsustainconsumptionduetoshocks–orfollowingtheirownfinancialerrors(Selby1997).Wearecommandedtogivetothosewhohaveimmediateacuteneedsfromhungerandlackofclothingandshelter(1John3:16-18)asdocharities.Butatothertimeslendingisseenasanappropriateresponse,asinDeuteronomy15:7-8“freelylendhimwhateverheneeds”andLuke6:30-35albeit“withoutexpectingitback”.Thisistoenableindividualstomaintainselfrespect,toacknowledgetheirresponsibilitytocareforthemselves,andtoaffirmdesireandhopetorepay.MeanwhilethelenderisactingasGodwould,beingwillingtoforgivedebts.Thispointdoesnotextendtothosestillabletorepaytheirdebtsbutrefusingtodoso.Forthem,theBiblestressestakingresponsibilityforactions–thereisanobligationonborrowerstorepaydebtsincurred(Ps37:21)“Thewickedborrowanddonotrepay,buttherighteousgivegenerously.”Thebibleacceptstheuseofcollateral,implyinganexpectationofrepayment(Deuteronomy24;10-13).Bankruptcyshouldnotbeseenasaneasyoption,andespeciallynotiftheborrowerknewfromthetimeofborrowingthattheirfinancedwereoverstretched.Evenifisforcedintoinvoluntarybankruptcy,theScriptureenjoinkeepingone’sword(Numbers23:19,Hebrews6:13-20).Sotherecouldbeanattempttomakeamendsforearlierlossesforthelenderoncetheborrower’sfinancialsituationimproves.Responsiblebehaviourincludesalsoavoidingtheneedforassistance,ifitlieswithinourmeans.Forexample,wehaveseenthatacorollaryofthedebtbingeisinadequatesavingforpensionsandariskofbeingaburdenonothers,whichPaulwarnsChristiansabout(2Thess3:10-12).The“profligatecohort”seeminglyrelyingonhouseprices,socialsecurityandthegenerosityoftheirownoffspringtobailthemoutisactingirresponsiblyonthisbasis.James4:13-17,besidesillustratingthearroganceofbankers,isrelevanttothe“presumptiononthefuture”thatnotsavingsufficientlyentails.Thecommandtowriteoffdebtsafter7yearsinDeuteronomy15:1isalsoalimitonthedurationofdebts,assumingthelenderwantedtoretrievehisassets.Thelenderwastoknowthatifheloanedmoneythatcouldnotreasonablyberepaidwithinthe7years,thiswouldbewrittenoff.Accordingly,thelenderwouldbeincentivisedtocareforthelong-termbestinterestsoftheborrower,wherethelatterisassumedtobeinapositionofrelativeweakness.Notlendingtoomuchandbeingallowedtoextendtermsincaseofdifficultyareamongtheresponsesthatlendersshouldadopt.Wenotethatwithfreeavailabilityofcredit,housesmaybepricedoutofthereachofthoseonlowincome,i.e.thereareexternaleffectsaswellasdirecteffectsofindividualdebt.Thisisakintothepropheticconcernaboutlandholdingsandpoverty.Itcouldbepersonal,asinthecaseofseizureoflandfromthepoor(Micah2:1-2)andstealinglandbymovingboundarymarkers(Proverbs23:10).Or,itcouldbe“structural”asinthecaseoflegalisedoppressionofthepoor(Amos2:6-7),acorruptlegalsystem,andunjustdecreesfavouringtherich(Isaiah10:1-2),leadingtoconcentrationoflandholdings(Isaiah5:8).Itisclearthatthereisan 29upcominggenerationwhohavelostoutmassivelyfromthehousingbubblesimplybecausetheycannotaffordhouses,andarehavingtorentorstaywithparents(aswellasbeingburdenedwithstudentdebt).Allofthisisredolentofinjustice.Evenwiththefallsinhousepricestodate,theyremainveryexpensiverelativetoaverageincome.Theoldergenerationandthebankshavearesponsibilityforthis.Afallinhousepriceswouldhelptoresolvethesituation,atacostinparticulartocurrentindebtedhomeowners.Onthepositivesideofdebtistheunderlyingbiblicalvalueofhavingproperty/housing,asinthefutureenvisagedinMicah4:4.Indeed,SchluterandClements(1986)arguethattheOldTestamentimplieseventodaythateachfamilyshouldownaplotoflandinperpetuity,withthreegenerationslivingtheretogether.Overall,theimplicationisthatborrowingforinvestmentpurposesasinmortgageborrowingismorebiblicallyacceptablethanconsumerborrowing“takingthewaitingoutofwanting”.Butwehavejustarguedthathousepricesareexcessiveandremainso,thuslimitingpeople’sabilitytogetintothehousingmarket.OneshouldnotexaggeratethesupportintheBibleforpropertyrights.TheconceptofJubilee,thedebtSabbathaftersevenyearsandjustice,meansthatpersonalpropertyissubordinatedtotherelationshipwithGod.Brueggemann(1977)arguesthatthedebtSabbathforexampleaffirmsthathumansocietyisnotbasedfundamentally“onbuyingandselling,owningandcollecting…peoplelikelandcannotbefinallyownedormanaged”.Jesus’attitudewasfinallyoneofrenunciationofproperty(Luke12:22-34),tellingfollowerstoignoreeconomicsecurityandavoidpursuitofwealth–notleastinthelightofthecomingendoftheworld,andjudgementafterdeath.AnimportantissueiswhethertheBibleforbidsinterest(theissueofusury)(Cloughetal2009).UsuryisawordbasedontheHebrewto“bite”or“exact”somethingfromsomeone.Usuallyitentailsdebtinthecontextofapersonaltransaction,andnotacompetitivecreditmarketaseconomicsassumes.TheimmoralityisthatwhenthelenderhasbeenblessedbyGod(withsufficientresourcestolendmoney)thentheyshouldofferthesamekindnesstoneedyneighbours.Exploitationofthepoorbytherichiscentral,inotherwords,totheconceptofusury.IntheBible,interestisgenerallytreatedasusurious,unlikemodernusagewhichseesusuryasaformofexcessiveinterest.Nehemiah5:7-11condemnsinterestexactedfromfellowIsraelitestopayforgrain.Leviticus25:33statesthatinterestshouldnotbecharged“ifoneofyourcountrymenbecomespoorandisunabletosupporthimselfamongyou”.Theinterestisthentakinga“bite”fromfutureincome,threateninglongtermviabilityofthehouseholdofthepersoninquestion.ItiswidelystatedinScripturethatloanstothepoorshouldbeatzerointerestoutoftheheartoflovethatGodhasforus,andGodwillrewardthelender(Exodus22:25,Proverbs19:17).AparalleltotheabuseshighlightedintheBiblecouldbetheheavilymarketedstorecardsthatdemandhighinterestandareoftendirectedtothoseonlowincome.Andwehavenotedabovehowdebtsofanykind“bite”intofutureincome,alsothreateningpensions.Thefocusoftheaboveisonloanstothedistressed,seealsoLeviticus25:35-36.Ontheotherhand,Ezekiel18:8intriguinglystatesofarighteousmanthat“Hedoesnotlendatusuryortakeexcessiveinterest”suggestingmoderateinterestisacceptable.ItisevidentlyacceptableintheBibletodemandinterestfortradewithaforeigner,formutualbenefit(Deuteronomy15:3).BanksandmoneychangerswereacknowledgedintheNewTestament(Matthew21:12,25:27,Luke19:23)asdiscussedInSection3above.PassagessuchasthishelpedCalvintooverturnthemedievalbanoninterestaslongasitwasforcommercialpurposes(“tomakeconcessiontothecommoninterest”).Butsincethen,thedistinctionoflendingforcommerce 30orconsumptionortorichorpoorhasbeenitselfblurredinawayCalvinhimselfmightnotagreewith.Furthermore,bankersremainsubjecttoGod’sjudgement,asdiscussedinSection3above.4.3ConfrontationandreconciliationAsforbanking,weconsideraccesstocreditessentialtohouseholdwelfare,andtheissue,ratherthancurtailmentofaccess,iswhetheritcanbedistributedwithlessriskoffinancialdistressforhouseholds.Theoptimisationofconsumptionoverthelifecycleaswellasthebiblicalconcerntoavoidexcessivedebtbothseemtosuggestaneedforlimitstobeputonhouseholddebt.Ifborrowerscannotbereliedupontoberesponsible,asthe125%mortgagestakenoninrecentyearssuggests,thenthisisanobligationforthelenderstosetlimits,andpossiblyforpublicregulation.Thiscouldbevialimitsonmortgagegearing(loantovalue(LTV)ratios,orinterestpaymentstoincome)forexample.ThisisthecaseincountriessuchasGermanywhereitisdifficulttoobtainamortgageloanformorethan80%ofthepropertyvalue,duetotheinabilityofbankstosecuritisehigherLTVloansasmortgagebonds.Ifthereweresuchlimitsondebt,whilehousepricesremainhigh,manymorepeoplewouldstayathomewithparents,asinItaly,orwouldrent.Thejusticeofthiscouldbequestionedfromabiblicalaswellasasocialperspective.Acomplementaryapproachmighthencebegreatertaxationofthehousingmarket,toreducetheattractivenessofhousingasaninvestmentandtherebyreducehouseprices.Alandtaxorataxonhousingservices(whichdidonceexistintheUK)wouldbewaystodothis.Anotherwaytoachievethisissimplytoreleaseplanningrestrictionssohousingsupplycouldcatchupwithhousingdemand.Fallsinhousepriceswouldtendtobenefitthoseunabletoaccessthehousingladder,althoughtherewouldbestrident“losers”.ItisnotablethatinGermanytherehasbeenverylittlehousepriceinflationinthepastdecade(althoughthepriceofahouseistypicallyhighduetobuildingstandards).Givenitsgreaterusebythepoor,andhencethehighdefaultrateitcauses,limitationsonuse18ofconsumerdebtmaybeevenmoreappropriate.Itafteralldoesnotprovideanassettopaybackthedebt,andisthemostproblematicforthepoorermembersofsociety.Giventhewayconsumerdebtentrapspeople,itcouldbeseenasakintothesellingofabirthrightoffinancialfreedominthefutureforaworthlessmeal,asinthestoryofJacobandEsauinGenesis25:29-34.Individualsmustberesponsiblefortheiractions;butthelendersareequallyculpable.Theconventionalbanksdonotmerelyoffertheseproductsandcompeteonprice-theyspendmanymillionsactivelyencouragingthebuildupofdebt,especiallyamongstthepoorercreditswherethegreatestmarginsaretobemade.Creditcardssentunsolicitedinthemail–whatwouldhavebeenunacceptablebehaviour20yearsago-isputtingpeople“inthewayoftemptation”assurelyastheserpentdidtoEve.AndGoddidnotabsolvetheserpentofblamewhenhecastAdamandEveoutofEden.Thisformofcreditisinourviewclosesttothebiblicalviewofusury.Alimitoninterestrateschargeablewouldbeonewaytoreduceconsumerdebt,sincebankswouldthenbemuchmorecarefulinlendingonthisbasis,theriskpremiumtocoverlossesbeinglower.Oralternativelycreditcardmaximacouldberelatedcloselytoincomeandacentralcreditregister(whichalreadyexists)usedtoensurethatindividualsdonotobtainmultiplecardsandsobreachsuchlimits.Athirdapproachwouldbetolimitadvertisingforconsumercredit,thushelpingto18Thesepointsapplyyetmorestronglyto“HomeCredit”theformofhighinterestdoorsteploansusedbythepoorestmembersofsociety. 31reversethesocialperceptionthatitisappropriatetousecreditto“haveitallandhaveitnow”,whichthefinancialindustryhasbeenfosteringsincederegulationinthe1980s.Wenotethatlimitsofconsumercredit,orevenbetterashiftinsocialperceptionstowardsamoretraditional“savefirsttobuydurables”viewwouldhavemultiplebenefitsforsociety.Havingbeenreintroducedtothebenefitsofsavingtobuygoods,individualswouldbemuchmorewillingandabletosavefortheirownretirement,whichwehaveseenisbeingeroded.BalancesheetsresultingwouldbemorelikethoseforhouseholdsinContinentalEurope,andwouldbebothmorerobusttoshocksandoffersustainablelevelsofconsumption.Aseconomicsandthetheologybothconsiderthatdebtistoohigh,thisraisestheissueofwhetherthecurrentburdenofdebtcanbereducedandifsohow–whatsortofJubileeisfeasible?(Ferguson2008).Unfortunatelythosewhicharefeasiblewouldcausemajorlossestoothersinthecommunity.Notably,whileinflationwoulddriveupwagesasdebtfallsinrealterms,thiswouldtendtoinflictlossesonsavers,whomaybepensionersreliantontheirinterest.Or,ifbanksweresimplytoforgivedebtsandbecamebankrupt,thelosseswouldeitheragainbeinflictedondepositors,ormorelikelyonthepublicdebt,asdiscussedinSection5below–andthuslargelyonfuturegenerations.Economicsseesinterestasasinequanonforbeneficialeconomicdevelopment.Inourview,evenfromabiblicalpointofview,thedebateonusuryshouldnotoverflowtoallformsofinterest.Itwouldprohibitsafeformsofsavingfortherelativelybadlyoffandpensioners,leavingthemtorelyonvolatileequity-typeproducts.Nevertheless,non-debtformsofhousingfinancecanbedevisedandareworthyofattention.Aformofequityloanasin19Islamicbankingcouldbedevelopedasanalternativetotraditionalmortgagedebt.Sharia-compliantproductscurrentlyavailableintheUKarebasedonIjara,MurabhaandMusharaka20methods.21Forexample,HSBCofferMusharakamortgages.Intheirwords,“wewillbuythepropertyjointlywithyou.ThepropertywillbeheldintrustforbothofusbyHSBCTrustCompany.Asyoumakemonthlypayments,yourshareofthepropertywillincreaseasthebank'ssharedecreases.Assumingyoupaya35%deposit,atthestartoftheagreementthebankwilltypicallyhavea65%shareandyouwillhavea35%share.Witheachpaymentyoumake,youwillpayusrentforuseofthebank'sshareofthepropertyandacquireanadditionalshareforyourself.Onceallthepaymentshavebeenmade,youwillownallthesharesandthepropertywillbetransferredtoyournameonyourinstruction.Youcanalsomakeadditionallumpsumpaymentswhichwillallowyoutoacquireadditionalsharesintheproperty.YourhomeisatriskifyoudonotkeepuptherequiredpaymentsandcomplywiththetermsofyourHSBCAmanahHomeFinanceplan.”Thelastpointisworthnoting.ItisnotthecasethatIslamic19Accordingtowww.islamicmortgages.co.uk,theoverarchingprincipleofIslamicfinanceisthatallformsofinterestareforbidden.TheIslamicfinancialmodelworksonthebasisofrisksharing.Thecustomerandthebanksharetheriskofanyinvestmentonagreedterms,anddivideanyprofitsbetweenthem.20UnderanIjarafinanceplan,thecustomerchoosesthepropertyandagreesapricewiththevendorinthenormalway.Thepropertyisthenpurchasedbythefinancier,whotakesitslegaltitle.Thepropertyisthensoldontothecustomerattheoriginalprice,withpaymentspreadoveranagreedperiodoftime.Duringthattime,thecustomeralsopaysthefinancierrentfortheuseoftheproperty.Oncetheagreedperiodoftimehaselapsed,ownershipofthepropertyistransferredtothecustomer.UnderaMurabahaplan,thecustomerchoosesthepropertyandagreesthepricewiththevendorinthenormalway.Similarly,thefinancierthenpurchasesthepropertyfromthevendor,butonthedayofcompletionitisimmediatelysoldontothecustomeratahigherprice.Thehigherpriceisdeterminedbythevalueoftheproperty,andthenumberofyearsthatthefinancierallowsthepurchasepricetobepaidoverandtheamountofthefirstpayment.Thecustomerthenmakesregularmonthlypaymentsuntilthepurchasepriceispaid.21Seehttp://www.hsbc.co.uk/1/2/personal/travel-international/hsbc-amanah/amanah-home-finance/how-it-works 32mortgagesareriskfreeandmaynotevenbesaferthannormalones,atthesamelevelofgearing.Owingtotheircomplexitytheymaybecostlier.Thechurchhasaclearroletoplayasofferinganalterativeculturetothatofdebtandconsumption.Giventhewayindividualsseemtomisjudgeeventheirownbesteconomicinterests,thiswouldbeofgeneralbenefit.Forexample,thechurchneedstobeacommunitythathelpsmembers,akintothechurchofActs2:44-45.Individualsneedtofeelaccountableandavailabletooneanother,andsupportoneanotheragainstpovertyarisingfromdebt.Thereisalsoaquestionofspendingprioritiesforthechurch,withmoreforthepoorandlessforopulentbuildings;andavoidanceofdebtforbuildingprojects.Thechurchisunabletoinsistongovernmentslegislatingagainstdomesticpovertyunlessitshowsanexample,actingassaltandlight(Matthew5:13-16).Again,whereastheeconomicparadigmisthatconsumptionisalwaysgood,recentexperiencehasshownitsrisksifpursuedtoexcess,whileScripturecautionsagainstgivingittoomuchprominenceinourlives.Churchesneedtopreachthismatter.Consumerism,definedbyGregg(2009)as“attachingtoomuchsignificancetomaterialgoods,eventotheextentofdefiningourselvesbythenumberandtypeofourpossessions,andmeasuringourworthintermsofwhatwehavecomparedtoothers”isakeychallengeforChristiansaswellasforsocietyasawhole.Wehavelostthevirtueoftemperance,which“moderatestheattractionofpleasuresandprovidesbalanceintheuseofcreatedgoods”(Vincent2008).ThismeansChristiansneedtoassesswhethertheyarehavebeenabsorbedbytheconsumersocietywithouttakingnote,inparticularwhethertheyareborrowingresponsiblyornot.Temperanceneedstobeproclaimedfromthepulpit.Thechurchshouldalsocritiquethesocialpressuresthatinducedoverindebtedness,assessingwhetherbanks–andthegovernmentviastudentloans-createaformofstructuralevil,asocialnormthatpeopleshouldgoheavilyintodebt.ThenthereshouldbefinancialeducationfromthechurchwithanethicalbasissuchastheCAPMoneyCourse,whichteachesavoidanceofdebtanduseofcashasameansofrestraintinexpenditure.Thereisaneedforteachingdiscernmentindebtandconsumptiondecisions.Andfinallythechurchmustmodelthevirtueofmercy,ofcaringforthosewhohavesufferedmisfortuneduetodebts,unemploymentorotherconsequencesofthecrisis.OneaspectisdebtcounsellingwithinthechurchorbycharitieslinkedtochurchessuchasCAP.Christianscanbeencouragedtoprovidefinancetooneanother,withinfamiliesandcongregationstoavoiddebt(Mills2009).Butmoregenerallythechurchmustshowmercybypastoral,personalandfinancialsupportforthosewhoarenowweakandvulnerableowingtodebtproblems.5Thegovernmentsector–publicdebt5.1TheissuefromaneconomicsperspectiveGovernmentdebtissuesonlyarisewhenthereisanimbalancebetweengovernmentrevenueandexpenditure,regardlessofthesizeofthepublicsector.Nevertheless,backgroundtotheissueofpublicdebtistheconflictbetweenthe“liberal”economicapproachversusthe“socialmarket”,whoseprimaryfocusisthesizeofgovernment.Thedifferencehingeslargelyonwhetherthereislaissezfaireorbenefit-based“safetynets”forthosefacingdifficultiesinlife.Theformerarguesforasmallpublicsector,focusedonareassuchaspoliceanddefence,whilethelattermightincludesocialsecurity,pensionsandpublichealthcare.AsnotedinSection2,apureutilitarianapproachtoeconomicsandeconomicpolicyoftenleadstoapreferencefortheformer,whileinclusionofsomewiderpoliticalelementsuchasasocialcontractmaytendtoencouragethelatter.Inpractice,theminimumoptionisrarely 33takenup,butthetensionremains,e.g.betweentheUSandJapan,withsmallpublicsectorsandEUcountrieswithlargeones.Theviewtakenoflaissezfaireaffectsviewsbothofthesizeofgovernmentperse(i.e.whatshareofGDPshouldbetakenupintaxationandgovernmentexpenditure)andthedegreetowhichtheeconomyisseenasself-rightinginresponsetoshocks.Thelaissezfaireapproachtendstosuggestthattheeconomywillrecoveranddeficitsanddebtsarenotneeded,whilethesocialmarketapproachiswillingtospendthewayoutofrecession.Onthesocialmarketview,fiscaldeficitscanbeseenasanoptimalresponsetocyclicalweakness,buoyingtheeconomywhendemandfalls.Andthisiswhathashappenedinthecurrentdownturn.Tosomeextentthiswilltakeplaceviatheoperationofautomaticstabilisers,whichentailadeclineintaxrevenueandariseinbenefitpaymentswhenthereisadownturn.Butalsogovernmentsmaycarryoutdiscretionaryfiscalboostssuchaspublicinvestmentprogrammestofurtherbuoytheeconomy.Allsuchdeficitswillgeneraterisesinpublicdebt,whichistypicallyintheformofbondstoberepaidinthefuture.Inthecurrentdownturntherehasalsobeenquantitativeeasingbycentralbankswhichisineffectgovernmentsprintingmoney,withariskoffutureinflation.Certainly,ifinflationweregeneratedthiswouldbeconsistentwithbehaviouroverthepasthalfcenturywhengovernmentshaveineffectexpropriatedbondholdersbyhighinflation,whichmassivelyreducedtherealvalueofbonds.Theinflationofthe1970sinparticularinflictedcatastrophiclossesonholdersofUKgovernmentbonds.Thereisaclearincentiveforgovernmentstoundertakethisagain,whichmaybeincreasedbythepartialuseofmoneyfinancing.Thereareargumentsastowhetherdeficits,especiallyifbondfinanced,willactuallyhaveanimpactonaggregatedemand,orwhetherhouseholdsandfirmswillreducetheirconsumptionandinvestmenttoallowforthefuturetaxestorepaydebt.Sucheffectsmaydependonhowmuchconfidencethepublichaveinthegovernment’sabilitytostabilisetheeconomy.Anadditionaloffsettotheabilityofdeficitstogeneratearecoverymayariseiftherearespillovereffectsofrisingpublicdebtonotherborrowersbyrisinglongterminterestrates,whichdiscouragesbusinessinvestmentinparticular.Suchrisesininterestratesmaybeparticularlylikelywhenforeignersarethemainholdersofdebtorwhenholdersfearthatthegovernmentwillgenerateinflationtoavoiditsdebtburden.Abroaderissuewhicharisesforpoorercountriesistheissueofunsustainableforeigncurrencydebtstotheinternationalcapitalmarkets,andrichcountrygovernments.Economistsdistinguishbetweencyclicalandstructuraldeficits,wherethelatterarepersistentevenwhentheeconomyattainsitsnormalrateofgrowth.Structuraldeficitsthreatencontinualrisesinpublicdebt,whichareofparticularconcerngiventheoncomingchallengeofpopulationageing.TheUKgovernmenthasbeenwidelyaccusedbyeconomistsofrunningastructuraldeficitintheboom,meaningthatthefiscalpositionwasweakerthanthatwhichisconsistentwithbalancedbudgetoverthecycle.Thisinturnmayhavemadeeconomicgrowthandthecredit/housepricebubblelarger.Itisarguedthatthiswasaconsequenceofthedesireofthegovernmenttohaverapidspendinggrowthforelectoralreasons,withoutraisingthenecessarytaxation.Thereareclearparallelswiththehouseholdsector’sdesiretoconsumebeyonditsmeansbyborrowing.GiventhelimitedamountofsavingintheUK,boththegovernmentandthehouseholdsendedupborrowingfromforeigners,directlyorviathebanks.Fiscalpolicyhasaspecificroletoplayinabankingcrisis–namelyrecapitalisationofbankswhichentailsastepriseinthelevelofpublicdebt.Andthishasbeenamajorexplanationoftheriseinpublicsectordebtsincelastyear.Butthedepthoftherecessionhasalsoledto 34majorrisesinpublicdebtduetoautomaticanddiscretionaryfiscaleasing.Itisanticipatedthatcutsinpublicspendingwillbeneededincomingyearstobalancethegovernment’sbooksinthecontextofmassivegrowthindebtandslowoveralleconomicgrowth.5.2TheissuefromatheologicalperspectiveTheBiblestartsfromtheideathatthestateandgovernmentshouldingeneralbesupportedbycitizensasinstitutedbyGodtobeasourceofstability(includingeconomicstability),being“God’sservanttodoyougood”seeRomans13:1-7.Alsothatpaymentoftaxesareanobligation,asJesusstatesinMatthew22:17-21.Therearetheologicalargumentstohelpthepoor–includingthoseaffectedbydebtproblems-thatapplyatthelevelofgovernmentaswellasforindividualsandareconsideredbymanytosupportasocialmarketapproachtofiscalpolicy.TheseimplyawelfaresystemandprogressivetaxationcanbeseenasBiblicallybased,providingaformofstructuraljusticeinsociety.Indeed,rulersareheldresponsibleforinjusticetothepoor(Proverbs28:3).TheservantinIsaiah,interaliaidentifiedasthenationofIsrael,Christhimselfandhischurch,iscalledtobringjusticetothenations(Isaiah42:1-4).ThiscouldbeseenasconsistentwithRomans13:1-7,oftenseenasmandatinga“minimalstate”ifthepursuitofjusticeisseentoincludejusticetothepoor.Asregardsborrowing,astateinasurpluspositionisblessed(Deuteronomy15:6,28:12-13),notablyifdebtisforeign.15:6forexamplestatesthat“theLordyourGodwillblessyouashehaspromised,andyouwilllendtomanynationsbutwillborrowfromnone.Youwillruleovermanynationsbutnonewillruleoveryou”.Theimplicationisthatthesurplusnationhasawhiphandoverthedebtor,ashasbeenthecasefordevelopingcountrydebt-andcouldyetbethecaseforadvancedcountrieswithveryhighlevelsofpublicdebt.TheEastAsiancountriesarethecreditorsofcountriessuchastheUSandtheUKandthiscouldyettranslateintogreaterpoliticalinfluence.Theargumentsabovefavourapublicsectorthatseekstocorrectsomeofthegrosserinequalitiesinincomeandlifechancesthatwouldbegeneratedbythefreemarket.Butitneednotimplyaneedtorundeficitsonaverageoverthecycle.Rather,Biblicalprudenceassetoutabovewouldsuggesttobalancethebooksoverthecycle,whilerunningdeficitsforstabilisationpurposesduringrecessions.Theprofligacyofgovernmentsrunningstructuraldeficitscouldbecomparedtothoserulerscriticisedfortheirextravaganceinthebible(Jeremiah22:7-23forexample).Adownsideofthecurrentgrowthindebtisthatthefuturegenerationsoftaxpayerswillbeobligedtofinancewhatcanbeseenaserrorsbycurrentgovernment,bankersandborrowers.TheBiblespeaksofintergenerationalfairnessandthe“sinsofthefathersbeingvisitedonthechildren”,paralleltowhichisthatourchildrenwillhavetorepaydebtsweincur.Jeremiah31:29andEzekiel18:2suggestthatitisnotGod’swillthatpunishmentshouldcontinuedownthegenerations,andsimilarlyweshouldnotplaceburdensonfuturegenerationsthatwedidnothavetobear.Equally,intergenerationalfairnesscouldbeseenascontrarytothescripturalgoldenruleofMatthew7:12“dotootherswhatyouwouldhavethemdotoyou”.Thisisthesamegenerationthathasalsosufferedfromtheriseinlandprices,aswellasadverseconditionsinstudentfinance,mandatedbythegovernment,wherethe“fathers”benefitedfromgrantsbuttoday’s“children”havetoincurmassivedebts. 35Alternatively,iflenderstothegovernmentareexpropriatedbyinflation,thenthisisakintofalseweightsandmeasuresthattheprophetsrepeatedlycondemned(Micah6:11)asdoestheLawofMoses(Leviticus19:36).5.3ConfrontationandreconciliationIscurrentfiscalpolicyplacingtoomuchofaburdenonfuturegenerations?Itcanbearguedthattherescueoftheeconomyfromthecrisisiswarranted,butthequestionishowloosewasfiscalpolicyaswewentintothecrisis.Therewouldappeartohavebeenastructuraldeficitduringtheboom,whichmeansthattheoveralldeficitnowismuchlargerandmoredifficulttoremovethanwouldotherwisebethecase–andthedebtbuild-upmuchgreater.Underlyingthestructuraldeficitisawillingnessofgovernment,forelectoralreasons,nottolevysufficienttaxtofullyfinancethelevelofpublicexpenditurethattheychoosetooffer.Thisiseconomicallydestabilisingandcontrarytothebiblicalinjunctiontopromotestability.Equallytobecriticisedisanyrealisationoftheriskthatthegovernmentdebtwillbe“monetised”–erodedbyinflationwhichwouldhavemajorredistributiveconsequences.Indeed,governmentcanbeaccusedofmisleadingthepopulationbyitsearlierfiscalpolicyofstructuraldeficitintheboomyears.Byboostinggrowth,itmadepeoplemorewillingtogointodebt,byleadingthemtobelievetheirincomegrowth–andhousepriceappreciation-wouldcontinuetobehigh.ThiswasaggravatedbystatementsbytheUKgovernmentthat22sustainablegrowthwasasmuchas2.75%whenrespectedindependentforecastersconsideredittobe2.4%.Thedifferenceisverysignificantoverthelongtermandmeantindividualswerenotcorrectlyinformedaboutthelongtermrisksoftheirbalancesheetpositions.Therearesimilarcriticismstobemadeintheshortterm.Quiteapartfromevidencefromcrisesinothercountries,UKexperienceof1974and1991showedthatcredit-drivenboomsaswasclearlyunderwayupto2007areonlytemporary,andthedownturnhighlydestructive.Accordingly,thegovernmenthadaresponsibilitytowarnthepopulationaswellasadjustingfiscal,monetaryandregulatorypolicytodeflatetheboom.TodootherwisewouldbelikethefalseprophetsofJeremiah,whoproclaimed“peace,peace,whenthereisnopeace”(Jeremiah8:10-11).Governments,ineffect,seemtohavesoughttocreatetheillusionthattheeconomycanberunona“no-risk”basis,whichhelpedgeneratethebehaviourofhouseholdsandbankershighlightedinSections3and4.Ineffect,suchabeliefwouldleadpeopletofeelinsulatedfromtheconsequencesofpoordecisionsandbadinvestments.Inmoredetail,itcanbearguedthatgovernmentsshouldhavewarnedthatwhenthebulkofthepopulationhasbecomefullygeared(i.e.havingdebtserviceobligationswhichleftnodisposableincomeafterongoingneeds),thegrowthofpersonaldebtandhenceconsumptionwouldstall.Thereisinitiallyasharpcorrection(asweseetodayintheUSandUK)asthosepeoplewhohavejobstrytorebuildtheirbalancesheets,andprivatedemandactuallyfalls.Thisaffectsboththestockmarket,asstockmarketvaluesrepresentthenetpresentvalueoffuturesalesgrowthandthehousingmarket,alsohittingpersonalwealth.Eveninthemediumterm,consumptioncanforsometimebeexpectedtoreverttothestatusquoantebeforefinancialliberalisationintheearly1970s,whenconsumptionroseasfastasaverageearningsandnofaster.Futuregovernmentsmustbemoreforthcominginwarningaboutthiscycle,aswellasavoidingfiscallaxity.Possibly,assuggestedbyMills(2009)anindependentfiscalcommissioncouldbeappointedtoensurethatgovernmentsrunresponsiblefiscalpolicies.22SuchastheNationalInstituteofEconomicandSocialResearch. 36Inassessingfiscalpolicy,itcanalsobeaskedwhetherthetaxsystempromotesthetypeofprivatedebthighlightedasaprobleminSection4.Certainlythisisthecaseforcompanieswheredebtistaxdeductiblewhileequityisnot.Thistaxbiashascontributedtotheriseincorporatedebtandarguablyledthelevelofbankruptcytobehigherthanitwouldotherwisebe.WhereasthetaxdeductibilityofmortgagefinancewasabolishedintheUKsometimeago,itcanbearguedthatthelowleveloftaxationofowneroccupiedhousinghascontributedtothehighlevelofhouseprices,andhenceofmortgagedebt.Inthiscontext,wealsoarguethatstudentdebtasmandatedbygovernmentisconditioningpeopletoexpecttobeindebtforalltheirlives,weakeningtheirresistancetocreditcards,excessivemortgagesetc.Therescueofbankswasevidentlynecessary,butthereisaneedforgovernmentstoactsothatsuchrescuesarenotneededagain.Followingthepointmadeabove,thesafetynetalsoledbankerstofeelinsulatedfromtheconsequencesofpoordecisionsandbadinvestments.Thedifficultyisthata“safetynet”leadstoriskybehaviour,ashighlightedinSection3,butalackofasafetynetexposestheeconomytoextremerisks.Thegenerosityofthecurrentapproachcouldstoreupgreaterrisksforthefuture,Hencethecurrentproposalsincludingforhighercapitaland“livingwills”forbanksincasetheygetintodifficulties.Regulationmaynotbethesoleanswer,assuggestedinSection3.3–oneresponseinlinewithjusticeisthatthereshouldbeno“freepardon”forbankerswhoseinstitutionshavefailedandwhoprovetobedirectlyculpable,asseemedtobethecaseforFredGoodwin.Likebanks,thepubliccannottreatthegovernmentassomethingautonomous,thisisagainidolatry.Rather,weallhavetheresponsibilitytounderstandtheseissues,takeaviewandpressforitinpublicandviaMPs.Andtostandinaccusationwhenwediscoverwearebeingmisled.6OverviewandrecommendationsWehavehighlightedthreelong-termissuesfromthecrisis,whicharetheroleofbanksinprovokingthecrisis,theburdenofdebtonhouseholdsandthedebtofthepublicsector.Biblicaltheologyhasimportantlessonstoteachinalltheseareaswherethereisnowa“conventional”wisdomfromeconomics.Theircombinationhelpsustoapproachpolicyandaddresspersonalbehaviourfromanewandincisiveviewpoint.Wehaveseenanumberofthemesemerging.Inparticular,weseethatavarietyofactorsintheeconomy–thebanks,thepublicandthegovernment–haveactedinrecentyearstomaximisetheirpersonalutilityinthepursuitofselfinterest.Thisispreciselyaseconomicspredicts.Bankerswereseekinghigherremuneration,householdsmoreconsumption,andgovernmentstobere-elected.Buttherewasaflawintherationalityofeachoftheseapproaches,contrarytotheexpectationsofeconomicsbutstronglyinlinewiththebiblicalviewofthefallandmankind’simperfection.Underlyingthis,weseecommonaspectsofgreed,selfishnessandimpatienceofmanyindividualsinallthreeaspectsofthecrisis.Theseaspectswhichwerenotonlyundesirableinthemselvesbutalsooftencounterproductive.Thebankersputtheirlivelihoodatriskbytheirself-interestedactions,sincetheirinstitutionsbecamedestabilised.Thehouseholdswenttosuchextremesofindebtednessthattheyriskeddefault,bankruptcyandrepossessionintheshortrun,andanimpoverishedoldageinthelongerterm.Bydoingso,theyfedthebankers’self-interestfurther.Intheboomwecontendthatgovernmentseffectivelymisledthepopulationaboutsustainableeconomicgrowth,also“doping”theeconomywithloosefiscalpolicyandgivingtheimpressionthatriskhadbeenabolished,intheeconomicrealmasinothers.Ultimatelyinsearchof 37(continued)power,theytherebyencouragedboththebankersandthehouseholdstobelievethathighlevelsofdebtcouldbesustainable,leadingtocatastropheformany.Fortherehavebeencasualtiesofthisprocess.Theseincludenotonlythebankersoutofworkandhouseholdswhoregretthedebtstheyhaveincurred,butalso“innocentbystanders”suchasthoseunemployedduetotherecessiondespitetheirindustrybeinguninvolvedinthe“bubble”,andthoseaffectedindevelopingcountries.Casualtiesalsoincludethecominggeneration,whichhasalreadybeenchargedhighlyforformerlyfreehighereducation,butisnowalsopricedoutofhousing,andwillbeburdenedwithfuturetaxestopayoffgovernmentdebt.Thereisstrongevidenceofinjusticeinanumberofthese.Wehavehighlightedsomepotentialremedies.Weagreethatconventionalbankregulationispartoftheanswer,asiscurrentlybeingdiscussedbygovernments–includingregulationofbonusschemes.Butwecontendthatawiderfocusonvalues,andencouragementofvirtuesinbanking,aswellasareestablishmentoftheimportanceofrelationshipsisneededtotrulygenerateastableandsociallybeneficialfinancialsystem.Equally,whilesomelimitsonhouseholddebtseemjustified,theunderlyingsocialpressureforever-moreconsumption–theideathat“aman’slifeconsistsoftheabundanceofhispossessions”needtobetempered.Thisisnotonlyintheinterestsofthoseconcernedbutisdesirableduetoenvironmentalaspectsalso.Abiblicalanalysisofthecurrentsituationimpliesthatidolatry–beitofbanksasinstitutions,ofgovernmentsasproviders,andofmoneyandwealthmoregenerally-needstoberecognised,andthestructuralinjusticesandevilssuchidolatrygenerates,condemned.Besidestheobviouspoints,thisincludesacallforindividualresponsibilitytobeacceptedsothatpeoplenolongerhidebehind“institutions”.Ifitcanfindavoice,thechurchwillhavearoleinthesenecessarytransformations,aswellasstandingreadytocriticisegovernmentswhentheyactcontrarytotruthorjustice,andofferingmercifulsupporttocasualtiesoftherecession.Inoutliningthebiblicalapproachwehaveineffectcometoacritiqueoftheoverallaimsofeconomics–wealth,consumption,power-incontrasttoJesus’proclamationoftheKingdomofGod,thelawofloveforGodandneighbourandresponsiblestewardshipofresources.Theaimsof“rationaleconomicman”havingbeentakenlargelyonboardbypolicymakers,thereisaneedtobroadcastthebiblicalapproachenergetically.Inmoredetail,someoftheissuesthatwehavehighlightedaswarrantingattentioninthewakeofthecrisisarethefollowing:•Challengingthedominanceofeconomicsasarulingparadigmofsociety,andaddressingtheimpactofitsamoralapproachonthewaywelive.•Questioningthecommonassumptionthatthemarketsystemisbothrationalandself-stabilising.•Regulationisnotenoughtogeneratestablebanks,valuesmustbeadheredtoandvirtuemustbenurtured–but“virtue”amongbankersmaybedifficulttoencouragewithoutreligiousfaith.•Accordingly,theimportanceofChristiansengagingintheCity.•Theimportanceofbanksretainingexperiencedstaff.•Theneedfortheimportanceandsizeofthefinancialsectortodeclinesomewhat.•Re-establishingtheimportanceofrelationshipsinlendingandotherfinancialtransactions. 38•Limitingthescopeofindebtedness–bybankbehaviour,regulation,andindividualrestraint.ConsideringthebehaviourofotherEUcountrieswherecreditislessfreelyavailableandsavingismorecommon.•Reducinghousepricesrelativetoincomes,giventheinjusticetothecominggeneration.•Ensuringresponsibilityistakenforthedestructioncausedbyconsumercredit.•Assessingwhetherexistinghouseholddebtcanbereduced–isa“Jubilee”feasible?•Arenon-creditformsofhousingfinancefeasibleandsuperiortointerest?•Thechurchasaproviderofanalternativeculturetodebtandconsumerism–anditsroleineducation,debtcounsellingandreliefofpovertygeneratedbydebt.•Theburdenofgovernmentdebtgeneratedbyfiscalpolicyonthefuturegenerations.•Theroleofstructuraldeficitspersistingoverthecycleinboostinggrowthandhencepotentiallymisleadingthepopulationabouttheirsustainablelevelofdebt.•Theresponsibilityofgovernmenttowarnoftheconsequencesofacredit/housingboom,andtoacttodefusetheboom.•Addressingthedegreetowhichthetaxsystem–orotheraspectsofgovernmentpolicy-promoteindebtedness.•Consideringwhetherwetreatthegovernmentassomethingautonomous,ratherthantheresponsibilityofthecitizen–orbankerstreatedtheirinstitutionsasawaytoavoidpersonalresponsibility.•Thecommonaspectsofgreed,selfishnessandimpatienceexhibitedbymanyindividualsinrespectofallthreeaspectsofthecrisis. 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42APPENDIX1:GenericaspectsoffinancialinstabilityandthecurrentfinancialcrisisAsoutlinedinDavisandKarim(2009),financialcriseslikethecurrentonearenotrandomeventsbutsharekeycommonfeatures.AshighlightedinTable1theprocessoftenstartswithafavourableshocktotheeconomyandfinancialsystemthatboostsgrowthandinvestment.Butinsomecircumstancesthiscanleadtoabuild-upofvulnerabilityintheeconomyandfinancialsystem,associatedwithoverextensionofbalancesheetsandbuildupoffinancialimbalances.Pricebasedmeasuresofassetvaluesriseandpricebasedmeasuresofriskfall.Balancesheetsgrow,shorttermfundingincreasesandleveragefalls.Theseexacerbatetheboomandleadingtoacrisiswhenasecondary(adverse)shockhitsavulnerablefinancialsystem.Thecrisiswhichthenensuesfeaturesliquidityproblemsforfinancialinstitutions(provokedbycreditriskormarketrisk)asdiscussedinSection1.Inturn,thereisfurtherpropagationinacrisisperiod(systemicrisk)thattypicallyentailspolicyreactionsifthecrisisissufficientlysevere,andconsiderableadverseeconomicconsequences(whatwecantermthe“costsofinstability”).PhaseofcrisisNatureExampleoffeaturesPrimaryDiverseDeregulation,monetaryorfiscaleasing,invention,(favourable)shockchangeinmarketsentimentPropagation-Common–mainNewentrytofinancialmarkets,Debtaccumulation,build-upofsubjectofAssetpricebooms,Innovationinfinancialmarkets,vulnerabilitymacroprudentialUnderpricingofrisk,riskconcentrationandlowersurveillancecapitaladequacyforbanks,UnsustainablemacropolicySecondaryDiverseMonetary,fiscalorregulatorytightening,(adverse)shockasymmetrictradeshockPropagation-CommonFailureofinstitutionormarketleadingtofailureofcrisisothersviadirectlinksoruncertaintyinpresenceofasymmetricinformation–orgeneralisedfailureduetocommonshockPolicyactionCommon–mainDepositinsurance,lenderoflastresort,generalsubjectofcrisismonetaryandfiscaleasingresolutionEconomicCommon–scopeCreditrationingandwideruncertaintyleadingtofallconsequencesdependsoninGDP,notablyinvestmentseverityandpolicyactionThisapproachcanreadilybeappliedtothesubprimecrisisasdescribedinSection1.2.Asregardsfavourableshocks,themonetarypolicystanceofmostcountrieswasrelaxedfrom2001onwards,aspolicysoughttostimulategrowthinthewakeoftheequitybearmarketintheabsenceofsignificantinflationarypressures.UnderlyingthiswastheadditionalshiftofglobalisationandthegrowthofChina,thelowpriceofwhosegoodshelpedtokeepinflationlow.Therewasclearlyaneasingofentryconditionstofinancialmarkets,leadingtoheightenedcompetitionandrisktaking.Easyfinancingofhedgefundsisoneexample;anotheristhegrowthofSIVsandconduitstoholdsecuritisedassets,aninnovationthatfacilitatedentry.Furthermore,originationoflendingtoUSsubprimehouseholdswasoftenbynonbanksnotpreviouslyactiveinthatmarket. 43Debtaccumulationandassetpricebooms,generatingvulnerablebalancesheetsinthefinancialandnon-financialsectors;risesindebtofboththecorporateandhouseholdsectorsintheUSandmuchofEuropetookplaceoverthemid2000s,withpricesofequitiesandrealestaterisingalongside.Thesewere,asnoted,potentiallyunsustainableandthemorerecentfallinassetpricescombinedwithhighdebthasledtoweakbalancesheetsandwidespreaddefaultsandinsolvency.Innovationinfinancialmarkets,whichincreasesuncertaintyduringthecrisiswasakeyaspectofthesubprimecrisis.Allfinancialinnovationsgiverisetoariskoffinancialinstability,becausetheirbehaviourinaperiodofturbulenceisunknown.Theinnovationofstructuredproductswasbyitsnaturelikelytogeneratesuchuncertaintyinextremeformgiventheopacityanddifficultyofpricingtheinstrumentseveningoodtimes,despitewhichtheybenefitedfromaliquiditypremiumassecurities,whileinvestorswereapparentlyunconcernedwiththeprincipalagentproblemswhicharefundamentaltothatinnovation.Riskconcentrationandlowercapitaladequacyforbanks,whichreducesrobustnesstoshocksisthefinalindicator.Banks’riskadjustedcapitalratiosseemedsoundin2007,buttheconduitsandSIVsgeneratedhiddendifficultiesforbanks,asdidwarehousingriskwithfailuretodisposeofloansbysecuritisationinamannerexpected.Intermsofanegativeshock,monetarytighteningwasindeedonthecardsin2007owingtoshrinkingoutputgapsandhigherenergyprices,althoughitishardertosuggestthatthisfeatureactuallytriggeredthecrisis.Andtheauthoritieshaveindeedbeenforcedtointervenemassivelywithpublicmoneytopreventthebankingsystemfromcollapsing,byrecapitalisingbanksandguaranteeingloansanddeposits. 44APPENDIX2Whybanksarefragile,andneedregulationStatingthatbankssufferedrunsorliquidityproblemsisnotsufficientforunderstandingthenatureandcausesofsuchevents.Asimplestylisedillustrationofbankbalancesheetshelpstounderstandboththeunderlyingfragilityofbanks,andtheconsequentneedforregulation,as23wellastheevolutionofbanks’activitiesinrecentyears.ConsiderfirstFigure1,whichshowsthebalancesheetofa“traditional”banksuchasasmallbuildingsociety.Assetsareliquidassetsandilliquidloans,whileliabilitiesareretaildeposits.Thedifferencebetweenassetsandliabilitiesisthebank’scapital.Thekeyfeatureofbankswhichleadstofragilityisthemismatchinmaturityofassetsandliabilities.Becausecustomersusuallyonlyrequirewithdrawaloffundsonarandombasis,thebankcansurvivewithlowlevelsofliquidassets(cash,shorttermgovernmentbonds)andinvestothermoniesinhigheryieldingbutilliquidlongtermloans,whileproviding“liquidityinsurance”–thepromiseoffullredemption-todepositclientsatalltimes(DiamondandDybvig1983).However,ifthedepositorsconsiderthatbanksmaybeunabletopaythemback,therecanbea“run”whenalldepositorsrequirefundsatonce.Inthisliquidityproblem,whichrapidlyexhaustsliquidassets,thebankisthenunabletosellitsilliquidassetsforfullvalue(duetoasymmetricinformation–the“firesale”problem)andbecomesinsolvent(asforNorthernRock).Abankcanofcoursealsobecomeinsolventduetosimplelossesonassetsinexcessofcapital(asfortheDunfermlineBuildingSociety).Then,bankrunscanbecomecontagiousacrossthesystemifcustomersconsiderbankstohavesimilarbalancesheetweaknesses(whichcannotbedetectedpreciselyduetoasymmetricinformation)and/orcounterpartylinkstothefailingbank.Figure1:“Traditional”bankAssetsLiabilitiesLiquidassetsCapitalRetaildepositsIlliquidloansBankregulationisawaytoreducerisksinthissimpleframework.Capitaladequacyregulationensuresthatthelevelofcapitalissufficienttocoverexpectedlossesduetoloandefaultsinadownturn.Liquidityregulationseekstoensurethatliquiditycanbeaccessedsufficienttocoverpeakdemandsfordepositwithdrawals.Andwhenliquidassetsareinadequate,theCentralBankaslenderoflastresortisaproviderofliquiditytothebank,atitsdiscretion,soastomeetdemandsforredemption.DepositinsuranceusuallyrunbyMinistriesofFinance,seekstopreventrunsfromoccurringbygivingdepositorsaguaranteeofthenominalvalueoftheirassets.Thekeychangestothisframeworkthatarerelevanttodevelopmentsinrecentyearsare,first,deregulationthathastypicallyremovedpreviouslimitstocompetitionbetweenbanks,and23Theauthorhasusedthisanalysisinanumberoftalksinchurchesandtomen’sgroups. 45henceputgreaterweightontheremainingprudentialregulations.IntheUK,deregulationhasentailed,forexample,theentryofbankstothemortgagemarket,growthofinvestmentbankingactivitiesbycommercialbanksandscopeforbuildingsocietiessuchasNorthernRocktodemutualiseandbecomebanks.Secondisthegrowthofwholesalefinancialmarkets(generallyshorttermborrowingfromotherbanks,moneymarketfunds,corporatetreasurersandotherinvestors)offeringanalternativetoretaildepositsforbanks’fundingneeds.Mostbanksthatfailedinthiscrisishadlargewholesalefundingneeds.Thethirdisthedevelopmentofsecuritisation,sobanksnolongerneedtoholdloansonbalancesheet,butcaninsteadpackageandsellthemtootherinvestors,benefitingnonethelessfromthesizeablefront-endfeesfromloanorigination.Securitisationandwholesalemarketssteminturnfromthedevelopmentofinformationtechnologyandglobalisationoffinancialmarkets.Figure2:“Modern”bank“Onbalancesheet”AssetsLiabilitiesLiquidassetsCapitalIlliquidloansRetaildepositsIlliquidsecuritiesWholesaledeposits“Offbalancesheet”LoansbeingsecuritisedIlliquidsecuritiesIlliquidsecuritiesinSIV/conduitAssetbackedcommercialpaperwithbankbackuplineofcreditThe“modern”bank(Figure2)suchascurrentUKclearingbankscanbeseenasaresponsetothesedevelopmentsthatalsoseekstomaximiseprofitabilitybyallpossiblemeans.Liquidassetsarehencereducedtothelowestpossiblelevelgiventheirlowerreturnthanotherassets.Capitalisequallyheldonlyatthelevelrequiredbysupervisors.Inordertogrowthebalancesheetfasterthanisfeasiblewithstickyretaildeposits,thebanktakesonaconsiderablevolumeofwholesalefunding(“liabilitymanagement”)althoughsuchfunding,typicallynotbeingcoveredbydepositinsuranceandheldbywell-informedinvestors,ismuchmoresubjecttorunsthanretaildeposits.Meanwhile,loangrowthcanbeextendedbeyondthatfeasiblegivencapitalanddepositsbyongoingsecuritisationofloans.FollowingtheBasel1agreementin1988,capitaladequacyiscountedonarisk-weightedbasis.Thisgivesanincentivetoholdaproportionofhighlyratedsecuritiesontheassetsideiftheyarealsohighyielding.TheproductsofSecuritisation,whichwecallABS(residentialmortgagebackedsecuritiesandespeciallyhigher-ratedtranchesofcollateraliseddebtobligations)couldprovideAAAratingsandhighyieldsandhenceprovedattractivetobanks.However,theiropaquenaturemadethemrelativelyilliquidcomparedwithothertypesof 46securities,andtheratingsturnedoutinretrospecttobeexcessivelyoptimistic.Themodernbankmightalsorunspecialinvestmentvehiclesorconduits,formsofsubsidiarydesignedtoholdsimilarsecuritiesfinancedbyassetbackedcommercialpaper,wherethebankprofitsfromthedifferenceinyieldbetweenthem.Thebankmightnonethelesshaveanobligationtothesubsidiaryifitgotintodifficulty,duetoreputationreasonsorduetoback-uplinesofcredit.Regulationofthemodernbankisclearlymorecomplex,althoughthesameprinciplesapply.Akeyissueisliquidityregulation,thatneedstoconsidertherisksofwholesalefundingaswellaslowliquidassetholdings.Butequally,capitaladequacyneededtotakeaccountofthemorecomplexrisksimplicitinthenewstructurethatbanksadopted.Withsecuritiesheldasassets,lossescanariseforfallsinpriceinthemarketaswellasdefaultsbyborrowers.
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