Economist Kleinknecht: ‘Left must address corporate governance, not clean up the rights’ mess.

Brussels, 13 December - Anti-speculation taxes far higher than the good-old Tobin tax are needed to re-stabilise the financial system,said economist Alfred Kleinknecht and former Attac-leader Sven Giegold during the second debate on the financial crisis of the 7th annual Heerlen conference. But whereas Giegold, co-author of his parties’ crisis remedy ‘The Green New Deal’ proposed a range of measures to recreate the system, Kleinknecht suggested to leave that sort of reparation jobs to the right. The left, he said, should concentrate on changing one of the major causes of the instability: the way companies are run.

Report by Michael Leibman

For prof. Alfred Kleinknecht, who teaches economy of the innovation in Delft (Nl) and Paris, one of the problems leading to the financial crisis were the rating agencies that ratified financial ‘products’ much too optimistic. They acted on behalf of the financial firms selling the products, he said, not on behalf of the buyers, and because they have to compete with one another for clients and therefore tend to be accommodating towards them, and because they are paid a percentage of the value of the products they rate. To get objective evaluations, ratings should be performed by independent state agencies.

Another factor, Kleinknecht said, is the role of new financial tools in amplifying economic cycles, like leveraged buy-outs: A firm X with a need in working capital of 100 000, that finances this need entirely with its own money and makes a profit of 10 000, yields a return on that money, equity, of 10%.’ Nowadays, there are more glamorous ways of running that firm. If an equity firm would buy out this firm by investing 5 000 in equity and borrowing the remaining 95 000 from banks at a 4% interest rate, the firm could, with the same profit of 10 000, pay back the 3800 in interest to the banks and retain the remaining 6 200. The return on equity would now be 6200 / 5000 x 100 = 124 %.’

Turbo effect

‘Now, that’s quite a bit more attractive. And given good cash flows in the firms being bought out, it is certainly the kind of incentive needed to feed bank borrowing. On the other hand, if such a firm begins to falter and to make losses, leverage buy-outs have a dangerous turbo-effect. If the firm in our example makes a loss of 10 000, the Return on Equity becomes minus 10.000 ‘negative profit’ plus a negative interest of 3.800, which totals minus 276%. So leverage buy-outs certainly reinforce economic downturns.’

‘Similar risky leverages exist in other areas. Assets, like houses, art objects, office space, shares and bonds, can be acquired through borrowing. As long as credit expansion takes place, there is high demand for assets and therefore asset prices rise. As long as the value increase of assets is larger than the interest rate on your loan, you get rich while sleeping. As soon as asset prices begin going down, a downward spiral starts: bank loans are withdrawn, which forces the sale of assets, so asset prices go down further, then more banks get nervous and withdraw credit; this causes more forced sales, and the spiral continues. So it is obvious that the turbo effect of leveraged financing creates high instability in financial markets.’

Panic sales

There is no certainty today on the size of the bubble of such over-valued assets on the volume of leveraged financing, on the sharpness of the various leverages. Nor can we predict how patient banks are likely to be with their struggling clients. Will they force their clients to sell more assets or help them until a general recovery occurs? We do not know if the worst is behind or before us. Areas of uncertainty include the possibility of a collapse of asset prices due to panic sales, the impact of lower asset values on consumer spending. Will there be more bankruptcies of banks, insurance companies, high-leveraged hedge funds or private equity firms?

Could domino effects occur? And what about banks that are too big to fail, so the government needs to save them, and too big to save, because the government can’t afford to save them? Their chance of bankruptcy is perhaps small, but if that happens, then what?

Marx’s Capital‘s selling again

How should the left respond to the current problems? It should, says Keinknecht, not exhaust itself in technocratic regulation discussions. ‘The right should come with the solutions to the problems it has generated. After all the right is on the defensive, as the crisis is leading to a change in the political climate. To give just one example: Marx’s Capital is selling again.’

‘Nonetheless, the left should think about a system of anti-speculation taxes that is more far-reaching than just the Tobin tax. It should also be wary of a new credit crisis, which may be building up in the Euro-zone. But more importantly, the left must address the issue of corporate governance. As things stand today, firms suffer from short-termism and opportunistic behaviour everywhere. Shareholders do not “hold” shares, but tend to just buy and sell them. With diffused ownership of shares, the ‘principal-agent’ problem becomes tremendous: shareholders no longer use their power to impose discipline and long-term strategies on the management. Managers maximize individual benefits – après moi le déluge – and hedge funds and private equity firms play pyramid games.

Educated worker

In that context, the only ones that still care about the long-term continuity of firms and jobs, the only party that has a vital interest in it are its employees. Therefore, they should nominate half of the Board of Directors, and have rights to veto basic decisions about out-sourcing, mergers etc. They are capable of it: the modern, highly educated workers should not be subjected to an authoritarian 19^th century top-down management system like they are now.

Giegold: General crisis requires holistic answers.

Attac founder, tax-specialist, and Green candidate-candidate for the Europarliament for Bündnis 90/Die Grünen Sven Giegold, analyses the crisis from a broader perspective. We are not merely talking about a financial crisis, he says, but about a more general crisis involving climate change, the overuse of natural resources and a growing gap between rich and poor, both within nations and internationally. For this general crisis we must find holistic answers. The failure of the Poznan climate conference, the wrecking of the European climate package and the distorted character of European integration all point to the failure of neo-liberal ideology and to the need for us to provide our answers not just in the financial area but in other areas as well.

There is a major problem, not just in the financial sphere but in the real economy as well. The various plans to remedy the crisis have so far proved inadequate. There is mounting pressure for more intervention, but the hundreds of billions spent up to now will only subsidize the old economy rather than giving the needed push to the new “green” economy.

Redistribute wealth

We must demand a New Deal. The sectors that should grow remain to be clearly defined and subsidised, but we can assert that among the main ones are health, education, environmental technology and renewable energy. Subsidising the car industry is not a valid proposition unless deep-going measures are taken to moderate car use and make products with more sustainable life cycles. We also need to institute mechanism for effective and long lasting redistribution of wealth between North and South and for re-regulating financial markets.

The crisis may have terrible impacts, but it also represents an opportunity for positive change. Major change occurs only at specific moments in history. We normally think of past revolutions, of the New Deal and of post World War II as belonging to that kind of upheaval. The current crisis represents a historical de-legitimisation of the ideology of neo-liberalism. Significantly, not only such an organization as Greenpeace but also various UN agencies and the Secretary-General Ban Ki-Moon himself have taken up the call for a Green New Deal. Of course, we are just in the initial phase of this ideological upheaval, which will require much work and coordination.

Euro zone split

The Green candidate also discusses in more details points he had been working on with ATTAC Germany in recent years, like taxation on financial transactions, regulation of the level of capitalization in firms of the financial sector, the need to close down tax havens, the need for an international currency. And he points out that the euro zone is running the risk of a major split because of a lack of coordination in economic policies.

Regarding taxation, for Giegold something further reaching is needed than the Tobin Tax – the small taxation on crossborder capital movements Attac has been promoting since the 90′s. ‘In fact different sorts of capital movements should be subject to taxation. The rate of taxation should be higher if the investment is more speculative in nature, and some forms of speculation should simply be outlawed.

Secondly, deep crises always involve excessive lending and insufficient levels of real assets in the financial sector. Measures need to be taken to insure that all lending firms have sufficient reserves in equity and deposits. Roosevelt’s New Deal separated financial banking from commercial banking. With the loosening of regulation and the development of new institutions and products, these separations have broken down; they need to be rebuilt and modernised. All these financial institutions and their innovative products must come under state scrutiny.

Independent international currency

‘Thirdly, time has come to shut down tax havens. These drain away taxation revenue from national budgets and economies and encourage speculative and illegal activity. We cannot expect a general international agreement on the subject. The European Union must act unilaterally on the basis of article 58 of the EC treaty, and build a coalition of countries who agree on basic rules and are determined to enforce them.

Stronger cooperation is also needed among member states. Some financial market experts are already speculating on the notion that some countries might, at some point, pull out of the Euro and a 1 percent difference in interest rates has appeared between Greece and other European countries. This trend must be countered. And finally, Keynes’ projects for more international economic cooperation and his advocacy of a common currency, independent of national ones, is drawing renewed interest. It is clear that there is a discrepancy between markets, which are worldwide, and regulation, which remains predominantly national in scope.

Some interesting Green New Deals