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Another financial meltdown?

Is the world on the brink of another financial crisis? It is according to Rana Faroohar, Time magazine economist correspondent and author of a new book Makers and Takers: The Rise of Finance and the Fall of American Business (Crown Publishing, 2016). Recessions typically happen every eight years. If past performance is any indicator of the future then be warned: we are apparently due another one around about now. We have barely recovered from the last; with many countries including the UK and US seeing the slowest sluggish economic recovery in living memory. 

Given the massive bank bailouts and financial stimulus from governments that totalled an eye-watering US$ 29 trillion since the 2008 crisis, have lessons been learnt? Not particularly, argues Faroohar. She believes banks are still too focussed on looking after No 1. Traditionally, finance served the needs of business - the “makers” - by providing capital for the production of goods and services (the “real economy”). But, since the deregulation of the 1980s onwards, finance - the “takers” - make profit by manipulating money and debt. She describes this as the “financialisation “ of the economy where financial institutions use their access to information and capital to creating an un-level playing field. Stock markets are pumped up through speculation to make short term profits rather than longer term investments in manufacturing, technology or employees. In fact, lower wages mean lower corporate costs, which results in greater profitability and a higher share price. That’s another way of saying that the rich get richer and the poor get poorer. Over the longer term poorer workers buy fewer goods and services which weakens the real economy and so the gap further widens. This resultant widening of this inequality gap causes social unrest, as we see across Europe and the US today, with the anger at the “1%” or the “elite” fuelling support for far-right and far-left candidates exploiting the discontent. 

Faroohar is no socialist. She believes in capitalism, but one where finance is reigned in so capitalism can work more efficiently to grow the real economy.  The purpose of capitalism is to funnel people's savings into new business via the financial system that creates real jobs and greater opportunities. Faroohar says that only 15% of capital in today’s financial institutions performs this function - the rest, rather than create new ideas and projects, trades on existing assets which are then bought, packaged up, sold and resold again and again making financiers money but to no social benefit. It was the packaging up and selling and reselling of mortgage-backed securities that led to the US housing and global financial crash of 2008. 

So what’s the solution? Faroohar argues for greater regulation to prevent market manipulation that damages the real economy. Changes to the tax system that currently benefit debt over equity and income from capital over wages. But also for changes to what is taught at business schools to MBA students. So rather than focus on the interests of investors and shareholders, future business leaders should also consider the needs of employees and consumers too.

More pragmatic than radical, even these solutions are not likely to happen any time soon. And certainly not in time to prevent the next crisis.

Asim Siddiqui is a trustee of the Muslim Institute and former chair of the City Circle.