The crisis & building an ethical financial system Steve Keen University of Western Sydney

Overview Crisis caused by growth & collapse of biggest private debt bubble ever Banks succumbed to inherent temptation to create excessive debt Ethical system must break debt-asset price feedback –Break temptation of “unearned income” to borrowers Relate debt to income of asset, not borrower Reorient finance to support productive investment, innovation “Modern Jubilee” needed to overcome current crisis Conventional economics misunderstands debt & banking –New economics needed as well as new financial architecture

Debt and Depressions US Private Debt to GDP 1920-Now indicative of global phenomenon:

Debt and Depressions Global phenomenon –Schularick & Taylor: biggest debt bubble in recorded historySchularick & Taylor

Debt Dynamics & The Crisis Crisis caused by reversal from rising to falling debt –Decline in income relatively mild… –But decline in debt change huge…

Debt Dynamics & The Crisis Empirical evidence on role of debt (theoretical analysis later)

Debt Dynamics & The Crisis Empirical evidence on role of debt

Debt Dynamics & The Crisis Empirical evidence on role of debt

Margin Acceleration & Change in Australian Shares Acceleration of margin debt & change in Australian ASX

Why was this allowed to happen? Conventional economics ignores banks, debt & money –E.g., Paul Krugman on my analysis of the crisisPaul Krugman on my analysis of the crisis “Keen … asserts that putting banks in the story is essential. Now, I’m all for including the banking sector in stories where it’s relevant; –but why is it so crucial to a story about debt and leverage?...” Neoclassical “Loanable Funds” model ignores banks –“If I decide to cut back on my spending and stash the funds in a bank, which lends them out to someone else, this doesn’t have to represent a net increase in demand.” –Sees level of debt as having no macroeconomic consequence…

Neoclassical “Loanable Funds” Patient lends to Impatient Patient’s spending power goes downPatient’s spending power goes down Impatient’s spending power goes upImpatient’s spending power goes up No change in aggregate demandNo change in aggregate demand Banks mere intermediaries (ignored in analysis)Banks mere intermediaries (ignored in analysis) All the action on liabilities side of bank ledgersAll the action on liabilities side of bank ledgers

Post Keynesian “Endogenous Money” Empirically-based “Endogenous Money” sees banks as crucial –Bank lending creates new money & demand BankBank grants loan & creates deposit simultaneously NewNew loan puts additional spending power into circulation AggregateAggregate demand exceeds demand from income alone Structure of banking tempts banks to create excessive debt Bank income rises if debt rises (relative to income)

Temptation to create excessive debt Increase in lending/decrease in repayments increases bank income

Ethical Finance? Primary role of finance should be supporting industry & community –Working capital for firms –Debt-financed purchase of long-lived consumption items –Developing infrastructure But limited profits entice lending for asset speculation instead –Difficult to remove temptation for banks –Possible to remove temptation to debt for borrowers In asset purchases, base lending limits on income of asset, not buyer –Now, if 2 people compete for the same house –The one with higher leverage wins –Proposal: “Property Income Limited Leverage” Maximum loan 10 times imputed rental income of property No possibility of higher leverage advantage for buyers Buyer with higher savings wins –Proposal: Maximum borrowing for share purchase based on prospective dividend yield of shares

Escaping the crisis Fundamental cause of crisis excessive lending for asset speculation –Responsibility overwhelmingly lies with lenders, not borrowers Far greater resources to analyze viability of loan Lending based on trust: abuse of trust & fiduciary duty Best way out of crisis to reduce debts –“Debts that can’t be repaid, won’t be repaid” (Hudson) Best means a “Modern Jubilee” –Can’t just abolish debt as in Biblical Jubilee Securitized debt means non-bank savers would suffer –Central Bank fund injection directly to public via bank accounts Those in debt must repay debt Those without debt keep cash injection –Bank debt reduced—bank income falls –Securitized debt holders lose: fall in value of & income from bonds But compensated by debt injection –Deleveraging drag on aggregate demand eliminated

Without deliberate action? Deleveraging could dominate economy for 20 years…