Proposals for alternatives to finance-driven capitalism.

Our proposals for an alternative economic policy to counter the financial crisis and the looming recession in Europe start from John Maynard Keynes' famous notion that public policy must envisage the 'euthanasia of the rentier'.

More than ever it is necessary to overcome speculation and an untenable 'shareholder value' orientation through a democratic transformation of finance (see section 1). A democratic transformation of the economy will also require addressing the vast concentration of power in the hands of giant corporations (section 2). In an alternative scenario, credit should not be employed for short-term financial gains but rather for encouraging productive investment so as to promote full employment and good work and to contribute to the fight against poverty and exclusion (section 3). At the same time it must contribute to ecological sustainability, particularly to the resolution of the problems of energy provision and climate change (section 4).

Democratic transformation of European finance

The course and depth of the financial crisis call on the one hand for immediate measures to secure the functioning of the financial system. On the other hand they call for further reaching policies which transform the financial system and embed it into a framework of democratically controlled economic and social development. Four levels should be distinguished:

Immediate measures

On the first level of immediate measures the smooth functioning of the payment system, the provision of the economy with sufficient credit, and the safety of deposits and savings of the people must be secured. For this purpose stronger and different measures are needed than those which several big EU member states initiated in a more or less concerted action in October 2008.

Large subsidies, huge bail-out guaranties and re-capitalisation of banks via the injection of state capital with no or very little voting rights or control maintains with very little modification the existing financial mechanisms and structures. It continues to subordinate the stability of the financial system to the same profit-oriented perceptions and decisions of bank managers which caused the present crash. Under these conditions, it is very questionable whether banks will fulfil their necessary functions for the economy and society. They might well fail to do so, either as an act of blackmail in order to get yet higher subsidies or as a result of continuing mutual mistrust and fear of real--or fictitious--risks.

To secure the basic functions of the financial system a regime change is necessary. We propose that the states should take over relevant parts of the leading banks in their countries, and thereby create a strong and permanent basis of public or semi-public banks over which they should exert efficient control to secure the fulfilment of the basic functions of the financial system. This step is logical since, first, during the last few months every government and the European authorities have repeatedly and correctly emphasised that the stability of the financial system is an important public good, and, second, the current crisis demonstrates again (after many crises in the past twenty years) that the private sector is not able to deliver this public good.

Nationalisations should therefore not be regarded as a temporary rescue action for private banks but as a decisive step towards a new and democratic banking and financial market regime. This requires of course more than just the shift from private to public ownership but a change of the regulatory framework for banks and financial markets.

Financial market reform

The second level of financial market reform should permanently ban from the EU the most harmful practices which have triggered and exacerbated the recent bubble and crash.

* Securitisation of loans and trade in loan packages should be prohibited for European banks and on European markets, because they are, on the one hand, a circumvention of legal capital requirements and, on the other hand, a driving force for speculation. Exceptions to this rule should be subject to permission and oversight through national and European supervisors.

* Credit provision for leveraged take-overs, acquisitions and other financial investment should be severely restricted, require higher minimum capital holdings and made subject to special supervision.

* The business model of hedge funds--not only short selling--has been demonstrated to be much more destabilising than stabilising, and therefore it should be terminated. Hedge funds should not be permitted to operate--from inside or outside--in the European Union, and European financial institutions should not be allowed to invest in hedge funds or operate such funds outside the EU.

* Special incentives for managers to engage in short-term speculation and/or boosting market capitalisation of their firms--like stock options--must be abolished. Bonuses should be restricted and linked to service quality and employment of the firm.

* Offshore centres with insufficient or no financial supervision and low or no taxes have been important bases and allies for the destabilising activities of financial investors and speculators. They should be closed down and where this is not possible direct and indirect business with such centres should be prohibited for financial institutions' operations in the EU.

Measures on this level can be adopted and implemented immediately, and some are already on the way. Where it is not possible to agree on them globally, the EU could and should take the necessary steps, and it could protect itself against capital flight via article 59 of the EU Treaty, which explicitly allows capital controls under certain circumstances. To push the European authorities in this direction member countries like Germany or France can and should play a pilot role in adopting the proposed measures.

Revision of the rules for European banking system and capital markets

The third level is a thorough revision of the rules for both the European banking system and European capital markets.

With regard to the banking system transparency should be increased by setting up a European credit-register, but this is by no means sufficient. The whole business model of banking needs reform with the aim of concentrating activities on taking deposits and extending loans to non-financial institutions. Trading in securities should be strongly restricted and trading on their own account should be excluded from banks' activities.

What is also needed is a thorough reform of the Basle II system and its replacement through a Basle III framework, which includes at least three points:

* First, the polarising and pro-cyclical character of the Basle II regime should be corrected through built-in stabilisers, like varying capital requirements at different phases of the business cycle.

* Second, the quasi-privatisation of bank supervision through the admission of 'internal risk models' of banks has been a great mistake and should be corrected. Risk assessment should therefore be re-transferred to public supervisory authorities on the European and on the national level.

* Third, the regular capital requirement rate of 8 per cent is too low to restrain banks from excessive credit creation. It should be raised to 20 per cent, and could be modified, e.g. to 10 per cent for SME and to 30 per cent for financial investors.

The comprehensive character of the banking crisis suggests that the best prospect for sustainable reforms is a solid basis of state-owned and democratically controlled banks and that therefore underlines the proposal for nationalisation and democratic control of a relevant part of the banking sector.

With regard to European capital markets the main thrust of measures should be deceleration, i.e. lower volumes and velocity of trade in the secondary markets for securities of all kinds. This orientation contradicts the microeconomic logic of immediate response to perceived profit opportunities. But since such response often translates via herd behaviour and contagion into increased volatility, turbulence and boom-bust patterns the avoidance of these systemic disadvantages must have priority over microeconomic benefits.

Measures to this end include:

* Strict limitation on the investments of pension funds to European government bonds, with no investment in hedge or private equity funds, foreign exchange, derivatives and equity.

* A substantial reduction of the number and complexity of so-called structured products and other derivatives and certificates. They should be standardised and not traded over the counter but on regulated and supervised exchanges.

* Financial transaction taxes on all currency and secondary securities transactions. The purpose of these taxes is primarily to make short-term speculation less attractive; therefore the rate of the tax must be sufficiently high to meet this objective, and could be modified in response to changing circumstances. The proceeds of such taxes should be assigned to the EU and contributed to the necessary increase of the European budget.

* Rating agencies must be thoroughly restructured. Private rating agencies must be licensed and supervised by public authorities. There must be a strict separation between the assessment and the consulting side; for that purpose rating agencies should not be paid by the firms which they assess but out of a fund to which the rated firms contribute.

Overall these reforms would lead to a shrinking of bank activities and profits, which is very appropriate in view of the excessive expansion of activities which largely served (and very successfully) the purpose of extracting profits from the economy and contributed to instability and chaos. The loss of employment in these activities could and should be compensated by the extension and improvement of the service quality in the retail sector.

The roots of the crisis

The fourth level of reforms addresses...

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