Premier John Brumby’s $3.1 billion desalination plant, the cornerstone of his plan to drought-proof Melbourne, appears to be in trouble as major project finance dries up around the world.

Banking sources say the project faces a funding gap of between $1 billion and $2 billion. Some in the infrastructure industry say a mere $300 million to $500 million is available from banks for all major projects across the country.

The shortfalls confront the Brumby and Rudd governments with either finding the money to bail out the controversial plant, along with a string of other projects across the country, or shelving it.

There’s something that doesn’t add up here. The credit crunch is all too real, sure. But there are still loans being made. And, on the information publicly available, lending money to build a desal plant for Melbourne looks like one of the financially safer loans a bank could offer.

The winning bidder will have a contract with the monopoly distributor of water in Melbourne. And, given the low storage levels, even if rainfall returns to something closer to the historical average, the re-establishment of gardens and letting the reservoirs refill should mean that the desalination plant will be running at full capacity for years to come. If the government so desires, it could even turn off the controversial Goulburn pipeline as an “environmental measure”, and instead use the desal plant.

Obviously, there are other risks to this project that a bank would have to consider before putting up its money. But the nature of this project means that perhaps the single biggest risk – the risk that nobody will buy the product it produces – is largely taken care of. So why can’t they get it financed?

In the wake of this crisis, blame is being sheeted home to the average person, who is apparently running up too much debt. Well, mercy, what a surprise, it’s the people’s fault. Let’s face it, people only consent to this crappy society because of what they can rack up on debt. If you’re going to spend forty years of fifty hours a week – your whole one life on Earth – in the same office, doing crap you don’t want to do, damn right you want a frikkin flat screen TV at the end of it. And to eat out. And drink stupid overpriced cocktails in awful resorts.

The short point is that if we close down easy credit, the rationale for Western capitalism collapses instantly. Because the rest of it is so godawful, that without rewards, no one would put up with it. Hence the need, over the last eight years, to keep it all bubbling, at any cost.

Robert Reich, in perhaps a less colourful way, made a not entirely unrelated argument in the New Statesman recently. In essence, he argues that the stagnation in middle-income America in large part caused the explosion in debt that led to the credit crunch:

The earnings of non-government workers who are paid by the hour – and who comprise 80 per cent of the American workforce – are lower today than they were in 2000, adjusted for inflation. They are barely higher than they were in the mid-1970s. Indeed, the income of a man in his thirties is now 12 per cent below that of a man his age three decades ago…This underlying earnings problem has been masked for years as middle- and lower-income Americans found means to live beyond their earnings…

…Americans turned to a third coping mechanism. They began to borrow. With housing prices rising briskly through the 1990s and even faster from 2002 to 2006, they turned their homes into piggy banks. Now, with the bursting of the housing bubble, Americans are reaching the end of their ability to borrow and lenders have reached the end of their capacity to lend.

Reich’s prescription for fixing the ails of the American middle class is fairly unremarkable – single-payer health care, improved education, and a more progressive tax scale – but, still, if an Obama administration makes some progress on all three of those it’ll be a considerable achievement in the US political context. From an Australian perspective, however, the most interesting thing is that Reich (Clinton’s labor secretary) says out loud that progressive taxation – that is, taxing the rich more and the poor less to reduce inequality of outcomes – is a good idea. I wonder when that idea might just make its way across the Pacific?

If a bank wants to borrow money, a broker needs quickly to find someone prepared to lend at an attractive rate; if a bank wants to lend, he – it’s a predominantly male profession – needs to find a borrower ready to pay a good rate. So a broker needs continuously to know who wants to borrow, who is prepared to lend, and on what terms. As one of them said to me, a broker might ‘speak to his big clients … have conversations with them maybe twenty-five times a day, which is twenty-five times as often as they speak to their wives’.
A broker needs to pass information to his clients as well as to receive it: that’s a major part of what they want from him, and a good reason to use the voicebox rather than the screen.

The brokers’ code of conduct prohibits passing on private knowledge of what a named bank is trying to do (unless a client is about to borrow from it or lend to it), but that restriction leaves plenty room for brokers to tell traders what has just happened and to convey the ‘feel’ of the market. There’s a grey area in which euphemisms can be used: in context, a broker and a trader might both know which bank is meant when the broker says that ‘the usual German’ has just done something.

That’s from Edinburgh Sociologist Don Mackenzie’s extraordinarily rich account of brokerage in the Current London Review of Books (the broader project of which it’s a part is outlined in this 2005 paper). As they say, read the whole thing. However, as Krugman pointed out yesterday, even if these and other credit markets are ‘unlocked’ (which – if the easing of the LIBOR price is anything to go by – they look like they will be) there is still ‘real world’ economic contractions to take place: GM will close plants, regardless of how politicians ‘talk up’ or ‘talk down’ the economy.

Elsewhere: Andrew Bartlett on Boosting First Home Owners Grant:

Why spend $1.5 billion dollars of taxpayer money to push up the price of housing? There may be downward pressure on house prices in some parts of Australia, but it is from a seriously overvalued level. We should try to let the air out of that bubble slowly, not use public money to keep pumping it up, especially when there are still so many problems with housing affordability in other parts of our housing markets.

Update: Will Hutton: The nightmare continues – on a high street near you

“If the Government pulled the plug and delayed the system now, the level of uncertainty would be even more difficult to deal with,” said Maria Tarrant from the Business Council of Australia.

“It is critically important for business to know exactly what the Government is planning and if they pulled back now it would be highly problematic, but the economic situation makes it even more important that it gets the design of the scheme right.”

Minerals Council of Australia chief executive Mitch Hooke said a “delay would just add to the uncertainty. All of my concerns can be addressed by the Government getting the design, the framework right.

It seems like the government is holding its nerve, at least on the timing of the ETS. Good for them, but you’d wonder if the economic conditions are going to scare the government into giving the carbon lobby what they really want – a “measured policy framework”, in other words, an ETS with such weak targets it doesn’t actually force them to reduce carbon emissions. There’s already evidence of backsliding globally – for instance, the EU is preparing to hand out a bunch of extra free permits to industry (essentially shifting the cost back onto everyone else, but anyway…). Here’s hoping, somewhat folornly, for some courage from Rudd and co.

More broadly, the financial gyrations of the past couple of weeks, and the government response to them, show that political leaders can move swiftly, and globally, to act in response to a crisis. Now all that’s required is to get it established in their minds – not only here, but in laggard countries like the United States – that climate change represents a greater challenge still.

In The Guardian, Will Hutton explains why measures to halt the cascading crisis have been ineffectual to date. He might have made more explicit the implication that one of the basic structural problems is that action taken at the level of the nation state can be counter-productive given the disseminations and movements of capital, and that there are real domestic political barriers to coordinated action, as well as all the obvious problems of concertation through institutions such as the EU and the G20.

But he does make this point – harmonising with the note I’ve been sounding repeatedly – very clearly indeed:

There was no effective opposition. The left and organised labour collapsed as intellectual, social and political forces; there was no conviction that any alternative to this shareholder value-driven, financial, ‘securitised’ capitalism existed, or any political muscle to support it even if there were. Mainstream culture moved away from public purpose and fairness; the new priorities were individual self-fulfilment, personal experience and loyalty to self.

Hutton is perhaps more sanguine than I am, though, about the capacity of state action to turn all this around. In essence, he’s making an argument he’s been making for some years – about the virtues of other forms of capitalism than that which has been hegemonic in the neo-liberal Anglosphere. He briefly had some success in influencing Tony Blair in the early days of New Labour – in opposition, to be precise – in pushing ideas about “Stakeholder capitalism”. Whether a reorientation to a capitalism focused on the medium rather than the short term and on the real rather than the financial economy would work now – or whether as John Quiggin seems to think the Gordon Browns of the world are predisposed to be pushed, however much they might kick and scream, in something like the correct direction, is perhaps anyone’s guess as events continue to move at breakneck pace.

Immanuel Wallerstein puts a contrary view. I’m not quite sure if I agree – though he’s right more often than most. It is certain that what is occurring is Schumpeterian “creative destruction”, but whether or not the capacity to begin the cycle of valorisation and capital accumulation anew exists is something I think it’s better to be agnostic about at this stage. While I dare say he’s right about the end of a Krondatieff cycle, beyond that, prognostication seems to have a very short shelf life in these times.

It’s also interesting to observe that some are suggesting that the Canadian Tories’ “steady as she goes” approach is precisely what is leading to their decline in support in the campaign which has reached its final stretches. It may well be that Stephen Harper has more problems than just perceived inaction in the face of the credit crisis, but it probably is significant that voters are demanding state action to propitiate fear. In the Australian context, I wouldn’t be at all surprised if Kevin Rudd and Labor are able to consolidate their support at a time when their momentum may have been sagging. The “cut through” of the opposition really diminishes at times of crisis, and it may be that Rudd has a chance to entrench himself with his response. To some degree that’s dependent on how far Australia is able to resist the global push towards recession, and again, I really would hesitate to place much value in any predictions at this stage.

Iceland right now is apparently in a state of shock and gives a snapshot of what a depression with the Great in it will look like everywhere – “cafes were half-empty, real estate agents sat idle, and retailers reported few sales” says the AP.

This after the government basically took over its banking sector, with Russian money, which as noted in the linked post, has real geopolitical implications.

Meanwhile, the British government is laying out 500 billion pounds to take equity in its banking sector, but basically proposing business as usual. Co-ordinated interest rate cuts are having very little impact on the stock market, and more worryingly, on the liquidity crisis. Paul Krugman writes:

We’re way past the point at which conventional monetary policy has much traction.

In America, in the eye of the economic storm, the Fed has basically become the financial system, but to little avail:

The time for a recession was 2005. At that time simple macroeconomic policy; simply raising interest rates, would have ended the bubbles in credit and housing at the cost of a standard if somewhat nasty recession. Trillions of dollars of intervention would not have been needed. Just standard macro policy. Even in 2006 it might still have worked. The Fed blew it, and they broke the system, and now with the system broken they may have to either buy it all out (and Paulson may be considering that after all) or just become the system. And even if they do that may not work, because, well, who wants to borrow and invest right now?

Bernanke and Greenspan are certainly in the “worst Fed chairman of all time” stakes in a big, big way.

So what does all this mean? It’s not “financial socialism” or the “end of capitalism”. While there are some truly absurd narratives circulating about how the meltdown is all the fault of… you guessed it, regulation, the Left and/or Bill Clinton, this nonsense is not unrelated to the coincidence between the financial meltdown and the American Presidential election, and it can be disposed of very easily:

Although financial institutions were evaluated for compliance with the act, it never required they lose money on mortgages or that they be given to people with slim prospects of repaying them. Even if, as some claim, the legislation ultimately played a part in encouraging excesses, such as the bundling of sub-prime loans into packages that hid their riskiness, that was a failure not of too much but of too little regulation.

[Mike Steketee]

What conservatives can’t point to, ultimately, is any form of regulation that actually caused the crisis. No one put a gun to the head of US bank executives and made them lend to people without the means to repay loans. No one threatened dire retribution to investment bankers unless they packaged sub-prime securities. And no one compelled Standard and Poor’s and Moody’s to inexplicably and wholly irresponsibly rate those securities at AAA levels even when they didn’t understand the packaging mechanisms being used.

[Bernard Keane]

As Keane points out, this sort of thing is a classic example of the moveable feast that is the right wing opinionating machine – an “ownership society” and aspirational citizens were the mark of the success of right wing governments yesterday, and today evil lefties encouraged passive banks to lend money to all sorts of unsuitable poor people.

While it may be difficult at the moment for the Right to point to capitalism as a roaring success story, what’s occurring in response is very far from being socialism, or even nationalisation.

John Quiggin writes:

This kind of instalment-plan nationalisation seems to offer the worst of all worlds. At some point, a more systematic approach will have to be adopted, and given the rate at which markets are plummeting, the sooner that point comes the better. This isn’t the return of socialism, but it certainly looks like the end of the kind of financial capitalism that has prevailed for the last few decades.

And his opinion is echoed by a socialist blogging sociologist:

And what about the future of capitalism itself? No one is saying the system itself has collapsed, rather what has gone down the tubes is a particular way of organising capitalism. It is too early to tell what could replace it, though a number of participants flagged up the possibility of a more regulated capitalism, albeit without the welfare and full employment commitments of post-war Keynesian capitalism. It’s also likely that Neoliberalism will continue to cast its shadow.

And in a rather pithy article from Andrew Crook of Business Spectator:

Western economies, with their manufacturing industries gutted and the entrails shipped abroad, are struggling to actually produce anything beyond amorphous “services” and intellectual property. This has mirrored the spread of cancerous and impossible-to-decipher debt instruments, producing the biggest financial bubble in world history. That bubble has just burst.

Sub-prime mortgages may have been the bitter pill, but it’s the yawning distance between these debt vehicles and the bricks-and-mortar of our everyday lives that could prove fatal.

Assuming the current crisis doesn’t result in the second coming of socialism, we’re left with the familiar remedy of ever more-regulated domestic markets. But the genuine policy levers of an earlier era remain out of reach.

Over the last 30 years, the Keynesian social fabric has being steadily eroded by the slavish adherence of Western governments to global market forces (“external harmonisation”) as a non-negotiable pre-cursor to domestic policymaking. Despite the tinkering of Rudd and co, this remains broadly the case. Not that they’d have you believe it.

As I’ve been arguing, the political logics behind neo-liberalism remain well entrenched, despite the recourse had by panicked “free markets” to the “nanny state”. Mark Davis agrees neo-liberalism isn’t finished:

It’s a nice idea, but underestimates just how deeply embedded neoliberal ideas are in the global finance system. My sense is that the bail-out, now passed by the US senate and to be revoted on in Congress tomorrow, will happen, even if it won’t necessarily work because there’s more to this than simply lancing a boil. Regulatory noises are being made and some tightening will take place. But the system will stay relatively unchanged because too much depends on it and because money and power have little respect, in the end, for principle.

We have essentially two problems at the moment from the point of view of the conjuncture of political economy and the alignment of social and economic forces. The first is that social democratic parties have bought into the logic of the dominant paradigm to such an extent that there are very few alternatives on offer. The second is that neo-classical orthodoxy has led to such a mismanagement of the global economy that states appear bamboozled in the face of a liquidity crisis, and few orthodox solutions appear to offer any hope of turning the situation around in the short term. We will probably see some sort of stabilisation, though perhaps not for a while, and we will also see the emergence of a new orthodoxy not too dissimilar to the old one as the superficial lessons of the crisis are absorbed and the wagons of the powers that be circle the camp.

So, if the policy cupboard is bare, and ideologues are trying desparately to readjust themselves to some version of “culture wars as usual”, what is to be done? Andrew Crook, once again, is absolutely on the money:

The broader challenge for the Left, and for politics, is to imagine a radically-different regulatory framework with actual meaning for alienated individuals struggling, in a world of tumult, to carve out a viable identity and a cohesive personal narrative. This won’t come from centre-left policy elites—it requires a new breed of social movements to organise around these faultlines and assert their right to economic and cultural autonomy.

But the outline of such a movement is only just being sketched and echoing Paulson’s doubters on Wall St (the Dow has lost 13 per cent of its value in the last five sessions), there’s little reason to believe conditions on Main St, or anywhere else, will begin to improve any time soon.

Update: New post here. Comments are now closed on this one.

Federal Treasurer Wayne Swan says he has directed the Australian Office of Financial Management (AOFM) to invest in residential mortgages.

The decision follows the chaos in the United States housing market, but Mr Swan says it is a good news announcement because it will increase competition in the mortgage market.

It’s worth noting that this is quite different to what the US government is proposing to do with its bailout, and it’s solving a different (though related) problem. Australians haven’t started defaulting on their mortgages in massive numbers. Nor has the Australian property market gone into freefall. Nor – so far – have any of the Australian banks revealed they own inordinate amounts of American “toxic sludge”. The problem we face is that competition in the mortgage market has apparently dried up because of, essentially, guilt by association.

As I understand it, the smaller Australian banks, and the non-bank lenders, don’t have a huge deposit base to fund their lending. Instead, they parceled up their loans, and sold them on as mortgage-backed securities. As far as I can tell, there’s nothing fundamentally wrong with that practice. However, the credit crunch in the USA means that nobody will buy any mortgage-backed securities whatsoever, despite the fact that Australians have continued to, as a group, pay their mortgages on time. Hence, the small banks and non-bank lenders haven’t been able to continue lending, and the big four banks have increased their market share while pushing up their margins.

So the idea is that, to allow these financial institutions to get back into lending money, the Australian government will step into the breach and start buying Australian mortgage backed securities.

If this idea sounds familiar, you’d be right. The principle, though not the mechanism, is similar to the AussieMac proposal by Joshua Gans and Christopher Joye. Gans is rather pleased:

This is not an Aussie Mac as a long-term institution but is along the lines we had been suggesting earlier as a short-term or transitional measure and, more recently, as critical piece of insurance, as the crisis grew deeper. Aussie Mac was designed for the future. This use of the AOFM is for right now. It is an appropriate move and my expectation is that it will have an effect on those markets right way. Hopefully, we will see the non-banks and smaller banks get right back into this market and we will be able to turn the ticker on aussiemac.org off.

There is one more person who will be feeling rather pleased with themselves – one Malcolm Turnbull. Turnbull called for this to be done last week – though in such an unclear fashion he apparently had to spend some time on Q&A last night explaining himself. The government must have been considering this plan for more than a week; indeed, the legislation that made it possible dates back some months. I wonder why Wayne Swan, when Turnbull raised the idea, didn’t simply say “thanks, but we’re already on it, Malcolm”?

It’s easy, with the benefit of hindsight, to shake one’s head at the flaws in the risk modelling that they did. Using the example of a real (but anonymized) block of subprime mortgages Moody’s rated, one of the many flaws in the process becomes clear:

A month after Zandi’s report, Moody’s rated Subprime XYZ. The analyst on the deal also had concerns. Moody’s was aware that mortgage standards had been deteriorating, and it had been demanding more of a cushion in such pools. Nonetheless, its credit-rating model continued to envision rising home values. Largely for that reason, the analyst forecast losses for XYZ at only 4.9 percent of the underlying mortgage pool. Since even the lowest-rated bonds in XYZ would be covered up to a loss level of 7.25 percent, the bonds seemed safe.

Hanging around on American blogs, around this time I began to hear about property flipping – the same sort of behaviour that was familiar from the dot-com boom of the late 1990s. When people are buying property (or shares) on the basis that they’ll be able to sell it immediately for more money, it’s a pretty good sign that there’s a bubble that will pop sooner or later. It does amaze me that this wasn’t starting to ring alarm bells.

But beyond that, the article points to some more evidence of the view that the ratings-agency model provided incentives for the agencies to tell the story that their customers – the people trying to sell financial instruments – wanted to head:

And it seems to have helped the banks get better ratings. Mason, of Drexel University, compared default rates for corporate bonds rated Baa with those of similarly rated collateralized debt obligations until 2005 (before the bubble burst). Mason found that the C.D.O.’s defaulted eight times as often. One interpretation of the data is that Moody’s was far less discerning when the client was a Wall Street securitizer.

There were endless points in the chain where destructive behaviour was rewarded. Amongst the justified clamor for more regulation of the financial markets, one thing that might be looked at is whether regulation can prevent some of these incentives for stupidity.