There's no such thing as a free lunch. Never has been; never will be. Someone has to go out there and grow the vegetables or catch the fish. But it becomes increasingly apparent that one heck of a lot of free lunches have been had in the past two decades - predominantly and in the first instance by bankers and brokers (an apposite term for our times) in the finance industries.
I came across the "free lunch" phrase again recently in a Time magazine article by economist and Nobel-laureate Joseph Stiglitz. He was attempting to explain exactly how we all got into this mess - the financial meltdown, that is.
He takes it back to the collapse of the tech-bubble in the early 2000s and the subsequent flood of cheap money injected by Bush-Greenspan in an attempt to rev-up the economy. The problem was that "low interest rates and easy access to funds encouraged reckless lending".
And so we - or at least the United States - discovered the now notorious "sub-prime mortgage": essentially no-deposit, interest only, lax documentation loans which people took, or were persuaded to take, on the back of rising house prices. It didn't much matter if the punters fell short on meeting their repayments, as they did in ever-increasing numbers when delayed interest rises kicked in, because as they had been told at the outset, they could always refinance.
The mortgage brokers and the bankers laughed all the way to their vaults - weighed down by the copious fees and bonuses earned. Until, predictably, the market slowed and the giddy hikes in real estate came to a grinding halt.
But by this time the fallacious assumptions - along with numerous new "products", sophisticated practices, and "toxic" mortgages - had insinuated themselves not only into the US financial system, but the world economy.
Risky mortgages are not the only questionable phenomena associated with low interest, plentiful money and lax regulation environment the meltdown has pulled into focus.
Take Private Equity - a buy-out mechanism that has over the past 20 years or so created enormous wealth for its practitioners. There are variations, but typically what happens is that the PE company puts a portion of the required funds from its own pocket into its buy-out target, a company not listed on the stock market - and which must have guaranteed earnings - and funds the rest of the purchase through cheap loans. The "private" nature of the deal precludes serious scrutiny. Various permutations minimise tax implications.
Say the take-over target has annual profit of $10 million and is acquired by the PE company for $100 million. It might put down $20 million of its own capital and borrow $80 million. In four year's time it sells the company for the $100 million it paid for it, having over those four years put its annual $10 million profit back into the loan. That loan is now reduced from $80 million to $40 million, and at the completion of the sale, the company is able to pay back the outstanding $40 million, leaving it with equity of $60 million - a $40 million profit on the deal. Not bad work if you can get it.
If the PE company has managed to trim down the work force, off-load various assets and cut other costs so that it's annual profit is substantially increased - say, to $15 million a year - then the loan is reduced over the four years to $20 million and the profit on the deal rises to $60 million. The PE company executives typically earn millions in fees and bonuses.
The practice of debt-funded infrastructure follows similar logic. The company or bank buys huge infrastucture concerns - toll roads, bridges, tunnels, transports and services - that have guaranteed income streams, using cheap loans. They then sell the projects to the public, with the shareholders taking over the debt.
Again, the figures involved are often vast and the small - in percentage terms - fees add up to tidy sums for the bankers. It was a model pioneered by Australia's largest investment bank the Macquarie Group, and again, according to Time, its days are thought to be numbered - owing to decreases in asset prices, and the credit collapse.
Such mechanisms have created immense fortunes for a few and led to an increasing disparity between the best off and the poorest - in the US and elsewhere.
There has been nothing overtly illegal about it all, but morality-wise, it has not been unfettered capitalism's finest hour. Some will argue differently as to the merits of cheap money, deregulation and free markets, but I'm with Mr Stiglitz. The first rule of economics: there's no such thing as a free lunch.
- Simon Cunliffe is assistant editor at the Otago Daily Times.
