Let us remember that very few months ago bankers and politicians alike threw ashes on their heads and promised both to repent and reform: this was …..
Today, both groups like to talk about “green shoots”, of narrowing spreads, of a reversal of the stock market crash, and so on: optimism is in full swing, at least as far as the financial sector is concerned. However, I have the uneasy feeling that they just want to get on where they were stopped before they got us into the biggest financial and economic crisis in 70 years. Lessons learned? – We don’t want state interference! Repent? – Let’s pay back government money so we can finally get our deserved 2008 bonuses! Reform? Let us not destroy the green shoots, no heavy-handed regulation, especially not on an international level! Remuneration Reform? We want to create value for the shareholders!
This last week was remarkable for being host to several significant events:
– The BRIC countries (Brazil, Russia, India and China) met in Yekaterinburg and demanded more say in international financial affairs;
– US President Obama outlined the US plans for a revamping of the financial markets regulatory system;
– UK Chancellor Darling and Governor King outlined their respective plans for regulatory reform of the UK system:
– The European Council gave its o.k. to the European Commission’s plans to improve European regulation, based on Jacques de Larosiere’s proposals.
Shall we say that “A mountain has given birth and out came a mouse”????? A momentous opportunity has been lost.
Maybe this judgement is unfair, but the combined response to this ongoing crisis is disappointing, to say the least. There are bits and pieces in the individual proposals, but neither individually nor jointly do they tackle the most severe problems which brought the world economic system close to collapse. Let us recall some of these:
a) the persistent global imbalances where large and continuing current account deficits and surpluses were accumulated over more than a decade, enabling the US to absorb 2/3 or the world’s savings, enter an unsustainable consumption spree and creating bubbles in the stock and real estate markets across the globe;
only the BRIC proposals address this point, calling for a more balanced and symmetric system of international finance and a gradual changeover to a more balanced world reserve currency
b) abundant credit, a spirit of financial market self-regulation and deregulation, the scuppering of the Glass-Steagall Act in the US, ending the separation of commercial from investment banking, the outsourcing of risk – all these led to a gigantic “innovation” spree in financial products and instruments with vast profit/bonus taking of the financial sector; it was especially the separation of risk-taking from its source, the securitization and on-selling of diverse products (mortgages, car loans, student loans, credit card loans) which spread contagion across the whole global financial system; many banks have become so large that they are “too big to fail” and need to be saved by the taxpayers.
c) the “search for yield”, the “25%” required minimum return (Ackermann), the capital hunger of emerging and developing countries led to an explosion of credit and equity flows from developed into less developed countries: these flows increased more than sixfold within 5 years to 1 trillion $ in 2007; no risk was too big, no M&A (merger and acquisition) too risky, no leverage too high; While the Basle Committee worked on risk-weighted assets as the basis for capital requirements, the financial sector ignored risk, or farmed it out to “somebody else” – who for various reasons, including the “performance” of rating agencies, had no idea of which risks she was buying.
d) there is a Viennese wine song “Sell my clothes, I am going to heaven” (“Verkaufts mei Gwand, I fahr in Himmel”) meaning that no precaution for the future needs to be taken, because the present is so abundant: This describes the actual sentiment in financial markets well; irrational belief that stock markets would keep rising forever, that business cycles were a thing of the past, that “new economics” had replaced classical, neo-classical or Keynesian economics, that thus pyramid-game like financial engineering could be sustainable. The few warning voices were ridiculed; of course, politicians basked in the glory of growing economies, buddied with the gurus of finance (and envied them for their phenomenal salaries). While economic growth during the past years was (nearly) unprecedented, nobody looked at the more and more skewed income distributions, which meant that median household incomes in real terms had been stagnating in many countries and all or most growth dividend had been reaped by corporate, mainly financial sector profits and the obscene compensation of traders and financial sector managements. Discussion of that was relegated to “envy”, its threat to the confidence in the system and to social cohesion was ignored.
All this was recognized and admitted when the “bubble burst”. The various G formations (especially G-7 and G-20) called for repentance and reform, vowed to get to the root causes of the crisis and make sure that another one like this one would not occur again.
The result (so far): taxpayers have put up previously unheard-of sums as equity and guarantees for the rescue of the financial system; many banks have been taken over by the various governments, the real sector is suffering the worst crisis since World War II; in spite of the talk of “green shoots”, much of the real economy recession is still ahead of us, including a strong increase in unemployment.
As for lessons learned (exemplified by the recent events mentioned above):
– The US will maintain its maze of 8 supervisory bodies (eliminate one and add one for financial consumer protection), strengthen the Federal Reserve and mandate it with more prudential systemic supervision, but they will not break up the large banks (two thirds of the members of the 12 regional Feds are nominated by the respective banking industries); off-balance sheet entities will need to register, so regulatory arbitrage should be reduced; higher equity will be required for mortgages, banks will have to keep more risk on their books.
– The UK chancellor is mainly intent on defending London’s role as most important financial center of Europe: he relies on board members and executives of financial institutions to become “more responsible”; the Bank of England governor is braver and calls for breaking up too large banks, lodging more supervisory power with the Bank, registration of hedge funds and rating agencies: but both are vehemently opposed to more “European” supervision, since it might endanger London’s position.
– The European Union did not dare to impose rules on recalcitrant UK (and a few others) and passed a watered-down version of a new European regulatory body (chaired by the ECB President and made up of the member states) without mandatory powers over the financial centers and their public budgets of the members. The widely dysfunctional Lamfalussy maze of reporting-in-circles institutions for banks, insurance companies and stock markets remains intact. The idea to centrally supervise the “systemic” cross-border financial institutions has been dealt a severe blow.
– There is no discussion about a wholesale rethinking and remaking of the role of the financial sector in the economy: what socio-economic value does the pervasive system of trading create? What risks are thereby created? Which functions are really needed and which serve mainly the sector itself and the enrichment of speculators? Is the theory that laying ever new markets over markets really efficiency-enhancing and value creating – or does it not create a veil of non-transparency over the whole system, making it so complex and diffuse that more risks are created than necessary? Has the bonus system, originally designed to align the interests of managers with those of the shareholders, not been perverted into even more managerial discretion – at the expense of the stakeholders of the enterprises? Do we not need global supervision of global institutions, and does globalisation not render national supervision inadequate? Many questions were on the table and have been swept under it, instead of attempting answers at solving them.
Of course, this is not yet the end of the story. But there are ominous signs on the wall: the complicity of the US administration with the financial institutions which caused the crisis; the intense lobbying efforts by UK institutions during the past weeks to significantly weaken a joint European supervisory effort; the only half-hearted proposals by the EC towards a simplification and centralization of supervision, and more.
It is left to “private” attempts, like the joint IFI initiative, like the “Vienna Initiative” to correct (at least regionally) some of the shortcomings of the system. But these efforts are only partial and only voluntary: they can not replace a radical restructuring of the world’s financial market supervision.
Hyman Minsky during the 1970’s warned of risk running amok if not properly managed and supervised: many politicians during the past year have paid lip service to him and his ideas. They have not followed up with deeds.
If what we have seen this past week is all the repenting and reforming there is we better put our seatbelts on, because the next crisis is just around the corner.