Escaping the financial morass

Inclusive Economy21 Sep 2011Michiel Verweij

The West is sinking deeper and deeper into the financial morass. It tried to escape the swamp by having its institutions buying up one another’s debts. Over the last few years we saw governments saving banks and banks saving governments and ultimately central banks saving banks, governments and the rest. They apparently found inspiration in the adventures of Baron Von Münchhaussen – known for having miraculously escaped the swamp by pulling his own hair. And, it must be said; so far the incestuous buying up of debts helped keeping money markets afloat. Yet the underlying problems remain unaddressed; we are still stuck in the sucking mud.

Beliefs, Ignorance, and malicious behavior

Mr Greenspan was one of the captains in charge of the contemporary adventure in Western market capitalism. In his book ’Age of Turbulence: Adventures in a New World’ (2007) Greenspan writes about how he came to believe in self-regulation and the “invisible hand” for alignment of personal- with public interest. He describes how these ideological beliefs shaped the dominant financial policy and reality of the Twentieth Century. But history proved him wrong. Disappointed about the selfish and irrational human behavior, he made the historic confession that his worldview had a flaw. This outstanding example of adult learning could have earned him a tap on the back and encouraging words: “Capitalism is one big learning experiment, next time better”. But is encouragement the right response to somebody who is co-responsible for maneuvering us in this mess?

Other bankers, if not intentionally evil, were at least ignorant and negligent. It’s more, they suffered from gross negligence. Just think about bankers who admittedly didn’t understand the financial products they sold, or the risk they were immerged in. Shame! And what grand vision guided the pumping of huge financial resources into consumption (housing). Instead of ensuring capital buffers to cover long term risks, bankers and insurers decided to divide the gains? Shame! Risk, I had learnt as a boy, meant you had to be prepared for the worst and if it didn’t strike this time, it would definitely strike later… and harder.

It can’t be worse? Well, perhaps it could. What did bankers feel when they helped clients camouflaging their high debt levels? Did they realize they saved small reputations at the cost of the well-being of generations? Shame! And how do you call the practice of migrating large risks out of sight on off-balance sheets: Münchhaussen border-line behavior or crime? Shame is also due on all economists and auditors and others who followed mainstream thinking without raising red flags for suspicious bookkeeping practices.

Fair accountability

Justice and fairness are core principles of defining humanity. However, some argue about the impossibility to hold people accountable for mistakes, misjudgments and misdeeds that caused the financial downfall with the argument that this was an overall systemic brake-down. Everybody – and thus nobody – was to blame. But what does justice say in case of actions guided by ideological beliefs? Or what would be a fair punishment in case of negligence? How would we treat a ‘risk loving’ baker selling special bread with unknown, possibly toxic, ingredients?

The good thing of the financial disruption is that financial stability is now a fully acknowledged ‘Global Public Good’. President Obama referred several times to America’s responsibility for the global financial stability. Even one of the spokespersons of ‘Haute finance’ Mohamed El-Erian, chief executive of the investment fund PIMCO, talked about the need for new suppliers of the public good of international financial stability. Bankers, politicians and economist are busy crafting new institutions and rules to ensure financial stability (e.g. Basel III accords). Probably one of the major legislative pieces produced so far, is the Dodd-Frank act for financial stability of 2010. However, this act clearly outlines its responsibility: restoring the American financial stability; no single words about global financial stability.

So, who should provide that global financial stability? Will financial stability be safe in the hands of governments and public institutions? No, say some because government will asphyxiate risk taking entrepreneurship and thus stifle innovation. Or, the alternative, can we expect Wall Street to prudently govern our collective good. No, say others: just look at the “money-mad pirates” recent behavior? What role can be expected of the United States, China, Germany, Europe, the IMF or the emerging markets, Captain Africa?

Emergency rules

Remember, time is running out: the morass is sucking us down. Urgent actions are required to avoid sinking deeper into the swamp. Rule number one is, as I remember from the boy scouts: ‘stay cool’. As with quicksand, the more you move the faster you will sink. So the current unrest and market volatility is doing no good. Secondly, continue the Münchhaussen stimulus by calling into existence new institutions and facilities like the financial stability funds that can absorb more debt. It will work as long as people believe it will work.

The third urgent measure has to deal with decreasing the pressure on the soft underground by spreading the weight over a larger contact surface. Shared and coordinated responsibilities among more and different players. And wasn’t it one of the crisis major lessons that a systemically interconnected world demands, some sort of, system for international (global) financial governance. Stability likely will benefit from global arrangements for financial regulation.

With the dwindling power of the United States we have – now more than ever – the option to embrace the emergence of a multipolar world as El-Erian and others suggest. From accepting multipolar power distribution it is a small step to visualizing multipolar responsibility in relation to the management of global public goods. In the case of finance, shared responsibility among more nations and power blocks would allow spreading risks as well as laying the foundations to redress current imbalances ( in a broader framework of common international interests.

The obvious practical challenge is to develop adequate capacities and skills, including attitudes, for international relations and cooperation. Not a small enterprise if you consider the United States will have to learn to work more through international institutions, Asia to adapt more cooperative behavior regarding international issues, Europe to talk more with one voice based on shared values and vision, Africa first needs to be more successful in moving out of poverty, Latin America that is too busy enjoying its own success and Russia…Russia what?

Only after stopping the further sinking in the morass, structural solutions can be devised such as pumping excess water out, restore levees, and search for the rock bottom for new foundations.

Response to ‘Escaping the financial morass’

Fabian Heus | November 08, 2011

Dear Michiel,

I was pleasantly attracted to your plea for escaping the financial morass; I would like to raise the following amplifications:

First I would like to note that the main aim of finance (in its broadest understanding) should be to contribute positively to the lives of human beings. Nowadays the opposite seems to be true: citizens need to behave in line with and to consolidate so-called economical ‘laws’ in order to maintain a ‘well’ functioning economy. Two notions must be emphazised:
1. One direct effect of the globalized market is that it can not be controlled by world citizens nor by individual countries: as we do not have elections other than in individual countries, this is a flaw. Besides that it is useful to bear in mind that the notion that the above mentioned cooperative behaviour will be beneficial to citizens is just an implicit assumption: what is good for (big) companies no doubt will be good for citizens; what is good for global economy for sure will be to the benefit of people. This assumption is not valid in all cases: it can only be valid in an environment with a very direct connection between economical activities and its actors (citizens). In the current globalized economical environment, however, this direct connection has since long disappeared.
2. An economical ‘law’ is not to be compared with e.g. the Gravity Law: these economical laws are principles only valid in a specific cultural environment; ‘it will only work as long as people believe it will work’, you wrote that already. These principles are believes of which you could wish (for very valid reasons) to be dependent on. But it always is a choice; we could also choice not to obey these principles, but to obey other ones.

Second I would like to dwell a little bit longer on the argument of some people that a systematic brake-down means that people can not be held accountable for its mistakes. I believe this argument is true, insofar nobody oversees to the full extend the consequences of its global financial actions: we all are very aware of the complex and even inextricable relations between the several governmental and privately owned economical institutions. It is one of the biggest flaws in the current globalized economy that there is nobody who can or will take responsibility: the risk at stake is enormous: economical institutions, people, companies can and will act without any engagement other than short term profits. Is it likely that this will be beneficiary to citizens in the short and long term? No.

Third: when a citizen enters into a contractual relationship with an banking company, the General Conditions of e.g. a mortgage always and only put requirements on this citizen: he has to behave decent, he has to fulfil and do all sorts of demands. In addition to your emergency rules, Michiel, I demand that these documents become reciprocal: they must describe load and clear what the banking company has to do and fulfil and how the citizen is being safeguarded in case this banking company becomes bankrupt.

Last but not least: economy is not about economy. Economy is about human behaviour: experiencing sensations and new emotions of all kind in order to distract citizens from emptiness or from a globalized world. Economy has become hard drugs.