Monday, June 07, 2010

Accident, Suicide or Negligent Homicide? Autopsy of the U.S. Financial System

Financiers and some politicians on both sides of the Atlantic still hold the line that the 2007/08 financial crisis was an unprecedented and wholly unpredictable accident. We know it was no such thing: the crisis was evident for many years and, and as sure as day follows night, will repeat again and again unless root and branch reform is carried out of most of the institutions of financial capitalism.

But questions still go unanswered: how could such a massive pile-up occur without at least some of the key players raising the alarm? why did bankers rush, lemming-like, to almost certain destruction despite red warning lights flashing across many of the key markets, not least the residential property markets which went into 'bubble' mode from 2005 onwards? and why did credit rating agencies (and let's not forget auditors) fail almost comprehensively?

In this recently published paper, Ross Levine of Brown University explores these questions. His focus is exclusively on the US financial markets, but the issues have wider relevance. As the paper's abstract makes clear, the origins of the crisis are rooted in the laissez faire attitudes of regulatory authorities, who (under the misguided tutelage of Alan Greenspan of the Federal Reserve) had long since given up on the job. On this basis, Levine concludes, the crisis was not accidental, or even a case of suicide; the root cause was negligent homicide on the part of regulatory agencies and politicians:

Abstract: In this postmortem, I find that the design, implementation, and maintenance of financial policies during the period from 1996 through 2006 were primary causes of the financial system’s demise. The evidence is inconsistent with the view that the collapse of the financial system was caused only by the popping of the housing bubble (“accident”) and the herding behavior of financiers rushing to create and market increasingly complex and questionable financial products (“suicide”). Rather, the evidence indicates that regulatory agencies were aware of the growing fragility of the financial system due to their policies and yet chose not to modify those policies, suggesting that “negligent homicide” contributed to the financial system’s collapse.

And as Levine also notes in his conclusions, policy makers and regulators were either wilfully blind to the activities they were duty-bound to monitor, or they purposefully encouraged the behaviour that precipitated the crisis. In this respect, as the paper's final remark by Senator Carl Levin makes clear, the root of the crisis lies in the aggressive 'beggar-thy-neighbour' nature of contemporary financial capitalism:

“The recent financial crisis was not a natural disaster; it was a manmade economic assault. It will happen again unless we change the rules.”

We fully share Levin's stark view of this crisis. But the problem runs too deep to be remedied by just a few changes of the rules and tightening of regulatory effort. The current period of laissez faire financial capitalism can be traced back politically to the de-regulatory measures implemented by the UK's Conservative government under Margaret Thatcher. The 1986 "Big Bang" deregulation of London triggered a downward spiral of lax regulation and the complete abandonment of any attempt at controlling bank credit. Arguably this process began even earlier, in the late-1950s, when the Bank of England turned a blind eye to the development of the Eurodollar market in London. These moves were justified by the almost universal buy-in to the ideology of 'efficient market theory' and 'rational expectations'. Any attempt by governments to control market forces would undermine these ideological constructs, so politicians and their advisers simply sat back and let the 'magic of the market' do its stuff.

Greenspan and his disciples (please understand that 'efficient markets theory' is as much an act of faith as belief in any other metaphysical deity) have partially recognised the deficiencies of their thinking, but the dogmas they espoused still hold sway. As a consequence, we are not at all confident that politicians and regulators in the major financial capitals, let alone in the mickey-mouse satellites that acted as incubator sites for so many of the securitised instruments that Levine refers to (Jersey and the Cayman Islands are prominent in this respect) have even begun to recognise the scale of the sea-change of thinking required to prevent a repeat catastrophe.

You can download Levine's paper here.


Post a Comment

<< Home