Exactly
one year ago, the Wall Street investment bank Lehmann
Brothers was allowed to go bust, in a move that is generally
seen to have brought on the global financial crisis.
Shock waves hit the financial markets; stock markets
collapsed in waves of contagion across the world; credit
seized up in most developed and many developing economies;
and for a while it really did seem that global capitalism
was facing direct threats to its very survival.
The collapse was not entirely unexpected. The implosion
of the US housing market over the past year had already
exposed the massive fragilities in the global financial
system, with institutions interlocked in such opaque
ways that the full extent of liability was not known
even to the most experienced players. In consequence,
the summer of 2008 had already witnessed the US Federal
Reserve bailing out several major financial institutions,
beginning with providing a dowry for the failing bank
Bear Stearns in its shotgun marriage with JP Morgan,
and then going on to protect and then effectively nationalise
the mortgage holding agencies Freddie Mac and Fannie
Mae. It was well known that many major investment banks
and other financial institutions (such as the insurance
giant AIG) were all extremely vulnerable, and short-selling
by those betting against such institutions only hastened
the likely denouement.
After the Lehmann Brothers debacle, the US government,
and indeed other governments in Europe and elsewhere,
swung into action on an unprecedented scale to prevent
what seemed like a possible financial and economic catastrophe
of global dimensions. Monetary policy was loosened to
the absolute limit and fiscal stimuli were introduced
to maintain spending. Most of all, there were more bailouts:
huge injections of liquidity that directly and indirectly
benefited certain big financial players who were seen
as integral to the functioning of the system.
On year on, it can be said that that particular crisis
was averted. The world economy went into recession,
but did not collapse altogether. Today there is talk
of recovery everywhere, even in currently recessionary
Europe and certainly in the US. So was the emergency
response successful? And have policy makers learned
the important lessons from the crisis?
Unfortunately, this does not seem to be the case. Most
significantly, hardly anything seems to have been learned
in terms of required regulation of finance. Despite
overwhelming evidence to the contrary, there has been
no moving away from the ''efficient markets'' hypothesis
that determined the hands-off approach of governments
to the financial sector. Financial institutions have
been bailed out at enormous public expense, but without
changes in regulation that would discourage irresponsible
behaviour. Banks that were ''too big to fail'' have
been allowed to get bigger. Flawed incentive structures
continue to promote short-term profit-seeking rather
than social good. So we have protected private profiteering
and socialised its risks.
One of the worst consequences of this flawed manner
of dealing with the crisis is that moral hazard is now
more pronounced than ever. The Palgrave Dictionary of
Economics defines moral hazard as ''actions of economic
agents in maximising their own utility to the detriment
of others, in situations where they do not bear the
full consequences''. In financial markets, these problems
are especially rife because such markets are anyway
characterised by imperfect and asymmetric information
among those participating in the markets.
The moral hazard associated with any financial bailout
results from the fact that a bailout implicitly condones
the earlier behaviour that led to the crisis of a particular
institution. Typically, markets are supposed to reward
''good'' behaviour and punish those participants who
get it wrong. And presumably those who believe in ''free
market principles'' and in the unfettered operations
of the markets should also believe in its disciplining
powers.
But when the crisis hits, the shouts for bailout and
immediate rescue by the state usually come loudest from
precisely those who had earlier championed deregulation
and freedom from all restriction for the markets. The
arguments for bailout are related either to the domino
effect - the possibility of the failure of a particular
institution leading to a general crisis of confidence
attacking the entire financial system and rendering
it unviable - or to the perception that some institutions
are too large and too deeply entrenched in the financial
structure, such that too many innocent people, such
as small depositors, pensioners and the like, would
be adversely affected.
The problem is that this leads to both signals and actual
incentives actually encouraging further irresponsible
behaviour. Both financial markets and government policies
have operated in such a way that those running the institutions
that might or do collapse typically walk off from the
debris of the crisis not only without paying any price,
but after substantially enriching themselves further.
Because those responsible for the crisis do not have
to pay for it, they have no compunctions in once again
creating the same conditions.
This is why these enormous bailouts should have been
accompanied by much more systematic and aggressive attempts
at financial regulation, to ensure that the same patterns
that led to this crisis are not repeated. Similarly,
there must be regulation to prevent speculative behaviour
in global commodity markets, which can otherwise still
cause a repeat of the recent crazy volatility in world
fuel and food prices that created so much havoc in the
developing world.
This opportunity wasted by governments – reflecting
the lack of basic change in the power equations governing
capitalism – will prove to be expensive. We should brace
ourselves for an even worse replay of the financial
crisis in the foreseeable future. And the lopsided government
response – benefiting those responsible for the crisis
without adequate concern for the collateral damage on
innocent citizens – may give public intervention a bad
name, at a time when we desperately need such intervention
for more democratic and sustainable economies.
|
