by Jerome a Paris
Sat Jan 26th, 2008 at 04:54:27 AM EST
The FT has an editorial about The start of the great unwinding of what they call "hyperfinance." And they are actually asking the right questions, if not quite yet offering the right answers, nor moving from their position (understandable givne who their readership is) that financial markets should thrive.
If the US suffers a recession in 2008 or 2009 it will not be due to an industrial decline or an oil price shock. It will be a recession that began in the financial system. The response of the general public is confusion, tinged with horror, at how intangible finance can impinge on their daily lives. Even some bankers and traders must be struck by the chaos their business can unleash, and feel awe at just how powerful they have become.
A fundamental question therefore arises: is the financial system broken, corrupt and in need of reform; or is the system sound, yet subject to external pressures, notably heavy monetary stimulation, with which it could not easily cope? On that diagnosis rests the future of our highly liberalised financial markets.
My, my, "broken" and "corrupt"... even with question marks, this shows how far the mighty have fallen, and suggests that there is a chance right now to make the case for different policies. And in an odd way, the FT's arguments to defend financial markets help point the blame in the right place: politicians.
They suggest two scenarios:
Analysis One would begin with the actions of the Federal Reserve in 2001-02. In the wake of the internet bubble the Fed, under then chairman Alan Greenspan, cut interest rates to 1 per cent in order to stave off the threat of deflation. One result, arguably, was to create a new asset price bubble in the housing market, fuelled by the sudden affordability of mortgage loans to subprime borrowers who previously could not afford them.
At the same time, to protect against a repetition of 1997’s Asian financial crisis, China and others pegged their currencies to the dollar at undervalued rates. The only way to keep their currencies down was to buy ever more US bonds. A supply of cheap credit met its demand.
The final part of this view would be a resulting explosion in the depth, liquidity and inventiveness of financial markets that went too far, too fast. The acronyms – CDS, ABS, CDO – swarmed faster than the markets’ institutional capacity to price and manage them. Even the losses at Société Générale can be explained in this way. Twenty years ago a whole floor of traders would struggle to lose €5bn even if they were trying. Today, thanks to the deep liquidity of futures markets and the anonymity of electronic trading, one man can do so in days.
Analysis One is benign for the financial markets: they are the acted upon, not the actors.
In terms of what happened, this is a pretty accurate description, and it does not put the blame (like Martin Wolf still does) on a "savings glut" from the emerging economies, but rather from policy decisions in Washington, followed by others in Beijing and elsewhere.
While the tax cuts are not mentioned, and the general creed that "greed is good" is only implicitly suggested (the markets spontaneously took advantage to the utmost of a favorable context), the attempt to clear the markets of guilt, in saying that they are just a ruthless machine to exploit situations created by others points to two things:
- the guilt of politicians in creating a macro-economic framework that created such huge imbalances (the combination of tax cuts for the rich, an endless push to weaken labor market rules, and a loose monetary policy which led to stagnant wages, skyrocketing debt and asset inflation);
- the very ruthlessness of the financial machine, brutally and amorally exploiting that context for maximum immediate gain (in the way of capture of future revenues from the real economy).
These points are certainly worth flagging. But there's more:
Analysis Two would put markets’ own failings at the centre of current events.
The core of this second analysis is the vastly increased complexity of hyperfinance. Once upon a time, banks lent depositors’ money to their customers. Now, money market funds buy asset-backed securities from conduits filled by banks originating loans from brokers. The advantage of this system is that no one entity need be overexposed to any one borrower. The disadvantage is that the seller at each step has the ability and incentive to offload bad loans to the buyer.
Complexity also adds to the danger that any one part of the hyper-financial system can bring down the whole. (...)
Another conflict of interest that has become pronounced is between banks’ shareholders and their employees. This is the more cynical interpretation of Société Générale. If employees make profits they are paid bonuses; if they make losses, they are sacked. Their incentive, from graduate trainee up to chief executive, is to take more risk and so increase the potential profits. (...)
If this second view is right then regulators have failed. They will have to change the rules to try to eliminate the conflicts that imperil the financial system.
This goes even more directly to the heart of the overall culture of greed. In blaming regulators, this editorial only underlines how prevalent the permanent requirement for returns and efficiency is driving people to ruthlessly cut all corners, and go around rules - and it certainly has not helped that these rules have been deliberately weakened (a point still conspicuously absent from this article).
All in all, a ferocious, if still partly implicit, indictment of the Anglo Disease. something to build upon.