“Why a complete rethinking of our political economy is necessary”
Here is review in yesterday’s Irish Times of Out of Crisis: Rethinking Our Financial Markets by recent RWER contributor David A Westbrook
Why a complete rethinking of our political economy is necessary
BOOK REVIEW: Out of Crisis – Rethinking Our Financial Markets By David A Westbrook Paradigm Publishers 176pp, $15 (€11)
THIS BOOK is targeted at the relatively sophisticated financial reader, which includes many readers of this newspaper, in view of the steep learning curve they have had to endure on the topic over the past 18 months. Although based on US financial markets, the analysis is international – and relevant to Ireland.
The focus is on exploring what former US Federal Reserve chairman Alan Greenspan told Congress in October 2008: “This modern risk-management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year.”
This is not just an intellectual problem. The risk-management paradigm has been taught, accepted, practised and lived by most people in the modern economy. It has failed.
We have yet to develop a new consensus on how to think about how the financial system and how economic systems should work. As Westbrook puts it: “There is little reason to believe that this generation of policy thinkers, who were trained in the old, now largely discredited paradigm, really knows how to tackle the problems before it.”
The now common left-wing and right-wing attacks on “the system” play to a continuation of the old financial game, with some tinkering, rather than what is truly needed after a complete failure: a complete rethinking of our political economy.
Westbrook suggests the following starting points:
- Markets cannot be relied upon to be efficient (price is not always a fair value and is not always a reasonable social judgment).
- Financial markets need regulation.
- The information available to market actors, and their supposed sophistication, is insufficient to prevent occasional institutional catastrophe and even threats to the overall system (“Smart money is not always smart”).
- Confronted with the threat of a risk to the system, governments will intervene whatever their hue.
- There is no “moral hazard” stopping financiers taking big risks when they know that when they succeed they get the payoff – and when they don’t the government bails them out.
- Subjective uncertainty, rather than objective risk (which many in the industry thought could be eliminated by mathematical models, transparency, dispersed portfolios, etc), is a major problem to be addressed and cannot be eliminated (one of the key lessons of John Maynard Keynes, largely ignored over the past three decades).
One of the great successes of modern finance has been the extraordinary increase in liquidity through a huge amount of financial ingenuity devoted to getting money into the hands of those who want to spend it. One way or another most of us have availed of this success. However, as with gearing and risk spreading, there is always a counterparty or counterparties to such deals.
So when the music stopped, liquidity vanished overnight, gearing or borrowing frequently became a nightmare or “life-threatening”, and the uncertainty about the other party to each deal froze the hyper-integrated system. This left many with no chair to sit on and a hard fall to a rough concrete floor.
The great “successes” of modern finance suddenly became its greatest weaknesses, magnifying the various bubbles and enabling the subsequent crash and recession.
Westbrook makes a strong case against the National Asset Management Agency (Nama) approach to solving the problem of “bad banks”. Instead, he favours nationalising them and doing an orderly liquidation through a resolution authority of the relevant financial institution.
However, Westbrook concludes – as many governments have also done – that “the nationalisation and liquidation of corporations that pose systemic risks are probably politically unrealistic”.
He believes the Nama approach will fail because it doesn’t see the wood (how do we get the financial system running properly?) for the trees (how do we “sell” toxic assets that nobody wants to buy? Or, how do we avoid declaring insolvent banks insolvent? Or, how do we avoid taking the financial system’s liabilities on to the government’s balance sheet?).
Westbrook provides considerable detail on the supports the US government gave to AIG, Goldman Sachs and many other key financial institutions to help keep them in business when their business models failed. Much of this detail is new to me and I suspect it will be new to most of Westbrook’s readers.
That detail gives the lie to self-serving statements from such institutions that they never really had a problem at all and that their business models worked.
Such continuing denial, evident in a number of US institutions, and in certain respects in some Irish ones as well, is a considerable threat to the effort to design a finance system that will not repeat the same mistakes. A definition of insanity is doing the same thing over and over again and expecting a different result.
Though short, this book contains much to help the reader begin to understand fully what happened and why. If I could put a copy in the briefcase of every financial regulator and executive in the world, I would.
Ponder this: if institutions are judged too big to fail, is that not an open invitation to excessive risk and even corruption?
Richard Whelan is a commentator on international affairs. http://www.richardwhelan.com