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“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  

RICHARD WHELAN 

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 

  1. April 13, 2010 at 3:24 pm

    The author has no idea about the concept of a truly free market. The economies of the world have suffered severe governmental intervention, so how can one justify claiming that non-existent free market has failed? What is needed is a rethinking of statist fallacies.

    • Jon Cloke
      April 14, 2010 at 9:56 am

      That’s exactly right! What we’ve had is not *enough* free market, not too much! Just like, we haven’t had too much war, we haven’t had a chance to let war work properly… what we need is a cataclysmic, all-out nuclear war and then we’ll really see what good things a true war can accomplish!

      • Alice
        April 16, 2010 at 11:30 am

        Yes I agree Jon – the problem with current policies is that we handed out extraordinary freedoms on the march towards unquestioned free markets. This caused massive market failures but now some, like Fred Foldvary want to suggest the failureb was caused by the fact that we ddnt march far enough towards free markets…nad that had we tried harder…Nirvana is there somewhere if only we had the faith in God that Catholics have…we would find ourselves rewarded eventually in heaven. Bah humbug. We have had to live with the ideas for three decades. Long enough trial period. Its over. Its finished as a theory.

  2. Danny L. McDaniel
    April 13, 2010 at 6:25 pm

    Americans need to rethink the economy in general. What the US needs is strong dose of “Back to the Future” economic policy;that is, more manufacturing. The financial house of cards came tumbling down because the US no longer has the jobs in manufacturing it once did. Just go to Detroit and see first hand. America has excess manufacturing capacity to the tenth power: people and physical plants sitting idle and rusting. It is not the financial markets as much as getting the economy making things again.

    Danny L. McDaniel
    Lafayette, Indiana

    • s h a r o n
      April 14, 2010 at 1:31 am

      Oh, for sure. Everyone (not just “Americans”) needs more “things”–especially, if those “things” require some expenditure of funds.

      So, sure, Danny L., let’s get busy making more “things” to sell to people who [think they] need more “things.

      GMAFB

  3. Jim Whitman
    April 13, 2010 at 10:12 pm

    The word ‘squander’ comes to mind when I think of the financial system. Fred – you’re so off beam that I begin to wonder if you are from another planet. What we have is free speculation – a casino finance system. People and institutions that place bets expect both to win *and* be bailed out by government and the real economy if they lose. The market I visit sells vegetables in a car park outside of the national museum in Wellington. Fred – if you think that that writ large is what we need to sort our problems out create a comune. For the rest of us, we need strong states to police the bandits that roam our financial streets.

  4. Peter Radford
    April 14, 2010 at 6:19 pm

    Fred: Since you and I appear to disagree totally as to the possible existence of free markets I wonder whether you could point me to an example of one? I cannot locate one either today or in history. In fact the only plausible location I can come up with is in the minds of economists who want to describe the economy to conform with their pre-existing political views. This is not scientific economics, and it is not real world economics.

    As a measure of the unlikely occurrence of a ‘free market’ I point you towards the activities of our business leaders. Not one operates their company in conformance with ‘free market’ principles. They are appear to be centrally planned. Evidently central planning as a strategy dominates decentralized planning whenever complex business operations need to be established and run.

    Given that none of these companies is as large or as complex as a national economy, it seems unlikely that total decentralization will be the strategy of choice at that level either.

    So the textbook vision of a ‘free market’ remains a nice, but utopian, ideal against which we can measure real world activity. Even then it offers little practical guidance for us to manage our affairs since any theoretical advantages it has rest upon totally implausible and, frankly, ridiculous assumptions.

    From my perspective the sooner we rid ourselves of the charade of ‘free market’ economics the sooner we can all get on with the bigger, and more urgent task, of understanding the real world.

    Fortunately for us, as the correspondents at this site and others attest, there are plenty of folks eager, capable, and more than willing to take up that task!

  5. Deniz Kellecioglu
    April 19, 2010 at 3:33 pm

    The perception of free markets is an illusion in almost every case. They are, however, free FOR rich individuals and corporations, but also planned (to a large extent) BY them. The world economy of today is actually a PLANNED economy and market – see the size and the links between the largest companies of the world.

    Also, I strongly agree with Sharons ironic comments. We certainly don´t need more things produced. We have more than enough of that.

    What we need is development from below with the resource the world, or any nation, already have. Even the most poor nation, by GDP levels, have enough riches to have a prosperous citizens, see D.R. Congo as one example of the potential.

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