The Market's Melting.Look Busy! - No. 159

April 22, 2008

The Market’s Melting … Look Busy!



by Jim Stanford, Canadian Auto Workers
No.159, April 22, 2008

When disaster strikes, political leaders know they must be seen to act - even if they have little idea how, or to what end. They can hardly stand there, hands in their pockets, and shrug. They must at least pretend they know what they're doing.

This motto applies to financial disasters, as well as natural ones. And based on the noises emanating over the past week from the G7 and the Basel Committee on Banking Supervision (13 rich countries, including Canada, who write the global banking rules), looking like you're doing something is pretty much the order of the day.

The G7 finance ministers pledged to enact recommendations from a recent report on financial stability - within 100 days, yet. These include requiring banks to provide more disclosure on their exposure to risky derivatives, and stronger guidelines for credit rating agencies.

The Basel experts, meanwhile, want tighter capital adequacy requirements on banks. That would force banks to play the markets with a bit more of their own money, rather than just their clients'. And they proposed computerized "stress tests" to simulate whether banks are vulnerable to collapse (today's financial derivatives are so complicated even brokers can't understand how they fit together).

The emphasis in these proposals is on oversight and transparency, not genuine regulation. They wouldn't significantly change the hyper-risky behaviour that produced the current meltdown; they would just shine a little more sunlight on it. They wouldn't prevent the rise and fall of future financial bubbles - but they might allow a bit more of the blame to be shifted to the victims (who, in a more transparent world, should have known what they were getting into).

Finance Minister Jim Flaherty mimics this "look-busy" strategy in his own approach to the crisis. He's blamed brokers for selling products they themselves don't understand. He's blamed provincial securities regulators for not supervising the brokers (following Ottawa's script that if anything at all is wrong in the national economy, it must be the provinces' fault). And he's pledged to move up a meeting with Canada's major banks (originally scheduled for May) to discuss what is happening. Not a moment to waste.

Unlike the optics-driven dithering of elected politicians, global central bankers have been spurred into genuine action by the sheer scale of the crisis. Led by the Americans - still, ironically, the most Keynesian and interventionist of the lot - they have waded forcefully into the fray. They've tossed around many tens of billions of dollars of liquidity, bailed out failed brokers, and (in the U.K.) actually nationalized a major bank.

These actions were prudent, helping to avoid (for now, anyway) a much wider conflagration. Indeed, I am awestruck at the speed and deep pockets with which central banks have rushed to the aid of troubled but privileged financiers. If only government would respond with equal determination to the scourges of substandard housing, preventable disease, or environmental degradation. But that's another story.

Trying to stabilize the current crisis is one thing, trying to prevent it from happening again is quite another. And financial officials will have to move a lot further down the road of re-regulation than the G7 and Basel declarations have indicated, if they are serious about stopping the destructive boom-and-bust routine that has been occurring every five years or so since the 1980s.

Make no mistake: despite all the finger-pointing at lazy credit-raters and unethical brokers, the current meltdown is rooted squarely in the innovative but blinding greed that is the raison d'être of private finance. The bankers and brokers have no-one to blame but themselves, and their clever efforts to design and sell ever-more-complicated paper assets, reaping massive short-term profits but risking our real economic progress. We need to control and constrain that greed, not ratify it.

Is that even possible, given the hyper-activity and hyper-mobility of modern finance? Absolutely - but only if we focus back on the bread-and-butter basics of what banking is supposed to be all about. The real economy needs credit, delivered in a stable and predictable way, to lubricate everything from home-buying to business investments in machinery and equipment. That can be done efficiently without any recourse whatsoever to the gigantic paper casino that now sucks up an astounding 40 percent of all profits generated in the U.S. economy.

Mundane mortgage and business lending should be guided by sensible rules governing everything from ethical lending behaviour (flouted so disastrously by bonus-obsessed U.S. salesmen) to a strong public guarantee system to prevent crises of confidence. Banks and other lenders should not only be required to meet minimum capitalization standards, they should be required to do so in the form of real money held for safekeeping with public deposit and mortgage insurers.

Removing the huge tax subsidies that stimulate speculative behaviour sector (like Canada's massive loopholes for capital gains) would also help calm the waters. And if push comes to shove, and the contraction of private credit starts to directly curtail real consumer and business spending, reestablishing a publicly-owned presence in the mundane, bread-and-butter credit business would play a healthy, stabilizing role. We did just that in the Great Depression, and we may have to do it again - perhaps sooner, than later. Indeed, since the risks associated with profit-driven finance are always socialized (not just through taxpayer-funded bailouts, but through the economic price we all pay when each financial bubble inevitably bursts), we should socialize the upside of this business as well - marshalling the power of credit-creation for broader public purposes (like job-creation, affordable housing, and economic development) rather than bankers' profits.

Above and beyond all that, if financial sophisticates really want to gamble on things like derivatives and credit swaps, it will be hard to stop them. But make sure that their unproductive game-playing is firmly separated with strict financial firewalls from the mundane credit system we all depend on.

The timid incrementalism of the G7 leaders wouldn't have made any measurable difference to the current crisis, let alone prevent the next one. If we really want to get off the destructive, repetitive roller-coaster which has come to dominate global finance, we'll need our financial leaders to do more than look busy. We need them to actually get busy.

A version of this commentary was originally published in the Globe and Mail.


Print Print  Send to a friend Send to a friend  Feedback Feedback