The Bush Administration’s ideology of greed that Sen. Obama has been complaining about has broader tentacles than we knew:
The financial crisis spreading like wildfire across the former Soviet bloc threatens to set off a second and more dangerous banking crisis in Western Europe, tipping the whole Continent into a fully-fledged economic slump.
Currency pegs are being tested to destruction on the fringes of Europe’s monetary union in a traumatic upheaval that recalls the collapse of the Exchange Rate Mechanism in 1992.
“This is the biggest currency crisis the world has ever seen,†said Neil Mellor, a strategist at Bank of New York Mellon.
Experts fear the mayhem may soon trigger a chain reaction within the eurozone itself. The risk is a surge in capital flight from Austria – the country, as it happens, that set off the global banking collapse of May 1931 when Credit-Anstalt went down – and from a string of Club Med countries that rely on foreign funding to cover huge current account deficits.
The latest data from the Bank for International Settlements shows that Western European banks hold almost all the exposure to the emerging market bubble, now busting with spectacular effect.
They account for three-quarters of the total $4.7 trillion £2.96 trillion) in cross-border bank loans to Eastern Europe, Latin America and emerging Asia extended during the global credit boom – a sum that vastly exceeds the scale of both the US sub-prime and Alt-A debacles.
This provokes a host of questions:
- Are European banks insufficiently regulated?
- What additional regulations would have prevented their problems?
- Was the excessive risk taking abetted by an ideology of greed?
- Did they contract this ideology from the Bush Administration?
My own views are that greed is a human quality, not uniquely characteristic of the Bush Administration, and that the underlying problem is too much concentrated wealth, much of it in the form of sovereign wealth funds, chasing too few assets. Like G. K. Chesterton I don’t have any problem with capitalism, I just wish there were a lot more capitalists.
Nice post Dave.
The sad thing is what percentage of people do you think actually get it?
I don’t think the problem has much to do with SWFs. Unless you mean at the global macro level — the “global savings glut” or whatever explanation for the recycling of excess liquidity and export surpluses through the US consumer and Pentagon. But then the SWFs are merely a symptom — one mechanism among several which surplus countries adopted to manage the recycling phenomenon, like the US banks recycled petrodollars to Latin America in the 70s. Just the symptom, not the cause, of the financial imbalances that resulted in Latin America’s lost decade of the 80s.
As for your questions re regulation. Many European banking regulators were as or more guilty of failing to regulate leverage as the US regulators and they relied too much on the Basle II approach. A lot of the “greed” we’re seeing catch the European banks is of the Belgian dentist variety. Retail customers chasing yield being sold apparently “safe” exotic AAA instruments that were anything but safe. And plunging into the carry trade as both investors and borrowers. The supervisory system should have placed some brakes on these sorts of risky retail products being sold as safe and sensible.
Furthermore, once we have national financial systems so intertwined globally across so many asset classes and types of institutions (formal and shadow banking), the run on a fairly narrow bad part of a national system can spread to other parts of the global system that are otherwise quite healthy. In just the past week, we’re seeing a mind-boggling acceleration of contagion (both amounts and speed) as the shift to recessionary conditions in the real global economy and the global flight from financial risk are producing huge currency effects, even for countries that had adopted stronger banking supervision regimes, shifted to more prudent fiscal policies or built substantial reserves. Those currency effects in turn are spreading financial and real distress even further.
I don’t think the financial markets meltdown stems from concentration of wealth/decision-making as you suggest. It’s just the nature of financial markets throughout history, but over the past decade placed on steroids. What’s surprising is that so many people are surprised. I’ve never understood the folks who elevated the rational markets model (a convenient simplifying hypothesis) into an article of faith that that’s how the real world works. It never worked that way in the past, but the Greenspans et al managed to convince themselves that the bad old days wouldn’t return because the “market” had magically learned to managed risk via financial innovation. It wasn’t just Fukuyama who declared an end to history. Ha!
I don’t see it as an excess of “greed”, per se. Bankers, even of the dull, safe variety, have been and always will be lemmings. They move to where the (apparent) profits are to be found, and the last ones in always lose their shirts. That’s why we use regulation to put limits on leverage of different tiers of capital, insist on diversification of risks, impose different levels of haircuts against different classes of assets, require reserves against potential loan losses, etc. Even so, financial markets tend to overshoot (especially when tied to clunky asset markets like real estate given the long lead times for supply to come on stream and then for markets to clear oversupply of housing and commercial projects).
These eternal verities got an extra juice this time around from apparently “objective” sources of “truth” that substituted inadequate quantitative risk models (rating agencies, VAR models etc) for independent analysis. Asset managers could always protect their backsides by relying on “objective” standards while chasing yield even though spreads narrowed ridiculously and PE ratios went through the roof — it wasn’t just over-exuberant housing prices where we had easily identifiable asset bubbles that are now bursting. And managers and supervisors relied on the false comfort that new “risk management instruments” had adequately hedged risk — even though LTCM had taught us a decade earlier that apparently-diversified risks might actually be correlated in scenarios that models failed to account for.
This time the lemmings were turbo-charged by perverse incentives, often exacerbated by regulatory regimes that left major gaps while turning apparent safeguards into new sources of risk. The whole “debate” about de-regulation versus re-regulation is a red herring when we should be examining instead how to change the regulatory model to work better. There are many areas where we indeed do need a bit more government regulation. But we also need to do some pruning and revising of government regulation to encourage the market’s own self-regulatory capacity. For example, the portion of the OTC market in CDS which did not involve highly-rated regulated financial institutions seems to have worked pretty well and confidence is recovering as DTCC is providing netting services for settlement, etc. But the CDS market was awful where regulated financial institutions effectively sold their credit rating without either supervisors or the marketplace insisting on greater transparency and on their protecting against contingent liabilities. So we can draw lessons about how some fairly minor changes to market practices and government supervision would allow the CDS market to improve its own self-regulatory risk management functions. We don’t need a new army of supervisors to make that market work better and safer.
We can also make government regulation smarter when it comes to some of the perverse incentives that regulation has too often ignored (e.g. non-bank financial institutions, originate-for-distribution compensation practices, weak consumer protections) or that regulation produces (e.g. the rating system). And we can put a greater emphasis on systemic risks, which our current highly-segmented regulatory regime not only ignores but exacerbates through regulatory arbitrage.
I do place a good deal of responsibility for the scope of the current unholy mess on the Bush Administration for its ideological opposition to common sense supervision as the various bubbles took off. Throughout the post-WWII era, the US markets and government have had a huge impact on the global approach to financial market operations and supervision. For the past decade, the US regulators (including the Fed) and the captains of Wall Street didn’t just ignore danger signals, they celebrated them and did everything in their power — most effectively by competition encouraging regulatory arbitrage — to forestall other countries from adopting different approaches. All the while moaning and groaning that Sarbanes-Oxley was putting them out of business because they couldn’t compete. (I think S-O needs some revision, but the whinging by the US financial sector has been embarrassingly excessive and has been used as a convenient cudgel to oppose other unrelated, sensible financial regulation.)
There will always be financial markets fires that get larger than necessary, but instead of taking their duties as firefighters seriously, too many of the Bush regulatory agencies blinded themselves to the fact that a fire had started. In that, of course, they had lots and lots of serious company.
So back to “greed”. Given how ubiquitous financial bubbles, crashes and panics are over the past several centuries, I don’t think “greed” helps us understand the dynamics of financial market dislocations very well. Greed is always with us, but it doesn’t always produce financial disasters. Episodes of irrational exuberance have more to do with the mechanisms of wishful thinking, of how people convince themselves that this time the laws of gravity have been overcome, and even for people who recognize a temporary bubble, how they come to believe that they’re smarter than the average bear and will get out while the getting is good. (The number of sophisticated folks who get caught in pyramid schemes they know are pyramids never ceases to amaze me, and is a cautionary tale.) And then on the downside, how rational fear feeds irrational panic because the financial markets can move so much more rapidly than the real economy can adjust.
I do, however, think that certain eras elevate certain “greed”-related values more than others, and in those eras we are likely to see market excesses and government failures reinforce each other. The ideological insistence that some constraints on private wealth accumulation is “bad” is all too consistent with the lack of a soupcon of shame that a CEO gets a golden parachute measured in the tens of millions of dollars after bringing a venerable institution to its knees, or after having been in office for less than a couple of months. When no one seems to be able to look beyond his own narrowly defined interests to step up and show some leadership by example.
In that sense, “greed” as used by both presidential candidates is a shorthand for our current crisis of credible leadership in both the public and private sectors.