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As we wade through a long line of international economic meetings—G-20 ministers of finance last week, G-20 heads of government in Pittsburgh coming up, IMF–World Bank governors meeting in Istanbul in early October (and all the associated "deputies" meetings, where the real work goes on)—it seems fair to ask: Where is regulatory reform of our financial system heading?
Long documents have been produced and official websites have become more organized. Statements of principle have been made. And the melodrama of rival reform proposals has reared its head: continental Europeans for controlling pay vs. the United States for raising capital vs. the United Kingdom not really wanting to do anything. But what does all of this add up to, and what should we expect from the forthcoming summit sequence?
Nothing meaningful.
This is a sophisticated delaying action and you are seeing masters of economic policy spin at work. When something goes wrong on a colossal, global scale, here's the playbook (e.g., as applied to capital requirements).
- Agree that there is a problem, but be very vague about it. "It's complicated" is a good watch phrase.
- State some completely bland principles to which no can object.
- By all means, have a spat with the French or Germans. But then patch it up amicably at the big summit; agree to do a bit of everything, in principle. People are wowed by your leadership.
- Send the job of formulating technical details to a committee of experts, asking them to report at the end of 2009—and then make adjustments through the end of 2010.
- Rely on the experts to produce a report of mind-numbing detail, which few really understand. The experts know their job and will deliver.
- Provide leaks of this work and your "true feelings" to sympathetic reporters. They will help declare victory against great, albeit vaguely specified, odds.
- At this point, it's 2011 and either (a) new people are in power, or (b) other things have gone sufficiently well that everyone has forgotten about the financial fiasco of 2008–09.
The brilliance of this approach is that you can say, whenever someone objects that capital requirements are not being increased as much, "we are doing that, but the details are not yet fully settled," or "but we agree with that principle; of course the details are complicated."
And, in this context, the point of a G-20 or IMF meeting is to have the world's economic policymakers show mutual support. After all, our opinion leaders reckon, if everyone is on board, then this must be the right way to go.
There will be some minor changes, and these will be much trumpeted. But what will really change in or around the power structure of global finance as it plays out in the United States, Western Europe, or anywhere else?
Nothing—and you know this because otherwise the CEOs of all our top financial institutions would be mounting massive PR campaigns against the proposals, with op-eds, Internet ads, innumerable cable appearances, and a virtually constant presence at Treasury. Just think back to how active they were earlier this year, when FDIC-type resolution for big banks was on the table.
Unless and until our biggest financial players are brought to heel, we are destined to repeat versions of the same boom-bust-bailout cycle. If you find a government willing to state this problem clearly and really take action to confront the relevant powerful people, let me know.
Also posted on Simon Johnson's blog, Baseline Scenario. The following was previously posted on Baseline Scenario.
Good Finance Gone Bad (September 5, 2009)
As the Lehman anniversary approaches, defenders of the financial sector struggle into position—partly in response to readers' comments. They offer three main points:
- We need finance to make the economy work.
- Financial innovation delivers value, although it's not perfect (but what is?).
- Don't kill the goose that laid the golden egg.
Point number one is correct, but this does not necessarily mean we need finance as currently organized. The financial sector worked fine in the past with regard to supporting innovation and sustaining growth. Show me the evidence that changes in our financial structure over the past 30 years have helped anyone outside the financial sector.
On number two: Financial innovation has obviously benefited the people who run and operate large financial companies. Has it helped anyone else, including their own shareholders? And if you can show broader social benefits (e.g., lower cost of capital, better ability to take nonfinancial risks that make sense, or anything else), do these outweigh the massive social/fiscal costs that are now apparent?
Which leads to point number three: what kind of egg did the finance goose lay? Obviously we now need to go back and recalculate economic growth—if much of what was done by finance was issue loans that were not likely to be repaid (while not recognizing the probable losses).
But the unfortunate side effects of finance lie much more in the future than in the past. It's not lowering recent growth by some fraction of a percentage point that should bother us, it's the likely behavior of large-scale finance, now more powerful and with greater concentration of power.
Private sector capture of the state is bad enough, wherever it happens in the world. But when the captors have an unparalleled ability and willingness to "tax" the rest of us, we should really be afraid.
The business model of big finance is not to consolidate their position and live on comfortable annuities. It's to take as much as they can ("otherwise the competition will hire our best people") while stuffing the risk ("that ordinary people don't understand") onto the taxpayer. The technical details of this arrangement are loosely referred to as "financial innovation."
Modern finance is more than quack medicine. This is state capture, an old tradition for bankers, and in the modern American version their hands are in the deepest set of pockets ever. Why would they ever let go?
