Financial crash not unexpected

08/10/2009 - 00:00


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Flouting basic economic principles can have disastrous consequences.

Financial crash not unexpected

"WHY didn't anyone see it coming", is a question still being asked about the global financial crisis.

Even State Scene has once or twice written a version of that question by wondering that, if our Treasury, Reserve Bank and Productivity Commission were such smart agencies, why didn't anyone within their well-paid ranks foresee the GFC?

As things have it, that question remains unanswered.

Why didn't they? Why didn't just one Australian official employed by one of those agencies foresee it? Why were they all so blind?

It appears that the more general question posed at the start of this article, however, has become redundant, because it seems three individuals did see the GFC coming.

Each has now been recognised, even if they're still not widely known for their prescience and intellectual and moral calibre.

Two are outstanding American women, the third an outstanding Canadian male.

Praise should be bestowed where it's due and deserved - and the three in question most definitely deserve it.

I learned of them after reading a review of a just-released book written by another outstanding woman who became interested in the emergence, a decade ago, of a whizz-bang financial services invention known as derivatives.

That woman, Gillian Tett, has written a book, Fool's Gold: How Unrestrained Greed Corrupted a Dream, Shattered Global Markets and Unleashed a Catastrophe, which is reviewed by Sydney writer, Lincoln Wright, in September's issue of Quadrant

Tett, Wright says, writes for the highly regarded English daily, The Financial Times.

She has a doctorate in social anthropology from Cambridge University.

“She took her anthropological eye into the largely ignored world of derivatives almost by accident in the mid-1990s," Wright says.

“She soon sensed that this highly mathematical area of high finance had been unfairly ignored and she set about to understand this new world of credit.

“Fool's Gold is a history of how financiers at JP Morgan developed and applied the idea of what are now known as credit derivatives."

The financiers who engineered these new forms of credit and risk transfer came to be known as the "Morgan Mafia" and their methods and practices quickly spread throughout the international banking sector and, despite the efforts of a brave few, remained unregulated.

According to Wright the Morgan Mafia's members: "Saw themselves as modern-day alchemists of money, working on new financial technologies which they thought would disperse the rise of lending, thereby liberating capital to create a new era of prosperity."

At this point it's tempting to recall that quote about the best-laid plans of mice and men.

And Wright says precisely that, although somewhat more colourfully. "The creation of credit default swaps was just the beginning of the story of how derivatives became what Warren Buffet called 'financial weapons of mass destruction'," he says.

But what of the three little-known but farsighted individuals who chose to confront virtually the entire American financial fraternity, including US Federal Reserve [the Fed] chief, Alan Greenspan, Washington's powerful financial lobbyists, and many others within the political establishment?

First is William White, economic adviser and head of the Monetary and Economic Department of the Swiss-based Bank for International Settlements (BIS).

Before joining BIS, Mr White spent 22 years with the Bank of Canada and had earlier been with the Bank of England.

Wright says that, in 2003, Mr White publicly confronted central bankers at an annual get-together in Wyoming over what he saw as grave problems ahead.

“White warned his audience, which included Greenspan, that the United States Fed's hands-off policy of easy money and the widespread securitisation of mortgages posed a major risk to the world economy," Wright says.

“He urged bankers to take action against the bubble economy before it was to late, but to no avail."

Then there's Brooksley Born, a member of the Commodity Futures Trading Commission.

She made efforts to bring about regulation of "swaps that are traded at no central exchange, known as the dark market".

However, her efforts were blocked by Alan Greenspan, and US Treasury secretaries Robert Rubin and Lawrence Summers.

In 1998, Securities and Exchange Commission chairman, Arthur Levitt, joined Messers Rubin and Greenspan objecting to Ms Born's attempt "to shed light on the dark market".

“Summers, [Barack] Obama's chief economic adviser, now recognises that he erred, as has Greenspan," Wright says.

“There's no question that with hindsight, stronger regulation would have been appropriate," Summers told Newsweek last March.

The other brave and outstanding woman is Sheila Bair, chairman of the Federal Deposit Insurance Corporation,

As well as paying a crucial role in managing the GFC during 2008, Ms Bair had been the first government official to recognise that the sub-prime mortgages forced by Congress upon America's banking sector were a major problem.

Her crucial oversight role in the crisis prompted Forbes Magazine to rank "her as the second most powerful woman in the world behind Germany's Chancellor, Angel Merkel".

Each of these three deserves our highest commendations.

Let's finish with a quote recently located by Melbournian letter writer, Richard Morgan, and published in The Australian Financial Review, in response to comments by Paul Krugman, who won the 2008 Nobel Prize in Economics for his contribution to what's dubbed 'new trade theory' and 'new economic geography'.

Professor Krugman seems fixated with anything he regards as new, thereby overlooking some of the old truths and verities, including especially those stated by the outstanding Scottish Enlightenment figure and founder of economics, Adam Smith, who backed to the full individual freedom of economic endeavour as the surest way of ensuring wealth was generated by and for mankind.

“Paul Krugman (AFR, September 11) called for 'new economics'. In fact, what is required is old economics - Adam Smith's economics," Richard Morgan wrote.

“What Krugman and Alan Greenspan as chairman of the US Federal Reserve overlooked was the advice from the 'father of economics' that the banking sector be carefully regulated to protect society.

“He said in The Wealth of Nations: 'Such regulations may, no doubt, be considered as in some respect a violation of natural liberty. But those exertions of the natural liberty of a few individuals, which might endanger society, are, and ought to be, restrained by the laws of all governments; of the most free, as well as of the most despotical. The obligation of building party walls, in order to prevent the communication of fire, is a violation of natural liberty exactly of the same kind with the regulations of the banking trade which are here proposed'.

“The metaphor of firewalls is apt, showing how serious Smith was about his advice.

“He saw a clear distinction between the free market for goods and services and the banking sector.

“Unfortunately, the authorities responsible for regulation of the financial system in the US and some other major countries, including central banks, evidently failed to maintain adequate control on the amount and type of credit being extended by financial intermediaries, resulting in excessive risk-taking based on unsustainable expansions of debt."

So when you're next asked: "Why didn't anyone see it coming", promptly say that Adam Smith did, 233 years ago, way back in 1776, in his great contribution to mankind - An Inquiry into the Nature and Causes of the Wealth of Nations.


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