In a previous posting some weeks ago I suggested that the US model of capitalism, fuelled by easy credit, driven by greed, and populated by a deluge of complicated financial products that few people even pretend to understand, is doomed. Many agree with me. It is a simple enough proposition. The evidence is clear. And it appeals to our sense of justice given the mess we are now in. Surely it is in our nature to seek a scapegoat? Knowing who to blame gives rise to a form of indirect emotional compensation.
But it is not as easy as that. The financial crisis that plunged Wall Street into panic and spread so rapidly across the world and into every economy is in many ways symbolic of the very worst of the corporate-dominated political and debt-based economic systems with which we are encumbered. Systems that need urgent reform.
The US is experiencing the effects of the largest leveraged asset bubble in history. It also happens to be the greatest regulatory failure of all time. The leverage institutions like Lehman Brothers, Bear Stearns and Goldman Sachs found acceptable beggars belief. For example, in mid-2007 the average large financial securities firm in the US market was leveraged 27 to 1. That this degree of leverage is unsustainable would be evident, I would have thought, even to an imbecile.
What is more these ambitiously greedy, arrogant and reckless companies were effectively unregulated. When left to their own devices they built a house of cards that was vulnerable to anything other than a simple market correction.
It is useful to examine the suite of corporate behaviours that eventually marked the downfall of these firms as the lessons are bound to inform future regulatory policy.
Influence Unbecoming
Possibly most obvious, in hindsight, was the unjustified, occasionally blatantly dishonest, influence and collusion being used by company executives to acquire and exert political power. Over the past few years this clout was clearly targeted at getting rid of many of the regulations that previously restricted these companies commercial activities.
Regulatory Passivity
The inability and unwillingness of various regulatory agencies to enforce what rules there were, particularly against predatory lending, helped the housing bubble expand. While a few regulators had sought to exert authority over financial derivatives, they were stopped by finance-friendly figures in the Clinton administration and Congress, thus enabling the creation of the credit default swap market. Even Alan Greenspan now concedes that that market (worth $55 trillion in notional value) is imploding in significant part because it was not regulated. This is government negligence on a massive scale.
Short-term Thinking
It was apparent to anyone examining historical trends that the United States was experiencing a housing bubble. Many key individuals in the financial sector, however, had somehow convinced themselves that there was no bubble. Others must have been less myopic, but they either kept quiet or their arguments were dismissed as cautionary mischief. In any case, all the Wall Street players had an incentive not to pay attention to any bubble. They were entirely focused on achieving stratospheric bonuses based on annual results. Even if they had recognised there was a bubble and were convinced the bubble would pop at some stage in the future, they had every incentive to keep making money.
Smoke and Mirrors
In each year between 2005 and 2007 profits in the financial sector were more than 35 per cent of overall US corporate profits. Consulting firms like McKinsey & Co. used this as evidence to suggest that the most profitable and successful industry in corporate history would most probably continue to rake it in – at least doubling already obscene profits and revenues over the coming decade. They saw only upside in being a banker. But instead of serving the real economy the financial sector was taking it over. We had allowed a sector that made nothing of value to take the driver’s seat.
Profits Before Social Utility
Effectively the corporate-driven economy was (and still is) being driven by what can make a profit, rather than what will also serve a social purpose. Although Wall Street hucksters offered elaborate justifications for why exotic financial derivatives, private equity takeovers of firms, securitization and other (so-called) financial innovations helped improve economic efficiency, by and large these financial schemes served no socially useful purpose.
Externalized Costs
Worse, these financial schemes didn't just create money for Wall Street money jocks and their investors. They often made it at the expense of others. The costs of these schemes were foisted onto workers who lost jobs at firms gutted by private equity operators, unpayable loans acquired by homeowners who bought into a bubble market (often made worse by unconscionable lending terms), and now of course the general public.
What Now?
In spite of such serious misdemeanours, what is most instructive about today’s financial meltdown is the inherent instinct of corporations to make money above everything else. Nothing will stop them. Nothing dominates their consciousness as much as profits and returns to shareholders, which they will pursue at any cost. If left to their own worst instincts, many corporations will even destroy themselves as well as the system that nurtures them, in their quest for profits.
In the past we tended to praise such focus. We rewarded CEOs with obscene payments for growing the business irrespective of how many people were thrown out of work. Some great economists even proclaimed that it was the sole responsibility of business to make profits. But the world has changed and there can be no going back.
It is rare that this lesson is so graphically illustrated. It is one the world must quickly learn, if we are to avoid the most serious existential threats our species has yet faced.
I suspect we will see almost immediate changes in the regulations and standards governing capital markets. We will see greater transparency in financial products and reporting. And we will see a new social contract emerge between business, government and consumers.
But the more interesting adjustments are more likely to arise from increased public awareness and activism as well as very different values and norms in society. In that regard I suspect it will not be long before we insist upon more ethical forms of capitalism, the overthrow of practices that reward the wealthy at the expense of the poor; and the deployment of more responsible and equitable forms of producing and distributing the world’s wealth.
I do not perceive this to be an idealistic nor necessarily utopian point of view. On the contrary it is most likely a vital pre-requisite for our own survival.
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