Thursday, October 16, 2008

Global Finance in Crisis

We're off on a tangent, political economy, aka the credit crisis, global recession, market meltdown. M y previous post focused on this and questioned specifically what caused the market to tank, banks to stop lending if that is indeed the situation, and well, putting us all through another Black October.

Fareed called it "hiding mountains of debt in complex instruments." As is often the case the Economist has attempted to provide an answer including info on the financial instruments and policy to blame, perhaps, such as credit default swaps, interest rate swaps, derivatives, options, futures. In a word however, the slant is not surprisingly a policy question concerning regulation. In A Short History of Modern Finance, the closing question is whether the future of the increased regulation that seems inevitable will be as benign as the past "liberalized" capital regime has been for growth.

To my mind, tactically, questions should be couched in terms of transparency and disclosure. For instance, at some point during the previous 18 months, when oil and gasoline prices started to ratchet upward for reasons which must remain unspoken, when mortage defaults first started to become noticeable, coupled with and perhaps caused by job losses, slowing growth, and slowing demand for, and then plummeting home prices, all related to core inflation and stagnant wages, who could have failed to see the risks increasing with respect to the securities tied to home mortgages. By then, of course, it was too late to do anything except sell. Hedging seemed like a good idea, but this only increased exposure if you guessed wrong about the direction of the market, and ratcheted up volatility.

And how do you sell something that is an "off balance sheet" instrument, by definition something you don't want the investing public knowing about. And there is another problem, there is no market or clearinghouse for these things, not surprisingly. So my question from the previous post still remains, how could reasonably smart people have been enticed to continue to sell these things knowing that the rapid rise in home prices could only mean one thing, an asset bubble. Bubbles are a recurring phenom, so...? Greed is the word. As AIG executives have recently shown, taking junkets with taxpayer dollars, stupidity is also rampant.

Finally, after Enron, how could regulators have failed to outlaw similar "off balance sheet" transactions? Or, was the investing public hoodwinked into believing the practice was obsolete?

My question is this. In times of good growth anything goes and nobody notices a few bad decisions, even sleazy ripoffs. When things get tough, when prices are falling, and when people are losing jobs, it is not regulation or the lack thereof that is the problem. It is just that times are tough. Free trade might take it's share of the blame. Let's not forget the corporate execs who forgot to pass along the cost savings and other goodies realized from free trade and robust growth to consumers and workers while socking away golden parachutes, bigger boats and mansions to pass the time. This seems less of a crisis in global finance than a crisis in global productivity and the division of labor, aka the global distribution of wealth. This is a failure of the notion of the Economy and the discipline of Economics itself, as we know it. This is called politics and it is criminal, paying lip service to the theme of this blog. Heads must roll.

The rich have been allowed to get away with far too much. The blame rests squarely with the failed execution and incoherent policy of the current, soon to be ex, President and the cronies who ran his administration. I predict that we will not see another such disasterous presidency, not at least until my grandchildren are grown.

Just one more thing. When banks fail you know we are in for a rough ride. So just on more question to think about. How could we have allowed matters to come to this?

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