Office Hours: The Next Credit Crisis

As the world inexorably slips towards round two of the credit crisis, an open, honest debate on whose interests the financial system currently serves, and who it is ultimately accountable to, has never been more needed.

 

In the dark days of 2007-2009, when the possibility of a total collapse of the banking system was a very real prospect, there was an outpouring of indignation among politicians, regulators, economists and the general public about the self-serving excess inside international finance and how it had held the world to ransom. There were promises of major overhauls of the regulatory architecture of finance.

 

Instead, once the initial sense of urgency passed, we have largely returned to business as usual, and there has been a marked lack of fundamental structural change. The problem is that the system is so big, its interconnections so complicated, and its contribution to GDP now so large, that the opportunity for fundamental change was largely lost in the face of economic imperatives like creating employment, lending to businesses and returning to the profit and growth levels that we saw pre-crisis, all of which is now seen to hinge on the health of the finance sector. Importantly, the risks that international finance generate are so difficult to unpick and anticipate, that no one really wanted to do anything radical for fear of unintended consequences.

 

Finance has become so central to our economies that financiers are easily able to scare politicians with threats to curtail lending and other financial activity just at the weak point in the economic cycle if tough restrictions are imposed. Our economies have become "financialised" — i.e. the financial sector has grown so big over the last 20 years that it is now in the driving seat in the world economy. 

 

While this was great for a while, it has left a legacy of crises behind it – not just the credit crisis, but a steady round of increasingly severe crises over the last two decades that have occurred with regular frequency: Mexico (’94), Asia (’97), Russia (’98), Argentina (2001), the dotcom bubble, and of course the 2008 credit crisis. 

 

The human costs of these crises have been enormous, but there appears to be little attention paid to the social costs of systemic risk in debates on reforming the financial sector. Instead, the mantra of competitiveness has again overshadowed the debate, with new regulation being watered down or delayed for fear of its impact on the banking sector.

 

What we need is more transparency in the financial sector — it is hard to have true democratic accountability of the system when most of its operations are so remote and complicated that you need specialists to understand them. This leaves it open for vested interests to hijack public interest debates. We also need a far higher standard of responsibility in international finance for the inevitable social damage that flows from their mismanagement of risk.  The hard part is how to build that responsibility into the financial sector without triggering another major crisis.

 

Photo Credit: Wikimedia Commons