Who is to blame for the financial crisis?

Given the complexity of the financial crisis, I suppose it’s no surprise that a wide range of candidates have been suggested as to who we ought to blame for it. Here are a few of them.

The market
A first generic response is to blame the market. All of it. This is a kind of backlash against the neocons or neoliberal dominance that has undoubtedly been present for the last thirty years or so. This is good in the sense that the blind faith in markets that has overtaken us, at least in the US and UK, hasn’t been terribly healthy. Our governments appear to have reached the conclusion that markets can solve everything, and that, if only markets were more widespread, more widely used in areas such as the public sector, things would be better.

However, this is also sloppy thinking. Markets, in themselves, don’t solve anything. Markets aren’t always competitive, and competition isn’t always a good thing is every setting. We need to think a bit more carefully in the future as to where competition can be used to make things better, and when marketplaces need to be more carefully regulated and controlled. Markets aren’t the solution to everything – they are social institutions that we make the rules for. They should serve us, not dominate our lives.

The government
A second obvious agent of blame is the government. First we can allow the government for allowing the financial crisis to happen. The US and UK governments have for several years been telling us that they’ve solved the problems of economic boom and bust through a combination of independent central banks, low interest rates, and in the UK prudent public spending. They staked a great deal on the financial sector being the dynamo of their respective economies.

This seems to have been a substantial mistake. It will be some time before we know whether the entire economic growth of the last ten year (or more) has been wiped out by the financial crisis, but it seems plausible to suggest this is the case. This puts the focus back on the so-called ‘real’ economy to deliver growth for us, but this carries with it substantial risks.

We are at the end of a long boom of activity that began in the 1950s (so called ‘Fordism’) and it’s not clear what goods and services might help us achieve a new one. IT is trotted out as the answer (but remember the tech-collapse of the late 90s?), but it is not clear how sustainable economic growth can be achieved in the same way from what is, in effect, a service technology to improve productivity rather than the potential source of a new growth period in itself. Perhaps it’s time to think about learning to live with what we have and accepting that economic growth year on year is no longer possible or desirable? It may be well that our environment requires this kind of thinking.

The regulators
Another obvious candidate is the regulators, who have been portrayed as being ‘asleep at the wheel’. In the UK, the complex three way split of regulation introduced by Gordon Brown, splitting control between the Bank of England, the FSA and the Treasury seems to have resulted in no-one wanting to take control, or responsibility, for what happened. In the US criticisms have been made that the initial response, the so-called TARP programme, was badly-thought through and may have made the crisis worse.

This is the toughest one to crack. My sense is that regulators became too focussed on individual banks and not enough on the system as a whole. Systemic risk was allowed to build up through the use of complex derivatives, with too much leverage building up and not enough capital to back it up. Any individual bank may have been able to make the case it was reasonably secure, but the system as a whole was far over-leveraged. Regulators should have seen this happening, but they didn’t. They also allowed the growth of a ‘shadow’ banking system where the real commitments of financial institutions were extensively hidden from shareholders, and even from some senior bankers themselves. Some serious lessons to be learned here.

The financial instruments
We can also, of course, blame the financial instruments that created the crisis. The growth of SDOs, CDFs etc, all within a relatively short period of time, has been extraordinary. The idea of securitization, in itself, however, does make sense. Making markets more liquid through their use has a logic. The argument Gillian Tett makes in her books (and columns) is that they were extensively mis-used. This makes a good deal of sense. CDOs and CDFs were transplanted from their original context into others where, perhaps because those designing them did not really understand the dangers involved, they were not appropriate.

The story Tett tells is of J P Morgan bankers who originated these financial instruments looking out at the marketplace wondering how other financial institutions using them with sub-prime mortgages are possibly making money from them. J P Morgan’s bankers couldn’t make the instruments work in that setting because to do so would require extraordinarily high insurance (CDFs) against the risk being taken on. It turns out that the other companies made CDOs in subprime products work by not adequately insuring them, and by credit rating agencies apparently not understanding the nature of the underlying asset.

The financial instruments themselves were not to blame. That is like saying knives are evil because they are used as murder weapons. It’s their mis-used that is the problem.

The bankers
At the beginning of the financial crisis it was popular to lame the bankers for the crisis. They had got us into a terrible mess through selling bogus financial instruments, claiming colossal bonuses, and requiring government bailouts. Things went quiet for a while, and we’re blaming them again now that banks on both sides of the Atlantic are beginning to make money again. Is this fair?

It is partly. Institutions that have required public bailouts, and so which would not exist unless taxpayer’s funds had been used to intervene, seem to have gone back to ‘business as normal’, paying huge bonuses and being rather bullish. It’s hard not to feel a touch resentful about this. At the same time, nationalised banks in the UK seem to be making massive losses, which we are having to pay for, but at the same time sometimes continuing to pay executives extraordinary amounts to work within them. It’s pretty ghastly.

A lot of the banking pay argument seems to me to rest on two ideas. The first is that, in order to get good people, you have to pay market rates. There’s something in this, but I can’t see that the rate for executive bankers was very high a year ago when the banks were going bankrupt left, right and centre. If we were paying market rates then, salaries would have been pretty close to zero. Market rates have to work in both directions.

Second, there seems to be an assumption that bankers need to be incentivised through huge bonuses. This seems pretty close to nonsense to me. Are you going to work significantly harder if offered a million pound bonus rather than a £500,000 one. Will you work twice as hard if there is potential for a £2 million bonus instead? What kind of logic is this? Is it so horrible being a banker that we need to pay this kind of money just to get people to do the job?

My view, as I’ve said in other entries here, is that bankers need to start behaving more like professional, and less like second-hand car salesmen. Perhaps we might respect them a bit more then.

Foreigners
Last, xenophobia gets an airing. The argument is that the Chinese/Arabs/whoever-else-you-don’t like caused this by buying up our assets and forcing them into a financial bubble that has now come crashing down. Their investment in our economies caused interest rates to be too low for too long, and they kept their own currencies from appreciating to keep selling us good cheaply so that they fuelled a boom from which we have now moved to bust.

Oh dear. Lots of nonsense here. Yes, the economies of the world have received substantial investment from China, petro-countries (including Russia) and yes, that investment has kept interest rates lower than they would have been, and yes, they have sold us an awful lots of goods. But I don’t remember us blaming these countries while the boom lasted. If you want to blame China, don’t buy Chinese goods, but I suspect you’ll have a hard time avoiding them. Blaming other countries for what we ourselves have done isn’t going to solve anything.

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