21st century finance: too complex to exist? Andrew Pickering
June 22, 2009 | More on Economics and development, Global system, North America | 3 comments
As we push on through the recession, one thing that we haven’t seen enough of is solid original thinking about the causes of the crisis and what can be done to stop such a systemic disaster ever happening again. However Duncan Watts, writing in the Boston Globe, has a bold idea. Not only were banks to big to fail but the system as a whole is simply too complex to exist.
Rather than waiting until the next cascade is imminent, and then following the usual modus operandi of propping up the handful of firms that seem to pose the greatest threat, it may be time for a new approach: preventing the system from becoming overly complex in the first place.
It’s well known that few in the financial sector (let alone regulators) understood the instruments that were being used. Risk assessors refused to believe that a firm like Lehman Brothers could ever fall so easily and as a result, the consequences of such a collapse were not accounted for in risk models. In an ever more interlinked world, the danger of contagion effects means that everyone has an interest in the way the system works. If only a few people understand it, so much the worse for the rest of us.
An alternate approach is to deal with the problem before crises emerge. On a routine basis, regulators could review the largest and most connected firms in each industry, and ask themselves essentially the same question that crisis situations already force them to answer: “Would the sudden failure of this company generate intolerable knock-on effects for the wider economy?” If the answer is “yes,” the firm could be required to downsize, or shed business lines in an orderly manner until regulators are satisfied that it no longer poses a serious systemic risk. Correspondingly, proposed mergers and acquisitions could be reviewed for their potential to create an entity that could not then be permitted to fail… Perhaps what we need is an “anti-systemic risk” law that would aim to avert systemic risk before it is too late.
Watts concedes that this degree of intervention in the market is concerning, but one thing that everyone seems to agree on is that the era of market fundamentalism is over. If we’re willing to allow the state to intervene in bailing out failed banks, why not intervene to prevent them becoming unmanageable in the first place? Think of it as bonsai banking. As E.F. Schumacher said, ’small is beautiful’.
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I agree. Although right now, the trend is in precisely the opposite direction – Bank of America merging with Merrill, Lloyds merging with HBOS, and so on.
The big banks are now back in expansion mode – Barclays, for example, is now expanding its equities division, and has hired some 500 senior bankers in the last few months.
Market fundamentalism may be dead, but no one has a clue what to replace it with.
I suggest the future lies in state-supported development banks which also use retail deposits and perhaps are managed in a co-operative model, answerable to their depositors rather than to the state or shareholders. Depositors should have a say in how their money is lent.
You… you … COMMUNIST!
Communists…lol…
About your suggestion: check out the Caisse d’Épargne Desjardins, a communist, just kidding, co-op set up by Alfonse Desjardins in Quebec, Canada many moons ago. Movement Desjardins is now one of the largest banks in the province and major economic forces in Quebec.
I completely agree with Duncan Watts bold idea: We must impose restrictions on the major corporations.
How’s about: Small brother is watching.
Wouldn’t that be a nice change.
Small IS Beautiful.