Sunday, November 16, 2008

The party's over

In the wake of the Enron fiasco, gray-haired men who knew business and its inner workings counseled us all that hastily conceived regulations aimed at preventing another fubar situation involving off balance sheet accounting and risky trades in derivatives would likely yield unintended consequences and actually cause more harm to the efficient operations of business enterprises than good for the safety of investors and the public. Regulations in general are bad for business, it was argued.

Government isn't the solution, quoth Reagan and his apostles; Government is the problem.

Tell it to Somalia.

But anyhow, back in 2002, Bush said “we need men and women of character who know the difference between ambition and destructive greed, between justified risk and irresponsibility, between enterprise and fraud.” His post Enron solution was to encourage rational, ethical behavior among the business class. In the words of LA Times reporter Ronald Brownstein:
Bush offered much the same balance Tuesday [July 9, 2002], suggesting that a key to solving problems in the boardroom was for chief executives to set a “moral tone.” Embedded in that summons is the conviction that the crisis of corporate ethics is primarily a problem of individuals who go bad, rather than a financial system that encourages even good people to make bad decisions–and a regulatory system that fails to deter them.
We all know how well that worked out.

So last week Bush offered this opinion on financial matters:

One vital principle of reform is that our nations must make our financial markets more transparent. For example, we should consider improving accounting rules for securities, so that investors around the world can understand the true value of the assets they purchase.

Second, we need to ensure that markets, firms, and financial products are properly regulated. For example, credit default swaps - financial products that insure against potential losses - should be processed through centralized clearinghouses, instead of through unregulated, "over the counter" markets. By bringing greater stability to this large and important sector, we would reduce the risk to our overall financial system.

Third, we must enhance the integrity of our financial markets. For example, authorities in every nation should take a fresh look at the rules governing market manipulation and fraud, and ensure that investors are properly protected.

Fourth, we must strengthen cooperation among the world's financial authorities. For example, leading nations should better coordinate national laws and regulations. We should also reform international financial institutions such as the IMF and the World Bank, which are based largely on the economic order of 1944. To better reflect the realities of today's global economy, both the IMF and World Bank should modernize their governance structures. They should consider extending greater voting power to dynamic developing nations - particularly as they increase their contributions to these institutions. They should also consider ways to streamline their executive boards, and make them more representative.

Improved accounting rules! Maybe we can make them even reflect reality!

Regulated trades for credit default swaps! What a concept! Could it be that a financial system representing several times the US GDP might need a little look-see from a regulator or two now and again?

Tighten up fraud laws! Can free markets survive?

International cooperation on financial regulations! Can world government be far behind?

We are witnessing the end of the latest incarnation of laissez-faire capitalism. Stubborn adherence to Reaganite dogma got us into a hellish mess, and even Bush knows it. It's over. Laissez-faire arguments will persist. Witness the silly calls to repeal capital gains taxes when Paulson first floated a bailout plan before Congress. Perishing few Americans can claim capital gains on anything right now. The tax bogeyman came to the lips of some conservatives almost as a Pavlovian response to a crisis, not a reasonable and pragmatic tactic in the face of bad financial conditions. But on the whole, the Reaganonomics ideology -- its worldview -- lies in ruins along with Lehman Brothers. Individual ethical choices are not the solution. Indeed individual choices are the problem, and the point is not ethics. Rather the point is that we must moderate capital's demand for more and more and more and ever higher returns on investment. And we must do so because excesses threaten capitalism itself.

What that moderating structure looks like remains to be seen. The G20 summit this weekend was a start, and apparently a pragmatic one. From the Economist:

Just what path the G20 will take is not yet clear. All sides interpreted this communiqué from the summit a little differently. Mr Sarkozy talked about the “historic” shift in America’s attitude to financial regulation. The Bush administration focused on the summiteers’ commitment to pro-growth policies and open markets. Leaders from emerging economies, not surprisingly, concentrated on their new global role.

In some areas the leaders clearly papered over their differences. The communiqué, for instance, nodded to Europeans’ desire for more regulation by promising to ensure that “all financial markets, products and participants are regulated or subject to oversight”. But it quickly tempered that point with phrases more to the Bush administration’s liking: promising to make sure that “that regulation is efficient, does not stifle innovation, and encourages expanded trade in financial products and services”.

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