Lena Komileva, global head of G-10 strategy in London at Brown Brothers Harriman & Co., speaking Sept. 12, 2011 on Bloomberg Surveillance
“Crisis brings us back to the basics of how economies and financial systems work. They are social structures that are purely man-made, and they depend on trust. This is what we don’t have in the European banking system at the moment. The English word ‘credit’ comes from a Latin expression meaning, “He believes,” or, “He trusts.” And indeed, modern economies are dependent on financial systems being trustworthy, to make payments, to store wealth and manage risks, to help economic activity run. So recent developments have brought these fundamentals into question.
“The normal structure of finance has governments standing behind it, so that when markets fail, when banks are in trouble, governments stand up and shore up the system. We have all been reminded through this banking crisis in Europe that financial and economic activity depends on entirely on people, that includes governments, keeping their commitments. What the European governments have done, however, is said, “No we cannot keep our commitments, not only can we [not] pay off all our loans, but we cannot possibly shore up the financial system.” Indeed, there is no single European national budget that is big enough to backstop the level of financial liabilities that are currently a risk. I mean, Ireland is a very good example. Whereby Ireland was, is, a very solvent economy but it has an insolvent financial system, and the governments struggle to backstop this. Unpayable loans have brought the whole economy into a depression-like scenario.
“So, the lesson here is that it is time for governments to step back in. It’s time for trust to return. Once it’s lost it needs to be won back. And the speed with which it returns depends crucially on whether politicians, who decide what governments do, realize that a breakdown in trust in financial instruments and in financial institutions is bound to have a very central, core effect on economic activity in the Euro area.”
Our comment: Well, yes…but the problem is for the last decade plus, the players in financial systems have been screaming that they ought to have no regulation, and be free to take whatever wild risks they choose, keep the profit, and socialize those risks. Now they want rescue, while still being free to serve themselves rather than the broader public interest (though in their rhetoric they tend to equate their action in their own self-interest with ultimate broader public interests via the magic of free markets that turn unbridled greed into virtue). And any attempt by politicians to demand broader responsibility to those ultimately shouldering the risk – taxpayers – is still met with outrage from the dependent financial system. The situation is very much like the US Savings and Loan debacle: deregulation of the industry permitted wild risks to be taken, and when it all came crashing down, the government stepped in to pick up the tab. A cynic would say that it all was a government-sponsored means of transferring wealth from poor to rich, and a cynic would say the same process is underway right now. And a cynic might be right.
What politicians are grappling with now is a battle over who pays for what, from whom and to whom wealth is being transferred going forward, and what will be the ultimate structure that emerges. Unfortunately, the ideology of unfettered risk-taking (with an implicit government backstop that must never be mentioned for fear of justifying government regulation of risk) is so deeply entrenched in the functions and functionaries of modern finance that it will be very difficult to let these people return to business as usual. At the same time, it is very difficult to develop a new form of business as usual if the architects of the current system are responsible for building the new structures. Yet this is the most likely scenario, given the wealth and political power that those the existing financial system amassed during the last decades. As a result, any ‘solutions’ that emerge are likely to lead to much greater problems in the future.