De-regulated Markets Cannot Self-Regulate!

Finally, there seems to be some mainstream acknowledgement that, underlying the ideology of deregulated markets, the world has been Living in a Global Casino [hat-tip: Prof Gaddeswarup]..

A couple of weeks back, a set of European political figures sent this Open Letter to the present President of the European Commission, José Manuel Barroso.

They included:
- 2 former European Commission Presidents (Jacques Delors and Jacques Santer)
- 2 former French Prime Ministers (Lionel Jospin and Michel Rocard)
- 1 former German Chancellor (Helmut Schmidt), and
- 1 former Danish Prime Minister (Poul Nyrup Rasmussen)

some excerpts:

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Dear President,

Financial markets can not govern us!

The current financial crisis is no accident. It was not, as some top people in finance and politics now claim, impossible to predict. For lucid individuals the bell rang years ago. This crisis is a failure of poorly, or unregulated markets, and shows us, once more, that the financial market is not capable of self-regulation. It also reminds us of worrisome escalating income discrepancies in our societies, and raises serious questions about our ability to engage developing nations in a credible dialogue about global challenges.

Financial markets have become increasingly opaque and, identifying those who bear and evaluate the risk is frequently more than a formidable task. The size of the lightly or not-at-all regulated “shadow banking sector”, has constantly increased in the last twenty years. Major banks have been involved in a game of “origination and distribution” of highly complex financial products and in pretty questionable packaging and selling of debt tied to high risk mortgages. Inadequate incentive schemes, short-termism and blatant conflicts of interest have enhanced speculative trading.

Dubious mortgage credits, wrongly based on the idea that never-ending housing price increases would pay for debt repayment, are only the symptom of a broader crisis in financial governance and business practices. The top three rating agencies in the world rated odd securities as relatively risk-free. One investment bank earned billions of USD by speculating downwards on subprime securities while selling them to its clients, epitomizing the loss of business ethics!

We were warned of the dangers... Poul Volcker too has warned against this crisis in the making years ago. Paul Krugman warned against the threats posed by the expanding non-regulated financial entities about a decade ago.... In 2003 Warren Buffett called derivatives “financial weapons of mass destruction”. A Bank of England report on financial stability highlighted the dangerous distance between lenders and the consequences of their decisions.

The problem is a model of economic and business governance based on underregulation, inadequate supervision and an undersupply of public goods.

This financial crisis shows all too clearly that the financial industry is incapable of self-regulation. There is a need to improve the supervision and regulatory frameworks for banks... a need to revise the regulatory frameworks for investment vehicles... financial instruments (like CDOs) has to be regulated... the level of leverage should not be unconstrained. Last but not least, incentive schemes have to be corrected so that reckless risk-taking be not stimulated at the expense of prudence.

About the consequences of all this crisis in the real economy, it seems that the world economic expertise is shy! Practically all institutions devoted to forecasts are lowering their evaluations of growth for the developed countries in 2008 and 2009.... Rising income inequality has gone in tandem with an ever growing financial sector. It is true that technological progress has contributed significantly to rising income differentials by favouring highly skilled labour. However, misguided policies have had their major role too in this respect. Financial assets now represent 15 times the total Gross Domestic Product (GDP) of all countries. The accumulated debt of households, financial and non financial companies and of the American public authorities amounts to more than three times the US GDP, twice the level in 1929.

The financial world has accumulated a massive amount of fictitious capital, with very little improvement for humanity and the environment. This financial crisis has thrown some light on the alarming income differentials which have increased in recent decades. Ironically, for many CEOs salaries and bonuses reached incredibly high levels while the performances of their companies stagnated, or even went down.

There is a huge ethical issue here.

Free markets cannot ignore social morals... Profit seeking is the essence of a market economy. But when everything is for sale, social cohesion melts and the system breaks down....

...The spectacular rises in energy and food prices compound the effects of the financial turmoil and are ominous for what lies ahead. Quite tellingly, hedge funds have been involved in driving up the price of basic staples. It is the citizens of the poorest countries that will be most affected. We risk unprecedented destitution, proliferation of failed states, migration and more armed conflicts.

etc. etc...

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Read on...