Anger runs deep. It is aimed at financiers, who first earned huge and conspicuous bonuses and now successfully force taxpayers to pay for their mistakes. It is also aimed at financial markets, whose merits have been oversold.
The mantra that financial markets always allocate resources better was never true. Financial markets suffer from very serious failures, chiefly information asymmetry. The subprime saga started with beneficial risk diversification until it became a channel for contagion. The saga also revealed the depth of herding among financial institutions – the exact opposite of risk diversification among them. Having followed the same strategy, they all suffered simultaneous losses.
Financial operations are about risk-taking, which means uncertainty and, occasionally, crashes.
On this ground, anger is universal. US congressmen compete with themselves to lash out at the financiers who created this mess. But, outside the Anglo-American world, we see an outburst of resentment against the US and British approach to finance and banking. With people angry and scared at what may happen next, political leaders find it more difficult than usual to resist populist tendencies and seek to distance themselves from a possibly serious downturn. With market failures crudely in the limelight, they feel pressed to reassert the role of government. Nationalism is always a convenient spare wheel for difficult times.
Once again, Anglo-American capitalism is a bad word and globalisation is next in line. Speeches at this year’s United Nation General Assembly by leaders from every continent reveal the depth of contempt that has been lying low, buried underneath the apparent success of the globalisation process.
A first reason for this backlash is the delicate balance between individualism and solidarity. Americans are famously known to encourage and practise individual responsibility. In many other countries, solidarity is more highly valued and individualism is seen as the other side of egoism. Generous welfare states do not just reflect this view, they also create incentives to support collective insurance arrangements, even if they are inefficient. Adam Smith’s invisible hand, the assertion that individualism delivers the common best, is not popular: we know that his assertion is only approximately correct because it assumes that markets are perfect, which is not the case in practice.
Where individualism is considered a virtue, deviations from the ideal outcome are seen as a regrettable side-effect. But in most parts of the world, where individualism is considered morally wrong, the law of the market is tolerated as long as it delivers prosperity. When it fails, its legitimacy is soon questioned. The world’s major financial markets are in New York and London. No wonder, then, that anger is aimed at Anglo-American capitalism.
The second reason is related to the way financial markets operate. The US and the UK have championed arm’s-length finance, the financing of corporations through issuance of shares and bonds to anonymous stakeholders. Continental Europe – and south-east Asia – has long favoured face-to-face deals between entrepreneurs and bankers. Deals can be shoddy and cliquish, but they provide for some stability. Over the past two decades, arm’s-length finance has made headway in continental Europe, beating back the old boys’ networks. No wonder that the old boys are now hitting back.
Strikingly, Nicolas Sarkozy, the French president, and Peer Steinbrück, the German finance minister, have both announced the end of Anglo-American financial supremacy. It is not clear what their prediction is based upon.
They have denounced excesses, such as bonuses, but that does not even begin to address the root cause of the crisis. They have described financial markets as unregulated. This is simply wrong. Financial markets are tightly regulated. The problem is not just that the regulation is inappropriate, but also that supervisors have not enforced it.
We knew of the hundreds of billions of dollars in dubious claims parked off bank balance sheets in a clear effort at circumventing existing regulations. Regulatory arbitrage, as this is called, has gone unchecked for years.
Both leaders had harsh words for “speculation”, but this misses the fact that finance is speculation. Both zeroed in on short selling. Short selling is like cars. Drivers can be reckless; disciplining them seems more reasonable than banning cars. Denouncing market short-termism runs against evidence that markets better predict companies’ long-term performance than their own managers.
Mr Sarkozy and Mr Steinbrück may be simply captured by their own old boys, but the fate of Fortis, the Belgo-Dutch banking and insurance group, may give them second thoughts. Pain is travelling across the Atlantic and could hurt more good European banks. Mr Sarkozy promised that no French depositor would ever suffer any loss from any French bank. He might soon find the price tag pretty steep.
So will Anglo-American capitalism fade away? Maybe, but that will be decided in Washington, not Paris and Berlin. One thing is sure, neither France nor Germany can mount a serious challenge, at least as long as their people and leaders mistrust and misunderstand finance.
Originally published at Financial Times and reproduced here with the author’s permission.
- Related RGE Spotlight Issues:
- European Banking Crisis: No Common Bail-Out Fund Agreed, Bank Rescues Continue At National Level
- Beggar Thy Neighbor? Germany and Greece Follow Ireland With Blanket Deposit Guarantee
- Eurozone: Sliding Into Recession