Monday, May 18, 2009

Five Lessons From The Economic Crisis

The economic crisis, as many have said, is too good an opportunity to waste. But what can we learn? Here are five things:

1. The financial services sector is bloated and inefficient. The market will correct some of the issues, such as those rating agencies more concerned with maintaining good relations with institutions than with adequate and risk assessment. Trust has been broken between many of the firms and institutions and will only be reestablished with better business practices in the market place. Now that everyone perceives the many under-assessed risk and over-promoted gains, returning back to the status quo is impossible. So self-reform will occur in the market.

2. Self-interest amongst financial institutions should ensure major changes, yet the sector is incapable of true self-regulation. They simply do not understand what’s best. They do not even know what’s right, what’s sound or in some cases what’s legal. So we now know that formal regulation is needed, necessary and long overdue.

3. The current systems of regulation are inadequate. The failure to identify the fraudulent Madoff enterprises despite many warnings and red flags indicate that the SEC basically failed. We need not only new regulations but also a new regulatory order with less cozy relations between the players and the regulators.

4. Economic deregulation as the dominant ideology has been dealt a deathblow--at least until the current interventionist mode is delegitimized. There have been three dominant economic ideologies in the US. At the beginning of the twentieth century, laissez faire capitalism held sway until the Great Depression rendered its underpinnings of limited government obsolete. The New Deal and Keynesian economics inaugurated a more interventionist government and mixed economy system. The stagflation of the 1970s forced a reassessment, and the election of Thatcher in UK and Reagan in the US reflected the political rise of a deregulated, minimal state. Opinion shifted to the right so that even New Labour and the Democrats boasted of cutting income taxes and of reducing the size of government. The latest economic crises have swept away the assumption that unfettered markets lead to untarnished growth. We are now at the beginnings of a new fourth era, one in which government has a larger and more central role in terms of both direct fiscal intervention and of greater regulation.

5. Our sense of time is affected. To live in period of sustained long-term economic growth makes it easy to believe in timely progress towards bigger and better and brighter things. All the pension funds, for example, are based on the assumption that investments will always just grow and grow. That linear sense of an upward trajectory is being replaced by a more circular sense of repeating cycles: our present condition is compared and contrasted with the Great Depression. Yet whether or not we are repeating or avoiding history is moot. What is not moot is that our confidence in a steadily increasing curve of growth and expansion is shattered. The future is now, but it is not the optimistic future we have been led to believe.