Houses of cards, chickens coming home to roost – pick your cliche. The new low in the financial crisis, which has prompted comparisons with the
We had become accustomed to the hypocrisy. The banks reject any suggestion they should face regulation, rebuff any move towards anti-trust measures – yet when trouble strikes, all of a sudden they demand state intervention: they must be bailed out; they are too big, too important to be allowed to fail.
Eventually, however, we were always going to learn how big the safety net was. And a sign of the limits of the US Federal Reserve and treasury’s willingness to rescue comes with the collapse of the investment bank Lehman Brothers, one of the most famous Wall Street names.
The big question always centres on systemic risk: to what extent does the collapse of an institution imperil the financial system as a whole? Wall Street has always been quick to overstate systemic risk – take, for example, the 1994 Mexican financial crisis – but loth to allow examination of their own dealings. Last week the
The present financial crisis springs from a catastrophic collapse in confidence. The banks were laying huge bets with each other over loans and assets. Complex transactions were designed to move risk and disguise the sliding value of assets. In this game there are winners and losers. And it’s not a zero-sum game, it’s a negative-sum game: as people wake up to the smoke and mirrors in the financial system, as people grow averse to risk, losses occur; the market as a whole plummets and everyone loses.
Financial markets hinge on trust, and that trust has eroded. Lehman’s collapse marks at the very least a powerful symbol of a new low in confidence, and the reverberations will continue.
The crisis in trust extends beyond banks. In the global context, there is dwindling confidence in US policymakers. At July’s G8 meeting in
How seriously, then, should we take comparisons with the crash of 1929? Most economists believe we have the monetary and fiscal instruments and understanding to avoid collapse on that scale. And yet the IMF and the
It was all done in the name of innovation, and any regulatory initiative was fought away with claims that it would suppress that innovation. They were innovating, all right, but not in ways that made the economy stronger. Some of
Joseph E Stiglitz is university professor at