The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Thursday, July 21, 2011

Cannibalising capitalism...

An economist buddy brought to my attention former US Treasury Secretary Lawrence Summers' latest views. Summers declares that, "There must be a clear and unambiguous commitment that whatever else happens, the failure of major financial institutions in any country will not be permitted."

You must be kidding, right? Have we learned nothing from the global financial crisis (GFC)? Offering open-ended taxpayer guarantees of private companies is precisely what regulators should be seeking to avoid. It is 'too-big-to-fail' writ large.

The turmoil our world endures today very much derives from the gullible ‘socialisation’ of private problems via the insidious nexus between the Western financial 'oligarchy' and senior bureaucrats, who tend to be former financiers, or wannabe financiers.

One genuinely attractive feature of Australia's system of governance is that there tends not to be so much cross-over between the two cohorts. That is, we have a professional class of life-time bureaucrats who are not constantly on the make for big payouts by shifting into private practice.

The socialisation of non-public risks involved bailing out many bad US, UK and European banks that should arguably have been allowed to fail (or been fully nationalised until they were cleaned-up with equity and credit holders completely wiped out), and imprudently pouring tonnes of financial fertiliser over economies reeling from credit rationing.

Don't get me wrong. It does make sense to ensure that 'systematically important financial institutions' (jargon for big banks) are not allowed to fail in a manner that disrupts the vital, economically oxygenating bank-intermediated function that entails the transformation of short-term household and business savings into long-term investment. This is, after all, the lifeblood of all economies.

Yet when faced with an important private institution that has made parlous decisions, such as taking on business risks that it should not have borne, or seeking higher returns through excessive leverage, nation states should not subsidise the executives, shareholders and creditors to that entity: they should nationalise the institution, cauterise and then eviscerate the problems, and ultimately set it free to flourish as a newborn in the market wilderness.

Following the first 2007-08 private credit crisis, we now confront an even more perverse 'sovereign debt' crisis as politicians and policymakers learn that insuring private sector mistakes with public money merely transfers the problems from one party to another. More worryingly, it fundamentally thwarts the private market's Darwinian process of natural selection whereby good businesses profit, and bad business disappear.

My contention, which I have yet to read elsewhere, is that the policy reactions to the GFC, which was in part caused by the ‘heads we win, tails taxpayers lose' attitude known as ‘moral hazard’, have actually started to embed those same moral hazards into the public sphere.

If other foreign taxpayers bail sovereign states out of their financial obligations, as most European and US authorities believe is such a sensible idea today, future public debtors will rightly assume that they can behave irresponsibly and default on their repayments the next time the global game of pass-the-risk-parcel emerges.

What makes this public sector moral hazard all the more galling is that it is actually being driven by the original private sector moral hazard, which the Summers' quote above highlights. That is, we (taxpayers) can never, ever allow major private institutions to fail. Nor should we even speak of the possibility! Meanwhile the executives running these companies are allowed to make out like bandits with the benefit of their explicit and implicit guarantees.

In the current context, policymakers at the European Central Bank and IMF have been convinced by bankers that if they allow smaller European states to default on their debts, which are mostly held by private banks, the write-downs the banks take will compel them to stop lending and trigger a second GFC. So, the argument goes, we need to bail-out governments to protect private creditors.

Surely somebody can see that this cycle of perpetually deferring responsibility for risk-taking has to eventually stop. At some juncture, we have to allow both businesses and sovereign states to suffer the conditioning consequences of default and financial neglect. If we don't allow competitive markets to discipline poor decision-making, we will undermine the very basis of capitalism.

Indeed, thinking forward, as the world's centre of economic gravity inexorably migrates towards China, we must do everything possible to safeguard democracy and its private market equivalent, capitalism, as the dominant social model of our time. The risk is that moral hazard, and corruption wrought from dysfunctional public-private relations, result in capitalism cannibalising itself...