Financial Times

Three years on, the markets are masters again

By Philip Stephens

Published: July 29 2010 21:39 | Last updated: July 29 2010 21:39

Ingram Pinn illustration

It has been three years since the roof started to fall in. And only a year and a bit since the more faint-hearted stocked their cellars with bottled water and canned food lest the financial crash presage a descent into anarchy. So what has happened since? Simple: not much. The markets (and the bankers) still rule.

Look back at the grand declarations made by political leaders as the global financial system teetered on the edge of self-destruction. The promises and pledges came from left, right and centre – from Gordon Brown and Barack Obama, from Angela Merkel and Nicolas Sarkozy, from central banks and the International Monetary Fund.

Finance, we were assured, would be pulled from its gilded pedestal. Main Street would reassert its primacy over Wall Street. The laisser faire capitalism of the Washington Consensus had had its day. The world’s richest economies would turn their minds to nurturing real, as opposed to financial, engineering.

One or two things have indeed changed. Economics has been exposed as a faith-based discipline. Long-time slaves to rational expectations and efficient market theories have gone back to basics and rediscovered Keynes. A perch at Goldman Sachs used to bestow a certain cachet as well as a private jet. God’s bankers have lost their sheen of respectability.

Public opprobrium, though, seems a small price to pay for the calamities visited on everyone else. A banker of long acquaintance tells me that he expects to earn as many millions this year as he has ever done – even if he will take rather less home in suitcases of cash.

There has also, of course, been one really big change: hundreds of billions of dollars in toxic assets that once sat on the books of the banks have been piled on top of the deficits caused by the crash-induced recession. Families are paying the bankers’ bills through rising taxes, shabbier public services and higher unemployment.

Political resolve has given way to fear. No one waxed more eloquently than Mr Sarkozy about the iniquities of liberal markets. This was the moment, the French president told us, when capitalism would be remade in the image of the European social market. All this, though, was before the Greek sovereign debt crisis saw the eurozone under siege. Now Mr Sarkozy lies awake each night worrying that France might lose its triple A credit rating.

He is not alone. As they struggle to reduce huge budget deficits, western politicians almost everywhere are in thrall to global capital markets. David Cameron has made no bones about it – Britain’s prime minister says he is slashing spending on the welfare state and paring back the nation’s global role because the Bank of England has told him that the rating agencies would be satisfied with nothing less.

The rating agencies – remember them? Some may recall that these very same organisations were deeply complicit in the chicanery that saw worthless debt instruments repackaged as top-notch financial securities. I am sure I heard the politicians say they would be cut down to size. It never happened. The rating agencies never repented; and now they are masters again.

From the beginning, this crisis was replete with ironies. One of the big reasons why such vast amounts of money were sloshing around the system – ready to be lent to American homebuyers who could never repay the loans – was that many of the world’s rising nations had taken the west at its word.

After the financial crash of the late 1990s, Asia learnt by heart the IMF’s catechism of fiscal prudence. The money it subsequently saved was recycled back to the spendthrift west to underpin the easy credit that gave the world subprime mortgages and collateralised debt obligations.

Most Europeans, of course, laid the blame for the crash at the door of unbridled Anglo-American capitalism – only to discover their own institutions had been wholly complicit. Even as Ms Merkel railed against hedge funds and private equity funds (as it happens, relative innocents in the calamity), it turned out that Germany’s publicly owned regional banks had been among the most eager players in the casino.

None of this is to absolve governments and regulators of responsibility for the crash. Britain’s then Labour government was content to look the other way as long as the City of London continued to generate the tax revenues that would fund its social ambitions. Greece was fiddling the fiscal books long before most people had heard of AIG. The US Federal Reserve’s Alan Greenspan and Ben Bernanke made the mistake of believing their own propaganda.

Now the policymakers will tell you they have acted to remedy these mistakes. Some governments have imposed windfall taxes on the big banks; the US has legislated for a tougher regulatory regime. The most egregious excessive bonus payouts now include a tenuous link to performance. The Basel committee of regulators is to impose tougher capital requirements – though not, we must understand, until 2018.

Worthwhile as they probably are, such measures look like tinkering when set against the capacity of capital markets to wreak economic havoc. Financial institutions are still extracting large profits from trading activities described by Lord Turner, the head of Britain’s Financial Services Authority, as inherently useless. Lord Turner, however, has been almost a lone voice in suggesting a fundamental rethink.

The crisis in the eurozone shows how the herd instincts of capital markets can destabilise an entire continent. The consequence has been to push European governments into a premature, and risky, race to slash fiscal deficits before economic recovery is assured.

With a little help from the regulators, the big banks can now declare themselves duly stress-tested, but the systemic instabilities remain. International markets have moved far ahead of the capacity of political leaders to understand, let alone properly oversee them. This failure of political governance to keep pace with global economic integration is as apparent now as it was in 2007.

Even if politicians better recognise the risks of interdependence and the vulnerabilities of particular institutions and financial instruments, they are far from any consensus on how to share responsibility for global oversight. So, three years on, things are much as they were – except that most of us are poorer. The markets rule. OK?

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