Finance and the fear of flying

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: Another financial crisis; another ritual orgy of breast-beating and ululatory lament: what went wrong? Why? Who is to blame? Why is private folly being bailed out at public expense? Don’t we need tougher regulation to strangle banks, non-banks, exchanges, brokers, and financial firms? Isn’t financial sophistication just camouflage for pyramiding? Isn’t financial capitalism fundamentally flawed? Aren’t financial derivatives dangerous instruments of mass financial destruction? And so on, ad nauseam. Every crisis triggers this litany of retrospective recrimination, implosive introspection, elliptical expatiation, and perambular pontification. The current crisis is, alas, no different. These questions have been asked after all the crises of the last half-century. Each time the answers have failed to predict or prevent the next crisis.

The modern era of financial crises began in 1971 when the US unilaterally abandoned the fixed redemption price of $35 per ounce of gold. Since then, we’ve had the debt crises of 1982-87, the Tequila crisis of 1994, the Asian financial crisis of 1997-99 and a number of country crises in between. Now, it’s “déjà vu all over again”. The 2007 crisis has the same roots as in 1971. What—despite the angst and Q&As—have we learnt over the last 40 years?

Not much, apparently! What is different this time? Well, size, shape, geography and impact. Starting out as a subprime crisis in the mortgage market of the US in late 2007, we now have a global financial debacle in 2008. We do not know its full dimensions yet. We have no idea how long it will last. Underlying macro-meso-micro causes are similar to previous crises: that is, government failure, regulatory failure, market failure, and induced institutional failure in financial services. It has also been management and risk-management failure; compounded by a compensation culture in the financial world that generates perverse incentives and is now past its sell-by date.