By Kaufmann | March 9, 2009 1 Comment »
There is no ‘theory-independent’ way of viewing reality. We see and analyze world events through our own prism, shaped and tinted by upbringing, experiences, training and professional field of expertise. So it is not surprising that when it comes to the many explanations given for the current financial crisis, they differ greatly.
Among economists, a number extoll ‘macro’ explanations of the financial crisis, focusing on the ballooning fiscal deficit and lack of savings in the US, as well as on the explosive (and euphoria-driven) growth of the financial and mortgage sectors, far outpacing the growth of the real sectors of the economy.
Financial specialists tend to focus on the technocratic and institutional failures in financial regulation, oversight and disclosure. Some opportunistic politicians and other pundits like to put blame the on notions that are vague and high in rhetoric, such as ‘greed’, ‘loss of trust’, or even pointing to the whole capitalist system as the culprit…
By contrast, less emphasis has been given to the interface between politics, finance, and regulatory capture. There has been a reticence in rigorously studying the extent to which money in politics, ‘legal corruption’, and capture may have played a significant role in causing the mammoth crisis we are in now. As discussed previously in this blog space, I have been studying this issue, and writing about it (here and here).
My line of inquiry would not necessarily compete with (or substitute) the macro or the technocratic financial regulatory explanations of the crisis. Instead, I submit that understanding the major challenges of money in politics, capture, and legal corruption offers insights into the macro-economic excesses, and also into the abject failures in financial regulation, oversight and disclosure in the US.
Therefore, frankly discussing the governance links between finance, politics and regulatory capture therefore complements the other more traditional explanations. In fact, while they do not belittle the macro and micro-financial explanations of the crisis, these manifestations of misgovernance are more fundamental, because they to the former (it is naive to claim that the problem was mere ‘ignorance’).
While there are still insufficient writings on this misgovernance aspect of the crisis, I am not alone in speaking about it. Actually, at some level, I have been in pretty good company. These are excerpts from a major speech that Barack Obama gave:
“In recent years, we have seen a dangerous erosion of the rules and principles that have allowed our market to work and our economy to thrive. In our government, we see campaign contributions and lobbyists used to cut corners and win favors that stack the deck against businesses and consumers who play by the rules. In the business world, it’s a mentality that sees conflicts of interest as opportunities for profit.
The quick kill is prized without regard to long-term consequences for the financial system and the economy. It’s bad for business when boards allow their executives to set the price of their stock options to guarantee that they’ll get rich regardless of how they perform. It’s bad for the bottom line when CEOs receive massive severance packages after letting down shareholders, firing workers and dumping their pensions….
And it’s bad for the market when there are over $1 trillion worth of loopholes in the corporate tax code, or when some companies get to set up a mailbox in a foreign country to avoid paying any taxes at all. ….It also means that investment goes to the companies that are best connected instead of the ones that are most productive…
Economics 101 tells us special interest politics distorts the free market. These anti-market, anti-business pr
actices are wasteful, unproductive, and antithetical to the very spirit of capitalism. They benefit the undeserving few at the expense of hardworking Americans and entrepreneurs who play by the rules. In fact, the danger with this mentality isn’t just that it offends our morals, it’s that it endangers our markets.
Markets can’t thrive without the trust of investors and the public. At a most basic level, capital markets work by steering capital to the place where it is most productive. Without transparency, investment doesn’t flow to the place where it is most productive…
If the information is flawed, if there is fraud, or if the risks facing financial institutions are not fully disclosed, people stop investing because they fear they’re being had. When the public trust is abused badly enough, it can bring financial markets to their knees.
And we cannot help but see some reflections of these practices when we look at the subprime mortgage fiasco today…and yet, time and again we were warned this could happen. Ned Gramlich, the former Fed governor who sadly passed away two weeks ago, wrote an entire book predicting this very situation. Repeated calls for better disclosure and stronger oversight were met with millions in mortgage industry lobbying…
There are a number of lessons that we must learn from this going forward. We know that much of this could have been avoided if the market operated with more honesty and accountability. We also know we would have been far better off if there were greater tran
sparency and more information…[T]here are a few steps we should take to prevent future crises of this kind and restore some measure of public trust in the market:
First, we need more disclosure and accountability in the housing market…we should finally enact the meaningful mortgage disclosure laws that the mortgage industry has been lobbying against for far too long.
Second, we must be able to trust the judgment of our rating agencies. We cannot let the public trust be lost by a conflict of interest between the rating agencies and the people they’re rating.
Third, we need to do is look at other areas in the market where a lack of transparency could lead to similar problems… We all have a stake in ensuring that the market is efficient and transparent; that it inspires trust and confidence; that it rewards those who are truly successful instead of those who are just successful at gaming the system.
Turning a blind eye to the cronyism in our midst can put us all in jeopardy… We will not tolerate a market that is rigged by lobbyists who don’t represent the interests of real Americans or most businesses…we are going to have to adapt our institutions to a new world…”
Impressive statement, in my view, even if it masks the full problem of money in politics and the conflict of interest among politicians and legislators, who also bear a major responsibility.
Then why is it that this speech and analysis are not given its full due by the media and the decision-makers today? Well, because this speech was given by then Senator Obama, a year and a half ago. It was a major address at Nasdaq in New York, on September 17th, 2007, and it is here.
Nowadays there is a lot of generic talk about ‘responsibility’ and ‘transparency; there is also outrage at some Wall Street CEOs and their perks, and there are a few noteworthy initiatives to try and have some accountability in the stimulus package. But much of the concreteness of the early insights of then Senator Obama have withered away.
Let us hope that such a loss is temporary, justified perhaps by the urgent need right now to stem the financial meltdown and revive the economy. And given the need to muster support from Congress for key legislation, one may also understand in the very short term the politically correct attempt by the Obama administration not to confront the political and legislative elite by calling for difficult reforms that would threaten many of their special interests.
In fact, in his very recent and major address as President to the Congress, which did touch briefly on the excesses of Wall Street executives, he avoided the issue of of money in politics and of accountability by politicians and legislators.
Yet as we go forward, reforms regarding money in politics and capture will be essential if to build a foundation for a more solid and trustworthy institutional framework in finance and the macro. The problem is not merely the greed of some CEOs, or their ignorance, or some regulatory glitch necessitating a technical regulatory fix. Politics do matter.