The deeper economic question

That we are in the middle of a financial crisis and an economic recession is a fact. That we are not sure how long it is going to last or even how either one of them will evolve and affect the other is also true. We are just guessing.

We know that a recession was impending, but without a financial crisis it would have been all that much easier to mitigate its distributional effects. It is clear now that the financial crisis was generated by an excessive amount of capital searching for scarcer return opportunities around the globe and that in a lax regulatory environment they promoted the bubble that distorted the real picture of the economy and promoted a larger and more painful plunge.

The leaders of the 20 countries who gathered recently in Washington produced a text that essentially calls for more regulation, global standards, more transparency and more accountability. They also call for the creation of a super global regulator from the ashes of the IMF/World Bank combination.

However, the deeper economic question here is one of trust. In paper, all the regulations were in place and after the financial crises in Asia and Latin America it was understood that the systemic problem behind most crises is excessive risk-taking on the part of financial players during economic expansions.

Sometime before the economic cycle reaches its peak and the stocks of public companies are enjoying a prosperous market, the financial sector transforms itself from being speculative to being outright irresponsible or super speculative as the more solid investments become harder to find. Excess liquidity only exacerbates the behavior. This is why the sub-prime debacle took place at the end of the upward part of the economic cycle partly precipitating the inevitable.

Thus, if we understand all this very well, why are we calling for a radical transformation of the financial sector?

If the central problem is one of trusting the regulators, then the issue is relatively simple, change the regulator who failed for another one who has a stronger work ethic. That settles the secondary question of ownership. Ultimately, whether the State takes control or not we still need honest people.

Instead, the real effects of this reform so far have been an increased concentration of power in fewer hands leading to a much less competitive environment. Worse yet, fewer and larger financial institutions will have greater political power, ergo more lobbying power and will be more difficult to regulate.

And why do we need a new super regulator?

The IMF/World Bank combination has enough infrastructure to be one today, but their problem are the people working there, their ideology and the models they use to analyze the world.

Perhaps what we really need is to fire the people who failed at their jobs and hire other people who we can trust. Instead, we are hiring the same people who have failed at their jobs to redesign the system and we are spending billions in making it less competitive. It seems we are doing nothing short of planting the roots of a future crisis.

If the real problem is one of regulation, then we need more and better regulators, and some tougher laws. We understand what is wrong. What we really need is a group of leaders in which we can trust so our current institutions can be more effective at doing their alleged job, to maintain the trust in the international financial markets.

An economic stimulus package will go a long way to mitigate the plight of the unemployed and to promote consumption and production, but it will not restore faith in the financial sector. And that is the deeper economic question.

— Luis Brunstein