In de decennia voorafgaande aan de financiële crisis, werd de toon van het economische debat gezet door voorstanders van de ‘vrije markt’. Hoewel sinds de deregulering van de financiële markten steeds meer landen werden getroffen door bankencrises, gingen de meeste economen rustig verder op de oude voet: het ontwikkelen en toepassen van theorieën en hypothesen waarin wordt uitgegaan van de geruisloze werking van het marktmechanisme. Als we willen leren van de financiële crises, kunnen we waarschijnlijk beter ons licht opsteken bij een antropologische of politicologische benadering.
by Dirk Damsma
The majority of economists are still working on a model in which markets ensure superior outcomes if left to themselves. This is why they did not see the financial crisis coming before 2008 and today are still at a loss as to why it happened.
As I argued before, these models are invariably based on absurd assumptions that have no basis in reality and can never be relaxed. So, it would be very strange indeed if these models provided adequate policy prescriptions. Despite this obvious shortcoming, economists succeeded in convincing politicians that markets mimicking the model’s assumptions more closely, would perform better. So financial markets were fiercely deregulated after the early 80’s. Technology that expanded the capacity for calculating risks was eagerly adopted. The financial derivatives that were thought to help spread risks across a large number of market participants were enthusiastically embraced. In combination with the supposed rational behavior of market participants, all this was supposed to ensure that the financial market was close to perfect. So major disruptions would be a thing of the past. Nobel Prize winner Lucas (2003) went even further: ‘[Macroeconomics’] central problem of depression prevention has been solved, for all practical purposes, and has in fact been solved for many decades.’
Theoretical constructs that deny reality
Banking crises were virtually nonexistent between the end of WW II and the mid 1970’s. In the fiercely deregulated financial markets of the mid 1990’s the number of countries experiencing banking crises shot up to 20% of all countries (weighted by their share of world GDP) (Reinhart & Rogoff 2008; cf. Chang 2012). Unphased by these developments, many economists at the same time propagated theoretical constructs like the efficient market and rational expectations hypotheses (EMH and REH respectively). These constructs tell us that sufficiently deregulated markets will always get it right on average and will neutralize the effects of any attempts to interfere. Yet markets do not always get it right and they tend to behave cyclically, with booms and busts. Many economists however, claim that this fact does not demonstrate a failure of EMH or REH. They developed Real Business Cycle Theory (RBCT) expressly to counter these criticisms. RBCT tells us that business cycles do not originate in markets and can best be explained by exogenous shocks that emanate from outside markets. As long as markets are left to themselves (and are sufficiently insulated from shocks) EMH and REH ensure that the market itself cannot be at fault. In short, EMH and REH sing the praises of the market, while RBCT helps to reassign blame if events seem to prove that praise misguided (Varoufakis 2013).
Working in the City
However, both EMH and REH require market participants’ time-horizons to be long. Moreover, traders should stand to gain as much from a good deal as they are to lose from a bad one. Anthropological research by best-selling author Luyendijk (2015) has shown something completely different. People working in the London City (and in Wall Street and other financial centers as well), do not even remotely abide by these assumptions. Luyendijk describes a world of zero job security in which people who make smaller than average profits on their trades are periodically ‘culled’, that is, fired by the hundreds. As this can happen on a moment’s notice, long-run consequences of decisions play no part in any decision making, and as trades are assessed only on the profit – and not the risk – they entail, traders have very strong incentives to secure their jobs and their bonuses by taking excessive risks. If the gamble turns out right, you get a big bonus. If it does not, it is only ‘other people’s money’ that the trader is not personally liable for. So, far from harboring a randomized distribution of risk-loving and risk-averse as well as short and long term oriented traders, this institutional set-up means that only short-sighted risk-lovers have any chance to survive in the business. Ironically, as governments and ultimately tax-payers are squeezed to cover bank losses, their thinking turned out to be right all along. If everything goes wrong, they will ultimately be bailed out with other people’s money.
Breathing life into dead markets
Not only does this seem incredibly unfair, it also implies that today’s financial system is not a free market at all, let alone an efficient one. In a functioning market, after all, competition should ensure that companies that manage their costs and risks most prudentially can stay in the market longest. But if you are a too-big-to-fail bank you will be bailed out first and the worthless assets you created due to excessive risk-taking will be bought by central banks (CBs) under the guise of quantitative easing (QE) later. CBs thus artificially breathe life into markets that would collapse if they were left to themselves (as economists usually argue they should).
In theory, QE will prop up banks’ reserves and entice them to step up their lending for productive investments. This can only happen if such investment opportunities exist, however. As effective demand slacks under the weight of the recession and deteriorates further due to austerity measures and low wage policies, such opportunities are few and far between. So the surest way for banks to invest the proceeds of quantitative easing profitably, is to buy the very assets that CBs’ quantitative easing programs are targeting. Thus, a new bubble is forming through the unholy alliance of financiers, governments and CBs. So, whereas the bubble bursting in 2008 was at least in part caused by overoptimistic households taking on excessive debt, households have no part in creating it this time (but I do fear they will be forced to pick up the tab again when it implodes).
Of course, governments cannot allow too-big-to-fail banks to actually fail, for if they did, all their clients would go down with them. So what else should they have done? I like the suggestion Steve Keen made in Room for Discussion (2016), where he says that the failing banks should have gone bankrupt as commercial banks, but instead of going off the market and taking their clients down with them, governments should have nationalized them and continued their services.
Moreover, instead of throwing good money after bad (through QE), the state would have done better to expand CBs tool kit. The CB’s new tool should enable them to scrap private debt directly through a program that Keen dubs the “people’s QE”. Such a program would improve banks’ financial health by relieving the underlying private debt causing the bank’s assets to lose value in the first place. Thus, it would shorten the banks’ balance sheets and deflate the original bubble, rather than replace it with a new one. Through the shortening of the banks’ balance sheets, a modicum of market discipline would be restored, while the associated debt relief would boost consumer confidence and demand (thus upping profit opportunities and productive investment to boot) (see also Blyth & Lonergan 2014). The latter effect would surely result in rising inflation, but, as Keen points out, this is exactly what CB’s are trying to achieve through QE anyway, but as long as QE money sloshes around within the financial system, they will keep on failing dismally at it. All in all then, the people’s QE deflates bubbles that need deflating, relieves the debt burden for those that are least responsible for the crisis (but suffer its consequences most) and restores some market discipline instead of suspending it.
So why doesn’t this happen? It doesn’t happen because regulatory capture (see e.g. Buiter 2009) keeps many career politicians hostage: after their term is up, politicians hope to cash in on the favors they extended to banks by pursuing careers there (and these careers pay a LOT better than political ones). Meanwhile, the many (financial) ties between many influential economists and financial and insurance companies, suggest they are not immune to regulatory capture either (my source is focused on Dutch economists that frequently appear in the media, but the Inside Job documentary suggests economists elsewhere are hardly more independent). So criticizing the status quo impedes politicians’ careers and the most influential economists are in no position to offer objective advice. No wonder then that proposals like the People’s QE are hardly ever seriously discussed.