Monday, 26 October 2009

A missed opportunity

Sometimes, American attitudes towards the cross field between morals, finance, and politics can be quite exasperating for people not reared in that country. Including me.

Friday and into the Weekend President Obama held several speeches where took the high moral grounds, telling the executives of the financial sector that now is not the time to go back to silly bonuses.

Excuse me! The Obama administration just a few months ago had a once-in-a-century opportunity to force reform upon the financial sector. They let this opportunity lapse, and now we have to listen to ineffectual banging on the drums. Somewhere down the line something must have gone wrong. The way things stand now, it is only a question of time before the financial sector will be back to its bad old ways, possibly with some changes on the margin reducing the obviously dangerous aspects of some asset types (read: CDS's and other OTC derivatives).

Let me explain: Last summer the American banking sector was insolvent because of losses incurred on products that had been pushed without any understanding of the underlying risks. As a modern economy cannot function without a banking sector, the US government stepped in and poured obscene amounts of money into the banking sector in order to replace the lost capital and keep the system afloat.

In a much smaller country far away something like that had happened 15 years earlier. A country supposedly the closest you come to socialism in the post-communist era, Sweden took a very capitalist approach to a crisis that was every bit as serious as the US crisis. The Swedish government took the logical approach that shareholders who had not put a proper oversight in place deserved to lose their investments and the bank managers deserved to lose their jobs. And so it happened. The banks were nationalised with no "compensation" to the shareholders, managers were unceremoniously kicked out, and the impaired balance sheets of the banks were kept as part of the government balance sheets for the time it took to restructure and re-sell the banks in the market. Bad debt was put into a separate company floated on the stock exchange. The banking landscape was changed and the government probably ended up making a small profit on the entire transaction.

This somehow embodied the essence of capitalist ethos: If you win, you get rich. If you lose, you lose.

The American rescue of the banking sector somehow seems a muddled version of a socialist rescue in the sense that a lot of money has been poured into the financial sector, but no real consequences were forced upon the shareholders and the managers. Now that the crisis seems to be all but over, the banking lobby is back with a vengeance trying to block attempts at reforming the financial market legislation. Bonuses are creeping back to pre-crisis levels, and Obama, elected on a vaguely defined platform of "change" has to resort to public speeches in order to try and make the banking sector cooperate. It just will not work. If not followed up with action, such words only serve to give the public an impression that their president is concerned. Otherwise it is empty talk, just showing that at least Obama has the right morals...

Behind all this, there is of course another game going on. It is a power game, a game about influence. When the Swedish government made short shrift of the shareholders' and managers' interest in the early '90s, it was of course because the underlying attitude was that such interests had to be subsumed under the broader national interest of having a well-functioning banking system without tendencies to excesses. In the US, there has been no political will to suppress these interests. As Simon Johnson, a former IMF chief economist noted in a very interesting article in The Atlantic, the financial sector's influence in the US is bigger than in any other civilised country. The influence is in fact so powerful and pervasive that we have to go to Third World countries to find a parallel.

In this respect, the rescue of the US banking system was a muddled one, because it did not attack the root courses of the crisis. The reason is obviously that there was no politician who had the stomach to take on the financial sector, even when it was deadly wounded. So we are now on our way back to a system where the economic interests of the banking sector dominate the interests of the tax payer, and the power of the financial sector is rebounding.

It makes me cringe listening to Obama's moral teachings under these circumstances, knowing that the US Administration missed a chance to grant itself far more power and freedom. Financial sector reform is first and foremost a power struggle and the US Government did not seize the moment. Instead US tax payers will have to pay and pay.

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