26 outubro 2011

Disentangling the financial mess

The financial system is so deeply intertwined that to get us out of this financial mess onto a healthy platform will require great coordination and political will among governments, and self-restraint, patience, and a contribution to the common good on the part of all, including investors.

To understand how the banking system has arrived at this weakened state, it would be worthwhile to read the Wincott Annual Memorial Lecture of Oct. 24, 2011 by Andrew Haldane, Executive Director for financial stability at the Bank of England. Martin Wolf has an interesting column on this in the FT:

He explained how the increase in bank leverage to approximately 20:1 (and much higher before the crisis) helped improve dramatically the return on equity. Contrary to what the average citizen on the street may believe, this did not help shareholders of banks, at least not long-term shareholders. An investor who bought a portfolio of bank stocks 20 years ago is sitting on losses today. But in the interim, many short-term traders reaped vast profits and, of course, the bankers large bonuses, fed by incentivization of risk-taking, encouraged by governments. In analyzing banking history, Haldane concluded that we have moved from relatively safe, small banks within a small banking system to relatively unsafe, giant banks within a huge banking system.

One can deduce from this analysis that the financialization of the economy has given us fragility and not lasting benefits. Short-term trading adds to volatility, but not long-term economic value. Measures to curtail this, from a tax on financial transactions to the Volcker rule, need to be introduced. Legislation relating to derivatives and other synthetic instruments are likewise necessary. Banks need to be recapitalized and capital rigour maintained (Basel III). Governments need to put their finances in order. Investment in the future infrastructure should be implemented, perhaps via a new Bank for Reconstruction, taking into consideration environmental challenges and building a framework to meet this. Investing in community projects to create jobs at the local level and promote societal well-being would be a better alternative to dead money parked at banks. (The exodus from risk assets is causing such a flow of cash into banks that some US banks are considering the charging of a fee to maintain deposits, hence, leading to negative interest rates! Savers will thus be penalized, while bank profits enhanced.)

The financial crisis is a call to re-think the purpose of finance and how we manage it. We often attribute the financial crisis to greed. This is the case, but there is little discussion of the cause of this greed. This is an area where the Catholic Church can provide guidance through reflection and teachings on virtue.

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