The Great Financial Crisis: The Infallible Mainstream - Part I
By Farooque Chowdhury
22 February, 2011
Countercurrents.org
The Great Financial Crisis has shown “higher” level of knowledge, wisdom and infallibility of the mainstream. Its democratic practices, accountability, etc. that it strives to teach the poor countries have also been confirmed by the crisis. These are the reasons behind its arrogance and feeling proud, its moral standing to sermon leaders of poor countries. Generous reference of the mainstream is enough to stay informed of its business.
At the center of the center
It has been claimed that the financial crisis was avoidable. But it was not avoided. That is the reason that it happened. What was the force that refrained all concerned from avoiding the crisis? The question haunts after the US Financial Crisis Inquiry Commission, divided along partisan line, presented its report.
The commission concludes its report: The crisis, the result of “human action and inaction, not of Mother Nature or computer models gone haywire”, could have been avoided. It was led in large part by government mismanagement. The Bush and Clinton administrations, the current and previous Fed chairmen, and Geithner, the US treasury secretary, all bear some responsibility for allowing the crisis to descent on this material earth. It singled out former Fed Chairman Greenspan for backing “30 years of deregulation.”
The commission blamed “reckless” Wall Street firms, bankers, “weak” regulators, government officials and even homeowners for the crisis. Regulators “had ample power … and they chose not to use it”, said the report.
It sounds like the Time story that identified “top 25 people to blame for the financial crisis.” The 25 included everyone, from former Fed chairman Greenspan to former president George W. Bush to the former CEO of Merrill Lynch to the American consumers. Even one Chinese fellow was blamed.
Widespread failures, the report said, in financial regulation including Fed’s failure to halt the “tide of toxic mortgages”, and dramatic breakdowns in corporate governance, with too many firms taking on too much risk were two of the causes of the crisis that made giant banks collapse and shook the world economy. The report informs: 26 million Americans are out of work, and about $11trillion in household wealth has vanished. “The impacts of this crisis are likely to be felt for a generation.”
One can recollect Ferdinand Pecora’s, head of the commission set up to find out the causes behind the Great Depression, statement. About eight decades ago Pecora said that his investigation had shown the way “men of might – not because of principle but because of economic power and wealth – have by the waving of a hand and adoption of a resolution taken millions and millions of the hard-earned pennies of the people and turned them into gold for themselves.” (“Pecora Denounces Stock Manipulations,” The New York Times, Feb. 19, 1933)
The report mentioned other causes behind the crisis: excessive borrowing by households and Wall Street; policymakers’ ill-preparation to face such a crisis and lack of “full understanding of the financial system they” presided over; systemic breaches of accountability and ethics at all levels.
It, as appears from the report, was a mutually consented gambling. All turned accomplice to all: mortgage-holders borrowed with the intention of never paying it back while lenders lent knowing that the borrowers could not afford that.
The FCIC said: collapse of the housing bubble, trillions of dollars in risky, sub-prime mortgages, triggered the collapse. The impact of the bubble burst was magnified by complex financial derivatives based on those loans as its risks were woefully underestimated. The crisis, however, was years in the making.
It was increase everywhere, a bon voyage for the gamblers! From 1987 to 2007, debt held by financial sector increased from $3tn to $36tn; sub-prime mortgages increased from 5% of loans to 20% in 1994-2006; financial services firms emerged as an increasingly disproportionate part of the US economy: 27% of all corporate profits in the US during the same period compared with 15% in 1980.
Fed failed to set more prudent limits, a crucial role in creating the crisis, said the report. Firms, actually speculators, “made, bought and sold mortgage securities they never examined, invested blindly and did not care about defective investments.” Banks went to aggressive expansion that made the banks incapable of managing their assets.
All, AIG, Citigroup, Goldman Sachs, Merrill Lynch, were efficient. The commission found: Citigroup’s “too big to fail” turned into “too big to manage”. Goldman Sachs
multiplied the effects of the collapse of sub-prime loans by funding and creating billions of dollars of bets based on the back of the loans. Merrill Lynch’s $55bn investment in “super-safe” mortgage securities resulted in losses in billions of dollars. The AIG’s senior management was ignorant of the terms and risks of its $79bn derivatives exposure.
The findings weren’t endorsed by the commission’s four Republican members, who wrote two dissents and criticized decisions by Phil Angelides, the Democratic chairman. The commission entangled in infighting is now getting prepared for congressional investigations. The dissenting opinion and infighting are significant.
The six Democrat commissioners concluded that the financial crisis was triggered by a wide range of abuses, ranging from lax oversight of derivatives to poor decisions by credit rating firms to governance and risk management failures by large banks. The Republican commissioners detailed 10 causes topping by the credit bubble. The Democrat commissioners, as has been claimed by the Republican commissioners, looked “at individuals and policy or regulatory failures” and did not “talk about a credit bubble” while the Republicans placed “greater influence on economic forces”.
It now appears that accountability and ethics were there only to make as much profit as possible within the shortest possible time; similarly, ample power was used to manage and govern profit. A significant portion of capital, with its standard of ethics and level of management, has made it vulnerable with its vast power to gamble, and has proved its incapacity to secure it, it has generated that higher level of knowledge that is incapable of helping it. Other than generating catastrophe it cannot manage its profit making business. It has set its own standard of ethics, accountability, democracy, etc. Thus, it has mesmerized its die-hard followers only. “While millions of ordinary Americans are struggling with unemployment and declining standards of living, the levers of real power have been all but completely commandeered by the financial and corporate elite. It doesn’t really matter what ordinary people want. The wealthy call the tune, and the politicians dance.” (Bob Herbert, “When Democracy Weakens”, The New York Times, Feb. 11, 2011) So, reasons behind the crisis, discussed by non-mainstream long ago, hide from searching eyes that declines to search facts.
The Great Financial Crisis: The Infallible Mainstream- Part II
International big brother
International Monetary Fund downplayed economic risks ahead of the crisis. It provided few clear warnings about the risks. The agency’s Independent Evaluation Office found these in an inquiry.
The inquiry report said: “Weak internal governance, lack of incentives to … raise contrarian views, and a review process that did not ‘connect the dots’ or ensure follow-up also played an important role while political constraints may have also had some impact.” It found that “several senior staff members felt that expressing strong contrarian views could ruin one’s career”, and “area department economists felt that there were strong disincentives to speak truth to power” as there was a perception that they might not be supported by management.
The report suggested encouraging alternative views and diverse opinions both within the agency and from outside experts so that IMF “speaks truth to power”. The report said: IMF staff “felt uncomfortable challenging the views of authorities in advanced economies on monetary and regulatory issues, given the authorities’ greater access to banking data and knowledge of their financial markets, and the large numbers of highly qualified economists working in their central banks. The IMF was overly influenced by (and sometimes in awe of) the authorities’ reputation and expertise.” IMF staff tend neither to share information nor to seek advice outside of their units.
Focusing on the IMF’s surveillance functions from 2004 to 2007 the report said: the fund’s ability to “correctly identify the mounting risks” was hamstrung by, among other things, “groupthink”, and a mindset that a major crisis involving advanced economies just wasn’t likely because markets were sophisticated enough to “thrive safely with minimal regulation.” The fund largely endorsed many of the types of policies and financial practices that help to precipitate the credit crunch, pronouncing that financial markets were fundamentally sound and large financial institutions could weather possible problems.
The IMF didn’t pay enough attention to risks of spillovers from a crisis in rich economies, such as the sovereign debt crisis that threatened to undo the euro zone and push Europe – and the rest of the world – into a double-dip recession. And, advanced economies were not included in the Vulnerability Exercise launched after the late 1990s Asian crisis.
The risks that the IMF did mention in its annual Global Financial Stability Report were presented only in general terms, without an accurate assessment of the scale of the problems. Critics have often focused on the way final reports touch politically sensitive issues: exchange rate policy is often muted from original drafts.
In 2006, IMF said, banks in UK were in good shape. The report blamed IMF’s incapability to spot Britain’s looming banking crash. IMF’s report on Iceland only a year before the country went bust, had not made the ballooning of the banking sector to 1,000% of GDP the focal point of discussions.
The international institution’s message was characterized by overconfidence on large financial institutions, and endorsement of the financial practices in the main financial centers. The risks associated with housing booms and financial innovations were downplayed.
It said that when studying the policies of the US and the UK in the years leading up to the crash, the IMF had “largely endorsed policies and financial practices that were seen as fostering rapid innovation and growth”.
The report said: IMF did not sufficiently analyze the force making the housing bubble or the policies that might have played in this process. It failed to see the similarities between developments in the US and UK and the experience of other advanced economies and emerging markets that had previously faced financial crises. The IMF failed to spot looming crash and praised the US and the UK financial regulation.
The crisis, as the report provides evidence, has exposed the international big brother’s belief-, knowledge- and analysis-systems, level of governance and transparency, and market-blindness. The apolitical appearing institution is influenced by politics of masters, and there is no room for dissension. In fact, it serves the dominating capital that dictates the institution’s performance. Its speaking truth is dependent on power of its masters although it is master of poor countries: it is the dictatorial power of a dictated institution. The real face is shrouded with now-told-half-truths and denial to accept explanation by non-mainstream. Further questioning of already-told-half-facts will dig out reasons behind the agency’s failure.
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