Making Sense Of Global Financial Crises

Making Sense of the Global Economic Crisis- arifanees.com

MALING SENSE OF GLOBALFINANCIAL CRISES

Global Economic Recession


Overview

The current global financial crisis & the massive bailout of financial and non-financial institutions have implications for:

- Capitalist’s market economy & “Creative Destruction” A “New market economy” Economists’ analytical tool


What created the crisis?

United States housing market bubble that burst (as housing values deviated remarkably from their fundamentals or intrinsic values, hence the correction)

Subprime mortgage crisis in the USA leading to high incidence of mortgage delinquencies and foreclosures with major adverse consequences for banks and financial institutions around the world


What created the crisis?

Securitization-the innovation that allowed the original lender to offload mortgages before maturity to other investors (spreading risks); served to replenish lender’s funds, originate more loans, earn fees now led to emphasis on originating loans and not on credit quality- any and everyone can qualify.


Still on what created the crisis….

Securities (in several trillions of US dollars) backed by this subprime mortgages held around the world lost value, leading to large decline in the capital of many banks and credit crisis with the associated contagion effect

Speculation (with overleveraged borrowers having several investment properties)

Sharp lending & borrowing practices(risky beh.)

Falsified and inaccurate credit ratings on MBSs and the borrowers


On the origin of the crisis General lax in the regulatory

environment Failure of self regulation of

investment banks Greed (bonuses were tied to

“performance”) “Too big to fail” syndrome & moral

hazard


When the bubble burst it led to: (A) Deterioration of asset values

(B) Bankruptcies

(C) Huge Consolidations

(D) Massive government intervention & bailout


“Creative Destruction” & The Market Economy Joseph Schumpeter ( a Harvard University

Professor) and “creative destruction” [1942] That the market economy has an inherent

rejuvenating power to create new ideas, innovate, equilibrate demand and supply, reallocate resources and to sweep non-performing market institutions away

That innovative entry of new firms was the force that sustained long-term economic growth as it destroyed the value of non-innovating existing companies


“Creative Destruction”

He is interpreted to mean that the lifeblood of capitalism was “creative destruction” with companies rising and falling to make the economy stronger

He also recognized that as corporations are formed, they may nurture values that are hostile to the market economy

But that there are penalties for those who operated outside the rules of the market; penalty 4 greed and non market friendly behavior as well as wrong investment decisions


“Creative destruction” The concept first introduced in 1942 lived on Even as trust diminished and we saw the

ascendancy of greed The death of the socialist planning system

provided no alternative to the market economy as its superior features (market economy that is) became self–evident especially following the economic successes of Reagan and Thatcher

It was this that gave us the structural adjustment program – that recommended pared-back govt. & pronounced any direct government intervention in productive activities as anti-growth and anti-development


A redefinition of market failure In spite of market determinism,

economists have always recognized instances of market failure where government intervention is necessary …but this window was more narrowly defined to our detriment (until now)– it certainly does not accommodate the extent and magnitude of the recent bailouts

So what happened to “creative destruction”? Why did we not allow the system to endogenously destroy “bad boys” and their companies?


The New Reality

o Globalization & interdependence o Great advances in ICTs, speed and complexityo The bigger the better –with mergers etc.o Greed, Absence of Trust & CEOs financial

recklessness & false accounting (our examples)o Post 9/11 World – “the age of turbulence”o Closer link between wall street and main streeto Great global contagion effect & systemic riskso Weak regulation & weak audit technologyo A system that has privatized profit but socialized

risk[Schumpeter did not live in this era]


The elements of the “New Market Economy”

A new focus on the private & public sector corruption [illicit financial flows]

Strong institutions for positive values and cultural orientation (the libertarian world of freedom of choice in a mkt society is a cultural utopia – behave as you wish? No way!)

Strong Taxation regime including contingent tax Strong social security provision


The new reality is defining the features of a “New Market Economy”

Very robust regulatory regime Regulating the regulator Strong audit technology by the regulator

“Police patrol” or “fire fighting” Capacity for early warning system A regulator of systemic risks

Redefinition of market failure Strong role for the state The resurgence of development planning


The new market economy

Rule of law in the strictest sense Would require strong dose of patriotism

and democratic ideals Strong corporate governance practices

and regulation [Board members need to add value to the institutions they serve]

Knowledge-based institutions with technocrats or techno-politicians managing the economy


Trust is a key element of a market economy

Trust – key to most business transactions in the market economy – it affects everything from credit, inter-bank loans to our believe in the system- stock market; regulating institutions; audited accounts etc.

Trust is in short supply in Nigeria [the story of participants in my lecture in Lagos]


Trust

Yet you cannot legislate trust or regulate your way out of it – test of probity & character for CEOs essential.

The CBN, SEC, NDIC, NSE, ICAN etc. must “shine their eyes” Yes o!

The Key is to “Trust but verify!” Property rights combined with the

tradition of trust is at the heart of the market economy.


Economists & their Tools

Tools available to economists for the management of the economy have been growing in sophistication, sharpness and robustness especially with the infusion of mathematical modeling into the discipline

Economists know a lot about the economy but certainly do not have all the answers…current training and tools are now clearly inadequate[my Arusha, Tanzania experience in the early

90s]


Economists & Tools

These tools are proving not to be as sophisticated as they seem:v have weak predictive power v Stronger with corrective measuresv Falls short in the face of current reality – the

age of turbulence, greed, great uncertainty and the globalized world

v Human behavior and nuances are getting more sophisticated & difficult to model and predict


The inadequacy of the tools

The current global financial crisis has further exposed the inadequacy of the tools:§ - lack of full appreciation of the

larger/global implications of the sub-prime lending in the United States & the credit crisis that ensued

sudden burst of the bubble The timid market response to the huge

governments’ interventions


Still on Tools….

The new ICT world of borderless, seamless financial transactions

Innovations in the financial services and products


The new tools The new market economy requires economists with

more than two hands: Those with adequate skills (flexible) Understand the complexity of the globalized world With greater intuition An understanding of social psychology underlying human

behaviour beyond the utilitarian approach With a mastery of nuances Very strong understanding and appreciation of new and

ever evolving financial products and processes A greater appreciation of science and innovation With an understanding of the Social and governance

dimensions of poverty Skills of how to remain globally engaged and yet nationally

secure


Conclusions

The world has changed remarkably There is no “industry leader” in the management

of the economy Nigeria must manage its economy in its unique

way as to remain globally engaged but locally relevant – guided by its own history, experience and knowledge

The age of “self-doubt” should be over The New market economy requires state

vigilance The way we teach economics has to change

Making Sense Of Global Financial Crises

Economy & Finance

Transcript of Making Sense Of Global Financial Crises