Five winners of the Nobel Price for Economics share their views on
what the future global finance order should look like in exclusive
essays for German news magazine Spiegel.
Later this week, the heads of state and government of more than 20
countries are to meet in Washington to discuss the consequences of the
global financial crisis. While some countries are satisfied with strong
government influence on incentives systems for managers, others are
demanding more far-reaching action: nothing short of a radical shake-up
of the global financial system complete with new controls and new
monitoring mechanisms. Spiegel asked five previous winners of the Nobel
Prize for economics to provide their own advice for what world leaders
should do.
Edmund S. Phelps, 75: What Has Gone Wrong Up Until Now
It is preposterous to speak, as some Europeans have, of the "end of
capitalism." A good life requires a rewarding workplace - one of
change and challenge - and that requires some sort of well-functioning
capitalism.
There is no question that the banking industry in the United States
has gone awry. In buying mortgages for packaging in mortgage-backed
securities, the banks exported to the rest of the world a profusion of
assets that were overvalued by the financial companies that purchased
them.
The ratings agencies, which made their calculations based only on rosy
scenarios, and never on a worst-case basis, were complicit in this
over-valuation.
In selling derivatives, such as default insurance and other
collateralized debt obligations, the banks were selling assets that
were too complex for a great many investors to understand.
Finally, the banks were their own worst enemies. The level of their
loans and their borrowings to make those loans reached so high a level
in relation to their capital, or equity, that any serious disturbance
to asset prices - a default shock or a shock to liquidity premia -
could have devastating effects on the equity of any bank and thus on
its ability to function and to survive. At some banks, measured
leverage was not extraordinarily high but the opacity of the assets and
the resulting uncertainty over their future returns was very high.
That the banks chose to take on ever-greater levels of risk, with no
end in sight until the collapse, was an effect of employee
compensation: Fortunes could be made for each additional day that the
bank could operate. There was no claw-back provision that would pay
bonuses only for performance over the long term.
Is regulation required here? Undoubtedly some new regulations are required here and there.
Yet, many observers have argued the lack of restraints on the
banking industry was more a failure of the regulatory authorities to
exercise their powers than it was an absence of regulatory authority to
act. A new mindset is required, above all.
A fundamental issue that regulatory discussions must confront, however,
is what function society needs the banking industry to perform.
Increasingly over the past two decades, the banks have tried to make
money with mortgages, residential and commercial. As this has proved
difficult, the banks will either have to shrink their supply of credit
to the economy as a whole or else redirect some their credit to the
business sector.
Unfortunately, the banks for the most part appear to have lost the
expertise to make business loans and investments, which they once had
in the fabulous years of investment banks such as Deutsche Bank and
J.P. Morgan.
Wíll the big banks in the U.S. be able to regain such expertise?
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