The Roots of Crisis: Examining Financial Catastrophe

The financial crisis! It's all the news right now. You can hardly pick up a single newspaper or magazine, let alone turn on the TV, without mention of some form of fallout and the economic woes of the global economy. It is important to make the distinction however, between the poor financial footing on which many banks and governments find themselves and the economic woes that currently inflict states around the globe.

Perhaps most importantly, the culprits must be recognized.

First, Wall Street's culture of self-interest, greed and deceit must be recognized. Since the beginning of the latest boom, which included the technology, real estate and credit bubbles, the culture of the American financial sector has encouraged debt spending, overleveraging, negligence, greed, and excess. There is a vast conceptual and ideological differnece between greed and profit-making. Most pointedly, one caters to the extreme short term. There has been little attempt made in the firms that have become the biggest culprits for the failures of this generation to invest into sustainable business models for the long term. Instead, cases continue to arise where individuals in decision-making positions made poor short-term oriented decisions that inevitably led to disaster.

Second, a lack of regulation on the part of the SEC, the CFTC, and the United States government as a whole allowed Wall Street free rein of the financial markets, with little punishment for gross negligence and a legal system that was applied almost arbitrarily, depending often on personal connection and government preference. For instance Lehmen Brothers and Bear Sterns were allowed to fail, while Bank of America was allowed to buy Merrill Lynch, and Morgan Stanley and Goldman Sachs were permitted to become bank holding companies. But what does that mean? Certainly it does not mean that the investment banking business is dead, nor does it mean that these companies will in some way be hamstrung in their business models going forward. Sadly, the mass public fails to understand the implications of the health of the financial system on the rest of the economy as a whole.

Third, gross negligence by both the people of the United States of America and investors in failing to demand proper accountability by their elected representatives, by their elected corporate officials in the case of publically held companies, and by the very information they were depending on in order to determine the credibility of investments. Without the proper experience, information and knowledge, public investors were left at the mercy of information that was opinionated, misleading and often twisted by greed and ignorance.

Finally, I must mention the inherent nature of fractional-reserve banking coupled with a central banking system that relies upon active monetary policy to ensure economic stability. This is not a flaw so much as it is a function of an ideological choice accepted by this generation of economists and lawmakers. Markets operating under these institutions are prone to bubbles, booms and busts, and encourage contagion and stampeding in the markets. Coupled with a culture of increasing greed, negligence and self-interest, the recipe for a corruption of the roots of the financial system becomes complete. This debate alone is lengthly and complex, and will be examined in a later piece.

There is nothing wrong with free markets. A vast amount of empirical analysis conducted over the past half century, as markets have opened following World War II, shows that scaling back regulatory systems directly results in an increase in trade, investment and growth. However, what is missing in these analyses is the implementation of Westernized regulatory systems and the inherent nature of a Western market system. Although its democratic-capitalistic model involves lower amounts of regulation relative to the ex-Soviet states, it also requires a key aspect that an unregulated market lacks: the rule of law. This must be present in order to ensures a system of incentives and punishments, which in turn assure that market participants play fairly and by the rules, even if the rules are not actually enacted by exacting legislation.

A misdiagnosis must be avoided in order for this crisis to be put firmly behind us. This is not a case of a failure of globalization or a product of markets that are too free. The "credit crisis" of 2008 is the epitome of a culture of a greed and excess, poor regulation and accountability, informational opacity, and an overall lack of willingness to act responsibly and honorably. To assume or operate otherwise would be to cripple the very markets which have provided the vast majority of the world's population to enjoy a standard of living that is unheralded in history.