For the last couple of years, in the wake of the financial crisis, the banking and finance community has darkly warned about the dangers of over regulating the sector. “We mustn’t impede the free flow of capital”, it is claimed, “otherwise efficiency and productivity will be lost and the real economy will not recover.” The other camp claims that the finance sector must be reined in, re-regulated, otherwise crises will continue to happen. The dichotomy is entirely false. Finance is rules. You cannot increase or decrease the amount of rules in rules. You can only change their character. And you can decide who will set them.
And that is what this argument is really about. Power. Who has the power to set the rules of finance. For a quarter of a century, governments have progressively given up their power to set the rules and given it over to private players, who, to say the least, made up their own rules: forwards, futures, options, swaps, CFDs, CDSs, CDOs, securitisation … And my favourite, volatility derivatives, which can be translated as “we make the mess, then we make money from the mess.”
False dichotomies are the stuff of political rhetoric and make no mistake, the wresting of power from government by the private sector has been a political exercise, starting in the Reagan and Thatcher years. It has been spectacularly successful. Well, up until the point where its absurdities started to result in the system almost collapsing, that is. When the serpent began to eat its own tail.
The false dichotomy about regulation inevitably led to another false dichotomy. That the only choice facing us is between bad government and good markets. You can see how it works in the Economist article on LIBOR (the London Interbank Offered Rate that sets the interest rate for the world). Never let a chance to blame government go past, even when the traders have been caught cold rorting the system:
BOOSTERS of financial regulation are making hay from the widening scandal over allegations that LIBOR, a key interest rate, was rigged repeatedly for at least five years since 2005. Yet the trove of documents that have emerged also reveal the very flawed nature of regulation, in which government bureaucrats are asked to keep tabs on high-flying financial sorts. Transcripts of calls between officials at the Federal Reserve Bank of New York and traders at Barclays show that regulators didn’t really pick up on cues, even when they spelled out misbehaviour.
The same sort of bashing of government can be seen in Karen Horn’s article for Standpoint, one of many examples of the rear guard action being mounted against criticisms of the ideology of the market state. Horn announces that the “anti-capitalists are coming out of the closet”, eliding, as ever, democracy and markets. Underlying her critique is the neat use of dichotomies, bad government, good markets. Markets have pricing. Governments don’t:
Of course it is only through ignoring the pervasive evidence of government failure that they can have their cake and eat it: sure, spontaneous coordination in the marketplace is efficient and innovative, but let’s rein it in as we see fit. Rules are not enough; we are entitled to some enlightened ad hoc regulation. That will make the market process non-spontaneous? Oh well, it’s for our benefit, and some greater good.
This circular bashing of the state is typical of the quasi logic of the pro-market apologists. The market is defined as inherently better because it has pricing and supply and demand, whereas the state is defined as inherently inefficient because it doesn’t have those things. In other words, the market is the market, the state is the state, and therefore the state is not the market.
Such Manichean circularities are pursued, wittingly or unwittingly, to create the impression that, although markets may be bad at times, governments are always worse. Yet such a dichotomy of bad government v (mostly) good markets is not the choice that faces us at all, at least not in the financial markets. The choice is between good government and bad government. In the final analysis, as we are graphically seeing, governments have to set the rules. Traders rely on the basic legal structures that underpin transactions, even when they are based on assent rather than enforcement.
If they are allowed too much freedom to set their own rules, it eventually collapses and guess who has to pick up the pieces? Governments. The euro crisis, for example, has become so intractable, because there is no single government underlying the currency. If one needs reminding how political finance is, go no further than Europe.
It is at this point that 25 years of the political rhetoric of the de-regulation proponents has become so damaging. Francis Fukuyama alluded to this recently in the Financial Times. He commented that the Left has no answers, and that the best way forward is for the right to rethink:
If contemporary conservatives could get over their ideological aversion to the state, they would recognise that American government is both necessary and in great need of reform rather than abolition. Private sector companies have undergone huge chang.es in recent decades, flattening managerial hierarchies, upgrading workforce skills and experimenting ceaselessly with new organisational forms.
American government, by contrast, seems trapped in a late 19th-century bureaucratic model of rules and hierarchy. It needs to be smaller but also stronger and more effective. And this will not happen unless people see public service as a calling, rather than a despised occupation for people unable to make it in the private sector. In this regard, conservatives have an advantage because they can call people to public duty on the basis of the American nation rather than abstract ideals.
What will eventually emerge is a recognition that government must set the basic rules of money. Even taking into account the fact that there are massive cross border flows of capital which are beyond the reach of any one government. The only question, I suspect, is if this will occur after yet another set of crises, or in advance, through an effort to improve the quality of government from within, as Fukuyama is urging. The reality is that, just as you cannot have a legal system without government setting the rules, you cannot have a financial system without government setting the rules.
Improving government will then require the asking of some basic questions about ethics, morality and what the financial system is for. Political questions, in other words. Questions about what is a good and bad society. Of course, while the finance sector enjoys such political reach through its various funding and lobbying campaigns, such a discussion will be hard to instigate. But in the end, as we are seeing with the dysfunctionality of the system, it is inevitable. The political debate contest over the role of governments and the markets has not been conclusively resolved. Political contests never are.