The Vision Thing
by digby
Krugman does a great service today by putting the financial system crash into perspective and laying out the case for fundamental change in the system itself rather than restoration. And such a thing shouldn’t be scary to anyone but the highest flyers in the financial system. The stock market will still be there and will be open for prudent investment. People still need places for their money to grow and businesses needs ways to raise money to expand, so the markets aren’t going anywhere. But this over-dependence upon arcane financial instruments that no average citizens or even wealthy investor can understand is too dangerous. And having institutions that are “too big to fail” actually increases risk.
He talks at length about the way the system worked in the decades after the depression and then writes:
It all sounds primitive by today’s standards. Yet that boring, primitive financial system serviced an economy that doubled living standards over the course of a generation. After 1980, of course, a very different financial system emerged. In the deregulation-minded Reagan era, old-fashioned banking was increasingly replaced by wheeling and dealing on a grand scale. The new system was much bigger than the old regime: On the eve of the current crisis, finance and insurance accounted for 8 percent of G.D.P., more than twice their share in the 1960s. By early last year, the Dow contained five financial companies — giants like A.I.G., Citigroup and Bank of America. And finance became anything but boring. It attracted many of our sharpest minds and made a select few immensely rich. Underlying the glamorous new world of finance was the process of securitization. Loans no longer stayed with the lender. Instead, they were sold on to others, who sliced, diced and puréed individual debts to synthesize new assets. Subprime mortgages, credit card debts, car loans — all went into the financial system’s juicer. Out the other end, supposedly, came sweet-tasting AAA investments. And financial wizards were lavishly rewarded for overseeing the process. But the wizards were frauds, whether they knew it or not, and their magic turned out to be no more than a collection of cheap stage tricks. Above all, the key promise of securitization — that it would make the financial system more robust by spreading risk more widely — turned out to be a lie. Banks used securitization to increase their risk, not reduce it, and in the process they made the economy more, not less, vulnerable to financial disruption.
You can’t have a stable society if economic ups and downs are too dislocating. It’s possible that this is a once in a century event and everything can readjust and go back to the way it was a couple of years ago, but it’s doubtful. We have seen over and over again that this reliance on complexity too often turns out to be fraud — see the Enron energy market, the AIGFP CDS market etc. This recent implosion has shown us just how risky it is to allow such opaque, inscrutable deal making to dominate our financial system. Thre incentives are all skewed th wrong way.
William Greider makes a similar point in his new book Come Home, America: The Rise and Fall (and Redeeming Promise) of Our Country
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