The caption of the photo of a founding father facing the New York Stock Exchange caught and held me. It stated, “It takes a willful blindness to liken financial crises to natural disasters.”
I was hooked. Wall Street, our government and politicians have repeatedly, willfully and wrongfully branded the 2008 financial crisis a natural disaster, among other falsehoods, and there was a respected economist and college professor laying out her premise of how wrong they were and why. The essay quoted Dr. Anat Admati, the George G.C. Parker Professor of Finance and Economics at Stanford Graduate School of Business on her concerns and dismay regarding our government’s inability to “create a better financial system.”
Dr. Admati is frequently quoted on her position on why regulations have failed. She takes aim at several fallacies which are advanced by government and regulators, their deliberate “willful blindness” on the financial crisis and the bill of goods they’ve sold to the public on the causes and excuses that justify their lack of accountability.
Dr. Admati says, “policymakers who repeatedly fail to protect the public are not accountable, partly because of false claims obscure reality, create confusion, and muddle the debate,” and she is determined to educate the public in how they can be “savvier consumers of the financial system.”
Dr. Admati advances four myths on the “willful blindness” of our politicians, regulators and others which I’ll summarize and add my own two cents as well.
Myth 1- Financial crises are like natural disasters — they will inevitably occur at some point, and they are impossible to predict or prevent.
She asks, if that’s the case, what’s the point to “passing regulations to improve safety in advance? The best we can do is rescue victims if necessary and minimize the harm when a crisis occurs.” As she comments, we do act to circumvent or minimize damage from natural disasters in advance. Her analogy to building codes points out the fallacies inherent in this myth and how disastrous weak or nonexistent safety codes can be. Whether it is building codes in anticipation of fire disasters and earthquakes, floods or hurricanes, we at least attempt to set up safety systems that may minimize dangers.
Yes, safety standards cost real resources, she says, but they can make the financial system safer. “Much of the extreme fragility of the financial system is entirely unproductive and unnecessary … It benefits primarily those within the system, while endangering and harming many others.”
And I agree with her fully in that it is false to claim we can’t predict a financial crisis. There were many widespread danger signs before the last crisis, including many warnings about the weakened underwriting standards and the epidemic of liar’s loans. Dozens of us pointed out the dangerous path we were on and were ignored. Some bankers even gambled on the outcome; witness Goldman Sachs and their big short! “Fiasco.” That was a natural disaster?!
“If the public believes that crises are unpreventable and that the persistent scandals associated with companies in the financial sector are just the result of “a few bad apples,” she contends, then those who are in a position to improve governance can avoid accountability and continue to fail the public.” And they do.
Myth 2- Problems in banking are just about flaws in the plumbing of the system.
While the comparison is colorful, she’s right on. Huge myth. The 2008 crisis did not happen because of an unpredictable drying up of liquidity! As Dr. Admati says, “Liquidity problems, panics, and runs do not happen in a vacuum.” She claims that suggesting that the problem is only or mostly in the “plumbing” or “liquidity” — which implies a relatively easy technical fix such as “liquidity support” from central banks like the Federal Reserve — diverts attention from the root causes of those problems.”
And Dr. Admati notes the disastrous effects caused by the huge amounts of fraud committed in the financial crisis, with the regulators allowing the payments of settlements without admissions of guilt and with the details not being revealed to the public. She observed, “Fundamental governance failures allow few to harm many with impunity.”
Myth 3: Stricter banking regulations have “unintended consequences” as financial services move from regulated banks to an unregulated “shadow banking system.”
This is another one of those misleading ideas which can actually – and I believe is – taking us toward another breakdown in our system as government caves in and actually panders topressures to deregulate.
Dr. Admati says, ”The lesson is not that we should avoid regulation, but that we must do a better job of it, just as we try to close tax loopholes rather than giving up on tax collection. It was the failure to enforce effective regulations ten years ago that had the ‘unintended consequence’ of ushering in an awful financial crisis.”
Myth 4: Regulations always come at a cost because they constrain what corporations can do and interfere with the efficiency of free markets.
I agree with her premise, “In fact, so-called ‘free markets’ can create their own distortions and inefficient outcomes.” Further, “Laws or regulations are sometimes essential for enabling markets to work better.” We have experienced what unbridled lack of attention to the regulations we did have did to our economy. The unparalleled greed amongst the TBTF when regulations are relaxed is proof enough.
One of the solutions she poses is that banks use more equity funding. The government still “enables and subsidizes banks’ excessive borrowing, through explicit and implicit guarantees and tax subsidies” which feeds debt addiction. And the process continues to break down our system.
Dr. Admati has written extensively on why our present regulations are inadequate and fundamentally flawed. The question is when she and others are so vocal about the issues, why are they still ignored? “You can’t quite understand the implications unless you understand the underlying forces that come to bear,” Dr. Admati says. “A problem in the financial system is that too few people understand it. We all interact with this system and we need to be better educated about it because otherwise, it does not serve us as well.”
She has also created an interdisciplinary course, titled “Finance and Society” which she teaches at Stanford. Her course includes readings from her book (with Martin Hellwig) The Bankers’ New Clothes: What’s Wrong with Banking and What to Do about It. The book includes documents such as Federal Reserve statements, media stories, essays by guests, news stories, and commentary and noted financial services speakers.
Dr. Amati is on a crusade to enlighten the public so they may in turn force some accountability amongst our government enablers. She is to be commended in her mission to teach students and the public. She contends that if the public were more aware of the consistent breakdowns and lack of effective regulations, they would demand more accountability in government. I sincerely hope she is right.