ON THE financial Richter scale the first signs that all was not well were recorded exactly five years ago, in July 2007. The tremors continued for 14 months. Then came the big one – the collapse of Lehman Brothers in September 2008 plunged the world economy into its worst slump in living memory. Tens of millions were made jobless across the world. In the worst affected regions – Europe and North America – public indebtedness soared as had never before happened in peacetime. In the worst-affected countries, governments were forced to seek international bailouts, one of many previously unthinkable happenings that have taken place as a result of the 21 century’s great crash.
After a half decade of crisis, how much has changed in international finance? Not enough, is the answer, as the latest revelations from the City of London illustrate. Barclays, one of the world’s largest financial institutions, was fined last month for its manipulation of a vital interest rate – the London inter-bank offered rate, or Libor. It is unlikely to be the last institution charged in the case. If it turns out that many more banks were involved in setting Libor then the case for more radical reform of the system will become stronger still. In any event, ensuring greater transparency and scaled-up penalties that hurt reckless practitioners would help assuage public anger.
That is not to say that there has not been regulatory reform, either already implemented or in the process of being implemented. But if leading global banks were engaged in systematic and sustained fraud, despite all that has happened, finance is in even greater need of reform than anything contemplated to date. The chorus of financiers claiming they are being victimised reflects absence of contrition and humility in an industry that has wrought so much havoc over the past five years.
Globalised financial systems need international regulation. But forging agreement among many countries has tended towards lowest common denominator outcomes because governments fear the effects of downsizing the industry. Ireland’s opposition to an EU-level financial transactions tax is just one of many examples.
Another problem in framing reform is the complexity of the financial system. Nobody can claim to have fully understood just how fragile that system had become in the years up to 2007/08. The consensus before the crisis was that a sophisticated system, using sophisticated products and run by sophisticated people had made finance safer, not more dangerous. That consensus was entirely wrong.
The system’s complexity has hampered reform efforts. Even discounting purely political concerns, the conceptual challenges in designing a system that is both efficient and safe are enormous, as evidenced by very different prescriptions on what needs to change. The financial system is to the economy what the cardiovascular system is to the human body. There is evidence it is diseased and dysfunctional. It is not clear if anyone has the solution to curing it so the economy it exists to serve can return to full health.
Recovery should be pursued through a process of sustained, incremental reforms to reduce unacceptable and high-risk practices within international banking. If that is the prime focus, a cure becomes more realisable.