Finance had same delusions of safety as 'Titanic', forum told

GLOBAL FINANCE before the crisis which began in 2007 was like the Titanic, according to the most-cited academic economist in the world.

Speaking at a conference in Trinity College Dublin, Andrei Shleifer, professor of economics at Harvard University, said that just as those who designed the ill-fated ship believed it to be the safest afloat, those at the helm of large financial institutions believed the wider system was sound. He said they did not understand its weaknesses and the risks they were running.

This ignorance was the most likely explanation for the financial crisis, he said. In support, Dr Shleifer cited the internal reports of some large investment banks which he believes strongly suggest they hugely underestimated the riskiness of their businesses as late as 2008. He went on to reject moral-hazard-based explanations of the financial crisis.

Among the most frequently articulated explanations of the crisis is that those who ran financial institutions “too big to fail” took excessively risky bets on financial markets. This was in the knowledge that they would profit if the bets paid off but that government would step in to bail them out if their losses proved too large.

In the US those who ran these institutions will spend the next decade in consultation with their lawyers, he said. He did not believe they knew they were running such a risk before 2007.

He also rejected arguments based on the crisis being an aberration and thus impossible to predict. Although the crisis may be bigger than previous crises in recent decades, he said, it was not sufficiently different to support the freak-event thesis.

Dr Shleifer, who coined the phrase “zombie banks”, described credit ratings agencies as “idiots”.

He was giving a keynote address at the ninth annual Infiniti conference on international finance. With 250 delegates from 42 countries, it is the largest such conference in Europe according to the conference chair, TCD’s Prof Brian Lucey.

It is understood Dr Shleifer held a number of meetings with politicians and policymakers during his visit, including the governor of the Central Bank, Patrick Honohan.