A stark analysis of the international fiscal meltdown and its consequences

BOOK OF THE DAY: Engineering a Financial Bloodbath: How Sub-Prime Securitization Destroyed the Legitimacy of Financial CapitalismBy Justin O'Brien Imperial College Press 196 pp, £29 - A FORMER investigative reporter for RTÉ and the BBC and a professor of corporate governance in Canberra, Justin O'Brien's new book is a sober examination of the global financial crisis and the perils of inadequate regulation.

His thesis is a strong one: ethical failure was the primary cause of the financial meltdown. Far from being the fault of a few blinkered bankers, the crisis was made possible by legal – if ethically questionable – behaviour across the corporate spectrum.

Short-term incentives saw loans happily extended to all and sundry. Conflicted rating agencies awarded AAA ratings to dodgy subprime securities (a deal “could be structured by cows and we would rate it”, as one analyst admitted).

Meanwhile, the regulatory and political elite, “mesmerised by financial alchemy”, sat by and watched in admiration.

O’Brien is at his best when he allows his journalistic self to shine, particularly in his brief but excoriating coverage of the Irish banking fiasco. Ireland resembled a “crooked casino” characterised by “staggering regulatory, corporate and political incompetence”.

He relates the sorry saga of Irish Life and Permanent’s underhand transactions with Anglo Irish Bank, noting that the board eventually accepted with “utmost regret” the resignations of its disgraced top executives, men of “utmost integrity”.

The bank and Financial Regulator demonstrated a “complete lack of understanding of international regulatory developments”, he notes.

Not that international regulators are spared. In the US, the Securities and Exchange Commission allowed its own authority to be undermined.

Chairmen who espoused libertarian, anti-regulation views headed the agency. In 2004, it allowed the banks to rely on their own in-house computer models when deciding the riskiness of investments, enabling them to leverage to the hilt. “If anything goes wrong,” admitted one commission executive, “it’s going to be an awfully big mess.”

Innovation was prized over security, O’Brien asserts, with regulators and central bankers like Alan Greenspan imprisoned by an ideological world view that demonstrated blind faith in ostensibly omniscient markets.

The collapse shook those beliefs. Greenspan admitted to a “flaw” in his world view, while former commission chairman Christopher Cox belatedly agreed that “voluntary regulation does not work”. Europeans have called for a “new global financial order”, while President Obama has promised extensive change in the regulatory architecture.

It will not be easy. O’Brien notes the challenge of sovereign wealth funds (SWFs), government asset holdings that have already eclipsed hedge funds and private equity ($15 trillion is predicted to be held by SWFs by 2015). One such fund has warned of the dangers of “rash regulation” in a world “thirsty for liquidity”.

Policymakers and academics, rather than the general reader seeking to make sense of the global financial carnage, appear to be the book’s target audience.

O’Brien recommends that regulators not only adapt a more assertive prosecutorial stance, but “informal approaches to guide behavioural change”, citing recent moves by Australian regulators as a possible way forward. Institutions must move away from mere notions of technical compliance, where any action is deemed acceptable as long as it’s not specifically prohibited.

There are obvious practical difficulties in embedding general ideas of integrity and ethics, however, and one senses that the author himself is not particularly optimistic. Key Obama appointees to regulatory positions have been “firm supporters of self-regulation” in the past. Nor is there any evidence of a “Pauline conversion” among market participants.

O’Brien’s big fear is a repetition of past cycles, where initial moves towards reform founder as the immediate crisis recedes.

Many commentators caution that that pattern is under way. It seems the one thing we learn from history, as Shaw famously lamented, is that we learn nothing from history.

Proinsias O’Mahony is a financial journalist