The economic, political, and financial problems behind the financial crisis
I didn't want to run over my article on the five places to watch for the next financial crisis with secondary commentary, as then, none of you would've read the underlying piece. But now that it's been up for a while, a few more thoughts.
The basic point of the article is that there are structural problems, both inside and outside the financial system, that we're not fixing.
Outside the system, global capital flows are still wildly imbalanced, with developing economies pushing torrents of money to developed countries; inequality is increasing and ordinary Americans are seeing their incomes stall and slip, which is creating more pressure for easy credit and other illusory fixes to wage stagnation; and Congress remains a cheap investment over the long term, making it hard to imagine reforms in a sector as complex as the financial industry sticking over the long run.
Inside the financial system, the shadow banking market, which is where the run that began this whole crisis happened, is being brought under the regulatory umbrella and its actions are being made visible, but we're not doing anything on the scale of deposit insurance, which is what finally ended systemic runs in the consumer market; and regulators, who, by definition, run financial regulation, will still be vulnerable to intellectual capture and inattention and overconfidence.
Some of these problems have solutions and some of them don't. But the solutions, in all cases, are difficult and structural -- much more so than anything we've done in financial reform. Take wages. Extending false wage increases in the form of easy credit, Raghuram Rajan says, was attractive because the actual solutions are tough and slow. "The real fix would be to deal with the problem at its source," he explains, "which is that too many Americans don't have the qualifications for the jobs being produced in this new economy. That means far more time and attention to education, retraining, and skills. But it will take time." How do you tell someone whose incomes are declining now that we might have this solved in 10 or 20 years?
Or global imbalances. We really don't have the capacity to fix this on our own. We can do a bit, by making our investment markets less attractive to outside investors, but we're not going to do that. The real answer is currency changes on the part of developing countries like China and a rapid maturation of their homegrown capital markets, so their investors see homegrown opportunities for their money. "Asian bond markets are incredibly small and underdeveloped," says Kenneth Rogoff. "That’s one of the reasons people who want to hold bonds look to Europe and the United States."
When we think about fixing what went wrong, we tend to date what went wrong to late 2007, or maybe a few years before. But if you go back further, you find a shaky economy that wasn't working for enough people but that was being hidden by cheap foreign money and easy domestic credit. A weak political system wasn't able to anything about it, and nor was it able to keep up with the financial system when it started rapidly transforming itself in response to these new economic realities. We've made progress on some of these problems, but not enough of them. In fact, some of them aren't in the discussion at all.
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