Tuesday, February 03, 2009

Gowan: Consequences of the New Wall Street System

Much of the mainstream debate on the causes of the crisis takes the form of an ‘accidents’ theory, explaining the debâcle as the result of contingent actions by, say, Greenspan’s Federal Reserve, the banks, the regulators or the rating agencies. We have argued against this, proposing rather that a relatively coherent structure which we have called the New Wall Street System should be understood as having generated the crisis. But in addition to the argument above, we should note another striking feature of the last twenty years: the extraordinary harmony between Wall Street operators and Washington regulators. Typically in American history there have been phases of great tension, not only between Wall Street and Congress but also between Wall Street and the executive branch. This was true, for example, in much of the 1970s and early 1980s. Yet there has been a clear convergence over the last quarter of a century, the sign of a rather well-integrated project. [30]

An alternative explanation, much favoured in social-democratic circles, argues that both Wall Street and Washington were gripped by a false 'neo-liberal' or 'free-market' ideology, which led them astray. An ingenious right-wing twist on this suggests that the problematic ideology was 'laissez-faire'—that is, no regulation—while what is needed is 'free-market thinking', which implies some regulation. The consequence of either version is usually a rather rudderless discussion of 'how much' and 'what kind' of regulation would set matters straight. [31] The problem with this explanation is that, while the New Wall Street System was legitimated by free-market, laissez-faire or neo-liberal outlooks, these do not seem to have been operative ideologies for its practitioners, whether in Wall Street or in Washington. Philip Augar's detailed study of the Wall Street investment banks, The Greed Merchants, cited above, argues that they have actually operated in large part as a conscious cartel—the opposite of a free market. It is evident that neither Greenspan nor the bank chiefs believed in the serious version of this creed: neo-classical financial economics. Greenspan has not argued that financial markets are efficient or transparent; he has fully accepted that they can tend towards bubbles and blow-outs. He and his colleagues have been well aware of the risk of serious financial crisis, in which the American state would have to throw huge amounts of tax-payers' money into saving the system. They also grasped that all the various risk models used by the Wall Street banks were flawed, and were bound to be, since they presupposed a general context of financial market stability, within which one bank, in one market sector, might face a sudden threat; their solutions were in essence about diversification of risk across markets. The models therefore assumed away the systemic threat that Greenspan and others were well aware of: namely, a sudden negative turn across all markets. [32]

[30] There were tensions between Wall Street and New York state regulator Eliot Spitzer after the dot.com bubble burst, but this simply highlighted how strong was the consensus at a higher level.
[31] References to these kinds of debates can be found in Andrew Baker et al., Governing Financial Globalization, London 2005.
[32] See Greenspan, ‘We will never have a perfect model of risk’; Alan Beattie and James Politi, ‘Greenspan admits he made a mistake’, FT, 24 October 2008.

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