Ten years have passed since the U.S. Federal Reserve Bank allowed Lehman Brothers to file for bankruptcy, attempting to signal to the market that no firm is too big or important to fail. That mistaken belief triggered panic across the global financial system. The next day, a chastened Fed decided to rescue AIG, the insurance colossus ensnarled in a credit default swap tsunami that threatened to bring down much of the financial system with it, beginning with Goldman Sachs.
The media waves are filled with analyses of causes and expert testimony on what’s changed, and questioning if it can happen again. Unfortunately, most of this decade on analysis fails to go deep enough to assess true root causes that lie in issues like purpose and systems design principles. Without such analysis, we can say with confidence, as many pundits agree, that it can and will happen again.
To avoid such an outcome, to which governments are far less capable of responding than they were ten years ago (perhaps one of the most dangerous consequences of the crisis), we must fully internalize four fundamental lessons from the crisis:
Lesson 1: Finance is a sacred trust upon which societies rise and fall, and the modern global financial system is inexorably dependent upon the support of Central Banks, and the U.S. Government (and China) in particular.
The unprecedented, multi-trillion-dollar rescue of finance largely worked as hoped. And any pretense of a “free market” financial system is a fraud. We should understand the global finance system as contingent socialism. The system, when in crisis—which is the only time the socialist part is relevant—is fully backstopped by the full faith and credit of the world’s major governments. There can be no other way, so we must think and act accordingly.
While many bankers lost their jobs, including some fat cats, few lost everything, and most recovered just fine. The real human costs of the financial crisis have been born by ordinary citizens in the real economy. Trauma of this magnitude causes damage that reverberates for generations. Millions lost their jobs and homes with profound consequences on families’ life-long emotional and financial well-being. Billions more around the world had their livelihoods profoundly shocked or worse. More have been permanently scarred from the cascading effects of the credit crunch on consumers, businesses, towns, schools, hospitals, indeed the entire real economy and with it, the social fabric of society. Local, State, and National Governments have had their financial positions damaged, leaving them far less resilient to weather the many interconnected crises arriving at an accelerating rate, from bridge collapses to storm devastation, from the opioid addiction to the mental health crisis affecting our children.
Such costs should be seen as unacceptable by modern governments with an interest in survival, no different than invasion by an enemy power. The scale of government response must reflect this reality. This is the implication of a contingent socialist financial system.
Lesson 2: The global response to the financial crisis was wrongly focused on saving finance to save the economy.
It is true that a financial collapse would destroy the economy, but it does not follow that saving finance will save the real economy. In the contingent-socialist finance that we have, like it or not, it is incumbent upon governments of the leading powers to create structures and institutions that protect economies from catastrophic loss. Finance has lost the opportunity to self-govern itself in such a way to make it safe for society. All actions have consequences. Similarly, it was necessary following WWII to conceive of NATO to protect Nation States (and society) from themselves.
The lesson is that Finance is embedded in, and inseparable from, the real economy and society as a whole. Any notion of a “financial sector” apart from the broad economy is, in reality, a fiction, useful to clever financiers who exploit the contingent socialist contract for massive gains, on the backs of the citizens without their knowledge or consent. The speculators even have a name for it: The “Fed put” which allowed them to actually increase risk-taking focused on banks, knowing full well that the Fed would not allow the system to collapse. Heads I win, tails society loses, while the speculators’ bet has a floor under it. It’s like free insurance, and financiers understand the value of free. The aggressive ones load the boat on “free” to the direct detriment of society.
Modern Finance extracts by design, and therefore undermines the health of the host within which it is embedded (the real economy). In fact, “to extract value” is an ordinary and unquestioned term within the practice of finance. The distribution of costs and benefits from financial activity is asymmetrical and extreme. Finance takes a disproportionate share of the winnings when times are stable, while distributing the losses across society during crisis: this is contingent socialism.
Lesson 3: Malfeasance coupled with injustice has consequences.
The injustice of the bailout has been seared into our collective psyche. None of the worst offending fat cats went to jail. Few were held accountable in any meaningful way. No doubt the political tribalism here at home and across Europe is, to a significant degree, a result of the financial crisis and associated human misery, made worse by the ill-informed austerity policies the crisis brought in its aftermath. Then, to make a terrible situation unpalatable, there has been a complete lack of accountability for those responsible (private sector and public sector alike). The public knows in their guts that this contingent socialist system (referred to now as simply “Wall Street”) is fundamentally unfair, they are understandably angry, and the western political order is in great peril.
Lesson 4: Without a fundamental strategic reassessment, we cannot change the nature and ideology of finance. Indeed, it has not changed.
Many of the regulatory responses to the financial crisis were tactically correct, but, as can be expected, they had unintended consequences. It was correct to increase the capital and liquidity buffers of banks (it arguably should have been more). It was correct to tackle the off-balance sheet derivative exposure through the use of centralized exchanges for much of the counterparty risk. It was correct (but unrealistic) to attempt to create “living wills” for banks. It was correct to attempt to reign in speculation with the Volcker Rule. Nevertheless, all these changes have been heavily negotiated by the banks who retain too much power to determine their own fates. And some of these good intentions have proved to be practically very difficult (Volcker Rule in particular). And the cost of dealing with all this new regulation means greater fixed costs for all, harming the smaller banks we need more of, while creating further economies of scale for the very largest. Indeed, the too big to fail banks of today are much larger than during the financial crisis a decade ago. Even if they are better capitalized, they most certainly remain too big to fail, and they are far from fail-proof.
Tactical responses to the flaws of the last crisis without a fundamental strategic reassessment about what is the purpose of finance, and what kind of financial system do we as a society want (and in fact need), can only deliver incremental improvements. Tactical responses cannot change the nature and ideology of finance. Indeed, it has not changed.
A strategic assessment of what went wrong a decade ago (and what went wrong on the hundreds of prior financial crises) must begin with two questions:
First, what is the purpose of finance?
And second, will we accept any financial activity that is deemed by society not to be in the interest of the health of the whole system (the real economy within which finance is embedded)?
I would suggest a thorough and serious evaluation of the first question is long overdue. And I hear virtually no real discussion by those in power about the second question beyond some bashing and shaming the villains in finance. What is missing is an evaluation of our finance ideology and the grip it has on us as a society. We must find the right questions to ask.
Questioning financial activity and its consequences for society, like the fact that much of modern finance emanating from Wall Street is dedicated to short-term speculation which we confuse with “investment” rather than in service to the real economy. Or like the predatory nature of much of the rush to securitize assets in what has become known as financialization or even the positive-sounding and implied “market completion” by financial economists. Let us be clear: the subprime crisis was never primarily about extending home ownership to low-income households as we would be led to believe by the “market completion” narrative. It was about manufacturing massive quantities of securities with high yields that could be sold to yield hungry investors with correspondingly massive fees taken out in the middle by financial predators. The tail wagging the dog with horrendous human consequences. We as a society can and must decide whether we need to allow anything just because it’s possible (we don’t). Yet we do allow it.
To begin a conversation about these important questions and more, I plan to release “Regenerative Finance”. The thought piece asks a singular question: what would finance look like if it were to operate in service to the economy and a healthy biosphere? Such an approach to finance is one that is aligned with the principles of regenerative economics as articulated in my previous work, “Regenerative Capitalism: How Universal Principles and Patterns Will Shape the New Economy” (2015).
We will take a living-systems view of what the design principles of systems that sustain themselves for long periods of time actually look like, and use this as an objective, ideology-free lens to assess finance strategically, rather than reactively and from engrained ideological positions which is the conversation one usually sees in the Financial Times and the Wall Street Journal. Political difficulties with policy implementation are suspended while we get clear on where we actually need to go.
We will present the project in the coming weeks and months in four acts following an introduction to provide context:
Act I: Implications of the Regenerative Paradigm for Finance
Act II: The Failures of Finance
Act III: Towards Regenerative Finance and a New Investment Theory
Act IV: Agenda for the Genuine Financial Reform We Need
Your feedback and suggestions are not only welcome but they are also a vital part of the project. So please send your thoughts in writing to feedback(at)capitalinstitute(dot)org and accept our sincere gratitude in advance. You can also share your suggestions on social media using the hashtag #DearFinance. Our aim is to revise the draft based on your input before publishing a final product by year-end.
I sincerely hope this project will be worthy of your good energies and can be shared among your networks. Collectively we can begin to shift the conversation on Finance, an ideology that has come to hold a grip on us, and even absent bad behavior by financiers, threatens all we hold dear in the process.