Posted on 02/21/2008 9:20:42 PM PST by TigerLikesRooster
The fall of a financial model
By Jean-Louis Beffa and Xavier Ragot
Published: February 21 2008 17:26 | Last updated: February 21 2008 17:26
Recent changes in the world economy and financial markets mark the end of the present standard model of financial capitalism, built up over the last decade or so. In this model, financial stability is mainly based on the self-regulation of the financial sector, which alone assesses the risks produced by its financial innovations.
Moreover, the link between finance and the real economy hinges on an adequate return on investment for shareholders, who punish poor management by making share prices fall, leaving the company open to takeover. The only role assigned to governments is to guarantee free circulation of capital between companies and between countries. As alternative economic models collapsed over the past two decades, public opinion came to accept this model of financial capitalism. Today, governments and labour unions accept profit as the most relevant criterion for assessing a company’s efficiency. This model is experiencing three crises, all of which refer to changes in the relationship between governments and markets.
The first concerns the significant, yet silent, return of governments to the economic playing field. Three of the five richest nations by total gross domestic product have become de facto neo-mercantilist, setting their sights on trade surpluses. China is keeping its currency artificially low in order to increase its trade surplus and lower its costs of production vis-a-vis competitor countries. Japan is pursuing government-oriented policies to bolster its position in high-technology markets. Finally, and to a lesser degree, Germany has been carrying out reforms to restore industrial competitiveness. In addition, countries that have access to natural resources, notably oil and gas, have revenues that serve as both an instrument and aim of their international policy. Trade surpluses have resulted, demonstrating the capacity of governments to acquire massive amounts of foreign assets through sovereign wealth funds. The problems that arise are not economic, but political. Governments may use technology transfer or control of strategic national assets as a means to increase bargaining power in international affairs.
The second change involves company ownership. Three transformations should be noted. The first relates to the emergence of active shareholders, who build up significant stakes with the aim of exerting strong influence on management. The second relates to activist shareholders and their demand for short-term returns, resulting in decisions that are not in the company’s long-term interests. The third involves leveraged buy-outs, closely linking the interests of managers and shareholders and taking advantage of easy credit.
These shifts in the distribution of power raise questions: what is the relationship between shareholder meetings and boards? To what extent should companies be allowed to protect themselves from hostile bids or creeping takeovers? In what form and how frequently should accounting information be provided to shareholders?
Company ownership has not yet found a new balance, as shown in Europe by the absence of agreement on the takeover directive and on one share/one vote rather than multiple voting rights. Regulators’ desire to increase supervision of creeping takeovers is telling. The trends are risky: a shareholder can pursue speculative or self-interested aims to the detriment of other shareholders and against the company’s best interest by breaking up the business or by avoiding taking risk.
The third crisis is the one rocking financial markets. Unlike the internet bubble, this is not a crisis based on irrational behaviour but one of sophistication and disintermediation. The new risks produced by financial innovation were left to a sector that alone was considered able to understand its instruments. The crisis demonstrates the costs to the real economy and lack of an efficient self-regulating system.
All these risks call for a new relationship between the workings of financial markets and regulatory actions of governments. Democratic governments will have to deal for a long time with less democratic economies that use financial market mechanisms for political ends. Each sovereign investor must clarify its intentions and define its code of conduct. Governments must also define with greater precision the sectors they consider strategic.
The changes in company ownership also call for greater transparency in order to prevent actions that offend business ethics, such as creeping takeovers and speculative strategies that undermine companies’ long-term interests. The board’s role of defining solutions that satisfy shareholders’ divergent interests will have to be strengthened. It should allow for corporate governance that encourages long-term strategies while satisfying shareholder interests. Finally, regulators should supervise the whole of financial markets to assess systemic risk, eliminate off-balance-sheet ambiguities and bring within the scope of supervision actors that have eluded market authorities.
How governments deal with these crises will depend on their national interests. These issues will be difficult to deal with in Europe where country responses will diverge. One can expect to see the co-existence of various models, varying by level of government intervention in financial markets. There is a great distance, however, between co-existence and compatibility.
Jean-Louis Beffa is chairman of Saint-Gobain and co-president of the Cournot Centre for Economic Studies. Xavier Ragot is associate professor at the Paris School of Economics
Ping!
perhaps it's different in the UK, but self regulation has been around in the US for a long time.
Notwithstanding, the talking points are about "regulators not doing enough" on both sides of the pond. This too is nothing new, but as most rhetoric seems to be these days, it's unusually demanding and rude.
It's amazing how much these media mouths "plagiarize" one another.
The left plagiarizes the left. But that’s not the point. The point is that they’re pursuing their agenda 24/7/365.
Government intervention on both the upside and the downside is the problem. Instead of propping up failed companies/financial institutions/homeowners (actually renters) governments should allow them to fail, colossally at times. This would eliminate at least for a generation, susceptibility to the latest financial and investment craze. Government intervention inhibits players’ common sense in the market.
Self regulation works fine. Get the damn meddling government out of the picture and the markets will correct themselves.
So what. Capitalism is a constant process of creation and destruction.
Back in the late 1970’s banks lent money to Latin American countries on easy terms and they couldn’t pay it back. Then a little later the S&L crisis was caused by S&L’s throwing money around after regulations were eased. Back in the 1830’s banks lent money to anybody who was buying land auctioned off by the government . There are probably many more examples, but it appears that banks screw up every time they are flush with cash. It’s not just subprime or the redlining thing.
The imprudent ones that screw up need to go out of business. Financial Darwinism.
People are not going to leave all their wealth in the hands of bureaucrats who work for somebody else's interests.
If you want to abolish our characteristic way of getting things done by inducing private interests to run them efficiently, then everything will simply be run badly, straight into the ground.
This is all so stupid and so French...
There is a reason we are richer than we were in the 1830s, and it isn't government, nor imaginary infallibility. It is the cumulative result of a hundred and eight years of risky trial and error. These simpletons think they can abolish the errors by abolishing the trials. It is foolishness.
The sub-prime collapse will go down in history as the first recession caused by Affirmative Action. Not only did the USA govt force lenders to loan money to unqualified home buyers, but the govt also gave lenders a back door escape route. Lenders did not have to hold these loans. Lenders were allowed to immediately bundle these high risk loans and sell them off to Fannie Mae and Freddie Mac. Fannie and Freddie are Government Sponsored Enterprises (”GSE”) that trade like regular stocks on the NYSE. Previously, Fannie and Freddie would not have been allowed to accept these loans. The govt changed the rules. Unfortunately, most people who buy Fannie and Freddie stock think the USA govt guarantees the loans. Whoops! The value of Fannie and Freddie stock has fallen by 60% in six months! Since many of the people who own those two stocks are often senior citizens or very cautious investors, this price collapse is a disaster. Yet, I have not heard one word about this from Bush or from any presidential candidate.
btt
Isn't going to change either. BTW, historically, banks become MUCH bolder when there are good times generally, the exception being the idiotic ''sovereign loans'' of the 1970s, led at first by Citibank and Manny Hanny and Chemical.
FReegards!
The explanation that I read said that the banks were flush with oil money, and that's why they got sloppy with the sovereign loans.
Has there ever been a command economy that worked?
Some years ago I spoke to a former member of the Communist party (old USSR) and she asked how we knew what to charge for things. She said they had a horrible time coming up with "prices" and were often reduced to getting old U.S. catalogs ( like Sears) and converting our prices into rubles. It was crazy.
As you'll recall, the gov't had by then deregulated interest rates paid to savers in many cases, and interest rates were rising generally. For example, those banks that were heavily into fixed long-term loans (Citi and Chem, to name two) were either upside down or close to it on a LOT of them. Their decade-long practice of continually violating the Golden Rule of Banking, namely ''Lend short, borrow long'' had caught up with them. Their loan portfolios in toto were as smelly as Limburger.
Effectively, their pouring capital into 'sovereign loans' was a Martingale, an attempt to recoup their losses and clean up their balance sheets by doubling down.
When one lends based on the 'full faith and credit' of another party, one had better be damned certain that the 'full faith and credit' is solid. In the cases of lending to Peru, Congo, Mali, and so on, the 'credit' was nonexistent and the 'full faith' mostly imaginary. Idiots.
If you've a mind to, you can still trade some of this funky sovereign paper, typically around 3-7 cents on the dollar.
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