‘Expert’ views that spark bad solutions

In: Uncategorized

23 Feb 2009

The following review by me appeared in the latest Fund Strategy (23 February).

Attacks on greedy financiers are becoming so shrill it is worth revisiting some financial basics. Sadly, most financial “experts” are guilty of what could be called “one-dimensional thinking”.

Take two key propositions that superficially seem true but on closer inspection are gross oversimplifications. First, that greedy financiers, through their enormous risk taking, are largely to blame for the crisis. Second, that the main problem was the massive extension of credit.

In relation to the first, it seems to have been forgot­ten that the financial instruments that have caused so much trouble were designed to help avoid risk. Both mortgage-backed securities and credit derivatives, for example, were essentially risk management tools.

Of course, things did not work out as their designers or users intended. Instead of removing risk they simply transferred it from one party to another. Indeed, they were the basis for “contagion” to create “toxic assets”. But the fact remains that the intention was to manage risk rather than to increase it.

In relation to the credit boom, it is clear that once the bubble burst it had a damaging impact on economic activity. But to stop at this observation is to miss the point that credit kept the global economy growing far faster than it would have done otherwise.

Although credit expansion eventually became a problem, it was for a long time encouraged by the monetary and fiscal authorities in the West, who were motivated by a desire to offset the sluggishness of western economies rather than by simple foolishness.

America was the prime example of this trend. It managed reasonable growth on the basis of huge ­capital flows from Asia and the Middle East. In effect many of the world’s relatively poor countries were subsidising American consumption.

Contemporary economic thinking, particularly that of the more popular pundits, plays down the importance of such complexities. Instead it starts with superficial observations before quickly descending into morality tales about greedy financiers.

It would be far better if more effort was made to go beyond one-dimensional thinking. Rather than present fables about the dangers of greed, an attempt to grapple with real economic trends would be a huge advance. Crass thinking tends to lead to a crass ­discussion which results in crass solutions.

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