Turning Economic Crisis Into Opportunity

As we are staring into the abyss of economic collapse and as we are understandably pre-occupied with stop-gap measures to contain the decline in both depth and breadth, we must recognize the tremendous opportunity that lies before us.

We are given the chance to reflect on the basic assumptions of our economic model. Accordingly, we are provided with the chance to make global structural adjustments at a scale rarely afforded to a generation.

Let me propose some resolutions:

1) Let us contain private-sector communism.

The last 20 years have been marked by the unparalleled magnitude and number of mergers and acquisitions in the real economy. Some of these M&A activities have created companies with the necessary economies-of-scale. By and large, though, they have produced unmanageable and often inefficient conglomerates.

However, the defeat of Big Steel by so-called mini-mills in the United States should lead us to question even some of our most basic assumptions about “natural monopolies” or “economies-of-scale.”

The chairman of General Motors admitted as much when he stated: “In practically all of our activities, we seem to suffer from the inertia resulting from our size.” Admittedly, the chairman quoted was Alfred Sloan, and he made this statement in 1941 at a hearing in the U.S. Congress on the concentration of economic power.

In his usual wit, Ross Perot — who served as a director on the board of GM — put it this way in 1988: “At GM, if you see a snake, the first thing you do is hire a consultant on snakes. Then you get a committee on snakes, and then you discuss it for a couple of years. The most likely course of action — nothing. You figure the snake hasn’t bitten anybody yet, so you let him crawl around the factory floor.”

This is a scathing condemnation of concentration of economic power and the inefficiencies of conglomerates.

Of course, we all knew this. In fact, our capitalist model is based and dependent on a competitive and transparent market. The proliferation of national and sometimes global monopolies/oligopolies has introduced unreasonable risks and inefficiencies to the proper functioning of the global market.

It should be recalled that antitrust legislation, which exists in many countries, was designed to protect consumers, to create efficient markets and to avoid systemic risk. The proper enforcement of such antitrust legislation also ensures the effectiveness of our fiscal and monetary policy tools. The more we digress from the ideal market model, the less potent these tools become. Our current policy conundrum is living proof.

2) While we must undo the oligopolistic structure of our real economy, the diffusion of power in the financial sector is of even greater importance — because the latter functions as the circulatory system of the real economy.

Yet, during this time of crisis, regulators and treasury departments are doing the opposite by advocating the merger of one systemically important, bad bank with another. By so doing, they are building banks that are no longer “too big to fail” — but instead “too big to save.”

This is a recipe for disaster. After all, a little over two months ago, near-defunct Wachovia Bank and Citigroup apparently got the official blessing for their shot-gun wedding, a deal which fell apart days later when Wells Fargo made a counter offer. It was not before long that Citigroup itself had to be bailed out by the U.S. government.

Large financial conglomerates which have mushroomed over the last ten years are creating an unacceptable systemic risk. It has become increasingly apparent that even the best-intentioned management simply does not have an informed view of the risk exposure of their one-stop shops.

Concentration of power in the financial sector also further enhances homogenization of risk management techniques, which leads to instant systemic failure when event risk materializes.

3) We must rethink the major policy objectives of the central bank model. Price stability is the key goal for many central banks. This is interpreted to mean a fight against consumer price inflation. In the United States, this dogmatic self-restraint induced a double bubble in housing and consumption that is at the heart of the current crisis.

Central banks should develop methodologies to measure asset price inflation and to counter such inflation, if observed, with monetary policy.

4) A global financial market must be regulated and supervised by a global regulatory and supervisory body. As a first step, though, each jurisdiction must streamline its own regulatory and supervisory framework

From a regulatory perspective, we might embrace three core tenets: No more off-balance sheet accounting, no more offshore banking and no more non-bank banks.

We should also resist the calls for abandoning fair value accounting. It is hardly prudent to change the rules of the game in order to create a more favorable appearance of the balance sheets of our financial institutions.

As far as supervision is concerned, it should be brought under one umbrella covering banks, investment banks, hedge funds, insurance companies and other non-bank banks. This means that we look at the financial system in a holistic way.

Once such streamlining at the national level has been concluded, such national oversight should be integrated into a global oversight regime. This requires international standardization of regulation which will be politically difficult, but it will have the benefit of reducing regulatory arbitrage — both between industries and between countries. It will also require the establishment of an effective global supervisory body, at least for systemically important institutions.

These are just some proposals to make use of this unique opportunity to redesign our economic and financial model. Some are provocative, some controversial. Some have a proven record, others are innovative and new. All of them are intended to stimulate a discussion aimed at creating a stable economic and financial equilibrium.