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Ten Lessons for the Tenth Anniversary of the Financial Crisis

by Barbara Ridpath

Posted: 29 Aug 2017

 

 

I was there. On 8 August 2007 I held a responsible position in finance when, with one European bank's action to suspend withdrawals from two of its funds, some of my colleagues and I began to sense that market liquidity and confidence might be turning. However, none of us had any inkling at that stage of what was to come. Ten years on, I keep feeling I should be able to make some kind of useful statement about what we have learned, what we have not yet learned, and what these lessons may imply for the future.[1]

What we have learned

First, most of the people working in finance ten years ago were not evil. But they were self-centred , some greedy, and they hadn't considered the ramifications of their actions, notably 1) what might happen when they all bought or sold the same risks at the same time, and 2) what impact their actions had on the wider world.

Second, too many people who were not numerate understood mathematical models as 'truths' and not as approximations of reality. The very precision of a finite number as an answer tended to make non-mathematicians take it not as model of reality but as reality itself. Models are not always correct approximations of behaviour. This is particularly true of correlations, a key tool in modelling. What we learned was that in a crisis, all correlations move to one, meaning the prices of all asset classes move together. There may be a lesson here for the future as so many businesses and services increasingly rely on algorithms.

Third, outsourcing of services to third parties carries significant risks. Banks outsourced credit work to rating agencies to save costs. They outsourced loan originations to brokers and compensated them on the quantity, not the quality of the business they originated. Outsourcing has only increased since the crisis in an effort to reduce costs. Complex controls and compliance mechanisms have been built around outsourcing, but it is wise to beware of any firm that outsources its core business.

Fourth, like generals, regulators tend to fight the last war. When the next crisis comes, which it will, the causes will differ from the last one. The only constant is that as soon as you start hearing the words 'paradigm shift,' you are well on your way to another crisis.

Fifth, making the population as a whole pay, with taxes, recession and job losses for failures in the banking system that were not of their making has led to resentment and distrust. This is even more galling when most of the population perceives bankers as the one per cent, living well with seemingly unchanged behaviours and attitudes.

 

What we haven't learned, are inclined to forget or need to remember

Sixth, as a result of the last lesson above, we need to remember that some costs are not priced into goods and services. These are known as externalities in economics and they need to be borne by someone, whether these are the costs of financial crises, environmental pollution or any of a number of other costs (or benefits) that derive from individual or firm behaviours. Policymakers need to recognize these costs and make them explicit if costs are to be allocated appropriately in the future.

Seventh, memories are short and getting shorter. Financial crises usually recur when no one at work can remember the last one. But this time, already there are voices in the US calling for a loosening of financial regulation, before we have any track record of the difference it is making. As George Santayana said, 'Those who cannot remember the past are condemned to repeat it.'

Eighth, not all that we value can be valued. We have permitted neoliberal economics to be inappropriately applied to all walks of life, goading people into thinking everything has a price: even leisure, art, and good health. And yet, what brings real life satisfaction is often community, friendship, love, family and selfless giving to others. We need to learn that economics and finance are mental models and no more. They are not sciences, and their unchecked application to other domains diminishes and demeans what it is to be human.

Ninth, each of us needs to take some responsibility for the crisis, both bankers and individuals alike, if only for our complacency if not our complicity. Savers sought the highest interest rates without regard to the risks of the banks they chose; presuming someone else had evaluated that. In the upswing, individuals were asking regulators to open up high risk investments to all, so they too could get rich quick. Perhaps, we need a Truth and Reconciliation Commission for the financial crisis?[2]

And the last thing we need to remember is that the world is neither too big nor too complex to keep any one individual from being a catalyst for change. We must 'vote' with our purchases and our voices for the world we want. We must live our beliefs, even when at the cost of some hardship to ourselves. Only such actions will send a message to companies and governments about the world in which we want to live. As voices raise, they will coalesce into communities of action, and hopefully perhaps diminish our lack of trust in each other, and in effective democracy.

 



[1] For full disclosure, I was running the Europe, Middle East and Africa regions of Standard & Poor's Ratings business from my sitting room, as I had broken my leg a month earlier and had to work from home for six weeks.

[2] TheTruth and Reconciliation Commission(TRC) was a court-like restorative justice body assembled in South Africa after the abolition of apartheid in 1994.


 

 

About this author

Barbara Ridpath is the Director of St Paul's Institute.


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The opinions expressed in this article are those of the author, and do not necessarily represent the views of St Paul's Institute or St Paul's Cathedral.