Book review: Contradictions confronting financial globalisation

  • Gaurav Choudhury, Hindustan Times
  • Updated: Jul 31, 2016 10:06 IST
An employee leaving the headquarters of Lehman Brothers, shortly after the American investment bank went bankrupt on September 15, 2008. (Paris Match via Getty Images)

Thomas Piketty’s Chronicles: On Our Troubled Times is essential reading on why it is important for regulation to stay ahead of markets

On September 15, 2008, the stunning collapse of Wall Street icon Lehman Brothers triggered a credit crisis that pushed the world economy into a tailspin. There were warning signs as far back as 2004 but the Lehman Brothers debacle still caught administrators napping.

The housing loan crisis was brought about by a competitive banking system as they resorted to sub-prime lending. Sub-prime refers to a loan given to a borrower who does not qualify for a regular home loan, because of a poor credit record, low income and no job security. Banks in the US gave out many such loans in their zeal to keep ahead of their peers. Banks extended housing loans to many customers, who did not actually possess the requisite repayment ability. The resultant payments default triggered a massive fall in banks’ and real estate incomes.

Lehman Brothers and Merrill Lynch, two of the world’s largest financial institutions, booked big losses on account of their exposure in some highly risky assets. Lehman Brothers was counting on the real estate boom and had overexposed its investments in the sector. As property prices went bust so did the optimism of Lehman’s prospect on those investments. Lehman Brothers posted a loss of $3.9 billion (Rs.17,500 crore) in the quarter ending June 2008. This created panic among investors and the company’s stock price descended into rubble, leading it to file for bankruptcy. Merrill Lynch posted a second quarter loss of $4.65 billion. While Lehman could not find a saviour, on September 15, 2008, Bank of America came to the rescue of Merrill Lynch.

Thomas Piketty’s Chronicles is essential reading on why it is important for regulation to stay ahead of markets, as exemplified by the 2008 crisis that still has wounds festering across the world economy.

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The sub-prime crisis perhaps illustrated the ugliest side of neo-liberalism, when state policy was closely aligned to suit capitalist interest with limited independent and sovereign oversight. Hefty bonuses to financial sector executives encourage unregulated risk-taking, which can lead to systemic collapses.

“We have to put an end to the obscene compensation packages of the financial sector, which helped stimulate excessive risk taking. This will require more heavily progressive taxes on high incomes,” Piketty says in an October 28, 2008 article entitled “A Trillion Dollars”

The period after the collapse of the Lehman Brothers, saw governments across the world swiftly swinging into action with never-seen-before kind of interventions primarily aimed at restoring stability in the markets. These included the US government’s Troubled Asset Relief Program (TARP), a $700 billion bailout for a string of financial companies and banks. Two weeks after the US Congress passed TARP, the European Union announced its own framework for stabilising the continent’s beleaguered banks.

French economist Thomas Piketty on the sidelines of the 69th Cannes Film Festival on May 13, 2016. (AFP Photo)

Piketty, Professor of Economics at the Paris School of Economics, raises a few pointed posers on such state-sponsored bailouts. “It is legitimate to intervene to avert a systemic crisis, but only on several conditions. First, there must be guarantees that the shareholders and the managers of banks bailed out by taxpayers will pay a price for their mistakes… Second, aggressive financial regulation must be put in place.”

The subprime crisis is a result of individual incentives and a lack of accountability. As risk spreads globally, its ripple effect might surface in the unlikeliest of places.

The credit history of borrowers is essential. There has to be greater check on the background of borrowers and their repayment ability. Rating agencies are typically paid by issuers and only for the initial rating. Therefore, true assessment should be carried out through a robust and appropriate re-rating system.

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His previous book “Capital in the Twenty-First Century” questioned wealth concentration among the few. Chronicles, an omnibus of Piketty’s essays that originally appeared in the pages of the French newspapers Liberation and Le Monde, from 2008 to 2015, is as much a critique of neoliberalism as it is a reminder for building institutions that are fiercely independent.

The tricky bit is in regulation for it is very difficult to say what will go wrong until something goes wrong. Contemporary history is replete with examples of how the economy can catch everybody by surprise. It is necessary to set terms and conditions, but risks often hide in the bells and whistles. Stringency can deter corporations from bringing in capital. On the other hand, lax rules on capital can ravage the economy. Taking a blanket position either way can lead to unforeseen consequences as nothing can guarantee that the system will not run into a pitfall.

Cyprus, the smallest of the Euro zone economies, is a case in point. Cypriot banks had given out loans to Greek borrowers that had accounted for nearly 160% of Cyprus’s GDP. When the Greek economy ran into a crisis in 2010, the Cypriot banks were among the hardest hit. A slowing economy also meant that the government did not have the adequate finances to bail out its banks. Russia also has a close financial relationship with Cyprus. It is believed that the collapse of the Soviet Union led Russian oligarchs, who were scouting for a place to park their surplus cash, to Cyprus. As Piketty says: “The Cyprus crisis illustrates some of the thorniest contradictions confronting financial globalisation.”

The biggest hitch, however, is creating a global financial regulatory architecture compatible with domestic politics. Piketty’s observation is striking. “Politics is not an exact science and the border between honourable and dishonourable compromise is always difficult to pinpoint.”

In the final analysis, profits, politics, regulation and equity should cease to be mutually exclusive objectives.

Piketty’s Chronicles makes a strong case of it.

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