The financial community has lost all credibility

Here is my monthly column for May for the Economy supplement of the daily Le Monde. It was translated, courtesy of Bénédicte.

For every attempt at a financial overhaul, a similar method has been used: consultation of the financial community by the authorities, followed by negotiations towards a compromise between the demands of both parties.

The essential condition for such a method to succeed is that the financial industry would relate with the common good and recognize and promote the need to ensure a framework that maintains the sustainability of financial institutions without affecting the overall health of the economy.

Is there any evidence supporting the hypothesis that every financial institution will stand up for the common good at the expense of its own particular interest?

Alas, no: quite the contrary. What’s happened throughout the crisis of 2007 and 2008 has proven it instead as an unfounded belief.

The U.S. Senate report, released April 13, confirms what the auditions of executives at Goldman Sachs in April 2010 had already highlighted. Namely that the firm – and several others, including, foremost, Deutsche Bank – has not only betrayed the trust of some of its best clients by selling them financial products (collateralized debt obligations – CDOs) that were structured in such way as to be of the worst possible quality, but that it also developed new derivative products (“synthetic” CDOs) to wager on the downfall of the entire U.S. mortgage industry. It has doomed those who were naive enough to position themselves on the other side of the bet, but also it has hastened the fall of the global financial system as a whole!

We read in the Senate report that the head of the mortgage division at Goldman Sachs promised “ginormous” bonuses to anyone who would manage to sell these products. In the meantime, one of the bank’s executives in Australia said in an email, referring to a sucker who was ready to buy these toxic products: ” I think I found white elephant, flying pig, and unicorn all at once.”

The financial establishments in question are pursuing their business unhindered. None of their officers has been charged. Better yet, they can be found sitting at the negotiating table, objecting to propositions uttered by regulators representing the community as a whole.

The method needs to be changed. Regulators need to write rules that allow to dramatically lower systemic risk.

While hedging positions neutralize an existing risk in an insurance-perspective, speculative positions, because they are wagers, create a risk that didn’t exist beforehand.

The speculator puts forward his contribution to liquidity in order to justify his presence on the future markets. This argument should be ignored: a liquidity supply is pointless when offered at speculative levels of pricing and, and even more so, it doesn’t compensate for the increase in systemic risk that it causes.

Once the appropriate measures have been defined, they should be implemented without any further negotiations with the financial industry: the inability of its leading representatives to relate with the common good has been amply proved during the most recent three years.

One thought on “The financial community has lost all credibility

  1. Dear Mr. Jorion,

    I read the article about you in my paper (NRC) with the greatest interest, I am (already for about half a century)an –international- businessman and since abt. 1994, I am highly interested in everything that relates to globalization and it.s social consequences, as a sideline one of course also gets involved in the financial world.

    Therefore in relation to this article one question:

    I am very intreaged with the developments concerning the “less well performing” Euro countries and the consequences for the Euro as a whole

    In 1946, I think, with today’s standards all our countries would have been bankrupt, but I do not think that then there were companies like Standard and Poor, Moody’s etc, judgeing the credit worthiness of countries.

    I have my thoughts about companies like these

    For instance, there is the investigation in the US now, concerning bad practices of Standard and Poor within the mortgage market.

    As far as I know S&P used to be part of Goldmann Sachs and might still work in their interest.

    My question: is it possible that because of short positions (futures) in Euro’s they are trying to push the value of the Euro downwards?

    Best regards,

    Jens Bos

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