[OPE] Trichet on risk (again)

Jean Claude Trichet provides a clear official statement of what conclusions
the ECB draws from the financial crisis (Speech at the "Annual conference
2009" organised by the Asociación de Mercados Financieros Madrid, 23
November 2009). There are some remarkable turns of phrase in the speech, but
among other things he says:

"Long-term value creation was not a concern in the pre-crisis world.
Collectively, this has resulted in excessive risk taking."
http://www.ecb.int/press/key/date/2009/html/sp091123_1.en.html

But a Marxian economist would, with much more validity, invert Mr Trichet's
cause and consequence here: there was no concern with longterm
value-creation, precisely because longterm value-creation meant
comparatively more risk, as against less profit!

The novelty of the new "financial products" was not only that they created
new opportunities for speculating in asset trades, but also that they
enabled traders to insure themselves relatively cheaply against the risks of
speculation, providing the ability to make capital gains rapidly, at
relatively low risk. That was the main point of the new "financial
products". It is just that the new financial insurance techniques themselves
became profitable trading assets, in which a roaring trade was indeed done,
so long as the real economy grew steadily.

But nobody really knew what the limit of credit expansion was, and indeed
for many financial assets it became impossible to specify what they were
really worth, because what they were worth depended on future yields which
could at best be probabilistically extrapolated from past trends. It became
a problem. Perversely, the capital insurance schemes therefore made economic
expectations not more certain, but increased the level of market
uncertainty, since it became practically impossible to gauge the overall
effects of the gigantic global maze of financial dealings, and that, in
turn, reduced the incentive to invest long-term in expanding production even
more. People became obsessed with economic indicators, and even just a
slight downward revision of real GDP estimates nowadays has an instant
effect in Wall Street and other financial centres. Scientifically it's
ludicrous, but it's the perceptions that count here.

The best proof we had of this uncertainty thesis, was (1) the sudden
enormous collapse in investor confidence, a veritable financial panic,
which, in reality, was far in excess of the magnitude of the economic
problems, and (2) the inability of even the leading experts to predict or
divulge the outcome with any accuracy. The true reason for the exaggerated
panic was, that it had become impossible to estimate the global financial
repercussions of an observed downturn in key economic indicators for major
economies. In a situation of too many unknowns, investors and traders
withdrew funds very rapidly around the whole world, and then the whole thing
snowballed.

What is spectacular in Trichet's speech, is that he makes no mention at all
of providing financial incentives to aid new business start-ups, the
lifeblood of a growing capitalist economy, you would think. Mr Trichet does
admit that "the financial sector will have to return to its role of
providing the best possible service to the real economy" but there is no
mention at all of stimulating entrepreneurial activity. Who is going to
employ all the extra unemployed people, and how is this all going to happen,
if there are no financial incentives to do, so compared to the risks?
Admittedly, this is something that the financial sector cannot do on its
own, it is also a matter of state policy - often, the selfemployed and small
business people are punished by the tax system, while large corporations can
write off most of their corporate income tax. But the financial sector can
do much to aid businesses who want to "take the risk of employing people".
The reality is that the rewards and risks of wealth-creating activity have
become very badly misaligned, and if a society can no longer reward
constructive effort appropriately, its ethics are no longer healthy.

Mr Trichet's crisis story in fact comes close to the vulgar idea that
traders and investors started to gamble a bit too much with money, and that
the whole thing got out of hand - the gamblers took "excessive risks"
("casino capitalism"). But this is an ideological fiction, because, as I
argued before, the main point of the "financial products" was precisely to
insure against risk, to reduce risk. It was the capacity to reduce financial
risks ("risk spread") which fueled the speculative boom. People will gamble
with a few hundred dollars or even a few thousand dollars, but they don't
gamble so much with billions of dollars. If you have a billion dollars, you
can insure that asset, and you can insure the income from that asset. In
reality, financial dealers are not "gamblers" very much at all, because
their placements are based on a rational-scientific calculation of
comparative risks, against which they aim to insure themselves as best they
can. For a true gambler, however, there is no insurance against losses, you
win or you lose, and if you lose, you don't get your money back. "Casino
capitalism" doesn't really exist - a better term is "insurance capitalism"
in which the big investors have "a bob each way".

The final tragedy is that the "risk spread" now devolves the liabilities of
speculation on the taxpaying population, at the very time that rising
unemployment and very low economic growth reduce the available funds in
state coffers. We all know what sort of policy that leads to - "there is
nothing we can do, because we don't have the money". Yet, the money which
was disinvested doesn't simply all disappear, and assets which were devalued
can also be revalued. The challenge is getting people who have a lot of idle
capital, to invest it wisely for the good of the society which enabled them
to accumulate it. But about this - which was really Keynes's primary
concern - Mr Trichet sadly has nothing to say at all. Not even a hint of
anything like a "healthy entrepreneurial ethos", never mind "the euthanasia
of the rentier". It's depressing, and it doesn't set a good example.

It often seems like the haute bourgeoisie nowadays has lost its belief in
its ability to do very much at all to create a better world, beyond
"reducing carbon footprints" and suchlike. It's sort of like, "shit happens
while you are making other insurance plans". That however creates a
"political time-bomb", since people really incurring serious losses cannot
very well do nothing. To survive, they have to do something. And if people
have little or nothing to lose, what will they do? Historical experience
provides us with many illustrations in that respect. If we are to bet on
something, it's a fairly safe bet that in the end, class struggle will make
a comeback, since more and more people find they really do have to struggle,
it's not rhetoric anymore, and, since an individual has only so much clout,
the only way to get anywhere is to band together with others who are in the
same predicament. The trouble there is that, typically, the more struggle
there is, the more social and economic instability there is, and thus the
worse the investment outlook becomes. That "social impact" stuff isn't yet
factored into many longer-term economic forecasts.

Jurriaan

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Received on Wed Nov 25 18:19:33 2009