October 14, 2011

We were warned 25 years ago

Filed under: Economic Crisis — Tags: , — drderrick @ 10:21 am

The current crisis in financial markets should have come as a surprise to no one.

In April 1986, the Bank for International Settlements published a study titled “Recent Innovations in International Banking”. With remarkable prescience, it warned that:

“in a world financial system with many imperfections. there can be no guarantee that increased efficiency in financial intermediation at the individual firm level will necessarily improve economic welfare overall.   Many innovations have been designed to exploit existing imperfections in the financial system. Some of the ‘imperfections’ around which innovations are manoeuvring their way represent official measures, such as capital adequacy requirements imposed in the interest of safety and soundness of the financial structure, or measures to deal with liquidity problems or to promote market stability.  Others constitute regulations designed to meet the needs of domestic monetary and credit policy objectives; and still others are meant to serve investor protection needs.”

The report identified a “major source of concern to be  that “many new financial instruments appear to be underpriced, “that is, that gross income from the transactions is insufficient, on average, to compensate fully for their inherent risks.”

Also in 1986, the late Professor Susan Strange of the London School of Economics published a book titled “Casino Capitalism”. It begins:  “The Western financial system is rapidly coming to resemble nothing as much as a vast casino.”  She argued that those who should be in charge rarely know what is going on, while those operating in it are often doing so in the dark. “Yet none of us could escape the disastrous consequences were the precarious edifice to collapse.”

We were warned.


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