If this years crisis has shown us anything, it is that the current model of the global financial system is broken. There are so many aspects of it that dont work that its hard to know where to begin fixing it, but one of the most importantperhaps the core of the problemis the fallacy of self-regulation. In decades to come, when historians are chronicling the great financial upheaval of 2008, readers will gasp and wonder, What were they thinking? Time and time again, traders, bankers and corporate executives, left to their own devices, have shown that they cannot be trusted to regulate their own behavior. Provoked by the usual demons of fear or greed, they make disastrous decisions, leaving chaos in their wake.
Some have complained that increased regulationparticularly global oversightwill inflate costs and dent the financial sectors profitability. That is probably true, but how profitable has the financial sector really been? Sure, the industry was on a tear over the past decade, but factor in the eye-popping write-downs and the desperate losses of the past year or so, and you have a very different story. With a sensible system of global regulation, you might not get the sorts of highs that weve seen recently, but you also probably wont see the sorts of lows that have become all too common this year.
A knee-jerk overtightening of the rules is not the answer. Supporters of free markets are understandably disturbed about the restrictions slapped on short selling by the US and the UK authorities, for example. Blanket bans are certainly not a workable, long-term solution, but free, unregulated markets will work only if everyone within those markets can be trusted to be honest and open and to not cheat the other market participants. Its a lovely ideaquaint, evenbut it is ideal only in the way that anarchy is an ideal political system. Sure, if you can trust everyone to act responsibly and fairly, then you can do away with government. Unfortunately, you cant.
What is needed now is a measured approach to the creation of a global regulatory system that oversees the increasingly global marketplace. Building such a system is a huge task, but a glance at the mess created by the current ad hoc system should be enough to convince the skeptics that change is desperately overdue. Within the carnage of recent months lies an opportunity of historic proportions. It is up to those with their hands on the levers of power to grasp this opportunity and create a financial system that is truly globaland truly fair.
Until next month,