I came across this article by Percy Mistry (thanks to Ajay Shah for the pointer). The article states how financial crisis is part and parcel of economic cycle and how each time modern finance is always blamed for the crisis. The article further goes on to criticise RBI and its policies (I have my comments here)
Mr. Mistry laments that with all these developments modern finance is suffering. Though I have still not figured out what do these experts mean by Modern Finance? Derivatives market? Or these days we often hear the term – BCD nexus – Bond, currency, derivative? What is it?
On the contrary, I would say it is antiquated finance as we know derivatives have been there for ages and we still keep saying the same problems as we have seen before. Like the author says, there has hardly been any learning from the previous crisis.
We need to argue both ways. Like it is not the fault of finance if crisis keeps revisiting similarly, the developments in financial system are such that it keeps leading to a crisis. So, obviously regulators would be worried as all the hard work of number of years can be wiped away in few seconds. For instance the Great Moderation is being questioned
The article says:
No one complains when they are making easy money in stock or property markets quickly (because they are brilliant) but wail, ululate, and demand revenge and redress when they lose it (because it is someone else’s fault). It goes unnoticed that a financial system is in distress when asset prices are rising too rapidly; and is actually emitting sound corrective signals when such prices correct downwards sharply. But aam aadmi never sees it that way. In fact he sees it in exactly the opposite way: i.e. that the financial market is great and healthy when his portfolio is increasing in value at 10% a month, but that all financial operators are thieves and crooks, and regulators are corrupt and stupid, when that momentum reverses.
Well, why shouldn’t the investor cry hoarse? It is his fault as he didn’t do his homework well , but he was also sold the financial product on the presumption that all will be well. And worst of all he realises he has lost his yacht but the person who sold the yacht still manages to maintain it or perhaps has bought a few more. Moreover, the nature of the financial system is such that we can’t distinguish a conman from a good man. So, he will cry hoarse.
He compares ills in finance to other items :
A kitchen knife can be used to murder someone. It is more usually used to cut onions, vegetables, bread and meat. Murders often involve kitchen knives. Does that mean knives are inherently dangerous and should be banned? Or should their possession be restricted only to certain types of consenting adults with Ph.Ds and an intensive 4-year training course in knife-use? The same is true of cars, planes, trains, ships and buses. Accidents happen. They are part of the game of life. Should we ban all transport and traffic to avoid any accident happening at any time? Should we stop issuing driving licenses altogether? Should we introduce bicycle-riding tests that take a day or car driving tests that take a week? And yet this is what command-control freak regulators, and supposedly wise commentators, seem to be suggesting when it comes to correcting all that ails finance. It is at times like these that common sense, especially on the part of supposedly intelligent people, escapes and becomes unusually uncommon.
Imprudent knife usage doesn’t lead to the kind of harm that imprudent application of finance does. Accidents happen and cause injuries to those involved in it. They don’t cause the injuries to others who have nothing to do with an accident. But in a financial accident we see that those involved in the accident escape and mostly the others suffer!
Another thing is Phds and those who have done a 4 year intensive course in finance do behave as if they know it all and throw all caution to the winds. Their behavior can lead to some limitation in risk as people invest on the basis of their advice. For instance, those who see business news know when sensex was at 20,000 plus levels most experts said- equity markets are not overpriced and would continue to rise, India is a long-term growth story etc etc. Now most have revised their estimates when markets have collapsed and growth figures don’t look as rosy.
In the end all I want to say is, it is true that finance (modern/antiquated) shouldn’t be blamed for all the ills in a crisis. But we can’t absolve finance as well as developments and incentives in financial markets lead you to take higher and higher risks. We need to be balanced and can’t take a one-sided view.
Further, the author says:
Such commentators seem sagacious. They write so well that they obscure flaws in what they say. But they can, on occasions like these, be eccentrically off-the-mark: i.e. by proverbially hitting their thumbs, rather than the intended nail on the head, with their verbal sledgehammers. And, because they have a wide audience, they run the risk of destabilising the situation even more, with ill-considered, ill-timed remarks, when everyone who was anyone, is too nervous, stressed and broke (their stock options are now worthless) to think straight, and lacking in confidence in their own judgements
I think the same applies to people who keep defending finance no matter the situation. Even they write well and are off the mark and have a wide audience. Hence, we don’t see anything new in finance