Virtually every financial crisis in the past 100 years has been followed by hearings,civil and criminal litigation,and ultimately new laws and regulations.The current crisis overshadows previous crises in four key ways:
1.complexity,
2.inflexibility,
3.speed,and
4.scale.
Complexity appears in exotic securities,the complex financial institutions,and the innumerable linkages among the firms and markets-making it difficult for decision makers to know what is going on.
Inflexibilty is reflected in the historically low reserves and high borrowing of firms and individuals in early 2007.
Speed appears in our ability to get news and transfer funds at the speed of light-this means that trouble can travel rapidly.
Scale is evident in the massive losses on subprime loans and others debt.
Leaders should address these four novelties as they design the new global financial system.
The antidotes to Complexity is Transparency.Complexity can hide the reality about financial conditions.This leads to greater uncertainty in the minds of investors and can cause irrational behaviour among players.Runs on solvent banks arise where depositors can not tell the difference between those banks which can meet their financial obligations and which can not.the first remedy to future crises is greater transparency in the form of stronger reporting requirements to the public.
The antidote to inflexibilty is insurance.Firms and individuals who want to borrow should be required to purchase "shock absorbers" with which to withstand a loss of income,natural disater or default.the most basic kind is a "rainy day account",a reserve fund of cash that a firm or individual could use in case of adversity.
The antidote to speed is a coordinated braking mechanism.Trading in markets can be suspended,as can cross-border capital flows.The theory is that suspension can provide a "cooling off" period in which news and information can disperse,allowing panicked players to assess the situation more fully.The brakes need to be applied infrequently and carefully.If players in the market can correctly anticipate a reaction by governments,the players will begin to game the system.The word coordinated,deserves special consideration by the leaders:it makes no sense by the new york market to suspend trading when many of the same securitiescan be traded in London and Tokyo-in this era of global financial markets,players can simply end-run the interventions of any one country by moving their trading to another venue.We will likely see greater coordinationamong countries in the future.
The antidotes to the massive scale of losses will be the creation of larger reserve institutions.The international monetary fund was created at Bretton Woods in 1944 to be the lender of last resort to countries experiencing financial crises.But the capital base of the IMF today is only $265 billion.this is insufficient to make a dent in the scope of America's financial crisis.Global leaders will have to create a more muscular multilateral institution.These antidotes,however are not panacea;they can only influence the occurance and severity of future crises;they can not prevent them.
Finally though the sense of urgency is laudable,to start tinkering in the depths of a crisis seems hasty.As the saying goes,the road to hell is paved with good intentions.
