Ali’s blog

Mostly quant stuff with occasional digressions

George Soros in the FT

Posted by alifinmath on April 3, 2008

In the FT:

False ideology at the heart of the financial crisis

The proposal from Hank Paulson, US Treasury secretary, for reorganising government regulation of financial institutions misses the point. We need new thinking, not a reshuffling of regulatory agencies. The Federal Reserve has long had authority to issue rules for the mortgage industry but failed to exercise it. For the past 25 years or so the financial authorities and institutions they regulate have been guided by market fundamentalism: the belief that markets tend towards equilibrium and that deviations from it occur in a random manner. All the innovations – risk management, trading techniques, the alphabet soup of derivatives and synthetic financial instruments – were based on that belief. The innovations remained unregulated because authorities believe markets are self-correcting.

Regulators ought to have known better because it was their intervention that prevented the financial system from unravelling on several occasions. Their success has reinforced the misconception that markets are self-correcting. That in turn allowed a bubble of excessive credit to develop, which extended through the entire financial system. When the subprime mortgage crisis erupted it revealed all the weak points. Authorities, caught unawares, responded to each new disruption only after it occurred. They lacked the ability to foresee them because they were in the thrall of the market fundamentalist fallacy. They need a new paradigm.

I agree with Soros here but there’s more to it than the state just intervening in markets. On behalf of whom does the state intervene? On behalf of capital or on behalf of everyone else? If the latter, we need a competing ideology. If the former, we have to drop the sham that the state is anything but an instrument of capital.

The ideology of neoliberalism has been based on the wisdom of the markets, on the notion of self-correcting markets. If this basis is considered no longer valid, the ideology cannot remain in place either. In other words, intervention has to be whole hog or not at all. In yet other words, intervention requires an ideology of its own. It’s because of this lack of ideology, or equivalently, the reluctance to jettison neoliberal dogma, that has made the authorities so diffident, so half-hearted, so perplexed in their fire-fighting exercises.

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