Corrupting risk on top of the surplus pyramid

States and risk

If prudential regulation is an appropriate response to both the inherent features of financial markets and the provision of state-guarantees for deposits, then we are, yet again, confronting the paradox of rulership--that we need rulership to protect us from social predators but rulership is the most potentially dangerous form of social predator. For no institution separates decision-making and risk as thoroughly as rulership. Hence voting is a way of connecting risks facing citizenry to risks facing rulers. Alas, it is far from a perfect way of doing so. To paraphrase Winston Churchill, it is the worst way of doing so; except for all the others that have been tried from time to time.

Examining the means by which financial markets have been corrupted, the operation of state power is laced through it. Whether it is the IMF loading stolen loans onto ordinary taxpayers, kleptocratic rulers, provision of implicit or explicit government guarantees, or the bailing out of failed financial institutions, states and their agencies have been major players in the destruction of prudence and so in the corrupting of finance.

The obvious political advantage for sitting on top of the surplus pyramid is in having plenty of surplus to throw around, including into political donations. It is not high finance's only political advantage, however. The apparent complexity (and so obscurity) of what they do helps shield them from accountability while finance's very crisis-generating capacity gives them the weapon of fear.

Which creates a perverse incentive structure--the more the finance industry can shield its decision-makers from downside risks, the greater the private return to risk-management but also the greater the social costs and so the more they are able to wield the weapon of fear to shield its decision-makers from downside risks.

While the evidence that political spending significantly influences results of election campaigns (or votes in legislatures) is limited, donations do buy political access. Which is clearly enough.

The first stage in dealing with a problem is acknowledging it. Markets--the operation of a profit and loss system--and voting--the imposing of "throw the rascals out" responsibility on rulers--are our barnacle-removing systems. Unless and until their interacting dysfunction is untangled, any apparent improvement will only be temporary. An industry whose central role is risk-management has become one where the management of risk is profoundly corrupted. Unless that is understood, and the implications grasped, we are set to continue to have a spiral of rising instability and ever-greater financial crises.