During this financial crisis much has been written about the apparent failure of capitalism and how it has to be replaced by something that does not deal so harshly with individuals, businesses or ideals.
No one seems quite sure what the replacement system may look like but one response to these premature pronouncements is to adopt a quote from Winston Churchill about democracy. He once said that democracy was the worst form of government except for all the others that have been tried. Similarly, markets may seem to be an imperfect way to allocate resources, but for the fact that it beats all the other systems.
Markets have their faults. They boom and bust, and are a haven for unsavory characters looking for ways to cheat people of their money. Markets need regulations and strong agencies who will deal with the cheaters before the media hails them as business leaders.
The real issue is whether the financial storm, which has now moderated but is far from over, has highlighted the need for any major changes in the financial system. We will discuss the international system in a moment but for Australia the answer is a qualified no. Like it or lump it Australia is set to emerge from the crisis with some credit. For our financial system generally fared better than most other advanced countries, albeit with some help by circumstances.
When the storm hit our securities market was booming but was well short of a classic bubble, where prices completely outstrip any underlying reality. Perhaps more importantly, the property market, which can be the root cause of a lot of greed and poor bank lending practices, was long off its peak, and is now even due to swing back.
As a result, although the resulting market fall out has exposed weaknesses, these failures have been tiny compared with those that were eventually exposed by the 1987 crash. Back then colourful entrepreneurs - the likes of Chris Skase and Alan Bond - could build up vast empires of debt controlled by corporate structures that resembled mazes, and issue prospectuses and annual reports that bore no resemblance to reality, and be lauded in the press.
My recollection of working in Perth as a journalist in 1987 was that the city had more sillyness per market dollar than any place on earth. There were four companies developing engines to replace the standard car engine; a cheque guarantee company that issued an endless stream of releases about how well it was up to the moment it folded unexpectedly; a company with a new way of making artificial gems (OK, I wrote about that one); and the deposit-taking merchant bank known as Rothwells where the principal, Laurie Connell, took a lot of the money for himself and lent the rest to associates who lost it. That is just a sample of the goings-on. Much of this activity was not so much criminal as bizarre, although the state premier, Brian Burke, was sent to jail briefly for rorting his travel expenses.
Although not matching WA in sillyness, the other states had their moments with the State Banks of Victoria and South Australia sinking under the weight of their financial misadventures, to eventually be taken over by Westpac and St George respectively. Present problems seem pale by comparison.
Corporate regulation and financial supervision has been considerably tightened since then. The rules which accountants must follow in framing financial reports for listed companies, for example, are much stricter and enforced much more closely than they were 20 years ago. Lawyers and accountants have to concern themselves with the substance of prospectuses, rather than just check that they contain the required declarations.
Company collapses can and still do happen, of course. No amount of regulation is going to stop crooked senior executives from doing the wrong thing, if they are desperate enough. However, as noted, the current crisis is tame compared to the good ‘ol days of the late 80s and early 90s, at least in Australia, and there is correspondingly far less need for additional regulation.
I am not sure that the recent government declaration that it would guarantee deposits for five years really changed much, incidentally, although many investors seem to think that it did. No Australian Government in its right mind could let an institution like Westpac or even St George fall over - not unless it had a death wish. Guarantee or no, any banks with real problems would be eased into corporate oblivion and its deposits taken over by others, as happened with the old state banks.
The situation is different elsewhere. The Americans obviously need to take another look at their system, and other European countries will have to unwind a lot of investment made in haste during the crisis, but that is their problem. The markets in those countries may change but they will still be markets.
Will there be changes in international banking structures or regulations that will change the way the Australian financial system operates? Perhaps. There is a loose international banking framework already in the place with most advanced countries adhering to the Basel II accord - a set of rules which deals with the amount of capital banks are required to keep on hand, and on the calculation of risk profiles. The accord is named after the Swiss city containing the headquarters for the Bank of International Settlements.
One lesson we can draw from this financial crisis, which was not evident in the late 80s, was that the markets of the advanced economies are now inextricably linked, and that something stronger than Basel II is needed. This is a matter for much further discussion but whatever happens, the result will be a further evolution of the world’s financial system, not a revolution. Capitalism with all its excesses and problems, will be with us for some time to come.