"Power tends to corrupt, and absolute power corrupts absolutely." Lord Acton

Returning to the Real Economy

In the April 24 edition of the Vatican newspaper L’Osservatore Romano, Ettore Gotti Tedeschi focuses on the origins and lessons of the global financial crisis. In a previous article, Gotti Tedeschi argued that the downturn is an opportunity for Italy to reform its economy and cut down on unnecessary public spending.

He now examines what the crisis means for the state of international finance and draws some unusual but noteworthy conclusions. In his view, the principal answer for improving global financial architecture cannot be provided by more government regulation.

Instead, Gotti Tedeschi interprets the crisis as a wake-up call to return to “other rules – older rules which restore the priorities of the banking profession.” These rules of sound economics have been partly eroded by an excessive lowering of interest rates by central banks, inducing other actors to take excessive risks in their financial operations.

The over-stimulation of markets led bankers and business leaders to abandon the path of solid long-term growth in favor of short-term gain: “Too often managers with a poor sense of responsibility have created the illusion of realizing miraculous growth and profitability.” They abandoned the search for “concrete results and above all, long-term sustainability.” His advice is to return “to what is real, responsible and durable.”

He suggests that what is needed is a spiritual refreshment to deepen the understanding of how a successful bank or business is run. This would enable people to resist temporary financial fashions and evaluate real risks and possible gains adequately.

Gotti Tedeschi is in a good position to combine the practical insights of the world of banking with a profound theoretical grasp of business ethics. While he is one of the most well-known bankers in Italy, he has also found the time to write books about the relationship between Christian values and economics.

His advice deserves to be taken seriously. As politicians around the world propose a whole range of new regulation in response to the credit crunch, it must not be forgotten that public authorities provided the markets with cheap money and excessive stimuli. The result was a widely distorted perception of risk and profitability. It would be unfortunate if a period of over-stimulation was followed by a period of over-regulation.

‘Casino Capitalism’ or Personal Failure?

Two weeks ago, French bank Société Générale announced that off-balance sheet speculation by a single “rogue trader” had cost the company 4.9 billion Euros ($7.2 billion). The scandal had enormous repercussions in international markets leading some commentators to decry the rotten nature of global “casino” capitalism and to call for the reversal of financial liberalization. However, the actual circumstances of the case do not justify more government intervention in financial markets but illustrate individual moral failings and poor internal governance on behalf of the bank.

A new report also suggests that a lack of internal controls and weak enforcement of existing rules may be the real source of the problem at one of the oldest banks in France.

On January 24th, Société Générale said that it had discovered a “massive fraud” through “a scheme of elaborate fictitious transactions.” The event caused a great stir not only for the magnitude of the bank’s losses but also because it is partly blamed for the worst European stock market collapse since September 11, 2001.

Jerome Kerviel, who worked as a junior trader in the arbitrage department at Société Générale, was responsible for betting on markets’ future performances. The bank claims that he had made unauthorized and concealed bets of around 50 billion Euros on European markets. According to the New York Times, Mr. Kerviel told prosecutors that his bets would have resulted in a profit of 1.4 billion Euros for the bank if they had been cashed out by the end of December. However, at the start of this year, stock markets experienced a sharp downturn turning the projected profits into losses.

The French bank discovered the bets in mid-January when auditors in the risk management office noticed a series of fictitious trades on its books. Société Générale then conducted a dramatic market sell-off operation in order to neutralize Kerviel’s deals. Traders estimate that the bank unwound contracts in the range of 20 billion to 70 billion Euros from January 21st to 22nd.

Many suspect that selling all these positions into an already volatile European market contributed to the shocking stock market performance in Europe around that time. This in turn, provoked an unexpected and controversial interest rate cut by the Federal Reserve of 0.75 per cent in order to protect the New York Stock Exchange which had been closed on the day when European markets dived. The curious series of events was summed up by a hedge fund manager who told Reuters that: “The real story here is basically, this guy, paid 100,000 Euros a year, sitting in some office at SocGen, forces the Fed to cut interest rates by 75 basis points, which is basically what happened”.

The huge and wide-ranging market repercussions have given ammunition to the critics of financial liberalization. An editorial of the French newspaper Libération sarcastically entitled “Casino” laments that no one controls the huge sums of money moving around in financial markets and demands tighter regulation of financial markets. It also claims that the scandal embarrasses President Sarkozy’s alleged embrace of laissez-faire capitalism. (more…)

Banking: Latin America’s Achilles Heel

Despite strong overall growth, a number of internal problems, including excessive regulation, continue to limit wealth creation throughout Latin America, reports Samuel Gregg. The regulations Dr. Gregg examines include those on starting a business and on banking.

Dr. Gregg explains that while it takes as few as 5 days to file the appropriate paper work to start a business in the United States, it takes an average of 152 days in Brazil. Dr. Gregg states that there are fewer loopholes to starting a business in Iran, than in most of Latin America.

Dr. Gregg also examines, in detail, some of the legacy economic laws that exist in much of Latin America, which regulate banking. These laws, intended to protect people from unjust interest rates, often hurt the people best in the position to increase the economic prosperity of Latin America - namely first-time entrepreneurs who are will to take risks to gain the capital needed into order to create wealth. Dr. Gregg argues that removing some of the regulations mandating interest-rate ceilings would benefit Latin American much more than it helps to protect it.

Read Dr. Gregg’s commentary here.