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“It Takes A Village To Maintain A Dangerous Financial System”

September 28th, 2016 | by Richard Paul
“It Takes A Village To Maintain A Dangerous Financial System”
Business and Finance
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Reassurances that regulators are doing their best to protect the public are false, warns Stanford’s Anat Admati in her latest report on the collusive dissonance within financial markets. She discuss the motivations and actions (or inaction) of individuals in the
financial system, governments, central banks, academia and the media that collectively contribute to the persistence of a dangerous and distorted financial system and inadequate, poorly designed regulations.  The underlying problem is a powerful mix of distorted incentives, ignorance, confusion, and lack of accountability. Willful blindness seems to play a role in flawed claims by the system’s enablers that obscure reality and muddle the policy debate.

Excerpts…

In banking, the public interest in safety conflicts with the incentives of people within the industry. Protecting the public requires effective regulations because market forces fail to do so. Without effective regulations, dangerous conduct is enabled and perversely rewarded. Because the harm is difficult to connect to specific policy failures and individuals, it persists. Even if a crisis occurs, the enablers of the system can promote narratives that divert attention from their own responsibility and from the fact that much more can be done at little if any social cost to make the system safer and healthier. The narrative that crises are largely unpreventable shifts attention to emergency preparedness and away from better rules to reduce the frequency of emergencies in the first place.

Many aspects of the financial system in developed economies are unjust because they allow powerful, better informed people to benefit at the expense of people who are less informed and less powerful. The injustice can be described from a number of perspectives. First, the system contributes to distortions in the distribution of income and wealth, as some of those who benefit from it are among the most privileged members of society, while those who are harmed include the poorest. Second, by allowing the privatization of profits and the socialization of losses, the financial system distorts basic notions of responsibility and liability. Financial crises affect employment and the economic well-being of many segments of society, but those who benefit most from this system and who enable it tend to suffer the least harm. The persistence of this unjust system illustrates how democracies sometimes fail to serve the interest of the majority of their citizens.

It takes many collaborating individuals, each responding to their own incentives and roles, to enable a dangerous financial system. Who are the enablers and what are their motivations? Enablers work within many organizations, including auditors and rating agencies, lobbying and consulting firms, regulatory and government bodies, central banks, academia and the media.

The enablers have reasons to defend the system and the regulations and to avoid challenging the financial industry and each other. Their actions, or failures to act, endanger and harm the public even as some of them are charged with protecting the public and most claim and are believed to act in the public interest. Some enablers are confused or misinformed, but the confusion is often willful.

The media can play an important role in informing and educating the public and improving accountability.

If the news media gives more access and coverage to the industry and its enablers, and if it echoes rather than challenges flawed claims and fails to clarify issues in investigative reporting or commentary, it helps maintain or exacerbate confusion and diffuse accountability. Sometimes reporters or commentators accept claims made by people considered experts because examining the claims’ validity requires expertise that reporters lack.

Utterances by “important” individuals are reported as news, and these individuals are interviewed and quoted frequently with little if any scrutiny. Power and status also enables easier access to opinion pages where desired narratives can be promoted.

The distorted incentives and power of those who control the financial system do not fully explain the failure of financial regulations. Confusion and misunderstandings interact with distorted incentives and play an important role.

The financial system is dangerous and ineffectively regulated largely because the industry and the many enablers get away with their “spin” on reality and on specific issues. 

Powerful people are not immune to confusion and to putting trust in people who may be conflicted or misinformed. Anecdotal evidence and discussions with many insiders suggest that “blind spots” about key issues related to banking and finance are pervasive. People are reluctant to question the assumptions behind convenient narratives and to engage with alternative and less convenient ones. They often display “motivated reasoning” (Kahan 2016) and variations of Upton Sinclair’s famous quip: “it is difficult to get a man to understand something when his salary depends upon his not understanding it!”

 

Many false and misleading claims about the health and safety of the financial system, the effectiveness of regulations and the costs and benefits of different approaches are made by people within the financial system and its enablers. These flawed claim obfuscate reality and create the confusion that allows a bad system to persist.

Tenured academics, who have the most expertise, job security and academic freedom to express themselves and to engage in policy without being conflicted, are in a unique position to bring about positive change. Yet, some academics are important enablers of the badly regulated and dangerous financial system. By such behavior as making false statements in textbooks, creating models and narratives with assumptions that distort reality in critical ways, misusing or tolerating the misuse of research to propose or support bad policy, or making vague and misleading claims whose flaws, often subtle, can be difficult to detect, these economists exacerbate confusion, muddle the debate, and harm instead of promote the public interest. Someone with sufficient background to understand the academic literature, who has been employed by major financial institutions, quipped recently when discussing some statements by academic economists: “with such friends, who needs lobbyists?”

 

Entrenched and powerful systems resist change, but a just society must not tolerate a situation in which critically important systems like the financial system are run against the interests of the vast majority. More people must become aware of the problem and understand what is wrong. Then they must demand that policymakers do better. Change is possible, but it will take a village to repair a financial system.

Tyler Durden

Full report here

 

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