The Debt Crisis and Plans for Financial Reform :

What are the Unanswered Key Questions ?

Some views from a private sector background

What has been done ? Many measures have been taken at G 20 and FSB level, and, mostly in that framework, by the Basel Committee and Iosco. The main areas involved were prudential : a major solvency ratio, two liquidity ratios (partly under development), a leverage ratio, and measures on global systemic institutions (G-SIFIs). And secondly, on markets : mandatory clearing, rules on compensation ; plus various issues such as credit rating agencies etc.

Other significant measures have been taken (or are being taken) at national/ European level, the most significant one bearing on resolution procedures (including bail-in), but also resolution and contingency planning ; in some cases on the structure of banks (Vickers and Volcker). Some jurisdictions have also taken measures on market structures (mainly in the US, in favour of trading on platforms).

Assessment

1. The measures

It seems there were not many wrong decisions : most of what has been done goes in the right direction. But even when considered in themselves some significant limits appear. First, there has not been any real global impact assessment of the combined impact of the decisions, and of their consequences for the economy. This is particularly the case in Europe where that impact will be probably more significant than in the US (because of the much more significant role of bank lending). In addition there are very significant problems of coordination of implementation : differences between jurisdictions, extra-territorial impacts of some of them. There are also cases of clear failures (such as the harmonisation of accounting rules). In addition, a lot of work has still to be done technically (beyond remedying the above-mentioned deficiencies) : assess the impact, especially of prudential ratios, devise and implement corrective measures if deleveraging threatens the economy and even society (as in Europe), check the actual capacity of ratios to measure the real risk etc.. Finally the jury is still out on shadow banking, which is a major issue. But work is in process here.

2. The philosophy

This is perhaps an even more important area of concern, which is the insufficient effort to think in depth the issues at stake and the magnitude of the problem. The work done has been dominated by prudential issues and by systemic issues (with the limits mentioned).

It means that very little thought has been given for example to the question of markets themselves. What do we expect from them ? What is a good market ? How to reduce their opacity and/or collectively erratic moves ? It is in particular the case for emblematic market structures like stock markets, and even more for specific wild markets like CDSs or commodities.

Similarly, little attention has been given to the role of banking ; or more precisely it has been limited to the question of the structure of banks (commercial vs. investment banking). This is in spite of the evidence of the importance of lending rules (especially for real estate), as the crisis has shown.

And more broadly little attention has been paid to the basic issue : how best finance the economy ? In particular the reality of global excessive leveraging has not been examined as such ; some measures will contribute to reduce it (solvency ratios for example), but other decisions do go in the other direction (quantitative easing for example) ; and anyway the reflexion on the excessive role of debt compared with own funds (stocks) in our economies is still very limited.

A third area where reflexion has been limited is what Caritas in veritate has emphasised : the question of global authority, or more technically, of the lack of a global framework for monitoring finance with an actual decision making power . Technically it begins to exist partially (especially with the Basel Committee, Iosco etc.) But it is not quite representative, and does not have any binding power. Which means this is mainly a political issue, and a difficult one at that.

The broader picture from a Christian point of view

From a Christian point of view, the task is huge, involving two major features : first, the development of Christian thinking itself, second, the question of sending messages to society and governments at the appropriate level. I do not think that the appropriate level is the technical level (such as : transaction tax or the structure of banks) but a deeper and more fundamental level ; which makes the elaboration of a Christian thinking even more urgent . I would put a particular emphasis on the following.

We should go much deeper into the philosophy of markets.

We should not consider a market as something given, which has just to be monitored. Caritas in veritate has been much more aware of what is at stake : a market is a meeting of human persons, and its result will depend not only from the rules that govern that meeting of will ; but even more from the values of the participants, their actual priorities.

As regards the rule governing the meeting of orders on a market, we must have a clear idea of the rationale of that meeting of intentions. The objective is to organise the best confrontation of the opinions of investors that is achievable, if we understand by opinion what they perceive as the right price for the product dealt with, and not the guess of smart players about possible collective frenzies. This is something that needs to be organised.

My perception of an ideal market is a place where first the information is clearly available to all, and where all are put on the same footing as regards their participation to the transactions. This means that markets should be as open and organised as possible. The scope of this remark includes commodities markets, now closer to jungles than to collective tools of price discovery. Second, an ethical vision of the behaviour of a participant should be elaborated : they participate in the elaboration of the price, but they are not here to take advantage of irrational moves of the market (bubbles). Third, financial institutions, their dealers and their managers should be responsible for their acts, including on their personal wealth, well after each transaction is concluded. This has moral as well as legal consequences.

A particular Christian contribution should be done on ethical investment (SRI).

As Caritas in veritate expressed with great lucidity, the priorities of the participants to a market are one of the main factors determining the end result of that market and therefore the whole impact of finance on society. We therefore need reflexion and action on the behaviour of investors and their priorities.

This means first reflecting on Christian SRI versus plain SRI. Caritas in veritate again has been clear on the ambiguity of the word ‘ethical’, especially in our contemporary environment. There should be schools of thought elaborating Christian views and practices on SRI.

Additionally, in the end ethical investment should become not a kind of luxury, but the normal behaviour of investors. This starts with very simple gestures. For example if the manager of a pension fund is benchmarked by stock market indices, he will manage the funds on a very short term basis. It means that other benchmarks must be devised and used to remedy this. The decision on benchmarks is in the end taken by the pensioners themselves (or of clients more broadly). This means that the role of clients and their priorities is central in the financial system.

This brings us to the more global issue of the alternative use of money : the necessary Christian reflexion on how best use our financial capacity, each of us, towards the common good. Including of course what can be done on international imbalances, reducing poverty etc. since the issue is not merely a government issue. But this will not have consequences if it is not linked with actual behaviour ; which means analysing the decisions that each of us has to take.

We should reflect on the respective role of debt and equity.

Traditionally in the past the Church was reluctant towards interest lending (then called usury). That doctrine was not technically justified ; but philosophically there was a profound and valid intuition : debt should be a subordinated and limited form of financing. Not only because of its risks (its binding power on the debtor, the domino effect it creates in case of crises etc., as is evident in the present one). But also because it does not create and in fact is not based on a real association with a real solidarity between the person providing the funds and the borrower, as equity financing is (or more precisely, could and should be). If well understood and managed, equity is the moral from of financing. Christians should be all in for equity or more precisely ethical equity investment - which again has consequences on the structure of firms, in particular on their governance. Equity investors have a special responsibility towards the community that a company actually is.

What about government borrowing then ? Generally it finances short term spending (in general mere consumption) on a promise of repayment by future taxpayers. My view is that it is therefore fundamentally immoral, except of course self-financing projects, or emergency cases, or short term measures.