Wall Street worries

The only thing one can predict about the financial crisis presently engulfing Wall Street and spreading outwards is that it will make us all rich in retrospective wisdom. Indeed, I forecast that the wisdom of hindsight will be in inverse proportion to the decline in the Dow Jones index.

For the moment, few have dared question that the sky is falling.

One is a journalist who urged, on a website called TPM, US journalists to be more skeptical about the $700-billion Paulson bail-out plan for troubled Wall Street financial institutions.

David Cay Johnston, a Pulitzer Prize winner, writes: “Journalists should be insisting that officials make the case that there is a crisis … not just accept that there is one because they say so. And then reporters should ask hard questions about who benefits from the bailout; whether there are alternative solutions that would be less costly or more effective.”

The reason the financial crisis is so worrying is the potential effect through the contraction of credit on the economy outside of the financial markets.

Johnston urges journalists to be careful about assumptions on this score too.

“The news is full of anecdotal evidence of companies and individuals having trouble getting credit. But there is no sign that this is other than cherry picking specifics because in the ordinary course of business lots of people get turned down or have their credit lines frozen.”

Much of the coverage of the crisis revolves around the failure of regulation to defend the market against the wave of financial services company failures. I cannot understand this fretting.

It is as if policymakers and bankers should have been so prescient, so in control, that they were able to ward off this meltdown, and that they haven’t is some kind of moral failing.

It’s a blame game. While the bankers and brokers were making money for themselves and others, few questioned their wisdom. While Greenspan was presiding over an era of champagne and cigars all round, we even almost forgot he was once a disciple of Ayn Rand. Now he’s a villain.

So with relief I read, in the Financial Times of September 29, some of the few appropriately sober words of warning about regulations and crashes.

Duncan Black, a partner in a financial services firm observes that market cycles and shocks are inevitable, and that regulation cannot change this, though it may mitigate the worst effect of market forces.

“The fact is that bubbles form, and burst, and this is how a free market system works. They are a necessary escape valve. Structures change from time to time but oscillation will always happen. The reality is that free markets create great opportunities to make money and therefore also to lose money. You cannot have one without the other. Volatility is inherent and necessary.”

Black notes that financial regulation has other objectives than protecting against crashes, notably protecting consumers, and this is largely being achieved.

I must stress that we have not seen the last act of this play. It could also be that the panic is justified. Share values could fall even lower and take decades to recover, as they did after the 1929 crash. It’s not impossible.

I just don’t know. I do know that worrying about that eventuality will not help. Since this is not 1929, what may have worked then won’t necessarily work now.