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David Ignatius


LONDON — Bannered across the front page of the Daily Telegraph Thursday was the grim headline: "Slump is worst since the war." The story quoted Mervyn King, governor of the Bank of England, warning that Britain was in a "deep recession." The Telegraph described his comments as "the most pessimistic assessment of Britain's prospects in the modern era."

If it's any consolation for Americans, the financial crisis here is as severe as in the United States. Economists and traders describe a global economic pandemic, with the countries most open to free flows of trade and capital the ones that are hardest hit.

Here's a distillation of what I heard from economists and financial traders.

Start with a thought exercise: Imagine that a Chinese mandarin is sitting in the Forbidden City, taking stock of the global economy. Surveying the past several hundred years, the Chinese official would conclude that free-market capitalism has succeeded brilliantly in producing goods and services. But as a way of organizing the financial sector, it has been far less successful. For more than 200 years, it has produced recurring financial crises, bank runs and panics.

The theme of financial collapse is a staple of 19th-century British fiction. In the novel I brought on this trip, George Eliot's Daniel Deronda, the heroine Gwendolen Harleth receives a grim letter from her mother: "A dreadful calamity has befallen us all. You know nothing about business and will not understand it; but Grapnell & Co. have failed for a million and we are totally ruined."

This tendency of our financial system to go bust periodically has gotten more dangerous in the era of globalization. Clever minds have produced ever more exotic products that are barely understood even by the people who trade them. These products — synthetic securities divorced from their underlying assets — really are the financial equivalent of weapons of mass destruction, as investor Warren Buffett has argued.

And the more complex the financial system has become, the more vulnerable it has been to sudden shocks. The complexity has been part of the system's undoing — creating giant companies and electronic trading that even the smartest people are unable to control.

Take Citigroup, which has become a case study of bad management. Who were the idiots that allowed this monster to destroy Wall Street? Well, they included Robert Rubin, the former treasury secretary; Sandy Weill, who until a year ago was regarded as the savviest dealmaker in the financial world; Stanley Fischer, a top economist; and William Rhodes, who for decades has managed financial crises in the Third World.

I don't mean to excuse the Citigroup team; they made ruinous decisions. But the problem here is more than greedy or stupid individuals. It's the system itself.

Another popular bunch of villains are the regulators who allowed this mess to happen. But we've had thousands of bank examiners and accountants poring over the books of the institutions that now sit like beached whales. The regulators didn't see it coming. After the Enron scandal we had a drastic regulatory reform, the Sarbanes-Oxley Act, which was supposed to force CEOs to attest personally to what was on their books. But obviously, that didn't work.

What should be done to fix a financial system that has a propensity to blow up every 15 or 20 years? I'd like to see new limits on the ability of regulated financial institutions to take risks, and magnify those risks by borrowing to make even riskier bets. But I recognize that tighter regulation and less leverage will drive greedy investors (an oxymoron) into higher-yielding, unregulated assets. That's what undermined the Glass-Steagall banking act, created in the Great Depression and abolished in 1999.

What makes sense is to apply the old trust-busters' ethic to the financial sector. It turns out bigger isn't better in this world. We need smaller, nimbler banks that are closer to their customers — and that can be allowed to fail if they make mistakes. So as we bail out the behemoths, let's also think about breaking them up into smaller units that can be managed by normal human beings.

David Ignatius' e-mail address is [email protected]

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GETTING BEYOND BOOM, BUST, REPEAT 02/14/09 [Last modified: Sunday, February 15, 2009 4:05am]
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