I do not think it is controversial to suggest that the bank has not had a good month in pursuing its stated goal, "to maintain the euro's purchasing power and thus price stability in the euro area".
Rules to protect trust and not buying power
The world financial crisis, and the Greek case as a recent manifestation of it, shows the need for robust cross-national global financial regulations, writes Stephen Mezias The main task of the European Central Bank (ECB), according to its website, is "to maintain the euro's purchasing power and thus price stability in the euro area". I do not think it is controversial to suggest that the bank has not had a good month in pursuing this goal. Of course, the ECB alone is not to blame, and the malaise of Greece cannot be sensibly separated from the lingering financial hangover from the global meltdown of September 2008. Indeed, I would claim there is a thread linking the irrational exuberance of the late 1990s, the bursting of the technology bubble in 2001, the housing debt explosion that followed, and ultimately the financial crisis that began in 2008 and continues with the current predicament of Greece and the euro.
That thread is the erroneous belief that the behaviour of markets can be reduced to individual incentives. This belief continues despite the fact that the guru of free markets himself, Alan Greenspan, a former chairman of the US Federal Reserve, admitted in October 2008: "Those of us who have looked to the self-interest of lending institutions to protect shareholders' equity, myself included, are in a state of shocked disbelief."
In the same testimony to the US Congress, he also admitted that the model of managing risk that had been the basis for regulation of financial markets had collapsed. Yet there has been noticeably little change in how regulators react to financial crises, and they still seem to behave as if economic concepts such as cash flow and purchasing power are the key to financial recovery. What alternative construct would I suggest that regulators incorporate into their deliberations? I have a one-word answer to that question: trust.
The ideology of the free market is compelling, and I would claim that I am as fond of markets as the next man. Nonetheless, the current view of markets elevates them to a place in the firmament of social life that is undeserved for both historical and substantive reasons. Historically, the market primacy view ignores the facts: highly developed financial markets are a relatively recent human innovation, and they have proven fraught with difficulties.
Substantively, the belief that markets are a generic solution to all manner of social problems and issues is clearly incomplete. People vote, tip and raise children despite that fact that these can appear to be irrational from the perspective of economic self-interest. Indeed, a world where people do little more than calculate their individual self-interest and act accordingly would be a dismal place. I would make an even stronger claim: it is the moments when people make leaps of faith, when they feel sufficient trust in institutions and others to take a risk, that are the truly signature moments of our species.
So, what does this poetic turn tell us about how to react to the Greek financial crisis? The beginning of my answer to that question is the claim that the financial crises of the past two years have demonstrated the need to make room for alternative ideologies at the regulatory table. In particular there is compelling need for greater understanding of how trust in financial markets is created, maintained and undermined. To make this happen, a first myth that needs to be debunked is that cash flows, earnings per share and other economic measures are the sole or even the principal measurements needed to monitor the functioning of financial markets.
The apparatus of modern finance provides a compelling and persuasive story that should contribute to trust in financial instruments and markets. Nonetheless, we also need to be directly measuring the impact of such economic data on the actual beliefs of persons participating in markets. Towards that end, I salute the work researchers at two Chicago-area business schools who have put together a website offering continuous measure of trust in financial markets.
Considerably more attention needs to be paid to the measurement of trust as part of the regulation of financial markets; as we learn to measure it more effectively, we can improve the design of regulation to ensure that requisite trust is generated. As far as maintaining trust in financial markets, the key lesson I draw from the ongoing crises in Greece for the euro zone and for global markets over the past two years is that regulators should not appear to be asleep at the wheel.
To borrow the metaphor of a colleague from a conference I attended last month, the financial industry should be regulated like the airline industry. When problems are reported, airline executives cannot call their friends at the regulatory authorities to prevent closer investigation. They cannot present incomprehensible data to regulators, who then do nothing to get closer to the truth. When there is a crash, there is a serious, professional regulatory investigation that leaves little question in the mind of the public that it is seeking the truth.
What does this suggest for the current Greek debt crisis? There should be a thorough investigation of Greek finances both retrospectively and prospectively. This investigation should explain to the public why the deficit was allowed to exceed agreed-upon targets, how it will be brought into line, and how recurrence of the violation of financial targets will be prevented in Greece and other euro zone countries.
As far as undermining trust in financial markets, it is hard to imagine how the Greek crisis could have been handled more poorly. The ECB issued mushy statements that had little meaning and negative impact. The politicians dithered while the euro burnt. Greek financial authorities continued to provide little useful information, and there is virtually universal agreement that their proposed austerity measures are inadequate to reduce the debt to sustainable levels in the long run. These are extraordinary times that require responses to ongoing aspects of a continuing global financial crisis that go far beyond business as usual.
Regulators need to be loud and clear about re-establishing the perception that they are overseeing markets in a manner that will protect the public. They must do more than focusing on numbers and trying to patch together something that can barely meet the standard of being an economic response to the realities of Greek debt. Regulators of financial markets across the globe should be working hard to establish cross-national standards for the regulation and investigation of financial services, just as they were established long ago for air transportation. The current race to the bottom in regulatory standards is not sustainable, not least because it destroys the very trust that is the lifeblood of financial markets.
We need to remember that, in the end, economic exchange evolved to create value, not cash flow. Despite the beautiful apparatus of modern markets, I would assert that their vulnerability is revealed when behaviour that betrays values is exposed. This problem is exacerbated when regulators can only punish these betrayals after the fact with long-delayed investigations that reach their culmination years after the events in question.
To restore trust in markets, regulators need to do a much better job promoting the values that financial markets should pursue. This means the regulatory tool kit needs to be expanded to include the power to prevent violations of these values and ensure that powerful financial executives or government officials do not stand in the way of regulators. Stephen Mezias is academic director at the INSEAD Middle East Campus in Abu Dhabi