Has anything changed since those freewheeling days before the global financial crisis? I believe the answer is no, writes Abu Dhabi-based Insead professor Stephen Mezias.
US downgrade soap opera has little credibility in the plot
Much has been made recently of the downgrading last month of the rating of US government bonds by Standard and Poor's (S&P).
Considerable volatility was introduced to various financial markets, including foreign exchange, bond and stock markets across the globe. Barely two weeks later, on August 18, however, US stock markets had returned to the same price levels that preceded the S&P downgrade. Why would it not matter that the credit rating of the US government was downgraded?
A first part of the answer lies in understanding the lack of credibility that the messenger has earned in recent years. In testimony before the US Congress in October 2008, a former head of mortgage securities at S&P admitted the firm did not base its ratings on the best available data.
Under oath, he stated that profits, not faithful execution of their rating function, drove the firm in the years leading up to the financial crisis. Indeed, later in the same hearings an email was introduced in which one of his colleagues ordered him not to require more data from banks when assessing mortgage-backed securities. The sterling rating that S&P gave to these highly risky securities played a major role in the meltdown of global financial markets in 2008.
Has anything changed since those freewheeling days before the global financial crisis? I believe the answer is no. S&P and its fellow rating agencies maintain only the faintest illusion that they are stewards of financial truth and accuracy devoted to protecting investors.
When the Obama administration received warning of the downgrade from S&P, it quickly revealed a flaw in the accounting mathematics S&P provided as a justification for the decision.
Within 24 hours, S&P agreed that its original maths to justify the downgrade was in error, but generated a new rationale and proceeded with the downgrade. Additionally, the failure of the other rating agencies to agree that there should be a downgrade further undermines any claims to neutral truth. I believe S&P is behaving as a profit-seeking political activist that envisages gain in volatility and has little love for the current administration or the Tea Party minions battling with it.
A second part of the answer lies in the incredible lack of alternatives to US markets for global investors.
A particularly ironic moment came with the scathing criticism of the US by the Chinese. One paradox arises when a country with a lower credit rating of its sovereign debt, China, criticises a country with a higher rating, such as the US.
Indeed, one can hardly take the squabbling seriously in light of the unabated flow of Chinese foreign reserves to US capital markets. Meanwhile, across the Atlantic, the Europeans are working as hard as they can to ensure no one could reasonably have more faith in the euro than they have in the dollar. The end result is that big money has nowhere to hide from the dollar.
What does all this mean for the vast majority of the human race that lives outside of the money centres and are mere spectators to this ugly soap opera? First, you can safely turn your eyes away; the spectacle of the greedy pushing to procure a place in the feeding frenzy that pretends to be "rational" financial markets in the West need not worry you. If you have money, you probably have no current alternative except to invest it in securities that are somehow tied to US financial markets. Unless you are incredibly wealthy, you should not take the risks associated with. nor are you likely to have access to, cost-efficient markets for commodities, gold and the like.
Second, it is now clear that economic growth in the 21st century is shifting to the East and South, away from the existing financial centres. At the same time, financial markets closest to the new centres of economic action remain underdeveloped. Perhaps concerned citizens, government officials and knowledgeable businessmen can work together to ensure local financial markets can adequately support business and employment growth for the coming boom.
Small businesses and new industrial sectors in emerging economies need more support from financial markets.
Figuring out creative ways to keep more capital local and encouraging community economic and social development would be the best response to the failings of the current crop of global financial oligarchs.
A Stephen Mezias is professor of entrepreneurship and family enterprise at Insead business school in Abu Dhabi