One of the decisive policy responses to the crisis of 2008 was a tilt toward macroprudential supervision of the financial system. In other words: more attention to the big picture and to forestalling emerging threats that might lead to massive dysfunctions or contagions, also known as systemic risks.
If institutional and regulatory failure nearly brought down the financial system and, with it, the global economy, then better, analytics-driven oversight should go a long way toward preventing the dreaded recurrence. But what if the crisis did not just expose weaknesses in the financial structure? What if the “fault lines” — as University of Chicago finance professor Raghuram Rajan called them in his 2010 book of that title — cut more deeply into the capitalist system itself?
Financial capitalism’s triumphs over the past four decades amount to “one of the most significant revolutions in history,” Yale University economics professor Robert Shiller wrote in his latest book, Finance and the Good Society. But there are no appointed macroprudential regulators responsible for keeping capitalism safe and sound. If capitalism is at risk, so are those victories and the free-market principles that underlie them — and so are the cycles of creative destruction and innovation on which economic growth depends.
Indeed, theorists like Shiller acknowledge the possibility that something happened in 2008 that was more fundamental than a breakdown in banking and credit.
“Clearly this was a crisis of regulated capitalism, but the pressing question is whether it was the capitalism or the regulations that were primarily responsible,” political scientist Jeffrey Friedman, a visiting scholar at the University of Texas at Austin, wrote in the introductory chapter of What Caused the Financial Crisis?, an anthology that he edited, published last year.
These are mainstream, not Marxist, critiques of systems gone wrong and strategies for righting them. Many take note of widening income inequality and shrinking middle classes, and the Occupy Wall Street and Tea Party movements as expressions of popular outrage directed, albeit amorphously, at big banks and governments. “Something is going on,” Shiller said in a recent speech. “Where are we going with financial capitalism?”
In fact, Harvard Business School professor Michael Porter, famed for his work on competitive strategy, began a January-February 2011 Harvard Business Review article with the words “The capitalist system is under siege.”
In contrast to the Occupiers, these critics propose specific prescriptions. Coming as they do from capitalists, their ideas reflect a belief in the sustainability of the system as an ultimately human enterprise whose checks and balances at times need realignment.
Shiller, who warned in advance of the 2000 stock market bubble and the more recent subprime debacle, concedes in Finance and the Good Society that the financial industry has suffered severe damage, reputationally and otherwise. He asserts that finance can be improved and democratized: “Government’s task is to provide a clear set of rules for the game, one that protects consumers and preserves the public interest while enabling the players to compete in doing what they do best: delivering better products and services.”
Shiller speaks of the need to humanize the institutional forces. He endorses the use of insights from behavioral finance and economics to “smooth the rough edges off our financial system — those aspects that can cause trouble when people make mistakes” and to ensure that customers “take full account of their emotions and wants before they sign a contract.”
Also in a humanizing vein, Harvard professor Porter called for a reinvention of corporate social responsibility — and hence of capitalism — in the aforementioned HBR article, “Creating Shared Value,” cowritten with Mark Kramer, co-founder of consulting firm FSG. Diminished trust in institutions has prompted tighter regulation, they argued, which in turn undermines competitiveness and economic growth: “A narrow conception of capitalism has prevented business from harnessing its full potential to meet society’s broader challenges.”
Massachusetts Institute of Technology economist Daron Acemoglu, co-author of the recently published Why Nations Fail, wrote in Friedman’s financial crisis anthology: “In reality, what we are experiencing is not a failure of capitalism or free markets per se, but the failure of unregulated markets — in particular, an unregulated financial sector and unregulated risk management.” There is cause for optimism, however, “provided that markets are based on solid institutional foundations.”
We are still working on those. • •
Jeffrey Kutler is editor-in-chief of Risk Professional magazine, published by the Global Association of Risk Professionals.
