12 propositions for reforming our financial system (See also the original version in German)
The importance of the financial sector in the global economy has grown immensely in recent decades and has diverted considerable resources and attention from other sectors of the economy. The impact of the global financial crisis of 2008 has been – and continues to be – enormous in terms of unemployment, income and the costs to public finances. Even if some progress has been made since then, much remains to be done, especially at the European level, so that financial markets regulation can ensure maximal welfare.”
First, we should note that many of the previously dominating hypotheses about the nature of financial markets have been proven to be wrong in reality:
- The potential for a negative impact of financial markets on the real economy has been massively underestimated or neglected.
- The ability of financial markets to self-regulate and self-stabilise has been overestimated and market failures have widely been underestimated.
- The crises emanating from financial markets are the economic crises that have had the greatest impact and spread most worldwide. Unregulated financial markets do not contribute to stabilising the real economy. Financial markets often suffer from harmful herd behaviour. Unregulated financial markets tend to intensify the crisis: in good times they fuel excessive credit growth and in bad times they accelerate the downward spiral.
- Risks in financial markets are often intransparent. The complexity and opacity of many financial instruments is often unnecessary and does not spread risk, but rather hides it. The actual risks are therefore easily underestimated – with serious consequences.
- If banks become too big, it is no longer possible for the public sector to save them in budgetary terms: “too big to fail” can thus also become “too big to bail/too big to rescue“.
A new consensus?
The financial crisis has slowly led to the evolution of a new consensus based on the following key points:
- Financial market regulation is necessary: The state must play an important role in the financial sector; state intervention against market failure is nowadays accepted as often needed.
- Credit is an essential part of a market economy, but excessive credit growth is dangerous: an excessive increase in personal loans leads to bubbles and risks in financial markets, which can trigger severe crises and a sharp rise in public debt.
The importance of fiscal policy
Financial markets and the real economy must be viewed together in terms of economic policy, because only a good interplay between financial market policy and fiscal policy allows effective overall control in an economic crisis. The consequences of the global economic crisis after the financial crisis were further exacerbated in the EU by a restrictive fiscal policy – ” austerity” – while in the USA the Obama administration relied on stimulative fiscal programs and the recession in the USA was thus overcome more quickly.
A new consensus has asserted itself in this area as well: If the central bank is already at its limits to act at a zero interest rate, active fiscal policy should be pursued in order to come out of a long recession more quickly. The long-standing stagnation of the Eurozone economy was a consequence of the implementation of the political priorities and views of conservative and neoliberal forces. This cost the European economy and the population a great deal, and thus indirectly contributed to the influx of populist movements.
The real economy needs functioning, robust financial markets that serve it and do not decouple as an end in themselves; we all need stable financial markets in order not to suffer the fatal consequences of a new financial crisis. Good financial market regulation is central to this.
12 Theses on financial market regulation
Back in 2009, at the G20 summit in Pittsburgh high targets were set for financial market regulation in response to the financial crisis of 2007/2008. Since then there has been some undeniable progress – higher capital ratios and more intensive banking supervision e.g.. But as soon as the financial crisis was left in the past, more and more voices have started calling for a new push towards deregulation and less supervision. The current fragmented regulation as well as the tendency towards a new push to deregulation – and thus the condition for a next crisis – must be counteracted. The following twelve theses are intended to serve as guidelines for a socially just and economically stable financial market economy:
- We need more courage for simplicity – complexity in the markets is currently countered by the complexity of regulation
This complexity benefits financial market players because they successfully use lobbying or court proceedings to find exceptions or loopholes. Complexity leads to even more “too big to fail”, as only large companies can afford compliance and legal advice to understand and apply this regulation optimally.
If one really wanted effective regulation, certain products and practices would simply have to be prohibited or regulated much more strictly. Political will and courage to do that is still lacking. Politicians seem to believe the lobbyists of finance capital that capital is very shy and would instantly flee from Europe from any additional regulation. The politicians thus underestimate their own room for action and are afraid to introduce and implement simple, understandable basic rules.
- “Too big to fail” is still a reality
The promise to divide huge financial companies in such a way that they are no longer too big to be handled in an orderly manner or to go bankrupt has not been followed. Giants like Deutsche Bank would still lead to serious systemic crises if they were to run into serious difficulties. This market failure is also not corrected by competition law. Politicians must develop effective solutions in exchange with academics.
- Bail-in instead of bail-out does not work (yet)
Before the financial crisis, only a few shareholders were sharing high profits from a typical bank in good times. On the contrary, during the financial crisis, the massive losses of financial sector entities were often borne by the public sector and were thus socialised. One often heard political promise was that tax money would never again be used to save banks in the future. As recent examples show, the fulfillment of this promise is at best doubtful.
Politicians must find the courage to bring creditors to bear some of the losses and thus to make it clear to them that higher interest rates or returns are always associated with a higher risk. It is important to enable the regulated withdrawal of banks from the market if necessary. Mechanisms must be created to prevent small investors from financing bank crises disproportionately (compared to major shareholders). The existing gaps in the European legal framework must not lead to the erosion of the principle that whoever has caused the disaster though has to pay for it.
- There was no debate on the socially desirable structure of the financial system
Savers’ deposits in a bank continue to “cross-subsidise” speculative and risky investment of this bank. The important and necessary system of deposit insurance can itself contribute to the distortion of risk and thus to more speculative behaviour on the part of both the bank and savers.
Apart from attempts by the new ECB banking supervisory authority to “clean up” a few problematic banks, there has been no fundamental change in the banking landscape. A Commission proposal on structural reform in the banking sector was not acceptable to the European Council and the European Parliament and was withdrawn. A number of large banks continue to determine market developments and often also the political agenda. On the other hand, small cooperative banks are struggling to survive, but they fail to mention that they often participate in the same speculative transactions as many large banks through big consortia.
- The bank’s general role as a financial intermediary was not questioned
The question why banking and credit in the Internet age should still be organised similarly to decades ago should at least be discussed critically. Many political questions are being currently overrun by developments in digitization and fintech, which are increasingly driven by US Internet giants, where traditional competition law may not be sufficient to guarantee fair markets. In particular, it must be examined whether government solutions would not be superior to private-sector ones as in the case of public utilities.
- Financial capital lobbyists have an immense influence on regulation
Lobbyists from banks, insurance companies and securities trade providers all too often manage to push their concerns in the European institutions. The same applies to national governments, where finance ministries all too often equate the interests of representatives of domestic banking groups with the “national interest”. The concerns of consumers, savers and employees often have no voice in Europe. Stricter rules for lobbying and more transparency must be enforced so that the interests of consumers, savers and larger parts of the population are better represented.
- Independent expertise in the financial sector is rare and not always easy to identify
All too often experts and institutes, which should speak from a scientific point a view, have a (partly undisclosed) close relationship to the financial industry and are economically dependent on it, e.g. through lecture activities and third-party funding. Critical scientists who oppose the mainstream sometimes even risk their employment. Especially for a field in which such considerable sums are at stake for society, politics must ensure independent research and expert advice and publicly finance the corresponding institutions and positions on a long-term basis.
- The free movement of capital is neither an end in itself nor untouchable
Restrictions are necessary under certain conditions. While in the Greek and Cypriot crises the taboo of restrictions on the free movement of capital suddenly fell to restrict small investors, there is no political will and/or courage to do the same for all – especially large financial market players. When it is necessary to enforce effective financial market regulation, restrictions on the free movement of capital must not be a taboo.
- Profits generated on financial markets are currently not taxed fairly
Working people shoulder the heaviest tax burden, while financial market players do not pay a fair share of the tax revenue. The financial transaction tax would be a step in the right direction and must finally become a reality. Furthermore, cross-border transactions and entities for tax evasion purposes must be banned in order to impose a fair tax burden on all financial market participants.
- Financial literacy reaches only a fraction of the population
To enable people to take better financial decisions, financial education must be part of compulsory education. Everyone must know that more income can only be achieved in combination with more risk. Financial education must not, however, serve as an alibi for transferring responsibility to consumers.
- The European Banking Union is still a work in progress
European crises (including global crises with repercussions for Europe) require European solutions. The establishment and expansion of the European Banking Union (consisting of the three pillars of joint supervision, bank resolution and joint deposit guarantee) is therefore essential: rapid successes have already been achieved in the establishment of joint supervision, with the ECB as an existing and powerful European institution being responsible for it via the SSM. The establishment of a European resolution system with, in particular, an European Resolution Board to prevent the burden on the public sector [see Theses 2 and 3] is an important and urgent task. The system could not yet absorb another financial crisis. The European deposit guarantee system as the third building block for the pan-European protection of savings of up to 100,000 euros is still missing. The European banking union urgently needs to be completed.
- Politics has lost its primacy over the economy
Although many financial market players have only recently been helped or saved by public intervention – and often by taxpayers’ money – politicians too often allow horrific, but widely exaggerated scenarios such as an alleged threat of a “credit crunch” to deter them from sensible regulatory measures such as bans on certain product categories or practices. The overriding goal of financial market policy must be to regain the primacy of politics for the common good of society.
The field of financial market regulation should not be left to lobbyists of financial capital and financial market experts guided by interests. As the turmoil following the financial crisis has shown, any imbalance in a larger bank has the potential to destroy the volume of several tax reforms. Profits, on the other hand, continue to be privatised, while national banking groups are protected by national governments and in some cases kept alive artificially. Financial market policies and regulation can only be conceived on the EU level. Individual member states action at the national level does not promise success. Financial market policies should be aimed at serving the real economy, at social justice, at crisis prevention and financial stability.