When capital markets plunged in 2008 we were all shocked by the enormity of losses. The bubble that had burst in sub-prime mortgage loans spread rapidly and forcefully, leading to disruption in the financial sector and capital markets, which then led to disruption in industry and the broader economy, impacting everyone, worldwide, directly or indirectly, on a scale that had not been seen in a long time, if ever. The shock since subsided, we can look back now with cooler heads, as we try to understand what happened and how it may be prevented in the future. In so doing, the first step would be to identify the chain of events and assess causality, isolating roots and exterminating these where they may grow. The shock, however, triggered a reflex action, and the financial reform that is largely the result does very little to address root causes.
The chain of events, narrowly speaking, began with the credit bubble that burst. This was a primary driver – the catalyst for much that followed and that is in ways still following. But this chain is narrowly described. The sub-prime bubble bursting was not itself the first cause, because the world did not begin on the day that poorly structured mortgages reached their peak. While we don’t need to retrace our steps back to Adam or the Big Bang – at least not for purposes of this article – when a bubble bursts this is itself a result of prior errors rather than the root of cataclysm. The economic disruption that became pronounced in 2008, in other words, began more properly speaking long before. It began not with the bursting of an investment bubble, but rather when this was in the first place inflated. The value that was lost when markets plunged, never truly existed. The investments that were wiped out, were investments in air, that should have not happened.
It is important to think about these causalities and roots today as we consider our new financial legislation. This promises to reshape and mitigate, to guard and protect, and to stand its own as a regulatory event to be reckoned with, even when stacked up against prominent predecessors such as Sarbanes-Oxley and Glass-Steagall. Our present condition, however, and the financial trends and waves that have led us to this point, have all taken shape in an environment in which these regulatory predecessors and others had worked their way through our finances and systems already, and bubbles nevertheless grew and blew up, all with complete legitimacy and sanction.
Whether derivatives trading is housed in one entity or another, whether private equity funds are integrated with commercial lending or spun out of banks, whether licensing is required for hedge fund managers – these are all subjects that will give rise to new legal specializations and practices, no doubt, and will reshape a financial system that has already been shaped and reshaped several times over. But these and other provisions have nothing to do with the prevention of market collapse – and, by extension, economic disruption – because the expansion and bursting of bubbles are not a matter of regulatory oversight, but of bad investments, bad analysis, bad decisions, and bad strategies, en masse, in a global market that is integrated and inter-dependent.
In the causality of collapse and disruption, in the chain of events, regulatory practices are at best somewhere around the middle stage, but more likely on the perimeter looking in. Laws come with loopholes, and herd mentality cannot be prosecuted. If only…
