CESR Senior Researcher Niko Lusiani argues that, alongside weak regulation and growing inequality, systematic failures in accountability also helped cause the global financial crisis.
It’s been almost six years since the global financial crisis struck, and as time passes, we’re beginning to understand better the structural causes of the calamity. Growing income and wealth inequality has emerged as a key contributing factor to the financial crisis. Low- and middle-income working families in the US experienced stagnating income through the decades between the 1960s and the 2000s, despite the doubling of GDP per capita over this period. To cope with falling real income, credible reports argue, household debt levels skyrocketed, doubling in the 1980s to over 100% of GDP before the crisis broke. In the meantime, the top 1% of the population doubled its share of the national income in this period to almost 16% - the highest level of wealth inequality since 1929 and the Great Crash. Top earners could not consume all the disproportionate increases in wealth, and so funneled some of their gains into increased supply of debt. It was the combination of this rapid accumulation of capital at the top, and the simultaneous explosion of debt at the bottom, which generated a level of financial fragility and risk not seen since the Great Depression, a key contributing factor to financial crisis as soon as debts became unsustainable and debt defaults started.
Much has also been made of the role of de-regulation, or rather biased regulation favoring financiers over working people, in undercutting the ability of governments to implement their duty to protect people against both individual financial abuses, like predatory lending, and systemic risks posed by poorly regulated financial actors.
Yet, the systemic lack of accountability of financial actors—while related to regulation—is less discussed for its role in sparking the financial crisis. Moral hazard, flawed incentives and the abdication of personal or institutional responsibility for the downside costs of financial activities is no doubt a related contributing factor to the financial crisis. Financial actors feared no meaningful sanctions or corrective actions enforced either by the market or the State. Financial industry professionals assumed correctly that the State would ultimately assume the downside hazards for the risks inherent in their financial dealings, while they would continue to enjoy the upside gains. The failure of government to establish an effective and predictable system of risk and remedy management and accountability systems to prevent and deter extreme risk-taking further exacerbated this problem by freeing financial actors from having to directly bear the costs of their own misconduct. Financial sector players felt free to leverage themselves to excessive levels, to an extent they never would have had there been predictable consequences. The financial market actors responsible for aggressive speculation, unethical lending practices, and promoting the type of de-regulation which fuelled the crisis have by and large not been held to account for their actions, certainly not criminally. Even where proper regulations were in place, such as criminal offences or fraudulent malpractice (e.g. in the writing of sub-prime mortgages), regulatory agencies lacked the will or capacity to effectively enforce them, leading to a dearth of meaningful accountability. Even the most powerful attorney in the world, US Department of Justice Secretary Eric Holder, more or less admitted that big banks were too-big-to-jail, a position which the Dodd-Frank financial regulation bill did little to change. Justice, in other words, is not blind.
So, it was not only the inadequacy of pre-distributive, redistributive and regulatory policies that were at the root of the crisis. It was also the absence of robust mechanisms of accountability and predicable punishments and remedies for misconduct that could have preempted the displacement of private risks onto public accounts, obliged risk-takers to absorb the consequences of their own actions, and protected those groups who too often find themselves at a disadvantage, particularly low- and middle-income taxpayers who have been forced to bear the brunt of the crisis.
In this sense, effective remedy for the social costs of the financial crisis is not only about making those responsible pay the price for their role. Justice and accountability is essential in order to prevent foreseeable harms financial institutions will continue to pose in the years to come.
If we are going to get real about preventing another systemic financial collapse, concerted action by governments—individually and in cooperation—to exercise their regulatory, redistributive and remedial roles in the economy is now more important than ever.
This blog article, by CESR Senior Researcher Niko Lusiani, was originally written for the joint civil society initiative Righting Finance: A Bottom-Up Approach to Righting Financial Regulation.