Every time moneymaking seems to become too easy to be true, a crisis erupts. These crises are called by different names – the dotcom bubble, yen carry trade, subprime crisis, euro zone crisis etc. But look closely and there are often striking similarities between them.
Take for example, the US subprime crisis and the recent PIGS (Portugal, Italy, Greece and Spain) crisis in Europe. One had overleveraged Wall Street banks; the other had peripheral European nations in deep debt. One set was too big to fail. The other was too interconnected with the European Union to fail. One has raised questions on the functioning of investment banks; the other has rattled the idea of common currencies.
Ironically, the response to the two recent crises has been contrasting. The US reacted swiftly to the credit crisis. It exercised all its options, fumbled along and changed course several times. But there was no lack of intent whatsoever. In sharp contrast, the response to the euro zone crisis was rather limp. In fact, the European Union dilly dallied a great deal before coming out with the rescue package. While the US Fed didn't think twice about unleashing the genie of inflation from to the influx of liquidity, its European counterpart lost much sleep over the issue.
In our view, it is time to question the very idea of the European Union. A sovereign state like Greece without the ability to print its own currency is defenseless in such crises. It also cannot raise interest rates or devalue its currency. While we are not big fans of financial indiscipline, it does make us wonder if Greece would be a similar bind if it could control its own currency.
On a broader level, the results of every economic experiment take a long time to unravel. Even when they are conceptualised and implemented by the best and the brightest. Hence, there is something to be said about conservatism in the design of financial systems and preparing for the worse case scenario.
More disclosure from rating agencies
Market regulator Sebi is on an overdrive these days, plugging the loopholes in several areas. It has now proposed stronger disclosure norms for credit rating agencies. As per the proposals, ratings agencies will have to disclose their shareholding patterns. They will also have to put up a list of their publicly outstanding ratings that have moved by more than one notch over the preceding six months. While these are still at the proposal stage and are not final regulations, we believe it is high time the rating agencies were made more accountable for their actions.