A call for radical financial reform

October 9, 2013

The governments of developed countries have the power to rescue economies from defective finance. There is a radical solution. It would be relatively easy and at least as fair as the current slow generation-long recovery from the 2008 financial collapse.

I have been suggesting massive “start from scratch” financial reform for several years. The response is usually a mix of incredulity (it’s too hard to do) and indignation (it would be unjust). A thought experiment might help deal with those objections. Pretend that the current situation – excessive debts and deficits, unprecedented and risky monetary policy, overly powerful banks, slow GDP growth and unacceptably high levels of unemployment – was the result of a recent war.

Under those tragic circumstances, it would not be strange to say that the prevailing financial order was a relic from a lost period. Perhaps the arrangements were effective and fair back then, leaders would say, but the old promises, practices and privileges are now helping the few, hurting the many and holding the economy back. So finance needs to be reconstructed.

The experience after the Second World War provides an encouraging precedent. Strong German and Japanese governments led the rebuilding of devastated economies. Surely the developed countries of today could manage the much easier task of rearranging financial obligations.

Here is a simple post-pretend-war agenda.

Recalibrate debts. Debt writeoffs are not ideal – obligations should normally be honoured – but it’s better to restructure national balance sheets than to allow excessive debts to discourage job creation and investment. Writeoffs can also serve social justice when the debts in question are owed by the relatively poor to the undoubtedly rich, so often the case in increasingly unequal developed economies.

Strong governments – perhaps under the auspices of an invigorated G20 – could organise a total balance-sheet restructuring to disentangle the current system. There would be two goals: to reduce the quantity of burdensome debts and to ensure that savers are not punished. It is hard to do both, since a borrower’s reckless and unaffordable obligation is often the lender’s prudent investment. The trick is to combine debt reduction with the maintenance of value for savers. The former requires a combination of writeoffs, writedowns and debt-for-equity swaps. The latter can be done by taking advantage of governments’ ability to create new money and place it directly in bank accounts.

There are many debts to be evaluated – sovereign, corporate, personal and financial – and a corresponding collection of assets. Each of the judgments of a right new value would undoubtedly strike someone as unfair, but the comparison is not with a perfect world. It is with the current arrangement of ultra-low interest rates for savers and unwarranted gains for many asset holders.

Make government promises affordable. The mountains of government debt are a big part of the financial overload. The debt recalibration would reduce them to manageable hills, but the debts would soon pile up again unless governments matched their entitlement programmes (for the old, ill and otherwise suffering) to their tax bases. A one-time shift, some combination of higher taxes and lower benefits, will be more effective and less unjust than the current approach, which amounts to a mix of tinkering and wishful thinking. The new arrangements could be introduced gradually – although Latvia has managed pretty well with a sudden, post-war-style shock. Gradually, but more decisively than the current policy agenda.

Reconfigure the financial system. Thanks to the debt explosion, the financial-political complex has become big and powerful in developed economies. It is now far more parasitic than productive. Strong governments would crack down. They would separate everyday finance from risky lending, divide big banks into little ones, strictly limit trading, favour equity over debt financing and ensure that financial markets were either sufficiently competitive or tightly enough regulated that bankers’ pay was not noticeably high. The existing financial reform project goes only a small way towards these goals.

Thankfully, there has been no war to justify such drastic plans. It is a matter of debate whether the current system qualifies for emergency treatment. Bankers and other beneficiaries of the financial status quo would argue that the economies are not working badly enough to justify taking the risks of radical reconstruction, which might well wreck the economy by destroying confidence in the financial system. That is a risk, although it is only fair to point out that confidence in current financial arrangements is low and that the economy is hardly thriving.

In reality, governments are neither courageous nor respected enough to consider anything like such truly drastic plans. Political authorities are stuck in ruts, when they are not engaging in pointless and possibly disastrous quarrels – for example, the current debt pyrotechnics in Washington. American politicians currently lead the global contest for ineffectiveness, but the race is close. And by post-war standards, even the relatively popular Japanese and German administrations are timid.

Governments sit at the centre of modern economies; their weakness is probably the greatest threat to global prosperity.



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wow, great, lets summarize:

1) gov’ts are likely already beyond what they can realistically pay back, so for “social justice” reasons we need to write-off our own futures (since our own banks, insurance cos, retirement savings & pensions are holding all this gov’t debt),

1b) many financial institutions, which are boat-loaded with all this gov’t paper, are really screwed,

2) the problem with all this gov’t borrowing has been that gov’ts have been too weak and they need to get stronger and/or commandeer more of the economy, because they’ve done such a great job already. once gov’t has this new power, they’ll selflessly, and with great forethought, go through everyone’s debts – “sovereign, corporate, personal and financial” – and figure out what each should be worth,

3) all those promises political leaders have made to their populations (pensions, health care, services) are really just a scam and/or a ponzi scheme, since they can’t be paid for; and all the working stiffs who’ve been paying taxes and counting on this stuff should just ‘be OK’ with eating cat food,

4) but really, the only straightforward solution to all of this is for the gov’t to “create new money and place it directly in bank accounts”, ’cause that will end well.

you just might get your “war” (social- or shooting-) sooner than you think.

why all these hypothetical thought exercises? why don’t you just lay out in plain words the ramifications of your assertions: western gov’ts are bust!

Posted by boredinvestor | Report as abusive

‘Strong German and Japanese governments led the rebuilding of devastated economies’…. Edward seems to forget that Germany and Japan were in economic chaos until the Marshall Plan (funded by the USA) stepped in to make them ‘strong’….

‘There are many debts to be evaluated – sovereign, corporate, personal and financial’… And just like in Edward’s pretend war situation: ‘accountability’. After WW2 we demanded accountability from those who caused the problem in the first place. Or maybe Edward has also forgotten Neuremburg….

We have yet to have our Neuremburg, and until we do, the financial community will be seen for what it is…

Posted by edgyinchina | Report as abusive

I think reckless journalistic speculation is a valid way to generate a given number of words to be sold for profit when inspiration fails. The quality of thought evident in most of your columns is of such quality I have gleaned only this from this one:

You suggest that governments match “…their entitlement programmes (for the old, ill and otherwise suffering) to their tax bases.” What a radical idea! If it caught on, government might even extend that concept to other areas of the budget. (In our dreams)

“A one-time shift, some combination of higher taxes and lower benefits, will be more effective and less unjust than the current approach…”. Now you’ve crossed the line between literary license and fiction!

One need only link the word “government” to a whole selection of words to create almost endless oxymorons: “Efficient government”, “Responsible government”, Competent government”, “Effective government”, “Accountable government”, Responsive government”, “Economical government”…

The Social Security program is one born of the highest and most noble hopes that older Americans have a “better life”, aging with reasonable dignity without poverty. Benefits were to even be protected from the inevitable ravages of intentional inflation of the dollar by the American government. Today there remain but a trail of broken promises, past, present and future.

The money of “We, the people” was extorted with promises that our money would be “set aside” in trust, presumably earning interest. Congress ultimately yielded to the temptation of all that money, took it and spent it leaving only I.O.U.s and virtually no receipts evidencing wise use. It has already diddled with the inflation index once, to the disadvantage of recipients; and is poised to so so again when the “Chained Index” is adopted.

So there is no trust fund, no interest being paid, ever decreasing purchasing power and today the program is seen as an unfunded “entitlement” “our” government may or may not honor. Medicare is a wonderful program if you’re a senior; not so much if you’re a doctor. The government’s administration of it has an ever increasing number of doctors no longer willing to participate.

With fewer and fewer in “family practice” it is already all but impossible to get in to see the doctor when one is sick, yet both parties are going to roll out the welcome wagon for 11-20 million illegal aliens with a “path to citizenship”. With a 30% increase in the number of patients, we can expect today’s ten minute chat with our doctor to drop to maybe six minutes.

Waiting rooms will be more like day care centers with multitudes of hyperactive “engines of distribution” spreading the germs of their affliction with unparalleled efficiency on the chairs, tables, magazines, desks to be thereafter carried by one and all into the local community to share. I genuinely fail to see “progress” when it is a healthier decision to stay home and try to self medicate than incur such inconvenience and risks to see “our” physician.

And let’s not forget the effects of such increasing burden as all these new citizens will bring to Medicaid and eventually transfer seamlessly from Medicaid to Medicare and Social Security, drawing out much more in benefits than they ever contribute to our society. Forgive me Edward, but I increasingly trust “our” government with MY future and MY money about as much as I would trust a vampire in a blood bank.

Posted by OneOfTheSheep | Report as abusive

Some nice ideas. Without term limits and the elimination of the corrupt campaign structure we use there is absolutely no chance that any of this will come to reality. Interesting that you mention war. Another thought experiment could suppose that the current financial situation becomes the eventual cause of war.

Posted by Missinginaction | Report as abusive

Talking about financial reform of any magnitude, especially of the scale discussed in this article, is really putting the cart before the horse. The people who would stand to lose the most from meaningful reform, i.e. international banks from financial reform and pharmaceutical companies from healthcare reform, weild a staggering amount of power over our legislature. The source of their power is their deep pockets.

A twisted and corrupt financial system, a healthcare system that robs everyone who isn’t an executive or shareholder of it, these are merely symptoms of a deeper problem. That problem is that our legislature is elected with their money, so they make decisions with their interests in mind, not ours.

Campaign finance reform is where all of our attention must go before any of these other issues can start to be unwound. Until meaningful progress is made on this front, the proposals made in articles such as this are just flights of fancy.

Thank goodness we have appointed Supreme Court justices to protect our interests by weakening money in politics… oh wait, no, they’ve done the exact opposite of that.

Posted by smanchwhich | Report as abusive

Loosely quoted Einstein said “The problems of today will not be solved with the thinking of today”. Your thinking is starting to approach the problem with the thinking of tomorrow but the issue is there are too many people who cannot bridge that gap to go with you. The mistake must be repeated again and the suffering must be more before enough are prepared to give up their comfort zone.

Posted by BidnisMan | Report as abusive

So hear is a solution, leveraging the insights expressed above:

A. Term Limits – total LIFETIME limit of 12 years in Congress.

B. Campaign financing reform with funding (and limits on amounts contributed) only from individual residents within the state. That means no union money, no PACs, no funding from the national parties or from outside the state. Each election is only for the citizens within that state. The only exception is for the office of President–the only true “national” election.

C. Adoption of a flat tax (or consumption tax). No deductions for anyone.

D. Balanced budget required, with exceptions only by a super-majority in each house of Congress, and only for a predefined time frame, but not greater than 3 years.

E. Congress may not exempt themselves or any other person from the legislation they pass.

By taking the money and influence out the equation, change will happen.

Posted by COindependent | Report as abusive

Radical it is and that makes it rather unrealistic. But why not start just from smaller things proposed like reforming the banking sector? Why not introduce balance budget principle which by the way Germany is already introducing?

Posted by wirk | Report as abusive

So it seems that most commenters here believe in one way or another that a better government is the answer to the new problems of the 21st century. So Mr. Hadas, perhaps some of your thinking will emerge in as that slowly happens. Thank you for having the nads to publicly speak about it. As globalization and automation settle in to our lives, it is inevitable that the bulk of the population will be on some sort of government programs. In just a few short decades robotics will truly mimic a human being both physically and mentally ( on the average 100 IQ at least). This will force a state-sponsored form of capitalism to take shape. Right now we have three competing candidates. The Chinese model, the EU model, and the USCA model. Currently it is looking like the Chinese model is adapting better to changes, but I think the EU model may surprise us in the next decade. I don’t think the USCA model will last much longer as it is very dependent on weak government. Changes like @COIndependent offer could change that, but are unlikely to occur with a major crash of the system. If that happens, the other two models may take the opportunity to shine even brighter.

Posted by tmc | Report as abusive

“China’s official news agency has called for the creation of a “de-Americanised world”, saying the destinies of people should not be left in the hands of a hypocritical nation with a dysfunctional government.”

Our political parties are seriously hurting the country now. Both of them. We need a referendum vote on Term limits for congress and SCOUS and campaign finance reform. Nothing more or it will be turned into a never ending argument and well get nothing. Just those two things and all things can be achieved after just one or two election cycles. DEMAND IT!

Posted by tmc | Report as abusive

The second half of the 20th century was marked by the rise to power of the American middle class. This exceptionally large and powerful group of people dominated US politics, economy and culture, both in the US and worldwide. It was the world’s real superpower to be served, envied, and followed.
But like other historic large-scale sociopolitical phenomena (e.g the conquest of the West, colonialism, communism, etc.), the US middle class’ rise to domination was the product of a particular set of circumstances. As soon as these changed, the American middle class started losing its economic power, its political influence, and finally – its optimism.
The 90’s dot.com bubble and the credit bubble of the first decade of the 21st century represent a broad effort to maintain the US middle class’ standard of living by inflating stock and home prices, and riding on popular irrational beliefs (optimism).
Corporate America seems to have learned its lesson from the 2008-9 crisis, but the political parties and the Fed still haven’t fully digested what’s going on, and they’ve sown the seeds of a new crisis.

Posted by reality-again | Report as abusive