–Professors Phelps, Galbraith Highlight Weaknesses In Fin System

HELSINKI (MNI) – The gobal financial system will have to be
overhauled to limit the fallout from future crises, the governor Chile’s
central bank said Friday.

“The world has still many macroeconomic problems to solve before we
can declare victory,” Jose de Gregorio Rebeco told a financial
conference here.

“Indeed the same policies that averted the collapse require careful
review to avoid planting the seeds for the next crisis,” he warned.

“Although crises will continue to happen, we must not conclude that
since crises are unavoilable, there is nothing we can do about them,” de
Gregorio said. “Instead, the proper way to act is to strengthen the
financial system and macroeconomic policies in order to minimize their
occurrence and consequences.”

“First, there is a need to think seriously about moral hazard,” he
said. “It is true that during the crisis this was a second-order
problem. But in the gestation of asset price bubbles there was the
commitment that if and when the bubble burst, the Fed would take care of
the mess.”

“This is exactly the same as the build-up of currency mismatches in
emerging markets, when authorities promise to ensure exchange rate
stability,” he said. “In addition we have witnessed a messy bailout of
banks, and more worrisome, bailout of countries with weak public
finances.”

“The world has gone through the worst crisis since the Great
Depression,” the central banker reminded. “There were many similarities
between the two crises. However, the subsequent evolution of the global
economy was quite different from that of the Great Depression and it was
certainly the result of good macroeconomic management. There was a
failure in crisis prevention, but the policy response has been good so
far.”

“More remarkable has been the response of emerging market
economies,” de Gregorio said. “In particular, Latin America, a region
that historically magnified the global cycle, this time will perform
better than the world economy’s average.”

Speaking at the same conference, Nobel Laureate Edmund Phelps,
professor at Columbia University, said “the medium-term outlook for the
for the U.S. is not bright — though not as dim as it is for Europe.”

“The best hope for the long run is pinned on a fundamental
refounding of Anglo-Saxon capitalism — the very system that has been
saddled in recent decades with many perverse institutions and many
failures on the regulatory side,” Phelps said.

“In the meantime, the West must seek to avert a ‘lost decade’ by
taking measures soon — but not hastily — to reverse the decline in its
economic dynamism and in its economic inclusion,” he warned.

Professor James K. Galbraith, professor at the University of Austin
in Texas, compared financial markets to “a criminal industry. ”

“Although some of the banks have become insolvent, it does not mean
that the scheme has not worked,” he said, arguing executives in
companies like AIG could not have ignored internal developments.

“The executives are still free and rich,” Galbraith quipped. “The
situation of the financial industry is a train wreck and has kept me
interested.”

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