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Post-Crash Financial Landscape


There's life after market apocalypse.

Question: When might a futurist be unhappy to see his predictions come true? Answer: when the prediction is for a descent into chaos, and the instability begins to arrive right on schedule (but before said futurist has built his bunker in Idaho).

Ten years ago, Simon & Schuster published my book, The Future in Plain Sight. The book is a thought experiment in which I used stability (or the lack thereof) as a lens through which to envision the contours of the future. While predicting specifics about the future – e.g. we'll all be tooling about in personal flying machines -- has made fools of many wise men, my idea was that we could know a lot if we could make an informed guess about the boundary conditions of the future. That's what I did, posing the question: would the future be more or less stable than the present? After discarding a number of factors that I felt might be addressed with sufficient political will (such as the rise of international gangs), I settled on nine long-wave length phenomena, what I called clues, which presaged future instability.

These clues ranged from the rise of fundamentalism, to the breakdown of ecosystems and climate instability. They also included economic and financial factors such as the persistent and growing wage gap between the rich and poor, and the destabilizing tensions inherent in markets such as herd behavior, moral hazard and counterparty risk – all of which are very much in the news today.

The second part of the book consisted of a series of scenarios set in 2050 in which I tried to envision how these destabilizing forces might interplay in various ways. In the scenarios I put myself in the place of an investment banker in London, a farmer in Kansas, an advertising executive in New York, a peasant in Mexico, etc., to flesh out how different life would be if the remarkable stability of the past decades came to a close. (The third part of the book looks at the inner workings of the consumer society for indications of whether it can adapt or what might be its successor.)

Stability and instability are facts of life; they are neither evil nor good. Bugs and microbes thrive amid instability, for instance. If you're human though, stability is what you want (though climate instability in the deep past coincided with rapid brain development in our hominid ancestors). In stable times, societies prosper, innovations proliferate, and investment horizons expand.

In unstable times, societies turn inward, there is less tolerance of strangers and less innovation (the sad truth is that necessity is not the mother of invention), and both bankers and consumers are very careful with what dimes they have. We've had a long run enjoying the fruits of stability, particularly since the end of World War II and the fall of the Soviet Union (I have to constantly remind myself of how lucky we are that the Soviet Empire collapsed without bringing the rest of the world down with it), but now, unfortunately, it looks like were going to get a taste of the other side of that coin.

The key point is that life in unstable times is very very different than what we have experienced in recent decades (unless you live in Rwanda or Darfur). It's not all bad of course. As economic insecurity increases, people seek more traditional forms of insurance such as bolstering ties to family, church, and community. Values become more important as a bulwark against anarchy. Character and integrity come to the foreground, while entrepreneurship and daring recede. People tend to make a virtue of necessity, and as Professor Depew has pointed out in "Five Things…", even today, consumers are reacting to unsustainable debt levels by embracing second-hand buying and austerity. If things continue to get worse, expect a backlash against gilded-age type excess and conspicuous consumption.

I titled the scenario involving finance "The Vicars of Finance." The date I picked for the beginning of the end of modern monetary arrangement (remember I was writing in the mid-1990s) was mid-2006, when in response to economic hardship a populist government swept into power during mid-term elections, and a wave of protectionist sentiment spooked foreign holders of trillions of dollars in dollar-denominated instruments.

I won't go through the entire scenario here, but it resonates strongly with much of what has been unfolding over the past year (even including a credit crisis reverberating around the world). Rather, I'll offer a few of my thoughts on what it might be like to be a banker in the decades following a systemic financial collapse. Keep in mind that bankers (or farmers, peasants, or advertising execs) don't operate in a vacuum. In unstable times diseases proliferate, cults and authoritarian leaders spring up, ecosystems and agricultural lands are stressed, as are municipal budgets and governments, and all these things interact in unpredictable ways.

Here's a few paragraphs from the scenario that give the "back to the future" flavor of such times:

"…Financial shocks continued to reverberate through the financial markets for years after 2006 as governments, major corporations, and bankers desperately sought measures to reduce risk and restore investor confidence. The meltdown ruined many former masters of the universe, and drove others to despair if not outright hiding. The decline further fed paranoid sentiment, and politicians around the world responded with ever more confiscatory policies and taxes. Guerrilla wars and terrorist movements spread anarchy in nations like Indonesia, China, Russia, and India. Poor nations in Africa returned to barter and subsistence economies. Sophisticated international gangs gained power as the strong and the ruthless banded together to profit from the spreading chaos. Coupled with changes in climate and the collapse of services in the cities, infectious disease spread rapidly, killing millions and further fueling xenophobia and isolationism.

The plague and chaos spurred a burgeoning religious revival as people sought to understand their plight. Increasingly, ordinary people turned to non-material satisfaction, a trend that was driven in part by the practical circumstances of living in an age of diminished material prospects. The more spiritual and moralistic mood turned the public against the corrupt and lawless elements in society. By the beginning of the third decade of the new millennium, intolerance and vigilantism rose to the point that authorities found the backbone to tame the gangs. In some parts of the world, democracy gave way to authoritarian regimes as scared and angry people accepted dictatorships and military regimes, believing them to be the price of restored order. The religious revival that began in the 20th century continued to gather strength with every passing year. Conservative forms of Christianity and Islam gained new adherents at the same time that pantheistic and syncretic cults flourished.

Even in this climate, there were still fortunes to be made, but banking became a very dangerous game. The public was quick to blame the financial community for the misery caused by the depression. For the financial community, the most urgent issue was to regain the trust of ordinary citizens, and so bankers and traders alike devoted considerable efforts to building a reputation for rectitude. Gunslingers had long since slunk away to be replaced by pillars of the establishment who paid attention to social, cultural, religious, and community values as well as financial return. In this sense the financial managers of 2050 whether in London, New York, or Frankfurt, superficially resemble the staid establishment that periodically dominated the financial markets in the late nineteenth and early 20th centuries.

Though immersed in political and economic chaos for over a decade after 2006, the U.S. had powerful tools of recovery because of its long-standing tradition of respect for law, sound, if tattered, market structures, and great reservoirs of technical, legal, banking and managerial talent. The process of sorting through the wreckage called upon all these abilities…

…Great Britain and France also faced recovery with the advantage of a history of laws and market structures and the disadvantage of an impoverished resource base. To address this second problem, both nations took the expedient approach of bolstering ties with their former colonies in Africa, now weak federations of tribes desperately in need of technical assistance… In order to rebuild markets, governments around the world imposed a number of new regulations on both stock and bond markets starting in the years immediately following the meltdown. Among these restrictions were extraordinarily high requirements on margin accounts, instantaneous settlement of trades, and transparency provisions that allowed brokers and traders to reassure themselves at any time of the solvency of their customers and partner institutions. These regulations, bolstered by acute consciousness of the risks of failure, had the effect of retarding the pace of investment. Investment and trade slowed even further as investors shied from anything perceived as risky, and consumers hoarded their scant savings.

Finance thus entered a schizophrenic period during which technology permitted an integrated global, light-speed economy, but caution, xenophobia, and regulation imposed a stately pace and parochial outlook on finance…

There's a lot more in the scenario, including speculation of what kind of monetary system might emerge as the dollar lost its supremacy. A good part of the scenario looks at the financial landscape through the eyes of a junior analyst looking for value in the detritus of the ruined economy. The rocket scientists who created structured finance, their financial card castles now collapsed, have returned to academia. The scenario ends with a summary look at this brave new world:

"…The global market of 2050 is but a shadow of its buccaneering antecedent at the end of the 20th century. Through its excesses, capitalism ultimately created its worst nightmare -- a suffocatingly regulated marketplace. It limped along, a wounded bull, still the most powerful tool around for matching money and ideas, but hobbled and prodded at every turn. This is the price to be paid for an earlier obstinate and obsessive fixation on the short term. Now the long term is powerfully represented by government regulation and the suspicions of the community. Finance adapted to its reduced role in human affairs. Humans tend to overdo things, and, of course, it is open to debate whether the claustrophobic world of finance of 2050 will in the end be any more responsive to human needs and aspirations than have been the unfettered markets of the late 20th century."

Looking at this scenario from the vantage point of the present I really wouldn't change that much (although I might change the date of the beginning of the downward spiral to 2007 from 2006). The scenarios in The Future in Plain Sight offer just one view of the future, of course, and clearly one that few, including me, would want to see come true. Also, vulnerabilities in the global financial system are just one piece of the gathering clouds. Finding a soft-landing for the credit crisis might not forestall future instability given the enormous forces that point towards such an outcome. If we do nothing, however, or if we do the wrong thing, the currently unfolding credit crisis could produce something far worse than a recession. This makes you wonder whether the banks and regulators offering one timid, self-serving or stillborn remedy after another appreciate the stakes.
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