World’s Financial System in Limbo – What to Expect!

In my recent article about investor protection and financial market size, I emphasized the world’s financial system being made up of a cluster of market-based and bank-based financial systems. I reiterated that whilst the U.S. and U.K. financial systems are predominantly market-based, that of Germany and some other European countries are bank-based. Now, whatever system is dominant in a country, market-based and bank-based systems form the main source of financial capital for investors, governments and individuals.

In other words, the interaction and integration of the two systems is what constitutes the financial systems of countries. The extent of their integration has promoted the situation where any failures or setbacks in one system permeate the other system. During the recent economic downturn, the world witnessed initially the failure of the market-based financial system of U.S. which had a spillover into the bank-based and market-based financial systems of the rest of the world. This confirmed the inseparability of market-based and bank-based financial systems and the global nature of the financial system.

Quite recently, there has been much talk about the urgent need to protect investors, customers, markets and banks with regards to both types of financial systems through government intervention. Government intervention is primarily to deal with what is called “agency” problems in finance and economics. Unfortunately, even as immaculate protection of these entities is impossible and unfeasible, inordinate protection can lead to inefficiency of the financial system, or what is called “deadweight” in economics.

Agency problems are inherent of financial system and it is not possible to completely eradicate them. Government regulations may improve transparency in the financial system and help also restore confidence in a country’s global competitiveness, but it cannot abate completely the agency problems which emanates from the discrepancy between the management’s self-interest and investors or stakeholders interest. Now, the federal government’s expansion of power through regulations into the management of a country’s financial system in order to deal with agency problems has its ramifications. The regulations may be towards the avoidance of the repeat of the financial meltdown and the rooting of potential “Madoffs”; however, care should be taken to avoid the production of “mechanical” managers and curtailing of “innovative” managers. For the proper functioning and sustainability of the world financial systems, there is the need for strong ethical moral innovative managers and not ethical moral mechanical managers. Ethical moral innovative managers are endowed with unlimited power and they would act in the interest of majority of stakeholders in the presence of external stimuli influence.

Contrarily, mechanical managers are those with limited discretion and who take decisions in response to problems based on an external stimuli or influence. As a matter of fact, mechanical managers do not have the freedom to make decisions that are in conformity with their own interests and that of the investors or stakeholders. Thus, an action plan by governments in the form of regulations should avoid providing a stringent documentation of regulations encompassing what managers, CEOs and those in higher authority should do or not do. This is because it would impede the existing deregulation in the world’s financial system.

Most importantly, the regulations should avoid telling the managers what they should do. Such an action plan has the potential proclivity towards the production of mechanical managers. Meanwhile, any government pursuit of extra transparency which is very important in a market-based bank-based systems should be applauded and commended as it would offer an appreciable level of protection for investors, markets, banks and stakeholders in general. The regulations should seek to prevent scandalous activities, promote compensation of managers tied to earnings and stock price methodology whilst preventing socialistic tendencies of government’s ultimate interest and control of the systems. Judiciously, the trajectory of government’s intervention should be towards transparency, accountability (that is better accounting disclosures) and probity to ensure sound financial practices in an atmosphere of flexibility in financial operations. Anything more than this, infringes on economic or financial freedom of the system.

The days when companies in the financial system paid huge sums to managers, CEOs without regards to earnings and stock prices are over. The future demands ethical moral innovative managers to promote transparency, accountability and probity in the financial system and to prevent a repeat of the meltdown. Now, too much legitimate power from the government can exacerbate the situation by turning innovative managers into mechanical managers. This is prevalent in most socialist and communist countries. These managers can be effective and efficient if they can collaborate with the government on the regulations whilst both parties make conscious effort to avoid the production of mechanical managers. Technically, efficiency and effectiveness is what distinguishes an innovative manager from a mechanical manager. For it is possible to be efficient without being effective and vice versa. By definition, efficiency is a measure of how well or productively resources are used to achieve a goal.

Effectiveness is a measure of the appropriateness of the goals an organizational entity is pursuing and of the degree to which the entity achieves those goals. Mechanical managers may have effectiveness because of complete subjection to governmental control but lack efficiency due to absence of creativity and innovativeness. They may operate under too much of government control and so lack the freedom to be innovative or creative. Such managers cannot reconcile organizational goals with government regulations for efficiency. Consequently, they are not able to use the resources productively to achieve organizational goals. Production of mechanical managers has often resulted in wastage of human or intellectual capital over the years in several countries.

In spite of the efficacy of ethical moral innovative manager’s positive impact on a financial system, there are associated negative dimensions. First, the setback in the government’s regulations with respect to innovative manager’s production is creation of utilitarianism-oriented systems — a system with principles that advocates for the greatest good of stakeholders — in that it supports the option that provides the highest degree of satisfaction to stakeholders. Secondly, this principle focuses on the results of our actions and not on how we achieve those results. The fact is that stakeholders have wide ranging needs and values and it is almost impossible to satisfy all these needs and values. If utilitarianism is to hold in this case then these innovative managers may be compelled to engage in unethical behaviors and decisions to attain results that seem ethical to some stakeholders (for example the government and some people of higher authority).

Thus, what is ethical is relative with regards to stakeholders. This is also analogous to a contravention of the “public choice” theory in that the government’s interest may not be the interest of the majority of stake holders. If the government seeks to regulate the financial market it would have to enact policies that are not totalitarianism-oriented but somewhere in-between egalitarianism and utilitarianism.

Egalitarianism principles advocate equality among all peoples socially, politically, economically and civil rightly. There are various forms of egalitarianism which includes gender, racial, political, economic, religious and asset-based. However, economic and asset-based egalitarianism would be of prime importance in the financial system. Egalitarianism is hard to achieve now because the economic inequality gap based on Gini coefficient analysis worldwide continues to widen due to the recession. This is also precursory that economic inequality is insurmountable in future. Though utilitarianism is dominant now, the best shot of government intervention is to produce policies that are in between the two principles. Why? Because utilitarianism has failed the system and there is the need for modification. Indeed, the recent financial meltdown is the result of utilitarian principles that have prevailed in the financial system. That is to say governments were focused on the results or positive outcome in the financial system and not on how the results were achieved. Consequently, the “smart” guys in the room took advantage of the situation and produced the worldwide financial mess.

Another underrated defect of government regulations is curtailing of financial innovation. Unfortunately, any unreasonable regulation may also create an incentive for banks or financial sectors or “gurus” to get around the regulation if it is unfavorable for business. They argue that it is financial innovation that has brought products like credit cards, debit cards, CDs, ATMs, internet billing, automatic banking transfers and determination of variable rates for transactions (mortgages, loans e.t.c). Thus, there is the tendency that government regulation that seeks to put a cap on how banks or financial institutions do business with clients would create an incentive for these institutions to act otherwise. These institutions would look for ways to get around it indirectly producing unpleasant financial innovations such as uncalled for penalties, unjustified fee charges and interest rates, bonuses and the likes whilst maintaining or declaring the needed profits. For example, one should not be exasperated if rates on ATM transactions increases as a result of a government regulated financial system.

Another example could be the conversion of fixed rates into variable rates on loans, credit cards, unjustified declaration of bonuses for managers, CEOs based on market oriented explanations. All these are forms of unpleasant financial innovations which is possible under a regulated system. The fact is that the financial institutions are constantly seeking for ways to improve services as well as earn larger profits by lowering the cost of doing business and increasing the returns from their transactions. These institutions assert that they need financial capital to support their huge investments and assets and would try to get around these regulations in order to stay in business and do that.

These developments lead to two questions. Is the world to be worried about regulations? No. Is the world to be worried about the repercussions? Yes. The world is not to be worried about regulations because it would seek to promote transparency, accountability and probity. However, the world is to be worried about the repercussions because of the response of the financial system to the government regulations if the regulations are unfavorable and most importantly infringes immensely on financial freedom and innovation of the system.

In conclusion, the government regulations should seek for transparency, accountability and probity and not an imposition of stringent measures on the financial system. The government should redefine these terms of transparency, accountability and probity for the sector without inhibiting favorable financial innovation or creating an incentive for unpleasant financial innovations. Redefining transparency, accountability and probity should produce a documentation of guidelines and regulations established by consensus. Such redefinition would cause the financial sector to be cautious in their transactions knowing that at the end of the day transparency, accountability and probity would have to be met. There is the tendency for collusion with contention resulting in a situation that forces the two parties into what is called “Nash equilibrium” in economics where there is an incentive for one party to default. In this wise, the documentation should include a frame work that prohibits contention and promotes collusion besides any unwanted spillovers to stakeholders. Let’s not forget the proverbial saying that “when two elephants fight, it is the grass and the ground that suffers.”

Financial Modeling For Individuals

Most people concerned with their financial well being will maintain a budget and keep track of how their investments are performing. People desiring to be more sophisticated in their financial planning might even hire a financial planner to help them target specific goals and develop an efficient way to achieve those goals. However, most people stop short of modeling their financial future. This articles touches on the meaning of financial modeling, its merits, ways to implement it and things to watch out for.

Financial modeling is the projection of a set of financial figures to some future point based on a set of assumptions. One might create a base model with assumptions that he or she believes to be the most probable and then vary certain assumptions to see what the outcome would be. This is done by every major company and is even required for many types of companies that fall under regulatory scrutiny. However, individuals rarely have used this valuable tool for their own financial well being.

The benefits to individuals of financial modeling in this author’s opinion are tremendous. Merely in order to build a financial model, an individual must have a grasp of several important items. One is having a good understanding of their current financial situation. Assumptions for financial models, such as expense levels, are often developed based on a person’s financial history. The base step for a financial model is for a person to have at least a rough plan for the actions they might take during the model period that would affect them financially. Each of the items is a valuable tool that would help an individual before a financial model is even started.

Once the financial model is created and a base model using the most likely assumptions is established, a person should have a clear picture of where they are going. A person might be pleasantly surprised or this might be a rude wake up call. Either way, the person is better off having the knowledge available to them.

The most valuable part of a financial model is its application to analyzing risk. Have you ever asked yourself what would happen if you retired early? Would your savings carry you? What if you lost your job? How long could you survive without your main source of income and what expenses would you need to eliminate or reduce? How would a major purchase such as a vacation home or a recreational vehicle affect your financial position? You may know that your current budget has room for the loan payments, but may the purchase derail your retirement plans? Financial modeling helps you answer the question, “What if?” By adjusting your assumptions to reflect different possibilities such as the ones I have mentioned here, you can identify and understand the risks to your financial future and even test how effective plans to mitigate those risks are.

There are several ways to build a financial model. If you have the skills to do so, you can build one yourself with a spreadsheet application such as Microsoft Excel. Many people are not that comfortable with financial mathematics. For those of you that fall in the latter category, there are still several options available. There is software available on the market at varied costs and levels of sophistication. Financial planners often offer this service for free in order to up-sell their other services. There are also consultants that will build a financial model for you. There are, of course, plusses and minuses with each of these methods.

If you chose to build your own, you will need to verify the output. Good techniques include entering only portions of your finances with known outcomes to test the results, testing extreme assumptions to make sure the output makes sense under those conditions and having someone with the appropriate background peer review your work.

If you chose to use a financial planner, you should be aware that his or her analysis may be geared more to up-selling their products than to giving you a detailed financial analysis. Also, beware of the software they use. It is unlikely the person putting your analysis together is the one who created the software. Therefore, the program might be a black box to the financial planner. This is often the cause for errors due to not understanding the computations that the program uses to perform the analysis.

The software option also presents this black box issue. If you choose to use software, you should make sure you have a good understanding of how the software works and what each input you enter means. Buying a software package that is user friendly, but still sophisticated in the calculations behind the seen is the best way to go.

Using a consultant is probably the best route. This is especially true if the consultant created proprietary software to create the model. A consultant can provide you sophisticated results displayed in an easy to understand manner. The consultant can explain what assumptions were made and any simplifications that were made in building the model. The consultant is also not going to try to up-sell you on other products. The main draw back to using a consultant is cost. Specialized attention to you as a customer is often on the expensive side. Also, the consultant has no other products other than his services to use to offset his charges.

Regardless of the method chosen, the benefits of financial modeling are well worth the effort. It is time that more individuals start to use this tool that companies world-wide have always found essential.

Creating Money: The A to Z Guide for Financial Abundance

What does it take to have financial abundance? If you’re not born into it, and especially if you were raised with a poverty/lack mindset, it takes work to change your circumstances. But this is not the kind of work that you think. Action-work takes a lot of effort and can be exhausting. The kind of work I’m talking about is vibrational. Becoming financially abundant in an easy and relaxed way takes energy-work. By shifting your energy, you can live a prosperous and wealthy life. This A to Z guide for financial abundance will assist you in shifting your energy vibration to match that of abundance.

Even though there are many attributes to financial abundance, you do not have to consciously practice everything on this list at every moment. As you become more aware of this knowledge, it will become a natural part of your consciousness over time, and your thoughts and behaviors will change with little effort on your part.

“Knowledge has organizing power inherent in it. It is simply enough to know, to be aware of the principles; the knowledge will be processed and metabolized by our bodies, and the results will be spontaneous. The results do not occur overnight, but begin to manifest gradually over a period of time.” ~Deepak Chopra, Creating Affluence

A is for Appreciation, Acknowledgment, Alignment, Allowing, Attention

The key to an abundant life is appreciation. When you acknowledge and give thanks for what you have, your attention shifts from what isn’t working in your life to what is. This brings you into alignment with Source Energy (God) and who you really are (an extension of Source Energy). A thankful heart puts you in harmony with the creative energies of the Universe. When you are in alignment, you are in an allowing mode and money can flow more easily and abundantly to you. If your appreciation is strong and constant, the Universe will respond strongly and continuously.

B is for Birthright, Beliefs

Financial abundance is your birthright. You were born into your physical body to live a joyful, expansive life. That is your purpose. To make the most of yourself is to make the most of Source. It is your right to have unrestricted access to all things necessary for your physical, mental, and spiritual unfolding. There are no limits. The only things that have prevented you from having what is yours are your beliefs. When you start believing that your are worthy and deserving of financial abundance, and that it can be easy to achieve, it will become your reality.

C is for Choices, Consciousness, Clarity, Creativity, Connection

You have total freedom of choice. You can choose to be rich, or you can choose to be poor. If it seems like financial abundance has been evading you, it is because you have been emitting a vibrational frequency of lack. When you are not making conscious choices, your life unfolds by default. Becoming aware of this empowers you to now choose to connect with Source Energy and ask for help in turning your situation around. Once you have made this connection, your vibration will shift, you will begin to have more clarity, and your creative juices will flow. Money likes to be a part of flowing energy, so making this connection is important for you financially.

D is for Decisions, Desire, Deserving

Once you have made the conscious choice to be financially abundant, decide how much you want. Think big. Whatever you want, you can have. You deserve it! Your desire is the driving force in the creation of it. Remember, you are an extension of Source Energy, and no amount is too much for Source. You have access to everything Source has, so decide what you want and let go of any limiting beliefs that say you can’t have it. Once you make a firm decision, the Universe will kick into gear to make it happen for you.

E is for Easy, Energy, Expectancy, Evidence

It is just as easy for the Universe to deliver to you $1,000,000 as it is $1. Money is energy and there is an unlimited supply of it. If you believe that it’s hard to attain $1,000,000, then you will experience the evidence of your belief. If you release your limiting beliefs and shift your mindset to expectancy, you will experience the evidence of financial abundance manifested into your reality.

F is for Flow, Faith, Focus, Feelings

If you focus on your lack you will inevitably attract more of the same. If you want financial abundance, keep your focus on your goal. The Universe responds to your feelings so practice the feeling of already having it, and have unwavering faith that it is coming. Money, as with all forms of energy, must flow. So remember that when you spend money, have appreciation in the releasing of it, and have faith that it will return to you multiplied.

G is for Generosity, Giving

Generosity is a natural attribute of higher wealth consciousness. If Source Energy is your role model, you are always willing and open to share what you have. Many people give ten percent of their income to causes they care about. That can also include giving it to yourself – you are important too. This lets the Universe know that you love and care about yourself, and the Universe responds abundantly to acts of self-love. When the money starts flowing to you in larger amounts, you can extend the generosity to others.

H is for Happiness, Harmony

Happiness is our number one goal in life. It is the goal of all other goals. Everything we want is because we think we will be happier in the having of it. When we seek money, or any other thing, we are really seeking happiness. Most people have it backwards. They believe they won’t be happy until they have the money. It’s a paradox but if you want financial abundance, seek happiness first. The money will soon follow. Being happy brings with it harmony, which are two things money can’t resist.

I is for Intention, Inspiration, Increase

Manifesting an increase of money first requires desire. Once you have the desire, then you can set your intention. An intention is an aim of purpose from which potentiality flows. Once you set your intention, follow your inspiration. Inspired action is from Source and will always lead you on the highest path to your ultimate happiness.

J is for Joy, Journey

Most people believe that the manifestation of their desire is where their joy is. And although achieving financial abundance is definitely rewarding, exciting, and fun, the true joy is in the journey. Watching and experiencing the unfolding of it, as well as knowing that you’re getting closer every day, can be empowering and fulfilling. Remember to enjoy the journey!

K is for Knowledge

Knowledge is power. As you move toward financial abundance, educate yourself in all areas that apply to your intentions, from knowing who you really are, what you really want, and how to stand in your own personal power, to how to manage your money wisely so that it continues to increase. As your knowledge increases, so will your power. As your power increases, so will your financial abundance.

L is for Love

Do you have a love-hate relationship with money? Love it when you have it, hate it when you don’t? If you want money to flow to you freely and abundantly, it’s time to release all your negative feelings around it. Take the time to work on your relationship with money so that you feel love and appreciation for all that it is, and what it has to offer, whether you have it or not. Money shows up for those who love it, who give it their attention and care-just like in a healthy relationship, it will take care of you in return.

M is for Momentum, Money

Financial abundance means having money, and lots of it! Thinking about it and giving your attention to it starts the creation process. It only takes 17 seconds of focused thought to get the momentum going on a manifestation. For each additional 17 seconds after that, the momentum picks up speed. The longer you give it your attention, the faster the momentum. Spend time every day focusing positively on your financial intentions to keep the momentum going.

N is for Natural, Nourish

The desire to be financially abundant is our natural state of being. It is our right to have everything we want for our growth and greatest potential. Don’t let anyone squelch this natural part of you. Nourish it and allow the abundant you to flourish.

O is for Observation, Open, Opportunity

Quantum physics has proven that nothing can exist without observation. Only by giving your attention to something, can it exist. So if you want to manifest more money, pay attention to money. Hold good feeling financial abundance thoughts in your mind. Appreciate what you have and be open to opportunities for more. Take inspired action as necessary.

P is for Purpose, Passion, Power, Peace, Persistence

You have the power to achieve financial abundance. Step into your power confidently and state your purpose to the Universe with passion “Financial abundance is my birthright. I claim it. I own it. Thank you.” Have peace that it is coming and be persistent in the creating of it.

Q is for Questions

If you don’t know how to get from where you are to where you want to be, start asking questions. Your subconscious mind loves answering your questions, and since it is directly linked to the Universe, you’ll want to take full advantage of this eager and unlimited resource. Questions activate the Universe into action. So start asking, “What will it take for me to have financial abundance?” “How can I increase my income by 100%?” “What can I do today to become a vibrational match to my financial desires?” Note: avoid asking “why” questions as they have a victim mentality vibration. You are not a victim. You are a creator.

R is for Receive, Release Resistance

Two very important factors to manifesting financial abundance are 1) Releasing resistance. You know you are holding resistance when you are feeling negative emotion. You can release this resistance simply by shifting your focus to anything that makes you feel better. And 2) Be open to receive. Many people believe that it is better to give than to receive. If this is you, it’s time to shift your beliefs. Money flows abundantly both ways. Be ready to receive it!

S is for Source, Self-love/appreciation, Service

You are the Source of your financial abundance because you are Source Energy. You have the power to allow it to flow or not. Be aware that if you feel negatively about yourself, you are pinching yourself off from Source, and from the flow of abundance. Self-love and appreciation are key elements in achieving joyful abundance in every area of your life. Also, offer your loving, amazing self through service to others. Service of any kind is beneficial, paid or unpaid, as long as it is from your heart. The Universe always responds to a loving heart.

T is for Trust, Time, Thoughts, Tenacity

There is a buffer of time between your thoughts and when they manifest. This allows you to get clear on what you want. Trust that your thoughts are powerfully magnetic, and with sheer tenacity, will manifest in perfect timing.

U is for Unlimited, Understanding, Universe

When you have an understanding of the universal laws and principles, you know without doubt that financial abundance is unlimited to everyone who desires it. The Universe can provide anything, to anyone, at anytime. It truly is unlimited.

V is for Vibration, Vision, Vortex

Abraham, a collective group of non-physical beings who speak through Esther Hicks, tells us in their teachings that everything we have ever wanted is being held for us in energy form, a vibrational escrow if you will. They call this vibrational place The Vortex. To receive what’s in your Vortex, you must be a vibrational match (having a similar vibe). To become a vibrational match to your desires, simply stay positively focused on your vision, believe you can achieve it, and think good feeling thoughts. It can’t get any easier than that!

W is for Wealth, Well-being, Without Worry

Your natural state is one of absolute well-being. When you are living your life as the powerful person you really are, you are happy, healthy, and prosperous. Financial wealth and joy are natural by-products of this. To return to your natural state of total well-being, live without worry and stay focused on a life that feels good to you.

X is for Expression

Source Energy wants us to have financial abundance so that we can have access to all the wonderful things this physical life has to offer. Source Energy expresses itself through us so it only makes sense for us to strive to be all that we can be, for the highest good of all.

Y is for Youthful

As you pursue the attainment of financial abundance, avoid getting too serious. Remember to laugh, play and have fun. Your youthful attitude will serve you well by keeping you in a state of high vibration.

Z is for Zest, Zen

The keys to financial abundance and living a joyful life are having a healthy dose of balance. Zest: enjoyment, enthusiasm and excitement, and Zen: being in a state of peace and awareness of your connection with the world and everything in it. We all come from the same energy. This includes money. Financial abundance is part of who you really are.

As you assimilate the concepts on this A to Z list, your energy will shift from a vibration of lack to one of abundance. It may not happen over night, but be assured that it will happen. Your thoughts and behaviors will change for the better, the Universe will faithfully respond, and your financial situation will greatly improve. Enjoy the journey!

Global Financial Crisis

The financial distress of the last two decades has revived interest on the question of the stability of the financial system. On the one hand, the “pessimist” view, associated primarily with Minsky argues that not only that the financial system is prone to such crises (“financial fragility” in Minsky’s terms) but also that such crises are inherent on the capitalist system (“systemic fragility”). On the other hand, the monetarists see the financial system as stable and efficient where crises not only are rare but also are the fault of the government rather than the financial system as such. For many others, however, financial crises may be largely attributable to the financial system but they are also neither inescapable nor inherent in a capitalist economy.

Therefore, the issues we have to examine here are how common are such crises from a purely historical perspective; to what extent we can identify a common pattern between all crises which would suggest an endogenous process that leads to crises; a theoretical framework which explains both the process and the frequency of such crises and finally examine the extent to which these financial system characteristics that make it prone to crises are inherent on the capitalist system.

The first question, i.e. the frequency of financial crises partly depends on our definition of crisis. A financial crisis has been defined by Goldsmith as “a sharp, brief, ultra-cyclical deterioration of all or most of a group of financial indicators – short-term interest rates, asset (stock, real estate, land) prices, commercial insolvencies and failures of financial institutions”. The question here is of what intensity and/or intersectoral spread should a financial disturbance be in order to be considered a crisis.

In any case, it appears that though major crises leading to the (near) collapse of the financial system are quite rare (the only one being 1929 in the US), more moderate ones are frequent enough to allow the argument that the financial system does suffer from a certain degree of fragility. In the post-war period, after an almost complete absence of crises until the mid 60’s, the financial system has been at strain on many occasions including the 1966 credit crunch, the 1969-70 and 1974-75 crises, the 3rd world debt problem of the early 80’s and the stock market crash of 1987.

Again a casual observation of financial crises will find a wide variety of different causes and forms as each crisis seems to have occurred in response to a unique set of accidents and unfortunate coincidences. But quoting Kindleberger “for historians each event is unique. Economics, however, maintains that certain forces in society and nature behave in repetitive ways”. Indeed, it is not difficult to distinguish a rough pattern which has been graphically presented by Minsky : crises tend to occur at the peak of the business cycle following a period of “euphoria.”

This has probably been initiated by some exogenous shock to the macroeconomic system (“displacement”) which results in new profit opportunities. The boom is fuelled by an expansion of bank credit as new banks are formed, new financial instruments are introduced and personal credit outside the banks increases. During that period there is extensive “overtrading”, a not very clear concept which generally refers to speculation for a price rise, or an overestimation of prospective returns due to euphoria. This stage is also often referred to as a “mania” emphasising its irrationality and “bubble” predicting the collapse.

Eventually, some insiders decide to take their profits and sell out and the increase in prices begins to moderate. A period of “distress” may then occur until speculators realise that the market can only go downwards. The crisis may be precipitated by some specific signal such as a bank or firm failure or a revelation of a swindle; the later are quite frequent in such circumstances as people try to escape the imminent collapse. The rush out of the real or long term assets (“revulsion” in Minsky’s terms) lowers the prices of these real assets which were the object of the speculation and may develop into a panic. The panic continues until either the price falls so low that people are tempted to keep their illiquid assets or a lender of last resort intervenes and /or manages to convince the market that money will be made available in sufficient volume to meet the demand for cash.

Minsky, unlike many others who otherwise accept much of his model, believes that this process will always result to a crisis. Minsky classifies the demand for credit to “hedge finance” when cash receipts are expected to exceed the cash payments by a significant margin, to speculative finance” when, over some periods, expected earnings are less than payments and to “Ponzi finance” when the payable interest in the firm’s commitments exceeds its net income cash receipts; thus a Ponzi unit has to increase its debt to be able to meet its commitments. Once the Ponzi finance situation becomes general, a crisis is inevitable. Others, however, believe that there are ways to prevent Ponzi finance from becoming too widespread.

This model described above implies that crises are in part endogenous and in part outcomes of exogenous disturbances. Whether this conclusion supports the “financial fragility” view depends on the weights given to the disturbance and the endogenous part of the process. If the shocks necessary to set off this process are of exceptional size and rare then obviously the financial system can be thought as stable. Indeed it has been suggested that the recent crises have in fact showed the resilience of the financial system against huge adverse shocks. If instead the speculative forces are triggered by even relatively small shocks we can then blame the financial system even if the shock were exogenous.

This is both an empirical and theoretical issue. Empirically the euphoria-distress-revulsion process seems to conform with the experience of many crises such as the 1929 stock market crash, though many others have not gone through the whole process. Theoretically, we have to explain the assertions of the above model, namely for the existence of speculation and other “irrational” behaviour as implied by “manias” and “overtrading”.

Friedman rejects the notion of destabilising speculation completely as a destabilising speculator who bought when the price was rising and sold when it was falling, would be buying high and selling low so that he would be losing money and fail to survive. The answer may be that we can distinguish in two groups of people: the “insiders” who are rational and possess a lot of information and the “outsiders” who may not be “fully” rational and/or not possess adequate information. In such a world, the insiders have incentives to speculate and gain at the expense of the outsiders. We may also distinguish in the 2 phases of the bubble, a first “rational” one based on “fundamentals” and a second where agents’ behaviour is best described by ‘mob psychology’. Other possibilities are that agents may choose a wrong model of the economy or fail to anticipate the quantitative rather than the qualitative reaction to a certain stimulus, especially if there are time lags.

The question, however, is whether outsiders learn by experience though it can be argued that in rapidly changing complex financial markets such learning may not be very effective. Still “euphoria” arguments may be a little naive when applied, for example, to contemporary bankers who have access to a wealth of sophisticated advice. Indeed a criticism of the Minsky model is that though it might have been true of some earlier time, it is no longer so as big unions, big banks, big government and speedier communications have improved the stability and efficiency of the system. Hansen similarly argues that since the mid 19th century the main outlets of finance were the industrialists rather than the traders and merchants reducing the instability of credit. As we shall see later on, especially after the recent deregulations such arguments are questionable.

The monetarists further object to this theory because they argue that we should distinguish between “real” or “true” crises which were caused by changes in money supply and “pseudo-crises” which were not. For example, Friedman has argued that the 1929-32 crisis was largely due to a fall in the money supply. There is little reason, however, why the supply of money is more than an element in financial flows and stocks and indeed Friedman’s explanation of the Great Depression has been challenged.

Minsky has further argued that the fragility of the financial system relative to disturbances and speculator behavior depends on three factors: the mix of hedge, speculative and Ponzi finance in the economy, the levels of liquid asset holdings (what he calls “cash kickers” and Margins of Safety) and the way used to finance Investments of long gestation. He further argues that inherently and inevitably the capitalist system will result in the worst combination of the above as far as financial stability is concerned. Minsky bases such conclusions on what he calls a “Wall street economy” paradigm as contrasted to the essentially barter economy of the neoclassical paradigm. Minsky in fact traces his views on Keynes who also expressed his concern for an increasingly speculative and unstable financial system governed by animal spirits.

In an initially robust financial system, he claims, agents will overestimate the stability and success of the system and will increase their indebtedness (an “euphoric economy”), so that speculative finance will become the norm. Similarly overconfidence will make agents reduce their Cash Kickers although such margins are crucial for speculative finance units. These mean that the economy and the financial system become very sensitive to variations in interest rates. Finally, investment projects which have a long gestation period can be financed either sequentially or by prior financing. For similar reasons agents generally chose the risky way of financing projects sequentially which not only further increase the interest sensitivity of the financial sector but increases the volatility of interest rates themselves as they imply an inelastic demand for finance given sunk costs plus possible effects in the real economy through falls in Aggregate Demand. This, however, does not sound a very robust argument as one would expect that as Wallich argued, once the system becomes fragile, the agents will get scared and reverse the trend towards speculative finance.

Moreover, the Stiglitz paradox argues that destabilising speculation is an inherent characteristic of the system. A financial system is an information infrastructure and as any infrastructure being a public good poses problems in being paid by the price system. Hence “noise” is needed to remunerate active financial markets.

Here we could also mention that many of the disturbances which cause financial crises, may in fact, be endogenously caused by the capitalist system. Nevertheless, this argument cannot be stretched too far and on the other hand one could attribute the apparent greater instability of the financial system the last 2 decades to the hardships of the real economy (oil price shocks, stagflation). In this later case the financial system emerges as particularly resilient , certainly more so than the real economy. Indeed, many people such as Kindleberger, believe that financial disturbances are neither inherent in the system nor is it inevitable that they will develop into crises. Most concentrate on the issues of appropriate monetary policy, regulation structure and lender of last resort facilities.

Monetarists obviously support that a monetary rule is adhered though others, including Minsky, fear the consequences of high volatility of interest rates. The lender of last resort facility has generally proved to be quite effective in preventing financial collapse throughout the post-war period. The problem, however, is that it creates a moral hazard problem as agents are encouraged to be more risky. This problem may increase in significance in the future as the importance of the commercial banks relative to other financial institutions declines and for most of these institutions the moral hazard costs are considered to be much higher and lender of last resort protection is not generally widely available to them. Also in our increasingly globalised financial system, there is none really able and willing to play the role of the international lender of last resort; the collapse of 1929-32 is often partly attributed to a similar lack of lender of last resort as Britain was unable to play this role anymore and the US were unwilling.

The widespread deregulations of the last two decades have also attracted attention regarding their effect on financial stability. On the one hand, it is argued that the subsequent rationalisation not only increased efficiency, the quality and the variety of financial services but helped stability as well by for example allowing a better allocation of risk towards those who can bear it more easily. Others, however, point to the increased difficulties for conducting monetary policy, the increase in indebtedness, the increase in credit risk as business finance shifted towards securities and the greater freedom in speculative behaviour.

Furthermore, as Kaufman feared, completely liberated markets will increase instability by allowing crises to quickly spreading to other sectors and countries. In many respects, the Savings & Loans debacle is typical of the problems of deregulation: Though most people would agree that deregulation was long overdue, its timing (coincided with a crisis in the S&L industry which encouraged speculative behaviour) and the easing of “safety-and-soundness” regulation proved catastrophic. Indeed there is a significant group of economists who while support deregulation, strongly recommend the imposition of restricted safety and soundness regulations to increase the stability of the system.

If through either of the above instruments, crises can relatively easily be prevented or stopped then it is clear that they are much less dangerous and less important. Indeed, since one could include such government actions as part of the actual financial system, then one could conclude that the system endogenously prevents crises from occurring.

Concluding, I believe that the financial market has in fact shown remarkable resilience and adaptability in the face of the condition of the real economies, the shocks experienced and the rapid deregulation. The issue of financial instability is and should be a concern but probably the best policy towards that objective is to have a healthy and stable “real” economy. How to achieve this is indeed another question.

It may be useful to summarize the argument. A system of financial regulation was crafted out of the financial turmoil of the 1930s. It had two defining characteristics, the restriction of competition and government protection. This institutional structure was created in conformity with the concrete conditions at the time (low debt, high liquidity, low inflation, and low interest rates). It was successful in the postwar period in the United States in part because of that conformity. The high profit rates in the early postwar period also helped to create a situation in which no financial crises occurred.

Eventually, however, those conditions changed: debt increased, liquidity declined, profits fell, and inflation and interest rates increased. The worsening financial conditions in the later postwar period contributed directly to the reemergence of financial crises. The old institutional structure, rather than leading to stability and profitability for financial institutions, resulted in instability and financial difficulties in the context of these new conditions. Banks and thrifts found themselves in a difficult situation intensified by the tight monetary policy beginning in the early 1980s. Financial crises increased, as did failures of thrifts and commercial banks. Eventually the banks and thrifts searched for riskier, potentially more profitable, but ultimately more speculative areas of lending.

The Most Important Thing Your Doctor & Lawyer Have That 99% of Financial Advisors Don’t – Fiduciary

FIDUCIARY – A Financial Advisor held to a Fiduciary Standard occupies a position of special trust and confidence when working with a client. As a fiduciary, the Financial Advisor is required to act with undivided loyalty to the client. This includes disclosure of how the Financial Advisor is to be compensated and any corresponding conflicts of interest according to Focus On Fiduciary – an industry watchdog resource organization.

If you haven’t heard of a Fiduciary Standard of Care, you haven’t done your homework on selecting your financial advisor. The single most important thing your doctor, your lawyer, and your accountant (your accountant has an implied Fiduciary Standard) have that 99% of all financial advisors DO NOT have is the Fiduciary responsibility to you, their client. Every financial advisor should be held to a Fiduciary Standard, but 99% of them will not put it in writing, legally binding them to that extra level of care and responsibility.

So just what is a Fiduciary Standard? A Fiduciary Standard is the absolute and undeniable obligation to provide you (the client) the most appropriate financial advice and guidance REGARDLESS of personal gain (compensation/commission/fees/perks, etc.). A Fiduciary Standard entails acting with complete disregard as to how the recommendations and planning advice will affect the planner, but rather how those recommendations and the planning advice will benefit the client financially and accomplish the clients financial goals. A Fiduciary Standard requires a complete and consistent focus on the client from the beginning stages of the financial planning and investment process, through the execution, implementation, and monitoring of the clients financial plan.

What would you think, how would you feel if you went to your doctor with a life threatening condition and they weren’t held to a Fiduciary Standard of Care? What if they received compensation or perks for recommending one drug over another? What if their income was dependent on which drugs or course of treatments they recommended? What if they needed to sell “X” amount of “ABC” drug and the generic counterpart never entered their mind?

You’d feel betrayed, you’d feel distrust, you’d think your doctor didn’t have your best interests at heart, you’d be hesitant and concerned as to where to find real honest medical advice. You’d have every right to feel that way.

Attorney’s have a similar Fiduciary responsibility to their clients. An attorney must act with good faith and in their clients best interests always. The client is trusting the attorney to represent them in the most prudent manner possible, and the attorney must not breach this confidence placed in them by their client.

Yet everyday the average consumer with financial and investment needs signs over their financial security and future to an individual not held to a Fiduciary Standard of Care. Every day the average consumer continues to re-hire that same NON-Fiduciary financial advisor – because not firing a non-Fiduciary advisor is the exact same as re-hiring that person everyday that passes. Every day millions of investors naively but trustingly believe they’ve received the most prudent and unbiased advice possible, when this isn’t necessarily the case.

Your doctor has a Fiduciary Duty, your attorney has a Fiduciary Duty, and your accountant by implication is generally held to a Fiduciary Standard of Care as well.

Why would anyone accept anything less than a complete acceptance of the Fiduciary Standard on the part of their financial advisor? Simple – 99% of financial advisor “professionals” choose not to (or cannot) adhere legally (or philosophically) to a true Fiduciary Standard. They’re enriched by large commissions, perks and other hidden fees to sell products rather than solve problems. Their incentive is lining their own pockets, not helping you achieve your financial and retirement goals. These financial advisors are paid from the Wall Street firms or insurance companies they work for, not their clients.

Most consumers assume the Fiduciary level of responsibility and duty is already present in the financial services industry, and they’d be right to a limited extent. The Investment Advisors Act of 1940 mandates that to offer financial advice one must be a Fiduciary. To avoid this higher standard of care and responsibility the securities industry created what was coined the “Merrill Lynch Rule”, exempting certain types of fee-based accounts from coverage under the Investment Advisors Act of 1940 (labeling them brokerage accounts rather than advisory accounts).

The Merrill Lynch Rule was overturned in May of 2007 thanks in part to the Financial Planning Association’s legal efforts. Wall Street does NOT want the imposition of a Fiduciary Standard because it clearly opens them up to more regulation and lawsuits from many standpoints, including a breach of fiduciary responsibility and suitability. But the simple fact remains that a Fiduciary Standard protects you, the consumer of financial and investment services.

Although the Merrill Lynch rule was overturned, there still today does not exist any reasonable or consistent set of Fiduciary Standards in the financial planning and investment management industry. The primary reason this issue is so challenging for the industry to manage is compensation. If a financial advisor is paid directly from the client (or the financial advisor’s only source of income is through fees from the client in some form), they can in theory embrace a Fiduciary Standard. However, if a financial advisor is paid by some Wall Street investment banking firm or insurance company – their responsibility is to their employer who signs their paycheck first!

If you believe that extra level of care and responsibility should be present in your financial advisor, demand clearly and in writing from them that they agree to be held to a Fiduciary Standard as described under the Investment Advisors Act of 1940. Demand they put your best interests first. Demand they provide you exceptional and unbiased financial and investment advice.

A Fiduciary Standard is the highest standard of care, duty and responsibility in a relationship. Anything less than a Fiduciary Standard of care from your financial advisor is unacceptable. This is your financial future, your nest egg, your retirement, your family, and your security we’re talking about…right? Isn’t it time you expected more from your financial advisor?