Financial crisis: is there a need for paradigm shift?

Citation

Mollah, S. (2010), "Financial crisis: is there a need for paradigm shift?", Studies in Economics and Finance, Vol. 27 No. 2. https://doi.org/10.1108/sef.2010.31827baa.001

Financial crisis: is there a need for paradigm shift?

Article Type: Guest editorial From: Studies in Economics and Finance, Volume 27, Issue 2

Global financial crisis, the most serious one since the great depression, caused by an uncontrolled credit expansion, which began in the USA and then spread to Europe, has become global and requires a global response by an institution that is inclusive and that has political legitimacy. In responding to the global financial crisis, much of the attention had been on the global financial markets and its major players, but as the crisis unfolds, there must be a need for a paradigm shift away from market fundamentalism towards more financial market regulation to restore stability, prosperity, justice, and peace. There must also be a need to regulate every aspect of financial market, encompassing capital, derivatives and currency markets and the world needs unprecedented economic growth, protect past gains in macroeconomic stability and continue reform.

Noble Laureate Professor Joseph Stiglitz indicated that any response should be based on social justice and solidarity that goes beyond national boundaries. He stressed the need to reflect on the role of financial markets in the economy, said they should be evaluated on how they serve citizens and added that they were not an end in themselves – they were a means to economic growth and prosperity for all, including homeowners, ordinary people and the poor.

Credit rating agencies (CRAs) came under serious scrutiny during the current financial crisis from many quarters. Critics argued that CRAs and investors failed to accurately price the risk involved with mortgage-related financial products, and that governments did not adjust their regulatory practices to address twenty-first century financial markets. Securities and Exchange Commission (SEC) (2008) observes that CRAs were under considerable commercial pressure to meet the needs of their clients and to undertake ratings quickly. The quality of the work by CRAs has been a significant issue in the current turmoil. IOSCO (2008) recommended a strengthening of the voluntary code, the Financial Stability Forum (FSA) (2008) and the SEC also took the issue seriously. The FSA notes that:

[…] poor credit assessments by CRA have contributed both to the build up to and the unfolding of recent events. In particular, CRAs assigned high ratings to complex structured sub-prime debt based on inadequate historical data and in some cases flawed models. As investors realized this, they lost confidence in ratings and securitized products more generally.

The SEC (2008) has released a report highly critical of the practices of CRAs and proposed a threefold set of comprehensive reforms to regulate conflicts of interest, disclosures, internal policies and business practices of CRAs. The Senior Supervisors Group also noted that some banks relied entirely on the ratings and did not establish their own risk analysis of the instruments (UBS, 2008). Such banks have fared badly in the crisis. Some market participants and regulators have proposed to eliminate references in regulations that establish a specific use of ratings (e.g. restricting some investors from buying securities less than investment grade) in favor of one that in principle encourages internal risk assessments and due diligence by investors, banks, etc. It is obvious to review the regulation of risk management of banks, but also of bond insurers and the reporting activities of CRAs.

The special issue of the journal addresses the major aspects of global financial crisis and its prospective paradigm shift as the accepted papers analyze the evolution of the crisis, its causes, stock market volatility and its spillover effects on global economy, the corrective policy actions including macroeconomic policy changes that were put in place, regulating CRAs, in order to assess whether the prerequisite for a “complete change” is present so to achieve a genuine paradigm shift on the matter. Nevertheless, post-communist capitalism under the financial crisis was an important issue adds value of the special issue. I think the special issue achieves its initial objective. I am glad to have an enormous response for this issue. Special thanks to the anonymous referees to make this as a success.

Sabur MollahGuest Editor