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Eighteen months into the deepest economic slump since the Great Depression of the 1930s, one thing is abundantly clear: the world economy is once more suffering the incalculable shock effects of a massive market failure.
The bursting of the global credit bubble, predictably, is paralysing virtually all market sectors in most countries, even those (like Japan) that took earlier measures to fit 'bank proof' shock absorbers to their economies. Governments have been dazed by the scale of corporate debt issuance and 'securitisation' - the risky bundling of debts on such things as mortgages and credit cards. Panicked reactions and contradictory stopgap measures are multiplying. Trying to calm jitters, the International Monetary Fund's Dominique Strauss-Kahn has recently pronounced that the world faces a 'great recession'. Suddenly, as if through overnight conversion, politicians rail against 'greedy' bankers and corporate fat cats. Moralists are out in force and talk of victories against banks by 'people power' (John Prescott, former Deputy Prime Minister of the United Kingdom) is having a field day. Scapegoats - Bernard Madoff, Sir Allen Stanford, John Thain - have become household names. So have words like 'bail out', 'toxic debt' and 'rescue packages'. Of significance - Obama's 2009 budget points in this direction - is the appearance of first-stab efforts to formulate redistributive policies that protect citizens against unemployment, loss of savings, deteriorating public infrastructure and other effects of the bursting bubble.
Such moves against the old free market consensus resemble slamming shut the gates after the horse called Equality has bolted. Among the documented effects of the credit bubble is that most democracies experienced a 30-year widening of income and wealth inequality. The whole trend - toward hour-glass shaped societies - has been bad for democracy. It has spawned an underclass. Middle-class people were deluded into thinking they were growing richer by the day. The spirit of solidarity so necessary for citizenship was corroded by market selfishness. The present bursting bubble is deepening these undemocratic trends. In poor countries, according to the World Bank, only a quarter of governments have the resources to cushion their citizens against the great recession; net capital flows in their direction have fallen to less than a fifth of the level two years ago. In richer countries, where 'de-leveraging' is rife, mortgage defaults among the poor are rising. Private wealth levels are plummeting (the Asian Development Bank has estimated that the equivalent of a year's global economic output has so far been lost in financial assets alone). Pension funds are threatened; in Britain alone an estimated 90 per cent of final-salary schemes are technically now under-funded. As companies slash dividends, preserve cash and reduce employment, trade unions find themselves challenged. Bank bailouts and other mega-forms of government intervention are sharpening the sense of many citizens that while the rich get billions the people get pennies. Then there is the most worrying threat to equality posed by the bust: that when the huge rescue package bills are finally presented, governments will try to rebalance public finances through spending cuts and increased taxes that have further socially regressive effects. Hence the searching question posed recently by Richard Bruton, the Finance spokesperson for Ireland's opposition Fine Gael party: 'The banks bailed out the developers, the government then bailed out the banks, today the taxpayer is being asked to bail out the government once again. The question I ask is: who is going to bail out the taxpayer?'
To the extent that democratic institutions have failed to live up to their own standards of citizen equity we can speak of democracy failure. But there is a more troubling sense in which countries such as Britain and the United States have suffered democracy failure. After 1945, when there were only a dozen democracies left on earth, a major sea change took place in the real world of democracy. Monitory democracy was born. A clue to its novelty is the invention of scores of power-scrutinising mechanisms - human rights organisations, summits, forums, integrity commissions, participatory budgeting and citizens' assemblies - whose combined effect has been gradually to alter the political geography and everyday dynamics of democracy as we know it. Democracy is coming to mean much more than periodic elections - though nothing less. It means the permanent public scrutiny and restraint of power, wherever it is exercised in the domestic and cross-border fields of government and civil society. The historic struggle for one person, one vote is over. In the new age of monitory democracy, elections still count, but parties and parliaments now have to compete with thousands of monitory organisations and networks that try to keep power on its toes. The old meaning of democracy as the periodic election of representatives based on the rule of one person, one vote, is being replaced by democracy guided by a different and more complex rule: one person, many interests, many votes, many representatives, both at home and abroad.
The key exception to this unfinished trend that began in 1945 is the failure of monitory democracy to penetrate the banking and credit sectors of the global economy. Authorities like central banks and the IMF never publicly questioned the false belief that selling credit risk to third-party investors would disperse credit risk. Bankers, often lacking professional qualifications, biased by their own company training programmes and happy to collect handsome 'slice and dice' fees, seemed ignorant of the risky structured products and quantitative models they embraced. National governments nurtured the unsustainable credit culture. Journalists unspecialised in the field seemed neither to care nor to understand the dangers attached to new-fangled debt instruments, such as collateral debt obligations and mortgage-linked securities. Worst of all, cross-border leveraging of capital went unchecked - an astonishing fact when it is considered that in most other sectors of the global economy regulatory bodies like the IMF, the World Bank, the United Nations Convention against Corruption and the G8/G20 were deemed necessary for protecting local economies from the bubbling anarchy of market failure.
The true cause of our present difficulties is that democracy slept through the making of a deep crisis. It is not that the road to our present hell was paved by good or bad intentions. We find ourselves heading for hell because nothing was ever done politically to prevent it. Democracy failure bred market failure. Unelected regulatory bodies and elected politicians, parties and whole governments let their citizens down. The self-regulation model palpably failed; empowering bodies like Moody's and Standard and Poor's and the UK Financial Services Authority to look after the credit and banking systems resembled putting alcoholics in charge of a wine bar full of celebrating bankers. There were few or no monitory bodies to blow whistles or sound alarm bells. Those brave individuals (among them Harry Markopolos, recently awarded a 'silver whistle' in recognition of his thwarted appeals to the US Securities and Exchange Commission to crack down on 'front running' and 'Ponzi schemes') who did so were ignored, silenced or sacked. The consequence: banks, investment firms and hedge fund operators, shrouded in secrecy, were allowed to pursue reckless adventures that brought the world's banking and credit institutions to the edge of a cliff.
The symptoms of democracy failure are palpable. Almost everything that matters to citizens is suddenly rising or falling, as in a wild stock exchange session. Full-time (professional) jobs are disappearing; short-time working and part-time employment, especially among women forced to supplement household income, are generally rising. So too are levels of household debt and families' felt sense of material insecurity; for the first time in a generation, the size of the middle class is shrinking, along with hopes that its children will in future be better off. Levels of state debt have reached all-time highs. In some circles, there is nervousness about the long-term viability of the greenback - the global currency of the global power which runs a current account deficit of more than 6 per cent of GDP, a level normally linked to a government about to suffer a foreign exchange crisis. The veto power of the Chinese government, its ability to stop purchasing Treasury bonds, and thus to pull the plug on the United States and tip the world into a tumble, is meanwhile growing. More immediately worrying is the way frustration and anger with parties, politicians and governments are mounting, particularly in highly vulnerable countries, such as Iceland, Belgium, Hungary and Latvia, whose democratically elected governments collapsed under pressure either from distress or despair, or from irruptions of public violence.
China is obviously a key player in handling the crisis. We shall see what happens there: whether the signatories of Charter '08 impeccably timed their demands for monitory democracy, or whether instead the Party authorities can handle the (poorly reported) growth of private and public anger, perhaps even by escaping the dollar trap and using current American weaknesses to accelerate the drift toward bipolarity in world politics. We'll also see whether the fledgling institutions of monitory democracy can survive this crisis. The French historian Emmanuel Todd, concentrating on the rise of Berlusconi-style governments, forecasts its death. That seems premature, if only because the prediction understates the novelty of our times. During the build-up to the last Great Depression, democracy arrived late on the scene; in consequence, it failed badly in countries as different as Chile, Poland and Japan. This time around things may turn out differently. Monitory democracy is more shockproof than old-fashioned representative democracy; and much now depends on shocks unknown, choices unmade and policies unformulated.
Jean-Claude Trichet, head of the European Central Bank, has rightly pointed to the immeasurability of what lies ahead: 'We don't know the laws of probability of future events.' Warren Buffett has a pithier version of the same thought: naked swimmers will only be spotted when the economic low tide comes. This is the most worrying effect of democracy failure: the scale and depth of the bursting bubble are simply unknown. We know neither the extent of leveraging that has taken place nor the measures needed to rein in its lethal effects. And we have no ready answers to the toughest question: whether the credit culture that mushroomed for three decades, fed by deregulation, the meteoric rise of China and India and the anchor role of the United States, itself both the backbone of the global currency system and the world's biggest debtor country, is any longer sustainable, environmentally or in market or political terms.
No doubt there are democratic opportunities amidst the ruins. Sensitivity to the fact of market failures is rising. Market-based solutions are for the time being unfashionable. Responsible government and redistributive policies are back on the political agenda. Green jobs programmes, social investment and citizen care schemes and other public solutions to privately suffered problems are important priorities. The short-sighted worship of GDP and 'leveraged' mass consumerism will everywhere have to be restrained, especially in high-debt countries such as the United States and Britain. But whether and how citizens and their representatives can survive the current onslaught of unchecked power from above is less clear. Culpable governments need to be thrown from office, as has happened in Iceland. Yet monitory democracy - the best weapon so far invented against folly and hubris - must also be strengthened. It follows from the analysis of democracy failure that blind trust in either markets or government regulators is folly, and that an urgent priority is to find more open and equitable ways of preventing future breakdowns of credit markets, which are bound to remain the drivers - and potential depressors - of markets in general. The question is not just whether governments are too big or too small or whether they work (the words used by Barack Obama in his inaugural address). The question is also whether both governments and market institutions are held publicly accountable for their actions by citizens, and by their various elected and unelected representatives.
The quest to extract folly and hubris from capital markets - to rein in the ruinous power of foolishly inflated expectations - may never fully succeed. The suddenly fashionable vision of 'boring banking', of tightly regulated, low-margin, buttoned-down financial markets, is probably a pipe dream. Risk taking and (broken) promise making in the banking and credit sectors are by definition neither fully predictable nor controllable. The implication is that capital markets cannot fully be guided by rational calculations that keep things in permanent equilibrium; especially when left to their own devices, private banks and credit institutions will always retain the power to fuel major market movements that take on lives of their own, entrap investors in foolish illusions (Keynes called them animal spirits) that have the effect of seducing other market participants into expecting permanent gains - until feedback signals driven by actual underlying trends puncture the foolish illusions, at which point, as we know to our cost, a boom-bust sequence with incalculable effects takes hold.
Bursting bubbles have regularly plagued market economies since the seventeenth century Dutch tulip craze; they are intrinsic to unregulated markets, contagious and destructive of human lives. That is why, given the pickle we are in, new early warning systems are urgently needed. More democratic ways have to be found for doing things that central banks, bankers, securities regulators and accounting standards boards manifestly failed to do. There is of course a feel-good factor when speaking about greater public accountability of markets. Who (aside from some bankers and hedge fund operators) could be against it? The trick therefore is to find toothier ways of clamping down on market failure. Platitudes about 'oversight' and the need for 'real reform of our regulatory architecture' (phrases now used by Henry Paulson, Lord Turner and other failed regulators desperate to save their own skins) are simply not good enough. Tough talk needs to be translated into the construction of new monitory bodies. The College of Supervisors and other reforms proposed for the EU by Jacques de LarosiÃ¨re certainly count as examples. Proposals by the US Treasury secretary to set up a new 'systemic risk regulator' to supervise hedge funds and traders of credit-default swaps and other exotic financial instruments run in the same direction. So would first-ever global regulatory structures in the fields of banking, insurance and securities - credible forums that would crack down on fraud, discourage excessive risk-taking, foster best practice through open-minded counsel and provide a means by which those hurt by this crisis may seek redress.
At its London summit in April 2009, the G20 acknowledged the pressing need for new global regulatory structures. 'The era of banking secrecy is over', it declared. It agreed to rename and upgrade an obscure close-knit body of central bankers, finance ministries and regulators known as the Financial Stability Forum, whose replacement, the Financial Stability Board, will include representatives from all G20 countries - so making it the prototype of the world's first financial monitor. Based in Basel and working alongside the IMF, the FSB will have an elevated mandate to 'provide early warning of macroeconomic and financial risks and the actions needed to address them'. For the moment, its officials deny they plan to act like guardians of the global credit system. Their diffidence reflects the fact that there is no formal provision for enabling citizens and independent experts to input their views to the FSB, which will operate entirely at the behest of states, some of which (the United States, China, India) are in any case profoundly sceptical about the need for stronger global-level intrusions into markets. The secretariat of the FSB is to remain tiny; it has no formal powers to impose anything on anybody; and, for the time being, it will function as a clearing-house advisory and information-sharing body that hosts meetings and sets up 'supervisory colleges' that issue reports on 'potential risks', 'best-practice principles' and revamped 'regulatory systems'. How the FSB would act to avert or resolve cross-border disputes triggered by the future insolvency of troubled companies like Citigroup, AIG and the Royal Bank of Scotland is unknown.
The new FSB will certainly be better than nothing. The proposed EU College of Supervisors and the commitment of G20 governments to clean up domestic banking and credit practices are also promising initiatives. But whether potent and durable monitory institutions within financial markets in fact result from these beginnings, or whether these monitors will be built quickly enough, is for the moment quite unclear. Tough and testing is the road ahead. Just one thing is absolutely certain. Given that the root cause of this crisis is political, the solution has to be political, this time by finding the best remedy for democracy failure in the strengthening of democracy itself.
John Keane is Professor of Politics at the University of Westminster and WZB and a Fellow of the Royal Society of Arts. Founder of the Centre for the Study of Democracy, a consultant to the United Nations and a recent member of the American Institutions of Democracy Commission, his books include Global Civil Society?, VÃ¡clav Havel: A Political Tragedy in Six Acts and the prize-winning biography Tom Paine: A Political Life. His full-scale history of democracy, The Life and Death of Democracy, is to be published in June 2009.