While the crisis cannot be blamed on one single entity because it came about as a result of greed and complacency of consumers, investors and businesses alike, it is widely argued that the lack of good governance at the public and private levels led to this meltdown.
Good governance, in the private and public sphere, is the ability to exercise power, and to make good decisions over time, across a spectrum of economic, social, environmental and other areas.
At some level, the leadership at the public and private institutions that has been involved in this crisis are being held accountable – top executives at these banks are being questioned and will be missing out on some of their bonuses; Greenspan is being called into question for his lax oversight of the markets.
But perhaps this call for accountability is a case of too little, too late.
The concept of good governance has typically been used in development economics as a way to describe the system of aid-recipient countries – developing economies.
The recent economic crisis has brought this concept into light in developed economies where governance, both public and private, has been assumed to be sound.
There are many ways to define good governance, however, there seems to be a general consensus that key factors, as outlined by the OECD programme on Public Management and Governance (PUMA) include: Technical and managerial competence of leadership is an obvious factor of good governance.
Consumers are at fault for over-borrowing, banks are at fault for over-lending, investment banks are to blame for over-securitizing, and regulatory institutions are at fault for allowing this excessive behaviour.The exemption would free up billions of dollars held in reserve as a cushion against losses on their investments.Those funds could then flow up to the parent company, enabling it to invest in the fast-growing but opaque world of mortgage-backed securities, credit derivatives, and other exotic instruments.The Wall Street Journal and CBS have reported that Freddie Mac and Fannie Mae spent millions of dollars lobbying some influential members of congress, in exchange for, among others, lax capital reserve requirements.As a result of their lobbying prowess, these obsolete institutions became virtually untouchable behemoths.In loosening the capital rules, which are supposed to provide a buffer in turbulent times, the SEC also decided to rely on these investment banks’ own risk models, essentially allowing them to monitor and regulate themselves.The 2004 decision was a chance for the SEC to supervise the banks’ increasingly risky investments in mortgage-related securities, but the agency never followed through on this and it remained a low priority, until now.Both government and private sectors firms proved to be inadequate in this regard, and a case in point is the failure of the Federal Reserve under Alan Greenspan.The Federal Reserve under Greenspan was operated by the will of one rather than by a system of checks and balances.Greenspan, along with most other banking regulators in Washington, also resisted calls for tighter regulation of subprime mortgages and other high-risk exotic mortgages that allowed people to borrow far more than they could afford. Reliability requires governance that is free from distortionary incentives – through corruption, nepotism, patronage or capture by narrow private interest groups.The story of Freddie Mac and Fannie Mae is a classic case of policy capture that highlights the importance of reliability in governance and the effects when it is absent.