The global financial system is fundamentally flawed and will need more than mere regulatory reforms or fiscal 'pump-priming' to put right, says Steve Keen, Associate Professor at the University of Western Sydney.
Speaking at the Ethical Investor Australian Sustainability Awards, Professor Keen, dubbed Australia's "Dr Doom" because of his consistent and controversial forecast of a long and severe recession, calls for systemic reforms to correct what he described as an "inherently unethical" financial sector.
"Reforms, or ethical behaviour, alone won’t do it: reforms will be 'reformed' away in tranquil times," he warns.
He describes the crisis that the world now faces as "very real".
"We have got a debt problem that cannot be solved. But Australia is not alone - look at most the 15 leading economies in the OECD," he adds. "It's now more real than anytime in human history."
"How can the majority behave ethically when the system rewards legal but unethical behaviour?" Keen asks an audience of corporate and finance sector executives, gathered in Sydney's Darling Harbour to celebrate corporate achievements in environmental management, community support, labour relations and corporate governance best practice.
"Finance has the innate capacity to expand money/debt. You can't 'reform' this away. But you can reduce possibility for 'Ponzi' profits."
Keen suggests that removing the possibility a debt-financed house-price bubble, for instance, would see lenders implement a loan ceiling based on a multiple of inputed rental yield, rather than borrowers' income. Of course, borrowers would be able to pay what they like for a property, but any amounts over that ceiling must be borrower's cash or an unsecured no recourse loan.
To avoid a repeat of the credit crisis that has hobbled the world's financial system, regulators and legislators must remove the temptation to fund what Keen calls "Ponzi investing".
The Ponzi scheme was named after the early 20th century conman Charles Ponzi who promised to double investors' money every 90 days by investing in an arbitrage scheme to exploit mis-pricing of international postage reply coupons.
Professor Keen pointed to a number of speculative debt bubbles since mid-1960s, where Ponzi investing has dominated: in 1972-74, 1985-90 and now - 1994-2008.
"Honouring irresponsibly created debt will lock us into a permanent slump," Professor Keen says.
What is to be done?
The crisis can't be overcome without debt reduction, Professor Keen suggests, noting that US debt levels – at 290 per cent of gross domestic product (GDP) – are nearly twice as large as prior to those in the Great Depression (150 per cent). In Australia, the debt/GDP level has more than doubled to 165 per cent, from 64 per cent.
"A long-run recession is very likely," he says.
Professor Keen warns that when debt stops growing, spending slumps. Even debt stabilisation would mean a drastic drop in demand: a debt reduction by, say, 75 per cent (still triple 1960s levels) would mean a $100 billion cut in demand for the next 10 years.
"Conventional economists have got it badly wrong so far," Professor Keen says, noting the OECD World Economic Outlook (June 2007) reported "the current economic situation is in many ways better than what we have experienced in years. Our central forecast remains indeed quite benign." The crisis began two months later.
And here, the Treasury predicted 1-2 per cent real growth in 2008-09, yet first-quarter GDP came in at 0.1 per cent, while non-farm GDP actually shrank 0.3 per cent.
Citing the late economist Hyman Minsky (1919–1996), Professor Keen says the financial sector is "inherently unethical".
Minsky said that capitalism is inherently flawed, being prone to booms, crises and depressions.
"This instability, in my view, is due to characteristics the financial system must possess if it is to be consistent with full-blown capitalism. Such a financial system will be capable of both generating signals that induce an accelerating desire to invest and of financing that accelerating investment," Minskey said.
This article was provided by Ethical Investor