Corruption as an Element in the Financial Crisis - Forbes

The only surprising thing about this essay is that it appears in Forbes.

After the demise of Glass-Steagall the gloves came off and corruption became an unusually prominent factor in our financial system. There should be little doubt that the taint reached the highest levels in the US over the past ten years or more, and is still a serious problem.


Forbes
Corruption And The Global Financial Crisis
Daniel Kaufmann
01.27.09, 02:58 PM EST

The financial debacle has many causes and implications, but it would be wrong to underestimate systemic corruption.

It would be very convenient to start this article by stating that corruption is a challenge mainly for public officials in developing countries and that it is unrelated to the current global crisis.

I also wish I could claim that corruption has declined worldwide as a result of the global anti-corruption and awareness-raising campaign, the many effective anti-corruption commissions, and the recognition that poverty and culture are the reasons why corruption prevails.

But none of it is true. For starters, corruption is not unique to developing countries, nor has it declined on average. Some developing countries, such as Chile and Botswana, exhibit lower levels of corruption than some fully industrialized nations. And countries like Colombia and Liberia have made gains in recent years, while others, such as Zimbabwe, have deteriorated. Bribery remains rife in many countries, totaling about $1 trillion globally every year.

In truth, anti corruption commissions, revised laws and awareness-raising campaigns have had limited success. Focus on petty or administrative bribery has been misplaced at the expense of high-level political corruption.

One neglected dimension of political corruption is "state capture," or just "capture." In this scenario, powerful companies (or individuals) bend the regulatory, policy and legal institutions of the nation for their private benefit. This is typically done through high-level bribery, lobbying or influence peddling.

The cost to society of bribing a bureaucrat to obtain a permit to operate a small firm pales in comparison with, say, a telecommunications conglomerate that corrupts a politician to shape the rules of the game granting it monopolistic rights, or an investment bank influencing the regulatory and oversight regime governing them.

As a country becomes industrialized, its governance and corruption challenges do not disappear. They simply morph and become more sophisticated: Transfer of a briefcase stashed with cash is less frequent.

Instead, subtler forms of capture and "legal corruption" exist: an expectation of a future job for a regulator in a lobbying firm, or a campaign contribution with strings attached. In many countries this may be legal, even if unethical. In industrialized nations undue influence is often legally exercised by powerful private interests, which in turn influence the nation's regulations, policies and laws.

This has dire consequences: Witness the various forms of corruption underlying the current global financial crisis that started in the U.S.

There are multiple causes of the financial crisis. But we can not ignore the element of "capture" in the systemic failures of oversight, regulation and disclosure in the financial sector. Concrete examples abound...

(The examples given are Fannie Freddie, AIG, the mortgage lenders, and the Investment Banks)

The new U.S. administration has stated its intention to address the challenges of transparency and accountability in its stimulus plan. The devil will be in the details. Merely creating an oversight institution will not do; system-wide reforms in incentives are required. Deep-seated transparency reforms need to be a cornerstone in the government's plan, and should apply to U.S. public agencies as well as domestic and international financial institutions. Regulations supporting effective disclosure, as well as improved audit, accounting and risk-rating standards, should be preferred to restrictive regulatory controls that block innovation and growth.

Humbly learning from other nations will also go a long way. The situation in the U.S. warrants studying other countries--for instance, Sweden and Chile, which successfully addressed their financial crises long ago. Chile also offers guidance on how to structure less corrupt and effective concessions in infrastructure, where the U.S. is a novice.

In order to restore confidence, citizens, entrepreneurs and bankers need to have renewed trust in the financial system. That way they can be persuaded that it is no longer a giant Ponzi scheme. Transparency is the key.