Ever since she began her career with the Federal Reserve Bank of New York in the 1970s, Sheila Tschinkel has encountered financial bubbles of one sort or another.
Whether the bubbles originated in Latin America, Europe, Asia or the United States, their impact has been felt globally and resulted in plummeting asset values and economic hardships for institutions as well as individuals.
While she was director of research for more than 10 years at the Federal Reserve Bank of Atlanta until the mid-1990s, she witnessed the savings and loan crisis and “Black Monday” when stock markets around the world crashed.
As a resident adviser of the U.S. Treasury on monetary and financial policies from 1997-2009, she saw financial crises cripple Mexico, Russia and countries throughout Asia.
Closer to home, there have been today’s economic problems and a high-tech bubble to contemplate.
During a filmed program on May 5 at the office of GlobalAtlanta, Ms. Tschinkel seemed resigned about the inevitably of financial bubbles and mistaken policies that will encourage them.
Committed to free market principles, she nevertheless called totally unregulated markets “a fiction.” “Self-regulation is not effective,” she said flatly. “The capitalist system shouldn’t be a completely unregulated system.”
A lack of transparency is dangerous in an unregulated market, she added, where buyers and sellers deal in the “shadows” and decide what the values of the goods are without any check to their opinions from open, independent valuations.
Even if buyers have the right of “caveat emptor” to ask sellers if they are confident enough to invest in whatever good is being traded, they often don’t make use of it, she said.
Today’s mortgage bubble, she added, was sustained by a widespread attitude that housing values would continue to climb into the future.
Even if payments exceeded the ability to pay, the accepted wisdom, she said, would be that the owner could sell a property at a higher price than what they had bought it for.
With the advantage of hindsight, she traced the current crisis to a number of economic factors.
These included a decade of stimulative monetary policies based on the budgetary surpluses of the 1990s, the cost of maintaining armies in Iraq and Afghanistan and a flood of imports from China making inflation appear to be lower than it was.
“You can’t avoid policy mistakes,” she added, “and they will take hold again.”
Despite the inevitability of policy errors, she defended free markets and discounted the role played by the often-cited esoteric financial instruments such as derivatives in causing today’s crisis.
She defined a derivative as a financial instrument that allows one party to transfer risk to another, such as a farmer who agrees to sell his produce at a fixed price in the future, not knowing what its value will be.
“A transferal of risk is not a removal of risk,” she said. “By selling crops forward, a farmer can determine how much to plant.”
“I don’t think that speculation is a bad word,” she added. “Some can tolerate risk while others can’t. There’s nothing bad about the instrument itself.”
As an adviser to officials in emerging economies, however, she often faces a dilemma.
While working as an in-house adviser of the U.S. Treasury, she was involved with countries that were formerly in the Soviet Union. She also was providing advice to countries that were formerly in Yugoslavia.
A proponent of free markets, she encouraged their officials to adopt capitalist and free market practices, but often had to keep them from contemplating financial tools such as derivatives before establishing the underlying markets upon which they are based. For instance, a forward market in agricultural products is impossible without a market comprised of buyers and growers.
And she is often faced with their questions about the origins of capitalist bubbles.
The emerging economies had for years been cloaked in secret and shadowy transactions and their current officials expect something different under a free market system, she said.
“What sort of example do we have for emerging nations?” she asked. “And why have a free market if there is no difference from their non-transparent systems.”
While the U.S. Congress mulls over financial reforms and international banking regulations are being discussed in Switzerland, Ms. Tschinkel is not calling for a systemic overhaul.
But she does have specific complaints.
Derivatives such as the mortgage debt obligations comprised of slices of many mortgages pooled together into bond-like instruments and credit default swaps that hedged on the values of the mortgage debt, should be traded on open exchanges, she said.
She cited the Standard & Poor’s Index in which 500 widely-known stocks are traded on a transparent exchange as a model for the derivatives instead of over-the-counter trading where the valuations are less well-known.
Banks should never be “too big to fail,” she added, and supports increased taxes as they grow in size. She also encouraged regulators to have a larger perspective on the inter-connectivity of financial institutions and not focus on the problems of one individually at a time.
In addition, she is concerned about the cozy relationship that the rating agencies such as Moody’s, Standard & Poor’s and Fitch Ratings have with the institutions selling financial instruments. “Why do we have a system that we think is ‘fair’ if the rating agencies are being paid something by the issuers?” she queried.
On the ticklish issue of whether financial institutions should be able to trade financial instruments on behalf of their clients as well as on their own, she remained noncommittal.
The policy often cited as the “Volcker Rule,” named after Paul Volcker, former Federal Reserve chairman who chairs President Obama’s economic-advisory panel, is too difficult to implement, she said.
“There is a problem created between being an adviser and a market maker,” she added. “The advisory role should be separated, but I don’t know how to do it.”
“It would be a lot easier if the players weren’t fouling each other all the time and weren’t trying to bribe the referee,” she also said, citing the need for more support for the country’s regulatory agencies.
“There’s no support for fixing these problems,” she said of the general public. The regulators are woefully underpaid and vastly outnumbered by the Wall Street financiers that they are supposed to be regulating, she said.
Nor is there any support for increasing their numbers or their pay scales through increased taxes, she added.
Ms. Tschinkel currently is principal of SLT Finance and Economics, a consultancy to governments and regulatory agencies on economic and financial policy. She may be reached by sending an email to email@example.com