Breaking through open door

On 12 May 2009, Edmund Conway of The Daily Telegraph published an analysis "Who is to blame for the financial and economic crisis?" based on a letter from experts of Institute of Economic Affairs (iea).

Mr Conway is not correct to state that no one and everyone is to blame for the crisis. The current crisis is a result of collapse of a pyramid scheme(s). Creating a financial pyramid scheme is a criminal offence. Therefore anyone who did it, and there are people responsible for that professionally, quite a number of them, must face justice. They cannot be treated any better than Albanian gangsters who engineered their own pyramid schemes in 1996 – 1997 and a number of them languish in jail. It is clear that Mr Conway is trying to shift a criminal responsibility of financiers, regulators and government officials, who organised or allowed to organise, financial pyramids onto a general public who were, unwittingly, customers and now are victims of this criminal activity. Again, it looks like establishment protecting establishment. Please also read "Cover up and blame shifting".

In fairness to iea experts, Mr Conway’s conclusions cannot be logically inferred from their letter to The Daily Telegraph.

Below is a response to this publication:

Dear Sirs

I have read your letter, on iea headed paper, printed in yesterday’s Daily Telegraph (B5 page) with great interest. It seems to me that you are going in the right direction but at the same time you make it overcomplicated.

The financial crisis’ causes and mechanism appear to be very simple indeed:

1. The current crisis is a classic result of a collapse of the financial pyramid akin to Albanian crisis in 1996 – 1997. However this time it is a much larger collapse on international scale.

2. The mechanism of pyramid was lending with loan to deposit ratio above 100%. This gives an exponential function base above 1, i.e. it is a pyramid. Indeed this is one of the most classic mechanisms of constructing a financial pyramid. To make it clear: this mechanism was a sufficient condition for the current crisis to come about. Therefore the current crisis was inevitable and completely predictable. (My conclusions do not have an element of benefit of hindsight but are rudimentary conclusions from existing science as it has been known for decades if not centuries.)

There is, of course, a question if the current crisis would have occurred at all or to what extent should a loan to deposit have been kept below 100% (and how much below). Whilst some kind of crisis, typical to economic cycle, would have happened at some point, I doubt that its scale and depth would have been comparable at all to the current crisis. (At this point we could go by history and look into typical crises, e.g. early 1990’s.) There are also factors - other than loan to deposit ratio above 100% - that exacerbate the effects of the collapse of the pyramid: but they are contributory and by themselves would not have had comparable effect.

3. Since creating financial pyramids has been illegal for some, there was no failure in law and regulations. The failure was that the existing law that prohibits financial pyramid schemes was broken. Therefore I do not see a necessity but I do see a need (see point 4 below), based on the current crisis, to regulate more. However I see a must to administer law and regulations, as they are, effectively. If anyone creates a pyramid scheme, this process must be stopped at once, and a perpetrator must be prosecuted.

For more analysis you can refer to my blog: "Financial crisis? It’s a pyramid, stupid.".

In particular:

- "The largest heist in history" especially Appendix A at the very bottom of article; this article was accepted as a memorandum by the Parliamentary Treasury Select Committee.

- "Example/exercise – how does it work?".

4. I also proposed that loan to deposit ratio be regulated. For more please refer to: "Towards improved regulations – maximum loan to deposit ratio".

Yours faithfully and respectfully

Greg Pytel