Financial Crises: If Hindsight is 20-20, Why Does History Repeat Itself?

With investors dumping foreign-currency denominated assets and parking their cash in safe havens, slowing foreign direct investment, lagging foreign demand, and slumping commodity prices, the after-effects of the U.S. financial crisis will have an acute affect on Latin America's growth prospects for the next few years.

In his speech at the 25th Session of the Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting (ISAR) held in Geneva during the week of November 3, 2008 André Baladi, the representative of the International Corporate Governance Network (ICGN), a U.K. based not-for-profit company, explained that the current crisis is not unique but rather part of a chain of similar cyclical crises that have periodically rocked financial markets since capitalism’s inception.

Mr. Beladi mentioned collapses and crashes that took place in Europe in the early 1700s, in the U.S. in the 1900s, and more recently at companies like The Bear Stearns Companies, Lehman Brothers Holdings Inc., and Societe Generale S.A. (Paris Stock Exchange: GLE) (Soc-Gen).

The notion that free market capitalism and financial markets are susceptible to periodic crises is backed by a substantial body of academic work based on the research of financial economist Hyman Minsky’s pioneering research. Many economists have explained that the current crisis affecting financial markets follows the trajectory of previous boom and bust cycles. The most recent Economic Outlook Report from the International Monetary Fund explains that “financial systems are inherently procyclical” and are affected by the business cycle in which the “buildup of financial imbalances [is] followed by a sharp correction.”

Public outrage in the aftermath of a crisis-induced series of high-profile corporate collapses is likewise not a new phenomenon. In 1720, investors who lost fortunes in the controversial collapse of the “South Sea” stock bubble were furious. After the crash, Thomas Gordon, an influential classical liberal whose ideas helped paved the way for thinkers like John Locke, Adam Smith, and Milton Friedman condemned the “execrable arts of stock-jobbers” and argued forcefully that the public good would be best served if harsh punishment was served to the directors who presided over the company behind the collapse.

In the wake of a new wave of corporate collapses, as global markets are besieged by volatility, compensation policy and corporate governance reform will yet again sail to the center of the legal and regulatory agenda.

History repeats itself. Hindsight may be 20-20, but memories of economic downturns tend to fade in the exuberance of subsequent upswings. Following the current crisis, we should hope that public attention is turned not only in the short-term to “execrable stock jobbers” and highly-compensated CEOs but also to key corporate governance reforms that could help better align executive and shareholder interests and better promote long-run financial market stability.