The bigger picture

The unravelling of the US credit markets is being called the biggest disaster to hit the financial industry since the Great Depression of the 1930s. Costs are now estimated at around $1 trillion, according to the IMF. On Friday, the normally publicity-shy think tank the Financial Stability Forum - a sort of Opus Dei of the financial world - gave a series of recommendations to the G7 nations.

It was hardly earth-shattering stuff. Key nuggets of advice include improved oversight of the behaviour of financial institutions and greater transparency all round. But the FSF advisory was a good opportunity for the people running the world's biggest economies to reassure each other that there is a way out of this mess; that there is light at the end of the tunnel. More than that, the real purpose of the G7 meeting was to restore credibility to the Western financial system as a whole.

These are great days for the anti-capitalist movement. Indeed, for anyone who has ever owned a mortgage or had to take out a student loan, there has been a whiff of schadenfreude in the air as the credit markets have unravelled (provided, of course, you are not the end of a receivership). Only in this atmosphere would the French public hail as a hero Jerome Kerviel, the rogue trader who allegedly brought Societe Generale to its knees.

And Kerviel is only the tip of the iceberg. Despite the best attempts of governments to bolt the barn door, it is already apparent that some very weird things have been lurking in the Augean stable of finance, and not only in the housing and loan markets.

Take black box trading, or statistical arbitrage. Back in the 1970s and 1980s, trading became increasingly automated as it became clear that computers controlling a big fund of stocks did a far better day-to-day job of following and responding to market patterns than human beings. Until the market took a wrong turn, that is, prompting Wall Street's army of clones to all head in the same direction: off a cliff. Of course, black boxes are far more sophisticated these days, but then again so are our globalised markets.

And it seems that the chaos in the US stock markets last August was partly caused by worried traders switching off their auto-pilots en masse, creating some truly bizarre (ie human) trading patterns.

Before we take too many pot-shots at the Western financial system, however, it is worth remembering the old adage about throwing stones in glass houses. Like it or not, most of us live in that system. And there are very few plausible alternatives.

Islamic finance is one. But even Islamic banks cannot entirely escape exposure to the international markets. Yes, many Sharia-compliant finance houses can claim with good reason that they are not exposed to derivatives markets and so are protected from the fall-out from the credit crunch. Their insistence that every transaction has an underlying asset prevented them on getting involved in the market for IOUs.

One upshot of this, however, is that many Islamic banks are now heavily invested in the commercial real estate market. And however much liquidity is sloshing about the Gulf, there is some distinctively western-style speculation going on that market.

So now is not the hour to be complacent, or to indulge in the misfortunes of Western financiers. It is instead time for us all to learn from the numerous cases of Emperors being exposed in public, and to double-check our own suits of clothes. It may seem a bit lacklustre, but the advice from the FSF may the best we have to go on.