Worlds’ elite gather at Davos but will they get their hands dirty?

As the world’s elite and crème de la crème of business, politics, and society gather for their annual meeting in the Salubrious climes of Davos, the attention is slowly veering around to managing the complex financial system that they have built over a period of decades.

Ever since the global financial crisis struck in 2008, the slippery slope towards financial destruction has been accelerating and the world economy hurtling towards disaster. 2012 was no exception as not only did the financial system careen towards failure, but also the seeming inability of regulators and even the industry experts to comprehend the magnitude of the global economy became apparent.

Simply put, the global financial order is something, which should rightly take the centre stage at Davos, but the elite seem to be giving it a cold shoulder.

For instance, the widely respected bank, J P Morgan, and its charismatic CEO, Jamie Dimon, have admitted to their trading being beset with layers and layers of complexity. Despite the losses suffered because of the infamous “London Whale” trade that resulted in a write down of around $40 Billion, Dimon seems to gloss over the incident and instead, is focusing on other topics.

Similarly, the US Federal Reserve, which is tasked with overseeing the global financial system, is seemingly asleep at the wheel. Putting two and two together, it appears as though the banks and the regulators are allowing the system to slumber on instead of tweaking with the fault lines. Indeed, this development should worry the investor community as the potential for another cataclysmic event like the collapse of Lehman Brothers that froze the financial world is increasing by the day.

Apart from these “black swans”, there is the question of automated trading or the so-called HFT (High Frequency Trading) systems, which are also known as “dark pools”. These trading programs gave the financial world many sleepless nights in 2012 as the chances of catastrophic drops in the stock markets and the trading systems became more pronounced.

Given the fact that there were the “flash crashes” and the “fat finger” crashes in the NYSE at various times, the worry and the alarm over such events is not entirely misplaced. Which brings us to the other facet of pricing risk and accounting practices. On both counts, the investment banks have been guilty of not stating the facts and the regulators have been caught napping.

The road ahead for 2013 looks like we would have to live with uncertainty, risk, and instability in the financial world as few of the underlying causes for the Great Recession have been addressed. Instead, what we have is band-aids being applied to the deep wounds brought about due to reckless trading and manic risk taking.

Increasingly, in a world dominated by HFT systems and algorithms, 2013 may well turn out to be the year in which the entire house of cards comes crashing down. If only the elite who have gathered at Davos were to address this urgent issues. Without going into the finer details, which only the traders and the investor community truly understand, the Davos crowd can at least discuss how to rein in the Mad Max trading order that is the reality.

Finally, no prognosis of the financial world is complete without a mention of the role of boards of the banks in self-regulation. As the saying goes, charity begins at home, and hence, the least the banks and boards can do is to set their own house in order first. As pointed out earlier, the regulators have their task cut out as well. Without sounding alarmist, it is clear that unless these twin imperatives are met, 2013 can well be the year in which the global financial system folds upon itself.

On an optimistic note, the recognition that computers now rule the markets is dawning on the financial world and hence, the hope that such awareness would contribute to a better understanding of systemic risk and the causes of market crashes. The implications of this cannot be lost on the world’s policymakers. Davos! Are you listening?