Solving problems of the past

Karel Van Hulle (The Actuary, Jan/Feb, bit.ly/1RbR1FW) notes that the development of Solvency II into its current form took 15 years.

The post-Lehman meltdown was more than business as usual. It marked the beginning of the end for the current system that we call neoliberalism but in the UK is better known as Thatcherism.

The macroeconomic principles that anchor the architecture of modern neoliberal finance can be summarised in three points:

• Fiscal policy is ineffective

• Responses to shocks are reflected quickly in a return to full employment
  
  
• Inflation is solely a function of the money supply.

The ongoing financial crisis has destroyed these key principles. Monetary policy in the form of quantitative easing has been unable to generate target inflation anywhere in the OECD, including the UK. Full employment is a very long way off, seven years post-Lehman. 

Real unemployment in the US is 10% and even worse in the Eurozone. Monetary policy is currently ineffective. The financial system is prone to stagnation and current policies have led to another phase of this.

Solvency II is also praised for its market-consistent approach. John Authers of the Financial Times notes three weaknesses of financial markets:

• They are prone to herding. Markets can follow trends long after they should be given up

• Emotions dominate over reason
  
• Markets are unable to price tail risk.
  
  

Insurance companies following Solvency II today all assume market pricing is correct. UK equities are propped up by Central Bank actions and priced on the assumption of growth, while gilts are priced on the basis of future deflation. They can't both be correct.

We are going through a phenomenally destabilising phase of capitalism where neoliberalism is breaking down, yet there is nothing coherent to replace it. Market consistency must be treated with care. Perhaps a margin may be in order.

17 February