Pakistan's population up by 46.9 per cent since 1998

On March 30, 2012, the Dawn reported that Pakistan's population increased by 46.9 percent between 1998 and 2011.

India's officially counted populations in 2011 is more than 4 times its population at the time of independence in 1947. And some Indians think that Indian population may be 1.5 instead of 1.2 billion due to under counting. On top of that, even well-informed and well-meaning people in India often talk about "population dividend" from a large proportion of population being young, albeit uneducated and unskilled. This would seem like living in la-la land, cleaning the beaches while the tsunami is on the horizon. But nobody likes people who go around warning "the sky is falling." People use their considerable intelligence to find rationalizations until it is too late. That, I think, is the tragedy of social sciences. In spite of all the professed rationality and spirituality in India, ultimately, it is Charvaka's Lokayata philosophy: "yaawat jeevait, sukham jeevait; rinam kritwa, ghritam pibet" (as long as you live, live in luxury; borrow money, and enjoy life) "at least for the current generations. How else do we explain the European and U.S. financial crisis?

The crisis has its roots in the moral foundations of our civilization (reproduction, preservation of life, and consumption as treasured values). It worked until Louis Pasteur disturbed the balance between life and death. China (the only country that has done something deliberately in the policy field to address the issue through its one-child policy) is condemned on moral grounds, while we merrily rush towards starvation, pestilence, war, and annihilation. Here faith in God (He has made us all, he will provide for us) is a problem.

Financial Reporting and Financial Engineering

Let me comment first on the relationship between financial reporting and financial engineering, and then on government accounting.

For over seven decades we have worked on the assumption that writing accounting standards improves financial reporting, ignoring financial engineers who make a living out of finding ways around the written accounting standards. It may take them less than three hours to find a way around a standard that may have taken three years for standard setters to prepare. Standards affect only those who are willing to comply with them. This interplay between financial reporting and financial engineering was a fundamental issue in the creation of the financial crisis. For example, much of the securitization of sub-prime mortgages was motivated by desire to get debt off the balance sheet.

We can think of accounting in two quite different ways. One is as a satellite camera - which quietly photographs from a great distance and has no discernible effect on the images it records. The second is as a photographer paired with a model, where the model smiles and poses for the camera. We may want accounting to be like a satellite camera but it has a reflexive relationship with what it records.

There is a large gap between what standard setters can achieve and what they are expected to achieve. Social systems are so complex that it's unrealistic to expect anyone to have the knowledge and ability to design a better system. We need a better balance between the top-down imposition of standards and bottom-up evolution of accounting practice, and between dependence on rules and dependence on judgement. Over the past 70-plus years we have moved from almost total dependence on judgement to almost total dependence on written rules. The British idea of a "˜true and fair' override would help improve financial reporting.

As the crisis has moved on from banks to governments, it is worth thinking about government accounting. Just as it is difficult to stop corporate CFOs from manipulating earnings, civil servants have little power to refuse to manipulate government accounts if they are told to by the politicians. Disciplining sovereign states for poor accounting - think of Greece and its problems - is a major challenge for accounting, and it seems to be a largely unaddressed aspect of the current financial crisis.

Dealing with the Too-Big-to-Fail

Can we hope that, in dealing with the  crisis in financial markets, US government has dodged a bullet without inadvertently lighting the fuse to fire a canon ball?

Bear Stearns was judged to be too-big-to-fail because the hard-to-predict network effects of such a failure would have been potentially devastating to the US and possibly the global economy. Therefore, the government arranged a takeover of Bear Stearns by J.P. Morgan Chase and subsidized it with taxpayer money and guarantees.

Having swallowed Bear Stearns, J.P. Morgan has grown. If either of them was too-big-to-fail then, the consequences of letting the combined entity fail would be even less acceptable.

The wizards who run and oversee the financial system permitted creation and growth of, and risk taking by private financial institutions which they knew could fail, but could not be allowed to. Then, at the brink of failure, they combined them into larger institutions subject to the same risk and logic, only at a bigger scale. This is postponing the day of reckoning with compound interest.

After a year of crisis, the world financial system is rapidly consolidating into a handful of US, European and Asian giants such as Bank of America and J.P. Morgan Chase.  In what sense, and for how long will these firms and the economy remain private and capitalistic if they can walk away with their profits, and dump their bad bets  on taxpayers?

The financial private sector can be protected from progressive nationalization by placing limits on the size of firms. Too-big-to-fail, instead of absolute size, can serve as a natural bound on how far private financial institutions are allowed by regulators to grow through organic growth, mergers or acquisitions.

The traditional rationale for intervening in the size of firms has been antitrust "to limit power and promote competition in product markets to promote economic efficiency. Government bailouts of giant financial institutions in order to safeguard the domestic and the global economy suggest another new criterion for reviewing proposed mergers and acquisitions: Will a proposed merger or acquisition create an entity which the government (US Federal Reserve System, US Treasury, European Union, or national governments in Europe as the case may be) will feel compelled to save from failure for the fear of its domino effects? If the answer to this question is yes, the proposal should be disallowed to reduce the chances that the government may have to intervene at some time in the future to save the larger combined firm.

Under this arrangement, the Federal Reserve and Treasury will review all merger and acquisition proposals to certify that they will not result in an entity that is too big to fail.

Since firms could also grow organically, the legislature could require an annual certification from the Fed and Treasury that no firm in the financial sector (defined as banking, investment banking, insurance, mutual, hedge and pension funds, and brokerage) is too big to fail. If a firm is found to have crossed that threshold, it would be required to divest itself in the manner of antitrust enforcement.

Will this leave the European and Asian giants free to crush the American pygmies in the global market place? EU, Japan and China will have to decide for themselves if adopting a similar policy to save the private financial institutions, and reaping the benefits of their efficiency, is in their best interest.

Placing the responsibility of such reviews on the Fed and the Treasury will create an incentive compatible system for these regulators; they would not be able to rush to Congress and the public exchequer when a financial firm is about to go belly up. US Congress will soon consider legislation to commit public funds to save the financial sector. This is also the only time the legislation to limit the size of financial firms can possibly be passed as a part of a rescue package. Ones the public money hss been committed, pressures from the industry lobby will make it all but impossible to achieve this end.

The short-term solutions to the current financial crisis carry the risk of setting us up for even more severe problems later. The time for establishing a mechanism to limit on the size of financial firms to protect the financial system and the public exchequer is now.