has forged a broad consensus : financial markets are not always efficient. they do not always use the available information in such a way as to correctly value the assets that are exchanged between financial market participants. recent experience has shown that there is a natural tendency to underestimate risk when markets are euphoric and to overestimate risk during crises. these behaviours are derived from the incentive that the market participants have to maximize the return on capital employed, on their own account or on behalf of their clients. there is now a large body of literature that explains why, even with rational agents, markets cannot be efficient at the aggregate level, and in particular give rise to speculative bubbles. 1 the reforms of the financial system that are currently under discussion in the various bodies that report to the g20, like the basel committee, the financial stability board and the imf are intended to establish or strengthen existing rules that reduce pro - cyclical behaviour, for example, through the banks ’ capital requirements, accounting rules, the mechanisms that determine managers ’ remuneration, the specific constraints on major financial institutions. the effectiveness of the new rules and of the supervisory authorities that will implement them will depend on their ability to affect the incentives of individual market participants and financial institutions. some have expressed misgivings about it, because it is difficult to change the incentives of financial market participants. some people think that crises are inevitable in advanced financial systems. as alan greenspan, the former chairman of the us federal reserve, remarked : “ the crisis will happen again but it will be different. crises are all different, but they have one fundamental source. that is the unquenchable capability of human beings when confronted with long periods of prosperity to presume that it will continue. ” 2 in other words, financial crises are part and parcel of our society. the question is whether human nature can and wants to change in order to prevent crises like the present one from recurring. on the one hand, it is to be hoped that the current experience will push the financial community to exercise greater caution in future, especially in risk assessment. on the other hand, the incentives to resort to behaviours like those that preceded the crisis are so ingrained as to constitute an obstacle to change. in particular, it is difficult for an individual market participant to act in an anti - cyclical way, that is, to go against market trends, if the valuation parameters are based on the average trend of the market. during favourable market phases,

lorenzo bini smaghi : lessons of the crisis – ethics, markets, democracy speech by mr lorenzo bini smaghi, member of the executive board of the european central bank, at unione cristiana imprenditori dirigenti ( ucid ), milan, 13 may 2010. * * * the events of recent weeks, particularly the greek crisis, show that the period of economic and financial instability which began almost three years ago is not over yet. the first phase of that instability, starting in august 2007, occurred mainly on the financial markets, ranging from the money markets to the stock markets. with the failure of lehman brothers in september 2008, the crisis spread to the real economy, causing trade, consumption and investment to fall worldwide. the economic policy authorities have tackled the recession with massive injections of funds to support the economy. public deficits have risen to unprecedented levels, driving up the debts of all the industrialised countries : the international monetary fund has described the current situation as a “ wartime debt, without a war ”. we have moved into the third phase of the crisis in which the financial markets have begun to question the sustainability of economic policies, in particular as regards public finances and, consequently, the sustainability of the economic recovery itself. this third phase of the crisis has hit europe first. financial markets consider, rightly or wrongly ( in my view more the latter, but i won ’ t dwell on that point ) that in countries where there is a perfect overlap between the monetary and fiscal authorities the risk of insolvency is limited because the central bank can print money and create inflation to reduce the burden of public debt. however, the euro area, which cannot monetise its debt, has to tackle the problem immediately and ensure that each country is solvent without a monetary contribution. if the euro area is able to overcome the current difficulties and restore its public finances in time, it will exit from this “ public ” phase of the crisis before others. the crisis, in its later stages, has revealed a number of common issues to which, it seems to me, insufficient thought has been given, and even less action taken. at our last meeting, in october 2008, shortly after the collapse of lehman brothers, i examined the problems facing modern democracies in making decisions that require citizens to make short - term sacrifices for long - term gains. lehman brothers was left to go bankrupt, with devastating effects on the global economy because the us congress – under