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Central banks could learn more from experience

February 15th, 2010

My column from last week’s Fin, over the fold

Central banks could learn more from experience

The Reserve Bank of Australia is fifty years old, having been separated from the old Commonwealth Bank in 1960. The anniversary has been a happy event, given the Bank’s success in managing the Australian economy, at least since the ‘recession we had to have’. Through the Asian financial crisis, the dotcom boom and bust and the global financial crisis, Australia has enjoyed almost uninterrupted economic growth.

But the world as a whole has not done so well. As Janet Yellen of the Federal Reserve Bank of San Francisco observed at a symposium held in Sydney to mark the anniversary, a few years ago, central bankers in general would have been congratulating themselves on a job well done. Thanks to the adoption, in the mid-1980s, of inflation targets and ‘Taylor rules’ for setting interest rates, the world had entered a ‘Great Moderation’ in which the volatility associated with the business cycle had been tamed.

While few believed that the Australian experience (nearly twenty years without a recession) could be replicated, or sustained indefinitely, there was widespread confidence that the future was one of stability. With the Asian financial crisis and the dotcom boom and bust fading into the rear-vision mirror, calls for a ‘new global financial architecture’ were quietly forgotten. The handful of policy responses to the excesses of the 1990s, such as the Sarbanes–Oxley legislation in the US were derided as unnecessary over-reactions.

There was a similarly benign attitude to global macroeconomic imbalances, and to the massive growth in liquidity that sustained them. The ‘consenting adults’ school of thought held that, as long as growth in international indebtedness was driven

But, as Yellen observed, that was then. Now, with much of the developed world in deep recession, and the global financial system still on life support, the self-congratulation was more muted.

The key ideas that have debated policy debate since the 1970s were found wanting in the global financial crisis. The Great Moderation turned out to be an illusion. The idea that macroeconomic policy could be run on the basis of judicious interest rate adjustments was abandoned as policymakers resorted to massive purchases of fiscal assets and, in Australia and elsewhere, equally massive fiscal stimulus.

The efficient financial markets hypothesis, which provided the theoretical basis for deregulation, has been abandoned by all but its most dogmatic advocates. And the general belief that governments should keep out of the way and let markets do their work has been replaced by the recognition that in a crisis, governments provide the last line of defence against systemic collapse.

In attending the symposium, on the topic ‘What have policymakers learned over recent decades, and what needs to be reconsidered’, therefore, I was rather more interested in the second part of the question than the first. What, I wondered, did central bankers see as the key weaknesses in the theoretical and policy frameworks that led us into the global financial crisis, what policy responses to the crisis had worked well or badly, and what were the most promising new lines of thinking about the future?

On the whole, I was disappointed. The only issue that received serious reconsideration was the question of whether central banks should target asset prices. As RBA governor Glenn Stevens correctly pointed out, it’s misleading to phrase this question, in terms of the desirability of using interest rates to ‘prick asset price bubbles’. By the time an asset price bubble has emerged, policy has already failed and all the options are bad ones.

For a central bank with only one instrument, interest rates, the implication is that rates should be raised early in the business cycle, before asset price inflation has a chance to get going. That’s a reasonable judgement, and Jean- Trichet of the European Central Bank engaged in some justified preening at the expense of critics of the ECB’s similar tightening. There was also some discussion of ‘open mouth’ operations of the type undertaken by former RBA governor Ian Macfarlane in the early 2000s when he warned housing investors not to count on ever-rising prices.

But surely the deepest global recession, since the 1970s, and on some measures since the 1930s, calls for a bit more reconsideration than that. As long as we combine unrestricted financial innovation with an effective guarantee that no systemically important firm will be allowed to fail

On the contrary, the main message from Trichet was ‘…’

The handful of policy responses that might make a serious difference to the operations of the financial system were dismissed the panelists. Proposals for a tax on international financial transactions, first put forward back in the 1970s by Nobel laureate James Tobin, are finally on the global policy agenda, but they got no support at the symposium. Although there was general agreement that financial market outcomes were far away from those predicted by the efficient markets hypothesis, and that huge transaction volumes were part of the problem, the Tobin tax was rejected because ‘it would impede market efficiency’.

Paul Volcker’s proposals to separate the ordinary financing activities of the publicly guaranteed banking system from the speculative ventures of hedge funds and investment banks received similarly short shrift.

Coming out of the symposium, it was clear that the lessons of the 1970s and 1980s had been learned well, perhaps too well. By contrast, it seems that little or nothing has been learned from the failures of the past decade.

John Quiggin is an ARC Federation Fellow in Economics and Political Science at the University of Queensland. His book, Zombie Economics: How Dead Ideas still Walk Among Us will be published by Princeton University Press later this year.

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  1. TerjeP (say tay-a)
    February 15th, 2010 at 22:27 | #1

    The anniversary has been a happy event, given the Bank’s success in managing the Australian economy, at least since the ‘recession we had to have’.

    I know I’m splitting hairs but does it really “manage the economy”? I thought it just regulated the value of the dollar by modifying supply and provided some prudential oversight of banks. Admittedly a job that if done ought to be done well.

    The handful of policy responses that might make a serious difference to the operations of the financial system were dismissed the panelists. Proposals for a tax on international financial transactions, first put forward back in the 1970s by Nobel laureate James Tobin, are finally on the global policy agenda, but they got no support at the symposium.

    I suspect it would make a difference. However your not clear about how it would make a difference and whether all things considered it would be a good type of difference. Can you ellaborate.

    Paul Volcker’s proposals to separate the ordinary financing activities of the publicly guaranteed banking system from the speculative ventures of hedge funds and investment banks received similarly short shrift.

    I think this is worthy of wider debate even though I oppose government guarantees. I think the notion of a risk free investment that pays interest is deeply problematic. Risk free investments should entail demurrage not interest. A risk free return that is positive leads us to discount the future far more than we ought to.

  2. been there
    February 16th, 2010 at 06:28 | #2

    No, APRA does the prudential oversight. Just as well. You don’t want the institution doing that getting distracted by other things like monetary policy.

  3. February 16th, 2010 at 07:29 | #3

    Pr Q said:

    Proposals for a tax on international financial transactions, first put forward back in the 1970s by Nobel laureate James Tobin, are finally on the global policy agenda, but they got no support at the symposium. Although there was general agreement that financial market outcomes were far away from those predicted by the efficient markets hypothesis, and that huge transaction volumes were part of the problem, the Tobin tax was rejected because ‘it would impede market efficiency’.

    Nothing will change until the public feels sufficient pain to get “mad as hell and not going to take it anymore”. And until the bankers are so up to their armpits in debt that they cannot afford to bribe political and industrial elites to wink at their institutionalised scams, rorts and rip-offs.

    “Financialism” is a form of economic parasitism that has evolved to exploit gainful opportunities presented by globalisation and technologisation of money making. What is needed is a institutional (not individual) purge of the financial system. Nothing short of root and branch annihilation of this viral infestation will keep the patient clear and avoid relapse.

    THe “huge transaction volumes” of financial market churn are causing massive inefficiency, instability and inequity. Therefore any policy that slows down churn will, for sure, “impede market efficiency”. It follows that this impedance is a feature, not bug, of Tobin Tax.

    We are dealing with rent seekers whose only desire is to lather, rinse and repeat the cycle ad infinitum. Anything that throws sand in the wheels of financial commerce has got to be a good thing.

    I’ve been boosting for a Tobin tax ever since LTCM in 1998. But all I ever get is a blank stare of incomprehension.

    More generally the problem here is one of politics, not policy. Here I follow Chernyshevsky’s rule, “the worse, the better”. (Brutal behavioural conditioning worked for Nazi Germany and Nippon Japan, after a couple of nukes and fire bombings they knew better to “not go there”.)

    The only thing that will change banker behaviour sufficiently is a massive bout of pain. How to hurt a banker is to make them bankrupt. That means that we should have bit the bullet and let the “too big” bank fail. This would have bought on a Great Depression, but its going to happen one day anyway.

    It would also have created a vengeful public and weakened the bankers political suction by draining their slush funds.

    At that stage there would have been a niche for an honest politician to re-regulate and re-nationalise rogue financial institutions (which in this case is pretty much all of Wall Street). That is how the banks were brought under control by FDR after 1933. (Note he let them dangle in the wind for months after his election, then stuck a fork in them.)

    Instead policy wonks have saved the bankers bacon. The fiscal stimulus and financial bailouts worked all to well, or well enough, to pull the bankers chestnuts out of the fire.

    So now the bankers think its a return to (risky) Business As Usual. Hence their nonchalant ease with which they award themselves obscene bonuses for a job ill done.

    Where’s the outrage? Obama suggests that Lloyd Blankstein of Goldman Sachs is a “savvy businessman”. I’m sorry, but he lost me there.

    There is no hope for financial reform until we get to the no-hoper stage.

  4. February 16th, 2010 at 07:40 | #4

    Pr Q said:

    Paul Volcker’s proposals to separate the ordinary financing activities of the publicly guaranteed banking system from the speculative ventures of hedge funds and investment banks received similarly short shrift.

    And what would he know. I mean the guy only managed to restore the US’s industrial system to something resembling its former glory. In the space of a few years, in concert with Reagan, Volcker brought down both unemployment and inflation from double digit to low single digit values.

    That set the stage for a return to relatively high economic growth for the next twenty years or so.

    But of course Volcker’s performance has been written out of the history books. Whilst everyone treated Greenspan (who inherited a sound economy) as a rock star.

    Even though Greenspan did have the decency to finally say “I was wrong”.

  5. TerjeP (say tay-a)
    February 16th, 2010 at 08:11 | #5

    Jack – I think the big banks should have been allowed to fail. However I don’t believe it would have lead to a great depression. Other banks would have soon emerged from the ashes and everybody would be more careful in future (for a while at least).

  6. Chris Warren
    February 16th, 2010 at 08:42 | #6

    A Tobin tax is one of the most desirable of all reforms to protect the welfare state.

    If international banks can simply charge me whopping fees when I use an ATM or exchange currency, why cannot I charge banks even the smallest fee when they transfer money?

    If Tobin is so bad, why do we have huge bank fees?

  7. Tim Peterson
    February 16th, 2010 at 10:46 | #7

    As far as puncturing asset price bubbles with monetary policy goes, Milton Friedman and Anna Schwartz’s research showed that this is what the Fed was doing in 1928, causing the initial phase of the great depression (eg before the collapse of the banking system). Monetary base contracted in 1928-29 and interest rates were high. The Fed did this again in 1938 when stock prices recovered, causing a relapse into depression for over a year. Taken together with the tightening of monetary policy in 1931 at the height of the depression, the Fed both caused and prolonged the depression.

    There has to be a better way of dealing with bubbles; the Hunt brothers bubble in silver in 1980 was brought down with a margin call on futures contracts.

  8. Michael
    February 16th, 2010 at 11:14 | #8

    @Jack Strocchi
    @TerjeP (say tay-a)

    This is an interesting speculation. Has there ever been a smooth large bank failure before? Would a large bank failure have caused other banks to fail? If a big bank had been rumoured to be on the brink would accurate information travel fast enough through the market for people to make rational decisions or would panic have prevailed? Would the state have been able to step in to maintain supply? How many individuals or business have diversified banking arrangements to see them through a bank failure?

    I have long thought that the idea that the big retail banks in Australia wouldn’t be rescued to be a nonsense only an economist could believe. We would need an entirely different banking system for this to even approach reality – maybe a good thing but I don’t see any evidence we could or would move to such an arrangement.

    I’m aware there a various alternative scenario’s in history but I wonder how many provide a realistic comparison to the current world where information, accurate or not can get around pretty fast. Certainly it seems a gross injustice that the culprits were not only saved supposedly to save the rest of us, but are back to business as usual.

  9. Jim Birch
    February 16th, 2010 at 11:15 | #9

    A few of questions re a Tobin tax:

    Could a country institute it unilaterally?

    What would be an appropriate level?

    Would an rate that escalates with volume be practicable and useful? It seems to me that ideally you’d want to allow trading and adjustments but clobber anyone participating in a run. OTOH this might create a new crowd gaming the differential rates.

  10. David C
    February 16th, 2010 at 11:15 | #10

    By the time an asset price bubble has emerged, policy has already failed and all the options are bad ones.

    This argument seems to be suggesting that asset bubbles are almost instantaneous and cannot be predicted. This appears to me to be misleading on two counts.

    Firstly I am certain that the data would show that it took nearly a decade for house prices to reach the stratospheric levels they are now at in Australia. To be more precise, if you look at the graph titled “Real House Prices and Real Incomes” in this post by Steve Keen, it shows two distinct bubbles between 2001 and 2003 and 2006 and 2008 (inclusive). It would have been clear by the end of 2002 and 2007 that asset bubbles were developing.

    Alan Greenspan’s proclamation that there was no general house price bubble in the US would lead the cynic in me to believe it was more of a case of feigning ignorance.

    On the second point, even if we cannot predict when asset bubbles will occur, and even if raising interest rates after the horse has bolted seems unpalatable, the mere threat of it should keep borrowers and lenders in check. If central banks don’t do it every now and then everyone gets use to it and the threat no longer exists.

  11. Chris Warren
    February 16th, 2010 at 12:06 | #11

    @Jim Birch

    A rich country, focusing on trade with China, can institute it unilaterally on outward flows.

    A poor country desperate for trade and investment from OECD economies cannot institute unilateral FX taxation.

    The level just needs to be low – around transaction costs, or the normal fee levels banks currently charge for FX.

    For more information see: “The Tobin Tax – Coping with financial volatility” ed Haq, Kaul, Grunberg, OUP, 1996.

  12. Chris Warren
    February 16th, 2010 at 12:09 | #12

    @Jim Birch

    Is there any evidence of groups currently gaming bank fees?

    When banks put up fees and rates, do the ‘friends-of-capitalism’ challenge this with vague threats of gaming?

    Seems odd.

  13. Jim Birch
    February 16th, 2010 at 12:45 | #13

    @Chris Warren
    Chris, I was saying that if you didn’t have a flat rate but a rate that adjusted – either via controls or automatically – then there would be a potential for a “get your AUDs here now before the new rate kicks in” situation. The tax would be aiming to introduce more friction into the system not create a new financial service.

  14. Fran Barlow
    February 16th, 2010 at 13:09 | #14

    @Jack Strocchi

    I’m inclined to agree with Jack, without taking a view on the “Tobin Tax” issue. I very much doubt Obama’s winning prospects would have declined after September 15 2008 if he’d simply said nobody is too big to fail, but there are millions of Americans who are too small for us not to give them a helping hand, and refused to approve bailouts. Indeed, the Republicans would have been on the wrong end of a massive wedge and by the time February 2009 rolled around, Obama could have had a position in which he could have reformed the banking sector rules, lifted standards of corporate governance and positioned the Republicans as entirely responsible for the problem and looking to save corporate shills from moral hazard for essentially ideological reasons.

    Obama could then have carried out sweeping reform not only of banking, but the health sector as well. He could have restructured auto at a fraction of the cost. Public housing would be back on the agenda and he could have called the whole thing “rebuilding America” just to annoy the Republicans.

  15. Michael
    February 16th, 2010 at 13:23 | #15

    @Fran Barlow
    I ask this out of ignorance because I’m not an economic historian – has there been any recent precedent for letting the banks fail that didn’t end painfully for the average person? I’m not in anyway defending the banks, or their rescuing, just genuinely curious to know if this could have been done in a why that wouldn’t have been too disruptive.

    I am personally sympathetic to the idea of separating retail banking or utility banking from casino banking. If we took the other direction of letting the banks look after themselves with no bailouts – presumably they would be smaller and the public would also not follow the current practise of putting all their eggs in one basket also. Wouldn’t that just be a pain in the arse and inefficient having to look after multiple accounts.

    If you believe the system is broken, how do you go about fixing it without causing mass disruption that in my opinion is just as likely to end with extreme politics as it is in a sensible resting of power away from the banks.

  16. Andrew
    February 16th, 2010 at 14:01 | #16

    Fran Bailey – “I am personally sympathetic to the idea of separating retail banking or utility banking from casino banking”

    This is part of the problem – a complete lack of understanding of what investment banking is about. It’s not all ‘casino banking’ – in fact a very small part of investment banking is ‘casino banking’ – by which I assume you mean speculative trading activities?

    Investment banking is predominantly about being the middle man between providers of capital and users of capital. Investment banks play a vital role in ensuring efficient allocation of capital. Investors need investment banks to be able to invest in projects/companies with strong returns and corporates/governments need investment banks to be able to tap equity and debt capital markets.

    JQ – perhaps you’ll have to rename your book? Maybe something like – “Phoenix Economics, How dead ideas have risen from the ashes”

  17. Michael
    February 16th, 2010 at 14:25 | #17

    @Andrew
    I used the term casino banking because much of the behaviour that caused the GFC wasn’t involved in playing a “vital role in ensuring efficient allocation of capital”. Maybe it is unfair to brand all activities of investment banks as speculative trading activities. Either way there is a enough substance in the association to let stand. Apologies to those investment bankers whose conduct was as pure as the driven snow. Perhaps sure some of their names so we can give them their due recognition.

  18. Michael
    February 16th, 2010 at 14:26 | #18

    “PPerhaps sure some of their names” was meant to be
    “Perhaps share some of their names”

  19. sdfc
    February 16th, 2010 at 14:34 | #19

    @Michael

    Michael the answer to your question is no there isn’t. In fact for the US the 1930s is a fine example of the pitfalls of such a policy.

  20. Peter T
    February 16th, 2010 at 14:40 | #20

    The system seems extraordinarily resistant to change – or even to recognising the need to change. Even when the Great Moderation was in full flower, there were serious underlying issues that noone paid attention to – like the decreasing link between productivity and wages, and the accompanying rise in debt, best seen in the US.

    Elizabeth Warren has a nice summary here:

    http://www.huffingtonpost.com/elizabeth-warren/america-without-a-middle_b_377829.html

    I would like to know if her figures are generally agreed with. If they are, the US would seem to have been papering over the rot for decades, and is still doing so. This sense of the GFC being just the last straw seems to drive a mood of revolt in the comments seen on that post – and on the BBC’s Stephanomics blog – are.

    A detached commentator might note that surely this is hard to reconcile with any view of humanity as broadly rational, given that the turkeys have repeatedly voted for Christmas.

  21. smiths
    February 16th, 2010 at 14:49 | #21

    ahh central banking, what a gas,
    The exciting race to become the ECB’s next president is down to two men: Axel Weber and Mario Draghi
    Draghi joined Goldman Sachs in January 2002 as Managing Director, Vice Chairman of Goldman Sachs International, and member of the “Group’s Commitment Committee”;
    his job,
    was to “help the firm develop and execute business with major European corporations and with governments and government agencies worldwide.”
    Goldman helped Greece create a series of agreements with banks that it may have used to conceal mounting debt
    did Greece lie its way into the EU?
    Goldman could be blacklisted from working with eurozone governments for the foreseeable future
    Mario Draghi, Was he aware of the Goldman-Greece deal?
    Did he or his associates engage in any such transactions for Italy when he was at the Ministry of Finance?
    And the US government economics team is virtually Goldman Sachs
    Otmar Issing, a former senior European Central Bank official, came out strongly today against any kind of rescue package for Greece
    but guess what he forgot to mention …
    he is an adviser to Goldman Sachs
    wowee
    almost makes me wish we had Turnball running for Prime Minister, formerly of Goldman Sachs

  22. Chris Warren
    February 16th, 2010 at 15:06 | #22

    Jim Birch :
    @Chris Warren
    Chris, I was saying that if you didn’t have a flat rate but a rate that adjusted – either via controls or automatically – then there would be a potential for a “get your AUDs here now before the new rate kicks in” situation. The tax would be aiming to introduce more friction into the system not create a new financial service.

    Ok but I thought I covered off this by having a rate low near transaction costs. Whatever you gain through this gaming – you loose most through transaction costs plus the new Tobin tax.

  23. Chris Warren
    February 16th, 2010 at 15:06 | #23

    Jim Birch :
    @Chris Warren
    Chris, I was saying that if you didn’t have a flat rate but a rate that adjusted – either via controls or automatically – then there would be a potential for a “get your AUDs here now before the new rate kicks in” situation. The tax would be aiming to introduce more friction into the system not create a new financial service.

    Ok but I thought I covered this by having a rate low near transaction costs. Whatever you gain through this gaming – you loose most through transaction costs plus the new Tobin tax.

  24. Andrew
    February 16th, 2010 at 16:22 | #24

    “Apologies to those investment bankers whose conduct was as pure as the driven snow. Perhaps sure some of their names so we can give them their due recognition.”

    well ‘pure as the driven snow’ may be a high hurdle (for anyone – not just investment bankers!) – but I’d suggest the vast bulk of employees at Goldmans, Morgan Stanley, JP Morgan, Citi, Deutsche Bank, UBS, RBS, Macquarie etc etc are motivated by exactly the same things that motivate the vast bulk of people who head off to work each day. Labelling them all as ‘casino bankers’ is not only simply wrong, it also shows a complete lack of respect and understanding of what an investment banker does.

    It’s symptomatic of the generally uninformed view of what caused the GFC – it’s just all too easy to blame a pack of greedy, rapacious investement bankers heh?

    The GFC originated in the US sub-prime crisis…. toxic debt from the lax lending practices in the US clogged up the banking system because the banks were all too scared to take on counter-party risk…. the safety valve came with government bail-out of the toxic debt positions and credit guarantees… that got the investment banks lending again and the system recovered.

    The globe recovered because the investment banks started working properly again!

  25. Michael
    February 16th, 2010 at 17:56 | #25

    Andrew :
    I’d suggest the vast bulk of employees at Goldmans, Morgan Stanley, JP Morgan, Citi, Deutsche Bank, UBS, RBS, Macquarie etc etc are motivated by exactly the same things that motivate the vast bulk of people who head off to work each day. Labelling them all as ‘casino bankers’ is not only simply wrong, it also shows a complete lack of respect and understanding of what an investment banker does.

    OK – lets agree that there are shades of grey. Not all investment bankers are bad.

    it’s just all too easy to blame a pack of greedy, rapacious investement bankers heh?

    Yep. Bankers were a big part of the problem and the inability to seperate the utility side of the banks meant governments were more inclined to rescue them. Banks are different from other types of businesses. The banks know this, the government knows this and the banks have been active in lobbying the US government and lawmakers for changes in regulation.

    the safety valve came with government bail-out of the toxic debt positions and credit guarantees… that got the investment banks lending again and the system recovered.

    Thank goodness for governments being there to step in when the market gets itself in a muddle. I think Dr Paul Woolley asked an interesting question
    “But the reality seems at odds with received wisdom and the predictions of economic theory. By most measures finance has become the dominant industry sector accounting, for example, for between 30% and 40% of the aggregate profits of the quoted corporate sector in the US, UK and globally, compared with only around 10% forty years ago. What model can explain its dominance? It seems strange that an industry whose role is that of intermediation rather than the production of consumption goods and services should command such a high share of capital, profits and brains. Is it a coincidence that the industry whose role it is to allocate resources, retains the biggest share for itself?”
    http://www.abc.net.au/rn/bigideas/stories/2008/2149972.htm

  26. February 16th, 2010 at 18:49 | #26

    @Michael
    “It seems strange that an industry whose role is that of intermediation rather than the production of consumption goods and services should command such a high share of capital, profits and brains.”

    Perhaps the level needs examining, but the change should be uncontroversial. Middlemen in their various forms produce information, and we live in an information age. Growth in their influence should cause no perplexity.

    “Is it a coincidence that the industry whose role it is to allocate resources, retains the biggest share for itself?”

    Woolley (and others) are right to raise this issue (though I’d disagree with the quantification). Financial companies are taking too big a slice of the pie, IMHO. Unfortunately, politicians and public bureaucracies are unnecessarily complicit in this, as exemplified by your comment: “Banks are different from other types of businesses. The banks know this, the government knows this and the banks have been active in lobbying the US government and lawmakers for changes in regulation.”

  27. TerjeP (say tay-a)
    February 16th, 2010 at 19:46 | #27

    We have had very few bank failures in Australia During the great depression (one I think). And even then I think depositors got most of their money back eventually. EconTalk discussed this recently and notes that the problem in the US banking system had a lot to do with a lack of bank diversification (due to branch regulation) and a high dependency between individual banks and individual industries. As trade sanctions hit particular export industries (via Smoot Hawley and responces) the associated banks took a hit. Australia for all it’s problems avoided most of this. From memory so did Canada. I’ll dig up a link to the talk and post it.

  28. TerjeP (say tay-a)
    February 16th, 2010 at 20:00 | #28
  29. Peter T
    February 16th, 2010 at 20:34 | #29

    See this report by Andrew Haldance of the Bank of England:

    http://www.bbc.co.uk/blogs/thereporters/robertpeston/2009/07/why_bankers_arent_worth_it.html

    The salient point:

    “Since 2000, rising leverage fully accounts for movements in UK banks’ ROE [return on equity] – both the rise to around 24% in 2007 and the subsequent fall into negative territory in 2008.”

    In other words, any gain in rewards to banks in that time – and they were very substantial – was a direct transfer from other parts of the economy. If they were being rewarded for their role as information providers – well, they seem to have kept none for themselves.

  30. Alice
    February 16th, 2010 at 21:44 | #30

    @TerjeP (say tay-a)
    Terje

    “We have had very few bank failures in Australia During the great depression (one I think).”

    According to this paper more than 9000 banks failed in the US during the Great Depression. I would find it surprising of only one bank failed in Australia. Do you have any evidence for your view that only one failed in Australia?

    http://cama.anu.edu.au/Working%20Papers/Papers/2009/Lee_Sanning_Shaffer_162009.pdf

  31. TerjeP (say tay-a)
    February 16th, 2010 at 22:21 | #31

    A quick google throughs up this source:-

    http://fsgstudy.treasury.gov.au/content/Davis_Report/04_Chapter2.asp

    2.3 Australia’s early experience with failure is punctuated by a number of important episodes. The banking sector throughout the nineteenth century experienced considerable turbulence and numerous bank failures. Key events included the 1826 liquidity crisis and the depressions of the 1840s and 1890s.3 The twentieth century was less volatile with just three Australian banks suspending payment. The last bank failure in which Australian depositors lost money (and then only a minimal amount) was that of a trading bank, the Primary Producers Bank of Australia, in 1931 (Fitz-Gibbon and Gizycki 2001). Since the early 1930s, banking sector problems have been resolved without losses to depositors.

    The EconTalk does talk about some of the unique characteristics of US bank regulation that helped ferment such wide spread failure. It is a long talk but I think it is well worth it.

    http://www.econtalk.org/archives/2010/01/rustici_on_smoo.html

  32. Alice
    February 16th, 2010 at 22:32 | #32

    @TerjeP (say tay-a)
    Terje – I only have one minor problem with the view that “if only one bank failed in the Great depression” then Australia must have been travelling OK and our financial policies were sound.

    The real problems now well recognised in Australia’s approach to the Great depression was that the banks, under tha advice of the fiscally conservative Sir Otto Niemeyer and teh Melbourne agreement were in fact protected and a regime of austerity measures imposed on the people…such as the insistence on balancing the budget if it meant higher taxes, lower welfare payments and cuts in public expenditure and public sector salaries.

    Many would take the view that the Australian banks were protected during the Great Depression but the people were not (and after all …Britian really didnt want Australia defaulting on its debts and that, it would seem, came first in policy).

  33. TerjeP (say tay-a)
    February 17th, 2010 at 05:55 | #33

    Attack deleted – nothing more like this please Terje. Alice, please stick to 1 c/t/d

  34. Michael
    February 17th, 2010 at 07:10 | #34

    @TerjeP (say tay-a)
    Thanks for the link. Perhaps after the dust settles there should be a more explicit stating of what is and isn’t guaranteed in the long term. I personally would like to know where I stand. I still believe there is a role for utility banking given that everyone is more or less expected to have a bank account whether you want one or not, and not everyone can be realistically expected to be in a position to construct personal hedging strategies.

  35. Andrew
    February 17th, 2010 at 08:29 | #35

    Michael “Yep. Bankers were a big part of the problem and the inability to seperate the utility side of the banks meant governments were more inclined to rescue them”

    Michael – there is no doubt that some of the products that investment bankers generated were a contributor to the scale of the GFC. I’m sure most buyers, sellers and intermediaries in ythe CDO market really had no idea of the real risks in the product. There is also merit in a review of whether we should separate (or at least make transparant) aspects of investment banking – more so than the Chinese walls that exist today.

    But it’s a big stretch from there to say that investment banks caused the GFC. As I stated above, the GFC was born from the sub-prime crisis in the US. That was caused by lax lending practices in the US. I’m sure it was all well intentioned – but the ‘utility’ banks were all being encouraged to lend money to people who really shouldn’t have been borrowing it. All well and good while houses prices kept rising – but once that bubble started deflating, a whole lot of battlers in search of the American dream woke up to a mortgage nightmare.

    Thankfully in Australia – we never got to the point where we pressured the banks into lending to anyone just because we wanted to share the home ownership dream around.

    So at its heart – the GFC was started in ‘utility’ bank land – not ‘investment’ bank land.

  36. Michael
    February 17th, 2010 at 09:05 | #36

    Andrew :
    But it’s a big stretch from there to say that investment banks caused the GFC.

    ok – I don’t think I said that investment banks were the sole cause of the GFC. You seem to have read a lot into my use of the word casino banking. BTW I’m aware of the complexity of the crisis.

    but the ‘utility’ banks were all being encouraged to lend money to people who really shouldn’t have been borrowing it. All well and good while houses prices kept rising – but once that bubble started deflating, a whole lot of battlers in search of the American dream woke up to a mortgage nightmare.
    Thankfully in Australia – we never got to the point where we pressured the banks into lending to anyone just because we wanted to share the home ownership dream around.

    I didn’t qualify my remarks sufficiently but I think you paint a rather simplistic account of the involvement of the investment banks and the drive to offer subprime loans. I agree that utility banks were involved, but they weren’t behaving as utility banks should IMHO, blurring the line between investment banks and retail banks.

    I admit I’m not an expert in investment banks but have read enough to know their involvement was not benign or limited to only misconstruing the risks associated with CDO’s.

    “In a landmark case this month, Goldman Sachs Group, a Wall Street investment bank involved in the subprime lending crisis, was held accountable for its actions.  The bank agreed to pay up to $60 million to stop an investigation into its lending practices.  Up to $50 million of the settlement will go to homeowners with mortgages from Goldman Sachs affiliates to allow them to reduce the principal on their mortgages by as much as 50 percent.
    ……..
    The settlement is a major victory for homeowners in Massachusetts.  While the 714-home case represents a mere drop in the bucket of the mortgage crisis, the settlement sets an important precedent.  With Goldman Sachs now held accountable for its role in predatory lending practices, other investment banks may soon follow.”

    from http://www.examiner.com/x-10213-Soulful-Leadership-Examiner~y2009m5d20-Goldman-Sachs-investment-bank-held-accountable-for-subprime-lending

  37. Fran Barlow
    February 17th, 2010 at 10:56 | #37

    @Andrew

    Fran Bailey – “I am personally sympathetic to the idea of separating retail banking or utility banking from casino banking”

    You get my name wrong and then attribute someone else’s remarks to me.

    As the cricket comms would say oh what a disappointing start! He’s walking away to square and shaking his head at how carelessly he played at that one ….

    I don’t have a problem with delivering the functions of either retail or investment banking so I’m not sure what your point is.

    @Michael

    I ask this out of ignorance because I’m not an economic historian – has there been any recent precedent for letting the banks fail that didn’t end painfully for the average person?

    No, but we have a very limited data pool, so it’s not all that significant. It would be possible to set up rules of governance that would lower the risks both of bank failure and that would lower the blow to those depending one way or another on their services and then “allow” banks to fail. The problem in the US was that de facto or de jure the context in which banks, especially the investment banks operated in the US from about 1999 weakened the protections and skewed bank trading policy in favour of more unfunded (and sometimes unevaluated) risk. That, combined with US administration policies that pushed underqualified borrowers out into the market was the driving factor in the GFC. So much was obvious from the early 2000s and pretty much a slow motion disaster in progress from about August 2007.

    It would have been possible to allow banks to collapse while protecting residency for home occupiers. It would also have been possible to acquire bank and other assets in the firesales that followed and set up state-based retail banking services in parallel.

  38. Peter T
    February 17th, 2010 at 11:08 | #38

    Andrew

    That’s one reading – and one the the financial community would like to see accepted. It does, after all, put some of the blame on the silly people who took out mortgages they could not afford. But the crisis had deeper roots, and another immediate cause.

    Wages have been pretty flat in the US since the 70s, but the costs of being in the middle class (health care, college, housing) have been rising. So the financial sector solution was lending, increasingly packaged to disguise risk through securitisation. Utility banking products onsold through investment banking. This had to come unstuck at some point.

    The GFC was a crisis of interbank lending when the banks realised they could not trust each other to pay for the garbage they had been sold. A bit like selling poison to the neighbours, and then realising that you can’t risk taking tea with them.

  39. Andrew
    February 17th, 2010 at 11:09 | #39

    Fran – Sorry! Got your name wrong and misattributed a quote all in one breath. My sincere apologies…. *tucks bat under arm and trudges off

  40. smiths
    February 17th, 2010 at 11:09 | #40

    my posts are dissappearing, whats going on?

  41. Andrew
    February 17th, 2010 at 11:23 | #41

    Peter T,

    Absolutely – agree with all that. Although I wouldn’t blame the ‘silly people who took out mortgages’. People will do what they can get away with. I blame the government and ‘utility’ banks for irresponsible lending practices.

    I particularly blame Clinton’s politically motivated changes to the Community Reinvestment Act to expand home ownership to people who shouldn’t have been borrowing. Clinton pressured Fannie Mae and Freddie Mac to loosen critieria such as credit histories and debt-to-equity ratios.

  42. smiths
    February 17th, 2010 at 11:27 | #42

    Andrew, who pressured Clinton to repeal Glass-Steagell?
    Is Citi a utility bank?
    Most intelligent commentators think investment banks and hedge funds have been predatory and engaged in fraudulent activities, not lax lending as you put it,
    Simon Johnson describes Goldman’s activities as “fundamentally destabilizing to the global financial system”

  43. Andrew
    February 17th, 2010 at 11:54 | #43

    Smiths…… I’m not denying that some investment banking practices contributed to the scale of the GFC. But to then label all investment banks as ‘predatory and fraudulent’ is stretching things.

    The investment banking products which ‘fundamentally destabilised’ the global financial system were simply products that spread risk – they didn’t actually create or mitigate any risk. The biggest problem with the spreading of risk is that no-one had any idea about how big the the US housing debt problem had become because it was spread so thinly across the globe. Manly council and Norwegian pension funds took on a tiny sliver of the US mortgage debt risk without understanding the full extent of the problem.

    The risk itself wasn’t created by the investment banks – it was created in the US mortgage market. If the investment banks hadn’t spread the risk around through their securitisation then there would still have been a sub-prime crisis – but it may well have happened earlier and been contained to the US market. The US government would have had to bail out Fannie Mae and Freddie Mac.

    Two key lessons –

    1) Banks shouldn’t be ‘encouraged’ to lend money to people who can’t afford it to meet a social policy agenda, and

    2) Securitisation of debt obligations is probably a bad idea – it just delays the inevitable reckoning and encourages bubbles to form. If the ‘utility’ banks weren’t allowed to spread their risk then perhaps they would have pushed back more on Clinton’s push for housing for all.

  44. Michael
    February 17th, 2010 at 11:56 | #44

    Andrew :
    Peter T,
    I particularly blame Clinton’s politically motivated changes to the Community Reinvestment Act to expand home ownership to people who shouldn’t have been borrowing. Clinton pressured Fannie Mae and Freddie Mac to loosen critieria such as credit histories and debt-to-equity ratios.

    I’m no doubt getting out of my depth here but….
    From Matthew Yglesias (http://yglesias.thinkprogress.org/archives/2008/09/blame_the_cra.php)
    “For one thing, the timeline is ludicrous. The Community Reinvestment Act was passed in 1977. Are we supposed to believe that CRA was working smoothly throughout the Carter, Reagan, Bush I, and Clinton years and then only under Bush II did overzealous anti-”redlining” enforcement come into play, perhaps a result of Dubya’s legendarily close relationship with ACORN? Or maybe overzealous enforcement back in the late 1970s is somehow responsible for a real estate blowout that only materialized 30 years later? It doesn’t even come close to making sense.

    Beyond that, the mere existence of “subprime” loans — i.e., mortgages given to less-creditworthy individuals at higher interest rates — isn’t the problem here. The problems have to do with what was done with the loans after they were packaged, sold and used to make leveraged plays.”

    Did the existence of subprime loans drive the CDO market or did the demand for CDO’s drive the subprime market?

  45. smiths
    February 17th, 2010 at 12:15 | #45

    The investment banking products which ‘fundamentally destabilised’ the global financial system were simply products that spread risk – they didn’t actually create or mitigate any risk.
    this is simply not true,
    throughout the 1990s numerous commentators and banking institutions including BIS and the US GAO wrote papers outlining concerns that OTC derivatives could produce a catastrophic market meltdown due to high concentration of dealers and extensive linkages
    in 1991 eight U.S. bank dealers accounted for 56 percent of the total worldwide notional (or contractual) amounts of interest-rate and currency swaps
    and what you describe as spreading risk was referred to in the case of Lloyds as a reinsurance spiral
    anyway, all attempts to regulate the ballooning derivatives market were stymied by the banks and their enablers like Greenspan,

    it might be possible to say now that people ‘thought’ these products spread risk,
    but to continue to say now that they ‘do’ spread risk is untenable,
    the evidence against is overwhelming

  46. sdfc
    February 17th, 2010 at 12:40 | #46

    @Fran Barlow

    Fran
    The data pool is significant. We’re not talking about rainfall here but rather historical episodes of financial collapse and the effect on the real economy. Your solution to allow banks to collapse and then set up state based retail banks is a little naïve to say the least. Letting an institution such as Citi or Bank of America just fold would send shock-waves through the financial system that would make the Lehman collapse look like a picnic. The only alternative to propping up these too big to fail banks is nationalisation.

    It’s quite fashionable it seems to blame Fannie, Freddie and the CRA for the subprime crisis, however I am yet to see any evidence that banks were “forced” into making imprudent loans on a mass scale. As for Fannie and Freddie, the following paper sheds some light on what was happening with new loan originations and who was making the majority of risky loans. This is not to absolve Fannie or Freddie of their role in the crisis however let’s not forget it was the profit motive of the US financial sector as a whole, fed on a diet of cheap money, that was at the heart of the crisis.

    In other words it was good old fashioned financial instability.

  47. sdfc
    February 17th, 2010 at 12:42 | #47
  48. Alice
    February 17th, 2010 at 12:43 | #48

    @smiths
    Smiths – I agree. If you read “inside the collapse of Lehman” – according to the author – a long time commodities trader with them, Lehman who bundled the CDOs and on sold them also owned / had financial interests in the lending institutions who promoted and retailed the loans to borrowers who could not afford them, all predicated on a continually expanding bubble in US house prices. They were packaged at teaser rates below market rates with reset dates in fine print but in addition borrowers were offered additional funds on top of the 100% loan eg 30 or 40K to buy furniture or a car or whatever else.
    They were marketed aggressively. It suited the retailer and it suited the wholesaler so to suggest that the large financial institutions acted indepedently of the “lax lending” utility financial firms that sold the loans on the ground is simplistic. Even without ownership, agency agreements would have ensured a river of commissions between them.

  49. smiths
    February 17th, 2010 at 12:57 | #49

    Barclays’ investors on Tuesday had their eyes firmly fixed on a financial performance that beat analysts’ expectations and saw the bank deliver record profits
    wow, record profits
    it takes a special kind of blindness to see what is plainly evident here,

    Central Banks, which are umbilically linked to private banks in most cases have learnt from experience,
    if you see their role as helping sovereign states manage their economies then it looks like they have learnt nothing,
    but if you see their role as aiding their mates at the private banks hoover up the middle class wealth of the world then they are masters at it,
    it is clear form Goldman, Morgan, Citi, Barclays, Deutsche etc etc that bankesr, whichever side of the revolving door they happen to be on at the time have learnt very well from the past, and a far smarter than most commentators give them credit

  50. smiths
    February 17th, 2010 at 12:59 | #50

    and by the way Andrew, Barclays profit tripled and the big driver was the Investment banking didvision,

    please explain to me how the investment banking division multiplies profits during the biggest downturn in a century

  51. Andrew
    February 17th, 2010 at 14:06 | #51

    smiiths – 2009 was a bonanza year for the investment banks as they helped corporates recapitalise their balance sheets. Debt is a dirty word post the GFC so the hot item in 2009 was equity raisings. Have a look at corporate Australia – bonanza years for equity raisings. That also just happens to be one of the highest margin businesses for investment banks who are prepared to underwrite the raising. Corporates are very happy to pay investment banks to give them equity raising certainty – a CFO’s worst nightname would be an under-subcribed equity issuance.

    Investment banks make money because they take a tiny tiny cut of a HUGE number

  52. smiths
    February 17th, 2010 at 14:22 | #52

    yes but where did all the money come from for these equity raisings?

  53. Andrew
    February 17th, 2010 at 14:37 | #53

    The money came from the investment community – which in Australia is probably roughly split – 25% retail investors / 40% Australian private superannuation funds / 20% international institutional investors / 15% government or industry funds. (my guesses).

  54. Fran Barlow
    February 17th, 2010 at 14:37 | #54

    @sdfc

    Letting an institution such as Citi or Bank of America just fold would send shock-waves through the financial system that would make the Lehman collapse look like a picnic.

    It would reintroduce the restraints on conduct that Greenspan wrongly assumed were there. If you think you could lose, then you will probably resist getting into high risk low return options. What you want is to reconcile ensuring that the people who invested unwisely lose while everyone get basic protection from ruin. When assets return to their actual (rather than notional) value, the state can acquire so many of them as it deems consistent with good public policy — housing and other infrastructure assets are the obvious targets here.

    That way you don’t need to coercively nationalise anything. The asset holders will simply hand it over and thank you. The public sees that only the state stands between them and ruin, and can then reason to the next questions — what assets should the state hold? In what ways can state control serve public utility? Under what circumstances and under what conditions should assets be reprivatised?

    At the moment, the Obama administration is being challenged by people who ought to be discredited and bankrupt but who are pretending the administration is the friend of Walls Street AND socialist. A shakeout would have made this approach unthinkable and forced the Repugs and their parasitic allies to climb over each other to avoid drowning.

    We could have had a new broom go through not only housing and infrastructure policy but through health and environment and much else. Instead, the Repugs are now re-energising through a bizarre but apparently not implausible to some Americans brand of right wing populism.

  55. TerjeP (say tay-a)
    February 17th, 2010 at 16:05 | #55

    TerjeP (say tay-a) :
    Attack deleted – nothing more like this please Terje. Alice, please stick to 1 c/t/d

    No attack intended but I will rephrase.

    Alice – you seem to be attributing to me an outlook that I don’t hold. I didn’t claim that Australia had sound policies (nor the opposite). I merely noted the different experience in Australia versus the USA and pointed to a possible cause in the way of branch regulation. We had one bank failure they had many thousands. Clearly differences exist and we should be inquisitive about what those differences were.

  56. smiths
    February 17th, 2010 at 16:33 | #56

    i wrote a post about central banks which has again dissappeared, did you remove it john?

  57. sdfc
    February 17th, 2010 at 16:59 | #57

    Let me put it simple terms for you Fran.

    Big bank A goes down because some bright spark reckons it is a good idea to teach the fat cats a lesson. Banks B, C and D go down with it because all of a sudden they can’t get the cash they need to keep their doors open. This is largely because banks E, F and G are concerned with counterparty risk and so hoard funds rather than engage in the interbank money market. Several thousand businesses have to close their doors because all of a sudden they have no access to credit.

    Nationalisation is not coercion, it is the state stepping in to administer a bankrupt financial institution. Bailout or nationalisation that is your choice.

  58. Ernestine Gross
    February 17th, 2010 at 18:43 | #58

    @sdfc

    Concur completely.

  59. Michael
    February 17th, 2010 at 20:37 | #59

    Fran Barlow :
    It would reintroduce the restraints on conduct that Greenspan wrongly assumed were there. If you think you could lose, then you will probably resist getting into high risk low return options. What you want is to reconcile ensuring that the people who invested unwisely lose while everyone get basic protection from ruin.

    Wouldn’t it be great if this could happen without collateral damage. A pipe dream perhaps. If this could happen peacefully and orderly without a bank failure then maybe we might be constructively tackling climate change without waiting for “proof” it’s already causing widespread misery.

    At the moment, the Obama administration is being challenged by people who ought to be discredited and bankrupt but who are pretending the administration is the friend of Walls Street AND socialist.

    It seems he is on a hiding to nothing. But of course the socialist wall street bankers are no doubt at the centre of the communist plot to install a world government via the IPPC. Getting close to a unified theory a la rouche!
    We could have had a new broom go through not only housing and infrastructure policy but through health and environment and much else. Instead, the Repugs are now re-energising through a bizarre but apparently not implausible to some Americans brand of right wing populism.

    Sad indeed. One can only hope that the teabaggers eventually turn their deranged bile on each other.

  60. Michael
    February 17th, 2010 at 20:41 | #60

    Fran Barlow :
    @sdfc

    It would reintroduce the restraints on conduct that Greenspan wrongly assumed were there. If you think you could lose, then you will probably resist getting into high risk low return options. What you want is to reconcile ensuring that the people who invested unwisely lose while everyone get basic protection from ruin.

    Wouldn’t it be great if this could happen without collateral damage. A pipe dream perhaps. If this could happen peacefully and orderly without a bank failure then maybe we might be constructively tackling climate change without waiting for “proof” it’s already causing widespread misery.

    At the moment, the Obama administration is being challenged by people who ought to be discredited and bankrupt but who are pretending the administration is the friend of Walls Street AND socialist. A shakeout would have made this approach unthinkable and forced the Repugs and their parasitic allies to climb over each other to avoid drowning.

    It seems he is on a hiding to nothing. But of course the socialist wall street bankers are no doubt at the centre of the communist plot to install a world government via the IPPC. Getting close to a unified theory a la rouche!

    We could have had a new broom go through not only housing and infrastructure policy but through health and environment and much else. Instead, the Repugs are now re-energising through a bizarre but apparently not implausible to some Americans brand of right wing populism.

    Sad indeed. One can only hope that the teabaggers eventually turn their deranged bile on each other.

    Apologies about the double post – the last one had formatting errors. Just about everytime I attempt a joke I get tripped up by a typo or something. Serves me right.

  61. Peter T
    February 17th, 2010 at 21:08 | #61

    Couple of points

    Some succinct analysis of derivatives I have read makes it plain that these things were very risky – they created a whole new class of risk. RBS in the UK, for instance, was using derivatives to support leverages of up to 50 times its initial investment – and selling them as A-grade securities.

    Second is that while a fall in house prices played a major part in triggering the collapse, the prices that fell were not just the riskiest end of lending. And the leveraged derivatives market fed not just house prices but also college loans, credit card debt, municipal bonds and much else – anything that could be packaged, rated, and on-sold. It was house prices that acted as the trigger, but it could have been almost anything.

    A final point is that I find the ascription of the crisis to “moral hazard” quaint. Moral hazard is to people what flying is to birds – it’s the way we live because we are ultra-social animals. This kind of naive deterrence theory has repeatedly been shown not to correspond to reality in other fields (eg think of the death penalty), so why should it operate in finance?

    I see no way to run a bank where the operators will feel personally liable for losses unless we re-introduce the stocks, or tar and feathers. I suspect the latter would fit the popular mood.

  62. Alice
    February 17th, 2010 at 21:15 | #62

    @TerjeP (say tay-a)
    Seeing I am allowed one post per thread per day…Terje – I will say this. I made the comment on weekend reflections that I agreed with JQ that he was seking more civility and less personal attacks – and I think its a good idea and especially from those on the right that seem to me to have a natural tendency for rudeness of expression in their responses.

    I dont know what comment of yours was deleted Terje (and I dont care to know at this point) but I would like you to remember this. You are posting three comments a day on average in a thread and I am restricted to one. Yes, I would like you to keep your personal attacks to a minimum.

    If you see the difference between the US and Australia as interesting in your point that “Australia had only one bank failure in the great depression” – yes I would like to know what point you are making… and why…and I do note you made the same point on ALS website Terje.

    Was this really in Australia’s advantage or not Terje? I would like your opinion on that..not a personal attack thanks (and bear in mind Im not at liberty to defend myself against unwarranted personal attacks just yet).

  63. TerjeP (say tay-a)
    February 17th, 2010 at 22:49 | #63

    Alice – firstly I intended no attack and I’m very surprised that JQ interpreted it as such. I think that removing my comment and leaving the edit remark that JQ entered makes it look like I said something terribly antagonistic. It is not in my nature to attack people although I’m sure my remarks may at times offend some people. I was merely being defensive in terms of pondering why you appeared to be putting words in my mouth but perhaps it came across poorly.

    In terms of which side of politics is more or less civil, that is a discussion I won’t buy into today.

    My point about Australia and the US being different was in response to comment #8 and #19. I don’t think the USA in the 1930s makes the case for protecting big banks. I think it makes the case for removing branch regulations. In other words it indicates that banks shouldn’t be restricted from diversifying geographically (and hence across multiple industry sectors) as they were in the USA. Australia was better placed in this regard. However I wouldn’t conclude that the Australian banking sector, or regulatory framework, was without problems.

  64. Gerard
    February 17th, 2010 at 22:49 | #64

    That the cra was in any way responsible for the gfc is a pure rightwing myth. I’d go into mor
    e detail but I’m limited to an iPhone at the moment, however you only need to look it up on wikipedia to find references to the relevant academic studies that debunk this tired old lie. Professor q should include this cra BS talking point in the book

  65. TerjeP (say tay-a)
    February 17th, 2010 at 22:54 | #65

    p.s. And whilst it is quite long I really do recommend the podcast from EconTalk.

    http://www.econtalk.org/archives/2010/01/rustici_on_smoo.html

    The online summary for the talk reads as follows:-

    The standard view is that the decrease in trade that followed Smoot-Hawley was not big enough to be a significant contributor to the Great Depression. Rustici argues that this Keynesian approach that looks at aggregate spending misses a crucial mechanism for understanding the impact of Smoot-Hawley. Rustici focuses on the impact of Smoot Hawley on bank closings and the money supply. Smoot-Hawley launched an international trade war that reduced world trade dramatically. This had large concentrated regional effects in the United States and around the world in areas that depended on trade. Those were the areas where the first banks collapsed, contracting the money supply via the fractional reserve banking system. Rustici argues that the Keynesian indictment of the price system ignores the policy failures that destroyed the institutions that make the price system work.

    Even if you end up disagreeing with the conclusions the historical account of how events unfolded is fascinating.

  66. TerjeP (say tay-a)
    February 17th, 2010 at 23:00 | #66

    Gerard – I presume this is the link you are refering to;

    http://en.wikipedia.org/wiki/Community_Reinvestment_Act#Relation_to_2008_financial_crisis

  67. Peter T
    February 17th, 2010 at 23:19 | #67

    Surely a purely econometric analysis of the tariff misses the point. Key parts of world trade in 1930 relied on US demand to earn the money to pay loans from the US that had financed the war or, in the German case, the reparations. This was a fundamentally unstable system, particularly as it consistently offered Germany – the major debtor – too little too late. Once Germany showed signs that it would not play by rules set by the creditors in London and New York, the rest followed.

  68. Andrew
    February 18th, 2010 at 07:56 | #68

    Thanks for the link Terje.

    Yes – lots of opinions for and against the role of the CRA. For Gerard to sneeringly dismiss the role of lax lending practices as the root cause of the GFC is pure left wing spin. It’s much easier to blame greedy investment bankers isn’t it.

    Fact 1 – the GFC was a result of inter-bank lending grinding to a halt due to toxic debt clogging up the system
    Fact 2 – the primary source of this toxic debt was the US mortgage market
    Fact 3 – the reason the US mortgage market turned ‘toxic’ was that too many people were borrowing too much money against inflated property prices that they couldn’t really afford
    Fact 4 – there was a big push in the 1990s by the Clinton administration to ‘encourage’ lenders to make make home loans widely available.

    From the wiki article Gerard was alluding to –
    “Bob McTeer, president of the Dallas Federal Reserve Bank from 1991 to 2004, said “There was a lot of pressure from Congress and generally everywhere to make homeownership affordable for poor and low-income people. Some mortgages were made that would not have ordinarily been made.” He also said “When a bank made a decision to purchase mortgaged-backed securities, they would somehow determine if some of them were in zip codes covered by the CRA, and therefore they could get CRA credit.”

    Of course the GFC is a lot more complicated than that little precis suggests – and there were many contributing factors. But this debate started because an earlier poster labelled investment bankers as ‘casino’ bankers and wanted to blame investment banks for the whole mess. I was debunking that simplistic explanation. Commentators like Gerard also need to acknowledge that lending money to people who can’t really afford it is not a good idea – I know that doesn’t fit comfortably with a left-wing view of ‘equality’

  69. Michael
    February 18th, 2010 at 08:33 | #69

    Andrew :
    But this debate started because an earlier poster labelled investment bankers as ‘casino’ bankers and wanted to blame investment banks for the whole mess. I was debunking that simplistic explanation.

    Just to set the record straight. I did use the term “casino” banking (OK that was a flippant remark and I withdraw the unintended implication that ALL investment banks are engaged in socially useless speculative activities). The term “casino” was used in relation to the activities of investment banks by Bank of England Governor Mervyn King.

    I also never said investment banks were solely to blame or that lax lending practises were not part of the problem.

    I would dispute the framing of your “Fact 3.” The reason the market turned “toxic” was that securatisation had made it impossible to know exactly what the exposure to subprime mortgages was – not simply because they contained subprime mortgages. These predate the GFC.

    Concerning Fact 4. Perhaps others are in a better position to judge the significance of that, but this was restricted to the US, and I still find the timing strange to blame this on Clinton since the CRA predates him and also operated under Bush II.

  70. Chris Warren
    February 18th, 2010 at 08:48 | #70

    @Andrew

    Andrew

    Your rightist blinkers are showing.

    Your fact 1, is a symptom
    Your fact 2, is a synonym
    Your fact 3, shifts the blame onto the victims
    Your fact 4, shifts the blame onto Clinton.

    However a more mature consideration would start with the long-run tendencies of capitalism to increase macro-economic imbalances and inflate asset prices.

    This is independent of housing. Earlier it was IT assets (dot.com boom), and even earlier it was tulips.

    Interbank lending blockage, was a consequence, or a symptom, of the long-run tendency.

    The long-run problem has been highlighted by OECD economists in 1985, and well forecast in “The Economist” 18-24 April 1998.

    All your of politicised ranting merely demonstrates is that you are poorly informed and a very slow learner.

  71. smiths
    February 18th, 2010 at 11:34 | #71

    john, like chris warren i took Andrew’s simplistic inaccurate fairytale of the GFC to task,
    unlike Chris Warren my posts keep disappearing,
    if i have breached some code could you let me know, if a post is removed can it be replaced with a note as Terje’s was,
    it seems to me from my own biased point of view, that libertarian and ignorant comments about economics sit happily on these pages but comments that challenge the toxic viewpoints dissappear

  72. Peter T
    February 18th, 2010 at 12:40 | #72

    Andrew

    On Fact 3 – would it not be more accurate to say “a lot of people were being sold mortgages they could not afford” (by banks eager for commissions, and intending to package and on-sell the mortgages. There was a lot of very fine print, misrepresentation, dodgy salesmanship etc, and no intention on the part of the vendors to maintain a lasting financial relationship. The “toxicity” was created by the banks, and passed to others as rapidly as possible.

    Chris – can I say (as a bystander) that I think your final comment was unnecessary.

  73. smiths
    February 18th, 2010 at 13:19 | #73

    peter T, i disagree,
    i have just spent the last hour reading about barclays investment banker bonuses, barclays tax avoidance, barclays role in creating tax havens in ghana for the looting of mineral wealth, etc etc
    it angers me deeply,
    so when i read the swill that andrew writes i admire the restraint chris warren showed in wording his criticism in the way that he did,
    the impunity with which mega banks and mega corporations are looting the world and trashing decent political institutions is horrifying,
    and yet,
    when deluded or sycophantic supporters of these activities write in praise or defence,
    we are to remain civil and eloquent,
    i struggle

  74. Andrew
    February 18th, 2010 at 13:24 | #74

    It’s ok Peter – I’m not offended by Chris’s personal attack – it’s par for the course that many commentators on this site equate a different point of view with being uninformed. It reflects badly on them when they make those comments – but that’s their problem not mine.

    Smiths – why do you implictly link libertarian with ignorant? Surely you can be well-informed and reject a hive-mind approach to life?

    Chris – no fact1 is not a symptom – you’re mixing up cause and effect. I guess it depends how you define what the GFC was – but I think the common wisdom is that the GFC started with the collapse of Lehmans which then caused every other major bank to stop lending to each other in case the were lending to the next Lehmans.

    Chris and Peter – I’m not shifting the blame onto the victims with fact 3 – I’m merely stating a fact. I didn’t ascribe any motivation to anyone – just stating that too many dodgy loans were handed out. In fact I go on to blame the US government in fact 4.

    You just simply can’t escape the fact the GFC originated because too many Americans were borrowing beyond their means using over-inflated asset prices as collateral. Some activities of investment banks exaggerated the problem because they spread the risk far and wide through the CDO market. However the investment banks did NOT cause the GFC – the US mortgage market would have collapsed under its own weight regardless of what was going on in the CDO market.

    I know you guys would love to blame the investment banks because they represent everything you abhore about a captialist society – but at best that’s simplistic and at worst it’s simply wrong.

  75. smiths
    February 18th, 2010 at 13:34 | #75

    why do you implictly link libertarian with ignorant?

    one of my skills as a human is recognising patterns in information over time

  76. Andrew
    February 18th, 2010 at 13:37 | #76

    I get it – sort of likethe pattern recognition in; left wing = impractical dreamer?

  77. smiths
    February 18th, 2010 at 13:38 | #77

    also if i could add, i dont personally abhor certain elements of a capitalist system,
    i just dont think capitalist is an accurate label for the system we currently have sitting on this planet suffocating it,
    it is a mafia capitalism where the rules are made by the strong and in almost every clash between civil society and giant corporations civil society loses,
    if the current trend continues it will slip quietly from capitalism into corporatism into fascism,
    if it hasnt already

  78. smiths
    February 18th, 2010 at 13:40 | #78

    andrew both of the wing tips exhibit the same behaviors to the extent that it is really more like a circle,
    when you have gone far enough to one extreme you have in effect joined the other side

  79. Chris Warren
    February 18th, 2010 at 13:41 | #79

    @Peter T

    Don’t worry about it.

    Anyone who plays cards such as:

    #

    is pure left wing spin. It’s much easier to blame greedy investment bankers isn’t it.

    – I know that doesn’t fit comfortably with a left-wing view of ‘equality’

    Gets repaid in the same coin.

    Andrew gets only the same respect he shows to others.

  80. Andrew
    February 18th, 2010 at 13:43 | #80

    Smiths – yes – I absolutely agree with that sentiment. I would describe myself as a centrist libertarian. In an Australian context I’m your typical swinging middle class voter – I’ve voted for both the ALP and Libs before. I’d never consider voting for the extremes which in Australia are represented by One Nation/Family First on the right and by the Greens on the left.

  81. Michael
    February 18th, 2010 at 13:44 | #81

    Andrew :
    However the investment banks did NOT cause the GFC – the US mortgage market would have collapsed under its own weight regardless of what was going on in the CDO market.

    I don’t believe there is a single cause. Do you think the volume of subprime loans would have been made if the CDO market didn’t exist to dice them up and on sell them? Who created the CDO market and profited the most from it? Have you read any reporting by Gillian Tett of the FT in this issue?

  82. Andrew
    February 18th, 2010 at 13:48 | #82

    Chris – where in those comments is any sort of personal attack? My comment about ‘left wing spin’ was a direct rebuttal to Gerard’s ‘right wing myth’ comment. The second comment is a simple observation that through a left-wing prism the ideal society seems to be one where we’re all equal – unfortunately that’s not how the world works and if you try to shoe-horn the world into that view you can end up doing silly things like lending $300k to someone on $30k/yr income to buy a $300k house that’s probably only worth $250k.

  83. Chris Warren
    February 18th, 2010 at 13:49 | #83

    Andrew :
    I get it – sort of likethe pattern recognition in; left wing = impractical dreamer?

    And so they continue….

    Andrew is asking for a kicking.

  84. Andrew
    February 18th, 2010 at 13:53 | #84

    Michael – I don’t believe there is a single cause either – which is the point I’ve been trying to make all along. Blaming the investment banks is simplistic. I think I’ve ackowledged all the way along that actions of the investment banks have certainly contributed – I agree, the problem would not have become nearly so big without a CDO market to spread the risk. As I said in an earlier post – Manly council and Norwegian pesnion funds had no idea what they were buying – you can blame the investment banks for that. However – the root cause was the root cause – bad housing loans in the US

  85. Andrew
    February 18th, 2010 at 13:55 | #85

    Chris – time out…… Peace!

    I had tongue firmly in cheek with the impractical dreamer comment…..

    ….. he started it with his ‘uninformed’ comment Mum!!!

  86. Chris Warren
    February 18th, 2010 at 14:01 | #86

    Most neutral people will not equate (or associate)

    Andrew :
    lending $300k to someone on $30k/yr income to buy a $300k house that’s probably only worth $250k.

    with;

    a left-wing prism the ideal society seems to be one where we’re all equal

    Neutral people will see this lending as a practice of ………….. banks.

    Only ideologues would spin this some other way, which is what Gerard was generally indicating.

    Your continual, misconstrued, tagging of peoples’ neutral views as “leftist” is obviously deliberate and provocative.

    The whole idea that bank lending is caused by “shoe-horning into that view” is politicised SPIN.

    It seems you are deliberately provoking responses so you can play the victim, about how unfair it all is. This is an old trick.

  87. Andrew
    February 18th, 2010 at 14:25 | #87

    Neutral! hah – mate, given your comments I bet you’re a Green voter…… a big hint – that aint neutral. If it was – Bob Brown would be PM!

    I’m not a victim – never have played one, never will…… if you can’t engage in a debate on the issues without descending into personal attacks then that reflects on you not me.

    I entered the fray to defend the role of investment banks…. no they’re not perfect, and yes they had a role in the GFC – but they’re not the root problem. I’m not interested in continuing a silly personal debate with you.

    Over and out…..

  88. jquiggin
    February 18th, 2010 at 14:45 | #88

    OK, enough of this back and forth, please

  89. Fran Barlow
    February 18th, 2010 at 16:20 | #89

    @Andrew

    I’d never consider voting for the extremes which in Australia are represented by One Nation/Family First on the right and by the Greens on the left.

    The Greens are not as far to the left as One Nation/Family First are on the right. The Greens are actually more like what you’d have if traditional ALP had had a small l-liberal makeover in social policy. The ALP has moved sharply in the direction of political conservatism, while the official conservatives have been shunted even further to the right in botgh the major strands of policy.

    On the substantive question on lending, I’d certainly prefer more robust restrictions on lending. As I’ve said here in the past, I’d like to see an incrementing equity rule on residential property which would provide that each month the required equity to receive a mortgage where residential property was collateral would require cash equity of not less than 5% initially, and which incremented each month from the time of introduction by 25 basis points, so that ultimately everyone needed 20% equity. Nobody would be able to acquire loans requiring service of more than 30% of household income after all other debt service obligations had been accounted for. Anyone who offered a loan outside these terms would not have action for recovery in debt default upheld by the courts and could be liable in the case of serious malfeasance for forfeiture of everything above the benchmark tests.

    I’d see the steady fall in low-income earners getting marginal loans for housing as a benefit of such a policy rather than as a deficit. In the longer run, such a policy would undermine asset values, and support urban consolidation. It would make it less costly to build up public housing stock and to develop a range of new and more socially inclusive models for housing people.

  90. February 18th, 2010 at 17:29 | #90

    Fran,
    In the long run what it would mean (IMHO) is that there are more rich landlords and a large number of lower-income people permanently locked out of the housing market. I doubt that asset values would be affected as the people would still need to be housed, and would still want larger houses, they would just have to rent them rather than own them.
    In practice, the trend to home ownership has (in the majority of cases, but by no means all) meant that the increase in asset values has been captured not by the banks (who earn little more than base rate on housing loans), not by the rich (although they certainly do get some of it as their large houses appreciate) by by the poor.
    Sorry, but all I can see from your plan is that the poor will just end up renting for the rest of their lives.
    .
    The Greens are, in many of their economic positions, pretty dirigiste. Most of their social positions are now quite libertarian. As far as One Nation is concerned they had an old fashioned left wing industrial policy and an old fashioned (ALP) immigration policy. Not an awful lot of difference there except in social policy.
    .
    One further note – some people seem to be confusing me with “Andrew”. I am not him.

  91. TerjeP (say tay-a)
    February 18th, 2010 at 18:28 | #91

    On social issues the Greens are not libertarian. Take drugs for instance. The libertarian position is that you own your body and it’s your business what you do with it. They believe that the state should not stop you from buying and consuming drugs. Of course libertarians also believe in personal responsibility so the consequences of taking drugs is something you need to deal with. The Greens have backed away from ending prohibition but assuming they came good on that point they still don’t believe in personal responsibity. They believe that society is responsibe if you kill your brain with drugs and need to be hospitalised. They believe that the private sector should not produce drugs but rather the public sector should provide them. They are libertine not libertarian. They want freedom to do as you please but also the freedom to call on the resources of others if there are consequences. The Greens are a waste of space when it comes to the pursuit of liberty. They crowd out sensible arguments for liberty and replace them with stupid recommendations for societal decay.

    Of course conservatives also fail to believe in personal responsibility. They want to stop you hurting yourself with prohibition up front. It is unclear which approach is more offensive but quite clear that they both suck.

  92. February 18th, 2010 at 18:39 | #92

    Terje,
    I did say “quite libertarian”, not “libertartian”. They are more libertarian socially than most of the parties.
    It does not make me any more likely to vote for a dirigiste party – either Green or One Nation.

  93. Alice
    February 18th, 2010 at 19:02 | #93

    @Andrew Reynolds
    Andrew – I can identify with that. People confused me with Alicia.

  94. Michael
    February 18th, 2010 at 22:20 | #94

    @Andrew Reynolds
    “Libertartian” I think the other worldly connotation is sometimes appropriate ;-)

  95. Andrew
    February 19th, 2010 at 08:09 | #95

    Fran – I’m coming back out for my second innnings!

    I partly agree with you here if your starting point was the ALP under Whitlam – yes no doubt that Hawke/Keating/Rudd have shifted the ALP to the right since the failed Gough experiment.

    BUT – again it’s a matter of perspective. If your world view is naturally left inclined – then of course you’d see the Greens as only a little to the left and One Nation/Family First well to the right. But the vast bulk of Australians who vote ALP or Coalition would see the Australian party political landscape as I do – Greens well to the left, ON/FF well to the right – and ALP/Coalition comfortably in the middle.

    I imagine there is a sense of disappointment in Rudd from Green voters – who saw him as a panacea to a decade of Howard government. IMHO – Greens lost perspective on the true Howard by turning him into a cariacature (“ratty”, “Bush’s Deputy Sheriff”, etc etc). Middle Australia quite liked Howard (obviously – they voted for him for 11 yrs) – and doesn’t really mind Kevin Rudd either. Rudd is seen as bit of a geek – but then so was Howard in his early years. Howard grew into a statesman – Rudd may do the same.

    They are both fairly middle of the road politicians who make us feel ‘relaxed and comfortable’ about Australia’s place in the world. It means that they don’t have to worry about politics too much – which of course for mainstream Australia is actually a fairly boring topic.

  96. Fran Barlow
    February 19th, 2010 at 08:32 | #96

    @Andrew Reynolds

    what it would mean (IMHO) is that there are more rich landlords and a large number of lower-income people permanently locked out of the housing market.

    I disagree. It would mean that real capital gain in housing became much less common because the credit to underpin asset price inflation would be staunched. Landlords, such as they were, would have to make all of their returns on dividend (rent), and one could legislate standards for housing, meaning that the quality of stock would improve. Reductuions in real growth in housing cost would mean that the state could directly or indirectly increase public housing stock at acceptable cost.

    In practice, the trend to home ownership has (in the majority of cases, but by no means all) meant that the increase in asset values has been captured not by the banks (who earn little more than base rate on housing loans), not by the rich (although they certainly do get some of it as their large houses appreciate) but by the poor. [typo corrected]

    The “capture” when it does occur, is illusory, fort the new “equity” is required to fund a new purchase of new real estate and it comes at the cost of exposure to risk of loss, serious debt serviceing stres and of course it drives housing choice to the urban periphery causing sprawl and marginalisation. It also drioves up infrastructure cost. The benefits, where they are utlimately realised in liquid form tend to go strongly to the upper half of the populace and especvially the top 20%.

    There is nothing wrong with renting. I’ve been a renter since 1991 and have survived the sale of the property in 1998.

    As far as One Nation is concerned they had an old fashioned left wing industrial policy and an old fashioned (ALP) immigration policy.

    Parochial and xenophobic are not “left-wing”. Left-wing industrial policy would be for industry-wide policy and across national frontiers, under the aegis of workers’ control. I must have missed that in One Nation’s platform.

  97. Fran Barlow
    February 19th, 2010 at 09:57 | #97

    @Andrew

    Middle Australia quite liked Howard (obviously – they voted for him for 11 yrs)

    This misunderstands the 11 years of Howard rule. Haoward had a strong ideological core vote and he then put together other constituencies to which he wasn’t entitled, exploited malapportionment and clung on. In 1998 he lost the popular vote but the Democrats allowed him to get the votes of those who opposed Telstra privatisation and the GS&T and those who supported it or would endure it.

    In 2001 he was looking like his run had ended until TAMPA and 9/11 came along and incumbency and xenophobia came to his rescue. In 2004, ALP disarray (especially in Tasmania) and the Latham factor and hostage voting saw him win again, by default. Howard was never widely liked. He was tolerated and lucky.

  98. February 19th, 2010 at 10:05 | #98

    Fran,
    I would disagree. The credit would only flow to holders of the 20% equity – i.e. those already wealthy – and the basic drivers of the housing market would still be there. Many people want larger houses and they tend to want to live near each other. They would just be paying through rent instead.
    I have no problem with people financing their place of abode through rent (I have done it myself for extended periods) but that it what it is. A financing option, not a means of redistribution. The capital gain goes to the owners and restricting people artificially, which is what you are proposing, just means those so restricted find it more difficult to own.

  99. Fran Barlow
    February 19th, 2010 at 10:23 | #99

    @Andrew Reynolds

    The credit would only flow to holders of the 20% equity – i.e. those already wealthy – and the basic drivers of the housing market would still be there.

    yes, and no … The people qualifying for credit have a weaker rationale for buying if prospective real capital gain is smaller. That will be so because demand for credit and money supply within the housing sector would fall. They will have a far more static and illiquid asset. Those with access to credit would likely shift their investment portfolio in favour of more rewarding sectors of the economy with similar risk.

    Those that did buy property at or near the 20% equity rule would have lower debt service both because they had greater equity and because the purchase price would be lower. People would buy property for absurd reasons like “I’d like to live there”. There would also be a massive disincentive to overcapitalising, so we’d have less waste as well as less urban sprawl. People would sell when they no longer wanted to live somewhere and they could buy into a non-inflated market. And with lower propertyy values, there would be downward pressure on rent.

    People would probably save more too, because they would have an incentive. If you know that houseprices are rising faster than you can save, your incentive is to borrow rather than save, and vice versa.

    So in the end, nearly everyone would be ahead.

  100. February 19th, 2010 at 12:51 | #100

    Fran,
    There are a lot of claims in there, but I cannot agree with many of them. People would still need houses and the supply of them would still be restricted in the same way they currently are. The difference would only be that those unable to raise the 20% equity would have no choice but to rent.
    The pool of renters would therefore expand greatly – raising the returns to those with the funds to cover the 20% hurdle. This would just mean that those that can finance housing that might otherwise put the money into the stock market or elsewhere would be now putting it into housing and making more out of it, while those who cannot raise the hurdle would be paying rent and not getting any capital gain.
    The rich get richer and the poor lose out – the usual outcome of these sorts of restrictions.
    If you claim to be a libertarian, Fran I would see this sort of argument as being more akin to a Rothbardian one – focussing as it does on the (supposed) problem of credit creation and the (supposedly) adverse results.
    Personally, I disagree with the idea that these are problems in and of themselves. Credit creation is not a problem provided it is allocated in an efficient way. These sorts of restrictions merely serve to distort individual incentives to improve their own lot – leading to a drop in overall welfare. In this case all I can see happening is that the poor will have their access to credit restricted, meaning they lose the prospect of capital gain. I cannot see this as a good outcome.

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