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.
John Quiggin 
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.
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.
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.
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.
Pr Q said:
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.
Pr Q said:
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”.
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).
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?
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.
@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.
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.
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.
@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.
@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.
@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.
@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.
@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.
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”
@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.
“PPerhaps sure some of their names” was meant to be
“Perhaps share some of their names”
@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.
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.
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
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.
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.
“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!
OK – lets agree that there are shades of grey. Not all investment bankers are bad.
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.
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
@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.”
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.
Found the link:-
http://www.econtalk.org/archives/2010/01/rustici_on_smoo.html
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.
@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?
Click to access Lee_Sanning_Shaffer_162009.pdf
A quick google throughs up this source:-
http://fsgstudy.treasury.gov.au/content/Davis_Report/04_Chapter2.asp
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
@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).
Attack deleted – nothing more like this please Terje. Alice, please stick to 1 c/t/d
@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.
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.
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.
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
@Andrew
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
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.
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.
Fran – Sorry! Got your name wrong and misattributed a quote all in one breath. My sincere apologies…. *tucks bat under arm and trudges off
my posts are dissappearing, whats going on?
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.
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”
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.
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?
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
@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.
Sorry, forgot to put the link in.
http://www.frbsf.org/publications/economics/letter/2009/el2009-33.html
@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.
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
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