What happened to the global economy and what we can do about it
with 22 comments
“Banking on the State” by Andrew Haldane and Piergiorgio Alessandri is making waves in official circles. Haldane, Executive Director for Financial Stability at the Bank of England, is widely regarded as both a technical expert and as someone who can communicate his points effectively to policymakers. He is obviously closely in line – although not in complete agreement - with the thinking of Mervyn King, governor of the Bank of England.
Haldane and Alessandri offer a tough, perhaps bleak assessment. Our boom-bust-bailout cycle is, in their view, a “doom loop”. Banks have an incentive to take excessive risk and every time they and their creditors are bailed out, we create the conditions for the next crisis.
Any banker who denies this is the case lacks self-awareness or any sense of history, or perhaps just wants to do it again.
The Haldane-Alessandri “doom loop” is fast becoming the new baseline view, i.e., if you want to explain what happened or – more interestingly – what can happen going forward, you need to position your arguments relative to the structure and data in their paper.
For example, at Mr. Bernanke’s reconfirmation hearing, these issues will come up in some fashion. The contrast between the hard-hitting language of the “doom loop” and Ben Bernanke’s odd statements on the dollar yesterday could not be more striking. Still, there is no reason to regard the Haldane-Alessandri version of the doom loop as the final word; in fact, this where the debate now heads. (This link gives as useful introduction to relevant aspects of banking theory, as well as Eric Maskin’s insightful personal take.)
To help move the discussion forward, here are some issues for Banking on the State raised in discussions with top experts (who prefer to remain anonymous):
The overall conclusion of the paper follows uneasily from the main analytical thrust. How can we believe that for the regulators, “next time is different“? Most likely, next time will be exactly the same, with different terminology: the financial sector “innovates”, regulators buy their story that risks are now properly managed, and the ensuing bailout (again) breaks all records.
It’s all politics. Unless and until you break the political power of our largest banks, broadly construed, we are going nowhere (or, rather, we are looping around the same doom).
Barney Frank points out that small banks have political clout also, and of course he’s correct that this drives some issues. But how many small banks spend their time (and lobbying dollars) on Capitol Hill insisting that large banks must not be broken up?
Our core problem is that we now have banks that are Too Big To Fail; if you don’t agree, read and publicly refute Haldane. In theory, these big banks could be effectively regulated, but this is a leap of faith that experienced policymakers (e.g., Mervyn King and Paul Volcker) are increasingly unwilling to make.
The biggest banks must be broken up. This is not sufficient to end the doom loop, but it is necessary.
By Simon Johnson
Written by Simon Johnson
November 17, 2009 at 8:14 am
Posted in Commentary
Tagged with Andrew Haldane, Mervyn King, Paul Volcker, too big to fail
Regulation Does Not Work; Financiers Are Smarter Than The Regulators
From the Bank of England:http://www.bankofengland.co.uk/publications/speeches/2009/speech409.pdf
The evolution of the banking and financial system has been accompanied by a growing support system from the public sector to the point where “Today, perhaps the biggest risk to the sovereign (state) comes from the banks.” Banks “game the state”, and exploit the state safety net. “State support stokes future risk-taking incentives, as owners of banks adapt their strategies to maximise expected profits. So it was in the run-up to the present crisis, “when banks adopted riskier strategies through a combination of increased leverage, proprietary trading, and by increasing the riskiness of their asset pool. The riskier strategies result in higher payoffs in good times and deep losses in bad times, “often cushioned by the state.”
http://www.bankofengland.co.uk/publications/speeches/2009/speech409.pdf
fwm
November 17, 2009 at 9:11 am
Exactly – not sufficient but necessary.
Every reform proposal has to be judged first by that litmus test: does it proactively break up the big entities and ensure they never cohere again.
“Doom loop” – great term for the boom-bust, bubble-crash, rent collect-disaster capitalize cycle. (I guess the establishment would still like to use “Great Moderation”.)
Russ
November 17, 2009 at 9:43 am
“Banks have an incentive to take excessive risk and every time they and their creditors are bailed out, we create the conditions for the next crisis.”
Insurance companies, too.
The Raven
November 17, 2009 at 9:47 am
The Austrians aren’t looking so nutty these days, are they?
"Every truth passes through three stages before it is recognized. In the first it is ridiculed, in the second it is opposed, in the third it is regarded as self-evident"
Cheers, Carson
Carson Gross
November 17, 2009 at 10:28 am
Now that I know how it works, I’m wishing they can do it one more time myself – though I hope it won’t be my money this time they do it with if that makes any sense.
luko
November 17, 2009 at 10:48 am
My professional experience is not consistent with your points 4 or 5 above. The banks were aggressive providers of leverage to HFs until they suddenly reversed course in October 2008. They forced liquidations by pulling lines at the worst possible time. Those borrowing relationships led to worse outcomes, rather than the better ones that you posit. Personally, I believe that the better outcomes were because the HF area is much more competitively Darwinian than the medium to upper management levels of the banks. Your point(5) regarding Meriwether is accurate but fails as a generalization. Pre 2008 I think you’d have a hard time assembling sufficient critical mass of HF managers who collectively ran large amounts of assets who had a really major blowup in their past. Notwithstanding these observations I love your work and believe you perform a great public service.
k
November 17, 2009 at 11:06 am
Has anybody remotely credible even tried to make the case that the large banks should not be broken up?
(Note: Those whose personal fortunes are tied to the sector — like CEOs of said banks or structured finance lawyers — do not qualify as “remotely credible”.)
Nemo
November 17, 2009 at 11:08 am
The typical political response is some variation of the "Genie is out of the bottle", we cannot go back in time, and whatever problems we have can be solved by regulation.
There are public policy issues that politicians would prefer not to address, such as W.T.O restrictions on re-regulation of financial institutions, and the implicit international rules of cross-border bailouts and loss-sharing arrangements. For example, Fed is rumoured to have bailed out some foreign banks; the Fed has a blank cheque, little accountability, and one of the least likely government entities to explain themselves.
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