Libertarian Think Tank Wants Government to Fuel Booms and Make Busts Worse

January 14th, 2010 by The Parallax Brief

Dr Eamon Butler of the Adam Smith Institute needs to think harder about this:

“I was interested to see this remark by the hugely intelligent John Stepek of Money Week, in one of his morning bulletins:

Every government, authoritarian or democratic, is terrified of growth slowing. Why? Because they’ll lose their jobs. Whether that’s at the end of a rope or more benignly at the ballot box doesn’t make any practical difference in economic terms. The fact is that the people in power will always do their damndest to keep a boom going for as long as possible. And that’s what ultimately does the economic damage.

Absolutely spot on… I have wondered (rather worrying) if democracy is our problem – that politicians simply have to keep promising higher spending and lower taxes to win elections…

I would like to see the UK and US in particular fess up to the fact that big over-expansions are what produces big crashes. Once they do fess up, then we can do something about it. Like have some kind of constitutional limits to government spending, borrowing, debt, and tax levels. This is exactly what the President of Georgia – one of the fastest-growing countries in the world, following its economic liberalisations – wants to do. His Liberty Act would amend the constitution to cap government expenditure at 30% of GDP… budget deficits at 3%… and public debt at 60%.”

Quite apart from the incongruous sight of a professed libertarian wondering about the benefits of democracy and idolising a petty despot who cares little for freedom or democracy (something which the Parallax Brief has highlighted about the Adam Smith Institute before), none of this actually makes sense.

If government expenditure and budget deficits were limited to a certain percentage of GDP, government spending would rise during good times and fall during bad times. One doesn’t need PhD to see the consequences of this: booms would be fueled as government spending increased with GDP, and busts would be made worse as the government stopped spending, putting more people on the dole and sending more businesses into bankruptcy.

Surely Dr. Butler has actually described the opposite of the government ideal? Surely government should try to smooth the economic cycle, not accentuate its bumps?

And if politicians are inevitably drawn into a taxation and spending bidding race, that’s an argument for better economic education, creating an environment in which more responsible politicians can flourish, or perhaps changing the way fiscal policy is made and enacted, not for introducing a fixed, arbitrary, economically nonsensical,  pro-cyclical new law.

Tags [ , , , , , ]

Categories [ Economics and Finance, UK Politics ]

Comments [ 2 ]

JP Morgan CEO Made Catastrophic Mistake — That Made JP Morgan Billions and Improved its Market Position

January 14th, 2010 by The Parallax Brief

Matthew Yglesias exposes the grotesque irony of the banking sector bailouts:

At today’s hearings, Jamie Dimon said “We didn’t do a stress test where housing prices fell.” Kevin Drum is astounded:

“Wow. By 2006, housing prices were nearly double their trend growth levels and JPM never even considered a scenario in which they might fall. Just wow.”

The really jaw-dropping thing, though, is that even in retrospect Dimon has been a nearly perfect CEO and JP Morgan basically a perfectly-run company. During the boom, they all got filthy rich. During the bust, a bunch of their competitors went out of business. Thanks to the bust millions of people around the country are now unemployed. Hundreds of thousands of children have been pushed below the poverty line and are suffering consequences from it that will last a lifetime. The entire younger generation is going to suffer because of the massive debt-overhang. But Dimon and the Morgan crowd are still getting filthy rich in part thanks to government emergency measures designed to mitigate the crisis.

And this is not because Morgan had tons of foresight. They didn’t even consider a scenario in which housing prices might fall. It’s an idiotic mistake. The exact same mistake that everyone else made. But they made it to a somewhat lesser extent than their leading competitors. So rather than suffering, they’re benefitting.

It’s the miracle of capitalism!

There just not really much more one can add. Except perhaps that this Friday JP Morgan is expected to award Mr. Dimon, his management team, and several thousand of its investment banking and finance staff a total of USD18 bln ($18,000,000,000) in performance bonuses.

Tags [ , , , , , ]

Categories [ Economics and Finance ]

Comments [ 0 ]

Political Needs Trump National Interest

January 13th, 2010 by The Parallax Brief

Danny Finkelstein uses his column in today’s Times to savage Prime Minister Gordon Brown:

The Chancellor [Alistair Darling] is insisting — as his predecessor Philip Snowden did in 1931, as Roy Jenkins did in 1968, as Denis Healey did in 1976 — that a plan for public expenditure reductions be agreed to retain the confidence of the markets. Gordon Brown — like Arthur Henderson in 1931, Aneurin Bevan in 1951 and Tony Benn and Mr Crosland in 1976 — is resisting. To dress up this resistance as if it was part of some new fangled clever (or even stupid) campaign strategy is to deny the force, the true importance, of what the Prime Minister is doing. It is to end up having a debate about things that really matter (tax, spending, debt, public services) in a sort of code (strategies, dividing lines) that only insiders can understand.

As Chancellor, Mr Brown spent money as if there would never be a bust — an absurd hypothesis. And now, as Prime Minister, he is blocking the measures necessary to put right this error.

For this dispute over public spending is different in one way from any of the past 100 years. The Prime Minister is refusing to support his Chancellor. MacDonald threw away a lifetime’s service to Labour to support Snowden, a man who cordially loathed him. Attlee sided with his Chancellor, Hugh Gaitskell, from his sickbed (“I am afraid they will have to go,” he mumbled to Gaitskell, who at first heard the remark as “very well, you will have to go”). The normally tricksy Harold Wilson gave solid backing to Jenkins. And Callaghan won round the critics by showing that he and his Chancellor were indivisible — if he had not done so, Mr Healey would not have prevailed.

Mr Brown, unlike any of these predecessors, has put himself at the head of the spending rebels. Far from backing his Chancellor in what needs to be done, he forces him to water down his proposals, making clearly inadequate plans to deal with the crisis.

The common attack on Mr Brown, the one we heard again last week from inside his party, is that he is a poor leader, that no one likes him, that he is a loser. But this verdict, damning though it is, is too kind.

It’s a brilliantly withering attack, but the Parallax Brief wonders whether Mr. Finkelstein hasn’t missed the two key points.

First, that part of the reason for the Prime Minister’s dalliances on public spending cuts is unavoidably the approaching election. Of course it is shabby to put party politics before the national interest, and a damning indictment of Labour that it seems to be entering the election with the no-policies policy usually reserved for the opposition. But to ignore the political realities of an approaching election is integral to the story, and should not be ignored.

Second, while it is true that the absence from the pre-budget report of a clear, tough plan of spending cuts to reign in the deficit was an appalling concession to brazen electioneering, it is also true that even if such a plan were in place down the minutest detail, it would not be implemented until after the election. Not because Labour doesn’t want to go to the polls as the party which savaged public services — which it surely doesn’t — but because cuts now would plunge the economy back into recession and have the peverse effect of increasing the debt-to-GDP burden.

And just as Parkinson’s Law tells us that work expands to fit the time available, so it is an unbreakable law of politics that no government will ever raise taxes or lower spending on key services until the last possible minute.

None of this makes Labour’s appalling fiscal policy in the run up to the crisis acceptable. Nor does it excuse the party’s inertia when it comes to dealing with the nation’s problems. Mr. Finkelstein is right to criticise both, and is probably justified in his evisceration of the Prime Minister. He is also correct to note that the country desperately needs a plan to deal with the deficit if it is to retain the confidence of the markets and maintain the ability to borrow cheaply.

But the real “old story” isn’t Labour squabbling over spending, but a party putting politics before country.

Tags [ , , , , , , , , , ]

Categories [ Economics and Finance, UK Politics ]

Comments [ 0 ]

Has Labour Sacrificed it’s “New Labour” Credentials with 50% Top Rate, Banker Super-Tax?

December 16th, 2009 by The Parallax Brief

Via UK Polling Report, the Parallax Brief recently read an article in the Independent by John Rentoul in which he argued that the pre-budget report, with its soaking of bankers though the 50% super-tax on bonuses, “has postponed the Labour Party’s return to electability until 2028” by completely sacrificing the economically conservative credentials the party worked so hard to build in opposition and in government.

This strikes the Parallax Brief as risible proposition.

Labour’s reputation for economic soundness was destroyed long before the pre-budget report. It was destroyed by the party’s fiscal incontinence before the crisis, and the onset of that crisis, not its response to it.

Government economic policy should be counter-cyclical, cooling the economy when bubbles may be forming, and saving money in the good times, but conversely taking on more debt in the bad times to compensate for a muted private sector, while mitigating slumps by injecting stimulus. When Labour should have been saving for a rainy day, it was splurging the cash like a government fighting total war, both adding flames to the boom and leaving the country bereft of a safety net. It has meant that Britain has had to rely on monetary policy to do all the heavy lifting during the crisis, something which is enough in normal recessions, but insufficient for the current crisis, where the economy was still plummeting when monetary policy reached the zero lower bound and could therefore help no more.

Britain needed fiscal stimulus, but it hardly got any, because we were already mortgaged to the hilt; Britain needed the public sector to take up some slack left by a ravaged private sector, but the public sector couldn’t, because it was already bloated to bursting point.

To argue in the face of that damning indictment that the Labour Party’s economic reputation was poleaxed by the decisions to raise the top rate of income tax and impose a one off super-tax on bankers bonuses, seems rather like arguing that George W Bush destroyed his foreign policy credentials by not bombing Iranian nuclear facilities.

But beyond this, one must ask the question whether the policy of asking the rich to bear a greater burden was even the wrong thing to do? Is it morally reprehensible? Is it a political blunder?

No, no, and no.

From a moral and economic perspective, the super-tax on bankers’ bonuses was the right move. First, the bonuses are not deserved. Banks have been able to make such large profits only because of government guarantees — explicit and implicit — on their liabilities, as well as government equity support and regulator monetary and financial support. It is preposterous to have large portions of this support siphoned off into private hands. It is wrong for the sector of the economy which caused the crisis to reward itself after the taxpayer picked up its bills while that very same taxpayer is suffering.

Second, in the same way that one can justify the swingeing taxes imposed on packets of cigarettes as de-incentivizing socially undesirable behaviour, so one can justify taxes on bankers bonuses. The gargantuan bonuses paid to bankers encourage short term risk taking that leads banks to take on far greater risk than should be the case. Furthermore, much of the trading and financial “innovation” is not socially useful, and paying people so handsomely deprives other, more useful sectors of the economy of sharp minds. Which maths whizz kid in his or her right mind would want to become an engineer earning GBP50,000 a year, when he or she could easily earn 250 times that in the City? In which occupation would that maths whizz better serve the country?

Equally, taxing those who earn more than GBP150,000 was likely less about ideology, and more about the government proving to the bond market that it had the ability to address the country’s deficit with unpopular measures. It was likely a sign of economic rigour more than it was an ideological policy.

Finally, the Parallax Brief isn’t really sure if the move is the kind of political blunder which, as Mr. Rentoul puts it, leaves “the centre ground abandoned to the enemy”.

The centre ground is the middle classes, not the super rich. And while the centre ground generally want lower taxes for hard working people (like themselves) and less spending on welfare (on people who aren’t like themselves), there’s nothing to suggest they wouldn’t support higher taxes on those they see as grossly overpaid (people who also aren’t like themselves).

Indeed, polls by YouGov and ComRes seem to support this hypothesis. ComRes shows that 66% support the notion that those with high incomes should pay more, and YouGov shows that a whopping 79% support the super-tax on bankers’ bonuses. When was the last time a government policy had support from 79% of the population? The first Iraq War, perhaps? The Falklands?

From a moral, economic and political point of view, Labour’s moves were the right thing to do. Indeed, after the crisis hit, Labour hasn’t performed so very badly.

But that doesn’t mean it shouldn’t be punished for its pernicious pre-crisis economic policies.

Tags [ , , , , ]

Categories [ Economics and Finance, UK Politics ]

Comments [ 0 ]

The Echo Chamber on the Right

December 10th, 2009 by The Parallax Brief

It seems the Right’s echo chamber is alive and, well, not working very well. Both Guido Fawkes and Dan Hannan, the Muckraker in Chief and eminence grise of the Right, respectively, have make the same, and, in the Parallax Brief’s view, utterly ludicrous, point about the government’s pre-budget report.

Guido:

The Budget Britain Needs Was Delivered in Ireland

By coincidence here in Ireland it was also budget day, the Finance Minister Brian Lenihan delivered a 7% cut in public expenditure to match the 7.5% fall in GDP in 2009. To equal that Alastair Darling would need to have announced £40 billion in public expenditure cuts today.

Dan:

Ireland is trying to spend less, with cuts across the board. Everyone will share the pain, from cabinet ministers to benefits claimants. The Taoiseach, who is expected to take a 20 per cent salary reduction, reckons that the new budget will reduce Ireland’s deficit by 4 billion euros.

The United Kingdom, by contrast, wants to spend more. Alistair Darling will continue to expand the budget, and will raise taxes accordingly.

But, hang on a second: is the Parallax Brief the only one around here who has read some pretty disturbing things about the pernicious impact of all these cuts in Ireland and just what they’re doing to the economy?

LeftFootForward has the goods:

- Irish unemployment is 12.5 per cent

- the country is experiencing deflation at -6.6 per cent deflation

- GDP has fallen 7.4 per cent over the past year (and GNP by 11.6 per cent).

- And despite the cuts they have still had their credit rating downgraded.

Or, as Ambrose Evans-Pritchard said about Ireland’s economic policy with his customary elan and effortless erudition in the Telegraph earlier this year:

Depression buffs will note the parallel with Britain’s infamous budget in September 1931, when Phillip Snowden cut the dole and child allowance to uphold the deflation orthodoxies of the Gold Standard – though in that case the flinty Pennine rather liked hair-shirts for their own sake.

Though few had any inkling at the time, Snowden’s austerity drive would soon push British society over the edge. It set off a mutiny – a Royal Navy mutiny at Invergordon over pay cuts, in turn triggering a run on sterling…

This is torture for a debtors’ economy. You can survive deflation; you can survive debt; but Irving Fisher taught us in his 1933 treatise “Debt Deflation causes of Great Depressions” that the two together will eat you alive.

Those with a libertarian bent on the right really would sacrifice the Lion and the Unicorn on the altar of erroneous orthodoxy.

Tags [ , , , , ]

Categories [ Economics and Finance, UK Politics ]

Comments [ 0 ]

Why a Hung Parliament Might Savage the Economy

November 30th, 2009 by The Parallax Brief

Benedict Brogan, on his blog on the Telegraph’s website, today highlights a point that was lost when the political hacks and talkingheads released a week or so ago their flurry of opinion editorials about the potential consequences of a hung parliament.

“Morgan Stanley Research Europe has just put out a note assessing the UK’s future prospects, and its findings are a timely addition to the hung parliament debate…”UK becomes the first of the G10 to have a major fiscal crisis as elections lead to a hung parliament. The context is an ugly fiscal picture, relatively weak economic recovery, aggressive monetary stimulus and political uncertainty”"

The easiest way to think about this point is to consider the criteria for loaning money to someone. Whether or not you loan a person money, and the interest you want for doing so, is based on your view of that person’s likelihood of paying that money back. The more likely you think it is that they will be able to pay your money back, the less interest you would want to loan them money, because the risk of not getting back the money would be reduced.

The bond market is the same. When investors buy government bonds, they set the interest rate, or yield, the government pays on those bonds. This rate is essentially a function of what the investor thinks inflation will be (because as inflation increases the investor needs a higher interest rate on the bond to cover the portion of the investment eaten by that inflation), and his view on how able the government will be to pay that money back, known as “default risk” in the trade.

Right now, the UK has high — but not catastrophically high — debt that’s fast rising because tax receipts have fallen in the face of the crisis while obligations have remained the same, or, in some cases like social security, risen. One might imagine that this would push interest rates up. But as things stand, the interest rates on government bonds in the UK are still low. Some might argue this has something to do with the Bank of England’s quantitative easing program, and there are certainly several, complex reasons for this, but it’s essentially because the UK still has enough of what’s known as “fiscal credibility”: in layman’s terms, the bond market still believes that Britain can, one way or the other, pay back it’s debt.

Paying back all that debt, though, won’t be pleasant. It will involve either tax hikes or painful public spending cuts, and more than likely both at the same time. In short, it will involve actions which will be both unpopular with the electorate and difficult to pass through parliament.

If the Conservatives are elected with a thin majority, or even take control of a minority government, how easy will it be for them to ram through an unpopular budget? Will the right of their own party let them raise taxes? Will the other parties vote for the harsh spending cuts required to get the fiscal house in order?

The bond market will have to assume that Britain’s fiscal credibility had been reduced. Wouldn’t you if it was your money?

The consequences?

The morning after an election had produced a hung parliament, the yield on British bonds would immediately increase — possibly precariously. The pound would fall, likely passing 30-year lows against the Yen, Dollar, and Swiss Franc, as well as all time lows against the Euro. The cost of borring for private businesses would jump immediately. Raising equity for larger businesses would be more difficult, as fewer investors would want to hold assets in pounds. The cost of Government borrowing would also increase, making it more difficult to continue financing the deficit, and making fiscal help for the economy ever more difficult.

The best we could hope for is that any hope of rapid recovery would be nipped in the bud, and a long, turgid slog back — something like the economic stagnation in the late 70s and early 80s — would take its place.

The worst case scenario, albeit a not particularly likely one at this stage, would be an Iceland style monetary crisis in the absence of a quick (and implausibly magnanimous) commitment from all parties to take tough steps and vote for a cross-party budget. Indeed, the effect of this type of hung parliament scenario may well be a some kind of government of national unity to get through the Commons a budget that could stave off a fiscal crisis.

Of course, this isn’t so very likely, but it’s not inconceivable. And it is through this lens that one should view the Labour Party’s decision to increase the top rate of income tax to 50p in the pound. The Parallax Brief believes that this was not to soak the rich in a pique of partisan policy making, but an effort to show the bond market that Britain, and the Labour Party, had the iron will needed to push through unpopular and politically difficult policies to get the country’s fiscal house in order.

Tags [ , , , , , , , ]

Categories [ Economics and Finance, UK Politics ]

Comments [ 2 ]

Comrade Portillo: Spending Cuts “Impossible”; Tories Should Raise Taxes

November 23rd, 2009 by The Parallax Brief

Peter Hoskin on the Spectator’s Coffee House blog has an interesting take from Michael Portillo, who the Parallax Brief last remembers in Government as the uber-Thatcherite Dark Prince of the Right.

Ever the contrarian, Michael Portillo makes a case that you don’t hear from many on the right in his interview with Andrew Neil on Straight Talk this weekend. George Osborne has given “a fair amout of detail” about the Tories’ debt-reduction plans, he says, but that could be the wrong approach:

“I wouldn’t seek probably to give very much more detail …. You know, I was with Margaret Thatcher when she came in to Government in 1979, we faced a big public spending problem. It was terrible. It was a hard slog but she didn’t cut public spending. I was Chief Secretary between ’92 and ’94 – big public spending problem – I was trying to cut public spending; I did not succeed in cutting public spending. I don’t think the Tories will succeed in cutting public spending. Now this is what they won’t want to tell you. The reason they’re not telling you the cuts is that I think the cuts are almost impossible to make and what will happen, whoever wins the next election, is not so much that there’ll be public spending cuts, there will be restraint, but that there will be tax rises.”

The Parallax Brief has argued for a long time that the Right are going to be sorely disappointed if they think that an incoming Conservative government will be able to stabilize Britain’s desperate and exigent public finances through spending cuts alone. But he also believes, as does the Spectator, that the scale of the problem suggests that tax hikes alone cannot solve the problem either — public expenditure will have to be cut after the economy starts to right itself.

It’s interesting to see key figures on the right, such as the Spectator and Portillo, now supporting this view. The Parallax Brief wonders if they are paving the way for a more gentle approach to spending from the Conservative Party than many on the Right had hoped, and in the media had assumed?

Tags [ , , , , , ]

Categories [ Economics and Finance, UK Politics ]

Comments [ 0 ]

Economic Improvement Won’t Help Labour

November 19th, 2009 by The Parallax Brief

UK Polling report notes that despite polling trackers showing the economic expectations of voters have improved, this has had little impact on Labour’s opinion poll standing.

“Economic optimism has already returned. There are several different trackers following people’s expectations on the economy, they have all come back strongly since 2008 and early 2009, with some in positive territory. However, it does not seem to have produced any meaningful recovery for Labour. However, I’m still not ready to conclude for certain that it’s not going to have an effect – if an improved economy is going to improve Labour’s position in the polls, I think the trigger may be when the recession formally comes to an end, when the good news will no doubt be plastered across the media and the government will be primed to capitalise. That was expected in the last lot of quarterly economic figures, but never arrived. With the rest of Europe emerging from recession it must be very likely that the next lot of figures will show the formal end of the recession.”

What’s important to understand here is the difference between abstract terms and figures useful for measuring the strength of the economy, and the actual effect the economy has on the lives of individuals. It is unemployment, not GDP, which provides the lens through which voters view the health of the economy.

And unemployment figures are unlikely to provide any succour for incumbent governments anywhere in the developed world anytime soon.

The Free Exchange blog on the Economist’s website, explains the point:

“THE good news is, the OECD’s latest economic forecast revises up sharply projected economic growth for member nations. The bad news is, that still leaves OECD economies in pretty dismal shape. The organisation is now projecting that OECD members will grow by 1.9% in 2010, up from an earlier 0.7% forecast. The OECD estimates that the American economy will expand by 2.5% next year, where earlier 0.9% growth was anticipated.

It’s nice that expectations have risen, but we had all better hope that they rise more. In the two years after the end of the 1982 recession, the American economy expanded by 4.5% (1983) and 7.2% (1984), and at the end of that period the American unemployment rate was still above 7%.”

Similarly, the Parallax Brief noted in a previous blog post that:

“In both the 80-81 recession and the 90-91 recession, Britain’s GDP started moving back up in the 6th quarter after recession started, yet in the 1990-91 downturn, unemployment didn’t reach it’s peak until the 11th quarter. The 80-81 slump was even worse, with unemployment still at its high watermark in the 17th quarter — over four years after the recession started, and two and a half years after it finished. On both occasions, a full 19 quarters (nearly five years) after the recession started, unemployment levels were still above their pre-recession levels, despite GDP reaching it’s previous levels around three years after the recession began.”

That’s because unemployment lags GDP, moving up well after GDP recovers.

Even if the economy roars back before the next election — which it won’t — it is likely that unemployment will stay near its high watermark, or just as likely, continue rising. Given that personal economic hardship is far more important to individual voters than general economic health — especially when demonstrated by abstract numbers like GDP — it seems doubtful that the economy will give Labour much help.

Of course, rising GDP might make it slightly more difficult for the Conservative Party to beat Labour about the head with the Economy Breeze Block, especially if Labour can show that it has done better than might have been expected given the conditions, but it’s unlikely that Labour can get back into power through economic improvement alone.

And considering the mess we’re in, that’s exactly how it should be.

Tags [ , , , , ]

Categories [ Economics and Finance, UK Politics ]

Comments [ 0 ]

Will Free be the New Standard?

November 18th, 2009 by The Parallax Brief

The Adam Smith Institute has been wining and dining with Geordie Greig, editor of the London Evening Standard, with whom they discussed his paper’s shift into Freeconomics.

He outlined the brave new business model at the Standard, which used to charge 50p but is now given away free on London’s streets and at commuter stations. I don’t think any newspaper makes money these days – most have found that advertising revenue has collapsed during the recession – but the new strategy has cut losses and greatly increased the circulation (and hence the attractiveness to advertisers) to 600,000 and rising, so the Standard hopes to be in profit within three years’ time. And, of course, the Standard has seen off two other free papers, The London Paper (which Murdoch pulled the plug on last month) and London Lite (which closed last week).

What this does, really, is apply the business model of the internet to the world of printed media. The best explanation of this phenomena — better than the one offered at the ASI blog article quoted above, if the Parallax Brief may be so bold — can be found by reading Chris Anderson’s definitive thesis on this matter in Wired Magazine.

In effect, what the internet does is prove that money can be made by giving something away for free but charging people (advertisers) for targeting your audience by piggybacking on your product.

Anderson’s Wired article really is a fascinating exposition of an nascent and potentially revolutionary business model, and the Parallax Brief believes the newspaper industry is far more likely to follow the lead of the internet than bend the internet to its will.

Perhaps Russian oligarchs know more about how to run a paper than Rupert Murdoch?

Tags [ , , ]

Categories [ Economics and Finance ]

Comments [ 2 ]

Can Bank Regulators be Trusted with Banking Regulation?

November 18th, 2009 by The Parallax Brief

Former IMF chief economist Simon Johnson has written today about a terrifically illuminating paper published by the Bank of International Settlements (the central banks’ central bank) called Banking on the State.

Co-authored by Andrew Haldane, Executive Director for Financial Stability at the Bank of England and, according to the Baseline Scenario, closely in line with BofE supremo Mervin King, the paper offers a gloomy assessment of the current financial system. In broad terms, it argues that the banking system is locked in a boom-bust-bailout cycle whereby the taxpayer lifeboats provided to the management, shareholder and creditors of the banks lay the foundation for the next crisis by encouraging excessive risk.

In order to “drive the conversation forward” the Mr. Johnson discusses seven talking points touched upon by the paper. However, the Parallax Brief would like to concentrate on just two:

1—The authors say that it is clear, in retrospect, that banks were excessively leveraged. But how did regulators/supervisors miss the implications of this at the time? Banks’ balance sheets started expanding from 1970 onwards (page 3) and by 2000 “balance sheets were more than five times annual UK GDP.” This was not an overnight development – see the last sentence on page 8 which says “Higher leverage fully accounts for the rise in UK banks’ return on equity up until 2007″. It may be difficult for a central banker to come clean on who convinced whom that modern banking in this form is safe – but at a minimum the authors should draw lessons from earlier failures of regulators/supervisors when discussing prospective changes in the framework of regulation. Could some of the changes being proposed suffer the same fate as all previous attempts to regulate big banks? It seems the authors answer is that just moving things to Pillar I (from Pillar II) will help. This sounds like wishful thinking.

2—The author are right that US banks faced a leverage ratio constraint, which European banks did not. But US banks circumvented this by setting up SIVs – see the damage at Citi for details. Again, what were the regulators/supervisors thinking when they allowed this?

When placed in these plain terms, it becomes nauseatingly clear that those responsible for the regulation of banks have been outright negligent. How was it possible to the banks to become so huge, so leveraged, and so dangerous? All right under the noses of the regulators.

And more to the point, now that Gordon Brown and Mervyn King seem to be clashing antlers over which of the Treasury-FSA-BofE regulatory menage a trois should hold what responsibilities and for whom after the financial system has been reorganized, can we trust any them? After all, each and every one seemed to be blissfully oblivious to the fact Royal Bank of Scotland had liabilities larger than Britain’s GDP. Was it not, like, you know, pretty obvious that if anything should happen, it might be in trouble?

Talk about missing the elephant in the room.

Mr. Johnson’s conclusion rings depressingly true:

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).

Tags [ , , , , , , , ]

Categories [ Economics and Finance, UK Politics ]

Comments [ 0 ]

« Older Entries