The causes of the crisis
James Forsyth 3:23pm
Niall Ferguson has a typically sharply-argued piece in the New York Times Magazine disputing the idea that the current financial crisis was caused by deregulation. Here’s the nub of his argument:
It sounds so obvious as to be hardly worth saying, but the key point about regulation is whether it is effective. More regulation is hardly a good in itself. Also, the exclusion of asset prices from inflation both here and in the States made us confuse the deflationary shock provided by the entry of China into the world economy with having solved the problem of how to produce growth without inflation.“The reality is that crises are more often caused by bad regulation than by deregulation. For one thing, both the international rules governing bank-capital adequacy so elaborately codified in the Basel I and Basel II accords and the national rules administered by the Securities and Exchange Commission failed miserably. It was the Basel system of weighting assets by their supposed riskiness that essentially allowed the Enronization of banks’ balance sheets, so that (for example) the ratio of Citigroup’s tangible on- and off-balance-sheet assets to its common equity reached a staggering 56 to 1 last year. The good health of Canada’s banks is due to better regulation. Simply by capping leverage at 20 to 1, the Office of the Superintendent of Financial Institutions spared Canada the need for bank bailouts.The biggest blunder of all had nothing to do with deregulation. For some reason, the Federal Reserve convinced itself that it could focus exclusively on the prices of consumer goods instead of taking asset prices into account when setting monetary policy. In July 2004, the federal funds rate was just 1.25 percent, at a time when urban property prices were rising at an annual rate of 17 percent. Negative real interest rates at this time were arguably the single most important cause of the property bubble.”
One final point worth noting from Ferguson is this one about German banks:
“last year average bank leverage was four times higher in Germany than in the United States. Schadenfreude will be in order when the German banking crisis strikes.”
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Fred
May 17th, 2009 3:56pm Report this commentTo sum up this interesting argument: everything the banks did was within the rules. Gordon would agree. Where have we heard this before?
Jim
May 17th, 2009 4:38pm Report this commentI think you also have to look at motivation. As we've seen with the expenses scandal, many of the actors in this drama are crooks. The central banks knew perfectly well they were stoking up an asset price bubble, as they could and did make fortunes from it. There attitude was 'to hell with the consequences'. The bill is now coming due and we are about to find out what the consequences will be.
Short the UK
May 17th, 2009 4:44pm Report this commentAs the whole British elite were caught up in the property bubble how are we going to purge our system so that so much capital is not wasted again on such an unproductive asset?
The Renegade Economist on YouTube has some ideas. He seems to be the only guy talking about a Land Tax. He is worth a check.
As a country we must start saving and investing in the productive part of the economy.
Problem is, the whole elite has been warped by the illusion of property wealth, they cannot change the system. The voters won't stand for it unless they are properly informed. How can they be informed when the elite are blind?
The march to becoming an Undeveloping Nation will be unstoppable unless we fundamentally re-engineer our economy to productive wealth creation based on savings.
Jim
May 17th, 2009 4:48pm Report this commentGresham's Law is proved correct for the umpteenth time. Bad money, if permitted, will drive out good.
AndyLeeds
May 17th, 2009 5:03pm Report this commentThings would have been vastly different had the Bank of England still been in charge of bank regulation. Yet another of Gordon's many crimes.
porkbelly
May 17th, 2009 5:17pm Report this commentAnother unintended consequence of regulation is that it creates a false level of confidence in investors' minds - even if they don't fully understand what they are getting into they think that somewhere a crew of Government Experts have analyzed the market and stamped their seal of approval on it. And with a strict regime of regulation comes an implicit guarantee that if it all goes south the powers that be will be there to bail them out. Markets would be a lot more cautious without this sort of unwarranted confidence.
Simon Cawkwell
May 17th, 2009 5:45pm Report this commentSurely, it cannot merely be claimed that poor regulation in practice was to blame for this disaster. It should also be remembered that Brown quite deliberately removed understanding and independent assessment of aggregate credit in the UK so that he could fiddle his way to his political advantage and our ruin. This was a deliberate refusal by Brown to regulate when power and an obligation to do so had been conferred upon him by the electorate.
Tom Willis
May 17th, 2009 5:56pm Report this commentSounds well argued to me. Which possible government in the UK would improve regulations, and which would just increase the regulatory burden?
I would be much happier if I could believe that the Conservatives would improve regulation, because sure as eggs (New|Old) Labour will just increase it. And how would a significant LibDem presence affect this? Would UK hands be tied by the EU and/or USA in any case?
Whatever the rights of the case, I expect we will see greatly increased regulation and an effective straightjacket for the banking system for the next 30 years or so: the politics of the possible will allow no other outcome.
David Bouvier
May 18th, 2009 5:07pm Report this commentThe two points are linked - the low interest rate policy meant that bank margins were low and they could only maintain profitability by increasing leverage.
The Basel made the fatal error of linking the risk assessment to ratings agency ratings - which meant that ratings became just a tick box requirement.
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