Financial reform: a call to arms
Post-crisis attempts to stimulate the economy and create safer banks only allowed to keep a vicious system /
Financial crises and the subsequent prolonged economic disease indicate a complete failure in the economy and politics. Moreover, the full their misunderstanding. Since that time we have learned a lot. But knowledge was not enough to avoid a repetition of this painful situation. We still live in an unbalanced and unstable financial economy. We need to be much more radical than before. Politicians do not expect the crises that broke out in 2007. At the same time, they not only did not expect them, but many were proud of their role in the creation of the so-called era of “great calm.” Since inflation has been stable, they believed that everything is for the best in this best of all the economic and financial worlds. These are the “old orthodox principles” existed before the crisis. The authorities did not see any particular risk in the rapid growth in lending. In general, they cared little increase in the proportion of borrowed funds; They thought that financial innovations have increased rather than decreased the stability; and they believed that it is easier to restore order after the rupture of bubbles in asset markets, than to prevent their growth.
It turned out that they were wrong in everything what they tried to warn the late Hyman Minsky, the words of which no one paid attention. Among his many arguments about how to actually operate financial systems, in contrast to many economists, was the opinion that stability is ultimately destabilizing. The longer the stable, the more risks people will find useful. Worse yet, the associated increase in leverage will be accompanied – and in fact provoke – an increase in asset prices. This will allow to justify taking risks creators borrowed capital. Such good results are stored until – suddenly and unexpectedly – it does not cease to be true. So it was this time. In the period up to 2007 people took themselves very much risk. In the global and liberal financial system, this infection could spread across countries.
After a fall in prices of assets and loss of risk appetite came a deep recession and a prolonged post-crisis illness as the economy is not only deprived of the fuel in the form of additional loans, but were forced to deal with the debt burden. I think, at the heart of this story were the world economic shocks: savings glut (or rather the lack of investment); global imbalances; increasing inequality and therefore weak growth in consumption; low real interest rates on safe assets; Search income; and the creation of relatively safe, but relatively high-yielding financial assets. Central banks, which was expected, that they will keep inflation in the economy in the face of strong deflationary pressures, felt obliged to provide monetary fuel in a large quantity. However, the conditions of its use has defined the financial sector. It could ignite in flames productive investment. And it is, on the contrary, provoked a sharp rise in housing prices, the increase in debt and the rapid growth of leverage within the financial sector.
Credit booms and subsequent recession is clearly unavoidable cost terribly expensive. This fact is confirmed by all the practical research. Looking back, carefree politicians in relation to risk-taking seem daunting. But now arises the main question: whether they have learned the necessary lessons for the future? In his new book, I talk about the “new orthodoxy principles”, which effectively replaced the principles that have disappeared during the Great Recession. Ben Bernanke is partly described these new orthodox views in a lecture he gave, as chairman of the US Federal Reserve, in 2012. Under these new principles of orthodox monetary policy is the main instrument of macroeconomic stabilization, with fiscal policy plays a minor role, if any, has any -What value. The aim of monetary policy – to maintain low and stable inflation, although some central banks (especially the Fed) explains that the goal is to ensure maximum activity at achieving the inflation target. However, central banks expanded their arsenal of tools to unconventional measures, including “quantitative easing.” Meanwhile, the financial sector as a whole will be the same as before, despite the tightening of regulation and establish higher capital requirements. It is also necessary to strengthen control over the fragile financial framework in macroprudential policy system.
These new orthodox principles – only the corrected version of the old principles. But do they work? There are several reasons to think that the answer is no. Firstly, the policy rely on too monetary policy as a preferred instrument stabilization. But at the basis of monetary policy is based on asset prices and credit expansion. This combination is certainly fraught with the risk of recurrence of the crisis. This is especially true if there is a structural deficit of demand. Policies can be destined to the creation of new bubbles, which will replace the old ones. Secondly, experience has shown that the low inflation target, which are committed to policies that are not high enough to ensure that short-term interest rates could remain above zero under any circumstances. Nevertheless, there is a high risk associated with the increase in target levels, as it inevitably would undermine the credibility of any target level. Therein lies the dilemma. As it is written in the work, co-written by Andrew Heldeyn made from the Bank of England, the most important result of the American Great Depression in terms of regulation was the Glass-Steagall Act, written in 37 pages. At this time, the Dodd-Frank Act was 848 pages and requires regulators drawing nearly 400 regulations. As a result of this rule-making could lead to 30,000 pages. At the same time in Europe for the regulations it will almost certainly require an even larger amount. Thirdly, there may be conflicts between monetary policy on the one hand and on the other macroprudential policies. Think about the problems faced by US policy in the first half of the last decade. If regulators stopped the flow of credit caused by the formation of the housing bubble, they would reduce consumption and investment in housing. In response to the Fed, worried about low inflation, it might have been forced to further reduce interest rates, thus struggling with the consequences of its own macroprudential policy.
All of this normative action says about undermining trust between the government and financial sectors. And it does not indicate between the new interim agreement. Cynics may recall a note in the work of Tomazi Di Lampedusa “Leopard”: “If we want things to remain as before, everything has to change.” They may conclude that it is manic rulemaking designed to hide the fact that all of these efforts are aimed at preserving the system that existed before the crisis: it will remain the global; it will continue to depend on the interaction of large financial institutions to free capital markets; it will also be used by a large proportion of borrowed funds; and it will continue to rely on profits as a result of the successful management of huge discrepancies between maturities and risks. As for the future, concern is the financial sector and the economic role of debt. In my view, it is important to go beyond the new orthodox principles.
The business model of a modern banking system is this: make the most debts, directly or indirectly secured by guarantees; use as little of the share capital; promise great return on equity; bonuses bind to obtaining this target yields in the short term; make sure that in the event of a disaster as much as possible on a smaller scale to compensate for a fee; and make a fortune. For banks, this was a wonderful model. For everyone else – a catastrophe. The new regulatory regime – is surprisingly difficult measure to respond to the collapse of this model. But “just – it does not mean bad” – this is a good rule in the regulation, as in life. A reasonable solution seems obvious: to force the banks to fund themselves at the expense of the share capital to a much greater extent than now. So what the capital would have been sufficient? The answer is – a lot more than 3 percent, discussed in Basle. According to his book “New clothes bankers ‘Anat Admati and Martin Hellwig (The Bankers’ New Clothes), significantly more capital – with a real share of borrowed capital in the ratio of not more than 10 to one and all the same, ideally, in a smaller size – I would give important advantages: it would limit the hidden subsidies for banks, in particular for the “too big to fail”; would reduce the need for such an intrusive and integrated management; and to reduce the risk of panic.
An important feature of the higher capital requirements – is that these requirements should not be based on risk assessment. In fact, risk assessment, used before the crisis, were highly questionable and in fact very misleading. It’s inevitable: the risk assessment is almost always neverny.V general, will tend to invest excessively in what appears to be a relatively low risk. In the latter case, it was the assets secured by real estate. Such loans would seem safe as long as it will be possible to avoid a general fall in property prices. Otherwise, it would be risky lending. Unfortunately, calling a specific activity relatively safe, we increase the likelihood of excessive lending. Market reaction itself will make erroneous prediction of its relatively low level of riskiness. Another, perhaps more importantly, the proposal seeks to decrease in leverage economies. Perhaps the most important lesson learned from the crisis is the fact that at some point in the growth of debt increases the fragility of the economy more than the increases in personal wealth or aggregate demand. Atif Mian and Amir Sufi convincingly write about it in his book “Debt house» (House of Debt). New orthodox principles, although it recommended a more moderate restriction of leverage than, in my opinion, it is necessary, allow you to convert certain categories of debt into equity in the case of de-capitalization institutions. But this idea, though attractive in theory, in practice, is likely to be difficult to implement. This is particularly likely in a system panic if only in a passive vulnerable institutions will not appear large amounts of long-term debt which can be restructured and which is owned by investors, able to bear such losses. Nevertheless, such a debt, by its nature, is quite close to the capital stock. The only justification for such a proposal – debt can be deducted from the amount of tax. But this requires a radical tax reform.
Ideally, the new financial contracts would have shareholders’ equity, included in them from the beginning. Such contracts would automatically allocates the risk between lenders and borrowers. Take loans secured by residential real estate as the main example. Under the new contract loans would automatically decreased in the event of the fall of the overall level of housing prices, according to a specific index, and would increase in the event of their growth. In such a “contract with the joint equity” financial providers would share the risks and rewards in case of change in house prices. These new contracts could be very attractive for long-term investors. Avoiding excessive debt inflexible contracts that undermine the stability of the economy would require further policy changes. The existing favorable tax regime to cancel: the debt must be taxed and not subsidized.
The dominance of institutions with highly leveraged greatly complicates the development of such contracts with a share capital. Over-reliance on such institutions as strongly destabilize during booms, as well as in a recession. During the boom they have produced too many loans and debts. During recessions, they create panic, so as lenders are beginning to think that the institutions in which they keep their money, not as safe as they had hoped. ? When people think that the money they hold in banks are safe, while the latter freely give out their risky categories of borrowers, crises are inevitable. Worse still, in the present circumstances the bank institutions create a huge amount of money in the economy as a byproduct often unreliable risky lending. Because people think money only safe asset, the system, in essence, should be subject to crises. It could be replaced, at least in theory, restoring the function of creating the state money. The need to reduce dependence on intermediaries with highly leveraged agreement with another, more radical option: the transition to a 100 per cent reserve banking, the financial intermediary should be carried out outside the banking system. There are different versions of this radical reform, starting with the left and right ending. This is not unreasonable.
Such proposals are inevitably controversial. Certainly make the transition would be difficult. However, this could give great benefits provided effective new forms of differentiation of the banking sector and other segments of the financial system. Moreover, even if you do not go that far, we can recognize that the current experiments with quantitative easing is a small step in this direction. One could now raise reserve requirements to the present high level, thereby increasing the amount of money provided by the state. It was also possible to create money, not only for price manipulation on the assets as at quantitative easing today, but also for the direct financing of the government. Direct financing of public spending, in particular the increase in investment or tax cuts, would be an effective way to generate additional demand without debt. This idea that the late Milton Friedman called “throwing money from a helicopter” is still relevant.
These radical proposals involve risks. But since the decision as to how much money you want to create is up to the central banks, they can be controlled. In particular, the distribution would be more effective than the use of central bank’s ability to create money only to enhance the value of assets owned by the rich. This story is not over yet. Yes, the economy is recovering. But the losses are huge and most likely they are not going anywhere for a long time. Pre-crisis orthodox principles were wrong. New orthodox principles speak about positive dynamics. But many important aspects remain in question. The financial system remains fragile. High risk of new crises. So you need to be more active.
Forexpf.ru prepared based on The Financial Times Source: Forexpf.Ru – Forex Market News
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