Does the financial crisis put an end to technocrats?


by Left Outside    
3:20 pm - November 20th 2012

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Airing one of my more unfashionable views for no other reason than because Chris Blattman echoes me.

The reasons that corruption should hurt growth are so persuasive that economists have been pretty surprised not to find much evidence. One team reviewed 41 different cross-country studies of corruption and development. Two-thirds of the studies don’t even find a negative correlation. Cross-country studies have mostly bad data and empirics, so we should not rest here. But Jacob Svensson has a nice overview of the broader evidence and draws the same conclusion: there’s not much to show that corruption reduces growth on net.

I think Acemoglu and Robinson put it best…

Here is a conjecture: corruption is a way for many economists and policymakers to talk about bad political outcomes without talking about politics… Corruption is an attractive talking point for both politicians and many economists because it is fundamentally viewed as apolitical. But poverty, alas, is not.

This fear of politics ties into the technocratisation of policy making.

Following the 1980s people began to think that economics was best left to economists. That they would work out clever answers to complicated questions and that clever people would implement them. Even if the electorate was stupid and didn’t want them, technocrats could win the battle of ideas.

The last fifteen years or so, at least since the Asian Financial Crisis, reality has been punching technocrats in the face again and again and again. Of course, most of the punches came from the developing world and could be safely ignored. Finally, in the face of massive suffering in the Eurozone and the US technocrats like Brad DeLong began to think again about politics and political economy.

Its the institutions, stupid. And it is stupid people who build institutions. They’re built by the stupid because we are all stupid. Everyday the worlds stock of knowledge expands more rapidly than you can learn. We are all progressively getting more stupid. If you want long term positive change then you have to force people towards your idea of it. The best organised and most convincing win because it is only in groups that we can overcome our innate ignorance.

Over a long enough time frame, humanity will return to the stone age or die trying. For a long time, people have accepted that ideas matter, but the old idea that putting lots and lots of people behind those ideas is coming back into fashion.

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About the author
Left Outside is a regular contributor to LC. He blogs here and tweets here. From October 2010 to September 2012 he is reading for an MSc in Global History at the London School of Economics and will be one of those metropolitan elite you read so much about.
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Reader comments


We are speaking about continuing events with unresolved problems for national economies, which are unprecedented for the period since WW2 and about which notable economists – as well as politicians – have divergent views.

As the banks are greatly involved, we can be sure that powerful vested interests are at stake too. Fiscal austerity programmes in several EU countries are inflicting acute social misery. It is grossly misleading to suggest that there is some broad consensus among technocrats – or among politicians or among “sensible” people off the street – about the diagnostic analysis or the policy remedies.

In a visit to the LSE by the Queen in 2008, she asked why no one had seen the financial crisis coming?

In fact, some economists and financial commentators had previously remarked years before on the continuing presence of financial market conditions capable of generating a crisis.

The conditions necessary for maintaining stable currency unions, such as the Euro, have been extensively discussed in a large professional literature – it’s just that many political leaders in Eurozone countries chose to ignor that literature as well as the safeguards which Delors, the EU Commission President at the time of the Maastricht Treaty of 1993, had built in. On the eligibility criteria in the Treaty, only Luxembourg was qualified to join the Euro at the launch in 2000.

The truth is that we have to pick out the appropriate group of technocrats for advice on policy options and that selection is a challenging problem in itself. It may be disappointing but an informal discussion over a few beers at the local pub or at a party constituency meeting is unlikely to solve anything.

2. gastro george

Economics used to be called Political Economy – for a good reason.

I have an interest in Spain and follow Edward Hugh, who lives in Barcelona I think.

http://www.economonitor.com/edwardhugh/2012/11/19/el-rosario-de-la-aurora/ (my emphasis)

… What we have is a country where not only are people of working age leaving in growing numbers, whole regions may want to go. A country where deficit numbers have been flouted time and again while bank interventions have been consistently implemented using the principle of always try to do too little too late. The country suffers from what the ECB calls deep competitiveness problems, yet there is not a single proposal on the table at present which would do anything substantial to correct this.

The pension system is spiraling quickly into a substantial structural imbalance, yet the government will hear nothing of any deep long-lasting pension reform. I could go on and on. I would like to be optimistic, but five years of watching this train crash in slow motion have left me with the feeling that this one now has no solution. The country’s political leaders just aren’t up to the levels of complexity involved (see this excellent summary of some of the “matters arising” in this regard from César Molinas here, and Europe’s leader[s] not only drag their feet, they stick their heads in the sand at the same time. …

And,
http://iberosphere.com/2012/11/spain-news-catalonia-independent-state7226/7226

At bloody last. Now we we send Ed Balls back to uni?

@OP, LO: “Following the 1980s people began to think that economics was best left to economists. That they would work out clever answers to complicated questions and that clever people would implement them. Even if the electorate was stupid and didn’t want them, technocrats could win the battle of ideas.”

I’m not convinced about the timeline — in the UK we understood from the 1980s that economic fixes had unforeseen social consequences, ones that we are still ignoring. I’m not convinced that UK and EU governments since that time have been technocratic.

Experts in a discipline understand the limits of their knowledge or analysis. Experts expect to make mistakes and to try to understand what to do next. So if the accused governments had really been technocratic, they’d have applied scientific principles.

But they used short term performance measures. They sought processes to determine human behaviour. They applied quick fixes to problems which require long term resolution. They used control of thought and action to conceal their mistakes.

They were managerialists pretending to be experts pretending to be technocrats.

A potential good is that managerialism mars the appeal of true technocrats.

John Redwood, eh? He is rational and thoughtful and a technocrat. I didn’t think that you want him running anything either, but he is a useful brain on the sidelines whatever your political leaning.

The launch of the Euro, as it was done, was a decision made by elected politicians against the advice of the EU Commission and by ignoring a large professional literature on the required conditions for “optimal currency areas”.

This was a classic case where the technical issues and reservations were swept aside because of over-riding political imperatives to speed up the process of European integration. Countries joining the Euro necessarily gave up national control over setting interest rates to suit national conditions and the option to resolve “competitiveness” issues by changing the exchange rate of the national currency.

Unpicking the consequences is exceptionally challenging because debt positions have been built up across the Eurozone area and beyond. Dropping out of the Eurozone and the constraints of a single currency will mean a collection of financial institutions having to bear substantial financial losses. The policy measures being applied are intended to preserve the Eurozone in order to prevent such losses materialising regardless of the social pain inflicted. Some believe that departures from the Euro are inevitable because the social pain will turn out to be intolerable.

The Eurozone crisis is only one set among interlocking problems. There are further problem sets relating to fiscal policies to restore economic growth – without which indebtedness burdens become worse, to reform the structure and regulation of financial institutions and markets, so as to prevent any recurrence of the banking crisis, and also to boost bank lending to businesses and households. The remedies for some sets of problems will likely conflict with the solutions to others – trade-offs are almost certainly inevitable. One glaring example is that requiring banks to hold more capital in reserve conflicts with the policy objective of boosting bank lending.

As others have already said, extricating Britain’s economy from the predicament it is in, will be a slow, protracted process lasting many years.

Gordon Brown technocrat extrodinaire gave us `dodgy growth’ theory and boy did it turn out to be dodgy. Basically let the masters of the universe create as much counterfeit money as they like and fund government spending from the tax it generates or as Mandy put it: get rich and pay your taxes. This was super charged Thatcherite de-regulation of the financial markets based on the bogus notion that `englightened self-interest’ would prevent these private interests from allowing the supply of money to get out of hand. But of course they ripped us all off and bankrupted themselves in the process. They created gazillions of basically counterfeit claims on global wealth and the recession soon to be depression is the result of the dash for cash i.e. turning these crappy counterfeit bankers bonds into currency and then gold and the fact that the back room presses of the banks have been switched off. The balance sheets of states are being destroyed, centuries of accumulated national wealth is being liquidated and currencies are being debased Weimar-style to bail out the bond holders and to pretend that nothing has happened but in actual fact capitalism as a functioning economic system has ceased to be. It can no longer reproduce itself and there is no possibility of it ever again being capable of that. Sclerotic, monopolised, decrepid and bankrupt the film of globalisation is being wound backwards in what will be an increasingly unedifying spectacle. Socialism or barbarism folks as was so marvelously prophesised as eventually the only possible choice by none other than K Marx 150 years ago. No mode of production disappears until it has completely exhausted its potential. Folks we’ve arrived and no technocrat can fix that.

8. Richard Carey

What we are seeing is hopefully the final collapse of the Keynesian anti-economics paradigm, which has ruled the roost for 80 years. Most of what passes for economics is really nothing of the sort, just playing around with statistics, anything that can be measured will do, when the really important factors in economics cannot be measured. Technocracy is just another version of the collectivist fallacy that a small group of people need to be put in charge to centrally manage and plan the economy.

Probably the biggest disaster is what they have done to the money. Without any link to gold since Nixon’s decision in 1971, there has been absolutely no restraint over the printing presses and the private banks’ privilege of creating new money through fractional reserve regulations have got us staring down the barrel of Weimar, and this time it’s the whole of the Western world caught up in the inflation.

8

“What we are seeing is hopefully the final collapse of the Keynesian anti-economics paradigm, which has ruled the roost for 80 years.”

Not so according to John Kay:

“The macroeconomics taught in advanced economics today is largely based on analysis labelled dynamic stochastic general equilibrium. The unappealing title gives the game away: the theorists are mostly talking to themselves. Their theories proved virtually useless in anticipating the crisis, analysing its development and recommending measures to deal with it.

“Recent economic policy debates have not only largely ignored DSGE, but have also been remarkably similar to the economic policy debates of the 1930s, although they have been resolved differently. The economists quoted most often are John Maynard Keynes and Hyman Minsky, both of whom are dead.”
http://www.ft.com/cms/s/0/19491372-472c-11df-b253-00144feab49a.html

For guidance on keynesianism updated, try this Prof De Grauwe: Lectures on Behavioral Macroeconomics (Princeton UP, 2012). He makes a convincing case. Dynamic general equilibium theory really doesn’t wash. How come so many countries are seeing an upsurge in unemployment at about the same time? Keynesian demand deficiency?

Prof De Grauwe is now at the LSE.

10. Richard Carey

@ Bob B,

“Dynamic general equilibium theory really doesn’t wash.”

Of course not, but those who are trying to scurry around with their new models are still within the dying paradigm I mention. Like Churchill said of America, perhaps economists will do the right thing, having exhausted all other possibilities, and get back to what Keynes arrogantly dismissed as ‘orthodox’ economic science.

Richard Carey

Far from being dead or even dying, the keynesian paradigm has provided far more useful insights into the financial crisis, its ramifications, contagious spread and remedial policies than the conventional wisdom of pre-keynesian times. Compared with other western economies, the American economy is relatively buoyant but that is a consequence of the substantial fiscal boost the Obama administration applied in 2009.

Eurozone governments are sadly locked into the futile notion that balancing bugets is all that matters to restore stability and create jobs. But that won’t work for this reason:

“Prof Paul de Grauwe from the London School of Economics (LSE) said austerity measures imposed on the Club Med with no offsetting stimulus by the creditors was creating a contractionary bias to the whole system and and leading to a ‘very dangerous situation’. ”
http://www.telegraph.co.uk/finance/financialcrisis/9681868/1930s-medicine-pushes-Europe-back-into-double-dip-recession.html

From my perspective, many of those damning Keynes and all his works haven’t read the General Theory and don’t even understand what the keynesian revolution was about. But then as the Party slogan went in Oceania: Ignorance is Strength

12. Richard Carey

@Bob B,

“many of those damning Keynes and all his works haven’t read the General Theory and don’t even understand what the keynesian revolution was about. But then as the Party slogan went in Oceania: Ignorance is Strength”

That’s fair comment, or at least it would be if I wasn’t pretty sure that in the past when I have suggested to you books to read and economists to note, you hadn’t dismissed them all as ‘fringe’. I may be wrong in this, in my memory I was referring to Benjamin Anderson’s ‘Economics and the Public welfare’. As for Keynes’ so-called ‘General Theory’ I have done better, as I have read the line-by-line refutation, provided by Henry Hazlitt in ‘The Failure of the New Economics’ (another ‘fringe’ writer, I suppose, at least in the dying paradigm).

Most of this boils down to the monetary system. Keynes told governments; ‘it’s okay to inflate, the commoners won’t notice’, and I suppose he was right, up to a point, but now all the chickens may be coming home to roost.

Richard Carey

Frankly, I don’t take any of that seriously. Hazlitt didn’t refute Keynes.

The keynesian influence is clearly evident in mainstream texts like Dornbusch: Macroeconomics (McGraw-Hill) and Olivier Blanchard: Macroeconomics – A European Perspective (Financial Times 2010).

The latter carries an endorsement on the front cover by Charles Bean, Deputy Governor of the BoE and previously the BoE’s chief economist. Blanchard is chief economist at the IMF. Hazlitt doesn’t appear on student reading lists, not least because there are more recent and potent textbook criticisms of keynesian economics, like Barro: Macroeconomics.

In his General Theory, Keynes was seeking to develop a paradigm which could explain how a market economy could get stuck at a relatively high level of unemployment and remain in such a state for years without collapsing but also without much relief to the continuing stagnation. The conventional wisdom at the time regarded that state of affairs as “a temporary aberration”, a departure from equilibrium which would revert to equilibrium in due course. Hence the much quoted damning retort of Keynes: In the long run, we are all dead.

Keynes wasn’t prescribing relentless inflation. An implication of his paradigm is that economic growth and jobs can be increased through a fiscal stimulus, always providing the economy is able to respond to an increase in aggregate demand. No one is suggesting that an under-developed economy, lacking infrastructure, skills and means of communications, can be boosted just by a fiscal stimulus.

From the press reports of meetings of the BoE’s Monetary Policy Committee, there is a continuing discussion as to the effectiveness of Quantitive Easing and about whether more of it is more likely to cause inflation to accelerate or output growth to increase. There is a similar dilemma in deciding on a fiscal stimulus so we find recent research studies such as Bill Martin: Is the British economy supply constrained? (July 2011)
http://www.cbr.cam.ac.uk/pdf/BM_Report.pdf

14. Richard Carey

@ Bob B,

“Frankly, I don’t take any of that seriously. Hazlitt didn’t refute Keynes.”

Have you read the book? I doubt that you have. Feel free to contradict me, because the significance of your comment is different if you have.

“Hazlitt doesn’t appear on student reading lists”

Classic appeal to authority, which says nothing about whether Hazlitt was right or not, and everything about why the economics profession cannot discern their idiocies and errors, because they insulate themselves from criticism.

Keynes was wrong. His ‘General Theory’ is not a general theory, even the title is wrong, as is clear from your brief description of it.

“The conventional wisdom at the time regarded that state of affairs as “a temporary aberration”, a departure from equilibrium which would revert to equilibrium in due course.”

The ‘conventional wisdom’? or the straw man of what the conventional wisdom was for the ‘unorthodox’ Keynes to knock down? Keynes could hardly comment on ‘conventional wisdom’ as he was largely ignorant of economics, except for Marshall and Pigou, and a little bit of Ricardo. If I’m wrong, who else does he refer to in his ‘General Theory’?

“Keynes wasn’t prescribing relentless inflation.”

Indeed not, but he did prescribe it as a means to lower real wages without the ignorant workers realising, such was the arrogance of Keynes, the elitist snob. Needless to say, the workers noticed.

“From the press reports of meetings of the BoE’s Monetary Policy Committee, there is a continuing discussion as to the effectiveness of Quantitive Easing and about whether more of it is more likely to cause inflation to accelerate or output growth to increase.”

Yeah, and I’m sure Ceausescu continued to discuss his Five Year Economic Plan right up to the end. Now, the future is uncertain, and it’s possible that things will carry on, but thanks to Keynes and those who carried on his work, our monetary system is like a city built on a smoking volcano, and it could blow at any time.

Keynes presented cynical ideology as science. He was the `philosopher’ of monopoly capitalism advising how, by recycling some of their super profits they could continue to support a Tory voting middle class that would keep the corporations in power. That ship has now sailed. When told that his measures would spell long term doom for capitalism his response was: in the long run we are all dead. Meaning just rip up the planet now for the profit of the current generation and screw the future.

A `geneeral theory of interest’. It’s like Monty Python’s theory of dinosaurs which is that they are thin at one end much much thicker in the middle and thin again at the other end. What the hell does a general theory of interest even mean? Interest is interest is interest if you look at it generally, particularly or universally. Was there a particular theory of interest prior to his general theory? Just pseudo science and pragmatism dressed as something important attempting to bask in the glory of the great physical theories that had emerged shortly before.

Fuck Keynes and his New Labour groupies. Time for socialism.

Richard Carey: “Indeed not, but he did prescribe it as a means to lower real wages without the ignorant workers realising, such was the arrogance of Keynes, the elitist snob. Needless to say, the workers noticed.”

You have completely misconstrued the analysis. What Keynes was saying was that raising the level of employment would (almost inevitably) involve a reduction in real wages – which was an impeccably orthodox position to take, rightly or wrongly. The previous conventional wisdom was also that the real wage would have to fall for employment to rise because of diminishing returns from employing more workers – perhaps especially previously unemployed workers.

Where keynesians fell out with the previous conventional wisdom was in keynesian criticism of the conventional policy for increasing employment by general cuts in money wages.

The keynesian analysis is that a general cut in money wages would likely be resisted by workers and, importantly, would result in a reduction in aggregate monetary demand because of lower money incomes. With competition between suppliers, it would be likely that prices would also fall so real wages wouldn’t change.

More importantly, falling prices leads to expectations that prices would fall further so businesses and consumers would likely postpone spending on the possibility that they will be able to buy what they had intended to buy but later at lower prices. The consequence is further reductions in aggregate demand thereby leading to more price reductions as well as fuelling expectations of a continuing deflationary spiral.

The keynesian prescription for avoiding this impass is to boost demand by a fiscal stimulus, most effectively through a public works programme. Prices would rise in response to the increase in aggegate demand thereby reducing real wages, which both previously conventional wisdom and keynesian analysis believed (correctly or otherwise) to be necessary in order to make it profitable for employers to create jobs in a market economy.

I can only conclude that you simply don’t understand the fundamental differences between keynesians and previous conventional wisdom.

Peter Emms: “Fuck Keynes and his New Labour groupies. Time for socialism.”

Which particular variety of Socialism do you have in mind? The Soviet kind, the variety with Chinese characteristics or the national socialist variety?

Keynes – a signed up member of the Liberal Party – embarked on developing a new paradigm capable of explaining how a capitalist market economy could get stuck with maintaining a relatively high level of unemployment for years. This was no exercise in cynicism but in challenging deeply embedded conventional wisdom which held that nothing much could be done, certainly not a public works programme to create jobs in a depressed economy as that would necessarily “crowd out” equivalent private spending so there would be no net increase in employment – which was the regular position of HM Treasury in the 1930s.

17. Richard Carey

@ Bob B,

you keep repeating the Keynesian mantra about ‘conventional wisdom’, but you didn’t respond to the point I made that it was a straw man and that Keynes knew little of economics beyond Marshall. As such, ‘conventional wisdom’ is just a variation on ‘orthodoxy’ which Keynes uses throughout his book to portray himself as a Galileo-type rebel, battling the old thinking. All this makes Keynes a great polemicist, but not a great economist.

“Where keynesians fell out with the previous conventional wisdom was in keynesian criticism of the conventional policy for increasing employment by general cuts in money wages…”

Not conventional *policy*. A mere understanding of supply and demand.

“… The keynesian analysis is that a general cut in money wages would likely be resisted by workers..”

Hence his desire to con the workers by devaluing their wages through inflation, like I said.

“I can only conclude that you simply don’t understand the fundamental differences between keynesians and previous conventional wisdom.”

And likewise I can only conclude that you have no interest in even knowing what the critics of Keynes, outside the circle-jerk of the self-proclaimed mainstream, have said. Whereas if an economist suggests a minor little tweak to the great man’s equation, you think that’s worthwhile, but if anyone attacks the fundamentals of Keynesianism, then you stop up your ears. So, you put Keynes on an unassailable pedestal, and throw out all the previous economists, who Keynes and you never bothered to read, and only listen to those who pay homage to your bepedestalled hero.

“John Redwood, eh? He is rational and thoughtful and a technocrat. I didn’t think that you want him running anything either, but he is a useful brain on the sidelines whatever your political leaning”

Worst welsh secretary ever. Fucked things up so bad he made William Hague look like Churchill in comparisson. Almost every problem in the welsh economy, education system and local government in particular can be traced back to his period in office.

Richard Carey

“So, you put Keynes on an unassailable pedestal, and throw out all the previous economists, who Keynes and you never bothered to read, and only listen to those who pay homage to your bepedestalled hero.”

I don’t put Keynes on a pedestal: I just follow the mainstream economics literature, which was and is greatly influenced by the keynesian revolution that flowed from Keynes’s General Theory.

Where we are now is a greatly developed and reconstructed varient. I’ve already mentioned De Grauwe’s lectures on behavioral macroeconomics:
http://www.econ.kuleuven.be/ew/academic/intecon/Degrauwe/PDG-papers/Contributions%20to%20books/Behavioral%20Macro%20Book-Fin.pdf

20. Richard Carey

@ Bob B,

just to show you that I’m not like you, I shall read that link, but I must say from the first paragraph it already looks disastrously dumb. Apparently the writer thought that the economy had entered the sunlit uplands of prosperity for all, guided by the benign philosopher kings of the keynesian bloodline. These are the people who laughed when it was suggested that a housing bubble had been blown up in the American economy.

Your ‘mainstream economic literature’ is an hermetically-sealed echo-chamber. All they do is work on models, which they know do not exist in reality, nor, and this is important, can they exist logically. In order to make their models work they have to disregard the very key elements of economics. You might as well use that octopus who was picking the winners in the World Cup for your economic projections.

Anyway, now I’ll read your link, and here’s your homework:

http://library.mises.org/books/Henry%20Hazlitt/Failure%20of%20the%20New%20Economics.pdf

Richard Carey

There are very real and challenging policy issues currently at stake without getting sidetracked into infantile exchanges over what some crank, like Hazlitt, had to say about Keynes’s General Theory:

- What changes in fiscal/monetary policies are needed to get Britain’s economy growing again to alleviate the budget deficit.

- Reforming the structure and regulation of the banking system to prevent a recurrence of the financial crisis of 2008.

- Boosting bank lending so increased business investment and consumer spending can take up the gap left in aggregate demand from the cuts in public spending

- What to do about the unholy mess in the Eurozone.

The fact is that you have no understanding of macroeconomics. One hugely important change that Keynes brought to macroeconomics – the currency of that very term was an outcome of the keynesian revolution – was to oblige economists to consider the systemic effects of changes in individual decisions and policies.

If I decide to save more, I can accumulate additional financial assets without that having much impact on the economy. If lots of people attempt to save more at about the same time, consumer spending falls so shops and retail services sell less and supplier inventories rise so their incomes fall, which means they are likely to spend less, thereby generating second round effects of those initial decisions to save more.

A piece of special, topical interest in the latest issue of The Economist:

ON THE face of it, economics has had a dreadful decade: it offered no prediction of the subprime or euro crises, and only bitter arguments over how to solve them. But alongside these failures, a small group of the world’s top microeconomists are quietly revolutionising the discipline. Working for big technology firms such as Google, Microsoft and eBay, they are changing the way business decisions are made and markets work.
http://www.economist.com/news/finance-and-economics/21567079-meet-economists-who-are-making-markets-work-better-micro-stars-macro-effects

23. Richard Carey

@ Bob b,

“ON THE face of it, economics has had a dreadful decade: it offered no prediction of the subprime or euro crises,”

Economics *did* predict the subprime and euro crises. Not your ‘mainstream’ jerk-circle, but the ones you call cranks. Doesn’t that give you pause for thought? The ones who you refuse to consider, and dismiss as ‘cranks’ GOT IT RIGHT. The ones you follow, who you will allow no criticism of, GOT IT WRONG.

I know you won’t listen. Your emperor is naked, and all you want to do is argue about the stitching on his imaginary hemline.

Richard Carey

We can manage without the cranks. In fact, several very mainstream economists and market analysts did foresee a looming financial market crisis and duly issued warnings – including Nouriel Roubini and Warren Buffett. Others – such as Goodhart and Roger Bootle – warned about inflating asset price bubbles.

Try this from 2003 by Warren Buffett, a legendary stock market investor, rated as probably the third richest man in the world.

“The rapidly growing trade in derivatives poses a ‘mega-catastrophic risk’ for the economy and most shares are still ‘too expensive’, legendary investor Warren Buffett has warned.”
http://news.bbc.co.uk/1/hi/business/2817995.stm

“CHARLES GOODHART, a former member of the Bank of England’s monetary policy committee, warned yesterday that the Bank is failing to take sufficient account of the house price boom in setting interest rates.” [Telegraph 2002]

Sadly, their warnings were ignored by governments and financial market regulators – house owners love inflating house prices. In a review of 2009, Turner, chairman of the outgoing Financial Services Authority (FSA), admitted that the FSA fell down on the job of adequately regulating the banks.

And compare this illuminating comment from Alan Greenspan – previous chairman of the US Fed – in his testimony on 24 October 2008 to the US House of Representatives Oversight Committee: “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief.” [WSJ]

The bankers were ripping off both customers and shareholders. In the last few days in the press, there is much about how “shadow banks” will have to be brought under the scope of formal financial regulation to ensure stability of the financial system.

In an interview on the BBC Today programme on 4 November 2011, Bob Diamond – late CEO of Barclays Bank – said that the Banks must accept responsibility for what went wrong. In the interview – which I listened to – he repeatedly said that banks must work towards a situation where banks could fail without taxpayer support and without causing systemic instability.

In the last few days, the press has been carrying stark warnings about the urgent need to bring the “shadow banking” system within the scope of formal financial services regulation to maintain financial stability. For one, try this from Reuters:

“(Reuters) – The shadow banking system – blamed for aggravating the financial crisis – grew to a new high of $67 trillion globally last year, a top regulatory group said, calling for tighter control of the sector.”
http://uk.reuters.com/article/2012/11/19/uk-shadow-banking-regulation-idUKBRE8AI0SJ20121119

There are several pieces in the FT, Businessweek etc relating, and a forthcoming book Gary Gorton: Misunderstanding Financial Crises – Why we don’t see them coming (OUP forthcoming).

26. Richard Carey

“John Maynard Keynes, the man — his character, his writings, and his actions throughout life — was composed of three guiding and interacting elements. The first was his overweening egotism, which assured him that he could handle all intellectual problems quickly and accurately and led him to scorn any general principles that might curb his unbridled ego. The second was his strong sense that he was born into, and destined to be a leader of, Great Britain’s ruling elite.

Both of these traits led Keynes to deal with people as well as nations from a self-perceived position of power and dominance. The third element was his deep hatred and contempt for the values and virtues of the bourgeoisie, for conventional morality, for savings and thrift, and for the basic institutions of family life.”

http://mises.org/daily/3845

27. Derek Hattons Tailor

@ 24 The only way to achieve that is through more, smaller banks,something that, ironically, becomes harder with greater regulation. One of the reasons there are so few banks (relative to customers) is the capital needed to set yourself up as a bank. Even relatively “new” banks like Virgin are effectively subsidiaries of established banks for this reason. Capital requirements have increased post crash, and will probably increase further.

28. Richard Carey

@ 27 a good point, but I don’t think it’s ironic that regulations act to protect the big players. It’s usually the big players who call for regulations for this very reason.

29. Derek Hattons Tailor

Ironic might be the wrong word. Increased capital requirement as a component of greater regulation are seen as part of the solution to preventing contagious bank failure. At the same time they are an entry barrier to the banking sector. It is addressing symptom rather than cause.

26 Richard Carey

As usual, not argued analysis of different macroeconomic theories, just puerile abuse. And no attempt to address any of the real policy issues @21

The Von Mises cranks believe in self-regulating markets. If markets are self-regulating why are there so many pressures from governments and monetary authorities in the US, the EU and from Britain to bring the shadow banks – like hedge funds and other financial institutions which don’t take deposits directly from the public – within the scope of financial regulation?

Evidently, a lot in government and the monetary authorities don’t believe that self-regulation is sufficiently dependable to prevent another financial crisis.

27 Derek Hattons Taylor

You are absolutely correct that requiring the banks to hold more capital as an insurance against the contingency of future failure does limit their scope to increase lending to businesses and consumers now. One way of reducing this trade-off is for banks to cut staff bonuses. One bank – Lloyds – has announced that it is to scrap all incentives linked to product sales:
http://www.ft.com/cms/s/0/4fc20e54-1d1c-11e2-a17f-00144feabdc0.html#axzz2DBXzseFW

Presumably, the calculation is that the cost of the compensation being paid out to victims of the mis-selling is greater than the extra business brought in by the sales incentives. By reports in the press, the compensation being paid out by Lloyds for mis-selling Payment Protection Insurance (PPI) has risen to £5.275bn. The total compensation bill to the banking industry for the mis-selling is estimated at over £11bn.

Another way of reducing the dilemma is the Bank of England’s “Funding for lending” scheme – low interest loans from the BoE to banks which increase their lending to businesses and consumers.


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