Speaking money

HowtospeakmoneyYesterday evening the Festival of Economics 2014 kicked off with the author John Lanchester in conversation with Izabella Kaminska of the FT. Lanchester, who is promoting his book How to speak money, had some very interesting and important things to say about the language of finance.

His key point was that the fact most people don’t understand or engage with the language and practices of finance has consequences. It means that bankers and economists are able to get away with obfuscation and mystification in order to hide their own ignorance or render opaque activities of very questionable social value. Because most people don’t really understand what is going on in finance they do not appreciate the risks that are being run or the ethics of some dubious practices. This lack of knowledge reduces public demands for greater regulation of the financial system, to the great benefit of the financiers.

But it is not simply the bankers and the public who are in the dark. Lanchester noted that last month the US bond market witnessed a seven sigma event – in terms of the volatility of short term interest rate movements. This is something which, if the models commonly used to analyze financial markets are right, is near impossible. The most obvious conclusion to draw, therefore, is that the models are wrong. So the analysts are in the dark as well. [Read more…]

Inclusive capitalism

Mark Carney’s speech yesterday to an Inclusive Capitalism conference has attracted plenty of press coverage. And rightly so.

It is a fascinating speech. But it is not necessarily fascinating for the arguments it sets out. The arguments are familiar. It is fascinating because it is Carney who is making the arguments. Markets erode social capital; inequality undermines the legitimacy of capitalism; more robust regulatory structures are insufficient on their own to deliver a safe and socially useful financial system; banking should be viewed as a support to broader, more important social objectives rather than an end in itself; we need to rediscover a focus on the long-term and the systemic.

These arguments have had currency among the critics of the established financial order for many years. And they have achieved much greater profile and urgency among those outside the citadel since the global financial crisis.  The need for the financial system to undergo an ethical overhaul becomes ever more compelling as each new area of fraudulent market-rigging becomes exposed.

Now the arguments are more clearly registering with insiders. [Read more…]

The economics we need, not the one we’ve got

econafterthecrisisA little late in the day I’ve just finished Adair Turner’s Economics after the crisis: objectives and means, published in 2012. It is based on Turner’s 2010 Lionel Robbins lectures.

Economics after the crisis is a thoughtful book which makes a number of relatively simple but profound points.

The early pages note some of the findings emerging from the literature on happiness. In particular, it examines the paradoxical finding that there is an apparent disconnection, once national income per head reaches a certain level, between further rises in average incomes and reported levels of happiness. More money on average doesn’t appear to make people happier.  Turner notes some of the mechanisms that could generate this finding. He notes that trends towards increasing income and wealth inequalities, which seem to accompany market-based economic growth, exacerbate the problem.

These empirical results present a challenge to simplistic views about the desirability of pursuing economic growth as an overriding policy objective. Turner argues that a proper understanding of the conventional economic arguments means they don’t justify the policy anyway. It is a radical simplification of these arguments that gets used to justify simplistic policy prescriptions associated with uncritical marketization.

And that is before you consider the arguments from behavioural economics about the importance of relativities in consumption. Some of the new behavioural economics thinking moves you even further from conventional thinking on growth. [Read more…]

Filling in the b(l)anks

the bankA couple of weeks ago Martin Wolf blogged on the way in which modern macroeconomics has neglected the explicit and integrated treatment of the financial sector. The consequences of this omission have turned out to be of enormous practical significance. It left analysis mostly blind to a range of important real world developments. He provided a brief summary of the characteristics of the banking system that he considers economics students need to be familiar with.

This is a theme developed by Professor Wendy Carlin in the revision of her textbook currently under development. She blogged about the aim of the project a year ago. The revision seeks to move instruction beyond a three equation model which does not explicitly incorporate money or credit. The approach retains that three equation model at its heart, but grafts on to it a financial sector that is, rather than a gross simplification, relatively rich in institutional detail. The motivation is that the model needs to be able to explain how changes in financial markets shifted and intensified risk in ways that ultimately precipitated the financial crisis and the subsequent macroeconomic turbulence.

It strikes me that this is an important project. Rather than leaving consideration of the impact of a highly developed financial system to more esoteric later study – if it is ever studied at all – it starts students off with an appreciation of the fundamental significance of finance for the functioning of the macroeconomy. [Read more…]

Is financial innovation a good idea?

fin innovat bookIs financial innovation a good thing or a bad thing? Is it possible to tell in advance? Some might recall Warren Buffett’s comments in 2003, when he characterised derivatives as financial weapons of mass destruction, and suggest that perhaps it is.

We know that novel, complex and non-transparent financial products were at the heart of the Global Financial Crisis. So should we draw the conclusion that financial innovation is inherently problematic?

Or should we conclude that the problem was, on the contrary, that the crash of 2007-2008 and its aftermath are in part a result of a failure to innovate sufficiently. From this perspective, more, and possibly more complex, financial innovations could have averted the recent and ongoing economic catastrophe.

This is the territory which a new book entitled Financial innovation: Too much or too little?, edited by Michael Haliassos, seeks to explore. The book originates in a symposium held in Frankfurt in 2009 in honour of Robert Shiller.

The editor is upfront about the perspective on offer (p.i):

Contrary to often voiced opinions, the book promotes the view that it was too little and too unbalanced rather than too much financial innovation that lay behind the global financial crisis that began in 2007. Correspondingly, preventing future financial crises neither requires nor is assisted by regulation that stifles financial innovation but is aided by policies and a regulatory and legal framework that helps broaden the informed use of financial innovation and distils its positive impact on the economy.

The contributions that follow don’t all, it would be fair to say, take quite such an uncritical stance towards financial innovation. Indeed, the editor himself qualifies the position somewhat as he develops his discussion. There are, nonetheless, some comments that struck the wrong note for me. For example, a little later the editor notes (p.viii):

The policy and regulatory environment is crucial to the process of financial innovation. Regulation can prevent useful innovation from happening but, interestingly, it can also encourage beneficial innovation aimed at circumventing the rules.

It isn’t exactly a secret that financial institutions will spend time and money trying to come up with new ways of evading regulatory requirements. We note Andrew Tyrie’s recent calls for electrifying the Vickers ring fence. But this is the first time that I’ve encountered these activities portrayed in quite such positive terms. [Read more…]

On banking reform

funny concept of happy face and dollar eyesThe debate over the future organisation and operation of the banking industry seems to have spluttered back into life.

Just before Christmas the first report of the Parliamentary Commission on Banking Standards made its appearance. The report focused on structures. Its most eye-catching and newsworthy recommendation was that the ring-fence between retail and investment banking, proposed by the Vickers Review, should be “electrified”. The aim is “that banks be given a disincentive to test the limits of the ring-fence”. That relatively simple statement is perhaps more revealing of the ethics and operation of the banking industry, and hence the regulatory challenge, than it first appears.

The continuing focus on the Vickers proposals is troubling. Even more troubling is the working assumption that if the Government holds its nerve – or there is sufficient pressure from outside to make sure it doesn’t backslide – so that the Vickers proposals are implemented in full then that would be an ambitious policy triumph that would tame the banks and deal with the problem. It is nothing of the sort.

There are straightforward arguments against this focus. Banks operating very different business models got into serious, and in some cases terminal, difficulty during the financial crisis. Some of the worst casualties – for example, Northern Rock, Bradford and Bingley – had no investment banking component. Their failure had everything to do with bad decision-making, poor risk management and weak regulatory oversight. As Frances Coppola has recently pointed out, this is not untypical. Looking back at previous banking crises problems of risk management and management oversight are much more frequently the source of banks getting into difficulty. But we seem incapable of learning this lesson.

The Parliamentary Commission proposes further reports later in the year covering a broader range of issues including organisation culture in banking. It will be intriguing to find out the shape that those reports will take.

The latest – and perhaps slightly belated – contribution to this debate is the publication of the IPPR’s Don’t bank on it: the financialisation of the UK economy. [Read more…]

Revisiting Capitalism Unleashed

Capitalism unleashedOver Christmas I went back to Capitalism Unleashed: Finance, Globalization and Welfare by Andrew Glyn. It is simultaneously a sparse and a sprawling book. The text has fewer than 190 pages, and yet it covers an immense amount of territory. I returned to the book to look for clues.

Glyn’s broad argument is that the post-Second World War period is a game of two halves.

During the 1950s and 1960s western industrialised economies experienced an unprecedented period of stability and growth during which the division of economic output was renegotiated – in the face of full employment and better worker organisation – away from profits and towards wages.

The crisis of the 1970s was followed by an extended period during which these gains for labour were eroded in the face of austerity politics, economic restructuring, globalisation, deregulation and privatisation. Glyn notes that capital account deregulation and financial innovation, in particular, reduced national autonomy, increased disruptive economic volatility and created dysfunctional incentives for senior management. He uses the now-famous example of the failure of Long-Term Capital Management and the contagion experienced during the Asian financial crisis to illustrate some of the key points. Environmental degradation sits ominously in the background as possibly placing an upper bound on future economic growth.

Glyn notes that the post-1980 marketising and liberalising policy agenda was not notably successful in improving the performance of the relevant economies. It was, however, successful in reordering the beneficiaries of the fruits of economic activity. There was a rebalancing away from wages and towards a greater share to profits. More income was also derived from property. These changes led to increasing inequality.

Glyn’s key observation is, however, about the resilience of social institutions, although he doesn’t quite frame it in those terms. Over an extended period there has been a cross-national policy agenda – sponsored by International Organisations – directed at welfare retrenchment. However, the institutions of the welfare state have proved remarkably robust, particularly in continental European countries. Glyn sees this as a positive sign. He argues that the welfare state is worth fighting for. It is the most effective means of mitigating the “market inequality” exacerbated by liberalisation and of providing adequate social insurance.

The book finishes with a brief discussion of the possibilities for introducing a Basic Income for all citizens. This is a means of moving away from the pernicious effects of means-testing benefits. It is also a means of coping with the fact that achieving adequate living standards will not require everyone to work full time, and that there is more to life than paid employment. Achieving this goal is not an economic impossibility. The barriers are primarily political.

You may be asking why, specifically, I was revisited Glyn’s book. What sort of clues was I looking for? [Read more…]

Two cheers for Barclays?

The audacity of Barclays’ actions in seeking to manipulate LIBOR is not in doubt. The scandal, quite apart from exposing how odious and unethical some of Barclays’ business practices were under Bob Diamond, has exposed profound weaknesses in the microstructures of financial markets. These weaknesses should not come as news to those who operate in, regulate or study financial markets. But the scandal has shone light upon the innermost workings of the global economy in a way that has allowed the rest of us to catch a glimpse of what is going on. And that has shaken any remaining faith people had in the banking industry. The scandal has genuinely global ramifications.

And that is even before raising the possibility that the bank’s attempt to subvert the LIBOR process was at the bidding of politicians or central bankers. The circumstantial evidence for political influence is growing. If direct interference is demonstrated then the entire British political and financial elite could go into meltdown. [Read more…]

Is The LIBOR Scandal A Milly Dowler Moment For The Banks?

[Originally posted at Dale&Co, 30/06/12]

My first reaction on hearing the news that the FSA has fined Barclays for a piece of sharp practice was little more than a raised eyebrow. After all, it’s hardly the first time. We’ve become rather inured to it. It was only in April this year that Barclays had to set aside an extra $300million – on top of the existing provision of £1bn – to compensate the victims of mis-sold Payment Protection Insurance. And Wednesday’s fine may not even be the only sanction handed to the bank this week, if the FSA’s report on the mis-selling of interest rate swaps to small businesses emerges on Friday as expected.

We seem to have faced a long succession of cases involving parts of the financial industry taking advantage of information asymmetries, inertia or lax regulation in order to trouser a few (million) extra quid, to the detriment of the consumer. And, of course, sitting on top of this is the mother of all scandals – the sub-prime mortgage crisis that triggered the Global Financial Crisis.

A striking thing about this sordid succession of scandals is that anyone is at all surprised when news of another one breaks. Similarly striking is the frequently supine response of the regulators. [Read more…]

On flash crashes and their prevention

How often do you encounter something important and find yourself thinking “how is it that I didn’t know about this already?”. It happened to me last week when reading an FT piece (£) by Gillian Tett on the flash crash experienced by the US equities market in May 2010. On the afternoon of 6th May the market lost nearly a $1tr in value in half an hour, only to recover most of that value by the close of the day’s trading. An enquiry followed, but no one has yet established precisely what happened.

Tett’s article draws on a Foresight report by Dave Cliff and Linda Northrop for the Government Office for Science that looks at the global financial markets from a perspective rooted in ICT and systems engineering. Cliff and Northrop argue that the world economy had a lucky escape in May 2010. Had the flash crash happened a couple of hours later the market would not have recovered before closing. As a consequence East Asian markets would have plummeted and worldwide financial meltdown could have been triggered.

Given that all this was news to me, and is clearly highly significant, I spent some of my New Years Day reading the report. [Read more…]