King speaks

Mervyn King’s stint on the Today programme yesterday was curious. It was much anticipated in some quarters. The reality then proved to be less revelatory than some might have hoped. I’m not sure what people were expecting – after years of buttoned-up discretion it was unlikely he was suddenly going to let all hang out. But some of the interpretation of King’s comments has been intriguingly partisan.

We are now only too familiar with the Coalition’s inclination to pin the blame for the financial crisis of 2007-08 on the last Labour government.  But asked directly yesterday whether he thought Labour were to blame he stated:

I am not going to talk about individual parties’ culpability because I think the real problem was a shared intellectual view right across the entire political spectrum and shared across the financial markets that things were going pretty well.

There were imbalances – we knew things were unsustainable – but it was not entirely obvious where it would come unstuck – and I think that is something everyone shared, and the right thing is to make it better for the future.

This has been interpreted in some quarters – notable by the Guardian – as King shifting his position and exonerating Labour. [Read more…]

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…]

Not us, guv

Academic economists are smart people. In my experience, a few are rather too self-consciously smart. And one or two adopt the characteristic economist persona – perpetual patronisation of, and impatience with, those unfortunate souls working in the lesser social sciences – without obviously having the track record to justify the hauteur. If, that is, it can ever be justified.*

The unwary might be forgiven for thinking that the Global Financial Crisis of 2007-2008, which it is generally agreed most macroeconomists did not anticipate, would take the wind out of economists’ sails somewhat. Some might argue that a degree more modesty about the discipline’s achievements would be appropriate in future.

And there was undoubtedly a period of reflection and self-criticism around 2008-2009. Senior economists were willing to speculate publicly on where it all went wrong. It’s an issue I’ve blogged about on previous occasions.

However, it wasn’t long before some of that smartness had been put to work articulating a range of reasons why the GFC should not be seen as a failure of economics as a body of knowledge, and nor should economists be seen as in any way culpable for the economic havoc that followed the implosion of the financial system in 2008.

Business as usual was returning. The familiar swagger was back. [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…]

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…]

Putting the brakes on housing booms

Home buying processProperty markets are frequently implicated in economic booms. It isn’t always residential property. But often it is. The last boom, which eventually triggered the Global Financial Crisis, had a strong housing market component.

A while ago the Bank of England created the new Financial Policy Committee (FPC) with responsibility for macro-prudential regulation. Within its regulatory remit is action to stop the development of housing booms and bubbles. The FPC favours using so-called “sectoral capital requirements” (SCR) to take the froth off the market, rather than setting out rigid rules for loan-to-value (LTV) or loan-to-income (LTI) ratios to restrain borrowing. This approach was restated earlier this week.

The FPC’s proposed approach has been reported differently by different newspapers. While some are billing it as the arrival of strong new powers, others are rather more critical. The critics argue that while there is evidence from other countries that regulating LTV or LTI directly can be effective in restraining house price inflation, the performance of regulating capital requirements in the aggregate is rather more uncertain.

This is quite an interesting regulatory question. We can all agree that avoiding run away housing booms would be good, not just for the housing market but for the broader macroeconomy. But how to achieve that? All regulatory interventions have strengths and weaknesses, they all carry downside risks. Might the blunter instrument of direct LTV or LTI regulation be better? There several possible issues. [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…]

The reopening of the economic mind?

Where is the revolutionary thinking in economics? That was one of the first questions posed by a speaker at the Festival of Economics held last weekend in a very damp Bristol. It is also one of the most pressing and the most intriguing.

I was among the hardy souls who bought a season ticket for the event and got a feel for the range of material covered. But rather than review the whole event I want to consider the issue of revolutionary thinking – posed as part of the session on The future of capitalism – in the light of the discussion in the last session on Economics in crisis.

The question about revolutionary thinking was part of a discussion reflecting upon the way in which paradigm shifts in economic thinking are associated with previous economic crises. Most notably, the rise of Keynesianism occurred in the aftermath of the Great Crash of the 1920s and the adoption of monetarism – and neoliberalism more broadly – took place after the apparent breakdown of Keynesianism and the appearance of stagflation in the 1970s. Where is the new thinking – the reconceptualisation of the macroeconomy and the role of the state – to go alongside the current crisis? [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…]