Another Financial Crisis is Unaffordable

Andrew Haldane made a speech in Ireland in which he discussed how another financial crisis is unaffordable.

THE world cannot afford another financial crash like that of 2008, which has already cost 30pc of global GDP in government support for the banking system, the Bank of England's head of financial stability said in Dublin yesterday.

Andrew Haldane said that in the UK alone, the implicit guarantee to the banks amounted to £100bn (€118bn) -- the same as running the National Health Service for a year.

"All this gives an incentive to the big banks to become bigger and more concentrated," Mr Haldane said. "This is the origin of the 'too big to fail' problem.

"Bankers had a 20-year party, but their market value relative to assets is back where it was 20 years ago."

Capital

Analysis suggested there were things regulators could have done to prevent such a huge crash. "They could have insisted on higher loan to value ratios as asset values rose. They could have made banks hold more capital as their loans expanded.

"If higher capital ratios had been in place in Ireland and the UK, it is possible that the credit boom would not have got out of control," he said.

With the permanent loss of output from the crash estimated as at least 100pc of global GDP, the world could not afford another crash on this scale. "The risk of another one will have to be combated with more and better regulation.

Actually, the existing regulations might have prevented the crash had there been current asset-level disclosure for all financial institutions and structured finance products. 

"Things like that are always said after a crash, and saying them wasn't much of a success this time."

Mr Haldane said he was optimistic that the new forms of capital, such as contingent convertible bonds, or Cocos, could change incentives for the banking system. These are loans to banks which convert into equity if the bank has trouble meeting its debts.

"If executives were paid partly in Cocos, and shareholders received part of their dividends in Cocos, it would make them more careful about the risks being run, because it could reduce the value of those payments.

Supporting Cocos because they would give management an incentive to be more careful about the risks being run is nuts and has already been shown not to work!  The heads of Bear, Stearns and Lehman Brothers had at risk and lost hundreds of millions of dollars from not properly managing the risks their firms took on.  Unless all of an executive's pay is in Cocos that they cannot sell for a decade after retirement, it is highly unlikely to have any impact on their risk management capabilities.

"The market price for such instruments could also serve as an early warning for regulators. There is a chance that they could provide simplicity and prompt corrective action rolled into one," Mr Haldane said.

In the absence of current asset-level disclosure, how could the market price of these instruments serve as an early warning over CDS prices or the firm's stock price?