Saturday, December 17, 2011

Simon Jenkins answers the Queen's Question with the failure to listen to the lessons of the 1930s

In a Guardian column, Simon Jenkins answers the Queen's Question by observing that the cause of this recession was the failure to listen to the lessons of the 1930s.

Regular readers know that your humble blogger thinks that their is only one major lesson that is not being listened heard.  That lesson is transparency restores confidence, financial markets and the real economy.  It is being silenced by Wall Street's Opacity Protection Team.

Mr. Jenkins offers up his idea on why the lessons of history are not being heard.
The Queen, reported the Daily Mail, was wearing a speckled cream suit and matching hat. Her Majesty was at the London School of Economics, listening to a professor, Luis Garicano, talk about the credit crunch. "It's awful," she said suddenly. "Why did nobody see it coming?" 
I did and it is a matter of public record.
For three years I have pondered the Queen's question, and the answer. (LSE was institutionally flummoxed; a year later, it gave her a waffly reply, that "everyone thought they were doing the right thing," and that "wishful thinking was combined with hubris".) 
It resurfaced last Tuesday with the publication of the Financial Services Authority report into its own conduct of the 2008 collapse of RBS and the attendant chaos. It is like expecting the Cosa Nostra to investigate the mafia. We are all sinners, ruminated the FSA, and need forgiveness, but no one was really to blame. It is a rough old world. 
Had the banking fiasco been a Russian invasion, nuclear meltdown or outbreak of plague, every expert would have faced inquisition, damning or being damned. Soldiers would have been cashiered and scientists ruined; doctors would have choked, blaming government cuts. 
Yet from the profession of economics and its gilded acolytes in the City, nothing but silence. 
I feel that the report is far better that Mr. Jenkins gives it credit for being.

This report confirms that the UK had the same problems that the Nyberg Report documented lead to the Irish financial crisis.  In both cases, the financial system was dependent on the regulators to properly assess the risk in the banking system, communicate this risk to all market participants and to take action.  In both cases, the regulators fail on all three tasks.

In both cases, the excuse for why they failed was also the same.  They failed because they were under political pressure, because the banks were lobbying them and because not everyone in the regulatory bureaucracy agreed with the risk assessment.

These finding are highly significant.  They show that so long as the regulators have a monopoly on the current asset, liability and off-balance sheet exposure details in the banking system, we are gambling with financial stability.

The only way to ensure that the stability of the financial system is not dependent on the regulators is to end their information monopoly by requiring banks to provide utter transparency.  Then, no matter how much pressure regulators are under by politicians, lobbyists or the inability to agree on a risk assessment, market participants are not dependent on them for their risk assessment.

Market participants can assess risk for themselves and exert discipline on the banks.
The Queen's question remains on the table, its acid quietly eating into the woodwork.
The world economy is in a mess....
Please see my prior posts on the Queen's question as they answer the question and provide the key to ending the mess the world economy is in (see here, here, and here).
At each turn the financial gurus assert that a recession will be temporary and "different". Over the past two years each prediction, including from Britain's Office for National Statistics, has been wildly optimistic. Mathematical models have proved as useless to economics as leeches and blisters once were to medicine. As Krugman notes, whatever the evil tidings, "things have turned out considerably worse … and are running fairly close to the historical norm". 
The western world is in the grip not of a blip or retrenchment, but of "the second great contraction" of modern times. It matches that of the Great Depression of the 1930s, out of which the west climbed only with the spending spree of Hitler's war. 
Its roots lay in the same cause, a speculative bubble (this time in housing) linked to reckless bank lending to individuals and states. That lending concealed wide imbalances between national economies. 
The fact that no remedy has seemed to work has had remarkably little impact on policy.
Partially, this is a function of the fact that each remedy is addressing the symtoms and not the cause of the problem.

That the failure of each remedy has had remarkably little impact on policy is a reflection of group think.  It is a very small group comprised of individuals with the same biases that policymakers listen to.

Let's look at Mr. Jenkins' list of remedies that did not work.
During the Depression Milton Friedman's call for an increase in money supply proved ineffective when that increase was merely hoarded by stricken banks. Thus pumping up the banks is exactly what the Bank of England is doing today: to the same minimal effect. 
Likewise in the 1920s and 1930s governments that forced national budgets into balance through austerity saved their banks, but exacerbated stagnation and slump. 
Krugman accepts that deficit finance is more acceptable today than in the 30s, but it is as yet insufficient to stimulate real growth. 
Equally disastrous was forcing nations to sustain overvalued currencies in deference to the gold standard. Yet the EU is still trying to shackle the weaker European states to an overvalued currency....
Notice that absent from this list is ending opacity in the financial system.  None of these remedies stands a chance when market participants do not have the information they need to assess risk and value assets.
The question is not what history says but who is listening. 
Please re-read the previous sentence.
The relaxation of global regulation in the 1980s arose from the influence over government of a profession that was becoming both rich and arrogant. Bankers paid lobbyists and courted politicians. 
Their influence is vividly narrated in Madrick's Age of Greed, as they moved their lending into sovereign debt on the thesis that "countries don't go out of business" and were "too big to fail". It was a phrase they deftly applied to themselves when disaster struck. 
This week Britain's bankers likewise persuaded David Cameron that "the national interest" required a refusal to accept or even participate in a new regulatory regime, despite such a regime being palpably needed. 
The same lobby resisted pressure to reduce bonuses, erect Chinese walls or adopt the recent Vickers report on bank restructuring. History is clear: as long as sectional interest overrides prudence or common sense, there is another crash....
It is only ultra transparency that ends the power of the bankers' lobbyists.  With ultra transparency, everyone can see what the banks are up to and exert market discipline on the banks so that they return to their traditional roles of intermediating between borrowers and savers and operating the payment system.
The message of economic history is similar. It can scream as loud as it likes, but if power is not listening it might as well be mute.

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