Notes from a talk given at Trinity Business School, Dublin, on 26th May 20164
Well, it depends what sort of crisis you mean. Have we done enough to prevent a crisis like the last one?
Yes. We have scared ourselves so much about the dangers of disorderly bank failure that no way are we going to allow that to happen again – at least, not until we who lived through the crisis, and our children and grandchildren whom we tell about the crisis, are long gone and our legacy forgotten. No-one now would allow a bank like Lehman to fail. We might close it down, but we wouldn’t simply allow it to go bankrupt overnight.
We learned from the 2008 crisis that systemically-important banks must not be allowed to fail. And since we do not really know which banks are systemically important and which are not, that means that anything large enough to save, must be saved. Only very tiny banks can fail. The rest will be rescued, one way or another.
Most often, banks are rescued by merging them with other banks. But we have paid a price for this. Banking systems are now much more concentrated than they were. The UK has lost its entire middle tier of banks, not because of the high profile failures of RBS and HBOS, but because of the fallout in the mutual sector. In Ireland, there are now only two major banks. Greece has only four. Cyprus is down to two. Such concentration is bad for customers, since it reduces the competitive pressures that give customers choice and encourage banks to provide good service and value for money. And even more worryingly, such concentration increases the chance of bank failure leading to systemic meltdown.
But we also learned from the last crisis that we cannot risk meltdown of the financial system. So we put our faith in centralised institutions – not only central banks, but also things like CCPs. We transferred increasing amounts of responsibility to regulators, because we don’t trust the managers of financial institutions. We substituted public sector safe assets for the private sector assets that failed us. And we demanded that political institutions ensure that there can never be another failure like the last one.
Political institutions have done a huge amount. Higher capital requirements for banks, solvency requirements for insurance companies, liquidity buffers, new measures of solvency and liquidity, macroprudential and microprudential regulation, conduct regulation, stress tests. Never have we had such intrusive regulation and control.
But political institutions themselves are fallible. After all, regulators failed to address the excessive leverage and risky behaviour of financial institutions prior to the financial crisis. And the regulatory focus can be far too narrow. The spotlight is on banks and insurance companies: but intense regulation tends to drive dangerous activities into the shadows. The shadow banking sector is bigger than ever. And new providers in retail banking and payments are disrupting traditional banking models. If history is any guide, the next crisis is more likely to arise from these exciting new ventures than from our sclerotic banks.
Regulators and central banks are not the only institutions that failed to prevent a crisis. Two years after Lehman fell, it became apparent that Eurozone institutions had failed to address the excessive leverage and risky behaviour of Greece.
Greece’s crisis could also have been blamed on banks. But the world chose to believe, with some justification, that the fundamental problem was corrupt and dishonest government. Suddenly, populations around the world decided that the large deficits that were the legacy of the financial crisis had to cut back, and voted in governments that would do the necessary fiscal butchery. No-one wanted to risk being another Greece.
Loss of faith in government was even more damaging than loss of trust in banks. The austerity measures voluntarily and involuntarily inflicted by governments squashed the green shoots of recovery. The result was years of stagnation and lost output. Arguably – in Europe, at least – the Eurozone crisis has had more lasting effects than the fall of Lehman.
All crises are political. They just manifest themselves in different ways. So the 2008 financial crisis was political, both the decision to allow Lehman to fail and the preceding decisions to bail out Fannie & Freddie, Bear Sterns and – in Europe – Northern Rock and BayernLB, decisions which raised expectation of bailout.
And the sovereign debt crisis was also political. It was not really about Greece, Portugal, Ireland, Spain….it was all about the Euro project. The European elites will do “whatever it takes” to preserve their dream of one currency for one continent, even if that means decades of depression for some countries and the destruction of the hopes and dreams of an entire generation.
So have we done enough to prevent another crisis?
No. We have not changed the core beliefs that generate crisis. Indeed, they are hard for us to recognise, let alone change. They are deeply rooted in our history and even our biology. Belief that there can be returns without risk, and gains without losses: that safety is cost-free; that following the herd is wise, and being contrarian is dangerous; that saving is good and borrowing, bad; that surpluses are a sign of strength, and deficits, weakness; that good luck is due to talent, and wealth the result of hard work. These are the beliefs that lead to crisis. These are still our beliefs.
The story of the post-crisis years is one of asset owners desperately trying to hold on to wealth, wealth that they accumulated in the boom years and are now reluctant to relinquish. The losses that they should have taken in 2008 were pushed on to governments: then when governments failed, the losses were pushed on to the silent majority. They have now endured years of unemployment, falling real wages and cuts to pensions and benefits. And for some, there is no end in sight. Politically this is unsustainable.
We cannot see where the next crisis will come from. But of one thing I am sure. It will not be like the last crisis: but in our inadequate response to the last crisis, and our failure to recognise the source of all crises in our own irrational beliefs, we are already sowing the seeds of the next.