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The Global Financial Crisis: Lessons Learned, Lessons Already Forgotten? Alexander K. Swoboda

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Title: The Global Financial Crisis: Lessons Learned, Lessons Already Forgotten? Alexander K. Swoboda


1
The Global Financial Crisis Lessons Learned,
Lessons Already Forgotten?Alexander K. Swoboda
  • Presentation prepared for the Panel on China and
    the Global Financial Crisis Implications and
    Future Perspectives
  • Shanghai, May 27 2013

2
Outline
  1. The Crisis global, pervasive, lingering
  2. A different financial system?
  3. A major threat to international financial (and
    economic) stability Exit in a still fragile
    financial sytem
  4. What, if anything, have we learned?

3
I. The Crisis global, pervasive, lingering
  • After the great moderation, the crisis came as a
    shock. Some had begun believing that the
    moderation was due to 70 policy (especially
    monetary) skill, 20 improved structure and 10
    luck. (vs. 1/3,1/3,(1/3).
  • Its propagation revealed that financial system
    had become increasingly global, interconnected
    geographically and across markets but, at the
    same time, increasingly complex and opaque.
  • It also confirmed that regulation was highly
    pro-cyclical it tended to amplify rather than
    dampen macro shocks and credit cycles.
  • And it led to questioning the benefits of
    financial innovation/integration, sometimes
    sensibly, sometimes in populist unhelpful
    fashion. In a deeper sense, it became a crisis of
    confidence and trust in finance, its organization
    and public policy.

4
II. A different financial system?
  • The post-crisis financial system what has
    changed?
  • More concentrated rather than less
  • More fragmented (cf. Eurozone)
  • From private to public debt, from bank to
    sovereign doom loop
  • Some progress in regulatory policy
  • Attention paid to procyclicality /
    macroprudential policy
  • Some moves towards coordination (e.g towards a
    single supervisory mechanism in the Eurozone but
    well short of a true banking union), etc.
  • Move towards simple non risk weighted leverage
    ratios and some progress on anti-cyclical buffers
  • But fundamental problems remain
  • Too big to fail too large to save little
    progress
  • Lack of fiscal space in short run and
    consolidation in medium to long run

5
III. Exit in a fragile financial system
  • The more highly leveraged a financial system, the
    more interconnected and the more opaque, the more
    fragile that system . (Fragmentation /
    interconnectedness paradox).
  • With no action on the fiscal front, with
    macroprudential still far away, monetary policy
    is overburdened and conflicted. The exit from QE
    and UCMP becomes particularly delicate.
  • Worse, any interest rate spike, whatever its
    source threatens a financial crisis.
  • The current system is still fragile and leverage
    is increasing. So are lending and margin chains
    making the management of counterparty risk at a
    system level problematic. The we are fully
    hedged syndrome.

6
III. Exit in a fragile financial system
(continued)
  • There is evidence that (i) intermediation chains
    in the shadow banking system are increasing again
    (cf. securitization and collateral chains), which
    combined with a search for yield, threaten to
    provoke asset price collapses if a shock
    decreases the value of assets in those chains and
    leads to a rolling sequence of margin calls.
  • Some hints
  • Stocks purchased on margin on the NY stock
    exchange
  • End March 2013 USD 379.5 billion
  • July 2007 record USD 381.4 billion
  • Three figures from the 2013 U.S. Financial
    Stability Oversight Council

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11
III. Exit in a fragile financial system
(continued)
  • The dilemma is that you are damned if you do and
    damned if you dont
  • If interest rates are not raised, leverage and
    thus fragility increase, making any future
    tightening more costly and threatening to
    stability
  • It also makes the system more fragile to any
    shock to interest rates whether policy induced or
    resulting from increased risk aversion or what
    have you
  • Not to mention the hysteresis effects of
    persistent low interest rates, including effect
    on pension fund balance sheets and possibly
    solvency
  • If interest rates are raised or rise too fast
    the sensitivity of the system to any spike in
    rates may be so high that a crisis ensues

12
IV. What, if anything, have we (or should we
have) learned?
  • Crisis has brought a number of central issues to
    the fore
  • Pro-cyclicality of credit cycles, of leverage and
    of much regulation
  • Complexity and opaqueness (risk management
    issues)
  • Too big to fail
  • Policy inaction or delay (kicking the can down
    the road)
  • Instrument shortage Obstfelds trilemma and the
    burden on monetary policy.
  • We know what we need to do, why dont we do it?
  • A political economy or politics problem
  • Its never a good time to reform
  • Distributional issues including political power

13
What, if anything, have we (or should we have)
learned? (concluded)
  • Some simple lessons for policy
  • Ask of every regulation whether it is pro or
    anti-cyclical. Contingent rules important
    discretionary policy too often leads to inaction
  • Regulations should be as simple and few as
    possible. This means concentrating on essentials.
    (Haldane). Dodd-Frank!
  • Too big to fail cf. Richard Fischer, too small
    to fail
  • Act quickly (related to but not equal to big bang
    vs gradualism)
  • Attack problems at source (not only Tinbergen
    principle but also Mundells assignment
    prescription) to avoid unwanted side effects and
    instabilities

14
What, if anything, have we (or should we have)
learned? (concluded)
  • All this is easier said than done especially in a
    world that is getting more integrated and
    interconnected but where many distortions
    subsist. With greater factor mobility the overall
    cost of such distortions is likely to
    increaseand so may the likelihood of financial
    instability.
  • And, more fundamentally, there is no easy recipe
    to resolve the tension between increasingly
    interconnected financial markets and a fragmented
    policy and political world.
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