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

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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

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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?

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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.

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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

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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.

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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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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

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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

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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

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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.