Tuesday, July 12, 2011

Bank of England Lessons from the Global Financial Crisis

Greetings from the Australian National University, in Canberra, where Charles Bean, Deputy Governor of the Bank of England is speaking on the role of central banks after Global Financial Crisis. This appears to be an updated version of a talk from 2008 (excepts appended). The talk is part of the 40th Australian Conference of Economists.

This is the second talk on lessons from the Global Financial Crisis (GFC) by a central banker in the last few weeks. Dr D. Subbarao (దువ్వూరి సుబ్బారావు), Governor of the Reserve Bank of India, talked on "India and the global financial crisis – what have we learnt?" at the Australian National University in Canberra, 23 June 2011.

What I found interesting in both central banker's talks was that there was no mention of the cost and value of information in economic policies. It seems to me that the GFC occurred partly because no one in the system, companies, banks or governments, knew exactly what was happening. Banks had loans secured against assents which they not only did not know the value of, they did not know exactly what the assets were. Along with deliberate dishonesty, this lack of accurate and timely information caused a global lack of confidence. It would not be acceptable to operate a air traffic control system where you did not know the location of the aircraft minute by minute, but the financial system is operates largely on dead reckoning much of the time. We have the technology to provide accurate and timely information.

The second point of interest was the extent to which the type of measures common in Islam banking might help prevent such a crisis. In 2008 I attended the Malaysian Corporate Governance Conference at the Securities Commission, Kuala Lumpur, the regulator for Islamic capital markets in Malaysia. The Australian government issued a report "Islamic Finance" in February 2010. What struck me was that Islamic banking has much in common with the approach of ethical investment by companies such as Australian Ethical Investment. Having an ethical basis to the financial system might help prevent some of the difficulties of recent times.

Billboard Event

Public Lecture

Central banking: then and now

Dr Bean will look at how the roles of central banks have changed in the wake of the Global Financial Crisis. In a recent address at a University of Chicago conference Bean said that any GFC type ‘quantitative easing’ during normal times would risk giving the impression that central banks were subsidising the cost of government borrowing, and raise “doubts about the central banks’ independence.”

Charlie Bean has been Deputy Governor of the Bank of England since 1 July 2008. In addition to his membership of the Bank’s critical Monetary Policy Committee, he has specific responsibility within the Bank for Monetary Policy, including monetary analysis and money market operations. Formerly head of the Department of Economics at the LSE, he has published widely, in both professional journals and more popular media, on European unemployment, on the European Monetary Union, and on macroeconomics generally. He has served on the boards of several academic journals, and was Managing Editor of the Review of Economic Studies (1986-90).

The Sir Leslie Melville Lecture was established in 2002 as part of the celebration of the 100th birthday of Sir Leslie Galfried Melville (1902-2002), and to mark more than half a century of Sir Leslie’s distinguished public service in the fields of monetary policy and higher education. Befitting his key role in pioneering central banking in Australia, most Lecturers have had roles in central banking, and have included two Governors of the Reserve Bank of Australia. ...

Speaker/Host: Dr Charlie Bean, Deputy Governor of the Bank of England
Venue: Shine Dome, Australian Academy of Science, Gordon Street, Acton
Date: Tuesday, 12 July 2011
Time: 5:30 PM - 7:00 PM

The present financial crisis has many parents, encompassing both market failures and supervisory shortcomings. A non-exhaustive list would include: inadequate incentives for care in the origination of loans if the risks are to be passed on; extreme opacity in the nature of the risks underlying complex structured finance assets; too much reliance on statistical models of risk based on past behaviour; disproportionate dependence on ratings by end-investors and a failure to observe due diligence; excessive closeness of the ratings agencies to those who were issuing debt; compensation schemes in financial institutions that encouraged excessive risk-taking and a focus on short-term returns; a failure by originating banks to realise the extent to which distributed risks could return to them; excessive reliance on short-term wholesale funding and inadequate attention to the potential liquidity of assets; and a failure by regulatory and supervisory authorities to appreciate fully the risks inherent in the ‘originate-to-distribute’ model. The ongoing work of the Financial Stability Forum and G20 to address these and related issues and to strengthen the financial system against any future repeat is, of course, extremely welcome.

But these are just the collective match that ignited the conflagration. You need fuel to make a fire too. And that was provided by the ex-ante excess supply of global savings over investment, which pushed real interest rates on safe assets to historically low levels, reinforced by loose monetary policy. That in turn encouraged a ‘search for yield’ and a compression of risk premia as financial institutions sought returns high enough to meet end-investors’ unchanged expectations. Moreover, higher asset prices raised the net worth of financial companies, allowing more borrowing and further compressing yields. ...

In my view, it is a mistake to point the finger at any individual country’s choice of policies. Given historical experience and the desire to facilitate rapid development, the Chinese strategy of export-led growth and high savings, facilitated by a weak
renminbi, seems entirely rational. But that meant the rest of the world, and in particular the United States, needed to be willing to run a substantial current account deficit and capital account surplus if overall macroeconomic balance was to be maintained. ...

From: ‘Some Lessons for Monetary Policy from the Recent Financial Turmoil’, Remarks at Conference on Globalisation, Inflation and Monetary Policy, Charles Bean, Deputy Governor of the Bank of England, in Istanbul, 22 November 2008

No comments: