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It could have been worse

So what if the American taxpayer hadn’t bailed Wall St out of the financial crisis a decade ago? Or central banks hadn’t dumped money on capital markets, delivering windfall returns to those owning financial assets? Or governments hadn’t blown their budgets on fiscal stimulus?

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Ten years on there are pretty clear answers to these questions: we would have been worse off.

"An emerging narrative in Australia is not that ‘Fortress Australia’ survived the crisis but that survival has driven complacency, arrogance and regulatory capture in the financial system.”

True, for many, this is natural justice denied. The American investment bankers who blew up the system were very quickly back earning unimaginable bonuses. None went to jail.

Meanwhile society has paid the price in terms of a lost decade of economic growth and opportunity, where lower income groups have seen wage stagnation and household debt growth.

The conduct fines paid by international banks in the wake of the crisis total more than $US100 billion but even that many would consider far from enough.

But it could have been worse: The European sovereign debt crisis which embroiled Greece, Spain, Portugal, Ireland and – still – Italy was a direct result of the European Union failing to adopt the same saturation of the financial system with quantitative easing measures and bank re-capitalisations.

For the better, the American banking system was back in action in a couple of years, funding an economic recovery. Europe continues to struggle.

Australia moved relatively rapidly to offer a government guarantee on consumer deposits and bank wholesale funding at the height of the crisis – taxpayers actually earned half a billion dollars from that measure.

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Pic: The Australian Financial Review's front page on the day the global financial crisis hit Australia - coverage anchored by current bluenotes columnists Tony Walker and Andrew Cornell Source: The AFR

However, the anniversary coverage of recent weeks about the crisis makes clear things may have gone very differently.

Had the Australian Labor government not taken Treasury Secretary Ken Henry’s advice to “go early, go hard, go households” then – in the short term – the budget position may have looked healthier but a severe recession in the absence of stimulus would have crushed any short term benefits and done greater long term damage.

The best analysis of this invidious situation is in a paper delivered by Ben Bernanke, the US Federal Reserve chairman at the time of the crisis, at a Brookings Institute conference which also included the two other principle figures in the US response, George Bush’s treasury secretary Henry Paulson and Barack Obama’s Timothy Geithner.

The simple conclusion of this research is in order to save the ordinary economy = 'Main St' – it was necessary to save the financial system – 'Wall St'.

These principals are under no illusions the rescue was not popular and as the enormity and uncertainty and sheer panic of the times recedes into memory, it becomes less and less popular.

The fortress

An emerging narrative in Australia is not that 'Fortress Australia' survived the crisis but that survival has driven complacency, arrogance and regulatory capture in the financial system.

Despite anniversary interviews from people like then Reserve Bank governor Glenn Stevens, there’s no shortage of second guessing the response. But Stevens has been adamant: “I think when it’s a confidence event, the risky strategy is to say, ‘well let’s not try and do too much, let’s do a bit and see if that works and then if it doesn’t we’ll do a bit more’,” he told The Australian newspaper.

Stevens said the truly acute phase of the crisis only last six to eight weeks “but in that period I think the decision-makers were not going to die wondering, ‘Should I have done more?’ and that’s probably right.”

As Geithner has said recently, collateral damage from the response has been a "huge loss of confidence in public institutions”. For Paulson “what we did was so unpopular … I was never able to make the connection between (Wall St and Main St). (But) we weren't doing this for Wall Street”.

With the rise of populism (not because of the crisis but certainly not helped by it) the danger is political expediency will take precedence over the longer term good of the economic system which underpins society. Who today wants to bail out a banker?

Yet Bernanke’s conclusion is true for Australia as well as America – and the research as well as the exception of Europe’s tardy response supports this – “policymakers' aggressive actions to end the financial panic on Wall Street were crucial in preventing an even more devastating blow to Main Street”.

As to whether too much was done, probably. That’s the beauty of 20/20 hindsight. At the Brookings conference, Bernanke emphasised at the time no one knew: “what’s more important, heart beat or respiration?”

The unwilling

In much of the commentary around the crisis in recent weeks (and in the coverage of current day malfeasance, such as reporting of Australia’s Royal Commission into financial services), what’s frequently at play is cognitive biases, the way our minds try to turn complex phenomena into more simple ones.

A critical bias humans harbour is what is known as 'base-rate neglect' – essentially an unwillingness to believe statistical data and actual evidence. What we humans do is make judgements based on individual examples and vivid anecdotes. Often the latest we’ve heard.

Because of that bias, we think the whole system is crooked because we have these examples of individual, terrible human behaviour. In the post-crisis analysis what is missed – and impossible to measure – is the counter-factual argument: what would have happened had the US not bailed out its banking system? What would have happened in Australia if there had not been fiscal stimulus?

Would the economy had been better off if we had concentrated on vengeance rather than restoring the financial system?

There will be another crisis and it will relate to a misunderstanding – and, in financial system, a mispricing – of risk. It will probably relate in some way to property.

We have some inkling: there is still too much debt in the global financial system. The regulated sector – banks, insurance companies – is much safer. Debt to equity leverage is lower, equity capital is higher, supervision is greater.

The issue is there appears to be a popular emphasis on doing more in the visible regulated sector while risk is growing in the unregulated or less regulated “shadow” banking system.

Andrew Cornell is managing editor of bluenotes

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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