12 Sep 2018
A decade ago - that is, about a year after the acute phase of the global financial crisis - the world financial system was still iffy. The ongoing anxiety was about system stability, institutional survival and fiscal stimulus.
Stage two of the crisis - following the collapse of Lehman Bros in September 2008 and the implosion of the sub-prime mortgage market - was starting to play out on the regulatory, monetary and strategic fronts in 2009.
"In that acute phase of the crisis, far less in the spotlight was competition, innovation and disruption.”
And reality was starting to dawn that financial crises were different to crises in the real economy. They are more pervasive, more corrosive and longer term. So it has proved.
Take the United Kingdom, where the impact of the crisis was particularly severe (and the government still has stakes in financial institutions acquired to rescue the system).
“It gradually became apparent that the hit to demand had been accompanied by a large and permanent hit to the level of productivity - that is, the amount of output the economy was actually capable of producing - and a sustained slowing in its growth rate,” said Bank of England deputy governor Dave Ramsden in a recent speech.
“Gross domestic product (GDP) took many years to return to trend growth. And that trend was itself much weaker than what had become seen as normal in the pre-crisis decades.”
The international banking regulator, the Bank for International Settlements (BIS), has just released papers from its conference on the theme: "Ten years after the Great Financial Crisis: what has changed?"
To emphasise this crisis is still playing out, the focus of one key paper is “why the financial system is not as resilient as policymakers currently claim - despite extensive regulatory reforms from a very weak starting point”.
In that acute phase of the crisis, far less in the spotlight was competition, innovation and disruption.
To save the system, there was a recognition that competition would decline - weaker institutions would fail or be taken over, lowering the number of players in markets. Some disruptive business models - like the non-bank mortgage originators in Australia or online banks in the UK or sub-prime funders in the US - would fail.
One BIS paper, by former Bank of England (BoE) deputy governor Paul Tucker, notes explicitly an aim “to spark and contribute to the debate on the second phase of stability reforms that will be needed”.
Yet the popular and even informed attention span is brief. The value of stability recedes as focus shifts to perceived benefits of competition and disruption. Rather than take the opportunity of relative stability to reinforce and constructively re-engineer regulatory authorities, the current global mood seems to be one of antagonism and turf wars.
Indeed, this destructive cultural response is another scar from the crisis, according to the Financial Times’ Martin Wolf. He argued previously unthinkable events like Brexit and the election of Donald Trump were symptoms of the crisis - although it wasn’t the only cause.
“Economic and cultural phenomena are interrelated,” Wolf argued. He made the point the antagonism towards immigration, despite demonstrable humanitarian and economic benefits, can be framed by economic forces unleashed by the crisis.
“The financial crisis and consequent economic shocks…not only had huge costs. They also damaged confidence in - and so the legitimacy of - financial and policymaking elites. These emperors turned out to be naked,” he said.
Private profit, social loss
Populists in politics and the media have exploited these anxieties for their own ends.
It’s easy to see why: no one went to jail for the financial crisis and corruption of the sub-prime mortgage market, yet millions globally had their lives impacted. Meanwhile, measures adopted to combat the crisis - which were justified - including fiscal stimulus, monetary easing and quantitative easing inflated the value of assets predominantly owned by the wealthy such as shares and property.
Profits in the run up to the crisis had indeed been privatised while the massive losses were socialised.
That has made it simple, even when wrong, to emphasise the side effects of the cure rather than remember the disease. Witness the wilful forgetting that budget surpluses were used to rescue and resuscitate economies - as intended - and the championing of institutions and disruptors outside the established order. Because, well, the established order survived the crisis.
Memory is short when it comes to crises. Yet the financial crisis hammered home the horrific costs of short-term thinking.
“Economic policy makers now think as much about stability over the financial cycle as we do over the business cycle - a broader definition of resilience,” the BoE’s Ramsden said.
“The (BoE Financial Policy) Committee’s goal is to ensure the financial system is resilient to shocks, so that it doesn’t again act as an amplifier, worsening the impact on households and businesses in the real economy, as it did in the crisis.”
Bluntly, over-emphasising competition and disruption at the risk of stability carries potentially far higher costs for society. If there’s a central lesson from the crisis it should be that competition should be encouraged up to the point where the failure of new competitors threatens financial stability.
In Australia, the collapse of mortgage originators didn’t threaten the system - but the crisis did see market share growth by the major, incumbent financial institutions as they were perceived to be safer.
The other lesson from the crisis is “this time it’s different”. Wrong when it means a crisis can’t reoccur, right when it means every crisis will be different.
Following the crisis, I wrote a long series of articles for the Australian Financial Review on just why Australia survived the crisis as well as any advanced economy, staying out of recession and not suffering any major institutional failures.
A key factor, as then Reserve Bank of Australia governor Glenn Stevens said, was Australian regulators - across the RBA, the Australian Prudential Supervision Authority, the Australian Securities and Investment Commission and Treasury - spoke to one another.
This rather obvious point was not the case in other jurisdictions. In the US, large gaps in regulation allowed the sub-prime crisis to flourish. In the UK, confusing mandates - the prudential regulator was trying to juggle system stability and greater competition - led to poor policy decisions.
Turf wars are sometimes historic and always complex.
As US Federal Reserve governor Michelle Bowman said recently, the “nature of financial regulation and supervision in the United States argues strongly for better coordination”.
“This (US) system evolved over time, and as things stand, there are some advantages to this specialisation. But this division of labour may, at times, inhibit information sharing, and as a general principle, better communication can help overcome this challenge.”
Her point is competition between market players may be a good thing, between regulators it isn’t.
Meanwhile, a decade on, the global financial system remains in transition - even as new geopolitical and cyber threats emerge.
The lessons from the financial crisis are still being learned while some lessons are already being forgotten.
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.
12 Sep 2018
11 Jul 2018