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Begin in Barbados Dealing with small size through trade
Shared sovereignty in the Caribbean Common currencies (East Caribbean Dollar) Shared diplomatic services and central banks Common judicial systems, even supreme courts
Canada: “World’s soundest banking system”
Almost 200 U.S. banks have failed since early 2008, but not a single Canadian bank has
Delinquency rate in December 2009 for home mortgages in the U.S. was 9.5%, but 0.5% in Canada
International best practiceCareful federal
financial
supervision
Canada had no major bank
failures during Great
Depression, and did not
establish its Deposit
Insurance Corporation until
1967
How about the U.S. next
door?
StabilizationStabilization worked as
intendedPerhaps bank regulationregulation
during Great Depression also
helped stabilize GDP
Germany, France,
Scandinavia, others: Same
story
Not quite as clear, but standard deviation of per
capita growth fell from 3.1% 1831-1945 to 1.8%
1947-2003
Financial crises follow man like pandemics, with persistent regularityAbout every 20 years or so in United States at
least from 1792 until Great Depression 1929-39
Then, long-lasting stability, with intermittent minor crises Confluence of two forces: Stabilization and regulationConfluence of two forces: Stabilization and regulation
And then, following ambitious deregulation, serious threat of another big one in 2008 following collapse of Lehman Brothers
A big one was avertedBy fiscal stimulus and a promised return to
sound regulation, against stiff opposition
In 1970s, criticism in academic circles against active stabilizationstabilization policiespolicies Practical and theoretical grounds
Government intrusion into private markets Discretionary stabilization policies can be self-
defeating on a day-to-day basis, so … … monetary rules replaced fiscal discretion
In 1980s, similarly motivated criticism of regulation, esp. financial regulationfinancial regulationSignificant reversal of 1930s financial
regulation Commercial vs. investment banks: Firewall torn down
in US in keeping with Europe’s universal banking No particular attention was paid to Canada’s
experience
Plausible to infer that deregulation encouraged banks to take excessive risksSubprime loans in US, housing bubble, etc.
Willingness to apply fiscal and monetary stabilization policies was still in placeConcerted, massive stimulus by industrial
countries turned the tideSome think they should have done even more
Consensus on need for reregulationHow exactly remains to be worked outAsk the Canadians!Beware of warnings against lesser efficiency
Paul Volcker, Chairman of the Fed 1979-87, said 8 December 2009 at a conference organized by the Wall Street Journal: ““I wish someone would give me one shred of I wish someone would give me one shred of
neutral evidence that financial innovation has neutral evidence that financial innovation has led to economic growth – one shred of led to economic growth – one shred of evidence.”evidence.”
He added that in the U.S. the share of financial services in value added had risen from 2% to 6.5%, and then asked: ““Is that a reflection of your financial Is that a reflection of your financial
innovation, or just a reflection of what you’re innovation, or just a reflection of what you’re paid?” paid?”
1. 1. Need legal protection against predatory Need legal protection against predatory lending because of asymmetric informationlending because of asymmetric information
Like laws against quack doctors, same logicPatients know less about health problems than doctors,
so we have legal protection against medical malpractice
Same applies to some bank customers vs. bankers, especially in connection with complex financial deals
2. 2. Do not let rating agencies be paid by the Do not let rating agencies be paid by the banksbanks
Fundamental conflict of interestAlso, prevent accountants from cooking the books
3. 3. Need more effective regulation of banks and Need more effective regulation of banks and other financial institutionsother financial institutions
Work in progress, Paul Volcker in charge
4. 4. Read the warning signalsRead the warning signalsFour rules, or stories
The Aliber RuleCount the cranes
The Giudotti-Greenspan RuleDo not allow gross foreign reserves held by the
Central Bank to fall below the short-term foreign debts of the domestic banking system
Failure to respect this rule amounts to an open invitation to speculators to attack the currency
The Overvaluation Rule Sooner or later, an overvalued currency will fall
The Distribution Rule• The distribution of income matters
5. 5. Do not let banks outgrow Central Bank’s Do not let banks outgrow Central Bank’s ability to stand behind them as lender – ability to stand behind them as lender – or borrower – of last resortor borrower – of last resort
6. 6. Do not allow banks to operate branches Do not allow banks to operate branches abroad rather than subsidiaries, thus abroad rather than subsidiaries, thus exposing domestic deposit insurance exposing domestic deposit insurance schemes to foreign obligationsschemes to foreign obligations
Without having been told about it, Iceland suddenly found itself held responsible for the moneys kept in Landsbanki by 300.000 British depositors and 100.000 Dutch depositorsMay violate law against breach of trust
7.7. Central banks should not accept rapid Central banks should not accept rapid credit growth subject to keeping inflation credit growth subject to keeping inflation low low
As did the Fed under Alan Greenspan and the Central Bank of Iceland
They must restrain other manifestations of latent inflation, especially asset bubbles and large external deficits
Put differently, they must distinguish between “good” (well-based, sustainable) growth and “bad” (asset-bubble-plus-debt-financed) growth
8.8. Erect firewalls between banking and politicsErect firewalls between banking and politicsCorrupt privatization does not condemn
privatization, it condemns corruption9.9. When things go wrong, hold those When things go wrong, hold those
responsible accountable by law, or at least responsible accountable by law, or at least try to uncover the truth: Do not cover uptry to uncover the truth: Do not cover up
In Iceland, there have been vocal demands for an International Commission of Enquiry, a Truth and Reconciliation Committee of sorts
If history is not correctly recorded if only for learning purposes, it is more likely to repeat itself
Public – and outside world! – must knowNational Transport Safety Board investigates every
civil-aviation crash in United States; same in Europe
10. 10. When banks collapse and assets are When banks collapse and assets are wiped out, protect the real economy by a wiped out, protect the real economy by a massive monetary or fiscal stimulusmassive monetary or fiscal stimulus
Think outside the box: put old religion about monetary restraint and fiscal prudence on ice
Always remember: a financial crisis, painful though it may be, typically wipes out only a small fraction of national wealth Physical capital (typically 3 or 4 times GDP) and
human capital (typically 5 or 6 times physical capital) dwarf financial capital (typically less than GDP)
So, financial capital typically constitutes one fifteenth or one twenty-fifth of total national wealth, or less
11.11. Shared conditionality needs to become Shared conditionality needs to become more commonmore common
As when the Nordic countries providing nearly a half of the $5 billion needed to keep Iceland afloat imposed specific conditions on top of the IMF’s conditions
This may come up again elsewhere E.g., in Greece if the EU and the IMF are called on
to support Greece together For this, clear and transparent rules tailored
to such situations ought to be put in place
12.12. Do not jump to conclusions and do Do not jump to conclusions and do not throw out the baby with the bathwaternot throw out the baby with the bathwater
Since the collapse of communism, a mixed mixed market economymarket economy has been the only game in town
To many, the current financial crisis has dealt a severe blow to the prestige of free markets and liberalism, with banks having to be propped up temporarily by governments, even nationalized
Even so, it remains true as a general rule that banking and politics are not a good mixbanking and politics are not a good mix
But private banks clearly need proper regulation proper regulation because of their ability to inflict severe damage on innocent bystandersinnocent bystanders
Do not reject economic, and legal, help from abroad