Another good video from Paul Solman of PBS ‘Making Sense of Financial News’.
In his new book, “The End of Alchemy,” Mervyn King still worries that the world banking system hasn’t reformed itself, eight years after its excesses led to collapse. He states that it’s easy with hindsight to look back and say that regulations turned out to be inadequate as mortgage lending was riskier than was thought. Furthermore, you are of the belief that the system works and it takes an event like the GFC to discover that it actually doesn’t.
Paul Solman asks the question that a large part of the problem that caused the GFC was the Bank of England and the US Fed were not able to keep up with the financial innovation that was going on in both of these countries. King refutes this by saying that there were two issues that were prevalent before the GFC:
- Low interest rates around the world led to rising asset prices and trading looked very profitable.
- Leverage of the banking system rose very sharply – Leverage, meaning the ratio of the bank’s own money to the money it borrows in the form deposits or short-term loans.
Central banks exist to be lenders of last resort. Problem: Too big to fail. And that’s what began happening in England, just like America, in the ’80s and ’90s. There needs to be something much more robust and much more simple to prevent the same problem from happening again. King makes two proposals:
- Banks insure themselves against catastrophe by making enough safe, secure loans so they have assets of real value to pledge to the Central Bank if they need a cash infusion in a hurry.
- Force the banks to keep enough cash on hand to cover loans gone bad as during the crisis banks didn’t have enough equity finance to absorb losses without defaulting on the loans which banks have taken out, whether from other bits of the financial sector or from you and I as depositors.
He finally states that the Brexit vote doesn’t make any significant difference to the risks facing the global banking system. There were and are significant risks in that system because of the potential fragility of our banks, and because of the state of the world economy.
Here is an interesting graph from the Economist “Free Exchange” column. What the article states is that all these stimulus actions haven’t led to any sort of growth but higher levels of unemployment – see graph.
There has been many research papers as to why this has happened. Here are some of the findings from them:
1. One school of thought is that a high unemployment rate is structural and immune to the stimulative effects of monetary policy.
2. That the US Fed commit to keeping policy easy until the economy reaches a particular target, such as nominal GDP (ie, output unadjusted for inflation) returning to its pre-recession path.
3. The Bank of England is doing by providing subsidised credit to banks that lend more.
4. Monetary easing usually works by encouraging businesses and households to move future consumption and investment forward to today. But it also has “redistributive” effects. For example, low short-term interest rates redistribute income from depositors to banks, which allows them to rebuild capital and encourages them to lend more.
5. Raising banks’ profits has not done much to restart demand because the real problem is that indebted households cannot or will not borrow. There is evidence that retail spending and car sales have been weaker in states that entered the recession with higher household debt.
With the Fed now looking at QE3 and the ECB discussing a resumption in purchases of bonds of peripheral euro-zone members one wonders if “more of the same” will have any impact on unemployment.
If you are teaching monetary policy in any course the graphic below shows a significant expansionary monetary policy. Remember in New Zealand the RBNZ changes interest rates to influence the level of economic activity in order to achieve price stability. Note the following:
• Implementation of monetary policy is one of the roles of the RBNZ
• The Reserve Bank Act established “price stability” as the main objective of the RBNZ. The RBNZ is therefore responsible for achieving “price stability”
• “Price stability” is defined in the PTA (Policy Target Agreement) as keeping inflation between 1 to 3% (measured by the percentage change in CPI)
In order to stimulate the economy the ECB cut benchmark interest rates to 0.75%. Chinese authorities cut one year yuan lending rate to 6% (still has ammunition left). The Bank of England reduced rates to 0.5%. This is in the hope that businesses will use the cheaper sources of credit to invest in their business and therefore create jobs. Lower rates would also ease the burden of those on floating interest rates.
Thanks to Simon for this very good clip from Aljazeera on the LIBOR. Max Keiser, American broadcaster and former equities broker, does get very excited in this interview – 12mins 15 sec. However he makes some very valid points regarding the lack of regulation/supervision and that we have gone from Free Market Capitalism to Rigged Market Capitalism. Phillip Booth suggests that strict standards of ethical conduct must be imposed on bankers by the Financial Services Authority and by criminal law. Keiser also intimates that Britain has been subsidising its banking system to stay competitive. Definitely worth a look and a bit of light relief for that first period back tomorrow.