november 24, 2008

Don’t blaim it all on the banks!

I think it is worth mentioning that not all the financial trouble we are facing right now is caused by the banks and their managers. Sometimes media portrays the “greedy bank manager” as the sole culprit. OK, don’t misunderstand me; I agree that mistakes have been made in the mahogany offices as well as on the trading floors of banks and other financial institutions. Overleveraging, poor credit- and liquidity-risk management, overreliance on models and instruments few understand and even fewer know how to use properly and ignorance of once-in-a-century events are some likely reasons for the current crisis.


However, there are several other causes of this crisis. At least if you ask me. These causes are clearly related to those above. Perhaps one can even say that they are the other side of the coin. Here are some suggestions:

-The low-interest rate policy followed by, particularly, the US since 9-11. I am one of those who believe that the ultralow short rate has contributed to the spending spree by banks, investors, house buyers and consumers.

-The bail out mentality of even the strongest supporter of the market economy, USA. It started with LTCM in 1998 and through this precedent the US has shown that they stand ready to save anything that moves, as long as it is big enough. We have since seen it with Fannie Mae, Freddie Mac (which are also semi-market constructs that in their own right might have helped create the credit crisis), AIG, Citigroup and soon perhaps GM, Ford or Chrysler.

-The lack of a global financial watchdog. With no global financial supervisor in place there has been ample room for banks and the likes to play domestic supervisors against each other. For instance, if they had regulated hedge funds in Germany the funds would just have migrated to Austria etc. etc.
-The Basel II regulatory framework, while an improvement upon Basel I if you ask me, still has its problems. One possible problem is the pro-cyclical character of the capital requirement rules (which give a lot of leeway to banks in good times at the same time as they force banks to unwind their [now too large] positions rapidly in bad times). The rules also seem to have failed to remove some of the regulatory arbitrage possibilities (remember the SIVs someone?) of the previous Basel I rules.

-The lack of a real estate hedging tool in all but a few markets. If one had decoupled the (residential) housing purchase decision from the investment decision it is possible that the house bubbles seen in several markets could have been avoided. I think the government should have been much more active in stimulating a market for this, such as real estate futures etc. I mean, a lot of people world-wide has borrowed hundreds of thousands of dollars to buy a risky asset called a house or an apartment. But who borrows $300000, with no or almost no initial equity, to buy a like-wise risky asset called company stock? Noone I know of at least!


To sum up, all these problems have been caused by too much, or bad, regulation as well as by policy mistakes by governments around the world. Therefore, I think we should blaim them as well as the banks! Also, remember, we have a fool-proof way of punishing the banks; sell their stock! I see no equally obvious way of punishing the governments (well, perhaps W wouldn’t agree with me there....).