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The View From the Rooftops

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A day at Wimbledon
This week, Mervyn King, the long-standing Governor of the Bank of England, said about the 2008 financial crisis, 'We should have shouted from the rooftops that a system had been built in which banks were too important to fail, that banks had grown too quickly and borrowed too much, and that so called 'light-touch' regulation hadn't prevented any of this.' Since one of King's colleagues, Andrew Haldane, has estimated the total global impact of the fiscal crisis at somewhere between $50 and $200 trillion, you'd think that any failure to hit the early-warning alarms would prompt a somewhat fulsome apology.

But no. King is largely unrepentant, saying, 'the power to regulate banks had been taken away from us in 1997. Our power was limited to that of publishing reports and preaching sermons. And we did preach sermons... ' In short, and to use a local London-ism, 'It wasn't me, guv.'

The same absence of contrition is equally apparent in the United States. Giving testimony to the House Committee on Oversight and Government Reform, former Chairman of the Federal Reserve Alan Greenspan, did admit that "those of us who have looked to the self-interest of lending institutions to protect shareholders' equity, myself included, are in a state of shocked disbelief." And yet, those moments of almost-apology never lasted long and thinned out the more they were tested.

The Maestro fiddled while Rome burned
Same thing in Europe. At a press conference given as he was standing down from the presidency of the European Central Bank, Jean-Claude Trichet responded angrily to a questioner (who was, by the way asking, quite reasonably, about the ECB's shocking accumulation of poor-quality sovereign debt). Trichet snapped: "Can I remind us, that in 2004 and 2005 some important governments in Europe were asking for weakening the Stability and Growth Pact? Do you remember that? Do you remember which governments? [A dig at France and Germany.] ... We have delivered price stability over the first 12 years and 13 years of the euro -- impeccably, impeccably. I would like very much to hear the congratulations for an institution which has delivered price stability in Germany better than what has ever been obtained in [that] country over the last 50 years."

Congratulations?
Triangulating between these comments gives, roughly, the gist of the central bankers' case for the defense. They kept inflation low. They warned about the coming risks. But, hey, what could they do? They didn't have the regulatory powers that would have enabled fiercer action and, sadly, their great and silvery wisdom had a blind spot: they couldn't quite imagine how dumb other people were.

And this is all wrong. Completely wrong. Central Bankers did as much to cause the financial crisis as any other group in the world. Arguably, they were the most culpable single group. One role of their job was to restrain inflation, an essential role which they chose to construe as narrowly as possible. The consumer prices (excluding food and energy) did indeed remain relatively subdued (constrained, very largely, by the flood of cheap goods from China), but excess money has to go somewhere. If it wasn't feeding a classic wage-price spiral in the real economy, it would have to boost asset prices.

The U.S. housing market was the most obvious bubble, but that bubble spawned smaller ones in a thousand other places. Mortgage-backed securities were wrongly priced. Credit default swaps, keyed off those securities, were also mispriced. As for the banks that held or issued these things, their debt was misvalued too.

High asset prices mean that the income yield generated by those assets looks paltry. So all that excess money and massive leverage went chasing off to find yield. Investors bought Greek bonds, they bought Spanish and Irish real estate, they bought the banks that traded these things, and they bought the bonds issued by the kind of highly leveraged companies which should have been filing for bankruptcy, not raising new capital. In market after market, prices and the amounts of insane leverage extended lost touch with reality. The collapse of 2008 showed up the costs of that inflationary failure.

Nor should we believe the central bankers when they say they knew all this and didn't have the tools to fix it. That's false and falser. Mervyn King stated in August 2007 that "our banking system is much more resilient than in the past. Precisely because many of these risks are no longer on [bank] balance sheets but have been sold off to people willing and probably more able to bear it." He made these statements just as the subprime market was starting to collapse. If that's what he means by 'preaching sermons' on risk, it's little wonder that the sinners kept on sinning. Furthermore, far from adding resources to the Bank's financial stability division, the Bank cut it. It was a similar story elsewhere.

Worse still: Nothing has changed. No lesson has been learned. Central banks are still spraying the financial markets with money. Yields on government bonds ought to be higher at the moment because sovereign borrowers (including the U.S.) are riskier now than for a very long time. Yet central bank intervention has driven those yields down to absurd levels. So everything else becomes mispriced too. I've written recently about Apple and Facebook, but you only come across egregious examples like these when the entire market is overhyped. The property market in Europe is still trading way over fair value. As for the impending crash in sovereign and bank debt, the potential costs there are so vast, it's barely possible to quantify them.

And of course, none of this is new. The Alan Greenspan Doctrine, born in the mid-1990s, was roughly, "If the financial markets hit a rough patch, do everything you can to bail them out." That was the posture adopted in relation to the Asian financial crisis, the bailout of LTCM (a hedge-fund), the dotcom crash, and the subprime mortgage bust. It's a doctrine, born in the U.S., which has spread almost worldwide, a doctrine now being most assiduously followed by the once-conservative European Central Bank.

The impact of these failures is colossal. Take, for example, the losses accumulating on the balance sheet of all these banks. When the Fed or the ECB accept dubious collateral for their cheap-money loans, they are exposing themselves to loss. Those losses were originally made in the private sector and should be borne by the private sector. That's capitalism. By effectively taking responsibility for these lousy assets, the central banks are taxing all those who hold and have savings in the relevant currency.

Furthermore, capitalism works through a restless, destructive creativity. Bad companies and bad lenders need to face the consequences of their actions. Shareholders need to take a hit. That way, the ground will be cleared for better managed companies and stockholders will be reminded about the responsibilities of ownership.

And central bankers should take responsibility too. Failure should mean failure: loss of office with immediate effect. But I'm not holding my breath. The evasion of responsibility starts right at the top. When Congress is esteemed lower than pornography and polygamy, you know that voters are trying to send a message. It's about time politicians -- and central bankers -- started to listen.

Mitch Feierstein is the author of Planet Ponzi: a short guide to financial madness and CEO of the Glacier Environmental Fund.