Topic of the day –”Ten years on, in uncharted waters”
The crises in emerging economies show how vulnerable they remain to the vagaries of U.S. economic policy
Economists thrive on crises. The East Asian crisis of 1997 caused a rethink on full capital account convertibility and fixed exchange rates. The Internet bubble and bust of the early 2000s led many to question the impact of new technology on long-term productivity growth. The scandals in the corporate world through the 2000s in the U.S. provided grist for a fresh debate on corporate governance.
None of these was any match for the opportunities for cerebration created by the financial crisis of 2007. The crisis, which peaked in early September 2008, occasioned an enormous outpouring ofscholarly papers, articles and books on the causes of the crisis and the lessons to be learnt. Have these made the world any safer? Unlikely, as we shall see later.
Centred In Regulation Failure –
The crisis of 2007 had multiple causes. Global macroeconomic imbalances, a loose monetary policy in the U.S., the housing bubble in the U.S. again and elsewhere, a bloated financial sector, aflawed belief in efficient markets, greedy bankers, incompetent rating agencies — these and others have been identified as among the villains of the crisis. All of them undoubtedly contributed their part. But each has happened before without on its own bringing on a global economic crisis.
Most of the blame for the implosion of the financial sector in 2007-08 lies elsewhere — in a failure of regulation. This failure manifested itself in several ways. One, banks were allowed extraordinarily high levels of debt in relation to equity capital. Two, banks in the advanced economies moved away from the business of making loans to investing their funds instead in complex assets called “securitised” assets. The securitised assets consisted of bundles of securities derived from sub-prime loans, that is, housing loans of relatively higher risk.
The switch from loans to securitised assets had enormous implications for banks. With a loan, losses are recognised over time. In contrast, investments are ‘mark to market’, that is, losses or gains on these have to be recorded instantly. As housing prices started falling and the securitised assets lost value, it translated into enormous losses for banks.
These losses eroded bank capital and created panic among those who had lent funds to banks. The lenders to banks, it turned out, were not primarily retail depositors but short-term lenders in the wholesale market. This was the third element in the failure of regulation, allowing banks excess dependence on short-term funds.
There were other failures of regulation. Banks had low standards for making housing loans. Bankers’ pay was designed so that it allowed them to take excessive risk. The boards of banks did not exercise adequate oversight.
These failures were not confined to the U.S. They infected banks in Europe and some in Asia as well. These banks were not merely exposed to American assets. As economic historian Adam Tooze has pointed out in a recent book and in an article in Foreign Affairs (September/October 2018), they had financed these assets through large borrowings in the American wholesale market. The sub-prime problem was thus not just an American problem but a problem for large chunks of the global banking system.
As wholesale markets dried up, the Fed provided dollar funds to central banks in Europe and in Asia. Governments everywhere rushed to save their financial institutions. Central banks provided liquidity support to banks. The failure of banks was sought to be counteracted by fiscal and monetary expansion. The loss of jobs and output has been enormous. Various political consequences have unfolded: the Eurozone crisis, Brexit, the rise of nationalism and anti-immigrant policies, the Trump phenomenon in the U.S. and the return of protectionism.
How did such a colossal failure of regulation occur? The problem was ‘regulatory capture’, the ability of financial institutions to influence polices of governments and regulators. Financial institutions are a big source of political funding. There is also the ‘revolving door’ syndrome. Bankers in the U.S. and Europe hop on to jobs in government and regulation. Government officials and regulators land lucrative jobs and assignments with banks.
WORDS AND MEANINGS –
thrive
Meaning : prosper; flourish.
Synonyms : develop , flourish
Antonyms : decrease
Example : “education groups thrive on organization”
crises
Meaning : a time of intense difficulty or danger.
Synonyms : change , deadlock
Antonyms : benefit
Example : “the current economic crisis”
rethink
Meaning : consider or assess (something, especially a course of action) again, especially in order to change it.
Synonyms : amend , reassess
Antonyms : spoil
Example : “the government were forced to rethink their plans”
grist
Meaning : useful material, especially to support an argument.
Synonyms : staple , resources
Antonyms : chunk
Example : “the research provided the most sensational grist for opponents of tobacco”
bloated
Meaning : swollen with fluid or gas.
Synonyms : distended , tumefied
Antonyms : deflated
Example : “he had a bloated, unshaven face”
flawed
Meaning : having or characterized by a fundamental weakness or imperfection.
Synonyms : faulty , flawed
Antonyms : accurate
Example : “a fatally flawed strategy”
greedy
Meaning : having an excessive desire or appetite for food.
Synonyms : eager , hungry
Antonyms : abstemious
Example : “he’s scoffed the lot, the greedy pig”
implosion
Meaning : an instance of something collapsing violently inwards.
Synonyms : bankruptcy , rupture
Antonyms : achievement
Example : “the star undergoes a violent implosion caused by gravity”
manifested
Meaning : clear or obvious to the eye or mind.
Synonyms : glaring , unmistakable
Antonyms : hidden
Example : “her manifest charm and proven ability”
implications
Meaning : the conclusion that can be drawn from something although it is not explicitly stated.
Synonyms : conclusion , indication
Antonyms : measurement
Example : “the implication is that no one person at the bank is responsible”
eroded
Meaning : (of wind, water, or other natural agents) gradually wear away (soil, rock, or land).
Synonyms : corrode , destroy
Antonyms : build
Example : “the cliffs on this coast have been eroded by the sea”
panic
Meaning : sudden uncontrollable fear or anxiety, often causing wildly unthinking behaviour.
Synonyms : confusion , dismay
Antonyms : assurance
Example : “she hit him in panic”
Fed
Meaning : a federal agent or official, especially a member of the FBI.
Synonyms : bolster , deliver
Antonyms : deprive
Example : “I don’t think he has any friends since he grassed to the Feds”
counteracted
Meaning : act against (something) in order to reduce its force or neutralize it.
Synonyms : correct , negate
Antonyms : allow
Example : “should we deliberately intervene in the climate system to counteract global warming?”
lucrative
Meaning : producing a great deal of profit.
Synonyms : good
Antonyms : unprofitable
Example : “a lucrative career as a stand-up comedian”
