What changed after World War II, and what changed it back? The obvious answer is regulation. By the late 1940s, most important economies had tightly regulated banking systems, preventing a recurrence of old-fashioned banking crises. At the same time, widespread limitations on the international movement of capital made it difficult for nations to run up the kinds of large international debts that had previously led to frequent defaults. (These restrictions took various forms, including limits on purchases of foreign securities and limits on the purchase of foreign currency for investment purposes; even advanced nations like France and Italy retained these restrictions into the 1980s.) Basically, it was a constrained world that may have limited initiative, but also left little room for large-scale irresponsibility.The tragedy that the above points out is that the lessons of the past haven't been learned and that the ideologues of today are impervious to learning the lesson. Layer in the soft corruption of big banks with lots of money to bribe politicians. Therefore we are condemned to repeat the follies of the past until we elect leaders with more backbone that Obama.
As memories of the 1930s faded, however, these constraints began to be lifted. Private international lending revived in the 1970s, making possible first the Latin American debt crisis of the 1980s, then the Asian crisis of the 1990s. Bank regulation was weakened, enabling the mid-1980s savings and loan debacle in the United States, the Swedish bank crisis of the early 1990s, and so on. By the early twenty-first century, the rapid growth of “shadow banks”—institutions like Lehman Brothers that didn’t accept deposits, and so were not covered by conventional banking regulations, but that in economic terms were carrying out banking functions—had recreated a financial system that was as vulnerable to panic and crisis as the banking system of 1930.
As all this happened, proponents of looser regulation extolled the virtues of a more open system. Indeed, there were real advantages to laxer control: without question, some people, businesses, and governments that would not have had access to credit got it, and some used that credit well. Others, however, ran up dangerous levels of debt. And the old cycle of debt, crisis, and default returned.
Why didn’t more people see this coming? One answer, of course, lies in Reinhart and Rogoff’s title. There were superficial differences between debt now and debt three generations ago: more elaborate financial instruments, seemingly more sophisticated techniques of assessment, an apparent wider spreading of risks (which turned out to have been an illusion). So financial executives, policymakers, and many economists convinced themselves that the old rules didn’t apply.
We should not forget, too, that some people were making a lot of money from the explosive growth both of debt and of the financial industry, and money talks. The world’s two great financial centers, in New York and London, wielded vast influence over their respective governments, regardless of party. The Clinton administration in the US and the Labour government in Britain succumbed alike to the siren song of financial innovation—and were spurred in part by the competition between the two great centers, because politicians were all too easily convinced that having a large financial industry was a wonderful thing. Only when the crisis struck did it become clear that the growth of Wall Street and the City actually exposed their home nations to special risks, and that nations that missed out on the glamour of high finance, like Canada, also missed out on the worst of the crisis.
Now that the multiple bubbles have burst, there’s obviously a strong case for a return to much stricter regulation. It’s by no means clear, however, whether this will actually happen. For one thing, the ideology used to justify the dismantling of regulation has proved remarkably resilient. It’s now an article of faith on the right, impervious to contrary evidence, that the crisis was caused not by private-sector excesses but by liberal politicians who forced banks to make loans to the undeserving poor. Less partisan leaders nonetheless fret over the possibility that regulation might crimp financial innovation, even though it’s very hard to find examples of such innovation that were clearly beneficial (ATMs don’t count).
And as many have noted, President Obama’s chief economic and financial officials are men closely associated with Clinton-era deregulation and financial triumphalism; they may have revised their views but the continuity remains striking.
In that sense, this time really is different: while the first great global financial crisis was followed by major reforms, it’s not clear that anything comparable will happen after the second. And history tells us what will happen if those reforms don’t take place. There will be a resurgence of financial folly, which always flourishes given a chance. And the consequence of that folly will be more and quite possibly worse crises in the years to come.
Sunday, April 25, 2010
Krugman & Wells Review Reinhart & Rogoff
The following is a bit from the review of the book This Time Is Different: Eight Centuries of Financial Folly by Carmen M. Reinhart and Kenneth S. Rogoff. The review is by Paul Krugman and Robin Wells: