Saturday, October 11, 2008

Beyond the Blow-by-Blow

. Saturday, October 11, 2008

Most of the talk of the financial crisis has rightly focussed on the breaking news and new developments. Even on a Saturday the news is significant: the Bush administration has reversed course and is now committed to partially nationalizing major banks rather than just providing liquidity (which begs the question: is it legal to use the cash in a way not approved by Congress?). Meanwhile, the much-ballyhooed G7 meeting has been underwhelming. A joint statement was issued, but it only included platitudes in place of actual concrete plans of action.

But it is sometimes helpful to step back, look at this crisis in context, and try to find ways to improve the future performance of the financial system. For example, everyone is calling for changes to the regulatory system, although those calls tend to vary along partisan lines. Left-leaning commentators are keen to increase any and all regulation, while those on the right tend to ask for "better" regulation, as if the system in place before the crash was intentionally or predictably deficient. Both views are understandable, but Avinash Persuad thinks they are both misguided:

This is the seventh international financial crisis I have lived through. At the end of each the focus on avoiding the next one has always been the same trinity: more transparency, more disclosure and more risk management. This is an inadequate response to systemic crises. At the heart of new, internationally co-ordinated regulatory initiatives, must be counter-cyclical capital charges a la Goodhart and Persaud. Crises do not occur randomly; they always follow booms. This is my fourth policy initiative. But there also needs to be shift in the focus of regulation, away from sensitivity to the market price of risk and notions of equal treatment for all institutions, to a greater sensitivity to risk capacity and a better appreciation that diversity is the key to liquidity. This is the fifth step. Systemic resilience requires different risks being held in places where there is a natural capacity for that type of risk. In the name or risk-sensitivity and equal treatment we ended up with institutions who had no liquidity, holding liquidity risk and those with little capacity to hedge or diversify it, owning credit risk.

Meanwhile, Arvind Subramanian wants China to give the U.S. an IMF-style "tied loan" in exchange for some structural adjustment. That'd be a bitter pill to swallow, but we may end up having no choice. Meanwhile Michael Clemens takes the long view and thinks that we'll be alright:

This is the best estimate of real income per capita in the United States since 1820. Over these years we had violent financial crashes of various types, bank panics, piles of recessions and a huge depression, many foreign wars and one enormous domestic war, had a central bank and didn’t, were on the gold standard and weren’t, had governments topple in scandal and multiple leaders assassinated, and what did it all amount to in the medium to long run? In per-capita income terms: Nothing. The overall trend does not bend or shift. Every bad year was followed by a good year that returned us to trend. The US average growth rate of real per capita incomes over the last 190 years has been 1.8% a year, and the same rate over the last 10 years has been…. 1.8% a year. Stare at that graph: The Great Depression was traumatic in countless ways, but astonishingly, it’s not clear that we are any worse off today than we would be if the whole thing never occurred. Anyone who made such a claim in the 1930s would have been scoffed at, but that’s what happened.

Here's his graph:


Beyond the Blow-by-Blow




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