Exiting the Great Depression:
lessons for today
Kris Mitchener and Joseph Mason
Discussion by
Marcus Miller
Warwick University
1
Discussant’s comments
What I liked
M and M’s outline of fascinating features like
• Extent of bank recapitalisation through RFC striking
• Anti firesales activity of Deposit Liquidation Board
Their flagging of key issues like
• Tackling asymmetric information via certification,
FDIC, etc.
• Political problems of reversing crisis induced
institutional support
2
What I missed
• Didn’t get their 3 R’s! How about• Rescuing the system, too little too late in 1930s
• Regulating banks: in 1930s prudential regulation
crucial complement to deposit insurance.
• Reform the system: in 1930s this included
Glass-Steagall, SEC, Chapter 11 Bankruptcy
I will use these as headings for comments to follow
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1. Rescue
(Image of the $1 trillion liquidity support by FRBNY)
4
‘The Great Escape’
• What would have happened to the US economy if
the Federal Reserve had not intervened by spending
7% of US GDP buying illiquid assets in 2008/9?
• The FRBNY have modelled the effect of a liquidity
crunch without such intervention; and then with the
liquidity injection of $1 trillion
• Results can be shown as:
5
Effect of a liquidity shock in US that lasts 10 quarters, Del Negro et al. (2009)
Solid blue : no intervention. Dashed blue: $1 trillion liquidity injection.
The Counterfactual
40 % fall of Investment
Output falling initially by 25%
Then down to 30%
The capital stock falling by 1% a
quarter until liquidity is restored
6
Help from Central Banks - since Aug ‘07
7
Plus support from Government
=3/4 GDP!
•
•
•
United Kingdom
Jan. 2007 Latest
United States
Jan.207 Latest
Government support
£ trillions
•
•
Guarantees of financial
institutions’ liabilities
•
•
Insurance of financial assets –
0.46
Capital injections to banks and
special purpose vehicles
–
•
•
–
Increase in public sector support
$ trillions
0.37
–
–
0.06
1.26
3.74
–
–
2.08
0.70
10.44
(including CB assistance)
• Percentage of GDP
–
88%
–
73%
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2. Regulation
• Crisis has revealed profound problems of
• asymmetric information
• Financial externalities (fire sales, network
effects)
• Market concentration
These lie outside the competitive paradigm of
economics, so tackling them will require
thinking outside the box
9
Challenges to the market paradigm
Competitive
Market paradigm
Missing
information;
missing
Externalities, e.g.
markets
systemic risk
Strategic
Power
Market
collapse
10
‘Greenspan defends position on free market’
Central Banking.com 6 Apr 2010
• Alan Greenspan, a former chairman of the Federal
Reserve, has refuted claims that his comments on
the recent failures in financial markets are in any way
a repudiation of the laissez-faire view that markets
can be trusted to police themselves.
• "There is no alternative if you want to have economic
growth, higher standards of living, in a democratic
society, to have competitive markets," he said.
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Externalities
• Economists use the term ‘negative externality’ to
refer to a side effect of economic activity that you
don’t pay for.
• One example is Global Warming: use of car has side
effects on global carbon build-up - and some
predicting Armageddon as a result.
• Another example is atmospheric pollution.
• We focus on ‘fire-sale’ and ‘network’ externalities.
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Two Regulatory Responses:
taxing externalities
• Some advocate Pigovian taxation of externalities
associated with HLIs ‘Highly Leveraged Institutions’*
who generate externalities – e.g. by capital
adequacy ratios and presumably liquidity ratios,
Korinek (2009) and Haldane(2010)
* inc banks, shadow banks and hedge funds who might
get involved in ‘fire-sales’
13
Key Problem: Tail risk within financial systems
is endogenous and often unobserved
• it is hazardous to believe there is a magic number
for regulatory ratios sufficient to insure against
tail risk in all states of the world. Because tail risk
is created not endowed, calibrating a capital ratio
for all seasons is likely to be, quite literally,
pointless – whatever today’s optimal regulatory
point, risk incentives mean that tomorrow’s is
sure to be different.
• A.G. Haldane ‘The $100b question’
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Prohibition
• Andrew Haldane “The $100 b question”(2010)
argues that:
• Banks will always be able to move faster than the
regulators , and avoid control by ‘regulatory
arbitrage’. Look at the US shadow banking industry!
• Hence the need for prohibition - to ban activities
that threaten to generate negative externalities.
• “Prohibition” may have a 1930s sound, and that’s
right
15
US in 1930s: Glass-Steagall
• Glass-Steagall : simple in objectives and execution.
• Clear aim - shaped by an extreme tail event (the
Great Depression) –was to avoid a repetition.
• It sought to achieve this by acting directly on the
structure of the financial system, quarantining
commercial bank and brokering activities through
red-line regulation.
• Lasted over half a century without a significant
systemic event in the US, until revoked in 1999 by
Gramm-Leach-Bliley Act . And then….?
16
Average assets relative to GDP of US commercial banks
Source: A.G. Haldane ‘The $100b question’
0.012
percentage of Nominal GDP
Average Assets per Commercial Bank as a
0.014
0.010
0.008
0.006
0.004
0.002
0.000
34
1
42
9
1
1938
0
8
6
5
5
6
4
1
1946 19
1954 19
1962 19
9
Year
1970
0
86
7
9
1
1978 1982
1
19
8
94
9
9
2
19
6
02
9
9
0
0
20
Average Asset Size of Commercial Banks scaled by Nominal GDP
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Concentration of the US banking system
Total assets of top 3 US banks (as % of total commercial
banking sector assets)
Source: A.G. Haldane ‘The $100b question’
45.00
40.00
35.00
30.00
25.00
20.00
15.00
10.00
5.00
0.00
1935 1939 1943 1947 1951 1955 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 2007
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3.Reform of structure
• In a context of asymmetric information, HLI’s
use the property rights of the capitalist system
to generate profits which reflect transfers
rather than value added.
• Why not change property rights? E.g.
• Volcker Rule to bring back Glass-Steagall
• Investment banks to be partnerships again
• Double liability for commercial bank shares?
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Let me out of here!
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What is not legally banned may be economically
attractive (with moral issues left aside)
Economic progress:
two possibilities:
•A: OK
•B: PROBLEM
Legally
banned
Morally
unacceptable
Is there not a risk that that well-heeled, politically savvy, financial
institutions - with the best lawyers and least moral scruples - will
stay ahead of legal and moral sanctions.
21
Postscript
• ‘Wall Street titans still recklessly speculate
with borrowed money. We cannot delay
action any longer.’
(Barack Obama)
• Goldman charged with fraud
FT Headline - 17 April 2010
• ‘US authorities yesterday accused Goldman
Sachs of securities fraud that caused investor
losses of more than $1bn (£649m).
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Competition between Cultures?
• In Western, market-based culture, the limitations on
property rights depends explicitly on legal sanctions
• But these are failing to internalise externalities
• In some Eastern cultures, the rule of law is not
paramount; and, in any case, there may be other
sanctions , e.g. shame, capital punishment.
• So they may be better able to internalise
externalities!
*Dipak Lal Unintended Consequences,
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