The credit crunch
The year of living dangerously
Aug 7th 2008
From The Economist print edition
As the crunch grinds past its first anniversary, central banks’ credibility is still at risk
ON AUGUST 9th 2007, after an alarming leap in interbank interest rates, the European Central Bank signalled its readiness to provide the banking system with the liquidity it suddenly lacked. What became known, with irresistible alliteration, as the credit crunch had begun. A year on, the crunch continues. Indeed, recent data suggest that Europe and Japan are flirting with recession. America has so far stood up surprisingly well; but banks there (and elsewhere) are still in pain.
Worse, a second shock-higher commodity prices-has made life doubly difficult for central banks. The combination of dearer commodities and a squeeze on credit has presented them with a conflict between their two main tasks: preserving the health of the financial system and controlling inflation.
To date, the central banks have just about passed the test. Their willingness to provide liquidity has prevented financial markets from melting down completely, despite some hairy moments. And the recent decline in oil prices may ease their worries about inflation.
But there have been many embarrassments along the way. The financial system was not as robust as most regulators thought. Banks had not shed risk altogether; it was hidden off their balance-sheets. The British tripartite system of oversight was ineffectual in the Northern Rock crisis. Inflation has been well above target rates in Britain and the euro area and outside the comfort zone of America’s Federal Reserve.
Worst of all, perhaps, is the perception that central banks have acted out of a desire to rescue their “friends” in the financial sector. Steelworkers and coalminers have to face grim economic reality and see their companies liquidated; bankers, it seems, do not. As Nouriel Roubini, an American economist, has remarked, this smacks of “socialism for the rich”.
The reason for saving a big financial institution that gets into trouble is the economic havoc its failure can cause. The historically minded need no
reminding of the Great Depression-least of all Ben Bernanke, the Fed’s chairman, an expert on the subject. It seems plausible that, even if the risk of catastrophe is slight, no chances should be taken. To borrow the title of a popular book: shoot black swans on sight.
We are all Keynesians again
The problem is that trigger-happy intervention also has its drawbacks. It has long been accepted that retail depositors should be protected, to maintain their faith in the financial system. But ten years ago the Fed helped organise the rescue of Long-Term Capital Management, a hedge fund (although no public money was involved). This year it went further and gave guarantees to Bear Stearns, an investment bank with no retail depositors. Last month it played its part in shoring up Fannie Mae and Freddie Mac, the twin quasi-private giants of the American mortgage market. If financial institutions are deemed too big and too complex to fail, their managers will have an incentive to make them big and complex.
问题在于随意的干预总体现出障碍性，长久以来人们一直以为出于稳定小额储户对金融系统信心的考虑，他们应该受到保护。但是十年前，联储帮助组织了对”长期资本管理”的援救，这是一个对冲基金，没有公众资金的介入。今年联储对Bear Stearns这个完全没有小额储户的投行进行了更加深入的帮助–对它进行担保。上个月，联储又支持了美国抵押信贷市场的孪生巨子，Fannie Mae 和 Freddie Mac。如果金融机构因为规模大、运作复杂而不可以倒闭，那么他们的管理层就会因为这个原因而使之变得巨大而复杂。
All this is reminiscent of the history of Keynesian economics. John Maynard Keynes explained how a sudden drop in investment could lead to a long-lived slump, because prices, wages and interest rates would not adjust enough to encourage fresh spending. The solution was for governments to provide the demand needed to return to full employment. By the 1960s and 1970s, Keynesian demand management was being used to try to avoid any kind of downturn. The result was an expansionary bias in policy and, eventually, inflation.
The “no bank left behind” policy of central banks has not yet led to the kind of inflation seen in the 1970s. But cutting interest rates as a first response to any distress in the financial sector has helped to blow bubbles in asset prices-dotcom stocks in the late 1990s, house prices in the 2000s. And it has led to a speculative mentality in financial markets, demonstrated by the importance of trading to investment banks’ profits. Why not take risks, if you know that central banks will intervene only in falling, not rising, markets?
The idea of giving central banks independence was that they would take decisions from which politicians would shrink. The central banks’ credibility depends on being prepared to do two unpopular things: raising interest rates, despite the economic pain, and letting financial institutions fail.
With interest rates that independence is (or should be) easy to maintain. Rescues are harder: public money benefits some firms and not others, and political pressure is easier to exert. Alan Greenspan, the previous Fed chairman, has one answer: a new, separate body to deal with bank rescues (see article). The central bankers would be consulted, of course, but the decision on whether to use taxpayers’ money has to rest with elected politicians. In practice, this could be hard to achieve, but he has identified one principle. Central banks’ credibility should be focused where it is most needed, on controlling inflation. That credibility was too hard-won to be tossed away.