When I wrote this post recently, I didn’t know my ideas would match with Charlie Bean of Bank of England. In his recent speech, he gives an excellent review of the crisis (though mainly focuses on the US which is disappointing as I wanted more of UK experience). He starts from the great moderation phase and follows with the discussion on the crisis. Much is known by now in numerous such speeches but this one is still a must read. It has superb graphs as well.
Now to the title of the post. He says there are a few lessons from the crisis:
First, in my view it would be a mistake to look for a single guilty culprit. Underestimation of risk born of the Great Moderation, loose monetary policy in the United States and a perverse pattern of international capital flows together provided fertile territory for the emergence of a credit/asset-price bubble. The creation of an array of complex new assets that were supposed to spread risk more widely ended up destroying information about the scale and location of losses, which proved to be crucial when the market turned. And an array of distorted incentives led the financial system to build up excessive leverage, increasing the vulnerabilities when asset prices began to fall. As in Agatha Christie’s Murder on the Orient Express , everyone had a hand in it.
🙂 Precisley what I said here.
Second, the economics profession has oversold the virtues of unfettered financial markets. We usually start from a presumption that markets work best when they are left to themselves, unless there are obvious market failures present.
Third, we need to pay more heed to the lessons of history. Financial booms and busts have occurred with some regularity ever since the Tulip Mania of 1636-7. Yet we tend to treat them as pathologies that happen at other times or in other places. Their frequency suggests that we would be better advised to think of them as a central feature of capitalist economies that our models should aspire to explain.
Fourth, we need to put credit back into macroeconomics in a meaningful way. Financial intermediaries are conspicuous by their absence in the workhorse New Keynesian/New Classical DSGE model.
All three have been discussed by other economists and reported by this blog. In the last learning he points to some interesting papers/ideas which are trying to get finance sector in basic macro models (but they are just models r’ber).
Lets see whether these lessons get implemented or just remain suggestions. It looks like latter is going to prevail as the second lesson goes. As things have started to improve fin market players have started reacting to any form of regulation.
Recently, there was a mention of Tobin tax on financial transactions by UK Chancellor. However, the industry reacted negatively. Here are some reactions:
Lord Turner’s critics said he had overstepped his remit as a regulator and risked damaging London’s standing as Europe’s leading financial centre.
Stuart Fraser, chairman of policy at the City of London Corporation, said Lord Turner was playing into the hands of rival financial capitals, such as Frankfurt and Paris.
Boris Johnson, the London mayor, said anybody who did not believe the FSA’s responsibilities included protecting the international competitiveness of the City was “crackers”.
John Cridland, deputy director-general of the CBI, said: “The government and regulators should be very wary of undermining the competitiveness of the UK’s financial services industry.”
The British Bankers’ Association was among the most trenchant in its criticism. “If we introduce the wrong kind of regulation or the wrong kind of taxes we could so easily lose that position by driving business abroad … On so many occasions in the past the country has lost chunks of industry through making the wrong decisions. Let’s not do that again.”
The Investment Management Association and the Association of British Insurers were critical of the likely impact on investors. “It is just illogical to want to shrink one of your most important industries,” said one London banker. “If you want to turn London into a Marxist society, then great.”
US bankers also opposed the idea of a global transaction tax. “We vigorously oppose a tax on the industry,” said Scott Talbott, head of government affairs at the Financial Services Roundtable, which represents the top 97 US institutions.
Some things never change really. After causing so much damage to the UK economy, they still think it to be all this. Really sad to see all these developments. How will things ever improve in finance sector? As the crisis eases further, there is likely to be more disappointment than hope.
Mostly Economics 
