We all cried foul but no one listened

After not walking the talk, another point which I have been noting is policymakers now saying they had cried foul, but no one listened.

ECB Chief Trichet in a speech (Jan 19, 2009):

Warnings by the authorities about the possibility of an abrupt correction in financial markets date back to 2006. Many warnings were made about the risks associated with what was essentially a “pricing for perfection” – which, put simply, meant that risk premia were not, or hardly pricing in the possibility of anything going wrong. Given such pricing, even a small change in conditions had the capacity to severely disrupt financial markets. At the same time, a number of financial stability reports – including from the ECB, the Bank for International Settlements (BIS), the Financial Stability Forum (FSF) and other organisations – analysed vulnerabilities of the financial sector and warned of emerging weaknesses. 

In particular, these reports often emphasised that the rapid pace of innovation in financial markets and products coupled with the low level of risk premia called for investors to take greater care in understanding and managing the risks they were exposed to. However, while it was perceived that a storm was brewing, it was not known exactly what would trigger it, but that it would be appropriate that the financial sector agents should prepare for it so that the correction would be as orderly as possible. Both the underpricing of the “unit of risk” and, even more importantly in my view, the underestimation of the “quantity of risk” turned out to be at the core of the crisis. 

 Rogoff (who was IMF chief Economist 2001-03) in his interview says:

There was a lot of criticism of the U.S. current account deficit during the early 2000s. Maury Obstfeld and I wrote a series of papers arguing that the global imbalances posed serious risk, particularly given the growing complexity of derivatives markets. We made this point in our very first paper, presented in the summer of 2000 at the well-known Kansas City Federal Reserve conference held each year in Jackson Hole, Wyoming. I followed through on this at an official level as chief economist at the IMF from 2001 to 2003, as did my successor Raghu Rajan.

Yet a sequence of Treasury secretaries and the Federal Reserve chairman just dismissed the concern. Alan Greenspan, following essentially exactly the same logic as in my work with Obstfeld, reached the conclusion that the U.S. current account deficit simply reflected greater financial globalization.

Raghu Rajan’s warnings have been much discussed – (WSJ, Krugman, WSJ Blog, Niranjan’s Blog, This Blog)

William White of BIS:

Another expert who dissented from the Greenspan-Bernanke line was William White, the former economics adviser at the Bank for International Settlements, a publicly funded organization based in Basel, Switzerland, which serves as a central bank for central banks. In 2003, White and a colleague, Claudio Borio, attended the annual conference in Jackson Hole, where they argued that policymakers needed to take greater account of asset prices and credit expansion in setting interest rates, and that if a bubble appeared to be developing they ought to “lean against the wind”—raise rates. The audience, which included Greenspan and Bernanke, responded coolly. “Ben Bernanke really believes that it is impossible to lean against the wind on the way up and that it is possible to clean up the mess afterwards,” White told me recently. “Both of these propositions are unproven.”

Between 2004 and 2007, White and his colleagues continued to warn about the global credit boom, but they were largely ignored in the United States. “In the field of economics, American academics have such a large reputation that they sweep all before them,” White said. “If you add to that the personal reputation of the Maestro”—Greenspan—“it was very difficult for anybody else to come in and say there are problems building.”

(Claudio Borio also wrote a paper in 2004 which is like explaining the current crisis in 2004)

Mervyn King of Bank of England in a speech:

For several years the Bank of England and other UK participants in the international fora argued for a major reform of the international monetary system and the IMF in order to address this issue.

I haven’t come across any Fed member saying the same.

I have prepared a short table summrising the views and blamegames

Institutions Reasons Blame
BIS Nature of Financial Markets, Monetary Policy Greenspan
IMF capital flows (Rogoff), role of incentives (Rajan) Greenspan
ECB underpricing of risk Financial Market Participants
BoE capital flows IMF

So we have a view from 4 prominent policy institutions that shape policies across the world-  ECB, BoE, IMF and BIS. IMF and BIS are independent institutions but have an important role to play in policies. ECB and BoE are directly responsible for their economies and both Trichet and King cite their own research which showed imbalances were developing.

None seem to have had the teeth to do anything. IMF and BIS case is still understood as they can only influence policies but not make them (However, this still raises the question of their effectiveness). But what about ECB and BoE? Why didn’t they do anything.

Instead they choose to simply pass on the blame – 2 blame Greenspan (for a coverage on Greenspan’s comments in 2004-07 see Krugman’s post; Acemoglu takes a dig at Greenspan; Greenspan did write an article admitting to a crisis but it was too late in 2007 and he was out of the Fed job), one financial firm and one IMF.

All this looks terrible. Infact Greenspan looks much better. Greenspan stuck to his views all along and admitted he was wrong in his testimony. However, all the others believed that there was trouble but did nothing about it except plain talk and research. I am sure if these guys had walked the talk others would have followed and may be things could have been a lot better.

Again, I am getting really wary about policies now (see earlier comments as well). It does not look good at all.

5 Responses to “We all cried foul but no one listened”

  1. How did Lehman et al survive the Great Depression? « Mostly Economics Says:

    […] I agree he was at fault, but there were other important policymakers (if not as powerful) who could have raised flags but chose to join Greenspan […]

  2. Iceland authorities knew things are wrong but were helpless « Mostly Economics Says:

    […] many others now, he says Bank of Iceland raised concerns but no one […]

  3. IMF says imposing capital controls could be considered! « Mostly Economics Says:

    […] is exactly what is needed from other leading institutions as well. I had pointed earlier that most (including IMF earlier) instead preferred to pass on the blame to […]

  4. But IMF does macroprudential analysis and it hasn’t worked « Mostly Economics Says:

    […] been using it and they have not been successful. IMF’s economists like Rogoff and Rajan did raise issues in their independent researches, but GFSR could not (ideally GFSR should have been able to see […]

  5. Regulators had powers but chose not to do anything « Mostly Economics Says:

    […] is not just limited to US but common across economies and instiutions. As I pointed in this post, the key people believed something was happening but did nothing. Why? The main reason is their […]

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