True finance and three lies of finance..

Interesting lecture by Mark Carney of Bank of England.

He talks about how the GFC has led to changes in the financial system for the good. But there can be no progress if we don;t know the three lies of finance:

  • Lie I: “This Time Is Different”
  • Lie II: “Markets Always Clear”
  • Lie III: “Markets Are Moral”

Hmm..

He says we should work towards true finance. Call it truer finance actually:

So this time is no different. Markets don’t always clear. And we can suffer from their amorality. What to do with such knowledge? And how to retain it?
To resist the siren calls of the three lies of finance, policymakers and market participants must bind themselves to the mast. That means building institutional frameworks that make it easier to resist as the lies regain their seductive power. If we can, we will build True Finance, an enduring platform for strong,
sustainable and balanced growth.

Over the past decade, great strides have been made.

Let me begin with the global reforms that have addressed the third lie that “markets are moral”.
In the cycle of scandal, response, integrity, drift, and new scandal, potential solutions have oscillated between the extremes of Light Touch Regulation and Total Regulation. There are problems with each. By undervaluing the importance of hard and soft infrastructure to the functioning of real markets, light touch
regulation led directly to the financial crisis.

….

The recognition that “markets don’t always clear” has spurred major reforms to make markets less complex and more robust.  A decade ago, OTC derivative trades were largely unregulated, unreported and bilaterally settled. When Lehman fell, uncertainty about such exposures sparked panic. Since then, the FSB has designed a series of reforms to make these markets safer and more transparent, including by requiring trade reporting and by encouraging central clearing of over-the-counter (OTC) trades.

…..

Turning finally to the lie that “This Time is Different”. If the experience of the financial crisis teaches us anything, it’s humility. We cannot anticipate every risk or plan for every contingency. But we can, and must, plan for failure. That is how we can create an anti-fragile system that is robust to both the intensification of known risks and the crystallisation of Rumsfeldian unknowns.

An anti-fragile system requires resilient banks. A decade ago, major banks were woefully undercapitalised, with complex business models that relied on the
goodwill of markets and, ultimately, taxpayers. Large global banks can now stand on their own. Their common equity requirements and buffers are now ten times higher than the pre-crisis standard. And to protect the system from risks we think are low but prove not, banks are subject to a simple, minimum
leverage ratio, which is robust to model risk.

Hmm..Only the next financial crisis will tell us how truer the picture has become or is it still about lies..

 

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