Professor of Finance; Alexander M. Knaster Chair;Fellow of the British Academy
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Not that we’re through the latest one, but will we see another global financial crisis?
Yes, there will be another one. The only doubt is: have we put in place the financial architecture to minimise its costs?
Do you believe we have?
No, not at the moment. I think there’s a great danger that we’ll revert to carrying on as normal. We do have some voices out there yet to be heard, such as the governor of the Bank of England.
The banking experts whom I talk with seem to think that more is being done here than in the States to cope better with the next financial crisis. There’s a better chance of a successful outcome here and maybe in Europe than in the US. We shall see.
What most worries you that we’ll have another crisis?
There’s an enormous barrier to making structural changes, primarily because banks — and you can’t blame them for this — say, “You impose regulation on us and we’ll move our head offices and some of our activities.” They are very mobile. So, it’s going to be politically difficult for the government to make the right structural changes, even if it believes the changes are right. It’s worried that it may impose costs on banks that other countries will not impose, so that banks will just pick up and depart for sunnier regulatory climes. How costly would that be to us? What’s the trade-off between the costs and the benefits? That’s hard. I wouldn’t want to be a politician faced with that question.
Did academics fail to see the current crisis coming?
Of course. Before the crisis, if you looked at 1,000 empirical papers on corporate finance, what would they have said in the data description? Probably this:our sample excludes banks and financial companies. Why? Because the balance sheets and so forth are opaque; and because, as a colleague said, we really weren’t interested in that area. Banking and finance, or at least the economics of banking, was the province of a small group of professors. Mainstream corporate finance and mainstream financial market research were not very interested in banking.
First of all, we thought there haven’t been a lot of banking crises. You had, say, the savings-and-loan crisis, which, from an academic point of view, wasn’t that interesting. That crisis cost $150 billion, maybe $200 billion; but it didn’t feel like a grand systemic crisis.
But the current crisis doesn’t lack in grandness.
Yes, we’ve had a systemic crisis of tremendous proportions. We missed this one — as did so many others, I might add. Now, of course, this systemic crisis will provide work for thousands of academics and PhDs, probably for the next half-century. We’re all interested in banking now —a bit late, though.
And by ‘all’, you mean all academics?
All academics and all other disciplines have taken a keen interest in the banking world — down, in many cases, to the man and woman on the street: just look at the impact recently of taxation, public services, public finances, all of that. Previously, if people thought at all about the banking system, it appeared opaque and arcane. It’s not so arcane now; it’s touched their lives. We’d better be more interested in it.
So what systemic changes should we see over the next five years or so that would make you less fearful of plunging again into the abyss of crisis?
We must see structural changes. I think we should look very carefully at what I call ring-fencing, guaranteeing less of the banking system, so that government — that is, taxpayers — will be less exposed to non-core banking activities. Reduce the volume and value of guarantees that the state makes available to the banking system. That’s something that the governor of the Bank of England has been very insistent about and rightly so. Look at what threatened poor old Ireland: they guaranteed their whole banking system. This is simply unaffordable. Ring-fencing reduces the taxpayers’ exposure. Politically, as I said, it’s not an easy thing to do. It’s very easy to talk about it conceptually and not so easy to apply and implement it.
But as time goes on and collective suffering diminishes, the appetite for change diminishes.
Surely, and banks are recapitalising and saying, “Look, we’ve raised a lot of equity, our leverage is less, we’re much more aware of risks than we were; things will be just fine now.” To that, I say there are very few advantages of being old, but one of them is a long memory. So I remember the banking crisis and property crisis of 1973–1974 and 1991 and again with the recent one, where banks over-lent on property.
You’ve got to ask yourself: why is it that every 15 or 20 years you get these crises? And one answer is that the people who were there at the time have retired and new people have come along and there is no institutional memory.
So, will banks rein in their property? Yes. But, in 10 to 15, years will they again be lending a great deal on property? Yes. Will there be another property bubble? Yes. Will that trigger another banking crisis? Yes, unless we make the needed structural changes, because you cannot rely on institutional memory to forestall a future crisis.
Are you saying we need mechanisms to remain vigilant even in good times?
Exactly. The fact that you have a very stable financial system today doesn’t mean we won’t have earthquakes tomorrow. As in the recent literal experience of Japan, the fact that we go 10 years or more without an earthquake doesn’t mean that the probability of another has been diminished.
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