Transcript The Global Financial Crisis .(English)

The Global Financial Crisis:
The View From German
Ordnungspolitik (秩序政策)
Prof. Dr. Carsten Herrmann-Pillath / 何梦笔
Fall 2008
Agenda
1
The Significance of the Crisis
2
The Failure of Economics
3
The Global Context
4
The Role of Corporate Governance and Regulation
5
The Political Economy of the Crisis
6
Cultural Change and the Ethics of Economics
7
The Way Ahead
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The Significance of the Crisis
 After two decades of transition, we now face a transition of capitalism:
– From Washington consensus to Beijing consensus?
– Reinstating the diversity of capitalisms (French, German etc.)
 Current situation: Difficult for forecasting
– Fact: We enter a global recession
– Unknown: Whether we face a global depression
– Unknown: How far the financial system is really affected:
• Reason: The status of the financial system is endogenous to the
economy
• Examples of unknown variables: hedge funds, credit card companies
(see American Express), banks of car companies (leasing), corporate
finance in general
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The Significance of the Crisis
 But the biggest unknown: The Lucas problem in forecasting!
– We observe far-reaching institutional changes, hence structural
changes of the largest economies of the world
• Specific example: downsizing and restructuring of financial asset supply
• And certainly: A new role of government in the economy
– Hence, our attention should focus on these: This is the perspective
of Ordnungstheorie und –politik / Institutional, evolutionary and
constitutional economics
 What is the institutional framework for finance in the future?
– Institutions of financial markets
– Embeddedness of financial markets (Interdependenz der Ordnungen)
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The Significance of the Crisis
 Conclusion:
– The crisis changes fundamental premises of
global institutional change and policies in the
past two decades. We failed to forecast the
extent of the crisis, and we will fail to forecast its
consequences. Thus, adapting our institutions to
our ignorance is the crucial challenge.
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Agenda
1
The Significance of the Crisis
2
The Failure of Economics
3
The Global Context
4
The Role of Corporate Governance and Regulation
5
The Political Economy of the Crisis
6
Cultural Change and the Ethics of Economics
7
The Way Ahead
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6
The Failure of Economics
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Economic theory is endogenous to capital market evolution
– Modern theory of finance major driving force in the production of new types
of financial assets (options, securitization etc.)
Neglect of the institutional dimension of capital markets
– No substantial role in theorizing about the role of continuous innovation in
financial markets
– Innovation continuously recreates patterns of asymmetric information
(increasing complexity of assets does not manage risk, but increases
information asymmetries, which exploded in the total loss of trust)
Tension between behavioral economics and mathematical modeling in risk
analysis and risk management
– Mainstream finance modelling assumes efficient markets and rationality:
Perfect arbitrage and the market portfolio
– The issue of probability distributions: Levy distributions and others, «rare
events», instead of normal distributions
– Neglect of the lemons problem in market dynamics, which interacts with
behavioral determinants («irrationality»)
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The Failure of Economics
 A systematic neglect of asset prices and wealth effects in simple applied
macroeconomics
– Asset price inflation versus CPI inflation: An unresolved issue in
central banking (which adopted inflation targeting)
– Stiglitz on Asia 1997: No role for bankruptcy in modeling crises
 The failure is endemic:
– In the crisis, we observe a sudden revival of vulgar-Keynesian ideas
about fiscal policies
– Central banks continue to be entangled in the flow-perspective on
macroeconomics: interest rate is the lever
 The real issue - choosing the right models:
– Hayekian model of credit cycles with very low real interest rates?
– Stiglitz‘ revival of loanable funds theory?
– General: Eschewing the pure macro-approach in favour of an
Austrian/evolutionary approach
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The Failure of Economics
 Conclusion:
– Economics played a major role in the genesis of
the crisis. It guided regulation and
institutionalization by wrong models of the
market and monetary policy. We need to rethink
economics as well.
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Agenda
1
The Significance of the Crisis
2
The Failure of Economics
3
The Global Context
4
The Role of Corporate Governance and Regulation
5
The Failure of Economics
6
Cultural Change and the Ethics of Economics
7
The Way Ahead
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The Global Context
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Bretton Woods II: The US as global lead economy and issuer of the global
reserve currency could maintain a very low savings rate by capital inflows from
China, in particular:
– China swaps safe interest returns from treasury bonds etc. for FDI inflows
which transfer technology under risk
– FDI profits from stable exchange rates and from the resulting Chinese
competitiveness
– China funds the American deficit and sustains the market for her exports
Chinese reserves serve different objectives (non-macro):
– a cushion for domestic banking system reforms and external shocks
– channeled into a Sovereign Wealth Fund, they help to reduce transaction
costs in Chinese FDI
– they are a pawn for Western FDI in China, and they are a commitment
device for Chinese cooperation in international policy coordination (because
of dollar denomination)
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The Global Context
 One of the main causes of the crisis:
– Expansion of US money supply creates reserve accumulation /
inflationary pressures worldwide
– Financial innovation major incentive for capital inflows to the US,
simultanously providing the stuff for asset price inflation
– However, asset price inflation and CPI inflation have been decoupled
because of deflationary pressures from China
 Will Bretton Woods II survive?
– If Chinese price competitiveness remains strong, a global recession
will not translate into a low demand for Chinese exports, rather the
other way round (e.g. automobile industry)
– Global investors will continue to be interested in investing in China,
given the dearth of alternative investments
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The Global Context
 Conclusion:
– A reinterpretation of the macroeconomic
imbalances of the past decade follows an
Austrian line of thinking: Macroeconomics serves
the optimal allocation of real capital in terms of
growth potentials, overcoming institutional
barriers and reducing uncertainty for
entrepreneurs. The major fault line was the Fed‘s
monetary policy.
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Agenda
1
The Significance of the Crisis
2
The Failure of Economics
3
The Global Context
4
The Role of Corporate Governance and Regulation
5
The Political Economy of the Crisis
6
Cultural Change and the Ethics of Economics
7
The Way Ahead
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The Role of Corporate Governance and
Regulation
 Both the Anglo-saxon and the Continental system failed because of a
lack of personal liability:
– In Germany, the Landesbanken were the main protagonists in the
crisis (public sector management)
– In the US, the supervisory system and the rating agencies failed to
curb overexpansion by ambitious managers
– In both cases, managers‘ incentives are distorted
 Leveraging and shareholder value: The false assumption that
shareholders will control excessive risk-taking by management
– As leveraging implies a high profit rate on equity, shareholders will
always support high leverage ratios, especially because they know
that they can sell the shares at any point of time
– Competition in financial markets is status competition, not „efficient
markets“, because status is a central signaling mechanism (Podolny),
hence no reason to curb managers‘ gains
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The Role of Corporate Governance and
Regulation
 Procyclical regulation supports risk-taking
– Rating agencies will improve ratings in boom times, and vice versa
– Regulation may also cause moral hazard (the higher the level of
regulation, the more responsibility can be shifted to the government)
 Regulation can never keep up with financial sector innovation
– There will be always scope for regulatory arbitrage, such that profits
will be made precisely because of regulation (securitization and risk
transformation), and by avoiding regulation (hedge funds)
 Regulation of single banks and regulation of the system differ – another
case of the fallacy of composition
– The government can only follow industry benchmarks and has no
external beacon to determine structure and level of regulation
(example: risk control under Basel II)
– On the systemic level, government is captured easily by the finance
industry (example: Bush‘s support of soft mortgaging schemes)
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The Role of Corporate Governance and
Regulation
 Conclusion:
– The most important single determinant of the
crisis was the lack of personal liability in the
financial system. Government regulation cannot
make up for this fault, unless it usurps financial
management, hence establishes state ownership
in the financial industry.
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Agenda
1
The Significance of the Crisis
2
The Failure of Economics
2
The Global Context
4
The Role of Corporate Governance and Regulation
5
The Political Economy of the Crisis
6
Cultural Change and the Ethics of Economics
7
The Way Ahead
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The Political Economy of the Crisis
 «Too Big to Fail»:
Regulation and
supervision
cannot overcome
the power-law
dynamics of
markets: Finance
is a network
business, neither
monopolistic nor
perfect
competition
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The Political Economy of the Crisis
 How can governments solve the problem of information asymmetry
between them and the financial institutions?
– The Lehman Brothers case: Trying to be tough, but weakness
afterwards, see AIG
– The deeper the crisis, the larger the asymmetries: Demand for
government support grows indiscriminately
 Special case US: The two goals of the Fed
– In-built tendency to over-expand the money supply and to adopt
activist monetary policy
 Politicians like to expand their influence
– Standard case of bureaucratic growth
– Politicians have to show off crisis management capability (see
Gordon Brown)
– Strong public resentment against increasing inequality of income
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The Political Economy of the Crisis
 Conclusion:
– The nature of financial markets leads to complex
patterns of collusion, co-optation and capture
between government and finance industry.
Facing elections, governments are also prone to
short-termism and to claim competences which
are in fact limited.
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Agenda
1
The Significance of the Crisis
2
The Failure of Economics
2
The Global Context
4
The Role of Corporate Governance and Regulation
5
The Political Economy of the Crisis
6
Cultural Change and the Ethics of Economics
7
The Way Ahead
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Cultural change
and the ethics of economics
 Are Bankers greedy? It‘s the system, as Karl Marx already recognized
– Status competition plus short-termism of unfettered financial markets
– Lack of personal liability
 The past three decades saw a cultural competition between different
models
– The Anglo-Saxon system of capital-market based finance
– The relational / credit-based banking model of Germany and Japan,
in particular
– The transitional banking systems of emergent economies (e.g.
Russia, China)
– Emergence of explicitly culture-based finance: Islamic finance
 Culture: Different mental models of risk and entrepreneurship, historical
roots of government-business relations etc.
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Cultural change
and the ethics of economics
 The relative advantages of the models are at least partly contextdependent:
– Finance is not independent from the structure of other markets,
especially labor (Aoki)
– Structural characteristics of markets determine the structure of
uncertainty (e.g. the relative role of generic / singular knowledge as
compared to semi-structured / meso – knowledge)
– Theoretical paradigm : complementarities and super-modularity, both
on the level of the real economy and the institutions
 Result: Finance is global, but banking is national!
 Is there a need for enhanced consumer protection?
– Again, the question of modeling arises: Hyperbolic time preferences
and commitment devices for savings
– What is the profession of bankers? A custodian, not a businessman?
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Cultural change
and the ethics of economics
 Conclusion:
– The competition among financial systems is also
a battle among different economic cultures. The
crisis will trigger cultural change supporting the
institutional diversity of the global economy.
Global regulation cannot substitute for national
regulation of national banking systems.
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Agenda
1
The Significance of the Crisis
2
The Failure of Economics
2
The Global Context
4
The Role of Corporate Governance and Regulation
5
The Political Economy of the Crisis
6
Cultural Change and the Ethics of Economics
7
The Way Ahead
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The Way Ahead
 Government bail-outs may help in the short run, but the long run
consequences can be desastrous:
– Increased government debt
– Together with low interest rates, the possibility of a resurgence of
stagflation, unless a Japanese scenario occurs
 Tighter bank supervision with
government equity injections cannot necessarily help
– Increasing moral hazard
in the system
– Triggering further direct
interventions of government
into banking
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The Way Ahead
 Solution: Less emphasis on business models of banks, but on
safeguarding product quality
– Stiglitz: Financial product safety commission
– Containing the role of rating agencies
 The root of the problem: How can the possible negative externalities of
finance business be contained?
– There are only two choices:
• Either curbing status competition, i.e. turning CEOs into quasi-officials
(following Bruno Frey)
• Or increasing personal liability, hence strengthening private banks
– Major challenge: Defining long-term success indicators for banks
which internalize externalities
• Caveat: There are also positive externalities of risk taking in finance,
supporting innovation in business!
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The Way Ahead
 There is no way to avoid crises in capitalism
– Failure is the king‘s way of learning: creative destruction
 But we can try to minimize externalities and collateral damages
– Central concern: The social security system must be entirely
independent from the financial markets, especially the pension
system
– Second concern: Maintaining the capacity of the financial system to
lend credit to companies, especially SME, thus maintaining the real
economy
– Third concern: Nurturing a diversified structure of the economy,
including finance, by means of competition policy
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The Way Ahead
 Conclusions:
– Central assumptions of Ordnungspolitik are
vindicated, again:
•
•
•
•
Personal liability
Containing big business, nurturing diversity
Primacy of monetary order and monetary policies
Strong, but autonomous government, against «crisis
management»
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