Deluded central bankers believe they've created a safer, fairer financial system
Andrew Sheng says six years after Lehman, the world economy is still at risk despite claims to the contrary
This week in Singapore, fresh from the G20 in Brisbane, Bank of England governor Mark Carney delivered a major speech outlining the future of financial reform. As chairman of the international Financial Stability Board (FSB), tasked with coordinating global financial stability, he patted himself on the back that the monumental task of designing a post-crisis system of prudential regulation is complete. The tough job ahead is implementation.
Congratulations. Six years after the failure of Lehman Brothers, the world's central banks and regulators have finally agreed on a set of regulations that may solve the last crisis - but not the next one.
It's staggering that Carney can declare that the global financial system is - not will be - safer, simpler and fairer, when the facts point in the other direction.
Is it safer? On the adequacy of bank capital, he pointed out that the capital shortfall was much smaller, at €15 billion (HK$146 billion) at the end of 2013, compared with €115 billion two years ago. According to the European Commission's Financial Stability and Integration Report in April, between 2008 and June 2013, €400 billion of the total European bank capital increase of €630 billion corresponded to increases in interbank positions and only €230 billion represented fresh capital injected from outside the banking system. Don't forget that the banks were fined over US$150 billion for misdeeds, half of which was for breaking sanctions.
On October 15, the US Treasury market had a heart seizure. The yield on the 10-year Treasury note moved 0.37 percentage points from peak to trough in about 30 minutes, equivalent to a "flash crash" in the bond market. It was probably caused by a combination of restrictions on the ability of bond market makers to take a position when the market moves and the high-speed trading on computer algorithms that triggered automatic sell signals that created the "crowded exit". When markets panic, liquidity disappears. It is not safer, even in the most liquid of markets.
Is it simpler? I cannot see how it can be when the regulations and trading models are so complex that you need a quantum physics expert to decipher what is going on. Furthermore, as a result of bank consolidations, the dominance of the top banks in the world is increasing, not decreasing.
Is it fairer? The FSB proudly announced that the Brisbane agreement on "total loss absorbing capacity" for globally systemic banks will result in these banks being supported in the future without recourse to the taxpayer and without jeopardising financial stability.
The financial system as a whole has not been fair since the central banks started introducing interest rates below the inflation rate. Guess who has been subsidising the large, concentrated borrowers? Pensioners, small savers and those who cannot afford to buy speculative assets on leverage. Guess who has been bailing out the speculative and leveraged players with massive injections of liquidity and lowered interest rates? The top four central banks, which tripled their balance sheets to US$10 trillion between 2008 to 2014.
I was truly disappointed that, in Carney's speech, the game-changing words that concern us all - "social inequality", "climate change" and "technology" did not appear at all. Instead, the solutions for a stronger financial sector "that can deliver strong, sustainable and balanced growth for all economies" were diversity, trust and openness.
Is diversity being created if we are concentrating derivative financial transactions into central clearing platforms? Can trust be generated when there is essentially very little between bankers who fear changes in the rules one day and being fined by regulators the next? Are we being more open when new regulations make the system more "Balkanised?"
The FSB has put the cart before the horse. The world economy is like a horse (the real economy) and the cart (financial system) working together. We had a financial crisis because the horse and cart were both overleveraged, with a driver punch drunk on more debt. Six years on, the horse is weaker, and even more leveraged. Yet the driver insists that the cart becomes a Rolls-Royce, with more capital, more robust and safe, trustworthy and open.
But the real economy horse, the engine of growth, needs more capital, not more debt. If the horse falters, the cart will keel over, irrespective of the increases in capital and liquidity. The major reason why financial markets are at record highs, despite serious problems in the real economy, is unconventional monetary policy.
As a former central banker, I am more used to central bankers who are financial market referees than players. We can all understand that when the game gets wild, central bankers must be goalkeepers, but I find it strange that central bankers playing as forwards to keep the markets bubbling along can also be the referee determining the rules. Under these rules, an own goal is a victory.
Andrew Sheng is a former central banker and financial regulator