Reflecting on what has been happening in the EU since the Financial Armageddon in 09/2008, one is ?bemused, bothered and bewildered??if not confused or disorientated. First, what is stirring in the EU financial firmament? Second, is it impairing recovery and threatening a slide into double-dip recession? Third, do EU governments understand fully the consequences of what they are doing?
In the aftermath of 09/2008 the EU governments, goaded by the outrage of their electorates, have opened banking?s Pandora?s box. They have done so by overindulging popular revulsion about the damage that banks and bankers?defined to include everyone in finance except tellers (performing the only financial service that the public now perceives as worthwhile)?have wrought. Day-after-day, politicians and regulatory agencies have made tendentious, inflammatory attacks against banks, bankers, speculators and financial markets. They have blamed them for every perceived economic problem that has emerged in the last three years.
That, of course, ignores the fact that any sense of proportion, ethics, morality or propriety seems now to elude not just the behaviour of bankers. It also escapes that of ministers and politicians in legislatures and governments, of journalists and executives in the press and electronic media, as well as top officials in the forces of law, order, and regulation. That is what the unfolding slow-motion disintegration of the Murdoch media empire seems to suggest! So, endowing bankers with a monopoly of behaving recklessly is no longer a supportable contention.
Most of the problems which need to be tackled now have been caused by governments, not banks, in the last 30 months. They have responded mindlessly to populist outrage and misperception about what fundamentally caused the crisis as opposed to what triggered it. The causes?outlined so well by Raghuram Rajan in his book Fault Lines?were profoundly mistaken public policies of excess credit creation; followed by over-indulgence in credit abuse, for mortgages and consumption that were simply unsupportable by growth in incomes. That was done by the public at large, encouraged by misplaced public enthusiasm for financial inclusion. But neither the public nor governments blame themselves for what happened. They blame only the banks.
The impact of these: (a) disastrous underlying policies, pursued for two decades by complacent governments, coupled with (b) financial system regulation, based on questionable theories about the financial market?s natural proclivity for sensible self-correction, became obvious when the pressures building up under the world?s financial tectonic plates finally erupted.
What caused the build-up to the crisis in 1990-2008 and what triggered its explosion in 2008?i.e. the incredible vacuity of banks and financial markets blowing up the system with worthless contracts including subprime mortgages, whose contagion was spread via collateralised debt obligations, asset backed securities and a pyramid structure of derivatives (which would have been fine had the assets and collateral been sound)?are two entirely different things.
Yet, after three years, neither governments nor publics appear to understand the fundamental distinction between underlying cause and ultimate effect. Instead, governments have responded to the debacle with an extraordinary display of ineptitude and incompetence, immediately after they reacted sensibly to save the global financial system from complete collapse, which they themselves triggered by letting Lehman Brothers collapse to exemplify their commitment to moral hazard avoidance. They did not understand the consequences of that action in unravelling a network of interconnected obligations which spanned the globe in ways that defied the imagination of governments and regulators. Having triggered the crisis, they have not since exercised political or administrative leadership in averting the prospect of future self-destruction.
By neglecting to do so, they seem unaware that before their economies can recover, and before employment growth can be restored, their banking or financial systems must be restored to robust health. They must function normally again. These systems cannot recover and function normally if EU governments keep intervening every day in ways that damage the asset quality, profitability, revenue, and equity of banks every time they are close to being normalised.
Nowhere is that disconnect clearer than in the way the EU?s sovereign debt crisis is being mismanaged. Consequently, a problem that was peripheral, confined to Greece, Ireland and Portugal, has now migrated to the EU?s core with Italy and Spain infected by contagion. The result is that the existence is threatened of the very banks that EU governments need. Without those banks being able to buy and market more widely (through regional or global financial systems) the huge amounts of public debt that the EU must issue in the next 5-10 years, Europe will condemn itself to a long dark night of growing unemployment and recession for the foreseeable future.
That EU governments seem unaware of the self-harm they are doing defies comprehension. They do not seem to realise that they need their banks now as much as their banks needed them earlier. And so, foolishly, EU governments are pursuing debt crisis management options that can only damage their banks and financial systems even more. Thus they are delaying recovery and risking a slide back into prolonged recession as credibility in their crisis management abilities, and in the integrity or solvency of their banks, is completely lost.
These counterproductive indulgences have been exacerbated and amplified by ill-conceived regulatory hyper-activism at national and regional levels. Taken together, EU governments? fiscal and debt crisis management policies, coupled with a growing tendency toward financial misregulation, represent not just vain attempts to close the barn door after the wild mustangs have bolted. They reflect an atavistic urge for revenge, retribution and blood-letting. One obvious example is the misdirected, if not unnecessary, regulatory intervention and wholesale revamping of regulatory architecture (like in the UK) which has caused more chaos and confusion (and resulted in much poorer regulation in practice) than intended. It is the modern equivalent of rearranging deck chairs on the Titanic after it hit the iceberg.
Given the peculiarly obtuse manner in which the British ?old-boy network? still functions, all the key players whose misjudgements (on moral hazard, light touch regulation, etc.) triggered and exacerbated the crisis have been left in place; some even knighted or ennobled. But the earlier regulatory architecture, which was (wrongly) blamed for the debacle, has been vandalised; perhaps to discredit the former Chancellor/Prime Minister, Gordon Brown who has much else to be criticised for.
The Bank of England has now been given far greater umbrella powers for regulation and supervision than it can exercise sensibly. The result is confusion and chaos in what used to be an understandable system of financial regulation, now to be implemented by a plethora of half-baked agencies that have yet to take shape and form.
If one examines what has happened forensically, the core problems that actually caused the financial debacle in the EU remain unaddressed and unresolved. The specific people in regulatory institutions who were responsible for letting the problem explode have been protected and elevated (not true in the case of the banks). The problems that have supposedly been solved are ones that did not cause the crisis nor exacerbate it.
Thus, in the EU, official interventions that were supposedly intended to reshape the future of financial systems, and alter the manner in which they are regulated and supervised?ostensibly so that 2008 would not recur for another generation or three?have achieved the opposite. They have introduced chaos and uncertainty into the future shape, structure and oversight of banks and financial systems, thus bringing forward the likelihood of another financial crisis exploding in the EU much sooner than anyone wants, or can cope with the fallout of.
In retrospect, much of what has transpired has been done in a prolonged but petulant fit of political, public and regulatory fury at being let down by the banks in 2008. Contrary to what is often asserted, it has not been done in thoughtful, constructive contemplation. Sadly, the situation has not been helped by the otiose insensitivity (if not idiocy) of senior executives and traders in banks reverting to enriching themselves quite unjustifiably in a manner that further fuels public antipathy. This is done by each bank in the name of retaining competitiveness; as if the prospect of the whole cut-throat industry, responding collectively and responsibly to a legitimate public concern, is simply unthinkable and beyond contemplation.
The picture in emerging markets is a bit different. In those countries ?thanks to unnecessary monetary and fiscal stimulus to ape the West in an entirely different set of circumstances?inflation is now roaring. It has been amplified by the effects of money-printing (sorry? quantitative easing) in the EU and the US. Such QE has had unintended consequences for emerging markets, triggering a resort to tighter remedial monetary policy.
Rapidly rising interest rates may affect, quite imminently, the future health of emerging market banking systems as they increase risks to household and corporate debt-servicing capacity, and weaken asset quality. In India, that is already visible in the rising NPAs of the public banks some of whose CMDs seem to have resorted to balance sheet adjustment timing and provisioning sleights-of-hand to boost artificially their reputations as astute managers, quite undeservingly. But the banking systems in these economies are not (yet) as debilitated, weak and as deep into recuperative therapy as those in the West.
Taking these realities into account, one might be forgiven for asking whether European (and US) legislatures, governments and regulators have their heads screwed on the right way around and whether they know which way is up? If they stay on course, will the EU (or the US) ever recover in a sustainable fashion without double-dips? The answer on present evidence seems to be NO.
The author is chairman,
Oxford International Associates Ltd