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"As usual Martin’s question is important
(even if, more unusually, the Queen asked it first)"
The Basel regime (European and American banks use either version 1 or 2) represents a monumental, decades-long effort at perfection, with minimum capital requirements carefully calculated from detailed formulae.
The answers were precisely wrong.
Five days before its bankruptcy Lehman Brothers boasted a “Tier 1” capital ratio of 11%, almost three times the regulatory minimum.
The Economist print Jan 21st 2010
That poses an obvious question for bank supervisors: if they have already tried and failed to make capital rules foolproof, why should they do better this time?
Yet for all this, a single, horrible truth exists. Because most big banks are too interconnected to fail, and could be brought down by a counterparty, the system is only as strong as its weakest member.
It was the 1988 Basel Accord that first created the opportunity for regulatory arbitrage
whereby banks could shunt loans off the balance sheet.
John Plender, FT November 6 2007
Is the discipline of economics succumbing to a twinge of self-doubt now? Or at least some heresy? Perhaps. In the last couple of years, the reputation of the profession has suffered badly, as a host of commentators – including the Queen of England herself – have asked why this well-paid priesthood failed to predict the financial crunch.
Gillian Tett, FT November 12 2010
Many economists insist this criticism is unfair. Nevertheless, there is a noticeable shift in the tone of debate and intellectual emphasis. The efficient market hypothesis is no longer in such vogue. Elaborate computer models do not command quite such reverence.
One might not expect much from economists, but one would surely expect them to warn us of a crisis on this scale.
Speech given by Martin Wolf, chief economics commentator, at the FT’s annual economists’ drinks party in London
Financial Times, 27/11 2008
The difficulty was that we all tend to look at just one bit of the clichéd elephant in the room. Monetary economists looked at monetary policy. Financial economists looked at risk management. International macroeconomists looked at global imbalances. Central bankers focused on inflation. Regulators looked at Basel capital ratios and even then only inside the banking system. Politicians enjoyed the good times and did not ask too many questions. And what of commentators? Well, they tended to indulge in the fantasy that the above knew what they were talking about. I am embarrassed to admit this.
I am not seeking to deny that a few people saw important pieces of the emerging puzzle and some saw more than a few pieces.
In my gallery of heroes are Avinash Persaud, who told us early and often that the risk-management models on which regulators foolishly relied were absurd individually and lethal collectively
(Long list of names.....and Nouriel Roubini, of course, who was Dr Doom before almost anybody else.)
The list is not exhaustive and I apologise to all those offended by my omissions.
Alternatively, we could have spent more time studying the work of Hyman Minsky.
We could also have considered the possibility that, just as Keynes’s ideas were tested to destruction in the 1950s, 1960s and 1970s, Milton Friedman’s ideas might suffer a similar fate in the 1980s, 1990s and 2000s.
What if we are now making new and even bigger errors in rushing back to Keynes? The thought worries me. What if now that households in the US and UK are no longer able, or willing, to borrow any more, we are set on breaking the back of taxpayers, instead? Is the end of this crisis the destruction of the credit of some of the world’s most creditworthy governments?
Economists have been given the material for research programmes stretching decades into the future! Tens of thousands of PhDs, not to mention a few Nobel prizes, are surely waiting to be hatched!
And if this crisis kills Real Business Cycle theory, as it surely should, it cannot be all bad.
More by Martin Wolf at IntCom
Various comments have suggested that I’ve been too nice, or not nice enough, about Real Business Cycle theory, the main contribution that got Kydland and Prescott their Nobel prize.
John Quiggin, October 13, 2004
This year's Nobel prize honours two economists
Edward Prescott and Finn Kydland
The Economist 14/10 2004