Banking Luddites threaten to wreck the engine of recovery

[Cees Binkhorst]

REPLY TO: D66 at nic.surfnet.nl

'Name calling' noemen ze dat geloof ik.
Iemand in het defensief dringen door de aanval (door Fanthom Financial
Consulting ;)

Als ik gehakt wil ga ik wel naar de slager. Maar als ik wil beleggen in
hypotheken vraag ik niet om financieel gehakt, maar in afgeronde hele
leningen.
Dan hoef je tenminste geen huizen te delen met honderden anderen.

Groet / Cees

http://www.telegraph.co.uk/finance/comment/5140414/Banking-Luddites-threaten-to-wreck-the-engine-of-recovery.html

Banking Luddites threaten to wreck the engine of recovery
The thirst for revenge over 'greedy bankers', and calls for a return to a
'back-to-basics' approach in banking risks undoing the financial
innovation that underpins our long-term growth prospects.


By Danny Gabay and Erik Britton
Published: 9:28PM BST 11 Apr 2009

Comments 5 | Comment on this article

Like the Luddites after the industrial revolution, or those who opposed
the spread of the railways in the US and the UK, the campaign against
modern banking does have some justice on its side. Rewards for top bankers
were grossly inflated and, as it turns out, largely unwarranted given the
industry's failure to predict, prevent or ease the global recession that
we have now entered, at huge cost to the livelihoods of ordinary people.
One only has to think of dark satanic mills or robber barons to see the
connection.

But if the Luddites or those who opposed the railroads had won the day, we
would all be far less wealthy now. The same is true with the financial
services industry today. Like it or not, we are going to need its help to
get out of this mess.

Business cycles are often led by technological innovations. True
innovation, whether it is the steam engine, the railways, electricity,
information and communication technology or, most recently, the raft of
supposedly risk-reducing derivative-based diversification strategies
through financial markets, implies that we can all expect to be wealthier
in future than we were in the past.

The problem is human greed and impatience. Faced with the prospect of
windfall gains sometime in the future, human nature is inclined to begin
spending some of that right away. Spending runs ahead of the productivity
shock that caused it. And financial markets are always more than happy to
facilitate, by allowing consumers and investors to borrow against these
expected returns.

Hence, as John Vickers, the former chief economist at the Bank of England
once observed in the context of the dot.com boom, we often see a boom in
demand ahead of any increase in productive supply.

Typically, people will greatly overestimate the impact of the innovation
on their future income, hence they borrow and consume too much.

If the authorities and regulators fail to lean against the prevailing wind
of optimism enough to dampen that excessive demand before it takes on a
logic of its own, asset prices – the key market measure of expected future
income – will form a bubble.

Both of these things happened in the recent cycle. First equities and then
house prices entered a bubble in which key ratios such as the equity price
to earnings ratio or the house price to rent ratio rose to ridiculously
high levels. Both were justified by appeal to a brighter future, in which
profits would soar, house prices would only ever rise and risk had been
traded away.

A correction, first in equity prices (one of the triggers of the 2001
global recession) and then in house prices (the proximate cause of the
current recession), was inevitable. Correction has now become recession,
and perhaps worse. And the cost of all this has been laid at the
taxpayer's feet.

None of which, however, means that there was no logic to the boom in the
first place. Despite the booms and busts that accompanied the spreading of
the railways to the US in the 1830s to the 1870s, the idea that railways
would transform the new country was essentially right.

Similarly, we may not be living in the "new economy nirvana" that some
over-excited analysts predicted we would be 10 years ago, but the impact
of computers is everywhere. Financial innovation really should mean that
we can reduce risk via diversification in a way that had previously been
impossible. Risk, like matter, may not be created or destroyed by
mathematical formulae, but properly used, financial derivatives do offer a
means by which it can be more efficiently spread and hence contained.

Too much, however, was claimed of these new and poorly understood methods
of risk-spreading. They were poorly applied − at times fraudulently
so. By the summer of 2007, market pricing was suggesting that risk had
more or less been eliminated for ever. And regulators took the market's
word for it.

The current recession can only be made worse and more prolonged, though,
if in a fit of pique we undo the financial market reforms that triggered
the cycle in the first place. Put starkly, we need them to get us out of
this mess. The financial market reforms of the 1980s triggered a wave of
financial innovation, which led to a surge in banking stocks relative to
the rest of the market – a surge that reached its pinnacle in 2006. That
entire surge has now been reversed. The market's current valuation of the
banking sector suggests that the Big Bang was all for nothing.

The markets are pricing in a grim mixture of heavy regulation, state
ownership and 'back-to-basics' banking into the foreseeable future. If
that is accurate, the Luddites will have won. We will have thrown out the
baby of financial innovation with the bath water of excessive
compensation, weak governance and poor regulation. It would be the modern
equivalent of ripping up the railways back in the late 19th century.

Such a victory would come at a heavy price, reducing trend growth by at
least 0.1% to 0.2% per year. That impact would come through the
contraction of the financial services industry itself and through the
permanently higher interest rates we will have to live with if the
innovations of the last two decades are scrapped.

At a time when our governments have, on the behalf of generations to
follow, taken on massive contingent liabilities, the last thing we need is
a moribund financial sector unable or unwilling to shoulder that risk.

Danny Gabay and Erik Britton are directors of Fathom Financial Consulting

**********
Dit bericht is verzonden via de informele D66 discussielijst (D66 at nic.surfnet.nl).
Aanmelden: stuur een email naar LISTSERV at nic.surfnet.nl met in het tekstveld alleen: SUBSCRIBE D66 uwvoornaam uwachternaam
Afmelden: stuur een email naar LISTSERV at nic.surfnet.nl met in het tekstveld alleen: SIGNOFF D66
Het on-line archief is te vinden op: http://listserv.surfnet.nl/archives/d66.html
**********