Some interesting reflections from Gillian Tett in today’s UK Financial Times:
Eight decades ago, economist John Maynard Keynes reputedly remarked: “When the facts change, I change my mind; what do you do sir?” Investors might do well to consider that question as, looking back at the past five years, it is clear some of the “facts” of global finance have been overturned.
Unsurprisingly, that has produced some visible shifts in most investors’ views. Nobody assumes subprime mortgage bonds are safe, for example, or blithely trusts triple-A credit ratings. Nor do they presume that big banks cannot collapse, or that western central banks cannot keep rates at zero.
However, one prominent and senior western central banker recently embarked on a personal exercise to explore how his conventional wisdom, and that of colleagues, has shifted in the past decade. And while (sadly) his bank would not let me identify him, it is worth listing his reflections – if nothing else because it might inspire us all to pursue similar mental exercises this holiday season.
Bigger is not better
So what was on this central banker’s list? In no particular order, he identifies eight points.
First, bigger is no longer presumed to mean better. Before 2008, investors instinctively cooed with admiration when they saw gigantic banks (such as Citigroup) or countries with gung-ho banking systems (like Iceland). No longer; we now know that economies of scale are sometimes an illusion.
Second, finance is no longer viewed as self-stabilising. On the contrary, it often seems “self-destructing” instead, as this central banker says. Witness the fact that even Alan Greenspan, former Federal Reserve chairman and doyen of the “self-stabilising” school, today sounds alarmed about the behaviour of banks.
Third, we know taxpayers are on the hook when finance goes wrong; no one vaguely hopes that a magic fairy will wave problems away. Just look, for example, at how sovereign and bank credit ratings, or credit default swap prices, have become entwined since 2008.
Fourth, leverage matters. Before 2008, this issue seemed irrelevant – or quaint; so much so, that when some European securitisation bankers created an amateur rock band in early 2007, they called themselves “Da Leverage”, as a joke. Today, though, nobody dares laugh about that “l” word.
Fifth, liquidity matters too. Before 2008, worrying about this second “l” word also seemed quaint; after all, financial innovation seemed to have “liquefied” most asset classes. Today everyone knows liquidity can vanish, usually when most needed.
Role of government
Six, bubbles do not just exist in baths. Before 2008, policy makers liked to think they could mop up after excesses, if necessary, rather than intervene in advance. No longer.
Seven, structural solutions are not taboo. Before 2008, it was almost outlandish to suggest policy makers might deliberately shape the direction of finance, with policy interventions. Today, even rightwing voices think it makes sense to restrict the size and behaviour of banks, and leftwing voices want to control far more.
Eight, shadows should not stay shadowy. Previously, the non-banking financial sector was generally ignored. Today policy makers and investors alike want to shine a spotlight on shadow banks – and governments (belatedly) want to create some controls.
Some readers probably have their own list of ideas. And I think perhaps one of the biggest and most important cultural shifts (which links many of the previous eight points) concerns the role of government.
Before 2008, investors often assumed that economies and markets were driven by apolitical and asocial forces. Today, however, nobody believes economics is just about hard numbers; on the contrary, “soft” political and social factors – not to mention the actions of central bankers – shape almost every asset class.
But irrespective of whether you approve or disapprove of these shifts (or have your own supplementary points), the crucial issue is this: our assumptions can stealthily change, often in ways we barely notice. Which is why, of course, we periodically need to ponder our ideas, and then ask ourselves another crucial question: could this conventional wisdom shift again, in the next five years? And if so how will this affect asset prices, or the policy debate?
Happy pondering, this holiday season.