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William White: Getting Tough on Banks May Not Hurt Economy

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Once a Cassandra, always a Cassandra? That seems to be William White’s fate.

White, the former chief economist of the Bank of International Settlements, is best known for his warnings in 2003 that many advanced economies were in the grip of housing bubbles, which Greenspan pointedly ignored. Although he is now celebrated for that call, his latest, admittedly less dramatic, observations again seem to be falling on deaf ears.

White’s presentation at the Jackson Hole conference (hat tip Richard Alford) has gotten little attention, and that’s a pity, because it contains some useful observations. It focuses on an analysis by Carmen and Vincent Reinhart of economic performance in the wake of severe financial crises. One of White’s astute comments is that weak credit growth may not be due as much to bank reluctance to lend as overextended borrowers getting religion and paying down debt. If lack of loan demand is indeed the main culprit, it says that regulators need not fear imposing tougher bank regulations:

Is the problem of credit de leveraging and increased private sector saving due primarily to a wounded financial system, and a decreased supply of loans, or is it primarily due to decreased demand for credit. This is a crucially important issue for policy. First, if the real problem is a decreased demand for loans, then restoring the financial system to good health will not be sufficient to get the economy expanding again. Second, it also implies that quickly tightening regulation and capital requirements will not hurt the economy as much as might otherwise have been expected….

A hunkering down by debtors, rather than credit restrictions by banks, also seems to me to be consistent with some of the evidence in Reinhart and Rogoff (2009). They note12 that a more normal ordering of events was for the recession to begin first, only followed by financial crises later, as household and corporate bankruptcies began to rise. Finally, as a Canadian, I was also struck by the evidence in Reinhart and Rogoff (2009) that Canada, Mexico and Indonesia suffered greatly during the Great Depression, even though their banking systems remained in quite robust health.

A less polite way to say this is putting the banks at the top of the priority list might not have been the best decision.

Second is his reading of the paper’s methodology, which he believes is likely to wind up overstating how this crisis will work itself out. And note the Reinharts’ forecast is far from cheery:

As to some of the more detailed results from the Reinharts’ paper, per capita growth rates are “significantlyʺ lower in the decade after the crisis than the decade before. Moreover, unemployment rises sharply, and generally does not fall to pre crisis levels even ten years afterwards. House prices also fall sharply (in 10 of the 15 Advanced Market Economies where data is available) and ninety percent of all the observations for house prices in the following ten years remain below pre crisis levels. Finally, the Reinharts underline that financial deleveraging (proxied by debt/GDP) is still going on 10 years after the crisis began. And to these observations we can add some ancillary points from the work of the IMF and the OECD. They note that household saving rates also rise very sharply in recessions following financial crises, while private investment also falls dramatically.

White finds multiple reasons to think recovery will trail these norms. Not surprisingly, the amplitude of the unwind tends to be proportional to how big the bubble was, and this last one was pretty large. Second, excessive concern with sovereign debt levels could make matters worse (and note White buys the idea that higher sovereign debt levels can slow growth):

These last points raise the obvious question of what else adjusts to satisfy the identity for saving and investment in the National Income Accounts [what has to adjust to accommodate the increase in household and business savings]. The answer given by the IMF is that the identity is typically closed by very significant increases in government deficits 9as well as major increases in exports. Of course the obvious corollary to these latter two points is less comforting in current circumstances. If government deficits are not allowed to rise, say because debt levels are already judged to be dangerously high, and if exports cannot go up because the downturn is occurring simultaneously across a number of countries, then the resulting recession could be significantly more serious than was typical after past financial crises.

White also does not subscribe to the “better policy responses mean recovery is just around the corner” thesis:

….one crucial fact that emerges from the Reinharts’ work, and that of others. It is that the deep slumps after financial crises all look very much the same. Are we to believe that there was policy error [after the crisis] in every case?

Finally, White contends that more should be done to restructure borrowers’ debts:

….we need to put more effort into debt restructuring, recognizing that half a loaf is always better than no loaf. This applies to household debt, corporate debt and the debt of financial institutions.

White is apparently quite busy in his supposed retirement. but his sensible remarks don’t seen to get much coverage in the US. probably because he’s shown himself not to be terribly taken with received wisdom.

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9 comments

  1. Sauron

    “One of White’s astute comments is that weak credit growth may not be due as much to bank reluctance to lend as overextended borrowers getting religion and paying down debt.”

    That comments like this are regarded as “astute” and not generally accepted no-brainers drains any optimism I feel about the future.

    The elites and their megaphonic minions deliberately, continually, cynically, and successfully get things bassackwards as a manner of policy. Trickle down economics, the idea that there are no jobs because “the economy” is bad and if we fix “the economy” then the jobs will return rather than the reverse. This is just the latest, financial version, of trickle down economics–if only the creditor class had more money, the debtors would be ok. Sigh.

    1. Sauron

      Oh, I just wanted to add that now we are reaping the whirlwind of a generational commitment to supply side economics. We have all been running harder to maintain our increasingly tenuous middle-class lifestyle.

      The disaster of supply side economics for the middle-class has been masked by the growth of the dual income caused by women entering the workforce, the growth of credit and debt, and lastly, the slow, fitful return of the extended family living under one roof (generally 20-somethings). Now we have run out of masks and our expectations (as evinced by reduced spending)are being down-graded.

      Next up: the intensification of the extended family trend, the end of retirement, and possibly even an “end to childhood”; a return to child labour as the crushed middle class falls from being the “rich poor” (i.e. those who still have the option to downgrade their spending and survive) to the simply poor that live hand-to-mouth.

    2. Stelios Theoharidis

      Although I think that this has been discussed before, it should probably be set as a disclaimer every time we discuss consumer debt deleveraging.

      If we broke the debt deleveraging of say the US population down into quintiles I suspect that it would be considerably skewed with most of the deleveraging going on at the top of the heap. I don’t presently have any evidence to back this claim up, but we do know that job losses and unemployment are skewed towards the bottom four quintiles. They have considerably less resources to deleverage with as well as little or no wage growth over the past 20 years.

      If that is the case and a significant portion of the population is only servicing their debt payments or defaulting rather than deleveraging it is unlikely that any desire for debt will resume amongst the general population and mostly deleveraging will occur in the top quintile.

      Furthermore due to the veritable dirth of returns that most people will have on investments amongst the wage group within the top 20% say 80%-95%. Since they lack of access to the high return investments that come to high net worth individuals. That group is likely to chose paying off high interest credit cards and other debts as an alternative to making investments.

      For those that can although most cannot, the incentive appears to be in deleveraging.

  2. Debra

    William White sounds like a wise.. RATIONAL man in this crisis…
    IF we were interested in dealing with this crisis in a RATIONAL way we would listen to him…
    BUT…

  3. Hugh

    The problem with bank regulation/reform remains the same as it ever was. It would expose the banks’ real insolvency. Whether A is not lending or B is not borrowing is irrelevant to this.

    1. Glen

      Yves, excellent post, and Hugh, could not agree more.

      I have NEVER understood the basis of the incredible threat made by Secretary Paulson concerning the dire need to bail out the the banks:

      http://www.independent.co.uk/news/business/news/paulson-reveals-us-concerns-of-breakdown-in-law-and-order-1750076.html

      But it would seem to me, that if our country is willing to start two wars to track down a a non-existential threat to our country, a terrorist that lives in a cave, then a threat which would lead to martial law (a real existential threat to our country) would demand more action than just wholesale bailout with taxpayer dollars and a weak FinReg bill.

      The only responsible thing to do is break up the TBTF banks, creating a functioning financial system where the failure of a couple of the largest banks does not jeopardize the entire system.

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