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Faustian pardon

23 October 2015 By Peter Thal Larsen

Scattered throughout Adair Turner’s “Between Debt and the Devil” is a little word that rarely features in most books about finance. The word is “we”. Its repeated appearance is a reminder that Turner is not just analysing the malaise of post-crisis economic policymaking: he is campaigning to upend the consensus.

In the opening chapters of this lucid and forcefully-argued book, “we” refers to the central bankers, regulators and other policymakers who battled to save the financial system. Turner joined that crew in September 2008, when he took over as chairman of Britain’s Financial Services Authority – a position he held until the Conservative government dismembered it in 2013.

This position gave him a crash-course in the failings of pre-crisis economic and financial policy, and a high-profile perch from which to join the subsequent debate about fixing the system. Yet this is no crisis memoir. Anyone seeking late-night anecdotes about the bailout of Royal Bank of Scotland will have to look elsewhere.

Instead, Turner summarises his voyage through the intellectual foundations of modern finance. The shibboleths of pre-crisis orthodoxy are comprehensively dispatched: unfettered markets are not necessarily more efficient; increased financial activity does not always lead to improved productivity; human beings acting in their own self-interest can produce catastrophic outcomes.

Seven years after the collapse of Lehman Brothers, none of this is controversial. Yet when looking at the responses to the crisis, Turner turns more radical.

The global economy is struggling with the burden of debt imposed by the crisis and subsequent economic slowdown. Policymakers face the challenge of sweating off the hangover while avoiding another crisis.

Turner’s diagnosis is that the remedies tried so far are ineffective. Near-zero interest rates and central bank bond-buying may have helped avert a deeper slump, but only at the expense of increased inequality and more risky lending. The overall debt burden is no smaller: borrowing has just shifted from the private to the public sector.

The improvements to the financial industry are equally feeble. Yes, banks and derivatives trading are safer. Yet Turner argues that the regulations have ignored the reality that unsustainable bubbles can be fuelled by healthy lenders. The tightly constrained banks which some reformers recommend, for example banks which can only invest in government bonds, would not solve the problem. Financial markets would still find ways to make too many risky loans.

Turner has an answer. Lending needs a guiding hand. “The amount of credit created and its allocation is too important to be left to bankers; nor can it be left to free markets in securitized credit.” He makes a compelling case for reining in real estate finance. In 2007, roughly 60 percent of bank lending in developed economies was secured against property; in 1970 the figure was 35 percent. Applying ever-expanding amounts of bank-financed credit to a finite amount of real estate seems certain to lead to larger and more dangerous speculative bubbles.

The notion of authorities deciding who is eligible for loans is not as radical as it may sound. Post-war Japan and Korea – and more recently China – channelled savings into cheap loans for manufacturing and infrastructure. Of course, this approach can store up big problems. However, it’s hard for Western policymakers to argue that their private markets for credit have produced better results.

Turner’s suggestion that monetary authorities boost demand by printing money is more controversial. For modern central bankers the notion that they should finance government spending is tantamount to heresy – the “Devil” of the book’s title.

The idea actually has a reasonably respectable intellectual pedigree: Milton Friedman talked about helicopters dropping freshly-printed bank notes, while Ben Bernanke once suggested that Japan try the modern equivalent to escape its economic slump. But real-life successes are harder to find than hyperinflationary disasters like Weimar Germany and Zimbabwe. Japan might be the next experiment. Its massive government debt is increasingly owed to its central bank and could effectively be cancelled at the stroke of a pen – the equivalent of printing money.

But who will determine how much money is printed, and where it is spent? There is no technocratic answer. Ultimately, governments will decide, and they might find the temptation to splurge irresistible – consider the British Labour Party’s recent suggestion for paying for infrastructure investment with bonds that the Bank of England would buy.

In the aftermath of the crisis, Turner said some parts of finance were not “socially useful”. The phrase crops up again in this book, where it raises a broader issue: if markets are not the arbiters of sound finance, then who is? This where Turner’s repeated use of “we” becomes fuzzy: it’s not clear whether he is appealing to fellow regulators, academic economists, politicians, or the man in the street.

Nevertheless, this book raises important questions, and Turner is not pretending he has all the answers. “We face a choice of imperfections,” he writes, “and some of the imperfections are unfixable.” That is something we can all agree on.




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