Central bankers aren’t gods, even if a few of them sometimes think otherwise. For proof of their mortal status one need only survey the various errors linked to this group in the 21st century. Yes, many central bankers made good, even superb decisions. But there were also some rather large lapses in judgment in matters of monetary policy and related matters in recent years. Arguably the ill-advised decisions overwhelmed the brilliant ones. A number of central bankers tell us so.
Of course, the private sector made more than a few errors too. In sum, the blame for the current troubles stretches far and wide. But when it comes to concentrated power, and the capacity for generating pain or pleasure, central bankers are second to none. They’re an influential lot—influential on a grand scale. For that reason alone, listening to what they say is productive, or shocking—especially when they’re deconstructing what went wrong in the run-up to the crisis now pummeling the global economy.
With that in mind, here are a few choice quotes (courtesy of The Bank for International Settlements) from recent speeches by members of world’s most elite and potent financial club. We don’t necessarily agree with all that follows, although much of what follows certainly rings true. In any case, we’re listening closely.
Mario Draghi, governor, Bank of Italy, 16 December 2008
One striking aspect of the crisis is precisely how its unfolding has continued to catch both policy makers and private sector players by surprise. It started with defaults in a marginal segment of the financial services industry, then quickly spread to virtually all assets. From being a US-only event, it has become global, and in fact it is forcing and accelerating the redressing of world macro imbalances that have been with us for 15 years. The current recession is the result.
Amando M Tetangco, Jr., governor, Central Bank of the Philippines, 2 February 2009
The roots of the US financial crisis can be traced back to the early years of this decade when the United States aggressively eased its monetary policy to facilitate recovery from the dotcom bubble and the September 11 terrorist attacks. If you will recall, the US Federal Reserve began a cycle of cuts in the Fed funds target rate from 6.5 percent in May 2000 to as low as one percent by June 2003. On the fiscal front, large public deficit spending beginning in 2001 was pursued to prop up the economy which was then on the brink of recession. The low interest rate regime fueled a boom in mortgages, including among borrowers with doubtful credit histories or those fancifully called NINJA loans – that is, loans to No Income, No Job or Assets loans. Thus, house prices in the US began rising in 2000, surpassing the growth of disposable income. The excessive lending itself would not have brought in such great financial distress because if the borrowers turned out to be poor borrowers, then foreclosures would just have followed. However, what made this risky behavior turn into a crisis event was the bundling of mortgages by various financial institutions into complex securities such as collateralized debt obligations (CDOs) which were largely unregulated.
Hervé Hannoun, acting general, manager, Bank for International Settlements, 7 February 2009
The global financial crisis and its macroeconomic fallout have dramatically changed the agenda of the central banks, fiscal authorities and supervisors and regulators. The change is illustrated by a remark surfacing repeatedly in the current economic debate: “We are all Keynesians now.” In some sense, indeed we are. But history teaches us that, in designing economic policies, policymakers always need to look beyond the short time horizon that crises seem to impose on us. In my view, current expansionary policy responses risk a failure to capture two crucial and interrelated facets of the present crisis. The first is that it is part of an underlying adjustment towards more sustainable macroeconomic conditions. The second is that it is a crisis of confidence which requires a recognition of the rational expectations of economic agents and of the behavioral effects associated with expansionary fiscal policies. To restore confidence in a sustainable way, policy actions should be credible from a medium-term perspective, address existing economic imbalances and pay attention to economic agents’ expectations.
José Manuel González-Páramo, member, executive board,
European Central Bank, 6 February 2009
The start of the financial crisis was triggered in the summer of 2007 by the realisation that the risks associated with the US market for sub-prime mortgages were not properly reflected in the price of related instruments, particularly mortgage-backed securities. A market-wide reassessment of financial risk led to sharp increases in premia and spreads across all segments of the credit market. The rapidly falling market values of credit instruments hit both the net worth and the profitability of the banking system.
Philipp Hildebrand, vice-chairman, governing board, Swiss National Bank, 5 February 2009
Financial markets react to incentives, and these incentives were misplaced in the past. It is in our power to start lobbying for clearly defined and risk-limiting conditions. If the responsible authorities wish to enact more stringent regulation, we ought to give them our unconditional support.
Christian Noyer, governor, Bank of France, 11 December 2008
In many respects, the current crisis is about valuation. To be sure, the factors underlying and accounting for the crisis are numerous. However, one of its significant features is that the uncertainty surrounding the “true” value of complex financial instruments has undermined the confidence of global markets, increased uncertainty about counterparty risk and led to contagion across asset classes, financial markets and economic regions. The crisis has highlighted the fact that the valuation of financial instruments is not only a question of accounting. It raises issues about risk measurement and management by financial institutions, prudential issues via the definition of capital requirements and, more widely, financial stability issues. However, valuation is also without any doubt an accounting issue. It is therefore hardly surprising that the debate about the application of accounting standards to financial instruments is a highly topical one.
Jürgen Stark, member, executive board, European Central Bank, 10 December 2008
For too many years financial market participants were used to a macroeconomic environment with high global output growth, low inflation and very low interest rates. Macroeconomic policies led to global and domestic imbalances which became increasingly unsustainable with debt financed over-consumption in one region and high savings in other regions. An overall benign macroeconomic environment led to (i) a general carelessness or a tendency to under-price risks and (ii) to a search for yield which in turn accelerated financial innovation.
Lorenzo Bini Smaghi, member, executive board, European Central Bank, 9 December 2008
When analysing the current financial crisis the temptation might arise to attribute all the responsibilities to the excesses of the US financial system. I think this would be a mistake. While excessive debt creation and risk mispricing are clearly the root cause of the crisis, we should not forget that in order to make a market you need buyers and sellers. And this crisis is as much a crisis of sellers as of buyers.