shaping the new financial architecture…

Why do we trust the financial priests?

Posted in TBTF by Kitty on January 10, 2010

*Source:   Why do we trust the financial priests? BBC, Robert Peston, Saturday, 9 January 2010

“The Icelanders have risen up and humiliated their political class over its handling of the financial crisis, as I mentioned on Thursday.

But there’s nothing terribly unusual about their sense of powerlessness and alienation from the writing of the rules of the banking and finance game.

When it comes to how banks are allowed to behave, sovereignty over decision-making rarely rests with citizens.

Did anyone actually ask us whether we wanted our banks rescued to the tune of £1.2 trillion during and after the crisis of 2008?

If they had, we might have said no.

So perhaps it’s a good thing that politicians and central bankers simply did what they thought was best for us, without consulting – because if the banks had gone down, the contraction in our economy would have been far far worse than it turned out to be. Better to leave it to the experts, eh?

But hang on a tick: who actually got us into this mess in the first place?

It wasn’t the fault of ordinary citizens like you and me.

It was those self-proclaimed experts who allowed our banks to become too huge, too complicated, too addicted to taking crazy risks, and too poorly endowed with life-preserving capital.

(more…)

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They can encourage concentration of market positions in the financial scene.

Posted in TBTF by Kitty on December 13, 2009

From Systemic Risk the Clare Distinguished Lecture in Economics and Public Policy by Jean-Claude Trichet, President of the ECB organised by the Clare College, University of Cambridge, Cambridge, 10 December 2009

~~~ ” … However, macroeconomic stability has not been a sufficient condition for financial stability. It cannot eliminated systemic risk altogether. Macroeconomic authorities have therefore been frequently called on to provide remedial action, once booms have turned into busts. The aim of their action has been precisely to avoid the transformation of individual financial risks into systemic risk.

Ex post remedial action has often been activated as soon as the financial firestorm has threatened the stability of the economic system. But such action risks raising expectations that macroeconomic policy will always insure against tail risks, no matter how large. Expectations of this sort can contribute to an under-pricing of financial risk in subsequent phases of the financial cycles. They can encourage concentration of market positions in the financial scene.

At the same time, the instruments of counter-cyclical policy have been used so intensely – and more so from one financial cycle to the next – that authorities might have tested the extremes of their control procedures. I am borrowing here from dynamic control theory. Repeated attempts to fine tune a mechanical or electronic system after a shock sometimes leads to “instrument instability” that makes the system spiral out of manageable bounds. [21] Economic and financial systems, I suspect could have some structural similarities with physical systems, leading to the same kind of “instrument instability”.

Moral hazard and policy instrument instability pose questions to which we are not in a position to a firm answer at this point in time. I would like to see these questions studied and debated in eminent academic institutions like this….”