As we near the tenth anniversary of the start of the Great Financial Crisis, it is worth taking a brief moment to review two of the main lessons we have learned over the last ten years.
First, we have rediscovered opacity is a banker’s best friend. Bankers like opacity as it allows them to hide when they are rigging the financial markets (see: Libor, FX).
Bankers also like opacity as it makes it impossible for investors to assess the risk or return of a security. This makes it easier to phish for fools as the inability to assess the security makes the gamblers who buy or sell these securities even more dependent on the stories bankers tell about the securities. After all, there is no way to confirm if the story is true or false. Of course, when gamblers finally discover the story is false, the market for these securities freezes. But that doesn’t bother the bankers as they have already separated the gambler for a large chunk of their equity.
Second, we have learned Economists assume the securities that are traded on the global financial markets are transparent. At the off chance this isn’t true, Economists even came up with the Efficient Market Hypothesis as a theory for how prices can reflect all the knowable information even when this information isn’t disclosed. It is a beautiful theory except for one small problem. It doesn’t work, particularly for structured finance securities or banks: the design of the former means no one has an incentive to ensure the price for the security reflects its actual value; the latter because bankers like their job.
This assumption about transparency is important because it underlies the recommendations Economists make and policies Economists adopt for how to respond to a financial crisis. If the most important assumption being made isn’t true (see opacity above), there is no reason to think the response will actually work.
Which lead us to the question of who is worse for the economy: Bankers or Economists?
The last decade has shown us both are capable of inflicting immense damage.
The bankers did this through the creation of billions of dollars of debt the borrower would never be able to repay.
The Economists did this by recommending/adopting policies to foam the runway so banks could realize the losses on this excess debt over a long period of time. In doing so, they create zombie borrowers who are swallowing economic growth. The cost of these policies is an order of magnitude bigger than the losses on the excess debt would have been if they were recognized at the onset of the financial crisis. In fact, the cost of the Economists’ policies is still mounting and can be seen in the rise of populism.