A few days ago, I wrote a post on the Bank of England’s Andrew Haldane confessing the central bank engaged in deception (some might say lied):
Had we been fully open and fully transparent about what was going on during the financial crisis, it would, let me tell you, have been a lot, lot worse. That would have been [like] shouting ‘fire’ in the theatre.
However bad it was, it would have caused an even greater haemorrhaging in confidence and even greater collateral damage for savers and borrowers. Sometimes, you have to be a bit selective. You have to be a bit secretive.
I was surprised by much of the feedback I received. As a columnist at a major international financial newspaper put it to me:
It’s obvious, though. That’s what has to happen in a crisis.
Let’s start with the simple fact there is nothing in the crisis response literature that suggests deception is a good way to end a financial crisis.
If you read Walter Bagehot, the father of modern central banking, he says the way to stop a panic is to lend freely at high rates of interest to solvent banks. He also says the public should be made aware the central bank made these loans.
Nowhere in his writing does he suggest lending at below market rates to insolvent banks and trying to deceive the market by claiming these opaque banks are solvent.
Deception also wasn’t used by the FDR Administration to end the banking panic during the Great Depression. At the end of the bank holiday, FDR had a fireside chat in which he said only banks that were viable would be allowed to reopen. This was a fact that was readily verified by depositors, because banks at that time had a history of providing transparency into their exposure details.
So why would central bankers suddenly start thinking deception was a good idea? Who could possibly benefit from this deception and was in a position to recommend deception be pursued?
In the Transparency Games prologue, I discuss how Ben Bernanke looked like a man in panic mode during his Congressional appearance seeking funding for TARP. It is only in panic mode that one forgets the four fundamental problems with deception and chooses to actively engage in deception.
Problem number one with deception: How does everyone know when you have stopped trying to deceive them?
According to Wikipedia, the US version of the crisis ended in June or July 2009. If deception during a crisis is acceptable, this should have been the end of the Fed’s engagement in deception.
Before he left the Fed, Ben Bernanke gave a 2013 speech in which he said the Fed still didn’t have all the data necessary to know if the Too Big to Fail banks actually passed the Fed’s stress test or not. Of course, not knowing if the banks had actually passed did not stop the Fed from saying the banks had passed.
So at least through 2013 we know by their own statements central banks were still actively engaged in deception.
Problem number two with deception: Who is involved in the deception?
Consider for a moment the Fed’s deception doesn’t work if the FDIC shows up each Friday to close another of the Too Big to Fail banks.
So deception wasn’t limited to just the central banks. All of the financial regulators had to be involved lest one of them inadvertently reveal the deception.
But the level of involvement in the deception couldn’t stop there. Consider for a moment what would have happened if the Department of Justice had actually pursued legal action against bankers who broke the law. This too could have revealed the deception.
So deception requires the consent of the politicians leading the country and enforcing its laws.
Problem number three with deception: Are you actually deceiving anyone other than yourself?
Mr. Haldane’s justification for engaging in deception comes down to the belief in markets that “you can’t handle the truth”. According to Mr. Haldane, had the markets been told the truth they would have react so negatively the damage caused by the crisis would have been significantly worse. (by the way, Mr. Haldane estimated the short-term global economic damage from the crisis with active central bank deception at $4 trillion and the permanent damage of the crisis between $60 and $200 trillion).
However, is there any reason to think the financial markets couldn’t handle the truth?
Is there any reason to think investors in 2008 couldn’t figure out how many opaque toxic securities had been sold?
Is there any reason to think investors in 2008 couldn’t figure out the banks had very large exposures to these securities and therefore were highly likely to be insolvent? Of course, not. The fact banks are black boxes meant investors didn’t have the specific exposure or the exact amount of insolvency at each bank. But that didn’t mean investors didn’t have a guess.
What Mr. Haldane would have you believe is investors guessing the worst about the banks were going to be shocked when they discovered the losses were even worse than this expectation.
Problem number four with deception: How do you ever regain the trust of or become credible again to the people you deceived?
To his credit, Mr. Haldane is aware central bankers may now be facing this problem on a permanent basis.
All experts were likely to get things wrong, and it’s not so much about whether you fail, because you will, as much as how you fail. An honest mistake is usually forgiven — not immediately, but eventually. A mistake that’s not admitted to, the public smell that really quickly, they don’t forgive that. And they’re right, actually, not to.”
So how do governments and financial regulators regain trust?
In the 1930s, it was well known the only way to do so was through transparency.
One reason for requiring the banks to provide transparency is it ends any temptation on the part of governments or the central bankers to deceive. There is no value in trying to deceive anyone when your deception is immediately exposed.
So how do central banks regain credibility?
This is actually part of the larger problem faced by all of Economics. The profession failed to see the crisis coming and marginalized those individuals in the profession who warned about it. The profession then chose lying about why it didn’t see the crisis coming and championing sunspots over admitting it doesn’t know why financial crises occur.
Until the profession is willing to admit its shortcomings, there is no reason to think it will ever be seen as credible.
This is not to say there won’t be politicians who are happy to champion any economic theory that supports what the politician wants to have happen. That will always occur. But that doesn’t make the economics profession credible.