Anunderstanding grew that profitable andwell-capitalised commercial banks shouldbe able to borrow cash from the centralbank if they had trouble maintaininga positive cash reserve balance. ukassociated arrangements were technical andcomplex, and were of no interest whateverto politicians and journalists.
Fashionableeconomic commentators regarded them,or rather ignored them, as the municipaldrainage of the financial system.Meanwhile the long period of peacebetween the world’s leading nations encouragedlending between banks in differentcountries to an astonishing extent, so thatby early 2007 the value of the internationalinter-bank market was on some measuresover $40,000 billion or almost two-thirdsof global output. In the middle of 2007 thismarket suddenly closed. Banks that hadbeen relying on it to finance their assetgrowth found, in many cases, that they wereactually or potentially short of cash. Evenif their assets were good, their capital wasample and they had complied with regulations,they had a cash problem. Of course,if their assets were partly of low-quality(or ‘toxic’, in the argot) and their capitalstretched, the cash problem was severe.But even in the exuberance of 2006 andearly 2007 all banks – including thosetaking the greatest risks – had to complywith regulations, not least because only bysuch compliance could they qualify for centralbank cash loans or equivalent supportmeasures.
When the international interbankmarket closed on 9 August 2007, skilfulmanagement of the emerging crisisand responsible commentary on its mainfeatures were essential to avoid a macroeconomiccalamity. Instead the management(by central bankers, regulators andso on, as well as the commercial bankers)has been low-grade and often chaotic, whilethe commentariat has indulged in spitefulbanker-bashing. The result has been a disaster,with tens of millions of jobs destroyedand avoidable output losses running intotrillions of dollars.As the crisis was breaking, particu larly valuablewould have been quality advice fromleading economists. High hopes might havebeen held, for example, of a worthwhile contributionfrom Joseph Stiglitz, who sharedthe 2001 Nobel economics prize, mostly forhis work on so-called ‘information asymmetries’in the financial system.
Instead,Stiglitz has been a prominent and articulatebanker-basher. Freefall is the fourth of aseries of popular books from Stiglitz whichstarted in 2002 with Globalization and itsDiscontents. It is also the worst.A clear differentiation between grants(sums given outright, with no expectation ofreturn), loans (sums extended for a periodand due to be repaid with interest) and injectionsof ‘equity’ or ‘capital’ (sums invested,to collect the residual amounts after meetingother claims) is basic to any meaningfuldiscussion of financial questions. Further, avery creditworthy agent – such as the stateitself – may guarantee the payment of sumsby other agents, usually for a fee. Accordingto common usage, a business that receivesa loan, a guarantee on its liabilities and/ora capital injection has not been given anything.It must repay the loan, honour theguarantee and do its best to ensure a positivereturn to shareholders.
Nowhere in the present crisis has the government’given’ money, in the sense of makingan outright grant, to the banks. Instead,central banks have made loans, in accordancewith understandings reached beforethe crisis, and governments have guaranteedliabilities and made capital injections.But in Freefall Stiglitz – along with dozensof other Left.leaning intellectual glitterati- repeatedly asserts that the American andEuropean governments have ‘given’ moneyto the banks, and that the state must nowseek a re turn over and above what they aresupposed to have ‘given’.Hence the argument for the bankers’bonus tax, the British government’s assortedlevies on UK banks (including those ithas appropriated from shareholders), evermore stringent regulations and so on.
Thesemeasures are of course hurting and shrinkingthe banks, but – because banks have tocut their loans and deposits (i.e., the quantityof money) – they are also hurting andshrinking the wider economy.The correct answer to the crisis waseither for central banks to clarify that,with full government support, they wouldlend without limit to solvent banks (andcharge a high interest rate) or for governmentto extend a blanket guarantee on theliabilities of any bank asking for one (anddemand an expensive guarantee fee). Theinter-bank market could then have reopened.That would have stopped thetens of millions of job losses and trillionsof output foregone. Tidying up the financialsystem thereafter might have takenfive to ten years, but the macroeconomicdisaster of 2009 could have been avoided.In only one advanced country, Australia,did officialdom see clearly what had to bedone when it introduced a general depositguarantee in October 2008.
Uniquely ithas not had a recession.Stiglitz’s tirade in Free/all symptomisesthe Left-wing’s intellectual bankruptcy inresponding to the crisis. Hayek, who wonthe Nobel in 1974, warned that future laureatesought to take ‘an oath of humilitynever to exceed in public pronouncementsthe limits of their competence’. Some membersof the Nobel family are reported to feelso let down by the economics prize that theywant their name dissociated from it. Thereis nothing wrong with Nobel prize-winnerswriting books for a lay audience, but – preciselybecause they are Nobel prize-winners- they should make every effort to ensurethat their popular writing is accurate,responsible and even-handed.