The Banking Bubble Began in 1986, Was Like 'the South Sea Bubble' Says Bank of England Official

In retrospect it should become increasingly clear to most that the Federal Reserve and its associated money center banks were responsible for systematically undermining all regulatory restraint and sound judgement for the sake of their private profits, without regard to the resultant destruction visited upon the public and the larger global economy.

To suggest that the regulatory process should now be concentrated in the hands of the Federal Reserve, still opaque and arrogant, is disgraceful and disqualifies the public officials from service who promote such a travesty of common sense and prudence.

Guardian
Banking system like South Sea bubble, says senior Bank of England official
by Ashley Seager
1 July 2009 13.26 BST

'Banking became the goose laying the golden eggs. There is no period in recent UK financial history which bears comparison,' says executive director for financial stability, Andy Haldane

A senior Bank of England official today compared the banking system over the last 20 years to the South Sea bubble of the early 18th century and said bankers had merely "resorted to the roulette wheel" to keep up with each other.

The Bank's executive director for financial stability, Andy Haldane, said in a speech in Chicago that having been stable over much of the 20th century, returns in the banking system relative to the wider stockmarket shot up after 1986 until 2006.

"Banking became the goose laying the golden eggs. There is no period in recent UK financial history which bears comparison," he said.

He said bankers and policymakers became seduced by the excess returns available: "Banks appeared to have discovered a money machine, albeit one whose workings were sometimes impossible to understand.

"One of the South Sea stocks was memorably 'a company for carrying out an undertaking of great advantage, but nobody to know what it is'. Banking became the 21st-century equivalent."

He said banking returns over the period were magnified by leverage as banks borrowed excessively, he said.

During the golden era, competition simultaneously drove down returns on assets and drove up target returns on equity. Caught in this crossfire, higher leverage became banks' only means of keeping up with the Jones's. Management resorted to the roulette wheel."

He noted that the 80% slump in bank shares since the credit crunch hit meant that returns from the sector were now back in line with their longer-run average (see graphic above). The market capitalisation of global banks has fallen by $3tn (£1.8bn) since the crisis began, he said.

"We should aspire to a financial system where there is greater market and regulatory scrutiny of future such money machines. In achieving this, there is a role for some body – a systemic overseer – which is able to detect incipient bubbles and fads and, as importantly, act to correct them. This role is about removing the punchbowl from future financial sector parties." (We had a group that were responsible for doing this. They were called The Federal Reserve under Alan Greenspan. And Greenspan became the whoremaster of ceremonies for perversion of finance in the bubble economy. - Jesse)

He said that in future there would have to be a greater distinction between management skill, which improves return on assets, and luck, when return on equity can be magnified by leverage.

"Good luck and good management need to be better distinguished. Put differently, returns to investors and managers need to be more accurately risk-adjusted if the right balance between risk and return is to be struck for individual firms and for the financial system as a whole."

A second lesson, he added, was that there would have to be much stricter system-wide limits on leverage, particularly among big banks whose stability is crucial to the whole financial system. (Perhaps some prohibition of the types of activity that banks can engage in like Glass - Steagall? Oh yes, we had that as well and the banks repealed it with the help of the Federal Reserve. Perhaps we should have regulatory reform and place all the oversight responsibility with one group. Like the Federal Reserve? - Jesse)

"For a number of diseases, 20% of the population account for around 80% of the disease spread. The present financial epidemic has broadly mirrored those dynamics," he said, adding that the failure of a core set of large, interconnected institutions such as Fannie Mae, Freddie Mac, Bear Stearns, Lehman Brothers and AIG contributed disproportionately to the spread of financial panic. (In this case there are a few Typhoid Mary's with names like JP Morgan and Goldman Sachs and Morgan Stanley, and they are still hard at work - Jesse)

"Epidemiology provides a second key lesson for financial policymakers – the importance of targeted vaccination of these 'super-spreaders' of financial contagion. Historically, financial regulation has tended not to heed that message." (Vaccination is one approach. Wall Street and the City of London really need a dilation & curretage - Jesse)

He welcomed a recent move by US authorities to bring the trading of credit derivatives, which were at the heart of the crisis, on to exchanges so they could be better understood and controlled. "This is a bold measure and one which deserves international support."

Haldane's speech was part of a growing debate among global policymakers to try to build a better system of regulation and control of the financial system to prevent such crises as the current one from occurring again.