CENTRAL BANKER: Global Investors Are A Fire Hazard

Getty/Carsten Koall

Andrew Haldane, the Bank of England’s chief economist, is arguably the world’s foremost authority on financial risk and certainly the central banking world’s most vocal critic of modern finance and financial markets.

In April 2009, just a month after the bottom in the post Lehman Brothers collapse in global stocks, Haldane delivered what he clearly hoped would be a landscape changing speech, Rethinking the Financial Network, where he likened the collapse of Lehman to the outbreak of SARS in 2002.

Haldane said that global finance needed to be considered as a complex adaptive system with all the interconnectedness that entailed. His prescription for improving stability was to increase data and communications, improve the regulatory framework and restructure the network “so as to reduce the chances of future systemic collapse”.

It is the exact blue print that the BIS globally and APRA here in Australia have followed to try to improve systemic strength and stability.

Overnight Haldane delivered an update on his thesis to an audience in Birmingham with a speech titledManaging global finance as a system. Haldane discussed the new orthodoxy – which he spawned – saying that it has:

framed the post-crisis regulatory reform agenda. It is why so-called macro-prudential policy has risen in prominence. It is why the world’s most inter-connected banks will in future be required to run with extra capital and liquidity. It is why OTC derivatives will in future be centrally traded and cleared. And it is why resolution of the world’s largest, cross-border banks has become such a priority. For the global banking system we now have a blueprint, an emerging new set of international rules of the road.

But looking at finance as a system still leaves Haldane with deep concerns because of the behaviour of investors who all tend to act as one. He likened investor behaviour to an incendiary device, throwing fuel on the fire in times of trouble.

Within limits, connectivity acts as a shock-absorber. Links in the system act as a mutual insurance device, helping distribute and disperse risk. These systems are then “robust” to shocks. But when shocks are sufficiently large, connectivity may instead serve as a shock-transmitter. Risk-sharing becomes risk-spreading. Links in the system act as a mutual incendiary device, amplifying risk. These systems are then also “fragile”…

But for a large-enough shock to financial strength, the system fundamentally changes shape. The network flips to a zone of systemic instability. That is because it is now operating as a shock-transmitter, a network incendiary device – and the greater the degree of integration, the sharper this knife-edge. So it was during the crisis.

Haldane warns that the “financial system has undergone a mini-revolution in the space of a generation as a result of financial globalisation. It has become a genuine system. This has altered fundamentally the risk-return opportunity set facing international policymakers: larger-than-ever opportunities, but also greater-than-ever threats. “

His prescription five-and-a-half years after his posy-Lehman blueprint to fix global finance
continues to be to advocate for more regulatory power, better monitoring and management of the players in global finance and the strengthening of the official sector’s ability to impose itself when necessary on the players in global finance.

Just like in 2009, here in Australia APRA – and most likely the Murray Inquiry – will be listening and even though some senior Australian bankers think that Murray has been too focussed on stability it’s clear that Haldane, Murray, APRA and the RBA still see banking as a clear and present danger to global economic health.

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