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Wednesday, June 28, 2017

No Banking Run In Our Lifetimes...

Fed Chair Janet Yellen was quoted by Reuters as believing that there would not be another financial crisis (presumably similar to the one in 2008) in "our lifetimes." Steve Keen was harsh, arguing that this is symptomatic of mainstream complacency about the financial system. I am not completely sure on the context of the comment, but it appears to me that it illustrates the ancient philosophical principle: you ask a stupid question, you get a stupid answer.

(I just got back from camping in upstate New York, and I am catching up on things. This short comment is a bit of a placeholder; I hope to finish a book review shortly.)

On the chance the reader has not seen the quote already, this is what Reuters quoted Yellen as saying (at an event in London):
Would I say there will never, ever be another financial crisis? You know probably that would be going too far but I do think we're much safer and I hope that it will not be in our lifetimes and I don't believe it will be
Firstly, it is entirely possible that she mangled her message during the verbal comments. Secondly, we have to remember that Janet Yellen is not just a mainstream academic economist; she is also head of one of the main banking system regulators in the United States. Asking her when she expects her regulatory regime to completely and utterly fail is going to get the similar polite response a Food and Drug Administration head would give when asked when would be the next mass loss of life due to failed FDA inspections.

The belief that there will not be a financial crisis of some sort in the coming years is too optimistic, from my Misky-ite perch. Business cycles over recent decades have not been terminated by workers deciding to take vacations at the same time (or whatever DSGE macro people believe now); they have all been ended by a financial crisis. The expansion is fueled by stupid borrowing within one or more sectors; growth is terminated when the lenders start to worry about the return of capital.

That said, there is no reason to believe that the crisis has to hit the core of the banking system (which I believe what Janet Yellen was referring to). In recent decades, the stupid lending tends to happen in non-bank finance, or the "shadow banking" sector. Non-bank finance follows the precepts of academic financial theory, and tends to blow itself up real good.

It took a lot of effort across the entire financial system and regulators to allow the shadow banking system nearly take out the regulated banking system. As long as the regulators are not completely asleep, damage could be largely contained to the securities markets (as seen in the 1998 and 2001 crises). The obvious exception to keep in mind is the potential demise of the euro; a reversion to the national currency in a large country would create a massive balance sheet mismatch on multiple banks, and the contagion could be quite impressive. However, more pedestrian problems -- like the implosion of the Canadian and Australian housing bubbles -- should not pose a serious risk to the American banking system. In any event, the bankers would put away their free market hymn sheets, and come running for another bailout.

Given the rather tepid nature of fixed investment this cycle, it is unclear that there are particularly large excesses being built up in the financial system. Whether or not VIX is mispriced (one of the current worries of the perma-bears) is not an issue that poses risks to the banking system.

In other words, this is just another bit of silly summer financial/economic news.

(c) Brian Romanchuk 2017


  1. I remember Senator Charles Schumer being criticized in the media after his comments on the potential risks of a particular bank could be interpreted as having accelerated or even caused its failure.

    1. Yes, that's the issue. Any realistic answer would get Yellen in trouble.

  2. I had prepared a very insightful comment but then clicked on the show with John Candy and forgot it. It was probably very important but now we will never know. I guess it got "blowed up" in my brain.

    Oh well. Imagine the chaos if Yellen had said something like stability is destabilizing. It might have been a nightmare.

    1. Classic SCTV sketch. I have been watching the DVD's ("SCTV Network 90", volume 1, which is the first run of 90 minute sketches on NBC), and had to work it in. There might be more references to the Great White North coming as well, due to Poloz's new hawkishness. (He's hosing the housing market, eh?)

      If Yellen said that stability was stabilizing, it would have been ugly...


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