Thursday, 31 March 2011

The financial sector is sitting on an unjustified pedestal

Forget his debatable feats as chairman of the Federal Reserve, Alan Greenspan's article in the Financial Times on Wednesday raised an insightful question that I wish was being addressed too: To what extent does a large and 'sophisticated' financial sector improve our quality of life?

Greenspan's comment piece points to problems implementing the Dodd-Frank Act, a broad set of principles designed to stop the excesses that caused the financial crisis from happening again in the USA. He argues that the lawmakers and regulators tasked with turning the principles into a set of regulations, will 1) be unable to produce a list of regulations that could deal with all possible future crises (several regulatory bodies failed to foresee the 2008 crisis!), 2) create inconsistencies among the numerous rules, and 3) fail to acknowledge the degree of global interconnectedness in the financial sector.  

Dodd-Frank has its flaws, but complicated regulation, admittedly with holes in, is the cost of complex modern day financing, which we need to maintain economic growth. Right? 

The assumption that the modern state of finance is necessary for economic growth has pervaded the air. Since the second world war, the share of GDP devoted to finance in countries like the UK (one measure of the rising complexity of the system) has increased alongside a rise in living standards, but it is not obvious that there has been a causal relationship. A complex financial sector might increase the wealth of a minority with the know how, and there are reasons to think that their disproportionate wealth could reach others through some sort of trickle down effect, but is that enough when, as we well know, the financial sector can create such instability and crisis for us all?! 

Ireland has had to put aside about €70bn to bail out its banks, an amount equal to over half its GDP! Ireland has borrowed this money from its own people, who will also be paying for the servicing of the debt for many years to come. To put it into perspective, consider that Ireland is borrowing the equivalent of €35,000 per citizen, which is equal to the average annual wage before tax! 

Banking crises won't go away, but regulation and reforms can be put in place to reduce risk and contain the cost of crises when they occur. In deciding the best steps forward, we seem to be faced with a tradeoff between reduced risk and economic growth i.e. reforms that significantly reduce risk, such as a return to the simpler banking practises of half a century ago, will sabotage economic growth. 

I think the modern financial sector is sitting on an unjustified pedestal. The UK government, and policy makers worldwide, need to consider the long term and take heed of Greenspan's comment that: "In moving forward with regulatory repair, we may have to address the as yet unproved tie between the degree of financial complexity and higher standards of living."  

Sunday, 27 March 2011

The Alternative Vote #2: How does it work?

If you've voted before, the you'll know that under the present First-past-the-post system you can select one candidate from the ballot paper to represent your constituency. The number of votes for each candidate are counted, and the winner is the candidate with the most votes. Note that this means that a candidate can be elected irrespective of whether he/she has the majority of the support. 

Under AV, you're asked to rank the candidates in order, where 1 is highest. (In the proposed UK system, you don't have to rank every candidate.) The first step in determining a winner from everyone's rankings is to count all of the first preferences for each candidate. If one candidate has more than half of the first preferences, then he/she is elected. If no candidate has a simple majority, however, then the candidate with the least first preference votes is eliminated. The preferences of those voters who most preferred the eliminated candidate are not discarded though; their second preferences are taken into account, and are distributed to the remaining candidates. This procedure continues, with progressive elimination of the candidate with least support until a candidate obtains at least 50% of the votes.

I've made an example to reinforce the idea ...

First-past-the-post ballot paper

Alternative Vote ballot paper

An example

There are 4 candidates: A, B, C, D and 100 voters. 
The voters make their ranking and the ballot papers are collected. What happens next?

1) The first preferences for each candidate are counted and the results are A: 40  B: 30  C: 20  D:10.
Since no candidate has a majority, the candidate with the least first preferences, D, is eliminated. The votes of people for whom D was favourite are not eliminated though; their vote is re-allocated to the remaining candidate that they ranked 2nd favourite. 

2.) After the redistribution of D's votes, the results are A: 42   B: 35   C: 23.
Still, no candidate has more than 50% of the votes. C is eliminated, and the second preferences of those who most preferred C are distributed to A and B. If ones of these voters placed D in second place, then their third ranking is considered. 

3) After the redistribution of C's votes, the results are  A: 46   B: 54.
B has the majority of votes and is the winning candidate.

Note that B has won despite being fewer peoples first choice. AV works to identify the candidate that most electors would like as their representative if they cannot have their first choice because he/she doesn't have a majority support.


Saturday, 26 March 2011

The Taxman is a Woman!

Last night at dinner I sat opposite Dame Lesley Strathie, chief executive of HMRC (revenues and customs). She was visiting Nuffield College to participate in a conference held in honour of International Women's day, which celebrated its centenary on March 8th. As well as debunking the myth that the taxman is a man, the day's presentations and discussions explored the role and position of women today in the context of the criminal justice system, the economy and politics.  

I wanted to share some of the topics that were raised...

Spot the red top and find the taxwoman!

Women continue to be under-represented in our political system, which is supposed to represent the UK democratically. Just 21% of members of parliament are female. The situation is similar in the private sector: 12.5% of FTSE 100 board directors are women. Professor Sarah Childs (Bristol University) and Anna Bird (Fawcett Society) support quotas to solve this, which require that a certain number of places on party candidate lists, or on board committees, are taken by women. They argue that quotas are the only measure that will work quickly to increase female representation. Others, like Dame Strathie, prefer to set less rigid targets alongside measures that encourage women to apply, for example by ensuring that job descriptions/ advertisements are not gendered. Janet Beer, Vice Chancellor of Brookes University, spoke of how when she became a mother, the fact that she was able to job share meant that she could continue the trajectory of her career, and she aims to ensure this flexibility is on offer to her colleagues today. 

Whilst we should aim to treat men and women equally, it can be problematic if their differences aren't acknowledged. This is particularly relevant in the criminal justice system. When Vivien Brandon, now on the women's criminal justice team, was starting out in the civil service she was set the task to forecast how the prison population would increase, so that the right number of prisons could be built. In doing so, all prisoners were treated as 'men', and she believes that this was in part to blame for the current situation in which women's prisons are located in the middle of nowhere, where the often single mothers are far from any access to their children. 

The criminal justice system in the UK is so disturbing. Women are a small minority of the UK prison population (just 5%) and so maybe they are easy to forget, but these women are the most deprived in society, and are the most likely to have experienced abuse or great trauma. Chucking them into prison for short sentences has proven not to work, and is completely inhumane. The evidence shows that good day care, and helping those women learn how to cope are the most effective ways to reduce crime.

As a young, middle class and well educated woman in 2011, I can't say I have personally had much trouble. The little sexism I have directly faced, mainly from old male academics, was easy to laugh at or shrug off. In fact, it can sometimes work to my advantage. Yesterday, however, reminded me that inequality persists markedly in our society.

Inequality can lie deeper and be less visible too; it can reside in our language, or in our expectations. I was highly recommended the work of Cordelia Fine, who strives to show that many female/male differences we assume to be innate are actually socially created.

Solidarity x

Monday, 21 March 2011

The Alternative Vote #1

Forget the YES and NO campaigns - let me introduce to you the DON"T KNOW campaign!

I'm referring to the referendum, to be held on May 5th, in which the British public can decide whether to change the electoral system from 'First past the post' (FPP) to the 'Alternative vote' (AV). 

Have you decided how you will vote, or whether you'll even bother? The YES and NO campaigns have obviously made up their minds. Unfortunately, their campaigns, fronted by superficially appealing posters and flashy promotion, provide frustratingly little information from which the ambivalent person can make an educated decision.

The NO campaign recently claimed that switching to AV will cost £250 million, a frightful sum in this time of austerity. A look at the detail, however, reveals that their claim is a gross overestimate. Half of their estimate comes from the cost of the referendum and educating the public about AV. The other half accounts for the purchase of electronic voting machines, but there are no plans for these to be bought! More technically, the cost of the referendum (£90m) is a 'sunk cost' and should not be included in the cost of AV.  Ignore their posters and ask yourself whether £30m, not £250m, is too much.
Both crusaders are guilty of trying to lure voters through celebrity support. Who's more appealing to you - William Hague, Kenneth Clark and Esther Ranson, or Joanna Lumley, Colin Firth and Eddie Izzard? Hang on, how is this relevant?

Keep an eye out for the next posts in this mini series in which I will attempt, with the expert help from friends and colleagues, to explain how AV works, and what the arguments for and against it are.


Wednesday, 16 March 2011

Mark Sobel: Top US official discusses financial regulation and rebalancing the global economy

Ben Bernanke (Federal reserve chairman),
Tim Geithner (US Treasury Secretary) and Mark Sobel
On Tuesday morning I attended an intimate round table with thirteen other academics and Mark Sobel, US Deputy Assistant Secretary for International Monetary and Financial Policy. The discussion addressed the broad topic of US policy after the financial crisis, and it was fascinating to hear the American perspective from a top US official.

Numerous questions were addressed by Sobel and the group of academic attendees, whose interests lay mainly in global governance and financial markets. In my mind, the two most interesting issues raised were 1) whether new financial regulation had introduced any significant change, and 2) the US priority to rebalance the global economy.

(Please note that, in order to respect the fact that the discussion was "off the record", my summary will be quite general.)

Financial regulation

In the aftermath of the 2008 financial crisis US Treasury Secretary, Tim Geithner (pictured above with Sobel), believed that low capital requirements were at the core of the problem. This opinion is reflected in the BASEL III accord, yet to become legally binding in individual countries, which sets the minimum target for common equity capital at an increased rate of 7% or risk-weighted assets. 

Some at the meeting were skeptical that Basel III significantly altered the workings of financial markets. I think that, compared to the US, the sentiment in the UK is that regulatory action needs to address more than just capital requirements. The governor of the Bank of England, Mervyn King, warned that we have not yet addressed the "too important to fail" issue, and the Independent Commission on Banking is looking into breaking up the banks, and separating more risky investment activities from the saving accounts of normal citizens.

Others at the roundtable thought that Basel III had significantly strengthened the system both quantitatively and qualitatively. It was their opinion that the increased capital requirements, and a tightened definition of capital are significant changes and that, importantly, they are regulations that can be agreed upon globally. One attendee mentioned that Basel III requirements were 50% more robust than Basel II.   

It is understood that the increased capital requirements are not going to stop financial crises occurring; Merrill Lynch would have needed a 23% capital requirement to have stopped it from going under in 2008 (three times what Basel III is asking for)! In order to strengthen the proposed system we need to also design resolution mechanisms for failed banks that clear up the mess at minimum cost to the rest of the financial system and economy. Under the Dodd-Frank Act there is a presupposition that when a bank goes under, someone else will be there to buy it. One attendee suggested that it might be desirable to have legislation so that banks can be reorganised back into shape without needing to sell it on.

Those satisfied with the latest financial regulation also pointed to the widening net of regulation that now covers non-banks (like hedge funds) and credit rating agencies. Policy has reacted slowly in this area though, and is probably incomplete; the first paper on the shadow banking sector, which is apparently larger than the regulated sector, was published by the G20 and Financial Stability Board just this February. 

Rebalancing the global economy

A large part of the discussion focused, unsurprisingly, on global imbalances and exchange rates. The US imports much more than it exports, which, translated into the jargon of economics, means that the US has a large current account deficit. US officials would argue that this is, in part, because the currencies of South East Asian economies are undervalued, and so US consumers import too many goods from abroad, and export too few goods. This is bad news for American jobs. It has a less obvious impact too; I mentioned in my previous post that the low interest rates in Western economies (stemming from cheap import prices which led to low inflation expectations) gave rise to the "search for yield" that made risky assets with high returns so attractive in the run up to the financial crisis.

Chinese reserves of dollars went up from $5 billion to $3 trillion in just the last five years! As China buys more and more dollars they become more scarce and so are worth more, making US goods more expensive relative to Chinese goods. Is it no wonder, then, that the US points to China's actions as a cause of it's current account deficit? Well, actually, I now understand that revaluing the Renminbi alone would not actually rebalance the US economy. In fact, it was said at the meeting that revaluing all South East Asian currencies would create only a small effect on the US current account deficit! 

The other way to rebalance and economy, namely to reduce spending, is internationally problematic too. As the US saves, the rest of the world's growth will slow, and countries from which the US buys goods will need to encourage domestic demand to maintain growth. 

The Story of Economics

I've just listened to Michael Blastland's The Story of Economics on radio 4. This first of three episodes, 'Gods', addresses the role of morality in economics. The next episodes, 'Cogs' and 'Monsters', will consider economics from very different perspectives; as a science, and as the study of many animal spirits. Looking forward to them!

Friday, 4 March 2011

Inside Job: a collaborative review by Antonia Jeans and Marloes Nicholls

This week Mervyn King stated that he was surprised at the lack of public anger following the 2008 financial crisis. When Antonia and Marloes went to see Inside Job yesterday evening, we felt that our fellow cinema goers would strongly disagree. As we watched the crisis unfold with the rise of deregulation under the Reagan administration, Clinton's ratification of the Gramm-Leach-Bliley act and the collapse of subprime mortgage lending, the audience recoiled as if we were watching a horror film.

Christopher Ferguson's documentary doesn't just scrutinise the banking and finance industry, it pieces together the events that lead to the crisis with a gripping narrative and all the drama of a Hollywood blockbuster. Ferguson succeeds in making the complex world of CDOs and CDSs understandable to a layperson, without patronising the audience's intelligence.  This is in great part due to the minimal use of jargon in Matt Damon's narration, and clear use of diagrams to explain how financial instruments work.  

By focusing on first person accounts of the key players in the upper echelons of the finance and economics profession, the viewer personally identifies with the story and characters involved. Ferguson cleverly includes outcuts from the interview tapes, catching the interviewees off guard. There are some particularly intimate moments where his frank questioning leaves certain guilty parties embarrassingly (and sickeningly) exposed.

We did feel that a focus on US companies and politics, but an insistence on the relevance of the film globally highlighted a US-centric standpoint. The inclusion of French finance minister, Christine Lagarde, would have been welcomely accompanied by a UK representative such as Alistair Darling. Ferguson also chose to neglect the role of Globalisation in contributing to the financial crisis: low interest rates in Western economies (stemming from cheap import prices which led to low inflation expectations) gave rise to the "search for yield" that made risky assets with high returns like CDOs so attractive.

Having said this, it is widely acknowledged that the crisis of 2007/8 began in the US, and Ferguson couldn't include everything! What the film does best is to reveal the corruption and cronyism within the top tiers of the banking system. It is the same men who sit on the boards of banks who form US financial policy. President Obama's decision to continue the trend is worrying, but it's clearly difficult to find others with the expertise to do the job who are not subject to a conflict of interest.

Above all the film's cinematography remains most vivid. Striking images of Iceland's natural beauty, juxtaposed with the modern industry of the New York skyline, we felt, underpinned the difficult and depressing point that in the UK, as in the US, we are dependent on the banking system to drive the economy.  It provides the basic and essential services of looking after our savings and providing loans. During the boom years we enjoyed the successes and excesses of a system which seemed indestructible. It is left to current governments to negotiate banking reform for which, despite King's opinion, the public are clearly impatient.

A and M

Wednesday, 2 March 2011

John Redwood: The Future of the Euro

The Rt. Hon. John Redwood, Secretary of State for Wales under the leadership of John Major, prides himself for playing a role in the UK's decision to not join the euro. He recently came to All Souls College, Oxford, to present his ideas on "The Future of the Euro". Find my report on the seminar, written for the Oxford Institute for Economic Policy (OXONIA), here.

Rt. Hon. John Redwood, Old Library, All Souls College