By John Nellis
Editor's Note: John Nellis was a Senior Manager in the World Bank's Private Sector Development Department. He is now Principal of the consulting/research firm, International Analytics.
On March 2 and 3, I attended the annual World Bank Forum on Financial and Private Sector Development in Washington. Last year, as we teetered on the rim of the abyss, the keynote speaker was Nassim Taleb, author of The Black Swan, who (as I wrote) left no one in the room uninsulted. This year, as recovery stumbles its way forward, or sideways, both speakers and audience evidenced lower blood pressure, and, alas, less bombast and theatricality. Some reflections:
The first speaker was the very shrewd and able Moises Naim, presently Editor of Foreign Policy journal. He has been an Executive Director (i.e., member of the Board) of the World Bank, a professor, and, in the 1990s, Minister of Industry and Trade in Venezuela.
With apologies to Al Gore, Naim said he had some "inconvenient truths" for us. These were:
- The decline in investment and growth stemming from the crisis will last a decade; maybe more.
- Despite all the hoop-la, the architecture and rules of the game governing the financial sector will not be radically transformed; there will not be any new, comprehensive, global financial regulatory system. Reforms will emerge partially and piecemeal, in different countries and regions, and they will differ substantially from one another. This will present much opportunity for policy arbitrage; i.e., gaming the differences in the systems for profit. As another speaker put it, "regulation breeds circumvention."
- As patchwork measures surface to limit some activities of formal banks, the "shadow banks" -- the informal systems that arose in the period 1998-2008 and contributed greatly to the crisis -- will flourish. As for banks proper, they will be "de-risked" and come to resemble utilities. The wrong target will be struck. (Not stated at the conference, but an adage from elsewhere that seems appropriate: "All initiatives end by punishing the innocent.")
- The crisis has formalized the split in economic thinking; there is now a western and an eastern approach to ownership, property rights, finance and regulation. Much of the thinking in the west on private sector development uses the formal, publicly-traded firm as the building block; but the more common and quite different firm in the comparatively successful parts of the world (for now) is the family-owned, closely held, non-traded firm, the behavior of which is insufficiently analyzed in formal economics. And finally,
- The crisis has significantly lowered the barrier to the adoption of bad ideas (an hypothesis confirmed daily in legislatures around the world, spectacularly so here in Washington).
Not on a pessimistic par with Mr. Taleb's Black Swan address of a year ago, and delivered in a far less flamboyant manner, but unsettling stuff nonetheless.
I attended the second plenary on March 3, this time with a keynote delivered by Niall Ferguson, Professor of History at Harvard (and holding appointments at the Harvard Business School, the Gunzburg European Center, Jesus College, Oxford, the Hoover Institute at Stanford, several private consulting firms and the BBC -- don't you dare say you're busy). He spoke on the question: "Can developing countries learn from the history of money or are they doomed to repeat it?"
Ferguson describes himself as "a reasonably engaging speaker," and he is certainly that. He also says he "is proud not to be an economist." He is an historian. His last book was The Ascent of Money; he is now working on a history of the west's ascendancy. This book will be published as a companion piece to a 6 part BBC series on the same topic (in which, presumably, Mr. Ferguson will do for development what Richard Attenborough did for iguanas).
He begins by asking: Is the contribution of the financial sector to long-term growth negative? The opposite view is held by most scholars of the topic. Indeed, Ferguson cheerily notes that the premise of a thoroughly positive association between density and efficiency of financial intermediation and long-term growth underpinned his latest and quite successful Ascent of Money. But the crisis, and some recent research of his own and others, leads him now to wonder if this is correct.
He notes that the current crisis is one basically of western advanced industrial economies, and that countries with smaller and more constrained banking/financial systems, mainly but not exclusively in Asia, weathered the storm far better. Smaller financial sectors, he says, are associated with less debt, fewer bubbles, and current account surpluses. Perhaps we've had it all wrong?
He expands the notion to query what he considers as the conventional explanation of the crisis: that de-regulation of banks was the fundamental factor precipitating the boom and then the bust. Mr. Ferguson insists that problems in the banks was only one of 6 factors, and not the most important one, that contributed to our present mess.
- Yes, the banks (and he notes most western banks were culpable, not just those in the US) were excessively leveraged, but this by itself would not normally have caused a collapse.
- AAA abuse: the failure of the rating agencies and system was breathtaking.
- Massive error in monetary policy by the US Fed, which he says dates to 1999 when a group of high level economists (Larry Summers strikes again?) persuaded the Fed that rapidly rising asset prices -- houses -- could safely be ignored as long as the consumer price index was not tracking housing prices. The Fed did nothing to prick the housing bubble. (Note that Eugene Fama and other Chicago economists say there is no such thing as a bubble. Maybe Ayn Rand wrote this someplace too, thus persuading Greenspan?) The brakes were never applied; the throttle was left open. (A Toyota metaphor lurks here.)
- Financial insurance mechanisms went wacky. In his best line, Mr. Ferguson stated that insurance and swap devices were built not to see that "risk was borne by those best prepared to take it, but rather by those least prepared to understand it." Well done!
- Politicians contributed to the problem as much as CDOs and model-driven economists by giving incentives to home ownership to more and more "marginal borrowers." Ferguson asks what percentage of citizenry home ownership is needed to precipitate a financial crisis? The answer appears to be 69.
- And grand geo-political issues intrude as well; China's fueling the US debt furnace is another contributing factor.
What should emerging countries do to avoid such a mess? Follow Canadian rather than US regulatory systems. Realize that asset prices count. Don't push home ownership for its own sake. Realize that insurance should be based on calculable and understandable risk.
All sound and sensible, but a bit of a letdown following the breathless build-up. Still, it was presented with verve and a flourish, with asides and jabs and interesting slides. But we have heard most of this before, and the tone of the presentation --- I've put all the pieces of the puzzle together before anyone else -- is not justified.
Ferguson is, as he states, an historian; he looks for the whole story. The economist's search for the essential, for regressing to the key element that explains the largest "percentage of the variance" is antithetical to his approach. I enjoyed Ferguson's talk, learned a good amount, and was provoked to reflect at a number of points. But the rich fabric of his story on the crisis does not add up to a tight explanation. Mr. Ferguson should not be quite so proud of not being an economist.