The mood in the financial press is sombre this morning. From the possibility of a major downturn being the view of a few Cassandras (like me) it is now becoming widespread. Martin Wolf does, for example, now appear resigned to it.
For the record, I do not think we are facing an October 2008 scenario soon. Or maybe at all this year. But then, no one did at the beginning of 2008. I expected a crisis then, but not a crash of the sort that happened. And I expect a crisis now, but I hope not a crash.
But what happens if I (and most people) are wrong. Suppose some unforeseen event, such as a major currency realignment, leaves massive exposure in the world's banks or hedge funds that means derivative contracts fail in a big way leading to an immediate liquidity crisis (the thing we always have to fear most) akin to October 2008? What then? I think we do have to think about it because we cannot afford to repeat the mistakes of last time.
Let's be clear what they were. In no particular order I would suggest they were unpreparedness; panic in the face of potential bank runs with no plan for containing the demand for liquidity that resulted in massively unwise bank guarantees in some cases; over paying for crippled financial institutions; failure to stop some particularly harmful forms of trading in a downturn and inability to deal with the aftermath. I will ignore the last for now. Let me look at the rest.
First, I hope someone has done some serious contingency planning this time.
Second, hope against hope that someone has had the wisdom to print a lot of £100 and £1,000 notes that can be time limited in circulation. This is the big innovation I suggest to deal with panic. What do I mean by it? Simply that if anyone really fancies staging a run on a bank I suggest that notes be made available so that they can be paid in cash without having to offer the type of bank guarantees that crippled Ireland. And time delimited notes mean that they have to be deposited again within, say, a month when order has been re-established. And if they are not they are cancelled so that they cannot be used for crime. Their deposit in a bank outside the UK should also be barred: no bank should be able to claim settlement on them if they are. I am not sure such a technique has been tried before, but so what? What is required is short term liquidity. But the demand for short term liquidity should not create a long term difficulty as it did in 2008. Time delimited bank notes meet that need: the government will promise to pay, but only for a limited period after which redepositing has to occur. Confidence in being able to extract money from an institution is established. The demand for cash is then likely to fall. And the crisis has to pass in a short period.
In the meantime, and third, I hope security is planned for cash points.
And fourth, that plans for emergency legislation for the immediate, no compensation, nationalisation of any bank in trouble exist: we can't be caught paying for failed banks again.
Fifth, legislation to stop capital flight must be passed: tax withholding at an emergency rate would be appropriate. This might be variable to match demand: the rate would rise if demand increased. This would not apply to settlement of trade liabilities.
Sixth, emergency credit to ensure businesses unable to meet UK liabilities because of non-payment in other currencies must be made available. This could be by way of tax deferral. If that is insufficient facilities must be made available from a National Investment Bank. If not repaid within six months these should be convertible into equity stakes in the businesses supported. The National Investment Bank must be supported by People's QE. If the Maastricht conditions need to be ignored for timeliness, so be it.
Seventh, certain types of stock trading should be suspended. Stock lending should be barred. Short selling would also need to be barred. And if in consequence derivative positions are incapable of settlement emergency clearance should be arranged so that compensation in terms of margins made or lost could be settled instead of principal sums, where possible (although I stress, this idea needs development and is not my area of greatest expertise, and I admit it). The risks inherent in seeking to resolve such situations are noted to be high: any institution requiring emergency funding as a result would be subject to automatic nationalisation without compensation. Directors of such institutions would face unlimited liability with regard to losses.
Eighth, emergency legislation with substantial criminal and asset confiscation penalties must be passed to prevent anyone seeking to profit from trades with a regulated financial institution of any sort requiring emergency funding. This would also apply to non-financial institutions applying for emergency credit to survive.
Ninth, politically bi-partisan solutions should be sought. A government elected without a mandate for action in this situation cannot govern during it without the involvement of other parties.
Tenth, communication is key. It must be made clear money is and will be a available, come what may. Governments can and must print money in these situations until calm is restored.
Are these sufficient conditions for survival? No, probably not. Are there obvious problem areas? Yes, in derivatives most of all: Lehman took years to unwind. But the key point is any crisis will always be about liquidity and this time this must be provided in ways that impose least long term cost that by definition require reversal (hence time limited notes) and where the state takes control without being burdened with a debt obligation to those who should bear the real cost of the failure of the institutions in which they had invested, even if it was only a short term liquidity crisis that induced it.
And, of course, I accept that what I have written is not comprehensive. I am simply suggesting directions of travel to help curtail the risk if we do have another crisis. So please don't nit pick detail and stick to fundamentals. There are enough of those here to chew on.
(Please also note I am in meetings all day in Copenhagen; moderation may take a while).
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Yes, derivatives! I’m somewhat in favour of ‘useful’, ‘old-fashioned’ derivatives such as options and futures relating to crops and maybe some other commodities. Trouble is, even those have fallen somewhat into agribusiness (large scale monoculture + scarcity manipulation) and casino world.
As for most financial derivatives, they should be disappeared or completely disconnected from the saner bits of the financial system. I think Warren Buffett agrees: http://news.bbc.co.uk/1/hi/2817995.stm and he’s not exactly a left-winger…
Clearly some derivatives are extremely helpful
It’s just hard to spot them
I worry that we’re planning for the last war, not the next one: nevertheless, emergency liquidity and contingency measures for a credit crunch are the way to go.
I do not believe that there’s a credible contingency plan for intervention or a ‘living will’ plan for a failed bank or a trading house; nor do I believe that we have overhauled the risibly inadequate emergency support for companies hit by the withdrawal of trade credit and short-term credit lines in 2009.
No-one’s talking about non-bank entities – the ‘shadow banking’ players in the money market – and I suspect that we’ll regret that oversight. Or rather: lack of oversight for unregulated offshore players.
Meanwhile, we have become a much more fragile economy: I know that it’s unfashionable to talk about ‘Social Security’ – the popular phrase is ‘welfare handouts’ followed by ‘scrounger’ propaganda and thunderous applause from the Party Conference – but current levels of household debt, precarious employment, and yesterday’s alarming erosion in housing security for families on low incomes place us far, far closer to Argentina than you’d think by looking at a map.
Our last credit crunch was, on paper, far worse than the economic shocks precipitating both the Asian and the South American debt crises of the past two decades: but the economic and social disasters of those fragile societies were not replicated here.
Not that time, anyway: and the worst-affected countries clambered out of the economic pit-trap they were pushed into by pursuing social policies that are diametrically-opposed to those of Britain’s neoliberals – they recovered and regained their security and prosperity by rejecting and reversing policies which we are pushing harder, deeper, every day.
Which is to say: the next crisis in banking could be smaller than the credit crunch, and still have larger impacts in the real economy.
Hi Richard,
Can you give any opinion on the proposed “bail in” mechanism built into Dodd Frank and if and how the UK banks may initiate this redistribution of depositors funds?
This is an enlightening read.
http://www.maxkeiser.com/2015/12/a-crisis-worse-than-isis-bail-ins-begin/#more-79195
I am not familiar with it so sorry but I can’t
Learn a little (mostly USA but some Europe) here http://ellenbrown.com/2016/01/10/bail-ins-begin-interviews-with-greg-hunter-and-thom-hartmann/
I heard yesterday on Richard Wolff’s weekly economic update that the US government adopted legislation in the Dodd-Frank act that allows banks to use the Cypriot style of “bail in” approach to resolving future financial crises.
That is, if a US bank gets into trouble it can now appropriate some or all of its depositors money to bail itself out. I can only presume this got through the US legislators as they (or rather their financial backers) are so paranoid about avoiding any form of national or social bank ownership.
I think that shows the direction of travel that the banking world would like to see applied everywhere, creating an even greater threat of them gambling with other peoples money (on the basis that once deposited it really is the banks money anyway!)
This applies in effect for sums over depositor guarantee levels here in the UK
For now.
Pessimism is rife this year…..
http://thegreatrecession.info/blog/2016-economic-predictions/
A good starting point based on the experiences of 2008.
Even if the current market-worshipping Government of ours did one or two of your suggestions above that would be a big step forward. But I doubt it.
I still cling to the idea that what is emerging is purposeful disaster capitalism by design because again it enables a transfer of assets at cheap rates and other people’s limited wealth to the already extremely wealthy.
By now, Osbourne and other market advocates must surely realise that if there is another crash, people may simply not accept it and will actually end up voting themselves out of office.
So I see 3 possible factors that contribute to the ‘here we go again’ agenda.
1). The Tory’s in governemnt – being well off people who could have highly paid jobs anyway in business and finance – don’t really care if they get voted out because many of them do not believe in Government anyway. They will reek their self-serving havoc and then go back to being rich elsewhere when it is all over. In fact when they go back to where they belong, they will be even more rich!
2) Labour – the largest single opposition party (until the various other oppositions actually start working together) is either too neo-lib anyway (not much would change when they got in) or the current internal ructions will continue to eat up valuable time that could be used fighting the current Tory destruction of the UK. So who is going fight for some the excellent ideas above in Richard’s blog? Answer: Not George Osbourne.
3) The neo-lib media – let us not underestimate the ability of this lot to create a false consciouness about who/what is causing this. Expect our media to point the blame at immigrants, people who need social security, ISIS, refugees, and even garden gnomes in order to throw us off the scent of the real sources of these problems.
How to get around this?
What might help is that those who are part of the ‘counter-narrative’ (CN) must spend more time talking about what they agree about with each other than what they disagree about. This might contribute to the CN getting a better foothold with the public and opposition politicians.
Those in the counter narrative tend to be honest, forthright and more than willing to publically discuss where they disagree with their peers unlike your typical neo-lib proponents who stand shoulder to shoulder pedalling ideas that we know now do not work. Whilst debate and honesty is admirable, out here people are looking for answers – not debate. Debating too much detail about small differences between individuals could be contributing to part of the perception problem – that really no-one knows what to do (what I call the ‘Adam Curtis hypothesis’) about the current crises in the global financial system and in captialism itself.
From what I’ve read here and elswhere, new answers (solutions) are there. Lets us spend more time on them perhaps? Because they are to damned good to leave on the shelf.
BTW – I hope Copenhagen is not too cold. It’s certainly very chilly here in the UK today.
I like the CN
And it is very cold and I did not bring a hat
Brrrrr!!
Pilgrim- it’s worth tuning into Richard Wolff’s regular broadcasts and video lectures. He has a great teachers knack of getting the main issues accross without worrying about theoretical ‘purity.’
There is definitely a need for people to be given CLEAR explanations without burdening them with too much technical stuff that they neither have the time for or the head space given the pressures many are under (the latter feeds into the neo-lib agenda).
Labour ABJECTLY failed to do this on virtually every level, as we have discussed many times on this blog. This HAS to change (not holding breath).
I’ve got so frustrated with this that I am now (as a non economicst) offering myself as a speaker for my local CLP and have an invite to speak to a local 6th form economics group-if politicians won’t do it it’s a DIY job I’m afraid!
Talking to schools is great thing to do
“Second, hope against hope that someone has had the wisdom to print a lot of £100 and £1,000 notes that can be time limited in circulation”
I can’t see how this can work. Anyone being offered one of these notes is either going to refuse it or immediately deposit it into their bank account. They’d either then leave it there or pick up normal long-life cash from an ATM on the way out.
There is a good argument that there should be an element of use-it-or-lose-it attached to all cash though. That means deliberately allowing higher inflation in the economy.
The purpose is to allow anyone yo ha the option of accessing cash in an account without having to guarantee the account in the lingers
Redepositing in another instiution is the sole aim without people refusing a cash drawn on their previous instiution that may fail
If the neon situation is assumed safe then there is no incentive to withdraw non ime limited cash
If a transfer is available a run is pointless
sorry but I don’t understand your answer.
What I am saying is that time limited notes always mean that a transfer of funds between banks is possible in a crisis, but that the impact is limited
So, runs become irrelevant: the BoE will issue funds to make payment in the case of any bank and so the 2007 Northern Rock scenario need not arise. The animal spirits can be contained
But this is achieved without guarantees
And it is achieved in a way that has to reverse: the redepositing of funds has to take place, so the cash extended is almost as quickly cancelled and order re-established
There may be flaws in the idea: I am far from being able to see all consequences of a suggestion. But it would seem to me a way that avoids the need to formally guarantee deposits and which at the same time aids their orderly transfer if there was a crisis
The very fact that it does that probably mean that they may not be needed, whcih is the best outcome for all contingency plans
Seems all I have written about since 2009, has never been answered and thus the crap that was done to an afraid and lied to global population,— is about to be done, a second time.
I know this, because NO ONE, dealt with the ‘preferred creditor’ status given by governments to Hedge funds..
NO ONE, said anything,— about most of the little-or-no-interest-free bank bailouts done in 2009….So, all governments felt they ‘got away’ with it then and have inserted bank bailouts and bail-in provisions in every country’s budget.
All the while, these banks have been laughing and gambling, over the years, in derivatives….
And Hedge Fund owners, can hardly wait to reap their short, while only paying a 15% tax rate….
If all scared taxpayers (those that pay their taxes due) did nothing,… back when it could have made a difference,… by changing those very laws, regs and safeguards—they would have been done ….
BUT …taxpayers,….. stupidly trusted these leaders, who have proven to be co-opting them,… every way they can….
I mean, did any voting member or group,… demand an end to corporate/bank welfare subsidies by taxpayer monies….Or, even an accounting, to see if any value came from all the billions paid out—–NO.
So, why is everyone claiming again,…they didn’t see this fiasco coming —they let the very template stand, all ready to be set up and used again……
The only solution to bank/corporations operating out of control is to withdraw their money source—no subsidies, no tax cuts and no lowered tax rates that can’t be justified……The alternative is financial slavery,… as these trade agreements will also demonstrate,…. are yet,…just another scam to use ISDS clauses (tested in NAFTA to sue for taxpayers to pay their cost of
What preferred creditor status?
What 15% tax rate?
Sorry – I am not sure I am seeing those in the UK
Cont”…..doing business. As well the ponzi scheme of privatizing all that is ‘public’–misnamed deregulation…..under the scariest trade deal—the Trade in Services Agreement —that has a 5 year public non-disclosure clause to make sure the people affected do not know to organize until its effects have well-penetrated all systems and levels…of society…..see bilaterals.org for info on all global trade deals …asks for analysis so feel free to respond….take care…
I am not sure I see the point of time limited notes.
Nobody would actually hold the notes under the mattress would they?
What is the incentive to hold onto them? A run on the entire banking system?
If only a fraction (big or small) of banks are in trouble, any rational individual would simply remove all cash (time limited or not) and deposit in a safe institution. As long as the receiving bank accepts the notes you are fine. At that point the troubled bank basically has no deposits and is alive only thanks to central bank loans (which is what already happens). Even if all the banks are in trouble, some coordination between large depositors will make sure at least one bank survives.
As far as the troubled institution is concerned what kind of asset it receives from the central bank makes little difference. Time limited cash only works if you think the holders of such cash would ever let it expire. How would that work? Why wouldn’t you redeem the time limited money at the central bank immediately (through a safe or safer bank)? If you are not allowed to do that, then you are actually losing something (since your deposits go from cash to some form of lower value/liquidity asset), so a run is on the cards.
You have worked out the whole point of time limited notes
They prevent runs and allow orderly reorganization when people do not trust they will be paid
Their availability makes them largely irrelevant
So they would work
This proposal makes no sense to me. Evocative television images aside, bank runs nowadays are likely to take place mainly by electronic transfer of funds.
What does time limited mean? Would the Bank of England honour these notes or not? If so, what difference does the time limit make? If not, why should anyone accept them as money?
If the mere availability of bank notes were sufficient to stop a bank run, then there would be no need to make them time limited.
Yes there ids
We do not need them circulating for crime
Having recently watched Gregory Peck’s rather fun role in the black/white film ‘Million £ ($?) Note” which perfectly illustrates the point of ‘confidence’ in possessing large notes. They prevent panic contagion to other financial institutions. Time-limiting simply means the cash should be ‘spent’ rather than hoarded. It gives space to address the initial crisis while containing the spread of what caused the crisis. As a non-economist this idea sounds workable. So much so, one wonders why it wasn’t tried last time.
Richard
Are these large denomination banknotes going to be available from ATM machines?
No