Ciclo: " Los retos económicos para el futuro" Charles Goodhart Profesor Emérito de Banca y Finanzas de la London School of Economics. Madrid, 25 de marzo de 2009

1. Charles Goodhart
Charles Goodhart, Catedrático Emérito de
Finanzas y Mercados de la London School
of Economics, es una autoridad mundial en
Política Monetaria. Formado en Eton Colle-
ge, Trinity College Cambridge, y Harvard, ha
ocupado puestos de responsabilidad en el
Banco de Inglaterra antes de pasar al Ban-
co Mundial. Acuñó una ley monetaria que
lleva su nombre. Dice la Ley de Goodhart
que “tan pronto una magnitud se transfor-
ma en objetivo de la política monetaria, su
comportamiento tradicional experimenta
movimientos anómalos”.

2. EL FUTURO
DE LA
REGULACIÓN FINANCIERA
Por Charles Goodhart
Profesor Emérito de Banca y Finanzas de la London School of Economics
En esta conferencia Charles Goodhart analiza el denominado Informe Ginebra sobre
regulación financiera, el cual parte de la observación del carácter procíclico de los
criterios de regulación financiera establecidos en Basilea II, que ha podido tener en
algunos casos un papel agudizador de la actual crisis. Ello se debe a que dichos criterios
prestan una atención prioritaria a los aspectos micro-prudenciales, al nivel de cada banco
individual. El profesor Goodhart alerta contra el posible proteccionismo financiero que
podría surgir si distintos gobiernos promueven que los bancos realicen préstamos en la
fase de regeneración del mercado de crédito tan sólo en sus países de origen.
Fundación Ramón Areces, 25 de marzo de 2009
this particular crisis has aFFEctEd emer- refinancing of the IMF, providing the Fund
ging and developing economies, and particu- with sufficient funding to help restore health
larly perhaps those in Eastern Europe (which to economies which are much less strong
had absolutely nothing to do with the initial than in Western Europe and in Northern
financial problems), even more severely than America.
it has affected the developed economies,
where the financial crisis began. The crucial José Viñals mentioned my sheep farm. I
development at the G20 London conference, would not be here today was it not for the
to be held next week, April 2009, will be the fact that my sheep farm manager is having
LOS RETOS ECONÓMICOS PARA EL FUTURO 61

3. his, or rather had his first baby on March So, everybody always had perfect credit risk;
12th; because he had his first baby on March there were no risk premia whatsoever, and
12th, we moved our lambing backwards. because everybody had perfect credit risk,
Many people, even the very cleverest people, there was no need for any intermediaries,
will wonder how, with a lot of animals, you there were no banks, no financial interme-
can time the date on which the mothers give diaries and in fact, there was no need for mo-
birth. But it is actually very simple. You do ney in this model either, because if everyone
not allow the fathers, in this case the rams, always pays back what they owe, all you need
to consort with the mothers, in this case the is a kind of accounting system to keep track
sheep, the ewes, until of who owes what to
the moment occurs, whom.
because you know the
gestation period and The main macro- A model in which
you, therefore, know there is no default, no
the lags, and you put economics model that banks, no money, no
them in the field with has been in operation risk premia works in
the ewes at the right fact surprisingly well
time so that they do
in the profession and during normal times,
not start having baby has been used, is what when risk premia are
lambs until you want constant and defaults
them to have babies.
has got the name of do not happen very
Even very clever eco- DSGE model (Dynamic often, but, as you may
nomists sometimes Stochastic General imagine, does not give
fail to realise that. And one much guidance
when I am thinking Equilibrium) for occasions like the
about very clever eco- present. It is just in-
nomists, I might just sufficient. And why
add that among the central banks were
unfortunately wide range of groups of people prepared to take up a model, which excluded
who do not come out of this crisis well can by definition everything about which they
be also included macro-economists. ought to have been interested, I simply do
not understand.
The main macro-economics model that has
been in operation in the profession and has Anyhow, I am going to talk to you tonight
been used, (I am afraid rather uncritically by about the Geneva Report, which I helped to
many central banks –including the ECB and organise on “The Fundamental Principles of
the Bank of England–) is what has got the ho- Financial Regulation”. The reason why we
rrible name of DSGE model (Dynamic Sto- did this was because it was perfectly clear
chastic General Equilibrium) and I am not that the policymakers around the world were
going to bore you with it, except to say that about to embark on a whole series of discus-
this DSGE wonderful macro-economic core sions of various kinds, in various groups, to
model assumed, assumed, that nobody ever try and inform the financial regulation that
defaulted; everyone always paid back whate- we are going to have. There was the de La-
ver they borrowed with probability one. rosiere Group in Europe; there was the Adair
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4. LOS RETOS ECONÓMICOS PARA EL FUTURO 63

5. Turner Review, which has just come out in mework that we had –Basel II– and the ac-
the UK; there is a group which is being chai- counting framework under the IFRS –which
red by Paul Volcker –who now seems to chair is frequently described as mark-to-market or
everything in the United States– which has fair value accounting– amplified this cycle,
yet to report. And we were concerned; I was producing, (and this was a phrase that was
particularly concerned, that economists –as I repeated in The Economist, and came from
have said we are far from perfect and we miss another colleague of mine), “pro-cyclicality
a lot, but we do have something to offer– on stilts”.
that economists had been largely excluded
from the groupings of those who decided the Effectively, the mark-to-market, fair value
Basel I and the Basel II capital requirements. accounting system means that whatever ha-
Indeed, I remember in the Bank of England ppens to market prices immediately gets in-
that the financial stability group, the supervi- corporated into bank profits and bank capi-
sory groups, were the last groups in the whole tal. So these are driven up during the bubble
of the Bank to include economists and for a and then decline very sharply in the process
very long time such groups were rather proud of the crisis and the de-leveraging, in many
of their exclusion of economists; they felt that cases with markets becoming dysfunctional
regulation is something that sensible, roun- and not operating at all. So prices are driven
ded people who worked with practitioners, by those relatively few who are so distressed
rather than academic theorists, know about. that they have to sell at whatever the price
I thought that actually that there were consi- they can get, what is know as “fire sales”.
derable deficiencies in what had been done,
and so I hoped to put together a group of Another of the accidents, or calamities, of
people; of whom Markus Brunnermeier and economic theory has been the demise of the
Hyun Shin were eminent macro-economists; efficient market theory. This implied that
Avinash Persaud and Andrew Crockett had markets always provided the best estimate
a wide range of experience on the regulatory you could get of fundamental values. In the
side, and the purpose was to try and get our recent course of the crisis, it has been clear
paper out into the general public before the that many markets either did not work at all
policymakers and their groups came to any or, when they worked, there was a considera-
clear conclusions. So that was the context in ble divergence between the market, the price
which we were operating. that you could get at the moment when there
was great fear and uncertainty and shortage
The background to all this is that we have of liquidity, and the expected value of the fu-
observed a cycle, a really massive cycle of fi- ture cash flows of the interest payments and
nancial leverage, with financial intermedia- the repayment of principle at the end of the
ries taking on much greater leverage, a much duration of the debt.
higher ratio of debt of all kinds –deposits,
subordinated debt and all kinds of debt– to Basel II was related to credit ratings, and ra-
their equity. And then in the course of the tings go/migrate upwards during the boom,
bust –after the asset price bubble had bust value at risk appears to be low, and during
too– de-leveraging; trying to reduce the size booms usually volatility declines, as it did in
of their balance sheets. And the arguments course of the years 2003-2006. During the
that we make, being that the regulatory fra- crisis volatility increases, value at risk gets
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6. Effectively, the mark-to-market, fair value accounting system
means that whatever happens to market prices immediately
gets incorporated into bank profits and bank capital
worse –a lot worse– and credit ratings mi- blems. It is a fallacy of composition to belie-
grate backwards, which means that Basel II ve that, if each individual institution behaves
was inevitably highly pro-cyclical. When you prudently, the system as a whole will be safe.
combine the two, you get what other people
have described as the Doomsday Machine. Indeed, one can go further than that and
Why did this occur? It largely happened be- claim that most systemic crisis are caused
cause the Basel regulation was far too focused not just, or even not mainly, from the initial
on looking at the condition of the individual shock that may affect the system –in this case
bank; the individual financial institution. the subprime mortgage market– but from the
Now, that is very important, but it is not responses of the banks and other financial in-
the only thing that matters. And what mat- termediaries to that shock. This is what you
ters much more and is the key externality, is can describe as self-amplifying mechanisms,
the possibility that you can get contagion, or you can describe it with the words ‘endo-
particularly in relationships between banks, genous risk’. And there are number of such
which adversely affect the financial system as self-amplifying spirals but the two key ones
a whole. I want to mention are the “loss spiral” and
the “margin spiral”. And both of these relate
For the individual bank, when value at risk to a diagram that we owe to Markus Brun-
worsens, credit ratings migrate in the wrong nermeier, which he put into the Report from
direction and capital ratios come under pres- one of his many other papers on this.
sure, the obvious answer for the individual
bank is to reduce the size of its book; to sell One starts with an initial loss from some ini-
assets if it can, not to take on any more as- tial shock, and here we start with the pro-
sets, not to lend, to de-lever. And for the in- blems in the housing market, particularly in
dividual bank that makes a lot of sense, but if the United States. Though there is a tenden-
all banks are doing that simultaneously, then cy, I would imagine less in Spain than in some
effectively it drives the system downwards other countries in the Euro zone, to blame
into total crisis. Again, for the individual much of what has happened to things going
bank, it is very sensible to have a very widely wrong, and improprieties, in the housing
diversified portfolio. But if all banks diversify market, particularly in the subprime mar-
their portfolio in exactly the same way, then ket in the United States. That is not entirely
effectively the system becomes much more true. In my own county, there was a clearly
fragile, because if a crisis should occur and equivalent subprime market; Northern Rock
any particular bank gets into difficulties, it is was issuing 125% loan to value ratios, which
clear that all the other banks will be equally were entirely inappropriate. So we had our
in difficulties; so that you get the fear that the own subprime market in my own country.
banking system as a whole is subject to pro-
LOS RETOS ECONÓMICOS PARA EL FUTURO 65

7. Nevertheless, the initial loss from the subpri- Anyhow, the banks had done so, and they
me market was not all that great, and it is still had also raised the ratio of their assets; their
not all that great, although the probability of loans to their retail deposits, well over 100%,
default of many borrowers in that market has and very sharply so since the early years of the
been quite high and the loss given default has new century, so that many of the banks had a
been high. One of the main reasons why we loan to retail deposit ratio, somewhere of the
have got into our financial problem was that order of 140 to 150%. That gap was filled by
central bankers around the world looked at borrowing from wholesale markets. The effi-
the prospective loss from the subprime mar- cient markets hypothesis implied that these
ket and said “this ought to be manageable”. wholesale markets would always be open. So
After all, you can do the calculations and you long as the banks had enough capital under
can work out that if the New York Stock Ex- the Basel II arrangement, they would always
change falls by, shall we say, 3% on a day, be able to access the wholesale markets. But
and 3% declines on the New York Stock Ex- the Basel II capital arrangements had been
change have been common, they have been manipulated ‘gamed’, particularly by banks
two a penny over the last two years, then a in Europe, which is one of the reasons why
3% decline on the New York Stock Exchange this crisis has affected Europe just as badly as
actually cuts wealth by just about as much it has affected the United States.
as the expectation was of the losses from the
subprime mortgage market. The wholesale markets dealt in very short
term maturity loans. When you got this over-
So, it was not the size of the initial loss, and extension and you got the losses coming on
indeed, central bankers did not really spring the subprime market, the response of many
into action as quickly and as aggressively as lenders in the wholesale market was ‘better
they might have, because they thought that safe than sorry’. So they began to withdraw
that loss ought to be manageable by the mar- their money and that began to lead to fun-
kets. Rather, the problem was that the banks ding problems. When you get funding pro-
were wildly over-extended; leverage had been blems and you cannot sell safe assets –public
huge; they had reduced their market liquidi- sector debt– onto the open market or borrow
ty; the assets they were holding were far less from the central bank on that, you are forced
liquid than they had been twenty or thirty to reduce your position; you are forced to
years before. Indeed, when I was starting sell. This kind of distressed selling moves the
economics, the average ratio of public sector prices away from fundamentals; the prices
debt to the total liabilities in British banks of the existing assets held on banks balance
was over 30%, it was around 30 to 35%. sheets went down, that made them look even
What was it in 2007? It was 1%, 1%. The riskier, so the wholesale markets got even
banks had more or less denuded themselves worse; banks would not lend to each other;
of liquid assets, it was one of the reasons why the asset-backed commercial paper got with-
Mervyn King was rather loathe to help the drawn, the funding problems got worse and
banks out of the problem because he felt that so you went round the first of these spirals
the banks had brought a lot of this on them- –the loss spiral–. The margins spiral was very
selves by simply shifting out of safer public similar, it covers a wide range of financial ins-
sector debt into riskier, mortgage-backed, titutions, all those who are heavily levered,
and other kinds of risky securities. for example, the hedge funds.
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8. Now I am going to move on to the next table, take on has to fall to a third of what it was
which actually comes from a paper that Hyun before. So when these margin haircuts really
Shin produced. And this shows the repo hair- started to rise very sharply, it just forced the
cuts, or actually it indicates the amount of hedge funds into, together with withdrawal
margin that the intermediaries would have to of deposits from them, into a massive degree
put up, before the crisis started in April 2007 of de-leveraging and the de-leveraging, of
and in August 2008 when it was underway, course, takes you round the self-amplifying
but even before Lehman’s hit. And what you spiral, things get worse, people require even
can see there is that effectively, the margins higher margins and everything gets just cy-
that were required frequently increased by a cles away downwards.
factor of three or four. Let us say that you
are a typical hedge fund and let us say that So, the problem is how do you stop this cycle
you are levered, you increase the total size of –this systemic cycle– which has been so se-
your book on the basis of your own funds: vere, and which tends to play a role in most
say your own funds are one, and you increase of our financial crises. In the financial crisis,
the size of your book up to five. Remember there has been a very close interconnection
that hedge funds generally were less levered between the housing market, and property
than commercial banks, which were more market more widely, and the banking mar-
heavily regulated –but be that as it may– say ket. Now, I have argued that Basel I and II
that they were levered by a factor of five, focused excessively on the risks of individual
when you had the low repo haircuts. Then, if banks. They are right to be concerned with
the margin requirement increases by a factor the risks of individual banks because many
of three, the amount of leverage that you can of these are so big and so important that it
LOS RETOS ECONÓMICOS PARA EL FUTURO 67

9. is entirely proper that they are looked at in- time that causes so much problem. So all
dividually to make sure that they are looking three are important measures of where you
after people’s money properly, but you have stand in cyclical variation, i.e. leverage, cre-
also got to worry about the system as a who- dit expansion, (if you want rates of growth
le. That means that you have got to look at of asset prices) and maturity mismatch. And
what is being described as macro-prudential in the Geneva Report we regard all three as
regulations. The Basel I and II requirements essential elements of what a regulator/super-
are valuable, but we argue that they are in- visor ought to look at.
sufficient. There are a number of measures
of systemic cyclical va- Now, these are mea-
riation. One of these sures of cyclical varia-
(one I have been har- tion; leverage, credit
ping on), is straight expansion, asset pri-
leverage –the ratio of Another measure is ce growth, maturity
total assets to the equi- mismatch. How do
credit expansion, the
ty base– and a simple you apply them? Here
leverage ratio was used rate of growth of bank in Spain, they were
by the Federal Deposit lending in particular, applied to provisions
Insurance Corpora- –through dynamic
tion under its Impro- which I am glad to say provisioning– and this
vement Act of 1991 the Banco de España is fine; with the benefit
(FDICIA), and has of hindsight I would
recently been introdu- has been employing for have liked them to
ced by the Swiss Na- a decade or so have done even more,
tional Bank for UBS but it runs into the
and Credit Suisse. difficulties that the ac-
countants under IFRS
Another measure is do not like this; they
credit expansion, the rate of growth of bank do not like generalised, economically asses-
lending in particular, which I am glad to say sed but not specific provisions being applied
the Banco de España has been employing on the grounds that such losses will probably
for a decade or so. We would add to that yet happen; the accountants say we have got to
another measure, that of maturity mismatch. wait until it does happen. So the dynamic
If a volatile asset is backed by a liability of provisioning arrangements here, which have
the same duration then the individual inter- been excellent and have helped in many ways
mediary holding that asset, or the company to mitigate the financial difficulties in this
holding that asset, can live through the vola- country, are under threat from the accoun-
tility as the price declines and rises without tant and, to some extent, from the taxman
getting into difficulties because it does not as well.
have to sell it because it is supported by a
sufficiently long-term liability. It is the com- What we want to do is to interact the measu-
bination of assets whose prices can go up and re of cyclical variation; whether it is a leverage
down very sharply and the fact that you have ratio, credit expansion, maturity mismatch
to roll over your liabilities in the intervening or bits of all of them, with Basel II, because
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10. it is quite easy to game a single ratio. It is less down, preferably in public, as a commitment
easy to do so if you combine a ratio which is and as a rule; not as discretion. Virtually all
counter-cyclical and macro-prudential with regulator/supervisors say we must have dis-
a Basel II ratio, which is micro-prudential; I cretion because every crisis is different, and
think it would be more difficult for the banks every institution is different and we need to
to get round it. However, there is a problem. have discretion to apply what needs to be
Which Basel ratio do you choose? Because done to fit the circumstances. I know that
there is core equity, core tier one, then there argument, but I think that there is a stronger
is tier one and then there is tier two. And counter-argument, and it runs as follows. In
attitudes to which is a 2006 –at any rate in
more important defi- the first half of 2006–,
nition of capital have the subprime market,
been changing quite which is now regarded
rapidly in the course as almost demonic, a
of the last six mon- devil’s plaything, at
ths, or so, and now that time, if you can
there is a tendency for cast your mind back,
people to put much was regarded as one of
more emphasis –as the the great innovations
Germans, to their cre- of finance, was re-
dit, would always have garded as wonderful;
wanted us to do– on it was a mechanism
the core-owned equity for getting the disa-
and not worry so much dvantaged of Ameri-
about hybrids and su- ca –the Latinos and
bordinated debt, and the Blacks– onto the
the rest of them. housing ladder. It was
a way of extending
This particular part of the argument, that finance to the under-privileged. The politi-
there should be macro-prudential and pre- cians loved it, indeed, the politicians went so
ferably counter-cyclical capital requirements, far as to require Fannie Mae and Freddy Mac
that part of the argument has been won; it is to alter their normal regulations to take on
now, I think, accepted by virtually everybody these lower quality, subprime, mortgages and
that that should be done. The problem is that actually led, in part, to the downfall of tho-
the devil is in the detail, and the details and se GSEs. The lenders loved it, because they
the coefficients, and how you actually do it, were making lots of money. The borrowers
has yet to be estimated. While we were more loved it, because they never had to repay the
concrete in the Geneva Report than the de reset. If you took out a subprime, you took
Larosiere Report, there is still a lot of hard it out at a teaser rate, after two years, your
work on the details be undertaken. house value had gone up, you re-financed
at a lower rate because you now had more
One point that I would stress here is that the- equity and you never ever paid the reset. The
re is an absolute need for these counter-cycli- idea that this was all terrible because people
cal macro-prudential requirements to be set should have known that they could nor pay
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11. the reset is a function of ex post hindsight; move together, do have systemic effects.
they were never expected to pay the reset rate
and they never expected to do so. It was all And our argument is that you should have
based on the teaser rate and refinance, but rather simple macro-prudential regulations
you could only do that as long as housing for them. Next, there are those financial
prices went up. But everyone thought that intermediaries which are non-systemic but
housing prices would go on going up. And large, mostly the life insurance and pension
the idea that under those circumstances, the funds, (excluding of course institutions like
Fed, or anybody else, could move in and say AIG, which behave effectively as investment
“I think this is wrong, I am going to raise banks), and finally there are the tinies, the
rates and require a much lower loan to value really small. Then, there is the home/host is-
ratio, I am going to raise margins, I am going sue and I am going to defer that, although I
to make sure that the poor Latinos and the am just going to note that cycles differ from
Blacks are not going to get on the housing country to country, so if your main aim is to
ladder”; they would not have stood an ear- have counter-cyclical regulation, how do you
thly by chance of succeeding. deal with that?
Central banks, trying to take away the pun- And then liquidity; as I have already said,
chbowl just when the party is getting going, there had been no liquidity regulations.
face the opposition of everybody, including Back in the 1980s, the Basel Committee on
the media, so you are not going to succeed. Banking Supervision tried their hand to in-
That is really why Alan Greenspan said you troduce liquidity regulation along the lines
cannot do counter-cyclical policy because it of the capital regulation, but it was just too
is too unpopular. So you have got to have difficult and they dropped it. After that, con-
rules and pre-commitment if you are ever cern about liquidity fell away on the basis in
going to do it. To whom should such capi- some part of the belief that wholesale mar-
tal requirements apply? Again there is now kets would always be there when you wan-
general agreement that all systemic financial ted them, as long as you had enough capital
intermediaries should have both micro and under the Basel II requirement; of course,
macro-prudential control. The difficult ones neither of those beliefs were correct. So we
are the second group in our taxonomy, tho- are going to go back to liquidity regulations,
se institutions that are systemic as part of a based on maturity mismatch. We now recog-
herd, for example when the hedge funds as a nise much more than we did then, that both,
group are taking on leverage and expanding not only the asset but also the liability struc-
and when private equity is doing the same. ture, are crucial.
They are actually too small to be individua-
lly systemic; lots of hedge funds have gone We also have in our paper a proposal on mark
bust, lots of private equity firms have gone to to funding, which involves the concept that
the wall, and nobody has cared much. They the ability to hold to maturity depends on
are not systemic in that sense, but when they the funding structure, so that banks with a
all move together they become systemic as a much longer term funding structure should
group. And the question then is what do you have lighter overall liquidity requirements
do with a group which are not systemic in- than the banks which are more heavily ba-
dividually, and can be let go, but when they sed on short term, and particularly wholesa-
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12. One of the more difficult issues is whether governments
or regulators should intervene in mortgage markets, for
example by imposing limits on loan to value ratios or loan
to income ratios
le, funding. The problem is that there have a year end spike in interest rates, because all
been incentives to finance potentially illiquid the financial intermediaries want to window-
assets on the basis of short term debt, both in dress their balance sheets to show they are
good times –because its cheaper then– and in much more liquid (than under normal cir-
bad times –because that is the only debt that cumstances they actually are). So there is an
you can raise–. But somehow we need to ba- intense demand for liquidity over this one
lance that, particularly during good times. day, and this intense demand for liquidity
over this one day or period when they are all
Other regulatory issues, notably remune- doing their balance sheets, does lead to very
ration, has been very much in the press re- considerable distortions and to weakness.
cently. Here, the approach that the FSA has And we think that this should be stopped
been taking, which I quite like, in the UK, and we cannot understand why the authori-
has not been to intervene in setting remu- ties in various countries have not taken steps
neration, but to set out some principles on to prevent this continuing.
which they believe that remuneration should
be based. If individual institutions which Now I want to get on to the really difficult
have control over their remuneration should part. Well, the first part is not so difficult;
not abide by those principles, then the FSA the question of who does these new macro-
has the ability to raise capital ratio require- prudential and liquidity regulations. Now,
ments on a discretionary basis. within each country, I do not think it is that
difficult. I think that the macro-prudential
One of the more difficult issues is whether should go to the central bank and the con-
governments or regulators should intervene duct of business and micro-prudential –loo-
in mortgage markets, for example by impo- king at the individual banks, business plan
sing limits on loan to value ratios or loan to and so on– stays with the specialist, if you
income ratios. We think that they should. have got one, financial services authority.
The FSA is going to introduce a new discus- That does lead to minor inefficiencies in the
sion paper on this in September. And then sense that there are two groups of people loo-
there is the question of what to do with cre- king at the same big institutions, but I think
dit rating agencies, which is a large subject, that that is a good thing, not a bad thing.
so I am going to skip over it now. One of the reasons why I think it is impor-
tant that the central bank does the macro-
Finally, one of the points which we raise, that prudential regulation is because the ethos
is not being taken up almost anywhere, is and professionalism of an institution who-
that a lot of the pressures arise in the run up se main function is conduct of business is
to the year end, when there is almost always mainly the professions of accounting and the
LOS RETOS ECONÓMICOS PARA EL FUTURO 71

13. legal profession. The profession of an institu- Then there are the Icelandic banks; the Ice-
tion doing macro-prudential controls ought landic banks in the UK were largely branches
to be economic interrelationships between of those banks; and as branches, their retail
institutions; that is what makes the system deposit insurance was supposedly guaranteed
as a whole work; and that is essentially eco- by their home country. The Icelandic banks
nomics; and the profession of a central bank went bust, and effectively the Icelandic go-
is increasingly economics. You need to have vernment was also bust, and there was no
two sets of eyes, (it helps if they come from effective payment of the deposit insurance of
different starting points), looking at each the retail depositors in those Icelandic banks
major financial institution. in the UK. A number of curious exercises
then arose. One of them was that, in order
Now let me go on, and this is where I end, to try and prevent such assets as remained
to the really tricky bit. And this is the cross- in the UK from going back to Iceland, when
border home/ host issue. this was clearly coming about, the British go-
vernment wanted to shut down the Icelandic
As I have said, cycles differ between coun- banks in the UK to hold their assets in being.
tries; there is a second factor as well, which They discovered that they did not have a de-
I earlier passed over, which is that we have cent mechanism for doing so, so what they
discovered that cross-border banks are inter- did was they shut down the Icelandic banks
national in life but national in death, which under the Terrorist Act. So a couple of days
means that when a big cross-border bank co- afterwards, you had a list of Terrorists in the
llapses, the home regulator and home coun- UK, there was Al-Qaeda, there were the Tali-
try will take strong steps to support and keep ban and there were the Icelandic banks. The
going the operations of the bit of that inter- Icelandics, bless them, tried to sue the British
national bank within its own country and government, but they were effectively war-
they either will not, or cannot, or do not care ned by all the lawyers that trying to sue the
about the bit that is in other countries. British government in Britain is not a very
sensible or a very productive legal process,
My own country has had a couple of parti- so they actually dropped that. I was rather
cular examples of that. Lehman Brothers, for sorry; I was rather hoping to appear as an ex-
example; the broker dealer of Lehmans in the pert witness for the Icelandics. The other fas-
US was wrapped in such a way that it could cinating exercise is that, in order to meet the
continue after Lehman’s went into chapter deposit insurance, the British government is
11 bankruptcy. Lehmans Europe, which I lending money to the Icelandic government
usually think of as Lehman’s London, becau- so the Icelandic government can pay off the
se that is where its head office was, was cast deposit insurance.
adrift, as was Lehman’s Tokyo, and not only
cast adrift, it was cast adrift as a shell, because Other examples, slightly less lurid, of the fact
all the cash that was available was taken back, that when a cross-border bank tends to go
the previous Friday night, to Lehman’s New down, the rescue is done by the host nation/
York and there was nothing much left there, state are Dexia and Fortis. What we have seen
in Lehman’s London, when it all went down is that when there is real trouble, when there
on the Monday morning. is crisis management that has to be done, it
is the nation/state that has to do it and that
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14. when you have a cross-border bank, effecti- tor debt. Now that has immediately put the
vely the bit in your country, if you want to cat among the pigeons of all the other banks
keep it going rather than have it collapse in a –international banks with subsidiaries in
heap around your feet, has to be done by the London– because they can no longer manage
host country. their liquidity on a single home-headquarter
basis, moving their liquidity around the
Now combine that with the fact that cy- world as they see fit. So this liquidity requi-
cles differ from country to country and the rement is actually again shifting the power to
standard implication of the experience of the host country and putting frictions into
crisis is that the regulatory power, on the the international financial system, so this
macro-prudential side, should shift from whole international issue is really very, very
the home country to the host country. That difficult.
is where logic leaves it. The difficultly with
this, and particularly within the Euro zone, The final point I have got here is what we are
is that there is an equivalently strong desi- going to do about the international financial
re to harmonise and centralise regulation institutions of which the IMF –where José
and supervision, at the ECB / EC level in is going to become one of the pillars of the
such a way as to protect the single financial IMF– is the most important; there are a lot
market. And I understand that. But there is of issues related to the IMF, I do not have
this now enormous tension between the fact time to go into them. And if you want to
that crisis management is done effectively raise any questions about the IMF, ask José,
at the host country, host nation /country / he will now answer that.
state, and that cycles differ from country to
country and at the same time the desire to The financial stability forum: I will just end
have a much more European system. Whe- with a couple of comments on that. Like
re this tension will actually lead us all, I do the IMF, it is under attack because it is not
not know. I would very much like to see a sufficiently democratically legitimate and it
mechanism for providing fiscal support for is much too overly represented by G7, par-
crisis management devised and developed at ticularly again the Europeans, rather like the
the Euro zone or European level, but no such IMF.
mechanism is yet on the cards. So quite what
will happen on home vs. host control –which And finally in so far as the FSF or the BIS
is the really tricky issue on financial regula- introduces early warning procedures, the key
tion, particularly when you get into macro- point is not the warning; there were loads
prudential field– I do not know. of warnings before 2007; Bill White, the
chief economist of the BIS, was a one man
Let me give you just one more example, after early warning system, the problem was: you
Lehmans and with the appreciation that it always get warnings; what happens when you
is essential that banks do hold sufficient li- have made the warning? What is the proce-
quidity –asset liquidity–, the FSA in London dure to take from the warning into actual
has introduced recently a requirement that instruments that change the way that banks
all banks in the UK, including subsidiaries behave? It is instruments and procedures we
but not branches, should be required to hold need, not early warning systems.
liquidity in the UK in the form of public sec-
LOS RETOS ECONÓMICOS PARA EL FUTURO 73