The flawed global financial system essentially holds all major governments hostage. Whenever a crisis happens, the policy priority is to stabilize the financial system for short-term economic stability. This tends to favor TBTF financial institutions. Every crisis makes the problem bigger.
The vicious cycle between short-term economic stability and long-term financial risk begins with central banks easing monetary policy to stimulate growth. The systemic distortion of the price of money rewards speculation, which tends to make some financial institutions bigger and bigger over time.
True global stability will only come when major governments are willing to sacrifice short-term growth for long-term stability. That threshold will only be reached when the short-term situation is beyond repair. An inflation crisis is what it takes to change the policy dynamic.
The situation needs to get worse before it gets better.[…]
The accepted remedy for TBTF is to increase regulations, sort of turning big banks into semi state-owned banks. China is already there. If the government takes on the downside, why not become the owner to get the upside too. What Western governments are doing is to decrease the downside risk, not taking the upside. Neither is likely to work. Financial institutions tend to work for employees, not shareholders, customers or governments.
The U.S. government is trying to limit what banks can do. European governments try to limit bankers’ compensation. The Chinese government is trying to tell banks who to lend to. All have limited effectiveness and have incentivized shadow banking.
It is widely believed that U.S. banks have deleveraged, which is touted as one benefit of the Fed’s policy of low interest rates. But, the total debt outstanding for U.S. financial institutions, though down from the crisis level in 2008, is similar to that in 2006 when America’s housing bubble peaked. When the interest rate is near zero, what would be the incentive for banks to decrease leverage? It should be the opposite.
The euro zone banking system is over three times GDP in asset size. Any conceivable speed of deleveraging would take a decade or two to bring it down to a safe level. Regardless of what euro zone banking policies are, the TBTF problem will remain for the conceivable future.
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Dr Andy Xie 謝國忠 is Shanghai-based independent economist specialising in China and Asia. He is currently director of Rosetta Stone Advisors and of China Boqi Environmental Science and Technology.
Dr Xie is one of the few economists who has accurately predicted economic bubbles including the 1997 Asian Financial Crisis and the more recent subprime meltdown in the United States. He joined Morgan Stanley in 1997 and was Managing Director and Head of the firm’s Asia/Pacific economics team until 2006. Prior to that he spent two years with Macquarie Bank in Singapore, where he was an associate director in corporate finance. He also spent five years as an economist with the World Bank.