Next Monday sees the sixth anniversary of the collapse of Lehman Brothers. That bankruptcy has been blamed for the Global Financial Crisis and the meltdown in the Irish economy. Economic historians are already arguing about what would have happened if Lehman had not been allowed to fail.
This is a nuanced debate. It is hard to find anybody who now thinks that letting Lehman go to the wall was a good idea. But that’s where the debate starts: there is plenty of disagreement about what would have happened next. Some argue that the world was in such a parlous state that a financial collapse was inevitable; another catalyst, a different trigger, would have sparked a similar crisis even if Lehman was still in existence today. Others, a minority I think, suggest that we would have avoided a lot of the pain that subsequently transpired.
‘What-if’ experiments
These kinds of 'what-if' thought experiments are fun for the protagonists but pretty useless for the rest of us. We will never know what would have happened next if, like Merrill Lynch and all the other venerable US financial names, Lehman been rescued. Another, related, debate is over the lessons that we can learn from the different policy responses adopted around the world, given that Lehman's bankruptcy did catalyse a global recession.
Lots of books, learned articles and acres of commentary have sought to explain and understand the events of the past six years. One of the most recent efforts has been penned by the FT's Martin Wolf and is probably the best of the lot. It's a big book with a long title: 'The Shifts and the Shocks: What We've Learned - and Have Still to Learn - From the Financial Crisis'. Anyone who has read Wolf's FT (and Irish Times) articles over the last few years will be familiar with the themes pursued in his latest book. He isn't impressed with many finance ministers, is grudgingly approving of some central bankers and is scathing with just about anybody who claims to be in charge of the euro area. And he wants to completely rebuild, from the ground up, the global banking system.
Demystifying finance
The arguments about banks are quite simple. The reason they got into trouble is that they employ far too much leverage. At this point I recommend another new book, the excellent 'How To Speak Money' by John Lanchester. Anyone who wants to demystify finance and economics should read this excellent primer on the jargon that we use, usually to obscure rather than to clarify. Both Lanchester and Wolf are fans of the idea that banks should be made to use a lot less leverage. To be fair, so are regulators: there have been several rounds of new rules forcing banks to change the way they finance themselves. When banks use other people's money to make loans, that's leverage. When they use their own cash - well, the trouble is, they do far too little of this. And Wolf thinks regulators have been timid in the extreme in their efforts to curb banking excess: He wants to turn banking upside down: banks should use their own money when they make loans.
This would be nothing short of a financial revolution: it would not eliminate systemic banking risk completely but it would remove the ability of banks to create money out of thin air. This is more than a technical point: money creation is highly profitable and should be taken away from banks and restored to its rightful owner, the State. Anybody who thinks about banking for more than 10 minutes usually comes to this conclusion.
Best shape
Those countries that responded to Lehman with expansionary fiscal and monetary policy have come out of the crisis in the best shape. Essentially, that’s the US and the UK. The British talked more than they delivered on austerity; the Americans actually had a moderate fiscal expansion. Both countries had the wisdom to expand central bank balance sheets; by trillions of dollars in the case of the US. Europe only delivered fiscal austerity and is now thinking about billions, not trillions, of central bank asset purchases. The results of these economic policy experiments are plain for all to see.
Most economists currently agree on one thing: European policy makers are nuts to resist the free money that markets currently offer them. If the cost of capital is zero - or even negative - it cannot be too hard to find public sector infrastructure projects that yield a return in excess of the cost. That speaks to a potential budget priority for Michael Noonan, one that nobody mentions in the cacophony of calls for immediate tax cuts. The only real cuts in Irish public spending were to the capital budget. Priority should be given to public sector investment, not current spending or taxation. Restoration of the capital budget should be the budget priority for the next few years.
