This month, on the tenth anniversary of the global financial crisis, ten European finance ministries put together a position white paper to advocate that any public debt in the Eurozone, selected for restructuring, must be absorbed by the private sector up to a critical point, presumably the institutions’ solvency thresholds, before a public bail-out is imposed and carried out. The anniversary itself is also marked by a series of events, reviews and meetings to summary what we have learned, and what we can do better to prevent another such occurrence, where practitioners, academics, and public servants share their experiences, research, and recommendations. One such thought, emerging from the conversation, is for the construction of pre-defined and pre-agreed crisis management protocols, where all engaged parties, such as CEO’s of systemic banking and insurance institutions, central bankers and treasury ministers, are all aware of the available resources, responsibilities, and logistical steps to be taken in a time of severe financial crisis.
The Eurozone white paper proposal is a step in this direction. Such protocol adoption is aimed to improve transparency and extinguish any ambiguity to the capabilities and responsibilities of the public sector during such events, but also in the expectations of private market players. Foremost all key players are expected to have full comprehension of all steps and measures with timelines to be taken, once the alarm call is sounded. In a sense this framework aims to minimize uncertainty and ambiguity of prescribed actions. Secondly the size of available resources and funds to be deployed for crisis mitigation should be perfectly well known well in advance, and preferably at any time, to all market players and business originators. Both such foundational principles, put in place, are expected to have some preventive effect on risk takers. This should advance optimal risk reward, but also, loss and salvage type of decision making. This is optimal for the logistics of crisis managements, but also deters speculative players, which may interpret uncertainty and lack of clarity in action, as market signals of further trouble to come. One disadvantage of pre-defined protocols is that they may create an environment of moral hazard. Once institutions are aware that reserves are available to bail out, even in a limited capacity, they may modify their behaviors to take advantage of public funds. The strategy of predictable ambiguity by some central banks is thus justified.
When financial crisis come in their own unpredictable cycles, and all best laid plans fall apart in contact with reality, they come as a leveler of excess economic activity, whether it is supply of personal, corporate or sovereign credit, or fiat money. They play the market role of a Darwinian elector, or as Adam Smith put it an ‘invisible hand’, which separates the healthy from the sick market players. So the arrival of periodic crisis itself, as in the world and philosophies of Darwin, Hobbes, and Smith, becomes an overwhelming super regulator of economic health, which does not allow for poor economic actors to be propped up, but to be let to go to extinction with an inevitability of course of this simple mechanism, which has proved to be predictable, much more so, than interventionist action, and predictable many times over through time. Economic and social theories aside, ten years ago, the women and men at the Bank of England, the European Central Bank, and the Federal Reserve did not adhere to primal or economic Darwinism, did not view the world through the prism of Thomas Hobbes, and acted quickly and decisively to prop up the failing financial actors, and prevent a domino effect spreading across the rest of the economy. It was instinctive action more that prescribed protocol. Nonetheless, this time, it just about worked.
Location: New York, NY, USA