Never have governments and central banks spent other people’s money more freely to support incomes and boost banking system liquidity. Never before have the world’s major central banks’ policy interest rates been clustered so close to zero, if not already in negative territory.
Trillions of dollars of new debt will be stacked onto the mountain of debt that the US, the European Zone area and the UK piled up during the 2008-12 Global Financial Crisis (GFC). Yet none of them seems to have an effective plan to wind back the debt before the next crisis.
There is more than a whiff of desperation in the language governments and central bankers use to boost investor confidence and market activity. They appear to expect the public to take it for granted that its money will be spent wisely and prudently.
On 17 March, the UK chancellor of the exchequer Rishi Sunak promised to do “whatever it takes” to shore up the economy and support businesses in response to Covid-19.
“This is not a time for ideology or orthodoxy,” he declared. “It is a time to be bold, a time to have courage.”[1] He was of course talking about spending taxpayers’ money, not his own.
At December 2019, general government financial liabilities in the UK already exceeded financial assets by 80% of GDP. For the US it was a bit more and for the Eurozone it was over 60%. These are extraordinarily high peacetime ratios.
Central banks are also promising the earth. On 23 March, the US Federal Reserve announced a raft of support measures to deal with falling bond and share market prices.
These included an open-ended commitment to buy “Treasury securities and agency mortgage-backed securities in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy.”[2] That effectively told financial markets that it would spend “whatever” amount is needed.
Collectively, the central banks of the major G7 countries purchased securities worth about $US1.4 trillion in March 2020 – nearly five times the amount spent in the previous record month of April 2009. The US Fed has injected so much new liquidity in the first five months of the year ($US3 trillion) that its liabilities are now eight times higher than at the end of 2007.
What should be unprecedented has become worryingly normal.
The ratcheting up of public debt and liquidity with no credible plan for unwinding the excess is deeply disturbing for international financial stability and social cohesion. Technocratic language about preventing financial market disruption and banking system stress hides the reality that people who borrow heavily to chase higher yields in risky assets are being bailed out by the taxpayer.
Incentives have become perverse. High public debt ratios mean governments benefit fiscally from keeping interest rates artificially low and that encourages people to borrow rather than save. Authorities who tell investors they will do “whatever it takes” to insulate them from the consequences of their risky actions are compounding the problem. It is a road to disaster.
A for-profit system does not work when the greedy and imprudent can take big financial risks (often with other people’s money) and pocket any profits along the way, but when things turn sour the governments and central banks step in to limit their losses. The 2008 GFC proved it does not work.
Perhaps the most infamous and revealing comment about the perverse incentives of the situation was made to the Financial Times in July 2007 by then-chief executive of Citigroup, Charles Prince. He explained his group’s attitude to chasing profits from leveraged lending despite the risk by saying, “as long as the music is playing, you’ve got to get up and dance.” Only someone who didn’t care much about losing other people’s money could say such a thing.
Citigroup lost billions of dollars in the next three months and Prince resigned – but he still received $US38 million in bonuses, shares and options. Perhaps Citigroup was legally obligated to pay that bonus, but that would only underline how the remuneration system served the interests of management, rather than shareholders.
The public anger and outrage about that scenario was entirely reasonable. People were losing their homes and livelihoods while those who peddled over-priced and over-rated securities kept their wealth and weren’t sent to prison for negligence or fraud.
Admittedly the problem is not confined to Wall Street. Politicians spend other people’s money too and often fail to prove that their spending will benefit the wider community.
To any serious student of economics, a cavalier approach to risk, or to proving value-for-money from spending, point to a problem with institutionalised incentives.
A paper published last Friday by The New Zealand Initiative – Doing Whatever it Takes with Other People’s Money – traces this ongoing incentive problem back to the 1980s and 1990s when the “too big to fail” philosophy among central banks towards large multinational banks emerged.
That philosophy was dangerous then and it is dangerous now. No bank or government is too big to fail.
Under chairman Alan Greenspan’s direction from 1987 to 2006, the US Federal Reserve so regularly eased monetary policy to help Wall Street that the term “Greenspan put” was coined to describe how the Fed could be expected to underpin all high bond and share market prices.
This destabilising expectation was endorsed officially in 2012 when European Central Bank president Mario Draghi assured investors he would do “whatever it takes” to save the euro. Of course, he was throwing other people’s money at the problem too.
In the interests of social cohesion and financial stability, New Zealand should resist corporate welfare and going further down the path of rising public debt, increasingly bloated central bank balance sheets, and artificially low-interest rates. What is needed is a clear path back from these trends and a much greater focus on value-for-money from monetary and fiscal policy actions.