Each episode of financial disaster is a little different than the others
I spent Wednesday and Thursday of this week at a conference called “Are we ready for the next financial crisis?” Held at the Rotman School of Business at the University of Toronto, it was a terrific conference—i.e., both fun and interesting—bringing together academics, practitioners and regulators and topping off with a speech by Carolyn Wilkins, Senior Deputy Governor of the Bank of Canada.
A sad note was that the conference had been the brainchild of Prof. Christopher Kobrak, Wilson/Currie Chair of Canadian Business and Financial History at Rotman, who died suddenly in January 2017 and so did not see his idea to fruition. (Conference participants did receive a copy of the just-published book “From Wall Street to Bay Street: The Origins and Evolution of American and Canadian Finance,” which Kobrak co-authored with his colleague Joe Martin, director of Canadian Business History at Rotman.)
That the conference was held when it was is no accident. This week marked the tenth anniversary of the sudden collapse of the U.S. investment bank Bear Stearns and its Fed-mediated rescue by JPMorgan Chase, originally at a price of $2 a share, later amended to $10. In retrospect the handling of that episode looks almost textbook, certainly in comparison to what followed. But at the time there was blowback, especially in Congress, about taxpayer money being used to help one big bank take over another. There’s a school of thought that being burned politically in Bear Stearns caused regulators to hesitate six months later when Lehman Brothers got into similar trouble but ended up not being bailed out. Shock that Lehman was allowed to fail triggered a negative cascade in the stock market.
A phrase heard almost hourly at the conference was “this time is different.” That’s the wry title of an influential 2009 book (sub-head: “Eight centuries of financial folly”) by Kenneth Rogoff and Carmen Reinhart. The usual understanding of the phrase “This time is different” is that it’s how participants in speculative bubbles persuade themselves the frothy effervescence will continue indefinitely—long enough for them to make money at least—and will not end in tears, as most have done over the 800 years Rogoff and Reinhart cover.
But “this time is different” has another, more literal meaning. The social pathologies may always be the same, but in fact each episode of financial disaster is at least a little different from all the others. First it’s tulips, then it’s South Sea settlements, then it’s railways or gold or a new kind of investment vehicle or, most recently, it’s technologies for spreading risk that, when people don’t understand them, actually end up compounding risk by facilitating fraud, as mortgage-backed securities did in the run-up to 2008.
So it wasn’t entirely reassuring when several conference participants told us how much progress has been made over the last 10 years addressing the vulnerabilities in the financial system that are generally thought to have helped the trouble begin and then spread—much faster than wildfire—to the rest of the economy. In particular, work has been done to improve financial institution capital ratios and to create clarity about how the burden will be shared if, or more likely when, the next big institution goes down and has to go through “resolution.”
The reason all this wasn’t completely reassuring is that next time very likely will be different. The asset will be different or the institutions will be different or the technology or the area of the world or the precise channels of contagion will be different. That generals supposedly are always fighting the last war is thought to be a convincing knock against generals. Not so. Generals are people, too, and it would be very stupid of them if they lost another war the same way the losing side had lost the last one. Besides, figuring out how the last war should have been fought is far easier than deciding how the next one will be. Generals are not granted the gift of precognition any more than the rest of us. No one knows what’s coming next.
On a couple of conference panels, people were asked what keeps them awake at night. “Cyber” was a common answer, meaning cyber attacks or other computer disasters. On another, the question was “What unknown unknowns we should worry about?”—to which the usual answer, quite reasonably, was that if we knew that, they wouldn’t be unknown.
It was at least a little heartening that those who worked in one part or another of financial regulation seemed to understand that, while they would be negligent not to spend at least some time looking backward, they also needed to stay nimble and alert and keep to hand large pools of liquidity to quickly douse any local fires that do break out, wherever that may be next time round, so as to prevent conflagration.