Posted by: Dirk | July 6, 2010

Group of Experts in Banking Issues (GEBI)

The above is EU slang for a committee that “will advise the Commission on policies and possible legislative proposals concerning banking regulation. Secondly it will provide information, forecasts and analysis concerning the possible impact of banking policies and possible legislative proposals on various stakeholders” (source: EC). So, who is in that commission? Before I answer this question, here is a look at the commission that the EU had before the GEBI:

The banks have become past masters in the art of what’s known as entryism. For example, the legislation being drafted on European financial oversight stems straight from a report drawn up for the Commission and submitted on 25 February 2009. Now that report, which espouses “light-touch” regulation, was prepared by a group of “experts” presided over by Jacques de Larosière (ex-Banque de France chief, but more importantly current advisor to the CEO of BNP-Paribas).

Of the seven professionals by his side, three are from the private sector, even if they have held public posts at one time or another: Rainer Masera (ex-Lehman Brothers), Otmar Issing (Goldman Sachs) and Onno Ruding (Citigroup). Which makes four bankers (from three US banks). And then there’s Callum McCarthy, ex-Chairman of the UK Financial Services Authority, notoriously opposed to tight oversight. In other words, a majority of the panel are from or close to the financial industry. So how can we possibly wonder at the outcome?

It will come as no surprise then that ALTER-EU, the anti-lobbying organization, has issued a report last November that is summarized on their website as follows: “The vast majority of financial ‘experts’ advising the European Commission represent the banks and investors responsible for the global economic crisis, according to a new report published today by the Alliance for Lobbying Transparency and Ethics Regulation (ALTER EU).”

Now, the Group of Experts in Banking Issues (GEBI), you will not be surprised to learn, has 40 members, of which one is representing unions and 2 are representing consumers, according to the TAZ. US and European banks are in the majority. I have still in my ear the words of EU president Manuel Barroso’s June 23rd his speech in the European Parliament:

The second key area where we reached important agreement was financial services. We all know that the job here is not complete. And we all know how important it is to have the right regulatory basis for sound and responsible financial services in place, to give confidence that we have the bulwarks in place against future pressures.

Here of course the role of this Parliament is essential. As I did with Heads of State and Government last week in the European Council, I would likewise appeal to you to make every effort to ensure that the proposals on financial supervision are adopted before the summer break – so that the new arrangements can be in place for next year. The same urgency is there for alternative investment fund managers and capital requirements.

So what we have here is a political problem. It’s not that economists are wrong, it’s just that if you are not associated with the financial sector you will not get an opportunity to participate in drafting laws. Only those economists working for the financial industry get to make the rules that concern exactly that industry. While this is how it works in reality, the politicians (I don’t dare say “policy-makers”) – like Barroso above – try to put up a smoke screen by delivering speeches and promises in order to make the people believe that the EU is tackling the financial issues in order to produce the best rules possible – best for the people, no the bankers.

George Stigler in his “Theory of economic regulation” has described the mechanism in 1971 already:

Regulation may be actively sought by an industry, or it may be thrust upon it. A central thesis of this paper is that, as a rule, regulation is acquired by the industry and is designed and operated primarily for its benefit. There are regulations whose net effects upon the regulated industry are undeniably onerous; a simple example is the differentially heavy taxation of the industry’s product (whiskey, playing cards). These onerous regulations, however, are exceptional and can be explained by the same theory that explains beneficial (we may call it “acquired”) regulation.

While this blog was never intended to be a political blog, even economists cannot ignore the way things work in politics. In our models we have central banks which want to minimize inflation and unemployment, and there seems to be a trade-off. The preferences of the central bank in these models are that they favor both low inflation and low unemployment. In today’s system, it seems that the ECB doesn’t care too much about inflation or unemployment. It cares a lot about protecting financial assets and the financial industry, however. Here is Paul Krugman quoting ECB president Trichet:

But don’t worry: spending cuts may hurt, but the confidence fairy will take away the pain. “The idea that austerity measures could trigger stagnation is incorrect,” declared Jean-Claude Trichet, the president of the European Central Bank, in a recent interview. Why? Because “confidence-inspiring policies will foster and not hamper economic recovery.”

Well, it has been clear to me for a long time that inflation-targeting is a dead theory that has been useless since the beginning of the crisis in mid-2007. It seems that the ECB is now guided by what Krugman calls the “confidence fairy”. The underlying economic theory is that of “balancing the budget”, which drove economies into a hole in the Great Depression. Ben Bernanke is supposed to be an expert on this, but somehow it seems he has not understood the Great Depression as well as he thought.

Macroeconomics has taken a huge leap backwards in the last 30 years. It is the failure of ideas that has led to the financial crisis, I believe. The DSGE (Dynamic Stochastic General Equilibrium) models fail when inter-temporal substitution breaks down, like in a crisis. The models also failed to highlight the problems while they were building up. Economists should have discussed more, and by that acting like real scientists. Instead they chose to go down the mathematical avenue, which led them to believe that they can rule the world with a bunch of sophisticated equations.

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