Banking System Like South Sea Bubble

[BROF]

http://www.guardian.co.uk/business/2009/ju...outh-sea-bubble

'Banking became the goose laying the golden eggs. There is no period in recent UK financial history which bears comparison,' says executive director for financial stability

A senior Bank of England official today compared the banking system over the last 20 years to the South Sea bubble of the early 18th century and said bankers had merely "resorted to the roulette wheel" to keep up with each other.

The Bank's executive director for financial stability, Andy Haldane, said in a speech in Chicago that having been stable over much of the 20th century, returns in the banking system relative to the wider stockmarket shot up after 1986 until 2006.

"Banking became the goose laying the golden eggs. There is no period in recent UK financial history which bears comparison," he said.

He said bankers and policymakers became seduced by the excess returns available: "Banks appeared to have discovered a money machine, albeit one whose workings were sometimes impossible to understand.

"One of the South Sea stocks was memorably 'a company for carrying out an undertaking of great advantage, but nobody to know what it is'. Banking became the 21st-century equivalent."

He said banking returns over the period were magnified by leverage as banks borrowed excessively, he said.

"During the golden era, competition simultaneously drove down returns on assets and drove up target returns on equity. Caught in this crossfire, higher leverage became banks' only means of keeping up with the Jones's. Management resorted to the roulette wheel."

He noted that the 80% slump in bank shares since the credit crunch hit meant that returns from the sector were now back in line with their longer-run average (see graphic above). The market capitalisation of global banks has fallen by $3tn (£1.8bn) since the crisis began, he said.

"We should aspire to a financial system where there is greater market and regulatory scrutiny of future such money machines. In achieving this, there is a role for some body – a systemic overseer – which is able to detect incipient bubbles and fads and, as importantly, act to correct them. This role is about removing the punchbowl from future financial sector parties."

He said that in future there would have to be a greater distinction between management skill, which improves return on assets, and luck, when return on equity can be magnified by leverage.

"Good luck and good management need to be better distinguished. Put differently, returns to investors and managers need to be more accurately risk-adjusted if the right balance between risk and return is to be struck for individual firms and for the financial system as a whole."

A second lesson, he added, was that there would have to be much stricter system-wide limits on leverage, particularly among big banks whose stability is crucial to the whole financial system.

"For a number of diseases, 20% of the population account for around 80% of the disease spread. The present financial epidemic has broadly mirrored those dynamics," he said, adding that the failure of a core set of large, interconnected institutions such as Fannie Mae, Freddie Mac, Bear Stearns, Lehman Brothers and AIG contributed disproportionately to the spread of financial panic.

"Epidemiology provides a second key lesson for financial policymakers – the importance of targeted vaccination of these 'super-spreaders' of financial contagion. Historically, financial regulation has tended not to heed that message."

He welcomed a recent move by US authorities to bring the trading of credit derivatives, which were at the heart of the crisis, on to exchanges so they could be better understood and controlled. "This is a bold measure and one which deserves international support."

Haldane's speech was part of a growing debate among global policymakers to try to build a better system of regulation and control of the financial system to prevent such crises as the current one from occurring again.

[Guest sillybear2]

Yup, and the corrupt Parliament were all in on it too, just as this bunch are with their flipping and property empires.

Edited July 1, 2009 by sillybear2

[OnlyMe]

"We should aspire to a financial system where there is greater market and regulatory scrutiny of future such money machines. In achieving this, there is a role for some body – a systemic overseer – which is able to detect incipient bubbles and fads and, as importantly, act to correct them. This role is about removing the punchbowl from future financial sector parties."

Utter ********.

There already is one - with a remit to target financial stability.

The gamblers at the banks were happy to carry on gambling because the central bank kept on supplying them (and everybody else) with cheap money by artificially manipulating the interest rates.

[Meerkat]

In achieving this, there is a role for some body – a systemic overseer – which is able to detect incipient bubbles and fads and, as importantly, act to correct them.

This Mr Somebody is called "free market", i.e. no government intervention. No bubbles in the first place. And no need for anybody to detect them. Easy. Less bureaucracy, less taxes.

Edited July 1, 2009 by Meerkat

[A.steve]

There already is one - with a remit to target financial stability.

The gamblers at the banks were happy to carry on gambling because the central bank kept on supplying them (and everybody else) with cheap money by artificially manipulating the interest rates.

Unless "financial stability" is clearly defined (which it hasn't been) then the obligation for a symmetric CPI target tied the Bank of England's hands. Banker gamblers continued unchecked because the BoE had been stripped of its role in overseeing them - and this role was handed to the FSA - a body wholly unfit for purpose... staffed by the same charlatans who went on to milk the banking industry in the private sector. The problem (post 1997, at least) has been principally with the regulator not the bank... though, in the previous decade, it is hard to argue that the BoE didn't bear at least some responsibility... though, at the time, it was not "independent" - so ultimate responsibility must sit with the Treasury and government.

[interestrateripoff]

This Mr Somebody is called "free market", i.e. no government intervention. No bubbles in the first place. And no need for anybody to detect them. Easy. Less bureaucracy, less taxes.

Not quite.

The free market is quite capable of creating it's own bubbles.

[Guest sillybear2]

Somebody should have set up a website warning about the housing and debt bubble then people would have took them seriously and made amends before things got too out of hand, and there should have been a kind of supra-national financial body that issued economic fatwas on Brown's errant ways, and everyone would have took them seriously too.

[Meerkat]

Not quite.

The free market is quite capable of creating it's own bubbles.

Surely not a credit bust re-inflated every time it's about to pop by the almighty govy controlling money supply?

[Injin]

Somebody should have set up a website warning about the housing and debt bubble then people would have took them seriously and made amends before things got too out of hand, and there should have been a kind of supra-national financial body that issued economic fatwas on Brown's errant ways, and everyone would have took them seriously too.

[Harry Monk]

Dutch Tulip Bulb Market Bubble

One of the most famous market bubbles of all time, occurred in Holland during the early 1600s when speculation drove the value of tulip bulbs to extremes. At the height of the market, the rarest tulip bulbs traded for as much as six times the average person's annual salary.

The tulip was brought to Europe in the middle of the sixteenth century from the Ottoman Empire. Holland's upper classes soon competed for the rarest bulbs as tulips became a status symbol.

By 1636, tulip bulbs were traded on the stock exchanges of numerous Dutch towns and cities, encouraging all members of society to speculate in the markets. Many people traded or sold possessions to participate in the tulip market mania. Like any bubble, it all came to an end in 1637, when prices dropped and panic selling began. Bulbs were soon trading at a fraction of what they once had, leaving many people in financial ruin.

Same as that.

[interestrateripoff]

Surely not a credit bust re-inflated every time it's about to pop by the almighty govy controlling money supply?

It depends on how you wish to view the free market and how you want to interpret govt actions.

[Sinking Feeling]

I would say more like like the Mississippi scheme where a Scottish lunatic got a whole nation (France) to buy into his giant ponzi scheme, then when the plan started to collapse he (John Law) decided to print lots of money to put everything right again - which was unfortunately an unmitigated disaster.

Or perhaps the Darien Scheme where a Scottish lunatic (William Patterson) decide to get a whole nation to invest in his giant ponzi scheme which led to almost bankruptcy of the nation (Scotland).

[tinker]

I would say more like like the Mississippi scheme where a Scottish lunatic got a whole nation (France) to buy into his giant ponzi scheme, then when the plan started to collapse he (John Law) decided to print lots of money to put everything right again - which was unfortunately an unmitigated disaster.

Or perhaps the Darien Scheme where a Scottish lunatic (William Patterson) decide to get a whole nation to invest in his giant ponzi scheme which led to almost bankruptcy of the nation (Scotland).

What are you trying to say?

[lowrentyieldmakessense(honest!)]

I would say more like like the Mississippi scheme where a Scottish lunatic got a whole nation (France) to buy into his giant ponzi scheme, then when the plan started to collapse he (John Law) decided to print lots of money to put everything right again - which was unfortunately an unmitigated disaster.

Or perhaps the Darien Scheme where a Scottish lunatic (William Patterson) decide to get a whole nation to invest in his giant ponzi scheme which led to almost bankruptcy of the nation (Scotland).

i see a connection here to our glorious 0% growth leader

[shedfish]

Banking System Like South Sea Bubble

[lowrentyieldmakessense(honest!)]

Unless "financial stability" is clearly defined (which it hasn't been) then the obligation for a symmetric CPI target tied the Bank of England's hands. Banker gamblers continued unchecked because the BoE had been stripped of its role in overseeing them - and this role was handed to the FSA - a body wholly unfit for purpose... staffed by the same charlatans who went on to milk the banking industry in the private sector. The problem (post 1997, at least) has been principally with the regulator not the bank... though, in the previous decade, it is hard to argue that the BoE didn't bear at least some responsibility... though, at the time, it was not "independent" - so ultimate responsibility must sit with the Treasury and government.

you dont need to worry about financial stability if fractional reserve banking is abolished

the central bank ultimately benefit the banks only

but yes the FSA are a complete waste of money - like most regulations

[Guest sillybear2]

lowrentyieldmake... has John Law as his avatar

He was also a convicted murder that escaped justice and a compulsive gambler.

[Injin]

you dont need to worry about financial stability if fractional reserve banking is abolished

the central bank ultimately benefit the banks only

but yes the FSA are a complete waste of money - like most regulations

You cannot abolish pretending to have money.

[weebag]

You cannot abolish pretending to have money.

Yet another thread ******ed up by Injin.

I call for troll status.

[Injin]

Yet another thread ******ed up by Injin.

I call for troll status.

What's wrogn wioth that comment?

You cannot abolish fractional reserve banking because it's simply a mechanism where some people pretend to have money they don't and are believed.

You only find out when it goes wrong and that doesn;t fix the problem, now does it?

p.s do you ever post except to do sarky responses to mine?

[Meerkat]

Bulbs were soon trading at a fraction of what they once had, leaving many people in financial ruin.

Harry, hijacking your quote, just to expand the subject, as there are accounts suggesting that the bubble was created by artificial intervention and regulation.

Here is a UCLA professor's take on tulipmania from wiki:

On February 24, 1637, the self-regulating guild of Dutch florists, in a decision that was later ratified by the Dutch Parliament, announced that all futures contracts written after November 30, 1636 and before the re-opening of the cash market in the early Spring, were to be interpreted as option contracts. They did this by simply relieving the futures buyers of the obligation to buy the future tulips, forcing them merely to compensate the sellers with a small fixed percentage of the contract price.[45]

Before this parliamentary decree, the purchaser of a tulip contract—known in modern finance as a futures contract—was legally obliged to buy the bulbs. The decree changed the nature of these contracts, so that if the current market price fell, the purchaser could opt to pay a penalty and forgo receipt of the bulb, rather than pay the full contracted price. This change in law meant that, in modern terminology, the futures contracts had been transformed into options contracts. This proposal began to be debated in the fall of 1636, and if it became clear to investors that the decree was likely to be enacted, prices probably would have risen.

Thompson states that actual sales of tulip bulbs remained at ordinary levels throughout the period. Thus, Thompson concludes that the "mania" was a rational response to changes in contractual obligations.

Just interesting that, again, the bubble was created by an intervention of the parliament if this guy's interpretation of the distant event is correct. Smells of moral hazard. Familiar? Keep all the upside while downside is limited.

Edited July 1, 2009 by Meerkat

[Dave Spart]

I hear a certain Wall St bank is going into confectionary. Goldman Snacks's product range will include chocolate bars named "Aero" and "Whispers".

[godless]

I hear a certain Wall St bank is going into confectionary. Goldman Snacks's product range will include chocolate bars named "Aero" and "Whispers".

and crunchie.

[shedfish]

...not forgetting Double Decker, with it's mezzanine super senior tranche of chewy nougat

[shedfish]

lyin' bar

milk away

black hole nut