Wednesday, April 01, 2009
Hitler’s Specter Inspires Bill White to Battle With Greenspan
White challenged the former Federal Reserve chairman’s mantra that central bankers can’t effectively slow the causes of asset bubbles when he was chief economist at the Bank for International Settlements.
As heads of state gather for tomorrow’s Group of 20 summit, several former central bankers and regulators are advising them to advance the same arguments White has made for more than a decade: raise interest rates when credit expands too fast and force banks to build up cash cushions in fat times to use in lean years.
“We started worrying about this at the same time that Alan Greenspan started worrying about irrational exuberance” in 1996, said White, a Canadian who has remained in Basel, Switzerland, since retiring from the BIS in June. “The difference was he stopped worrying about it, or at least he stopped worrying about it publicly, and we didn’t.”
Chiefs of the world’s 20 biggest economies, including U.S. President Barack Obama and Chinese President Hu Jintao, will debate how the first contraction in the global economy since the Great Depression could have been avoided, and how to change systems for managing growth and regulating financial industries.
White, now 65, suddenly has company. His approach is reflected in position papers for the G-20 written by Jacques de Larosiere, former head of the International Monetary Fund and the Bank of France, and former Fed Chairman Paul Volcker.
“Concerns for financial stability are relevant not just in times of financial crisis, but also in times of rapid credit expansion and increased use of leverage that may lead to crises,” a panel led by Volcker said in a January report for the coalition of former central bankers, finance ministers and academics known as the Group of Thirty.
Stability matters because today’s economic stress could quickly lead to social unrest, which is what happened in the 1930s, White said in an interview across from his old office in Basel. He described how his father was killed in 1944 fighting Adolf Hitler’s forces in France near the town of Caen in Normandy. White was born on May 17, 1943, in Kenora, Ontario, about 400 miles north of Minneapolis.
In this crisis, the U.S. government and the Fed alone have spent, lent or guaranteed $12.8 trillion to try to prop up the banking industry and overall economy to stem the longest recession since the 1930s. The World Bank said last month that the global economy will probably shrink this year for the first time since World War II.
White’s warnings that credit risks were building up started while he was at the Bank of Canada, where he was deputy governor from 1988 to 1994. They were his constant refrain for more than 15 years, said Michael Mussa, senior fellow at the Peterson Institute in Washington and former IMF chief economist.
“I met Bill in 1991 or 1992, and we were already talking about this back then,” Mussa said.
In 1994, White joined the BIS, a counterparty for the world’s central banks and a forum for top policy makers and finance officials. He became head of the monetary and economic department in 1995. The BIS also houses the Basel Committee on Banking Supervision, which sets international bank capital requirements.
White took his argument directly to Greenspan on Aug. 28, 2003, at the Kansas City Fed’s annual meeting in Jackson Hole, Wyoming. Claudio Borio, head of research for White’s department, prepared for questions as White wrote his notes out in longhand at the Jackson Lake Lodge in Grand Teton National Park.
“Claudio said to me quite rightly, ‘We cannot miss this chance, everybody is going to be there,’” White said. Borio, still at the BIS, declined to comment.
Greenspan was unmoved by the presentation and said he pointed out that the Fed had tried and failed to stem a surge in stock prices by raising its target for the Federal Funds rate by 300 basis points in 1994. A basis point is 0.01 percentage point. He still isn’t convinced White’s monetary policy plan would work, he said.
“There has never been an instance, of which I’m aware, that leaning against the wind was successfully done,” Greenspan, 83, said in a Feb. 27 telephone interview. He added that spotting a bubble is easy. What’s hard is predicting when it will pop.
‘Out of Whack’
Greenspan, who retired as Fed chairman in 2006, did broadly agree with White’s position on safety margins for banks, he said.
“It has always bothered me that our capital requirements are so low,” he said. “We do not have an adequate cushion.”
Mark Gertler, a New York University economics professor who has collaborated on research with Fed Chairman Ben Bernanke, Greenspan’s successor, said that the U.S. housing boom and bust weren’t caused by low interest rates in 2003 and 2004. The problem stemmed from the decline in subprime mortgage lending standards and from leaving investment banks essentially unregulated even as they held mortgages and issued short-term liabilities like commercial banks, he said.
“The first-order cause of this crisis was the regulatory system was way out of whack,” Gertler said. “It’s not the case that you can get at this alone with interest-rate policy; it really requires smart regulatory policy.”
White’s policy plans recently have been endorsed through words and actions. Axel Weber, president of Germany’s central bank and a European Central Bank board member, said in a Feb. 10 speech in Malaysia that monetary authorities should consider raising rates if risk increases in financial markets, even if there is no short-term inflation-fighting reason to do so.
UBS, Credit Suisse
Bank capital regulation changes like the ones White promotes were adopted in December by Switzerland. The country set up new rules for UBS AG and Credit Suisse Group AG requiring them, by 2013, to hold between 50 percent and 100 percent more capital than the minimum 8 percent of risk-weighted assets under Basel rules. They could dip into the shock absorber in hard times. The regulator also instituted a leverage ratio, or a maximum amount of debt each bank could hold relative to its capital.
White will have influenced the discussion at the G-20 meeting, which he’s not attending, as part of a committee headed by the ECB’s former chief economist, Otmar Issing, which made recommendations to the German government. White also presented his views at a Feb. 18 conference in Toronto aimed at forming the Canadian government’s proposals.
White watched from the Bank of Canada as shares and real- estate prices soared in Japan in the 1980s. Asset prices then crashed, growth ground almost to a halt and unemployment climbed.
“It’s not rocket science in the sense that the fundamental insight is to watch the developments, what I would call the what, the why and the when of these crises,” White said. “When you’ve seen one of them and it’s made an impression on you, it’s easier for you to see the problems building up elsewhere.”
That led White to pen admonitions for a series of BIS annual reports.
“Some developments over the past year revealed disturbing laxities in internal governance, of both corporations and financial institutions, as well as in oversight and market discipline,” White wrote for the report published in June 2004.
No ‘New Era’
Two years later, he wrote, “The recent historical experiences of Japan, Germany and Southeast Asia all indicate that costly economic downturns are possible, even after long periods of exceptional performance.”
His darkest warning came on the eve of today’s financial turmoil.
“Virtually no one foresaw the Great Depression of the 1930s, or the crises which affected Japan and Southeast Asia in the early and late 1990s,” he wrote for the June 2007 report. “Each downturn was preceded by a period of non-inflationary growth exuberant enough to lead many commentators to suggest that a ‘new era’ had arrived.”
ECB President Jean-Claude Trichet praised the BIS as “obviously the most lucid institution in terms of its own research and publications” when asked about White after a Feb. 20 speech to the European American Press Club in Paris.
Beyond the current economic pain, White said the social costs of a severe economic crisis, in particular potential spikes in extremism, also propel him in his quest to find a way to limit boom-and-bust cycles.
“When you think about the big economic disruptions, what I always worry about is that you get into the fault lines on the political and social side of things pretty fast,” White said, citing the confluence of the Great Depression and Hitler’s rise to power in Germany.
White’s critics often mistake the symptom of asset bubbles for the cause, which is a rapid increase in credit, he said. While his policy wouldn’t stop asset appreciation, it might squeeze out some of the gains that didn’t stem from improved productivity or technology, he said.
Still, he is modest about whether his financial stability elixir is made up of exactly the right ingredients.
“I’d like to believe that having been right about one thing implies a greater probability of being right about the other,” White said, smiling. “But, of course, logically it’s not true. It doesn’t necessarily follow.”