Lack of trust among financiers is the core of our troubles as the great credit bubble of the past 30 years unwinds. Central banks have gone from being lenders of last resort to lenders of first resort. Market rates on liquid assets have been at a massive premium to the "official" rates set by central banks.
Our graph (see below) shows one such measure, for Australia, but in other places and with other measures, what we might call the "credit gridlock premium" is far wider.
This column has focused for six years on the setting of official rates, but this is a secondary matter at present. If the world's financial system is well managed, there will soon be a return to the standard focus on setting of official cash rates.
For now, keeping the world's financial markets functioning is the prime issue.
Central banks everywhere have been flooding markets with liquidity. Commercial banks have preferred to deposit spare cash with central banks than with their colleagues in other commercial banks. (Henry believes it is a universal human trait to judge others by one's own standards. Private bankers are mostly greedy, untrusting and lack courage. Their extreme defensiveness in this crisis is easily explained.)
In the US, Britain and Europe, banks have been nationalised or forced into hastily arranged marriages. Some, like Lehman Brothers, have simply filed for bankruptcy.
The Australian Prime Minister recently said that 25 banks worldwide had failed - he did not say "so far" but that was implicit.
A great debate is under way on the future regulation of private financial institutions. Henry hopes the resolution of this involves a return to the eternal verities of finance. Bankers lending only to good risks with truly valuable collateral. Asset managers buying only assets whose riskiness they know intimately. Retail customers remembering that the offer of high returns implies high risk, either because the assets backing retail products are genuinely risky or because the vendors are crooks.
When Germany was reunified, Henry asked a very senior (brown-eyed) Bavarian banker how he planned to check credit standards in the former East Germany. "We will look deep into their bright blue eyes and make a decision just as we used to do," the banker replied.
This man retired with every banking award it was possible to gather, and his record stood for many years. Low-tech, old-fashioned credit checks worked for him. A similar approach should work also for current bankers and their regulators.
It is sincerely to be hoped that financial system regulators do not try to turn bankers into bureaucrats micromanaging vast systems modelled on the controls that failed so decisively in the former East Germany and similar communistic states.
For the present, fear is locking financial markets far more effectively than even a mid-sixties communist regulator would have aspired to.
First published in The Australian on October 7, 2008.
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