Market Finance Time

What will happen when the next shock hits? We believe we may be nearing the stage where the answer will be – just as it was in the Great Depression – a calamitous global collapse. The root problem is that we have let a ‘doomsday cycle’ infiltrate our economic system. This is a quote from very interesting article, titled ‘The doomsday cycle’ by Peter Boone and Simon Johnson.
“So where are we going with our current reforms? It is now obvious that risk taking at banks will soon be larger than ever. Central banks and governments around the world have proved (once again) that they are willing to bailout banks at enormous public cost when things go wrong. Markets are now again providing very cheap loans to banks, with the comfort that the state will bail them out.

Today, Bank of America and the Royal Bank of Scotland are each priced to have just 0.5% annual risk of default above their sovereigns during the next five years in credit markets. This is a remarkably low implied risk considering that both banks were near to collapse just a few months ago. Creditors are clearly very confident that they will be bailed out again if necessary. Indeed, they are more comfortable lending to large risky banks than to many successful corporations.

There is no doubt that the regulatory environment is going to be tougher for the next few years. But nothing has changed to make us believe the regulatory system will succeed this time, when it has failed so enormously – and repeatedly – in the recent past. To bring about the dramatic change that is needed also requires international cooperation and consistency. We doubt such change is truly on the table as so few policy-makers seem to demand it.

Many of our current policymakers – Ben Bernanke, Mervyn King, Alistair Darling and Gordon Brown – are the same ones that inflated the last bubble. So we know with great confidence that they are the types that will bail us out each time things go wrong. They are all currently on course for seeding our next rise and collapse. Cheap rates and credit, with large moral hazard, are the initial stages of each cycle. Very few of these people, apart from Mervyn King, appear prepared to recognise their past role in creating our current problems and then to discuss resolutely how to change it.

The danger this system poses is clear, as Figure 1 shows. With our financial system now well oiled to take on very large risk once again, and to gamble excessively, can we be sure that we can continue this cycle of bailing out eventual failures? At what point will the costs be so large that both fiscal and monetary policies are simply incapable of stopping the collapse?

Last year, we came remarkably close to collapse. Next time, it may be worse. The threat of the doomsday cycle remains strong and growing.”

Youcan read complete text here – http://voxeu.org/index.php?q=node/4659