You gonna be close to those who regulate and you're going to hear their problems and their concerns and not hear those of
others whom you're more distant from. And so there is an incentive in regulators to often favor the institutions that
they regulate. And this need not be corruption. It may simply be the nature of things. You just hear more information from these
people. You know if you recall
when the treasury secretary during the early days of the global
financial crisis spent every day talking to the large money center banks and he wrote about it in his biography Paulson did.
And you know Paulson is an extremely honorable man. But in order to sort of deal with the problems during the global
financial crisis he could talk to the big players and therefore you hear their concern. So I would say it goes with the nature
of regulation that you almost bound to hear those kinds of concerns come up. Now I think what is more problematic is not so
much the regulatory capture which you have to be aware of. You have to guard against. But it's sort of a narrative capture that
you know you have a sense of the system and how it works. And that gives you a certain amount of confidence which may be
misplaced. What I thought was problematic before the global financial crisis was the sense that the smartest people in the
universe were in Goldman Sachs and Morgan Stanley. And if they were so smart how could they get into trouble. They obviously
knew ways of hedging themselves of managing their risks etc. Except it turned out the incentive structure wasn't aligned with
them. Taking adequate precautions and as a result you know the energies of some of those banks went in directions which were
problematic for the system. So with the regulators saying you're a smart people they'll get it right.
There was a missing sort of piece there which is do they have the right incentives to get it right. And I thought that was
what sort of failed us during the run up to the global financial crisis. It wasn't prime. It wasn't corruption as much. I'm sure
there were elements of that. And I have no doubt we have some evidence of it. But it was more that the belief was the private
sector will get it right because they're so capable and it turns out they can get it wrong also.
We certainly have upped the amount of capital that we want these institutions to run with. Remember there were
instances of banks running on 50 to 1 leverage and that meant there was very little margin for error. Now you
can think of capital in a number of ways. One is you know it's a license to to operate. So you need to convince enough people to
put up capital to allow you to operate. That itself is a challenge for some you know shady operations. But second it's
also a buffer in case things start going wrong. It gives the regulators it gives the supervisors time to react because there
is a certain amount of buffer you have to burn through before you become a problem for the system. So both from the license to
operate as well as above them. It's important. But I think also we've put a lot of emphasis on governance and on compliance.
And therefore some of the you know when the regulators see something going off track
they do come in. I keep saying supervisors rather than regulators they do come
in. They do look at what's happened. And banks now are you know recognize that they'll be fine enormous amounts if they're shown
to be non-compliant. So in that sense there is a lot more fear that you know if you
don't do things by the book you will get penalized. So that's a certain amount of implicit
capital over and above the explicit capital that they have at stake. Lastly I think this is important
you know for personal incentives it's a lot more of a focus on clawback. Now I don't think that people who took big risks
you know ever doubted their own capacity to make good and make lots of
money. But it is a fear at the back of your mind that you're putting all the bonuses you've earned over the last so many
years at stake when you take these really big risks. You have more of an incentive to behave right in the same way as when you
know these investment banks were partnerships with you know the stake of the partner at risk if the bank collapsed. They were a
little more sober about risk taking relative to when they became public limited company. So I think
the clawbacks of of salaries and bonuses have helped at the margin. But I would seem more than that has been the emphasis on
capital the emphasis on compliance all of which have made the banking system certainly safer.
Well eventually the system gets used to low interest rates but I think what is most dangerous is you when you move from a system
of higher interest rates to a system of lower interest rates when you've made one number of entities like insurance companies
pension funds have made long term promises based on higher returns and suddenly find they can't get those higher returns
and they have to stretch for yield to get those higher returns. And what we've seen over the last two decades is is really
various versions of that playing out. I can't get anything on on on short term fixed income. So let me go longer term. Let me
sort of push down the price of longer term bonds as I buy them because I really need that extra yield. And then once I've
exhausted longer term sovereign bonds let me move to emerging market bonds.
They are all sovereign but less less credit worthy than developed countries. And then I go to
bonds of corporations in the emerging markets and so on. I go down the risk spectrum and I'm desperately trying to get that
additional ounce of return without thinking of the additional risk that's taken.
And this does a version of you know if I if I'm stick if I take safe assets or hold safe assets I'm dead and might as well
gamble for resurrection by taking a little more risk. It's not as blatant as what happened during the savings and loan crisis
but there is a certain element of I wouldn't survive if I don't take more risks. I move into equities and move into
high yield bonds and so on. I think that
is is prevalent over time as we get used to these low interest rates. We will
not make such big promises and we will ask people to save more to get that level of pension that they want. We will ask for
higher insurance premiums but the transition from a high interest rate environment to a low one is is particularly
problematic. The other of course is you know to what extent do low interest
rate environments make you sort of focus on the really long term.
And the really long term is the area of great uncertainty. Right. You can build dreams on that. And so whether the
speculative element gets emboldened or gets gets more shape during a period of very low interest rates. I mean we've seen
all the tech firms with promises we are in the future. I'm making strongly negative earnings now. But don't worry 10 years
from now I'll be the next Amazon. And we have 50 other companies which are going to be the next Amazon and they're priced
accordingly. Whether that speculative element gets gets weighed it's I'm sort of saying something along the lines that Gene
Accomplice at Yale talks about whether whether you're empowering the speculators
the optimists I should say. That's it. That's that's also a question.
Broadly I would say that you know one hand would be helpful is a reasonable interest rate not a wildly fluctuating interest rate
over time. And say the systems I have gets used to it but obviously that may interfere with what is needed from a monetary
policy perspective. As you said if if our start is really low we need the nominal to move down to that level of perhaps perhaps
lower still in order to energize the economy.
Clearly in the time before the global financial crisis there was no such thing.
As a deep crisis in industrial countries right the last one had been 70 years before the SNL crisis in the 80s could be
considered a crisis. But that wasn't monetary policy. Well sort of. But you know there was regulatory aberration supervision.
So. So there was a sense that you could compartmentalize monetary policy since financial stability wasn't a big issue.
Basically monetary policy could focus essentially on macroeconomic issues. And I think the global financial crisis
essentially flipped that over and said look you need to worry about this other stuff also.
And of course the response from a number of macro economists has been yeah. But
let's not overtax monetary policy. Let that be macro prudential supervision. Let's give it back to the central banks. But in
their in their avatar as as macro prudential supervisors let them take care of those problems. And so we can continue
focusing on low and stable inflation. But I mean many of us feel macro prudential supervision first is not really conducted in
the United States. There is there is no authority which has separate responsibility for that. And second
you know when you push pushing on the accelerator the monetary policy accelerator
macro prudential becomes a much weaker instrument and doesn't have as much bite. And so at the very least there's
a need for the monetary policy authorities to talk to the macro prudential supervisors which you also have to see if you're not
having much effect. Should you use the monetary policy tool we're at to to maintain financial stability. In other words
going back to the earlier point when we talked about volatility surely a policy interest rates move less than would otherwise be
warranted especially on the on the lower end. Should your unconventional monetary policies be a little less
sort of aggressive when you don't know what the effects might be on financial
stability.