Samstag, 23. April 2011

Interview: Prof. Roger Farmer, UCLA

Roger E. A. Farmer is Distinguished Professor and Chair of the Economics department at the University of California Los Angeles (UCLA).

Why do the ratings agencies whip sovereigns for deficits and debt in a weak economy, but not warn the big banks to fund their activities with excessive leverage?

The three principal ratings agencies, Moody’s, Standard and Poor’s and Fitch are profit-making enterprises. During the recent financial crisis all three of these agencies failed to recognize the risks involved in holding large portfolios of mortgage backed securities. It is certainly true that the investment banks profited from the securitization of risky loans that were rated AAA.  But I do not think that there was collusion or fraud involved.

The most likely explanation for the failure of the agencies to recognize the systemic risk involved with mortgage backed securities and credit default swaps is the pace of innovation in the derivatives markets. Analysts at the ratings agencies had a hard time keeping up.  The best and the brightest minds were not employed by the agencies.  They were busily involved in the process of inventing new and exotic securities. 

Why are the agencies now “whipping” sovereigns for deficits and debt.  There I think it’s a case of “once bitten twice shy”.

Why TBTF is still TBTF?

Walter Bagheot warned us in 1873 that there is a tendency for big banks to get bigger.  Simon Johnson and James Kwak have reminded us that, along with economic power, comes political power.

There is tremendous resistance from the banks against regulations that break them into small pieces.  Once again, I don’t see an open conspiracy. But economists disagree about the benefits of regulation and one can argue, that large banks have high social value through their ability to channel capital more efficiently and foster growth. 

I think this argument is incorrect.  The growth of the financial sector over the past decade has more to do with implicit state guarantees than it does with the fundamental role banks play in channelling credit to industry to  foster growth.

Economists who work in investment banks are more likely to subscribe to the view that large banks have high social value since it justifies the high compensation and bonuses that they earn. The economic power of the banking industry means that many of those same individuals are appointed to important political positions where they are able to put their views into practice.

What is the matter with the Euro Zone? Why there is no solution of the sustained debt crisis in sight? 

The Euro Zone can only work effectively if monetary union is accompanied by political union. Germany and France have experienced relatively low wage growth and have strong economies and relatively low unemployment as a result. Portugal Ireland Greece and Spain (the PIGS) have experienced much faster wage growth, asset market bubbles and high unemployment rates.

Bringing the two halves of Europe back together requires relative wages to converge. In the absence of separate currencies that would allow devaluation of the PIGS, that process will be long and slow.

A solution to the debt crisis requires the German public to recognize that Greece is insolvent.  Since much of Greek debt is held by German banks, the question comes down to how the cost of Greek insolvency is to be divided amongst the member states of the EU and between taxpayers and creditors within each country within the EU.

Thank you very much.

Roger E. A. Farmer is Distinguished Professor and Chair of the Economics department at UCLA. He has previously held positions at the University of Pennsylvania, the European University Institute and the University of Toronto.

His two new books on the current economic crisis, “How the Economy Works: Confidence, Crashes and Self-Fulfilling Prophecies” (March 2010) and “Expectations, Employment and Prices” (March 2010).

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