Congratulations to this year’s Nobel Laureates in Economic Sciences Ben Bernanke, Douglas Diamond and Philipp Diebwig. As the quote reads, all three have “significantly improved our understanding of the role of banks in the economy, especially during the financial crisis.” Few of us in life, and some of the extinct economists, get to put their work into practice on the biggest stage, as Bernanke did in 2008. The former chairman of the US Federal Reserve wasn’t just having a hypothetical debate with his graduate students. He made important decisions under the most intense pressure. And there should be no doubt that the understanding of their exact nature is a crisis. [now often called the Great Recession] Saved the global financial system in 2008.
Keeping the debt creation process afloat by giving relief to the large US banks was a key element in promoting the latter’s recovery. Unlike many of his peers, Bernanke understood what was at stake. As in his Nobel citation, the collapse of the bank involves the loss of valuable information about borrowers that cannot be quickly rebuilt. The credit creation process is best handled by banks, but they cannot play that crucial role when they are hit by non-performing loans and capital crunch.
In Europe, measures to support the banking sector were less structured and comprehensive, with a greater emphasis on “punishing” those blamed for the crisis. As a result, the under-capitalized banks of Europe played no useful role in this. Post-crisis recovery. Instead, many countries remained in or near recession, eventually leading to a series of sovereign crises that still echo today.
Another way of looking at US banking recovery compared to Europe is the KBW Nasdaq Bank Index, which has risen 65% since 2008, against its nearest European counterpart, the Euro Stokes Bank Index, which is nearly 15 years later. Still more than 70% below its pre-crisis level.
In fact, despite their relative inaction, Europe’s banks and governments got an effectively free ride from Bernanke’s quick action to shield American lenders. Had the US not acted, there was a very strong potential for a global systemic collapse.
And yet, ultimately, there is no escaping the fact that the 2008 financial crisis was largely driven by policymakers and economists (in Bernanke’s case, it was one and the same) by the banking system’s ability to manage credit creation. By observation with great confidence in the capability. Bernanke was the leader of that movement.
This unreasonable belief in one of the most fundamental principles of market efficiency has been a factor in many famous economics Nobels. 1992 winner Gary Baker vehemently argued that the labor market was efficient enough that no action was needed against racist employers because market forces would only address the issue by putting them out of business. That argument has not stood the test of time.
Similarly, Franco Modigliani, who won the Nobel in Economics in 1985 and Merton Miller, who won in 1990, did valuable work on the capital structure of the firm. Yet their simplified assumptions about the cost of bankruptcy did little to normalize corporate debt and high levels of leverage. This was one of the reasons economists were so optimistic because the debt peaked before the 2008 recession.
The timing of this year’s Nobel Prize is remarkable. This comes at a time when the world is grappling with the consequences of excessive monetary intervention, which happened with bank bailouts. We may have made some progress since 2008 in understanding the need for practical bank regulation.
However, we are nowhere close to believing that the remedy to the crisis often sows the seeds for the next disaster. In fact, the financial sector is becoming the cause of our problems and not the helpless victim of the economy. This includes the economists running the show.
The Nobel Prize in Economics has a history of producing winners who present strong insights while failing to understand the practical realities and consequences of their findings. So, ‘Well done’ to Bernanke and his fellow award winners. But let’s not forget that the former Fed chairman was at least partly to blame for the circumstances that first led to the financial fragility of the early 2000s.
It would be hard to say that Bernanke was a firefighter who put out his own fire. Nevertheless, regarding the merits of the prize, the 1974 Nobel laureate, Friedrich Hayek, perhaps put it best: he said that the Nobel Prize “confers upon a person a right that no man in economics should have.” “
Stuart Trow is a credit strategist at the European Bank for Reconstruction and Development.
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