‘It would have done the Fed no harm to have had more people with a habit of making snap decisions’
What would it take to make economics more useful in a crisis? Not more rigorous or more realistic – although that would be nice – but simply better equipped to deal ad hoc with the financial equivalent of a burning building?
It’s sobering to read the recently published transcripts of the Federal Reserve’s Open Market Committee meeting held on September 16 2008, the day after Lehman Brothers filed for bankruptcy. Fed chairman Ben Bernanke and his colleagues knew AIG was also in trouble but not that the worst recession since the 1930s was under way.
The transcripts induce, at times, the frustration of watching Titanic. The ship is doomed, yet our heroes suspect nothing! The Fed committee raises the possibility of a sharp cut in interest rates but inertia wins out. They are unwilling to act until the dust settles.
The rearranging-the-deckchairs moment comes as the committee discusses the right words to use in its press release. Should it say it is watching developments “closely”, or “carefully” or just watching? Nobody really knows.
In retrospect, the Fed was slow to act – as subsequently evidenced by three later, large rate cuts in an attempt to catch up. But it would be unfair to suggest that the committee was clueless. The meeting begins with a crisp discussion of the impact so far of the Lehman collapse. That’s followed by an agreement to swap currency, without limit, with other major central banks.
The overwhelming sense, however, is of a group of men and women who are rooted to the spot in the face of uncertainty. One of the staff economists, Dave Stockton, presents a detailed economic outlook before admitting, “I don’t really have anything useful to say about the economic consequences of the financial developments of the past few days.” With hindsight, what that meant was that he didn’t really have anything useful to say at all.
Bernanke himself sums up the mood perfectly as he reflects on the rapidly evolving bank bailouts and the risk of moral hazard: “Frankly, I am decidedly confused and very muddled about this.” There is wisdom there – but not of a very reassuring sort.
Hindsight is a wonderful thing and nobody should envy policy makers in such a situation. But is there a better way to conduct emergency policy? I have three suggestions.
First, increase diversity. Despite the reputation of the US for having a revolving door between big business and government, the Fed’s board looked weighted towards government insiders such as Timothy Geithner, then head of the New York Fed, and academics such as current Fed chairwoman Janet Yellen and Bernanke himself. Not many board members had high-level business experience. A variety of perspectives tends to generate a more honest conversation, and it would have done the Fed no harm to have had a few more people with a habit of making snap decisions.
Second, overhaul the economic data available. The Fed was flying blind: it knew surprisingly little about who was exposed to a collapse of Lehman and, immediately after that collapse, a vast tangle of contracts sat in limbo while the picture was slowly sorted out.
In a speech in New York two years ago, Andrew Haldane of the Bank of England argued that financial regulators and risk managers should draw inspiration from the development of supply-chain standards. These standards turned the humble barcode into a way of tracking products as they moved around the world. Because firms could follow products through the production and logistics system, bottlenecks could be bypassed and supply crunches spotted in advance.
What we need now are barcodes for financial products and companies – and they are on the way. The Financial Stability Board, which tries to co-ordinate financial policies across borders, has been developing the building blocks of a system designed to identify specific financial products and legal entities. That last point sounds trivial but it isn’t. Lehman Brothers was a Gordian knot of corporate vehicles. An up-to-date network map of who owned whom would have been invaluable.
Once better data are available, they also need to be displayed in a clear, robust and timely manner. Emery Roe of UC Berkeley, author of Making the Most of Mess, studies high-reliability systems such as electricity networks, whose operators must keep the system up and running despite a constantly evolving set of constraints and setbacks. Roe argues that one key feature of such systems is a clear visual display of trustworthy information. Electricity network operators have this but finance is way behind. The ultimate goal should be for regulators to glance at a computer display and spot stresses and vulnerabilities in the financial system, in real time – not easy.
Perhaps we should also treat such endless firefighting with more respect. In economics, ecology and other disciplines, Roe argues, those making tough decisions in the field are disparaged as practising “agency science”. Yet somewhere there is an ecologist who needs to decide how to respond immediately to the latest toxic spill, and there is an economist who needs to decide how to respond immediately to the latest bankruptcy.
We need people with the art of real-time economics – an art that shouldn’t be dismissed just because it cannot match the rigour of the ivory tower.
Also published at ft.com.