The Wealth Effect


DATE: 1.00PM-2.00PM, 9TH APRIL 2019





NIKITA MALIK: Good afternoon. Thank you very much to everyone for coming, in this terrible weather, I know it’s not the easiest, but we are very excited today to be hosting Professor Jeffrey Chwieroth who will be speaking about his book “The Wealth Effect: How the Great Expectations of the Middle Class Have Changed the Politics of Banking Crises”. The books are also available outside. So we’ll break it down today by having Professor Chwieroth speaking about his book, I will briefly talk about his background, then we will open up the floor for questions and answers. So in this new book, Jeffrey Chwieroth and Andrew Walter use contemporary and historical evidence to demonstrate that the politics of banking crises have been changed by the “wealth effect” and how middle class wealth has generates great expectations regarding government responsibilities for the protection of this wealth. They show that crisis policy interventions have become more extensive and costly, and the political aftermaths far more fraught because of democratic governance rather than in spite of it. Using data from a large number of democracies over two centuries, and detailed longitudinal studies of Brasil, the UK and the US, the book breaks new ground in exploring the consequences of the emergence of mass political demand for government stabilisation. Thank you very much for joining us and looking forward to this discussion.

PROFESSOR JEFFREY CHWIEROTH: Thank you, and thank you for the kind invitation to come speak to you. The book that just came out, from Cambridge University Press about two weeks ago took about 8 years to write. And it’s a story about people like you and me, and the middle class and how we became increasingly wealthy in the past 3 decades or so. Not only more wealthy, but more connected to the financial system that in many ways the middle class were not decades ago or even a century ago. And the way this would have motivated this argument, I want to share with you some of the evidence we’ve gathered, showing just how profound this change has been in terms of how people like you and I think about financial crises.

So this first quote here is from the New York Times during a banking panic in the United States 1873 that was largely centred in New York but was particularly devastating in terms of its initial consequences. This is from the New York Times that stated in 1873 describes quite clearly how the predominant view then in the United States but also in other countries around the world as we show in the book, essentially governments bear no responsibility nor should they provide any protection for depositors like you and me, essentially saying why should be protect depositors any more than any other business dealing with anybody else. A century later, of course in 1984, after the failure at the time, one of the largest bank failures in the United States at the time, Continental Illinois, in the context of the savings and loans crisis, the New York Times reveals a dramatically different set of expectations. Using sort of quasi-religious language here, the New York Times describes how this bank was nationalised by the government, essentially taken over and recapitalised using public sector money. Showing that in the course of a century, our expectations as captured in these editorials showing quite clearly, at least initially, how much our expectations have changed. The initial question you are probably asking yourself at this point is why this change? Initially we looked at what is called the “wealth hockey stick,” as it resembles a hockey stick. This is showing you data on real net wealth per capita, how much individual wealth we have as a society, adjusting for purchasing power and exchange rates and setting it equal to a constant level of US$217.00, and you get this really nice hockey stick spread in the data graph. Average wealth per capita is fairly constant from 1870 until about 1970, then it jumps massively all the major advanced countries, and if I had the time I’d show you that a similar shift happens in emerging economies somewhat later, sometime around 1990. We still see this massive ramping up of wealth, and part of the reason we argue in the book is that people like us are wealthier than we were before, and now because banking crises now pose an even greater risk than ever before to our wealth because we have a much greater stake in financial market stability and our expectations of what governments should do in response to that have changed.

In the book, we largely look at two different elements: policies that the government has pursued, and the politics that follows these particular types of events. All of us in the room are familiar with the extensive interventions that occurred in this country but also elsewhere over the period 2007 and 2009. Governments intervened with extensive measures like guarantees of assets, large amounts of taxpayer money put inside to recapitalise banks, and all of these efforts combined prevented another great depression. We had a great recession, but we didn’t see what we saw in the 1930s. It also prevented even far greater wealth destruction than would have occurred. So if the governments hadn’t intervened, the amount of wealth losses that would have occurred would have been substantially greater. Now bear this in mind later on when I talk about the political consequences because many of us find that difficult to engage in that counterfactual reasoning. We see that we lost wealth after the financial crisis; house prices fell, maybe your pension portfolio was cut, maybe your ISAs were lower in value – but what you don’t see ever, and it’s hard to fathom is how bad it would have been done had the government done nothing. The amount of public sector support that I put here was tremendous in the amount. I show you some of the data from the UK and the US, then I talk about in terms of the extensiveness in the amount of protection. Insured and uninsured savings were protected, which is extraordinary in terms of the amount of capacity the government was willing to put forward. Despite these interventions, they were and they remain highly unpopular. Though citizens demanded the government protected our wealth, we were riled at the idea of bailing out the banks. That the bail outs themselves, while protecting our wealth, were perceived to be as unfair as redistributed. As a result of that, many incumbent governments lost office. Ask Gordon Brown that particular question, ask other people in the Republican Party in the US and other types of governments that lost office during this time. And as we can see going on around us in this country but also in the US and many other Western and emerging democracies, the polarisation during this time continues as a result.

Now in the political science and economics literature, this casts doubts substantially on prevailing theories that had been prevalent at the time. Prior to the financial crisis, there was a long set of arguments that said that democracies were better able to resist pressure from financial elites for expensive bail outs, more so than say autocracies as in autocracies we would expect crony capitalism and elites being bailed out by their supporters. In democracies, we would expect the taxpayer interests to be represented more fully, and as a result we would see constraints in the ability of governments to bail out financial elites – but in fact that was not the case. Same goes for arguments that say neo liberal ideology, globalisation may constrain the ability of the state to intervene, that ideas about market conforming policies, constraints imposed by mobile global capital or trade flows would prevent governments from intervening. And of course that was shown not to be the case. It was also shown to be the case that voters are not forgiving with events that are shown to be beyond government control. There is a long set of arguments in political science about how when voters have the ability to identify who is responsible for particular events. The clarity of political responsibility was high so you could clearly say “Gordon Brown was responsible for this” or “George W Bush was responsible for that” and would be forgiving when there was a lot of constraints that would prevent these individuals from doing what they wanted to do. What we see in the modern system because our wealth is so much at stake in terms of being evaporated by these crises is that we are less forgiving. And so in the book, what we try to do is offer a dynamic and panoramic account of how all these things come together – crisis, politics, policies and institutions. I want to outline for you the four elements to the argument, and then dig deeper into the evidence.

The first argument is one I introduced to you initially and how the book was introduced. Essentially the book is about how mass political pressure, people like me and you, are placing extraordinary amounts of demands on our governments to protect our wealth in an efficient manner. We do this, borrowing from Dicken’s classical book, because we have acquired “great expectations.” Just like Pip in the novel, when you become wealthy, your expectations change and as you become wealthier, you expect even more from the government. In response to these great expectations, governments provide more extensive and increasingly costly bail outs. These go beyond on the Bagehot Rule. The Bagehot Rule takes its name from Walter Bagehot who you might know was the Editor of The Economist in the 19th century. He famously argues how governments during crisis should provide limited emergency liquidity support to banks that are normally solvent and provide good collateral. What we’ve seen is our governments have gone well beyond this simple Bagehot Rule. In addition to that, when governments supply these emergency bail outs, when they meet our demands and expectations, we are not happy. As voters, our own ideas and preferences are conflictual – we want bail outs but bail outs that are fair, that distribute the cost to other people not ourselves. Another way of thinking about this is that we want bail outs for ourselves and Bagehot for our neighbours. As a result of this, when governments intervene, we punish them, we lash out because they have provided, say, bailouts for the bankers, because they have rewarded somebody else and not us, because we have lost in some way. This is compounded upon perceptions of when interventions are also delayed. If governments delay in intervening because of political institutions or other reasons, this compounds adverse market dynamics which makes the crisis even worse and we lash out for those reasons as well. But since these things are virtually inevitable, these great expectations produce great disappointments. And what we argue in the book towards the end is that these great expectations which have produced great frustrations are now, currently, in terms of the world around us today, even in parliament down the road, are being layered and compounded upon other types of structural issues. So the frustrations people have about bail outs from ten years ago are layered on top of long term trends in terms of demographics, structural changes in the economy, the hollowing out of particular regions, not just in this country but in the United States and elsewhere – and all of these layers have other effects on top of this, is producing dissatisfaction with Western democracy, not just with political parties, but with democracy itself.

So that’s the main elements of the argument. What I’d like to do now is present some of the evidence and unpack these arguments about the origins of the great expectations. So why do we have these new views whereas before we did not? So one of the challenges we faced was how do you know that people’s views have changed about what governments should do over 200 years of history? Those of you familiar with public opinion research will know that most public opinion polls don’t start until the post-war era. In most countries we don’t see these systematically taking until the late 1970’s, early 1980’s. So how do you know what people want? So in the absence of public opinion surveys what we did is we went back and we gathered newspaper editorials, in major newspapers in this country, in the United States, in Brazil and elsewhere, and had a team of RA’s code these for us, in terms of the degree support that these newspaper editorials offered for particular crisis intervention measures at a given point in time. We put these on a scale ranging from zero support to complete market conformity, essentially that everybody failed and the government did nothing, to five where the government should socialise all the losses of everybody in the system. We used a series of newspapers in order to avoid bias in terms of partisanship and regional affiliation. So we looked at The Guardian, The Times, The Economist and so on in this country and we brought it all together to see what newspaper editorials were saying about financial crises and what governments should do.

Look at what you can see here, we see this nice ratcheting affect over time. In earlier crises in the 19th century, by and large most editorials are silent on the ability and the willingness for their support for governments to intervene. By the time we get to the 2007 Crisis, not only are they writing more about banking crises, but their support is strongly oriented towards intervention. So in the UK what we see is this nice trend over time in terms of increasing the amount of support by editorialists for intervening in the economy. In United States we see a similar type of pattern even more clear than this and even more closely resembling the wealth hockey stick I mentioned earlier. If we go back to 1857 and go to the present, even through the Great Depression, 1984 and 2007 you can see overtime that editorials are increasingly talking about financial crises in a different way. They are supporting intervention in the same manner that that 1984 editorial did about nationalising continental Illinois to speaking about it less in the way in 1873 when The New York Times said we shouldn’t rescue anybody. We do the same for Brasil in the book, and I won’t go into that in the interest of time, but I can tell you that it basically follows the same type of pattern.

Hopefully by know you’re wondering: where do we get these expectations from? What are the mechanisms that are driving people like me and you to think the government should rescue us? Here we highlight three main features. The first is what we refer to as the ‘financialisation of wealth,’ essentially we become wealthier, that’s the so-called size effect, that wealth hockey stick. The second one we refer to is called the ‘composition effect’. Our wealth is increasingly not concentrated in things like savings deposits, which are generally protected, but are now exposed to riskier market traded assets: leveraged housing, defined contribution pension schemes, and stocks and shares, and so on (whose value can evaporate quickly after a crisis). In the book we go through this in detail across our major countries. How exposed are British households now to these type of market traded assets versus how exposed were they 100 hundred years ago (Same for the United States and Brasil)? Here is some quick data from the US to show you. This line here the top line shows you the middle class—the middle 50% of the income distribution. The black line shows you the top 10%. The top line shows you show much housing equity represents an individual’s’ net worth. What you can see from the middle class, by the eve of the crisis all the middle class’s net worth is concentrated in housing assets. Whereas the wealthiest class, the top 10%, sees about 10-15% of their assets concentrated in housing. A lot of their wealth is concentrated in business assets, financial capital and so on. What’s problematic for the middle class is that not only is their wealth concentrated in housing, but it’s increasingly leveraged. So, many of us cannot afford to buy homes outright, particularly in a place like London. So, we have large mortgages and again this shows you the amount of debt relative to net wealth. Wealthy individuals have very little debt. The middle class you can see is highly leveraged. When you have leveraged housing assets you are significantly exposed to wealth losses in the context of a crisis.

It goes beyond that. Not just financialisation of wealth, but to borrow from a paper from Jordà-Schularick-Taylor, we refer to the ‘democratization of leverage.’ Essentially, the people like you and me are increasingly connected to credit markets to maintain consumption, to buy housing assets, to by ‘marketised’ public service—education, healthcare and so on. We are forced to do this through what some call system of privatized Keynesianism. Essentially, the government relies upon us to consume and the way they accommodate those desires is through leverage booms. This is the amount of bank lending in advanced countries, this is the amount private sectors and household debt in emerging markets, and this is pattern for developing countries. Even though you might not be able to see it from where you’re sitting the magnitude is different, in terms of the scale. The process is similar across the board. Households in developing, emerging and advanced countries have seen an increasing amount of leveraging up over the past 10, 20, 30 years, which means we have a much stronger interest in the government stabilising credit markets in ways that we didn’t previously

The third element to this is that governments have told us over the past several decades that they would do something to protect our interest. Governments starting in the early 20th century increasingly made explicit policy commitments to protect us from financial instability. What this graph shows you, the bar shows you the number of democratic countries making a policy commitment to protect us from financial instability and the black line shows you the number of democratic countries. These types of commitments are things like establishing a financial regulator the first time, introducing banking laws for the first time, or taking extensive ownership of the bank through the state. We see these commitments firsthand and think that the government is going to do something to protect us, and when the government does something to protect us it produces this type of satiation, we begin financial stability is an achievable condition. Many of us in the room didn’t experience a banking crisis until the 2007 Crisis. There was a long period of history, particularly in the West, where there was an absence of a financial crisis. As financial stability became a universal policy goal, we ratcheted up our expectations. We expected government to do more to protect our wealth because they told us they could do it. They actually showed us for an extensive period of time that that was possible. In this country and the Netherlands we were actually able to find detailed surveys. The old FSA used to conduct consumer awareness surveys asking people like you and me: What do you know about financial regulations? What do you expect from the regulator? The FSA did this from 2003-2012. The Dutch did it for one snippet in time. I will just give you the Dutch survey evidence, just to follow through on this argument, to show you more forcefully just how unrealistic some of our expectations are. In the Netherlands, in a 2010 survey, two-thirds of respondents believed that supervisors must never not let a bank fail. Moreover, they incorrectly assumed that if a bank failed, the government would refund you all the money. Not only would they refund you all the money, but most people (80%) believed that you would get this money within three days, not a standard three months. If you look at the FSA results they are dramatically similar. People in this country, overtime, had the same types of views; they thought that the government would reimburse them. They would protect us from financial instability. Now that’s the argument, I want to give you some of the sense of the data we collected.

The empirical challenge we face is how do we capture, gather evidence, on what governments are doing? What we did was to look at over 100 different systemic crises, by systemic we mean the biggest of the big crises, not like the secondary bank crisis in this country in the 1970’s. We are talking about big crises that can bring this system down, like the one in 2007. We looked at these biggest of the big crises and we coded thousands of different policy responses that governments had. Governments can actually adopt a range of different policies. Governments can actually impose loses on us as depositors. Governments could close down banks. They could provide extensive liquidity provision. They could use our taxpayer fund to recapitalise the banks; they could nationalise them they could guarantee our assets and those of other intermediaries; they could freeze our assets; they could provide debt relief; and of course they could ensure our deposits. When you put all these different policies together you put them on a continuum, where governments rarely ever implement purely market-based responses—let everybody fail—and rarely implement pure socialism based responses—where they protect everybody. Instead, what we get are policies that resemble what Bagehot largely wanted or we get policies that are bail outs, so they are not socialising everybody there is some element of restructuring involved, there is some element of moving away from a pure market-based response. Even when provide emergency liquidity to solvent institutions there’s some sort of intervention that’s occurring here.

We put these all together and we create and index using technique known as “principle component analysis.” When we do that we get this type of graph overtime; where the top graph is showing you the average policy response over a given point of time, from 1840 to the present. The lower graph is showing you there number of systemic crises or big crises in the system. The index that we have ranges roughly from negative three to roughly two, where scores closer to negative three represent responses that were closer to market conformity, Bagehot, and the higher scales represent bails out policies. What you can see is this nice evolution overtime where governments largely implement Bagehot-style policies until the late 1930’s. In this last three decades we see it move towards bail outs. What we suggest in the paper that this is evidence for our arguments.

Let me show you some of the statistical results or some of the simulations that we put forward. What we wanted to look at was the extent to which the amount of housing wealth that people in the country had built up would incline the government to rescue, to provide for a bail out. This particular graph shows you the results of a simulation to look at how a country would fair if it experienced the same type of housing boom that Americans did from roughly 1929-2007. These are property prices from the US from 1890 to the present. Here is the housing boom from 70’s to the present. Here is the Great Depression. Here is the 2007 Crisis. What would you expect if a country experienced a similar level of housing prices increases from this crisis to that? You would expect something like this. When we compare the average country on our index of roughly 0.2, versus a county like the US, you get a stark difference in the propensity to bail out a country. When you experience this type of housing wealth by the middle class, you get a sharp increase in the propensity of the government to provide for extensive interventions. The same type of graph I can show you for household leverage, like that experienced in the Netherlands from a change in a major crisis in the 1920’s to 2008. What would happen for a country that experienced the same type of leverage boom in household sector as experienced by the Netherlands from 1921 to the present? Again we get the nice sort of picture that we expect. An average country looks like this and a country with the type of leverage that the Netherlands has looks like that, similar to the United States. The other two types of main effects that I would show you relate things that many in this room probably have, defined contribution pension schemes. Most of us in the room are probably less fortunate to have built up large amounts of defined benefit pension arrangements. Most of us have our pension arrangements exposed to market-related to risks. What this graph is showing you is that when you have countries that either have widespread voluntary defined contribution schemes, or if you look in countries where these schemes are mandatory (like in Chile, Mexico or other places like that) you get this really nice difference in effect. When you have counties that are exposed to defined contribution schemes they lean toward the bail out end of the spectrum. When you have countries where these types of schemes are absent they actually lean in the Bagehot area.

The final effect in the policy that I’d like to show you is about these effective pre-commitments. Earlier I suggested to you that when governments pre-commit to financial stability and they show us that they could actually achieve their particular goal that ratchets up our expectations for governments to do something. What this is doing is it is showing you that what if we look at countries that have a longer history of supervision versus countries with a shorter history of effective supervision? These countries have more crises; these countries have fewer. It is showing you when countries have fewer amount of crises and governments have pre-committed that the government intervenes to protect us.

What I want to do in the last few minutes is not just show you policy stuff but how people like you and me react to this. I will show you three slides on this from different eras in different countries to give you a sense of how people like you and I respond given the governments have intervened. So the first set of slides is to show you that people like us are putting mass political pressure on the government to intervene and they are responding to that. And, these next set of slides tell you that even when governments do that we are not always happy with the result. We have a number of different statistical chapters in the book. We have six different case studies chapters. We have a cases study on Brasil from 19th century. We have a case study in Brasil from the 20th century. We have got two chapters in the UK: one on the 19th century and one on the most recent crisis, and the same thing for the US. In the interest of time I won’t go over that. I will just provide you snippets from these different countries.

This is the United States. This is the different bail out or Bagehot scores the government had over a period from 1860 to the present. You can see the United States government largely leaning towards Bagehot until 1929 and then gradually began to increase the amount of support it provided until 2007; we see the biggest intervention that we ever recorded. Now, despite that bail out, what we saw and what many of you are probably aware of is that that the Republicans lost. They were significantly punished as a result of this particular policy failure. One of the reasons for that, we show in the book, is because a lot of people lost wealth in respect to the bail out. What this graph shows you is on a constituency level basis, there are different counties in the United States, this is showing you changes in house prices from 2007 to 2008. This is the share of the change of vote. What this is showing you that counties that are clustering down here suffered large house prices depreciation over the period from the financial crisis until the new member election. These people actually experienced gains. The people clustered down here lashed out about the incumbent party. We get this really nice negative relationship, as we talk about in the book, how these types of wealth loses and housing dramatically effected Republicans chances of reelection in that particular period. Contrast that with 1907. Those of you that know your history will know that the United States experienced a severe panic during that period. How severe? The economy contracted by roughly 11% percent in the period leading up to the election. Unemployment spiked significantly as a result of this. Despite a severe downturn in the economy and the government’s market-conforming response (which I would point out to you involved the imposition of loses on depositors), the people actually lost money and the Republicans returned to office. When we look at similar types of data, not on house prices, but on the amount of bank failures, so we gathered data on state level bank failures to look at the extent to which particular states suffered bank failures and the changing support for the incumbent party, we found little or no relationship. In fact, the Republicans won.

My last example before I conclude, I mentioned that we looked at Brasil and I want to give you some sense about what we looked at in Brasil because we haven’t talked about it that much. Those of you that know your Brasilian history know that the period leading up to the 1990 crisis was a period of accelerating inflation and the government was dealing with that. Despite rising wealth what the Collor government did at that time, in an effort to control the amount of money in the system, was impose a freeze on depositors for roughly 18 months. This deposit freeze was unusual because it imposed substantial costs on depositors in an era of rising expectations. As these assets were frozen in the system, inflation eroded their value by roughly 30% in real terms, so people lost money as a result of this deposit freeze. How did voters evaluate Collor? Not very well. If you look at his popularity you can see in the aftermath of the deposit freeze editorials at the time called it a “Savings Confiscation.” It plummeted, until overtime when his brother exposed evidence of corruption and he eventually resigns, he leaves office. We showed this in this particular chapter as a case where the government tried to defy rising expectations and was punished for doing so. It is also worth pointing out that it is not until the 94 crisis when the government actually responded with a bail out and that government was the first to be reelected in the modern democratic era. So tis government tries to buck expectations and this government follows through and is actually rewarded.

What are the implications? We think one of the implications, and here I am trying to be a bit provocative, is that rather than bail outs trying to be perceived as policy capture by bankers and connected elites, to some extent its policy capture by people like you and me. Essentially it’s not just policy capture from above its policy capture from below. In this sense there is a growing alignment, although not perfect, between the elites and the wealth-owning middle class. We both want the same thing and governments find themselves in difficult situations because they cannot necessarily protect our wealth without rescuing the bankers. This puts the government in a difficult situation because it leads to rising political risks. The third implication is that in many ways our expectations are creating a politically-induced Minskian doom loop, that essentially when the government responds to our expectations by rescuing us this produces rising moral hazard in the system. All of us expect to be protected. The government implicitly provides a floor under asset prices. So, as a result of that, financialisation progresses. We continue to leverage up. We see increasing asset price booms. And, as result of this, rising amounts of wealth inequality, intergenerational and intersectional conflict and eventually, deeper crises. So in essence, part of the blame for this doom loop is not just with banks and bankers but people like you and me.

The final point that I raise on this, and this brings us roughly to the present then, is that all of this dissatisfaction, all of these problems, are layered on to other factors, which we talked about earlier, which is producing the current crisis in democratic government in many western economies. Thank you for your attention. I look forward to your comments and questions.

NIKITA MALIK: Thank you so much. So, that leaves us with about twenty minutes for questions. If you could please sate your name and affiliation before asking the question that would be great. Yes.

HUGH REDROSE, CHARTERED ACCOUNTANT: Thank you fascinating talk. One thing has always struck me is the way that politicians can manipulate financial crises for their own ideology. It the 2010 election, David Cameron’s line on the financial crises was entirely caused by Labour’s profligate spending. The crises had nothing to do with the banks. It was Gordon Brown, and Gordon Brown only who caused the crisis. All the misery we suffered was caused by Gordon Brown. He did exactly the same with Ed Miliband. (inaudible) So, it goes on today. People on the street think that the 2008 financial crisis was caused by government overspending. The same thing happened during the gold standard crises in 1931 when the Labour government got blamed entirely for overspending. The other example is in the US the Republicans were blamed for the financial crisis. My question is how far do you think government’s spending has any responsibility for the financial crisis? Obviously it does in the case of countries like Venezuela, but in general, in the case of Western economies, what do you think?

PROFESSOR JEFFREY CHWIEROTH: Yeah so you raise a number of different issues. I will see if I can touch on those. We looked at some of these aspects of want your suggesting, what we would call blame apportionment. So, how are people fixing blame to particular actors to a given point it time? So, want we did empirically was to think about whether there was a change over time in blaming public sector actors or whether we focus on private sectors entities. What we find in the area of low expectations is that government’s largely escape blame. When the government failed to take responsibility for the financial system it’s not their fault when there’s a crises that happens. Once the government does take responsibility what we see is equal amounts of blame in the editorials for both public and private sector actors. The remarks you had about Gordon Brown and the criticism he faced, I think goes a little bit beyond that. We talked a little about this in the book. If you recall Gordon Brown tried to suggest that the crisis was not Britain’s fault, the origins didn’t lie in this country it was the Americans who were to blame. When, in fact, most of us in the room would say that in fact the Labour government had some degree of responsibility given the type of regulatory system it had put in place over the period of the past twenty years. So Gordon Brown’s efforts to deflect blame failed and we argue it’s because of that fact that clarity of political responsibility, there’s this big literature that says when authority is somehow diluted or shared with other actors you can escape blame, but what we argue is that in an era of great expectation, regardless of source (government, sector actors, private sector actors) that citizens are largely agnostic. They are just going to lash out because the stake is so high. They don’t care whether Gordon Brown was to blame or not they’re going to blame him anyway because they’re going to blame the person in charge.

The other question that you had about if governments play a role in financial instability, absolutely. But, it changes by particular crisis. So, did the government have some role to play in the financial crises in this country? Yeah, I tried to lay that out. Was it the only thing that was responsible? No, there was private sector issues at stake here. There were types of risks and strategies that banks took in result of this regulatory environment. A whole range of things can be blamed. The point of our book is that citizens are largely indifferent to these tales. He didn’t do it; I didn’t do it; and so on. They just kind of blame the person in charge because their material stake is so high, given the types of processes we’ve laid out.

NIKITA MALIK: Yes, in the black shirt.

AUDIENCE MEMBER 2: Thank you very much for your talk. It was really interesting. I just wanted to ask if you feel like generally people would be less hostile to those in government if they had seen maybe some better reactions to the crises. So, rather than maybe a debate on public spending, actually seeing some bankers go to jail, which a lot of people would have probably like to see, or even just an actual proper look at the regulatory frame work within which the banks were operating. Which, I think, most people agree was the core source of the problem. Do you think that would’ve made a difference, if governments had responded in that way, or do you think people would have just blamed them regardless?

PROFESSOR JEFFREY CHWIEROTH: Very good question. I’ll stick to the second point first about regulatory changes. What is a bit unsettling when you read some of the literature on this is that most individuals are largely unaware of regulatory changed. In fact, if you look at the FSA surveys that I referred to earlier, in some cases people aren’t even aware that there is a regulator. So there sort of completely unaware. So, your argument is that if we rank the regulation at the particular moment in time people respond better. So, I am pessimistic on this. You mentioned jailing bankers. That is maybe a bit more in the direction that people wanted, but what we argue in the book is that voters essentially want a rescue that is done quickly and decisively so it minimises the amount of market destruction and they want a bail out or rescue that is perceived as being fair, with the costs being fairly distributed. In this country you got a little bit of that once Gordon Brown intervened in 2008 with the rescue plan. You had this rapid response in terms of stabilising the system. But on the other hand, you have a lot of dithering about what to do about Northern Rock. Northern Rock was kind of kept on life support for a while and its loan book became even worse in terms of its ability to underwrite high risk mortgages and this escalates the amount of costs to the taxpayer. So, they did one thing pretty well and one thing not so well. I think the deeper problem is, even though you jail some bankers either rightly or wrongly, the wealth effects from the crisis. Essentially, what you have in this country, and also in US and elsewhere is you had certain parts of the economic system, particularly households, older households, who did better off than younger people. So, people with defined benefit contribution pensions, they were protected. People at the older end of the spectrum, people in the southeast, they did better than people elsewhere because of house price changes that occurred after the crisis. You had a lot of these “wealth shocks” or “wealth effect,” using the title of the book that were highly disruptive. These types of effects we’re actually seeing today, partly the Brexit referendum and the issues that we are dealing with today are some ways hangover from that period. You had people in these left-behind regions that not only were left behind for other reasons, but on top of that were layered with these pernicious effects from the financial crisis. To really get it right has to go beyond taking criminal action against people. It has to be perceived as fair, in terms of what they were able to do with respect to the bail outs.

NIKITA MALIK: Yes the gentleman (inaudible)

AUDIENCE MEMBER 3: It’s all good to go back through the past. You have obviously done an unbelievable job to know and understand what’s been going off. But, we can’t change the past, so I am more intrigued to know what you think the future is going to be. Say, if I was to pick here, rather than the states or any here else, is the middle class going to keep growing? When the next banking crisis comes because we know there will be one, does that stick keep going higher? I don’t know. Because you’ve got this in depth picture as to what’s happened in the past, perhaps you give us more or a picture of what you think could happen here. I’m choosing here because you have to be aware.

PROFESSOR JEFFREY CHWIEROTH: So that’s a great question. That is sort of what the concluding chapter tries to do. Okay, given what we’ve seen, how do you deal with this issue? Unfortunately, what the conclusion suggested is that both me and my coauthor are somewhat sceptical of if there is a way off of this doom loop. You have this process where people’s expectations are being ramped up and the government’s responding to this. So we get this ramping up of leverage in the system and financialisation. You talked about how the hockey stick just keeps going. That’s possible. In the book we talk about how there’s an unholy trinity or trilateral of sorts between democracy, financial stability and financialisation. You can’t have all three. You can’t have democratic country, a system like we have now, and financial stability. One of these has to go. Neither of us in the book go after represented democracy, saying you should curtail democracy. Although, we do talk about some of the unintended and unfortunate consequences of direct democracy. We point to the Brexit referendum, but also referendums in places like Italy that actually led to increasing amounts of backlash and problems in the system. We tried to look at different ways of dealing with things related to financial stability and financialisation. This is where it gets tricky because one thing you’d like the government to do potentially is to try to dampen down leverage cycles and asset price booms before they get out of control. The problem is, we quote Claudio Borio, who is one of the great thinkers of macro-prudential regulation, is that there is no ready-made political constituency against the inebriating felling of getting rick. Right? We all want to get wealthy. We all want to see our house prices rise. Even the young people in the room who don’t have houses, they want to get on. What does the government do? They provide them with incentives and programs to help them. But, what these programs do, like Help to Buy, is to help people like me and all of us in the room who already own homes to push to values of our houses higher and kick the ladder off from people beneath them. So the cycle goes on and on. What we suggest in the book, sort of as a hope, is that we believe that there is the potential for some moderate political party of the centre to come forward and to communication to people that there has to be some sort of way get off this train. We have to accept different levels of curtailment on this. So, one of the things we are exploring for future research is inter-generational equity. So you go to people and you say: “How would you feel about a measure that would curtail the appreciation of your house price, but would ensure that your children and your grandchildren can actually get on the housing market?” Will people actually respond to that kind of frame in terms of justifying it to somebody? Because if you just go to somebody and say you’re not going to provide for leverage assistance because they’re worried about financial stability, that doesn’t resonate well with people. People don’t understand financial stability, but that understand ‘well if my daughter or my son can’t get on the housing ladder then they’re in trouble, then maybe I might be willing to sacrifice some of the goodies from myself.

AUDIENCE MEMBER 3: Can I just ask a second question? My feeling is that life isn’t purely about trying to earn as much cash as you possibly can. I used to say that if that were the case then I’d be working on an oil rig in the North Sea. So, that’s proof that earning as much as you can is not the whole of what life is. So, caring for lead to a fulfilled life and this sort of thing. You always seem to pick on, “It’s all profit. I expect my wealth to keep going on and on.” When arguably, there’s more to life than purely that. Yet, you make no sort of comment about the other things which add to a person’s feeling about whether he is leading a reasonable life or so.

PROFESSOR JEFFREY CHWIEROTH: Right, so obviously that’s an empirical question as to whether or not people respond to what I would call ‘frames.’ So, you’re saying these are different frames. My assumption is, my prior, is that the median voter, the median person in this room, probably cares about their pension and about the value of their house. That’s near the top of the hierarchy.

AUDIENCE MEMBER 3: I don’t think you’re right there.

NIKITA MALIK: There’s a whole branch of economics on this, happiness economics. There’s a gentleman back there he has been waiting for some time. Yes, sir.

Thank you very much indeed. There was a study in the late 90’s on the impact on indirect taxes of share prices, the relationship. We said at the time, there’s really not much point. It’s much more housing because that was twenty years ago, different now. My question really follows on from the gentleman’s point early. Particularly you’re response, which I’m not sure the two positions are that far apart because people don’t have this idea to get rich, but I think you’re saying that they expect a pretty high level of financial comfort. My question, though, is the point about rising moral hazard. How much of the need to better regulate and be more prudent has to be imposed, if it exists? How much is genuinely been taken in by the financial sector itself. So, in other words, they are saying themselves, “we cannot let this happen again, or at least to the same extent.” Frankly, observing their private comments, I’m not entirely sure them the less. I share your cautious and sceptical tone.

PROFESSOR JEFFREY CHWIEROTH: I find myself agreeing with everything you were suggesting. The only thing that I would say is that I think that the financial sector is aware that households have this powerful expectation of being rescued. They use this to amplify their leverage over the government. Essentially, what you can see is that bankers, when they sit down with the government, they can basically say, “Look. If you don’t rescue us these people over here are going to come after you.” The moral hazard that is present is pervasive. The policy questions, the gentleman in the front was asking about the future. How do you claw this back? How do you minimize the amount of moral hazard? This is really difficult because it’s a question of how credible do you think efforts to enshrine what we call ‘bail in procedures.’ How credible that you think they are. I don’t think I find these particularly credible, particularly in the wake of the financial crisis. There were all these efforts to try to enshrine provisions about how creditors should take loses before the taxpayer. We saw in the case for Italy. In the Eurozone, for instance, they set up a set of rules called, ‘The Bank Recovery and Resolution Directive,’ which said the essentially creditors had to be bailed in first before the government stepped in. When push came to shove in Italy in 2016, they found a loophole in this to rescue these banks. The reason why is because in a place like Italy, the household sector, retail investors were heavily exposed to these financial institutions. You basically would impose loses on “mom and pop” who had invested their savings in these institutions in the name of some European directive. The Italians were unwilling to do that. So, if the Italians were unwilling to do that it’s unlikely, we talked about this in the book, that if something were the happen to Deutsche Bank or something to that effect, that even the Germans would be willing allow that bank to fail as well. It’s difficult.

NIKITA MALIK: I am conscious of time, so I will take the last two questions. I’m afraid we will have to keep the answers a bit brief. If you have more questions there are copies of the book outside and I’m sure we will have a little bit more time after this. The gentleman in the front…

Christ Marlin, Property Business: I don’t know if you’re familiar with the Banesto case in Spain in the 1900’s, whether you have some insight into it or an opinion to whether the takeover was justified. Was it a case of dirty politics?

PROFESSOR JEFFREY CHWIEROTH: I am afraid not. You can ask me afterwards maybe.

NIKITA MALIK: Yes, the lady.

AUDIENCE MEMBER 5: So I was just wondering in regard to the EU and their increasing idea of integrated fiscal policy, whether that’s going to make this problem worse or whether it might lead to better stability, financially.

NIKITA MALIK: And, the gentleman in the back.

AUDIENCE MEMBER 6: At the time of the bail out, the assumption that Gordon Brown made, the form it took, at the time was there anyone offering a serious alternative to the injection of bail to be a trickle down kind of bail out, rather than some of that wealth going directly to the people that might want it most (inaudible)?

PROFESSOR JEFFREY CHWIEROTH: Real quickly, on the European Union financially stability mechanisms, these types of facilities provide an extra layer of protection against financial instability. In terms of thinking about this, the worry I would have if you’re somebody that finds these institutions to be desirable, is that essentially what it could are threats to the European institutions themselves. If these institutions intervene or fail to intervene in an adequate way. What you could see is increasing backlash against these European institutions because you blame them for posterity or intervening inappropriately or inefficiently or in an unfair manner. That’s the really quick answer I’m afraid. That would be my worry. While they do provide a sort of extra layer of the financial social safety net, they also expose European institutions to the types of backlashes that we are all familiar with.

On Gordon Brown’s rescue, so there’s a lot of internal discussion about how to we do this. Do we provide internal guarantees? Do we provide re-capitalisations? In what form do we do it? And, so on. Without getting too technical. There was some debate about whether or not in the US case, for instance, versus the UK case, whether the re-capitalisations were designed in a way that they were most efficient to the taxpayer. There is a lot of discussion of whether or not the types of warrants they should have taken, the amount they should’ve charged the banks and so on, was the same. What we see in the US case is because they were able to get all to banks or force all the banks in the US to take the money, they were able to get a better deal with the banks in terms of the re-capitalisation. In the Labour government, because they only went after a few banks and the rest of them didn’t have to come in in a compulsory manner, the deal was not as beneficial to the taxpayer as the Americans got. I think the more important thing on the UK point though, a lot of the internal Labour Party discussion was about how do we make this fairer? This was an earlier question from a person on the left-hand side asking me about fairness and perceived inequities. In Labour, there was a lot of discussion of how high do we go in terms of increasing the marginal tax rate. Do we go up to forty-five? Fifty (right after the crisis)? What threshold do we put this at? What Labour did is they acted in a somewhat timid manner because they were afraid that if they went too high then they would destroy some twenty years of reforming new labour. So as a result of that, they didn’t make it sufficiently a redistributive, in terms of going after the wealth of your people. It may have damaged their long-run prospects as a result of that. So, they have been more aggressive in terms of increasing the amount of marginal tax at that particular point in time. They may have been able to show themselves as being more sensitive to some of the problems that normal people were facing in an era bankers are being perceived as rescue. That’s the main point of the book that we focus on.

NIKITA MALIK: Thank you so much!


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