Social Europe

politics, economy and employment & labour

  • Themes
    • European digital sphere
    • Recovery and resilience
  • Publications
    • Books
    • Dossiers
    • Occasional Papers
    • Research Essays
    • Brexit Paper Series
  • Podcast
  • Videos
  • Newsletter

Fighting The Next Global Financial Crisis

Robert Shiller 24th May 2016

Robert Shiller

Robert J Shiller

What do people mean when they criticize generals for “fighting the last war”? It’s not that generals ever think they will face the same weapon systems and the same battlefields. They certainly know better. The error, to the extent that the generals make it, must operate at a more subtle level. Generals are sometimes slow to get around to developing plans and ordnance for those new weapon systems and battlefields. And just as important, they sometimes assume that the public psychology, and the narratives that influence the morale that is so important in achieving victory, is the same as in the last war.

That is also true for regulators whose job is to prevent financial crises. For the same reasons, they may be slow to change in response to new situations. They tend to be slow to adapt to changing public psychology. The need for regulation depends on public perceptions of the last crisis, and, as George Akerlof and I argued in Animal Spirits, these perceptions depend heavily on changing popular narratives.

The latest progress reports from the Financial Stability Board (FSB) in Basel outline definite improvements in stability-enhancing financial regulations in 24 of the world’s largest economies. Their “Dashboard” tabulates progress in 14 different regulatory areas. For example, the FSB gives high marks for all 24 countries in implementing the Basel III risk-based capital requirements.

But the situation is not altogether reassuring. These risk-based capital requirements may not be high enough, as Anat Admati and Martin Hellwig argued in their influential book The Bankers New Clothes. And there has been much less progress in a dozen other regulatory areas that the FSB tabulates.

Consider, for example, regulations regarding money market funds, which, according to the FSB, only a few countries have developed since 2008. Money market funds are an alternative to banks for storing one’s money, offering somewhat higher interest rates, but without the insurance that protects bank deposits in many countries. As with bank deposits, investors can take their money out at any time. And, like bank deposits, the funds are potentially subject to a run if a large number of people try to withdraw their money at the same time.

On September 16, 2008, a few days after the run on the US bank Washington Mutual began and the day after the Lehman Brothers bankruptcy was announced, a major United States money market fund, Reserve Primary Fund, which had invested in Lehman debt, was in serious trouble. With assets totaling less than it owed to investors, the fund seemed to be on the verge of a run. As panic rose among the public, the federal government, fearing a major run on other money market funds, guaranteed all such funds for one year, starting September 19, 2008.

The reason why this run was so alarming as to require unprecedented government support stems from the narratives underlying it. In fact, the Reserve Primary Fund did not lose everything. It merely “broke the buck,” meaning that it couldn’t pay one dollar for a dollar on the books; but it could still pay $0.97. So why a crisis? After all, bank depositors regularly lose more when unexpected inflation erodes their savings’ real purchasing power (only the nominal value of those deposits is insured). But the narratives don’t focus on that. The loss of real value due to inflation hasn’t been a prominent theme of the public narrative in the US for decades, because sustained price stability has caused people to forget about it.

But they hadn’t forgotten about the Great Depression of the 1930s, even though most people alive today weren’t alive then. In 2008, the Great Depression narrative was being recycled everywhere, with all its colorful stories of financial panic and angry crowds forming around closed banks. Moreover, trusted authorities had seemed to say again and again that such events were historically remote and could not happen again. In the 2008 angry zeitgeist, the public reaction to a relatively minor event took on stunning proportions.

It took almost six years after the crisis for the US Securities and Exchange Commission to reduce money market funds’ vulnerability, by requiring in 2014 a “floating NAV” (net asset value), which means that prime money market funds no longer promise to pay out a dollar for a dollar’s nominal value. They will pay out whatever the depositor’s share in the accounts is. This does not insure the funds’ investors against losses. Yet this plausibly will help prevent runs because it means sudden withdrawals by some won’t damage the accounts of others who did not withdraw.

The international regulatory framework has changed for the better since 2008, but no such changes can anticipate all the kinds of change in narratives that underlie public animal spirits. Regulators could have imposed a floating NAV decades ago; they didn’t because they didn’t foresee a narrative that would make money market funds unstable. Regulatory authorities could not have been expected to predict the sudden public attention to the newly discovered risk of runs on nonbank financial companies.

As long as we have an economic system that produces growth by rewarding inspired actors and investors, we will face the risk that adverse talk and stories can suddenly and temporarily overwhelm the inspiration. Regulators must counter the risks implied by structures that are intrinsically destabilizing, as the money market funds were. But the most urgent regulations will always be time- and context-specific, because narratives change. And how these narratives resonate with the public may once again reveal chinks in our financial armor.

© Project Syndicate

Robert Shiller

Robert Shiller, Professor of Economics at Yale University and Chief Economist at MacroMarkets LLC, is co-author, with George Akerlof, of Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism.

Home ・ Economy ・ Fighting The Next Global Financial Crisis

Most Popular Posts

schools,Sweden,Swedish,voucher,choice Sweden’s schools: Milton Friedman’s wet dreamLisa Pelling
world order,Russia,China,Europe,United States,US The coming world orderMarc Saxer
south working,remote work ‘South working’: the future of remote workAntonio Aloisi and Luisa Corazza
Russia,Putin,assets,oligarchs Seizing the assets of Russian oligarchsBranko Milanovic
Russians,support,war,Ukraine Why do Russians support the war against Ukraine?Svetlana Erpyleva

Most Recent Posts

Gazprom,Putin,Nordstream,Putin,Schröder How the public loses out when politicians cash inKatharina Pistor
defence,europe,spending Ukraine and Europe’s defence spendingValerio Alfonso Bruno and Adriano Cozzolino
North Atlantic Treaty Organization,NATO,Ukraine The Ukraine war and NATO’s renewed credibilityPaul Rogers
transnational list,European constituency,European elections,European public sphere A European constituency for a European public sphereDomènec Ruiz Devesa
hydrogen,gas,LNG,REPowerEU EU hydrogen targets—a neo-colonial resource grabPascoe Sabido and Chloé Mikolajczak

Other Social Europe Publications

The transatlantic relationship
Women and the coronavirus crisis
RE No. 12: Why No Economic Democracy in Sweden?
US election 2020
Corporate taxation in a globalised era

Foundation for European Progressive Studies Advertisement

EU Care Atlas: a new interactive data map showing how care deficits affect the gender earnings gap in the EU

Browse through the EU Care Atlas, a new interactive data map to help uncover what the statistics are often hiding: how care deficits directly feed into the gender earnings gap.

While attention is often focused on the gender pay gap (13%), the EU Care Atlas brings to light the more worrisome and complex picture of women’s economic inequalities. The pay gap is just one of three main elements that explain the overall earnings gap, which is estimated at 36.7%. The EU Care Atlas illustrates the urgent need to look beyond the pay gap and understand the interplay between the overall earnings gap and care imbalances.


BROWSE THROUGH THE MAP

Hans Böckler Stiftung Advertisement

Towards a new Minimum Wage Policy in Germany and Europe: WSI minimum wage report 2022

The past year has seen a much higher political profile for the issue of minimum wages, not only in Germany, which has seen fresh initiatives to tackle low pay, but also in those many other countries in Europe that have embarked on substantial and sustained increases in statutory minimum wages. One key benchmark in determining what should count as an adequate minimum wage is the threshold of 60 per cent of the median wage, a ratio that has also played a role in the European Commission's proposals for an EU-level policy on minimum wages. This year's WSI Minimum Wage Report highlights the feasibility of achieving minimum wages that meet this criterion, given the political will. And with an increase to 12 euro per hour planned for autumn 2022, Germany might now find itself promoted from laggard to minimum-wage trailblazer.


FREE DOWNLOAD

ETUI advertisement

Bilan social / Social policy in the EU: state of play 2021 and perspectives

The new edition of the Bilan social 2021, co-produced by the European Social Observatory (OSE) and the European Trade Union Institute (ETUI), reveals that while EU social policy-making took a blow in 2020, 2021 was guided by the re-emerging social aspirations of the European Commission and the launch of several important initiatives. Against the background of Covid-19, climate change and the debate on the future of Europe, the French presidency of the Council of the EU and the von der Leyen commission must now be closely scrutinised by EU citizens and social stakeholders.


AVAILABLE HERE

Eurofound advertisement

Living and working in Europe 2021

The Covid-19 pandemic continued to be a defining force in 2021, and Eurofound continued its work of examining and recording the many and diverse impacts across the EU. Living and working in Europe 2021 provides a snapshot of the changes to employment, work and living conditions in Europe. It also summarises the agency’s findings on issues such as gender equality in employment, wealth inequality and labour shortages. These will have a significant bearing on recovery from the pandemic, resilience in the face of the war in Ukraine and a successful transition to a green and digital future.


AVAILABLE HERE

About Social Europe

Our Mission

Article Submission

Membership

Advertisements

Legal Disclosure

Privacy Policy

Copyright

Social Europe ISSN 2628-7641

Social Europe Archives

Search Social Europe

Themes Archive

Politics Archive

Economy Archive

Society Archive

Ecology Archive

Follow us on social media

Follow us on Facebook

Follow us on Twitter

Follow us on LinkedIn

Follow us on YouTube