Economic Crime really matter in the world of today?
Prof. Hans Geiger, Zurich
Monday, 3rd September 2012 - First, I would like to thank Barry Rider for again inviting me to this year’s symposium. I always enjoy these stimulating days at Jesus College and the contact with so many good friends.
In his invitational letter Barry asked a very Barry-like and thought-provoking question, which he implicitly answered himself indirectly.
“This initial session seeks to address whether economic crime, as it is understood today, really is a major threat to the integrity and stability of the financial system; or whether in fact there are far greater threats and consequently whether we have perhaps responded disproportionately to such issues as money laundering, corruption and insider abuse.“My answers are, very briefly: NO, YES.
Let me elaborate on my second
YES, there are far greater threats to financial stability than money laundering, corruption and insider abuse.
Here is a list of these other threats:
- Surprisingly, the biggest threat came and still comes from the regulators of the banks, i.e. from those authorities which are mandated to promote financial stability. The first objective of the Basel Committee is “to promote safety and soundness in the financial system“.There is one common denominator behind the three institutions Banks, Central Banks and Governments that a colleague calls the “trio infernale”. I prefer the French expression “ménage à trois” (love triangle). This common denominator that is responsible for the instability of the financial system is indebtedness or leverage.
- Another big threat comes from the central banks that print money like crazy. They flood the financial system with what they call “liquidity”, which is a synonym for “central bank debt”. The central banks are encouraged or forced to do so by their governments.
- The third big threat, you will not be surprised, are the governments, which on their part, accumulate large amounts of debt which they will be unable to service at market conditions in the future.
- The regulators introduced capital adequacy rules – the key words are Basel II and Basel III – which allowed the banks to overleverage their balance sheets. They allowed the banks to apply their own internal methods of measuring risk, and they accepted the most dangerous and misleading measure of risk in the capital adequacy rules: Value at Risk (VaR). VaR is a measure for the maximum loss which will occur with a probability of 99 %. The crisis – the phase of instability – is a rare and extreme situation, i.e. it is always outside the 99 % probability range. So for the purpose of our argument, we should redefine the VaR as the “minimum loss in the case of crisis or instability”. The regulators and supervisors made a big mistake when they accepted the proposal of the big international banks to apply this risk metric for the purpose of prudential regulation. The regulators are still under the influence of the big international banks and financial institutions, which are organized in the IIF, Institute of International Finance.How will this end? Barry Rider did not ask that question. I will nevertheless answer it: In the end, the debt will be reduced by high inflation and devaluation. Over many centuries, this has been the most successful option for governments. And if they cannot achieve the necessary high inflation, they will simply default on their debt.
- The governments are the 3rd threat to financial stability. Over the last 40 years, the governments of the western world have accumulated large debt burdens on their balance sheets and even bigger ones off-balance sheet, i.e. for the welfare and social security commitments. When the financial crisis and the following economic crisis hit the world the public finances got completely out of control. Today, the financial commitments of most western countries exceed their financial capacity. This is not only true for Greece or Spain, but for Great Britain, the US and Germany as well.
- The third party in the “ménage à a trois” is the central bank. Since the financial crisis central banks have blown up their balance sheets enormously, printing money which they invested in banks, which in turn they invested it in government bonds. The banks use the government bonds as collateral to borrow more money from the central bank, and so it goes on.