WASHINGTON: There they sat on October 9 interviewing each other, the famous writer who exposed Wall Street’s excesses, and the elegant French woman who leads the international agency set up to is assure financial stability. Big Short author Michael Lewis and International Monetary Fund chief Christine Lagarde agreed that eight years after the financial crisis progress has been made but more work is required to avert future catastrophe.
Lewis, who worked at Solomon Brothers before an illustrious career in journalism and books, told the audience at IMF headquarters, “the toxic relationship between the financial sector and the public has not been addressed.” Financial instruments, he said, remain too complex, salaries are still excessive. The problem began, he continued, when banks became trading entities and downgraded the services they provide to customers. Likewise, said Lewis, well-intentioned efforts to safeguard the public went astray—regulations became burdensome, complicated and poorly communicated.
The encounter between Lagarde and Lewis culminated six days of discussions by financial policy makers and a separate gathering of several hundred bankers. The mood was somber.
David Stockton, a former Federal Reserve official who prepares economic forecasts at the Peterson Institute of International Economics, gloomily observed that the U.S. economy is mired at two percent growth in a three percent world economy. He said “we’re a driverless car stuck in the slow lane.” IMF economists also have repeatedly downgraded their forecasts.
What went wrong? Why is the recovery from the great recession of 2008 so slow?
One economist with an answer was Mohamed El-Erian who invented the term “new normal” at the Pimco investment firm in 2009. El-Erian argued that the magnitude of the financial crisis was so severe that recovery would be slow and of long duration. “The advanced economies,” he said, “had bet the farm on the wrong growth model.”
Carmen Reinhart, now at Harvard’s Kennedy School of Government, argued that because the great recession was triggered by a financial crisis recovery would inevitably be very sluggish. Reinhart said that on average it takes about seven and a half years for the average advanced economy to regain its previous peak of output. By that standard Reinhart believes the U.S. recovery is on track and further advanced than Japan or Europe.
The really pessimistic group is the bankers. European bankers were particularly gloomy saying it is impossible to make money when interest rates are at zero. There’s too much regulation, they complained, and they don’t like revealing detailed financial data to regulators, fearing it could fall into the hands of rivals.
Andreas Treichl of Erste Bank in Vienna worried about potential disrupters, financial versions of Uber or Airbnb. Uncertainty reigns concerning London’s role as a financial center in the wake of Britain’s vote to leave the European Union. Share prices of European banks languish near historic lows and the continent’s biggest bank, Deutsche, groans beneath the weight of a huge fine from the U.S. Department of Justice.
Banks are on their back foot, laying off thousands of workers as they seek a new business model. The best and brightest university grads no longer flock to New York and London. Finance, as chronicled by Michael Lewis, is no longer the elixir of quick riches.
Larry Summers, the former treasury secretary, observed the somber mood at the Washington meetings. “The specter of secular stagnation and inadequate economic growth,” he said, ”and ascendant populism and global disintegration…led to widespread apprehension.”
El-Erian was even equally pessimistic. He said central banks have lost their edge in an era of low and negative interest rates and that a low growth economy can’t endure. “The new normal is coming to an end,” he said, “the reason is simple: it has lasted for so long that it is now breeding the causes of its own destruction.”
But to end on a bright note, officials from emerging market economies say they no longer worry about the impact of Federal Reserve moves to normalize interest rates. “The Fed has communicated its intentions very clearly,” said South African ReserveBank chief Lesetja Kgangyago. “Our reserves are bigger,” he said, and there is unlikely to be a repeat of the 2013 “temper tantrum” when equity markets temporarily tanked when the Fed indicated that quantitative easing would be scaled back.
Barry D. Wood has been covering global financial meetings for over three decades.