Bank policy

The Big Financial Experiment

  • Why it matters

    Why it matters

    For many, the new powers of authorities to curb speculation by restricting loans could finally be the answer to preventing future financial crises. But many of these powers are untested, and could end up hurting ordinary citizens.

  • Facts


    • Since the 2008 financial crisis, most industrial nations have created a supervisory board charged with identifying and stopping potential bubbles from developing in the financial system.
    • The financial crisis changed the way many regulators think. The market is no longer trusted with knowing whether the price of a house or another asset is appropriate.
    • The Financial Stability Board, once a little-known group of financial experts, has been charged with coordinating the global effort to curb excessive speculation.
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Wolfgang Schäuble likes to needle his colleagues by saying he has little real power: the German finance minister argues his voice is rarely heard in a cabinet of ministers with big spending plans.  And yet, Mr. Schäuble and many of his counterparts around the world are actually far more powerful than any of their predecessors.

The Finance Ministry recently hosted a low-key meeting of big-time financial experts in Berlin. The group, a kind of shadow economic government run by Mr. Schäuble, acts as a national supervisory board. It is charged with preventing the next financial crisis and has been given sweeping powers to restrict lending to consumers and companies – effectively slowing down the economy if needed.

The German experts are part of a growing international network designed to make the global economy more resilient. In fact, nearly all industrial nations have created similar boards to guard against financial excesses. The Financial Stability Board is the international organization overseeing these national groups.

For Mr. Schäuble’s group, its time in the spotlight may have arrived: record stock market closings and rising housing prices in many rich countries mean many governments are considering using their newfound powers for the first time. The Bank of England was among the first to act when earlier this month it restricted the amount of risky loans banks can make to British homeowners.

And so the world may soon bear witness to a brand new economic experiment. If all goes well, regulators could deal a decisive blow to over-speculation in the market place. But just like any other new experiment, there is a danger of it spiraling out of control.

New doctrine

This experiment begins with the story of Alan Greenspan, once considered the best central banker in history. The former chairman of the U.S. Federal Reserve believed that markets were best left to their own devices – bankers know better than bureaucrats whether the price of a stock or home is appropriate or overvalued.

Mr. Greenspan’s philosophy became a global doctrine. That is, until the U.S. housing market collapsed and the 2008 financial crisis began. Suddenly, Mr. Greenspan was derided as the worst central banker in history and regulators vowed never again to rely solely on the verdict of bankers.

Draghi h2
Mario Draghi, president of the European Central Bank, supports measures to increase financial stability. Source: AFP


Mario Draghi, now president of the European Central Bank, shared this new worldview. When the Wall Street investment bank Lehman Brothers collapsed in 2008, Mr. Draghi was leading the Financial Stability Forum, the Financial Stability Board’s predecessor. Back then the Forum was a relatively insignificant international body of financial experts. Suddenly, it took center stage, tasked by world leaders of the G20 to come up with an alternative to the Greenspan Doctrine.

The group expanded in 2009 and changed names. Now the FSB coordinates global efforts to rein in financial markets.

Schäuble’s board

In Germany, Schäuble’s supervisory board has 10 members. They include representatives of the finance ministry, the banking regulator BaFin and the central bank, the Bundesbank. They meet at least four times a year in a nondescript conference room on the third floor of the finance ministry.

They have a number of tools at their disposal to curb financial excess. For example, the supervisory board can order customers to put more money down on a home loan. This would essentially restrict people with fewer savings from getting credit, and housing prices would rise more slowly as a result.

Supervisors can also command a bank to keep more money in reserve for every home loan it makes, which would raise the cost of lending money. Switzerland implemented this kind of measure last year in a bid to cool down its own booming housing market.  Germany’s Finance Ministry has considered similar steps in the past, but the housing market situation didn’t seem serious enough yet.


“The crisis in Europe is not over and that means interest rates will have to remain at historic lows for a long time.”

Mario Draghi, President, European Central Bank

Mario Draghi is well aware that such talks are going on. That is why when he appeared before the European Parliament last week, Europe’s top central banker felt comfortable delivering the same message he has many times before: the crisis in Europe is not over and that means interest rates will have to remain at historic lows for a long time. If Germany’s housing market is overheating as a result, then this is a problem others will have to deal with.

All change

In that sense, many central bankers view the governments’ new powers to restrict credit as something of a godsend – a possible solution to the boom-and-bust cycle that has plagued global finance for centuries.

In the past, it was the job of central banks to raise interest rates to rein in financial speculation, the idea being that people are less likely to take risks if they get a good interest rate on their bank account. The problem is that higher interest rates don’t just curb speculation. They also affect ordinary companies and consumers. Sweden learned this the hard way, recently raising interest rates in a bid to curb speculation and causing an economic downturn in the process.

What makes the new supervisory powers so enticing is that they could allow central bankers to continue flooding the market place with cheap money. Any side effects can be handled with a surgical strike rather than a carpet bomb. For Adair Turner, the former head of Britain’s financial supervisor, credit controls can be the “method of choice” to keep financial markets in check.

But nobody knows if the measures will really work. Central bankers “don’t have much experience” with these kinds of credit-controlling measures, as Claudia Buch, the Bundesbank’s vice president, said recently.

A whole series of questions remain unanswered. Will banks find a way to get around the new measures? Are supervisors really in a place to correctly identify excesses in the financial system? Will they really dare to rein in markets when times get tough, even if it could mean losing votes? And how fair is it to take measures that could primarily hit low-income earners?

The strategy also amounts to a broad expansion of government powers. Where raising interest rates makes credit more expensive for everyone, the new powers essentially allow authorities to decide which companies can grow and which ones cannot. That means politicians will be operating “at the level of business sectors,” according to Hermann Remsperger, the long-time chief economist of the Bundesbank and now chief economist at the Center for Financial Studies in Frankfurt.

This is hard to stomach for many market enthusiasts. The stiffest resistance is now coming from the Bank for International Settlements, where the FSB is also based, in Basel, Switzerland. The BIS is an association of central bankers that has typically been run by hardliners. They have little sympathy for the idea of bursting bubbles by restricting bank lending practices. This is the job of monetary policy, they argued. In other words, “Time to raise rates!”

Yet this is not going to happen. In a rare display of unity, the heads of all major central banks rejected the BIS’ demand. Mr Draghi said the BIS had made an interesting recommendation – but he was of a completely different opinion.

And so the big experiment begins.

Christopher Cermak translated this story

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