The bill? $11.4 trillion

How much have governments committed for bailing out banks and financial institutions? $11.4 trillion, according to OECD estimates . That’s a lot of money – equivalent to the 2007 GDP of Japan, the United Kingdom, Germany and France combined. Or, as Dow Jones explains, about $1600 for every man, woman and child on the planet.

But that number needs to treated with a little caution. In effect, it represents a worst-case scenario for governments based on their current commitments.

$1600 for every man, woman and child on the planet

For example, it includes the cost of government guarantees, some of which will never be called on. It also includes the cost of purchasing assets and equity, the value of which may go up (or down). Because the job of supporting the banks is still a work in progress, the final cost won’t be known for years.

Of course, governments may still need to make fresh commitments in order to support banks. But assuming they don’t, the final bill could well be lower.

Useful links:

OECD Directorate for Financial and Enterprise Affairs

OECD on Financial Markets

Getting to the bottom of things

What – or who – caused the crisis? Slate offers not one but 15 answers to that question here. But if you’d like a more official response, you might like to keep an eye on the Financial Crisis Inquiry Commission (FCIC) in the United States, which is due to begin public hearings this week. The ten-member commission was set up by Congress with a sweeping mandate to investigate the causes of the crisis – everything from the possible role of fraud and abuse in the financial sector to the way bankers are paid.

There are precedents for this sort of probe. In the early 1930s, the U.S. Senate’s Pecora Commission investigated the causes of the Great Depression, and “unearthed a secret financial history of the 1920s, demystifying the assorted frauds, scams and abuses that culminated in the 1929 crash”, according to Ron Chernow. That investigation had a long-term impact on the U.S. financial sector, leading to the establishment of the Securities and Exchange Commission (SEC) and the separation of commercial and investigation banking.

Whether the FCIC will have the same impact remains to be seen, but its chairman, Phil Angelides, has made it clear that he wants the commission to ask – and answer – some tough questions. “You have millions of people unemployed, millions have lost their homes, and Wall Street is having a record year with record profits and record bonuses,” he told ABC News. “People want to understand why.” What questions should the commission ask? The New York Times and The Huffington Post have some suggestions.

The Commission is due to report by mid-December 2010, but members have indicated they plan to post important findings on their website (under construction) before then.

We are a bit bemused


 

A new name to add to the list of those who want to know what caused the crisis: Queen Elizabeth II. During a visit to the London School of Economics, the British monarch asked economists why they didn’t do a better job of predicting the timing and scale of the slowdown, The Observer reports. “She seemed very interested, and she asked me: ‘How come nobody could foresee it?,” Professor Luis Garicano of the LSE told the newspaper.

Stirred by the Queen’s query, some of Britain’s leading economic experts wrote to her to explain what they think went wrong. “Everyone seemed to be doing their own job properly on its own merit. And according to standard measures of success, they were often doing it well,” they told her. “The failure was to see how collectively this added up to a series of interconnected imbalances over which no single authority had jurisdiction.” While the crisis had many causes, they concluded, “[it] was principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole.”

A crisis of (over-)confidence?

Malcolm Gladwell is probably the world’s most famous “pop” sociologist. His work often focuses on “how little things can make a big difference,” to quote the subtitle of his bestseller The Tipping Point. No surprise, then, that the financial crisis has caught his attention. Here, he argues that the roots of Wall Street’s crisis were in large part psychological: The overconfidence of many of those working in financial markets, he argues, led them to suffer from the “illusion of control” – an inability to recognise both the limits of their own knowledge and their capacity to control events. Can such overconfidence be reined in? Not easily, says Gladwell: Confidence is the lifeblood of financial markets everywhere, and it’s usually the most confident (and even overconfident) players who score the biggest wins. But if everyone becomes overconfident – i.e., if everyone acts in the hope that their bluff won’t be called – realistic assessment of risks and rewards goes out the window.

If one of us fails, everyone suffers…

Trillions of taxpayers’ dollars were needed to save the very institutions that provoked the worst financial crisis in 60 years. The bailouts seem to have succeeded, but to stop the same thing happening again, the structure of the global financial system has to be rethought, notably to deal with the risks linked to counterparty failure and contagion.

Writing in the Wall Street Journal,  Adrian Blundell-Wignall of the OECD puts forward a proposal to contain risk by addressing what banks actually do. The proposal does not require draconian Glass-Steagall divestment of securities businesses from commercial banks. But it does require some important structural changes for banking conglomerates to make sure that the failure of one does not mean trouble for all.

Useful links:  The Financial Crisis: Reform and Exit Strategies

Mad math

J.P. Morgan saved the financial system twice. In 1895, following the Panic of 1893, the Federal Treasury had almost no gold left, following a run on the gold supply. Morgan came to the rescue, heading a syndicate that loaned enough gold to finance a bond issue that restored the Treasury’s surplus. He saved the day once again in the Panic of 1907, persuading New York bankers to follow his example by pledging money to consolidate the banking system.

So it’s ironic that the bank he founded was in some ways at the root of the current crisis. That may sound surprising, given the usual suspects (Lehman’s, AIG, Bear Sterns…). Yet, as Gillian Tett of the Financial Times explains in Fool’s Gold,  a team from J.P. Morgan invented a product called Bistro (Broad Index Secured Trust offering) that helped to fuel the massive expansion of the credit derivatives market.

(more…)

The roots of a crisis­­

To kick off our new site, we will publish From Crisis to Recovery, a new book from the OECD Insights series here on the blog, chapter-by-chapter.   This book traces the roots and the course of the crisis, how it has affected jobs, pensions and trade, while charting the prospects for recovery.

These chapters are “works in progress” and their content will evolve.  Reader comments are encouraged and will be used in shaping the book.

By way of introduction…

The events of 2008 have already passed into history, but they still have the power to take our breath away. Over a matter of months, a succession of earthquakes struck the world’s financial system – the sort of events that might normally happen only once in a century.

In reality, the warning signs were already there in 2007, when severe pressure began building in the subprime securities market. Then, in March 2008, the investment bank and brokerage Bear Stearns collapsed. More was to come. Early in September, the United States government announced it was taking control of Fannie Mae and Freddie Mac, two huge entities that underpin mortgage lending in the U.S. Then, in the middle of that month, came news of the collapse of investment bank Lehman Brothers. A fixture on Wall Street, Lehman had been a home to the sort of traders and dealers that novelist Tom Wolfe once dubbed “masters of the universe”. Around the same time, another of Wall Street’s legends, Merrill Lynch, avoided Lehman’s fate only by selling itself to the Bank of America.

It wasn’t just investment banks that found themselves in trouble. The biggest insurer in the U.S., American Insurance Group, teetered on the brink of failure thanks to bad bets it had made on insuring complex financial securities. It survived only after billions of dollars of bailouts from Washington.

How did the stock markets react? In New York, the Dow Jones Index fell 777 points on 29 September, its biggest-ever one-day points fall. That was a mirror of wider fears that the world’s financial system was on the brink of meltdown. The mood was summed up on the cover of The Economist, not usually given to panic, which depicted a man standing on the edge of a crumbling cliff accompanied by the headline, “World on the edge”.

What happened? Find out by reading the full chapter here The Roots of a Crisis