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17-06-2015, 10:42 AM
The lessons of crises
Anthony Rowley
The Business Times
Monday, Jun 08, 2015
IF there were such a thing as a doctorate in financial crisis management it would surely have been conferred upon Charles Dallara. With his remarkably wide-ranging experience in global finance, as both a public official and a private sector practitioner, he has gained unique insights into the causes of financial crises, and how to deal with them.
Against a backdrop of the Greek debt crisis ever ready to erupt into a Europe-wide crisis - memories are fresh still of the 2008 global financial crisis and high-level officials warning that a fresh crisis may be in the making - the former US Treasury and IMF official-turned-financial sector diplomat has some valuable lessons to offer.
In an interview held in the lobby of Tokyo's Peninsula Hotel where he stopped off during one of his globe-encircling journeys, Mr Dallara imparted some of his professional wisdom to The Business Times. That wisdom has been gained in a career spanning more than 40 years which has seen him serve, among other things, as senior US Treasury official, US executive director of the International Monetary Fund (IMF), managing director of JP Morgan Bank, CEO of the Institute of International Finance (IIF) in Washington, and now as vice-chairman of asset manager Partners Group Holdings, based in Switzerland.
As a "crisis doctor" par excellence, Mr Dallara stresses the need for those dealing with such events to have what amounts to a good bedside manner and to focus on finding solutions rather than "moralising, finger pointing" and apportioning blame in crisis situations.
He also talks of the pressing need for nation states to cede greater authority to global financial institutions, so that they can find and implement solutions to prevent or deal with crises. "Sovereignty has peaked and globalisation is here to stay", although governments around the world have yet to acknowledge this fact, he suggests.
Mr Dallara warns too of the dangers of asset inflation and of the "disconnect" between asset prices and underlying fundamentals. At the same time, he reveals where he thinks the next financial crisis (or crises) might come from.
What, I ask him, has been learnt from the crises that seem to be endemic to the world of finance?
"I've seen a lot of these crises," he says. "The first I was involved in was a crisis of confidence around the dollar which was in the late-1970s when I was a young US Treasury officer. The dollar came under considerable pressure in the context of high inflation, rising interest rates and a generalised lack of confidence in the US economy. That was perhaps my first lesson - that no matter how strong a country, a corporation or a financial institution is, you are never fully protected against a break in confidence.
"At the end of the day, it's that lack of confidence in an asset or a country or a corporation that seems to me to be such a pivotal dimension of turning a problem into a crisis. This is what happened to us in the late-1970s in America and it was particularly painful because this came after three decades of global economic hegemony and when (the US) had been under pressure for some time as a result of the Vietnam War and a growing trade and current account deficit."
More recently, he has been involved in the Greek crisis that began brewing two years ago "and which, sadly, continues today", he says. "I led the restructuring on the private creditor side. Again, we saw this dramatic break of confidence in Greece, which spread throughout the euro (area). This was all precipitated in this case by the sudden awareness that the world was much darker than it looked. The Greeks reported in 2008 a fiscal deficit in the range of 6 per cent (of GDP) but when the Papandreou government settled into office in the fall of 2009, they discovered that the deficit was nearly double that figure. When this became a fully transparent reality in the market, suddenly the markets froze and were closed to Greece.
"If you look at the Latin debt crisis (in the early 1980s) and the global financial crisis of 2008, what seemed to transform a problem into a crisis was a sudden break of confidence. Once you have that break it takes a long time and huge effort to put it back together because you have broken trust with market participants.
"This is a common factor in so many global financial crises. It often takes what may be seen in hindsight to have been a fairly modest event but one that can spread like wildfire, and I think that one of the things that has happened over the decades since that first crisis I was involved in 31/2 decades ago is the capacity of markets to take a localised crisis and turn it into a globalised crisis.
"I think what has transformed the features of financial crises over the course of the decades has been the growing liquidity in global capital markets and inter-connectedness of those markets, and the difficulties which both practitioners and policymakers have in finding firewalls for preventing these crises."
How has the nature of financial crises changed over the years?
"There was virtually no capital market lending to Latin America in the late-1970s and early-1980s," he notes. Capital inflows into the region "had all come through the famous petro-dollar recycling process". "Now, crises have much of a capital market and liquidity market dimension to them, which makes the fire spread much more rapidly and makes it much more difficult to put that fire out."
Pragmatic solutions
This being the case, how much can one learn from one crisis in order to solve subsequent crises, or is it that the system is becoming increasingly complex and that the potential for crises ever-expanding?
"Well", says Mr Dallara, "I think one can learn from crisis to crisis. I think there are some essential ingredients that can be key to the solution of a crisis, regardless of its particular nature." He cites the need for "close and open and honest dialogue among participants and dialogue that is not too heavily infused with blame and indictment".
"If I look at the handling of the Greek crisis and of the global financial crisis, I have found that there is a fair amount of moralising going on. There is finger-pointing and a fair amount of demagoguery. The principle I applied in all of my work on sovereign debt crises and also on larger crises is - try to contain the tendency to point fingers and (offer) blame; focus on pragmatic solutions and don't yield to the temptation to moralise."
Has the IMF tended to moralise, I ask.
"The IMF has at times moralised, as have many players in the game. If I look at the Greek situation, which is so much in the forefront of our minds, again today the tendency of many northern Europeans to moralise (about) the Greeks has been a real problem in finding pragmatic solutions.
"It was tempting in the early days of the debt crisis to do the same. It was tempting to look at Mexico and Brazil and Argentina and look down one's nose and say, 'you borrowed irresponsibly and you have not invested wisely, and if your economy is in trouble, that is due to your incompetence'. But there are always, in any crisis, broader issues at stake and the stakeholders increasingly are global. Those involved in trying to resolve crises have to recognise that they represent global interests and not just parochial interests. This again is something that is not easy to do but (for example) Germans don't represent just Germany, they represent all of Europe in dealing with problems like Greece.
"My sense is still one of deep regret that (investment bank) Lehman was allowed to fail because I feel that a huge miscalculation was made (regarding) the impact of this. There was some (hint of) 'you guys have behaved irresponsibly so you deserve what's coming at you'. I think that that is always a risky proposition in a world that is so interconnected as we are today. We have to take, in my view, a very long view of what (causes) a crisis and what helps to sustain it."
But how to recognise a crisis in the making, I ask.
"I'm a firm believer in trying to learn lessons but I'm also a firm believer in being sceptical of the notion that the next crisis will look like the last one," says Mr Dallara. "Some of the lessons have to be at a very high level of generality," he says, citing the need to "be open and transparent, work in good faith, work with the authorities and with your adversaries".
He continues: "If you look at some of the crises in recent years you will see that there has been a lack of good faith. Try to find certain rules of the game that can be applied to finding solutions. Be trustworthy and expect - even if it involves a little naivete - your adversaries and your counterparts to be trustworthy. Recognise the global nature of the game that we are playing today. There are very few local financial crises these days. Global markets and global economies are so inter-connected and with communications and social media being what they are today, the capacity of markets to transmit anxiety is such that the wellbeing of a poor worker in the middle of Szechuan province of China may be affected by how I may handle Greek debt restructuring. That global awareness is something that I think we all have to remind ourselves of."
We are presumably far away, I suggest, from having a kind of global super-agency capable of handling crises at the capital market level and the banking level?
"That's a very good question but many would question the desirability (of such an agency)," he replies. "Having lived through what I've lived through and having seen what I've seen, I tend to be a globalist but a globalist with a difference, maybe, in the sense that I think we need to build now stronger and more effective global institutions.
"But these institutions do need some degree of empowerment. They also need a profound sense of connectivity between the stakeholder and the decision-making, so that those who have an interest in the outcome have some capacity to voice a view and be part of the decision-making. Having spent my career in this really odd mix of public and private sectors, (I think that) the institutions we probably need are ones that are somehow jointly owned, if you would, by the public and the private sectors."
With your kind of perspective, perhaps, I venture.
"Whether people have my background (it doesn't matter). But at least, they should have some appreciation and the views of both the public and the private sectors (and make sure that those interests) are reasonably well represented around the table. I think one of the problems we have had since the global financial crisis erupted is difficulty in finding that balance between public and private sector. The tendency of the public sector is to sow the seeds of distrust in the private sector among the public at large.
"It's not that I would deny for a moment that some of the practices and activities of private financial institutions contributed significantly to the crisis - poor risk management, lack of sound governance structures, opaqueness in certain financial instruments, the flawed dynamics of ratings which stamped to a certain degree the certification of good housekeeping approval on certain financial instruments. There's more than enough evidence that shortcomings in the financial system and in financial institutions contributed to the crisis. But there's also ample evidence that the weaknesses in policymaking and in global institutional governance contributed as well. It's been so difficult for policymakers to acknowledge this."
Global institutions of the future need to have some degree of empowerment, he says. "Of course, it must be rooted in sovereignty but let's face it, sovereignty has peaked. It's a profound and simple statement that globalisation is here to stay. I think it remains unfortunate that national central banks and regulators have not seen the potential of ceding more authority to organisations like the Basel Committee or the Financial Stability Board. They have the capacity to frame global standards but not the capacity to ensure the consistent implementation. That creates nightmares for financial institutions and it creates so many standards and inconsistencies that one really chases one's own tail around the mulberry bush trying to be consistent with global regulations."
What will need to happen to improve the situation - another crisis, I ask?
Learning from mistakes
"Let's hope not," he responds. "Let's hope that wisdom does come through crises. Often it comes through experience and experience does not have to be laced day in and day out with crises. Unfortunately, much of one's learning derives from making mistakes. I think we all realise that but we are also smart enough to know that's what history and enlightenment are there for - to help us avoid some of the mistakes of prior generations. I also think that the solutions to crises also have to resist strongly the temptations of nationalism. I have seen evidence in so many crises I have lived through that the temptations of nationalism overcome good judgment."
What about the future, I ask. Is there another potential crisis out there and, if so, what or where are the threats to the system?
"I think there are seeds of crises being planted and I think our job is to identify them and to avoid fertilising and watering them, which unfortunately we have a tendency to do. First of all, asset inflation is real, it is serious, and it is widespread.
"Central banks developed so much energy and focus in the 1960s, 70s and 80s on fighting inflation that I find it ironic and to a degree sad that they have now seemingly lost sight of the realities of asset inflation. It may not be goods and services inflation but it is inflation nonetheless and it is inflation of the worst kind because it is separating asset values from their fundamentals and we know that that can only be sustained for so long.
"In my life today, I follow valuations in private markets and I can tell you that in large cap markets and leveraged buyouts there's a growing disconnect between fundamentals and earnings. Asset inflation has leaked into almost every corner of global markets. When I look at asset inflation that is circling around the globe, I worry that the adjustment process that connects fundamentals and asset prices is going to be painful and costly and disruptive.
"I think we have another crisis brewing in the legitimacy of democracy in the more advanced Western economies. We have this extraordinary paradox where politics are becoming more parochial and more localised at the domestic level while the world economy is becoming more globalised. I think we have to recognise that it is short-term politics that tends to dominate more and more, and the decision-making (processes) in our so-called advanced democracies are fundamentally inconsistent with sensible governance and a globalised world."
http://business.asiaone.com/news/the-lessons-crises
Anthony Rowley
The Business Times
Monday, Jun 08, 2015
IF there were such a thing as a doctorate in financial crisis management it would surely have been conferred upon Charles Dallara. With his remarkably wide-ranging experience in global finance, as both a public official and a private sector practitioner, he has gained unique insights into the causes of financial crises, and how to deal with them.
Against a backdrop of the Greek debt crisis ever ready to erupt into a Europe-wide crisis - memories are fresh still of the 2008 global financial crisis and high-level officials warning that a fresh crisis may be in the making - the former US Treasury and IMF official-turned-financial sector diplomat has some valuable lessons to offer.
In an interview held in the lobby of Tokyo's Peninsula Hotel where he stopped off during one of his globe-encircling journeys, Mr Dallara imparted some of his professional wisdom to The Business Times. That wisdom has been gained in a career spanning more than 40 years which has seen him serve, among other things, as senior US Treasury official, US executive director of the International Monetary Fund (IMF), managing director of JP Morgan Bank, CEO of the Institute of International Finance (IIF) in Washington, and now as vice-chairman of asset manager Partners Group Holdings, based in Switzerland.
As a "crisis doctor" par excellence, Mr Dallara stresses the need for those dealing with such events to have what amounts to a good bedside manner and to focus on finding solutions rather than "moralising, finger pointing" and apportioning blame in crisis situations.
He also talks of the pressing need for nation states to cede greater authority to global financial institutions, so that they can find and implement solutions to prevent or deal with crises. "Sovereignty has peaked and globalisation is here to stay", although governments around the world have yet to acknowledge this fact, he suggests.
Mr Dallara warns too of the dangers of asset inflation and of the "disconnect" between asset prices and underlying fundamentals. At the same time, he reveals where he thinks the next financial crisis (or crises) might come from.
What, I ask him, has been learnt from the crises that seem to be endemic to the world of finance?
"I've seen a lot of these crises," he says. "The first I was involved in was a crisis of confidence around the dollar which was in the late-1970s when I was a young US Treasury officer. The dollar came under considerable pressure in the context of high inflation, rising interest rates and a generalised lack of confidence in the US economy. That was perhaps my first lesson - that no matter how strong a country, a corporation or a financial institution is, you are never fully protected against a break in confidence.
"At the end of the day, it's that lack of confidence in an asset or a country or a corporation that seems to me to be such a pivotal dimension of turning a problem into a crisis. This is what happened to us in the late-1970s in America and it was particularly painful because this came after three decades of global economic hegemony and when (the US) had been under pressure for some time as a result of the Vietnam War and a growing trade and current account deficit."
More recently, he has been involved in the Greek crisis that began brewing two years ago "and which, sadly, continues today", he says. "I led the restructuring on the private creditor side. Again, we saw this dramatic break of confidence in Greece, which spread throughout the euro (area). This was all precipitated in this case by the sudden awareness that the world was much darker than it looked. The Greeks reported in 2008 a fiscal deficit in the range of 6 per cent (of GDP) but when the Papandreou government settled into office in the fall of 2009, they discovered that the deficit was nearly double that figure. When this became a fully transparent reality in the market, suddenly the markets froze and were closed to Greece.
"If you look at the Latin debt crisis (in the early 1980s) and the global financial crisis of 2008, what seemed to transform a problem into a crisis was a sudden break of confidence. Once you have that break it takes a long time and huge effort to put it back together because you have broken trust with market participants.
"This is a common factor in so many global financial crises. It often takes what may be seen in hindsight to have been a fairly modest event but one that can spread like wildfire, and I think that one of the things that has happened over the decades since that first crisis I was involved in 31/2 decades ago is the capacity of markets to take a localised crisis and turn it into a globalised crisis.
"I think what has transformed the features of financial crises over the course of the decades has been the growing liquidity in global capital markets and inter-connectedness of those markets, and the difficulties which both practitioners and policymakers have in finding firewalls for preventing these crises."
How has the nature of financial crises changed over the years?
"There was virtually no capital market lending to Latin America in the late-1970s and early-1980s," he notes. Capital inflows into the region "had all come through the famous petro-dollar recycling process". "Now, crises have much of a capital market and liquidity market dimension to them, which makes the fire spread much more rapidly and makes it much more difficult to put that fire out."
Pragmatic solutions
This being the case, how much can one learn from one crisis in order to solve subsequent crises, or is it that the system is becoming increasingly complex and that the potential for crises ever-expanding?
"Well", says Mr Dallara, "I think one can learn from crisis to crisis. I think there are some essential ingredients that can be key to the solution of a crisis, regardless of its particular nature." He cites the need for "close and open and honest dialogue among participants and dialogue that is not too heavily infused with blame and indictment".
"If I look at the handling of the Greek crisis and of the global financial crisis, I have found that there is a fair amount of moralising going on. There is finger-pointing and a fair amount of demagoguery. The principle I applied in all of my work on sovereign debt crises and also on larger crises is - try to contain the tendency to point fingers and (offer) blame; focus on pragmatic solutions and don't yield to the temptation to moralise."
Has the IMF tended to moralise, I ask.
"The IMF has at times moralised, as have many players in the game. If I look at the Greek situation, which is so much in the forefront of our minds, again today the tendency of many northern Europeans to moralise (about) the Greeks has been a real problem in finding pragmatic solutions.
"It was tempting in the early days of the debt crisis to do the same. It was tempting to look at Mexico and Brazil and Argentina and look down one's nose and say, 'you borrowed irresponsibly and you have not invested wisely, and if your economy is in trouble, that is due to your incompetence'. But there are always, in any crisis, broader issues at stake and the stakeholders increasingly are global. Those involved in trying to resolve crises have to recognise that they represent global interests and not just parochial interests. This again is something that is not easy to do but (for example) Germans don't represent just Germany, they represent all of Europe in dealing with problems like Greece.
"My sense is still one of deep regret that (investment bank) Lehman was allowed to fail because I feel that a huge miscalculation was made (regarding) the impact of this. There was some (hint of) 'you guys have behaved irresponsibly so you deserve what's coming at you'. I think that that is always a risky proposition in a world that is so interconnected as we are today. We have to take, in my view, a very long view of what (causes) a crisis and what helps to sustain it."
But how to recognise a crisis in the making, I ask.
"I'm a firm believer in trying to learn lessons but I'm also a firm believer in being sceptical of the notion that the next crisis will look like the last one," says Mr Dallara. "Some of the lessons have to be at a very high level of generality," he says, citing the need to "be open and transparent, work in good faith, work with the authorities and with your adversaries".
He continues: "If you look at some of the crises in recent years you will see that there has been a lack of good faith. Try to find certain rules of the game that can be applied to finding solutions. Be trustworthy and expect - even if it involves a little naivete - your adversaries and your counterparts to be trustworthy. Recognise the global nature of the game that we are playing today. There are very few local financial crises these days. Global markets and global economies are so inter-connected and with communications and social media being what they are today, the capacity of markets to transmit anxiety is such that the wellbeing of a poor worker in the middle of Szechuan province of China may be affected by how I may handle Greek debt restructuring. That global awareness is something that I think we all have to remind ourselves of."
We are presumably far away, I suggest, from having a kind of global super-agency capable of handling crises at the capital market level and the banking level?
"That's a very good question but many would question the desirability (of such an agency)," he replies. "Having lived through what I've lived through and having seen what I've seen, I tend to be a globalist but a globalist with a difference, maybe, in the sense that I think we need to build now stronger and more effective global institutions.
"But these institutions do need some degree of empowerment. They also need a profound sense of connectivity between the stakeholder and the decision-making, so that those who have an interest in the outcome have some capacity to voice a view and be part of the decision-making. Having spent my career in this really odd mix of public and private sectors, (I think that) the institutions we probably need are ones that are somehow jointly owned, if you would, by the public and the private sectors."
With your kind of perspective, perhaps, I venture.
"Whether people have my background (it doesn't matter). But at least, they should have some appreciation and the views of both the public and the private sectors (and make sure that those interests) are reasonably well represented around the table. I think one of the problems we have had since the global financial crisis erupted is difficulty in finding that balance between public and private sector. The tendency of the public sector is to sow the seeds of distrust in the private sector among the public at large.
"It's not that I would deny for a moment that some of the practices and activities of private financial institutions contributed significantly to the crisis - poor risk management, lack of sound governance structures, opaqueness in certain financial instruments, the flawed dynamics of ratings which stamped to a certain degree the certification of good housekeeping approval on certain financial instruments. There's more than enough evidence that shortcomings in the financial system and in financial institutions contributed to the crisis. But there's also ample evidence that the weaknesses in policymaking and in global institutional governance contributed as well. It's been so difficult for policymakers to acknowledge this."
Global institutions of the future need to have some degree of empowerment, he says. "Of course, it must be rooted in sovereignty but let's face it, sovereignty has peaked. It's a profound and simple statement that globalisation is here to stay. I think it remains unfortunate that national central banks and regulators have not seen the potential of ceding more authority to organisations like the Basel Committee or the Financial Stability Board. They have the capacity to frame global standards but not the capacity to ensure the consistent implementation. That creates nightmares for financial institutions and it creates so many standards and inconsistencies that one really chases one's own tail around the mulberry bush trying to be consistent with global regulations."
What will need to happen to improve the situation - another crisis, I ask?
Learning from mistakes
"Let's hope not," he responds. "Let's hope that wisdom does come through crises. Often it comes through experience and experience does not have to be laced day in and day out with crises. Unfortunately, much of one's learning derives from making mistakes. I think we all realise that but we are also smart enough to know that's what history and enlightenment are there for - to help us avoid some of the mistakes of prior generations. I also think that the solutions to crises also have to resist strongly the temptations of nationalism. I have seen evidence in so many crises I have lived through that the temptations of nationalism overcome good judgment."
What about the future, I ask. Is there another potential crisis out there and, if so, what or where are the threats to the system?
"I think there are seeds of crises being planted and I think our job is to identify them and to avoid fertilising and watering them, which unfortunately we have a tendency to do. First of all, asset inflation is real, it is serious, and it is widespread.
"Central banks developed so much energy and focus in the 1960s, 70s and 80s on fighting inflation that I find it ironic and to a degree sad that they have now seemingly lost sight of the realities of asset inflation. It may not be goods and services inflation but it is inflation nonetheless and it is inflation of the worst kind because it is separating asset values from their fundamentals and we know that that can only be sustained for so long.
"In my life today, I follow valuations in private markets and I can tell you that in large cap markets and leveraged buyouts there's a growing disconnect between fundamentals and earnings. Asset inflation has leaked into almost every corner of global markets. When I look at asset inflation that is circling around the globe, I worry that the adjustment process that connects fundamentals and asset prices is going to be painful and costly and disruptive.
"I think we have another crisis brewing in the legitimacy of democracy in the more advanced Western economies. We have this extraordinary paradox where politics are becoming more parochial and more localised at the domestic level while the world economy is becoming more globalised. I think we have to recognise that it is short-term politics that tends to dominate more and more, and the decision-making (processes) in our so-called advanced democracies are fundamentally inconsistent with sensible governance and a globalised world."
http://business.asiaone.com/news/the-lessons-crises
Research, research and research - Please do your own due diligence (DYODD) before you invest - Any reliance on my analysis is SOLELY at your own risk.
