Banking on central banking: What do the regulators know?

Dick Bryan, The University of Sydney

Howard Davies and David Green Banking on the Future: The Fall and Rise of Central Banking, Princeton and Oxford, Princeton University Press, 2009 (320 pp). ISBN 9-78140083-463-1 (hard cover) RRP $52.95.

As the drama of banks going underwater and government bailouts drained away, around the world there were bold claims for reform. Obama gave a number of ‘never again’ speeches about taking on the unbridled power of Wall Street. President Sarkozy of France and British Prime Minister Gordon Brown talked of a Tobin Tax—a global tax on all financial transactions to reign in the culture of relentless trading where nothing actually moves. Someone at the IMF even invoked the merits of a return to the Gold Standard—a position that has renewed credibility in the United States with those on the Republican right who prefer the hard stuff to tea when they party. Many on the left contended that bailouts opened the way to bank nationalisations, or at least turning banks from rampaging panzer divisions in search of yield and into benign public utilities.

There has been some reform, but it has been modest at best. None of the initial bold calls came to pass. Most would point to the power of Wall Street and the City of London. And it has to be said that, as a collective, they played their modest hand like the smartest guys in the room would. The banks were on their knees, having begged for state support. But as the time for regulating got nearer, the bankers claimed to be victims. At public hearings about the crisis, senior bank officials who had once been lauded as major financial tacticians were now contending that they didn’t know critical information in their own organisations. They lived out the institutional dementia Kate Jennings characterises so astutely in her novel Moral Hazard (2003), about the parallels involved in working on Wall Street and caring for a husband with Alzheimer’s. ‘I don’t recall’ or ‘I wasn’t made aware of that’ substituted for the 5th Amendment.

Yet further down the corporate chain, we see just how slapdash was the process of manufacturing financial products. Michael Lewis in The Big Short (2010) and Gillian Tett in Fools Gold (2009) (to take just two leading examples) give hair-raising accounts of how the egos of high finance got lazy and incompetent. In An Engine Not A Camera, Donald MacKenzie explains to us how the mathematical models became incoherent on the one hand, and, on the other, how hardly anyone actually knew that AAA rated asset-backed securities were really backed by much lower-grade assets.

Those sorts of accounts help us understand why everyone hates financial institutions, but despite it all, when the legislatures pass down the new rules, the financial institutions talk contrition but actually look very smug. Those of us outside the tent, all soaked in urine, simply ask how the banks could get away with it.

No-one has a good alternative policy strategy.

Still worse, they not only escaped a lynching, they and the intellectual discourse they live by, muscled up to provide the new regulatory solutions. While Black Panther Eldridge Cleaver once claimed ‘if you’re not part of the solution, you’re part of the problem’, the banks have been claiming ‘we weren’t part of the problem, so we must be party to the solution’. This self-belief and command of the discourse is precisely the political power of Wall Street and their intellectuals.

The question is: how did they do it?

The answer, surely, is that no-one, at least no-one in the circles of regulatory decision making actually has a good alternative policy strategy. There probably is no good alternative strategy, and the ‘never again’/Tobin tax/‘turn banks into utilities’ sorts of statements that set up reform expectations have been revealed as populist one-liners.

In part, this is about the impotence of the state. After all, to accuse bankers of incompetence, you have to have an idea of what competence looks like. The state regulators were generally not in control of their roles and, to be generous, it is impossible to regulate mirages. The underlying questions are deeper: about the blurring of the distinction between financial and industrial institutions, about the blurring of what is a financial and a non-financial asset, and hence to the deepest questions of all: What is money? How is money changing? What is ‘liquidity’? These are all questions critical to the regulatory process, but they lack definitive answers.

But it is also because the state looked to people who have established reputations for understanding the complexities of finance to lead the reform process, though they are also people who avoid these underlying questions. People like Hank Paulsen, Tim Geitner and Larry Summers, who have spent their professional lives moving freely between poaching and game-keeping, had no intellectual reason to believe that a revived Wall Street would look much different from the old Wall Street. So the reform agenda was focused on repairing the holes in the wall where the water had flooded in, and then selling the repair as structurally sound: indeed as a fully refurbished wall. Or others, such as Andrew Haldane, Executive Director of Financial Stability at the Bank of England, have rocketed up the regulatory intellectual charts arguing that regulators need more complex modelling techniques to beat the systemic risk bogey: Haldane looks to techniques of environmental modelling.

Most of us have been inclined to be sceptical about new solutions. After all, with such a long history of international financial crises—Charles Kindleberger (2000) identifies a significant one about every decade for the last 300 years—scepticism is just the financially honourable position of going short on the future, where the dividend is being able to say ‘I told you so!’.

But, to get practical, what could reasonably be expected of a reform process that could deal with ‘actually existing’ problems in the financial system, while avoiding both major systemic disruption and massive battles with vested interests? It’s not that I’m inclined to simply indulge ‘getting practical’ as a rationale for ad-hocery, but the question of what can be reasonably expected is the way of getting a handle on the current state of knowledge of banking and regulatory capacity. And surely getting a handle on the current state of knowledge is the starting point for imagining something different.

This book is not pushing a line, at least not strongly.

Not many of the plethora of books on the financial crisis and after contribute much to this knowledge. Most of them are either formulaic alternative strategists (I’m a public commentator, and here is the emphatic statement that will get people talking about me) or personal rationalisers (I was at the nerve centre, but don’t blame me for the paralysis) or financial gothic novelists (you wouldn’t believe how crazy they are inside those sky-scrapers).

Banking on the Future: The Fall and Rise of Central Banking, by Howard Davies and David Green, is a notable exception. This book is not pushing a line, at least not strongly. Rather, it reviews recent policy history and debates about that history. It is not about heroes and villains, but about processes and the emerging realisation of financial fragility. It is neither self-aggrandising or apologetic, although both Davies and Green were ‘players’ in financial regulation. Both had long experience in executive positions in the Bank of England and the other key British regulator, the Financial Services Authority. Both are scholars as well as regulators, and their book moves easily between academic and regulators’ debate. Indeed, it serves to merge the two. Banking on the Future is a book specifically about central banks, although when the issues include the limitations of central banks and how central banks share regulatory functions with other regulatory institutions, their bailiwick is wider than just central banks themselves.

The book was written in 2008 and 2009, and so published before the major financial regulation reform bills were tabled. Its objective is to set out the precise, technical nature of regulatory failure and look at a modest and likely range of reform scenarios. The book can be readily followed by a general reader, though with its detailed engagement in debates, it may seem to get dense. But it starts with a refreshing review of why central banks are important, the key issues of financial stability, asset prices and accountability of central banks and on to a discussion of their role in leadership. We get an insider’s view of the nuts and bolts of central banking, but not so inside that the authors are uncritical. They readily identify the pressure to change regulations or advice when regulators feel under pressure to display expertise in new issues. They describe, for example, the sudden fashion for central banks around the world to put out regular ‘financial stability’ reports, even though no-one really knew the key drivers of instability and the reports were of dubious merit. (Indeed, some central banks eventually decided not to publish such reports for fear their long-term reputations would be tarnished!) These are snippets of insight that only critical insiders know how to capture.

They want to give a sense of the complexity involved. Central bank regulation (and state economic regulation in general) always reveals that the solution to any one problem creates a displaced problem (there are always trade-offs, and no perfect solutions). This is the abiding theme of Davies and Green’s analysis: that the path into the crisis was about trade-offs and proposed paths out of the crisis all involve trade-offs too. They spell out these trade-offs with great clarity: enough to make us sympathetic to the plight of central bankers. Their central concern is that monetary and financial stability have become separated. In simple terms, controlling inflation (monetary stability) is going fine; stability of the financial sector is not. The two need to be reunited in policy terms.

Central banks are as fragile as the financial fragility they hope to counter.

But how do you put them together? I believe that the answer must involve engaging basic questions about what is money and what constitutes an asset as a ‘financial’ asset. Yet these questions have no clear answers. Indeed they are issues on which philosophers, sociologists and anthropologists have as much to say as economists. Opening these sorts of basic questions would take us into a conceptual fog, while policy requires clearly-delineated categories. So, in staying policy-relevant, Davies and Green systematically avoid asking whether the problems expressed in the financial crisis might lie ‘deeper’ than the domain of policy.

This is why their reform proposals tinker at the margins. Their final chapter is called ‘an Agenda for Change’: it is short, for these authors are expert enough to be modest in their claims. They are also modest in their aspirations. Policy making is complex and policy makers need to appreciate the history of evolving complexity. They say we need better data, more international co-operation, more transparency and more accountability and we need to get over the idea that regulatory specialisation—delineating different regulatory tasks to different regulators—is the path to better regulatory outcomes.

So their agenda oozes sensibleness—central banks with modest aims and regulators open and generous spirits. Who can disagree with sensible suggestions? Except ... cautious, modest suggestions signal how modest is the capacity of financial regulation to superintend the political potency of finance itself. Central banks are no Hobbesian Leviathans, capable of comprehensively overseeing the wellbeing of civil society. They are as fragile as the financial fragility they hope to counter. But they are fragile not simply because there is a relentless parade of policy dilemmas facing central bankers, but because what constitutes financial practices and financial assets is not within the state’s capacity to determine. If financial innovation means anything, it means the creation of new, fluid financial forms which sit outside (and perhaps have been designed to sit outside) the purview of the state.

So when Davies and Green subtitle their book The Fall and Rise of Central Banking, we have to ask: what rise? Is it about rising regulatory capacity, or a rising political profile of central banking? I see no evidence of the former, and the latter is surely a sign of desperation, not strength. Time Magazine named US Federal Reserve Chairman Ben Bernanke 2009 Person of the Year—wedged appropriately between cult political figure of Barack Obama in 2008 and Facebook computer geek Mark Zuckerberg in 2010. Is this a sign of the re-emergence of strong central banking, or of the world creating a cult figure out of a geek who muddled through?


Jennings, K. 2003, Moral Hazard, Picador.

Kindleberger, C. 2000, Manias, Panics, and Crashes: A History of Financial Crises, 4th edn, John Wiley & Son, New York.

Lewis, M. 2010, The Big Short: Inside the Doomsday Machine, W.W. Norton, New York.

MacKenzie, D. 2006, An Engine Not A Camera, MIT Press, Cambridge, Mass.

Tett, G. 2009, Fool’s Gold: How the Bold Dream of a Small Tribe at J. P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe, Free Press, New York.

Dick Bryan is Professor of Political Economy at The University of Sydney. He works on how financial markets, products and regulation are transforming wider social and economic relations.

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