A $200 trillion crisis and why Al’Qaeda provides lessons on how to stop it happening again.

By Jeremy Warner Economics

daily telegraph uk

How much has the banking crisis cost the UK and world economies? For more on this still unfolding horror story, just take a look at the latest measures announced today in Ireland to bailout the country’s stricken banks. They make grim reading. But Ireland’s misery is just the tip of the iceberg, as Andy Haldane, director of financial stability at the Bank of England, vividly illustrates in a fascinating speech to the Institute of Regulation and Risk in Hong Kong. He’s been weighing the issue of costs and how to legislate for them, and he comes up with some pretty astonishing numbers.

As the Nobel prize winning physicist Richard Feynman has already observed, to call the figures raised by the banking crisis “astronomic” would be to do astronomy a disservice. There are only hundreds of billions of stars in the galaxy. Some of the estimates Mr Haldane refers to dwarf the galactic data.

The narrowest way of measuring the cost of the banking crisis is simply to look at the direct costs of the government assistance provided. This looks like being relatively limited – at most, $100bn in the US, or less than 1 per cent of GDP, and around £20bn in the UK, or a little more than 1 per cent of GDP.

But these direct fiscal costs are but a tiny fraction of the damage to the wider economy, and therefore the true social costs of the crisis. World output is expected to be around 6.5 per cent lower than otherwise, and in the UK maybe as high as 10 per cent. This translates into output losses of £4 trillion and £140bn respectively. Even these numbers may underestimate the final costs. If you assume the lost output is permanent, or will never be recovered, you can get to numbers as big as $200 trillion for the world economy and £7.4 trillion for the UK.

OK, so these figures may be pretty meaningless. There wouldn’t have been a bust without a preceding boom and who knows where the economy would have been if this credit fuelled boom had been strangled at birth. Arguably, output may have been lower still.

Whatever. Mr Haldane’s point is that the banking system left to its own devises can be extraordinarily dangerous. If a systemic tax is to be levied to pay for the costs banks are capable of inflicting, a more precise measure may be needed of banks’ distinctive contribution to systemic risk.

What Mr Haldane then goes on to discuss goes to the very roots of the “”too big to fail” problem. I’m summarising complex arguments horrendously here, but his conclusion is that much of the banking consolidation that has taken place since the Glass-Steagall restrictions of the Great Depression were removed from the late 80s onwards has made the system fundamentally less safe. There are few if any economies of scale enjoyed by banks with assets of more than $100bn – to the contrary, there may be diseconomies of scale at these sizes – but potentially very great costs in implicit and occassionally explicit taxpayer subsidy.

So where does Al’Quaeda fit in? Mr Haldane’s analogy is a brilliant one that hadn’t occurred to me before. Al’Quaeda operates not as a centralised, integrated organisation but rather as a highly decentralised and loose network of small terrorist cells. This makes it extraordinarily resilient to repeated attempts to bring about its collapse. In industries other than banking, the examples of this structure are legion, and it has made them highly resistent to systemic collapse. If one bit goes wrong, the waters merely close over its head and things carry on as normal.

Mr Haldane is far too diplomatic explicitly to draw the obvious conclusion, so I’ll do it for him. Banking has to be made similar. The Glass-Steagall legislation ran to 17 pages. It was simple and effective. The recently tabled Dodd Bill on US financial sector reform is 1,336 pages long, and I doubt even he fully understands it. Certainly I’m never going to read it. Keep it simple, keep it small and the $200 trillion problem would disappear. Many policy makers seem to think the debate on financial sector reform has largely been settled. I’m betting it has scarcely begun.