Sunday, 24 May 2015

The Latvian financial crisis

This is not what you think it is. And it is not what I intended to write about, either. I was going to write about Latvia as it is now, after the deepest recession in the world in 2008-9 and an excruciatingly painful front-loaded fiscal consolidation. Has it really recovered, or is it just marking time?

But in looking at Latvia now, I find myself drawn to its history. Latvia's unusual response to the kicking it got in 2008 was because of its history. It had a deep recession 1991-3 and a severe financial crisis in 1995. These experiences undoubtedly coloured its response to the 2008-9 disaster. We should not assume that the harsh medicine Latvia swallowed in 2009-13 would either work or be appropriate elsewhere.

So, Latvia. For those who have never heard of it (apart from bad Eurovision songs), it is a tiny country sandwiched between Lithuania and Estonia, bordered on the East by Russia and Belarus and facing Sweden across the Baltic Sea. Here's a map:

Although Latvia has an ancient pedigree, its present independence has been hard-won. It was the subject of constant territorial wars from the thirteenth century onwards, finally being incorporated into the Russian empire in 1710. After a long campaign it was granted independence from Russia in 1920, only to be seized and forcibly incorporated into the Soviet Union in 1940. It was invaded and occupied by Nazi Germany in 1941 then recovered by the Soviet Union in 1944-5. It was then brought under close Soviet control and progressively "Russified": factories were built, farms collectivised and large numbers of Russian speakers relocated to operate them.

Latvia began a new quest for independence in the 1980s. The Latvian Supreme Council declared independence in May 1990: this was initially resisted by the Soviet Union but finally granted in August 1991. After independence, Latvia quickly became a member of the UN, the IMF and the World Trade Organsiation, and joined the European Free Trade Area in 1992. In 2004 it became a member of both the EU and Nato. It converted to the Euro in January 2014. 

But its independence has not only been hard-won, it has been extremely painful. Immediately after independence Latvia set about the task of converting from a command economy to a market economy. The effect on the Latvian economy was harsh. Soviet-supported heavy industry entirely collapsed, as the website Latvian History explains:
 In the Soviet period Latvia was the industrial center in the USSR. Soviets build a large amount of factories in Latvia and sent thousands of workers from whole union to Latvia. This caused mass immigration and downsize of Latvian majority. This leads to speculate  that massive industrialization was intended to assimilate Latvian nation. Large industrial enterprises worked only for Soviet market and were associated with main company bodies in Moscow. Also they were deeply connected with the Soviet military complex and half of the civilian industrial production was actually used for military purposes. After the fall of USSR these factories could no more compete with free market and lost contact with state and Russian military.  Large enterprises such as State Electronics Factory, Red Star, Alfa and others bankrupted. State officials done little to prevent whole industry collapsing. Today is still hard to answer could industry be saved and what should be done. However many say that it was impossible to save it. But the loss of large enterprises made a large amount of unemployed people. 
Re-establishing private property rights also caused agricultural production to fall:
Reforms hit hard also on agriculture. In Soviet era all agricultural property was in state hands. Collective farming (kolkhoz)  was the main subject in the country. When private property was established kolkhoz’s failed as the land was privatized.  In Soviet times all farm land was sowed and farms were rich, now because of poor handling of private property land became poor and undeveloped.
And, of course, Latvian branches of Soviet-owned banks suddenly found themselves cut off from their parents. Latvia's new central bank collected them all under its wing and allowed them to continue lending on a business-as-usual basis, largely unsupervised, while the Government decided on a privatisation strategy. Safely backed by the central bank, and accountable to no-one, they carried on lending to the collapsing industrial sector. Non-performing loans rose at an astonishing rate: an audit performed with the assistance of the Swiss government revealed NPLs of 25m Lat (about $250m).

In parallel with this, Latvia permitted uncontrolled creation of new, lightly regulated commercial banks. Unsurprisingly, banks proliferated: between 1991 and 1993 over 60 new banks were created. Some were "pocket banks" owned by state enterprises, some were created to raise deposits for on-lending to their owners, while others were solely intended to raise finance for specific functions: Olympija Bank, was created to fund the Latvian Olympic team. These banks grew very fast. By December 1994 85% of bank assets were in the new commercial banking sector. But the new banks, lacking adequate regulation or even - as it turned out - honest and competent management, were fragile and vulnerable to shocks.

In 1993 most of the former Soviet branches were sold to some of the largest of the new commercial banks. The remainder were consolidated under new management into a new state-owned savings bank, Unibank: the NPLs were removed from its balance sheet into a "bad bank" and replaced with government bonds.

In March 1995 the largest of the new commercial banks, Bank Baltija, collapsed, apparently due to lack of confidence after it was unable to provide the Bank of Latvia - or even its own auditors, Coopers & Lybrand - with accounts that complied with IASB standards. Bank Baltija was high-risk by any standards, expanding its deposits very fast by offering interest rates in excess of 90% when other lenders were offering a more restrained 14-20%. But no-one was paying attention to risky behaviour by banks. Consequently, when rumours started that Bank Baltija was in difficulties, there was a slow bank run not only on Bank Baltija but on other commercial banks too, most likely because of concerns that private deposit guarantees would turn out to be worthless.

The Bank of Latvia initially provided liquidity. But it soon became clear that providing liquidity was simply pouring money down the drain. Bank Baltija was deeply insolvent. Its negative net worth was estimated to be $320m, about 7% of Latvia's projected 1995 GDP. Bailing this bank out was not an option: Latvia was running a fiscal deficit of about 3% of GDP, rather high for an economy in transition, and it was barely recovering after the deep recession caused by the post-Soviet restructuring. The bank had to be resolved.

Initially, the owners and managers suggested a merger with the Latvian Deposit Bank and Centra Bank. This may have been a delaying tactic to enable them to salt away Bank Baltija's assets, principally via a Russian "pocket bank", Intertek, incorporated in Moscow and apparently owned by Russian oil and energy interests. By the time Bank Baltija was declared insolvent in July 1995, over half of its assets had mysteriously disappeared. Eventually, it was taken over and restructured by the Bank of Latvia.

But it is just as well that the merger did not proceed. The Latvian Deposit Bank and Centra Bank also failed. In total, seven banks failed in the Latvian crisis:

Other banks also required liquidity support.

Alex Fleming and Sam Talley at the World Bank, in a fascinating paper (pdf), drew five lessons from the Latvian crisis. I reproduce them in full here for reasons which will become apparent.

1. The banking systems of transitional countries are inevitably exposed to major strains and stresses, particularly during the first several years of the economic reform process.  This is for three reasons:
  • Restructuring and privatisations of state-owned enterprises limit their borrowing capacity and ability to service their debts. Privatisations are often a major part of reforms designed to liberalise a sclerotic economy, but eliminating state support for enterprises can pose serious risks to banks. This problem is as far as I know seldom if ever considered in the planning of economic reforms.
  • Reduction in inflation due to major economic restructuring, which is usually accompanied by (sometimes deep) recession, reduces the ability of businesses and households to service their debts, again with potentially disastrous effects on banks.
  • Economic liberalisation tends to result in largely privately-owned banking systems that lack adequate regulation, insurance or lender-of-last resort facilities. We would now call these "shadow banking" systems. 
2. If banking systems are exposed to stress, the government must take strong actions to protect against this vulnerability. This means:
  • establishing a sound legal framework for banking, developing effective regulatory and supervisory functions, and implementing good bank disclosure, accounting and auditing standards 
  • developing effective mechanisms for handling problem banks and closing insolvent banks promptly. The World Bank writers observe: "In Latvia, it was not just that Bank Baltija, the largest bank in the system, failed, but that when it was finally closed it was so deeply insolvent that the government essentially lost the option of bailing out this key bank in order to protect depositors and the payments system". When a bank is failing, delay is costly.  
3. State-owned banks can serve a useful function as "buffers" in a systemic crisis, as Unibank did in Latvia, provided they are well managed and are "relatively free from political influence".Perhaps we should not be quite so quick to privatise everything, or to assume that only the private sector can run banks efficiently and effectively?

4. Supervisory authorities should look carefully at banks which are 'outliers" in the banking system. "Banks that are expanding their assets or branch networks exceptionallv quickly, or banks that are offering particularly high deposit rates, should be subject to intense supervision. Activity in specific banks which is outside the norm may be an indicator of a problem in the bank concerned."

5. Fraud, managerial incompetence and excessive risk-taking can have devastating effects on a banking system, particularly if they occur in the largest banks. The solutions to this are:
  • Screen carefully those who want to work in banking
  • Impose frequent thorough on-site examinations on all banks: allocate the best examiners to the banks that pose the greatest systemic risk
  • Annual audits should be required for all banks regardless of size, and auditors must have a legal duty to report significant irregularities to supervisory authorities
  • Where banks are in trouble and there is a hint of fraud, authorities should act decisively to deal with the banks AND those responsible for the problem. 
Written in 1996, these are supposedly lessons for transitional economies. This is probably why they have been ignored. No-one imagined that the very same problems could occur - several orders of magnitude larger - in mature Western economies. But we now know better, don't we?

The lessons from Latvia's 1995 financial crisis resonate today as the Western world attempts to reinvent its dysfunctional banking system in the aftermath of the worst financial crisis since the 1930s. They seem eminently sensible: perhaps, if we had applied those lessons to developed as well as transitional countries, the course of history might have been very different.....

But there's a problem. In the 2008-9 crisis, Latvia suffered more than any other country despite its extensive bank reforms after the 1995 crisis. Yet only one of its banks failed (Parex): the rest were bailed out by their foreign owners. So the question is, if Latvia's banks were actually in better shape than those in other countries, why did Latvia suffer the worst recession in the world?

To be continued......

Wednesday, 20 May 2015

Redefining retail banking

Yves Smith at Naked Capitalism takes issue with me over my attempt to derail the "Banking should be boring" bandwagon. She claims that new research by the IMF proves that banking should indeed be boring:
The IMF paper is generally in line with the argument that banking should be boring, meaning that complexity, opacity, and leverage typically work far more for the benefit of the financier and at the expense of customers and society at large. Frances Coppola tries to turn that argument on its head and say that banking should be fascinating. Hun?
I am astounded by this interpretation of the IMF paper. These are the paper's actual conclusions:
First, financial development is multi-faceted and should be measured by looking at many indicators. Second, financial development can be promoted by putting in place a strong business, regulatory, and supervisory environment. Of the 93 regulatory principles, the critical principles that matter for financial development and financial stability are essentially the same. This means that better—not more— regulation is what promotes financial stability and development. Third, since the weakening effect on growth at higher levels of financial development stems from financial deepening, raising access or efficiency at any level of financial development would be beneficial. Fourth, to mitigate economic and financial stability risks, as well as reduce the likelihood of a crisis, too fast a pace of financial development should be avoided. Finally, there is no “one-size-fits-all” in terms of sequencing the development of financial systems, but the relative benefits from institutions decline and those from markets increase over time. 
How on earth do you get from these to "banking should be boring"?

Yves' interpretation directly contradicts what the head of the IMF said about this research, too. At the INET conference in Washington DC on May 6 -  which I attended -  Christine Lagarde took issue with Elizabeth Warren for saying “banking should be boring”. Giving a heads-up on this research, Mme. Lagarde emphasised the crucial importance of deposit-taking, lending and payments services for economic development and human well-being. And like me, she questioned how providing financial services to the real economy could possibly be regarded as boring.

I was particularly struck by Mme. Lagarde's concern for those, especially women, who are directly disadvantaged by lack of access to banking services:
Financial systems around the world are quite sizeable, but they exclude many individuals and firms from financial services. For example, data released during this year’s IMF-World Bank Spring Meetings suggest that 2 billion adults worldwide remain without a bank account. That represents a 20 percent drop in the number of “unbanked” over the last three years, but it is still a massive number.
Moreover, financial exclusion is far from being solely a low-income country or emerging market issue. For example, even here in the United States, surveys find that some 8 percent of U.S. households are “unbanked” and some 20 percent are “underbanked”.
Studies show that broader access to the financial system can boost job creation, increase investments in education, and help people manage risk and absorb financial shocks. Our own analysis that will be released later in the fall finds that financial inclusion is particularly important for women, empowering them economically. Indeed, the numbers suggest much scope for improvement in this area.
Globally, a staggering 42 percent of women lack access to basic financial services, compared to 35 percent for men. This gap is even bigger if we consider the role of women in the provision of financial services. In a world-wide sample of banks, less than 20 percent of board members are women, and only 3 percent of bank CEOs are women. Clearly, we need to do better.
We do indeed. But how, in heaven's name, can we improve financial inclusion while we are doing our level best to put people off providing essential banking services by describing them as "boring"?

Mme. Lagarde's comments were written up approvingly by Rona Foroohar in TIME magazine:
I do think that Lagarde was spot on to disagree with the notion that “banking should be boring.” This CW is often thrown around to indicate the idea that banks should do “plain vanilla” lending rather than complex deals with sliced and diced securities. Fair enough. But as the IMF chief pointed out, “Why should lending to the real economy be boring?” The shifts that need to happen to bring finance back in service to the real economy are myriad and complex. They include changing tax policy that rewards short-term gains over longer-term ones, reforming corporate governance, increasing personal liability, changing the structure of banks themselves and making our system of shareholder capitalism more inclusive. But the original mission of banking — finding new innovations and funding them to create growth in society at large — is anything but boring. The regulatory and cultural journey back to that, which will no doubt take several more years, should be interesting too.
I couldn't agree more. Intrinsically, retail banking is NOT boring. It has become boring because we have made it so.

Yves' observation that retail banks have become “stores”, with de-skilled workers whose job is simply to move products, is correct, but I was way ahead of her. I have now been writing for over four years about the deep structural problems in retail banking.  The transformation of retail banks into shops is the theme of  the post "Supermarket Banking" that I wrote back in 2012. This post was based upon my own experience of working for Midland Bank while it was turning its branches into shops, the first UK bank to do so. You see, unlike Yves, I worked in retail banking. I really do know what it is like.

In pursuit of profits in a low-margin, cut-throat industry (yes, this is RETAIL banking I am talking about), retail banks systematically downgraded the skills of front-line retail staff, removing from them all real responsibility and virtually all need for engagement with their customers. They turned them into salespeople, giving them impossible sales targets with severe penalties for failure. The jobs of retail staff became boring, hard work and poorly paid. Talent drained from retail banking into the better-paid, more interesting and sexier investment banking.

The consequences of making retail banking "boring" have been terrible. Transforming banks into shops and their staff into salespeople led directly to the swathes of mis-selling and outright fraud that have plagued retail banking in recent decades. Mundane, tedious, poorly-paid retail banking is now not even respectable. No wonder talented people don't want to do it. As Mme Lagarde says, we must do better.

Somehow, we have to make lending, deposit-taking and payments services to ordinary people and ordinary businesses interesting again. There is excitement to be found in financing innovation that generates growth, and satisfaction in supporting people's financial needs through their lives. Describing this as “boring banking” does not in any way help to achieve this.

Tuesday, 19 May 2015

Mirrors and Glass: the role of design in a time of change

W.H. Auden’s epic poem “The Age of Anxiety”, written during the dark fragmentation of the Second World War II, was widely acclaimed as defining the spirit of our time. Few claim to have read it, but everyone knows the title: as Daniel Smith put it in an op-ed in the New York Times, “as a sticker on the bumper of the Western world, “the age of anxiety” has been ubiquitous for more than six decades now.” Anxiety – and its cousins introspection and depression – is widespread, disrupting relationships, destroying connection and replacing happiness with fear.

Or is it? Smith goes on to point out that people in earlier ages in many ways had more reason for anxiety than we, and that “anxiety” as a condition was not even recognised before Freud. He argues that our anxiety stems from growing self-awareness. Indeed, this is consistent with Auden, whose poem opens with one of the principal characters gazing at his reflection in a mirror: just as the Queen in Snow White calls upon the mirror to reassure her of her outstanding beauty – betraying her underlying anxiety about being supplanted – so Auden’s character’s question to the image in his mirror betrays his sense of unreality and falsehood:
Does your self like mine
Taste of untruth? Tell me, what are you
Hiding in your heart?
The editor of the critical edition of Auden’s poem notes that in 1942, Auden wrote an essay for the Catholic journal “Commonweal” which starts thus:
Every child, as he wakes into life, finds a mirror underneath his pillow. Look in it he will and must, else he cannot know who he is, a creature fallen from grace, and this knowledge is a necessary preliminary to salvation. Yet at the moment he looks into his mirror, he falls into mortal danger, tempted by guilt into a despair which tells him that his isolation and abandonment is [sic] irrevocable. It is impossible to face such abandonment and live, but as long as he gazes into the mirror he need not face it; he has at least his mirror as an illusory companion. . . .
The mirror is the symbol of the “Age of Anxiety”, which is characterised by introspection, obsession with self-image, and distortion. At its extreme, it encompasses thinkers such as Ayn Rand, who rejected all forms of collectivism and regarded selfishness as a virtue, and politicians such as Margaret Thatcher, denying the existence of “society” and trumpeting the primacy of the individual.

It was not always so. In the immediate aftermath of World War II there was a sense of shared purpose. Social design was the hallmark of the time: housing projects, transport systems, the NHS…linking together the patchwork of existing social provision, rebuilding places and communities damaged by war and depression. But as Western countries rejected the Marxist-Leninist “collectivism” of the Eastern bloc and embraced Hayekian “individualism”, designers abandoned social enhancement and became drawn into shallow consumerism, building ever better mousetraps to meet consumer demand. Even today, “designer” is associated with expensive consumer products.

Frans de Waal’s 2009 book “The Age of Empathy” dismissed the notion that selfishness is natural for human beings. De Waal demonstrated that humanity’s closest relatives the Great Apes, together with other high-order social mammals such as dolphins and elephants, are predisposed to take care of one another, come to one another’s aid and in some cases, take life-saving action. De Waal argues that humans too are innately empathic and compassionate. If de Waal is right, then perhaps the “Age of Anxiety” has been an anomalous period. Perhaps the terrible cataclysms of the 20th Century, especially the “Cold War” that divided the world for three decades, traumatised humans to such an extent that they no longer trusted each other and instead turned inwards, relying on their own, albeit distorted, mirror images for comfort and guidance.

As the memories of the Great Wars fade, the introspective mood of the last thirty or so years is beginning to change. Supported by technology that enables openness and sharing as never before, a new generation is re-imaging “society” as a collaborative enterprise formed through trust and transparency. Selfish materialism is being replaced with concern for the wellbeing of others and for the environment. The mirrors of the “Age of Anxiety” are giving way to the windows of the “Age of Empathy”. The glass buildings of today symbolise our new-found openness.

The importance of connection

Empathy generates connection. And we now know from research by psychologists and neuroscientists that connection also generates empathy. The “Age of Empathy” could perhaps be called the “Age of Connection”. Re-connecting with others, with nature, with reality….this is the process of recovery from trauma.

Perhaps unsurprisingly, therefore, connecting with others is becoming crucially important for designers. Mariana Amatullo of Designmatters at Art Center says that the age of the “genius inventor” working alone is over: today’s designers work collaboratively as part of multi-disciplinary teams. Co-creation, co-design, unlocking the creativity of others, connecting diverse inputs into a coherent architecture: these are the roles of today’s designers.

To be sure, designers have always been empathic. Understanding “user needs” is the starting point for any design. But today’s young designers are more interested in inclusivity, public service design and social innovation than in developing the latest consumer gadget. Of 14 recent graduates from the Helen Hamlyn School of Design at the Royal College of Art, only one wanted to work in business. As Mat Hunter of the Design Council puts it, “public service design is what the cool kids are doing”.

Whether the new focus on inclusive social design is driven by the students themselves or by their teachers is hard to say. Rama Gheerawo, Deputy Director of the Helen Hamlyn School of Design, emphasises wellbeing as the principal goal of design. He sees people as “living – moving – connecting”. Living space, the ability to move around, connecting with others: these are the features that together make up wellbeing.

Focusing design on improving wellbeing can have surprising results. For example, a recent project run by the Design Council jointly with NHS England explored the causes of aggressive behaviour in A&E departments, a seemingly intractable problem. Mapping the processes that defined how the department worked showed that aggression was often associated with high anxiety levels in patients who could not find their way around in an unfamiliar environment designed to suit staff rather than patients. A simple solution was to provide improved signage so that patients knew where they were in the system. Prototyping with real A&E departments showed that signage was needed on ceilings, since patients on stretchers could not see conventionally-located signs, and in the car park, since even finding the entrance to the A&E department caused anxiety for many people. The design focused on improving the wellbeing of patients rather than reducing risks to staff – but because it addressed the causes of aggression, it was far more cost-effective than security measures to protect staff from aggressive patients.

Making life easier for people has been a principal goal of design since time immemorial. Even the consumerism of the 1970s and 80s was linked to lifestyle: Terence Conran’s Habitat famously promoted the “continental quilt” or duvet as a labour-saving device to make life easier for the “Superwoman” epitomised by Conran’s wife Shirley. Design enables people to spend less time doing boring and mundane things and more time doing things they enjoy.

Design can also make unpleasant but unavoidable things more bearable, such as the dreaded security checks at airports. After the 9/11 disaster, airports imposed intrusive and indiscriminate security checks. This raised anxiety and aggression levels among passengers, which perversely made it harder for staff identify genuine security threats. In conjunction with America’s Transport Security Agency, IDEO created a calmer environment at the checkpoints, redesigning physical spaces and retraining staff. Once the general stress level among passengers was reduced, people with “hostile intent” became easier to spot.

Despite the move towards co-design and co-creation, traditional attributes of designers are still important: creativity, which Amatullo defines as “the ability to create novel and useful designs”, and concern for aesthetics. Beauty in design is important not just as an end in itself, though this is important: people engage more with designs they find aesthetically pleasing. But beauty is also important as a means of understanding functionality. Elegant designs tend to work better.

But although empathy is important, design cannot be wholly democratic. Designers need to direct as well as facilitate, imagine as well as listen. And they must “own” their ideas. Empathic they may be, but they are not simply passive compilers of the ideas of others. Design is not limited to meeting wants and needs. It can involve challenging them.

Bold designs – even disruptive ones - may have their origin in a throwaway remark in an informal conversation, or in a seemingly minor incident. Gheerawo cites Mahatma Gandhi, whose lifelong commitment to social justice stemmed from being thrown off a train in South Africa. “Base your boldness on empathy and understanding”, says Gheerawo, “otherwise where are your business decisions coming from?”

The dark side of technology

The intrusive nature of big data collection and analytics raises concerns about privacy and the rights of the individual. Internet applications collect data without the knowledge of their users, parsing that data to determine people’s browsing habits in order to sell them more stuff. We may now value interconnection more than introspection, but that doesn’t mean we have entirely given up on consumerism. If you buy a mousetrap online, you will be helpfully presented with lots of adverts for better mousetraps. Your activities have been observed, interpreted and used to influence your future actions. But should advertisers - or anyone else, for that matter - be able to collect and use data in this way without people's knowledge or consent?

Similar ethical questions are raised when design is used to “nudge” people into “desirable” behaviours. For example, the Design Council’s Active by Design project aims to encourage active lifestyles through design or redesign of indoor and outdoor spaces, thus reducing the health problems caused by inactivity among the general population. Although the cost savings for the NHS could be considerable, some question whether behavioural change of this kind is a legitimate goal of public service design. Surely people have the right to be couch potatoes if they choose?

The idea that services should be “designed” is new, radical and potentially hugely beneficial for society. But it carries dangers. Public service designers risk being hijacked by political interests, whether those who see design as a way of minimising the cost of state services – or eliminating them completely – or those who see design as a way of preserving and entrenching traditional fiefdoms.

Mat Hunter spells out the dangers of technology-led design:

We can do amazing things with all this powerful new technology. But we haven’t lost what we learned about its darker side. We’re aware that it won’t automatically lead to good outcomes so we have to be more intentional about what we do. The question is now: “we’ve created all this [technology], now what do we want to do with it?"
The growing power and intrusiveness of technology raises important questions about the ordering of society that we have not yet adequately addressed. Just because we CAN monitor every part of human life and nudge people into behaving in certain ways, doesn’t mean we should.

When every action is subject to scrutiny, the risks of failure become very large. Mistakes are costly, not in financial terms but in reputation. And yet designers need the freedom to fail. Gheerawo describes the genesis of innovation as a “lightbulb moment” which removes fear of failure: once the problem is obvious, so is the solution. But informal discussion may result in the wrong lightbulb being turned on, especially if it involves the wrong people. Indeed, failure is inevitable: after all, how do you empathise with millions of people?  The freedom to get things wrong is essential to creativity. Thomas Edison (inventor of lightbulbs) famously said that he did not fail, he just found 10,000 ways that wouldn’t work. Nassim Taleb describes his trading approach as making many, many small losses which are outweighed by occasional very big gains. Throwing away something that doesn’t work is not failure, it is learning. The best designs may be found through trial and error.

So as empathy comes to dominate the design process, and technology pervades the most fundamental structures of society, we need to ask ourselves “what are the limits of connection?” Should every wrong decision, every silly idea, every inadequate design be subject to public scrutiny? Or do we need the glass windows of the Age of Empathy to be, at times, opaque?

What do we really value?

Measuring success or failure of design projects is a challenge in itself. Success is traditionally measured by the value added in financial or social terms: but today’s emphasis on wellbeing disrupts traditional measures of value. GDP, for example, is widely seen as an inadequate measure of human satisfaction: increasingly, governments are seeking to measure such nebulous concepts as “happiness”.

The effect of technology on work also demands that “value” be redefined. Time, for example, is becoming increasingly scarce - and hence valuable - for many.  Activities we have valued in the past – especially those concerned with production of goods – are becoming worthless due to automation, while activities we have undervalued – especially those concerned with creativity and caring – become more important.

Narrow financial measures of “value” are becoming increasingly inadequate. But we have yet to identify what we really value, let alone devise a coherent way of measuring it.

Attempts by those who hold power and wealth in the current paradigm to hang on to the old and resist the new result in what President Obama calls the “empathy deficit”. The Age of Empathy is being countered by a mass outbreak of callousness. But this is itself an opportunity for disruptive and radical redesign of public services and social enterprises.

Redefining value, redesigning work, reinventing the social infrastructure that supports enterprise, and above all rediscovering the importance of social connection, collaboration and sharing in a post-technological world – these are the new design challenges. The Age of Empathy is also the Age of Change.

Originally posted at Image from Sinoy Mirror Inc.

Did Osborne Pause Austerity in 2013?

No, says The Times' David Smith. He says that the notion that there was a pause in austerity is an "austerity myth".
He points to this chart from the Office for Budget Responsibility that shows fiscal consolidation as a percentage of GDP (relative to the 2008 Budget) continuing on throughout 2013 and 2014 and 2015:
But the OBR's chart doesn't actually show what I would define as austerity. It shows the size of the government budget as a percentage of GDP relative to previous budgets. That's a good deal of moving parts. And that creates a good deal of ambiguity. Under such a definition, if the economy grows and government spending stays constant, there has been fiscal consolidation. In fact, if the size of the budget grows but the economy grows more, there has still been "fiscal consolidation". 
What I am referring to when I claim that Osborne paused austerity in 2013 is the pause in the slashing back of government spending. Simply, up 'til 2013 the government was year on year cutting spending in real terms. The bottom came in 2013. In 2014 and 2015 — prior to the election — the government stopped cutting spending. 
This graph (via shows that's true in real terms. In fact, in real terms UK government total spending is estimated to increase in 2014 and 2015: 
There seems to be a similar pattern of a small uptick in real per capita terms, at least for fiscal year 2014 (there appears to be an error in the data for 2015 and 2016, so I left those years off the below chart): 
ukgs_line.php-3Another interesting picture — via the St. Louis Fed's David Andolfatto — shows government spending per working age person, alongside government revenue and transfers: 
This shows much the same thing. During the Coalition years, revenue and transfers per capita remained relatively static. Spending fell throughout 2010, 2011 and 2012, bottomed out in 2013 and remained static through 2013 and beyond. 
In other words, shake your fist all you like about the OBR's picture of fiscal consolidation, but the actual data on spending and transfers relative to revenue shows a pause in the austerity after 2013.
And no, that doesn't mean Osborne literally abandoned austerity altogether. He didn't reverse the cuts, if that's what someone might mean by "abandoning austerity". And the Tory manifesto promises more cuts henceforth. If that's what Osborne and co deliver in the coming parliament then that is the very opposite of "abandoning austerity".
But it does mean that the uptick in growth during 2014 is correlated with the pause in austerity. And it does mean that Paul Krugman is correct to say that the UK government "paused", and Simon Wren-Lewis was correct to talk of a "suspension" in austerity.

Banking should not be boring

Since the financial crisis, some people have argued that “Banking should be boring”. The idea is that banking should be limited to simple deposit-taking, lending and payments services. We don’t need the trappings of modern investment banking: structured lending schemes, derivative products, complex risk metrics, synthetics and the like. They may be fun to create, and highly lucrative to trade, but they aren’t socially useful. Let’s get back to basics. All we need is little banks, simple products and local bank managers operating the 3-6-3 rule: “Borrow at 3%, lend at 6% and be on the golf course by 3pm”. Banks are so much better when they are boring.

Of course, this depends on what you mean by “boring”. A friend of mine is a civil engineer. She is fascinated by sewers. No, this is not a joke (and yes, I know about the “Yellow Pages” advert for civil engineers that said “Boring: see civil engineering”). She really is. Peering into smelly sewers all day is not my idea of an interesting job: I’d much rather work in a bank. But to her it is fascinating. So those who regard vanilla banking as boring probably don’t want to be bankers. Bankers themselves may well see it differently.

In fact when I asked people on Twitter what they meant by “boring” in relation to banks, it became clear that they didn’t really know what they meant. Some people used “boring” to mean “not immoral or illegal”. Hmm. Just think about that definition of “boring” in relation to, say, sex….

Others used “boring” as a synonym for “safe”. Oh dear. Bankers who are obsessed with safety are anything but safe. They lend at risk (because that is what banks do), then they offload the risks on to someone else, wash their hands and move on to the next risky loan. Where those risks end up is not their concern. The trouble is, when everyone is playing “safety”, the risk ends up with some poor sucker who can’t afford to pass it on. When the time comes to pay out, those poor suckers can’t afford the payout either and the government has to step in. This is how financial crises happen. Risk aversion among bankers is a BAD thing. Their job is to manage risk, not to avoid it.

There is of course another way of playing “safety”, and that is not to lend to anything that looks even slightly risky. This has an extremely unfortunate economic effect. People who need finance for house or automobile purchases can’t get it. Businesses needing loans for expansion or working capital finance can’t get them. Businesses that already have loans or overdrafts may find their facilities reduced or cancelled. We have seen all of these since the financial crisis. And we hate it. We complain that “banks aren't lending”. We call lack of low-deposit mortgage lending a “market failure”. And we blame lack of bank lending for the slowest recovery since World War II. So we don’t really want bankers to play safe, do we? If “boring” means “safe”, then we actually don’t want banking to be boring at all.

One commenter insisted that excitement in banking is a bad thing. He wanted banking to be so dull that it is soporific. But soporific banking was exactly what we had prior to 2008. Bankers were so convinced that everything was fine that they weren’t paying attention to the risks. They were asleep at the wheel, along with their regulators, auditors and insurers. So were ratings agencies, politicians, economists, business leaders and the general public. There was a mass outbreak of narcolepsy, and it caused one of the largest car crashes in history. More sleepiness in the banking world is the LAST thing we need.

Ah, say some, but what we don’t want is all the creative stuff that nearly blew up the world in 2008. You know, the fancy derivatives, structured products, complex funding structures….

I do indeed think we could do with less of the fancy stuff. There must be markets in risk – after all, for everyone who is trying to reduce risk, there needs to be someone else who is willing to increase risk for a fee. And we do need depth and liquidity in financial markets. But we probably don’t need these markets to be as huge as they have become.

The trouble is that by defining the fancy stuff as “exciting” and basic banking as “boring” we are sending completely the wrong message. If we really want to attract more people into basic banking and fewer into derivatives trading, we need to change the narrative. Trading is boring. It really is. All traders do is move money around. It’s unutterably dull. Lending to small businesses, though….now that’s interesting. They are all different, and to establish whether or not they are sound, you have to find out quite a bit about them.

In fact I am totally bemused by the idea that “banking should be boring”. How can lending to small businesses that are doing exciting and important things possibly be “boring”? How can providing state-of-the-art payments services to support spending decisions by people and businesses be “boring”? How can helping people satisfy the financial needs that arise from their complex lives be “boring”? I don’t get it. This is fascinating stuff. It’s endlessly varied: it demands lively intelligence, rapid assimilation of knowledge, empathy with people’s concerns, creativity in fulfilling unexpected and unusual customer needs, advanced technological knowhow. Basic banking – lending, deposit-taking, payments services - should be one of the most interesting jobs in the world. Why on earth do we want to define it as “boring”?

Banking must be interesting if it is to be effective. Do you want to work in a boring job? I don’t. Nor would anyone who has enough talent to do something more interesting. But we need talented people to want to work in banking – not the fancy stuff, but the bread-and-butter business of lending, deposit-taking and payments. As the economist Anna Hedge explains:
Until and unless we eliminate scarcity, can simultaneously produce all goods everywhere and have no barriers to labour migration, we are going to need banks and a medium of exchange. I do not want those functions performed by dullards.
It’s also terribly dangerous for such an important job to be boring. Boring jobs create bored people. And bored people don’t do a good job. They are careless, they cut corners, they are indifferent to customer concerns. They may be cavalier about regulation designed to protect customers and maintain financial stability. They may even do insanely risky things just to relieve the boredom. We really don't want bored people managing our financial system. Banking must be interesting, or it is unsafe.

It is a tragedy that lending and managing money in the real economy has come to be regarded as “boring” while much less important functions are apparently “exciting”. And it is even sadder that well-meaning people reinforce this topsy-turvy view in the name of banking reform. Somewhere along the line our priorities and our values have become seriously distorted. We desperately need to reframe.

Related reading: 

How Women Will Fix The Economy - Rana Foroohar, TIME

Image: "Bored banker" from

Sunday, 17 May 2015

Mirrors and glass, and a sad farewell

My latest post at Pieria looks at the role of design in a time of change. Using mirrors and glass as metaphors, it maps the transformation of the "spirit of the age" from anxiety to empathy as the world heals from the trauma of the twentieth century's three Great Wars (yes, you read that correctly). And although it is optimistic about the new opportunities for collaboration and sharing that technology creates, it asks whether replacing introspection with connection and opacity with transparency is always a good thing. Read the whole post here.

It is also my last post for Pieria. With immediate effect, I am stepping down from my role as Associate Editor and staff writer. Pitches and requests for publication should in future be sent to Marco Nappolini via the "Contact Us" tab on the Pieria site.

My writing will of course continue both here on Coppola Comment and at Forbes. And perhaps elsewhere, in due course. I shall be looking for a new job....

I wish the Pieria team all the best for the future.


Thursday, 14 May 2015

Central bank lending and the Great Fire of London

My Forbes post criticising Senator Elizabeth Warren's attempt to restrict Fed liquidity in a crisis has caused something of a storm. It seems that people can't distinguish between providing unlimited liquidity to the financial system and providing unlimited government funding to banks. The first of these is essential. The second is not.

I do not, and never have, supported the second of these. Indeed I was one of the voices soon after the crisis that called for banks to be allowed to fail. But restricting central bank liquidity in a crisis is terribly dangerous.

Consider a fire in a closely-built city - let's call it the City of London. Because the houses are very close together - indeed many of them are interconnected - and are made of wood, fire spreads easily. Do you restrict the amount of water the fire brigade can use to put out the fire, even though there is unlimited water available from the nearby river? Do you tell the fire brigade it must only spray houses where the householder has fire insurance - the rest must be allowed to burn? Do you tell the fire brigade it must stop spraying water after thirty minutes whether or not the fire is out? No, you wouldn’t do any of these. You would regard it as madness. The priority is to stop the fire, not to decide who deserves to keep their house and who does not. That is the job of central bank liquidity. It stops the crisis.

Once the fire is out, then by all means decide who deserves to have their house rebuilt or refurbished by the government, and who does not. And redesign the city so fires can’t spread so easily, change building standards so houses are built of fire resistant materials (stone, brick, marble), tighten fire regulations, educate bakers about the dangers of leaving ovens unattended. 

Similarly, once the financial crisis is over, kill off banks whose capital has fallen too low, do radical surgery on banks that are damaged but could be restored, make extensive changes to the design and regulation of the industry to reduce both the likelihood of future crises and their damaging effects, and educate bankers on the importance of responsible risk management. We didn’t do this properly after the 2008 crisis: we did not kill off badly damaged banks, we did not restructure the rest as we should have done and we have taken far too long to tighten regulations and retrain bankers. On this, I agree with Senator Warren.

But redesigning the city and retraining the ba(n)kers doesn’t mean you can dismantle the fire brigade. Despite our best efforts, fires still happen. So do financial crises. We need to be able to deal with them. And we cannot deal with them if we hobble the central bank.

In my post, I observed that Bagehot's Dictum actually does not apply in a financial crisis. Bagehot's Dictum advises the lender-of-last-resort to "lend freely to solvent institutions, against good collateral, at a penalty rate". This is good advice for central banks in normal times. Individual banks that have good collateral and substantial equity buffers may meet liquidity shortfalls by borrowing from the central bank at penalty rates. Most central banks have this facility available at all times.

But lending of this type is emphatically not appropriate in a crisis, and Bagehot did not so regard it. This is what Bagehot had to say about central bank lending in a financial crisis:

"Lend that reserve most freely in time of apprehension". No restrictions. No "good collateral", "penalty rate" or "solvent institutions". Those are restrictions for liquidity support to individual banks in normal times, not in a crisis.

And why? Because failing to lend freely makes the crisis worse. Half-hearted emergency lending is worse than none at all. Bagehot is uncompromising: "To lend a great deal, and yet not give the public confidence that you will lend sufficiently and effectually, is the worst of all policies; but it is the policy now pursued." Stopping financial crises requires unlimited liquidity, just as ending the Great Fire of London required unlimited water. We would be foolish to turn off the taps.

The Great Fire of London was eventually put out. But the mediaeval City of London was in ruins. In the rebuilding programme, streets were widened and buildings were built of stone, not wood. There has never been another fire so devastating. But there have nonetheless been fires from time to time. We still need our fire brigade.

Related reading:

Cleaning up the mess

Image: Great Fire of London. from Wikimedia Commons