Middle Class Pays for Financiers’ Mistakes: Simon Johnson
By Simon Johnson
Bloomberg
Nov 6, 2011 6:15 PM GMT-0600
Simon Johnson is a professor of entrepreneurship at the Massachusetts Institute of Technology's Sloan School of Management. He served as chief economist at the International Monetary Fund in 2007 and 2008.
At one level, all financial crises are the same. A relatively small group of people, typically bankers, find the opportunity to take very big risks. For a while, financiers show high profits, justifying rising stock prices for their companies and large bonuses for their top executives. But these profits are never properly adjusted for what will actually materialize over five to 10 years, meaning that they understate risk and overstate true earnings.
Greater short-term returns are often available if you take more risk; just look at the Icelandic banking system after 2003. Three banks were allowed to develop very large offshore businesses, building up a combined balance sheet that was 10 times the size of Iceland’s gross domestic product, mostly based on short-term funding. Iceland’s political leaders thought they had found a new road to prosperity. In October 2008 they discovered a perennial truth: Giant profits involve giant risks. Iceland’s banks collapsed, plunging the economy into a deep recession.
The Icelandic attempt to run a country like a hedge fund may make you laugh or cry. But the unfortunate truth is that the U.S. and many European Union countries did something similar by allowing or encouraging parts of the financial sector to take on too much risk. This manifested itself in excessive lending to some combination of governments, real-estate developers and households.
(More here.)
Bloomberg
Nov 6, 2011 6:15 PM GMT-0600
Simon Johnson is a professor of entrepreneurship at the Massachusetts Institute of Technology's Sloan School of Management. He served as chief economist at the International Monetary Fund in 2007 and 2008.
At one level, all financial crises are the same. A relatively small group of people, typically bankers, find the opportunity to take very big risks. For a while, financiers show high profits, justifying rising stock prices for their companies and large bonuses for their top executives. But these profits are never properly adjusted for what will actually materialize over five to 10 years, meaning that they understate risk and overstate true earnings.
Greater short-term returns are often available if you take more risk; just look at the Icelandic banking system after 2003. Three banks were allowed to develop very large offshore businesses, building up a combined balance sheet that was 10 times the size of Iceland’s gross domestic product, mostly based on short-term funding. Iceland’s political leaders thought they had found a new road to prosperity. In October 2008 they discovered a perennial truth: Giant profits involve giant risks. Iceland’s banks collapsed, plunging the economy into a deep recession.
The Icelandic attempt to run a country like a hedge fund may make you laugh or cry. But the unfortunate truth is that the U.S. and many European Union countries did something similar by allowing or encouraging parts of the financial sector to take on too much risk. This manifested itself in excessive lending to some combination of governments, real-estate developers and households.
(More here.)
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