 It's a pleasure to welcome our speaker, Professor Danielson, John, who's the author of numerous books and the subject today will be the topic of his most recent book, The Illusion of Control, Why Financial Crisis Happen and What We Can and Can't Do About It. So the professor is going to speak for about 20, 25 minutes as is traditional and he looks forward to a robust questions and answers session and I think John is our first speaker from Iceland for quite a while. So I think there's some comparisons between the financial crisis that we had in 08 and Iceland and the outcomes and how they were dealt with. So maybe that's another topic we could delve into during the Q&A. You're very welcome. Floor is yours. Thank you so much for having me on. I realized last week how similar Ireland is to Iceland. When this event was put up on Wednesday, that is five days before, that's when the announcement is made, five days before the event. That's exactly how you would do it in Iceland. If you don't put up an event in London three months in advance, everybody panics and feels dissed. So you really have to, so I like that, but of course every time I go home to Iceland I find a bit disconcerting how late they plan everything. But I sort of felt like home a little bit. But I have to say it is so delightful to be in a country with sane politics, good economic performance and in the EU. And I think these three things are certainly correlated. And as I was on the plane yesterday, it was delayed by a drone for a couple of hours so I had a bit extra time. I was thinking about the relative performance of these two countries. And if you go back to the first year after your independence, you can see that what I find fascinating is that Ireland is sitting between Venezuela and Argentina in terms of GDP per capita. By the way, if you want the slides, I'll be happy to give them to you afterwards or the organizers will make them available to you. If you go back to the year I was born, Ireland has done it worse with sliding backwards, was now behind both Argentina and Venezuela. And then by the latest numbers I have is number six in the world. That is due to good policy making and therefore the illusion of control is what can policy take us in the right direction or in the wrong direction. And if you just do, I found this plot quite interesting as well. I usually want to talk in the UK, I only show the red line. But I added the blue line on yesterday to see exactly how things are diverging over time. And I'm so interested in what takes us on the right path, on the wrong path in terms of policy. However, let's get on to closer to the topic of today. And just to connect this to the latest crisis, the Silicon Valley Bank in the United States and Credit Swiss should not have failed. We were promised by the financial authorities everything is under control. I like quotes from the leaders of the financial system. Since I collect them and a few years later you can see how accurate the quotes are in that environment. I like this one from Mark Hani. Over the past decade G20 financial reforms have fixed the false lines that caused the global financial crisis. If they had fixed it, neither Silicon Valley or Credit Swiss, they would both be alive today. And I think for me, this is a nice way to frame the topic, the illusion of control, which is the book we are just discussing today. Which is when we try to enact financial policy, what works and what doesn't work. And I was lucky with the timing. So I thought when I wrote it, the worst thing happening is an epidemic. An epidemic is not financial. Crisis is 15 years old, all boring, old stuff. And then things heated up this winter and the topic became relevant again. I'm going to connect this to what I've called, and I wrote a piece of Charles Gotthard, on what we call the philosophy of modern regulations. And for those of you not in the financial regulation world, this might be a bit surprising to you. But this is how the ECB thinks about regulation. All important risk is properly identified and measured. It is used by the banks and by the authorities to determine the appropriate level of risk. You need more risk, more growth, reduce capital requirements like we did in March 2020. Things are heating up too much, crank up capital requirements like we should have done before 2008. Just like the thermostat in the risk managers office keeps the office temperature at a steady 21 degrees. You can tune up the AC or turn on the heat. And of course, next week, I'm in the Austrian Central Bank a week from today. And they asked me for basically the same talk, but they gave me a title called The Central Banker as a Risk Manager. This, I think, sort of frames the, I'm not sure if the deputy governor who is chairing my event will like the talk, but I'll find out next week. In this, accurate measurements of risk are essential for the philosophy of modern regulation delivering. And that takes me to what we call the trilemma of financial policy. Trilemma is a situation where you have to make difficult choices between three alternatives. In the UK, there's often called cacism after a real lustrous former prime minister Boris Johnson. The economy should grow. And basically usually growth is a dirty word, so therefore it's better to say we should have recessions. It means the same thing, but the second one is politically more palatable. Inflation should be at its target, 2% and financial stability high. Now this question, this trilemma has become quite controversial recently. Christian Lagarde, she made the effort to say a couple of months ago, there is no trade-off between price stability and financial stability. Now do we believe that in the past, for the past 15 years, it appeared to be so. All objectives, growth, inflation, and stability were in sync. QE, easy money, fuel growth, inflation, behaved state at 2%, and financial stability appeared high. However, the easy monetary policy also made the financial system dependent on low interest rates. And that's exactly what we're discovering is all the submarine or hidden problems that emerge when rates rise. Therefore, the way the policy authorities did it, if you want to be slightly more crude, it's a bet that low inflation and low interest rates will last forever. Because otherwise, all the countries and all the firms dependent on low risk are in for the shock of their lives. And the problem is that if you connect it to someone who drinks too much, the longer you drink too much, the harder it is to get off it. And that's exactly the situation here. My contention is that along the way, systemic risk, meaning the chance of a major financial crisis causing a recession, like we had in Iceland then in Ireland 15 years ago, increased. Now that is not supposed to be the problem because the regulations, what are macro-pru, which is designed to prevent the systemic collapse, that was supposed to contain that risk. Now why then, in my mind, does this financial policy cagism not work? Well, first of all, in the long run, a policy of high growth, no recessions, which means cheap money and cheap loans, we have to always connect it to what you do to get there, is inflationary and derodes financial stability. Reducing inflation to target, therefore, is recessionary and increases systemic risk. If you question that, just witness the gyrations coming out of the ECB and the FEDS recently about inflation, high financial stability needs capital and we have to keep in mind that if you make banks safer, the first thing to be hit is loans to small and medium-sized enterprises, SMEs. They are the engines of growth in the whiskey's loans. So the cost of making banks safer is you no longer fund the small companies. Now perhaps in Ireland you couldn't care, right? You do so well economically, but go to France or Italy or Spain. Well, if you don't fund the SMEs, you are fueling Mario Le Pen because the politics of extremism thrives on economic underperformance. So therefore, I think, SME lending is critical. Now this is all foreseeable and all avoidable and because the way we design our policy institutions in the year 2023, we house the regulators and the monetary authority in the same institution so that we get holistic policy making. Now then we get to the illusion of control part one, complexity. I think the financial system is infinitely complex and nobody has an incentive to reduce that complexity. Everybody likes the system to be complex. This means if you're infinitely complex, no matter how intensively the ECB patrols the financial system, there's always an infinite place where things can go peer shaped. And if you try to prevent that, you make the system so onerous that you end up in no financial system and you might as well move to Cuba or North Korea which don't have a financial system. I think this is why the Silicon Valley Bank, we could only spot the problem after the fact. And of course everybody blames the financial authorities or Donald Trump for what happened. I think that is misplaced. If there are so many potential problems, you can't spot them all. I mean, if someone had thought about this in the fact, five years ago, Silicon Valley Bank wouldn't have happened but that's somebody has to think about a million other things. So that's one problem with the philosophy of financial regulation. Second one is you need something called a riskometer. I think you plug that deep into the bowels of the Wall Street and out pops an accurate measurement of financial risk. Now, I apologize for giving you a chart, a plot here. So this is not sort of pseudoscientific but take the, on the red line, imagine that's the economy as it is today. Go from bad to good. What we want from policy is we want to reduce the chance of bad outcomes and increase the chance of good outcomes which means you shift from the red curve to the blue curve. I mean, this is sort of a mathematician of the policy objective as it should be by, say, the ECB. Problem is data lives in the middle of the distribution what they care about is in the tails. And I think this is fundamental to financial regulations is there's an enormous amount of data being created but that data is all about day to day events. Day to day events is basically irrelevant. What matters is the extremes. The extreme is what happened in Ireland 10 years ago in Iceland 10, 15 years ago, et cetera. It's the extreme events. They're unique, they're once off and it's really hard to identify them before they happen. After the event everybody said you were so stupid but that's not fair either. Events we care about live the tails on the right the left side, the data lives in the middle. I think this is a fundamental problem with risk measurement and therefore feeding this into the modern philosophy of financial regulations is what undermines it. What drives risk? The crisis in 2008 happened because of decisions made years earlier. Pick a year, 2003, every sign said everything is fine. Volatility is low, CDS spread low, expected short for lopitia risk measure. They all said risk is low. Then the authorities and the private sector, hey, go crazy, invest. But Minsky, one of the great underrated economists said 50 years ago, stability is destabilizing because you make the system stable you incentivize the misbehavior that undermines stability. Or to quote Chuck Prince, the previous CEO of Citigroup when the music is playing you gotta get up and dance. This by the way is also why it is so difficult or impossible for a policy authority in Ireland or Iceland or any other place to prevent the excesses that culminated in the crisis. Risk comes in many forms. Suppose this afternoon the US stock market plummets by 200 billion, nobody cares. In 2008, potential and not even realized losses of $200 billion in, and oh my God, the world almost came to an end by global crisis ensued. Same magnitude loss in one domain tanks the global economy in another domain is brushed off. The risk we know, we prepare for in the language of Donald Trump, known unknowns. The unknown unknown risk is the most damaging, but we don't know by definition what is the unknown unknown risk. That's what lives in the tales. But the risk we measure is the middle, the known unknown risk. And the driver of extreme risk, extreme outcomes to my mind is always politics. 2008 crisis, Italy, Brexit, Trump, Ukraine, Taiwan, Venezuela, real estate, inflation, all political at its core. Political allows the crisis to emerge, politics prevents solutions. The reason we can't deal with environment today, politics. Demographic control, politics. Now then, now if you ask the, if you put this to the ECB, it becomes a bit interesting. The central bank of Ireland or the ECB cannot regulate the politicians. That's undemocratic, democratic. But if politics drives bad or good outcomes, and if the objective of policy is to control good and bad outcomes, does it not limit the scope of the policy authority to deal with the most important things in this domain? But in a democratic society, certainly. And in a dictatorship, you would have to put a dictator in charge of the central bank. It's not gonna happen either. So to wrap this up, the philosophy of financial regulations calls for buffers when things go wrong. More capital, more liquidity buffers. These are calibrated by risk measurements. That's why the risk measurements are so important. The way we determine how much capital a bank has and how much liquidity it has is determined by these risk measurements. Problem is, buffers that protect you against all shocks are so large that they will be ineffective. You can't protect against all shocks. I want to instead work with shock absorption. Now I think the financial system is enormously good at absorbing shocks. So if you think about policy, not as a buffer protective entity, but as a shock absorption entity, we end up in a better place. The higher the shock absorption capacity of the system, the better you can tailor financial services to the user, the lower the cost of regulation, you end up with a win-win-win, more growth, better deal for savers and investors and more stability. Now for anybody investing, the principle of this is called diversification. We don't hold one stock in our portfolio. We hold multiple assets in the portfolio. If one tanks, the others do well. So why then, if the basic principle for diversification is different investments, why then do we regulate banks in the same way, making them more and more similar to each other, reducing diversification in the system? Now how can you do that? Well, you can tailor financial regulations to the types of financial institutions inside of instead what we have now. One size fits all regulations, which mean by the way, very high fixed costs and increasing returns to scale, the bigger a bank becomes, the cheaper it is to comply. So therefore you design the regulatory system to make banks big and few, which then increases systemic risk, because I find slightly perversive. Solution to that is to eliminate barriers to new entrants or reduce them, especially those with new business models. In the European Union, you cannot get a license to open a bank today. It's against the policy of allowing new banks. In the UK, they said, no, they're crazy. In Frankfurt, in London, we do, but they don't. If you talk to anybody trying to start a fintech in London, they found so many barriers that everybody gives up. So thriving market and license has not been used in London, by the way. Embrace financial technology, defy decentralized finance, perhaps by using central bank digital currencies and recognize that shadow banking is usually a friend, especially Europe, and not the enemy. And why does it not happen? Well, one reason is conservatism, we prefer what we know instead of what is new. The risk aversion, the regulators are not rewarded for making the system work. They are penalized when things don't work. So if you're penalized for failures, but not rewarded for success, how does it drive the behavior of the people regulating the system in the wrong direction? And by making everybody similar, it means collective failure, covers individual failure. If you were misbehaving in 2008 and everybody else failed, you said, ah, bad luck, I did nothing wrong. And finally, of course, lobbying because incumbents, they like the system the way they are. Nobody says those things. Usually stated, to quote the Simpsons, will somebody please think of the children? Meaning, of course, in the context, because something possibly could cause harm, it must be banned. Which is, if you're not in the financial regulation world, that's very much the attitude of the authorities. And ladies and gentlemen, that is at the core of the illusion of control. I'm sure you don't agree with, you agree with a few things I said, I like controversy, so challenge me.