 as I was telling Alan, this is really not, this is a parallel research interest of mine. I'm very interested in installing the Irish economy, particularly its collapse obviously, but what I do half of my day really is macroeconomic, so I look at, at the moment I'm building a new macroeconomic model for Ireland. So that's half of my job. The other half is looking at regulation. There were three main failings in the Irish crisis in my opinion and the Nyberg, the Regling and Watson and the Haunan reports all bring this out. The first is a political failure. I'm not a political scientist, don't even want to go there, not interested. There was obviously a failing of regulation and there was also a failing to model the crisis. If you look at all of the, if you look at all of the reports in 2006, 2007, even some in 2008, you would be forgiven for thinking that everything was going tickety-boo. The reason was that most of the models were looking, were looking at the real side of the economy where, you know, everything was still going up. And so in financial, in the financial sectors, there was a huge build-up of unsustainable credit and this was allowed to happen. So if you want to understand the Ireland's economic crisis, the first thing you have to understand is how the model fails, the second thing you have to understand is how the regulations fail. So based on that, I've been working quite intensively with a guy called Vince Dosolomon about this. So first off, I must apologize for the soup of acronyms. I'm about to drench you in. One of the things that I'm, I'm, I, this is not my key area of expertise. I'm more, I'm more a macroeconomist. My colleague, Vince Dosolomon, works with PricewaterhouseCoopers on the regulatory side and he throws around these acronyms like they're going out of fashion. So I won't have time to stop and give you each one. And I would probably maybe only get 70% of them myself. So, so, but the important ones I will define along the way. So I really like this quote from the philosopher John Gray. He's a fabulous book called Straw Dogs. Straw Dogs is about how humanism and the notion of human progress is actually illusory. What he basically says is we have little idea of the future we will bring, but we are forced to live as if we are free. The cult of choice reflects the fact that we must improvise our lives, that we cannot do otherwise as a mark of our unfreedom. Choices become a fetish, but the mark of a fetish is that it is unchosen. And the book is absolutely fabulous and you really should pick it up. It certainly, I found it extremely interesting and influential. But the, the message here really is that stop believing that you have a choice. Stop believing that you are an external agent in this, in this process. One of the very, very interesting things about the response that regulators have taken to the crisis is that they feel that they can choose arbitrary levels at which the economy or banks within the economy will lend and trade and save and consume and work and so forth. Policymakers have the same hubris. I don't think you can get into the gig unless you believe that you can in some sense influence the level of unemployment or the rate of growth. One of the promises of Keynesian economics is in fact that you can do this, of course, if you believe Keynesian economics. But I just want to, I want you to hold that quote in your mind, this, this idea that we have a choice and, or maybe that we don't. So a lot, this is, this is part of a much larger and longer research project that I'm engaged in with my colleague Vincent O'Sullivan. We've been banging away at this since 2009. And what we want to do is describe and model the interactions between regulation and the balance sheets of the European Union macro economy. We started looking at this from an Irish point of view. This is obviously, I, I have the geographical specificity thing. I'm very interested in the Irish economy. But if you want to look at an area where regulation collapsed and failed completely, this is a very good case study actually. And also in terms of the journals, you know, I'm an academic, I'm a publisher, parish guide. If you want to write a really sexy article, it's a bit like hitting a beach ball with a tennis racket, you know, talking about how regulation in Ireland failed. But that's fine. But, and that will be fine if I, if we were just academics, but we're not. Vincent is a practitioner. He, he works in the Center for Regulatory Excellence in Price Waterhouse Coopers in London. And so he doesn't really care that I can produce nice graphs. He cares about how can you actually propose an alternative risk management mechanism? Can you make things a little bit safer? Or not? So, so we've looked at a lot of stuff. And I hope that will the slides be available online afterwards. Yeah, that's great. Well, I've given some references in the next slide. But what we've looked at really are regulatory complexity and uncertainty, particularly looking at the capital requirements directive. We've looked at, you know, what caused the Irish banking crisis, UK regulatory reform. I have a bit of a rant in the Cambridge Journal of Economics about are we really the role model for austerity, looking back to the 80s, actually. And I don't think we are. It's the answer. The Journal of Banking Regulation published something that was the first attempt at this, what we're calling meta risk regulation, where we take an idea from the management of nuclear power plants and apply it to finance. What causes banking crisis is coming out. And all this stuff is all available on my website. There's more kind of stuff there. I'm not going to bore you with it. But basically, it's all available online if you're interested to read it. So, okay, why is it important? First and foremost, the pace of reform has actually been feverish, even by reforming standards. It has been absolutely feverish. These guys have been working very hard to reform the regulatory architecture at the European level. So while I began, I was very interested in looking at the Irish case. Actually, the Irish case is not that interesting, unless it's considered in its European context. Obviously, we have higher capital requirements for banks. We're looking at regulating credit agencies. And then there are, of course, further transparency and disclosure requirements. The regulator constantly saying, we need more and higher quality data. So the question is, okay, right, you've got all this data. What can you do with it? Can you actually analyze it? Do you have the facility to analyze it? Do you know what it is in the first place? There's not that. There really isn't that. There really are no clear questions to any of this stuff. Of course, there are the recovery and resolution plans. Some of these are the grandiose EFSF, ESM stuff. The others are much smaller and more concrete, if you like, and implementable problems. And then, of course, we have governance and internal controls requirements. I've put remuneration there in brackets because when I wrote the slide, I wasn't quite sure with the outcome of the, was it Barclays that they sued to get their bonuses back? They got it? Oh, yeah. Yeah, so maybe not even with regard to remuneration. So regulators are really, they're, they're, they were this sleepy guys in the back of a room, all through the boom. And then suddenly they were expected to down the capes, jump out the windows and solve the problem. Some of them may actually want to jump out the windows afterwards. There's the European Banking Authority, the European Security Markets Authority, Insurance and Occupational Pensions Authority. These are just the big ones. I'm going to show you a chart in a minute showing you the rest of them. We have a new EU macro prudential regulator. And then, of course, we now have a push to a single rule book about, I think a week ago, or 10 days ago, there was a big conference of all the, of all of Europe's regulators in the convention center here in Dublin. And it was absolutely fascinating sitting there. They're very smart, very subtle thinkers, extremely interesting people. And they even through their guarded language, you've got the sense that they didn't really know what was coming next. And that was, that certainly brought it home to me that they are operating in as much of an environment of uncertainty as policy makers, proper policy makers are. Their big issue was the creation of the single rule book, this notion that you would somehow stop regulatory arbitrage. And so for the uninitiated regulatory arbitrage is where you have Bank A that's choosing to locate in country A or country B. And Bank A is essentially going to each country saying, yeah, but their capital requirements are easier and they're nicer to us. And so bring it down. multinational, very large banking systems can actually do this. And of course, the issue then is not, is there a single rule book? The issue is, how is the single rule book implemented? How do you make sure that, you know, Unicredit, which is a global bank, operates in exactly the same fashion in Italy as it does in Germany? When they're dealing with two completely different legal systems, two completely different sets of customs and institutional regularities, how do they do this? This is a very, very difficult problem to solve. It's not simple. In fact, one of the, one of the things I'm going to talk about in a minute is complexity. Now these are intrusive and judgements based supervisory philosophers. The notion is we know better. Now, they clearly don't know better. If they knew better, they wouldn't be asking for all the information. Okay, there is a problem of asymmetric information in this system that we simply cannot solve. And it's owning up to that lack of information that we're really pushing on at the moment. So the principle based or risk based regimes, I think we can all say with confidence that they failed. You cannot have a principles based system, nor can you have a risk based system when the banking system is clearly shown that it doesn't know how to value risk correctly, especially things like credit risk. Principles based stuff. I think you just, people will start laughing at you if you bring it back. And there's lots more to come. So these are the series of regulatory innovations, if you like. They're coming down the line from the second quarter of 2012, all the way to 2019 when Basel III is fully adopted everywhere, I think except the United States. I don't think they've signed up to it yet. So we're looking at right now that the big the big thing is algorithmic trading and you can see proponents of algorithmic trading. People who would never have gone on Bloomberg or CNN before once in their lives coming out saying actually no, you shouldn't do this. You shouldn't regulate. We provide all the liquidity in the markets. The RRPs are coming in. Maybe the Dodd-Frank Volcker rule by third quarter of 2012, cash resolution packs, RDR, co-reps and so forth. That's only in 2012. By 2014 we're going to have these FICOL initiatives and then all the way up and again this is why I had to apologize in advance for the acronym SUB folks because it really is exhausting. And then all the way up to 2019. So we have, there's a plan, there's a plan to basically re-regulate all of the major product categories in the European financial system over the next seven to eight years. And I think that's the, that is stunningly ambitious. It's extremely challenging. Even getting one of these right is going to be really tough and you can see that they've got them all to do. So the policy response has been knee jerk. There was a problem. The Irish and European economies, but let's just pick Ireland for example, the Irish economy was like a marble rolling off a table in terms of regulation. Everything was ground up until the quarter that it was. And then suddenly fell over. And these guys are supposed to come in and stop that from happening again. Now what I'm going to argue, what we're arguing now in this book that's coming out in a while, is that that's impossible. You can't expect regulators to do this because not, because regulators are not external to the financial system. They're not an exogenous shock in the words of an economist and in the language of an economist. What they are actually, they're part of the system. And they experience cycles as well. And so what you're really looking at in this chart, if you want to be very cynical, is a job scheme for regulatory economists and policy wonks. Every one of these requires a highly paid director and reasonably large secretariat. There's gold-plated pensions all over the shop here folks. It'll all work out. However, will this actually achieve anything? People who run banks will say no, actually. The regulated tend to not like the regulators. One big problem that we've identified as part of our research, and I think we're upwards of 15 papers now on this, the regulatory agenda in Europe does not have a rigorous macroeconomic analysis part to it. There's no sense in which the regulatory framework is actually understood as part of the macroeconomy. There's a very good reason for this. Most regulators are not economists. They don't talk to economists. And if they met an economist at a party, they'd run away from them. I am an economist so I've had this happen to me. They're their lawyers. So they don't want, they don't look at this. They're not trying to look at this. However, we are sitting in an economy where regulation clearly fails. So they do have a macroeconomic part to play. Now, when you talk to regulators about this, they will say, well, no, hang on, stall the digger now. Stop. They're all Europeans and they don't say stall the digger. Maybe they do in a German accent, stall the digger. They say, we have cost-benefit analysis. We've done this. Cost-benefit analysis is the way forward. I've argued very strongly and the OECD actually have backed us up. Cost-benefit analysis, accompanying regulations, is not adequate to figure out whether the regulation is going to be adopted. It's going to be a success or a failure. It's simply not adequate in a situation where you have so much uncertainty. It simply won't work. So maybe the job scheme for the cost-benefit analysis guys might go away. So, right, why does this matter? Why does, you know, one more economist making one more model of matter? Okay, it matters because if you don't have the correct analytical framework, then this actually obstructs authorities implementing the reforms in the face of mental composition. You have to be able to say, look, if we don't implement this particular set of legislations and you guys blow up again, this is going to be the macroeconomic impact. That's what we want to be able to say. And I think that there's a value in saying that. There's not a lot of predictive power in economic models but you can get pretty close to a weather model actually in this. Now that's fine but what I've learned as a macroeconomist talking to a regulatory economist the whole time is that when we model banks in traditional economics, the way we model them is sort of mechanistically, you know, you drop the interest rate and they'll increase lending as if they're sort of, you know, 10 men. But of course they're not, they're organisms in a way on their own. But actually, the policy makers need jerk reacting saying, we must regulate more, regulate the banks to bits. Well, there's push and pull back from everybody. Regulators are now being asked to do the devil and all when it comes to this stuff. You know, the regulars have insufficient resources. At all times, all regulatory systems are characterized by limited resources. So it's very difficult for one person with a staff of 25 to, you know, and a budget of, you know, 6 million to regulate a banking system that's 3,000 times its size. At the conference a couple of days ago, a leading European regulator who was giving a speech at the time said, you know, I look out of my window, which is in the city of London, I look around at all the buildings. I think of all the people that are sitting there who are paid far times more than me, thinking up ways to beat the rules that I haven't invented yet. That's the challenge. That's the challenge. And they're, you know, it's hard, these guys are sitting there, they're making 100 grand a year and they were talking to a guy who's making 800 grand a year. And what they don't realize is they're being interviewed for the job. So firms, of course, firms are cash strapped, keeping retained earnings and cash flow is, of course, the name of the game. However, the firms themselves, and when I say firms, I'm not talking about Stephen's second hand bookshore stuff here. I'm thinking far more about IBM and Microsoft. They're interested in raising high quarterly capital. They're interested in keeping their profit margins high or staying in business, surviving even. And so the firms don't want to be regulated because regulation is basically an increase in the cost of doing business. Investors therefore face lower returns on equity. Industrial organizations are worried. And of course, the general public, the general public are frustrated by the slow pace of change. And I think if there's if there's one thing that will sap the public's ability to absorb pain, it's the fact that they don't see any change over the medium term, say three to five years. So what do I mean by regulation? Okay, you recognize you recognize that banking is unstable. It's important to impose rules to constrain risky behavior. No one will argue with this. This is a bit like saying, would you like growth or not mom and apple pie? Everybody agrees that yes, banking is unstable. It has been unstable for at least 800 years. You want to impose these rules. However, these rules carry a cost. The first cost they carry is they damage the real economy. The more rules that you impose, the more difficult it is for the bank to lend correctly. And the more difficult therefore it is for the for the real economy to flourish. However, if you leave these guys go run amok, then the system explodes. And that's exactly what we saw in 1825 in 1840 in 1870. And I'll show you a few more now. And we have capital adequacy ratios, Basel one, two, three, it's now about 8% of risk weighted assets for those of you that did first year and second year economics. I'm sure that there's a cold chill running down your back as you remember the reserve ratio and the ISLM model. It's the same thing here. Okay. And then of course we have the usual stuff about tier one capital capital and the risk weighted risk weighted bundles of capital and repo issues and all of that. But I'm not specifically concerned with that actually. The one thing I will mention about this is that valuation issues about it's not possible to correctly value a lot of these assets. You know, you can have a large series of mortgages on your book right now. You have a massive valuation issue. And if you're using those mortgage backed securities as repo for cash for the through the ECB, they don't know what they're holding either. So it's sort of past the parcel and the parcels are fizzling down. Eventually it may blow up on you. So that's what I mean by regulation now I want to talk to you about our theoretical frame. I've been very influenced by three economists, Charlie Kindleburger, Hyman Minsky and Richard Kuhn. Charlie Kindleburger was an MIT economic historian, wrote an amazing book called Mania's Panics and Crashes, where he basically developed a theory, a verbal theory of how banking crises happen. Hyman Minsky was a much ignored in his lifetime economist who who said essentially that banking exists for credit and credit creates its own reversal. In an amazingly poorly written book called Stabilizing an Unstable Economy in 1986, he essentially showed using a series of historical case studies that it was the case that after a slump, after a really bad bust, the economy took time to recover. As it took time to recover, regulators beefed up regulations, banks didn't lend out into the real economy unless they lent to very, very simple, very well put together projects. And that's more or less where we are right now. Then right after that, something happens. The economy continues to recover and so more projects come back in and the guys are making money. Then they start lobbying to reduce the number of regulations. They start saying no, no, no. People are forgetting it's five, ten years down the line now. Suddenly the regulations get cut back a bit, lending comes up, there's a little bit of financial innovation, whatever, a little bit of risk mispricing. Suddenly interest rates drop or the economy begins to boom. Then more and more risky projects get funded. As this happens, asset prices take off. Once the asset prices take off, then it becomes a self-fulfilling prophecy where everybody sees, oh my god, the price of that house is going up. I'm an idiot, we're not getting in the market, so on and so forth. So the economy experiences a euphoric moment actually. So he describes it as euphoria, mince key. And then eventually something happens. The assets are so unanchored from their fundamentals they simply explode. We had the subprime crisis in this case, it's the jump on fiasco in the 80s. And we can point back to the pin that pricked the bubble essentially. The economy explodes, it implodes rather. I don't need to tell anybody about that. But basically, in that moment regulation need jerks again. People go, oh my god, we need to re-regulate. So people will recognize that the largest explosion of regulation and institutional creation ever really was right after the Great Depression. And we're seeing the same event. It's the same thing. This time is not different. Okay. Everybody realizes that because credit has created its own reversal, you end up with massive leverage, you end up with balance sheet disaster. This is Kuh's point. Regulation then becomes necessary to attenuate the scale of the crisis. But of course, all what regulation does is close the door after the horse is bolted. Regulation builds up again, things calm down, they get a little bit better, regulation gets knocked down again. The cycle continues. This is why it's called the Minsky cycle. And the moment it pops is called the Minsky moment. I should say that this is not the Paul Krugman and Gary Egerton have a very good paper where they try to synthesize Kindleburger Minsky and Kuh. But the problem is they're throwing chalk at cheese and trying to make a ham sandwich. It's very difficult to do. So when I'm talking about this, please don't think that I'm talking about the Egerton Krugman story. I have my own story in 2009 in a book edited by Ronan Keane. So in the absence of effective monetary policy, Ireland does not have its own monetary policy. We don't have a fiscal policy, at least not an expansionary fiscal policy. Regulation is the third best or at least, you know, least worst solution. But actually, given where we are, it is the route to successful reform. Now, everyone has decided this. And I'm wary when the majority say anything actually. But regulation is part of the system. It's not external to it. It's a part of this cycle that we're going to describe in a minute. Regulation like choice has become a fetish. Yeah. And the problem of the fetish, as John Gray says, is that it's not built around choice. It's choice free. Okay. We must be aware of its limitations. So really the purpose of regulations to change behavior, we were talking about, I have three kids, I have a garden. And the garden has a very, very high wall, about a 10 foot wall. The one that the largest child is five, there's no way unless he turns into Batman, he's going to be able to get over that wall. However, the wall blocks the view. And it's a bit scary sometimes because there's the land behind our house, it's sloping down and the guy who owns the land has two horses. So occasionally, we're having breakfast and the horse sticks his head over the roof, which is quite a bit quite scary of a morning, disembodied horse staring at you. However, the way I think about it is that regulation essentially is a political concept. It's not an economic concept at all. It's political. And we need to understand it in relation to the economic organization, it's trying to influence. What that means, if you believe that story, that means that regulating unicredit, regulating unicredit in Italy and in Germany is a fundamentally impossible thing to do because there's two totally different legal systems. Even if you wiped out the legal system in Germany, totally and just impose the Italian one, you'd still have problems because there's their cultural differences. So that means when a German regulator comes to talk to an Irish regulator, even if they're speaking in English, they might be, as Mollier says, speaking in prose. Yeah, they might find it very difficult to actually speak to one another. Now, the reason I think we should regulate that there are three reasons why you want to, we want to reduce the externalities, the huge blow-ups associated with banking. And that's really what's interesting to me and it's why I remember reading a quote from someone saying, you know, these banks are toxic. They're like toxic waste. What they produce, these bad debts are like toxic waste. And I got me thinking, I remembered reading a story about how they had coped with the failure of Three Mile Island, the almost nuclear meltdown. And it got me thinking that maybe we should view bad debt as sort of like nuclear waste, actually, because some of the stuff doesn't have a half life of maybe 50 years. So the other interesting thing is regulators are not, you know, superheroes. They're not sitting there waiting to change everything. They are themselves bureaucracies. And the one thing bureaucracy want to do is expand. So the crisis has been a beautiful job screen, jobs initiative, if you like, for regulators. Right. Why does it matter? The Risk Society is a beautiful book by Colin Scott, where he talks about this, the Risk Society, where the government is increasingly responsible for regulating risk. I'm on the board of management of my local school. And it's very clear that the parents expect the school to regulate the risky environment that their children are in. I'm not so sure when I went to school that my father and mother expected that of the CBC Monk Sound. I think I can imagine the principle in the 1980s, having the kind of discussion that we're having now. So this regulatory state, the big government, the European Union, actually, according to Minsky, is a good thing. The reason it's a good thing is because the only thing that can attenuate the scale of the crisis is big government, the big bank, the big government. The banks blow up. They need to have somewhere to amortize their debts. They need to have something to absorb it all. And that is the big bank. Unfortunately, what that does is that institutionally legitimizes the failure. It injects moral hazard into the system because what it says is, oh, you messed up. Okay. Well, what are we going to do? We're going to allow this system to collapse? No. Well, what are we going to do instead? I think we should probably save them. But once saving them, you've just I don't know. I have no idea. I have no idea. Actually, I don't know. I'm sorry. You're the one who'd go down the cave afterwards. Yeah, you weren't actually, yeah, this is now your problem, actually, yeah, in many ways. So and then, of course, the collapse of Enron that created the Serbanes-Oxley Act. One is reflexive and reactive to the other. So we have this problem. This is how I like to organize my thinking around this. Right now, two big problems, balance sheet damage. So these are the balance sheets of firms, of banks, of governments. The balance sheet is in bits. Here, I better look at you. Again, this is your problem, damage balance sheets. Fiscal constraints, you can't spend your way out of the problem at all. And then the regulator comes along and they're asked, okay, fix it. Well, the regulator faces three main challenges, coordination, complexity, and contagion. The contagion I have in yellow there is because that's the thing everybody wants to avoid. The problem with Greece is not that everybody is worried about the Greek citizens per se. Actually, it's that they really don't want French and German banks to go belly up because if they do, Irish and UK banks will follow suit and then Obama won't get reelected and so on and so forth. So this is how most economists think about balance sheet. This is from a paper by Andy Haldane of the Financial Stability Authority in the UK, Prasad Ghai and Sonny Kappadhyam, in the Journal of Monetary Economics. The biggest journal in monetary economics in the world. It's a really, really great paper. And I'm going to show you a chart from in a second. But this is the state of the art. Anybody with any accountancy practice would be looking at this going, really? Is this really it? Is this how this is really how economists, like this, like this was published last year. This is really how economists few balance sheets and say, yeah, you know, we do. Really? Yeah, this is pretty complicated to model this properly. It's pretty complicated. So this is the current balance sheet view. However, this looks at one bank. And the problem is with regulators and everybody who isn't a macro economist effectively here, I put in the cape on the macro economist, the macro economist looks at it a bit like this. It's all balance sheets, basically. This is how I look at it. This is how I think about the economy. So we have households and firms, governments, central banks, commercial banks, special purpose vehicles, leverage finance, shadow banking, all that stuff, and then the rest of the world. One of the really interesting things about this chart or this table, if you like, is that it gives you a sense of the interconnections of one balance sheet with another. And I think that's vital. I think I think actually policymakers understand this at an intuitive level. They understand that if you if you let banks fail as intellectually satisfying and sort of morally satisfying as that would be, you're going to damage households and the firms, you're probably going to get voted out of power. The commercial banks would be in bits and the rest of the world will fall apart too. I think they naturally understand the connections between these things. They don't explain that to the public quite well. All the public see is you're bailing out corrupt bankers, right? And that's that's hard. It's hard to do. However, one of the things that's really, really interesting when you look at this is if this is where the problem is, then this is also where the solution is. The solution is to look at this and say, Okay, what is the one actor within the system that isn't bound by constraints, that isn't bound by constraints, the bank, the bank, the commercial bank there at the bottom left, it's bound by the fact that the two sides of that most most balance. It is bound by that by law. It is a fiduciary responsibility to that special purpose vehicles, Nama and so forth. Maybe they don't have the same amount of problems. Leverage finance. Who knows? Basically. However, we are sure we are sure that the one actor within the system that has the ability to change one side of that balance sheet is the central bank. It can change those bank reserves as and when it wants. It can change them because it just creates money. I was in I was driving up today and I was listening to an interview that Pat Kenny was doing with Shane Ross. And he was saying is the problem basically that the Germans are giving money to the ECB and then the ECB is giving money to us. So why don't we just cut the ECB out of it at all? Pat doesn't understand that the Germans don't give any money to the ECB. The ECB just says there's money there today and thus it is created. It means that the way to heal the balance sheets of this system is for the ECB to expand its mandate. But that's a that's a bit like that's a bit like asking my 72 year old Uncle Pat to wear a dress. He's not going to do it. Yeah, he can do it. But he's not going to. So it's an extra constraint. And it's a political constraint. It's not a constraint that the balance sheet itself holds. The the problem within the European system economically is a problem that can be solved with the big bank. If you look at it like this, expanding bank reserves allows liabilities of all of the other actors to be amortised. I think that's very, very important. There are of course, fiscal issues. This is from the the European macroeconomic surveillance initiative that you that the European Commissioner undertaking at the moment. This is the European system. The ones in gray there, what you're looking at really are the internal imbalances within the European countries. When they're in gray, it means they're in excess of the stability and growth packed processes. You can see private sector debt in Ireland, you know, 124 percent, I think. No, that can't be right. 340 percent. Yeah, that's right. Public sector debt 93. This is 2010. Remember, remember for the Halcyon days when we only had a debt to GDP ratio of 93 percent. That's 108.2. And so forth. The average unemployment rate. You can see quite clearly, you can see quite clearly that the set of fiscal issues and these are only the internal imbalances. These are only the internal ones. There are a suite of other external ones that are there are considerable. How do you solve this? I guess my point with these two slides is to show you that monetary policy and fiscal policy, they're both incredibly constrained. They can't really get us out of this problem. Either they're unable or they're unwilling to. All those countries in gray there are going to find it very, very difficult to pursue basic Keynesian demand expansion policies, even though we're hearing about a 200 billion euro growth packed, which presumably Francois Hollande is going to go mine. Thank you very much. Even then, I would use this and other pieces of evidence to argue that fiscal policy is not really the way out of this. OK, so if that's the case, if fiscal and monetary policy are at the window, largely, then we have to look at regulation. However, regulation has its own set of problems, coordination and complexity. This is another chart from the Haldane, Guy and Kapadia paper. Looking at this, you're looking at the network of large exposures between the UK banks in 2008. They are highly, highly connected, highly connected. Which one of those red dots do you think is the Bank of England, by the way? Which one? It's in the center there somewhere, but which one is it? Well, I'll give you a clue. It's not the biggest one. Isn't that a bit frightening? It's not the biggest one. The other figure shows the concentration of the UK and the US banking systems. Here you can see, these are just using the Herford Oil Index, basically, most banks have gotten bigger. This is evidence, in fact, for the Minsky thesis that what happens is the big banks become too big to fail. Their failures are institutionally legitimized. They're allowed to carry on. When things get better, they eat the weaker banks. That's basically what has happened. And you can see that in the UK and the US, the largest banks have this complexity and concentration issue. The coordination problem, the problem of coordinating how to regulate these vast systems of banks between various countries and the difficulty of regulatory arbitrage that comes from it actually comes from or was recognized by Adrian Heritor, who's a prominent economist. Back in 1996, she was saying, this is going to be a problem. It's going to blow up on us because we can't regulate all of these things effectively. At that time, there were one, two, three, four, five, six, seven supervisory authorities on top of the national regulators. Now, of course, we still don't have a solution to financial innovation just yet. And actually, from talking to a couple of regulators, there's no sense in which they want to remove financial innovation from the system, which I find that very interesting. I understand why they're saying that, but I find it very interesting. So, there's the other issue, which is the complexity of the rules. Dodd-Frank is enormous, absolutely enormous. Sorbonne-Soxley, enormous pieces of legislation. Somebody made the joke that I think the Bible is, the Ten Commandments are about a page and a half in good size text. The Code of Hammurabi is kind of two pages long. The European regulations on cucumbers is 26,000 pages. Yeah, so, we've had a go at increasing the complexity of the rule sets. They haven't done it and what they ensure is that implementation won't be the same. That means that regulatory arbitrage will be there. If you're a banker sitting in this room, you're going happy days. This is great. It means that we're gonna be able to make as much money as we did before just by diverting a little bit more resources into regulation. However, it does also mean that within the current re-regulated process are the seeds for the collapse of the next economy, maybe one of my sons, a teenager. So, here's Haldein. As a thought experiment, imagine instead we're designing a regulatory framework from scratch. Finance is a complex adaptive system. What properties would this ideally exhibit? Simplicity. We would regulate with simplicity. The key lesson here, phase with complexity, you try to get more complex than the problem you're trying to solve. However, when you do that, you introduce more complexity. So, we could search for simple and robust rules to do this. And if the banks were mechanistic systems, then this would be very easy to do. However, they're reacting the entire time to this. So, how do you stop this? How do you stop this? Well, as I was saying to Alan earlier on, the simplest thing to do, there would be no more problems, we just increase the capital adequacy ratio to 25%. Go home, you know, sign the paper, sign the paper to their minister, boom, and then it's all good. Problem is, the next day, the entire banking system will collapse. So, we can't do that. So, faced with the fact that we can't do that, can we come up with simpler ways to do it? The Stanford economist and at Matty, for example, has proposed that we end the subsidy to holding debt and try to get large financial institutions to hold more equity. This is a good proposal in my view, in practice, I think this may be more difficult because who's going to stand on the other side of a trade for Irish sovereign debt right now? Not me. Now, I'm a Green Jersey wearer, a lot of the time. So, for example, this is from a paper that we looked at. We look at the ESMA's regulation with the credit rating agencies. So, these were, what you're looking at there, that big dense paragraph, these are the headings of the regulatory and white papers that came out just to regulate one thing. So, we've massively increased the level of complexity involved in regulation. And I guess the question is, I guess the question is, will this actually solve the problem? It may dampen it down for a while, but what you've created essentially is a storm in which very smart bankers can dance between the raindrops. So, coordination is the other issue in implementation. The historical context, of course, is that all of this has happened before. I've talked about our frame before. Regulation, I don't think, is the solution to attenuating the Minsky cycle. It can only make it, it can only reduce it if we're very, very careful about what we do. This is a lovely chart. These are capital ratios from 1870 to 2007. You can see a couple of things. The first is that, the first is that this is for the UK, the US, and for the countries. The first is that we are in a historically low period of capital, of capital ratios for various banks. And what I would like you all to think about is, what do you think that line has to come up to? To make a stable system or to reduce the probability of an extreme event, a really big explosion? 10%? You know, 8%? 20%? What should it be? What should it be? That's a big question. It's a big question. It's not easy to answer. But you can see that over the historical cycle, basically, things have been getting more fragile to use Nassim Taleb's view. Here's the capital adequacy ratios from Schulrich, Jordan, and Taylor. Again, over the same period, again, you can see they're just getting much, much, much smaller. As essentially, the private risk from the bank is transferred into the public purse, to the public risk over time, as they get insured by the big bank. Right, digression on the Irish crisis. The next three charts I'm gonna show you are essentially data that we took from the regulatory authorities. The argument has been we didn't know, no one told us. Actually, you did know. All this data is coming from the regulator's own information set from their annual accounts each year. Total assets and total customer loans, residents exploded. Here's non-financial sector lending. It exploded. Again, if you're in 1995, this is clearly not a problem. But if you're looking at this in 2004 and 2005, the line is basically 70 degrees. You gotta be worried about this stuff. This is the increase in the loan book. Percentage increases. Gotta look at your channel, sorry. But actually, just to give you a minute, Alan joins here. Yeah, so here's the juke's moment. So it's all good. But you could see the increase in the loan. And that's a percentage increase year on year. So they knew that it was there. Or if they didn't know, they had the information. And there's that crucial distinction between information and knowledge. Right. History repeats itself in financial matters because of a kind of sophisticated stupidity to quote J.K. Galbraith. The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable form. And the banking crisis has hammered growth. So you can see recessions with banking crisis and without, they're two different beasts, basically. Two completely different beasts. They take an awful lot longer to resolve. And they damage potential output for upwards of a decade. Actually, we're not that different from the past. So the distance in years from the first year of the crisis is here. So with output losses, there's the difference in output losses here. The European Union is tracking, roughly speaking, the Great Depression. We have a massive debt problem, but the ECB is carrying it for us. Jorgasmuson was speaking here. His point was very, very clear. This, in fact, is the ECB and its mandate expanding massively over time. The flow funds in the Eurozone shows us very clearly, very clearly, that the banking system is not doing what it should be doing, okay? Which is a big worry. But of course, you've got to leveraging and that creates credit growth and decay. I'm just gonna leave you with this. Could you hand that out? This is a chart that I developed looking at the top 20 banks in Europe and they're deleveraging over a nine month period. It's a slope graph. I'll explain it to you in a little while. But basically, one of the big challenges is getting banks with large amounts of debt to deleverage quickly without destroying the economy. And this is very, very difficult. So one of the current challenges, the crisis is evolving and today's solution is not tomorrow's. We actually live in a low, high quality information environment. So the high quality information is the stuff that was in that chart before. But the information that every bank has to submit to the regulator may be actually low quality information or they might be very difficult to get any knowledge out of it. We must realize that banks are not passive actors. Regulation doesn't help them, in fact, to change. And balance, and this is something I can't stress enough, is not something to strive for. Regulators and policymakers look for balance. I don't think it's possible to do it. So we have a nice model that we like to look at. This is building on the Minsky view. The basic idea is the first thing that happens after the collapse is save us, regulate. And then assess the problem, which is kind of where we are now, then redesign the financial regulatory architecture. That's gonna take the next seven years. You've got to legislate for that. Then you have to implement that. That's the big change, implementing it. And then people go, well, hang on, do we really need all these regulations, all this red tape, got it? You rethink it, and then it all blows up again. Right, big issues for us. How long can the ECB support our banks? How long can fiscal policy support them? How do these banks raise capital? How do they maintain any kind of profitability? What is going to be done about shadow banking? We've been writing a lot about this recently. What is gonna be done about it? Macro-pronouncement supervision, who does it? How do they do it? Why? Are there good regulation principles? I'll talk about this later. What's the future? Okay, the Three Mile Island Meltdown in 1979 was a fascinating process. The later problem, the problem that came afterwards was quite simple. How did we get this wrong, lads? We followed all the rules. They realized that while they're following the rule books, they hadn't in any way built in the capacity to evaluate risks. So they couldn't evaluate their risk management system. They couldn't figure out is what we're looking at and what we're trying to get away from is that a good risk management system or a battle. And the nuclear industry has this risk analysis intelligence system. Interestingly, the only country that didn't adopt this is Japan. So a regulator needs to establish institutional structures to support a move towards this meta risk regulation. How they do that and connecting that into the next macroeconomic framework is the next step. So thank you very much. Thank you, Steve.