Bayoumi, Unfinished Business

Do we need yet another book on the financial crisis? For those who take banking regulation in the European Union and the United States seriously, the answer is yes. In Unfinished Business (Yale University Press, 2017) Tamim Bayoumi, a deputy director at the IMF, delves into, in the words of the subtitle, “the unexplored causes of the financial crisis and the lessons yet to be learned.” He shows that the Euro crisis and the U.S. housing crash were “parasitically intertwined.”

Policymakers were deluded by the efficient markets hypothesis into thinking that financial markets were largely self-regulating. And they were overconfident in the effectiveness of monetary policy. For instance, after the 1980s, when the U.S. experienced a noticeable decrease in the volatility of output (the “great moderation”), conventional wisdom attributed most of this moderation to better monetary policy. And after the technology bubble popped in 2001, the Federal Reserve “ascribed the limited impact on the US economy to its swift monetary response.” So why, if there was a major downturn in house prices, wouldn’t the Fed be able to do the same thing again?

Policymakers in the U.S. and Europe were not only overconfident in their ability to contain crises. They also adopted a stance of benign neglect, “the view that countries should look after their own internal affairs and that the benefits from cooperating with other countries are too small to be worth the trouble.” They were convinced that financial market spillovers between countries were small. “Across the North Atlantic, the main consequence of benign neglect was that policymakers missed the implications of increasing external financing of the US and Euro area periphery housing booms.”

Bayoumi extends his analysis by offering a history of the international monetary system in five crises: the collapse of the Bretton Woods fixed exchange rate system, the Latin American debt crisis, the European exchange rate mechanism crisis, the Asian crisis, and the North Atlantic crisis (which in many respects was “an amalgam of these earlier experiences”).

In the wake of the financial crisis regulations were imposed on banks in the U.S. and Europe. But “many deeper weaknesses remain.” There is, in the words of the author, “still an awful lot of unfinished business.”