A Year in Review, 2009

2009 will go down in economic history as probably one of the easiest years to predict. Given that the global financial crisis had already engulfed most economies by the last quarter of 2008, even those that refused to believe their own eyes and ears, it was clear that we were heading for a bumpy ride. And a bumpy ride we did have. However, what is still not clear is whether we are completely out of the woods yet. The past 12 months were almost unprecedented, both in terms of the risks that the global economy faced and the fiscal response that was amassed. More importantly, it was unprecedented since it was the first time that the global economy faced the same levels of risk as the great depression but that monetary authorities responded in exactly the opposite way of what took place in the 1930s. It does seem that with the aid of a huge fiscal and monetary stimulus we have avoided a full-blown depression, but it is still not clear whether we have simply delayed it for a few more years. The sad fact is that all of the factors that brought about the current crisis, namely excessive risk taking on the part of the major financial institutions, are still present today. If anything, these institutions are now feeling even more confident about taking excessive risks since they know that they are now certainly too large to be allowed to fail. They no longer need to test the hypothesis, they now know for sure. While the current debate is focusing on levels of executive compensation, the real issues remain. So, we should certainly be prepared for a similarly bumpy ride in the not so distant a future.

2010 does look likely to be a better year than 2009. Many do predict growth to accelerate in 2010, even though we have to take some growth figures with a huge pinch of salt. It is really not that clear whether China is growing at the rates it is claiming, neither are some other countries. The fact that Japan could miscalculate that its GDP had grown by almost 300% more than it actually had in the period between July and September 2009 (the 1.2% figure was revised down to 0.3%) without anyone blinking an eye when the initial figure was released demonstrates that it is literally impossible to calculate how much an economy has grown from the outside, and that is assuming that GDP figures can actually be calculated with any degree of accuracy. And, when you are dealing with dictatorships, such as China, you have to put aside your excitements at seeing an ever increasing growth data and actually question the validity of some of the numbers. In my opinion, just as the current gold prices are symptomatic of a bubble, so are some of China’s economic growth figures. I think we all remember how Greece manipulated its own data when it joined the Euro. Thankfully, Japan corrected its miscalculations given their cultural insistence on honesty; otherwise no one would have been any the wiser. And if you are relying on IMF to get accurate data and advice, just do a quick study of how accurately they had predicted any of the previous economic crises, how they managed the Asian crisis, and how many times they have revised world’s growth figures up and down during 2009. God help anyone, except the journalists who need something to fill the financial and economic pages with, that relies on IMF on economic data. They are almost as useful as the ratings agencies.

In terms of shocks in the New Year, I predict that gold will come down to earth with a bang. While it is never possible to determine what an asset’s fundamental price is, since none of the pricing models actually work in practice, it is possible to discern patterns that do highlight price overshootings. Gold is now exhibiting those characteristics, just as oil had a year or so ago. I think we were correct in our predictions that the price of oil will fall, despite some analysts predicting that it would hit $200 per barrel, and I believe we should be on the money with gold too. In today’s world there are far too many derivative instruments for hedging risk that the use of gold, and other precious metals, should not be necessary.

I still stick with my prediction that an economic recovery with high unemployment is not as sustainable as it once was, given the huge contribution that consumer spending now makes to the national GDP figures of most Western economies. People who are unemployed do not spend as much as they used to when employed. Add to that the risk that many of the formerly good quality borrowers might soon run out of money, due to being unemployed for a very long period, and start defaulting on their mortgages. The longer the recovery continues without falling unemployment the greater the risk of another major property market collapse. If banks don’t reduce the minimum deposit they demand for new mortgages and remortgages the market will remain as is, with the unemployment issue putting further pressure on the market.

All-in-all, I believe that 2010 will be a more exciting year than 2009, since many of the shocks will come as more of a surprise to international decision-makers. International financial institutions will most probably have a record breaking year in 2010, since they will certainly take on more risk and have less of a competition. Many of the write-downs will have been left in the past so that they can accelerate forward. I think the U.K.’s tax on bonuses will not make as many people leave the City as many suggest, since the alternatives are not as viable as many believe and there are far too many ways to avoid it. I think the U.K. chancellor is probably the most popular man among U.K. tax advisors right now. They are probably lighting a candle for him. Furthermore, many financial centers have had lower taxes than London for many years and yet they have never caught up. New York might be the only main benefactor of this move, but it is not clear exactly what the U.S. administration might do on bonuses, as they might also impose their own taxes. Germany probably won’t introduce taxes, hoping that Frankfurt can once again clash heads with London by attracting those who wish to run away from the tax hikes, but somehow I think the gap between the two is too large now to be cut short by such taxes. Oxford and Cambridge Universities don’t attract the best minds because they pay the most, they attract them because they are the best hubs of thinking. And, London is certainly that for anyone wishing to excel in Finance anywhere, except New York, of course.

From a more personal perspective, we published 3 very successful issues of the Journal of Financial Transformation in 2009. Our annual conference of the Cass-Capco Institute Paper Series on Risk in April was very well attended and the debates were at a very high level. We hope that the April 19th event in 2010 will also be as well attended.

My co-authors and I have started a series called “Economists’ Hubris,” which looks at the gap between academic thinking and business application. Three papers have already been published with their titles and links provided below. These papers have been very well received and I think that this debate will gather pace as we approach the next big shock that we expect to take place in the banking system in the not so distant a future.

Economists' Hubris - The Case of Mergers and Acquisitions -
http://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1431124_code342721.pdf?abstractid=1418986

Economists' Hubris - The Case of Asset Pricing
http://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1481557_code342721.pdf?abstractid=1469462

The Financial Crisis as a Symbol of the Failure of Academic Finance? (A Methodological Digression)
http://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1477399_code342721.pdf?abstractid=1477399

We hope that you have enjoyed our commentaries during 2009 and that you will join us again in 2010 for what will surely be a more interesting year. We also hope that more of you will share your ideas with our readers, as the Bulletin is intended to be a medium for ideas from anyone who is interested in sharing theirs.

On behalf of my colleagues who have contributed to the Bulletin over the past year, I would like to wish all our readers a Merry Christmas and a Wonderful New Year.