Jean-Claude Trichet, president of the European Central Bank, explained the attitude behind every asset bubble in history using four simple words:
“This time is different.”
He said such mindsets always pervade in the buildup to a crash.
Trichet, described by Newsweek as the fifth most powerful person in the world, lectured to a nearly full Owen L. Coon Auditorium on Tuesday about financial meltdowns and the efforts of central banks to mitigate their consequences.
“He’s one of the four or five major leaders involved in managing the financial crisis,” said Lawrence Christiano, the Northwestern economics professor who introduced Trichet.
“There was (Federal Reserve Chairman Ben) Bernanke, who was the key, and (former New York Federal Reserve president and Treasury Secretary Timothy) Geithner, but in Europe, there was Trichet. He moved vigorously … and supplied enormous amounts of cash and dollars.”
Trichet said the meltdown served as a “sanguine reminder” that all economies are subject to asset bubbles, or times when prices of economic goods or financial instruments, such as stocks and bonds, spike due to what former Federal Reserve Chairman Alan Greenspan famously called “irrational exuberance.” Inevitably, bubbles burst and prices crash because the values of the underlying economic factors did not go up during the bubble. As Trichet described it, “The real economy introduces limits on euphoria.”
“Those who don’t know history are doomed to repeat it,” Trichet said, quoting Edmund Burke.
Comparing the current crisis to the savings and loan crisis of the 1980s and the dot-com bubble at the beginning of the millennium, Trichet said a commonality of financial crises was an excessive amount of credit available before the crashes compared with levels of gross domestic product, a measure of economic output. With a large graph projected above him showing a spike in a key interest rate spread in 2008, Trichet said another common factor of the crises was a tightening of credit and rising interest rates in the money markets, the means by which banks lend to and borrow from each other. Trichet said although financial crises might have similarities, each event was still unique.
“Given the idiosyncrasies, history may provide little guidance in dealing with the specificities,” he said. Central banks need to “be prepared to act rapidly and decisively in response to a crisis.”
“The ideas made a ton of sense,” said Ben Vannier, a second-year Kellogg student. “You want to be alert. … Crises can’t be avoided.”
When Trichet was asked by an audience member for his opinions on the ongoing Greek fiscal crisis, Trichet said little more than that each country that uses the euro is responsible for its own fiscal health. Another student asked if the ECB will engage in buying government bonds to further ease tight credit markets in Europe and reduce the risk of a Greek bond default. Trichet said only that “we are following our own rules and I would not comment more.”
Some students said they were put off by how closely Trichet stuck to his script.
“He didn’t really meet my expectation,” Weinberg junior Sherry Wu said. “He was very general, very vague. I would’ve liked more concrete policy recommendations.”
Christiano said lack of oversight contributed to the problem in the United States, where “there is a great distrust of government regulations … and the regulators had to kind of look away for this to happen.” Christiano also added that the Federal Reserve in the U.S. faces much greater political pressures compared with the ECB, which he said was very independent, though “no government institution is ever independent from the society it’s in.”
He said Europe’s problems stem more from a common currency among separate governments.
“The problem in Europe is that they formed a monetary union without a political union,” he said. Explaining some risks the lack of a strong political union poses, Christiano said Greece dodged treaty conditions meant to prevent fiscal crises with “wildly profligate deficits.”
Trichet also gave a few general guidelines that central banks, which control national economies’ monetary policies, should follow in the future. He said they must be flexible and keep in mind their immediate goals, which for the ECB is price stability, adding that monetary policy is not a cure-all.
“Alone it will not suffice,” he said.
After assessing the history and causes of recent crises, Trichet spoke about the creation of the European Systemic Risk Board. The board will identify and assess risks in the financial sector, issue risk warnings and make policy recommendations for remedial action by regulators outside the ECB, which unlike the Federal Reserve, does not regulate banks.
Concluding his speech, Trichet quoted one final author, H.G. Wells:
“Human history becomes more and more of a race between education and catastrophe,” Trichet said.
He said central banks should walk away from the recent financial crisis with greater wisdom.
“Thanks to a prompt global response … catastrophe has been avoided,” Trichet said. “We must ensure the appropriate lessons are learned.”[email protected]
