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The 'Financial Repression' Trap
In Capitals Worldwide, Policy Makers Deliberately Obscure Market
Prices and Prevent InformedJudgments
By Kevin M. Warsh
The Wall Street JournalTuesday, December 6, 2011
http://online.wsj.com/article/SB1000142405297020477040457708018138491792...
Financial markets are in a precarious place, with European banks
and sovereign balancesheets in the cross-hairs. Bank regulators are
becoming increasingly aggressive, and euro-zone borrowing costs are
rising as the debts of years past are coming due.
In this environment, policy makers are finding their authority,
credibility and firepower beingtested. In turn, they are finding it
tempting to pursue "financial repression" -- suppressingmarket
prices that they don't like. But this is bad policy, not least
because it signalsdiminished faith in the market economy
itself.
Markets are not always efficient, but the market-clearing prices
for stocks, bonds, currenciesand other assets (like housing) are
critical to informing judgments, in good times and
bad.Market-determined asset prices often reveal inconvenient
truths. But the sooner the truth isrevealed, the sooner judgments
can be rendered and action taken.
In environments of financial repression, businesses are keener
to retrench than recommit theirtime, energy, and capital to new
projects. Trillions of dollars of private capital remains on
thesidelines. And the private-sector engine that drives prosperity
sputters.
Consider a few recent examples of this policy in practice:
In Europe, share prices are falling among the largest banks, but
these prices are little morethan a symptom. European banks suffer
from a lack of capital to offset future losses, and a
lack of transparency that makes it futile to try to judge their
financial wherewithal. The bankproblem is not some unfounded attack
by greedy speculators, so a leading proffered solution -- extending
the ban on short-selling shares in big banks -- obfuscates rather
than informs. Italso delays the necessary private-sector
recapitalization.
Second, when firms buy insurance to reduce risks in their
portfolio, the insurance has to beworth the bargain or else hedging
becomes unreliable and risks are exacerbated. That's whathappened
with the negotiated settlement in the Greek market for
credit-default swaps, whennegotiators "voluntarily" agreed on
principal reductions. Such policies give rise to default byanother
name. Counterparties aren't fooled. Neither should policy makers
be. Firms' exposuresto their counterparties require more
transparency and better tools for risk-reduction.
Third, ratings agencies have been rightfully criticized for
assigning higher ratings to variousfinancial products than were
justified by their fundamentals, yet now we see a dangerous
irony: Governments are trying to persuade ratings agencies to
assign higher ratings tosovereigns than deserved or justified by
market prices. Blaming the ratings agencies for thedysfunction in
funding markets will not lower funding costs. After all, the
largest globaleconomies do not have debt-rating problems. They have
debt problems.
Financial repression is sometimes the effect of policy even if
it is not the intent. It manifestsitself, for example, when policy
makers react more forcefully to declines in asset prices than
toincreases. Price increases tend to be treated with benign
indifference. But declines often leadpolicy makers to respond with
force, deploying fiscal stimulus and monetary accommodation.Market
participants then conclude that governments have their backs.
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7/30/2019 Warsh Essay WSJ
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Consider the fiscal trajectory of the United States. However
well-intentioned, the FederalReserve's continued purchase of
long-term Treasury securities risks camouflaging thecountry's true
cost of capital. Private investors are crowded out of the market
when the Fedshows up as a large and powerful bidder. As a result,
the administration and Congress maketax and spending decisions --
with huge implications for our standard of livingwithheightened
risks around future funding costs.
As measured against the administration's budget, every 1-percent
increase in interest ratesabove the current baseline would
translate into another $1 trillion of debt service over 10years.
And with financial repression at play, we risk missing early
warning signs from marketsthat our debt burden is intolerable.
Efforts to manage and manipulate asset prices are not new. But
history provides little comfort
that these practices work. Interfering with market prices
occasionally buys time, but rarely dopolicy makers seize the window
of opportunity to enact structural reform. Financial
repressionembeds the wrong incentives -- obfuscation begets delay,
and a robust recovery becomesunattainable.
The path to prosperity requires taking the long road. It
requires policy reforms that make theeconomy less reliant on the
preferences of government and more responsive to the market.That
means prioritizing long-term growth over fleeting market stability,
and giving precedence
to structural reforms over temporary stimulus and market
manipulation. Financial repressionis a tactic that may help get us
through the week or month or year. But it will come at asubstantial
cost to our long-term prosperity.
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Mr. Warsh, a former Federal Reserve governor, is a distinguished
visiting fellow at StanfordUniversity's Hoover Institution and a
lecturer at its Graduate School of Business.
