In the latter half of 2007, the Bank of England’s chief economist and executive director Sir Charlie Bean was hopeful that difficulties facing the economy would be over by Christmas.
Ten years on and Bean, who was promoted to become deputy governor of the Bank the next year, admits Threadneedle Street was slow to react to the ensuing crisis.
He is also fearful that another crash could be around the corner, with China looking vulnerable. Bean believes markets are currently looking overly optimistic and are pinning too much expectation of central banks’ capability to deal with another crisis:
On 9 August 2007, City A.M. reported on its front page: “King upbeat on sub-prime loan crisis”. Speaking at the unveiling of the Bank of England’s quarterly inflation report the day before, then governor Mervyn King played down fears around a growing sub-prime crisis engulfing the US, saying it “was not a threat” to the world’s financial system. The day after King’s reassuring comments, European bank BNP Paribas sent jitters through the market when it revealed it had frozen $2.2bn of funds because of the sub-prime crisis. A decade on, and 9 August 2007 is looked back upon as the start of the credit crunch and the global financial crisis, the effects of which are still felt today.
Bean, who left the Bank in 2014, is certain that “somewhere around the world there will be another financial crisis”. “If you’re looking [for the source] of the next one, China has to be the most worrying part of the world,” he tells City A.M. “Credit growth has been so high for so long, there has to be I think at some stage some correction there… And that will have some effects inevitably around the rest of the world.”
For Bean, the golden rule for central bankers is: “never relax”. And he is confident current governor Mark Carney are his team “are not relaxed”. “The time when it’s most dangerous is precisely the time when everybody thinks there aren’t any risks out there. Because that’s when people end up over-borrowing,” he says.
Bean also believes markets appear over-confident currently.
“I am puzzled at what appears to be the low level of risk priced into markets,” he says. “Given the number of things that could go wrong, and these are not necessarily just economic, it could be political – the uncertainty of how the Trump administration will fare in the coming years, how Brexit unfolds, what happens with North Korea – I’m surprised at the richness of some of the valuations in the markets.”
He says this confidence appears to be “predicated on the assumption that if something nasty happens” policymakers “will be able to ride to the rescue”. However, Bean believes that central bankers have less room to manoeuvre now than they did in 2007.
If another crisis were to occur now, Bean believes the world would be better placed to deal with issues arising from it: banks “are much more resilient” and there are “better mechanisms in place for handling them”.
But he believes central banks now have fewer tools at their disposal. “There was [10 years ago] a lot of room to relax both monetary and fiscal policy, there was a lot of macro-economic policy space,” he says. “If there is a big shock, an adverse shock, today, the fiscal space is less than it was – the debt-to-GDP ratio is double what it was then… interest rates are close to the floor, and we’ve had very high levels of asset purchases.
“It’s not true that the Bank of England and other central banks are completely out of ammunition. But there’s no doubt that the traction from further rate cuts and from further asset purchases is significantly less than we were able to inject in 2008 and 2009.”
Despite the Bank’s enhanced capability in 2007, Bean admits Threadneedle Street was slow to react to the credit crunch.
“There’s no doubt that in the early stages of the financial crisis, I think we certainly underestimated how virulent, how pervasive, it would turn out to be,” he says.
For Bean, the crisis hit home in September 2008, shortly after he took on his new role as deputy governor, when Lehman Brothers collapsed.
“That was genuinely scary through the second half of September and early October,” he says.
“You thought the markets must have bottomed out, and every day it got a little bit worse. And we really thought we were on the verge of the financial system imploding.”