After reading him for many years in the Financial Times, I finally got an opportunity to interview Martin Wolf. This was after he wrote his latest book The Shifts and the Shocks, which is probably the most masterful post mortem of the 2008 global financial crisis that you would encounter. Behind his somewhat stern exterior, Martin in person, is thoughtful, wise and realistic. He tells it as he sees it. Do read my review and interview - and his book!

1. D
URING an interview
with me in June 2007
(published in BT on Ju-
ly7), TimothyGeithner,
then chief of the New
York Fed, which regu-
lates Wall Street banks,
didn’t seem to have a
clue that a financial crisis was around the cor-
ner. Responding to a question on whether
so-calledfinancialinnovationssuchascollater-
alised debt obligations (CDOs) may be danger-
ous because of their complexity and opaque-
ness, he said: “The combinedeffect of these in-
novations probably makes crises less proba-
ble.”
He also suggested that “it’s very unlikely
that we’ll face again the sort of circumstances
thatled to theopportunity for collective action
that LTCM presented”, referring to the bailout
of the troubled hedge fund Long Term Capital
Management in 1998. In other words, all
seemed well and good.
A little over a month after Mr Geithner
spoke, the early contours of the global finan-
cial crisis came into view. In early August
2007, faced with a wave of redemptions, BNP
Paribasannounceditcouldnolongerrefundin-
vestors in three of its investment funds. On
Aug 9, the European Central Bank (ECB) was
forced to inject 95.8 billion euros (S$155.2 bil-
lion) into the markets to calm jittery investors.
On Sept 13, the British mortgage bank North-
ern Rock suffered the first big depositor run
since the 19th century. A string of other finan-
cial disasters were to follow, one after the oth-
er, all the way into 2009.
Few saw it coming. Policymakers were not
among them, not even then Fed chairman Ben
Bernanke, who infamously de-
clared in testimony to the US Con-
gress in March 2007 that “the im-
pact on the broader economy and
financial markets of the problems
in the subprime (mortgage) market
seems likely to be contained”.
The failure of policymaking,
both in terms of intellectual under-
standing and policy action, is one
of the themes in Martin Wolf’s lat-
est book, The Shifts and the Shocks
–oneofthemostdetailedexamina-
tions yet of the whys and hows of
the global financial crisis.
MrWolf–associateeditorandchiefeconom-
icscommentatoratFinancialTimes,andproba-
bly one of the most influential economic jour-
nalists of our time – suggests that the pre-cri-
sis economic orthodoxy, which relied on infla-
tion-targeting by central banks and light-touch
financial regulation, proved utterly misguid-
ed. Regulators were also naive to assume that
the financial system was as stable (and its par-
ticipants as honest) as they thought.
Added to these “sins of omission” were
“sins of commission”, he says. One was the ze-
ro-risk weighting of sovereign debt, which
came back to haunt the eurozone. The risk
management models of banks (based on
risk-weighted assets) were also fantastical.
The models showed, for instance, that UK
banks’ assets became progressively safer from
2004 to 2008; worse, regulators believed these
models.Anothersinofcommission wastheen-
thusiastic promotion of home ownership,
which helped fuel housing bubbles.
OneofMr Wolf’stheses isthatthecrisis was
not a singular event, but (like an earthquake)
the culmination of deep subterranean shifts in
the broader economy.
He identifies two shifts in particular. One
was the shift of the financial system from sta-
bility to fragility over 25 years. The main caus-
es were financial deregulation in the 1980s
and 1990s; the globalisation of finance, which
vastly increased the size of bank balance
sheets;financialinnovation;andtherise oflev-
erage, which was partly embedded in the new
financial instruments but was also a by-prod-
uct of the homebuying spree of the 1990s and
beyond.
Theother major shift was the emergence of
two macro megatrends since the 1990s: a glo-
bal savingsglut,aided bya huge reservebuild-
up by Asian countries after the 1997 Asian cri-
sis and the burgeoning surpluses of oil export-
ers. A second, related shift was growing cur-
rent account imbalances.
There were a couple of other seismic shifts
that Mr Wolf does not cover, though he has
written about them before. One was the shift
from wages to profits in the 1990s. The share
of wages in GDP in advanced countries fell on
average from 73 per cent in 1980 to 64 per
cent in 2007, while the share of profits rose
commensurately. The other was the huge ex-
pansion of the financial sector’s profits rela-
tive to the rest of the corporate sector. At its
peak in 2004, the financial sector alone ac-
counted for about 40 per cent of all US corpo-
rate profits, compared to 10 per cent in 1984.
The finance sector’s share of GDP is currently
just 6.4 per cent.
In an interview with BT, Mr Wolf concedes
that these shifts deserved more attention than
he gave them in his book. He suggests that the
most plausible explanation for the shift from
wages to profits was the “enormous effective
increase in the world’s labour supply”, espe-
cially after China and India became more inte-
grated into the world economy during the
1990s. Their combined labour forces – China
in manufacturing and India in services – had
the effect of depressing the price
of labour relative to capital in rich
countries. Income inequality also
grew and since the rich don’t
spend much of their excess in-
come,many richcountriesbecame
demand-deficient. Mr Wolf points
out that credit expansion “was one
vehicle to get the poor to spend
more”.This,togetherwithhighlev-
erage (associated with property
buying)mayexplainsomeof thefi-
nancial sector’s oversized profits.
All these shifts together created
the conditions for the global finan-
cial crisis.
Mr Wolf debunks the oft-cited view that the
decision by the US government to permit the
collapseoftheinvestmentbankLehmanBroth-
ers in September 2008 triggered the crisis.
“The crisis did not occur because of Lehman,”
he says. “The whole system was extremely
stretched; some sort of break was inevitable.
There was an immense amount of rot in the fi-
nancial sector – many institutions were going
to go down: RBS, UBS, Citi, AIG. The business
model of the broker-dealers was broken.”
As to what might have happened had Leh-
manbeenrescued,MrWolfspeculatesthatper-
haps the panic would not have been as intense
as it was. “We would have had a long period of
chronicmalaise.Theremay nothavebeenare-
cession, but the subsequent growth might al-
so have been weaker.” But the collapse of Leh-
man and the ensuing panic may have also had
a salutary effect, he adds: “The determination
to clean up the financial sector only happened
when the panic became so severe that you
couldn’t ignore it. It’s arguable that the Leh-
man collapse was a catalyst for both the panic
and the clean-up.”
NordidtheLehmancollapsecausetheeuro-
zone crisis, which had its origins in the diver-
gences between the economies of the 18-na-
tion area, the mispricing of sovereign risk, the
buildup of asset bubbles in some countries,
the relentless pursuit of fiscal austerity and,
perhaps most of all, the straitjacket imposed
by the common currency, the euro.
“The euro has been a disaster,” writes Mr
Wolf at the start of his sobering chapter on the
eurozone. “No other word will do.” He notes
that although it was intended to strengthen
solidarity, bring prosperity and weaken
Germany’s economic domination of Europe, it
“hasachievedpreciselytheopposite”.By creat-
ing a monetary union before creating a politi-
calunion,Europeendedupputtingthe cartbe-
fore the horse.
Mr Wolf offers a neat analogy: “Think of the
eurozoneas apolygamous monetarymarriage
entered into by people who should have
known better, in haste and with insufficient
forethought, without any mechanism for di-
vorce.”
The eurozone crisis was temporarily
quelled, thanks largely to the ECB’s pro-
gramme of Outright Monetary Transactions
(OMT) launched in August 2012, under which
it pledged to buy troubled countries’ sover-
eign bonds in secondary markets – which suc-
cessfully caused the yields of these countries
to fall and provided them breathing space.
Mr Wolf suggests that the OMT was actually
“a bluff, but an astonishingly successful one”.
The OMT programme was in theory unlimited,
but in practice conditional: countries have to
adheretoanagreedreformprogrammebefore-
hand, and if they do not, ECB support can be
withdrawn. The continued German backing
fortheOMTisalsoindoubt, giventhat thepro-
gramme has been judged to be in violation of
the German Constitution.
Thus there is actually no solid central bank
backstop for the eurozone debtors, which re-
main vulnerable, especially given that the eu-
rozone is flirting with deflation, which will in-
crease the real value of debt.
So what is the way forward?
There are three options, according to Mr
Wolf. The worst is a “disorderly exit” – which
might happen if a debtor country refuses to go
alongwithaprogrammeinreturn foraddition-
al financing. It issues a new currency, imposes
exchange controls and defaults on its euro-de-
nominated debts. The situation could quickly
slide into chaos, with a wave of bankruptcies,
lootingandrioting,maybeacouporevenaciv-
il war.
An “orderly breakup” – which sounds nice
intheory–isa“contradictioninterms”,accord-
ing to Mr Wolf. The redenomination of euro
contracts into national currency contracts
would be unacceptable to citizens of harder-
currency economies – who would also have to
contendwithsoaringcurrencyvaluesandsink-
ing economies.
The best bet for the eurozone would be to
try to turn the “bad marriage” into a good one.
A number of radical policies would be needed
here.First, ECBtomoreaggressivelyeasemon-
etarypolicy, adopting an inflation target of 3-4
per cent (instead of 2 per cent); second, fiscal
reflation by Germany to get its current ac-
count surplus down, which would help trou-
bled countries cut their deficits. Some debt re-
structuring would also be needed for those
(such as Greece) whose debts are simply too
large to service. Finally there would need to be
some eurozone-wide reforms such as a proper
banking union with central regulation and su-
pervision (which is in process) and a fiscal un-
ion which would ease fiscal transfers within
the eurozone and provide a collective back-
stop for the banking union.
Mr Wolf is also in favour of Eurobonds –
that is bonds for which eurozone countries
would be jointly and severally liable. Apart
from creating a huge and liquid bond market,
Eurobonds would provide the ideal collateral
for the ECB and make it easier for it to engage
in unconventional policies like quantitative
easing (QE). If a part of existing national debts
are converted to Eurobonds, the remaining
debt would also be easier to restructure. Final-
ly, the ECB needs more powers, including the
ability to finance governments directly.
Alas, not much of Mr Wolf’s proposed agen-
da is on the cards at the moment. As he
acknowledges, there are deep differences be-
tween economies, cultures and politics, as
wellas muchmutual distrust.Germany (which
dominates the eurozone) remains fixated on
keeping inflation low. Neither is it ready to ac-
cept many of the other reforms essential to
growth – not large-scale quantitative easing,
nor Eurobonds nor fiscal reflation nor debt re-
structuring nor yet a proper banking union.
As to what will actually happen, Mr Wolf’s
most optimistic scenario is that the eurozone
muddles through: monetary policy becomes
easier, confidence gradually improves, ad-hoc
assistance is provided to countries that need
it, and slowly but surely, consumption and
growth pick up. A return to crisis is also possi-
ble – if deflation gets worse, real debt levels
continue to rise, markets start to panic again
and long-term bond yields go up. The OMT
gets triggered, but countries don’t agree to ac-
cept its tough conditions, leading to a political
backlash.
There is one further possibility which Mr
Wolf sketches out in our interview: in despera-
tion, the eurozone debtor countries “capture”
the ECB and force it to buy their bonds as well
as pursue a really vigorous programme of
quantitative easing. Then Germany decides to
leave the eurozone – which in fact may be the
least painful option. Either way, it’s a grim
prognosis, and the eurozone’s much vaunted
resilience could face many tests yet.
Apologists for the eurozone’s current poli-
cies make much of this resilience, but the fact
that so much of the pain in Europe was avoida-
ble does not get the attention it deserves. This
comes through intellectually in Mr Wolf’s ac-
count, but he might have driven home the
point harder had he elaborated on just how
huge the costs have been, not only in foregone
outputbutalsoinhumanterms–thechronical-
ly high unemployment rates, particularly
among youthsin Spain andGreece; the fraying
of social cohesion, and more.
But he does go beyond the costs of the fi-
nancial crises: he reminds us that they can
change belief systems and be a force against
globalisation; crises create angry and anxious
people, and “angry and anxious people are not
open to the world”. They can also undermine
confidence in elites, and ultimately even in
democratic legitimacy. Putting things right
and preventing future crises will “require
more radicalism than most recognise”, he
says. Policymakers usually don’t like radical
remedies. But as Mr Wolf’s book makes clear,
that is what the doctor has ordered for the glo-
bal economy.
vikram@sph.com.sg
By Vikram Khanna
WE refer to the article by R Siva-
nithy, “Reinvent rules for remis-
iers” (BT, Nov 18).
He mentioned that trading rep-
resentatives (TRs) of broking hous-
es are prohibited from offering in-
vestment advice under the Securi-
ties and Futures Act (SFA). We
would like to clarify that the provi-
sionoffinancial adviceis regulated
under the Financial Advisers Act
(FAA).
TRs with necessary qualifica-
tions and who have passed rele-
vant examinations can provide in-
vestment and financial advice, as
long as they comply with relevant
businessconductrequirementsun-
der the FAA.
The required qualifications and
applicable examinations are set
out in the Notice on Minimum En-
try and Examination Requirements
for Representatives of Licensed Fi-
nancialAdvisersandExemptFinan-
cial Advisers (FAA-N13).
The business conduct require-
ments under the FAA are set out in
the Notice on Recommendations
onInvestment Products (FAA-N16),
under which TRs are required to
have a reasonable basis for advice
and ensure that the investment
product recommended to the cus-
tomer meets his financial objec-
tives,riskprofileandpersonalsitu-
ation through a needs-analysis as-
sessment.
We agree with Mr Sivanithy that
TRs can play a greater professional
and advisory role in the market
place. Many TRs of the broking
houses today provide what is
knownasexecution-relatedadvice.
Such advice is provided in relation
to enquiries from customers on
their share transaction decisions
and execution.
As the provision of such advice
does not take into account the fi-
nancial needs and situation of the
individual customer, it is not sub-
ject to a needs analysis of the cus-
tomer.
Qualified TRs who are prepared
to comply with the relevant busi-
ness conduct requirements under
the FAA can go beyond providing
execution-relatedadvice,toprovid-
ing a fuller range of personal finan-
cial advice for their customers.
The Monetary Authority of Sin-
gapore will work with the relevant
industry stakeholders such as the
Society of Remisiers (Singapore),
the Securities Association of Singa-
pore and the Securities Investors
Association of Singapore to pro-
vide greater clarity and guidance
to the industry on the scope of fi-
nancial advice that can be provid-
edbyqualifiedTRsandtheapplica-
ble business conduct require-
ments.
Bey Mui Leng (Ms)
Director (corporate
communications)
Monetary Authority
of Singapore
Dissecting the global
financial crisis
By Daniel Gros
Brussels
A
STORM-TOSSED ship near dangerous
cliffs needs a strong anchor to avoid
finishing on the rocks. In 2012, when a
financial storm engulfed the eurozone,
it was Germany that kept the European
ship off the shoals of financial disaster. But now
Europe’s anchor has become a brake, hindering for-
ward movement.
Of course, German Chancellor Angela Merkel
acted in 2012 only when she could tell her domestic
constituency that there was no alternative. But in the
end, she agreed to a permanent bailout fund for the
eurozone. She also backed the formation of a bank-
ing union, which remains incomplete but still repre-
sents a key step towards a financial system super-
vised by the European Central Bank (ECB). Thanks to
these measures, and ECB president Mario Draghi’s
vow, which Germany tacitly approved, to do “what-
ever it takes” to save the euro, the financial storm
abated.
But now the eurozone seems incapable of
escaping near-deflation, with little economic growth
and prices barely moving upwards.
That was not supposed to happen. When the
crisis struck, the economies of the eurozone peri-
phery were buffeted by the twin shocks of spiking
risk premiums and a collapsing housing market. At
the same time, the German economy benefited from
thereturn ofcapital fleeing the periphery. Real (infla-
tion-adjusted)interestratesinGermany becamesub-
stantially negative, triggering a housing boom. It was
assumed that this would generate strong domestic
demand in Germany, helping the periphery to export
more.
Instead, the German economy has barely grown;
indeed, weaker world trade threatens to put it in
recession. The current-account surplus, which was
supposed to decline sharply, has actually increased,
as savings have remained higher – and investment
lower – than expected.
Another problem, at least from the point of view
ofthe rest of the eurozone, is that inflation in Germa-
ny remains too low. With German prices rising at less
than one per cent annually, the eurozone periphery
needs falling prices in order to regain the competi-
tiveness lost during the pre-2008 boom years.
This lack of dynamismat the core ofthe eurozone
has now become its key problem. With no growth in
Germany, the rest of the eurozone might not be able
to reduce debt via external surpluses. And there
might be no solution short of a magic button to in-
crease German domestic demand.
Obviously, the German government is in charge
of the country’s public finances. But fiscal policy has
been roughly neutral in recent years, and thus can-
not be blamed for the German economy’s lack of
dynamism. This year, the public-sector budget
might move from a small deficit to what German offi-
cialscalla“black zero” –a verysmall surplus.But this
tightening by a fraction of a percentage point of
gross domestic product (GDP) implies no adverse
effect on growth.
The root cause of Germany’s sluggish economic
performance in recent years is the continuing unwill-
ingness of its households and enterprises to con-
sume and invest. And it is difficult to see what the
government can do about this.
Indeed, investment has fallen despite financing
conditions for enterprises that have never been easi-
er, both in terms of ultra-low interest rates and
banks’ willingness to lend. Yet Germany’s corporate
sector remains reluctant to borrow and invest in the
country, because it sees little reason to expect
long-term economic growth, given that the popula-
tion is set to decline and productivity gains remain
anaemic.
With investment unlikely to become a motor for
the German economy, consumption holds the key to
strongerdemandgrowth inGermany. Itsweakness is
somewhat surprising: Real incomes are up, and the
coalition government that came to power last year
has introduced a series of generous welfare mea-
sures, including a large increase in the minimum
wage,a reduction of the retirement age, and a special
top-up pension for women with children.
But even these measures, which foreign observ-
ers have largely overlooked, have failed to boost
consumer demand. So what more could the German
government do to wean the Germans off their abste-
mious habits?
Public investment is the one area where the gov-
ernment could act. But the growth fillip from public-
sector infrastructure spending can only be modest.
Increasing infrastructure spending by a quarter,
which would represent a huge administrative effort,
would lift GDP growth by just 0.4 percentage point.
The main danger now is political. A weak German
economy makes the necessary structural adjust-
ments in the eurozone periphery much more diffi-
cult. That, in turn, fuels the perception that responsi-
bility lies with the German government, which is
seen as unwilling to take the steps needed to
strengthen domestic demand – even as it prohibits
the periphery governments from spending more
themselves. As unemployment remains stubbornly
high and incomes stagnate in much of the eurozone,
the temptation to blame “the Germans” is becoming
ever stronger.
The German government, no surprise, does not
even acknowledge that there is a problem. With un-
employment remaining near record lows, the lack of
demand growth is simply dismissed, and the ab-
sence of inflation is taken as a sign of success.
This is a mistake. Europe’s German anchor has
become stuck, and the rising tide of anxiety among
Germany’s partners should not leave its government
indifferent. PROJECT SYNDICATE
„ The writer is director of the Centre for European
Policy Studies
Martin Wolf says putting things right and
preventing future global financial crises
will ‘require more radicalism than most
recognise’. PHOTO: ARTHUR LEE
„„ LETTER TO THE
EDITOR
Qualified
trading reps
can provide
investment
advice
Martin Wolf offers a masterly post-mortem of the Great Recession and after
„„ COMMENTARY
Europe’s German ball and chain
The Business Times | Thursday, November 27, 2014
OPINION | 25