Mohamed El-Erian is the chief executive of Pimco.
It is happening once more. For the third time in less than a decade, inadequate coordination â€" among government entities, as well as across national borders â€" means that the United States may again strike the wrong balance between financial soundness and economic growth.
The first costly episode is well known by now. In the run up to the 2008 global financial crisis, lax regulation and sleepy supervision fueled a leverage-driven bank quest for greater profits, including through the large-scale shifting of activities to unregulated and undercapitalized areas.
Profits rose, compensation packages soared, and analysts took for granted abnormally high returns on bank capital. In the process, the banking system fell into the trap of believing that the exchange of an ever-expanding universe of structured products constituted a sustainable business model. It forgot that it is part of a financial service in dustry whose raison d'etre is to finance productive activities in the real economy.
The resulting explosion of “shadow banking†and proliferation of “too big to fail†institutions helped push the world to the edge of an economic depression. And while enormous human suffering was averted by unprecedented policy actions, which substituted the public balance sheet for a rapidly deleveraging banking system (thus socializing huge losses after the enormous privatization of gains), society suffered nevertheless â€" including through the rise in unemployment and mortgage delinquencies.
Taxpayers â€" especially in finance-dependent countries like Britain, Iceland, Ireland, Spain, and the United States â€" were encumbered with enormous bills. Weak growth and a dismissal job situation made things worse, tipping some European into a vicious spiral of economic, financial, political and social dislocations.
The second episode is less well known yet also consequen tial. Widespread bank bankruptcies were averted by more than just the aggressive use of public finances. Banks also benefited from “unconventional monetary policy†that artificially lowered the cost of and increased access to stable financing.
The beneficial impact on bank profitability was accompanied by insufficient safeguards â€" from lax conditionality to astonishingly little appetite to tax banks' windfall profits. Not surprisingly, banks quickly reverted to some unfortunate old habits â€" the most visible being the re-emergence of large compensation packages. And as bankers regained their swagger, hubris resurfaced, together with tone deafness and too little appreciation for the scale and scope of exceptional public support.
The result was another blow to what remained of bank credibility. Popular anger was exacerbated by the perception that, rather than lend to credit-rationed firms, banks were happy to simply deposit their excess reserves with the Fed eral Reserve, especially now that the Fed was paying interest.
We are now in a third episode characterized by regulatory catch-up. This is a good thing overall; but it is insufficiently coordinated and is yet to be accompanied by sufficient measures to offset the reluctance of banks to lend to the real economy.
With banks involved in the scandal involving the London interbank offered rate, allegations of money laundering, lax risk management and inadequate disclosures, regulators are getting better at countering shortfalls in banking activities â€" some that have threatened the integrity of the market system, others that have distorted price discovery, misallocated capital and undermined national security.
But these efforts appear poorly coordinated among regulatory agencies, as well as across national borders. Moreover, greater oversight and enforcement are not the only factors deleveraging banks. Markets are also imposing greater discipline, if only becau se they realize that the public sector now has limited willingness and ability to again bail out the banking sector.
In this context, banks' natural reaction will be to retrench further, de-globalize more and curtail credit to an even greater extent. As a result, new investments in plant and equipment will be insufficiently financed, as will hiring.
This does not mean regulators should allow bank lapses. But it does point to the need for much better coordination, including in establishing robust credit pipelines. Some involve just the private sector. Others encompass public-private partnership and, in some areas (particularly pockets of basic infrastructure financing), the public sector needs to take the lead.
It is not too late to avert a third mistake through a major interagency effort, pushed by both the administration and Congress, and better international coordination. Lacking that, America would again strike the wrong balance between bank soundness and economic growth. And society would suffer once more.
