Buon Giorno good afternoon everyone thank you very much for coming the so numerous we are very glad to have this afternoon professor Paris link who is a professor at the of economics at Barnard College and who is the director of the training programs the Institute for new economic thinking many events come here to see a Lynette Kaku unit has organized many important events in these days allow me to make a short comment on the agenda or the program of young scholars initiatives which has been active for more than one year now extremely interesting can become part of a network and support new approaches and I'm sure that our guests indeed will have the opportunity to go back to that personally very happy to have him here we indeed can provide a very nice bird's eye view what has happened after the financial crisis also more than 100 years of financial and economic history professor Manning concentrated on the history of money and the history of Finance this approach or these approaches have been described in his books in one of his books entitled the money interest in the public interest which has not been translated in Italian or French anyway there are publishers who might think of publishing that book in these two languages he also published a book entitled Fischer black and the Revolution ideas finance based the life and work Fischer black where he describes modern financial activities his latest book published by Princeton University two years ago the new lumber Street how the Fed became the dealer of last resort still this book is not available in Italian but you can buy that in England Chinese if you want to read it I hope that will soon be translated into French Italian Spanish and so on because this is a really burning issue in the light of the present financial crisis so this book speaks about two focuses at the history of money and the history the world of finance there is a question today about the coordination of central banks is that coordination possible which are the challenges of financial globalization the future for central banks this is a subject which has been discussed for many years we have an experience who had an experience of coordination of banks of 20 years ago the past years we have been discussing about the nature of this coordination there is a very interesting case study this type of shadow banking which is very interesting these are the present challenges and these are the channel challenges for the future we have an experience of more than one century and the way which central bank's tackled Shak such issues after the presentation indeed we'll have the opportunity to entertain questions so professor modeling you have before thank you very much can you all see the slides behind me yes so I move to the first one and I'm going to try to speak slowly for the translation which is not so easy for me because I come from New York City and you may have heard the expression a New York minute so I have to pretend I'm Italian for today and have a slower pace of life and a slower pace of speech here is my first provocative slide forget the g7 watched the c5 this is the g7 of course is is the finance ministers of the of the important most important seven large economies of the world and but you probably haven't heard of the c5 so I will tell you who they are they are the five central banks that are the most important central banks of the world which are the Bank of England the ECB the Fed the Swiss National Bank and the Bank of Japan when I say about coordination of central banking I mean about coordination of these five central banks the five most important central banks all of which at this moment in one way or another specific to their local conditions are engaged in monetary innovation so-called quantitative easing coordinated I don't know how officially but they're all doing it the United States was sort of first and others followed along in the Bank of Japan is the final one to come into line with this policy I want to talk today about what quantity what is quantitative easing why they are doing it what it slightly effects are going to be but I also want to talk about the longer run I want to talk about the future of central banking this quantitative easing thing is about dealing with the emergency okay and the question is what are in the end and the central banks all five of them are trying to buy time that's essentially what this policy is doing buying time for us to build the banking system of the future to rebuild from the from the crisis that means involving the finance ministers that means involving the political authorities that means involving everyone okay and it's very important this is the most important message that I want you to take away today that we use the time that the central bankers are buying us okay to make important decisions for the future because I think if we use this time well the future could be quite right and if we use this time poorly we don't we will not have a chance and the things that they are trying to ward off with this policy will hit us so it's a very important moment we are living in a moment of opportunity but also of danger and it's an exciting time to be studying monetary economics I'm referring some of you will have gone to Andy Haldane's lecture this morning and I see this very much as following from that lecture so if you didn't go you should get it on tape and and see it and see them and I think this is the right order see them because his talk was mostly about issues of solvency and my talk is going to be almost entirely about issues of liquidity and so these are they're they're orthogonal but they're connected and you'll you'll you'll see so I hope I'm not speaking too fast I hope I'm not being too slow what is quantitative easing this slide here is the balance sheet of the Fed the central bank of the United States during the financial crisis and now I'm going to switch to an alternative technology here so that I can point to some of the things out yes hello on the top here this is the assets of the Federal Reserve Bank and on the bottom its liabilities which are plotted as negative numbers and it's a bank which means that assets and liabilities are the same size in total this is time along this axis and it comes from January o7 to March of 2010 the vertical lines are Bear Sterns the collapse of Bear Stearns and the collapse of Lehman and AIG in March of 2008 and in September of 2008 so you may not remember this particular time but I was teaching money in banking during all of this and every day something new happened it was a very exciting time to be alive and that's what led me to write this book that we're referring to the new to the new Lombard Street the crisis however began in the fall of or in the summer really August I would say of 2007 but you can't see it in this balance sheet that's because the feds first reaction to a balance sheet was just to lower the interest rate lower the Fed Funds rate from five percent to two percent there was very little balance sheet effect you can see here before the crisis the Fed was a very simple operation on the asset side where Treasury bills and on the liability side was currency yes there were some bank reserves on the liability side there were some other things on the asset side but mostly its Treasury bills and currency pretty simple things these dark blue that's Treasury bills that's currency and it transformed utterly in this crisis as you as you can see after Bear Stearns you could see that this policy of lowering interest rates in order to try to deal with a crisis was not enough and the Fed did warm and what it did you can see there it sold off half of its Treasury bills and lent the proceeds to broker dealers to whoever seemed to need it they were trying to to to help the system more broadly not just confining themselves to the discount window but term and term the term asset facility started here and so forth and that worked for a while but ultimately it wasn't enough and Lehman and AIG failed and then the Fed moved in to really hyperdrive and you can see that they had sold off half the Treasury bills they sold off a few more but mostly they expanded their balance sheet on both sides okay they borrowed from the Treasury that's what that is okay and they issued more reserves and they used the proceeds of that to lend to to the same people they were lending to here before but also six hundred billion dollars okay lending to foreign central banks this is the liquidity swap lines and and then ultimately this aqua thing here buying a trillion dollars worth of mortgage-backed securities if you got a mortgage or refinance the mortgage during this period it was the Fed that was lending you this is extraordinary this is innovation in the in monetary action and this is what we need to understand why did the Fed do this did it work is it gonna have to do it again is this where are we what does this all mean this is what I want to talk about today the Fed tripled in size during this period and its balance sheet its composition of its balance sheet changed the composition of its liabilities changed this is quantitative easing now I mention now I'm gonna return down here this method I I would say we are living in I'm saying we're living in a Badgett moment that's my view and what do I mean by that Walter Badgett wrote a very famous book in 1873 called Lombard Street a description of the money market that's the book there on the left and he was talking about the London money market he was talking about the financial crises that happened in the London money market which was then the centre of the world financial system in 1873 and he was looking back in history and he was saying noticing and pointing out to all of his readers this was a best-seller actually in 1873 pointing out to all of his readers that in a financial crisis the Bank of England always did the same thing okay they always lent freely at a high interest rate against good security this became known as the Badgett rule the central bankers always claimed that they didn't do this at all okay they denied that they did this but he said yes you are doing this not only are you doing this but it's the right thing to do and here's why and you should you should bring this rule up to consciousness and do it now on purpose and eventually central bankers said you know what that's right and this was the beginning of modern of modern monetary economics and modern central banking theory where central bankers said yes that is our responsibility to put a floor under the markets at a time of crisis and this is what we're going to do so everyone everyone now agrees that the Badgett rule is orthodoxy okay it was heterodoxy in 1873 but it's now orthodoxy and this is the origin of modern monetary policy also once the central bank takes responsibility for putting a floor under the crisis they in inevitably take responsibility for trying to prevent the crisis from happening in the first place and that means stabilization policy that means micro-prudential policy that means macro-prudential policy it means whatever it is that could keep this problem in the markets from dropping onto the balance sheet of the central bank no central banker wants to do this they do this as a last resort they're the lender of last resort and today so this this third book that I wrote the new Lombard Street is specifically referencing that for an audience that has heard of Badgett and has heard of Lombard Street my publishers were a little anxious that people wouldn't know what Lombard Street referred to and I told them not to worry they should and if they don't they will learn okay that it's important that they realize that we are living in a Badgett moment when we are having to reconsider as Badgett did in 1873 what should a central bank be doing what are what is the right policy for a central bank where does it fit in the political economy what is the role of central banking and why are we facing this problem we're facing this problem of course because of the crisis and I just showed you that central bank's the the central bank of the United States did things that it swore up and down would have sworn up and down it will never do okay and yet it did them okay and it has been swearing up and down that he will never do them again okay but only if there's not another crisis of this of this kind so we know the emergency is here but I want to here to tell you that the reason the Fed had to invent all these new things is because the financial system has been transformed we are living in a new financial world in this world of financial globalization which is not new in history as a matter of fact our world today is not so different from the world of of the late 19th century okay when England was the head and we had financial global financial ization they didn't have fancy derivatives they didn't have you know electronic exchanges they didn't have but the economics was very similar and some of the challenges they were facing were very similar London was the center of the world then New York as the center of the world now okay I often tell my students it's better to read books that are a hundred years old than books that are 50 years old because they're more modern they're more up-to-date for the world that we're living in today the world of nineteen fifty okay is completely an anomaly when the global financial markets were just in a shambles and it was all about government government markets and there was all of these government securities from the from world war ii inherited this is anomalous and in in some sense the world we're living in here is more normal for the long history of capitalism but it's not normal to us okay and so we have to learn learn about it here's another provocative claim I'm claiming on this slide shadow banking is the characteristic institutional form of the modern financial globalized world it's the characteristic institutional form something we need to understand because it's not going away okay it's with us it's not some mushroom growth created by the Wizards of Wall Street in order to bamboozle us okay it is the characteristic institutional form of the modern financially globalized world and it's this sort of form that we need to come to understand and understand what is the role of the central bank and what is the role of regulation and all of this for this new form okay not bank loans but but shadow banking or to use a less freita less ideological term market-based credit some people say non-bank that just seems to exclude everything but banks and when I have a positive term market-based credit when I say shadow banking what I mean is those words in quotations their money market funding of capital market lending money market funding of capital market lending that means typically global funding of local lending because funding markets are global whereas lending is always local it's some some entity you know in some particular geographic region borrowing a household in the mortgage market or a business it's also importantly typically means dollar funding because the world money markets are ultimately dollar money markets the dollar being the world reserve currency so for Europe it's in there's there's going to be a foreign exchange sort of element here if this is true what I'm telling you that that this is the characteristic institutional form of the modern system the second bullet point there the thing and that and I think maybe the most important thing to understand why market-based credit is different from your intuitions about bank loans is market pricing on both sides of the balance sheet market market pricing of the funding money market funding and market pricing of the lending of the of the securities okay that are that are created in this system both money and capital there are prices there are prices that make this system go that determined in competitive dealer markets and that's the third bullet point the key role of market making institutions in determining these prices quoting buy sell spreads in the funding markets quoting buy sell spreads in capital markets and it's these prices that make the system go from this point of view the key role of the central bank is backstopping not so much the shadow banks themselves which are doing money market funding of a market lending we're used to that it's backstopping the price making mechanism back stopping the dealer making mechanism this is what I mean to signal by the subtitle of my book how the Fed became the dealer of last resort so I think of us and I tell my students this back home as being at the very beginning of a process of intellectual inquiry and of institutional groping and invention for the world of the future and I thought to myself two or three years ago as we were in the middle of the crisis how can I help I'm a professor you know and there's this huge regulatory discussion going on and people with lots of knowledge about the details of the markets how can I help and I thought I can help by trying to look a bit further beyond the immediate crisis and think about the world of the future a vision of the future and and imagine well what would be necessary to make that world work and I imagined and I'm gonna imagine with you today and I invite you to come along on this journey a world in which there is only shadow banking there's only market-based credit there's no traditional banking at all okay it's all shadow banking how would we work a world like that what would be the source of instability in a world like that and how would we put bounds on it how would we run monetary policy in a world like that how would we do everything in a world like that so you see I'm doing the opposite abstraction of most people okay who are imagining that shadow banking was some sort of little little seed of evil that got dropped into the world okay and I'm saying let's just go the other way if we think of this as the characteristic institutional form of financial globalization and if we think that financial globalization is here to stay then shadow banking is here to stay and we better grab a hold of it not to say that there wasn't a lot of illegal stuff that happened that caused this crisis or a lot of nefarious things and but some of this is is you know bad people some of this is groping toward a new system that we didn't really know what we were building and so I'm gonna begin by imagining that we finished this groping and we now have this idealized shadow banking system that I'm gonna describe in this slide here so here's an imagination an imagination of a a world of that's only market based credit perhaps I'll move to the other technology again so that I can make some points and so this entity here that I'm calling a capital funding bank that's in order to avoid the word shadow bank but you can see remember my definition of shadow bank it was money market funding of capital market lending and that's what's going on there money market funding of capital market lending RMBS stands for residential mortgage-backed security so this is my example it could be any securitized thing but it's it's the u.s. example and so just imagine residential mortgage-backed securities so this is the shadow bank the funding for this Bank is coming from what I call a global money dealer this might be one of the global banks that is collecting deposits from all over the world and then on lending them here so there's deposits on one side Mike this is the wholesale money market so that's why I put deposits in quotes okay they may be shorter term than the money market funding which might be ninety days or six months or something like that and this is the global money dealer that's doing the funding this and this dealer is quoting a buy-sell spread this is where the price of funding gets determined okay I remember I emphasize that these are there's market pricing on both sides of the balance sheet where does the price of the residential mortgage-backed security come from it is sort of the the sum of the price of funding and all the various risks there that are in that that are that are embodied in that and what I'm showing here is an idealization that this capital funding bank is stripping out all the risk using derivatives okay this is an imagination there's no such thing as a perfect hedge but I'm imagining that there's a perfect hedge here and instead of using all the complicated mechanisms of the actual shadow banking system you've heard of them the slicing the dicing the thrashing the the CDO Squared's and all of that a much more straightforward risk transfer system where you just have credit default swaps for the default risk interest rate swaps to move these 30-year mortgages down into into a variable rate and foreign exchange swaps if if we're dealing with a security that is issued in something other than dollars those hedges if you combine with the risky asset give you a riskless asset riskless portfolio here on the asset side which is used as collateral possibly for borrowing in them in the in the wholesale money market here's the other important entity I said the money market the global money dealer was important for determining the funding price and I'm imagining a derivative dealer okay that is making markets in these various derivatives credit default swaps interest rate swaps foreign exchange swaps this is where the price of risk is determined okay from this dealer making two-sided markets in risk to complete the model I have on the right hand side there what I call an asset manager you could imagine this to be an institutional investor like a pension fund as Andy was mentioning this morning so it could be a pension fund this pension fund instead of holding residential mortgage-backed securities outright okay is getting the risk exposure to rest residential mortgage-backed securities by through this derivative exposure through holding credit default swaps interest rate swaps foreign exchange swaps it's on the other side the risk is being transferred from the shadow bank to the pension fund it may confuse you that I put this on one side of the balance sheet or the other don't you so I'm just just understand the words there are no conventions at the moment for how to book this stuff on balance sheets so I have developed some conventions for my students and I'm not sure they will stick okay but I think the ideas will stick so I'm showing this asset manager as investing as having capital and investing in the money market which is actually funding all of this okay and then getting exposure to risk markets through the derivative dealer here so again the important entities from this point of view in this model are these dealers who are determining the prices they're determining the prices I'll say one more thing about this and then move to the next line notice where the risk is in this world if the hedges are perfect and if these dealers have exactly the same risk on their liability side as on their asset side so they're short and long the same risks so they have mash booked the only risk in this system is the only net risk in the system is right here all of the risk is on the balance sheet of the asset manager and where is the capital in this system it's on all in the balance sheet of the asset manager so this is a very strong idealization right an idealization of a world where we've stripped out all the risk here all the risk here all the risk here there's no risk anywhere except here and so that's where you want the capital to be and that's where the capital is I put forward this model not because it's a realistic model of the world but because I think it may help us think about some of these issues of capital adequacy and so forth that people are thinking and in trying to be concerned about what is it that that we need capital for when we're talking about dealers when we're talking about shadow banks and what is it that we need liquid 84 and and so forth if the world were really like this you wouldn't need any capital anywhere except with the asset manager I'm this is not the real world even in my imagination I can't imagine that this is the real world and why not because these certainly these dealers are not going to be able to do their job of making markets if they're if they have to have matchbook all the time what does a dealer do a dealer makes markets by whenever somebody's demanding and no one's supplying they absorb that demand and that makes makes them have mismatched book so there's no way you can actually create liquidity in these markets if you insist on having only mass book so there's going to be mismatched books so let's move there so this is that same diagram but now what I've done is I put some reserves liquidity reserves on the balance sheet of the money dealers and the derivative dealers and I put some capital there so that if they have they're facing solvency risk they need capital they're facing liquidity risk they need reserves and I call this back stopping market making first resort because we definitely want these these dealers are profit seeking entities okay we want them to be absorbing the risk themselves we don't want to be back stopping them as a first resort by the central bank we want them to be back stopping themselves okay I'm not putting anything on the balance sheet of the shadow bank maybe we want something there but I'm trying to point out that the regulatory discussion has so so far very much focused on the shadow banks not on the dealers and from this point of view the dealers are much more important and so I'm focusing only on them in order to in order to make that point as a first resort solvency risk is handled with capital liquidity risk with reserves that role of the central bank in a world like this would be as last resort and not as a solvency last resort maybe the Treasury wants to do that or the taxpayer wants to do that but as a liquidity last resort and I'm putting that on the balance sheet here of the global money dealer and the derivative dealer as a contingent asset that they're their reserves that they can get access to through the central bank and as a contingent liability of the central bank and notice I'm saying or c5 okay the combination of central banks central banks working in consort to backstop the world financial markets it's an abstract idea how does it line up with what the experience was in the crisis I'm showing here in the left-hand side the balance sheet of the central bank of the United States the Fed as of December 15 2011 you can see that it had so this is after the crisis it had one point seven trillion dollars worth of Treasury bills at that time it was mostly bills they hadn't moved into QE three point nine trillion of mortgage-backed securities and other risky kinds of securities and on the liability side a trillion dollars worth of currency and one point six trillion dollars worth of excess reserves now I'm gonna do in the right hand side I am just adding numbers to both sides of that balance sheet so that I'm not changing the balance at all I'm not an unchanged adding the same number to both sides so I'm not changing the risk exposure at all either and I think now I'll switch to the other technology again we're testing out the availability your infant so on the others so I'm adding here risky securities 0.9 those are the same as that adding Treasury bonds risk free government bonds to both sides point nine trillion to give me and then I'm adding two point six trillion of Treasury bills to both sides and so that I'm the total is now six point four trillion so I haven't changed the risk exposure at all because I've added the same thing to both sides okay all I've done so these are sort of notional amounts and why am i emphasizing notional amounts because in the swap market the notional amounts are in the background and you're paying based on these notional amounts so you could imagine the Fed doing all of its activities not by buying and selling Treasuries and mortgage-backed securities but by buying and selling credit default swaps and interest rate swaps and things like that and in fact I've written it so that this line here is basically a credit default swap a long position in risky securities in a short position and Treasury bonds this line here is basically an interest rate swap a long position in Treasury bonds in a short position in Treasury bills and this top line is like the overnight interest swamp interest rate swap sort of money market term t-bills on this side and currency reserves which are paying interest on excess reserves on on the right hand side this is what the balance sheet would look like if in fact they had been engaging in actual swamps and I point that out just because you see there this is the balance sheet that I was suggesting a Fed that was acting as backstop of last resort okay of my idealized shadow banking system would be having a liquidity put on the liabilities side that would come into the money during a crisis and that's what I'm showing you that's exactly what happened with the Fed it had a liquidity put it came it they didn't intend to do this they weren't thinking about this they were responding to a crisis okay and this but this was their response this was their response their response was to behave in the way that I'm suggesting an idealized central bank might work in my idealized shadow banking system okay and that's why it worked I think that's why it worked in 1873 Badgett proposed a rule the Badger rule lend freely at a high rate against with security what I see emerging in this crisis is a new rule a rule for the market-based credit system okay where the central bank backstops not banks okay but asset markets but but capital markets okay it doesn't it the equivalent to the high rate for Badgett is an outside spread which is to say the Fed is willing to support these markets at a price considerably away from fundamental value say twenty or thirty percent away from fundamental value as a last resort so they're not trying to make these fair priced they're they're trying to put a floor on these on these prices and not on all prices but only core markets not periphery that's that's what I think is might may be the equivalent to lending against food security choosing a set of poor markets in the United States it was of course mortgage markets with the the US bought the Fed bought a trillion dollars worth of worth of mortgage-backed securities in in Europe the ECB is buying peripheral sovereign debt but it's a similar it's a similar operation so we can learn that the Fed so the lesson I'm taking from this is that during the crisis the Fed innovated did they always do the right thing I'm not going to argue that at all but I am arguing that in the process of this chaotic moment they invented some stuff that worked why did it work it worked because it put a floor it could recreate 'add the markets that were frozen up the money markets and the capital markets that's what it was was doing at the moment those markets aren't working all that well partly because the Fed is focusing on exiting okay instead of focusing on making those markets work better so I in in conclusion I have four points about unfinished business okay that maybe we can talk about in the in the in the Q&A period from this point of view quantitative easing should be understood as putting a floor under the finish market it's not stimulus not as stimulus it's not mine I mean I know central bankers talk about this okay but from this point of view it's not so much stimulus it's putting a floor stimulus would involve getting the prices wrong okay pushing pushing funding prices way way low or pushing asset prices below their fundamental value maybe they're doing that and maybe that's not such a good idea okay but the quantitative easing part that is to say the expansion of the balance sheet on both sides that's ultimately about supporting these these markets and as I said at the very beginning supporting them until they can support themselves okay buying time for these markets to recover that's the first point floor not a stimulus second point central bank coordination none of this would really be possible if speculators could flee from your currency into other major currencies I think this is one of the reasons why we have coordination why QE is happening in all five of the central bank's at the same at the same time to prevent instability at that level of the of the international monetary system it's not going to it's not preventing instability farther down because it's only coordination of these five central banks not not other central banks in the world that's the second point now that's still about the crisis but I really want to keep us focused here on the longer run because I think at times of crisis it's very helpful to have in mind where you're trying to go you know so that you don't focus too much on the short-term buffeting I think we are in early days of developing a structural reform that will make the International global globally finite financial globalization work that should be our goal I either global financial ization works or we are kind of doomed in my in my in my view and we haven't really begun to sort of think about it in that way it's still quite national to focus on on on reform and coordination of this reform globally is I think also also crucial so getting the structures right is the first step when we do that I think we will begin a process of intellectual exploration about how to make these this new system work better I said at the very beginning Badgett 1873 was the beginning of a century long exploration of what what we can use the central bank for once we put a floor we decided oh well maybe we can stabilize maybe we should manipulate the discount rate okay in order to prevent crises or ward them off or or so forth we're going to have to invent new monetary theory for this new financial system that is emerging and we're at a very primitive stage here a primitive stage is a good stage okay from the point of view of students right because that means there's lots of work to be done lots of dissertations to be written lots of careers to be built we're at the very ground floor of a brave new world okay that I'm hopeful we'll be able to build that we will hold it together long enough in order to create time to build this this new world thank you very much many sects professor we welcome now questions from the audience not only from PhD candidates but but from everybody interested to have some answers more precise answers maybe on one point of the other to add the topic to the discussion for soon please introduce yourselves when you ask questions my name is Roberto Tambourine University of Trento I have two questions the first is why should market-based credit suppose that is good or inevitable thing the that's here to stay with us should be shadow shadow banking means that is invisible to regulators so we why don't we have market based credit out of the shade I hope that we have it if it is a good thing the second question is more a curiosity if you can go back to the slide with this balance sheets of the three different imaginative okay that's one at first sight if we take the consolidated balance sheet on the Left we end up with a traditional bank our MBS visa vie capital it's more or less a traditional bank so my prerogative question is what we see here I think that it's a good approximation of what's going on in the world can can can we to interpret it as a complexification in order to create new new needs new services new sources of profit that's a marketing strategy strategy you create new perhaps usually things then they became inevitable and then you create new opportunities of business new opportunities of profits that's marketing so it's it's a bit provocative I'd like to see your reaction I think both both of these are are go right to the core so I appreciate I appreciate them and I'm sympathetic to the spirit where they come from so let me just be clear about that yes I think the I'm glad for the opportunity to confirm that my goal is exactly to bring the shadow banking system out of the shadows okay that it is it's partly been in the shadows I must say because regulators didn't know what to do with it you know they felt that they understood something and and they certainly coming from the United States you know the regulator's just said oh well that's all happening in Europe somewhere and some insurance companies over they're gonna get into trouble someday okay not my problem okay yes your problem I want to say you know everyone's problem that we need to bring this inside our discussion of regulation and I I will even go farther than that my intention with this this particular diagram here is to provide a roadmap for regulators to understand the different functions the different parts of the system which maybe you want to treat in different ways okay and which are maybe at the moment many of these are all jumbled together okay inside single institutions you know any large investment bank is basically in all four of these businesses and you I think it's my intention is to is to conceptually distinguish different functions so that you might want to then develop a reporting system about each of these four systems so that you pay attention to them a little bit differently and you capitalize them differently you reserve them differently and and so forth maybe they should be in different institutions or if they are in the same institutions maybe you want firewalls between them I'm not sure I'm trying to distinguish the functions so that we can see them now your second question about complexification I'm sympathetic to as well this diagram I should be clear is my attempt to simplify to simplify the famous map of zoltán pose are okay of the shadow banking system which had seven different columns and he was talking about the origination and then the warehousing and then the this and that thrashing and and it's very complicated and I said to myself okay I'm an economist what what is actually going on here what is what are the underlying economic functions and let me strip this down as simple as possible it's completely correct what you say okay that if you were to consolidate these balance sheets everything cancels out and it turns into an ordinary bank okay yes that's right although it's an ordinary bank that is completely capital financed okay because these are wholesale deposits right so I've abstracted from the whole retail sector retail deposits both business and and and and and and also I've abstracted here from government right there's no Treasury bills there's no nothing like that you can add these things in and I'm sure you can you you see that that's possible it's not meant to say that these are unimportant but to say this is the core of the system that we need to understand and this is the place where the instability comes from so you need to be focusing here I think it's a question whether you know some complexification to create new needs and to and to confuse people you know mispricing okay is a great source of profit okay for for banking okay if you can create something and no one's quite sure what its price should be then you get to state what the price is okay I am trying to strip this down to make it very commodified okay so that the massive profits of investment banks may go away that this becomes a utility okay that the that these global money dealers maybe they're just centrally clearing counterparties okay and they're and this becomes a utility that is used by other other other entities so I think that that the complications in terms of looking in the rearview mirror and thinking about history I agree with you there was a lot of complexification for the sake of complexification okay we don't want to we don't want that I'm trying to say what that was exploration took to put a positive view on it perhaps that was exploration of a new space we couldn't make it simple until we made a complex okay and now if we understand it we can say well what was this exploration about what was it looking for maybe it was looking for this this is what I'm throwing out for discussion that it was trying to create this this is this this picture here I put it to you is is an idealization of the shadow banking system but it's doing essentially what the shadow banking system was doing but much much more simply okay and in a way you know these this these dealers here all of this was on the balance sheet of private investment banks you know particularly the risk dealers right which was not transparent not visible not priced in any way that was commodified but with with central clearing counterparties it's it's gonna be visible it's gonna be product commodified it's gonna be much more much more generic and I think that's that's the future that I'm I'm I'm seeing and I think it's evolving naturally as a matter of fact toward toward that but if we try to align our regulation on and so forth with this vision of the future I think this is meant to be a roadmap so that you see all the different proposals people make where do they fit in this diagram and therefore how do they fit together how do you make sure that they're not working at cross-purposes that's the goal of this roadmap here is more to create a common language that we can that we can talk about what kind of future we we want thank you Senor Aquila something Thanks so don't yeah one one comment and then one question the comment is the experience that I had working in the derivatives markets you should introduce yourself I'm Rob Johnson the director of Ison is that there was a period in music in the United States where jazz music was developed by African Americans and the market for entertainment was largely Caucasian white people and so what happened was the African Americans would create the music and white artists would copy the music and then go book the clubs and they would make all the money and the response to that was created in Harlem and it was called bebop ax which consisted of Dizzy Gillespie Charlie Parker Thelonious Monk playing complex music that could not be imitated in my experience in the derivatives market is that a lot of the proliferation of products that you see is an attempt to create a complex music to protect profit margins because once anything becomes understood or or imitatable the profit margins collapsed it's why I I can hear stories about the ways of decomposition of a risk and so forth but I think a lot of the complexity is defending entry barriers if you will my question is in this schema I can see what's happening and consolidated or disaggregated but I don't understand where you think it is good public policy to intervene and support and where people should just experience the instabilities and gains and losses and have the market prices reflect which would I called just outcomes how does how does this attach to the real economy or not and what is you talk about the Fed acting is the deal of last resort I'm asking why what does that what is that doing for society and why should the public's balance sheet be put into play to support a system like this so I'll let the comment stand and just respond to the the question the and I appreciate where this one is coming from to I mean I'm in my own sort of intellectual heritage I view myself as following in the tradition of British central banking which is to say Badgett and Hawtree and Keynes and at very important in fact I think a fundamental dimension of that tradition is the observation that credit is fundamentally unstable the inherent instability of credit is is what is what Hawtrey referred to it as and I think all central bankers have a sense of that okay that the market or as Badgett said the the market will not money will not manage itself and and Lombard Street has an awful lot of money to manage this instability is both upside and downside okay that it in modern economics we tend to call this sort of bubbles I guess and collapsing of bubbles the instability but this is not about irrationality this is just the way credit works and a lot of this has to do with time the unknowability of the future that the people are making promises to pay that they're not sure they're going to be able to pay you know because nobody knows really the future and so mistakes get made and they build up in the system and they wash out and so the system tends to fluctuate it tends to be unstable a certain amount of that is just exploration of you know the system exploring what is the next new thing and people should lose money and they should win money and I I agree with that the problem comes when the system as a whole gets threatened by this instability and that's when it's bad for people for if the financial system collapses and we saw some of this this morning in Andy Holliday and slides that when you have a financial crisis and the consequence is that for five years you're 15% below trend trend GDP growth this is a lot of cost for ordinary people so I would definitely want to link up the cost of financial crisis with the with the making available of the public balance sheet there has to be a public purpose for for this that's would be my first point the second point I would make is about just to be clear the discussion I'm making I'm having right here it's a bit abstract but I'm trying to insist about liquidity intervention okay not about solvency intervention so that the kind of intervention I'm imagining in a certain sense doesn't cost you any real real wealth it's not about wealth transfers it's about moving certain bits of the system onto the balance sheet of the Fed temporarily you know and at very advantageous prices that's what I mean that's what Badgett meant by lending at a high rate and that's what I mean by buying at a low price so that it shouldn't if you do it right you know you should it shouldn't actually cost you anything okay in terms of real real resources now in real political economies so I'm now gonna anticipate your next question okay this is not such an easy needle to thread actually that was probably a mistake I'm not sure how that's going to get translated and in in the real world this is not it not an easy game to play that there's pressure always okay to buy at a high price for for the for the government to come in and bail people out and to do wealth transfers from the taxpayers I'm very aware of that and I'm very opposed to that I think that we want to that I see liquidity support as a way of getting around the too-big-to-fail problem that if you had a system where you could make sure that no matter what happened the system is not going to fail then you could let banks fail you could let people who made stupid decisions fail that's what you want that's what you want in terms of policing bad decisions and bad behavior okay and what you're worried about the reason why we have too big to fail is because at the moment the big banks or say well if you - if you let me fail the whole system is gonna come down with me okay and I think we I'm hoping that we can construct a system where we can call that Bluff and say you know what no it's not we know how to support the system without you bye-bye and I'll try them on the Queen well there's one more session here another one here I think we might have both questions and then the answer to both okay yeah Thank You professor meeting for a very interesting lecture I just wanted to have one comment and one question there's a paper by to be as Adrian and young-shin about the role of broker-dealers and maybe also money dealers in the role of the economy some it's to the extent that if they fail the response of the economy to a federal funds interest shock is much larger than otherwise so maybe this answers to some extent why this why there might be a social welfare reason for the central bank to intervene if the whole economy now such as real businesses are funding themselves via issuing of corporate bonds and so on what my question is what explains and what is the driver of the emergence of shadow banking so one could say this an exogenous determinant such as a technology technological shock that we have just IT available we have communication technology but what is the underlying driver that's led to the rise of this so is it the case that shadow banking arose because there's pressure to have more margins to be more efficient because there's lack of an underlying productivity growth or general GDP growth as mr. Halden was about to speak today this this morning or is it because it is genuinely an endogenous reaction to this to some something in the system thank you much grazie a for sillas ultra demand Akira there is a second question up there I wanted to ask if one interpretation of your proposal could be that we are trying to make money market funding as stable as retail deposit funding because one experience of the crisis was that retail deposit funding proved to be quite stable whereas money market funding was quite unstable but in a hundred years ago retail deposit funding was prone to bank runs before central banks became liquidity providers so I suggesting to make money market funding as stable as the retail deposit funding is today and do you think that's realistic and then if that's the case my second question would be how do retail deposits get transferred into money market funding in your in your framework thank you so I'm taking both yes so yes Adrian and chin yes this is a wonderful paper and everyone should read this paper so I I know both of these these people at Shin is at Princeton and Tobias Adrian at the New York Fed your question though is what what is the driver of shadow banking and you give me two choices technology or complexification and I want to take the third choice in fact this is the main point that I'm trying to make in this lecture so I appreciate this question I think financial globalization is driving shadow banking now I'm not you could ask what that just pushes it back to ask what is driving financial globalization but but let me not go there and just explain how financial globalization is driving this because I think that this is that the market pricing of this okay means that more people can be involved in this kind of a credit system who don't know one another who aren't in in the same network they aren't in the same country they can hedge out for an exchange risk they can they can look at a particular it's a security okay that you're buying in not a not alone it's a security that you're buying and if you don't want to hold it you can get rid of it okay you can sell it in an in another market okay and you're funding it in liquid wholesale markets and maybe you want to fund it in Euros and swap in two dollars maybe you want to swap it and fund it in dollars maybe you so the the financial globalization I think is the reason why we have market-based credit and the reason why we're going to have market-based credit um I'm sure that's a controversial claim but but just think back a little bit on history those people who know some of the history of banking the attempts to create what's sort of most like this you know syndicated loans you know there's attempts to make large loans that you can then cut up into chunks and sell to different banks around the world and you know there are other attempts to create mechanisms for for for this sort of international financial globalization I think those were steps on the way okay and I understand this as as as sort of the more mature maybe it's not the end of the road at all okay but it's the next step on the road so that's my hypothesis I guess I don't know how I would prove that but technology is necessary for this I think that's right and and technology isn't just you know information technology some of it is also you know pricing technology some of this mathematics and things like that I think the mathematics maddox did run amok and they created all kinds of interesting things because they could but that doesn't mean that the thing had no source in real you know wasn't meeting a real need I think it was meeting a real need it then overdid it and you know credit markets do that they they there is unstable and we we saw that so that's where I would go with that the second question do I want to make market money market funding as stable well my my let me approach this from an angle sometimes when I talk about this I argue and and so I'll make this point now that the globalization of funding okay is relatively old okay the the the dollar funding markets we have been through multiple crises the Asian financial crisis other other crises the IMF has been is used to dealing with this we're so that that the top of that diagram is pretty mature okay the bottom of that diagram is not very mature okay this is this is where we had all the strange new things okay with thrashing and CDO Squared's and so forth so it's my focus is not so much on making money market funding stable so it's not on the top of the diagram because I think we're doing pretty well there we know what we're doing there I think it's the bottom of the diagram where we need some institutional innovation and it's about making pricing of risk okay much more generic much much more transparent much more much less profitable to revert to Rob's idea where where I want everyone to be able to play bebop okay and even if that even if that maybe it's not such a good analogy for me I don't know music I should stop while I'm ahead here but and you and your final question was where do retail deposits fit in here it's you know they could be a funding source as well similarly government government debt could is there's going to be markets for that I'm trying to focus in on where the big numbers are this is the important thing to appreciate that the focus of economists on retail deposits where did this come from first of all they used to be big numbers relative to a wholesale they're not big numbers anymore and so now why do we focus on them well we want to protect widows and orphans you know the widows and orphans are the ones who have to have accounts at the pension funds which are doing this wholesale funding so I think that we need to get out of this sort of need your notion that that the Public Interest requires us to focus on retail I think not actually the Public Interest requires us to focus where the money is okay which is which is in these wholesale markets I don't think it's hard analytically to extend this this model but I don't do it in my talks because I I want to jar people out of the way they're thinking about the world and into into a new way of thinking about the world hey um over okay sir a quick question following up on Rob on more on a political side of whatever your proposal a lot of this expansion that happened from 2008 was done by the Fed was largely you talk about innovation yes but very desperate innovation all this stuff being invented more or less by the seat-of-the-pants rather than by design and and watching them push the limits of their regulatory and legal charter to do what they did could be hair-raising at times so in the sense almost I'm gonna ask the opposite question as well on of what Robert was asking he was asking about exposing the public to the vagaries of the market do we want to expose the market to the vagaries of a public institution in the sense do we want essential bank picking winners in this in these markets supporting certain markets for instance mortgage-backed mortgages above they're not there naturally I'm gonna put vaguely what should be the proper value proper valuation of some of these assets with their liquidity floors and to follow up on that also on the regulatory side there's been this ideal about the central bank's being autonomous institutions are they gonna remaining autonomous institutions or is there gonna be some political control or some political decisions being made to what they can and what they cannot do in this new environment these are these are big questions and they are important questions I would maybe and I and I want to say something about both of them but let me just frame a little bit I think that when when I say we're living in a Badgett moment I'm also you know I'm I'm a student of American monetary history and that makes me acutely aware of the political economic dimensions of central banking here in Europe you're used to thinking of central banks as sort of agents of the state okay in the US no we didn't have a central bank for a very long time and a lot of one of the reasons was we were afraid that it would be an agent of the state the other reason is that we were afraid it would be the agent of Wall Street there are two big bogeymen in American monetary history and they are big government and big finance and the central bank is both so it's kind of amazing that we got the central bank the other third big bogeyman okay is actually the big wide world okay the notion that the Fed would have some international responsibility because the dollar is the world reserve currency is another big bogeyman the fact that the Fed lends six hundred billion dollars okay to foreign central banks you know got Ben Bernanke in a lot of trouble okay in testifying at Congress and I've speak now to him as fellow professor Ben you missed a teaching moment this was a moment to explain to people how the system actually works I understand maybe you were under some pressure but it there's teaching to be done here about what would have happened if you had not done that if you had not lent that now so that's the frame that I use that I where I come from in in dealing with your specific questions do we want central banks picking winners definitely we don't want central banks picking winners what I was proposing as an idealization is an outside spread that you're you're you're saying if you're willing to sell to me at 70 cents on the dollar I'm a buyer and for a certain set of a certain set of assets now that's not I don't see that as picking winners but what you're observing is that that's maybe not the way it will really play out unless you're really careful okay that once you give the central bank the ability to buy assets the pressure is gonna be you know why don't you buy my asset and you know what not 70 cents on a dollar but how about a dollar ten okay and that's sort of what it's already doing in the mortgage market as a matter of fact as a sort of strategy for creating a housing recovery so it is a problem that my sort of liquidity support idea okay is is I think essential for the backstop of the system but it also is very vulnerable to misuse okay and but I think this is a general aspect of central banking you know what and I would go even maybe farther what it what has the Fed done that blowing up of the balance sheet this is war finance you know this is what what happens to central bank's in in world war one world war two to finance the government for essential purposes of the state for survival of the nation we've used those techniques to do what to rescue our private financial system okay we have done that that is a big move with big political economic consequences and the bill for that has not been paid yet and I think it's very important for economists to stand up and say that's what we did there's a quid pro quo now okay it's time to to put the system back into some into into some order you say central banks there's a lot of talk about central banks being autonomous is there danger that they will become political this talk about central bank's being autonomous is just not in the real world you know it if they aren't they never have been you know it's it's they are political and I just gave you a few examples okay so it's not something to fear for the future it's something to fear for the present okay it's it's it's already here but I think the notion that it could be otherwise is is just an economists dream political economy needs to be brought back into economics so that we engage with these subjects and we don't say I'm just going to be technical here and I'm gonna let somebody else worry about the political consequence of this I think that is is is selling the discipline short we need to engage with these political economic issues or we're not doing our job No maybe I will try a smaller small question since so he's not known from the audience with your fresh and distant look to to Europe how do you see the latest let's say attempt or event in for them to the Euro financial crisis like like shortly in Cyprus where you had also this discuss about strangely enough too big to fail for for Cyprus banks and relate to the Greek crisis and so on you see there is a specific human approach here or as you said there is a coordination of most major most major central banks including the ECB and at the end of the game it's more or less same kind of of acts from from the Europeans or is there something specific in the ending of the financial crisis on the sides of the European regulators and so on thank you well as I said at the beginning when I was speaking about central bank coordination I was mainly speaking about the c5 okay the the ECB the Swiss National Bank the Bank of England the Bank of Japan and the Fed but there is another level at which you could think about that and that is coordination within Europe of these national central banks that are sort of Confederated in this European monetary union and there's all this discussion of a banking union whatever that might mean again I view this through the lens of American history okay where we didn't have a central bank but we had regional clearing banks we had a lot of instability and so you're getting taste of that we didn't have a central bank at all so you know people may feel that the ECB is not strong enough to be a central bank well we didn't have a central bank at all okay but we had regional clearing banks and and major banking centers these evolved in the system to become the regional feds that we now see so San Francisco Chicago Cleveland those those regional feds I think one possible future for Europe is that sort of evolution okay that the that the national central banks become like those regional like those regional feds in a federated system in the in the in the in the in Greater Europe okay well they I would okay so you're saying they are professor Tony Allah says they are they are okay I will agree with that but they are not perhaps satisfied to be such or they're not happy being such or this is an evolution this is an evolution and here is the big contrast between American history and European history because these regional banks in the United States were not creatures of the state right they were bankers banks they were bankers banks and they their their catchment area for payments okay was not any particular political unit it was a bunch of states put together so it's a little more difficult this transition that you are making because there's this historical memory of being government bank being the agent of the state of an independent state which our regional feds had no memories of that at all but so the the there's hysteresis it's historically dependent and this is some of the difficulty that leads to mispricing of assets that leads to the kind of instability that that that that you're seeing but I would look through this crisis and again try to imagine what does the future what what possible future could there be you know and try to embrace this future that that professor Tony Aiello is saying is already here but is not in our minds here okay these are facts on the ground as the system is is evolving I'm very sympathetic to that point of view many things professor moaning it's it was very ninety minutes very interesting and fascinating we hope you will be back in the next years to tell us about the next step since you said we are only in the early days of this evolution in the meantime I've seen that almost nobody had their headphone so I think everybody could could read directly your last book and then maybe two to debate with you within some some frames like like the young scholars initiatives and so on grazie Mille the most represents I so no Altria venti or I thank all of you for being here and I hope you will enjoy all the other fascinating