he had to decide on the surname um we're very wise in picking up this one it means the head of a lion he is a quite important thinker with very important ideas and concepts i remember that when his first book was published and a book that made him very very famous man a book on keynes an important canadian scholar told us that this book was very important that we all should read it well usually in two months you never know of a name of a book being published in another continent but this is again not a coincidence axel followed his thread of research and most importantly he followed an important school of thoughts focusing on people that are never very importantly studied i.e vixel and keynes and this enabled him to below some skepticism physically the new terms of economic theories and by the way he uh devoted attention to many other subjects for those of you who are interested in learning more there's a nice book edited by elizabeth and tony containing some of these most important essays as well as a very thorough and exhaustive biography has been a very independent thinker and before going to the us he was a sailor as a young rebel and i believe that this has had important repercussions uh on his future life as an independent scholar again he recently financed an important project to try and put together original thinkers innovative thinkers who could have a say on what is actually happening for our eyes and he's been one of those scholars now we are here to listen to his lecture and i'm sure we are about to listen to a very interesting lecture so over to you kind introduction and let me start by just saying that it's a great pleasure to be back in trendo again this is the 15th year that i come here for some months and trento has become a second home to to myself and my wife and we always have great joy in coming back to this community and the surrounding beautiful landscape today's topic the financial crisis uh and the deep recession that's resulted from it have revealed serious inadequacies in financial regulations in various countries serious inadequacies in monetary policy doctrines and also in the economic and financial theories on which regulations and the policies have been based so the problem i want to discuss uh come under free headings information which is supposed to be the theme of the festival instability instability and incentives so i will take this free parch in succession now the united states mortgage markets has produced losses around the world of hundreds of billions of dollars to financial institutions and investors now much of this has been blamed on the lack of transparency of the new markets for securitized mortgages now lack of transparency lack of transparency is a fancy way of saying that investors did not know what they were buying and selling so that as a consequence the markets for these instruments did not know how appropriately to price the assets that were being traded now the new practice of securitizing loans was instrumental in bringing this situation about before these recent developments banks used to make the loans and hold them on their own books until they were paid off so that was originate and hold today the originator of a loan which may be a bank or a broker sells the loan to a financial institution which bundles it together with a few hundred other loans and then sells a securities that are claims on the income streams from this bundle the buyers of these collateralized debt obligations as they are called or cdos for short were then ended up being the actual lenders but these actual lenders knew practically nothing about the borrowers who were liable for the loans sometimes the ultimate lender would be even further removed from the borrowers because we had another practice where several of these cdos were bundled together as the basis for another security that we acclaim on this bundle of secure of uh or bundled loans so a whole uh hierarchy of loans where the higher level were several steps removed from the borrower so then the question is why were people willing to invest in these products where they had basically no information about the credit worthiness of the ultimate borrower well everybody in the market certainly knew that these were risky instruments but they lacked also the information to evaluate the risks and there were two basic reasons why the markets were able to operate despite this lack of information first many relied on the evaluation of the rating agencies this you know the names of the moody's standard and poor and fitch the agencies issued ratings on cdos based on the finance theory that these securities pooled risks and that these risks were not all highly correlated a mortgage cdo therefore would be less risky than the individual mortgages that it was based on that theory in the crash proved faulty when the crash came defaults turned out to be very highly correlated and the losses on the cdos then much higher than anybody had anticipated secondly many investors many institutions thought they could unload the risk of these instruments to other third parties through credit derivative swaps that a credit derivative swap is a form of contract that is in carries insurance against default so this meant shifting the risk to third parties who also knew absolutely nothing about the credit worthiness of the underlying loans now the development of these credit derivatives were widely believed to disperse risk throughout the economy so as to make the system as a whole actually safer but two things went wrong from this point of view first because the individual institutions thought they were had less risk the system as a whole took on more risk the economy as a whole took on more risk and secondly not all the risks were widely dispersed some very large concentrations of default risk developed that turned out to pose a systemic danger to the entire economy most widely known of these concentrations of risks were the american insurance company aig that proved to have very large uh holdings of one-sided credit derivatives had this insurance company been allowed to fail not only would people have lost their life insurance and so on which was a larger part of their business but um the the counterparties to the credit default swaps uh that that is the the other banks to which aig had sold insurance against the default of various entities and those counterparties included virtually all the big banks in the united states in britain and many in europe these counterparties would all have been in imminent danger of failing so the american government found that it was forced to bail out aid to the tune of 180 billion miliardi to you 180 milliardi the dollar of taxpayer money there was also a third factor that were inducing people to invest in these products that they know so very little about namely the policy of our central banks following the so-called.com crash the internet crash in the market in the united states the federal reserve system in particular pursued an extreme low interest rate policy now when the central bank holds a very low near zero interest rate it forces down the interest rates on all relatively short and relatively safe assets in the economy so financial institutions intent on showing good profits and who could not get their customary profits from investing in safer assets were induced to invest in riskier instruments and they and they could do these investments with money obtained at from the central bank at an interest rate that was virtually zero so let me just say about the present recovery or the present measure of recovery that one of the big worries about the present situation is that it is based on the same central bank policy of maintaining uh almost zero interest rate and that this policy in do is inducing the same behavior by all the major market participants has brought us into trouble in the first place so um um i forgot to advance uh this uh my my my the apostity positive now i want to turn to my second topic which is the instability of this of the system that we have allowed to develop you know first maybe i should give a little bit of historical background a very simple point so just look back to the 19th century the 1800s the financial system 150 years ago was essentially a banking system it was composed of banks now what were the characteristics of these banks the banks borrow on short term they borrow your deposits at that time they borrowed by issuing notes they lent on longer term and they held that's number two and number three they held relatively little capital in relation to their total liabilities all right those three characteristics proved to make the financial system of the 19th century unstable it produced periodic bank runs in financial crashes at great great social cost now it took us over a hundred years to learn how to regulate this old banking system so as to make it reasonably stable right now the financial system that has evolved over the last 30 or 40 years extends far beyond the banks that still remain in a sense its core but as a whole this modern system has the same characteristics as the banking system of the 19th century this financial system as a whole borrows on short term lends on longer term and holds surprisingly little capital in relation to its liabilities which is which is to say it's highly it's said to be highly leveraged so since it has the same fundamental characteristics as the 19th century system it is not surprising that this has proved unstable and its instability has resulted in truly enormous social costs we have not learned yet how to regulate these system just to stabilize it as a matter of fact we have even deregulated the banks that constitutes its core so we have made things worse and obviously we cannot afford to take a hundred years of trial and error to find out how to stabilize the financial system that we have now allowed to develop now i want now to put the the mess the problem of the american market for subprime mortgages and so on in perspective because so much of the discussion in the press in in the political circles has centered on these problems of information in those markets that i started by talking about and what i want more than anything to emphasize in this talk is that this is a serious problem it's a costly problem but in relation to the problem of the instability of the system it's a minor problem so we have to put it in perspective the losses in these markets are estimated in the subprime market are estimated these are bank of england figures to have been 160 billion or milliardi the dollar worldwide that that estimate is a few months old so maybe it's a bit bigger today we can add to that uh uh the alt-egg mortgages which are supposed to be a little bit safer than the subprime but where uh there also have been large losses and we come to a shift to a figure of 233 miliardi which is a nice sum of money from the standpoint of our individual households but uh it's dwarfed so this this figure let's say the 233 billion dollars is supposed in the general discussion to have been the shock that has hit the world economic system but now we have to see what have been its consequences the sum of the losses uh on mortgages is completely dwarfed by the losses uh in let's say the national income in the last two years in the usa the united kingdom and the euro area and uh the loss of income in the united states has been six trillion dollars that's uh say miller milliardi the dollar in the united kingdom 670 miliardi the pound sterling in the euro era cuatro mill miliardi the euro if you add those losses of income up you come to a sum that is 50 giganta times larger than the supposed shock or you can measure the relation between the shock and the effect by the loss in asset values at the low point in the market of course the market has now turned around but we will not discuss that at this point in in the united states the loss in asset values at the low point of the market was approximately 10 trillion dollars the h.e miller miliardi in the united kingdom 1 trillion pounds and in the euro area approximately 4 trillion euros if you add those numbers up again you come up with effects of the shock that are 50 times larger than the shock itself actually the last one adds up to 75 times larger another way of looking at it is the resources that governments had to commit in order to stop the collapse of this house of cards that we had erected and in the usa we had an increase in the deficit of over a trillion dollars in the united kingdom or 130 some uh miliardi in the united states the additional money creation is almost four trillion dollars in the uk 350 320 milliardi not billionaire i don't think we have billionaire and in the euro area uh close to 1 trillion and to that you should add 5.5 trillion in garan in guarantees by the government of private sector debts by and injections of capital into the banking system and in the american system also into the automobile industry and so on for the uk and the euro now adding these numbers together you should realize is adding apples and oranges you're not strictly speaking uh supposed to do that but you would come up with a number again that is 50 times as large as the short right so um this amplification of the shock demonstrates that we have a very very unstable financial system that poses a great danger and what is the lesson about that the lesson is we must not focus just on solving the problems of the mortgage market or of the market or of the markets for other securitized products like student loans auto loans credit card debts and so on those are those are serious problems all right but if we think that by solving those we solve our main problem we are completely in error and it's a very very dangerous error to make for us all because the unstable financial system can collapse for completely different reasons next time what we know about it now is that it is a house of cards where a little impulse will cause a collapse that gathers tremendous momentum and that it takes enormous governmental resources to hold and that's a general property of the system that has nothing in particular to do with subprime mortgages now the variable that is central to this instability is leverage which that is to say the ratio of debt to own capital of a firm or a household or for that matter of a country a few numbers that i don't have on this on the slides in in the last few decades the ratio of liabilities to the income streams that must support them out of which uh the servicing of the liabilities must come has reached heights unknown in earlier times for example in the united states if you go back to the 1970s financial sector liabilities were less than 20 percent of gdp today the figure is close to 120 percent of gdp so it's approximately leverage for the financial system is approximately six times as high and in the united kingdom the same figure has has multiplied by a factor of five approximately this is an enormous development now for the united states let me give you some figures compiled by the federal reserve bank of kansas city which shows that this long-time increase in leverage is not just within the financial sector but it's actually true of all major sectors of the economy for example household debt averaged about 50 percent of personal income if you go back 40 years to the 1970s in the year 2000 we'll have to see whether this talk comes to a natural end because my voice departs so 50 in in in 1970 in the year 2000 that i reached 76 percent was that increased by half over 30 years but by the end of 2007 american households had a debt that was a hundred and ten percent of their personal inc a personal annual income so in those those last uh seven years it had grown extremely rapidly if we go to non-financial business we find uh the same tendency also the figures are less alarming so non-financial businesses manufacturing farms and so on had around a depth of 60 in relation to gdp in the mid 70s and that 60 had grown to approximately 90 percent at the end of 2007 and very significantly of course the federal government's debt was 30 of gdp in the 1970s has now shut up shot up to over 60 percent and as you well know in the current recession it's growing very very rapidly so uh this increase in indebtedness is is a quite general phenomenon and and so the financial system is more important but it's it's affecting the whole us economy so um il scoya todo that is the symbol of the festival the economy i'm afraid it's not a good symbol for the economy of the united states it just doesn't fit very well unfortunately now so it's true about the economy as a whole but it's still the very large banks and the so-called shadow banks that are outside the proper banking system that are the heart of the problems we are experiencing now for example the leverage based on tangible common equity of the 10 largest banks almost doubled between 1993 and 2007. it was 18 that is the their debts were 18 times their capital in 1993. in 2007 it had reached 34. that's a very high likelihood ratio now that 34 figure does not include very important liabilities that the banks had managed to put off their balance sheet so you may know that for example corp had eight separate so-called sivs special investment vehicles in the cayman islands where they escaped the united states regulators which turned out to carry very very large liabilities that would have brought city corporation into bankruptcy if it hadn't gotten massive government help and it included uh these hidden liabilities included the 50 milliardi dollari that layman brothers managed to put under the rug with its uh so-called repo 105 tactic now what has been going on here let me try to talk about this in very in very simple terms um so you you can uh we start with this figure here you have an uh a bank this is a bit high but it makes the makes the arithmetic easy suppose it has a leverage of of 40 that is its liabilities is 40 times its own capital why is it up so high because if it's able to buy assets in the market that earn it half a percentage point more than its liabilities right then it can report a return on capital of 20 to its shareholders and this is much higher than is earned anywhere in the real economy that 20 rate of return of course is the basis for the high remuneration that the people in the bank are are taking so these enormous remunerations that bankers have taken are are motivated by the fact that they earn a 20 rate of return and are supposedly geniuses of finance but actually running a high rate of return is not difficult it doesn't take you to be a quant trained at mit or bocconi to do this as long as you dare to face the risk associated with the leverage of 40 in this example now you didn't start out at 40. we started out as the figures are cited was it 18 a leverage of 18 in 1993 and we got in a few years to a leverage of a 34 average of the big banks and some of them were quite a jp morgan for example was in better shape than the others what drove you to it well i start by i have a leverage ratio of 18. i i buy an asset that earns me half a percent more than uh than what i pay on my liabilities and so i report uh uh profits of what nine percent or something like that right so maybe the margin between the two rates of return were a bit higher but now other banks will will uh copy my investment strategy so they issue the same liabilities and they issue the same and they buy the same assets so the markets between the the margin between what i uh what my liabilities and my assets is shrinking but but my shareholders want me to shoot for a 20 rate of return so what do i do well i add leverage the first thing i do is add leverage i i just blow up my balance sheet in relation to uh my capital and the second thing i do is i look around and say these assets that i've been buying where the rate of return is coming down are not as profitable as they used to be so let's look around for some better rate of return where do you find a higher rate or return well you apply you find assets that promise a higher rate of return in more risky asset classes so the banks are moving to higher leverage and they are moving into riskier classes and the risk premia now because of this competition are also shrinking so at the end of 2007 the system has by competition trying to maintain a 20 rate of return and they are is ending up with historically unprecedented leverage ratios with historically unprecedented low risk prema in the market and as it turns out lots of assets that are about to turn poisonous right so high leverage is very profitable profitable as long as the going is good and the rate of return on capital the big banks was also about twice as high as it had been in the good old days of the 1970s twice as high until the crash of course right of those banks that were allowed to fail lehmann you know you have to end up with one last piece of the calculation which is to say oh in the last year you lost a hundred percent so high leverage means that small losses will make a bank insolvent and the trouble with this is that the attempt to reduce leverage will take this example if you take that same bank if it loses 2. 2.5 in the assets that it's holding and suppose well uh 20 of its assets are in in subprime mortgages right then it takes a loss of what 10 percent on those to make it insolvent now when all the banks are in this position and and you get these losses on on one class of assets and all the big banks know that the balance sheet of my competitors is very similar to mine and i am technically insolvent what does it mean it means i must not transact with my my usual counterparties any longer because they may may not be able to pay me back so all the interbank markets freeze and all the banks try to now reduce leverage so as to get back on safe soil again out of the deep water onto the beach so to speak but when they all try to reduce leverage uh it turns out the the credit markets are not no longer open to to the real economy there's no lending taking place uh they're trying to sell assets asset prices are falling and this is an unstable process because their attempts to save themselves makes the situation steadily worse and this this is the house of cards aspect of it which necessitates unprecedented government incentives government interventions okay what do we do about this we have to start from one basic realization governments around the western world were not in very good fiscal shape when this started all italians know this about their own government of course but the the crisis has essentially exhausted the ability of say the the government of the united kingdom to handle another crisis of the same magnitude and i would guess that the that the government of the united states would not be able to handle another crisis of this magnitude either so what does that mean but most immediately it means that we have to adopt policies that minimize the risk of a recurrence because the current crisis if you take a historic if you take an american perspective the current crisis has reduced the influence of the united states in the world enormously and including its ability to wage war in afghanistan and whatever other places we might wage the next war that you might see as a benefit perhaps but the point is that the crisis has changed basically the balance of power in the world so to minimize the risk of a recurrence what do we do well this is this is first and foremost a problem in in regulation and so let me end by discussing um this is where i am i always forget to press this button here i'm sorry you may think of the problem of of reforming regulations in in these terms that are two ways of thinking about it one is so to speak to accept the incentives of bankers as they are and say they acted so as to bring us into this situation so they had the incentive to do it uh we have to build fences around them which say you may not do this you may not do that you may not get a leverage ratio higher than this and and so on and hope that that improves the system the trouble with that is what the trouble of that is that the financial markets have proved probably the most innovative of any of our industries in recent years and much of the innovativeness much of the unquestioned brain power of wall street okay has gone into finding ways to circumvent regulations so what are the examples i mentioned two examples uh the the basil accords were supposed to tell the banks how high a leverage ratio they could keep how do you avoid the basal accord well you put special investment vehicles in the cayman islands or some other place and those liabilities don't count and uh or you hide your liabilities like uh lehman brothers did with uh uh with a rape repo 105 and so on now okay so we add rules against those things but the trouble is to keep one step ahead of the innovations not to discover years after the fact that they've come up with these methods of of evasion and that that is very difficult there are many reasons why it's difficult to keep one step ahead but the basic difficulty is that the guys that invent the new ways of getting around the regulations earn millions of dollars on wall street and the people who are supposed to anticipate derivations of of uh the regulations earn maybe a hundred thousand dollars a year in government service and that causes what that causes sort of a drain of the of the brightest brains from government service to wall street and the government ends up somewhat incapacitated so that's a basic problem so what is the other attitude what is the other approach to regulation the other approach to regulation is to say can't we change the incentives that people are acting on in the financial markets so the the lack of transparency in that we talked about in the mortgage market uh you can ask why was that there well because nobody had the incentive to provide the information that would make it possible for people to know what were the riskiness of the assets they were buying uh what you had was a long chain of transactions from the originator of the loan and the borrower to the holder of a cdo of cdos and along that chain the rule was just caveat emptor all the way with no information provided so what's the solution to that well it's basically legal changes that imposes on everybody in that chain a requirement of making of due diligence in in the securities that they sell and if due diligence is found to fail they are liable at court uh stronger than due diligence would be uh to improve to impose a strictly fiduciary duty on uh the banks uh to watch their clients to watch the buyer of of the securities that they do and that would cause the markets to become transparent if he moved in that direction but i said before that that's not the main problem we're facing the main problem is the instability of the system and the key to the main problem is high leverage particularly in the in the financial markets so i have a suggestion that will not be popular with bankers and it's the following if you go back in history in the early days of commercial banking the owners of the banks had unlimited liability if the bank failed the owners were liable to the full extent of whatever they own to cover the debts of the bank later in american history at least we had a long period in which bank of bank shareholders had double liability so they hold a share of the bank with a with a face value of a hundred dollars if the bank fails of course they lose to those hundred dollars but they also have to put up a hundred dollars from their uh from their own wealth to satisfy the debts of the bank that's called double liability my suggestion is uh we can't impose double liability on bank shareholders today i don't think and the reason is if we did that we would find probably that we cannot raise the capital that that uh you know the current financial system requires to operate in a socially appropriate way but we could make the management of the banks bear some responsibility for their actions that they do not bear today and how would you do that well uh also today higher level executives of the banks get some of their rumeneration in the form of shares or share options and i would make it legally required that executives or banks are paid with shares but a particular form of shares let's call them e-shares for employee shares and that these shares would be subject to double liability so you may have a scheme whereby employees in the banks that have nothing to do with their investment decisions are just paid in the usual way but people who are involved in the investment decisions have to be paid partially in e-shares and maybe the ceo of jp morgan or citibank should be paid 80 percent of his total remunerations in these shares they would have to hold these shares until let's say five years after they leave the bank to go into retirement or to switch to some other thing and if the bank fails during that period as before they they lose the value of those shares of course because the shares are now worthless but these people would also be liable to an equivalent amount of of their other other wealth which would help uh pay off the the the creditors of the bank and that would make at least a little buffer uh between bank management and the taxpayer because the first bailout would be in terms of of money coming out of these e-shares and it would i think make a very strong change in the incentives of bank managers and would make them more conservative those of us who are of an advanced age will remember that back back in the dim historical past the cliche of a banker was that a banker was a dull and conservative and cautious person right not somebody to invest to invite to your cocktail party okay well the the the bankers on wall street or in milan or in london today have nothing in common with that old old picture of a banker they are high-stakes gamblers you know people that should be in that should be in las vegas and not not in your bank right and uh and i think that the way to try to bring about a change in the in the culture of banking as it is now is this uh double liability it creates some other uh effects on banks because um it it may be a partial solution to the famous too big to fail problem why because if if these people are do are under double liability the bankers in one department of the bank will have a lively interest in what they are doing in other departments of the banks that they don't have today and that causes the fact that you know the people over here say we are we are threatened with our double liability losses for what you are doing will cause a lot of internal conflicts of interest within the bank and they may find it a suitable solution to that to spin off certain departments as separate entities and that would help solve the too big to fail problem and with that i have not solved all the problems of the world and i'm not able to do so in the three minutes left to me for which i apologize uh uh but um i think it would be best if i quit at this point i everything goes dark i go blank and you can perhaps post some questions or comments benevolent like to thank axel for this very interesting lecture as you've probably noticed annex has been focusing on something which is not normally focused upon that is the weakness of the economic system and that something different from what has just happened may happen with the same consequences as we've seen now alex has explained how we got to the situation and his combat with a possible solution so he certainly touched upon different subjects so that i believe that there are quite a number of questions from the floor there's time available so please do ask questions into the mic mike is not on the prophet profitability of the u.s industrial sector belonging to the 500 standard and poor companies declined dramatically from let's say eight percent to to let's say 1.8 percent so all the capital tried to direct itself to the financial sector in 2008 i'm not very sure of this date the financing sector in the united states gained 40 percent of the profits employing 5 of the people whilst the industrial sector with 95 of the labor force gained 60 percent of the profit my conclusion is that because of this uh solo profitability of the industrial sector in the united states will push the investment investment sector in particular investment bank to continue the activity of gaining higher i profits from their activity and this is is what which is being the reality of the moment because the investment banks return the capital add from the the states the state to the state itself in order to freely continue to gain profit from their activity gambling activity are you on this line or i wait for your answer well i think i i agree with the fact that too much resources have flown into the financial sector and of course you know from what i said before that that financial sector the the for the 40 share of total profits in the us i think is is correct uh but that that was earned uh uh by this very risky policy of of high leverage so let me backtrack a little bit the the dynamics of of high leverage that i talked about before which uh by competition in banking uh uh leads the banks into more and more risky uh assets and and uh and and higher leverage is one where they are where they cause serious systemic risk to accumulate so this is something that we would have a social interest in curbing part of this instability of the leverage accumulation process and then the collapse of it is that the high rates of return also attract a lot of human capital that would be better employed elsewhere and uh it would be a blessing for the united states if if some people graduating from harvard with with with the high grades and so on uh would avoid wall street and and and and go and try to fix the automobile industry or something like that so uh so we are we are dealing with a system where part of it's unstable and and and instability cons can bring the whole system down and and it's causing resources to be invested in the wrong direction it's generally true i should say this this goes beyond your comment uh that when the system is unstable lots of things that lots of economic varieties are turned on their head and that's particularly true when it comes to economic policy as we see in this in this collapse that when the collapse happens prudent macroeconomic policies make things worse and you have to do and it basically takes what are normally reckless policies to stop the collapse and i think we have to think in in these terms also in when we uh consider what would be the appropriate role of the financial sector over longer terms that as long as it's unstable lesser fair policies are not the the appropriate ones i'm not sure i gave an adequate answer it's based on leveraged the lucidor leverage high leverage not only for the bank that that point there um you pointed out that in sin from the 70s up to now uh leverage was higher not only in the banks but also in the among households and governments so general increase in that income all over actually what i wonder is that has a relation with the fact that at the global level uh that is the word level you notice an increase a huge increase in macroeconomic imbalance and macroeconomic imbalance that is to say that there are economic areas having a higher and higher debt and economic areas having iron higher assets to be invested in in in the united states so there are two things happening at the same time has a causal relation between these two things the first the second question is related to the bank and the financial sector you talk the financial sector as if it would be a homogeneous sector roughly homogeneous that is to say a sector having the characteristic of the american sector actually in the financial banking sector there are two quite different animals a commercial banking sector and let us call it an american sector financial sector in which business is mainly get from the difference between assets and liabilities in terms of financial asset and financial liabilities whereas the first one obviously there is also asset and liabilities but there are different nature lending and receiving money from families borrowing and and lending to to enterprises the difference of these two sectors is that the financial one has a very high profit the other one much lower profit the first one is much more risky the second one is less risky or a different kind of risk um i think that the the stability is given by the first but the second has the problem of survival because if two sector earns different profit economic theory suggested us that sooner or later the most profitable one will overcome the other one and will disappear unless there is a different something which how to say makes possible the coexistence of these two sectors in terms of different uh ownership some different rules about ownership or something else how is and also what you say at the end of your lecture about the incentives is very much appropriate for the first one and perhaps less appropriate for the second one how you can cope with the problem of having two different animals in the same cage okay the first question was do the do the global imbalances have a causal role in the buildup of leverage and i think the simple answer is yes i don't think it's a it's a matter of a single factor explanation but certainly the the the huge inflow of of capital in the u.s to finance its trade deficit changed the nature of american banking the other one i had talked as if you had a homogenous financial sector and and you brought back the distinction between commercial banking and investment banking uh you know that uh the bulker proposals now before congress uh paul walker uh his basic instinct is we must bring back the uh the distinction between between commercial investment banking and we must build a wall between them and i've been trying to think about this problem and i i guess i i think maybe it cannot be done and and the reason uh is the the one that you already alluded to namely the deregulation in the united states was partly it's true it was reckless the way it was done but it was not altogether unmotivated either and the commercial banks had basically been losing out they were shrinking they were not earning the rate of return of other financial institutions they were losing the deposits to the to the money market funds and and um which is that was their basic uh way of financing themselves this loss of deposits was in large part due to the fact that the banks were under reserve requirements that that made made the deposits costly to them in a way that did not apply to the for the money market funds and and uh as a consequence we basically abolished reserve requirements that was a big part of the dismantling of the glass-steagall act and so on so the the competition from other sectors uh were uh in in the early 90s people wrote papers with titles like will the commercial banks survive and and the way they were they were enabled to survive was to allow them to do all the investment bank functions and and then some now a fundamental problem of of the system that we have allowed to develop is has to do with what you call network connectivity and it's easiest to talk about it in relation to the old american system the glass-steagall system glass-steagall i used to say in class was built on the notion of a big ocean liner with many watertight compartments so each type of financial institution had a departure had its own compartment which dictated what liabilities it could issue what assets it could invest in and it couldn't go into the next department which had another liability and other class of assets and so on and the notion was that this made for an unsinkable ship well in the 70s and then in the 80s we had the the big crash of the savings and loan institutions in the united states that was at about that time a very big industry and the the interesting thing about it was that was was the mortgage industry in the united states that's where you got your mortgages all together you didn't get them from commercial banks you certainly didn't get them from investment banks you got them from savings and loan institutions so in the late 70s early 80s we had a big crash in the american mortgage markets we took eventually two took down this industry it disappeared with considerable cost to the to the federal government the point about it is so so a subprime market a market crisis had occurred before with big losses for those banks but it did not spread spread to the rest of the american financial system and it did not spread it didn't spread to the whole world all right why because it was confined within these watertight compartments so economists have some blame to carry for not understanding the one of the consequences of deregulation which was that when all kinds of financial institutions can be in all kinds of markets at the same time the the nature of the network of the of the network among that connects all these institutions changes so back in the 70s we could have failures in the in in mortgage financing in the savings and loan but it didn't affect the commercial banks it didn't affect the investment banks didn't affect uh well we didn't have hedge funds and so on but today we have a system that is so interconnected that a failure in one part of it is transmitted throughout and one reason why walker longs back to the old days he says if we could just divide them down the middle and the line would go between commercial banks and investment banks we would make it much safer it's not clear that it's feasible uh and the reason is if you recreate all commercial banks they won't earn the rate of return of other financial institutions and all the talent will go elsewhere and that that industry will shrink and it won't be able to do what we want the commercial banks to do so that's one reason why i argue for this double liability as as a possibility thank you very much it's very late i understand that the we don't have time for many other questions i'd like to thank axel who by the way uh has been named professor emeritus of the trento university and i believe that you now know why thank you very much to axel you