The Nobel Committee for Economics, chaired by the Swede Tore Ellingsen, made a strongly political choice by awarding three specialists in banking economics, including Ben Bernanke, former president of the Fed, the American central bank, at the time of the subprime and the sovereign debt crisis between 2006 and 2014.
In their press release, the Nobel Committee states that Ben Bernanke, Douglas Diamond and Philip Dybvig “They have greatly improved understanding of the role of banks in the economy, especially during economic crises“. To this he adds that “their research revealed how crucial it is to avoid bank collapse”.
Both historians of economic facts and economic researchers, the three Americans have worked on the functioning of banking systems and have shown, since the early 1980s, through demonstration and experience, that the role of banks in the intermediation of savings and investment was essential to ensure the smooth functioning of an economy.
The primary role of banks
The idea is to consider that the bank would have the best knowledge of the realities of the market and, as such, would be the most able to direct funding towards loans and saving towards investments. All this to better finance the economy and avoid crises and their multiplication.
For example, the three authors have developed the Diamond-Dybvig model, which shows the opposition between savers, eager to deposit liquid savings, in the short term, immediately available, and investors, in need of financing, on long-term projects.
Without the regulation and action of an intermediary, responsible for directing savings and credit decisions as much as possible, responsible for ensuring the maximization of financial profitability, the opposition between assets and liabilities would cause regular crises and permanent uncertainties. At the slightest shock in the economy, savers would withdraw their savings and investors would not have the means to finance their projects. Which would support self-fulfilling prophecies: Fear of seizures would cause seizures.
A political application of the theory developed by the winners
Therefore, the solution for Bernanke, Diamond and Dybvig would be to protect the banking sector, ensure its profitability and correct functioning so that it is responsible, due to its omniscient nature, for the optimization of credit and savings decisions. It is in particular this type of question that was asked, empirically, by Ben Bernanke when he headed the Fed, between 2006 and 2014, both under the mandate of President George W. Bush and under that of Barack Obama. .
His vision was to protect banks after the subprime mortgage crisis. Between the 1980s and the early 2000s, successive presidents, from Ronald Reagan to Bill Clinton, took the decision to deregulate the financial system and liberalize the banking system to finance the North American economy. Through a line of credit, American households, even the least solvent, could obtain credit and support the economy. These credits were then transformed into financial securities, the famous subprime, and resold on the financial markets.
In 2007, when families found themselves unable to repay their bills, the value of financial securities plummeted and many financial organizations lost their balance. This has caused chain events and an increase in bank failures.
Save the banks at all costs
For Bernanke, therefore, the solution was to quickly bail out the banks. The policies applied are also unconventional: reduction of the direct rate to reduce the cost of loans and repurchase of financial securities to save the banks on the verge of bankruptcy, he eager to part with these toxic investments. More than $ 1.3 trillion would then be injected into the US economy for the sole purpose of saving it.
Bernanke remained on his position of defense of the banking system, the best in his opinion capable of guaranteeing the proper functioning of the economy, even more so in times of crisis. Yet it might be remembered that, despite his decisions, despite the ECB’s application of a similar policy in Europe, the economy has stood still for more than a decade. Furthermore, the subprime mortgage crisis gradually turned into a sovereign debt crisis, as financial organizations demanded repayment of debts from states.
If we want to defend the banking system too much and consider that it is the most efficient way to solve things, we would almost forget its irrational character. Like all economic actors, the bank is casual, uncertain, doubtful, skeptical. In times of crisis it is also reluctant to grant loans, even if the institutions would have ensured its survival and granted an increase in its liquidity. This is what happened in the late 2000s and early 2010s. Economists speak of “moral hazard” in consensus relationships in finance.
The forgotten psychological variable
In theory, as developed by Bernanke, Diamond and Dybvig, the bank should, in the interest of profit, finance investments, hence the revitalization of economies, through the issuance of credits, covered by its assets. In times of crisis, political institutions, through “quantitative-easing”, support the economic recovery by lowering the reference rates and saving bank assets. The latter, playing the role of intermediary, will then come to lend to States and economic actors in need of financing.
Problem: While banks should have responded to political support by financing investments, they have instead, for fear of new inability to repay, tightened the constraints on granting credit and limited loans. The relationship of consensus between banking authorities and intermediaries was therefore interrupted. The experiment did not confirm the theory.
This is in fact what these three economists could be accused of: this inability to have integrated the psychological variable in the demonstration of banking omnipotence. The Nobel Committee has once again made a political decision aimed at demonstrating a spontaneous order of the economy, while experience on the ground confirms the persistent whims and uncertainties of the economic world. Let us remember once again: economics is simply not an exact science and economists are not scientists, whether they have a Nobel Prize or not.