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Lord Griffiths of Fforestfach was educated and later taught at the London School of Economics and then became dean of the City University Business School. He was a director of the Bank of England and served at No. 10 Downing Street as head of the prime minister’s Policy Unit from 1985 to 1990 with responsibility for domestic policy, including economics policy.

Since 1991, Lord Griffiths has been vice chairman and a board member of Goldman Sachs International. He is chairman of the Audit Business Practice and Compliance Committee.

He is a non-executive director of Times Newspaper Holdings Ltd. and Herman Miller Inc., and was on the boards of ServiceMaster, and the English, Welsh, and Scottish Railway and chairman of Land Securities Trillium. He was chairman of Westminster Health Care from 1999 to 2002.

He was appointed to the House of Lords and has been a member of various Select Committees in the House of Lords and is at present a member of the Select Committee on Economic Affairs.

Lord Griffiths is chairman of the Archbishop of Canterbury’s Lambeth Fund and Christian Responsibility in Public Affairs. He has written and lectured extensively on economic issues and the relationship of the Christian faith to politics and business, and has published various books on monetary policy and Christian ethics.

This Conversation took place Lord Brian Griffiths home in Westminster, England, July 14, 2009, and was updated in November 2009. Participating were Brian Griffiths, Al Erisman, and Al’s wife Nancy Erisman. Because Lord Griffiths role at Goldman Sachs is a board position rather than an executive leadership position, we agreed to stay away from questions related specifically to Goldman Sachs.

Al Erisman: In your view, what has happened to the banking world?

Brian Griffiths: We’ve had three decades of growing world output and growing prosperity, the collapse of Communism and the emergence of the BRIC’s countries (Brazil, Russia, India, China) as a growing economic force. Hence the change from the G-8 to the G-20. But this boom generated extraordinary euphoria which resulted in bad loans, a banking system which was under capitalized and major mistakes by regulators. Clearly the banks played an important role in the financial crisis, but I think the crisis is much bigger than just the banks. You couldn’t have had what amounted to a collapse in confidence in Western capitalism simply because of a lack of governance in banking; it’s much greater than that.

One commonly alleged cause of the crisis has been the imbalances which grew up over the last decade because of the high saving rate in China and the low saving rate especially in the U.S. This led to a balance of payments surplus in China and oil exporting countries and a deficit in the U.S. Some economists and central bankers argue that these are the things which drove the crisis.

I take a slightly different position. I would start by saying that imbalances between countries are simply the result of decisions that ordinary people make to consume or to save, to take risk, to invest, and so on. You will get imbalances in payments and in saving and investment between different countries and in principle the capital and foreign exchange markets should sort these things out. Foreign exchange markets are crucial in sorting out balance of payments problems and capital markets by allowing interest rate to move will sort out imbalances in saving and investment.

The question then is: Why did these imbalances become so important? I think a number of factors are important.

Factors in the Economic Crisis

One was that a number of central banks, but particularly the U.S. Federal Reserve, pursued a policy in the earlier part of this decade of having very low interest rates. Interest-rate levels frankly which could never be justified. Alan Greenspan, of course, had enormous respect as chairman and governor of the Federal Reserve System, and he didn’t believe it was possible to identify and correct asset bubbles in advance, because, he argued, you can only tell whether it’s an asset bubble after it’s happened. Intellectually I believe he’s on strong ground, but even he should have realized by 2005–2006 asset prices had developed a life of their own. Professor John Taylor, from Stanford University who developed the Taylor rule to set interest rates, has consistently argued that interest rates should have been 2–3 percent points higher in the U.S. between 2002 and 2004. At the same time as this was happening, the Chinese government resolutely fixed their currency to the U.S. dollar despite their huge growing balance of payments surplus.

“The fiscal position of the federal government was getting worse and still they cut taxes. I believe in low taxes, I also think the timing of the policy was an error of judgment.”

So, you had the Chinese financial surplus flowing into America, a growing financial deficit in the U.S., but then you have U.S. monetary policy accommodating the global savings glut and making it even worse because of very low interest rates.

Second, within the U.S. both the Bush administration and the Clinton administration bent over backwards to encourage home ownership. Home ownership is a good thing because people are building up some capital, and typically a family which believes in saving tends to be stable, and so in turn it leads to stable communities. But if you look at what HUD did in the 1990s and if you look at what Fannie Mae and Freddie Mac did earlier this decade, I think they went absolutely over the top in encouraging institutions to increase subprime lending, which by definition encouraged financial institutions to lend to borrowers whose chances of repaying were that much less. Now, there is nothing wrong in lending to risky borrowers providing you charge an interest rate with the appropriate risk premium, but what the politicians and bureaucrats wanted was to have low interest rates charged on risky subprime loans.

The third thing is that the Bush administration cut taxes three times when the U.S. had a very low saving rate at a time when the balance of payments deficit was growing. The fiscal position of the federal government was getting worse and still they cut taxes. I believe in low taxes, I also think the timing of the policy was an error of judgment.

And then there was remarkable innovation by the banking industry in creating new products as a response to the savings glut and low interest rates. Investors wanted a higher yield on what they were getting from holding government paper. So the banks, through securitization, devised very complex structured products and particularly asset-backed securities. They were off balance sheet with the result that that you had a growth in the “shadow” banking system. Rating agencies, central banks, regulators and ministries of finance were slow to grasp what was happening.

If you read the statement of for example Secretary of the Treasury Timothy Geithner, then president of the New York Federal Reserve, it is clear that the regulators and central bankers were taken aback at the speed with which things happened over a period of two to three years. Then they suddenly woke up and said, “My goodness, the world has changed.” The whole thing happened very quickly.

So, to recap, if you ask what has been the cause of the problem, I would say that mistaken government policies were a very big factor. The Chinese, by pegging their currency to the U.S. dollar and the U.S. Federal Reserve by setting very low interest rates, transformed natural imbalances into toxic imbalances. The growth of the shadow banking system was a response to these developments. Regulators and central banks were really taken by surprise, and then of course the collapse came.

The Role of Banks

So you don’t point any of the fingers toward the banks themselves in getting into the subprime lending and in pushing subprime lending to the point of absurdity.

I certainly would point a finger at the banking industry but first I believe it’s essential to understand the context. The crisis is much greater than subprime lending. The banking industry is culpable for making bad loans, having insufficient capital, incentivizing short-termism and creating products of such complexity that only the most financially sophisticated could understand what they were buying. This is a criticism of the industry as a whole with some banks behaving recklessly and some reasonably prudently. Very few can look back and say, “Yes, we got it right.”

I have often thought that this was the perfect storm because the people on the left can point to greedy bankers and the people on the right can point to bleeding hearts wanting people in their homes and while they are both pointing at each other, this crisis carries out. Now what is the future of banking? It would seem that we are part way into the stabilization of this, but we are not out of the woods.

We certainly are not out of the woods yet. Even back in September and October 2008 at the height of the financial crisis, I spoke on this subject on numerous occasions. I never felt we would have another Great Depression, a rerun of the 1930s for a number of reasons. One is because we have learned from Keynes that you can use discretionary fiscal policy to help restore confidence in the economy at exceptional times.

Watch Lord Griffiths speaking about setting meaningful company values

Second, in the 1930s, the Federal Reserve transformed a fall in stock market prices on Wall Street in ’29 into a major depression by allowing the money supply to fall by one-third. It was due to catastrophic monetary mismanagement. That did not happen this time. Central banks reduced interest rates and in addition they have employed quantitative easing, which is today’s equivalent of printing money.

In addition, the 1930s was a time when countries imposed tariffs and non-tariff barriers against each other and devalued their currencies to gain a competitive advantage. You have not had that this time because of the success of the G-20, first in November last year in the U.S, then in April in London this year and then again recently in Pittsburgh. The G-20 has been important in keeping countries together. I think that is a huge improvement over what happened in the 1930s.

For these reasons, I never felt that the financial crisis would become another Great Depression. I think where we are at present is that the banking system led the crisis and the banking system is the first to emerge from the crisis. I am not saying all is over, but the equity markets have risen in the U.S. and Europe by 30 percent plus from their low in March of this year and developing countries by 60–70 percent. Some credit markets, which were closed in October and November last year, have begun to open again. I think all of this is good news.

In addition to that, I think there will be improved regulation of banking. I hope not more regulation, but better regulation, in particular with respect to the need to hold more to capital and liquidity, provide greater transparency in what they do and set out principles for compensation, such as how much should be paid in cash, how much should be paid in stock, and how much should be in deferred stock.

All of these are being debated at present, and I think there is an emerging global consensus. If there is a divide, I used to think it was between the U.S. and the U.K. on one side and the European Union on the other. Today Britain is becoming much more socialist and going back to the pre-Thatcher era. This could seriously damage the U.K. I only hope the U.K. does not move in this direction.

Al Erisman | Lord Brian Griffiths Categories: Issue 68