— The virtues of quick and popular regulation —
In the aftermath of the 2007-2008 financial crisis there seemed to be no end to the search for a culprit, preferably a single easily-identifiable obvious one so that dealing with it would be swift and morally charging.
The culprit was soon found more by popular demand than by sound investigative processes, and was put on trial for just about anything that happened during and after that terrible economic earthquake. But it was not a swift deal: to date I cannot recall the name of one single banking executive brought to trial for his or her misdeeds. And while several tens of billions of dollars in fines were settled by various institutions, it was clear that justice was mostly imposed on the payers via “vote-counting” rather than a truly beneficial long-term examination of the issues.
Financial penalties were followed or preceded by regulatory moves that simply represented another round of a movie we have seen many times before. The plot is: good times for all followed by a crisis followed by political action followed by “and they all lived happily thereafter.” Political action usually translates in hitting at the very thing that went wrong this time.
Skip a few frames and we come to what we witness today. Clearly not everyone is living happily thereafter. The graph above depicts the last 5 years of yields for 30-year Treasuries (yellow line) and 30-year Bunds (white-blue line). As well publicized, the last two months have shown volatility in yields – especially European ones – of truly disturbing proportions. Some commentators have compared this move to the one observed two years ago (the “taper-tantrum” story) but as you can see this is not correct: the volatility in 2013 was significant but it occurred in a relatively more natural fashion.
Today’s bond yield volatility, which Draghi tells us is here to stay (see this article), is due to more than one factor or event: economic activity appears on the mend, inflation is no longer falling, commodities are stabilizing. Another contributor stands out for its unusual nature: the reported lack of liquidity in major government bond markets. While liquidity was probably exacerbated by extremely popular and concentrated positions (weak Euro, savings higher than bond supply, deflation, slowing economies, etc.) it is still hard to believe these markets could behave as if they were penny stocks under a squeeze.
The reason for higher volatility is in great part due to the regulatory reforms implemented in the wake of the financial crisis. These called for financial institutions to reduce balance sheets and increase capital. The reforms were perhaps needed in some form, but in the current status of things they appear to have pulled the rug from under the liquidity needs of world investors.
It is popularly believed that the previously mentioned lack of bodies to burn at the stake is the fault of a slow and inefficient (even corrupt?) judicial system. Let us hope we don’t try to correct it with the same shortsightedness used in the financial regulatory field.
Graph source: bloomberg.