A Nobel for avoiding financial crises: lessons for Argentina

There are things that should not need explaining, including the importance of avoiding a financial crisis. For this reason, this year the Royal Swedish Academy has awarded the Riksbank prize (which we call the Nobel Prize) to three professionals who studied the subject. ben bernanke, Douglas Diamond Y Philip Dybvig.

The truth is that the prize should be for citizens who live with and survive financial crises. Without financial markets, economies cannot develop, since there is no credit, and without credit it is very difficult to grow. Only those who generate enough funds to reinvest can do it, and not those who have a product or idea that will be successful and will be able to repay a loan.

There is a world of opportunity based on the difference between have the capital or be able to generate flow to be able to repay -in installments- that capital. In the first case, only those who already have capital can participate, but thanks to the financial system, in the second case all those with the capacity to work can do so.

The theoretical work of Bernanke it came in handy in the 2008 crisis, where despite a massive drop in property and stock values, economic activity was able to recover reasonably well. The measures taken had effects that remedied (but did not totally prevent) a major crisis. The problem we have now in 2022 is that the low rate remedy has been used for a long time and the economy has already created an addiction and it is creating problems now by raising rates. The economy suffers. As always, the problem that follows (Spoiler: the same thing happens in Argentina with the short-term measures that are taken and their bad effects in case what was short-term… is not).

Douglas Diamond Y Philip Dybvig In 1983 they developed the model that bears their name. It studies bank runs and analyzes the point of view of companies and people who need credit, who at the same time are the ones who save, and the expected behavior of the financial system. They suggest that deposit insurance is the best prevention to avoid a run on the banks, although this may generate a Moral Hazard (topic for another article, although it basically implies that the incentive to behave well is reduced).

It may interest you: The Nobel Prize in Economics was awarded to Ben S. Bernanke, Douglas W. Diamond and Philip H. Dybvig

Since the Central Banks of the world are facing problems right now, this Nobel Prize is a wake-up call. At this time the Federal Reserve You are faced with a strange scenario, where you risk losing money. Like any Central Bank, the Fed can try to determine the cost of its liabilities, but not that of its assets. Since the Fed buys government debt with the intention of holding it to maturity, its book value is unchanged. Rather, the value of its liabilities is affected by rapidly rising interest rates. In this way, an unprecedented imbalance is produced due to the speed at which it is happening.

Faced with this situation, nor when there was a crisis like the one in 2008 or other previous ones, it did not occur to any professional that putting traps and prohibitions and restrictions or corrals was better. I think it will not even occur to the Royal Academy to give an award to those who impose them.

The Nobel Prize winners recognize that a good remedy to avoid a financial crisis is a strong participation of the Central Bank providing liquidity, at the same time that deposit insurance provides solidity to the system and prevents bank runs. None of these teachings is being used in Argentina.

Our Central Bank not only does not provide liquidity but absorbs or withdraws it or, in technical terms, sterilizes the issue. That is to say, quite the opposite of what Bernanke studied, for which he was awarded the Nobel Prize.

The BCRA has two types of assets: Reserves and National Government securities, often “unavailable” and therefore cannot be sold. Even if the reserves were substantial, their price varies only in the event of devaluation.

It also has two types of liabilities: the Monetary Base, which are the pesos that are issued when reserves enter, and the Leliq, which are titles that are used to receive the pesos again. This has a high cost since to do so you must pay a high interest rate.

As the BCRA by definition does not generate its own funds, by paying high rates it incurs losses that can only be offset if the value of its assets rises. Even if it were devalued, the only way to pay for the Leliq is with an additional issue. This is a far cry from a deposit guarantee system, as Diamond and Dibvig tout.

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What is relevant is not only the conceptual difference between providing liquidity and good deposit insurance (by the way, in Argentina it should be provided by Sedesa (Seguro de Depósitos SA, is a public limited company created in 1995, which is an independent institution) The dimension of the problems is also relevant.Currently the daily accrued interest is $18,000 million.I repeat: daily.

The total amount of BCRA liabilities to avoid inflation by absorbing excess liquidity is for an amount that at this moment is already double the monetary base. In turn, the compound interest rate is approximately 100% per year. In other words, next year it would represent four times the monetary base. Being able to pay that debt would mean issuing the equivalent of four times our current monetary base. It is hard to imagine what the inflationary impact would be.

I have no doubt that the president of the Central Bank who manages to avoid a spike in prices with these data really deserves a Nobel Prize.

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