Presenting the annual Rostov Lecture on International Affairs at John Hopkins University’s School of Advanced International Studies, Turner examined the role of securitisation, shadow banking and the value of financial innovation.
Turner says securitisation – or the creation of pooled credit securities from multiple underlying loans – “might have had some potential to be a useful financial innovation” but added that its role in the shadow banking system was “inherently dangerous”.
’Shadow banking’, as defined by the Financial Stability Board, covers credit intermediation taking place outside or partially outside the traditional banking system, but involving the defining characteristics of banking such as maturity transformation and leverage.
This system expanded rapidly in the 30 or so years before the financial crisis, Turner pointed out, driven in part by the rise of securitised credit – which also started to take increasingly complex forms.
Turner says: “Any macro-level counter factual analysis of the impact of the whole package of innovations which contributed to shadow banking would, I think, clearly illustrate that if we had to choose between having the whole package and none of it, we would have been better off with none of it – no [structured investment vehicles], no [collateralised debt obligations], no credit derivatives.”
“Even if it could be proven, which is still unclear, that in some way this package did deliver the market completion and allocative efficiency benefits ascribed to it ahead of the crisis, there seems no possibility that the scale of that benefit – measured at the macro level as an increase in the obtainable level of income across the economy – could be more than a small fraction of the harm produced by the induced financial instability effect.”
Turner adds that the macro impact of the overall package of shadow banking innovation is “massively negative”, having led to an unsustainable credit boom followed by recession, negative equity and unemployment.
He adds: “It is difficult to think of any wave of innovations in any other sector of the economy about which we would be likely to reach such a negative judgement.”