Listener mailbag with Martin Wolf and more

This is an audio transcript of the Behind the Money podcast episode: ‘Listener mailbag with Martin Wolf and more’

Michela Tindera
Hey there, BTM listeners. Happy New Year! To kick off 2024, we’re doing something a little bit different. You might remember that over the summer I asked you to send me your top finance business and economics questions. Well, we heard from a lot of you and we got some really great submissions. So for today’s show, we’re going to go through four of those questions covering some pretty interesting topics, ranging from financial crisis fallout to quantitative easing’s impact on the stock market. To get these answers, I tracked down FT editors, columnists and reporters quite literally around the world. So thanks to everyone who sent in a question, and enjoy.

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First up, we have a question submitted by a listener named Adham Aloka about interest rates.

Adham Aloka
Who benefits from the interest rate hikes that we see now in the market? For example, my mortgage payment will increase by £1,000 per month next year. Who benefits from this? Who pockets the 1,000 extra pounds that I’m going to pay next year towards my mortgage?

Michela Tindera
Yikes. I’m sorry to hear that your mortgage is going up so much. But to help me answer your question, I got in touch with Rob Armstrong. He’s the FT’s US financial commentator and a frequent guest on the FT’s markets podcast Unhedged, Rob, what do you think? Who is benefiting from the increase in our listener’s mortgage payment?

Robert Armstrong
Well, it’s a bit of a complicated answer, but let’s just walk through the basics here. So on the first level, your bank gets another £12,000 a year and that is good for the bank. But you must remember: banks sell money to people too. So the money that banks lend to people like our listener has to come from somewhere and it comes from places like deposits, shareholders or bondholders and all those people who we might think of as banks’ funders or investors, broadly speaking, all of those people get paid more when interest rates rise too.

Michela Tindera
Tell me more.

Robert Armstrong
So one good thing for our listener is maybe they have a deposit at a bank too, as well as a loan. In America, you might have what you call a certificate of deposit. You might have a money market fund. You might have a plain old savings or checking account. But in any case, those things are paying a lot more now than they did a year ago. And that makes a big difference. So at the same time, as you’re paying more on your mortgage, if you have any savings, the yield on that savings is going to go up. So who benefits? Well, it’s a question of the balance of everyone’s net worth. Are you more a borrower or a lender? And the answer to that question is going to be different for every bank, every company and every household. But there is another risk for your bank, too, which is that maybe you or people like you can’t pay the additional interest burden that comes with higher interest rates. In that case, banks will start to see defaults. People go bankrupt, they don’t make their payments. And that is actually a more acute worry for banks and costs of funds. So a general answer to the question is interest income circulates all around the economy because everybody is a borrower and a lender almost at the same time. If you have a bank deposit, you are lending to a bank. If you have a mortgage, you are borrowing from a bank. And around and around we go.

Michela Tindera
There you go. Thanks, Rob.

Robert Armstrong
Thank you. It great to be here.

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Michela Tindera
Up next: it’s been more than 15 years since the global financial crisis first began. But this listener is still thinking about its ripple effects. And you know what? So are we.

Marie
This is Marie, calling from London. And I’m curious what your columnists think is the most impactful regulatory change that has happened since the financial crisis. And what was the worst regulatory change? And is there anything that regulators should be rethinking?

Michela Tindera
Thanks for your question, Marie. To answer this, the FT’s chief economics commentator, Martin Wolf, joined me from our London studio. So, Martin, Marie really has three questions here. So let’s begin with the first one. What do you think is the most impactful regulatory change that’s happened since the financial crisis?

Martin Wolf
So I think that’s a wonderful question. And my ... I think the most important answer is pretty straightforward. It was the decision to raise the capital of the banks. That is to say, increase the role of equity in their liability structure, which is lost bearing in any crisis. Before the crisis, many banks were operating with 2 per cent equity against their assets. It’s gone up to five, sometimes higher. That’s a big change. It’s not enough in my view, but that’s the single most important thing. Banks are just more robust than they used to be.

Michela Tindera
Why do you think that that was the most impactful change?

Martin Wolf
The most important thing that determines whether a bank can survive a crisis is whether people believe that it can survive a lot of losses. That essentially, it’s a robust institution. And if it’s a robust institution, the central bank can lend to it safely, knowing that its money isn’t at risk. What determines the robustness of a bank is how big the losses are that it can take while still being solvent. In other words, capital ultimately determines solvency, and solvency is a necessary condition for a bank to continue to function.

Michela Tindera
Mmm. So on to the next question that Marie had: what was the worst regulatory change that’s happened in the wake of the financial crisis?

Martin Wolf
Well, here I have two answers, and I’m not quite so sure which it is. I should say, by the way, in answering this question, I actually talked to some friends of mine who are pretty actively involved in central banking around that time. And one of the answers, which I think is right, is that was an extraordinarily large amount of detailed regulation, unbelievably complex, most bankers can’t understand it. It’s put enormous power in the hands of compliance officers and you get box ticking. And that’s a natural tendency for regulators to do that, to cover their backs, as it were. But it doesn’t improve things. So that’s a big issue. I always believe make the regulation robust and simple. The second big thing that worries me is they made the banks safer. But that doesn’t necessarily make the financial system safe because risk then starts moving out of the banking system into what’s sometimes called shadow banking. It might move into private equities, it might move into other sorts of financial institutions. And these are less well regulated, they’re less transparent. And there is a tendency and that really happened in 2007, that you suddenly find this enormous amount of risk you’re not regulating at all. And that’s what worries me about the financial system. Now, we’ll find in the next crisis that the risks are actually concentrated in places we haven’t been monitoring properly.

Michela Tindera
Mmm. Mm-hmm. And I think that actually leads us into our final question from Marie, which is: is there anything else that regulators should be rethinking today?

Martin Wolf
The first, most obvious, is they haven’t fixed fully the flawed incentives in the system, which was shown so clearly in the case of Silicon Valley Bank last March, where there was a run by the large depositors. The bank basically folded as an institution, and the person who was in charge of the bank walked away with pretty handsome rewards despite the disaster. There were many elements of that. One, that the people in charge could take huge risks with the bank, make it look profitable, attract lots of business, make lots of money personally. And when the bank failed, they walked away with the money they made. That’s a pretty perverse set of incentives and clawback, so-called, has improved, but it hasn’t improved enough, it seems to me. There are still huge rewards for taking risks in the hope that you’ll get away with it.

Michela Tindera
Next up, we have a question from a listener who wants to know more about quantitative easing.

Michael
Hi, this is Michael from Ireland. It seems like quantitative easing helped push up stock prices in the US. Did it just seemed like that, or is that what actually happened?

Michela Tindera
Thanks for sending this one in, Michael. First, before we dive in, I want to remind everyone what we’re actually talking about here when we say quantitative easing or QE for short. It’s basically when central banks buy up mostly government bonds as a way to fight financial crises and to stimulate economic growth. So to answer this question, I got in touch with a dynamic duo here: Robin Wigglesworth, the editor of the FT’s financial blog Alphaville, who joined me from London, and Colby Smith, the FT’s US economics editor who joined us from Washington, DC. So, Robin Colby, take it away.

Robin Wigglesworth
Oh, Colby, I mean, this is one of my favourite questions, actually. Mostly because it doesn’t have a straightforward answer. You want to get us going?

Colby Smith
Sure. I think what’s important to start with before we dive into the specific market reaction, is the fact that QE really did not happen in a vacuum. It was part of a really aggressive and broad effort by the Federal Reserve and other central banks at the onset of the Covid economic shock to stimulate growth and protect against a more pronounced downturn. So it’s really hard to disassociate, I think, between what QE specifically did in terms of the market reaction, at least in the post-Covid era versus the host of other easing tools that central banks put into place.

Robin Wigglesworth
But of course, like everything in economics and this is why I love this question, it’s always a bit more complicated the closer you get to the actual detail. And like you say, you have to see it in context, right? Colby, what about the signal effect? How much does the fact that the central bank is buying bonds, hundreds of billions of dollars worth of bonds, is this a signal effect to the market? Like, what does it mean? What does it say about what central bank policy is going to be for the next years?

Colby Smith
When we talk about things like a signal effect, we’re really saying, OK, what can investors, economists, what can they glean from policymakers about their overall stance in terms of their willingness to support growth, demand, et cetera? So it’s really kind of helping to shape expectations about where central bank policy is headed. And I think that’s kind of the main mechanism in which something like this does work because, you know, as I mentioned, QE is usually one tool in a broader set of tools that central banks use. You know, at the time that you get this program being rolled out, you’re also hearing a commitment really from central bankers that interest rates are going to stay at rock bottom levels. And it really shows market participants that the central banks are kind of there and standing ready to jump in as needed. And what better confidence boost can you get than that? 

Robin Wigglesworth
Yeah. I mean, on the market side as well, the orthodox explanation of why it pushes up stock prices is something called rather geeky, the portfolio rebalancing effect. I’ve also seen people call it the hot potato effect, which sounds a bit cooler and more interesting. But basically the idea that if a central bank buys a boatload of government bonds, that will push interest rates on those bonds down. And that means if you’re an investor that has money, you don’t want to buy government bonds because the yields are so low, the returns are so low. So you have to buy something a little bit riskier. So maybe you buy corporate bonds that pushes corporate bond yields down. And then anybody who’s sitting on corporate bonds think, well, actually, if I need to get the returns I need, I have to buy stocks. And that’s how you kind of ripples through the entire financial ecosystem. But I would say, you know, again, it’s so complicated because in practice, outside of the big crises like March 2020 and 2008, and 2009 when the Federal Reserve, for example, increased quantitative easing, bond yields quite often rose in the midterm after that because it meant that people became more optimistic about economic growth in the longer term and that lifted bond yields. So that’s why these relationships are just really, you know, way more complicated. And why still to this day, 15 years after the US start to experiment, we’re still really discussing how and why and if quantitative easing works.

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Michela Tindera
And for our last question of the show, we have a listener named Mark Baumann who has a question about Germany’s economy. We got this one over email. So our show’s producer, Saffeya Ahmed, is going to read it for us.

Mark Baumann (through email read by Saffeya Ahmed)
Germany has sort of become the sick man of Europe again. The economy is slightly shrinking and companies are having a difficult time. What are the reasons for this and how could it be reversed?

Michela Tindera
To answer this one, I spoke with the FT’s chief Germany correspondent Guy Chazan, who joined me from Berlin. So, Guy, maybe let’s tackle the first part of that question to start off, why is this happening? What’s going on with Germany?

Guy Chazan
Well, it’s certainly the case that the economy is flatlining and it’s been really buffeted by lots of different problems. It’s had very high inflation, it’s had high interest rates. But one problem in particular is really quite unique to Germany, and that is the extremely high energy prices that we’ve seen since Russia’s invasion of Ukraine. They’re not as high as they were, but they’re still double those we see in the US and China. And that is really pummelling a lot of German industry, especially as energy-intensive industries, things like chemicals and glassmaking and paper making, that kind of thing. They’re really been suffering. But there are other looming dangers as well. Germany has a dire shortage of skilled workers. It has a problem with bureaucracy where bureaucratic processes tend to take way too long. And generally it also lags its industrialised peers in terms of digitalisation. A lot of the administrative processes and corporate processes as well, are much too analogue, and Germany has long been criticised for that.

Michela Tindera
Now Germany’s had a pretty whirlwind past few months. You’ve been reporting on how in November the country was faced with this massive budget crisis which created a whole new set of problems, and then in December the government did eventually reach a deal to avoid a financial shutdown. But could you back up a bit and tell me more about why that all happened and what it means for Germany’s economy going into the new year?

Guy Chazan
Well, it was all triggered by a verdict of Germany’s Supreme Court on November the 15th. It’s a very complicated story, but essentially they decided that the government had acted unlawfully when it had repurposed credit lines that it had raised during the corona pandemic for the purpose of fighting climate change and modernising German industry. And that created a massive problem for the government. They had to essentially scrap the budget for 2024 and go back to the drawing board. They essentially had this challenge of trying to plug a €17bn gap in the 2024 budget, which had been opened up by this court verdict. In the end, they managed to come up with a solution, although it was very, very difficult and very painful compromise on all sides.

Michela Tindera
Right. So the country’s leaders were ultimately able to plug that gap in this year’s budget. But my understanding is that getting that deal done meant that they also had to make some big cuts to areas that could impact the country’s economy in the future, like green energy. Is that right?

Guy Chazan
Yeah. The problem is that solution has proven very, very unpopular with certain constituencies because it’s cut subsidies for certain things, and that has caused a lot of resentment. For example, one element of the solution that they came up with is to axe a subsidy for buying electric cars that expired now at the end of 2023, much earlier than it was supposed to. And that upsets the car industry and also many people who had actually ordered an electric car. There’s a lot of grumbling about that. There were various other things they did, such as cutting subsidies for diesel use by agricultural vehicles. So that’s annoyed the farmers as well. So there’s various constituencies who are really dissatisfied with this compromise. It hits their pockets and it’s made them a little bit less well-off.

Michela Tindera
Obviously, there are a lot of different issues going on with Germany, but what have your sources told you about how potentially this could be reversed?

Guy Chazan
Well, I think you have to break it down a bit. I mean, one of the things that is really a big challenge facing Germany is the skills shortage. And the way they’re dealing with that is essentially by relaxing their laws on immigration to make it just easier for foreigners to come to Germany to work. They’re also sort of very ambitious kind of digitalisation programs and programs to reduce bureaucracy and red tape and actually make Germany an easier place to do business. There’s enormous investment in renewable energy, onshore wind farms and so on and offshore as well, and big solar installations in order to bring down energy costs. So they’re working on all fronts to kind of improve business conditions. But it’s really the jury’s out on whether any of that will work, because if some of the challenges Germany faces, I think these are very acute problems. And it’s still unclear how they’re going to be able to deal with those challenges in the future.

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Michela Tindera
Thanks for listening to this week’s show and thanks again to everyone who submitted a question. Is there something else that you’d like to see us cover on the show, feel free to reach out. You can find me on X, formerly known as Twitter, or on LinkedIn, or you can drop me an email. I’ll leave that in the show notes. Behind the Money is hosted by me, Michela Tindera. Saffeya Ahmed is our producer. Topher Forhecz is our executive producer. Sound design and mixing by Sam Giovinco. Cheryl Brumley is the global head of audio. See you next week.

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