IamA Lecturer in Finance and Financial Regulation, AMA about The Big Short, global financial crisis, medieval and historical finance, and more!

Stupid question on the origins of banking in medieval times. What was the difference between usury and lending with interest? What made one acceptable to the church and the other not?

It is not at all a stupid question (my co-authors and I have written a couple of papers on this and there is a sizeable historical and theological literature).

According to a strict reading, any exaction of a sum above the principal was usury. Over time, this was relaxed to allow the charging of moderate interest (5-10% pa).

In any case, medieval merchants were skilled at hiding interest charges - which could be described as free gifts from the borrower, or the initial debt contract might specify a higher sum than was actually received. The most sophisticated method involved foreign exchange transactions.

That's a wrap everyone - thank you all for your great questions. I hope you've found this useful, if you're interested in exploring these topics further, the ICMA Centre is full of research staff like myself dedicated to these ideas (feel free to take a look at the website).

I know there are a couple of questions I haven't been able to answer - I will do my best to answer them when possible but I'm afraid I have to go.

Thanks everyone, let me know if you'd like anyone from the ICMA Centre to do another one!

Hi. I am wondering if there is any way average people can bet against these markets or if this practice is restricted to people with special licenses to trade? I.e. can a regular person short a stock? EDIT: words

You can short a stock using a brokerage account (but I would not advise it - there is no limit to the amount of money that you could lose on a trade).

It is more difficult to acquire Credit Default Swaps but I think there are some Exchange Traded Funds (ETFs) composed of CDS - again, I would not advise messing around with this sort of instrument.

None of this is investment advice!

I'm in no way considering this. I just was interested because in The Big Short the two young guys go to big banks to acquire some specific license to do what they want to do, they can't so they use Brad Pitt...

Good!

To trade these sorts of derivatives directly, you would need to be an accredited investor (or Brad Pitt). However, the financial system, in its ever-increasing ingenuity, is always developing methods for retail investors to speculate on more complicated products indirectly (e.g. via ETFs).

The thing that intrigues me most about the whole 2007 thing is who were the ones who got a 100% benefit. From what I've read, seen and heard, the big banks like lehmann went bankrupt, the people lost their houses, the middlemen lost their jobs, the US lost money from bailing out the banks, and perhaps the default credit bonds were the only thing to gain you some money. So in the end, if there was a fraud and a "plot" for this to happen, who were the ones who got the big money from all the shitstorm that ensued?

Well, the 'heroes' of the Big Short got some of it. Most of the big banks did not go bankrupt - Lehman was the only one that the government allowed to fail and the consequences were so severe that everyone else was bailed out. Even at Lehman, although the top executives lost their stock holdings when it failed, research by Lucien Bebchuk has found that they received about $1 billion in bonuses and equity sales during the bubble. In another sense, the money was never really there in the first place - something that J.K. Galbraith referred to as the 'bezzle'. It only existed on paper and the real beneficiaries were those who received bonuses, fees and commissions for facilitating the 'creation' of this paper wealth. So relatively few people profited from the crisis per se but lots of people made money during the bubble before it popped.

It was only in about the nineteenth century (that i am aware of) we started to realize that inflation was a thing. When you trawl history books and or primary sources you see empires and other kingdoms when in a tough spot just creating more money. As it obviously loses value, and then they freak out not knowing what the hell was happening. Why do you think this took so long to identify? Or if i am wrong when was inflation discovered and what did they do counteract it? Also are you a fan of the Venetian style during the forth crusade?

Actually, inflation was an issue during the Middle Ages (my period of study). Although in the long term, inflation was fairly flat between 1200 and 1500, at various points it could move dramatically, most often when the rulers changed the metallic content of the coinage (debasements). Writers like Nicolas Oresme identified inflation as a tax imposed by governments in the fourteenth century, long before Milton Friedman. Another period of relatively continuous inflation was during the sixteenth century as a result of the flow of silver from the Spanish colonies in the Americas (known as the price revolution) and it was a topic of debate amongst the later scholastics (the school of Salamanca). The fourth crusade was no-one's finest hour!

Are we hitting over regulation? The cost of regulation makes banking/finance much more difficult. We are now seeing a series of related businesses that skirt around regulation on the basis that they offer a partial service such as P2P lending, payment processing, etc without the same compliance burden.

One question that interests me about Fintech is whether it is a truly disruptive innovation or simply a regulatory arbitrage that avoids some of the restrictions placed (often for good reasons) on the formal banking system.

As with the question below, the question is not over the volume of regulation but its quality. In some areas, it seems that regulation may be increasing compliance costs on banks without necessarily addressing more systemic risks. There is also a danger that risks will move away from the formal regulated system and into the 'shadow' banking system.

One question that interests me about Fintech is whether it is a truly disruptive innovation or simply a regulatory arbitrage that avoids some of the restrictions placed (often for good reasons) on the formal banking system.

I was once told that every regulation is in reaction to historical events. Whether the same problems can happen in "Fintech" is anyone's guess, but many devote minimal resources for compliance.

As with the question below, the question is not over the volume of regulation but its quality.

I sat in a meeting with a national regulator when MiFID I was introduced. They were turning to us, a bank for ideas of what to look for in all the "Best Execution" data that they were collecting.

Now the volume and the detail has increased. For example, with the full B3 Liquidity reporting, it is possible for the Financial Stability Board to track major liabilities across a network of major institutions. The problem is that the regulators do not have the manpower.

Thanks for that interesting point. I think there is always a trade-off between the amount of regulation imposed and the ability to police those regulations - particularly since there doesn't seem to be the political will to fund the regulators adequately.

There is also a conflict between the need to get expert feedback and advice from the financial institutions on proposed regulations and avoiding the appearance of 'regulatory capture'.

Is the US headed for another crash like we experienved in 2007?

At some point in the future, there will be another financial crisis (a bold prediction) but it will probably not be a repeat of 2007. As they say in the movie "It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so." - instead we will probably find a brand new way to cause a crash.

is there substantiated evidence to suggest that Americas interest on borrowing will outgrow the GDP in years to come? (To my understanding that would suggest the fed would go into negative interest right?) Is it a very bad thing if this happens?

It is possible that the rate of interest that the US owes on its debts will drop below the growth rate of the economy. This need not be an issue, it simply means that the government would either have to run a primary surplus (increase taxes) or borrow more to meet those payments (which could lead to a debt spiral).

Obviously, that's not good for future taxpayers!

On the other hand, with the very low interest rates on government debt at the moment, it might be a good time to borrow to fund infrastructure investments/stimulate the economy. Economic growth will then help to reduce the debt:GDP ratio.

Question from /r/finance /u/m4hdi

"What is the risk of the US defaulting on its debt in percentage terms if you to guess? Inflating away debt? Is the US at risk of becoming a serial defaulter if another financial crisis happens? Do you think that reducing inequality is paramount to achieving 3%+ growth in the US?"

Technically, there is no economic reason for the US to default on its debt - as the Fed can always create sufficient $$$ to make any payments. Politically, the US government could decide to default on its debts - as during the brinkmanship of the debt ceiling crises very recent years. I would not want to put a percentage figure on the odds of a future debt ceiling crisis not being resolved in time.

Inflating away the debt is a possibility - but is very difficult with the low inflation rates today. There is more chance of deflation (which would increase the debt burden)

Personally, I think that the recent slow economic growth, growing complexity of the financial system and rise of inequality in the developed world are all linked - and solving the latter could help ameliorate the former.

Hello, Dr Moore. Thank you for lending us your time. You may be aware that many redditors are supporters of Bernie Sanders and his messages of economic justice. My questions are, exactly what does it mean to break up the big banks? And in your opinion, could taking power and influence from Wall Street lead to greater wealth equality?

In its simplest terms, breaking up the big banks means reducing the size of the largest financial institutions. This could be done 'forcibly' by establishing a cap on the size of any financial institutions (possibly assets as a proportion of GDP) or 'voluntarily' by forcing financial institutions deemed to be systemically important (SIFIs) to hold more capital - which might encourage them to become smaller to avoid such restrictions.

A bigger question is whether the size of the banks per se is the problem - perhaps more worrying are questions of leverage, inter-connectedness and opacity of the financial system as a whole. The failure of even a 'small' financial institution could cause major problems if it was a central node in interbank networks. Likewise, having a larger number of smaller banks might not avoid systemic crises if all those banks follow the same business strategies.

However, one thing that reducing the size of the banks might do is reduce their political power and influence - and thus their ability to sway governments and regulators in their favour. This might help with inequality in the longer term.

Do you think that the trend of increased regulation following the '08 crisis could be part of a long term shift in financial regulation?

Hopefully!

However, we are already beginning to see some pushback from the banks against 'over-regulation'.

We must also be careful not to confuse the quantity of regulation with its quality - there is a danger of imposing more 'tick-box' requirements that increase compliance costs but do not make the banks safer. One ongoing debate is whether we need detailed prescriptive rules (which might be gamed) or more general principles.

Isn't the real cause of the 2008 crash that the fractional reserve banking system had got out of control? And if this is true, what have financial institutions, central banks and governments done to correct this?

The problem was not so much fractional reserve banking as excess creation of credit by financial intermediaries - banks do not relend deposits but create deposits when they make loans (!). This is a very counter-intuitive position formerly associated with heterodox theorists (Modern Monetary Theory) but is now accepted by senior establishment figures like Adair Turner and Martin Wolf. It is difficult to get your head around but essential to understand the modern banking system. It does not appear in any of the main textbooks but the Bank of England produced a useful guide which you can view here

As to solutions, people have proposed narrow banking in which banks cannot create credit. Alternatively, the governments could impose a higher reserve requirement or capital ratio which would restrict the amount of credit that banks could create.

Is breaking up the big banks the best way to avoid another financial collapse? If not, what are some regulations you would propose?

Breaking up the big banks will probably not prevent another crisis by itself - although it might not hurt...

The real problem is the level of opacity, leverage and complexity in the financial system. Even a small bank could cause systemic issues because of its links to the wider network.

Requiring financial institutions to hold more equity/less leverage would help, as would moving 'over the counter' transactions to centrally-cleared exchanges.

One danger is that regulating/breaking up the formal banking sector will simply lead more risks to migrate to the unregulated 'shadow' banking sector.

The following sentence is written on my 20 pounds banknote issued by the Bank of England: "I promise to pay the bearer on demand the sum of 20 pounds" Let's say I'm going to the Bank of England and ask them to give me 20 pounds in exchange from that note, what exactly would I get?

On a Euro denominated note however, there is no such thing. Why is that?

The promise to pay the bearer on demand is a relic from the days of gold and silver currencies. Originally, if you brought your banknote to the bank of England (and before then, private banks that issued their own notes), they would provide you with the value of £20 in gold (or silver) coins. Until 1971 in the US, dollars were formally convertible into gold at a fixed rate.

Now, of course, we have fiat or paper currencies that have no link to precious metals and so the promise to pay the bearer on demand is of purely historical significance. You would only get a raised eyebrow if you went to the Bank of England with your note today!

Some religions and left wing advocates think usury should be made immoral just like medieval times. what is you opinion on this?

First, usury has a variety of meanings. Strictly, it can refer to any return above the principal sum lent. In practice, it can also refer to excessive or immoderate interest above a certain level.

Second, I would distinguish between morality and legality - many people today think that usury is immoral. The question is whether the government should impose legal limits on usury.

A third question is, even if you did prohibit the charging of interest - how would you enforce this? Throughout history, merchants have been very adept at circumventing such rules. In fact, many US states still have usury laws - although the banks have found creative ways round them (by incorporating in another state with less strict rules).

The final question is, if you could not receive any return, why would you lend to a borrower? Removing credit from today's economy would have massive effects.

So, personally, I am not in favour of placing legal limits on usury on the grounds that people will always find ways round the system and, by hiding interest charges and increasing the risk that lenders run, you will end up increasing the opacity and thus costs for the borrowers. I would prefer to concentrate on reforming the mainstream financial system to ensure that people have access to credit at reasonable rates and do not need to enter into usurious transactions.

Why is the Canadian dollar so low? It's made progress towards being par on the USD lately but it's still only worth $0.74.

Probably connected to the downturn in commodities - although this is not my main area so don't trade on that information!

If you buy stocks and you want to sell them, in stock market games this is just a click on a button and you instantly get your money "back". How is this working in reality? Do you get the money instantly, too, or do you need to find someone to buy the stocks?

Market microstructure is a complicated question. For a retail investor using a broker, you can usually trade at the quoted prices. The broker will route your order to one of the many different exchanges for execution (this can get complicated...)

Generally, your ability to trade depends on the liquidity of the market - if there is a liquid market with lots of buyers and sellers, you can probably sell (or buy) without too much difficulty. If the market is less liquid or you want to sell (buy) a larger quantity of shares, you may not be able to find sufficient buyers (sellers) at the quoted price, and have to reduce (raise) the price to attract more interest.

Other markets will have market makers who stand ready to provide liquidity by buying from your at the ask and holding that inventory until they can find someone to sell to at the bid rate (and profiting from the spread between the two).

I won't even get into more complicated back-office questions such as the settlement of transactions or use of margin.

How come history of finance is not taught in college?

I don't know! My guess would be that finance professors are more quantitative and not interesting in 'soft' subjects like history while history professors (with some exceptions) generally have an aversion to maths and prefer more qualititative subjects such as cultural or social history.

That said, since the crisis, there has been increased interest in financial history - both from financial academics and practitioners and from historians/social scientists. So, hopefully, it will be taught more in the future.

I know that banks were controversial in the US in the early years of the country. For example when Alexander Hamilton established a national bank it was very controversial, despite quickly helping the economy and lowering the national interest rate. What were the arguments against banks?

This is not my main area of expertise, but I believe the debates over the role of banks partly reflected a broader political divide between the landed farmers (later industrial interests) and the East coast city merchants - the former believed that the development of banking (and especially a central bank) would benefit the latter at their expense. Perhaps this is a theme that we can still see in some of the debates today.

What do you think about bitcoin ? Do you see a future for it ?

Personally, I am a sceptic about Bitcoin. Its value (in terms of existing currencies) is too volatile for it to work as a good medium of exchange, unit of account or store of value (the three essential characteristics of a currency).

Moreover, the computing requirements (and thus energy consumption) of continually verifying every block are huge. There are also question marks over the capacity of the system to deal with the volume of transactions necessary for it to take over from established payment systems - and how bitcoin miners will continue to be paid (at the moment it is a seigniorage system but there is a set limit to the creation of new blocks).

Izzy Kaminska at the Financial Times provides the clearest 'skeptical' take on Bitcoin and Fintech in general.

All that said, there may be some uses for the underlying Blockchain technology in settlement systems.

Just caught your notice in r/finance.

What were some of the key innovations in finance pre-20th century?

In rough chronological order: The development of tally sticks as records of credits and debts (c.40,000 BCE)

The invention of accounting in Sumeria using clay tokens (4,000-3,000 BCE) - interestingly, accounting probably preceded the written language

Introduction of coinage in Greek city-states (700-400 BCE). Again, ideas of credit and debt precede the creation of a standardised coinage

The development in medieval Italy (1000-1400 AD) of (deep breath) long-term funded public debts, the bill of exchange, deposit banking, commercial insurance, double-entry book-keeping (although its practical advantages over single entry systems have been over-stated)

The appearance of corporations with the Dutch East India company in the seventeenth century (although even this built on medieval foundations) and the development of stock markets

Banknotes and paper money from the later seventeenth century (although the Chinese had used paper money from the seventh century)

Joint-stock banking in the nineteenth century

I have concentrated on the earlier period but there are more that could be added...

Hi Tony! Hope all is well at the ICMA, am missing the place a lot. Just a question about hyperinflationary episodes throughout history. What was the worst episode of currency depreciation you came across during your research? Anything comparable to Hungary/Zimbabwe?

All the best,

George

Hey George, hope all is well with you.

Actually, there are relatively few hyperinflationary episodes in pre-modern history. In my period, probably the closest is the Tudor 'great debasement' (1541-52) when the metallic content of the silver penny was reduced from 75% to 25%. Once paper money was introduced, there were more episodes (under John Law or the later assignats in France) - but nothing that compares to the great twentieth century hyper-inflations.

Keep in touch,

Tony

Is there a history between publicly owned currency and privately owned currency that you are aware of and willing to discuss the pros and cons of?

There is a long history of discussions over the relative merits of public vs private currencies (such as the free banking era in the nineteenth century US).

My own personal view is that only a government has the legitimacy and resources to stand behind and support the value of a currency - as well as the legal authority to compel its acceptance. This is particularly important today given the scope of the financial sector and the centrality of credit/payment systems to the modern economy.

However, to a certain extent we have the worst of both worlds today, in that while currencies are supposedly issued by governments, in fact the majority of the money supply in developed countries consists of bank deposits - which are actually private debts of the banks. These sorts of fundamental questions have been neglected by academics but are now beginning to be discussed in a serious way (see Laurence Kotlikoff, Adam Levitin, Adair Turner or Martin Wolf on narrow banking or restricting the ability of private banks to create credit).

Is there any danger of sometime similar to the 2008 crisis happening in the near future?

Also, can you please explain the LIBOR scandal and what that means to me? Just please explain it to me Sesame Street style if you could please. Thank you.

I don't think there is much danger of something similar to the 2008 crisis repeating - that said, I think there is a risk of a different financial crisis occurring in the near future. Since the 1980s there has been an increasing number of financial crises - which seem to happen both more frequently and with more severity. Unfortunately, I suspect there remain structural issues within the financial system/world economy that have not yet been addressed and that will probably led to another crisis of some sort (even if it is unlikely to be a simple repeat of 2007-8).

Simply, LIBOR is the London Interbank Offered Rate - it is supposed to reflect the interest rate at which banks will lend to each other and was used as a benchmark when setting other interest rates. For example, a company might borrow at LIBOR + 100 basis points. So, if LIBOR was 2%, their rate would be 3%. LIBOR is a big deal because trillions of dollars worth of loans, bonds, mortgages etc are priced based on it.

However, LIBOR was based not on observed market rates but on the estimates submitted by a panel of banks - which left the possibility for them to try and manipulate LIBOR by submitting artificially high or low estimates. It seems that the rate was manipulated in two ways:

First, during the financial crisis, it seems that the submitting banks (possibly with a nod and a wink from the government) were understating the LIBOR rate - if it appeared as though the banks could borrow cheaply (at 1% rather than at 5%), then that might make them look more creditworthy and reduce the panic. Of course, in reality the banks were not lending to each other at all (Mervyn King, then head of the Bank of England, quipped that 'LIBOR was the rate at which banks don't lend to each other').

Second, the profits and losses booked by traders on their derivatives positions (mostly interest rate swaps) were determined by the LIBOR rate - i.e. if they were long a swap (betting that rates would rise) and they could persuade the LIBOR submitter at their bank to increase his estimate, then their trades would look more profitable and they would get bigger bonuses. Of course, their counterparties might be trying to persuade the LIBOR submitter at their bank to do the opposite - so it is not clear what actual impact this may have had. Several traders have been prosecuted for this manipulation (most notably Tom Hayes, who was sentenced initially to 14 years in prison).