Interview with Martin Upton about financial crisis

Martin Upton

Martin Upton has a background in financial markets and risk management.

1) Where did you study and where are you teaching now?

I studied at the University of East Anglia and the University of Leeds. Now I am Head of the Centre for Accounting and Finance at the Open University Business School.

2) On summer 1992 Bank of England and Bank of Italy were "fighting" against traders not to devalue british Pounds and italia Lira; since summer 2011 ECB is "fighting" against traders in order to keep low interest rates for government bonds; do you find any similarities between the 2 situations?

The similarity is that in both cases traders and investors took the view (in 1992/3) that the GB Pound and the Italian Lira were over-valued (at the ranges set for these currencies against the DM in the ERM) and that in 2011/12 traders and investors took the view that the bonds issued by the governments of Spain, Italy and Greece were over-valued (i.e. their yields were too low - and, by inference, their bond prices too high - given the background economic fundamentals of those countries). In both circumstances the view was taken by traders/investors that it was financially rational to sell Pounds & Lira in 1992 and to sell Spanish, Italian and Greek government bonds in 2011/12 since the market view was that in each case these assets were over-valued.

3) At the end of summer, on 16 th september 1992, british government decided to withdraw the british Pound from ERM (followed by italian government doing the same with italia Lira); do you think that the lesson learned is that it's useless (and a waste of money) to "fight" against traders on specific circumstances?

(Note that membership in ERM was not withdrawn but only "suspended"). I think both episodes – particularly the ERM debacle - show that trying to maintain the price of a currency or of bonds (or indeed other assets) above the levels perceived by the market as being their ‘correct market price’ is ultimately doomed to failure. The history of the UK provides plenty of examples of how the government and the Bank of England tried to defend the value of the Pound against economic logic only, in the end, to have to give way to market forces. The ERM debacle was only one such episode – see also the periods up to the devaluation of the Pound in 1949 and 1967.

4) In Europe there's a lot of talking about a anti-high yield mechanism (the ECB will buy government bonds when they reach very high yield), do you think it could solve the problems? I personally think it will be even worse: the traders could bet even more easily if they are 100% sure that the ECB will buy government bonds when they lose value.

Well such a mechanism would put a ‘floor’ on the bond prices (or ‘cap’ on the bond yields) so it would to a degree discourage those trying to make money by short-selling. Investors will also draw some comfort if they know of the maximum downside to their investments in such bonds.

5) It's been more than 2 years of talking of "saving the Euro", do u think that one currency can work with one central bank, 17 different ministries of finance and 17 different public debts?

My view has always been that you can’t have a stable single currency zone if you don’t have a single fiscal zone. The problems faced by the Euro zone show that you can’t have a single interest rate environment in a zone where member counties go ‘solo’ on their fiscal policies. Hence the rescue of the Euro has seen a move towards a greater centralization of fiscal policy decision making. Additionally the different nature of the member counties’ economies (particularly the differential importance of the housing market to them) weigh against the workability of a single currency.

6) The ECB decided to help some governments (like italian and spanish one) buying government bonds in the secondary market. Understarding that help is help, why not buying straight in the primary market ? Buying in the primary is giving money straight to the state, while buying in the secondary is giving money to the traders! So, ECB wants to "fight" traders (who bet against Italy and Spain) ... buying their devalued bonds! Don't you think that the ECB could avoid the hypocrisy and buy bonds straight from the primary market?

I suspect that the ECB only wants to act as the ‘buyer of the last resort’. If it bought primary issues the expectation in the markets would be for the ECB to be the ‘buyer of the first resort’ – and the size of the investments made by the ECB would potentially balloon. Buying in the secondary market maintains a defence against falling bond prices and helps underpin confidence in the primary market.

7) If there is a break up of the monetary union, what do you think it will happen? In the transition time, do you think people will try to use foreign currency (if there is enough of it for an area of 330 million of people) ?

Hard to speculate on this one. I suspect that the support of Germany and pressure from the US will continue to ensure that the Euro remains patched up. The worry is though that the crippling economic consequences of the budgetary restraint being applied to Greece, Spain and Italy – and Portugal and Ireland too – will create growing political and social strains. If a country does leave the euro zone its new currency (or restored legacy currency) would trade at levels implying a massive devaluation against other currencies. Additionally further support would be needed for the banking system – and not just within the country leaving the zone.