Events of the past several days have convinced us that the state of the global economy is getting worse and we have revised our analysis and proposals accordingly. In short, coordinated, large-scale actions by the U.S. and Europe, including bank recapitalization plans and guarantees of banks’ obligations, are necessary to limit the spread of a crisis that threatens to trigger national defaults in vulnerable countries around the globe.
Editor’s Note: The content below was originally a separate page, linked to from the short blog post above. I have consolidated it into this single post, after the jump.
Time for Action
During the last several days the world economy has taken a turn for the worse, with commercial bank bailouts all over the world, a near-default by Iceland, and the US and UK governments dedicating hundreds of billions of dollars in funding for the financial system. We want to highlight three specific developments.
First, the credibility of the US authorities seems to be running out. Despite the passage of the $700bn TARP program last Friday and additional actions taken this week, credit and equity markets continue to decline.
Second, the implications of Iceland’s problems are more serious than many people realize. The country cannot afford to bail out its banking sector, which will lead to a large default. More worryingly, when the Icelandic Prime Minister returned empty-handed from Europe on Monday, he commented that it was “now every nation for itself.” This smacks of the financial autarchy that characterized the 1997-98 crisis.
Third, this sets the stage for more defaults and credit panics in smaller countries and emerging markets. After Iceland’s fall, creditors to other nations with substantial current account deficits and external debt must be trying to reduce their exposures. Much of Eastern Europe, Turkey, and parts of Latin America are obvious risks.
If policy responses are not decisive and coordinated, there is risk of financial war, of “each nation to itself.” Joint action by the world’s leading financial powers has the potential to reduce the depth and severity of the crisis. In particular, we propose:
- National plans to require recapitalization of key banks
- Temporary guarantees of all bank obligations
- Continued interest rate cuts
- Commitments to providing additional liquidity
- Commitments to major fiscal stimulus programs
- Relief programs for struggling homeowners
However, partial and piecemeal actions will no longer work. The next opportunity for such action is the meeting of the G7 finance ministers on Friday at the US Treasury. The world will be watching to see if they respond to the challenge.
Our full analysis and proposals are in the Washington Post Outlook section, online version; print edition will appear Sunday, October 12.
Comments from the original version of this post are copied below.
It seems as though the world financial markets long ago traded in Adam Smith’s “invisible hand” of free markets for a Frankenstein/”Wizard of Oz” fabricated beast, created by the financial services lobbying out of pieces that they wanted without care for the health of the whole.
I wonder if this crisis would have been had lobbyists not had such strong influence over Congress? So now, we’re left with Reagan, Friedman & Hayek proponents advocating a socialization of the banking system. My goodness.
As the Chinese proverb goes, “May you live in interesting times.”
Y’know, too many folks are looking for the conspiracy. I grant you that there are quite a few egregious conflicts of interest out there, but the idea that most of these guys are actually out to cheat and rig the market is… I don’t know, naive? I mean, of course they used whatever influence they had to achieve for themselves the best possible place in society. Is that even a surprise? We all do that. But at the same time, conflicts of interest not withstanding, the fact is that most people believe that their own self-interest is synonymous with the public good. Hence, most folks see themselves as good folks trying to do the right thing.
My point is twofold. First, blame is not only a waste of time, it’s self-incriminatory. You show me a man who’s not out for his own family’s well-being, and I’ll show you a man with a family in crisis. Second, all of that misses the point. The point is that we’ve had the pedal-to-the-metal on the supply-side for so long that we’ve had to over-invest in crap. But just ’cause we bought it don’t make it worth anything. It’s still crap.
Fortunately, we’re all complicit. It’s a public problem. It can reasonably be attacked with public solutions. Unfortunately, we’re already in debt. Hence, we’re all going to be working for the Chinese soon as we try to pay off the note.
I am etremely pleased with the current crisis as I was very sad for a long time, when the word “liberal” became equated with irresponsibility in the US. I really hope the MIT School of Economics realizes that this is a great oportunity to re engineer the world’s economic aparatus. The knowledge to do so exists right on 30 Memorial Drive where I was once tought that market forces are to economic developement what gravity is to Civil Engineering. You can not disregard it, but you cannot let ruin your dreams.
Civil Engineering and Economics, MIT, 1972