Tag Archives: international

Decisive, United Action

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.

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G7 at Bat

All eyes turn to Washington this week for the annual meetings of the International Monetary Fund (and World Bank), which will include the finance ministers of the world (up to 185 of them, plus entourages).

Naturally, before these events there is another meeting that – arguably – is where the real decisions are taken. This is the meeting of the G7 finance ministers, which by tradition takes place in the US Treasury on Friday (with the broader meetings being Saturday through Monday).  To remind you, the G7 is the club of the largest industrialized countries: the US, Canada, Japan, France, Germany, Italy, and the UK.

Some people regard the G7 as the group that is really in charge of the world.  But as you probably noticed by now, no one is really in charge.  Still, the G7′s voice carries considerable weight on many issues.

This is a particularly important week for the G7 for three reasons.  First, the world economy is in worse shape and heading in a more dangerous direction than at any time in the recent past.  Old hands cast their minds back to 1982 for anything comparable in terms of global circumstances.  But 1982 was the beginning of an emerging market crisis, involving default and devaluation in Latin America, Eastern Europe and various other middle and low-income countries scattered around the world.  Now we have a crisis in the core of the system, clearly in the US and Europe and quite possibly more widely.

The second reason to look to the G7 is that, this time, they really can do something.  Their main policy tool is the communique, which is a joint statement that you should look for late on Friday.  This will tell you what they think is going on, and what should be done and by whom.  Of course, the language will be fairly indirect, but at least in this instance it should not be too hard to interpret.  The statement is not binding on anyone, but it will give us an indication of whether they are on the same page.

The third point is that prominent members of the G7 seem already to be on different pages.  The four European members had an unusual pre-meeting today in Paris, and their messages seem to be about the need for more regulation, looser accounting rules, and a change in the compensation system for executives so they take less risks. We’ll see what is the US position by the time we reach Friday; we guess there will be less than full convergence.

At least on one point, there is already a large gap in views opening up.  The Europeans still want to rescue banks on a case-by-case basis, whereas the US has definitively switched to a systemic approach of some kind. Given the gravity of the situation, we prefer the US position at this point, and none of the current European proposals seem to bolster confidence: the problem in Europe was not lack of regulation, but rather failure to enforce existing regulation (fact: European banks bought a lot more collateralized debt obligations than anyone realized); looser accounting rules would open up a massive can of nontransparent worms (a lack of transparency helped get us into this mess, and it’s not clear how less transparency will get us out), and executives in all kinds of incentive systems took on, in retrospect, way too much risk recently.

The G7 could, speaking together, help to decisively break the crisis of confidence that still – at the end of last week – gripped financial markets.  The indications at this moment, however, are that this unfortunately will not be the case.

Wake Up and Smell the European Coffee

At a Brookings panel today and even more so on a LA-based NPR radio show (“To the Point,” KCRW) just now, the impact on the “real economy,” i.e., people and businesses outside the financial sector, was the issue of the day. And people are beginning to understand the serious consequences of our financial system problems, with or without the Paulson Plan becoming law this week.

Here’s what I suggested at Brookings this morning, for the US, which is pretty close to what is in our Baseline Scenario, First Edition:

  1. Tell everyone that their deposits are safe. Explain that no one has ever lost a penny when the FDIC has been involved and, de facto, they always pay all depositors, even those with over $100,000. I recommend removing the deposit insurance cap. In other words, do what it takes to stop the run.
  2. Then work on bank recapitalization, right away (I think you can see the consensus moving in this direction already this week; I’ll try to post on the emergent schemes tomorrow)
  3. And deal directly with the underlying troubled mortgages (again, I hear ideas emerging fast; give that a couple more days before I do a survey)
  4. And get ready to provide a substantial fiscal stimulus. But don’t even think about this unless you have done 1, and much of 2 is in place, and the programs to deal with 3 are on their way.

Perhaps the overlooked issue of the week was the speed with which the crisis is clearly going global, with now a long list of European countries having banks in trouble. Europe also needs to stop the run on their banks before it gets out of hand.

One sensible way to do this would be with a large Europe-wide fund to inject capital and receive preferred equity in banks, on terms advantageous to taxpayers. Yes, this is point 2 above, on steroids. Of course, they have to deal with underlying domestic mortgages in Ireland, the UK and Spain (but not yet in other countries). The danger in Europe is that they don’t have as much fiscal space as the US (so point 4 is an issue) and their central bank is stuck with a mandate (i.e., just worry about inflation) that would have been nice to have in the 1970s, but may not be quite so appropriate today.

The severity of the global recession is going to depend, in large part, on the speed with which governments in Europe can organize swift, comprehensive and decisive support for their banking systems.  And, following that, it will depend on exactly how the process of deleveraging (this is jargon essentially, meaning reduced lending by the financial sector) is handled.

The latest news from Europe (timely, thanks to the Financial Times): there will not be an immediate systematic rescue.  It’s the French who seem to have understood what is really going on.  Unfortunately, as of now, their European partners have not yet woken up to the new realities.  In particular, Germany and perhaps the UK seem to stand in the way of a more systematic approach.  This has dangerous implications for the US.

Days to the election: 34

Henry’s Ark

In case you missed it, Simon (my co-author) was interviewed by Scott Simon this morning on Weekend Edition. One point he made, that I don’t believe has gotten a lot of attention in general, was about the global implications of the bailout plan. One way of putting this is that the plan creates a “Noah’s Ark” for financial institutions to escape the storm, but the next question is who will get a ticket onto the ark. The original legislative proposal would only have authorized Treasury to buy assets from “any financial institution having its headquarters in the United States.” While there was talk over last weekend about possibly including foreign banks, or their subsidiaries in the U.S., that was not mentioned in Thursday’s bullet-point agreement between the Executive Department and Congress (the one that was blocked by the House Republican caucus). Indeed, it seems hard to believe that Congress or the American public would be able to stomach a bailout of foreign banks. But if the reason to save financial institutions is the risk of cascading disruption to their counterparties – and that was the reason cited for both Bear Stearns and AIG – we have to be aware of the risk presented by global banks such as UBS that would have similar counterparty effects. While I’m not suggesting that the U.S. bail out every major non-U.S. bank, someone may have to, and right now there is a distinct lack of a coordinated global response.

Update: 9:20pm, Saturday, September 27th, the Financial Times on-line edition is reporting that Bradford and Bingley, a UK mortgage lender, will be nationalized tomorrow.  Sounds like Gordon’s Ark just got a bit bigger.