Forecasters at international organizations often find themselves in a delicate position. On the one hand, they have unparalleled access to hard data and intelligence about what is happening in every corner of the world economy. On the other hand, their main shareholders – the US and larger European countries – do not want to hear predictions that are inconsistent with their own preferred baseline.
And, in the case of the US today, nothing could be more sensitive: it’s a relatively optimistic baseline, with a quick bounceback next year, that underpins the mild “stress scenario” being used for banks. So if the World Bank or the IMF said that the world economy is going down and not coming back any time soon, that would raise major issues.
The World Bank clearly wants to speak truth to authority on this occasion, but can’t quite get the job done.
In a document prepared for the G20 meeting, the World Bank hints at more dire outcomes: global GDP will decline this year for the first time since WWII, with growth “at least 5 percentage points below potential” (translation: roughly minus 1 percent). But they don’t give any supporting country-level detail and they are completely silent on the key question for the US banking stress test – what will happen in 2010. They must have worked through this level of detail, otherwise they wouldn’t feel comfortable saying that the world economy will contract, and their body language (including the scale of funding requests for developing countries) says that this is going to stay bad for a while. But they can’t quite bring themselves to be explicit.
The document is a series of dire warnings, couched in rather indirect language – although, to an official ear, the general downbeat tone is quite clear. Then you reach section VII, “Urgent Priorities” and the recommendation for the financial system is: “restoring confidence”. This is completely vague and unhelpful – which, of course, is the point.
The President of the World Bank is, by tradition, appointed by the US government – specifically, in practice, by the Treasury. And there have long been voices – including from some now at the Treasury – suggesting that this should change, perhaps in return for more resources for the Bank/IMF from those emerging markets that still have deep pockets, e.g., China.
Still, what the odds that a more independent World Bank and IMF (the governance of which could be reformed in parallel) would ever play a decisive or even controversial oversight role vis-a-vis the US economy?
The US is just too powerful to be contained or constrained by international institutions. The idea of an global “early warning system” is therefore illusory.
We need to take this into account when redesigning our financial system. No one will warn us and we will not warn ourselves.
The Baseline Scenario 
I think Warren Buffet more or less revealed Geithner’s secret banking plan during his appearance on CNBC yesterday. Buffet thinks the earning opportunities for banks are manifold, what with interest rates at historic lows and spread so wide, and that many banks will earn their way out of their problems. Clearly, there’s an element of talking up his book here. But this seems to be the Geithner plan: give banks enough capital to keep them alive and hope that they’ll eventually earn their way back without necessitating a massive government takeover. This is delusional.
Clearly the US is too big to fail and should be broken up into more manageable pieces without the political power of the current US.
Buffett was definitely talking up hos book yesterday. This was especially apparent in his remarks about one of his biggest holdings, Wells Fargo (WFC)
Buffett predicted that WFC could earn $40 billion on a pre-tax basis in a few years and said that his only worry is that “the government will force WFC to sell new shares” at foolishly low prices sometime during the interim.
Buffett was referring, of course, to what happened to Citigroup. He doesn’t want to see that happen to WFC (and he also owns BAC, USB, STI, BBT and some other big banks) because his percentage ownership would probably be cut in half.
Buffett’s just like everybody else–he wasn’t the government to take care of his needs on a first, last and always basis.
While this fear of a “shoot the messenger” response on the part of the US is interesting, I think it’s important to differentiate between two functions of the US official baseline:
1) Plan actual policy
2) Manage public perception
In terms of part 1, we can hope that World Bank economists are talking with Treasury economists, and passing on those dire warnings even if they are not going public with them. (Whether Treasury is listening is another matter.)
In terms of whether or not the World Bank can serve as a check on US enthusiasm by alerting the world about US domestic policy failures, the answer is a resounding no. Any international institution acting in that manner would risk losing US support and alienating the current administration. Any administration which was beset by the World Bank would have an easy time protesting “international intervention” into a domestic policy issue – which is of course the same argument made by Vladimir Putin and Hugo Chavez when the US acts through multinationals to apply pressure to their domestic affairs. Such intervention can serve as a rallying point to strengthen public support for the current administration’s policies, and can actually be counterproductive (as an extreme case, look at what’s happening in Sudan).
Even the UN, which is considerably more hostile to US interests than the World Bank (largely due to its greater independence and ownership by other countries), still restricts its criticism of US actions. If the UN could not bring itself to condemn the War in Iraq, do you really think the World Bank will condemn US economic policy?
Which means that any long term restrictions on US policy need to be domestic. It is no accident that authority to print money is delegated to Congress by the Constitution itself.
The ultimate (political) challenge the US has is that banks can create money by extending credit, but this power is not regulated by something as difficult to change as the constitution. It can therefore be tampered with by any given Congress in any given year (i.e. undoing Glass-Steagall).
Creating an independent reserve bank to manipulate interest rates and credit (without political influence) was supposed to fix this, but apparently not – there seems to be a lot more than the interest rate which influences the propensity of banks to extend credit (and therefore create money).
Technically, if the US wants to commit itself to not stupidly undoing legislation that was intended to prevent us from destroying ourselves, the constitution allows international treaties to have binding authority. But if we sign up to such a deal, we’d better make sure we get it right.
Sorry for being completely naive in terms of international diplomacy, but what purpose does it serve to have these organizations (UN, World Bank, etc) if they can only be critical of smaller, less powerful nations? Is our financial support so vital to these organizations that they dare not communicate an honest assessment (which is after all their job)?
Dead right, Ben. Constructive criticism between friends is the sincerest kindness. Only tell your enemies what they want to hear – that way they never learn and continue to repeat their self-destructive behaviour patterns.
Barney Frank’s declaration that a modification of mark-to-market is in the works certainly supports your hypothesis.
The primary argument for relaxing mark-to-market during the recession is to allow banks to take lower official losses now, and slowly rebuild those losses. One can denigrate “official losses” as meaningless since the losses will need to be taken sooner or later, HOWEVER official losses are meaningful when you’re on the verge of bankruptcy. Official losses are what determine when you are “officially” going out of business, and how large your “official” capital base is. Which determines how much money you can loan out.
Various Fed actions – for instance, paying interest on bank deposits – are essentially designed to get money into banks without officially bailing them out. So the hope is that losses can be hidden, and slowly erased over time as banks generate large quarterly profits.
I suspect this would have had a better chance at working 6 months ago (oops). The problem now is that “potential bankruptcies” for homeowners that were anticipated by mark-to-market accounting of mortgage backed assets are converting to real losses due to plummeting real estate values, job losses, etc. This trend, which was dramatically accelerated – perhaps caused – by the crisis, is now causing hold-to-maturity values of those assets to rapidly approach mark-to-market value. Once an asset-deflation recession takes hold, it’s hard to reverse.
So now, the goal becomes stop bankruptcies from clearing through the system in order to slow markdowns in those assets. If they can stop that long enough, “official” bank profits could increase, and perhaps lead a recovery.
Wow. What a gamble. They’re really casting the dice. Add to this the announcement of re-instating the uptick rule (which may or may not do anything), and we have a story. That’s why the markets jumped 4% today.
The question now is, are we doing enough? (I’d rather overshoot than undershoot.)
Perhaps it will work, perhaps not. It’s clearly the route they’ve chosen, and Bernanke reiterated yet again his belief that restoring the financial system is the most critical piece to engineering the recovery. He certainly gets some sympathy points:
“Asked whether he ever has second thoughts about taking the job as Fed chief, Bernanke said he couldn’t deny there’s been “some dark days, some difficult nights, difficult weekends, but I don’t regret it.””
He also talked a bit about “too big to fail” and some long term systemic fixes. Somewhat encouraging.
Unfortunately if the World Bank did gain some measure of independence it would be labeled a threat to US sovereignty just like the UN. As long as the World Bank (and IMF) does our bidding, which is really the bidding of the “overclass” as it were, it’ll be all set. Cross that line and it will suddenly find itself getting dope-slapped and marginalized.
While at the moment I happen to find the World Bank and IMF “on our side”, in part because while they do the bidding of the overclass, the overclass isn’t simply outright insane like much of our Congressional leadership, in the end they are anti-democratic tools that do actually threaten our sovereignty. That is, though they are a quasi arm of our government, in the end they don’t really report to our government and the “rules” they implement are not necessarily consistent with the will of the people – it hasn’t mattered how conservative or liberal our current leadership is, for some time now the WB and IMF have implemented strictly conservative “super-capitalist” policies (ala “Chicago school”).
It’s sort of like the CIA – I have no doubt that if you belonged to the John Birch society you wouldn’t have problems with the background check, yet if you belonged to an anti-war group your application would risk being ditched. The sort of implicit underlying dogma of these government organizations is always ultimately conservative.
RESTORE CONFIDENCE? For who? Working people have little or no disposable income. Confidence without disposable income is fools play. How is the disposable income deficit going to be fixed? Who is kidding whom?
‘broken up’ and ‘managed’ in what way by what/whom?
The thing is Buffett is kind of right — there are great opportunities for banks to make money. But the only way for a bank to earn lots is to have consumer confidence. So the idea that a sick bank can “earn its way out” of problems is simultaneously wrong.
The sick banks like Citigroup and BoA don’t have the consumer confidence. So they won’t get the earnings, the earnings which would get them out of the crisis. Smaller banks which didn’t screw up during the crisis *will* earn lots of money.
Wells Fargo is not insolvent and has therefore not lost public confidence the same way Citigroup and BoA have. Banking is all about confidence and trust. So Buffett may be right about Wells Fargo, but it still doesn’t mean Citigroup can pull off the same trick.