Some economic crisis links (10.7.2008)

Another crisis of a crisis management regime

According to Willem Buiter of the Financial Times

It's reasonable to assume that the banking system in the North Atlantic region is insolvent and would be bankrupt but for the reality of recent government bailouts and the expectation of future government bailouts. Certainly, for the system as a whole, the marked-to-market value of its assets is way below that of its liabilities. I strongly suspect that even the hold-to-maturity value of its assets is well below that of its liabilities. Although the system as a whole is broke, there are no doubt individual banks that are solvent. We may not, however be certain as to which banks are solvent and which banks are not.

It is, therefore, a matter of trust and a willingness of key financial actors to take risks.

As Yves Smith of Naked Capitalism, who pointed to the Buiter article, notes: "This is a bold, troubling, and probably accurate assessment." Buiter continues

I also take it is given that it is desirable — essential even — to preserve the core of the banking system and to keep it operating without interruption, because it fulfills an essential role in the intermediation of funds between financial surplus units and financial deficit units — a role for which no substitute can be found or created in the short and medium term. The bulk of the banking system therefore needs to be bailed out. In practice this means that most of the large banks need to be bailed out in the first instance. Consolidation through mergers, acquisitions or liquidations will mostly have to wait until order has been restored in the global financial markets.

The main remaining question then becomes who will pay for the bail out, the tax payers or the existing creditors of the banks (including the shareholders and other providers of equity). I have a strong preference for putting much of the cost of a bailout on the existing creditors. This is in part for reasons of equity and fairness: the existing creditors made bad investments/loans; they ought to pay for their failures. They earned a risk premium while the going was good. They ought to eat the risk when it materialises. It is also for incentive reasons. Future lending to banks and future purchases of bank obligations will be undertaken with a better appreciation of the credit risk involved. Another massive over-expansion of the banking sector will be less likely [emphasis added].

So, the financial crisis is, essentially, a political problem, one that will implement a collectively binding decision to allocate risks and rewards. It is, then, a question of justice.

According to the Economist

Amid the uncertainty of the global financial crisis a pattern has emerged. First, the world's central bankers and finance ministers construct bail-outs and rescue packages for teetering financial institutions. Then investors give their manoeuvres an emphatic thumbs-down. The pattern is becoming ever more pronounced.

...As a result full-scale recapitalisation of the sector is edging ever closer.

It is clear that the financial markets have rejected "business as usual."

Mark Landler of the New York Times first refers to the possibility of a global recession before asserting that an internationally coordinated and systemic response is needed to resolve the crisis. Unfortunately, he then states that "As the problems in Europe have worsened, the crisis has taken on an 'every country for itself' quality," the opposite of what the situation requires. In other words, the European Union might disintegrate because of the mistrust generated by the crisis.

Ironic as it may be, some North Atlantic states may find it expedient to nationalize a part of their banking sector in order to resolve what amounts to a crisis of their contemporary crisis management regimes (see Offe, 1984, pp. 35-64). It would be ironic because, during the 1970s, some of these same states would have resolved the fiscal crisis of their Keynesian Welfare State regimes by turning to the market — that is, by implementing what came to be known as the neoliberal strategy. It is the consensus produced by this strategy that is now in crisis. If the 2000 recession "barely made a dent in this neoliberal arrogance," as Duménil and Lévy claim (2004, p. 7), the same is not true today when it has become common to compare the significance of the current financial crisis to the fall of the Berlin Wall in 1989. The financial crisis is becoming a system crisis thanks to the dominance of financial capital over the "real economy" in some developed Western countries.

Update (10.7.2008)

Stijn Claessens, M. Ayhan Kose and Marco Terrones of Vox (and via Naked Capitalism) use their research of contemporary economic crises to draw the following conclusion.

The lessons from the earlier episodes of recessions, crunches and busts are sobering, suggesting that recessions, if they were to occur, would be more costly since they would take place alongside simultaneous credit crunches and asset price busts. Furthermore, although the effects of the current crisis have already been felt gradually around the world, its global dimensions are likely to intensify in the coming months.

The main take-away of the past episodes is that some tough times are ahead for the global economy before matters get better. Nevertheless, the nature of a recession in a particular country, if it happens, would ultimately depend on a number of factors, importantly how healthy the financial positions of its firms, banks, and households are prior to the recession, and what policies are being employed. This is high time for policy makers to act swiftly and decisively to undertake the necessary measures at both the national and global levels to meet the challenges of the crisis.

When writing for the Nation, Tom Englehardt also searches for irony, and even finds a bit of it.

And here's one to consider. In the last year, the Bush administration's top officials have sunk much of their increasingly lame-duck energy into pacifying Iraq, and so getting it out of the news and the spotlight at least long enough for election '08 to happen (and undoubtedly long enough as well for them to get out of town in January). And then what happens? The administration is ambushed, not by Sunni militants or Shiite radicals but by its own people: investment bankers, lenders, hedge-fund managers, financial management types — the very people for whom they organized the world and who had long been playing fast and loose (and profitably) with our economic system. The ambush, of course, took the form of a financial meltdown of massive proportions for which, as in Iraq in 2003, the administration had clearly done no significant preplanning or war-gaming. And, as with the insurgency then, so now they operated by the increasingly worn seats of their pants. Their attempted $700 billion "surge," as stock exchanges around the world indicated yesterday, wasn't likely to pacify a global financial system near cardiac arrest.

If George W. Bush were to honestly consider his place in history, he may choose to travel by the Hindenburg to his next and presumably last "mission accomplished" speech.

Update II (10.7.2008)

The Dow plunges yet again, according to the New York Times. Federal Reserve Chairman Bernanke stated that the Fed would likely lower its interest rates at the end of the month. Despite the announcement, the Dow continued to fall.