World leaders meeting in
Davos will have plenty to debate, in particular about the causes and
the channels that allowed the trigger of the U.S. subprime housing market
to snowball into a
synchronized global financial and economic crisis of depression-era
proportions. This year, responding to the crisis will be the focus of
those gathered at Davos, meaning that global issues that were once at the
forefront of public concern ?such as
climate change,
food security, poverty and
creative capitalism, water and pandemics- are in danger of being
neglected. See our coverage of
The Davos of the South: The World Social Forum
In a useful overview,
Ramkishen Rajan notes that among the areas in need of particular
attention are:
global supervision for global capital markets; recognizing that self
regulation in the financial sector is no regulation; finding ways to
protect the real economy from financial feedback loops; including
emerging markets in finding a solution for
global imbalances and alleviating the impact on the
poor, who as in all crises, will bear the brunt of the adjustment.
With a renewed determination to remake the global financial system come
questions about the effectiveness of existing institutions to coordinate
these multilateral efforts. Despite a consensus about the need to
alleviate the economic crisis, many
global institutions are deadlocked and responses continue to be
national. The G20, whose members account for 80% of global output may
continue to be a key venue for economic policy given that emerging
economies are inadequately represented in other global bodies like the
G7/G8. The G20 have called for the Financial Stability Forum to be
expanded to include key emerging economies and they will need to be part
of the financial regulation process. Those meeting in Brazil at the World
Social Forum at the same time as Davos will take an alternate approach.
Meanwhile, governments in the advanced economies are struggling to
address the ongoing banking crisis that is starting to
weigh heavily on their public finances especially in smaller
countries in the EU. In the U.S.,
TARP 1 capital injections seemingly vaporized without fundamentally
improving the outlook for financial institutions. Given that loan losses
could be as high as $1.1 billion next to $700bn in mark-to-market losses
according to
RGE estimates, the need for a
comprehensive solution has increased substantially. During his
confirmation hearing, Treasury Secretary Timothy Geithner noted that in
the past, all successful banking crisis resolutions involved some form of
a good bank/bad bank model where good assets were separated from the bad
ones in order to stop the contagion. Fed Chairman Bernanke and FDIC
Chairman Sheila Bair concur with this view and a more detailed action
plan on the proposed
?aggregator bank? is expected within the next few days.
Short of an outright nationalization of the banking system, the so far
favored solution among policymakers is a variant of the TALF model. A
vehicle that combines an equity contribution from the Treasury and loans
from the Fed would be set up to finance the purchase of toxic assets from
banks in return for cash and ownership stakes in the new institution. As
was the case with the aborted
Super-SIV, the main sticking point remains the price at which
illiquid assets should be bought. A price close to current market values
forces potentially large writedowns on thinly capitalized institutions,
whereas a higher price involves a subsidy from the taxpayer to the
existing equity- and debt-holders. The debate about the
fair value vs. ?hold-to-maturity? value is far from resolved.
In the next few weeks,
European governments will also speed up similar bailout measures. The
UK has guaranteed toxic bank assets but solvency remains in question.
As
Nouriel Roubini suggests, avoiding an insolvency crisis requires
cleaning up the financial system including a triage of solvent and
insolvent banks, recapitalization of solvent ones and a plan to reduce
the debt burden of the insolvent part of the household sector.
German banks remain severely undercapitalized according to press
reports and vulnerable to further writedowns on their toxic assets. Yet
unlike the UK, Germany has been reluctant to contemplate a single
state-controlled ?bad bank.?
In these countries and around the world, most of the funds will come from
their fiscal finances. Even as advanced economies are realizing the need
to invest greater funds in their financial sectors, some of their past
funders are now preoccupied at home. The sovereign wealth funds who, a
year ago, were investing in global banks (and were swarmed at last years
conference), are now
investing at home. These sovereign investors face heightened domestic
liquidity needs to guarantee the corporate
foreign borrowings, provide deposits for the
financial sector which can no longer access wholesale financing and
establish
equity stabilization funds.
