Tuesday, February 3, 2009

Davos 2009: Rebooting the Global Economy

Don't worry, be happy. Just hit control-alt-delete and everything will come right back to normal. Or not:
We don't know what we're getting into.

Now I saw the Swedes did this for their bank rescue a few years ago, and they did it very well; but as was admitted by the central bank governor, they knew what they were buying. They knew they were dodgy properties in Uppsala or somewhere; it was a small country, people knew what the bad debts or likely bad debts might be.

We haven't got a clue, in the big countries! And we don't know where these debts are. I don't think some of the banks fully know their exposure to the subprime market at the moment. I'm not sure they know their exposure to the high levels of business leveraging that are out, particularly private equity; a lot of which have to be repaid quite soon.

They don't know what's going to happen, if unemployment rockets, as it might, how many people are going to be able to pay their credit card bills, and how many people are going to be able to pay their mortgages, and what repossessions will take place. They don't know. And the idea that somehow, the munificent taxpayer, suddenly with their arms open, 'give us your rubbish' and so on; I think, is very dangerous.

We're beginning to get very close to straining the patience of the population and the voter and everybody else in this area. Our grandchildren will be paying some of these debts already incurred. Don't take for granted that this is a technical issue anymore, I've got a feeling its gonna' run a lot hotter and a lot more widely than this, and rather than experts talking about things, people are going to ... get this social unrest is going to start chipping in quite quickly ... and politicians will find themselves scrambling, pragmatically, through whatever circumstances they face.

Which comes back to that danger of protectionism, and trying to get yourself in a Swedish position so at leas you know what you're doing. At the moment, you don't know what you're doing, not with the great big banks of the western world and where their possible toxic assets lie. -- John Monks, GenSec, ETUC
Meanwhile, the "official account" merely quips:
"John Monks, General Secretary, European Trade Union Confederation (ETUC), Brussels, suggested that the real problem is that we still don’t know what we are getting into. “Social unrest is going to start chipping in quickly,” he said."
This is what is being passed off as a transcript? Why isn't the quotation below (at 35:45 in this archive video) in the sorry excuse for an abridged transcript of this event? Where are the comprehensive transcripts?
"We have given $150B to AIG -- one company -- and most of that money has disappeared; now that's one company. We would have put social security on a sound financial basis for a hundred years or more with the money we've been spending on the banks. Giving all the old age people in America security for the next one hundred years versus bailing out a few banks. That's the "bad bank" idea. If you go ahead with that, I think it raises real issues about social values." - Joseph E. Stiglitz
This is the same guy that wrote the following back on December 11, 2007. I'm open to hearing explanations as to why the following comments apparently are not readily archived on any U.S. financial sites, but rather most easily found in the Daily Times of Pakistan.

Global economy is exposed to America’s houses of cards
By Joseph E. Stiglitz (Dec, 2007)

There are times when being proven right brings no pleasure. For several years I have argued that a housing bubble that had replaced the stock market bubble of the 1990s was supporting America’s economy. But no bubble can expand forever. With middle-class incomes in the United States stagnating, Americans could not afford ever more expensive homes.

Economists, as opposed to those who make their living gambling on stocks, make no claim to being able to predict when the day of reckoning will come, much less identifying the event that will bring down the house of cards. But the patterns are systematic, with consequences that unfold gradually, and painfully, over time.

There is a macro-story and a micro-story here. The macro-story is simple, but dramatic. Some, observing the crash of the sub-prime mortgage market, say, “Don’t worry, it is only a problem in the real estate sector.” But this overlooks the key role that the housing sector has played in the US economy, with direct investment in real estate and money taken out of houses through refinancing mortgages accounting for two-thirds to three-quarters of growth over the last six years.

Booming home prices gave Americans the confidence, and the financial wherewithal, to spend more than their income. America’s household savings rate was at levels not seen since the Depression, either negative or zero. With higher interest rates depressing housing prices, the game is over. As America moves to, say, a 4 percent savings rate (still small by normal standards), aggregate demand will weaken, and with it, the economy.

The micro-story is more dramatic. Record-low interest rates in 2001, 2002 and 2003 did not lead Americans to invest more - there was already excess capacity. Instead, easy money stimulated the economy by inducing households to refinance their mortgages, and to spend some of their capital.

It is one thing to borrow to make an investment, which strengthens balance sheets; it is another thing to borrow to finance a vacation or a consumption binge. But this is what Alan Greenspan encouraged Americans to do. When normal mortgages did not prime the pump enough, he encouraged them to take out variable-rate mortgages - at a time when interest rates had nowhere to go but up.

Predatory lenders went further, offering negative amortization loans, so the amount owed went up year after year. Now reality has hit: Newspapers report cases of borrowers whose mortgage payments exceed their entire income.

Globalisation implies that America’s mortgage problem has worldwide repercussions. America managed to pass off bad mortgages worth hundreds of billions of dollars to investors (including banks) around the world. They buried the bad mortgages in complicated instruments, buried them so deep that no one knew exactly how badly they were impaired, and no one could calculate how to re-price them quickly. In the face of such uncertainty, markets froze.

Those in financial markets who believe in free markets have temporarily abandoned their faith. While the US Treasury and the International Monetary Fund warned East Asian countries facing financial crises 10 years ago against the risks of bailouts and told them not to raise their interest rates, the US ignored its own lectures about moral hazard effects, bought up billions in mortgages, and lowered interest rates.

But lower short-term interest rates have led to higher medium-term rates, which are more relevant for the mortgage market. It may make sense for central banks (or Fannie Mae, America’s major government-sponsored mortgage company) to buy mortgage-backed securities in order to help provide market liquidity. But those from whom they buy them should provide a guarantee, so the public does not have to pay the price for their bad investment decisions. Equity owners in banks should not get a free ride.

It is the victims of predatory lenders who need government help. With mortgages amounting to 95 percent or more of the value of the house, debt restructuring will not be easy. What is required is to give individuals with excessive indebtedness an expedited way to a fresh start: for example, a special bankruptcy provision allowing them to recover, say, 75 percent of the equity they originally put into the house, with the lenders bearing the cost. There are many lessons for America, and the rest of the world; but among them is the need for greater financial sector regulation, especially better protection against predatory lending, and more transparency.

Joseph Stiglitz is a Nobel laureate in economics.

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