Monthly Archives: March 2009

By Nicholas Stern

When John Maynard Keynes from Britain and Harry Dexter White from the US were designing a system on international economic institutions, agreed at Bretton Woods in July 1944, their judgments were shaped by the preceding three decades of depression and World Wars.

The colonial structures were still in place and the Cold War was about to begin. But the world has profoundly changed in the past 65 years with decolonisation, globalisation, the collapse of the Soviet Union and the rise of China, India and other leading developing countries. Read more

By Kevin O’Rourke

This period last year seems an age ago. The fear then was of resource scarcity: of rising oil prices and increasing food prices, as biofuels crowded out food production and population continued to grow. Environmental worries also reflect resource scarcity, albeit of another type. Once this crisis is over, these concerns will inevitably return to the agenda, and could easily dominate it for the rest of this century. Read more

By Ricardo J. Caballero

We are not out of the woods yet, but the elements of the Legacy Assets programme are encouraging.

They combine the strengths of the public institutions involved – the US Treasury, the Federal Reserve and Federal Deposit Insurance Corporation – to produce a powerful combination of public equity, loans and guarantees to leverage private capital in the process of thawing frozen financial markets. Read more

Pinn illustration

I am becoming ever more worried. I never expected much from the Europeans or the Japanese. But I did expect the US, under a popular new president, to be more decisive than it has been. Instead, the Congress is indulging in a populist frenzy; and the administration is hoping for the best. Read more

By Michael Pomerleano

In an article this month, “Promising signs of progress in the ‘Bad Bank’ Plan” I wrote that the approach sketched out by Tim Geithner, US Treasury secretary, deserved consideration and support from the policymaking and financial communities for the following reasons: Read more

By Christopher D. Carroll

Maybe it was worth the wait.

Judging from preliminary details, the US Treasury’s plan to rescue the financial system is a lot savvier about the relationship between financial markets and the macroeconomy than are the usual-suspects: critics from both left and right who are already pouncing on the Geithner plan.

Unlike the critics, the Treasury has absorbed the main lesson from the past 30 years of academic finance research: asset price movements mainly reflect changes in investors’ collective attitude toward risk. Read more

By Photis Lysandrou

The financial sector is widely blamed for the financial crisis, with banks and their investment vehicles considered responsible for the products at its epicentre.

By contrast, investors who bought these products are seen as having played a largely passive role. In fact, demand-side pressures were the main driving force behind the growth of these products. As a result, governments will be unable to prevent crises if they restrict themselves to changing the global financial architecture. Read more

Lord Turner is the UK’s man for all seasons. A few years ago, he fixed pensions. Today, it is finance. The report by the new chairman of the UK’s Financial Services Authority is a turning point. The authorities of a country that used to boast of its light financial regulation have changed their minds: the UK has lost confidence in its financial sector.

“Over the last 18 months, and with increasing intensity over the last six, the world’s financial system has gone through its greatest crisis for at least half a century, indeed arguably the greatest crisis in the history of finance capitalism.” This is the report’s starting point. It advances two explanations for this disaster: exceptional macroeconomic conditions – particularly the emergence of excess savings in large parts of the world – and reliance on “the theory of efficient and rational markets”. As the report notes, “the predominant assumption behind financial market regulation – in the US, the UK and increasingly across the world – has been that financial markets are capable of being both efficient and rational”. So regulators were expected to stay out of the way. In the report’s new view, they should be in the way, instead. The financial sector no longer enjoys the benefit of the doubt: it may burn up the world.

The most important analytical points are that individual rationality does not ensure collective rationality, that individual behaviour is frequently less than rational and that, in consequence, markets can overshoot, in both directions. Above all, such failings create systemic risks: if everybody believes in the same (faulty) risk models, the system will become far more dangerous than any individual player appreciates; and if everybody relies on their ability to get out of the door before anybody else, many will die in the inferno. Read more

By Michael Pomerleano

We are witnessing the widespread use of guarantees, which suggests that policymakers consider them a “free lunch” permitting them to bypass budgetary scrutiny. I advocate that guarantees should be transparent, judicious and temporary and applied only in specific circumstances.

Previous financial crises have seen the use of government blanket guarantees, which are blunt instruments. Such measures for depositors and creditors were introduced in East Asia to protect banking system stability. Read more

Can we afford this crisis? Will governments destroy their solvency, as they use their balance sheets to rescue over-indebted private sectors? Read more

By Ricardo J. Caballero

Suppose it was possible to rewind the clock to the first time we had a strong urge to rewrite economic history. A favourite stopping date would be the days before the Lehman-AIG debacle last year. Until then, we were dealing with localised inefficiencies and predatory behaviour among the main financial institutions. There was plenty to fix but it seemed manageable, mostly a matter of accelerating the medicine and aggressively dealing with problems on a case-by-case basis. Read more

By Christopher Carroll 

In a speech in his hometown of Dillon, South Carolina, Ben Bernanke, US Federal Reserve chairman, recently promised that the Fed would “forcefully deploy all the tools at our disposal” in responding to the financial crisis.

This is excellent news, since the tools at the Fed’s disposal are awesome, and if deployed forcefully enough, could almost certainly end the acute stage of our financial panic.

The Fed has already shown remarkable boldness in responding to the crisis; if not for that boldness, financial markets and the world economy would be in much worse trouble than they are now. Read more

By Laurence J. Kotlikoff

The US federal government faces a long-term fiscal gap, which exceeds, from all indications, $70 trillion. This gap is the present value difference between all projected future expenditures and all projected future receipts.

Its size reflects the impending retirement of 78m baby boomers and the fact that when retired, they will receive annual benefits from social security, Medicaid (the healthcare scheme for people on low incomes) and Medicare (for the elderly and disabled) that average more than per capita gross domestic product. Read more

By Charles Goodhart and Dirk Schoenmaker

The recent de Larosière report on financial supervision and stability in the European Union should be praised for its rigorous assessment of the shortcomings of the current, mainly national-based regulatory system. It also makes some recommendations to resolve these shortcomings.

First, the report recommends the introduction of macro-prudential supervision. The financial crisis has illustrated that the micro-focus of supervisors on individual institutions does not suffice. This micro-focus
should be supplemented by a macro-approach to detect the development of imbalances in the financial system, such as excessive capital growth. Read more

The summit of the Group of 20 leading advanced and emerging countries in London on April 2 2009 will fail. Its members are refusing to meet what Lawrence Summers, senior economic adviser to the US president Barack Obama, calls “the universal demand agenda”. Conventional wisdom is the enemy. Alas, it is winning. Read more

By Ricardo Caballero

We are running out of time. There is no end in sight unless much political capital is put at risk now. We have a superb team of economists and technicians, but their voices seem to have been lost.

I recall Lawrence Summers, chief White House economic adviser, rightly claiming that if markets over-react, the government has to over-react even more. US Treasury secretary Tim Geithner, even in his much criticised first announcement, sounded like a man of the right principles: We must stabilise the financial system, regardless of cost, was the message delivered with clenched teeth. Read more

Another ideological god has failed. The assumptions that ruled policy and politics over three decades suddenly look as outdated as revolutionary socialism.

“The nine most terrifying words in the English language are: ‘I’m from the government and I’m here to help.’” Thus quipped Ronald Reagan, hero of US conservatism. The remark seems ancient history now that governments are pouring trillions of dollars, euros and pounds into financial systems. Read more

The UK government looks increasingly like a python that has swallowed a hippopotamus. In acting as insurer of last resort to the British-based banking system, it is taking on huge risks on behalf of taxpayers. If this turned out to be a global depression, with huge losses for British-based banks, fiscal solvency might even come into question. Can this make sense? I doubt it. Read more

By Edi Karni

Despite extraordinary government largesse intended to increase the availability of loanable funds, consumers and businesses alike are finding it hard to access credit, with grave consequences for the US economy.

The increased uncertainty caused by the worldwide recession means that loans are riskier, leaving banks reluctant to extend credit. In return for taking on this increased risk, banks must raise the interest rates they charge. However, the economic slowdown has reduced expected returns for businesses, making it difficult for prospective borrowers to bear the burden of higher rates. Consequently, fewer projects receive the financing they need. Read more

By Joseph Stiglitz and Nicholas Stern

We face two crises: a deep global financial crisis, caused by inadequate management of risk in the financial sector; and an even deeper climate crisis, the effects of which may seem more distant but will be determined by the actions we take now. Read more