04/02/2009

Don’t shoot at the ambulance!

Diagnosis of a financial crisis in the form of parabola

 

With what can one compare the financial crisis? It is like the AIDS:

 

It is a morbid state of the financial system which is acquired by risky behaviour such as: the cupidity of bankers, financial intermediaries, investors or the claims for excessive remunerations by corporate managers or Directors. One can also mention: the excessive use of leverage, the reliance on obscure financial “models”, the ignorance of conflicts of interests, incompetence, the skirting of the regulation, the laxity of the controlling authorities, and the over-indebtedness of the consumer without forgetting fraudulent conduct.  The disease can remain a long time in a latent state, gradually reducing the immunizing capacity of the system. It becomes then prey to a virus of the “subprime” or other variety which transforms the pathology to a virulent state.

 

The disease of the international financial system can be also compared with Cancer:

 

Having surfaced in a vital organ of the American economy - the residential real estate market - it generated metastases in other parts of the body. In the transmission process, it first contaminated the financial flows network itself, inducing, like leukaemia, the blocking of the interbank market. Then, the crisis propagated to the whole of the credit market affecting the corporate sector as well as private individuals, inducing a rise of unemployment and a reduction in incomes whose causes and effects spiralled in a vicious circle.

 

The crisis is also comparable with an epidemic of influenza:

 

It appears periodically in new forms requiring new antidotes. The virulence of the 2007-2009 variety resists, so far, all remedies used to treat traditional topologies: cyclical recessions, high inflation, and excessive budgetary or balance of payments deficits. This epidemic is of a very contagious nature, whose gravity makes one fear a situation comparable with that of the 1930’s.

 

Now let us examine the remedies which were tested to date.

 

In the first year of the crisis (summer 2007-08) the treatment was entrusted to the monetary general practitioners who prescribed the traditional remedies in ever increasing amounts (lower interest rates, easing of refinancing conditions etc.). These therapies stabilized the disease and avoided a fatal systemic crisis. Massive transfusions of liquidity, together with important amounts of anticoagulants, improved temporarily circulation. However, as from the summer 2008, the health of the patient worsened requiring that surgery be undertaken by governments. The system was particularly tested by the amputation of one of its members (Lehman Brothers) mid September.

 

The postoperative shock far exceeded fears of the doctors generating a slew of new interventions on many contaminated organs. Those called to operate did not have the benefit of a complete diagnosis, the reliability of the scanners being insufficient to evaluate the precise level of infection of the affected tissues. They had to operate largely by instinct.

 

There followed shortly a call for a coordinated approach considering the scale of the epidemic that had become planetary. In Washington, one insisted on the need for solidarity, on the integration of members formerly snubbed by the elites in the search of common solutions and on the avoidance of the errors of the past such as establishing sanitary cordons (protectionism) in the vain hope of stealing a march on others.

 

Each national team remains however free to prescribe the therapies deemed most suitable to treat local symptoms. Thus one witnesses attempts at tetra therapies: rescues by injection of capital; amputation of “toxic” bodies; measures to stimulate investment and/or consumption; tax incentives. These remedies are applied either simultaneously or successively, accompanied by strong doses of drugs acting through placebo effects, in the guise of official statements, meant to reassure the citizen. In spite of these commendable efforts, it has not been possible, to date, to restore confidence, an essential element of the effectiveness of the prescribed treatments.

 

Quite to the contrary, ever more contradictory and numerous prescriptions are likely to confuse  many patients: one preaches simultaneously the virtues of increased savings and consumer spending; one takes measures to facilitate the credit, while companies, in the face of the crisis, are reticent to incur further debt and /or invest. At the prescriptive level, differences between the speeches and the ordinances widen: sanitary cordons are being proposed under the label of  “national preferences” (United States), in calls for restrictions to the mobility of the workers (the United Kingdom) or in other forms such as monetary erosion (the U.K., again) etc.

 

What lessons should be drawn from this diagnosis?

 

First of all it is incomplete. It is not sure that the colossal means already disbursed or currently being mobilised, will be sufficient to prevent a propagation of the crisis. One has only a very approximate idea of the extent of the decontamination (de-leveraging) that the system must undergo to find a sufficiently stable state to initiate a process of convalescence. For example, the amount of “C.D.S.” contracts (Credit Default Swaps), reach, according to certain estimates, USD 60 trillion, a market that developed devoid of any regulation. Under the threat of this Damocles sword (or those wielded by Hedge Funds, structured products, etc) the 2 to 3 trillion dollars, to which the whole of the “stimuli plans” add up, could, nevertheless, prove to be insignificant.

 

Certain remedies are no longer available: the United States, Japan and, in the near future, the United Kingdom have exhausted their non renewable stock of the interest rate therapy. This induces increased recourse to new drugs such as: the purchase of toxic assets, recapitalisations, subsidies of all kinds, which, for lack of time, are not subjected to the normal process of clinical validation and for which the side effects remain largely unknown.

 

The future programmed massive increase of State indebtedness and budget deficits pose also a serious challenge. If saving the life of the patient is the absolute priority and justifies current policies, one should wonder, however, why these symptoms do not seem to generate a rise in inflation whereas, in theory, it would be the expected consequence. Could it be imbalances have reached such a level that the patient is impervious to any treatment? If so, one should expect that the patient to fall into a deep depression from which he will extricate himself slowly and which will leave deep scars. If therapy proves effective, at least stabilizing the patient at a tolerable level, it will be necessary to adjust rapidly the treatment at the time of convalescence to avoid a virulent inflationary epidemic with the devastating effects. The management of this second recovery phase will undoubtedly prove as challenging as the first.

 

It is also appropriate of distinguish clearly between the daily management of the crisis and the work being carried out in order to prepare for crisis prevention in the future.

 

Current intensive care management requires reinforcing the coordination mechanisms, already very effective at the Central Banks level. It would be useful to ensure the exchange of information as a precondition to the implementation of any measure liable to have an impact on any of the partners. On the level of the European Union and the Eurozone the crisis should give the impulse towards deeper economic integration, which would reinforce considerably the immunizing defences of the Union.

 

With regard the long term outlook, the London meeting at the beginning of April, should initiate the drafting of comprehensive protocols to be implemented under the aegis of a future “World Regulatory Organization”. A pyramidal structure on three levels (world, regional and national) would aim at integrating the requirements arising from the global character of the financial system and the taking into account the important number of operators whose action is limited to a region or to a single country. The objectives of prevention of financial epidemics should be central, but must be accompanied by constraining rules governing the exchange of information, controls and the sanctions.

 

The situation faces all actors with the responsibility not to weaken further the already critical state of the patient. It concerns all political and economic authorities as well as those in charge of the social wellbeing. There is no room for ideology or low level politicking. If the debate must be “open”, it is however highly irresponsible, to “shoot on the ambulances”. On the contrary, like every competent doctor, the authorities must explain to citizens the reality of the situation without causing false hopes of a fast cure.

 

The appeal made by President Obama during his inauguration, aiming at uniting all men of goodwill, should be used as a model for the non partisan approach that the situation requires.

 

That those who have ears, listen!

 

18:20 Écrit par Paul N. Goldschmidt 13 Ave. Victoria 1000 Bruxelles dans Général | Lien permanent | Commentaires (0) |  Facebook |

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