Page 1 of 2 G-20 fritters as crisis deepens By Hossein Askari and Noureddine Krichene
Finance ministers and central bank governors from the Group of 20 (G-20)
countries who met in London at the weekend to draft an agenda for the eagerly
awaited April 2 group summit in the United Kingdom capital failed to address
the nuts and bolts issues and misdiagnosed the reasons underlying the global
economic and financial meltdown.
There is still time to improve and strengthen the agenda before April 2. If
they fail, the April meeting will be piled on the trash heap of history,
another meeting with no substantive results.
The leaders must address a number of pressing issues and set up an effective
structure for addressing them. They cannot resolve
the world's economic and financial woes in one day, but they can set up a sound
foundation for addressing them and avoiding similar problems in the future.
Such an achievement, much more than soaring rhetoric, would give financial
institutions, investors and consumers around the world badly needed confidence.
The world needs assurance that there is light at the end of the tunnel. There
are today a number of committees for addressing global economic and financial
issues, most prominently: at the level of heads of state, the Group of Seven
(and the Group of Eight to include Russia), and more recently the G-20; at the
ministerial level, the G-20, The International Monetary and Financial Committee
of the IMF (IMFC), The Development Committee (World Bank and IMF), the
Organization for Economic Cooperation and Development (OECD); and at the level
of international institutions, the annual meetings of the IMF and the World
Bank.
Yet, with all of these forums and more, little economic coordination and
cooperation of significance seems to ever emerge. The most important reason for
failure is nationalism and the absence of commitment to international solutions
for what "appear" to politicians as largely national problems requiring
national solutions. Today, however, for the first time in recent memory,
leaders admit the world faces a truly global crisis, one that may be trumped
only by the Great Depression. To address these issues, world leaders must
address a number of overriding issues and set up the infrastructure to follow
up on what will, in all likelihood, be eloquent and potentially empty words.
The nuts and bolts issues
First, the G-20 leaders should commit to the G-20 as the forum, possibly
modified or expanded, to address global economic issues. The G-7 or G-8 forums
are no longer realistic avenues as they exclude China, India, Brazil and a
number of other growing economic powerhouses. If they make such a commitment to
the G-20, then they should set up a practical mechanism to address its
membership.
The G-20 was formed as in 1999 as an informal organization to address
international issues in a wider forum than the G-7 or G-8. If the G-20 is to
become the forum, then the leaders should address a number of issues. Is 20 the
right number for membership? While some countries should, without a doubt, be
members, should others - such as Argentina, Indonesia, Saudi Arabia, Turkey and
the European Union - today have a permanent seat at the table with no mechanism
for revising membership or rotating countries, as does the UN Security Council
for its non-permanent slots?
Given Europe's number of seats, should the EU continue to have an additional
seat? There must be no doubt as to the fairness in the structure of the G-20 to
foster global cooperation.
For the G-20 to achieve its mission and be effective, the temporary secretariat
structure (put in place by the rotating chairmanship, currently the UK) should
be replaced by a high caliber permanent secretariat to afford continuity to the
work agenda adopted by the G-20. Without such a secretariat, the G-20 will be
only a forum for photo ops and great, but empty, speeches.
Second, the international financial architecture is in dire need of overhaul.
Should we embrace a world central bank to control money creation to restore
financial stability and prevent an inflationary spiral? Should we create an
international reserve asset to replace the dollar to restore symmetry to
international financial system?
Third, financial supervision (including banking, investment banking and
insurance), financial regulation, accounting standards must be made global. We
have seen how the US subprime debacle has brought the world to its knees. How
can a globalizing world let individual countries act irresponsibly to the
detriment of the world? Every country has a stake in global financial stability
and it is the largest economies that significantly affect global financial and
economic wellbeing. While at the March 14 meeting the Europeans saw this as the
key issue requiring a remedy, the US continued to push financial bailouts and
coordinated stimuli.
The wrong diagnosis
Before adopting policies to address the global meltdown, the heads of state
have to agree on what ails the world. Here is where the ministers meeting truly
fell short. Let's first take a look back on what we have down in the last few
months before giving our diagnosis and prescription.
When US Federal Reserve chairman Ben Bernanke and the then US Treasury
secretary, Henry Paulson, pushed last September for the Troubled Assets Relief
Program, they said that the US$700 billion bailout was the best recipe for
American families. Without the bailout, life would end! They promised a quick
turnaround and that the economy would generate millions of jobs. When Bernanke
started his aggressive monetary policy back in August 2007, leading to zero
interest rates and massive liquidity injection, he promised solid economic
growth. Present Treasury Secretary Timothy Geithner, carrying the same message
as his predecessor, said unlimited bailout of banks was the best solution for
American families; without bank bailouts, American families would face an
unimaginable economic decline.
President Barack Obama's message is that his history-making budget deficit of
$1.8 trillion in 2009, 13% of GDP, would avert an economic catastrophe. In
early 2008, George W Bush promised that House Speaker Nancy Pelosi's $160
billion stimulus package would bring quick recovery in July 2008. Fear tactics
and promises!
Apparently record US fiscal deficits, incredible bailouts amounting to $11.5
trillion, vast stimuli, zero interest rates, and unlimited supply of credit
should be expected to make good on these promises and bring about fantastic
growth and fuller employment. Disappointingly and instead, banks are under
nationalization, stocks have collapsed, and unemployment last month rose to
8.1% and is expected to climb much higher. What happened to the Harvard
multiplier that it seems to be working in reverse?
Bernanke has wanted us to believe that the financial and economic crises are
due to the end of the housing boom in the US. Academics, media, and policy
makers have embraced his theory. In a Wall Street Article titled "Obama's
Mortgage Plan Is What We Need", Governor David Paterson of New York State said,
"What is sometimes lost in the public discussion of our current economic
crisis, amid the $787 billion stimulus package and the multibillion dollar
bailouts of banks and insurance companies, is the root cause. The economic
downturn began as a mortgage crisis and will not end until we solve that
problem. The Obama Administration seems to understand this."
Apparently, according to such soothsayers, we will remain in the abyss until
the mortgage crisis is solved.
What is the solution to the mortgage crisis? It depends on who you are, your
stake, and how you understand it. Recognizing that houses were bought by
homeowners who had no savings or even income to service any mortgage payment,
Bernanke wanted a full bailout for homeowners for the "public good". That is
certainly a radical solution compared with a piecemeal approach. It puts the
mortgage nightmare behind us.
Geithner wanted a Treasury funded "bad bank" or a public-private fund that
would buy trillions of dollars in toxic assets. Harvard academics wanted to
preclude any fall in housing price through full government subsidies. Some
proposed a tax credit of $15,000 on each house bought. Evidently, a market
solution that will avoid billions in taxpayers money and administrative cost
has been forcefully opposed by the US Congress, politicians, and academics
alike.
Besides subprime-meltdown view of the origin of the financial crisis, other
pundits retrace it to securitization and overleveraging. Their argument
suggested that hedge funds financed by investment banks were overleveraged 30:1
or even 100:1. Greed, fees, and self-interest led to overleveraging through the
proliferation of credit derivatives such as CDOs, CDSs, CLOs, ABSs, and so on.
Rating agencies were also enticed by high profits and rated everything triple
A. Ponzi swindlers such as the Madoffs and Sanfords of this world, found a
favorable environment for fraud.
One of the most exotic explanation for the crisis was put forward by some
academics who blamed the Black-Scholes option pricing formula and held it
solely responsible for the financial crisis. Yet the formula was published in
1973 and did not cause a crisis upon its publication. Moreover, the formula
only explained option prices that existed one hundred years before its
publication and can be seen as an extension of Paul Samuelson's 1966 option
pricing approach.
Finally, the thesis adopted in the G-20 summit in November 2008 was that the
financial crisis stemmed from unregulated financial
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