This article is a sequel to the one Baretalk wrote back in November 2007 (“The real subprime issue” at www.livemint.com/subprime.htm). The issues raised in the original article remain alive a year later.
Former member of the monetary policy committee of the Bank of England Willem Buiter advised global central banks in a recent blog post to shed their virginity and directly engage in unsecured interbank lending. Of course, from there, it is a short-step for the central banks to provide households with mortgage, auto and student loans. After all, a special purpose vehicle has been set up for the Federal Reserve to buy commercial paper directly from companies and it would start functioning from 27 October. In other words, this would amount to full-scale nationalization of the banking system and its functions.
Yet, far from stating it as such, the US treasury is throwing more money at banks and they seem happy to gobble it up without resuming their banking role. The system has frozen (maybe it is thawing too slowly) because it is weighed down by far too much of toxic assets that the banks are afraid to admit to and hence, unable to get rid of.
What is needed — as stated in a reader’s comment on Buiter’s blog — is for the banks to state publicly what they have and how they are valued and then the market and private investors would sort out those banks that deserved to and could be supported to survive and those that had no chance. Within days, the interbank market would resume its normal functioning, as the facts would be out. That is not being done nor is it being encouraged. In Sweden, which is often held up as a successful bank rescue model, the government did not recapitalize banks indiscriminately. It weeded out those that could not survive. That has not happened in America or in Europe, yet.
That is not all. Floyd Norris of The New York Times writes in his blog that the International Accounting Standards Board (IASB) has already allowed banks to stop recording changes in the fair value of their assets and make it retroactive from 1 July. Not satisfied with that, the European banking federation wants further “carve-outs” from accounting standards. If freedom to deviate from common standards is approved, it would be impossible to assess both the absolute and relative soundness of banks across continents. This move is in the direction of non-transparency rather than disclosure. Investor confidence would retreat further rather than return.
Then, there is the silence in the mainstream media on the issue of how the governments would find the money for the various bailouts announced. Of course, most of it is not revenue expenditure but capital expenditure. Therefore, they do not add to the fiscal deficit. In fact, only the cost of funding these commitments is revenue expenditure. Yet, one is unable to locate such questions raised in obvious places.
The other day, The Wall Street Journal rather matter-of-factly reported that the slide in US industrial production in September was entirely due to hurricanes and labour unrest at Boeing, as though the turmoil in the broader economy had nothing to do with it — and even as the manufacturing index in the Philadelphia region plunged. Of course, the plunge in the automobile sales had nothing to do with the slide in industrial production.
The reluctance to tell the truth even at this juncture is rather disturbing. Either it is too scary to face up to or no one is able to comprehend it yet.
In India, it is depressing to see how quickly things are unravelling and how, in the name of addressing the liquidity crisis, bizarre decisions which would have no impact on the immediate issue (reopening of the participatory note) have been taken.
Motivated by hubris and delusions of grandeur, businesses have expanded without concern for risk. Leverage threatens to undo corporate balance sheets and that would have ripple effects on bank balance sheets. Smaller political parties, unmindful of the immense strategic consequences at stake here, are playing bullies. For reasons that we do not fully understand, businesses are succumbing to blackmail.
Left unchecked, populist solutions would aggravate the problems at hand. Long-term damage to India’s economy and image would be colossal. Both the national parties must come together and use the crisis to initiate measures that raise not only short-term liquidity and relieve pressure on the rupee but also address long-term reforms. The signalling effect that such reforms would have on investor confidence would be considerable. They would reverse capital outflows.
This is the true test of the arrival of Brics and that of leadership in the country that is in the centre of it. If we set an example of decisive and moral leadership, the pay-off for the nation would last generations. If we do not, we run the risk of causing permanent and grievous damage to the nation’s integrity and security.
V. Anantha Nageswaran is head, investment research, Bank Julius Baer & Co. Ltd in Singapore. These are his personal views and do not represent those of his employer. Your comments are welcome at firstname.lastname@example.org