One element of the necessary response is in the making — giving banks access to unlimited taxpayers’ capital, guaranteeing interbank lending and pumping cash into the system. I suspect that only majority government control of the West’s major banks will now stabilize matters. But that is not enough. The markets no longer believe in the financial market structures they have invented. As a result, the US Fed, the European Central Bank, the Bank of Japan and Bank of England must become not just lenders, but insurers of last resort, providing the insurance contracts that the markets have stopped. Governments must write CDSs themselves.
In future, the global credit derivative markets will need to be organized into regulated, licensed exchanges rather than conducted in a way that made the Wild West look tame. We will need a global authority to supervise the credit derivative markets, write insurance contracts and stand ready to guarantee that contracts are settled. And we will need a global, independent credit rating agency to assess risk objectively. More immediately, there needs to be deep co-ordinated cuts in interest rates; last week’s half percent cut was useful but inadequate.
I don’t know whether politicians and their advisers can move as quickly as they need in so many areas and collaborate across so many countries to restore stability. Most of those who should be leading the world’s recovery are, politically speaking, numbered among the politically walking wounded or dead; either near the end of office like US President George W. Bush, in a fractious coalition like German Chancellor Angela Merkel, or leading a dysfunctional party like the weak Japanese Prime Minister Taro Aso.
Without collaboration and leadership, we face disaster. On Friday, there were terrifying signs that the contagion was spreading to the foreign exchange markets: for example, the Australian dollar dived 20 percent against the yen over the week; the pound fell 3 percent against the dollar. If investors start to think that politicians cannot control the situation and the necessary international action falls short of what is required, then the UK has got neither the GDP nor financial firepower to support the scale of capital flight and financial losses that will hit London.
The pound could fall by at least the 30 percent to 40 percent that currencies fell during the Asian financial crisis. London could become the center of the rout. If so, it will not just be complete nationalization of the banks we will be considering but the reimposition of capital and exchange controls.
For 30 years, greedy, callow, ignorant financiers, supported by no less callow politicians from all the political parties, have proclaimed the wonders of financial innovation and how proud we all should be of London. The price tag for their behavior is an economic calamity. We should never have bought such snake oil. The consolation in these dark times is that we never will again.
RSS