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THE GROWTH MYTH LEADS TO THE CRISIS by Paolo Savona
HOW THE FINANCIAL POWER CENTRE IS CHANGING by Marcello De Cecco
PROFILES AND PROSPECTS OF THE REAL ECONOMY by Fabrizio Onida
NAPOLEONI: A NEW BRETTON WOODS? COME ON… by Donato Speroni
PROFUMO: MORE GOVERNMENT, MORE REGULATION, MORE MARKET by Vittorio Borelli
THE TURMOIL SPREADS TO THE EAST by Fabrizio Coricelli and Debora Revoltella
FINANCIAL SHOCK by Antonio Barbangelo
WAITING FOR CHINA BY Alessandro Arduino and Cristina M. Bombelli
After the Tsunami
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DOSSIER
DOSSIERDRAMATIC TURN OF EVENTS ON THE FINANCIAL MARKET LED TO
THE
AFFIRMATIONS THAT THE MARKET HAD FAILED, WHILE THE USE AND ABUSE
OF FREEDOM OF ACTION WAS NOT ONLY ALLOWED, BUT ACTUALLY
ENCOURAGED BY POLITICIANS, AND THE FEW CONTROLS THAT SHOULD HAVE
DOSSIER
The growth myth
led to the crisis
by Paolo Savona
The crisis emerged because the U.S. used its economic policy, especially
the monetary aspect of it, to sustain income and employment growth
without accepting the balance of payments constraint that practically
every country in the world faces. And now the West should not envisage
getting out of the crisis by discharging responsibilities that are primarily
its own on China and Asia
If we do not give in to the temptation of “thinking badly,
convinced we are getting it right”, to paraphrase former
Italian prime minister Giulio Andreotti, we can reasonably
affirm that the control of finance slipped out of the hands of
American official authorities and private-sector managers,
with disastrous consequences for their country and
subsequently for the rest of the world. The problem, which
was initially financial, is now becoming real, and will end up
affecting the geopolitical balance. It is to be hoped that the
new American President will have the courage to immediately
reject a logical extension of the concept repeated by more than
one Treasury Secretary, i.e. that the dollar is their currency,
but our problem. There is not the shadow of a doubt that the
financial crisis is our problem, but it is theirs too, and the
ways in which it will be tackled could change the world’s
political framework and undermine the American leadership,
thereby putting the European Union in serious difficulty.
There has been one declaration of good intentions after
another, including joint ones, but no “political” diagnosis of
why this happened. And, with the exception of a few
monetary steps, action has been confined to the national level.
The crisis emerged because the U.S. used its economic
policy, especially the monetary aspect of it, to sustain income
and employment growth without accepting the balance of
payments constraint that practically every country in the
world faces. This was made possible by the fact that the dollar
is used as an international reserve currency and that the U.S.
enjoys confidence as the world leader. The policy of
indiscriminate support for internal growth can be considered
to be nothing short of subjugation to the “growth myth” that
has penetrated American politics so deeply that it conditions
the election of a president. If he is running for re-election, the
candidate has to convince citizens that he has worked well for
the economy, and if he is a first-term candidate he has to
show that he is capable of doing it. The difference in the way
the two American parties govern the economy has diminished
considerably in the past few decades and, after Kennedy and
Johnson’s ideal of a “Great Society” had demonstrated its
limits, the growth myth dovetailed with the conviction that
free initiative would satisfy the American dream better than
public intervention. However, the free market turned into
financial anarchy without political or business leaders
realising that they were heading down a dead end street. Nonbanking finance in particular used derivatives to abuse the
freedom it was given and the crisis became inevitable.
The dramatic turn of events on the financial market led to
affirmations that the market had failed, while the use and
abuse of freedom of action was not only allowed, but actually
encouraged by politicians, and the few controls that should
have been exercised were applied in a very “loose-knit”
manner. There are therefore several reasons to invoke
government failure, or at least both government and market
failure, and once again, those who will pay most dearly are
the ants, the people who were saving money, not the
grasshoppers who were getting into debt. The United States
will probably manage to limit the collapse of manufacturing
and get the stock market going again, making it possible to
reabsorb part of the serious financial losses it has incurred,
but pension funds and similar forms of savings accumulation,
i.e. the backbone of society and the economy in America and
the rest of the world, will still suffer damage. This backward
step on the road to wellbeing will be hard to explain to the
people who viewed their financial savings as a way to protect
them in their old age. However, instead of turning to the
market and asking the government to extract it from financial
anarchy, they will keep thinking of and asking for public
protection, thereby increasing the public debt and diminishing
the extent to which their own wellbeing can increase.
Frightened by the way the crisis was shaping up a few
weeks before the elections, the American electorate appeared
likely to turn to the Democratic Party led by Obama, who
promised to widen the social protection network without
questioning whether the U.S. Treasury’s commitment to save
what could be saved of the financial system would leave
sufficient room to fulfil the promise of more welfare. If, on
the other hand, the elements that make up the American
dream – free enterprise and the expansion of opportunities
offered to citizens – had continued to be held valid even after
wiser regulation of finance, then electors might have renewed
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BEEN EXERCISED WERE APPLIED IN A VERY “LOOSE-KNIT” MANNER.
THEREFORE IT WAS THE GOVERNMENT WHICH FAILED, TOO. BUT ONCE AGAIN,
THOSE WHO WILL PAY MOST DEARLY ARE THE ANTS, THE PEOPLE WHO WERE
SAVING MONEY, NOT THE GRASSHOPPERS WHO WERE GETTING INTO DEBT
their confidence in a Republican administration. The electoral
test was interesting not so much in terms of the traditional
right-left divide as in terms of ascertaining to what extent the
crisis had shaken up the American conviction of a domestic
and global free market being a good thing, albeit within a new
regulatory framework capable of forestalling abuse and crisis
as much as possible.
The problems the financial crisis has created on the other
side of the Atlantic and the Pacific, on the other hand, appear
to be less serious but more delicate to tackle. The “European
dream” put equal faith in market possibilities and thereby
allowed the birth of a single currency; however, it put less
faith in the virtues of competition, counting to a larger extent
on public assistance rather than job opportunities. The
European citizen insistently asks the State for more
guarantees. If the American financial crisis were to seriously
spread to the global real economy, the resulting social tension
could diminish an already insufficient will to forge a common
destiny for the “Old” Continent and strengthen the
centrifugal trends of the political union, which emerged with
the French referendum on the proposed EU Constitution and
the Irish referendum on the Lisbon Treaty. The first impact
would be an overlapping of the European dream within the
context of a “zollvereign”, a Customs Union. This could still
have its advantages, if not for the fact that economic history
teaches us that such unions do not last long unless they are
reinforced by common political will. If this were the only
political structure, the euro in its turn would come under
strain. It is no coincidence that it is the euro that has devalued
significantly at the worst time for the dollar. There is
obviously a loss of belief in the staying power of a political
European Union regardless of the fundamentals of its
economy, which, although far from brilliant, are nevertheless
less exposed to risk than those of the American economy at
this juncture.
The economic problems actually appear to be minor on the
Asian side of the Pacific. Very little is known of the extent to
which the financial crisis has impacted Chinese savings. One
news item has symbolic value, however: the Chinese central
bank has lost all its capital because of the devaluation of its
dollar investments – a unique event in the history of these
institutions. Of course it is nothing serious, because the loss
concerns the country’s State-administered wealth and will
have no direct impact on banks and financial markets, which
are, on the other hand, exposed to the winds of the crisis. The
global recession will slow down the process of export growth,
but China has such ample accumulated reserves that it can
substitute domestic demand for foreign demand by
accelerating its social spend, which is still lower than the rest
of the developed countries. If it does not do so, social tensions,
which are already running high, could increase further and
the problem would be transferred to China’s geopolitical
relations, especially vis-à-vis the United States, where their
crisis originated.
This interpretation principally points an accusing finger at
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the American authorities, but it is only correct to emphasise
that the American policy of sustaining domestic demand to the
point of running up a huge foreign debt by creating dollars
and selling financial assets allowed the establishment of an
insane laissez-faire on traditional and innovative financial
markets. Authorities in the rest of the world did not challenge
this policy, wrongly interpreting it to mean that despite
accumulating imbalances, it was useful for world growth. The
originating error was matched by passiveness at the receiving
end. And this passive attitude does not seem to be the focus of
critical revision and adequate decisions, considering that even
the latest documents produced after the meetings of heads of
State, finance ministers and governors of central banks contain
affirmations that, besides outlining measures to be taken at the
national level (supply liquidity, recapitalise banks, guarantee
deposits and support the financial system in various ways),
approve certain positions that are at odds with the stability
that appears to be the objective of their declarations of intent
and the decisions they have taken.
We believe that politicians have good reasons to gloss over
an examination of the origin of the crisis and its development,
since they have to mitigate its negative impact on
international relations. What we cannot understand is how the
central banks (all of them, in our opinion, but the Fed and the
ECB in particular), which have been guaranteed independence
from democratic bodies to make them freer to take the right
decisions, even unpopular ones, could sign a release saying
“We reaffirm our shared interest in a strong and stable
international financial system” and then add that “excessive
volatility and sharp currency fluctuations have adverse
implications for economic and financial stability” without
mentioning that the world’s currency exchange regime must
therefore change from “free” to “dirty”, i.e. managed, while
making a general statement that the objective will be achieved
by monitoring exchange markets and co-operation “as
appropriate”. Their statement is at odds with the desire for a
strong and stable international financial system because it
says that, “given China’s important role in the global
economy, we urge the authorities” (Chinese, of course) “to
allow accelerated appreciation of the effective yuan-renminbi
rate as a means towards a better balance in the domestic
economy and the promotion of external stability”.
Going by this release, greater stability and less volatility in
markets depend on the balance between Chinese exports and
domestic demand and a revaluation of the yuan. However, the
release makes no mention of the fact that these steps will
require a re-absorption of excessive U.S. domestic demand and
the laxity of U.S. lending activity, the creation of a global
monetary standard, the elimination of differences in exchange
rate regimes as a result of the WTO’s liberalization rules and
the re-organisation of the substantial build up of dollar
reserves to regulate their conversion into euros on the market
and their use by sovereign wealth funds. These problems must
be solved if we wish to ensure that we do not go from one
crisis to another.
How the financial power
centre is changing
by Marcello de Cecco
It is unclear who will take the place of Goldman Sachs and the other
broker-dealers. They could actually stay at the centre if a patched-up
“originate-to-distribute” model were to remain in place after various
bailouts. There is undoubtedly a Chinese power centre alongside the
traditional American one. Europe must work fast to forge a common
strategy
The “originate-to-distribute” model appears to have had its day, at
least as regards the possibilities it shows for further expansion. The
crisis actually casts doubt on its continuation, since the leverage
capacity the model requires will have to be considerably resized if
the absolute liquidity preference situation the system suffers from,
which has made it semi-immobile for nearly a year, is to be partly or
fully eliminated. Goldman Sachs and Morgan Stanley’s request to
become commercial banks and therefore be subject to Federal
Reserve supervision rather than the more indulgent supervision of
the SEC, which they had fought to obtain at the beginning of the
decade, is clear proof that these titans of the model, who formed the
centre of the huge network of innovative financial transactions
created in the past decade together with JP Morgan Chase and AIG,
feel that the model has no prospects and that the near future will
belong once more to institutions with a substantial deposit base.
So the financial power centre of the world is changing and it is
unclear who will take the place of Goldman Sachs and the other
broker-dealers. They could actually stay at the centre if a patched-up
“originate-to-distribute” model were to remain in place after various
bailouts. It appeared that the moves by Treasury Secretary Paulson
were to be interpreted along these lines, at least until the acceleration
of events forced him to act from a standpoint of absolute emergency
and actually abandon the attempt to set up a financial structure that
would allow investment banks to survive as the nerve centre of the
whole system.
Besides the “originate-to-distribute” model, the global financial
system has grown over the past two decades by creating the network
banking model and granting loans on so-called probabilisticinsurance principles and no longer on the basis of stable
relationships evaluated using traditional reliability criteria for
individual customers. Moreover, many loan relationships have been
turned into market transactions and shifted off-balance sheet to
follow and circumvent the Basel I regulations, which increased
capital coefficients and made them the central element of bank
supervision.
The question is whether this model too will end in crisis,
considering that the main reason it was able to develop was that
returns on loans granted in the new way are high if the loans are
treated as commodities that can be packaged into big securitizations
and rapidly sold so that the capital used re-circulates quickly. Also, in
the case of non-performing loans, the sale of packages to entities
different from the banks but owned by them generates a loss for the
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banks, which can be written off for tax purposes with the hope of
profits for off-balance sheet companies if they manage to resell
securitized loans at prices higher than the purchase price or collect
loans by the due date, possibly by selling them to special purpose
debt collection companies: separate entities that, however, remain the
property of the originating banks.
Another essential element for the model are credit default swaps
to cover potential losses, traded by the two earlier-mentioned
investment banks, the now-defunct Bear Stearns and Merrill Lynch
and the survivors AIG (now partly government-owned) and JP
Morgan Chase. This market grew by sixty times in volume since
2005 because it, too, was essential to the working of the new
business model that most of the world’s financial operators adopted
in the climate of marked uncertainty that prevailed on the market
post-2005, when U.S. monetary policy changed direction with a
rapid hike in the Federal funds rate. We will see the extent to which
the market will be transformed by the regulation on such
transactions that New York State has already announced and that
the head of the SEC has requested.
The regulation brings another important problem to mind: that
of the particular methods used to carry out the majority of so-called
innovative financial transactions, i.e. agreement between the two
parties for each individual transaction without any fixing of prices in
regulated or free, but centralised, markets. This method, known as
over-the-counter trading, is now being held responsible to a large
extent for the uncertainty related to evaluating the new financial
instruments, which has facilitated the creation of the state of
absolute liquidity preference that markets have been reduced to for
the past year. In fact, transactions carried out in this way give the
market no possible way to exercise its best-known and most useful
function: that of price discovery. The prices of individual transactions
are not public; they cannot be compared by agents, apart from those
directly involved, and therefore cannot form a basis for other
transactions.
Another activity essential to the functioning of the model is risk
evaluation by rating agencies. Even though they cut a sorry figure in
the first half of the decade with the Enron case, Parmalat etc., these
companies were still entrusted with essential functions like risk
analysis of bonds, which form the basis of securitization. The
systemic conflict of interest in which these companies found
themselves, and still do, because they are paid by the clients whose
products they rate, has been criticised several times, but nothing has
been done to eliminate the situation or replace the rating agencies
with other entities. In fact, ratings serve as the basis for the risk
evaluation used to calculate capital coefficients under Basel II.
Moreover, a change in the legal status of U.S. rating agencies in 2004
made it possible for them to be held accountable for their advice only
in case of fraudulent intent, not even in case of gross misconduct.
This amounts to virtual legal immunity. Ecofin and the Brown Plan,
as well as the IMF reform policy, now envisage supervision of these
companies by watchdog authorities. It would be opportune for the
latter to do so efficiently, starting by at least eliminating the
unbelievable clause that rating agencies have felt the need to add to
each rating they produce, which exempts them from all
responsibility.
DOSSIER
The collection of international regulatory standards known as
Basel I and II are also one of the basic reasons for the transformation
of international finance in the past decade. These accords chose
capital coefficients as the main instrument to measure banks’ credit
potential and credit risk. Alongside the regulations that go under the
collective name Basel I and II, there is a type of bank supervision
that takes only, or practically only, compliance of quantitative
coefficients into account (Basel II has modified this approach to some
extent) and almost totally abandons the traditional activity of credit
risk and asset improvement evaluation carried out by supervisors on
a case-by-case basis. And with assets in bank portfolios circulating
faster, massive recourse to bilateral transactions and the spread of
risk obtained – at least in formal terms – because of securitization, it
is quite difficult to evaluate the portfolio itself at any given time.
Additionally, the notion of capital coefficients loses much of its
effectiveness as an indicator of a bank’s solvency when the bank’s
actual assets are spread out among vehicle entities that are
independent of the bank on paper but really fully owned by it.
Legally, these entities are not consolidated in the bank’s balance
sheet, but as things turned out, they had to be consolidated when the
banks ran into difficulties and realised they would be more likely to
risk their reputation by refusing any responsibility for these entities
than by consolidating them into their balance sheets, even though
their capital coefficients plunged as a result. It was precisely for this
reason that the American authorities took a cue from the Brown
Plan and used a substantial $250 bn of the $700 bn allocated by the
Paulson plan to recapitalise banks, with the government taking
stakes in major banks (albeit in the least invasive way possible).
Looking at the way the global financial system has evolved over
the past two decades, particularly the evolution of the American
financial system, which forms its centre, the unavoidable conclusion
is that American economic policy authorities intentionally
encouraged this growth pattern; that most developed countries
imitated it with a combination of admiration and repulsion, and that
international financial organisations tried to impose it at every
opportunity on developing countries as well. The authorities’ actions
and omissions were aimed at achieving this pattern. For example,
regulatory and economic policy authorities in the U.S. and many
other countries, as well as most academic economists, viewed the fact
that the Basel regulations led banks to develop huge amounts of
officially off-balance sheet financial activity to comply with the
establishment of capital coefficients as legitimate financial
innovation and a sign that the more efficient operators were in good
health, rather than as clear evasion of existing norms in most cases.
However, if it is true that the end goal of economic activity is to
maximise the production of goods and services, maintaining that a
reduced level of financial activity would not have major
consequences on the activity of the real economy, as most of the
media and the authorities did over the past twelve months (until the
seriousness of the crisis revealed the inanity of their position), is
equivalent to estimating that the bulk of the financial innovation
that has taken place over the past 20 years is functionally irrelevant.
If financial bubbles can come and go with no serious effects on the
real economy, it means that finance is essentially an end in itself. In
that case, why view its evolution as a sign of progress? If progress
110
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stops and actually goes backwards, and the financial system contracts
as a result, it means that all the activities that compose the system
can disappear, with no damage to anyone apart from those working
in the financial sector.
If the size of the financial sector were to be reduced, however, at
least one consequence would be that a part of those employed by the
sector would be laid off, and this would negatively impact the
demand for goods and services. All other things remaining equal, a
country’s growth rate would diminish compared to the earlier
situation.
In some countries, such as the U.S. and the U.K., there would
undoubtedly be a significant effect on employment and income, at
least for some kinds of demand for consumer goods and services.
Generally speaking, maintaining that the financial system has
little relevance for the real economy corresponds to the neoclassical
position, which holds that currency is merely a veil covering the
economy’s real transactions: it is able to influence the general level
of prices but incapable of influencing relative prices.
How will the American financial system, which showed the way
for the rest of the world, change in the wake of the current crisis? It
is essential to stabilise the system, even if this seems extremely
difficult at the moment. It is easy to predict that it will head towards
reregulation.
It is easy, but does not mean much, given that the regulations
introduced over the past few decades have tended to demolish the
segmented financial system inherited from the New Deal, but were
in fact regulations that abolished and modified other regulations in
line with a philosophy opposed to the earlier one, without the
regulators ever leaving the scene. Consider, for example, the panoply
of regulations that go under the name of Basel I and II, or the
collection of U.S. regulations known as Prompt Corrective Action.
The philosophy behind them is undoubtedly opposed to the one on
which the previous system was based. Regulators have tried not to
prescribe specific behaviour to the regulated, but merely to create
environments within which each regulated entity can move freely:
the assumption being, however, that short-term maximisation of
profit by financial institutions should be the basic behaviour model –
or the default model, to use the current term, because it inevitably
leads to a more efficient system.
However, the new model of regulation introduced in recent
decades appears to have forced the authorities into a level of
interventionism that is greater, at the end of the day, than in the
previous period. Its introduction has been accompanied by an
increase in the frequency and seriousness of financial crises, which
has obliged the authorities to act in ways that contravene the
principles they have repeatedly affirmed on the self-regulation of the
financial system within a “light touch” regulatory environment. The
American and British reactions to the current crisis are only the
latest and most glaring example of this.
It was believed that the government’s role in safeguarding savings,
which had shaped the 1930s reforms, could be reduced to encompass
merely the weaker sections of society, while the strong could be left to
take care of themselves. Instead, governments have very often been
forced to invoke the protection of the weakest to get the strongest out
of the messes they have repeatedly got themselves into.
_Declarations by both Paulson and Bernanke
(above) gave firstly the impression that, in order to overcome the crisis, it was enough to
take measures that would serve above all to
reverse expectations
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DOSSIER
_The recent crisis has revealed the need to
take measures to move towards unified supervision at the European level. And also the
ECB (in the picture President Trichet) should
have a different philosophy to that of the United States
112
A new model of regulation must therefore take a direct and
unfeigned approach to the issue of moral risk that has been created
by the accumulation of a succession of crisis-resolution incidents
using public money and direct intervention by regulators in the role
of the saviours of the system and each of its components.
Specifically, following the current crisis and its probable
developments, it will be truly hard to maintain the credibility of the
notion that no market operator is too big to fail.
What are the lessons for Europe? If we take a pessimistic outlook,
regardless of any possible detailed intercontinental agreements
(which, however, seem improbable, even if they are now requested
out loud by the highest bodies such as the U.N. General Assembly),
measures to move towards unified supervision will have to be taken
at the European level, establishing in due time whether such
supervision should be entrusted to the ECB or to an institution
separate from it. Those who defend the latter hypothesis could risk
appearing in the same light as those who maintain that the lastminute lender should intervene to help illiquid but not insolvent
banks. In fact, it is near impossible to keep the two institutions, the
monetary and the supervisory one, separate in practice even if they
are located in different European countries. The important thing is
for both to be isolated from the influence of national governments
or even a EU government that might be created on the basis of the
Lisbon Treaty’s recommendations.
Both the ECB and a European watchdog authority should of
course have a different philosophy to that of their sister
organisations in the United States. While these philosophies may
concur, Europe’s must be the result of an independent thought
process to reflect the specificity of European financial institutions,
the European economic system as a whole and European values.
Even if Europe manages to create a common watchdog, the fact
remains that our real and financial institutions cannot isolate
themselves from a global trend towards wealth concentration that
has emerged particularly strongly in the past decade and
substantially led to the financial behaviour mentioned earlier
(excepting the spread of subprime loans, which is however also a
reaction to the trend, an attempt to keep two mutually exclusive
models going: wealth concentration and the “Saudi-Russian” model
preceding its spread and the model that gained the United States the
whole world’s affection over the past century. Subprime loans, Alt-A
loans and even Jumbo loans are basically the financial equivalent of
Wal-Mart and Ikea, as they are used to try and keep some income
groups within the middle class by allowing them access to assets
such as home ownership that have typified the middle class for
decades).
Like the growth of private banking, the hedge fund boom is also
part of the divergence of the distribution range. While it is true that
hedge funds have recently gone through a process of
“democratization”, they are the financial system’s response to the
new situation of fairly substantial wealth concentration, most of it
still in the United States but also on the rise in countries such as
Italy, France, Spain and even Germany in the 1990s and the new
century. Their growth was also caused by a progressive slump in
returns on mutual funds, based on global portfolios. Hedge funds are
now cutting back because of the non-availability of leverage and
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their customers fleeing, but if there is no change in the polarization
of income and wealth, the return to a banking model based on
collecting deposits through a widespread network of branches
through the country could coincide with either a decline in bank
profits or, worse, an attempt on the part of banks to keep profits high
by extorting their retail clientele, which has benefited from reduced
service fees because of increased competition in recent years.
Now Goldman Sachs and Morgan Stanley’s decision to become
commercial banks and probably buy up a few deposit and branchrich banks, which was preceded by Deutsche Bank’s acquisition of
Germany’s post office bank and Mediobanca’s initiative to create an
online bank to collect deposits on the lines of the ING Orange
Account, should demonstrate that the lead players in the system
believe they are turning the page and returning from the market to
the intermediaries.
If this is really the case, Europe, with its financial system in
which banks still predominate over the markets, its conservative
approach to mortgage lending and its ability, demonstrated anew
recently, to take shared action, after dangerous hesitations and
individual efforts, in order to follow a best practice example such as
the Brown Plan, should find itself in a better position than the
United States and able to withstand the competition from financial
systems such as China’s, which has huge reserves and is still very
dirigist.
However, the recent events have brought another problem to
light: the size of the big banks and that of the economies of the
countries in which they are headquartered. The “too big to fail” idea
conflicts with the effective credibility of the notion that the
monetary authorities and the government of a given country can
save a bank when the totals on that bank’s financial statement are
substantially larger than the GDP of the country. The idea has
therefore changed into “too big to be saved”, which is borne out by
the comparison between the balance sheet figures of some big banks
and the GDP of the countries in which they have their headquarters.
Taking this consideration too into account, the main question
remains: given that we will have to navigate on permanently stormy
seas, do we want the big banks, which can withstand shocks better, to
be strengthened in Europe, and put aside the entire philosophy of
the European Court of Justice, for example, or that of the European
Commission or some countries like Italy, of encouraging
transparency and competition? Should the recently introduced IAS
regulations, for example, be permanently changed as regards the
marking to market of bank assets? Big banking groups in France,
Germany and even the U.K. have long been making undercover
attempts to obtain a return to the old system. These efforts became
overt after the crisis worsened, to the point that authorities at the
national and supranational levels have declared the objective of
rejecting the new rules. We can now ask whether the decision to
allow some assets that have lost a lot of value because of recent
market trends to be classified as held-to-maturity instruments
instead of held for trading is only a temporary one dictated by the
imperative of emergency, or whether it indicates a lasting change in
the regulatory and accounting philosophy.
We are therefore looking at a systemic situation for the banking
systems of major countries, where bank consolidation prevails,
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DOSSIER
especially after the mergers and acquisitions caused or enhanced by
the crisis and encouraged by the authorities. Banks have therefore
become even bigger in recent times and the level of competition
within individual countries has diminished further as a result of the
crisis. But national authorities are still responsible for bailouts, except
for cases like Dexia and Fortis, where the national authorities
involved split up the task of intervening to save these cross-border
banks. This is obviously an untenable situation and Europe will have
to remedy it in a stable manner, and not through emergency
operations in which national authorities act together while claiming
that such joint efforts are exceptional.
Alternatively, should we do for the financial sector what was
done for the airline sector, with France and Germany allowing their
national airlines to have extremely large shares of the national
market and thereby be very dynamic on the intercontinental front
and very competitive, or is it better to follow the example of Italy,
which has liberalised the sector by encouraging the creation of a
number of small companies incapable of surviving and allowing the
national airline’s share of the Italian market to drop to 30%? This is
a rhetorical question and it is being asked after the fact, but the basic
question remains whether we wish to choose the path to follow by
developing a European financial system integrated into a global one
in which the “Chinese model” will probably prevail over the model
that the American authorities, the Italian authorities and the
European Court of Justice view as the right one. Do we want
neomercantilism at a pan-European level or not? This will decisively
depend on the direction taken by Europe’s main interlocutors, which
are still the United States and Japan. While it is not hard to predict a
more or less marked return to the mercantilist philosophy that
prevailed until a few years ago in Japan, it is harder to predict what
the United States will do, because the impression that actions by the
government and supervisory authorities have so far given is that of a
temporary slackening of rules and a philosophy of government
intervention justified by the need to tackle the emergency by giving
private sector operators public funds, but with no pretension of
contributing to any extent to deciding the operating strategies of the
private institutions in which the government has taken a stake. This
is clear, for example, from the government’s view of the legal status
of the two institutions the State bought after having created them in
the past. The current government does not appear to still consider
them public assets.
It is too soon to formulate precise opinions on the position the
new Democratic President will take vis-à-vis these issues. Perhaps
the position of the President and his collaborators will be initially
classifiable in one way and change radically after a few months. This
has already happened in the past: during Clinton’s first term, when
the U.S. went from a dirigist and mercantilist position such as
France’s and especially Japan’s, with a preference for a weak dollar
and the views of economists such as Laura d’Andrea and Joseph
Stiglitz, and then made a 180° turn under the influence of Robert
Rubin and Lawrence Summers and Greenspan’s very authoritative
support to adopt a strong-dollar policy and reposition the New York
stock exchange as the world’s top financial market, freeing
institutions of virtually all controls.
The current Democratic platform tilts far less towards a precise
114
world view as regards banking, finance and currency, reflecting the
caution that has so far seemed to be the watchword of the
Democratic President-elect. It is even harder to see which way the
cat is going to jump now that the elections are over. A lot will
probably depend on the turn the international financial crisis takes
and the consequences it will have on the real economy: consequences
that appear to be a lot more serious than those that many, including
the IMF, hoped for until only a few months ago and did not hesitate
to openly say.
Finally, we should remember that one of the worst sources of the
worsening of the crisis that has struck the international financial
system was its coincidence with the long American electoral
campaign. We cannot say how the American authorities would have
tackled the crisis without elections in the offing, but we do know
that many of the actions they did take were influenced by the
upcoming election deadline, reducing the range of these actions and
leading to a preference for a sequential approach of handling one
problem at a time with temporary and limited measures. In general,
observers got the impression, corroborated by declarations by men
such as Paulson and even Bernanke, that the American leadership
thought it was enough to take measures that would serve above all
to reverse expectations without really going to the roots of the
situation. Despite the warnings of experienced people such as Anna
Jacobson Schwartz, who co-wrote the well-known Monetary History
of the United States with Milton Friedman, this was said to be a
liquidity crisis that did not concern the solvency of financial
institutions. The American leadership thought that a market
liquidity freeze based on uncertainty could be melted with a barrage
of declarations and measures, which in their turn were declared
rather than implemented, such as the announcement of the setting
up of a $700 billion fund to buy up banks’ toxic assets. The
subsequent recourse, as mentioned earlier, to the “Brown model”,
with the State buying stakes in banks, demonstrated a delayed
awareness of the fact that insolvency, and not only illiquidity, was
the issue at stake, and that it was therefore necessary to go from
“Chinese shadow boxing” to “Western” boxing with genuine, not
merely simulated, blows.
Therefore, it is not in the least exaggerated to conclude that the
American leadership significantly worsened the crisis on finding
itself in the eye of the global financial hurricane. It generalised and
extended the crisis to the outreaches of the system by taking
reluctant and delayed action because it was concerned about the
electoral consequences of drastic and general measures, and therefore
determined to avoid them until they became inevitable. Since the
crisis had exploded in the United States, no one but the American
authorities could tackle it. The rest of the world therefore watched
the actions and omissions of American leaders with a growing sense
of frustration. Leaders elsewhere were aware that they could not
stand in for the Americans and would perhaps only be able to avoid
the consequences for their own financial institutions with a return to
marked national dirigisme: a far cry from the recent operating
philosophies of most of the governors and the governed in most
countries. They were also aware that the consequences of the
American financial crisis on the global real economy would be
absolutely unavoidable.
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DOSSIER
Profiles and prospects
of the real economy
by Fabrizio Onida
Grazia Neri_AFP
If Schumpeter’s “creative destruction” stimulates real economic growth
through the rapid spread of technology and strong competition
between companies, the financial crisis we are experiencing appears to
be more of a “destructive creation”, i.e. an excess of unregulated or
badly regulated financial innovations resulting in market paralysis
and triggering recessive crises. To gauge the extent of the phenomenon,
consider that the Bank for International Settlements has estimated
that the face value of all the financial contracts in the world went in
the space of one decade from US$ 75 trillion at the end of 1997 to US$
600 trillion at the end of 2007, i.e. approximately 10 times world GDP
_For Russia and other oil and gas producing
countries, the fact that international prices
have dropped by half compared to the early2008 peak has begun to seriously erode prospects of maintaining the growth rhythm of
household consumption and investments
116
1. What does economic theory suggest as regards the impact of
this financial crisis on the real economy?
A healthy, albeit delayed, rediscovery of Keynesian
macroeconomics provides the key elements of the response. The
primary effect, slowing household consumption, is the result of the
so-called “wealth effect”: the bursting of the speculative bubble in
housing prices in the U.S. as well as the U.K., Spain and many other
countries, and the related global bond market bubble, quickly resized
the purchasing power of savings, thereby generating a rapid
downward revision in planned spending, starting with consumer
durables such as cars, household appliances, furniture, computers and
televisions. The collapse of stocks and bonds on global markets
triggered by the subprime crisis through the upside-down pyramid
of opaque securitizations self-sustained this negative “wealth effect”.
In a climate of a generalised crisis of confidence in market risks and
credit and counterpart risks (without offending the stabilizing
“rational expectations”, so different from potentially destabilizing
Keynesian expectations), liquidity in the inter-bank market has dried
up drastically and household and business loans have tended to grow
rarer. Banks and non-banking financial intermediaries (from
investment banks to hedge funds) have been forced to sell off assets
to deal with withdrawals by customers and partners fearing for their
savings, thereby contributing to sending the share prices of the best
companies, which are more easily sold on the market, into a spin.
And current yield losses of savings in stocks and bonds have gone
into a dangerous tailspin.
It is a short step from the wealth effect to the “disposable
income” effect, because the drop in demand for durables translates
into fewer hours worked, less demand for intermediary goods, less
income and, in turn, less demand for consumer goods. The prospect
of lower sales and profits lead companies (manufacturing,
construction and services) to postpone investment plans, the other
important component of demand that supports GDP. Corporate
investments and working capital financing could risk strangulation
because of signs (so far limited ones) of a credit squeeze by the worst
hit banks.
Export companies try to expand their foreign clientele, sacrificing
export profit margins if need be, to compensate for the fall in
2. Emerging markets’ role as drivers of the world cycle to weaken
I fear this is still too optimistic a scenario because of the
progressive worsening of recessive signals in the “triad” countries
and the negative repercussions on the rest of the world, as well as
because many emerging markets (the OPEC countries, Russia, Brazil,
South Africa and others) will be hit by the downward trend in the
prices of vital commodities after these peaked all the way to early
2008.
The effect of decoupling the locomotive of the emerging markets
and the slow-running wagons of the wealthy countries could
however diminish in the coming quarters, because the recessive cycle
is tending to self-propagate through world goods and services
markets and increasingly interdependent capital. Juan Somavia,
director general of the International Labour Organization in Geneva,
fears that the number of unemployed people outside the triad
countries could go up to 20 million by the end of 2009.
China has been the world’s second-largest economy after the U.S.
for some time now based on GDP at purchasing power parity, and
recently also became second largest in current dollar terms, not to
mention the world’s second biggest exporter at market prices. The
IMF estimates that China’s growth will slow by nearly three points
in 2009 to less than 9%, while countries in East Asia, Australia and
New Zealand will suffer smaller markdowns. There has been a drop
of about 20% in outbound Chinese tourism, which has become a
significant foreign currency earner for many neighbouring countries.
The drop in property prices in coastal Chinese cities has gone hand in
hand with a 70% loss of value for the Shanghai stock exchange
compared to one year ago. However, one positive effect of the
Chinese economy’s slowdown is the fall in prices of many raw
materials and semi-finished goods, particularly iron ore and steel, for
which prices had climbed steeply in recent years precisely because of
the voracious demand sparked by China’s massive infrastructure
investments. One worrying sign of an international recession is the
steep dive (95% since May) of the dry bulk shipping index, the Baltic
Dry Index, which covers a range of commodities including iron ore:
the plunge reflects a strong downturn in freight movement from
countries like Brazil and Australia to China, America and Europe.
Despite the slowdown of the Chinese engine, several Asian
Grazia Neri_AFP
domestic demand for consumer goods and investments.
Unfortunately, the ploy does not work a time like this, when a
domestic demand crisis and the resulting drop in imports are
affecting most markets.
In recent years, when emerging countries showed robust GDP
growth rates, there was a lot of talk of “decoupling” the growth
prospects of different parts of the world, counting on the vigorous
expansion of these new players in the global economy to offset low
or slow growth in the advanced economies (the “old” Europe, the
U.S. and Japan). On 6 November, the International Monetary Fund
rushed to lower the 2009 world economic growth forecast that it had
drawn up three weeks previously (which had in turn been lowered
by nearly one percentage point compared to the April World
Economic Outlook) for the advanced countries, where growth is now
forecast at -0.8%, as well as the emerging markets, for which the
IMF now predicts growth of 5.1%.
_The International Monetary Fund has lowered the 2009 world economic growth forecast. The robust expansion of emerging countries is also slowing down. Growth in China,
which has long been the world’s second biggest economy in GDP terms, will slow by
nearly three points in 2009
117
DOSSIER
NAPOLEONI:
A NEW BRETTON
WOODS? COME ON…
edited by Donato Speroni
Early this year, Loretta Napoleoni, an expert in
terrorism and international economics,
published a bestseller called Rogue
Economics, which uses a number of disturbing
examples to demonstrate the effects of an
uncontrolled globalization accompanied by the
“death of politics”. Has the recent economic
crisis changed the overall picture? east put
this question to the author.
Not even you imagined that the system would
be hit by the crisis so quickly…
It seemed impossible that this crisis could
explode before the election in America. But the
US Treasury and the Federal Reserve
miscalculated the reaction of the markets and
thus created a situation that was
unmanageable on the eve of the election.
What will happen now? Are we witnessing the
return of politics?
The only solution to this crisis is a political
one. Let’s see whether Obama can regain
control. But I doubt it.
Don’t you think that this is a global crisis
which demands solutions involving
international governance? A new Bretton
Woods is being talked about.
I think that’s an illusion. Today’s world is very
different from the post-war world, where 62%
of gross internal product (GIP) came from
Western countries, which set down the new
rules. Contrariwise, the current crisis will
further increase the contribution of newly
industrialized countries to global GIP because
we in the West are slowing down. The Arabs
and the Chinese will hold the new Bretton
Woods…
Don’t you think that the global
economic slowdown will also affect
emerging countries? In China, factories
that export Christmas toys for Western
children have shut down…
The Chinese have a great deal of available
capital and a great need for infrastructures. If
the impact of demand from Western countries
decreases, they’ll find other markets or will
invent a New Deal of their own.
You’ve documented numerous cases in which
the Beijing government has looked the other
way (and in both directions) in response to
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countries have registered increased volatility in the foreign exchange
market, stoked by nervousness related to foreign capital flows,
perilously recalling the 1997-98 monetary crisis. South Korea’s
balance of payments has slipped in the space of a few months from a
comfortable surplus to a current account deficit and capital outflows
and the banking system is undercapitalized with respect to the size
and quality of the country’s debt exposure. The effective exchange
rate of the Korean won slipped by 30% in a few months, partly as a
result of the constant appreciation of the Japanese yen and (to a
lesser extent) the Chinese yuan against the dollar. The ASEAN
countries have begun to discuss the need for a common financial
watchdog.
For Russia and other oil and gas producing countries, the fact that
international prices have dropped by half compared to the early-2008
peak has begun to seriously erode prospects of maintaining the
growth rhythm of household consumption and investments. The
massive capital outflows from Russia in recent weeks reflect a
growing lack of confidence on the part of the leading financial groups
in the government’s ability to balance the books, and could cause cuts
in planned public investments: a worrying scenario considering the
urgent need to modernize basic infrastructure.
The drop in oil prices to below $60-70 despite the OPEC agreeing
on some supply cuts limits the scope of Chavez’s expansive populist
policy, with unfavourable consequences for the poorer countries
neighbouring Venezuela. In the Gulf States, alongside a net drop in
property prices there is the expectation of substantially reduced
revenue from oil exports, cooling the enthusiasm with which foreign
investors had increased the share of their oil-related stock portfolios.
The drop in international prices of many agricultural and mining
commodities, which benefits importing countries, therefore
jeopardizes the foreign currency position of many emerging markets
in South America and Africa. In Argentina, President Kirchner asked
Parliament to approve a plan to nationalise pension funds, which
administer US$30 billion for 9.5 million contributors, while the
Buenos Aires stock market plunged amidst fears of a default risk.
Argentina, and other countries where national earnings are strongly
dependent on exports, is worried about an export credit squeeze
caused by lower refinance loans from the international banking
system.
Finally, many Central and Eastern European countries, which
have significantly driven the “old” Europe’s production cycle in
recent years, are showing signs of fragility. The current account
deficit is spiralling towards dangerously high thresholds: 15% in
Romania and 25% in Bulgaria.
3. What are the prospects and risks in the response of
governments to the worsening crisis?
In the “Financial Times” dated 28 October, Jeffrey Sachs
estimated that a 6% drop in world GDP, with the recessive effect of
demand spreading over a few quarters, could be the direct and
indirect effect of the fall in property wealth in major countries,
starting with the U.S. Sachs believes we can avoid a hard-hitting
generalised recession (the spectre of the Great Depression in 193032 until the turning point of Roosevelt’s New Deal) by shoring up
domestic demand in China (the new locomotive of the world cycle?)
Grazia Neri
and through large-scale intervention by the IMF and central banks
to provide markets with loans. Many analysts believe that the huge
infrastructure investment programmes in the BRIC countries
among others should be maintained, as this is a pre-requisite to
removing the bottlenecks to full integration of emerging markets
into the global economy. Also writing in the “FT”, Steve Roach
urged central banks to consider the stability of financial markets as
important an objective as inflation control through money supply,
because the recent bubbles teach that the markets do not adjust on
their own: rather, they could worsen the crisis. Martin Wolf says in
no uncertain terms that “preventing a global slump should be the
priority” because “the danger remains huge and time is short”.
Larry Summers notes that 40% of American corporate profits in
2006 went to the financial sector and hopes that the skewed
distribution of income in favour of finance will soon be remedied.
The experience of the financial crises in Asia, Russia and South
America at the end of the last decade have led to critical thought on
the so-called Washington Consensus, particularly as regards the
traditional recipes of rapid and indiscriminate liberalization of shortterm capital flows. However, there do not so far seem to be any
solution to tackle a debt crisis and capital flight that does not involve
a steep hike in interest rates, as we observed recently at the
negotiations during which the IMF had bankrupt Iceland raise its
interest rate to 18% in exchange for a bailout. Meanwhile, an
increasing number of Central and Eastern European countries, from
Hungary and Bulgaria to Ukraine, are banging on the IMF’s door to
get loans to bolster liquidity reserves and prop up their currencies.
The 27-member EU, which was considerably less shaken up than
the US by the property bubble and especially the subprime crisis,
will have considerable responsibility in supplying adequate
responses to the worsening of the economic situation. In the absence
(for a long time to come) of genuine European political and
economic federalism, other, stronger collective actions such as the
ones recently undertaken under the French Presidency, which
expires end-2008, will be needed. The major issue of how to make
up for the systemic incapacity of markets to supply public goods
such as macroeconomic stability, safety, confidence and development
infrastructure has emerged once again.
There is an obvious risk that without reinforced cooperation
between national governments, the structure of the acquis
communautaire, i.e. the shared rules that guarantee full integration
of markets and a progressive push towards modernization and
competitive efficiency to the entire region, will be called into
question once more, starting with a revision of State aid compatible
with competition rules as outlined in Article 87(3) (b) and (c) of the
Treaty.
In short, these principles are: a) any interventions are to be
minimal, timely and temporary; b) they should be watchful of
taxpayers’ interests; c) institutions benefiting from State aid should
bear due consequences including the payment of fees and a
commitment to partial future repayment of previous aid, with
shareholders bearing losses and management taking cuts in
remuneration; d) the legitimate interests of competitors must be
protected and negative spill over effects should be avoided.
There is some concern in this sense about possible. There are
callous behaviors such as the exploitation of
labor and the failure to protect consumers.
Do you think this crisis will lead to greater
awareness?
These behaviors will not change over the short
term, but only with development. For those
living below the poverty line, certain
distinctions are meaningless. Such change is
an inherently natural process.
In concrete terms, then, what must be done?
Do we wait for China to develop?
I’m not offering solutions. I’m only describing
situations…
But in your book, you advance several
surprising theories on the economics of the
future. For example, you say that citizens will
revert to tribalism.
I’ve examined the way youth gangs operate.
Although they do represent an escape from
reality, they also express a demand for
participation that’s typical of tribalism and
which is common everywhere.
You also say that the Islamic system of
finance may be an answer. In what way?
It expresses the principle the bank and the
borrower share the risk. If the Sharia had been
applied, the speculative bubble that led to the
current crisis would never have occurred.
Without resorting to such extreme solutions,
perhaps a little common sense by financial
managers would have been enough, as in the
healthy capitalism of yesteryear…
No, what you call “healthy capitalism” did not
include the principle of copartnership that
distinguishes the Islamic approach to finance.
119
DOSSIER
signs of risk as regards political reactions to the ongoing crisis.
On the domestic front, in Germany Chancellor Merkel and
Finance Minister Steinbruck are studying selective measures in
favour of the automobile industry (such as tax credits on the
purchase of new non-polluting cars and car trading incentives) and
an extension of the Hermes export credit guarantee on capital
goods. In Italy, Economic Development Minister Scajola has mooted
similar aid measures for consumer durables such as cars and
household appliances. These are of course measures to sustain
domestic demand, which will however be carefully evaluated to
ensure that they do not contain any details to the detriment of
competition.
Poland could well increase aid to its shipbuilding sector, which is
now as uncompetitive as West Germany’s was in the past.
On the foreign front, governments will have to monitor the
additional problems that the current phase of the financial crisis and
the recent re-emergence of parties with a clearly populist inspiration
in Germany, Austria, the Netherlands and Denmark create for a
satisfactory conclusion to the WTO’s Doha Development Round. In
this context the EU could accept the recent proposal by two
American economists, i.e. encourage the governments of the main
countries (the G20) to start a detailed and committed global dialogue
on major issues such as food safety, energy and the environment,
which have been pressing for some time, and go beyond pure trade
liberalization, given that the WTO’s permanent action fortunately
continues to provide strong supervision to ward off scenarios of a
return to the ghosts of a distant protectionist past, such as the 1930
Smoot-Hawley Tariff.
Finally, it should be emphasised that there are good reasons to
exclude that the scenarios of the 1929-32 collapse of the world
economy will happen again today. These include:
a) The willingness of governments and central banks to exercise
cooperative strategies to stabilize markets and counter the
temptation of the “beggar thy neighbour” policies of isolationism
and exaggerated nationalism that typified the big crisis under the
regimes of the time;
b) WTO supervision of a multilateral trade regime is opposed to
the tariff war of the past, which produced the most autarchic dark
age of the 20th century;
c) The decision to give up attempts to fix unrealistic exchange
rates such as the return of sterling to the gold standard in 1925,
with the resulting overvaluation of sterling (similar to Mussolini
pegging the exchange rate at 90 lira per British pound);
d) The absence of degenerative phenomena such as German
hyperinflation.
We will refrain from any forecast, considering that some
(Anders Aslund of the Peterson Institute on the “FT” Economists’
Forum) do not exclude even worse scenarios than the Great
Depression for the near future. Such pessimism is based on
elements such as the risk of contagion panic (toxic shares) that the
huge power of the media and the Internet contribute to spreading,
destabilizing exchange rate fluctuations, the bursting of the property
bubble extending to regions such as Russia and the Gulf States and
the bankruptcy of some countries (with Italy likened to Iceland and
Ukraine!).
120
Profumo: More government,
more regulation, more market
edited by Vittorio Borelli
We are emerging from a long period of constant growth. The crisis was
caused by an excess of debt over capital. Emerging markets will keep
growing, but we will only come out of the crisis when America gets
going again. Europe needs a genuine, not just a theoretical single
market, UniCredit chief executive Alessandro Profumo tells east
As chief executive of UniCredit far the past ten years,
Alessandro Profumo has turned it into one of the most profitable
and highly capitalized banks in Europe, which has been named
Best Bank of the Year on more than one occasion. At the height
of the crisis, Alessandro Profumo found himself in the
unaccustomed position of being on trial. The markets, which had
symbolically elected him their champion in recent years,
suddenly turned their backs on him. It is well known that all the
banks in the world ran into difficulties, with their equity levels
rapidly proving to be inadequate as a result of the crisis. It is
equally well known that some of the major American and
European banks had to accept the help of their governments in
121
one form or another. But the difficulties of UniCredit and
Profumo, who had honestly admitted a few errors of judgement,
were splashed across the front pages, thereby worsening what
was actually a general crisis. How did the CEO of UniCredit
cope with the situation? What are his views of this major crisis
and its causes? What changes does he think are required to turn
the page? east interviewed him at the end of November, when
there still seemed to be no clear way out of the tunnel
At difficult times, we tend to forget the positive aspects of the
past. In Slaughterhouse-Five Kurt Vonnegut obsessively repeats
the catchphrase “So the world goes”. Once the panic caused by
the subprime crisis dies down, we will have to remember that it
was preceded by fifteen years of uninterrupted growth which
allowed many countries to hitch their wagons to the global economy train and lifted at least 500 million people out of poverty.
I agree that we do not only have mistakes and excesses
behind us. It would not be wise to throw the baby out with the
bathwater.
How did the crisis start?
By definition, growth is financed by capital and debt. The
problem is that in the past few years there was an excess of debt
over capital. We are now heading in totally the opposite direction
and if we do not find new balances, growth will obviously be
much slower.
What is the basis for recovery?
It is both technical and financial. Some aspects are connected
to the future development model, which will be based partly on
the market and partly on the public economy. This raises the key
issue of governance to hold together and make the two of them
work well. Merit should theoretically be the selection factor in
the market economy, while political participation should
obviously carry more weight in the public economy.
Who will act as the locomotive on the macroeconomic front:
China? Asia?
I think the United States will get us going again. Asia has
kept on pulling, but it has a big problem with domestic
consumption: a substantial part of its growth has so far been
export-driven. This is why I think America will once again be the
engine, psychologically as well.
What about China?
China has major resources that come from savings. In theory
this could get the consumer market going, but there is a
problem: the absence, in China, of an efficient welfare system. If
the Chinese government were to decide to do something in this
respect, the growth of domestic consumption could compensate
for the drop in exports. But this is not a realistic short-term
objective: it will take years.
Who is most to blame for the crisis, in your opinion?
That is an absolutely legitimate question, but the answer
could get us all into a muddle. There will be time and ways to
analyse the responsibilities: for the moment we must focus on
the answers. The emergency can only be overcome if we look
ahead. As I said earlier, there was excess debt and, as Professor
Tabellini wrote in an excellent article in “Il Sole 24 Ore”, this
essentially relates back to the authorities, which must regulate it.
It is true that the financial system threw itself blindly into the
situation, under-evaluating the risks of the excessive availability
of liquidity. But as the saying goes: People who live in glass
houses shouldn’t throw stones.
How can we rebuild market and consumer confidence?
There will have to be concrete and perceptible changes. Every
player should do his bit at this level: there are tasks politicians
are responsible for and others that are up to the authorities. As
for banking, I think it will all revolve around new products and
new customer relationship models. We will need time to recover.
Speaking of changes, at one point, given the daily, irrational
destruction of stock market value, someone proposed shutting
down the stock market the way Putin did in Russia.
The thing is that while you shut down the stock markets, you
have to do something to make sure that trading won’t restart the
same way as before when they reopen. Shared measures would
have been necessary in any case. I think the main problem is to
get the debt market working again, not least because the stock
market is basically the only liquid market left.
Various people in various places have said and written that we
are at an epoch-making turning point, that the market economy is
no longer enough and that we need more politics in the economy.
In fact, the way that first the American and then the European
governments took action on the banks seemed like a glaring
disavowal of Adam Smith’s “invisible hand” philosophy. Even
George Soros lashed out against “unchecked capitalism”.
The point to debate is this: do we want the State as player or
the State as regulator? I think the government should be a
stronger regulator than it has been so far. I’ll say it with a
slogan: more market and stronger regulators. I would be a little
scared of the State as player, except in emergency situations and
for a limited period of time.
What are the most urgent financial market reforms to be
undertaken?
Europe should create a de facto common market, not just talk
about it. Then we need a rule for all operators: many operators
are not at all regulated today. One of the problems is that
taxpayers in individual countries are made to contribute in
different ways. This is a tension factor for people like us, who
operate in many countries.
As things stand, these countries continue to function rather
well. And our banks in these countries are working very well.
Olycom
How has the crisis impacted the economies of the so-called New
Europe?
DOSSIER
No worries about the near future?
There are some concerns, for example about the political
situation in Ukraine. But we should consider that the effects of a
possible crisis on the accounts of the parent company would be
very limited.
From market champion to the target of attacks, including personal
ones: what does it feel like?
I’ve chalked it up to experience. I am resigned to it, and I am
certainly not about to start railing about the markets. The
markets do what they have to do.
One observer wrote that the acquisition of Capitalia snapped his
own sympathy for the market.
Maybe so. But I still think that that was a strategically important operation for UniCredit.
What about your relationship with the shareholders?
Rumours about misunderstandings with this or that
shareholder have been circulating ever since UniCredit was set
up. I would add that it is normal that there should be some
tension considering the situation that has been created.
You were one of the first people in Italy to talk about corporate
social responsibility, ethics etc. Like many other Italian
managers, you are now coming in for a lot of criticism for
earnings that are considered to be disproportionate – some even
say immoral.
I can confirm that around 75% of my earnings are strictly
related to the company’s results. So there is no possibility, unlike
in America, for me to earn staggering amounts of money when
the company is doing badly. I should add that I am not the one
who decides my salary: that decision is made by a committee,
with the help of external experts who all supply international
reference benchmarks. UniCredit is a multinational group that
compares in this respect too with other groups of the same type.
In fact we have chosen to position ourselves in the third quartile
of the salary bracket, not the highest quartile. I would welcome
any discussion on these issues as well, as long it is based on full
knowledge of the facts and not on rumours or for purposes of
scandal mongering.
124
The turmoil spreads to the East
by Fabrizio Coricelli and Debora Revoltella
One year after the beginning of the international financial
turmoil, high uncertainty and volatility persist at the global
level, with no signs of abating. The financial sector crisis is
deepening, moving from the US to the UK and Western
Europe. Stock markets have been falling for weeks; liquidity
has become an issue for the banking sector, while risk
aversion is strongly on the rise. The resulting global credit
squeeze means that the worst has to come for the real
economy, with growth forecasts for the next year ranging
around 0% for both the US and the Eurozone.
The hit is generalized. The crisis has its centre in the core
markets, but is quickly spreading to emerging markets, CEE
included. On top of lower international growth, re-pricing of
risk and strong risk aversion in international markets have
led to a substantial reduction in capital inflows towards
emerging markets. Need for quick realisation of investments
as well as some speculative attacks have also materialised,
testing, behind fundamentals, the solidity of single countries.
Not all countries are suffering and will suffer in the same
way, however.
The first, obvious, observation is that countries with
larger external financing requirements are more vulnerable.
Most of the CEE countries are running wide current account
deficits; an indication that the economy has been unable to
generate enough domestic savings. Economic growth has been
financed by “importing” external savings – mostly (at least
in Central Europe and in South Eastern Europe) in the form
of FDIs or private debt. The banking sector has played a role,
with strong lending growth – one of the main drivers of the
retail and investment boom – being largely financed from
abroad. The re-pricing of risk at the international level has
led to an increase in the cost (and more generally
availability) of such external financing, meaning a tightening
of monetary and credit conditions. In some cases, such
tightening has been moderate, leading to a cooling of
economic activity, in others more abrupt, causing a strong
correction in terms of growth.
The experience of the Baltic countries is a clear example. A
correction in the real estate market (also due to lower capital
inflows) has been combined with lower lending growth, as
the foreign owned banks (largely owned by Nordic banks)
Grazia Neri_Panos
One year after the beginning of the International financial turmoil,
high uncertainty and instability persist globally without signs of mitigation. The crisis of the financial sector is heightening, from the US to
the United Kingdom and Western Europe. Stock markets have been
falling for weeks; liquidity is a problem for the banking community,
while risk aversion is on the rise. The resulting global credit crunch
implies that the worst for the real economy is still to come, as the
growth expected for the next year ranges around 0% both in the US
and in the Eurozone
_In Kazakhstan the correction in the overheated real estate sector and the complete closure of the international market for domestic
borrowers has lead to a domestic credit crunch, which has again exacerbated the problems of the real economy
125
DOSSIER
COST OF RISK
have been aggressively tightening credit policies, while
reducing their funding to the local daughter companies. The
result has been a cooling of the economy, with Estonia and
Latvia entering into a recession and Lithuania – which can
profit from a relatively more diversified industrial base, a
lagged cycle and lower overheating of the economy prior to
the global turmoil – cooling more slowly.
Countries with greater dependence on foreign capital and
facing a higher cost of risk-insurance (credit default swap)
are more exposed to a correction. Figure 1 shows the
sensitivity of CEE countries to a slowdown in capital inflows
and their risk premia. The current account deficit is corrected
by deducting FDI funding. However, under the assumption
that some forms of FDI are more volatile than others, FDI in
real estate and in the financial sector were not considered a
corrective factor. The resulting external imbalance is than
divided by the value added
coming from the tradable part
of the economy (basically
1. SENSITIVITY TO CAPITAL
industry and agriculture,
INFLOWS AND COST OF RISK
construction and services
excluded). The obtained
measure is just a variation of
3000
the one used in the sudden stop
Ukraine
literature by Calvo and others.
2500
The idea is that under the
current circumstances, the
2000
more the economy is servicebased, the quicker lower capital
1500
inflows will revert in negative
Russia
effects for the real economy.
Kazakhstan
Latvia
1000
The cost of risk is measured as
Turkey
Romania
Bulgaria
the spread on CDSs.
Hungary
Croatia
500
The Baltics and Kazakhstan
Serbia
Czech Republic
Poland
Estonia
appear
more exposed to the risk
Lithuania
Slovakia
of
a
drop
in international
0,00 0.10 0.20 0.30 0.40 0.50 0.60 0.70 0.80 0.90
1.00
capital
inflows,
followed by
SENSITIVITY TO CAPITAL INFLOWS:
Current Account– FDI (excluding RE & Financial Sector)
South-Eastern Europe. Here
√VA in tradable sectors+Imp-Exp
the main challenge is probably
related to the possibility of a
Note - Sensitivity to capital inflows is calculated as Current account deficit net of FDI (excluding FDI in real estate
lower funding from
and financial sector), 2007. All divided by Value Added in Tradable Sectors, plus import, minus exports
international banks active in
the region to their local
daughter banks. However,
credit tightening does not necessarily mean a credit crunch.
Local Central Banks, which were actively intervening in the
market to constrain lending growth in the past, have room of
manoeuvre for enhancing liquidity, just by releasing the high
reserve requirements they have imposed in the past.
The second, less obvious observation is that aggregate, net,
figures such as CAD or net flows are not the end of the story.
When large segments of the economy have over-borrowed,
with a sudden stop it is not ensured that these sectors will be
helped and rescued by the surplus sectors, being other private
sectors or the State. This might explain the case of
126
Grazia Neri_Panos
Kazakhstan last year and Russia today.
In Kazakhstan the correction in the overheated real estate
sector and the complete closure of the international market
for domestic borrowers (banks included) has lead to a
domestic credit crunch, which has again exacerbated the
problems of the real economy, as both services and
construction contribution to GDP growth have been
vanishing quite quickly, while the rest of the economy has
failed to take over. The oil rich country is now using its
reserves in order to support a massive rescue plan, which
accounts for more than 15% of domestic GDP. The plan
favours a recapitalisation of a development agency which
should be used to fund strategic companies, like the major
real estate companies. Also, the authorities have been
offering to enter in the capital of the major banks, by
acquiring up to 25% of non voting shares, to allow a
recapitalisation of the banks. This is however an ex-post
intervention rather than a direct substitution of drivers of
growth, with revenues from oil being used to solve the
problems of the over-indebted part of the economy which
entered into trouble.
In Russia as well, despite positive current account
balances, the over-borrowing of some specific sectors of the
economy has caused several troubles. Increased cost of risk
and limited access to international and domestic capital
markets have led to a tightening of credit conditions for the
corporate sector. This has led to a liquidity crunch in the
banking industry, with even the large banks sitting on their
liquidity, but refraining from lending. On top of that, the
strong correction in stock market prices. Massive government
intervention to support the banking industry and the major
corporations will grant stability of the major players in the
market and might allow a solution of the liquidity crunch,
but will not prevent a huge worsening in credit quality.
Investments are likely to strongly contract next year, with
only State financed infrastructural projects (again financed
through the oil proceedings) providing some support to
growth. More generally, future prospects may be adversely
affected by the dominant role of the State in the economy.
The third point to consider is that, under the current
international scenario, countries might be hit more than what
their macroeconomic fundamentals would predict, just
because they are more exposed to international financial
markets. We can think of investors which might be forced to
realize investments (eg hedge funds or mutual funds having
to face unexpected redemption flows) or even speculative
attacks against specific currencies.
This might have been the case in Hungary. The country
was emerging from a period of low economic growth, which
was due to a strong fiscal correction plan implemented in
order to correct the internal and the external unbalance. The
fiscal correction plan had been successful. True, there were
some macroeconomic weaknesses, such as lower growth, the
still high external debt, current account and fiscal imbalances,
though not very large relative to other CEE countries. The
_Oil rich Kazakhstan is now using its reserves
in order to support a massive rescue plan,
which accounts for more than 15% of domestic GDP
127
DOSSIER
main weakness might have been that Hungary had a wide
and relatively liquid (for the region) debt and equity markets.
This made the country vulnerable in the current
international context. In the last weeks the bond market has
collapsed. The exchange rate has been constantly
deteriorating and the Central Bank has been forced in an
emergency move to hike rates by 300 bps to halt the
depreciation of the Forint. The IMF, the EU and the World
Bank came up with a 20 Euro billion package to rescue the
country.
Therefore, a more relevant place in the international
portfolios and the liquidity of debt and equity markets may
prove the key factor exposing
to the risk of a crisis in the
current context of global crisis.
2. SENSITIVITY TO INTERNATIONAL
Figure 2 summarizes the
CAPITAL MARKETS VOLATILITY
position of the different
countries in terms of their
importance in international
7%
Ukraine
portfolios and links this
Turkey
position to the volatility of
6%
exchange rates observed in the
5%
last 10 months.
Russia
Poland
Hungary
The countries more at risk
Slovakia
4%
appear Poland, Russia and
Turkey. Therefore, the risk of
3%
contagion from the global
Czech republic
Romania
financial turmoil is high for
2%
these countries. Given their
Croatia
importance for the economies
1%
Latvia
of the whole European region,
Kazakhstan
Lithuania Bulgaria
Estonia
governments and international
0%
10%
20%
30%
40%
50%
institutions’ actions should be
(PORTFOLIO EQUITY+SECURITIES HELD BY FOREIGN SECTOR)/GDP, 2007
quickly implemented to avoid a
repetition of a crisis like the
one occurred in Hungary. The
setting up of an exchange rate
stabilization fund, financed by the ECB, would help
preventing currency crises in the larger emerging European
countries. Alternatively, the announcement that the ECB is
ready to step in to support the exchange rate of new EU
members and candidate countries, such as Turkey, would
discourage currency attacks.
EXCHANGE RATE VOLATILITY (LAST 10M)
USD DE FACTO
BASKET EURO USD
INF. PEG
QUASI CB
CB
128
CB
USD DE FACTO
CB
Financial Shock
by Antonio Barbangelo
Yale professor and economist Robert Shiller’s book Irrational
Exuberance, published in early 2000, predicted the bursting of the
Internet bubble. In 2005, two years before it actually happened, he
warned that the US housing bubble would burst. Now that his predictions have come true, the academic reviews the real estate bubble in his
new book The Subprime Solution: How Today’s Global Financial Crisis
Happened and What to Do About It. The book develops one of the
author’s favourite themes: financial democracy
In the 1930s, says Robert Shiller, the U.S. reacted to the economic
depression by strengthening its financial system. Europe did not take
the same route and later regretted it. Today, lower income and
culture groups should be given access to unbiased consultancy and
financial information should be more amply provided to genuinely
help people to pick the right investments.
Shiller’s latest book was presented and discussed on 20 October at
the Institute for International Political Studies (ISPI) in Milan. Marco
Annunziata, chief economist with UniCredit, Franco Bruni, vice
president ISPI and a professor at Bocconi University, Mario Deaglio,
a professor at the University of Turin and Franco Venturini, a
columnist with “Corriere della Sera”, took part in the discussion. The
debate, moderated by Marco Liera of Italian financial daily “Il Sole
24 Ore”, focused on the cultural aspects of the crisis as well as why it
happened.
Take the issue of information. How did the media react to the
financial crisis? “I would like to focus on three of the various
interpretations that appeared in the media”, said Bruni, “one positive
and two negative. The positive one is that the crisis appears to have
made it clear to everyone that there is a need to tackle the
management of the global economy through multilateral dialogue.
Almost nobody denies that it is time to sit down at the table and
redefine some of the rules of the game”. As for the negative aspects:
“I totally disagree with the way finance has been demonized in the
media”, Bruni added. “Even Shiller is very clear on this point: he
says finance – even sophisticated aspects of finance, like derivates
trading – can be good for financial democracy”.
_The cover of Robert Shiller’s latest book. The
US economist is also famous for having developed the Case-Shiller index (maintained by
Standard & Poor’s), to evaluate the housing
market
Market economy under fire
To sum up, Franco Bruni commented on an idea that seems to
have forcefully emerged recently, i.e. that the crisis demonstrates the
failure of the market economy. “I consider this another negative
129
interpretation”, the Bocconi professor said. “Of course the current
situation should make us rethink the mechanisms of the market
economy, but I think it is better not to make simplistic declarations. It
is very hard to argue that the crisis is proof of a free market failure,
first of all because financial markets have always been regulated in
every country, even the U.S. They could not function without those
rules”. Here, too, Bruni agrees with Shiller’s view.
In real estate circles, the American economist is also known for
another reason: he developed the Case-Shiller index used by
Standard & Poor’s to evaluate the housing market. “The property
market worldwide now recognises the Case-Shiller index”, said
Mario Deaglio. “So when the Yale professor predicted the property
bubble burst two years ago, he was speaking from the bottom of his
heart, just like Paul Krugman, the winner of the Nobel Prize for
Economics. However, Shiller overlooks other aspects such as the
historical dimension. Let’s try and understand how the housing
bubble started. The Federal Reserve, then headed by Alan Greenspan,
cut interest rates by half a percentage point in January 2002 in
reaction to the crisis sparked by the 2001 terrorist attacks. Everyone
in the real estate sector got cheaper loans and the U.S. economy got
some breathing room. However, too many people focused excessively
on real estate; at one point, everyone wanted to invest in housing.
The extremely strong growth in demand was met by a huge rise in
supply. We can now ask whether American watchdog institutions
could have tried to slow down the phenomenon”.
U.S. regulators did not act
The question revived the doubts of those who have pointed a
finger at regulators. Bruni said: “The Fed could have taken action to
stem the degeneration of the subprime market: it either did not do
so, or did it badly. The public sector and American politicians
encouraged the situation. The SEC, the stock market watchdog, also
had the tools to restrict excessive lending by the big investment
banks, but did not do so – it actually did the opposite. Once again, we
cannot say it is the free market that has failed; rather, it is the SEC’s
policies that have failed”.
Deaglio added: “Besides this, there were several dishonest
operators involved. It is no coincidence that the Governor of the
Bank of Italy, Mario Draghi, spoke of a ‘parallel system’ in his speech
on the international financial situation in May. Those are very clear
words. They mean that some operators escaped all controls. This has
to be said out loud”.
So the big financial jolt would seem to have been very instructive.
“This crisis is teaching us that many of us – economists, journalists,
financial commentators - have to relearn some intellectual humility”,
said Annunziata. “Some, like Shiller, were able to spot the hurricane
a few years before it hit. Where were all the others? The housing
bubble burst more than a year ago, in August 2007: after 12 months,
almost nobody had hypothesized that it would get so much worse.
The roots of the financial upset can undoubtedly be traced to
financial policy errors, inadequate controls and behaviour bordering
on fraud, like the subprime loans given to American families that
would not be able to pay them off. All this has been proved true. But,
as Shiller points out, there was huge uncertainty on the information
front”. The UniCredit economist continued: “Before this flop, we had
had record levels of world economic growth for four or five years. So
we were in a situation in which elements of the property bubble
could be seen (as in the end-1990s, when the technological bubble
started spreading). This time around, too, there were elements that
should have seemed suspect, and instead… maybe we shouldn’t be
surprised that there was no interest in slowing it down”.
World balance
The participants also discussed another aspect of the financial
tsunami: how is it changing international politics? “We don’t know
yet”, said Venturini. “I don’t agree with some analysts who are
already giving the crisis the power to radically change world
balances. The financial crisis will not change world balances; it will
speed up changes that were already underway. What will speed up?
The passage to a multipolar world, but then this process was already
ongoing for quite some time. We know that there are emerging
countries such as China and India, others like Russia which are
trying to make a comeback on the international scene but have feet
of clay, others, like Europe, which are trying to assert themselves and
yet others, like the U.S., who are trying to defending their leadership.
The crisis could accelerate these trends”. Venturini also pointed to
the issue of world governance. “We know that the end of the Cold
War in 1989 created an institutional problem at the international
level. The U.N. no longer appeared to be able to provide responses
and the G8 was considered incapable of making decisions. Global
governance was already a problem and now the crisis could lead to
an acceleration – a tumultuous one in this case – towards a change in
governance”.
Will Europe change? “Almost without realizing it and without
discussing it”, said Venturini. “Europe has built an avant-garde. Four
countries (Italy, France, Germany and the U.K.) – first met in
September to tackle the emergency; subsequently, 15 countries got
together in London. This is a cultural revolution: the concept of
avant-gardes has been discussed for years as an antidote to excessive
enlargement and excessively speedy enlargement. The financial crisis
has supplied at least one advantage for now, at least as far as Europe
is concerned”.
Grazia Neri_AFP
New objectives for central banks
Having analysed what happened, the question is: What happens
next? “There has been a debate on the behaviour and objectives of
central banks for quite some time”, said Annunziata. “What should
central banks do? Until a few months ago we would have said that
they have to keep an eye on inflation and observe growth and
employment trends. I have talked to representatives of several central
banks recently and there is already a change of direction. There will
now have to be serious rethinking on the objectives of central banks.
We have already witnessed coordinated action by these monetary
regulators in October to resuscitate the financial market, especially
the interbank market, which had seized up completely, with a risk of
repercussions for the real economy. The measures to breathe new life
into the interbank market are working. There are significant signs of
a ‘defreeze’ as regards the financial crisis per se. The situation should
return to normalcy little by little. It will take time. We are looking at
a huge problem”.
Waiting for China
by Alessandro Arduino and Cristina M. Bombelli
The prospect of China stepping into the world financial crisis raises
doubts and fears. China’s central bank recently cut interest rates for
the first time in seven years, reducing its benchmark one-year lending
rate to 7.2%. The American financial crisis, which has spread as
rapidly as an oil spill, spurred the Chinese government to take preventive action
As recently as two years ago, international analysts were mooting
the possibility of China’s domestic economic problems
sparking a global financial crisis. Today, many view China’s
excess liquidity as a key factor in remedying the current
financial crisis. The fall of the Shanghai and Shenzen stock
markets, the dizzying rise in property prices and Chinese
banks’ bad loans fed a speculative bubble that everyone
predicted would soon burst and that no one is mentioning any
more. Meanwhile, the Chinese economy continues to
accelerate, with GDP growing at double-digit rates. Chinese
socioeconomic growth is proceeding apace, regardless of the
slump in exports and the recent implosion of the Shanghai
Stock Exchange. In this context, the People’s Bank has
continued to restrict easy loans by introducing new
regulations and continuously hiking interest rates. The central
government has passed macroeconomic measures to discourage
speculative short-term foreign investments.
Despite this evidence, the West continues to have an
essentially negative perception of China in matters related to
the economy. The general view is that the PRC competes
unfairly in foreign markets by hoarding global energy
resources, dumping goods and forcibly devaluing the yuan.
Accusations related to China’s rising trade deficit are backed
by criticism of adulterated Chinese goods, unfair competition
and the loss of jobs to outsourcing. China’s presence on the
international financial and money markets raises fears without
proposing suitable alternatives. The Chinese market socialism
model, which is hard to understand, is seen as a pragmatic
form of capitalism exercised by an élite made up of
technocrats: an obstacle or, worse, an enemy in the making.
In actual fact, the increasingly concrete possibility of a
recession provides an opportunity to give the PRC full-fledged
entry into global financial markets without obliging it to
change radically, and accept a perspective that is not
exclusively ethnocentric, with a view to mutual benefit. The
stable and gradual entry of Chinese finance could create a
virtuous circle and end the liquidity crunch in Western
markets while establishing a proper system of controls and
sustainable development within the PRC. The collapse of
various US hedge funds presaged the recent storm that hit
financial markets, starting with the disintegration of the Long
Term Capital Management (LTCM) fund, the founders of
which included two Nobel Prize-winning economists. With the
unexpected bankruptcy of the American investment bank
Grazia Neri_AFP
Lehman Brothers and the sale in extremis of Merrill Lynch to
the Bank of America Corp., China found itself having to resort
to preventive measures to avoid exposure to the damage
caused by an imported financial crisis.
China’s lawmakers made the fight against inflation the
priority in its 2006-2001 five-year economic plan in order to
encourage harmonious and sustainable development, but the
sudden relaxing of its credit squeeze helped to give the
economy some breathing room. However, the economy must
continue to maintain a sufficient annual growth rate to
survive. Having restricted corporate and individual access to
loans in recent years, China can now afford to relax the
squeeze to make more credit available for domestic
consumption.
It is worth asking at this point whether China will act,
through its national investment funds, to save or at least stem
the problems of global finance, and whether the country can
allow itself the luxury of being a passive spectator with a
global recession in the offing.
With the US and European economies on the brink of
recession or, worse, stagflation, a Chinese market-oriented
move could give a strong and effective signal of China’s ability
to react quickly to a sudden economic crisis.
Arab and Asian sovereign funds face a pressing need to take
defensive measures or take advantage of weak overseas
markets to speculate on sell-offs, as Chinese insurance giant
Ping An’s recent unsuccessful attempt to buy a stake in the
investment bank Fortis NV clearly shows. Fortis’s hostile
rejection of the 3.03 bn euros Chinese bid only enhanced the
insurance company’s share price on the Hong Kong stock
market: its 14% share price surge was a demonstration of
strength and stability at a time of crisis. Ping An’s desire to
become a leading international financial services operator by
upping its stake in Fortis from 4.99% to 50% came up against
a partial nationalisation of Fortis by the governments of
Belgium, the Netherlands and Luxembourg aimed at staving
off the Chinese threat on their territory. The cautious, waitand-see approach of Ping An’s management in regard to the
failed buyout reflects similar behaviour by big Chinese Stateowned companies, which have swapped the aggressiveness of
previous years for a more conservative approach. The fall in
the Shanghai composite index, which plummeted from 6,000
to 1,800 points in the space of only eight months, also hints at
a change of attitude. The State-owned Chinese investment
fund China Investment Corporation (CIC) has not so far
approved any significant acquisitions in 2008. Last year,
investments totalled $200 bn and included the Blackstone
Group (US$ 3 bn), Morgan Stanley (US$ 5.6 bn) and the
British bank Barclays, all of which underwent short-term
losses. The simultaneous Chinese stock market slump led to
widespread but unpublicised internal dissent about the capital
not being used to fund the local market, especially to help the
emerging middle class, which is losing a sizeable portion of its
savings on the stock market.
The political factor is of particular significance in the
DOSSIER
management of sovereign funds for the investing country as
well as the country receiving the investment. Over the past
two years, there has been open hostility towards overseas
M&As by State-owned Chinese companies. CNOOC’s failure
to acquire Unocal in the US is a reminder that such
investments are met with wariness or even outright hostility.
China’s moves on foreign markets are seen as predatory and
contrary to free market criteria, as they tend to be based on
geopolitical rather than purely economic considerations. At the
same time, sovereign funds’ requests for adequate financial
guarantees in the acquisition of majority stakes in banks such
as Morgan Stanley could lead the US government to issue a
guarantee to cover risks, thereby going against the opinions of
an impressionable public at election time. Problems with
approval by the relevant organisms within the Chinese
government could work against quick acquisitions such as the
one to buy a higher stake in Morgan Stanley. When
negotiations with CIC came to a standstill, the bank agreed to
sell up to 20% of its shares to the Japanese financial group
Mitsubishi UFJ: the slowdown was probably due to the
Chinese State Council taking too long to approve the deal.
The current restructuring on Wall Street could, however,
benefit Chinese financial institutions, which will find
themselves with a qualified pool of human resources in search
of new jobs, primarily U.S. degree-holders in China who have
embarked on a career in business and finance. Local banks will
be able to enhance their in-house talent by hiring returning
Chinese or expatriate staff fleeing the City or Wall Street. The
stock market debacle notwithstanding, most Chinese banks are
well placed to withstand the impending crisis. The injection of
funds by the central government and limited exposure to the
U.S. subprime crisis have given Chinese banks an aura of
stability that experts thought was nonexistent until only a
year ago. Bank of China and China Commercial Bank have
declared total losses of US$ 350 mn due to the bankruptcy of
Lehman Brothers: a figure that might be considered quite a
hefty one taken on its own, but that is equivalent to a loss of
0.01% when all the assets of these two banks are taken into
account (0.19% considering available liquidity alone).
The central government has declared that the objective of
its current financial policy is to maintain order on the
domestic front to continue with harmonious and sustainable
growth. The message being officially broadcasted by Beijing’s
mandarins is meant to soothe both domestic complaints about
excessive investment outside the country and countries that
fear a Chinese financial invasion. China’s leaders are focusing
their attention not only on the international financial crisis
but also on the need to guarantee land use rights to the rural
population and the increased income it will generate. The
objective is to reach per capita GDP of US$1,000 in 2015 from
US$550 in 2007 and lift 15 million peasants out of poverty.
While the declaration by the Communist Party’s constituent
assembly that “China must look after its domestic issues”
might suggest a marginal, wait-and-see policy as regards
global financial trends, it is worth remembering the symbiotic
134
Grazia Neri_AFP
relationship between the Chinese and American economies.
The RPC holds US$1.8 trillion worth of U.S. Treasury bonds
and is heavily dependent on exports to the U.S. If Chinese
banks, unlike their American and European counterparts, are
well placed, it is because they are presumed to have cash
reserves and are operating in a growing domestic bond market.
The ethnocentrism that causes the West to be wary of China
could therefore rule out fruitful collaborations aimed not only
at weathering the free market crisis but also at developing new
models of cooperation to contribute to increased Chinese
respect for market regulations, keeping in mind, however, that
China’s vision of growth does not necessarily involve
Westernization.
If there is no change in the West’s prejudiced outlook, there
will be inevitable questions about the damage and
consequences that China’s disorderly entry into financial
markets on the basis of its unmediated position of strength
could cause.
This is not a theoretical issue, and it does not only concern
the kind of strategy the Asian giant will adopt: given the fact
that the economic strength of the parties involved is different,
the question is whether the bill will be presented for payment
sooner or later.
_If Chinese banks, unlike their American and
European counterparts, are well placed, it is
because they are presumed to have cash reserves and are operating in a growing domestic bond market. In the picture, the Chinese
Central Bank
135