The financial crisis has led to a lot of talk about the failure of ethics in the banking sector. Greed overtook wisdom, we’re told. No doubt this is the case. Yet whilst bankers are to blame, it’s hopelessly naïve to suppose that a ‘return’ to some golden age of ethical business will solve all our problems.

There is a parallel with the expenses claims of British parliamentarians. Caught with their hands in the till, some cried out that the system was to blame for letting them get away with it. For all the cheek of that response, there is a lesson in it.

Individuals must take responsibility for their sins. But if we’re serious about making sure that these things cannot occur again, it really isn’t enough to call for more ethics in business. In fact, I’m beginning to suspect that this is a way to avoid having to enact any real change. As the crisis seems to be settling down, the British Chancellor of the Exchequer Alistair Darling has shied away from significant reform of the regulatory system and chose instead to blame bosses for being irresponsible. ‘Don’t worry,’ we seem to be being told, ‘we’ll just ask bankers not to be greedy any more.’ Forgive me, but I had hoped for something more robust.

It must be conceded that in sharp contrast to the plans of the British government, Barack Obama’s planned reforms are substantive and bold. But on a global level, concerns are growing that the opportunity for broader reform that this crisis provides is being missed as optimism returns alongside talk of ‘green shoots of recovery’. The Bank for International Settlements (BIS), often described as the central bankers’ central bank, published its annual report on Monday. According to the FT, the BIS:

said it was vital that thought be given to the ongoing structure of the financial system while the patient was still on life support. Efforts so far, it concluded, had been a “messy mixture of urgent treatment designed to stem the decline, combined with an emerging agenda for comprehensive reform to set the foundations for sustainable growth”.

It highlighted two main risks: first, that not enough will be done to ensure a durable recovery from crisis; and second, that the emergency action to stabilise the financial system will undermine efforts to build a safer system.

The G8, too, is jumping on board the ‘return to ethics’ bandwagon. MBA graduates have set up their own code of ethics, taking inspiration from the medical profession’s Hippocratic Oath. This is welcome. We do need to create a public environment in which ethics and responsibility are more emphasised (and more respected), but to expect a firm whose raison d’etre is the pursuit of profit to apply the brakes is painfully naïve. Business (and politics) should be conducted on more ethical grounds. This year’s Reith Lectures, given by Michael Sandel, address this point well. But in the meantime (between now and hell freezing over), we need rules that acknowledge people’s tendency to ignore ethics, especially in the heat of the moment. The great theorists of capitalism itself, such as Adam Smith, knew well that the system wasn’t moral. But neither is capitalism immoral – it’s simply amoral. If we want a moral system, we have to bring in the morality ourselves. But to expect bankers to do so on their own is to invite a conflict of interest. We do not expect the players at Wimbledon to make line calls on their own shots and, similarly, we should not expect the financial sector to judge the morality or wisdom of its own practices.

This is an important moment, but it’s not a moment of a new ethical kingdom, or of a new form of capitalism. Instead, we need to return to an older scepticism about the role of private interests in our society and the degree to which the doctrine of self-regulation is a realistic solution.

As David just noted, this morning’s Lex column in the FT is relatively upbeat about the dangers of protectionism, arguing that “the disaggregation of global supply chains, the source of the huge efficiencies that companies pass on to consumers, will not be easily undone.”

Whether or not that’s right (and like Willem Buiter, Martin Wolf is also a good deal more downcast than the Lex team), it’s interesting to compare today’s Lex column with what they had to say about capital flows to emerging markets just a couple of days ago.  Here’s the bit that made me sit up:

Take Brazil and India, the globe’s ninth and 12th biggest economies, according to the International Monetary Fund’s latest estimates. While the developed world is expected to shrink by 2 per cent this year, the IMF reckons Brazil will grow by 2 per cent, and India by 5 per cent. Why? One answer is that they have stable banks, relatively closed economies, and large internal markets. This has insulated them from much of the global turmoil.

The contrast with East Asia is stark. Singapore’s economy shrank at an annualised 17 per cent rate at the end of last year, South Korea by some 20 per cent. Yet this is not for lack of capital. Asian economies, after all, are global creditors. Their economies have shrunk instead because they are heavily oriented towards collapsing international trade. Meanwhile, their local markets are undeveloped and weak. Asia’s challenge is how to best deploy its accumulated surpluses to boost domestic demand.

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Thanks to Flickr user Oliver Ingrouille

Prepare to heave at this New York Times screed on how tough life is for bankers these days.

“Nobody in the investment banking world is expecting pity, or even a sympathetic ear, these days,” the article begins, before quoting banker after banker who not only feels  ”unfairly singled out“, but wants destitute home owners to accept the lion’s share of the blame:

Financiers tell their not-for-attribution account of the mortgage crisis like this: Americans undersaved and overspent for decades, relying on rising property values to bankroll their lifestyles.

But nobody on Wall Street forced United States homeowners to take out loans on houses they couldn’t afford, or refinance mortgages to spend money on cars they shouldn’t have bought.

Of course, others are at fault too. Ratings agencies failed to warn innocent financiers of the risks they were taking, while regulators… well, they should be ashamed of their many failings. Bankers did just one thing wrong. They trusted us too much – and we let them down.

Now they are spat on as they cross the sidewalk from their limousines and are too embarrassed to admit what they do at champagne receptions. “I’d almost rather say I’m a pornographer,” says one poor soul. “At least that’s a business that people understand.”

Then there’s the last devasting blow – having their bonuses cut:

“Fact is that this is a terrible way to make a living — except for the money,” Ken Miller, a former vice chairman at Credit Suisse First Boston and now a private investor, said. “The lifestyle is terrible — the hours, the sucking up. These guys must feel like they’re the victims of a capricious god.”

Yes indeed, Ken, it seems they do.

Over the past few weeks the UK government has been organising an extensive series of horizon scanning events to feed into the current revision of the National Security Strategy.  In all, some 24 workshops have been held on the full range of foreign policy issues; various other events have also been held, including the Wilton Park conference I mentioned a couple of weeks back. 

Having been to a few of these events, I must admit to being less than convinced that the sessions are really breaking out of the comfortable groupthink that can so easily characterise futures work.  Like Charlie, I’m starting to feeling a sense of deja vu each time I attend an awayday or brainstorming session that concludes that emerging economies are, well, emerging; that resources are becoming more scarce; that everything’s interconnected; and so on. 

I can see the utility of futures work that focuses on a pretty specific area – prospects for the pharmaceutical sector, say, or the future of UN peacekeeping – but I suspect that very big picture horizon scanning is only really helpful at this stage if it yields up insights or possibilities that are being ignored or overlooked.

For me, the really stand-out risk that barely got a mention in the events I attended was the possibility that serious erosion of states’ capacity and legitimacy undermines their ability to respond to all the global trends that we were discussing (viz. climate change, organised crime, economic meltdown, terrorism, energy scarcity – you know, the usual list).

Normally, when we think about state fragility we assume that we’re talking about the Lebanons, Somalias and Guinea-Bissaus of the world.  But as people who work in the counter-insurgency sphere have been pointing out for some time, the problem of erosion of state capacity is a whole lot more widespread than that.  (more…)

David Cameron yesterday warned that the UK could be forced to go cap in hand to the IMF, as it did in 1976 under chancellor Denis Healey. (This, by the way, at the launch of a new programme at Demos about ‘progressive conservatism’. Et tu, Demos?)

The question is, would the IMF have the cash. Click on more to read a story I recently wrote for my mag, www.emeafinance.com, which looks at the risk of the IMF running out of money in the next 18 months, and asks what the chances are of it receiving more funds from cash-rich G20 governments (answer: slim).

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I’ve been in Japan today, speaking at ‘Reforming International Institutions – Meeting the Challenges of the 21st Century’,  a seminar organized by the United Nations University and the British Embassy in Japan.

You can download my talk here (with pictures, references etc) – or the text only is available below the jump. There’s a webcast too.

Headlines:

• It’s going to be a tough year. The financial meltdown has a long way to go, and the downturn is risking turning into a global depression.
• Trade is a bell wether. Protectionist pressures are already on the rise. If they gain traction, take that as a warning of a wider loss of confidence in global institutions.
• The unravelling of global economic imbalances could prove corrosive to the international order. If countries start to devalue to protect exports, expect a tit-for-tat dynamic to kick in.
• Scarcity issues (energy, water, land, food, atmospheric space for emissions) remain the key medium term driver of global change. Commodity prices will spike again as soon as there’s recovery.
• The downturn has stemmed the uncontrolled growth of emissions, but also lessened the chance of a robust global deal on climate.
• Economic bad times could well drive increased conflict. A major new security threat might be the fabled black swan – hitting just when the global immune system is already overloaded.
• If we experience a long crisis (or a chain of interlinked crises), we are likely to see either a significant loss of trust in the system (globalization retreats), or a significant increase in trust (interdependence increases). 
• You need to stretch time horizons to get the latter – shared awareness (joint analysis of risks and challenges), as a basis for shared platforms (loose coalitions of leaders), which can lobby for a shared operating system (a new international institutional architecture).
• 2009 sets a challenging agenda for the G20 (financial reform and economic recovery – but framed by a broader vision on climate, resources, security etc.)…
• …the G8 (caucus of rich countries able to tee up Copenhagen and kick start development assistance if developing countries begin to teeter)…
• …the UN (especially Ban Ki-Moon’s proposed high level ‘friend’s group’ on climate, but also as a fora for getting to grips with scarcity issues)…
• and the Bretton Woods institutions and the WTO (first of all ensuring they keep their heads above water, then looking to ’save globalization from itself’).
• Oh and be ready for the backlash – people are angry and rightfully so, but that may well lead us down some populist blind alleys.

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Former US Deputy Treasury Secretary Roger Altman has a piece in the new edition of Foreign Affairs on the Great Crash of 2008, which takes the following as its opening premise:

The financial and economic crash of 2008, the worst in over 75 years, is a major geopolitical setback for the United States and Europe. Over the medium term, Washington and European governments will have neither the resources nor the economic credibility to play the role in global affairs that they otherwise would have played. These weaknesses will eventually be repaired, but in the interim, they will accelerate trends that are shifting the world’s center of gravity away from the United States.

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So it looks like we’re getting close to an announcement of a ‘bad bank’ here in the UK, with signs that this move has been co-ordinated with the new US adminstration.

According to the Telegraph:

The bad bank plan has climbed the political agenda in the past couple of weeks as the Government has become aware of the extent of the lenders’ bad debts.

Sources said that a bad bank would have to take on about £200 billion of toxic assets. That would take the Government’s total commitment to solving the banking crisis to almost £1 trillion in taxpayers’ money that has either been spent or pledged.

Valuation remains controversial, with banks scrabbling to extract as much as they possibly can from the taxpayer. One option (following the Swedes again) is to use an independent board to have a go at guessing what all the crap is worth.

Willem Buiter has a simpler suggestion – privatise the whole sector, with the government then making whatever valuation it likes as it transfers toxic assets into a new vehicle. Buiter, who thinks that even HSBC is now toast, points out that the current half-way house (partial state ownership) may be the worst of all worlds:

Ironically, by partially nationalising some of the banks, by making this injection of public capital expensive financially and as regards other conditionality, and by holding the threat of possible future (partial) nationalisation over the remaining banks, the authorities created an incentive structure that is biased strongly against bank lending, and against bank risk taking generally.  The best escape from this unfortunate halfway house is to go to temporary full public ownership of all the banks.  It would be cheap.  It should not cost more than £50bn for the state to buy the rest of the UK high street banks.  It could wait a while and get them even cheaper – possibly for nothing. But time is more precious than money in this case.

In last month’s New Atlantic, James Fallows had a fascinating interview with Gao Xiqing, Chief Investment Officer at China’s sovereign investment fund, and the man responsible for a significant chunk of China’s huge holdings of American dollars.

Gao – who Fallows dubs one of the US’s new banking overlords – thinks Americans need to learn some humility and fast.

“The simple truth today is that your economy is built on the global economy,” he says, “and it’s built on the support, the gratuitous support, of a lot of countries. So why don’t you come over and … I won’t say kowtow [with a laugh], but at least, be nice to the countries that lend you money.”

The US should disentangle itself from expensive overseas conflicts, Gao believes, raise its diplomatic game, and – above all – tell its citizens to get saving as part of a “long-term, sustainable financial policy.”

It’s all well and good, but maybe Fallows should have pushed Gao a little harder on whether China’s own financial policy is sustainable. After all, despite recent appreciation, the yuan remains substantially under-valued against both the dollar and the euro – the main reason why the Chinese has ended up holding so much Western debt.

Gao’s comments on the dollar are somewhat contradictory (and reflect all the ambiguity of China’s own dollar position). On the one hand, it defends its status as a reserve currency. The US is still the most viable and predictable market, he says. But on the other, Chinese investment in the dollar is widely unpopular at home. According to Gao, China’s citizens ‘hate’ its support of rich Americans (“people eating shark fins”) at the expense of “poor [Chinese] people eating porridge.”

More significant than public pressure, perhaps, is Gao’s belief that the dollar is highly likely to lose value over the short to medium term (with a corresponding appreciation for the yuan). This will wipe billions of Chinese reserves (reserves that have only been built up through consumption foregone) – while challenging China’s export-led growth model:

We are not quite at the bottom yet. Because we don’t really know what’s going to happen next. Everyone is saying, “Oh, look, the dollar is getting stronger!” [As it was at the time of the interview.] I say, that’s really temporary. It’s simply because a lot of people need to cash in, they need U.S. dollars in order to pay back their creditors.

But after a short while, the dollar may be going down again. I’d like to bet on that! The overall financial situation in the U.S. is changing, and that’s what we don’t know about. It’s going to be changed fundamentally in many ways.

Unravelling these imbalances seems certain to be ugly. Reading George Cooper’s book, The Origin of Financial Crises, on a plane the other day, I was struck by strong parallels between today’s economic woes, and a crisis we have heard little about recently – the ‘Nixon Shock’ that led to the end of the Bretton Woods system. (more…)

I’ve covered eastern European markets for about eight years, and all of those eight years, the region has been on a growth trajectory, either because it is converging with the EU, or, in the case of Russia and Kazakhstan, because it has lots of natural resources. It’s been a boom region, with GDP growth averaging above 6% for the last eight years.

In the last two months, the region has been hit by the global financial crisis, and engulfed by it. Now, many analysts say that of all the emerging markets, the CEE (central and eastern Europe) region is the most vulnerable and exposed.

The main reason is that several CEE countries have very high current account deficits, which mean that they rely on FDI to get foreign currency to pay off their FX liabilities. Countries with current account deficits over 5% include Hungary, Ukraine, all the Baltics, Romania, Bulgaria, and Serbia.

The FDI that used to flow to these countries was mainly foreign currency loans – syndicated loans from western banks, or Eurobond borrowing. But the credit markets have completely closed. Now these countries are facing real difficulties in meeting the FX gap, and their currencies are coming under severe pressure.

All these countries have banking sectors that are dominated by western banks. These banks have high levels of foreign currency loan exposure to CEE countries. They want to stop the CEE countries from devaluing, because then their foreign currency loans would be worthless, and some of the foreign banks might even go bust.

However, the CEE countries I mentioned earlier might be forced to devaluate sharply in 2009, because their economies are now grinding into severe recessions, with economies shrinking by up to 4% next year. In the words of one analyst ‘they will have to devalue, otherwise their economic systems might break’.

Another analyst told me, ‘Next year for the CEE region will be like 1998 for the Asian economies. A number of currency collapses and severe recessions.’

The western banks that are heavily involved in the CEE region are desperately trying to prevent an Asia style crisis happening within the EU. Those banks are mainly Austrian (Raiffeisen, Erste Bank, Bank Austria Creditanstalt), but also Italian (Unicredit, which owns Bank Austria) and French (Societe Generale, BNP Paribas).

A senior banker at Unicredit, which is the biggest bank in the CEE region, told me: ‘We have about six months to stop the region from imploding. The EU and ECB need to do more. So far they have felt, it is not in the eurozone, it is not our business. But if there is a crisis in eastern Europe, it will affect western banks, and then it will affect western Europe.’

He also told me there was the real threat of nationalism in eastern Europe, with foreign banks being nationalised for not lending more to CEE economies.

The international financial system is straining, because it depends on international banks, on banks acting as bridges between countries. Now, however, both sides of those bridges are crumbling – western governments are demanding that semi-nationalised banks do more at home; while eastern governments are demanding they support their foreign subsidiaries. It is difficult to obey both.

If the CEE region did collapse, it could put great strain on the local political systems in these countries, and could give rise to isolationist, xenophobic governments, as it did in some CEE countries in the early 1990s. We should remember that the last time there was a major Austrian / CEE banking collapse was in 1931, with the fall of Creditanstalt, which helped give rise to the Nazi Party.

The EU should have the firepower to stop such a crisis from happening – the Baltic and Balkan economies are not that big. The EU or ECB may need to provide major bail-outs or guarantees to the local CEE banking system, in order to help local banks raise credit. Otherwise we are faced with an asymmetric bail-out, where western banking is guaranteed and eastern banking is left to rot.

Another pressing question is what happens in Ukraine, which looks set for a serious devaluation in the new year, and which is now struggling to pay its debts for Russian gas. Much of the EU depends on the gas that comes through Ukraine from Russia, so the EU needs to make sure its supply is protected there.

In our paper on Bretton Woods II (pdf), Alex and I provide rather a gloomy assessment of financial crisis – which we suggest is going to last longer than many think…

Given that we now face what Gordon Brown has described as “the first truly global financial crisis of the modern world”, our bet would be that it takes as long as a decade to bring it fully under control.

Let’s unpack the assumptions behind our pessimism. We start from the premise that, six months back, experts were overly optimistic about how far-reaching the meltdown would be. This is based, in part, on April’s Progressive Governance summit, where heads of state were (a) clearly freaked out; (b) fairly sure they grasped the problem, if not the solutions; (c) not acting as if they expected any further big surprises.

Consider, too, what the IMF’s Dominique Strauss Kahn was saying at the time. He was as worried by inflation, as he was by economic slowdown. Although he was forecasting a “rather important, serious slowdown in economic growth” – the expected pain wasn’t really that bad:

Something around 0.5 percent as a rate of growth for the United States in 2008 and a slight recovery during 2009-an average of 0.6 percent for 2009, which is both linked to the financial turmoil, of course, but also the business cycle. 

Next, we look at the lessons of earlier banking crises that, in developed countries, have tended to take four or five years to unravel, cost around 12% of GDP to resolve, and lead to a cumulative loss in output equal to almost a quarter of GDP. The figures are drawn from this useful chart prepared by PIMCO’s Michael Gomez:

Then add in what we know about the banking crisis that gripped Japan in the 1990s, which the IMF ascribes to “accelerated deregulation and deepening of capital markets without an appropriate adjustment in the regulatory framework”. Hiroshi Nakaso’s account is worth reading in full – seven years of crisis management and fire fighting as a senior manager at the Bank of Japan.

“When the bubble burst in the early 1990s, no one expected it was going to usher in such a prolonged period of weak growth in Japan,” he writes. Policy makers underestimated the seriousness of the problem, while banks lacked the ‘foresight and courage’ to confront their predicament head on.

At the time there was considerable schadenfreude in the West about Japan’s failure to get to grips with its crisis. It was eight years or so before its policy makers even found the levers that would begin to inch the crisis towards a solution. Are we right to assume that we’ll now do better? (more…)

Ahead of this weekend’s G20 summit, David and I have published a short paper entitled A Bretton Woods II worthy of the name.  Key points:

- The summit is unlikely to be able to live up to its billing.  Leaders do not yet understand the nature of the problem well enough to be able to implement viable solutions.  However, the problem is more fundamental than a simple lack of shared awareness. 

 - History suggests that leaders will only think the unthinkable on institutional reform once the challenge they face has really hit rock bottom. But history also suggests that we are wrong to think that the worst of the crisis is now past, given that many past banking crises have taken five years or more to unravel.

 - Bretton Woods 1 looked across the whole international economic waterfront in 1944, while this weekend’s summit will be much more narrowly focused.  Leaders will make a big mistake if they try and tackle finance in isolation, given the growing impact of resource scarcity, and that 2009 is supposed to see another ambitious global deal – on climate.

 - We need to recalibrate what we expect from globalization through a serious debate about subsidiarity. Where has globalization gone too far, too fast? Where do we need more integration at a global level? These were exactly the questions that preoccupied Keynes in 1933, when he weighed the relative benefits of global versus local across a range of variables.  We need a similar debate today as a precursor to serious international economic reform.

 - Leaders need to extend their horizons in (at least) five directions: onto longer time scales; beyond financial regulation into wider resource scarcity challenges; into other international processes, especially climate; towards grand bargains with emerging powers; and beyond government, to non-governmental networks.

Full version after the jump, or better yet here’s the pdf.

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Bernard Keane and David Howarth in Crikey:

It’s disappointing that Crikey, like others in the liberal media, have fallen for the nonsensical line that the so-called “financial crisis” is either real or requires urgent action. Anyone who disputes this claim, which is advanced with evangelical fervour by its advocates, is howled down as a heretic and a “denialist”. The days of the witch-hunt are truly back.

Put simply, there is no evidence of a human-induced financial crisis, regardless of the hysterical claims advanced in trendy films like Al Gore’s Inconvenient Loot. The financial environment moves through cycles unrelated to human activity. Financial records from the distant past demonstrate that key indices have previously been much lower than they are today, and move up and down of their own accord. Man’s contribution to these movements is dwarfed by the natural rise and fall of markets.

The following graph shows that the long-term financial trend is – inconveniently for crisis fanatics – resolutely upwards:

And to anyone objecting that the market is now declining – what happened yesterday?

Another rise. So much for the purported, so-called, alleged myth of anthropogenic financial collapse, which is not real at all, but actually made up.

Any recent, temporary falls in the Dow Jones Index are nothing to do with human-induced crises. Quite apart from natural ups and downs, recent sun spot activity has increased the cash burn rate, contributing to a mild reduction in credit availability, but again it is a wholly natural cycle, unrelated to human activity. The current cycle of solar activity is due to end in the next couple of years, returning credit availability to normal.

If there is to be any attempt to mitigate this wholly fictional crisis, it should be done with moderate, balanced measures that take into account the needs of businesses and the importance of maintaining job growth and profit share. The fanatics urging us to take immediate action must be rejected.

We should take no unilateral action, but await a comprehensive international agreement that includes the big financial emitters like China. To do otherwise would be to risk our own economy without having the slightest impact on the problem we’re trying to fix. Local jobs will be lost due to “bailout leakage” as firms simply move offshore to countries where taxpayer money is not being wasted propping up uncompetitive firms.

Other industries will simply be wiped out due to massive increases in their costs arising from the additional tax burden. Our LNG (Lots of Noxious Gits) industry is particularly vulnerable.

If we are foolish enough to take unilateral action then we must ensure full compensation for affected companies so that they are not required to contribute to the bailout. A special Bailout Liability Underwritten Banking certificate (BLUB) crediting firms with the amount of money contributed to the bailout must be provided to all trade-exposed industries, particularly those in bailout-intensive sectors.

But before we proceed, further work needs to be done on an appropriate bailout target. Setting too high a bailout target risks imposing a massive burden on the economy. A low bailout target would provide a sensible transitional pathway to stabilising the financial sector at $550 million ppm (payouts per manager) by 2050.

This prudent, moderate, sensible, balanced course of action, while opposed by trendies and financial crisis fundamentalists, will ensure we protect the very jobs and businesses most at risk from this new secular religion.

[With thanks to Michael Mainelli.]

Oh, so you thought that the torrent of criticism directed at US Congressmen for voting ‘no’ on the bail-out meant that Senators would be more likely to vote yes tonight, and that this would finally bring some reprieve?

Well, Javier Blas at the FT has news for you: the world’s super-rich don’t share your optimism.

Investors in gold are demanding “unprecedented” amounts of bullion bars and coins and moving them into their own vaults as fears about the health of the global financial system deepen. Industry executives and bankers at the London Bullion Market Association annual meeting said the extent of the move into physical gold was unseen and driven by the very rich.

“There is an enormous pick-up in investment demand. I have never seen a market like this in my 33-year career,” said Jeremy Charles, chairman of the LBMA. “The gold refineries cannot produce enough bars.” The move comes as fears grow among investors over the losses at investment vehicles previously considered almost risk-free, such as money funds.  Philip Clewes-Garner, associate director of precious metals at HSBC, added that investors were not flying into gold simply because they saw it as a haven amid Wall Street’s woes. “It is a flight into gold because it is a physical asset,” he said.

Well, that’s a vote of confidence, eh readers? They’ve probably been perusing Nouriel Roubini, who reckons (bailout prospects notwithstanding) that “we are now back to the risk of a total systemic financial meltdown”:

The next step of this panic could become the mother of all bank runs, i.e. a run on the trillion dollar plus of the cross border short-term interbank liabilities of the US banking and financial system as foreign banks as starting to worry about the safety of their liquid exposures to US financial institutions; such a silent cross border bank run has already started as foreign banks are worried about the solvency of US banks and are starting to reduce their exposure. And if this run accelerates – as it may now – a total meltdown of the US financial system could occur.

We are thus now in a generalized panic mode and back to the risk of a systemic meltdown of the entire financial system. And US and foreign policy authorities seem to be clueless about what needs to be done next. Maybe they should today start with a coordinated 100 bps reduction in policy rates in all the major economies in the world to show that they are starting to seriously recognize and address this rapidly worsening financial crisis.

Doom, gloom.  Still, readers may also like to be aware that in noting the ongoing travails of Morgan Stanley and Goldman Sachs, Nouriel suggests that “the only institution sound enough to swallow Goldman may be HSBC”.  Another reason – as though one were needed! – why those of us who bank with HSBC’s lovely First Direct can shake our heads in bewilderment at those of you who choose not to. 

Now, if they only offered safe deposit boxes…

I’m out in China, where I’ve just spent a couple of weeks visiting Hong Kong, Beijing and the rural province of Yunnan. Some observations on China and sustainable development to follow in a separate post, but for now let’s focus on the big news of the week: the latest burst of financial meltdown. Lehman Brothers have filed for bankruptcy protection; Merrill Lynch have been bought out; the US Treasury has bailed out Fannie Mae, Freddie Mac and today AIG; every time I look at my blackberry, some new catastrophe seems to be unfolding.

As I’ve been chugging around China, I’ve been re-reading James Kynge’s excellent China Shakes the World – and noting with interest what Kynge has to say about the issue of bad debts. For example:

The ‘big four’ banks, which control more than half the country’s deposits and loans, are all owned by the state … The central bank, which regulates the banking industry alongside the recently established China Banking Regulatory Commission, has a track record of bailing out the ‘big four’ every time they need it … If the various cash infusions and bad debt relief for the state banks over the last five years are added together, it transpires that China has allocated nearly $250 billion to clean up its banking system.

But now fast-forward to today, a mere couple of years after Kynge’s words were first published.  Fannie and Freddie have already been bailed out – a move which, according to Nouriel Roubini, at a stroke injected around $200 billion of capital into the two of them, and took on $6 trillion of debt.  As Roubini concludes,

The nationalization of Fannie and Freddie is the most radical regime change in global economic and financial affairs in decades. For the last twenty years after the collapse of the USSR, the fall of the Iron Curtain and the economic reforms in China and other emerging market economies the world economy has moved away from state ownership of the economy and towards privatization of previously stated owned enterprises. This trend was aggressively supported the United States that preached right and left the benefits of free markets and free private enterprise.

Today instead the US has performed the greatest nationalization in the history of humanity. By nationalizing Fannie and Freddie the US has increased its public assets by almost $6 trillion and has increased its public debt/liabilities by another $6 trillion. The US has also turned itself into the largest government-owned hedge fund in the world: by injecting a likely $200 billion of capital into Fannie and Freddie and taking on almost $6 trillion of liabilities of such GSEs the US has also undertaken the biggest and most levered LBO (“leveraged buy-out”) in human history that has a debt to equity ratio of 30 ($6,000 billion of debt against $200 billion of equity).

So now Comrades Bush, Paulson and Bernanke (as originally nicknamed by Willem Buiter) have now turned the USA into the USSRA (the United Socialist State Republic of America). Socialism is indeed alive and well in America; but this is socialism for the rich, the well connected and Wall Street. A socialism where profits are privatized and losses are socialized with the US tax-payer being charged the bill…

And that was before today’s news that the US Treasury is taking on AIG as well, to the tune of another $85 billion, which (as the BBC observes) is “viewed by some as the most radical intervention in private business in [the Fed's] history”.  For Roubini, this is just confirmation of the worst fears:

At least in the case of Fannie and Freddie these two institutions were semi-public to begin with as they were Government Sponsored Enterprises (GSEs). Now we get instead the first pure case of a fully private company, actually the largest insurance company in the world, being nationalized. So the US government is now the largerst insurance company in the world. So the transformation of the USA into the USSRA goes a step further.

From where I’m currently sitting in Hong Kong, it’s hard not to cast your mind back a decade to 1997/8 and the South East Asian economic crisis, when the Washington Consensus still prevailed and liberalisation was the war cry.  As Steely Dan sagely put it: “those days are gone for ever; over a long time ago…”