Geithner’s damp squib fuels de-globalisation
Moves taken by the US will result in continued absence of normal flows of cross-border trade finance – the life-blood of developing economies
Global Eyes By PK Basu
THE global recession has entered a new and dangerous phase, as globalisation retreats, cross-border trade finance evaporates and manufacturing collapses across the world.
Unless something is done quickly to address the deepening crisis in credit markets – and the accompanying phenomenon of “financial mercantilism” that is devastating emerging markets in particular – the synchronised global recession could turn into a depression by the middle of the year.
As the epicenter of the credit crisis, much still depends on the US – and its fresh new Obama Administration. The former New York governor Mario Cuomo once aptly said about American politics that one campaigns in poetry but must govern in prose.
As President Obama settles down to the prosaic business of governance, he is disappointing some of his supporters’ loftiest expectations. The US$787bil fiscal stimulus package was signed by the president last week, and will certainly provide a substantial boost to the US economy from the next quarter (and especially the second half of 2009) onwards.
But ultimately its efficacy will still depend on the effectiveness of the Financial Stability Plan, the broadest contours of which were provided by Treasury Secretary Tim Geithner on February 11.
But the US continues to desist from taking the bitter pill that Malaysia and South Korea took with such alacrity in 1998-99 to quickly end their banking crises. The biggest lacuna in the plan is the US Treasury’s apparent willing to recapitalise large banks simply because they are large (and even if they are insolvent).
This approach will be much costlier to current and future US taxpayers than the Malaysian (Danaharta) approach of a decade ago – under which bank shareholders bore most of the costs (with banks obliged to sell their bad assets to Danaharta at a substantial discount to face value).
The experience of Malaysia, South Korea and Japan suggests that a weak (insolvent) bank should be closed or nationalised temporarily rather than kept alive through government support (as the US appears to prefer doing with several of its largest banks).
Eventually, the US government will be forced to recognise the folly of this approach (as Japan realised by 2002, after following this approach from 1998 to 2001; by contrast, the six largest banks in South Korea in 1998 were nationalised or sold to foreign buyers over the next few years, and a small but solvent bank called Kookmin was allowed to survive, and successfully grew its share of bank assets from 4% in 1998 to over 50% by 2002).
Federal Deposit Insurance Corp data shows that banks in 45 of the 50 states in the US are still profitable (and probably solvent). Since that is so, it is folly to keep the largest banks alive (even if some of them are insolvent) – as they will simply debilitate the entire system, and not allow the smaller, solvent banks to grow normally and help revive credit markets.
Geithner’s proposed “public-private partnership” to remove toxic assets from banks’ books is unlikely to work in its current form because private investors will offer market prices (which are at rock-bottom) for toxic assets – and banks will have no incentive to sell assets at those prices.
The purpose of a government-owned Troubled Assets Relive Programme (or the similar Danaharta/KAMCO solutions in Malaysia/South Korea ten years ago) would be to pay a price that is above current rock-bottom prices – but lower than the credible price at which those assets would be valued/sold in normal markets sometime in the future (say, two to three years down the road) after stability has been restored to markets.
This plan provides no mechanism for an effective work-out at prices/valuations that would help clear toxic assets quickly.
The plan as it now stands will not unfreeze credit markets. One important implication of this will be the continued absence of normal flows of cross-border trade finance – the life-blood of Asian economies.
While Asian banking systems have the wherewithal to eventually replace some of this financing, Asian (or emerging-market) banks cannot completely substitute for the big US and European banks that dominate the “globalised” world, including in areas like trade finance (especially the financing of counterparties in developed economies and several key emerging economies like Mexico where locally-owned banks have been emasculated over the past 15 years).
The honeymoon period of a new US President is the one time when radical solutions are likely to be acceptable; the failure of the Obama Administration to take the bull by the horns is, therefore, potentially very troubling for the prospects of the global (and hence Asian) economy in the medium term.
The US fiscal stimulus plan also contains “Buy American” provisions that will retard the prospects of a global recovery. Similarly, while British Prime Minister Gordon Brown excoriates “financial mercantilism” while speaking in Davos, his government back home is urging nationalised British banks to increase lending at home – which, in capital-constrained times, means they must reduce their overseas commitments.
This is leading to the perverse phenomenon of “risk-aversion” as major global banks cut back on cross-border credit, sell overseas assets and repatriate their proceeds back to the US (partly to prepare for Geithner’s impending “stress tests” of large banks).
Ironically, in the ten days since Geithner’s announcement, the US dollar has staged a strong rally – suggesting a renewed bout of severe risk-aversion.
US dollar strength is perverse when the US central bank’s balance sheet has more than doubled in the past four months. But US dollar appreciation is also diametrically the opposite of what is needed to correct the global imbalances at the heart of this financial crisis.
It was expected that Geithner’s strategy would go through several iterations before it gained credibility and traction with markets. But the half-baked announcement on February 11 has done more harm than good.
There is tentative evidence (for instance, in the well-designed initiative to deal with the housing market last week) that better-designed and effective plans will eventually emerge.
When such a plan does begin to emerge (hopefully by April), the clearest signal of the plan’s credibility will ironically be a sustained depreciation of the US dollar.
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