Financial Crisis: Beyond the „Fog of War“


Confidence has collapsed in the world financial system. Crisis management now means, first of all, panic suppression. But first elements of a new, regulated and multipolar financial system are emerging. And, there are indications that internationally coordinated infrastructure investment programs are being considered to prevent the financial crisis from turning into a depression of the real economy.

By Michael Liebig

On Sunday, October 5th, a strained-looking Chancellor Angela Merkel and a tense Finance Minister Peer Steinbrück appeared in the evening TV news to tell the German people that the government will guarantee all savings. „Not one Euro“ in German saving accounts will be lost, said Steinbrück. The nation was stunned, and so was I.

My next thought was: Merkel and Steinbrück have said: We guarantee the savings. They did not say: We guarantee the banks – by offering them a vast bailout fund of the kind which had been adopted by the US House of Representatives the previous day.

This American $700 billion bailout fund, euphemistically labeled “Troubled Assets Relief Program,” would supposedly calm down financial markets, paralyzed by the collapse of confidence among banks and a credit freeze on the interbank market.

But when the markets opened on October 6, stock markets crashed worldwide; an estimated $2,500 billion evaporated that day on stock markets internationally. The equity crash has since continued relentlessly, wiping out 25% of global stock capitalization during the trading week ending Oct. 10.

The trust in Anglo-American financial capitalism has irreversibly collapsed. Can one trust the supreme American “crisis manager” Treasury Secretary “Hank” Paulson? As CEO of Goldman Sachs, Paulson was a key operative in pushing the very financial “pyramid” schemes that have now imploded with devastating consequences. And, the American state is sliding towards a condition of insolvency vis-a-vis its foreign creditors. The latest calculations of the US budget deficit come close to $2,000 billion.

The central issue for the immediate crisis management is panic suppression. The already shaken confidence on Wall Street had broken down after the nationalization of Fannie Mae and Freddie Mac and the bankruptcy of Lehman Brothers. Since then, market angst has grown into hysteria and panic. Since, the panic has radiated from Wall Street to financial markets in Europe and Asia.

Re-establishing some basic confidence can only be done if China, Japan, the European Union, Russia, Arab and Latin American plus the International Monetary Fund take concerted action. Such action might include temporarily shutting down stock markets and declaring “bank holidays” to stop the self-feeding panic.

The German Position

On Oct. 6-8, I was in Berlin talking to several political analysts with good connections to the German government. In our lengthy discussions, the mood was sober, but not panicky at all. There was a consensus that Germany – and continental Europe – had no choice but to collaborate with the USA and Britain in immediate crisis management on a day-to-day basis.

My contacts noted that “basic stabilization” measures – not really resolving anything, but suppressing panic – may last longer than one might hope. It might take not weeks, but many months.

Financial aftershocks and relapses of market angst are likely to occur over an extended period of time. And the creditors of the United States will likely suffer massive financial losses. Holger Steltzer estimated in the Frankfurter Allgemeine Zeitung that China alone has already lost $500 billion of its investments in US assets. The losses for Japan and Arab countries have probably a similar dimension.

My contacts in Berlin emphasized that they foresee concerted international crisis management operations, but no “global rescue fund” modeled on the American “TARP” bailout fund. Germany has firmly rejected an “EU emergency fund” for troubled banks at the Oct. 4 European G-4 meeting in Paris. And both Merkel and Steinbrück have since firmly rejected the idea of some “supranational umbrella” for failing banks. However, the German government will – on a national and European scale – act to avert the collapse of “systemically relevant” banks. Steinbrück said he would aim at a “comprehensive” approach in doing so, without however giving details.

The government had to act on Oct. 4 in order to prevent the collapse of Hypo Real Estate (HRE) and her Irish Depfa affiliate. HRE’s de facto insolvency was due to the credit freeze on interbank markets, not exposure to subprime-related structured securitization. On September 28, HRE had been bailed out by a 35 billion euro package of credits and credit guarantees, jointly provided by the German government, the private and public banks. On Oct. 4, it became clear that HRE had significantly understated their refinancing needs. Now, the private banks tried to get out of the concerted action, leaving HRE’s bailout to the government alone. The government had categorically stated that HRE must not go bust because that would have wrecked the 900 billion euro market for “covered bonds” (Pfandbriefe), which is the traditional and orthodox form of securitization in Germany. On Oct. 5, the private banks had to back down to the government and were forced to increase their share in the emergency credit line for HRE.

So far, the German banking system was kept relatively liquid through the well-stocked saving accounts of “the small people” in a country with an 11% savings rate. Merkel’s guarantee for the saving accounts was also a reminder to the banks that their very survival depends on the “small savers”. Sofar, the “small savers” have kept their nerves, it is the banks that have panicked.

“8 Traffic Rules”

Beyond the acute crisis management for panic suppression, the German government is strongly pushing for a new, international regulatory framework for financial markets. Steinbrück has spoken of “the bankruptcy declaration of laissez-faire capitalism, which dominated large chunks of financial markets during the past decades,” adding that “self-regulation” of financial institutions has completely failed.

Instead, Steinbrück has put forward “ 8 Traffic Rules”:

1) Keep “innovative” financial instruments on the balance sheet
2) Increase bank liquidity cushions
3) New standards for personal liability of financial actors
4) Adjusting the incentive schemes of banks
5) Create an early warning capacity for the IMF
6) Ban short selling
7) Retention of up to 20% for securitization
8) Enhance cooperation of regulatory agencies

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Steinbrück’s “ 8 Traffic Rules” have been submitted to the meeting of the G7 finance ministers in Washington on Oct. 11. The continental European EU countries are backing these rules. And the same can be assumed for the other major actors, including China, India, Brazil and Russia. The German government is also strongly pushing for international action to quarantine unregulated financial “off-shore centers” and “tax havens”.

The Oct. 4 Paris Summit of France, Germany, Italy and Britain agreed to convene an international financial conference of the G7 plus China, Russia, India, Brazil, Mexico and South Africa before the end of this year. A few days later, US Treasury Secretary Paulson called for a meeting of the governments of the world’s 20 leading economies.

A new international regulatory framework for financial markets, including the “8 Traffic Rules,” will be part of a new world financial architecture. Such a new financial architecture might be called a “new Bretton Woods,” but it will be very much the opposite of the 1944 Bretton Woods, because the United States will not play a dominant role in the new system and the US dollar will be just one among several lead currencies.

But a new international financial architecture makes up only one half of what is necessary. The Oct. 4 Paris Summit of France, Germany, Italy and Britain decided that the “Maastricht” limits for deficit spending are effectively suspended. This removes a key impediment for governmental programs to stimulate the real economy in the European Union.

In Berlin, I was told that plans are being worked out for an internationally coordinated investment program for modernizing and expanding infrastructures, notably in the realms of energy, energy efficiency, and transportation. The past decades of laissez-faire capitalism have been an era of irresponsible neglect of vitally important infrastructures and ecological requirements worldwide. A consensus seems to emerge that the financial crisis is a disaster, but a worldwide depression would be much, much worse.

That might seem far fetched at a time when panic grips financial markets. But if you read the following sentences in the lead editorial of the erstwhile neoliberal-Atlanticist Frankfurter Allgemeine Zeitung, you know that radical shifts are possible: “The world is transcending from American hegemony to a multipolar order… The next G7 summit could be the last of its kind. The time has come to engage Russia, China and other countries. The earthquake on financial markets leads to tectonic shifts in the political constellations of the world. This means risks, but also chances for Europe.” A few days earlier, Steinbrück had told the German parliament: “The USA will loose their status as the superpower of the world financial system. The world financial system will become multipolar.”

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