Start the conversation
Comment on This Story
Or to contact Money Morning Customer Service, click here.
By Martin Hutchinson
Contributing Editor
Money Morning/The Money Map Report
The gathering of 20 largest industrial countries in Washington this past weekend – billed as a crucial G20 summit – turned out to be a rather dull scrum.
There were promises of a coordinated approach to bank regulation, additional economic stimulus packages, and increased allocations for the International Monetary Fund (IMF) –one of the five "aftershock-investing" opportunities Money Morning has counseled readers to watch for. But none of the G20 meeting proposals seemed even remotely likely to make a difference in the here and now.
Even so, when you consider the kind of mischief the world's 20 largest governments are capable of getting into, it's best to just breathe a sigh of relief.
The G20 communiqué starts by getting the cause of the crisis wrong. It blames banks that "sought higher yields without an adequate appreciation of the risks" as the primary cause of the crisis, while government was to blame only for inadequate supervision. That begs the question: What made banks – which for decades had been model citizens, leading perfectly blameless lives – suddenly go off the reservation in this way?
The answer, of course, is sloppy monetary policy.
These slapdash policies, pursued by the U.S. Federal Reserve since 1995 and by other central banks since 2002, have translated into very low interest rates, and asset bubbles that over-inflated the value of stocks, real estate and commodities throughout world markets. Naturally, since borrowing was cheap and asset prices always went up, bankers, acting like the well-trained economic men they are, leveraged too much and stuffed their balance sheets with all sorts of snoozy assets.
But central banks' misdeeds are not failures of the private sector; indeed, central banks are government institutions.
Likewise, the misdeeds in the housing market – while perpetrated by private-sector wheeler-dealers among the mortgage brokers and asset securitizers – were initially prompted by Fannie Mae (FNM) and Freddie Mac (FRE), two government-based enterprises (even though these companies tried to masquerade as private-sector ventures, so they could pay their top brass like Pharaohs, instead of the civil servants that they actually were). They were spurred on by the Community Reinvestment Act, which positively forced banks to lend large sums of money to impoverished unfortunates who couldn't pay it back – creating the subprime-mortgage market.
The G20's refusal to admit that government bears a large part of the responsibility for the crisis is important. Public beliefs about the cause of disasters can affect policy for decades. This happened during the 1930s. For decades the public was convinced that the Wall Street Crash of 1929 caused the Great Depression. Indeed, it was two other factors – the Fed's inability to expand the money supply during the banking crisis of 1931-33 (identified as a big problem by Milton Friedman and Anna Schwarz in 1963), and the highly protectionist 1930 Smoot-Hawley Tariff Act (not really blamed until the late 1970s) – were much more centrally responsible.
Only when another almost identical crash happened in 1987 – and no "Depression" followed – was this long-held misnomer finally put to rest.
But this long-held misdiagnosis caused U.S. policymakers to devote much effort to preventing another Wall Street Crash, in order to avoid another Depression. In doing so, they made matters much worse in some respects, notably by splitting commercial and investment banking by the 1933 Glass-Steagall Act. That legislation almost shut down the U.S. capital markets in the late 1930s, because the tiny new investment banks, split off from their commercial bank parents, could not afford to underwrite large, risky stock-and-bond offerings.
With its mistaken assessment of the market's current backdrop, the G20 will focus mainly on bank regulation, tightening down so that banks will be forced to keep more capital on hand to sustain their balance sheets – therefore unable to make as many risky investments or high-risk loans.
We're already seeing the fallout from this assessment. First, banks are de-leveraging as fast as they can, forcing down asset prices and helping fuel the whipsaw volatility that's become the market norm of late (hedge funds and other institutional players are de-leveraging, too, which is contributing to the chaos). Second, credit has tightened throughout the world economy, and we're now watching as one market after another is succumbing to recessionary forces.
Controlling the salaries of bank executives will also have a modest economic effect, probably in increasing the number of hedge fund and other speculators that infest the financial system – not a good recipe for stability in the long run.
What won't happen is a proper reform of the government policies that went wrong. There will be no tightening of monetary policy – until rapidly rising inflation forces it to happen, probably about a year from now, once the economy has touched bottom. There will be no reform of the housing market – we are unfortunately unlikely to return to the sepia-toned days when local savings-and-loan companies run by "It's a Wonderful Life's" George Bailey (Jimmy Stewart) made home loans directly to customers they deal with on a first-name basis. This failure to reform will make housing finance a source of future instability, and increase the bureaucratic cost and hassle of getting a mortgage.
Despite these many missteps, however, there's reason to be very thankful.
For all its mistakes, the G20 avoided the biggest blunder of all, the misstep that touched off the Great Depression – a move toward protectionism that could devastate world trade. Indeed, the group specifically pledged to avoid trade-inhibiting moves for the next 12 months and to work towards a Doha global trade agreement. I'll believe the reality of the latter when I see it, but if the world's statesmen are negotiating Doha, even unsuccessfully, they're not passing Smoot-Hawley.
Simply having the world's leaders meeting frequently keeps them from moving in this specific wrong direction – passing protectionist legislation is unpopular with leaders who know they will have lunch with their country's trading partners soon, meaning they'll do all they can to avoid that embarrassment!
With world trade unaffected, even this very unpleasant downturn is likely to be fairly short and nothing at all like the Great Depression. Twelve months from now, the world economy will be starting to emerge from a recession, stock prices will be rising and the major problem facing us will be rapidly accelerating inflation.
But at least we'll have inflation-hawk Paul Volcker around, advising President-elect Barack Obama on the moves to make to tackle that problem. That's one problem that won't be misdiagnosed.
News and Related Story Links:
- Money Morning Weekly Preview Column:
U.S. Automakers, Freddie Mac and Foreign Exporters Next in Line for Bailout Handouts. - Wikipedia:
Government-sponsored enterprises. - Money Morning Aftershocks Investing Series Part I:
The Five Financial Crisis "Aftershocks" Investors Can Play for Profit. - Wikipedia:
Community Reinvestment Act. - Wikipedia:
Subprime-mortgage market. - Money Morning Market Analysis:
Japan Officially Enters Recession as Exports Lose Steam . - Wikipedia:
G20. - Money Morning Financial Commentary:
It Was a 'Wonderful Life' Before Wall Street Hijacked the Home Mortgage Market. - Wikipedia:
Wall Street Crash of 1929. - Money Morning Market Analysis:
Eurozone Enters First Recession, U.S. to Follow. - Money Morning Market Analysis:
Doha Deal Could Offer $100 Billion a Year to Global Economy if it Gets Done. - Money Morning Market Analysis:
Doha Discussions Could Take Another Seven Years.
[…] Vote Despite the G20's Latest Missteps, Reason for Economic Optimism … […]
Your points are valid. The state capitalism in the the great developed countries is addict to bank money and public spending that is the main problem and major conflict of interest of our parlementary democracies. How to deal with this very strong state capitalism in order to avoid the next turmoil which will be more damaging our lives? You mention P Volcker, a former member of the Reagan team. But the situation demands more in my point of view.
"But central banks' misdeeds are not failures of the private sector; indeed, central banks are government institutions."
Could someone show me how the Federal Reserve is a public institution? The central bank of the USA is a private venture with no government oversight, aside from the President appointing the odd person to the Fed, no doubt on advice by the Fed. Just because it's called 'Federal' does not make it a public government institution.
Read "the creature from Jekyll Island" In my lectures throughout this nation, and in my appearances on many radio and television programs, I have sounded the toxin that the Federal Reserve System is not Federal; it has no reserves; and it is not a system at all, but rather, a criminal syndicate. From November, 1910, when the conspirators met on Jekyll Island, Georgia, to the present time, the machinations of the Federal Reserve bankers have been shrouded in secrecy. Today, that secrecy has cost the American people a three trillion dollar debt, with annual interest payments to these bankers amounting… Read more »
I feel sorry for Alan Greenspan. Hailed as an infallible genius for so many years; now the scapegoat as the house of cards comes tumbling down. The old goat has his share of blame, but what about the dogs who herded the sheep to be fleeced?
In my lectures throughout this nation, and in my appearances on many radio and television programs, I have sounded the toxin that the Federal Reserve System is not Federal; it has no reserves; and it is not a system at all, but rather, a criminal syndicate. From November, 1910, when the conspirators met on Jekyll Island, Georgia, to the present time, the machinations of the Federal Reserve bankers have been shrouded in secrecy. Today, that secrecy has cost the American people a three trillion dollar debt, with annual interest payments to these bankers amounting to some three hundred billion dollars… Read more »
It is neither the Fed nor the banks that caused this financial crisis. It is "Capitalism". Anytime you set up a system that promotes one to enrich onself at everyone else's expense, it is doomed to fail. As J.B.S. Haldane put it: "Capitalism did not arise because capitalists stole the land or the workmen's tools, but because it was more efficient than feudalism. It will perish because it is not merely less efficient than socialism, but actually self-destructive."
"They were spurred on by the Community Reinvestment Act, which positively forced banks to lend large sums of money to impoverished unfortunates who couldn't pay it back – creating the subprime-mortgage market." That is not correct, though it is the justification used by the banks. The only two institutions "forced" to make sub-prime loans were Fannie Mae and Freddie Mac under the 1992 FHEFSSA–the rest of them hopped on for the ride, using the law as an excuse, so they could excessively leverage the mortgages in the booming derivatives market. Place the blame where it is due–on the greedy financial… Read more »
What!? Government policies "made" banks neglect their fiduciary responsibilities, which caused the current financial mess? This is in direct contradiction to Money Morning's earlier reporting on credit default swaps being a if not the major reason for the meltdown – "The Real Reason for the Global Financial Crisis…the Story No One's Talking About" (and follow-ons to that). Blaming the government for this is like saying the government by allowing gun ownership is responsible for the criminal use of guns! Moreover, Freddie and Fannie DO NOT MAKE sub-prime loans, AND NEITHER they NOR the Community Reinvestment Act were the primary agencies… Read more »
Recently re-read "How to survive a recession" by Robert Hudson which I bought circa 1991. He frequently refers to the oncoming "Credit Crunch" which he forecast for 1993 in the UK! His book is valid today. Worth a look by any businessman.
As a UK citizen residing in Spain, I would appreciate an objective view on Gordon Brown's economics. He sold off Britain, yet sees himself as the saviour of the planet. I bet he wishes that he could get our gold back.
HEY WHAT ABOUT THOSE WHO SERVED IN GOV'Y WHO ENCOURAGED THE BANK TO GIVE OUT THOSE MORTGAGES WHO COULD NEVER MAKE THEIR PAYMENTS. THEY SHOULD BE IN JAIL OR WORSE! BARNEY FRANKS AND CHRIS —WHATZ HIS NAME?
I'm convinced that throwing hundreds of billions of dollars into all sorts of banks and finance companies won't fix our economic problems because without our consumers' ability to repay debt, enabling more of it only exacerbates the problem. The implosion of the housing market is not the problem; it is only the symptom. I believe the cure lies in stimulating long-term production, not short-term consumption. Possibly millions of jobs have been lost at the hands of America's labor unions, over-regulation, and mandated benefit packages. The combination has forced countless American manufacturers to look for lower-cost suppliers and workers abroad in… Read more »
They seem to be able to find the money – so here's a thought. Governments pay off EVERYBODIES MORTGAGES. That gives them cash to spare. We all spend and spend, even buy a holiday home (in Spain). I get to sell my place and rent instead. Interest rates rise and I get a better annuity before inflation kicks in. It's no more of a fantasy than we're hearing day to day from Gordon Brown. (Who is he, you ask?)
With its commitment to explore the "vulnerabilities" in the global financial system, the G20 conference is a first step toward part of the long range solution to the world's global financial instability, which is a Single Global Currency, managed by a Global Central Bank within a Global Monetary Union. The success of the euro shows that monetary union is the best way to ensure monetary stability. The primary problem with the euro and currencies of other monetary unions is the multi-currency system itself where currencies fluctuate in value against each other. If 16 countries can use the same currency, why… Read more »
[…] Errol Flynn, Gloria Steinem, Psychology and Personal Finance 22 Nov 2008 Evaluating the G-20 Conference by Carson Brackney Those who've focused on the shortcomings of the recent G-20 Summit have dismissed it as a "circus without a ringmaster," "Hamlet without a prince", and "a rather dull scrum". […]
[…] Those who've focused on the shortcomings of the recent G-20 Summit have dismissed it as a "circus without a ringmaster," "Hamlet without a prince", and "a rather dull scrum". […]