What Should the New G20 Agenda Be?

The new consensus on international imbalance monitoring and surveillance reduces the problems associated with implementing effective development and growth strategies in the face of several political and economic constraints to a problem of imbalances that can be solved by minor adjustments. These adjustments include achieving greater transparency; less regulatory arbitrage among lax structures; and changes in distortions like removing soft-pegged exchange rates and reducing fiscal and trade deficits. However, the political and economic constraints economic administrators face include negotiating strategies in the context of the economic hegemony of the neoliberal growth model and its promotion of the export-orientation of developing nations. This response invokes the old neoliberal model without recognizing its failure at the country level and thus it is unlikely to succeed, even in a revised form, with tremendous global cooperation. The neoliberal model must change and the policies that follow must be coordinated to effectively get us out of this global recession and onto a sustainable, more equitable growth path.

National financial ministers and the international financial institutions haven’t even agreed that the development of structured investment vehicles (SIVs) and conduits which were not robust enough to withstand changes in credit ratings and interest rates spreads were problematic. Nor have they been able to agree that the great articulation of the securitization markets that followed these innovations was an overgrowth that must be systematically scaled down, particularly by modifying home mortgages. The IMF’s latest Global Financial Stability Report laments how far we need to go to resuscitate securitization markets, as if that were desirable. And while Barney Frank and others can be commended for resuscitating the cram down legislation it still remains unpopular with the well-funded financial community.

The new G-20 consensus involves the same neoliberal themes embodying neoclassical assumptions and New Keynesian amendments, including the view that transparency can solve all problems associated with asymmetric information in credit ratings and overextension of risk. It is the same kind of assumption holds that labels on packs of cigarettes will stop the spread of cancer. There is no fundamental critique of capitalism.

There is the recognition of inequity. There is the understanding that the status quo represents the interests of the winners of the game who are few while the losers are many. This is expressed through the push by heads of state, appealing to populist sentiment, to impose stringent executive compensation standards and, more radically in the US, to standardize the incentive structures for all employees at financial institutions proposed by the Fed. There have even been calls in the UK and Europe for financial trades to be taxed to slow down speculative gains and to stifle destabilizing sell-offs echoing calls from progressives in the US. These recommendations acknowledge pure, short-term profit maximization (or maximizing shareholder return for public companies), which is at the heart of capitalism, is inherently destabilizing and leads to intolerable inequities as well as inefficiencies. This is a start, but judging by the backlash these modest proposals have received, implementing even more comprehensive redistribution plans and disempowering the financial sector are far from being on the table given the political capital of the elite who have benefited and will continue to benefit from both the upswings and downswings inherent to capitalism. When proposals are put forth--like allowing a scaled-down vanilla version of the financial sector to exist in return for counter-cyclical mechanisms for gains to be shared more equitably during the booms and for losses during contractions to be borne by those at the top of the income ladder--you know we will have had a shift in our system toward democracy.

The reforms currently on the table are largely Band-Aids. The calls for greater capital adequacy provisions seem to hope that extra padding—wearing elbow pads—would somehow be sufficient to prevent massive coronary attacks. The call for greater provisions to the IMF can be seen as desperation, the collection plate circulating to pay for the funeral, not a real solution unwind bad debt justly. The call for the IMF to make minimal increases to special drawing rights (SDRs) can only be seen as a down-payment on more fundamental reforms to address currency realignment. This would entail promoting continuous, equitable exchange rate coordination.

Although Zhou Xiaouchuan, Governor of the People's Bank of China has discussed the role of pro-cyclicality in precipitating and extending crisis, there is less discussion about what countercyclical mechanisms can exist without changing our current development model. The neoliberal mantra has been liberalize and prosper (and at times, liberalize or else). Nations that liberalize their financial markets are recommended to accumulate savings in lieu of implementing capital controls or gradually and partially liberalizing. They are told, even still, to accumulate savings in ways that do not promote distortions, (presumably through foreign reserves gained namely through export sales producing net foreign asset surpluses). Thus, their imbalances cannot be leveraged without structurally changing their circuits of production and investment which does not happen automatically when prices, i.e. relative exchange rates, change. This was historically demonstrated after the devaluation of the US dollar relative to the yen failed to change the structural imbalances with Japan, after the Plaza Accord was enacted in 1985. Currently, however, large fiscal deficits in importing nations used to pay for structural changes are discouraged (by lenders, the IMF, credit rating agencies and fiscal conservatives) while use of foreign reserves in developing nations is encouraged to boost consumption (by the G7 nations and the IMF). However, in these developing nations GDP is being derived from export sales and domestic markets are well developed, meaning increased domestic consumption will not automatically increase imports. Thus, offloading a significant amount of foreign held reserves could destabilize the reserve currency while if “effective” could cause the trade deficit to be skewed in another unsustainable direction, promoting stagnation and deflation. The fallacy of composition is operating in this line of thought. What is needed is more policy space for fiscal policy in industrialized nations to sponsor structural shifts. This should be paired with more lenience for developing nations to pursue expansionary fiscal and monetary policy as well as employ any and all necessary protections.

Protectionism perceived to be anathema to all. In crisis, especially, it is actually the knee-jerk reaction of a state to identify its best interests and to insulate those interests against complete annihilation. However, insofar as this conflicts with what other nations have identified as their best interests, we have a coordination problem, but importantly, not an essential problem with protectionism itself. What, in fact, we need is not only the ability of nations, developing and industrialized alike, to be permitted and emboldened to pursue industrial policy and implement economic plans; these need to be coordinated in an equitable international forum to ensure those nations with most vulnerabilities, requiring the most investment and protection are treated differently than wealthy nations and those with tremendous resource wealth and diversified export potentials. Full employment at equitable wages in all economies should be the overarching goal of this coordination experiment. This would require preempting two decades of multilateral and bilateral trade agreements and dismantling the liberalization and deregulation foundational tenets of the WTO but the coordination would be well-suited to function under the current WTO structure.

The industrialized nations have emboldened the IMF and made hundreds of billions in new commitments while the IMF now maintains developing nations, if well qualified, can run deficits not much larger than 2% GDP. The IMF was created to assist countries who would otherwise not be qualified for credit to avoid running deficits by borrowing a sufficient amount from the IMF, not to bail out failing banks either, so this concession is ironic, even if it’s the most generous the IMF has ever been on deficits for developing nations. The IMF still opposes the use of capital controls even as crisis and speculation are predicated on uncontrollable flows pouring in and out of an economy. There has been no recognition by the G8 or the IMF itself that the IMF’s recommendations for liberalization, deregulation and structural adjustment have failed; large checks are just being passed out. This is a bailout at the international level for those destabilizing the economies of developing nations; it’s a socialization of losses transferring the risk of the private sector to the tax payers in developing nations (let’s keep in mind these are loans with interest). So much for institutional accountability and a regime change away from free market capitalism.

What do good people think about this? See a sound list of demands here.

Americans’ for Financial Reform’s G-20 agenda includes:

• The IMF allowing countries with stand by arrangements to have flexibility to expand healthcare and education spending. They recommend the Fund give countries more macroeconomic flexibility in fiscal and monetary policy, including the use of capital controls and that the Fund prohibit the inclusion of financial deregulation as a condition of funding or a policy recommendation. They also endorse expanded debt cancellation, free from harmful conditionalities.

• Abandoning the terms of the WTO’s 1999 Financial Service Agreement (FSA) imposing financial deregulation on all nations regardless of their domestic laws.

• Supporting efforts to eliminate tax havens and regulate shadow banking, (hedge funds, private equity funds, derivatives and off balance sheet activity) by setting minimal regulatory standards agreed to by the nations of the G-20 in consultation with international bodies such as the International Organization of Securities Commissions (IOSCO) and the Financial Stability Board (FSB).

• Moving from antagonistic trade relations under unrealistic and counter-productive agreements to cooperation and leniency.

• Independence of financial regulatory bodies from the finance industry.

William White, head of the monetary and economic department at the Bank for International Settlements suggests taking a hard look at the monetary policy environment that feeds bubbles (less the current en vogue explanation that savings gluts in surplus nations were the cause of the global financial crisis) and warns of problems in executing fiscal stimulus programs in industrialized nations without coordinated planning to address structural issues.

Philip Augar, a former investment banker and the author of Chasing Alpha, and John McFall, chairman of the Commons Treasury committee recommend breaking up the banks and re-imposing a more aggressive Glass-Steagall and scaling back the financial sector:

Taken together, these reforms would represent a wise shift toward financial stability and provide the policy tools necessary for nations to develop domestic and international strategies to achieve stable growth. Doing so requires a tremendous amount of advocacy because it requires confronting organized capital and dismantling the ideology of free market capitalism that pacified our better judgment as inequities grew around us. Watch this website for more details on how you can help fight the fight.

Food Security: All Investment Is Not Created Equal

The G8 countries committed $20 billion in aid to address global hunger and promote more productive farming in the world's poorest countries this July in L’Aquila, Italy. Major commitments came from the United States and Japan. The challenge remains to make sure the investments are structured properly and the environment that caused the hunger crisis is reformed to ensure food security for all.

Tokyo has already begun targeting its investment in ways that might exacerbate food security problems in developing countries. This demonstrates the need to maintain pressure on donor countries and the international financial institutions (IFIs) to adjust their assumptions and protocol so that the crisis is addressed in the short, medium and long-term.

Tokyo believes that expanding food production, through public-private partnership with its local trading houses and other companies, will help mitigate future risks. Among Japan’s five mammoth trading houses, Mitsui & Co, Itochu and Marubeni are expanding into food commodities such as soyabean, palm oil, wheat and corn. . . . Beyond their homeland, where demand for grains and oilseeds is relatively stable, industry observers say the Japanese trading houses seek to tap the voracious appetite for soyabean and grains in China and elsewhere in Asia, particularly in Vietnam, Thailand and the Philippines, or in Middle-East countries such as Saudi Arabia.

What is being pitched as a new agricultural revolution using these forms of investment will look very much like the colonial model of exploitation with the exception that the output will meet commodity demand in high growth countries versus demand in the colonizing nation. Regardless, the same distribution of benefits will apply without proper safeguards. These should include mechanisms to coordinate international production as well as mechanisms to ensure investment is directed at local producers, and to ensure prices are low enough so that developing countries will have food security and access to their own goods. By simply funding industrial agricultural conglomerates, the company, in typical neocolonial fashion, will utilize the resources of developing countries, extract the raw materials and export them to sell in foreign markets at a profit.

The current framework discussed by the G8 nations and embodied in the new IFI push for investment assumes increased investment in agricultural production will generate greater supply, which will naturally decrease prices and address the problem. Although increased production will tend reduce prices generally, this does not mean that this strategy will address the global food crisis for several reasons. This line of thinking presumes the large run-up in commodity prices resulted from a uniform increase in demand against a less responsive supply chain. Leaving aside the ways in which speculative players affect commodity prices, there is a structural supply problem because of the increasing cost of energy.

However, this issue of increasing costs affecting global food prices predominates because a technological mode of agriculture production and transportation predominates. This mode is extremely capital-intensive, industrial and large-scale. Thus what we are seeing is not a food security problem as much as an investment problem in certain kinds of agricultural production and distribution. It is also a global food supply chain coordination problem. On the demand side, there aren’t fast growing populations of hungry people in the least developed nations driving up the prices of food; there are changes in the diet preferences of high growth nations representing a dynamic middle-class who are driving demand for more energy and resource intensive food sources.

Although demand exceeds supply, the demand for staple crops is driven by demand for livestock feed and for biofuel crops in addition to basic staple consumption by households. Thus, the problems of food security for the poor are being caused by structural distribution problems that drive up prices on basic staples. This leaves local populations, even in arable, land-abundant nations, without access to their own agricultural products.

International price fluctuations wreaking havoc on production in developing countries has been particularly damaging over the past 30 years of neoliberal development policy. This has occurred after the privatization of their development and agricultural banks and the liberalization of their agricultural and commodity markets. The export and foreign exchange-oriented development strategy which promote economic growth before food security presumes the distribution of gains from increased economic growth will benefit the population equally. However, the impact of privatization and globalization on the rural poor, historically has not demonstrated that this happens naturally. Income inequality has grown across the developing world during this period of neoliberal polices. Further what we have witnessed is the trend in the rapid transformation of small-scale agricultural producers into struggling slum dwelling communities. See more here. A solution to the global food crisis must then also address these neoliberal policy failures to address the root causes of the problem.

The original document drafted by the agricultural ministers to the G8 and the subsequent joint statement with G8 ministers recognized the significance of investment in smallholder farmers and women farmers. However, it still maintained that open and efficient trade markets were part of the solution. This part of the statement might have sought to draw attention to the large distortionary impact of US agricultural subsidies on the developing world’s agricultural markets. If this was the case, it should have stated explicitly that wealthy nations, particularly land and resource abundant wealthy nations, should work to scale-back their subsidies to large-scale, industrial producers. The ministers should have then gone further by endorsing developing countries’ use of protections to develop their agricultural sectors through whatever means are necessary including revitalizing publicly subsidized agricultural banks.

A well-coordinated strategy would use the WTO, not to police nations to reduce barriers to trade uniformly, but to coordinate international agricultural policy to ensure food security for all. Particularly, the WTO could be tasked to ensure short-term efforts to address food security via dumping excess commodities on low income country markets do not crowd out domestic production of agricultural crops in the medium- to long-term. Likewise, along the lines of the Kyoto Agreement, nations that are large consumers of staple-intensive livestock, should commit to lowering their consumption to less resource intensive foods. Treating wealthy nations that are agriculturally constrained differently from resource abundant nations that are poor when allocating IFI investment is also particularly important. The International Financial Corporation’s latest commitment to boost agricultural production by 30% would seem to be targeting production in developing and high-risk nations, however, the companies benefiting from the investments will be donor country corporations and budding domestic partners, not traditional farmers. Funding small local producers is the right thing to do socially and politically but also makes economic sense. Walden Bello states:

[S]mall farmers have confounded those who have preached their demise by showing that labour-intensive small farms can be far more productive than big farms. To cite just one well known study, a World Bank report on agriculture in Argentina, Brazil, Chile, Colombia and Ecuador showed that small farms were three to 14 times more productive per acre than the large farms.

Kanayo F. Nwanze, president of the International Fund for Agricultural Development (IFAD) explains the value of investing in smallholder farmers over larger-scale producers in the developing world even with reaching industrial levels of productivity:

Eighty percent of the farmers in Africa are smallholder farmers. The majority of them are women. They produce 80 percent of the food that is consumed by Africans. Obviously, if these are the people that produce the food that we eat we must invest in smallholder agriculture. . . . We have proof that investment in smallholder agriculture is two to four times more profitable than investment in any other sector or sub-sector. It's very simple mathematics.

The investment generated to address the food crisis must be tied to measures to ensure the domestic population gains from the increased production and use of their land, energy and resources. Thus, investment should be targeted toward local producers for local consumption in low and middle income countries. These countries should be allowed to maintain tariffs on their commodities if they choose to export to wealthy and middle-income countries. Likewise, price controls should be permitted for countries with hunger problems.

If the G-8 and IFIs were sincere about addressing the food crisis, they would be permitting more flexibility of developing countries' policy responses to address this crisis using all tools at their disposal. This would include channeling investment on favorable terms to local producers; working with the WTO on global food production and distribution coordination; encouraging populations in high-demand countries to eat further down the food chain; and reigning in speculation in commodity and futures markets. Now's the time to ensure the US doesn't follow in Japan's wake.

TARP Or Reconstruction? No Contest

At a conference hosted by Dēmos today, economic experts "lifted the TARP" to expose the flaws in the Treasury Department’s plans to repair the nation's financial markets.

“Lifting the TARP: Is a Reconstruction Finance Corporation a Better Way to Restore the Banking System?”, took a critical look at the Toxic Asset Relief Program and the implicit assumptions and criteria for intervention via the Emergency Economic Stabilization Act of 2008 (EESA). Damon Silvers, who serves as associate general counsel of the AFL-CIO and deputy chairman of the Congressional Oversight Panel on the TARP but who was speaking for himself at the conference, said that the Treasury Department said those assumptions and intervention criteria were:

1.) Protect all existing investors, including equity holders by all means necessary

2.) Keep these transactions off the Federal balance sheet

3.) Basic interventions are targeted at infusing liquidity without due diligence regarding what is being purchased and what price is justified

4.) Losses that have happened are not real, but are caused by a temporary disturbance in confidence that can be staved off by buying time.

Page 11 of the Congressional Oversight Panel’s latest Oversight Report, released April 7, states, “This approach assumes that the decline in asset values and the accompanying drop in net wealth across the country are in large part the products of temporary liquidity discounts due to nonfunctioning markets for these assets and, thus, are reversible once market confidence is restored.” But that, “Treasury and key policymakers in the Administration argue that the recently-passed fiscal stimulus passage, Treasury’s foreclosure mitigation plan, and the public-private program to revive markets for toxic assets will strengthen the fundamental value of these assets.”

Thus, as the revelation of losses echoing through the system became more real, the strategy shifted its assumption that all can be restored to its previous state, to the fiat all must be restored to its previous state by implementing programs that subsidize the activities of those experiencing the greatest losses and vulnerability.
This tack represents denial. Even if it were possible or desirable to return to the old system of structured finance and the proliferation of derivatives, Treasury's current outlays fall short of the need. Goldman Sachs has projected losses from U.S.-originated credit assets at $2.1 trillion, the International Monetary Fund estimated $2.2 trillion and Nouriel Roubini estimates losses yet to be written down at $3.5 trillion.

Robert Kuttner, a Distinguished Senior Fellow at Demos and the Co-Editor of The American Prospect, stated unequivocally that trying to restore the old system is antithetical to rebuilding a sound economy given “structured finance is parasitic of the real economy.” Our objective, he emphasized, must be winding down these sectors to approximate a plain-vanilla, pre-1975 banking system.

Thus the bailout efforts that stem from a fundamentally misguided assumption will continue to be misguided. While restructuring is being avoided and markets, instruments and entities are being supported under the assumption these can be temporarily sponsored and resuscitated in the near future, recognizing these losses and managing the distribution of the pain in an orderly, preferably fair way is the only way out of our crisis.
Toward this end, the report focuses on historical examples of financial crises handled correctly. Silvers outlined the sequence of steps all successful interventions share in common:

1.) New management replaces the old in failing institutions, not for moral reasons, but because of the difficultly in objectively evaluating the mess you’ve just made.

2.) The true value portfolios must be made. A hard valuation of the assets of the entities must be made, generally on a cashflow basis, which requires management overseeing the valuation can be trusted to appropriately estimate this revenue.

3.) Once the gap is established, equity is wiped out.

4.) For the remaining fixed obligations there is some flexibility in resolution with possible haircuts and different scenarios possible for debt holders.

5.) In this process, the more taxpayers are participating in funding the restructuring of these failed entities, the more upside should be sought for the taxpayer once these entities are restored and the stake unwound.

Tellingly, Silvers stated, the length of time it takes to get through the three stages—denial, subsidy and government takeover—determines the speed at which the crisis can be resolved and is a directly proportionate to how corrupt the system is.

Kuttner said that the situation of Japan and its 1990s "lost decade"—during which their economy was stuck in the subsidy phase because it was just successful enough to not require the authorities to move to plan B—is where we are headed. The point of this conference was clearly to identify a plan B. As the title of the conference suggests, the answer to, “Is a Reconstruction Finance Corporation a Better Way to Restore the Banking System?” is a resounding "yes."

Two pages of necessary reading identified by Walker Todd, a Research Fellow at the American Institute for Economic Research and former legal and research officer at the Federal Reserve Bank of Cleveland, can be found here under: “Six Lessons Learned from the RFC” page 27-28 and here scrolling down to the bottom to “Stress Testing the Banks”.

As Silvers notes, every moment is a potential moment for correction, but with every moment that passes the more costly it becomes.

Foreclosure Crisis Plan Coming Down the Pike

 According to Geithner’s announcement last week the following will be pursued to address the foreclosure crisis:

1.) measures to reduce the interest rates on mortgages using TARP funding,

2.) the Fed will continue to buy Government Sponsored Enterprise (aka GSEs, e.g. Fannie Mae and Freddie Mac) issued mortgage backed securities (MBSs are bundled securities made up of mortgages). The Fed will also buy debt. Both will be funded by increasing the original Treasury funded facility by $100bn from $500bn,

3.) $50bn will be used to prevent foreclosures for owner-occupied middle class homes,

4.) a set of mortgage modification guidelines will be devised as standards for government and private programs (although it’s not clear if these will be binding) and

5.) for outstanding mortgage foreclosure relief programs, modifications will be allowed for a greater number of borrowers.

Taking them in order:

 

1.) Measures used to reduce the interest rates on mortgages could very well involve buying long-dated Treasuries which is an indirect way at creating lending floors (by pushing down the yield which is used as a benchmark for mortgage rates) and also distorts the bond market and expectations on the dollar and thus on investment in dollar denominated instruments. A more direct way to do this has been floated, namely for the government to buy new mortgages from private issuers at a targeted rate. Both proposals would primarily encourage refinancing which could stop some foreclosures.

2.) Underwriting GSE issued MBS that would otherwise not be by the market led to our moral hazard problem with the GSEs originally. Going forward, the terms of the loans should reflect sound origination (common sense underwriting practices) and the MBS market should be allowed to contract. $600bn also might not be sufficient to clean up the system comprehensively. The benefit of this tack is only that the government is incentivized to modify the loans on terms that are actually reasonable to the borrower once we’re left holding them.

3.) It is unclear how the $50bn will be used to prevent foreclosures for owner-occupied middle class homes, but if he will be taking up recommendations circulating these funds might target servicers to grant them incentives to modify the principals and terms of distressed loans. More direct assistance to homeowners would be the government declaring modifications mandatory; the lenders would be let off the hook for the original amount and servicers would collect what could reasonably be paid. (Many contingents would be satisfied with the original Bair proposal.) Another idea was floated, in Fort Myers. “Obama outlined an arrangement in which banks would accept lower payments from homeowners in return for an equity stake once housing prices recover,” which I find to be asymmetric given the gains to the originators and those who sold the MBSs would not be encroached upon, but more to the point, it makes default more attractive to the borrower.

4.) Mortgage modification guidelines are absolutely necessary but would be most effective if they were binding, not recommended standards. Self-regulation and incentives will not solve this problem systemically by relying on voluntary writedowns.

5.) Mortgage writedowns should be harmonized and mandatory for all homeowners subject to a means test against outstanding debt payments particularly for mortgages that are underwater.

Other good ideas:

 

Reward Good Mortgage Underwriting with TARP Funds 

 

At the Thinking Big Thinking Forward Conference, February 11, Michelle Collins, Senior Vice President of Mortgage Lending at Shore Bank highlighted the fact that as a responsible lender ShoreBank did not issue one subprime loan. She stated however that currently her clients were suffering and indeed the mortgage crisis had spilled over into ShoreBank’s pristine portfolio. The criteria they use to deny new loans, 1.) insufficient income (affected by the larger job market contraction) and 2.) insufficient collateral (affected by the housing bubble bursting reducing these values) have stifled their ability to issue sound new loans. She identifies ShoreBank’s need for governmental support and makes the case that other local and community banks which have solid histories of common sense underwriting should be the first candidates for governmental assistance through TARP.

Dean Baker’s “Right to Rent” Plan 

 

Legislation embodying this idea, H.R. 6116--110th Congress (2008): Saving Family Homes Act of 2008, was introduced to Congress May 21, 2008, sponsored by Rep. Raul Grijalva [D-AZ], Cosponsors, Rep. Dennis Kucinich [D-OH] and Rep. Edward Pastor [D-AZ]. The bill,

[g]rants eligible mortgagors subject to foreclosure proceedings the right to continue to occupy foreclosed properties subject to the payment of fair market rent for a period of 20 years that begins upon the commencement of occupancy of such property. 

The cost would be negligible, but it would freeze the foreclosure crisis in its tracks.

In sum, it’s encouraging that Obama is taking this plan to the people and that it will entail restructuring household mortgage debt. Its true test will be the plan’s ability to stop foreclosures if not encourage a reflation of the MBS market.