Controls and transparency. Everything would appear to indicate that last month's turbulence will lead to considerable changes in how the financial markets work and that these changes will be positive overall. Most commentators consider that the events sufficiently proved that the financial world had exaggerated its, how shall we put it - creativity, to the point of taking precedence over the real economy. The abuses and excesses experienced are expected to lead the authorities to introduce greater transparency and more binding rules and controls (see yesterday's column).
The analyses, assessments and criticism made have largely gone beyond the specific causes of the crisis that upset the markets (and which has still not been completely overcome) and have unmasked several aspects of financial activity that contribute nothing to the economy but which help those working in this domain to get rich quick. I'll look at: a) carry traders who raise capital at practically non-existent rates in Yen and invest in Dollars; b) hedge funds that for a dollar's worth of shares or other real assets or Treasury bonds from a solvent country, put five dollars of high risk debt into their own portfolios;
c) the inventors of extremely complicated derivatives (one observer compared them to alchemy) which become incomprehensible to mere mortals like us, while making substantial profits for the middle men;
d) rating agencies that give the “triple A” rating to wild imaginings while advising their clients and making hefty commissions at the same time. The result has been, or should be, a clean-up of the financial markets. Healthy companies will be less exposed to competition than those that have been engaging in cooking the books, banks will be less aggressive and those who manage assets and liabilities seriously will be appreciated once again.
I will continue to dip into the good reading matter I obtained during those heated weeks. According to one commentator, the perturbations observed result from “a new cancer of creative finance turned in on itself, which has created instruments based on risks in order to obtain fat commissions”. They then stuff these instruments into financial products offered to savers resulting in “worthless bits of paper” that drown in certain portfolios. It is only when the balance sheets are drawn up (at the company or for the family's accounts) that the problems resurface. This example is not taken from a leftist or anti-globalisation newspaper. I deliberately chose it from a right-wing newspaper (it belongs to…Silvio Berlusconi) to underline the fact that the criticism made is not a result of the political allegiance of the author. These articles, however, rarely appear on the front pages of the newspapers where sensational headlines are reserved for spectacular developments. We find them a few days later in the pages of the specialist press (that the public at large rarely, if at all, reads) under small unobtrusive titles.
Conditions for regaining confidence. One commentator said that the degree of real estate loan risks was assessed in a way that was so far from the truth that he had to ask himself how many other financial products benefited from “risk calculations” that were just as mistaken. The real problem is, therefore, re-establishing a correct risk analysis. Several rating agencies have played a direct role in the elaboration of derivatives for which they then assessed the risk. The crisis of confidence, the doubt and concerns will last as long as public bodies (national central banks, European Central Bank and the US FED, stock exchange control bodies) are unable to control private certification of financial risk.
Those who defend a total globalisation of the financial markets sometimes affirm that they are inspired by the doctrine of David Ricardo. Paul Fabra in France and Giorgio Ruffolo (former MEP) from Italy, however, observed that Ricardo called for a system of free financial flows for goods payments and controls for capital. The latter should not be subject to any restrictions when they are funding trade in merchandise. Their stability was, even for Ricardo, a prerequisite for the freeing up of trade.
An overall conclusion of the analyses would more or less be as follows: the financial markets have been cleaned up in a brutal way, with considerable costs that are sometimes unacceptable and partially unfair to ordinary savers who naively thought that dividends would endlessly increase. “Today the market is in better shape than yesterday, a new more equitable season has perhaps begun”. (Giuseppe Turani)
Moderate reactions. How did financial market players react? First of all, with silence, and then in moderate tones. They stressed the economic advantages that come from the expansion of credit as a result of the new financial instruments: funding possibilities for business are greatly increased, and this benefits the economy as a whole. The problems were largely created by the FED monetary policy, which encouraged the consumer boom in the United States, beyond what the real situation with regard to the output of goods allowed. In addition, American savers did not act wisely enough, taking out commitments that they could not meet in the long term. This last comment was challenged. How can victims be held responsible for following the advice and encouragement to take up easy credit offers made by the banks? According to critical commentators, financial bodies cannot be absolved of blame: they firstly granted the high risk credit, then passed the risk on to other operators who, in turn, passed it on to savers who were not in a position to assess the dangers. Moreover, we still do not know today the part played by sub-primes in the various hedge funds. It must also be acknowledged, however, that several banks, after a few moments of uncertainty and sometimes even panic, adopted a responsible, and sometimes courageous, attitude.
Understandable caution from the authorities. The political authorities, understandably, chose to adopt a cautious attitude: any spread of panic had to be avoided in an area where sometimes an ill-judged sentence can bring disaster. Initially, Nicolas Sarkozy advocated joint reflection within the G7, but quickly abandoned this idea in the face of reservations from others and the need to avoid over-dramatising the situation. Mr Sarkozy's letter to Ms Merkel, speaking about an extraordinary G7 meeting, was described by one finance minister as a “nod in the direction of public opinion”, and in Brussels it was pointed out that the appropriate bodies - the European Central Bank, the Eurogroupe with its permanent presidency, the economic and financial committee - would certainly not be found wanting. These bodies were alive to the situation and did not need any published letter to move. When the time comes, the need for a G7 finance ministers' meeting will be considered. The Economy/Finance Council will take stock when it meets in Porto on 14-15 September. The European Central Bank is holding its usual meeting this Thursday.
The European Commission, last week, had an exchange of views at its first meeting after the summer break, and its spokesman said that the Commission felt that “in the immediate, there is no cause for concern over the serious and sustained impact on growth and economic development” in the European Union (see EUROPE 9490). The European Internal Market and Services Commissioner Charlie McCreevy confirmed his intention to carry out an assessment of the code of conduct that governs rating agencies; for his intentions on monitoring securities, see our newsletter No 9483. The European Parliament is in discussion on these issues with the European Commission and Council as I write, but the hearing with ECB President Jean-Claude Trichet will, at the request of chairwoman Pervenche Berès, take place at the meeting of Parliamentary economic and financial affairs committee on 11 September.
Avoiding the problem of the dollar. In this whole reflection (which is continuing and will probably result in operational decisions), one key element has been neglected: the massively high sums of dollars being held outside the United States, far exceeding the amount Washington could repay and which could allow the main holders (China is the largest) to acquire any Western company (see this column in EUROPE 9469). To my knowledge, only Tommaso Padoa-Schioppa has alluded to this, writing: “I believe that the United States external trade gap to be unsustainable and that is unlikely that it can be corrected without a slowing of the American, and thus world, economy”. The silence of our political leaders on this “dollar” aspect to the situation is understandable for obvious reasons. Even commentators are saying nothing about this issue. As far as I know, there are only two exceptions: Paul Fabra, quoted above, without being explicit, and Antonello Zunino with the following sentence: the American deficit represents “a huge danger; there are several ways to deal with this situation, and the least painful is for the dollar to continue to devalue”. In his opinion, the notion of an exchange rate parity of 1 dollar to 1 euro is completely unrealistic. That is maybe one of the reasons why talk about the US currency is avoided.
(F.R.)