The Financial Crisis And Asia

Perhaps far more than any part of the world, the Asian dimension of the American financial crisis is the most intriguing. A flood of cheap goods and money from Asia lulled the United States into a false sense of economic prosperity, in which Chinese and Japanese reserves and Arab petrodollars financed rising deficits and debt-driven consumption most evident in the housing bubble. In other words, Asians living below their means lent Americans money to buy Asian goods and together with inflows of Asian capital enabled Americans to live beyond theirs . It is this intricate economic embrace between the major Asian economies and the United States that turns the American financial crisis into a potential crisis and an opportunity for Asia. Not surprisingly, Asian governments have been watching the crisis closely and trying to manage its repercussions for their economies.

 

While the crisis puts strains on the model of export-led growth that has fueled China's unprecdented growth and the appeal of American capitalism, it opens new possibilities, in the eyes of some analysts, to develop Asian capitalisms freed from the suffocating grip of the reckless neo-liberal American brand. For others, still, it offers a rare opportunity to restructure the global economy and bring to an end the era of Euroamerican hegemony that has lasted over the last few centuries and accelerate the dawn of the new Asian century or centuries. Whatever the exact impact of the financial crisis on various Asian countries, how the continent's major economic powers understand and deal with it will have immense consequences for the rest of the world including Africa.

 

The following commentaries offer glimpses into how the American financial crisis and its prospects are perceived in China, Japan, India, South Korea, and Saudi Arabia. P T Zeleza, Editor, The Zeleza Post

 

THE VIEW FROM CHINA

 

Suggested Chinese Responses to US Credit Crisis By Cao Honghui

 

As I have pointed out in July this year, a second-episode to the US credit crisis was bound to happen.

 

In the recent two weeks, a series of high dramas have indeed taken place as expected, and the crisis is much more complex and shocking.

 

To begin with, the Lehman Brothers Inc had finally collapsed, months after news of it cracking-up emerged in June.

 

Then the largest insurance company AIG (American International Group) was also sinking, and the US government was forced to inject 85 billion dollars to save it, triggering a barrage of questions over why the same treatment was not extended to Lehman.

 

News then emerged that Morgan Stanley, another giant in the Wall Street, had held takeover talks with interested buyer; and later, all eyes turned to Goldman Sachs, doubting if it could survive the crisis unscathed.

 

Evolution of a Crisis

 

As the drama unfolded, the US government had adopted a "selective policy" in saving ailing financial institutions.

 

Though consideration was largely based on the degree of influence one financial institution had on the market, there were non-economic factors involved too. Moreover, the government itself was also bogged down with 10 trillion dollars of debts.

 

On Sept 18, the US Federal Reserve Board (FED) had signed currency swap agreements with the central banks in Europe, England, Japan, Canada and Switzerland in order to inject liquidity into the embattled financial market.

 

In addition, the US Treasury had drawn up an aid plan to takeover non-performing loans in banks, helping them to tie over the difficult time and prevent the crisis from worsening.

 

At this juncture, there is an urgency to make clear of how the crisis might evolve, and how far it might spread?

 

In the first phase, high default rates of residential mortgages led to contracted liquidity and ignited the sub-prime mortgage crisis.

 

At present, the crisis has spread beyond lending institutions and institutional investors who held mortgage-backed securities, it is now inflicting the mortgage insurance agencies.

 

Next, contracted liquidity would likely trigger cracks in the commercial real estate and related markets, and the risks for small and medium banks would be more apparent. Cash flow difficulties would soon force many small banks to collapse.

 

In addition, the climbing bad debt rate for credit card holders had also been getting on the nerves of US commercial banks. Though that may not hit the financial institutions badly, it could further impair the US economy growth, which is supported by credit spending.

 

When the FED raised the benchmark interest rate in 2006, it was the needle piercing the housing bubble. But even without that, the bubble would have burst sooner or later. All in all, there were too much greed on the part of financial institutions; as for the regulators, they had acted too slow.

 

How Should China Respond to the Crisis?

 

In the immediate fallout of the US crisis, it is inevitable that China's foreign exchange reserves would devalue, since dollar-denomination assets dominated the international financial market. For Chinese commercial banks, they would have to absorb the investment losses incurred.

 

In the short run, would it be the best opportunity to buy US investment banks or financial institutions?

 

In my viewpoint, it would be worthy of consideration, if Chinese enterprises could gain entry into the board of directors or decision making management team of US institutions that has mining resources or extensive financial services networks. However, if Chinese enterprises were to simply play the role of financial investor, that would be an unwise move.

 

The way for China to minimize negative impacts from the US credit crisis is to adopt decisive measures to maintain steady domestic economic growth, such as introducing policies that stabilize the capital market and strengthening risks management for financial institutions, as well as improving capital market regulations and supervision mechanism.

 

China should also use this opportunity to quicken its pace for reforms in taxation regime, pricing mechanism, and industrial sectors restructuring.

 

In the long run, China should seize this opportunity to push for changes in the international monetary system, that is to re-evaluate the status of US dollar as an international currency, encourage the usage of Euro, and accelerate the pace to internationalize Chinese currency.

 

In addition, China should advocate the establishment of an international coordination mechanism for regulating the global financial markets, and it should strengthen supervision on cross-border capital flows.

 

Cao Honghui is the director of International Finance Research Center of Institute of Finance and Banking, under the Chinese Academy of Social Sciences, a major think tank to the Chinese government.

 

From The Economic Observer Online September 24, 2008

 

What Admonishment Can China Get From Wall Street Crisis? By Ding Gang

 

The financial hurricane emerging from the Wall Street, in essence, is a credit crisis, which is related closely to frenzied overdrafts in the way of consumption. When the weakest link in the debt chain has finally snapped, the zeal for consumption will dampen and subside drastically.

 

At present, the intelligentsia in the West has begun mulling over and discussing issues on how the ongoing financial crisis will change the American-style consumption. In the meantime, we are reminded that as fewer orders have come in from clients and pressures from prices stepped up, it is more difficult for us to bring about economic growth by relying mainly on exports of key enterprises.

 

"Global consumption surged 63 percent between 2001and 2007, a bonanza fuelled by easy global credit conditions and soaring equity and housing prices,"indicated by statistics provided by the "Financial Times"of London. Since early 2008, however, the slump global economy has violently slashed these enterprises, and the outbreak of the current financial crisis adds to their problems as they are already deep in trouble.

 

The United States in recession is no longer the nation that used to go all out boldly to resort to credit for increasing consumption, and it is also sure to be the nation which does not favor "China-made"goods so much it did as before. Likewise, China's another leading trade partner, the European Union (EU), has also been in a trend of an augmented protectionism due to its own slow economic growth, an impact from the American financial hurricane and a growing deficit from its trade with China.

 

The thorny problem does not merely come from developed nations alone. When the economy loses strength and trade barriers heighten in these developed nations, competition between the developing countries has also turned increasingly more acute and fierce. So Danny Roderick, an ace economist at the Kennedy School, Harvard University, has pointed out that the expansion of South-South trade seems much more difficult than the expansion of North-South trade politically.

 

So, no one can accurately predict how long such an external economic predicament will sustain? Where is a new area of growth for global economy in months or years to come, and where lies an "engine"for fresh economic growth? These questions look quite ambiguous to date. The trend for the readjustment of global economy is however obvious and apparent and, against this backdrop, Chinese economy is bound to face a process of tough, arduous readjustment or restructuring.

 

In view of the overall situation in Chinese economy, it is immune to the Wall Street "virus"to some extent, as China has a limited degree of openness in its financial sector. Nevertheless, the more serious challenges ahead cannot possibly be the direct "contagion"but pressure from the transfer of its growth mode. The task we are now facing is not merely how to draw lessons but to make preparations to respond for the next step, that is, to take more initiative in readjusting (economic) setup and raise the country's domestic consumption.

 

When the prices of raw materials are on a steady, repid rise globally today, the endeavor to increase input in industrial sector and in equity and housing property business could possibly stimulate inflation further. Owing to the sluggish global market, more input in China's domestic production will also give rise to the glut of goods. Therefore, in order to enable the expanded domestic demand to achieve an anticipated result, it is essential and imperative to input more in such fields as social security, medicare and health work, and education.

 

In other words, the main purpose of imput is definitely not to turn out more goods or to build more high-rises or skyscrapers, but to bring about more and more consumers with substantial financial strength, so that ordinary citizens in the country are better able to resist and defend against risks. Such an imput will eventually effect the long-term benign growth of Chinese economy, and China will be capable of making even greater contributions to the development of the entire world.

 

From People's Daily Online September 24, 2008

 

Premier: China Confident of Continued Growth

 

Though faced with "the most difficult year" for its economy, China on Saturday showed a strong confidence in its sustained, rapid growth, with Premier Wen Jiabao telling a top-grade world economic forum that his country enjoys a favorable development environment as a whole.

 

"We have full confidence and capability to overcome various difficulties to ensure sound and fast growth of the national economy for an even longer period of time," said the premier while addressing the opening ceremony of the 2008 Summer Davos forum in Tianjin on Saturday afternoon.

 

And such a growth will be China's "greatest contribution" to the world economy under the current circumstances, said Wen during a brief question and answer session that followed his speech.

 

The two-day forum, also known as the Annual Meeting of the New Champions 2008, has drawn some 1,400 participants from nearly 90 countries and regions, most of whom are successful entrepreneurs and high-ranking government officials.

 

The meeting, second of its kind sponsored by the prestigious World Economic Forum, took place at a difficult time for the world economy, as a financial storm starting from the Wall Street rocked the globe and triggered widespread worries about economic slowdown or even depression.

 

"It has been an extraordinary few weeks on the financial markets, weeks with consequences across the global economy," said European Union Trade Commissioner Peter Mandelson, who is also in this north China metropolis to attend the forum, on Friday in a speech to the local European business people.

 

The costs of this crisis will be felt by all countries, including China through changing stock market sentiment, falling inward investment and a fall in export demand tied to falling consumer spending in Europe and the U.S., said Mandelson.

 

The Chinese premier also observed that the world economic environment is getting "tougher and more complex," with "exacerbated financial volatility" and "notable economic slowdown."

 

And this is just one of many "considerable difficulties" faced by the country, which also needs to address other prominent problems such as domestic price rises, a weak agriculture, energy and resources constraint, poor business management, and hidden problems in the financial sector.

 

"As I said earlier in the year, 2008 could be the most difficult year for China's economy," said Wen, who also cited natural calamities that struck the country in a row, including heavy snow and sleet storms in January and February and a devastating earthquake in May.

 

Nevertheless, he stressed that "the economic fundamentals in China remain unchanged" and the economy "is moving in the direction envisaged in the macro-economic control policy."

 

He listed out "many favorable conditions" for China to maintainits growth, including the rapid industrialization and urbanization process, abundant supply of labor and capital, huge potential of increased domestic consumption and investment demands, a vast domestic market, and improved ability of macroeconomic regulation.

 

But most of all, the premier's confidence derives from China's adoption of a correct development course, as reflected in the title of his speech: "Reform and Opening-up -- the Eternal Driving Force for China's Development."

 

"China's changes over the past three decades would not have been possible without reform and opening-up... Reform and opening-up must be carried on through the entire process of China's modernization drive," said Wen.

 

The fundamental solution to all problems China now faces, including unbalanced growth, pollution and corruption, lies in deepened reform, he stressed.

 

Applause burst out from time to time in the full-packed Plenary Hall of the Binhai International Convention & Exhibition Center, the meeting's venue, as the participants expressed their approval of Wen's words.

 

Many of them have come with the hope of finding a platform to pool the wisdom of business leaders and economic masterminds worldwide, to evaluate the impact of the current crisis and propose possible ways out.

 

They are also interested in what China will do in the face of the crisis, and whether the country could repeat its success in handling the 1997 Asian financial crisis.

 

"A crisis is often totally unexpected, and it always strikes atthe most unlikely links," said veteran Chinese investor Wu Ying. "That's why we are here -- to react to the crisis with innovative methods and approaches of imaginative power."

 

Asked about his prescription for the current crisis, the Chinese premier emphasized international cooperation and -- more importantly -- confidence, on the parts of economists, entrepreneurs, the public and the state leaders. "At this moment, confidence is even more precious than gold or any currencies," he said.

 

And some key participants of the forum share China's confidence.Klaus Schwab, founder and executive chairman of the World Economic Forum, predicted on Friday that the world economy will see a slowdown in growth in the next one to three years, but China will remain the fastest-growing economy with a growth rate of seven to eight percent.

 

Founded four years ago for growing enterprises, even though some of them were just of medium or small size, the forum of the new champions has picked "The Next Wave of Growth" as the theme for the Tianjin meeting.

 

In the context of the financial woes, this theme appears even more significant, as many people have started to view the new businesses, whose growth is often driven by inspiration and innovation, as a major leading force of the global economic revival.

And more attention was paid to the emerging economies like Brazil, Russia, India and China.

 

The infrastructure improvement in the developing nations has given them more opportunities to embrace new technologies and the new economy, such as bio-techs, which will bring new growth, said Peer M. Schatz, chief executive officer of Germany's Qiagen company.

 

"These young companies have the potential to list among the Fortune 500 in next five to ten years," said Schwab of the more than 200 new champion companies that have come to the Tianjin forum.

 

According to Premier Wen, China is ready to share its development opportunities with these new businesses, and Tianjin, designed to be "the economic center in north China" in the country's development blueprint, could be a perfect starting ground.

 

"Many of you are from growing enterprises that are most dynamic,competitive and full of development potential. You are welcome to invest in China, to start businesses in Tianjin and to seize the opportunity and pursue greater development," Wen told the forum participants at the opening ceremony.

 

From Beijing Review September 28, 2008

 

Financial Market Needs Right Tools

 

While the international capital markets were gripped by a sense of doom last week, a senior Chinese legislator heroically declared at a public forum that "it is time" to speed up the process of market deregulation in China to improve capital efficiency.

 

On first hearing, these words sounded brash at a time when excessive deregulation was blamed, at least partly, for the outbreak of the US credit crisis that sent the world capital markets into total disarray before a massive rescue operation was mounted last Thursday by the US government and central banks of numerous other countries and economies.

 

On second thoughts, maybe she was right. The Chinese capital market is too tightly regulated to allow room for financial intermediaries to effectively and efficiently match the respective needs and risk profiles of borrowers and lenders. And limited sources of funding are seen as a major constraint on the growth of a private sector comprising mainly of small- and medium-sized enterprises.

 

This problem has become increasingly pressing as the government pursues a tightening monetary policy to combat inflation. As bank landings dried up, thousands of factories in the light industrial centers of the Pearl River Delta region were closed down. There is certainly a need to promote what Wu Xiaoling, vice-chairwoman of the Financial and Economic Committee of the National People's Congress, described at the forum as "private sector financing" as opposed to bank loans.

 

Deregulation to facilitate private sector financing will invariably breed innovation as financial intermediaries are freed to create products that can best match borrowers' and lenders' requirements. But striking a balance between innovation and market risks is a duty that regulatory agencies tend to overlook from time to time.

 

As Joseph Yam, chief executive of the Hong Kong Monetary Authority, wrote: "It is important to remember that the financial system exists to serve the public interest in effective financial intermediation, not the private interests of the financial intermediaries."

 

When they were first introduced, subprime mortgage bonds seemed to be a prime innovative product that matched the needs of investors and fund raisers, who, in this case, were the hundreds of thousands of home buyers whose credit records would not have otherwise qualified them for loans.

 

The easy-credit induced buying spree pushed up property prices, which helped boost the value of the underlying assets of those bonds that had a relatively higher coupon rate. The high credit ratings of those bonds enhanced their appeal to investors, including some of the world's most venerable financial institutions.

 

The reasons behind the outbreak of the subprime mortgage crisis have been well documented. The sustainability of the scheme was brought into question when predatory lending tactics were employed by some lenders to rope in more homebuyers.

 

As has been disclosed, the total exposure of Chinese banks to the US subprime credit crisis is limited. And Chinese investors can take comfort in the fact that a debacle of such a scale can never happen in China's tightly regulated financial market.

 

The devastating force of the crisis that shook markets around the world has the potential to strengthen arguments for pulling back the pace of financial reform in China. And that is what many proponents of deregulation are worrying about.

 

China is facing challenges of an entirely different nature to those of the US, said Fan Gang, director of National Economic Research Institute. Speaking at the same forum, Fan said: "The Chinese financial market lacks effective financial tools, which has hampered the sustainable development of the (capital) market."(China Daily)

 

From China Securities Journal September 23, 2008

 

Danger Signals: Lessons From The Wall Street Crash of 2008 By Steven Xu

 

China's reactions to the collapse of leading US financial institutions and the government bailouts of those (barely) still standing range from the predictable to the pragmatic. Many ordinary Chinese onlookers are gloating over the comeuppance of Wall Street, hitherto seen as an embodiment of US power, prestige and arrogance.

 

Chinese policymakers, however, are busy trying to contain any fallout on China's own slowing economy. To bolster domestic investor sentiment, they have cut interest rates and eliminated the stamp tax on stock purchases. If things do not improve, they will almost certainly cut interest rates again. But as the dust settles, China must also do some hard thinking on what lessons it can learn from the Great Wall Street Crash of 2008 to avoid a similar fate in the future.

 

The first obvious lesson concerns how China should regulate its own financial institutions in an age of global and instantaneous capital flows. Since joining the World Trade Organisation and launching gradual liberalisation of the financial sector, China has regulated banks prudently. However, the government has a tendency to overprotect the banks, keeping the sector inefficient and underdeveloped.

 

For example, with deposit and loan rates heavily regulated, Chinese banks are guaranteed hefty interest rate differentials. These, and a strong economy, are why the "big four" state banks have all raked in record-high profits in recent years. So, in contrast to the excessively freewheeling US financial sector which needs more regulatory oversight, China should deregulate interest rates further and promote more competition among domestic banks.

 

The second lesson is more philosophical. Is the US government doing the right thing by undertaking a massive taxpayer-funded rescue of the country's most profligate businesses? This question is especially pertinent to many Asians. During the Asian financial crisis, a decade ago, they heard endless lectures by US officials to let sick firms and banks fail, and to keep interest rates high and fiscal policy tight for a speedy economic adjustment.

 

It would be tempting to criticise the US government for adhering to double standards. But policymakers should be pragmatic, not dogmatic. The lesson for China and other countries is that, if a systemic meltdown can only be avoided by a government intervention, do so sooner rather than later. Hence, given the mounting evidence of a US-led slowdown of the global economy, the Chinese government was right to make a U-turn on its tight monetary policy in recent weeks.

 

The third lesson is what to do about asset-price bubbles. Should central banks prick them before they grow "too big", even though no one can be sure about the precise timing? The Wall Street debacle suggests that ignoring bubbles - as long as the economy is booming and inflation is well-behaved - makes for a dangerous policy.

 

In fact, China too has seen its stock market bubble pop this year. The more than 60 per cent fall in the Shanghai Composite Index since last October has left millions of investors reeling and many companies with a sudden funding shortfall. Could China have avoided this situation if its central bank had raised interest rates and allowed the yuan to appreciate faster a couple of years ago?

 

Perhaps. But China's share-price bubble was also a result of the government's reluctance to relax capital controls at a time of double-digit economic growth. With few other places to park their savings, Chinese citizens flooded into the domestic stock market (along with property).

 

Bank deposits also kept rising, irrespective of low interest rates. And the country's high savings rate held in the face of the currency reform announced in July 2005 and the subsequent appreciation of the yuan. Yet, ironically, the Chinese monetary authorities who happened to be sitting on a huge pile of foreign reserves (now US$1.8 trillion) continued to worry about sudden outflows of hot money.

 

Having failed to manage the stock market on its way up, Chinese monetary authorities also missed the chance to bring it to a softer landing. In hindsight, they should have eased policy well before the Wall Street crisis spun out of control.

 

There were plenty of reasons to do so. Many Chinese companies were struggling with weaker external demand, a stronger yuan, rising commodity prices, and implementation of the new Labour Contract Law and tougher environmental standards. One thing the policymakers did get right, however, was not to have stuck to some arbitrary inflation target that would have severely aggravated the corporate sector's pain.

 

The last lesson for China is that it should be a savvier shopper at any Wall Street fire sale. To its great embarrassment, the global credit crisis has walloped the value of the Chinese government's initial batch of investments in US financial institutions, such as Morgan Stanley and the Blackstone Group. If China is looking at some timely vulture investments now, it should bargain no less ruthlessly than Wall Street firms did during the Asian financial crisis.

 

Steven Sitao Xu is the Economist Intelligence Unit Corporate Network's director of advisory services in China

 

From South China Morning Post October 2, 2008

 

 

THE VIEW FROM JAPAN

 

What is Needed To Make The U.S. Financial Bailout Plan A Success By Kenichi Ohmae

 

The refusal of the U.S. House of Representatives to pass the $700 billion bailout plan Monday may turn out to have been appropriate if the Congress correctly understands the priorities at hand. The issue is not whether the situation should be left to the market or whether the government should save those who lose their house due to foreclosure. The main challenge at this moment is to provide liquidity to the market, particularly to failing financial institutions.

 

From the experience of Japan throughout the 1990s, and also from the experience of Nordic countries, it is clear that the U.S. financial crisis is also going through a sequence of events - almost physical and also psychological - that are very similar to what happened elsewhere in the world.

 

The problem is that the U.S. leadership does not seem to understand exactly what happened and what lessons to reflect on, as is clear in the impulsive and almost heroic actions that they have exhibited over the last three months.

 

Now that the Paulson bailout plan is temporarily suspended, it may not be too late to state what I have been talking and writing about in Japan with regard to the problems of the U.S. approach to resolving its financial crisis and a possible solution to the imminent threats of meltdown of global banking systems.

 

There are three principles that must be observed in resolving a major financial crisis: (1) treat it as a systemic failure and do not act on individual situations; (2) know the sequence of events, so the right problem can be solved at the right time; and (3) construct a universal system later to prevent similar problems from occurring again. The U.S. government seems to be violating every one of these principles and mixing the sequence of events, hence aggravating an already dire situation.

 

What the U.S. needs to do under this scenario is to get help from the rest of the world in setting up a gigantic credit line, on the order of $5 trillion, to provide the necessary liquidity that will allow troubled financial institutions to come in and work on their assets and liabilities without fear of punishment and catastrophic failure.

 

This is similar to the "Emergency Room" that the Swedes set up in the early 1990s during their financial crisis. But the credit line should be far, far greater this time to eliminate any doubt that the liquidity will run out.

 

In setting up this facility, two principles should be observed. One is that the U.S. government should not be asked to print more money. It has already printed too much. One problem with Paulson's approach is that he is trying to solve all the problems with internal resources. The U.S., even before the $700 billion bailout package, had issued a lot of promissory notes that will in effect dilute the value of the dollar, a scenario that sparks fears worldwide. The second principle is that the facility should be big enough to eliminate any doubt that the money might run out.

 

During the Korean crisis of 1997-1998, the International Monetary Fund came in to replace the over-extended American banks. This time there is no trace of the IMF on the horizon, other than its occasional forecast of what the bad debts would be (currently at $1.3 trillion, but escalating over time).

 

From the U.S. perspective the IMF is too European. Maybe, but if the IMF does not work, this would be a good time to call for the establishment of a global pumping station, a place where financial institutions could come to receive an unlimited supply of liquidity transfusion until they have worked out their problems.

 

I stated that this facility should have at least $5 trillion because it should be large enough so people do not think it is a shallow oasis. It would seem that $5 trillion is an enormous number and unfounded. But we know that the Japanese poured in $3 trillion either in the shape of public funds or foregone interest to help their banks survive.

 

My personal calculation at the beginning of Japan's property bubble bursting was on the order of $2 trillion, while the government was admitting only $130 billion in bad assets in 1994. Former Bank of Japan Gov. Toshihiko Fukui admitted 15 years later that the burden of the bailout on the public was actually $3 trillion. So, while I am not in a position to calculate the right size of the liquidity facility for the U.S., any number smaller than the amount that the Japanese required would be a source of trouble. It has to be on the order of $5 trillion to $10 trillion.

 

The only way to get this kind of money assembled is for the U.S. to ask for donations of mercy, not only from its taxpayers but also from those who have piled up dollar-denominated instruments around the world - who will be hurt if the value of the dollar or U.S. government securities falls.

 

For example, China has piled up $1.5 trillion in foreign reserves through its trade surplus, which is mostly in dollars. Japan can contribute $1 trillion, which it does not need returned in a hurry. Taiwan and Russia could come up with $500 billion each, and the oil-rich Gulf states certainly could support Uncle Sam easily with $2 trillion. We can ask the European Union to contribute collectively something like $2 trillion if we make the facility available to their financial institutions. That totals $7.5 trillion, and if the U.S. adds $2 trillion to the pool it brings it close to the maximum I am talking about $10 trillion.

 

We are not going to lose this money. It is money on which we can even expect to earn 3 percent interest. After this liquidity facility is dissolved in three to five years time, when good banks are healthy again, donor countries can expect to receive back the amount they loaned.

 

For this to happen, the Bush administration will have to rethink its diplomatic relationship with quite a few countries. U.S. foreign policy has been built upon the fight against terrorism. Now Washington has to repair its relationships with some countries to gain their cooperation in the fight against financial terrorism, which Wall Street has triggered and spread around the world.

 

Judging by the experience of Japan, the major financial crisis will go through three phases, each requiring a different measure.

 

The U.S. is now experiencing the first phase, which mainly comes from the liquidity crisis. The Federal Reserve Bank has provided a credit line close to $1.4 trillion and major institutions are now at the mercy of this facility. Japan lost Yamaichi and Sanyo Securities in the first phase of crisis because they could not pull money from interbank facilities.

 

The second phase of the crisis comes mainly from working out the bad assets. In this phase the write-offs far exceed the equity, and financial institutions cannot raise fresh capital from the market because their share price has fallen to a meaningless level. The Long-term Credit Bank, Nippon Credit Bank and Hokkaido Takushoku Bank all failed due to write-offs on loans to failing or failed companies. At this stage, it is important for the government to inject fresh capital to let the banks revive and return to normal operation.

 

In doing so, the government could end up owning a bank directly or through debt-equity swap. Paulson's rescue plan is appropriate for this phase as its main purpose is to buy bad assets. But I think it could be implemented much later in the game as the more urgent need is for the banks to survive without the fear of being in a "wolf pack."

 

The reason for this is that we are faced with a systemic problem, not a collection of individual banks. The nature of the problem at hand is a lack of liquidity. In group theory this syndrome is known as "wolf pack." While the wolves are good at attacking the victim as a team, they have a tendency to attack the weakest of the cohort should extreme hunger prevail. The banking crisis resembles this metaphor, continuing until a few mega-banks are left.

 

The third phase is characterized by the massive failures of operating companies. This is because the financial institutions that have survived are under severe government scrutiny and they cannot easily extend loans to businesses, their traditional customers.

 

This creates a problem for companies, which have traditionally relied on bank loans for their operations. All of a sudden, a banker comes to the company and says, "Sorry, we need to close the credit line and you need to return the money to us as you are no longer bankable" (a new word they will invent to pull the money from otherwise a good company).

 

Japan has lost hundreds of companies, such as Daiei, its largest retailer, in phase three.

 

We know Japan could have come out of its mess much sooner had the government proactively, not reactively and unwillingly, faced the issues straight on. I am not sure if the Americans are addressing the right issues with the right priorities and sequence, and how long it will take to get back to "business as usual." It has taken Japan 15 years, and luckily, it is OK now as it has no further room to go down.

 

If you recognize that the three phases are like the law of physics (indeed it seems to me that what I have described is a general theorem of major financial catastrophe), then we should expect that the U.S. package should not be hastily worked out, but rather devised utilizing the wisdom of the rest of the world.

 

Kenichi Ohmae is the author of "The Borderless World," "The Invisible Continent" and "The Next Global Stage"

From The Japanese Times October 2, 2008

 

Japan Inc. In Payback Mode On Wall Street By Kana Inagaki

 

Resurgent banks in search of overseas action move to scoop up distressed U.S. assets, set up strategic alliances

 

Just as the economy was about to lapse into a recession, banking giants staged a stunning comeback with a frenzied series of investments into the cash-strapped U.S. financial sector.

 

A mere five years ago, these same banks were seeking much needed capital from foreign financial institutions to dispose of the bad loans accumulated during the bubble economy of the late 1980s to the early 1990s.

 

Now they're back to return the favor.

 

On Monday, Mitsubishi UFJ Financial Group Inc. announced that it will acquire a 21 percent stake in struggling Morgan Stanley, the second-largest U.S. securities firm, in a deal that is approaching ¥950 billion.

 

Beating other overseas bidders, Japan's largest brokerage, Nomura Holdings Inc., acquired the Asia-Pacific franchise and the European operations of failed Lehman Brothers Holdings Inc. in a deal that excludes any trading liabilities.

 

"This is a once-in-a-generation opportunity," Nomura President Kenichi Watanabe said Sept. 22.

 

"It was worth the wait. They will be good purchases," a senior official at the Financial Services Agency also said.

 

The string of announcements came amid one of the worst credit crises to ravage the U.S. financial sector in decades, prompting a $700 billion government bailout plan to clean up bad debt in a repeat of Japan's own banking crisis.

 

With bitter memories of the bursting of the bubble economy still fresh in their minds, the decisions did not come easy for the conservative, risk-averse Japanese financial institutions.

 

But observers said MUFG was able to clinch a deal with Morgan Stanley precisely because it had stood on the sidelines when oil-rich Middle Eastern investors and Asian sovereign wealth funds hastily stepped in late last year to rescue U.S. financial institutions deep in the midst of a housing crisis.

 

Morgan Stanley was quick to highlight that advantage, hailing MUFG as "the world's second-largest bank holding company with $1.1 trillion in bank deposits."

 

"These are carefully studied investments that have the potential to bring huge rewards," said Jesper Koll, former chief economist at Merrill Lynch Japan Securities and current president of Tantallon Research Japan K.K., an advisory arm of a Singapore-based hedge fund.

 

"This is the first time that you have got sizable capital participation of major (Japanese) banks," Koll said.

 

Despite the finely orchestrated moves, Katsuhito Sasajima, banking analyst at JPMorgan Securities Japan Co., said Japanese banks are still far from taking the reins in managing the U.S. financial institutions reeling under the subprime loan fallout.

 

"They will not be able to broadly expand investment operations in Europe and the United States (even) through the companies they have invested in," Sasajima said.

 

"If we consider the fact that Japanese banks have been downsizing overseas operations (for the past decade or more), it is unlikely that they will immediately step in to take control of management," he said.

 

A senior official of a major bank also admitted that "Japanese banks do not have the caliber to manage" the aggressive Western investment banks thirsty for high-risk transactions.

 

MUFG's decision to take a stake of more than 20 percent in Morgan Stanley's shares also came amid fears that greater control by the Japanese bank will trigger an exodus of Morgan Stanley employees, said Shinichi Ina, banking analyst at Credit Suisse in Japan.

 

"It is better not to bring the Mitsubishi color upfront and to maintain (Morgan Stanley's) independence" because the vastly different cultures of the two companies may clash, Ina said.

 

With the top two U.S. investment banks about to become bank holding companies regulated by the U.S. Federal Reserve, Ina said profits at Morgan Stanley may fall as it retreats from risky operations.

 

"One risk would be the possibility of an overblown investment if (Morgan Stanley) fails to achieve the level of profits MUFG is betting on," he said.

 

And yet whatever the hidden risks may be, many experts were quick to draw a line between the brash real estate investments Japan made in the late 1980s and current moves to sweep up the failing Wall Street firms.

 

"These are strategic alliances that are being built here . . . the start of true globalization for Japan's financial services," Koll said.

 

"They are going beyond pure investments to expand operations abroad that are not growing in Japan, and to do that they will utilize talented resources and networks" of U.S. financial giants, Credit Suisse's Ina said.

 

From The Japan Times October 2, 2008

 

Financial Giants Targeting U.S. Firms, Editorial

 

The intensifying financial storm in the United States is accelerating a global shakeout in the financial services business. Japanese financial institutions have quickly become major suppliers of capital for battered Wall Street titans.

 

The targets of Japanese investments are all big U.S. investment banks. Nomura Holdings Inc. will buy failed Lehman Brothers' operations in the Asia-Pacific region, Europe and the Middle East. Lehman was the fourth largest investment bank on Wall Street until it filed for bankruptcy protection earlier this month.

 

Mitsubishi UFJ Financial Group Inc. has reached a basic agreement with Morgan Stanley to acquire a stake of up to 20 percent in the second biggest U.S. investment bank.

 

Sumitomo Mitsui Financial Group Inc. has shown an interest in buying new shares to be issued by Goldman Sachs, the top dog on Wall Street.

 

The financial crisis that began in the United States last year has reached a critical stage in the past few weeks. In a desperate attempt to defuse the crisis, Washington swiftly decided to spend as much as $700 billion (about 75 trillion yen) of government money to buy up troubled mortgage-backed securities and other related assets from financial institutions.

 

The focus is now shifting to how the embattled financial institutions can survive by enhancing their capital bases through their own efforts. The question is: Who is able and willing to provide capital for them?

 

In the global investor community, government-run investment funds in the Middle East, China and other Asian countries, which went on a shopping spree at one time and are now reeling from the huge losses their investments have incurred.

 

Meanwhile, Japanese financial institutions are emerging as capital suppliers after years of operating under cautious, risk-averse management strategies amid the lingering aftereffects of the collapse of the asset-inflated bubble at home.

 

Disastrous mistakes by many powerful rivals have created an unexpected opportunity for Japanese financial firms. Taking advantage of this opportunity, however, requires bold decisions based on a clear understanding of the risks involved. We applaud the quick actions by Mitsubishi UFJ and Nomura.

 

These acquisitions and investments could allow the Japanese financial companies to bolster their uncompetitive investment banking operations by capitalizing effectively on the U.S. giants' glamorous customer bases, which include leading investors in the world, and their personnel well versed in sophisticated financial technologies.

 

But these strategic moves also pose many tough challenges for the Japanese players.

 

Western financial behemoths boasted huge profits for many years. In retrospect, however, their staggering profitability was supported by various financial bubbles to a considerable extent.

 

Now, they need to find new revenue sources that don't depend on bubbles. Will Japanese companies be able to lead efforts to reinvent their businesses? Possible new revenue sources include mergers and acquisitions aimed at making industries more sophisticated, as well as investments in emerging countries.

 

Japanese financial firms may not be very good at controlling and managing the operations of Western investment banks, a very different type of organization.

 

During Japan's economic boom in the late 1980s, Japanese financial institutions invested in banks, brokerages and investment banks around the world. But after the collapse of that bubble, they had to withdraw from these investments without acquiring much business expertise. They should remember this bitter experience to avoid making the same mistake.

 

There are wide differences between Japanese and Western companies in the way they use human resources. Japanese firms generally operate under a slow but steady system that stresses division of labor and team spirit. In contrast, Western firms give huge power to a small number of talented people so that they can exercise strong leadership to get things done quickly.

 

In particular, Nomura, which will operate Lehman's overseas units directly, will have to radically change its own corporate culture.

 

These acquisitions and investments as a whole will be a big test on how much the Japanese financial industry can change itself.

 

Only the players willing to change can survive. We hope the Japanese financial firms will keep that in mind and march toward success through bold but careful moves.

 

From The Asahi Shimbun September 26,2008

 

Bailing Out Wall Street, Editorial

 

September turned out to be the stormiest month in the history of world banking. And it couldn't have ended on a more jarring note. On Monday, the U.S. House of Representatives rejected a $700 billion (about 75 trillion yen) plan to rescue, with tax dollars, banks and securities houses drowning in bad assets.

 

Cringing from a potential global meltdown, stock markets collapsed around the world.

 

The crisis spread further as some European banks were nationalized on the same day. The House rejection of the bailout plan came in the immediate wake of announcements by the Federal Reserve Board, the Bank of Japan and major European central banks to provide additional dollar funding in order to ease the crippling global credit crisis that has paralyzed interbank dollar lending and borrowing.

 

It is no exaggeration to say that the global economy is on the brink of depression. Should the failed bailout bill be allowed to simply die, the global financial system could be thrown into total chaos. The U.S. government and the Congress must understand their responsibility. It is crucial that they come up with a revised bill and pass it before the end of this week.

 

Putting the $700 billion rescue bill together was a herculean task to begin with. The lame duck administration of President George W. Bush is no longer in a position to assert leadership. And with the voting public vehemently resisting the very idea of using tax dollars to rescue Wall Street fat cats who have made more than a bundle, lawmakers who are up for re-election on Nov. 4 were leaning toward opposing the public fund injection.

 

After bitter haggling, numerous conditions were added to the bailout plan. It was agreed that $250 billion would be spent first, to which the government might add another $100 billion at its discretion, and then the remaining $350 billion would be spent subject to congressional approval.

 

Clauses were also inserted to cap the exorbitant remunerations of the executives of financial institutions who would be rescued under this plan. But many U.S. voters are still dissatisfied, and protest rallies are being held around the nation.

 

When the House voted on the bill on Monday, it was rejected by 40 percent of Democrats and nearly 70 percent of Republicans--the latter in defiance of their own president. We can well appreciate the refusal of American citizens to let their tax dollars be used so readily. The same thing happened when Japan was thrown into financial crisis a decade ago.

 

But people in Japan cannot even begin to imagine the colossal gap between the rich and the poor in the United States--a result of misplaced faith in the ability of the market and the financial industry to regulate themselves. The anger and grudge of the American people toward Wall Street today is far more intense than what the Japanese felt 10 years ago. Americans have traditionally tended to oppose government interference in, and support of, corporate activities. This thinking is especially pronounced among Republicans.

 

Perhaps the U.S. public is optimistically thinking that the present problem will somehow go away without spending tax dollars. But now that the huge bubble has burst so spectacularly, there is ultimately no choice but to inject public funds if the nation's financial system is to be saved. This is not for the sake of Wall Street. It is for the nation's economy. It will not be easy to persuade the public to accept a bailout plan, but the clock is ticking.

 

With Election Day only a little more than a month away, this is a highly politically charged time in the United States. Still, we urge Bush and congressional leaders to do everything in their power to persuade their colleagues and the public.

 

From The Asahi Shimbun October 1, 2008

 

 

THE VIEW FROM INDIA

 

Nothing Infallible About Markets By Rajrishi Singhal

 

A much-revered finance professor in one of the top, east coast B-schools got visibly upset when I mentioned to him how large corporations in the US were too closely tied to the stock markets. And, then when I asked him whether it was a good thing for CEOs of these companies to constantly keep looking over their shoulders at their share price, much to the detriment of their core business operations, he walked off in a huff. I didn't even get an opportunity to thank him for the excellent lunch he'd bought me.

 

He had reasons to be angry. The core philosophy that operates at the heart of US-style capitalism was being questioned. It was like attacking the core of the campus-industry consensus, a compact that had proven to be not only immensely successful but showed all signs of becoming an inviolable covenant for American business culture. The fact is too many CEOs have gone to excessive lengths to put some zing into their share prices, even if that meant sacking people arbitrarily to cut costs, or selling businesses with the sole purpose of showing increased revenues, or even cooking up books (a la Enron).

 

Over the years, reliance on markets has become all-consuming - people have come to depend on their company's share price for a host of issues. In short, their lives revolve around it. Markets have also evolved from their original mission of being essentially an efficient and cheap mechanism for firm-level capital allocation. Sure, a company's share price is like a report card - it manages to capture (though not with total accuracy) what outsiders think of the company and its future prospects.

 

But, concern about share prices has now acquired an obsessive edge. Even that's fine because people are entitled to their private obsessions, whether it's cricket or Bollywood. But, the fixation starts treading on slippery ground when stock markets start getting treated as the perfect proxy for divine powers. This belief extends to even bestowing supreme and omniscient powers to the markets. From there to the common refrain that "the markets know everything" is just one small step.

 

This then is like the ultimate argument clincher. There is this unshakeable belief that if there's anything to know about anything, the markets always get to know about it first and build that into their pricing of a particular stock or into the pricing of the market.

 

The biggest anomaly here is the idea that the market is a separate entity, and that it behaves with a mind of its own. Somehow, advocates forget that a market is nothing but an aggregation of the perceptions of its participants and eventually projects the dominant views in the marketplace.

 

Pause here for a moment. If the markets were indeed perfect and all-knowing, how come they keep getting new jolts every time? The reason is because it is a myth - because there's no such thing as a perfect market. And there are good reasons for this. The first condition for a perfect market is the assumption that all information is available to all participants at the same time.

 

In short, nobody has more information about a particular issue than the next person. If this were indeed the case, economist Joseph Stiglitz would have never got his Nobel Prize. A whole body of work around "asymmetry of information" has grown over the years, which posits that access to information is skewed, that there is always someone who has more information than the others. This leads to distorted pricing.

 

The second assumption is that all participants are rational human being and they are always making rational choices and decisions in the market. Well...the less about this one, the better.

 

The third condition is that a perfect market allows for free entry and exit of participants without placing undue costs on one segment of participants. This is obviously not the case, even in the most free of markets around the globe. As is evident from the above, none of three non-negotiable pillars for a perfect market exist.

 

There is no doubt that markets are important for increasing efficiency of capital raising and aiding the process of price discovery. Faced with a choice, markets are infinitely better than a government-regulated system, which introduces distortions and inefficiencies.

 

Here's what David Strom, president of Minnesota Free Market Institute, wrote in a recent article: "Businesses often make huge mistakes, and we have known for centuries that markets are constantly fluctuating, even wildly... Markets, though, correct... Markets work well - not perfectly, but well - because they are not engineered from the top-down. They are chaotic. They encourage experimentation. They allow mistakes. In markets, even the mighty can fall. Not so in regulated markets."

 

So, here's the thing. Yes, markets are not flawless, and often screw up the orderly process of whatever they are supposed to achieve. But, despite these shortcomings, markets represent the real forces of the economy, act as the unbiased arbiter between demand and supply and satisfy human needs.

 

None of this is possible under a fully-regulated market. So, the bottom line is: choose markets over bureaucratic control, but do not expect them to perform miracles. And never - never ever - believe that the job of markets is to only keep going up.

 

From The Economic Times September 22, 2008

 

The Perils of Inclusive Loans Swaminathan S Anklesaria Aiyar

 

Inclusive finance - giving loans to everybody, including the poor - is desired by politicians in India, and in all democracies. Yet, the current US financial crisis shows the perils of taking this goal too far.

 

The crisis arose from the bursting of a housing bubble. That bubble was created, fundamentally, by government policies and institutions seeking home ownership for all Americans, including low-income ones. Politicians rooted for such inclusive finance. But this 'inclusion' extended finance to ever more borrowers with fragile and low incomes, causing disaster. This holds lessons for India.

 

Wall Street investment banks like Lehman Brothers and Merrill Lynch have been pilloried, rightly, for magnifying the bubble. Yet, they did not create it - that job was done by politicians and government-backed institutions.

 

The biggest Wall Street firms were pygmies compared with two quasi-government entities, Fannie Mae and Freddie Mac. These two held mortgages and other assets totaling $5 trillion, five times India's GDP. Fannie Mae was created by Roosevelt to shore up the housing market in the Great Depression. Freddie Mac was created later to compete with Fannie Mae.

 

Although they had private shareholders, these firms carried an implicit government guarantee. So, they could borrow much more and more cheaply than rivals. This implicit subsidy was justified as reducing the cost of home loans for all. These institutions bought and underwrote mortgages originated by the whole banking system. This reduced risks for banks, enabling them to spread home loans far and wide.

 

Now, as mortgagers of last resort, Fannie and Freddie should have kept a watchful eye on the housing market. If a bubble grew and burst, they would be left with many worthless mortgages. But instead of being watchdogs, the mortgage twins became active participants in inflating the bubble. Many experts warned that the bubble would burst. These warnings were ignored by politicians, who refused to rein in the bubble-makers. Legislators cheered the housing finance boom for making housing available to all.

 

Politicians had long created special incentives for home-owning, starting with the creation of Fannie and Freddie. They mandated tax-free interest on all first mortgages, and on the first $100,000 of second mortgages. This encouraged Americans to own houses (and get tax breaks for monthly interest payments) rather than rent accommodation (rent payments were not tax deductible). Capital gains tax was waived for the first $500,000 of profits from home sales. If a buyer provided 20% of the cost of a house, the balance of 80% from banks was insured by a federal agency, lowering the interest rate.

 

Next came a financial innovation - securitisation. Instead of keeping mortgages on their books, banks sold these to Wall Street firms that chopped them into bits, bundled top-grade mortgages with dubious ones, and sold the bundles as mortgage-backed securities to investors. These securities gave relatively high returns, yet appeared safe because they were backed (and bought) by Fannie and Freddie.

 

As securitisation grew explosively, banks lowered lending standards to shovel out ever more subprime loans to poor borrowers, without verifying their income, assets or ability to repay. By 2006 they were giving NINJA (No Income, No Job or Assets) loans. Many banks offered teaser loans with low interest for a short period followed by soaring rates, attracting poor borrowers who didn't realise what they were getting into.

 

Why did banks take such risks? Because the risk was transferred to investors who bought the loans and mortgage-backed securities, including Fannie and Freddie. The buying spree of the supposed watchdogs yielded them high profits when home prices rose, but made them bankrupt when home prices started falling. The government had to take them over.

 

Experts like Alan Greenspan had warned over the years of the risks of concentrating such huge financial power with such light regulation on Fannie and Freddie. Breaking them into smaller entities, subject to stricter regulation, was urged by many reformers. But Fannie and Freddie hired lobbyists to resist reform. Major recipients of campaign finance from employees and political action committees of Fannie and Freddie included Barak Obama ($125,000), Hilary Clinton ($75,000) and Senate Banking Committee chairman Dodd (over $165,000).

 

The strategy worked: the mortgage twins remained unfettered even when, in full public view, they bought subprime mortgages and inflated the bubble. Many politicians supported subprime mortgages as worthy loans to the needy, not realising the consequences. Subprime mortgages are only 6.8% of all mortgages, yet add up to a massive $1.3 trillion.

 

In sum, financial inclusiveness is fine in small doses, but leads to disaster on a really large scale. India is just at the start of financial inclusion. But as it prospers, political pressures for cheap loans to the poor will grow. The lesson from the US is that inclusive loans on a sufficiently large scale can sink the whole financial system.

 

So, the poor and needy should be given grants, not loans that they cannot repay, or may be encouraged by politicians not to repay. We have already received warning of this from the fiasco of IRDP, India's first inclusive loan programme in the 1980s. The US crisis drives home a similar lesson.

 

From The Times of India September 28, 2008

 

Global Financial Crisis: A Slippery Slope By Arun Duggal

 

We are going through the most serious global financial crisis since the Great Depression.

 

It is centred in the United States, but its implication s are worldwide. The nationalisation of Bradford & Bingley in the UK and financial support for Fortis in Europe highlight the dangers of contagion.

 

Only concerted action by governments and monetary authorities, particularly those of the US, can prevent a global disaster. The crisis is as much real as it is based on the fear in the minds of participants in the financial system. That is why the $700 billion Troubled Asset Recovery Plan proposed by US treasury secretary Paulson and rejected by US House of Representatives is so important. The US government must commit large amounts of taxpayer funds and show firm determination to solve the problem.

 

There were four main factors behind this crisis. One, the US had long and continuous economic expansion with low inflation over the last 15 years, making financial markets and regulators complacent. They forgot that there is a "business cycle". Only 18 months ago, regulators, particularly the US Federal Reserve, were focused on dealing with the so-called ‘liquidity glut'. In the process, they missed noticing the emerging risk due to asset price inflation, particularly in real estate.

 

Two, during these good times financial institutions (FIs), particularly investment banks, grew very large. They took big risks and made huge profits. In recent years, FIs contributed nearly 40%, as against the normal 10%, of total US corporate profits. They paid huge salaries to recruit the best and the brightest from top business schools, who, in turn, helped create and sell complex financial products, credit derivatives and other securities whose risks were not understood by either investors or the top managements of investment banks.

 

Three: The good times encouraged banks to take higher risks. Highly leveraged transactions with "life covenants" became the norm. Investment banks themselves, became highly leveraged: 32:1 for Lehman Brothers before it failed, as against 8:1 for a conservative bank. Investment banks did not have sufficient capital to support the risks on their balance sheets.

 

Four, there was major failure of leadership at most FIs. Dealmakers took charge and risk managers were completely sidelined. Credit was mispriced so much that there was only small difference in the yield between junk bonds and US treasuries.

 

The very first inkling of the crisis came in February 2007 when Bobby Mehta, chief executive of HSBC, North America and another executive of HSBC, USA were sacked for catastrophic forays into high-risk US mortgage securities. These two bankers had received $40 million in bonuses the previous two years. The bank was forced to issue the first profit warning in its 142 years history but the timely action to recognise and deal with this problem has served HSBC well. Few market participants picked up the implications of this market signal.

 

Since early 2008, treasury secretary Henry Paulson and Federal Reserve chairman Ben Bernanke have been spearheading the fight against the financial crisis. Their challenge is to prevent systemic failure and recession, without creating a moral hazard, which would encourage people to act irresponsibly in the future.

 

They orchestrated Bear Stearns' merger with JP Morgan to stabilise the markets in March. Last month, they took over Fannie Mae and Freddie Mac, virtually government enterprises believed to have "the full faith and credit of the US government" behind them. They let Lehman Brothers file for bankruptcy as it did not represent a systemic risk. By this action, they also gave a salutary warning to shareholders and creditors of FIs that the US government would not always bail them out.

 

Merrill Lynch's merger with Bank of America, nudged on by the regulators, was a smart move. It addressed a problem before it became serious. AIG had to be rescued. Its normal insurance business continues to be sound, but it has assembled a huge portfolio of structured securities and credit default swaps that posed a risk to the entire financial system. Washington Mutual's takeover by JP Morgan, and Wachovia's acquisition by Citigroup underline the current fragility of US banking system.

 

Depending upon how effective the US government and other monetary authorities are in dealing with the current crisis, it would take at least a year, possibly more, for the credit markets to get back to normal. In the medium term, we will see US lawmakers impose fresh, perhaps, too many, regulations, on the financial system. The structure of the financial industry will undergo a major change. After the Great Depression, the Glass-Steagall Act separated commercial banks and securities firms. Ironically, the current financial crisis has led to combination of the two.

 

There will be other changes. Insurers will have to stick to their basic business and not take on huge risks on unrelated ventures. There is likely to be more regulations on hedge funds and other unregulated financial entities. Capital requirements for most FIs will be further enhanced. There would be an overhaul of executive compensation, and strengthening of risk management. Most derivatives such as Credit Default Swaps would become exchange-traded to eliminate counter party risk. Rating agencies will completely revise their approach to rating of mortgage and other complex securities.

 

This crisis will have some impact on India as well - we are not decoupled from the global financial systems. We have already seen the Indian stock market move in tandem with global markets. Capital flows into India will, the in short term, slow down. The rupee will depreciate.

 

On the other hand, our domestic financial system is robust and well capitalised. The Reserve Bank has already initiated sound measures to control inflation and excesses in the property sector.

 

There is an additional concern and an opportunity. Indian corporates who made large acquisitions overseas in recent years, with significant leverage, will be challenged. At the same time, asset prices are very depressed, particularly in the US and Europe, presenting Indian companies with interesting acquisition opportunities.

 

From The Economic Times October 1, 2008

 

Valley of Dollars By Davinder Sharma

 

The markets are smiling. After all, with American taxpayers pumping in $1.8 trillion so far to provide a life-saving shot to the failing markets, investors couldn't have asked for more. And who cares if all the investment banks in Wall Street have faded into history.

 

Three of America's top five investment banks have disappeared. The remaining two - Morgan Stanley and Goldman Sachs - have now been converted into commercial banks. With ace investor Warren Buffet promising to invest $5 billion in the now-nationalised American International Group (AIG), investor sentiments are high.

 

In the week following the mayhem on Wall Street, central banks in Britain, the European Union, Japan, Switzerland, Canada, Russia and India have pumped in $600 billion in multiple rescue acts. Ironical, isn't it? The private-sector giants are being rescued by the government's treasury. In the past one year, the US treasury has already spent US $900 billion in bailouts.

 

Expressing urgency, US President George Bush offered another whopping sum - a $700 billion bailout package. It sure is the ‘mother of all bailout' packages considering the proposed legislation making it clear that the measures are non-reviewable and cannot be challenged ‘in a court of law or any administrative agency'.

 

The political urgency with which the US government, and for that matter governments elsewhere, have come to the rescue of the financial system from getting worse exposes their double standards. The $600 billion, which was coughed up in just one week after the mayhem, could have wiped out hunger (the Food and Agriculture Organisation estimates 854 million people go to bed hungry every night) from the planet. The additional $900 billion that the US has spent in the past one year could have pulled out the world's estimated 2 billion poor from poverty.

 

In short, $1.8 trillion (including the proposed $700 billion bailout package) that the Bush administration has provided in the past nine months could have wiped out the last traces of poverty, hunger, malnutrition and squalor from the Earth. Buffet sounds so hollow when he compares the collapse of the Wall Street with Pearl Harbour: "It is not like Pearl harbour where you could look at what happened with your own eyes and decide you had to do something that day. This is sort of an economic Pearl harbour we're going through." Buffet is probably not aware that the world is silently living through tens of Pearl Harbours every day. An estimated 2,042 people died in Pearl Harbour whereas the UN estimates 24,000 people dying each day in an endless wait for their next morsel of food.

 

And if the global leadership was honest enough, a similar urgency could be demonstrated in tackling poverty and hunger. There would have been no need for the United Nations to provide a cover-up for their collective guilt in the form of Millennium Development Goals.

 

Look at the market mantra: when the going is good, the government must step back and allow the bull a mad run. And when the collapse comes, the losses are picked up by the taxpayers, whose savings actually line the pockets of corrupt CEOs. The trillion dollar question that arises is: Why should the governments intervene? Aren't the markets supposed to be self-regulatory and self-contained? And if not, does it not mean that capitalism is not the right model of economic growth?

 

In India, pressure is on to disinvest the public sector firms and nationalised banks. The arguments are same, you have often heard them. And when the private sector goes bust or the markets explode, it is invariably the governments that are expected to nationalise them.

 

If you think of it, the $85 billion bailout for AIG by the US government is the biggest nationalisation in history. Rescuing AIG was crucial because its failure posed a much bigger threat to the financial system. The $1.8 trillion that is being pumped in to write off the losses is in reality what will keep the markets alive. No wonder, Prof Nouriel Roubini of New York University's Stern School of Business had once called it "privatisation of profit and socialisation of losses".

 

Devinder Sharma is a New Delhi-based agricultural scientist and food policy analyst.

 

From Hindustan Times October 02, 2008

 

THE VIEW FROM SOUTH KOREA

 

Decoupling From Neo-Liberalism by Kim Ho-ki

 

Korea must use its imagination, vision and policy alternatives to globalize outside the boundaries of neoliberalism

 

A financial tsunami from the United States is shaking the world. Wall Street investment banks, known as spearheads of globalization, are going bankrupt one after another, and the fallout is hitting the world's economies, one after another. Korea is no exception. The nation's stock and foreign exchange markets have been through a series of rises and falls. After the rumors of a September financial crisis subsided, another dark cloud has cast its shadow over Korea.

 

Assessments and recommendations for how to deal with the financial crisis are diverse. Paul Krugman, who has long been critical of the Bush administration's economic policies, warned that the crisis could be the beginning of the end for the United States as an empire. Joseph Stiglitz gave some specific recommendations including the establishment of a committee that would assess the safety of financial products.

 

The U.K.-based Financial Times claimed "the return of the state" is needed instead of U.S.-style privatization, liberalization and deregulation, while Kenichi Ohmae proposed the establishment of an international organization to solve the liquidity crisis.

 

Experts have predicted this crisis. As globalization accelerated, capital has become "Prometheus Unbound." The risks associated with globalizing financial capital were well-known, but we have become drunk by attractive bubbles. The Bush administration injected massive public funds to calm the market, but the root of the problem has not been completely removed.

 

A financial crisis depresses the real economy, and there is still a possibility that a rupture could come from an unexpected part of the global financial network.

 

There are two views about the financial crisis. One is that the U.S-style financial system has shown its limits. The other is that the end of U.S.-led neoliberalism has begun.

 

There is hardly any objection to the first argument. Both right- and left-wingers agree that regulation of financial capital must be strengthened. Even the Republican presidential candidate, John McCain, supports this idea.

 

Opinions, however, are split over the second argument. While some say it is too early to talk about the collapse of neoliberalism, others say that its end has been clearly demonstrated.

 

The problem for Korea's economy is that the Lee Myung-bak administration's financial system is modeled after the United States. At a time when transparency and regulation should be reinforced, the government's plans are largely based on deregulation.

 

Of course, strengthening regulations will not have a magical effect. In order to improve the financial system's health, old regulations must be lifted, while necessary ones should be added. What is worrisome is that the wild goose, which was flying in front, is now falling, but the other geese failed to notice and continue their flight along the same course.

 

Korean society must separate globalization and neoliberalism. There is no way to avoid globalization, but neoliberalism is not necessarily the only way to achieve it.

 

What controls Koreans' thinking are the dictum that "globalization equals neoliberalism" and globalization versus anti-globalization dichotomy. Conservatives are caught by the first trap while liberals are ensnared by the second.

 

We should examine other countries, such as Finland, the Netherlands, Ireland and the European Union, which have sought sustainable globalization. Such models have globalized without blindly following U.S. neoliberalism.

 

While heightening competitiveness in the global market, they have tried to achieve social balance domestically. In other words, they took their unique qualities into account when addressing the pressures of globalization.

 

The core of the problem is that Korea practices either unsophisticated imitation or denial.

 

While the conservatives are preoccupied with the politics of imitation, believing they must follow any U.S. model, the liberals practice the politics of denial, believing they must reject globalization of any kind.

 

After the 1997 financial crisis, the Kim Dae-jung administration implemented restructuring based on neoliberalism. After the ambiguous "leftist neoliberalism" of the Roh Moo-hyun administration, Korean society now faces the Lee Myung-bak administration's market fundamentalist neoliberalism.

 

This is a critical time. Korea must use its imagination, vision and policy alternatives to globalize outside the boundaries of neoliberalism.

 

Kim Ho-ki is a professor of sociology at the Yonsei University.

 

From JoongAng Daily September 26, 2008

 

The Dying Dollar By Lee Chul-ho

 

The silver coin bearing the portrait of Roman Emperor Domitianus was the strongest and most important currency in the world. With its 100 percent silver content, the denarius was the most common coin produced for circulation during the Roman Empire. However, in the midst of an economic meltdown in the 3rd century B.C., the silver content of the denarius began to be gradually reduced.

 

The copper content of the Roman denarius soon exceeded as much as 95 percent, with a silver content of just 5 percent. It was more a silver-plated copper coin. The world began ignoring it, and the Roman coin lost its function as a key currency.

 

The Roman denarius, the British pound and the U.S. dollar are historically the three leading currencies that ruled the world. If a superpower's currency establishes itself as the world's major currency in international transfers, it becomes very powerful.

 

The seigniorage effect is a prime example. The currency in which each penny is spent has an enormous value in exchange. Currently America issues countless numbers of colored pieces of paper to the world and imports goods into the country. Thanks to the seigniorage effect, the U.S. economy has stood firm despite an annual trillion-dollar deficit in finance and trade.

 

However, the sun does not always hang high in the sky. If the economy remains sluggish and its currency value is depreciated, a key currency can no longer maintain its position. The only way to regain its prestige is to take the "Bagehot solution." As editor in chief of The Economist magazine, Walter Bagehot advised the government to raise interest rates and spend a huge amount of money on promoting the development of blue chip companies when the British pound showed a sluggish growth outlook and gold slipped out of the nation. The pound, however, miraculously escaped this fate.

 

Due to unfavorable winds from the U.S. financial crisis, we are witnessing unusual changes in skyrocketing dollar values. Yesterday, the won-dollar exchange rate exceeded 1,200 won. It may be a temporary phenomenon as U.S. financial companies in trouble struggle to take dollars from overseas.

 

According to Bagehot's solution, America is still immersed in adopting only half-right solutions. It seems to be busy trying to release money on the market via relief loans, rather than raise interest rates. If they leave it as it is, the U.S. dollar will soon collapse.

 

Can the dollar be saved like the pound or will it breathe its last like the denarius? The dollar is standing at a difficult crossroads.

 

Lee Chul-ho is an editorial writer of the JoongAng Ilbo

 

From JoongAng Daily September 30, 2004

 

How To Avoid Meltdown, Editorial

 

The United States House of Representatives rejected a proposed $700 billion bailout plan, sending financial markets around the globe into a tailspin and spreading fear in the world's markets. The Dow plummeted 777 points, the biggest drop ever in its history, leaving the United States facing a crisis that could collapse its entire financial system. Insecurities in the financial sector are spreading rapidly on complicated networks of financial derivatives.

 

Korea's economy, which is also an open economy, hasn't escaped harm's way and has been pushed closer to the abyss. This situation is now at least as serious as the mayhem caused by the financial crisis that hit the country 10 years ago. It is true that Korea's companies and financial sector have become comparatively healthier since then, but then the international economy was in good shape as well and our economy could be restored with relative ease.

 

Now, it's a different ball game. The entire global economy is peering over the cliff's edge. Everyone, from governments to households and companies, should prepare themselves for very troubled times ahead.

 

We need stable management of the foreign exchange market if we are to avoid a complete financial meltdown.

 

Finance Minister Kang Man-soo announced yesterday that the government would inject U.S. dollars from the foreign exchange reserves into the foreign exchange market, if need be. But the government's foreign exchange policy should be decided more carefully. Unless confidence about the rescue package in the United States is restored, it is difficult to expect the financial markets to be stabilized.

 

The government should refrain from intervening in the market until there are certain signs that the U.S. market has stabilized and the current account deficit improves.

 

When foreign exchange transactions are absolutely needed, the dollars from the foreign exchange reserve could be used to help with the transactions. But it is risky to leave the foreign exchange reserve wide open in an attempt to protect the won's exchange rate.

 

President Lee Myung-bak said yesterday in Russia that thanks to the government's preemptive responses, Korea's stock prices and foreign exchange rate were not damaged as much as in other countries.

 

That is uncomfortable self-praise since no one can predict when the U.S. financial crisis will end. A gloomy scenario that sees U.S. hedge funds going bankrupt is spreading, and most of all, it is not clear if U.S. lawmakers will pass the revised bailout bill. If the rescue plan becomes ragged in the course of revision, the market will become more suspicious about its impact.

 

It is not the right time for the government to show optimism. The government should be honest and urge people to work together. Stabilizing the foreign exchange market should be top priority, setting aside other economic policies for consumer prices or economic growth.

 

History tells us that there is only one way to overcome an economic crisis. Households, companies and the government must be alert about the looming crisis and cooperate to overcome as much as possible.

 

From JoongAng Daily October 1, 2008

 

A Korean Brand of Capitalism By Kim Jong-soo

 

It would be good for scholars from various fields to hold a full-scale debate in search of a distinctly Korean brand of capitalism.

 

The Korean economy is swaying unsteadily as ripples from the financial crisis in the United States spread out. The Korean stock market is dancing to the U.S. market's tune, and as funds in the U.S. dry up, Korean financial companies are also getting thirsty. It is apparent that the U.S. economy will fall into a recession due to the aftershocks of the financial crisis. Then our exports, which have been barely holding on, will collapse. The fire of the financial crisis spreading on the other side of the ocean is now showering sparks on our heels.

 

For its own economy to survive, the United States will take care of the financial crisis in its own living room, no matter what it takes. The process may be hard and the aftershocks and pain could last a long time, but it will survive. Certainly, it will look different from the country we knew before the crisis.

 

But never mind the U.S. economy. What is urgent for us is to take care of the Korean economy, which has been hit by a stray bullet from the financial crisis. The foreign exchange crisis 10 years ago was caused by big mistakes we made, but this time we cannot be blamed.

 

This fire was caused by unexpected lightning. We did not do anything wrong, yet it seems that we will suffer burns from a fire that started outside our house, and our economy will be in tatters, bruised and cut.

 

There is no way the United States, which has to save its own skin, will help us. We must learn to avoid being bit by flying fire, and treat burns and bruises ourselves.

 

These days, varying expert diagnoses and prescriptions regarding the current financial crisis and the Korean economy are rampant. Progressive economists say that American neoliberalism has come to an end and claim that the Korean economy, which has been based on the American model, needs to change its direction.

 

Specifically, they say that the government should discard the advanced financial system pursued by the Lee Myung-bak administration and strengthen regulations in the finance sector, taking this crisis as an opportunity to do so. They are also against the plan to privatize Korea Development Bank and ease regulations on the separation of finance and industry.

 

Although he is not one of the progressives but rather a scholar who uses a systematic approach, Professor Ha-joon Chang of Cambridge University has also defined the situation as "the bankruptcy" of neoliberalism and has raised objections to government policy that nurtures investment banks and reduces taxes. On the other hand, the voices of economists who support the Citizens' Coalition for Economic Justice and pursue shareholder-centered capitalism, or economists with traditional liberal tendencies, can hardly be heard.

 

Generally, the anti-neoliberal camp is raising its voice as if this is their time, while the neoliberal or traditional liberal camp is remaining silent. While people are openly throwing stones at American neoliberalism, people who defend the free market economy are strikingly absent.

 

So which way should the Korean economy go? The assertions of anti-neoliberals are diverse, from the extreme theory of government intervention to the theory of partial government mediation. Although they share a criticism of neoliberalism, they are not able to come up with a clear alternative on which they agree. Although there are differences of degree, it is clear that government regulations and intervention in the market should be increased, instead of maintaining the policy of one-sided liberalization. Coming down on the side of anti-intervention is editorial writer Joung Suk-ku of The Hankyoreh Sinmun. Joung takes the position that the failure of the neoliberal market should not necessarily lead to the revival of government intervention and stronger regulations. In essence, he says there is no guarantee that the government will do any better simply because the market has failed.

 

Seen from the above perspective, the debate on the direction the Korean economy should pursue can be summarized by deciding to what degree the government's role should expand.

 

Even anti-neoliberals are not saying that the capitalist economy should become completely socialist. Ultimately, the focus of the discussion comes down to the problem of adjusting the degree of government intervention in the market while maintaining the structure of a market economy.

 

In this case, there is room for rational discussion. This is a good chance for us to create a Korean model of capitalism through sincere discussion and social consensus instead of extreme confrontation staged in an "all or nothing" manner. Taking this opportunity, it would be good for scholars from various fields to hold a full-scale debate in search of a distinctly Korean brand of capitalism.

 

Kim Jong-soo is an editorial writer of the JoongAng Ilbo

 

From JoongAng Daily October 02, 2008

 

THE VIEW FROM SAUDI ARABIA

 

Speculation Makes Short-selling Incredibly Risky By Mushtak Parker

 

As US and UK authorities struggle to come up with plans to bailout banks - in the case of the US with a $700 billion taxpayers rescue plan - several regulators have launched inquiries to see whether any executives at the institutions caught in the worst global financial crisis since the 1920s were up to no good and were breaking the law.

 

Already the FBI has arrested two bankers at Bear Stearns, the first US bank to be rescued, for alleged fraud through miss-selling. No doubt there will be more such dramatic developments as beleaguered governments and regulators are clearly keen to be seen to be taking action for both political survival and the stability of their financial markets and systems.

 

The blame game has not only centered on individuals but also on corrupt business cultures and dubious practices such as greed and short selling. In addition, inadequate and non-existent regulation has left regulators and governments dealing with the fallout of the excesses of their financial services sectors. The US Treasury has already committed taxpayers $1.835 trillion, with another $700 billion on the cards for the current bailout plan and another $500 billion for the possible recapitalization of Fannie Mae and Freddie Mac, the two major US mortgage providers which had to be rescued through nationalization.

 

Retribution and regulation seems to be the flavor of the time, although some critics warn that it is the redress of customers and taxpayers that also needs urgent attention. At the same the US model of capitalism has come under severe scrutiny, with the deregulation of the financial markets being blamed following the repeal of the Glass-Steagalls Act in the 1990s, paving the way for a free-for-all banking culture. Investment banks such as Goldman Sachs, Merrill Lynch, Morgan Stanley were allowed to restructure with totally inadequate capital adequacy requirements, as it has been proven, and as if they were oblivious of the requirements of the Basel I and II Concordats, which in turn have and are proving to be wholly off the mark.

 

However, the two major trends over the last four decades which have contributed to the current state of affairs in the financial markets in the US and Europe, are the blurring of liberal democracy with business; and the rise of the so-called exotics - largely derivatives such as hedge funds, credit default swaps etc in the global financial space.

 

In the US, from Reaganomics to Dubyanomics, the lines between the democratic process and big business have become increasingly blurred. The world is now firmly rooted in a "bizdemocracy" culture, where poachers are now asked to do the jobs of gamekeepers. A good example is Henry Paulson, the US Treasury secretary, who until a few years ago was the CEO of Goldman Sachs, one of the very institutions now in trouble.

 

In the UK, we had Thatcherism, the British version of Reaganomics, which also presided over two "boom and bust" episodes leading to two recessions in just over a decade. The cultural shift became even more evident when Tony Blair's New Labour came to power and was hailed the new Thatcherite kid on the block. The truth is that Blair's economic supremo for the decade was none other than Gordon Brown, his successor as premier.

 

As to the cultural shift in banking, institutions such as Goldman Sachs, Morgan Stanley, Deutsche Bank etc., moved away from their traditional conservative investment banking structures to become effectively gigantic hedge funds chasing billions of dollars in profits, bonuses and dividends. Greed not only engulfed senior executives and managers but shareholders themselves. And as this was generating instant wealth, regulators and government treasuries were only too keen on cashing in on the tax dollars and pounds.

 

There is a truism that innovation drives regulation; and that since bankers are the innovators, regulators always lag. It is a catch-up game where regulators will always lose. Belatedly, regulators are now trying to change the rules of the game, by telling bankers that we will legislate and you will innovate within that framework.

 

Both the Fed in America and the FSA in the UK have banned the practice of short-selling, albeit temporarily until January 2009, to help stabilize the market by taking pressure off the shares of the troubled institutions through shorting in the market.

 

While the practice of short selling is completely legal, it is considered very risky. To put it crudely, short selling is basically gambling that stocks will fall in price.

 

Shorting occurs when a trader, usually acting on behalf of private investment funds called hedge funds, borrows a financial contract such as a number of shares or bonds from an institution (such as bank) for a fee. The trader then sells those shares in the market at a price; with the aim of buying back those shares at a later date but a lower price. The difference in the price is the trader's margin or profit. The hope is that the share price will fall, but the sheer risk of speculating on this hope makes shorting incredibly risky.

 

Because the potential financial rewards are often substantial, the incentives to help prices fall are large. Traders have been suspected and accused of spreading rumors about company performances or through the signal that significant amounts of short selling sends to the market that many believe future price falls are likely. The more people act on this generated speculation, the more it can affect the value of an otherwise healthy investment. The shares of HBOS, the British bank, for instance, suffered this fate recently which has seen the bank being taken over by Lloyds TSB.

 

According to the UK Department of Business, Enterprise and Regulatory Reform's IFSL Research, assets under management in hedge funds globally totaled $1.9 trillion at end 2007. As such, the problems they could potentially cause when things go wrong are enormous. Unfortunately, the current turmoil in the global financial markets happens to be such one example.

 

What is amazing is that, while regulators are keen to temporarily proscribe the practice of short-selling, they are only too quick to close ranks with their friends in the financial services industry to defend the practice of short selling. The same breadth they ban the practice, they also defend and laud its efficacy, stressing that short selling make an important contribution to liquidity management and to the orderly operation of the market. Short selling, they argue, can play a key informative role; often exposing the real value of company's shares.

 

The governments and regulators cannot have their cake and eat it. This is where the benign blurring of democratic government and business is at its most potentially corrupt. There are plenty of other ways to generate and manage liquidity. The truth is that short selling for decades has been seen as an ideal way of making a quick few billions or so, especially in a decade of economic boom. What has happened to the traditional so-called Protestant ethic of wealth creation through thrift, hard work and generating returns through investments in the real economy, which has the added bonus of generating jobs?

 

Perhaps the Islamic system of economic and financial management has something new to offer to the conventional financial system. In Fiqh Al-Muamalat, Islamic law relating to financial transactions, short selling is definitively banned because it is tantamount to gambling or speculation in this sense (Maisir, which is similarly proscribed. Under Islamic investment principles, you simply cannot sell or trade a share or bond which you do not own.

 

The danger of course is for Islamic bankers to fall into the same trap ostensibly from pressure of investors looking for diversification of asset allocation and higher rewards. The fact that many bankers in Islamic finance are from the conventional sector, means that the tendency to imitate or "Islamize" conventional structures is simply too overwhelming.

 

Hedge funds and shorting are no exceptions. Earlier this year, Shariah Capital Inc. of the US launched the first Islamic fund of hedge funds, in which the Dubai Multi Commodities Center Authority (DMCC), an agency of the Dubai government, is seed investing a $250 million - $50 million in five hedge funds through the Al-Safi Trust alternative investment platform, established by Barclays Capital and Shariah Capital Inc.

 

The promoters devised a Shariah-compliant equivalent which replicates shorting using the contract of Arbun. Under this arrangement, the trader who wishes to short a stock in the Al-Safi platform can put a sell order through Barclays Capital's prime brokerage, which would record the transaction as a purchase and not a loan. This process establishes ownership of the asset before sale to the market. In Islamic finance you cannot sell an asset which you do not own.

 

As such, an investor cannot borrow shares from a brokerage house or a bank and sell them in the market for an eventual gain. Al-Safi also tracks each trade and each position of each hedge fund manager through separately-managed accounts to ensure strict Shariah compliance. But while the mechanics of the structure in this respect is different, the economic effect is similar to the conventional short sell. The reality is that the transaction is more a long-short arrangement.

 

It would be interesting to know the current situation of these so-called Shariah-compliant hedge funds. Other attempts at Shariah-compliant hedge funds by Fimat, the prime brokerage arm of Societe Generale, and Al-Fanar, owned by Worms & Co. and SEDCO, used the Salam contract, effectively using a forward sale concept for equities. But they failed to thrive.

 

From Arab News September 30, 2008

 

Lessons From America's Economic Failings By Osama Al Sharif

 

The US economy is facing a crisis that is conjuring up images of the calamities of the Great Depression of the 1920s. European and Asian financial markets are tumbling as terror and panic hits Wall Street. And when US lawmakers failed to pass a controversial $700 billion rescue package on Monday that promised to stop the credit market from shutting down, stocks plummeted forcing the Dow Jones Index to shed 7 percent of its value or over a trillion dollars, the biggest single drop since 9/11.

 

The threats to the global economy are real and daunting. The collapse of America's mighty financial institutions will have far-reaching ramifications on almost every country on the planet. This is the nature of the global world we live in. The failure of the biggest economy on earth will usher challenges that few can fathom or imagine.

 

Already there are those who have declared the death of capitalism, almost 20 years after the collapse of communism and the unraveling of the Soviet Union. Others, like Germany's finance minister, are predicting the demise of the United States as a financial superpower. And there are those, like France's President Sarkozy, who believe the world should get ready for a new global financial system.

 

In reality, it is early to pronounce the death of anything. The American economy is in deep water and the prospects for a quick recovery are dim. The so-called meltdown is already happening but it would take weeks and months before the full extent of the damage, which started with the collapse of the subprime mortgage market in the US, is fully uncovered.

 

Chances are we will see more bloody Mondays in the coming weeks before the turbulent markets settle down and begin to recover. Meanwhile, we should brace ourselves for more bailout actions for failing banks and financial institutions around the world. More than a handful will not make it. It will be a time for quick mergers and acquisitions. The structure of the world economy will never be the same.

 

When communism went bankrupt, American philosopher Francis Fukuyama was bold enough to predict the end of history arguing that "liberal democracy and free market capitalism as the most fundamentally satisfying form of government and method of organizing the economy, represents the final stage of human government." Witnessing America's economic turmoil of the last eight months negates such prediction. One of the conclusions of the current crisis is that economic liberalism and free market capitalism are at a crossroad; both have failed to deliver and both are in trouble in their native land.

 

Critics of American-style capitalism are many and it would be redundant to go through their grievances and objections. America today is a unique case study where millions of citizens are about to lose their homes and where the life savings of the working man are in danger of disappearing overnight. America owes trillions of dollars to foreign governments; its so-called brick and mortar industries, from autos to airlines, from beverages to foodstuffs, are either out of business or have been picked up by foreign investors. Millions are jobless and tens of thousands are losing their only source of livelihood every week. Unlike many in Western democracies Americans have no national health system.

 

And there are those who believe the problem is not in the system, but in leadership. Like Democratic presidential candidate Barack Obama, they believe the current predicament is the result of eight years of short-sighted Bush policies, which has favored the rich and mighty, the highly paid executives, the oil companies, while spending hundreds of billions of dollars on unpopular wars in Iraq and Afghanistan. This argument could be true as well.

 

In reality, it is difficult to pinpoint the direct reasons for the present crisis. Leadership or lack thereof, deregulation, weak government oversight, avarice, unbridled consumerism, and corruption have all contributed to some degree to the problem. Whether a new leadership that calls for change and reform will be able to save the world's biggest economy from imminent disaster will have to be seen.

 

Meanwhile, the world is not safe. Capitalism has contributed directly to the complex challenges that humans face today from climate change to soaring energy prices. As the Americans get busy trying to fix their economy, the rest of the world should get busy as well in an attempt to figure out ways to cushion the effects of America's financial downfall and chart a new course for hundreds of smaller, and more vulnerable, economies.

 

In the Arab world, we should pay attention to what is happening in America, more so because in the past decade or so liberal economists appear to have taken the lead pretending to have a magic wand in their hands. Not to be confused with liberal politics, their doctrines have shaken the foundations of our societies and cultural beliefs. The net result of their policies has not been added up yet, but the symptoms are not encouraging.

 

We are yet to come up with solutions to poverty, unemployment, lack of social justice, corruption and misuse of public funds. We are yet to provide free health and education to all, harness consumerism, tame inflation and preserve our cultural heritage in the process. And we are still far from building vibrant civil societies that guarantee equal opportunity and provide for transparency, good governance and the rule of law.

 

We could either heed the lessons from what is happening to America and other countries, or bury our heads in the sand and pretend that the reverberations will not reach us. These are historic times and history is very much alive and kicking. Those who fail to learn from it will pay dearly.

Osama Al Sharif is a veteran journalist based in Jordan.

 

From Arab News October 2, 2008