G-20 MYTHS & TRUTHS - April 1, 2009

 
   
The G-20 comes together this week, long anticipated, but the outcome is still

not within the box of standard expectations. There are perhaps as many

disparate agendas as there will be heads of state/governments in London.

Some are focused on the need for regulatory change, others on greater stimulus, a few on the plight

of their own vulnerable populations and a few more on defending exclusively domestic interests. Enhanced protectionism is a possible outcome along with ill advised relief founded upon misdiagnosed causes. What is a good starting point is to identify the causes as well as the potential consequences of this global economic crisis. (By the nature of this column, the analysis will have to be abbreviated, if not perhaps appearing unduly truncated).
  
GLOBAL CRISIS IS NOT LINEAR NOR UNIFORM
   

While the current economic downturn is relatively global, it is not uniform nor linear in its effect. China is not technically even in recession. (The GDP purportedly continues to grow at 5%). However, the economy at the Chinese coast continues to experience a rather positive growth at 10% or even better. On the other hand, inland areas in China are experiencing no positive growth or worse, all with threatening social and political upheaval.
   
Similarly, exporting global economies are most impacted. Also, those states with local sources of capital and credit have been faring better and some appear already on the road to recovery. In this context, Europe appears the most disparate: The "new Europe" is most affected in large part hamstrung by a dependence on banks with HQs outside of their borders reacting to other regulatory and business priorities. Citizens, particularly the old Europe with built up welfare or social/economic safety nets, are impacted less in their daily lives and their ability to maintain standards of living.
  
Developing states, such as India or Turkey, and many who will not be represented at the G-20, are most at risk. They are at critical moments of pulling themselves out of dependence into relative economic independence. They could be shoved back into marginal poverty and some even upon reliance or handouts rather than self-help.
   
BLAME THE RATING AGENCIES?
   

The rating agencies are not the problem, but do share responsibility. By focusing blame on them, some have been able to deflect accountability for their own contributions. More so, we may be missing both the deal specific and systemic issues within and beyond the mortgage backed securities market that drove the global economy to the brink and ultimately off the road.
  
SPEED & LEVERAGE KILLS ESPECIALLY WHEN HITTING A "BUBBLE"?
   

The current process of deleveraging would seem to point toward leverage as a primary cause. Like speed, leverage appears relatively benign as long as most others are driving as fast. And, like speed, does not actually kill until there is a crash.
   
It is though too simplistic to blame pure leverage. The "real asset bubbles," (from oil and commodities to real estate), that leverage helped pile up are more a direct factor, although again by no means exclusive. It is accurate nonetheless to consider the role of leverage as a major contributing factor when the economic highway becomes a pileup. Unfortunately what may appear as driving at or slightly above the limit can be deadly when everything ahead comes to a stop, like a liquidity crisis with no access to credit. Still, it is appropriate to inquire what may have created or exacerbated the pile up and made normal breaking, reduction in leverage not possible before the fatal crash?
  
ASYMMETRIC REGULATION
   

Perhaps the question for the London G-20 Summit should not be so much more regulation over less. Rather, the issue is asymmetric regulation that appears to have allowed different types of institutions to be policed to varying or no degrees regarding their activities while in effect driving down the same financial highway. It is not appropriate to make the rules of the road exactly the same; however it is wise to consider the compatibility across the board, especially when some maybe engaged in predatory behavior exacerbating or even creating the crash.
  
PREDATION IN FINANCIAL MARKETS
  

It was dangerous, perhaps even reckless, to assume so much leverage. What made it worse is that there are predators in the markets helping push financial institutions off the road. Perhaps in the past, management leadership would gather the warning signs and begin to take responsible corrective steps to bolster balance sheets. It could have been by reducing leverage or terminating more risk prone activities or simply by accessing more capital.
  
This time around though institutions were more targeted than just identified. Short selling and other predatory activities within more exotic markets as "Credit Swap Derivatives" rapidly accelerated the vulnerable institutions toward crash. Vulnerable institutions could not raise capital, had unexpected and unprecedented calls on their counter party positions with no capacity to meet such and ultimately faced a prefabricated collapse in confidence and ability to do business normally. Perhaps they should have been more cautious from the outset, but with a global field, hedge funds and anonymity it was quiet possible that the targeted financial institution, while prey, was lending money to those who were hunting it into extinction. Leverage became both a vulnerability of the prey and a weapon of the predator.
  
"MARK TO MARKET"
   

Mark to Market accounting, (providing valuation to financial institutions' assets on basis of bids for such made in current marketplace), is a contributing factor and another example where regulatory intervention may be having a contrary affect. If there is a disruption, dysfunction or even manipulation in the marketplace, then a pricing of assets on basis of current bids is either improbable or worse misleading. Mark to Market pricing may be best snapshot view of situation available , but it also may be substantively misleading as to the value of the assets in stable, fair market conditions and thus provide a definitively inaccurate barometer of the holder's financial health.
  
WHY THE FOCUS ON RATING AGENCIES?
    

When "AAA" ratings went to "D" (for default), the rating agencies such as Standard & Poors and Moodys were labeled as the non-virtues. However, the rating agencies perhaps more carry the scarlet "D" on behalf of collective hypocrisy of the regulatory and business "players" within the financial industry. The rating agencies certainly are not madam in this morality play. There are insiders who carry much greater responsibility for gaming the system to maximum advantage based upon even more risky multiples of leverage. They reaped much greater profits and had better insight as to the possible outcome. It is perhaps fair to state that the rating agencies were seduced and did surrender a necessary level of virtuous distance, at least from the perspective of the time when I served at Standard & Poors over 20+ years earlier.
   
The more that the rating agencies defend themselves, though, the easier it becomes to focus upon them as scapegoat. The rating agencies were simply outgunned in the blame game and readily positioned to deflect accountability from others. More critically to the future, the rating agencies have become the fulcrum for a transoceanic debate with regard to a new global regulatory regime. The rating agencies were a byproduct of the US system. They were the methodology and means of transforming the global financial system into a US like model. Successful or not, such was not a desirable development for many European, Asian and developing economy leaders. The current crisis seems to be a point for reprimand for the US model just as was the apparent success and dominance only a few years earlier a point of self congratulation. 
  
REGULATION v. STIMULUS
   

The US model is neither the success that it was heralded a couple of years earlier nor the failure that some would judge it now. The pace of change in the multidimensional global economic system does not allow for a still, two-dimensional snapshot to be representative of the situation. The London G-20 Summit may be defined by some as a choice between more regulation or more stimulus. However, that may be a false choice.
   
More comprehensive and considered regulation may be necessary to address too much risk and/or leverage, address predatory behaviour and develop a more even field in a rapidly evolving environment. However, regulatory overcompensation when the "bubbles" started deflating may have as much prompted the bursting and consequent economic compression. It certainly did not make things better in terms of immediately needed relief.
  
The US needs stimulus perhaps more as compared to most other developed economies, (that have more robust social safety nets and spending programs). However, the globe as a whole needs it and, most importantly, to be coordinated. Otherwise, the globe faces the risk of stagflation, protectionism and most likely both.
  
LOOKING BEYOND
  

My guess though is that as in most such events, the result will be one step forward and one sideways. One group of countries that cannot afford to be lost in the shuffle are the most vulnerable, those states, more accurately, populations still dependent on food and other aid. On the eve of the Summit the UN and other institutions have warned of the possible catastrophic risks when it is second nature for most to look more inward and not see the issues and needs beyond their own borders. 
 

Muhamed Sacirbey

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Author of the article is a former Vice-President of Standard & Poors.

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