Obama, heading for the G20 gathering designed to slay the dragon of international financial meltdown and incipient worldwide depression, finds himself the ham between the sandwich of British Prime Minister Gordon Brown and Canada's financial gunslinger and former head of the Bank of Canada, David Dodge.
Brown, he of the shaggy hair, creased suits and dour countenance, had long been overshadowed by the effervescent and GQ-like Tony Blair. But now his time seems to have come, as he strides the world financial stage, dropping sombre prophesies to his countryfolk and everyone else who will listen to his flat, plodding, boring tones.
Listen to what Brown says about the choice between regulating the shadowy non-bank financial system (the choice of the European Union) or pumping billions on dollars into the economies to stimulate more lending and more buying on credit (the choice so far of Obama):
"How much safer would everybody's savings be if the whole world finally came together to outlaw shadow banking systems and offshore tax havens?"
Right on the mark, Brownie! Heckuva job, Brownie!
And this is what David Dodge has to say (quoted in a must-read lucid article on the issues facing us, written by Boyd Erman in today's Globe & Mail):
"That's where next weekend's G20 meetings come in: The next key is to create an international movement to bring the shadow banking system into the regulatory light. "At the end, the shadow banking system will have to come out of the shadows," said David Dodge, the former head of Canada's central bank. He said regulators need to require standardization of lending and other products, and better underwriting standards. "Because obviously the big change that's going to come is that you're not going to have a system where you can ignore the credit quality of the underlying assets," he said."
Right on, David! Heckuva job, Dodge!
What is the issue, and how did we end up in this dreadful pre-depression? Erman's very useful article leads us through the thickets.
The problem we face right now is that people are not buying products and services, and so the economies of the world are contracting, shedding jobs left right and centre. Consumers are scared – fearing loss of jobs; they are also unable to get credit to buy new homes and new cars, because a huge whack of financing has disappeared off the face of the earth in the past 18 months or so.
Over the past decade a new system of financing arose, which at its peak rivalled or even exceeded the traditional banking system. This has been called the shadow banking system. It is the securitized market – the hedge funds and others. People found that they could get credit from these new entities, who packaged the mortgages and credit card debt and car debt into parcels which were then sold to hedge funds throughout the world. The theory was that you avoided or reduced risk by spreading the purchase of these debts to people all over the world, so that nobody was taking too much on their own balance sheets.
The problem was that this artificial construct did not work. There was no regulation of these shadow banks. As Erman puts it:
"Growth was fast, and unhindered by regulators whose mandates were to look at traditional banks. The shadow system grew up inside a black hole where few rules applied."
At its peak the volume of loans bought through this shadow banking system toppled $10 trillion dollars. An astounding sum.
The rot that set in was that people paid no attention to the underlying credits. The house of cards collapsed when the people buying cars and homes and clothes and going on holiday on credit did not pay their debts. The cascading losses brought down the hedge funds – from a peak of over 10,000 a year or so ago, they dropped by more than 1,400 in the past year, and the bankruptcies are continuing apace.
It is as if the whole banking system was being wiped out.
How to deal with the freeze in credit markets that resulted is at the core of the discussions at the G20 meeting. Obama (and here in Canada, Harper) decided to prime the pumps by having the governments step in. Obama is doing this with his $1 trillion securitization project by Secretary Geithner. Harper is pumping $12 billion into auto loans.
The Browns of this world are more cautions. They believe that if the patient is ill because the patient borrowed too much money and could not afford paying off debts, then the cure should not be to shovel more money into the patient's pocket, but to regulate the black hole shadow banking system and make sure the same thing does not happen again.
And to let the system burn off the unwarranted excess credit through bankruptcies and the reduction of the economies, including higher job losses, until the right level of credit is achieved.
A tough love approach, ameliorated by better EI systems designed to help those hardest hit.
As Erman puts it:
"But even if the system can be restarted and made safer, the fundamental economic questions remain. After all, it was reckless borrowing that got the U.S. in trouble, and now that many borrowers are in even worse shape than during the boom, shouldn't lending actually be scaled back? "It's the wrong way to go if we think that encouraging people to borrow more and leverage up more and to spend more will get us out of this mess, because that's what got us into this mess in the first place," Ms. Tavakoli said."
The Cat sides with Brown on this one. Best to let the fat be burned off and start afresh in a few years time with a better system, but take care of those who suffer job losses. This means a lower GDP and very high unemployment (well over 10% for Canada and the USA).
