(Seminar sponsored by Madariaga – College of Europe)
I found the answer to this intriguing question in a text some 2000 years old reported from a source with impeccable ethical and moral credentials which seems perfectly adapted to the current environment. I quote:
“For I say unto you, that unto every one which hath shall be given; and from him that hath not, even that he hath shall be taken away from him.”
(From the Gospel according to Saint Luke Chapter 19 § 26).
There is, indeed, little doubt in my mind that it will be the most vulnerable segments of the population that will, once again, be the main victims of the excesses that have lead us into the deepest financial and economic crisis since the great depression of the 1930’s.
I will certainly not attempt to read into a crystal ball wondering about the “next crisis”, because it should be evident that we are far from being out of the present one for which we have only started to pay for.
There is a general consensus that the present crisis is one created by excessive indebtedness exacerbated by an unsustainable degree of leverage. This left borrowers extremely vulnerable to small fluctuations in underlying asset prices which, when they occurred, created a domino effect amplifying at an ever increasing speed the number of counterparties affected. From an initial downturn in the subprime segment of the US real estate market, the crisis quickly spread to the real estate mortgage backed securities (RMBS) which had securitised manifestly unsound mortgages. Having multiplied exponentially the amount of securities linked to real estate by creating “virtual pools of assets” that merely shadowed the behaviour of the existing securities (CDO), the exposure of financial institutions to the market ran totally out of control. Financial “innovation” further clouded the picture by promoting Credit Default Swaps (CDS) on these same securities, often written by institutions with no knowledge of the underlying risk they were assuming and relying excessively on misguided ratings. These practices multiplied dramatically the counterparty risks associated with the ever more complex securities and lead, eventually, to the freezing of the interbank market as banks refused to lend to each other. The intervention of Central Banks to maintain liquidity in the banking market, starting in August 2007, and, in a second stage, to the rescue operations by Governments of several systemically important institutions after the Lehman failure, prevented the implosion of the global financial system.
The next step was the contagion of the economy in general leading to a severe global recession, never experienced before, which was the result of the globalisation of world markets over the previous decades which had significantly increased the connectivity between markets. Once again Governments stepped in with huge stimulus plans, while Central Banks maintained interest rates at very low levels to counteract declining consumer spending and increasing unemployment.
As we look at the situation today, one must conclude that, to the extent financial institutions and consumers have attempted or been forced to reduce their indebtedness, this trend has been very largely compensated by an equal increase in public sector indebtedness, leaving the system as a whole as leveraged as before. It also has brought the indebtedness of many Governments close to their limits, especially in the Eurozone, where governments have transferred monetary sovereignty to a common authority, the ECB, removing devaluation from the tool box available to them.
So, while there has been a lot of shuffling around one must recognise that up until now the main price of the crisis has been paid by those losing their jobs, both in industrialised countries and in developing nations and also by those many millions of citizens who have seen their savings and/or retirement prospects severely impaired.
It is a myth, carefully nurtured by politicians, that it is the “Taxpayer” who has shouldered so far the main burden. The role of the taxpayer has been carefully differed by forcing him to underwrite increased government indebtedness, more in the form of a guarantee than as an actual charge on his current wealth. Indeed, I have not noticed any meaningful tax increases; on the contrary, great care is given to explain that this cannot be envisaged before the economic recovery is well underway.
There can be no doubt that tax increases will have to be part of the solution in decreasing the leverage that is currently within the system but it appears totally unrealistic to think that a sustainable new equilibrium can be established over time exclusively through economic growth, a more rigorous budgetary discipline and higher taxes, as our political masters would have us believe.
I have expressed since a long time that, in the end, the deleveraging process will be least painful if inflation is also part of the solution, despite its own disadvantages. The vast majority of the world population has experienced at some point in time, the woes of inflation, particularly in the years between 1950 and 1990 and, understandably, considers it as the greatest evil. Those, however, who have studied - or at least heard of – the Great Depression of the thirties may realise that this episode wrought even worse hardship on the population at large, culminating in the 50 million victims of the Second World War.
Since it is inevitable that there is a very high price to pay for the excesses committed over the last decades, in which the financial markets have played a very significant role, but for which the Executive and Legislative branches of Government as well as Regulators, lobbyists of all walks and consumers must also share in part the responsibility, it follows that we will all be called to contribute to this very painful exercise.
The main duty of our political leaders is to ensure that the burden is fairly distributed so as to protect to the greatest extent possible the most vulnerable citizens. This means essentially eliminating tax rules that clearly advantage the wealthier sections of the population, ensuring proper collection as well as enforcement of tax laws. It also means, without degenerating into a witch hunt, that those who violated existing laws should be made fully accountable for their transgressions so that justice is both done and seen to be done.
It is only in such an environment that citizens can be expected to accept the inevitable sacrifices that lie ahead and that Governments will have the necessary legitimacy to reassert their sovereignty over financial markets.
Brussels, 5th June 2010
Paul N. Goldschmidt
Director, European Commission (ret); Member of the Thomas More Institute.
Tel: +32 (02) 6475310 +33 (04) 94732015 Mob: +32 (0497) 549259