A whole new world af­ter the fi­nan­cial cri­sis ends, es­pe­cially for the bank­ing sec­tor

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the fi­nan­cial cri­sis is that some­thing which hap­pened in just a few coun­tries has now be­come every­one’s prob­lem,” says Al­berto Trejos, Costa Ri­can econ­o­mist and Pro­fes­sor at Latin Amer­i­can busi­ness school, INCAE. “In a world that is so in­ter­con­nected through fi­nance and trade, all coun­tries, both de­vel­oped and de­vel­op­ing, have been im­pacted.”

Trejos, speak­ing at a fo­rum on the global fi­nan­cial cri­sis at the Uni­ver­sity of Pre­to­ria’s Gor­don In­sti­tute of Busi­ness Sci­ence, in as­so­ci­a­tion with the Bren­thurst Foun­da­tion, says that the abil­ity of young and emerg­ing coun­tries to sur­vive the cri­sis is based on sev­eral fac­tors. “ Their re­silience to the cri­sis will de­pend on the abil­ity of that gov­ern­ment to re­spond with ap­pro­pri­ate fis­cal stim­u­lus pack­ages. It also de­pends on the unique po­lit­i­cal is­sues fac­ing a par­tic­u­lar coun­try and the strength of its po­lit­i­cal lead­er­ship. Also vi­tal is the fragility of that econ­omy’s bal­ance of pay­ments and how in­fla­tion­ary pres­sures play out in each mar­ket.”

Trejos iden­ti­fies sev­eral causes of the global cri­sis but ad­mits there is cer­tainly no con­sen­sus as to the cul­prits. “One of the causes is that fi­nan­cial dereg­u­la­tion be­gan to run amok. From the mid 90s, we saw the start of a trend whereby the free mar­kets be­gan to take over from the reg­u­la­tors, and the rea­sons for this were well founded. How­ever, this dereg­u­la­tion led to some ex­ces­sive lib­er­ties in the US and we saw as­sets be­ing cre­ated through sub-prime mortgages and col­la­terised debt, banks were load­ing risky as­sets into their port­fo­lios, and com­plex de­riv­a­tive and lever­aged fund prod­ucts were be­ing sold to in­no­cent and un­in­formed in­vestors. Pro­ce­dures be­came less strin­gent, data qual­ity was poor, and there was a lack of in­de­pen­dence from those as­sess­ing fi­nan­cial risk. Banks were now fac­ing new types of risks with no his­tory that could point them to­wards recog­nis­ing po­ten­tial prob­lems. Some grossly reck­less lend­ing prac­tices were tak­ing place, be­ing repack­aged and on-sold across the world.”

A sec­ond con­tribut­ing cri­sis fac­tor was the world­wide eco­nomic im­bal­ance that had de­vel­oped. “Asia was sav­ing ex­ces­sively and build­ing up large re­serves and sur­pluses af­ter be­ing caught short by the cri­sis of the late 90s. In con­trast, the US was on a mas­sive shop­ping spree, bor­row­ing money to fund this. Such im­bal­ances were be­ing sup­ported by mon­e­tary pol­icy which kept the US Dol­lar strong, forced down in­ter­est rates and led to a chase for yields. Vast amounts of money were slosh­ing through the fi­nan­cial sys­tems, which had be­come heav­ily dereg­u­lated.”

The im­pend­ing cri­sis was fur­ther be­ing fed by the build-up of a real es­tate bub­ble that in­evitably had to burst. “A large gen­er­a­tion of re­tirees was driv­ing up house prices with the ac­qui­si­tion of sec­ond house pur­chases and the height­ened surge in hous­ing ac­tiv­ity and prices were be­ing fed by Asian money. Even af­ter a 50% growth in hous­ing construction, prices were still dou­bling, even tre­bling in the pre­ferred ar­eas.”

Trejos says all th­ese fac­tors es­tab­lished a new cul­ture of high risk. “ There was easy ac­cess to credit, uni­ver­sal liq­uid­ity and un­usual se­cu­rity struc­tures were be­ing cre­ated. Not to men­tion the egos and ar­ro­gance of the highly in­cen­tivised fi­nan­cial play­ers.”

It had to come crum­bling down, start­ing with the burst of the hous­ing bub­ble and the col­lapse of construction in the US. “Be­cause of the highly con­nected na­ture of the banks and the in­ter­na­tional prop­a­ga­tion of th­ese un­usual and risky struc­tures, every­one was af­fected and the fi­nan­cial melt­down tainted even the qual­ity in­sti­tu­tions, as­sets and debt. With the av­er­age Amer­i­can in­vested 50% in his house and around 35% of his as­sets in the stock mar­ket, the con­se­quences were se­vere.”

Trejos ques­tions whether this cri­sis will be the same as the Great De­pres­sion. “ The man­u­fac­tur­ing trend so far says yes. How­ever, in that de­pres­sion, man­u­fac­tur­ing con­tin­ued to fall for four years and then took an­other ten years to re­cover back to trend. Pol­icy re­sponse this time round is dif­fer­ent with an ag­gres­sive fis­cal re­ac­tion, and we should not see a re­peat of the Great De­pres­sion.”

How­ever, unique to this cri­sis is that the fi­nan­cial sys­tem has to re­cover be­fore an eco­nomic up turn is pos­si­ble. “ This cri­sis started in the fi­nan­cial sec­tor and th­ese prob­lems must be re­solved be­fore the up­swing can com­mence. If we reach an eco­nomic bot­tom but there is still a lack of liq­uid­ity and ab­sence of credit ac­cess at this trough, we will be set for an un­ap­peal­ing L-shaped re­cov­ery. We need func­tion­ing banks, liq­uid as­sets and re-lever­ag­ing for a suc­cess­ful up­turn to emerge.”

Trejos praises Pres­i­dent Obama’s role in this cri­sis. “ The world is lucky to have him in of­fice at this time and he is the best man we have seen in quite a while. He in­her­ited a cri­sis and a trade deficit of 5% of GDP and is re­spond­ing with ap­pro­pri­ate pol­icy. In or­der to re-es­tab­lish credit, the US gov­ern­ment has in­tro­duced the Trou­bled As­set Re­lief Pro­gramme, Term As­set-Backed Se­cu­ri­ties Loan Fa­cil­ity and Pub­lic-Pri­vate In­vest­ment Part­ner­ship so­lu­tions. It also has an $819 bil­lion pack­age which will en­hance de­mand and com­bat fall­ing out­put and unutilised ca­pac­ity through tax re­duc­tions and pro­mot­ing ex­pen­di­ture.”

Trejos notes that Obama at this time “… has a tough nee­dle to thread. He has to bal­ance the need to get out of the cri­sis against not be­ing too for­giv­ing on the banks that caused all of this.”

The fu­ture econ­omy will never re­vert back to what we had in 2006 and this cer­tainly means fi­nite liq­uid­ity and in­creased state pa­ter­nal­ism. “How­ever, we must be care­ful of be­ing too pro­tec­tive and over-reg­u­la­tory as we then run the risk of rev­ers­ing some of the good trends which ac­com­pa­nied the cri­sis build up. And the ba­sic prin­ci­ples of cash flow man­age­ment cer­tainly need to re­turn to the busi­ness schools,” con­cludes Trejos.

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