It may be too much to ask the G-7, which normally reserves its energy for pointless but massively expensive annual summits in deluxe resorts like Heiligendamm, Germany, or Sea Island, Georgia, to take dramatic steps to address the financial crisis that is sweeping the world. But we should at least expect that the seven most powerful national economies would not make things worse at a moment of global need. Or should we?
The world's economists have been nearly unanimous in saying that only a coordinated, worldwide effort can stem the current credit crunch and companion market meltdown. Their proposed solutions include: cut interest rates, recapitalize the banks and insure deposits; get governments to step in and guarantee short-term interbank lending. "The first good thing about this situation is that it does not call for different central banks and Treasuries to do different things, but rather for them all to do the same thing in unison without fouling each other's oars. That should be relatively easy to arrange," wrote University of California, Berkeley, professor J. Bradford DeLong in a new e-book about the crisis.
Maybe. The G-7 Finance Ministers and central bankers met in Washington this afternoon and issued what they called a plan of action, although it was a curiously action-free plan. In fact, the document they produced was only an opaque statement of principles, devoid of action. "We commit to continue working together to stabilize financial markets and restore the flow of credit, to support global economic growth," the statement said. No specifics were mentioned. They may be, over the weekend, away from the glare of global stock markets.
U.S. officials were quick to back the nonaction plan. "Behind the principles are an expectation of action, just not a detailed plan for action," said a White House official. President Bush tried to put a positive face on things in a statement on the economy Friday morning, but all he could manage was to argue that through the international meetings, "the world is sending an unmistakable signal: we're in this together, and we'll come through this together."
Global stock markets were sending an unmistakable signal too: panic. The Dow Jones industrial average finished its worst week ever, off about 22%. On Friday, the market swung wildly, dropping 500 points on three occasions, then vaulting into positive territory before coughing up its gains in the last half-hour of trading to finish the day down 128 at 8,451. The NASDAQ managed a small gain. But European and Asian markets were pummeled again.
The danger is that the G-7, always fractious and inclined to inaction, may be unable to agree on what moves to make. Worse, it's not just the G-7 that's in the spotlight. The other pillars of 20th century international financial stability are meeting this weekend in Washington, and expectations for action by the International Monetary Fund, the World Bank and the G-20 are also low. The less the international organizations seem likely to do, the louder the cry for help becomes. "This is a financial crisis that is global and needs a global response," says Professor Helge Berger of the Freie Universitat in Berlin. "Piecemeal won't work."
What should the G-7 and the other international institutions do?
There's absolute agreement that banks have to be recapitalized. Britain, for one, has already done so, offering its big banks $692 billion in capital in return for preference shares. U.S. Treasury Secretary Henry Paulson announced this evening that the U.S. is working on a plan to go this route, saying that it intends to use some of the $700 billion rescue package passed by Congress to pour money (with some strings attached) into any bank that needs funds. But Japan and E.U. countries like Germany have been reticent.
To get credit markets moving again, economists have called for governments to guarantee short-term interbank loans. "Recapitalization by itself won't fix the interbank lending market," says Roger Craine, another Berkeley professor and a former Federal Reserve economist. The big problem now is that banks are unwilling to let go of their money because of counterparty risk the fear that the borrower may go under, sticking the bank with the loss. "If the bank you lend to has assets in a hedge fund that goes under then they are likely to go under," explains Craine. A coordinated interbank debt guarantee by governments would temper that fear of lending. There's a moral hazard here, too, in that a guarantee might tempt banks to get too risky again, but most experts say that hazard can be handled by forcing the banks to put up some of their own capital as margin. At the same time, depositors need to be assured that their money is safe. That's why the FDIC moved to temporarily raise the insurance limit on savings accounts from $100,000 to $250,000. Ireland and England have made similar guarantees.
There's also a role for the world's lender of last resort, the IMF. The IMF, say economists, should step up and publish details of a ready-to-use financial-help package for any countries that may be in danger of going the way of Iceland, which was unable to bolster overleveraged banks that failed. Panicked trading Friday in Eastern Europe raised concerns that some emerging economies there could be in trouble. The IMF should set aside many of the more stringent conditions it has imposed on borrowers in the past to encourage countries to draw on its assets.
Lastly, the G-20 central banks need to unveil another coordinated rate cut to increase liquidity. The European Central Bank, for instance, has been resistant to cuts because it focuses on inflation. Nouriel Roubini, an economics professor at New York University and one of the few who predicted the extent of the current crisis, called yesterday for "at least 150 basis points (1.5 percentage points) on average globally." Roubini also backed the idea of deposit guarantees, guaranteeing interbank lending and other measures. "At this point, anything short of these radical and coordinated actions may lead to a market crash, a global systemic financial meltdown, and to a global depression."
Roubini has been particularly apocalyptic, but given how things have gone in the world economy over the past few weeks, it's worth listening to this prophet of doom. Maybe things aren't as dire as he says. But maybe only the prospect of global catastrophe can compel world leaders to act forcefully while we still have some money left.