Financial Crisis 101 - 11/17/08

PHILADELPHIA - November 17, 2008 - Citigroup Inc. has announced it will slash 53 thousand more jobs from its payroll over the next several quarters. The banking titan had already announced last month that it was cutting 22 thousand jobs. This all amounts to a 20 per cent jobs reduction as the bank aims for a 20 per cent cut in expenses for 2009. The Chairman of Citigroup has not ruled out the possibility that the company's leaders will forgo their bonuses this year. But it may be that the decision has already been made for them by another firm.

Over the weekend, word came from Goldman Sachs that its 7 top executives will not take their bonuses for 2008. That could amount to tens of millions of dollars in savings. The Chairman of Goldman took home a reported 68 million dollars last year. This year, he'll settle for a base pay of $600,000. A spokesman for Goldman said, "While the firm has distinguished itself through many aspects of the crisis, we cannot ignore the fact that we are part of an industry directly associated with the ongoing economic distress." It's hard to imagine that executives at all the major investment and banking firms won't follow suit.

So how did the G-20 summit go over the weekend? Well, that very much depends upon whom you ask. The G-20 conference saw leaders of the G-7 plus 13 other countries come together in Washington to come up with a plan to get us out of the global economic crisis and prevent this kind of thing from happening again in the future. The conference got some positive reviews, some mixed and some bad. Here's a negative excerpt from a longer piece by John Kemp, who's a columnist for Reuters.

"The G20 summit must be considered a disappointing failure, even by the relatively low expectations set for the event. Leaders produced a long agenda of further studies, reports and work, but failed to provide a clear direction or tackle even the most fundamental decisions. On the key issues, leaders displayed a worrying irresolution. Without unambiguous instructions from the top, discussions between finance ministers and officials will prove protracted and risk getting bogged down in detail. Negotiations between officials can fill in the details; they cannot make the kind of fundamental choices about strategic direction that leaders avoided at the weekend."

There is this bit of hopeful opinion from a longer editorial by

"As well as promising a "broader policy response" to the current crisis, the G20's leaders laid out a detailed plan for financial reform. They promised to "strive" for a deal on the stalled Doha round of world trade talks by the end of the year and, more importantly, made a collective pledge not to raise any barriers to trade and investment over the coming year. Add in the promises made around the gathering's fringes, particularly Japan's pledge to bolster the IMF's kitty by lending it $100 billion, and the weekend yielded enough to justify the traffic jams in Washington, DC - and to mark an important shift in global economic governance. "

The non-partisan Peterson Institute for International Economics published this summary of the G-20 conference. The piece reflects the disappointment of its author, who's biography I include after his opinion.

A G-20 Assessment: Just Disappointing or Potentially Dangerous?
by Simon Johnson | November 17th, 2008 | 09:43 am

Initial reactions to the G-20 summit are fairly positive. The communiqué and associated press conferences conveyed: (a) There was no open acrimony; (b) The body language was broadly supportive of countercyclical fiscal stimulus policies; And (c) there may now be a serious international regulatory agenda.

None of this is really new and it could all have been arranged by finance ministers (probably over the telephone), but I agree there is some useful symbolism in having heads of industrialized and emerging-market governments convene for the first time ever on these kind of issues.

I will admit to disappointment that no more explicit commitments were made to fiscal stimulus. I thought the British and the French were heading in this direction, and that they could create some momentum in the right direction. If Europeans (or anyone else) would like to compete for a "special relationship" with the United States after January 20, they might consider coming to the next summit, in April, with a substantial fiscal package in hand (as will President Obama).

If the latest rounds of global economic diplomacy were the Olympics, then China gets gold in the fiscal stimulus category, Germany gets silver, and the United Kingdom (so far) is the distant bronze - but the United Kingdom does get one more throw next week. Not the ordering of world economic leadership that one would ordinarily expect, but perhaps that's a good thing.

In the category of "largest cash contribution designed to save the world from serious disruption," Japan easily finishes first. Their $100 billion pledge to the International Monetary Fund (IMF) just before the meeting was timely, targeted, and hopefully not temporary. Sadly, there were no other entrants in this category. Perhaps the chemistry and cooking at the White House dinner on Friday will prompt further contributions in the near future.

But there is unfortunately another way to read the communiqué if you are a government or international official, for whom this text really is a set of instructions to be implemented. The whole first part of the document is generic and definitely not new. An official's eye would skip through that quickly. The real issue is the deliverables in the plan of action, with a pressing deadline at the end of March (this is pretty much like saying "do it tomorrow" to a government bureaucrat). This is where we - an official reader would be thinking—must concentrate our immediate attention and efforts. And most of these specific actions are about tightening regulation on and around credit, or beginning processes that definitely point toward many dimensions for this kind of tightening - accounting standards, hedge funds, risk disclosures, financial-sector assessments, credit-rating agencies, risk management and stress-testing models, international-standard setters, sanctions for misconduct, reporting to supervisors in different countries, and more.

There is, of course, nothing wrong with making regulation more effective. This is surely needed - in both the United States and Europe, and probably elsewhere - to help lower the odds of another global financial crisis developing in the future.

But we are still not out of this crisis. And tightening regulations quickly in the midst of a worldwide credit crunch is one good way to make sure that credit contracts further and faster. Lending standards naturally tighten in a crisis. The issue to address going forward is how to prevent standards from loosening too much in the next boom, which is at least several years down the road. I am in favor of starting early, but I do not like precipitate action just because you want to look busy and you could not agree on the more pressing issues, such as fiscal policy, support for the IMF, shoring up the eurozone, and so on.

It is true that one (among many) of the stated principles is: "Mitigating against pro-cyclicality in regulatory policy." But that is a general statement that is not mapped into operational requirements - except that the IMF and Financial Stability Forum (FSF) should work together on this, which is a good way to make sure it doesn't happen. What officials have to deliver on, by the end of March, is substantive progress regarding tougher and tighter regulation of credit. There is a real danger that this action plan - within such a short time frame - can actually make the global downturn dramatically worse.

Simon Johnson

Economic Counsellor and Director, Research Department,IMF (March 2007-August 2008)

Simon Johnson was Economic Counsellor and Director of the Research Department at the IMF from March 2007-August 2008. Mr. Johnson was on leave from the Sloan School of Management at MIT, where he was the Ronald A. Kurtz Professor of Entrepreneurship. Mr. Johnson is an expert on the financial sector and economic crises. Over the past 20 years he has worked on crisis prevention and mitigation, as well as economic growth issues in advanced, emerging market, and developing countries. His work focuses on how policymakers can limit the impact of negative shocks and manage the risks faced by their countries. His PhD is in economics from MIT, while his MA is from the University of Manchester and his BA is from the University of Oxford.

I wanted to give you a break from the raging arguments over whether the government should bail out General Motors after including pro and con opinions almost every day last week. But I have come across perhaps the definitive works about this critical issue. An automotive bailout has vaulted to the top of the crisis agenda, at least among congressional Democrats and President-elect Obama. If you want to understand both sides of the controversy, to bail or not to bail, link to these pieces.



With all this brain busting information, and let's admit it, it's not easy to ingest, I thought I would share a web site that I stumbled on this morning. I won't tell you what it is; you just have to go there on faith. Just don't spend the rest of the day staring. Enjoy.

Jim Gardner

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