THE MARKET IS NOT A SAFE BANK

On the world financial crisis. Only international rules can tame the bank managers who are out of control

By Helmut Schmidt

[This article published on: Zeit Online 40/2008 is translated from the German on the World Wide Web, www.zeit.de/2008/40/01-Finanzkrise.]

No one likes being a messenger of disaster. Nevertheless the financial crisis in the United States is dangerous. It is the most serious bank crash since 1929. While it is a crisis on the financial market, there is a danger of a momentous destruction of the real world economy. A great crisis of trust could occur going far beyond financial management. That cannot be excluded.

Though the situation cannot be compared with the world depression of the 1930s, it is serious enough. It needs a surgical operation and long-term therapy.

The main culprits sit in New York. But these persons are not the ones who suffer the crisis. Many managers with high incomes lose their jobs but go home with their golden parachutes. A lack in long-term perspectives and a moral deficit are manifest on Wall Street.

Politicians follow the Wall Street managers as culprits. The politicians in Washington did not see what was wrong. They did not understand the development. They have a partial re4sponsibility for lack of insight and vigor rather than for a moral deficit.

The arrogance of the government in Washington is crucial. They know everything better. Whether in Iraq, Georgia, the turbulences on the financial market or the hurricane in New Orleans, this government knew everything and did little. It swam along in the profit-soaked euphoria that spread from Wall Street to the North American nation and England and from there over the whole world to the Far East. The president and his cohorts were filled by the ideology that the market accomplishes everything.

This crash was avoidable – if people had done what was vital and had not been half-hearted: introduced tighter controls, issued security and transparency-rules for financing instruments and established a stronger monitoring of financial institutes, banks, funds, financial conduits and the like. The fact that American investment banks are not subject to any normal bank supervision is scandalous. This can only be understood historically. The investment banks were originally stock brokerage firms that dealt with securities and were subject to securities monitoring. In reality, they acted the big shot with the help of credits – like many hedge funds.

Who suffers in this situation now? The first ones to suffer were the employees of these banks who became jobless. Secondly, millions of Americans have suffered grievously for months. They try to sell their houses that are heavily laden with mortgage debts and quickly lose value. Thirdly, consumers suffer because prices soar owing to the enormous money creation by the central banks. To a lesser extent, this will also affect Europeans and even the Chinese. Fourthly, those suffer who will probably become unemployed in the real economy. Fifthly, the taxpayers suffer who at the end will pay the bill for rescuing the banks.

The crisis of trust will expand if the political and economic actors tell citizens of America and Europe that they have things under control. Short-term, medium-term and long-term measures are crucial.

In the short-term, a collapse of the financial system must be prevented. Cooperation between the Federal Reserve Bank in Washington, the European central bank (EZB), the Chinese, Japanese and Russian central banks and the leadership of OPEC is necessary. An immediate summit meeting of the heads of these central banks and the finance ministers in these countries would be helpful, not of the heads of state who hardly understand this.

In the medium-term, one of the most important imperatives is removing the imbalances in the world economies that first made the past system possible and now enlarge the danger of a worldwide economic crisis. The American balance of payments deficit has been high for years because Americans do not save but are accustomed to indebtedness. This is true for individual citizens and for the US state. The basic optimism of American society is behind this. The US balance of payments deficit is between five and six percent of its gross domestic product. Since at least a half decade ago, American society has allowed foreigners, Chinese, Japanese, Europeans and Russians to pay for its investments and its consumption.

On the other side, promissory notes have accumulated in the hands of these foreigners, IOUs of the American state, low-interest government bonds. The Chinese could make policy with these securities by threatening to sell them. They probably won’t do this. They could buy raw materials and are already doing this in Africa and Central Asia. The Chinese could even be the rescuers of American banks by buying up failed investment banks and funds and so supporting the American system. Americans do not want to see this and try to prevent this.

Financial transactions must be subject to rules and security standards. When Charles Lindbergh flew over the Atlantic in 1927, he did not need any traffic regulations. He didn’t need to pass any pilot exam; no authority could take down his aircraft. He was entirely alone. He did not need any alternative rules. No one prescribed his flying altitude.

Nowadays hundreds of airplanes fly over the North Atlantic. Therefore traffic regulations are necessary. There are all kinds of security standards for every airplane, every motor and all electronics. Tests for pilots must be repeated. Obviously there are alternative international rules. The heavier the traffic, the more rules and regulations are needed. This is also true for the many banks, hedge funds and the like traded internationally today. However there are relatively few international regulations for them that are legally enforceable.

The world financial market and the world economy need monitoring rules and security standards valid worldwide. Someone must design a system of financial monitoring for all financial institutes – including funds and private equity companies – and for all financing instruments.

In the past, the classical financing instruments were called shares or loans, mortgages or bank credits. These instruments were managed by financial institutes named Deutsche Bank or Kreisparkasse Pinneberg and were subject to bank supervision. A share had to be approved by the stock exchange board. For that, businesses presented a prospectus and were examined. An auditing firm according to the law scrutinized a stock company. If something misleading was approved, those responsible would be imprisoned. So-called financial derivatives have replaced the old instruments today. In the US, these financial derivatives are not subject to any review. No one goes to jail!

In the long term, all financial institutes and financing instruments must be monitored according to the same principles. No new army of overseers is required. The same international monitoring rules must be followed. This is crucial. Americans cannot fulfill this task alone. Europeans must join in, Chinese, citizens of India, Russians and the governments of Dubai and Riad. Everyone must receive a mandate. The summit conference of finance ministers and central bank chiefs that I stimulated could resolve: the International Monetary Fund (IMF) should make a draft. There is enough independent expertise. The IMF should present the draft in the course of the next two years. The European governments together should press for this.

TAX HAVENS IN THE CARIBBEAN MUST BE DRIED UP

A regulation should prohibit any credit to an institute that legally settles on an island without a functioning financial supervision and a tax authority. These control-free islands must be dried up. Their air must be taken away! It is no accident that the majority of the 9000 investment funds that exist in the world have their legal home in one of these financial islands. They evade supervision and criminal justice. It is grotesque that respected bankers carry out massive financial transactions on these islands in the Caribbean!

Can such a worldwide monitoring of the financial markets really be achieved? The likelihood for that is not very great. Americans and Brits resist this. Maggie Thatcher can rise from the dead and explain to the English people the markets should be left in peace. Therefore I am not very optimistic about the chances in the present crisis. Still the attempt must be made. If nothing happens, the worst banking crisis since 1929 could expand into a world crisis as in the 1930s.