Five steps to solve the financial crisis
Pablo Diaz de Rábago
October 7, 2004
1.- Deposit stability. Via increased State guarantee schemes (will take 1 minute).
2.- Liquidity boost. Via TARP or BCE discount window or mix (will take 1-3 months). Lower interest rates, check weekly Monetary Supply and Credit Growth numbers. Reflate!
3.- Orderly recap. Assign the losses and recapitalize (will take 3 years). Moderate and manage the process (from now on only driven by government rescue and resale) by limiting capital erosion (do not eliminate mark-to-market but laminate effects over asset maturity)
4.- Consolidating champions. Avoid, to the extent possible, regional monopolies and political mingling (will take 1 year).
5.- More aggressive global wage inflation (decoupled from housing meltdown impact) to avoid wage deflation. Use liquidity, tax-withholding, – rates or even regulation.
6.- Do not worry about creating another housing asset bubble. With the panic, crunch and fall in prices, it will not happen for another generation.
Can Europe take steps 2, 3, 4 and 5?
Whilst 3 and 4 will happen in the market (except for political filibustering), 2 is essential to keep the system going and will have to be put in place. 5 will probably come naturally with a return to real economic growth in a couple of years.
Can Europe risk losing non-EMU or marginal economies? Look at the interbank positions and see that the money at risk is global.
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Pablo,
in view of the recent developments in the last 3 days, are these 5 steps still valid? it seems to be the financial sector is way too big to respond to governments measures. what do you think?
best, Jose
Comment by JMA — October 10, 2008 @ 11:52 am
I find Pablo’s comment very inspiring, especially in these moments of distress.
Present crisis -as most of them- is esentially a crisis of confidence. Credit flows scarce and very expensive because there is a general distrust in the capacity to repay it. The main task of economic authorities is to avoid panics and, if possible, to rebuild confidence. But it is not easy. Credit has grown so much during the last decades that budgets seem ants trying to lift a fallen elephant. Public debt, if rapidly increased, crowds out private investment -in this time of credi crunch!-. Printing massive amounts of money may create a huge inflation, especially in a context of recession. Cutting interest rates might not be effective (see what happened this week).
I therefore think that the challenge is not only to take the right measures, but also to do it in a coordinate and serious way, so that they convey the confidence markets need. Much is expected from the G-7 meeting this weekend.
Comment by Víctor Torre — October 10, 2008 @ 3:56 pm
José, next Sunday afternoon Paulson will anounce partial nationalization of US banks, following UK’s example, going directly to step 3 and probably reducing financial stress in a matter of weeks.
Large countries in Europe will have to follow the same path.
We are retrenching to a national Bank model after waiting in vain for one year for private Banks to solve their capitalization problems.
We need to see consumer reactions to this new environment to make a judgement as to how deep this crisis has affected global economies. My view today is that the effect is not severe.
Comment by Pablo — October 10, 2008 @ 4:32 pm
All the solutions that you explain are the short way to be in the same scheme where we are now in some point of the future. All the “strategies” to fight against the economic cycle have failed. The fiduciary monetary system is dead without confidence and today’s governments are unable to restore it.
Some kind of gold standard should be explored.
Comment by Concepto Global — October 19, 2008 @ 1:44 pm
No hay duda de que los “policy makers” han seguido en buena medida tus recomendaciones. Te envío sus respuestas a tus sugerencias (todas ellas publicadas después de que enviaras tus propuestas) :
1. Deposit insurance
http://europa.eu/rapid/pressReleasesAction.do?reference=IP/08/1508&format=HTML&aged=0&language=EN&guiLanguage=fr
2- Liquidity ECB
http://www.ecb.int/press/pr/date/2008/html/pr081015.en.html
http://www.ecb.int/press/pr/date/2008/html/pr081013.en.html
http://www.ecb.int/press/pr/date/2008/html/pr081008.en.html
Regarding national TARPS : A number of national initialives led by the UK have been announced
3- National TARPS have been oriented to a large extent to recapitalize banks and to lower extent to buy assets. Although, mark to market rules in Europe have been definetly watered down….
It is your recomendation 4, the one that is most at risk …
Proposals 5 and 6 are not compatible with the economic recesion scenario that we are facing or any sound central bank policy would not be compatible with fostering inflation
Comment by MJN — October 20, 2008 @ 10:46 am