Canadian Council of Churches Forum on Faith and a Sustainable Economy: The Financial Crisis John Dillon KAIROS: Canadian Ecumenical Justice Initiatives.

Canadian Council of Churches Forum on Faith and a Sustainable

Economy: The Financial Crisis

John DillonKAIROS: Canadian Ecumenical

Justice Initiatives May 12, 2009

Orphans and Widows

• Number chronically hungry will increase by 75 to 100 million this year

• 50 million may lose their jobs in 2009

• 700,000 children may die over the next few years

• up to 200 million climate refugees unless we reduce greenhouse gas emissions

Need to change structures as well as provide immediate relief

“The world needs alternatives, and not merely regulation. It is not enough to rearrange the system; we need to transform it. This is a moral duty. In order to understand why, we must adopt the point of view of the victims of this system. Adopting this point of view will allow us to confront reality and to express the conviction that we can change the course of history.”

Rev. François Houtart at Oct. UN panel on the crisis

Root Causes of the Current Financial Crisis

While the current financial crisis can be traced to a multitude of factors,

two inter-related causes stand out:

1) globalized markets and

2) speculative bubbles made possible by financial innovation.

Neither of these is new

• This crisis follows the pattern described in Charles Kindleberger’s historical study on Manias, Panics and Crashes

Mania stage – $8 trillion housing bubble

Subprime Mortgages

• US housing overpriced by 50%• Up to 100% in some places e.g. Miami• Buyers enticed with low interest “teaser loans”• Disproportionately from black and Latino

communities• Not always informed of the fine print in contracts

regarding future interest rate increases

This crisis also has unique roots

• Financial innovations involving little-understood derivatives played a crucial role.

• Lenders repackaged loans for sale to outside investors - banks, hedge funds or pension funds located anywhere in the world.

• Bundled consumer loans and home mortgages became the biggest US export business of the 21st century. More than $27 trillion of these securities were sold between 2001 and October 2008.

Credit Default Swaps (CDSs)

• CDSs were invented to spread the risks inherent in ownership of packages of loans.

• CDSs are akin to insurance policies. • Creditors purchase CDSs to protect themselves

against the risk of default. • Issuers of CDSs collect fees for taking over from

creditors the risk that a loan will not be repaid. • There can be multiple CDS contracts on a single

package of loans without any requirement to have a direct interest in the loans.

Nominal value of CDSs grew to US$62 trillion by end of 2007

• more than the Gross Domestic Product of the entire world.

• But the maximum amount of debt that might conceivably be insured through these derivatives was US$5 trillion.

• When the US housing market collapsed the market for CDSs was thrown into turmoil.

Financial markets seized up

• CDS issuers had insufficient capital to cover their losses

• Banks and insurance companies like American International Group (AIG) had to be rescued

• Investors stopped buying financial products whose actual risk was undisclosed.

• Derivatives like CDSs proved to be what Warren Buffett aptly called “weapons of mass financial destruction.”

Crisis spread to global South

• Falling commodity prices• Dwindling remittances from migrant workers• Export markets contracted by 30%• Harder to access credit• Failure of small, private banks (not “systemically

important” for G7)• Capital repatriated to North• Speculation against Southern currencies

Regulators Failed to Restrain Risky Financial Practices

Financial Deregulation

allowed the unrestrained use of innovative instruments that became avenues for speculation detached from the real economy where actual goods and services are produced.

US Regulators were warned

• Brooksley Born, head of the US Commodity Futures Trading Commission, proposed tighter regulation of financial derivatives in 1998.

• Opposed by Federal Reserve Chair Allan Greenspan, Treasury Secretary Robert Rubin and his deputy Lawrence Summers.

• Wall Street executives lobbied furiously against new regulations.

Collapse of LTCM unheeded

• After Long Term Capital Management collapsed in later in 1998, Ms Born said it was a wake-up call.

• LTCM invested borrowed funds that were many times larger than their own capital.

• LTCM had accumulated $1.2 trillion in speculative investments on equity of $5 billion.

Congress proceeded with more deregulation

• repealed the Depression-era Glass-Steagall Act which had separated commercial banks where deposits are government insured from more lightly regulated investment banks.

• US Commodity Futures Modernization Act of 2000 removed derivatives such as CDSs from regulation.

• Commercial banks took advantage of these opportunities by expanding their off balance sheet operations that are not accountable to regulators.

Speculation overtook investment in real goods and services

• Value of speculative trade in 2002 was 35 times bigger than the real economy.

John Maynard Keynes

• “Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation.”

A Failure of Moral Conduct Archbishop Migliore

“At its root, the financial crisis is not a failure of human ingenuity but rather of moral conduct. Unbridled human ingenuity crafted the systems and means for providing highly leveraged and unsustainable credit limits which allowed people and companies alike to pursue material excess at the expense of long-term sustainability.”

Global Imbalances

Developing economies, especially in Asia, emerging from financial crises since the mid-1990s tried to shelter against the cold winds of global capital markets and IMF conditions by accumulating large amounts of foreign exchange reserves.

Developing Countries Immense Reserves Outweigh Debts

Reserves and External Debt 2007

0

2000

4000

bill

ion

s o

f U

S d

olla

rs

Reserves 71 3,778

Debt 2007 2,442 2,558

USA Developing Countries

10 Emerging Countries vs G7 Reserves - Sept. 2008

US$ billions

1906

295 243 207 79 73 57 47 34 31

2972

1516

0

500

1000

1500

2000

2500

3000

China

India

S. Kore

a

Brazil

Turkey

Mex

ico

Indone

sia

Argen

tina

S. Afri

ca

Saudi A

rabi

a

Total 1

0 Em

ergin

gG7

Developing countries finance US

• Low-income countries are lending trillions of dollars to the US, at very low interest rates;

• while there are so many urgent needs on which the money could be spent.

US interest rates & the housing bubble(US interest rates 1990 – 2009)

What enabled the US Federal Reserve Board to cut interest rates without fear of sparking inflation was the ability of the United States to borrow vast sums at very low rates from Asian countries, particularly China, to finance is trade and fiscal deficits.

Niall Ferguson The Ascent of Money

“Chinese imports kept down US inflation. Chinese savings kept down US interest rates. Chinese labour kept down US wage costs. As a result it was remarkably cheap to borrow money … . [G]lobal real interest rates – the cost of borrowing after inflation – sank by more than a third below their average over the past fifteen years … . The Asian ‘savings glut’ … was the underlying reason why the US mortgage market was so awash in cash in 2006 that you could get a 100 percent mortgage with no income, no job or assets.”

UNCTAD Task Force

“the absence of a cooperative financial and monetary system created an illusion of risk-free profits and licensed profligacy through speculative finance.”

Breakdown of Bretton Woods System

• based on fixed, but adjustable exchange rates and the US dollar as the central reserve currency gave relative stability to the world financial system until the late 1960s

• After 1971 a new era - removal of capital controls, deregulation of domestic banking and massive increases in private international capital flows.

• After 1971 “credit creation spiralled completely out of control.” Gillian Tett Financial Times

Keynes Plan for “financial disarmament”

would allow national governments to pursue such goals as full employment without worrying about disruptive capital flight.

International Clearing Union

• A type of world central bank• With its own currency - the Bancor• As assets would equal liabilities, the clearings

union itself would always remain solvent • Countries in deficit would have automatic and

unconditional access to credit. They would not have to fear running out of foreign currency.

Differences from IMF conditionality

• Under IMF austerity conditions, indebted countries are forced to cut back spending, increase taxes, devalue their currencies and raise interest rates.

• With access to bancor -- they could spend on domestic priorities.

Opposition from Wall Street

In 1944, just as today, the Wall Street bankers did not want a truly international monetary system that would cost them all the lucrative fees they earn from managing transactions.

An “exorbitant privilege”

• US Treasury was then, and is now still, unwilling to give up what Charles de Gaulle called the “exorbitant privilege” that accrues to the nation that issues the world’s reserve currency.

• enables it to print money at will and pay for imports or overseas assets with dollars whose future value may well deteriorate.

• Euro zone enjoys similar privileges.

Joseph Stiglitz

“The existing system, with the US dollar as reserve currency, is fraying. The dollar has been volatile. There are increasing worries about future inflationary risks. At the same time, putting so much money aside every year to protect countries against the risks of global instability creates a downward bias in – aggregate demand – weakening the global economy.”

A New Global Reserve System

• Viable alternatives to continued reliance on the US dollar as the central reserve currency already exists.

• Starting in 1969 the IMF began to create Special Drawing Rights (SDRs) as a type of international reserve asset that can be held by central banks.

Advantages of an SDR-based reserve system

• It can be internationally managed • initial acquisition of SDRs does not entail a

real cost in the way acquiring a reserve currency does

• a bias in favour of poor and vulnerable economies can be built into SDR allocation

• Sustainable – not dependent on mining gold or a national currency.

G20 approved SDRs worth US$250 billion

SDRs allocated according to IMF voting rights:

60% will go to developed countries Only US$19 billion could go to poorest

countries because of their low IMF quotas. (But some cannot take advantage due to

IMF/World Bank Debt Sustainability Framework)

UN Commission of Experts

• appointed by Rev. Miguel d’Escoto, the President of the General Assembly

• chaired by Joseph Stiglitz• A New Global Reserve System based on an asset

like the SDR is “"feasible, non-inflationary, and could be easily implemented".

• Within 6 months - Pedro Páez Pérez, Ecuador’s former Minister of Economic Policy Coordination.

Advantages of a new system

• Developing countries would no longer lend their large amounts of foreign exchange reserves to developed countries at low interest rates but instead invest in sustainable development.

• The instability caused by over dependence on the US dollar whose future value is likely to deteriorate would be eliminated.

Necessity of a New System

“The world economy cannot go back to where it was before the crisis, because that was demonstrably unsustainable.”

Martin Wolf –

Financial Times

April 21, 2009

Rev. Sam Kobia WCC General Secretary

“What we need are brave and new measures to correct this unjust and unethical system in order to prevent such a crisis from occurring once again...”

“It is possible today to push for radical changes because international opinion and the commitment to cooperation are favourable. … However, for such a transformation to be successful and sustainable, this debate should become part of the agenda of the United Nations where all countries are participants. …fighting global poverty, the food crisis and climate change should be given the same attention as salvaging the financial meltdown.”

Primary Proposal

New Global Reserve System based on an SDR-like asset distributed to low-income countries as proposed by UN Panel;

June 1-3 UN Conference on the World Financial and Economic crisis and its Impact on development;

What will Canada do?

Bank bailouts exceed Aid

US and European bank bailouts - $9 trillion

75 times larger than all Official Development Assistance;

Immediate need for measures that may not in themselves constitute a paradigm shift but are feasible steps forward.

Currency Transaction Tax

A tax of just 0.005% on foreign exchange transactions can raise US$33 billion of independent, global and stable revenue each year.

(Rodney Schmidt – North-South Institute)

Global carbon tax

• A global carbon tax on all CO2 emissions

could raise from US$130 billion to US$750 billion per annum and at the same time deter greenhouse gas emissions.

• One feasible immediate step – levy on air tickets already implemented by 13 developed and developing countries raising about US$200 million a year.

Rev. Sam Kobia World Council of Churches

“… this crisis is not merely a financial and economic one…. [It] has moral and ethical dimensions … We are witnessing an era when greed has become the basis for economic growth. It is therefore necessary, in the understanding of the churches, to go beyond short term financial bail out actions and to seek long term transformation based on sound ethical and moral principles which will govern a new financial architecture…”