• Alan S. Blinder • Howard W. Lutnick • Robert J. Shiller
Moderated by • Martin Wolf
Friday 30 January
The financial system is under tremendous strain. The measures being taken in leading countries to battle the crisis, including aggressive fiscal stimulus packages, are generally regarded as the correct ones. However, recovery will take time. According to one panellist, not only is the US economy not about to turn the corner, but nobody knows where the corner is.
Just as in the 1930s, the crisis offers an opportunity for innovation that could lead to an improved and strengthened system.
Key points
• The crisis is being fought on two fronts. There is a financial meltdown, which is not over, and there is the more conventional macroeconomic fight. About the latter, we know what to do, and that is what UK economist John Maynard Keynes recommended 70 years ago: fiscal stimuli and deficit spending.
• On the financial meltdown, there are two holes to fill. Balance sheet deficits are being partially met by governments, but public and private cooperation will be needed to complete the job. “Closeted” private sector capital – estimated at around US$ 4 trillion – will eventually be mobilized, but no one knows when. A more slippery question is the confidence deficit, and here there are no ready remedies. What we need is to get some “greed” back, one panellist said.
• The US government is currently the only buyer of commercial paper. Before people can talk about recovery, they need to know when the money market is going to be repaired, another panellist stated. Banks need around US$ 120 billion just to get back to where they were before the crash. Governments are working well, but the market tools are broken and will not be fixed for three to five years.
• For another panellist, the good news for the new US administration is that things are certain to look better by the time the next election comes around. If in 2012 President Barack Obama poses the Ronald Reagan question: “Are you better off today than four years ago?” the electorate will probably answer “yes.”
• A paradigm shift is underway. The belief in market efficiency is being replaced by one that is more Keynesian. Furthermore, the Greenspan-Bernanke consensus about “letting bubbles rip” is being rethought. The central bankers failed to distinguish between bubbles fuelled by irresponsible lending, such as sub-prime, and those inflated by exuberance that had nothing to do with lending, as during the dot.com boom.
Suggestions
• Housing finance needs to be “democratized” so it works better for people. The government should improve financial advice for citizens, and even subsidize the cost of this service. There should also be a real estate futures market, which would give early warning signals to builders. Mortgages should have workout terms written into them from the start. New types of debt that can be converted into equity in times of crisis should be created.
• The financial system must be less leveraged. Improved risk management skills are required and there must be an end to the “go for broke” incentive systems, both for traders and for corporate chiefs. There should be limits on “wild” derivatives, with better and safer capital requirements.