Revista nº 153. The current economic crisis: in the world and the EU

For years there have been cycles, with their successive phases of recovery, prosperity and boom. And after them, the crisis changed in its trend from upwards to downwards: slowdown, recession and depression.

The first economic cycle recorded in History, as far as I know, was in the first Book of the Bible, in Genesis, 42, in the occasion of the so-called dream of the Pharaoh, as it was interpreted by Joseph:

In the future, according to the plan of Yaveh, there will be seven fat cow years of great plenty, followed by seven years of thin, ugly cows of famine. Therfore, let the Pharaoh conduct his affairs in this way: do appoint officers to collect one-fifth of the produce of the land of Egypt during the seven plentiful years, and let them store up that grain under the authority of the King, as a reserve for the seven years of famine, so that Egyptians do not perish.

Coming now to our times we can say a depression is a prolonged period characterized by high unemployment, low output and investment, depressed business, low confidence, falling prices (deflation), and widespread business failures. A milder form of business downturn is a recession which has many of the features of a depression to a lesser extent; the precise definition of a recession today is a period in which real GNP declines for at least two consecutive calendar quarters.

The most famous Great Depression in Economic History covered a period of low economic activity and very high unemployment, which characterised the years 1929-1935, when it became world-wide. In the primary producing countries its feature was very low prices, while in the manufacturing countries very high unemployment; the highest in the USA, followed by Germany and Great Britain. In the US Roosevelt introduced his New Deal policy, and towards the end of the period most Governments attempted some relief, though without a great deal of success. Relief eventually came with re-armament and the outbreak or war, though it took some years before unemployment disappeared in Great Britain.

It was to try to prevent the recurrence of a depression that many Governments after the Second World War accepted responsibility for the maintenance of full employment, according to the teachings of J.M. Keynes. In that sense, the Marshall Plan (1948/1952) was a real economic policy masterpiece.

After our brief remembrance of History and concepts, we now enter the present crisis that started, we could say, in the USA, during the summer of 2007, when a series of banking problems appeared. As a consequence of the credit-bang that permitted a huge housing bubble, which ended when prices began to drop in the markets due to market saturation.

It is generally accepted that the main origin of that bubble can be fixed in 2002, when after the previous dot. com crisis, the Federal Reserve System, the Central Bank of the U.S. injected great liquidity into the banking system with the aim of providing it with enough funds to loan to the market-makers; and so to restrain the collapse of equity in the Stock Exchange.

Therefore, bankers were provided with a great lending capacity at a very low rate of interest, and to profit those huge resources, they invited almost everybody to underwrite mortgages to buy new houses. That was the beginning of a very complicated process of a general speculation trend, that promoted higher and higher prices in the markets. Even the poorest, the so-called ninjas (for “no income, no jobs, no assets”) got into the circuit, in spite of their low or nil reliability to later honour their commitments in back payments. That”s why, not being first class clients, the ninja”s mortgages were considered subprime, to become afterwards toxic assets; when borrowers started giving back their houses keys to banks and saving banks to forget their misfortune. Those assets were devalued by the markets themselves, thus conducting banks to very difficult situations.

The aforementioned credit-bang was possible because of the special conditions prevailing in the US monetary and banking deregulated markets, which permited personal mortgages to be transformed by the ordinary banks, through a slicing and dicing process, to become the so-called collateralised debt obligations (CDOs). Which afterwards permited their acquirers to issue mortgage-backed securities, or bonds to be sold in the capital markets; in the aim of getting new funds to repeat the circuit once and many more times. That was the case of the famous Fannie May and Freddie Mac (FMs) the semi-public mortgages US Government super-agencies, that eventually entered into great trouble.

The credit-bang ended only when the underlying assets, i.e. housing, diminished in prices because of the market saturation. In other words, the two bubbles, housing and finance, exploded at the same time, producing great damage all around, in industry and services; with the consequences of a great slowdown in the GDP and employment, which had great feedback effects in the crisis itself.

Let us now pose a question to go deeper into the origins of the crisis: What were the main sources of the financial process we have so rapidly explained? The answer cannot be but one word: greed. Greed was the sin of the whole cast of characters of the drama: the agents looking for mortgage-clients to be brought to the banks, rich or poor (ninjas); the rating companies that without real study evaluated the mortgage banks even with AAA; the investment banks, like Lehman Brothers, which pushed their own capacity to buy CDOs too much; the insurers (like AIG) assigning guarantees (CDs, or collateralized debt swaps) to any bond issuers, without taking account of the growing risks, and ignoring their own assurance limits. In all those steps, there was always the expected payments of more and more commissions, that permitted a rapid and reckless enrichment to many financial agents and highly reputed CEOs, even in honourable companies created more than a century before.

And at both the beginning and the end of the whole perverse chain, appeared the main players of the game: regulators, and supervisors that so frequently turned a blind eye to all kinds of speculative operations: even those based on pyramidal methods, as was the case with asset managers like the sadly famous Mr Madof and Mr Stanford.

The first cases of bank defaults due to the double bubble blow-out, were Bearn Stearns in the U.S. and Northern Rock in Britain, which were followed by a lot of cases; the Central Bank trying to solve the successive situations favouring takeovers of the broken banks by the larger and healthier ones, or entering directly in their capital with special and urgent support.

That was the case-by-case experience, except when in September, 2008, the abovementioned investment Bank Lehman Brothers (LB), because of the lack of official support, had to declare bankruptcy. An event with catastrophic consequences for the whole world financial system, since LB had sold great amounts of its bonds and other financial products to many financial firms in more than 30 countries. Thus, suddenly, many overseas countries were contaminated, in what can be qualified as a global contagion.

Afterwards, all experts considered it to be a great error not to save LB. In that sense, Professor Samuelson said: “the first obligation of any central bank is to prevent private banks from going under chapter 11. And the Federal Reserve did nothing to save LB. The cost of that error was dramatic.”

In the following days when the insurer AIG was going to be in the same situation as LB, the Bush Administration decided on a global intervention plan, lead by Hank Paulson, the Secretary of the Treasury and Ben Bernanke, the President of the Federal Reserve System.

Briefly, the official U.S. intervention, that has followed with the same patterns in the Obama administration, pursued various targets: to buy toxic assets from the banks, to reinforce their capital with massive transfers; and summing up, to prevent a banking collapse. Furthermore, different kinds of stimuli to the productive sector were fixed, and namely in favour of the automobile industry.

In Europe, the economic crisis had its development on a very similar path to that of the USA, and consequently the attempts to relieve so many economic pains were implemented, according to the U.S. arrangements. And it happened that with the worsening of the crisis, special connections linked the EU and Washington D.C.. In that sense, both parts entered into the common drafting of far-reaching arrangements; along the two conferences of the G-20, first in Washington (November 15, 2008) and later in London (April 2, 2009). In both rendezvous the U.S. and the EU got the support of the emerging countries (the BRIC and a few more) and also of the less developed nations.

To size up the analogies and differences between the Great Depression 1929-1935, and the current crisis, we must remark on what happened in the London International Economic Conference of 1933, when no agreements were reached, and protectionism was implemented everywhere. With the result of a world trade collapse, that was followed by a great GDP contraction in the main countries, accompanied by unemployment above 20 percent of the active population. In those conditions the crisis worsened, and national measures did not work. Even the much-praised New Deal of President Roosevelt did not have much effect in recovery terms.

In Western Europe profiting the problem of the middle classes, the Nazis seized power in Germany, the Fascism of Mussolini consolidated in Italy, and autocratic regimes proliferated all over Europe; including Franco”s Regime after the Spanish Civil war. In a few words, what had begun with a stock exchange crash in 1929, ended with the Second World War in September 1, 1939.

Contrary to such dramatic events, the London 2009 Summit —with the very helpful presence of Presidents like Obama, Lula, Hu Jintao, Sarkozy, Merkel, Putin and Rodríguez Zapatero and other EU chiefs of State or Government— had a few good returns: protectionism was condemned, and full cooperation emphasized, reinforcing existing UN organizations like IMF, the World Bank and WTO. And there was a great welcome to the idea of creating a new global regulation and supervision organization, under the name of the Financial Stability Board.

Besides that, the welfare state is performing, thus permitting a more bearable life to the unemployed than in the thirties. And, in that sense, more flexibility and better political relations offer at present a brighter look than in 1933, so that world peace can be assumed, according to recent reports on topics like the Middle East, Iran, North Korea and arms race negotiations.

Of course, we have very controversial points of view on how and when the current economic crisis will end. But we can agree on a few aspects, such as to point out that it would be difficult to evolve to a Great Depression (GD) as terrible as the one in 1929-1939. Some reasons for this:

-Central Banks and other national economic institutions are performing at a much higher degree of capacity than during the GD. That is to say, we have a much better security net work.

-Most of the international institutions we have at present, did not exist during the G D. And now they are working with not little endeavour.

-There is a common conscience almost everywhere on the principle that global problems are to be solved with global tools.

Of course, all those advantages do not mean that recovery is within one”s grasp. Recession will persist, and the beginning of a new cycle will depend much on the adopted measures. In that sense, more flexibility and a more sustainable growth model will help a lot.

Now let us enter into the last part of this lecture to see how the crisis is affecting the environment policies regarding, public or private projects, big or small. In this sense, we can say that nowadays, the one world feeling when referring to the environmental questions of Planet Earth is very much extended that 80 years ago. And more specifically in the next to the last point (28) of the London Declaration of G-20 says:

We the leaders of the world, confirm our commitment to face the menace of the irreversible climactic change. On the basis of the principle sharing differentiated responsibilities, so that we can achieve an agreement at the UN Conference on Climactic Change to be held in Copenhagen next December, 2009.

Of course, there will be people who believe that the previous encouraging proclamation could reflect, more or less, some kind of rhetoric translated to empty words. But as far as we can foresee, in all recovery plans in any country all kinds of environmental measures appear. And the search for alternative energy sources (sun, sea, wind, geothermical, etc.) are fixed in the first ranks of all governmental priorities.

In the case of the EU, environmental purposes, as far as it can reasonably be foreseen, are not going to suffer because of the crisis. The Union is, until this moment —and even if it can be presumed that Obama is not going to become a great Eco-herald— the strongest force to change things for the better in a series of world scenarios: global warming, biodiversity, deforestation, ocean and sea pollution, and so on. And let us hope that inside all those policies, fiscality will plays an important role.

Besides that, according to the EU Financial Perspectives for 2007/2013, a bigger amount of resources is going to be assigned to Environment. Therefore, as a summing up and answering one of the possible questions from my very distinguished colleagues here, I can state that among economists it is very strong, the idea that inflation is a big factor in all economic crises, being verified that high prices come from a very concentrated demand on fossil fuels and other natural resources, in the lack of a sustainable framework.

It seems clear, then, that the present model of development has to be reformed to a sustainable one. Which means that we, who in the past were called, as Schumpeter remembered, “the dangerous sect of economists”(and the same could be said of fiscal ecologists) we must regain, at least the majority, that very same title. To confirm that our mission is, as Schumpeter also mentioned, “to disclose to Mankind the hidden sense of its struggles”.

Summing up, although we cannot support panglossian attitudes, in the sense that “we live in the best of the possible worlds”, we can see that the crisis as also an opportunity; to enhance new and better perspectives in all environmental questions. That”s why we must pay attention, so that encouraging horizon does not change to a new tale of misfortunes.

Thank you for your attention

Eucotax Wintercourse Barcelona 2009

By Professor Ramón TAMAMES

Catedrático at the Autonomous University of Madrid (CAM);Jean Monnet Chairholder, EU.; Member of the Club of Rome