Rob Cox: Race to bottom of global subprime begins

By Rob Cox
April 7, 2015

 

U.S. Senator Paul announces candidacy for president during an event in Louisville

The author is a Reuters Breakingviews columnist. The opinions expressed are his own. 

During the go-go years of America’s housing boom, borrowers had it made. As property prices zoomed upwards, even the most unworthy credits among them saw lenders throwing money at them. Banks reduced their demands for collateral, ignored the need for documentation of income and generally let down their guard. It didn’t work out so well.

The implosion of the subprime mortgage market provides a glimpse of what can happen when some kinds of competition run too far. While it might be great for consumers who want to live beyond their means, the risk is that in an effort to book new business, financial institutions make greater and greater concessions that invite danger. In extremis that leads to ruin. At a minimum it necessitates the imposition of new regulations and lending guidelines.

It thus stands to reason that the same thing could be happening in the global version of subprime lending, or the market for economic development dollars. Ever since the creation of the World Bank and International Monetary Fund at Bretton Woods near the end of World War Two, the two multilateral institutions, with heavy guidance from Washington and European capitals, have dominated the business of extending money to governments either in crisis (the IMF’s purview) or trying to reduce poverty (World Bank).

That hegemony now faces an existential challenge with the emergence of a new Chinese financial framework, starting with creation of an Asian Infrastructure Investment Bank and extending to a Silk Road investment fund and a development bank that includes the Middle Kingdom and other so-called BRIC developing economies. Like new entrants to the mortgage business in 2006, these emerging lenders will be looking to put their capital to work.

In theory, that’s a good thing. There are still billions of people living without adequate healthcare or access to potable water, much less education or the internet. So the more money, regardless of its provenance, available to lift people out off scarcity the better.

“If the world’s multilateral banks, including the new ones, can form alliances, work together and support development, we all benefit – especially the poor and most vulnerable,” said World Bank chief Jim Yong Kim in a speech on Tuesday to the Center for Strategic and International Studies.

As with the U.S. subprime housing analogy, however, there is a danger that the competing global forces of multilateral lending will weaken private institutions, prop up bad governance and potentially increase the gap between the rich and the poor. It’s not hard to imagine an instance where an impoverished country, run by a corrupt and despotic leader, plays the new Asian institution against the World Bank or IMF in an effort to secure the best financial deal with the fewest conditions or covenants possible, with little discernible benefit to its people.

Ironically, this has been the central argument put forward by the mostly Republican U.S. legislators whose opposition to reforming the IMF arguably gave China a green light to go it alone.

Take Senator Rand Paul, who on Tuesday announced that he will seek the Republican nomination for the presidency next year. Four years ago, when running for the Senate, the Kentucky politician argued that the United States should withdraw financial support from the World Bank and IMF, saying they’ve “outlived their usefulness and harmed global economic development.”

Paul argued that China and India were emerging from poverty because of domestic reforms, not World Bank lending. Ditto Chile and South Korea. He said in Africa some of the tens of billions of dollars the World Bank handed to regimes with bad economic policies was “stolen and wasted” or used to avoid reforms and “retard the evolution of democratic government.”

As for the IMF, Paul said its lending to “corrupt and inept regimes” saved them from borrowing on the capital markets, where higher interest rates would have imposed greater fiscal discipline. By extending subsidized money, the IMF “encourages irresponsible behavior among governments and private lenders – both of whom expect to be bailed out.”

It was this philosophical position that led Paul, along with his primary opponent Senator Ted Cruz of Texas, to object to an aid bill for Ukraine that contained a provision that would have allowed for a reform of the IMF, as had been agreed by the fund’s board in 2010. The changes, which still remain unapproved by Congress, were designed to increase representation at the IMF for emerging market economies, including China.

That makes sense given global economic realities. China’s IMF quota comes in at 4 percent, below that of the UK, whose economy is a third the size of China’s. Under the proposal, that would have increased to 6.39 percent. Brazil would have expanded from 1.79 percent to 2.32 percent. In both instances, their IMF quotas still would have been below their shares of global GDP, according to the nonpartisan Congressional Research Service.

Absent ratification by the U.S. Congress, however, none of that has happened. So China is going its own way with the Asian Infrastructure Investment Bank – without American participation. The starting gun has been fired on a new global race to the bottom.

Additional reporting by Stephanie Rogan. 

No comments so far

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/