The end of the Davos consensus
— James Saft is a Reuters columnist. The opinions expressed are his own —
Think of it as the “Davos Consensus,” a loose alignment of principles that held sway in this Swiss mountain resort and in large parts of the world over the past decade.
This consensus, which generally favoured the market over the state, “light-touch” regulation of financial services and the free flow of goods and capital across borders, is somewhere between on the defensive and in full, not always organised retreat.
What is a lot less clear is what might replace it.
It’s true that the global economic crisis and the debt bubble that preceded it did not deliver on much of the promises made by defenders of globalisation and market forces. Instead it was one of the biggest misallocation of resources in history; to housing and consumption that either wasn’t needed or really couldn’t be afforded.
Banks wiped out much of their capital base and their regulators failed spectacularly too, missing everything from the dangers of a build up in leverage to the Madoff Ponzi scheme.
Now the state is in the ascendant, both as an “investor” and regulator and as an economic force. Everywhere the talk is about stimulative government spending and although it’s intended to be a temporary measure while the economy recovers you do get the feeling that the shift in the balance between state and private enterprise might outlast the downturn.
And even though banks have not yet been widely nationalised, there is no doubt that the state is actually directing which parts of the economy get cash. The United States is buying mortgage related debt, Britain is bailing out its auto industry, and there is every chance that further investments in banks by governments will mean more control of how, where and to whom they lend.
It is too a huge contrast from last year, when the debate was about how much globalisation, in the form of sovereign wealth fund ownership of the western banking system, was tolerable. The sovereign funds aren’t buyers any more and the cash that is flowing into banking is mostly within individual states; governments ploughing funds into banks.
It’s really not too far-fetched to speculate that globalisation might have reached its high-water mark.
It is also absolutely certain that regulation of finance will be tighter.
“The ideology of the last decade was self-regulation which means no regulation,” NYU economist Nouriel Roubini told a panel discussion in Davos.
“If we don’t want a backlash against trade we have to have prudential regulation of the financial system.”
REGULATORY FREIGHT TRAIN
One tiny problem is that the stuff underlying the Davos consensus really was pretty good at doing lots of things, not least raising living standards in huge swathes of the developing world. States aren’t traditionally all that great at allocating resources either, and it is by definition impossible for them to explain when and how they will step back and let individuals pick up the ball.
Maybe most concerning is the threat of protectionism. Most governments who rescue their banks and spend money trying to stimulate their economies have a natural incentive to try and capture as much of the benefit as they can for their voters. If you are on the line for the losses of a big international bank, do you really want it to continue taking chances lending abroad? Wouldn’t it be more sensible to just go back to “basic” banking, lending to businesses you really know? That is a line we will hear more of and it is protectionism in another form.
There have also been moves in the United States to attach “Buy American” provisions to the $825 billion economic stimulus package. While it’s not exactly the Smoot-Hawley tariffs that made the Depression so much worse, it is a slippery slope. Even more regulation of financial services, needed or not, will tend to make states eager to bottle up their banks at home, the better to watch closely that they are not taking the wrong kinds of risks.
And while the move to allow judges to force loan amendments, so-called “cramdowns” on to investors makes very good economic sense, given the collapse in housing and the complexity of many mortgage securities, it raises questions about what other contracts won’t be honoured and will be repudiated by the state.
So what’s next? The consensus here is that the state will have to come in and clean up everybody’s messes but business executives don’t seem to have twigged yet that regulation is heading at them like a freight train.
Whatever the new rules are, the sooner governments can spell them out the sooner everyone else can get on with their newly diminished roles in the rebuilding.
— At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.