The end of the Davos consensus

By J Saft
January 30, 2009

– James Saft is a Reuters columnist. The opinions expressed are his own –

James Saft Great Debate It’s not exactly a wake, but participants at this year’s World Economic Forum have witnessed many of their most cherished beliefs being challenged, upended and sometimes ground in the mud.

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.

12 comments

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Talking about protection, note that only US steel is to be used in projects covered by the Obama nspending programme.

Posted by Hilario | Report as abusive

“If we don’t want a backlash against trade we have to have prudential regulation of the financial system.”

Too late for that, the old way of doing things is dead. We need something entirely new. For a time we need to take a step back, and that means that governments need to have a look first at their national economies and their citizens. After all, this is not about the well-being of corporations and their managers, it’s about the well-being of the people. That’s what governments are for. Therefore, you cannot really have US Tax dollars being spent abroad, this would not create the jobs that are needed in the US.
Of course. there would be another solution, just pay every citizen a guaranteed monthly income of USD 2400, but no one, besides me and I do not count, is prepared to do that.

Posted by Robynne | Report as abusive

As I see it and what I would do:
International trade is good, “globalization” is an academic pipe dream and fraud.

$800b – USG to buy up all of the “toxic” consumer and business debt and hold it until it could be sold off, terms restructured or otherwise permanently disposed of.
Remove the senior management and boards of directors of any company that accepts federal bailout money. Investigate and jail those executives and board members guilty of collusion, dereliction, incompetence and outright fraud and criminality. No exceptions.
Every federal bailout check that is delivered to any business would be presented by a Defense Contract Audit Agency Auditor who then takes up permanent residence in that company and is supervised by a Federal Receiver… The DCAA is tough and thorough. If these companies can’t “take care of business” the DCAA can do it for them.
Those folks who bought houses they couldn’t afford and were ripped off by predatory lenders and mortgage brokers would be allowed to stay in their houses until the USG could sell the house.
Arrest, prosecute, jail and confiscate ALL of the property, assets; financial and otherwise, transferred and otherwise of all of the perpetrators of this mass thievery, fraud, corruption and incompetence. Perps such as Angelo Mozillo, Chris Dodd, Richard Fuld, John Thain, Barney Frank, Alan Greenspan and many, many more of these swindlers and thieves down to the lowliest mortgage broker. Their confiscated property would in turn be used to retire that portion of the federal “bailout”.
End business deregulation. We’ve had three major business scandals during the 25 years plus of deregulation. Enough is enough, deregulation doesn’t work, Corporate America has proven time and again that it is not to be trusted and the thieves and BS artists always rise to the top.
The USG must enforce, anew, the anti-trust laws. The orgy of businesses engulfing and devouring other businesses must be stopped (Pfizer and Wyeth for example) to preserve the give and take of competition.
Trust will NOT return on the part of the people until ALL of the perpetrators of this massive swindle are jailed for the rest of their lives, their families are turned out into the street and their ill-gotten gains confiscated and used to repair the damage they caused. This economic disaster is not the result of the serendipity of business but the result of corporate crime on a massive scale.
These people are common thieves and profiteers. And profiteers used to be hanged…

Just one opinion from a citizen who has been mugged.

Posted by RFL | Report as abusive

I think the issue of massive regulatory failure needs to be addressed much more explicitly. I am a former bank regulator (a Director of Research of the New York State Banking Dept.) and I have spent many years in the investment banking world involved in risk management, risk reporting and risk technology. Lately there have been several proposals for revising the regulatory process, including establishing a clearing house for credit-default swaps. consolidating regulators, new reporting requirements, etc. But there seems to be a failure to recognize that the regulatory process can only work if there are good regulatory people looking at the matters every day. If I may let me offer the following comments:

1. The bank regulators have had the authority to examine any aspect of a bank’s activities. They had the authority to figure out what was going on at the banks and to limit it. The regulators did nothing. So all the new regulations on paper will mean nothing if the regulators cannot or will not do their jobs.

2. Mr. Timothy Geithner recently said “First, the multitude of overlapping regulators must be rationalized into a coherent few, the communication between them improved and their turf battles ended”. Unfortunately consolidating the regulators will produce some streamlining but will not likely achieve the desired goals. Sending a regulator who makes $50,000 dollars a year to examine the activities of sophisticated financial traders who make millions of dollars a year is not a fair battle. And if you have ever worked in a government agency, as I did for over 4 1/2 years, you will be intimately familiar with the viciousness of the turf battles among the senior officials. There is a lot of deadwood at the top of the agencies and it needs to be cleaned out. A Herculean task if there ever was one.

Posted by S. Hellinger | Report as abusive

Well said RFL and S.Hallinger. This needs to stop, a solution needs to be devised by at least the G-20, led by the G-8, in order to prevent another financial meltdown and trade imbalances between countries that will eventually undermine any globalisation or trade growth, protectionism will come full force, which is not the answer. In our stimulus plan, yes we need to buy American to a certain extent, but please don’t put it into legislation…all you are doing is causing a very secretive and cautious China to become even more cautious about investing money in the U.S. China needs to stop blaming the U.S. for being such a spending powerhouse when they themselves have been profiting like crazy from our consumer spending. If they want to speak ill of the U.S., then they need to be prepared for a dramatic decrease in their exports coming into the U.S. This is why protectionism needs to be avoided, but at the same time there needs to be a more definitive solution to the trade imbalances and there needs to be a large focus on creating jobs again in the U.S. China needs to focus on domestic spending at home, and stop relying on everyone else, and stop hoarding the money they receive from their exports…the imbalances need to be scrutinized. Our regulators should have caught these problems, but that’s what happens when you pay someone $50,000 dollars a year to regulate an industry that spends that much on on an individual toilet. You wont get top talent to prevent crisis like this on a regulator level unless you are willing to spend a little money and raise the salary, that’s why our government regulators are not that good, they aren’t paid enough so they don’t care whether or not something is wrong. And where is all the supposed job growth in the $700 billion stimulus plan..I see maybe $100 billion in infrastructure…I think the stimulus plan is backwards and $700 billion is nowhere near enough the way the stimulus is set up now. We need 3 to 4 trillion dollars alone to shore up the financial sector, including banks but that doesn’t even touch on the job loss and future job loss. This recession can be turned around, but it needs to be taken care of as fast as possible and with meaningful, modern regulations in place and a global cooperation like no one has ever seen in this lifetime or ever.

Posted by Damian Palmares | Report as abusive

The more I read about this disaster the more convinced I have become that this entire enraging affair is a massive criminal enterprise perpetrated on the world’s economies by an interconnected group of key players and enablers who by deliberate action, colusion or acquiescence looted the world’s bank and investment companies. Computers facilitate the movement of massive amounts of money at the click of a mouse. How easy it is…
It is this conviction that causes me to demand the extreme action I call for in my previous post.

Posted by RFL | Report as abusive

Move from Wall Street to Pennsylvania Avenue and from London to Brussels to tailor the straightjackets.

Posted by Armand Bogaarts | Report as abusive

Protectionism is the inevitable result of a left leaning regime. The problem with the banking system in the US is over-regulation. The Clinton administration forced the banks to lend to an undeserving minority and all of the tradional credit control standards were thrown out the window leading to the debacle of what we see today. Too much government spells disaster. Remember the totally regulated USSR? 72 years to nowhere.

Posted by Cross | Report as abusive

I think the crisis we have now has more to do with criminality, greed and fraud than it has to do with government regulation. Bernie Madoff, Richard Fuld, Chris Dodd and Barney Frank didn’t operate in a vacuum.

Posted by RFL | Report as abusive

I agree that it has more to do with greed and fraud than it does with regulation, the rules are in place, they just are being ignored and not enforced, although some international enforcement should take place. And what you said in your second post:

“The more I read about this disaster the more convinced I have become that this entire enraging affair is a massive criminal enterprise perpetrated on the world’s economies by an interconnected group of key players and enablers who by deliberate action, colusion or acquiescence looted the world’s bank and investment companies. Computers facilitate the movement of massive amounts of money at the click of a mouse. How easy it is…
It is this conviction that causes me to demand the extreme action I call for in my previous post.”

It could easily be done…the markets can be moved with enough money or loss of confidence. Definitely something worth thinking about.

Posted by Damian Palmares | Report as abusive

I used to be a fervent advocate of free market. After this past year I am concerned that individuals can put at risk our country’s wealth by poor investments. I don’t believe that anyone believed that these reset rate bonds were capable of being adequately serviced after the low rate period. If you read some of the people who purchased on these terms it seemed that in reality it was a hope that the prices would go up to get equity in the property. In reality these (toxic today) bonds had to be packaged with other better bonds to get a rating. That in itself says it all if it is such a good thing than why did it have to bundled up with others and why was the interest so low in the teaser period. Simply put to avoid default early on in the process.

I don’t believe that countries can trust each others oversight,legislation and banking system anymore and essentially I want our citizens protected from themselves. I don’t want more of our national wealth squandered in taking risks that relate to another country not stopping the unscrupulous from creating these houses of cards.

So for the first time ever I start questioning whether the USA can be leader of a free world. Whether it can ever repay its debts ? How many years will it take for the rest of the world’s banks to recover from these losses ? How much wealth was transferred to the USA by buying what is now worthless assets ? How could no-one stop Madoff in a scheme that must have been going on for decades ? So I don’t trust the USA financially let alone politically.

I for the first time now want government checks and balances so that no-one can play Roulette with our assets. Its no different as to the controls you have to have to stop fraud. So maybe we all need banks that look to the needs locally first and are not blinded by better rates elsewhere but which have higher risk. We all survive if our local economy is stable the international trade is equally important but that must be funded by those economies in the first instance.

SO I THINK WE ALL NEED TO PUT OUR OWN HOUSES IN ORDER AND FRONT UP TO THE LOSSES. THEN WE NEED TO CONTROL THE EXUBERANT RISK TAKES AMONGST US AND LASTLY GET OVERSIGHT AND CONTROL SO THAT WE CAN ONCE AGAIN TRUST EACH OTHER. THAT DOES MEAN MORE CONTROL IN THE HANDS OF GOVERNMENT AND I SEE NO OTHER WAY OUT.

Posted by Joe | Report as abusive

Much is being said about the culpability of many bankers, investment bankers, hedge fund operators, speculators, traders, derivative makers, etc. Most of the criticism is justified as are the calls for some form of retribution for those who have caused so much misery.

To me a far more telling issue is the clear inability of so many highly regarded financial practitioners to make meaningful suggestions to help solve the problems. This is extremely revealing because it suggests that many of the financial wunderkinder are men and women of straw who did little more than ride a wave of global prosperity to vast personal wealth. Their behaviour suggests that they are not only inadequately equipped to contribute to a solution but they are indifferent to the need to ensure that this never happens again. These people should be forced out of the financial services industry if there is to be any hope of enduring recovery

Posted by anton kleinschmidt | Report as abusive

[...] It’s not exactly a wake, but participants at this year’s World Economic Forum have witnessed many of their most cherished beliefs being challenged, upended and sometimes ground in the mud. 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. Read article [...]