The Current Discussion:The global economy is quaking. Are we heading toward a global recession? Who's to blame?
Most developing economic managers spend the past week reassuring worried local markets that their countries’ will survive the financial problems that caused U.S. investment bank Bear Stearns to go belly-up. Although the brunt of the credit crunch so far has only affected developed markets – the U.S., European Union countries, the UK and Japan – developing markets feel the ripples, too. In fact, a delayed reaction may yet hit those markets. A case in point is South Africa. Although the country’s financial system is relatively strong, a global slowdown caused by this financial crisis will hit the country’s high economic growth rates. The South African Treasury has already revised its growth prospects down to 4% from the 5 % average levels for the past four years, partly in anticipation of a global downturn. Emerging market economies are very much tied to global economic tremors. The combination of risk aversion, lending freeze and lower confidence associated with the current financial crisis may cause capital outflows from some emerging markets. It is remarkable how a crisis that started with a local U.S. home loan market problem has, because of the interconnectedness of the global financial system, spilled-over globally. If anything, this financial crisis must lead to decisive reform, in the same active way the U.S. Federal Reserve intervened to prevent the country’s financial system from free-fall, when it took guarantee of US $30 billion of Bear Stearns assets in the biggest central bank bailout in American history.
In this financial crisis, the governments and taxpayers are picking up the tap of risky speculations by financial institutions and fund managers, which have lost unimaginably vast sums of money through irresponsible lending. Across the channel the Bank of England released a £5 billion loan package to UK banks to prop them up against financial system turmoil and to ensure liquidity in the markets there. Earlier the UK government nationalized Northern Rock after a run on the bank. The fact that governments and taxpayers will take the tap for the imprudent behavior of bankers and fund managers means that governments must introduce reforms to prevent this from happening again. The long-term solution still lies with strengthening the powers of financial regulatory institutions and central banks to curb irresponsible financial behavior. Smarter regulation by the U.S. Securities Exchange Commission and the Federal Reserve is certainly still possible. This also goes for regulators and central banks in developing countries.
Sure, we have seen the odd high-profile resignation here and there, and the likes of Joe Lewis, Bear Stearns’s second-largest shareholder with a 9.36% stake, saw his investment shrink from US$967.8m to $22m. But in general, there have not been significant individual repercussions for banks’ bad decisions. But individuals responsible for irresponsible investment decisions must be punished. Not to do so, while offering bailouts with public money, will be to encourage reckless behavior. There are still many options open to the U.S. Federal Reserve and central bankers beyond cutting interest rates and pumping liquidity into the market. Yet, if the crisis worsens instead of improves, it won’t be a bad idea either for the U.S. Federal Reserve and other central banks to consider purchasing mortgage-backed securities, to put a stop to the tumbling prices and forced sales, and to prevent the spread of the crisis beyond the borders, including to developing economies.
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