A Global Credit Squeeze Is Felt Unevenly By FLOYD NORRIS

January 30, 2009
High & Low Finance
A Global Credit Squeeze Is Felt Unevenly By FLOYD NORRIS

DAVOS, Switzerland

Decoupling is last year's discredited theory.

It may also be tomorrow's reality. The world's efforts at economic recovery could well turn into a case of every country for itself. Call it "capital protectionism."

A year ago at the World Economic Forum, many chief executives and government officials hoped that an American recession, if one came, would be mild and would not spread overseas. The strength of world economic growth would enable Europe and Asia to "decouple" from the American economy.

What happened instead was the downside of globalization. Readily available and cheap capital played a crucial role in lifting growth around the world, and its absence for all but the safest borrowers is causing pain everywhere.

But what is not the same everywhere is the ability of governments to stimulate the economy. While the United States debates the details of how to spend a trillion dollars or more to bail out banks and stimulate the economy, the governments of some other countries find themselves caught in the credit squeeze.

In Latvia, the government got a bailout from the International Monetary Fund by agreeing to draconian measures that include wage cuts, spending reductions and tax increases. There were riots.

The president of Latvia, Valdis Zalters, was diplomatic when I asked him Thursday if he thought it was unfair that the United States could easily borrow when his country could not. "It's the way it is," he said. "The U.S. has a AAA rating. We had no choice."

The best positioned are those countries that have huge foreign currency reserves — think China — or printing presses for the international reserve currency — think the United States.

"The money is flowing out of all markets," said Ferit F. Sahenk, the chairman of Dogus Group, a Turkish conglomerate. This, he said, raised the risk of inadequate capital "not only for the banks but for private sector debtors as well."

That risk is only increased by what Steven Roach, the Morgan Stanley economist, called "the rising tide of economic nationalism." In both Europe and the United States there is pressure on bailed-out banks to increase lending — but not to just any borrowers.

"Some countries are encouraging their banks to invest mostly in domestic assets," Mr. Sahenk complained. "This is a new form of protectionism."

That worry is widespread. "Large economies are accessing international capital markets for themselves," said Trevor Manuel, the finance minister of South Africa.

He wants the big countries to share the borrowed wealth, but fears they will not.

Lord Adair Turner, the chairman of Britain's Financial Services Authority, voiced the same concern, calling it "the risk of a new mercantilism," centered on credit availability rather than trade. "It is not easy to avoid this," he added. "It could get out of hand."

The onset of credit protectionism, if it comes, will be the result of a drastic shift in the financial system. Private allocation of credit played a major role in the extraordinary world growth of the last quarter-century, but that system blew up when financial innovation led to a huge overextension of credit to borrowers with dubious ability to repay, whether they were subprime mortgage borrowers or highly leveraged companies.

With the banks crippled and shown to have taken what now look like foolish risks, it has fallen to governments to allocate credit, either indirectly by deciding which banks to bail out and on what terms, or even directly if, as some expect, many banks are eventually nationalized.

The pressures for nationalization come in part from worries that bank balance sheets are bottomless pits of toxic assets, and concern that it is unfair to taxpayers to let the benefits flow to the shareholders who stood by as the banks took too many risks.

Alan S. Blinder, a former vice chairman of the Federal Reserve and now an economics professor at Princeton, said he did not think nationalization would be the first or second choice of American policy makers, but that it could be the third or fourth.

And he added that the risk of credit protectionism would rise if the banks were nationalized.

It is hard to imagine that governments will do a particularly good job of allocating capital to its most productive uses, given the political pressures they will face. But there is no agreement on how to get the private banking system operating in an adequate fashion.

Pumping capital into the banks has not yet worked, even if it has stirred public outrage over high pay and perks for the bankers who got us into this mess. There is renewed interest in some kind of "bad bank" approach that would separate the toxic assets from the good ones, leaving the government with the bad stuff. But figuring out what to pay — assuming the banks have not been nationalized — is likely to be contentious.

At the same time, there is much talk about how to reform the regulatory systems around the world, and how to standardize regulation to avoid the "regulatory arbitrage" of seeking out jurisdictions with the least stringent rules.

"We allowed a series of near banks and shadow banks to grow without being regulated," said Lord Turner. In a new regime, he added, one rule must be, "If it looks like a bank and quacks like a bank, we have to regulate it like a bank." To do that, he would give regulators wide discretion to get information on how hedge funds and other institutions are operating, with the ability to impose regulation if they start to act too much like a bank.

Some economists fear that would stifle financial creativity, and even some who think far more regulation is needed question whether regulators can amass the expertise to make needed decisions promptly and wisely.

Mr. Roach predicts that this will be the first year since the Great Depression that the gross domestic product of the entire world declines. Fiscal stimulus plans may help to ease the pain, but it is hard to see how the world's economies can resume decent growth until the private financial system is operating much better than it is now.

"We've all been building this big, integrated financial system," said James Rosenfield, a co-founder of Cambridge Energy Research Associates. "We didn't consider what would happen when it disintegrated."

http://www.nytimes.com/2009/01/30/business/30norris.html?sq=Floyd%20Norris%20January%2030,%202009&st=cse&scp=1&pagewanted=print

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