WORKING DOCUMENT. EN United in diversity EN. Committee on Economic, Financial and Commercial Affairs Globalisation and the financial crisis

Transcription

1 Asamblea Parlamentaria Euro-Latinoamericana Euro-Latin American Parliamentary Assembly Assemblée Parlementaire Euro-Latino Américaine Assembleia Parlamentar Euro-Latino-Americana Committee on Economic, Financial and Commercial Affairs WORKING DOCUMT Globalisation and the financial crisis LA Co-rapporteur: Oscar Darío Pérez (Parlandino) DT\ doc PE v02-00 United in diversity

2 THE FINANCIAL CRISIS AND THE BIRTH OF A NEW WORLD ORDER The monumental events of September 2008, when the United States Government and Congress were forced to adopt a rescue package worth billions for the country s financial markets in order to ease the current financial crisis, changed forever the face of the free market capitalist system ruling the financial markets of Wall Street and the capitalist world. Summary In order to maintain the frenzied level of domestic consumption, US financial institutions found themselves obliged to attract large-scale custom by offering loans at very low interest. As competition between banks grew, riskier loans were granted in order to boost business. This led to the rise in popularity of subprime loans 1, which were granted to borrowers described as NINJA No Income, No Job or Assets increasing borrowing demand and boosting all sectors of the economy. The system worked for as long as the new property owners made their mortgage repayments, and the buying and selling game, fuelled by the above conditions, continued and spread to credit card lending (new cars, new furniture, holidays, etc.). The increase in financial transactions led to a loss of liquidity for the institutions in question, which turned to international banks for help by issuing securities. Within this vicious cycle, profit margins were in the millions: the securities were issued with very high rates of return and subject to very low interest. The drawback of this system is that it is driven and supported by NINJA borrowers, i.e. people without a good income, job or assets, meaning that these excesses relied on the timely repayment of subprime loans. At the beginning of 2007, there was a rapid fall in mortgage payments as borrowers realised that they had been paying over the odds for their homes. It was at this point that the purchase of mortgage securities gradually came to a halt. When the market discovered the nature of the securities, financial institutions lost confidence, becoming averse to all risk. Customers realised that their money was not safe, which prompted an unusual surge in withdrawals, in response to which the US Federal Reserve raised interest rates. As the member of the Andean Parliament Luis Fernando Duque pointed out, The August 2007 mortgage crisis erupted when investors began to hear alarm bells: the gradual raising of interest rates by the Federal Reserve and the increased level of repayments to be made on subprime loans. Evidence that major banking institutions and large investment funds had tied up their assets in high-risk mortgages caused these financial bodies to cease lending, leading to huge stock market disruptions. This, in turn, generated a spiralling loss of confidence and panic among investors and a sharp fall on stock exchanges around the world, owing to a lack of liquidity. The crisis culminated in the collapse of leading financial institutions: IndyMac Bank, the largest mortgage lender in the United States, Lehman Brothers, Merrill Lynch and Bear Stearns among others. At this point, the Federal Reserve decided to intervene by bailing out 1 Subprime loans are a specific type of loan, usually granted for the acquisition of property and aimed at customers with a low repayment capacity. The level of risk means that the interest rate is higher than for personal loans. US banks are required to observe restrictions imposed by the Federal Reserve on lending of this kind. PE v /5 DT\ doc

3 the next likely victim of this domino effect, the insurance giant AIG. Now, instead of looking for a scapegoat, we should be asking, What is the solution? A new financial world order The present difficulties faced by free market capitalism and the adverse impact the latter has had on the global economy are a sign that the international financial order needs to change for good. The proposals put forward at the World Economic Forum in Switzerland are therefore of huge importance. With over 40 heads of state and hundreds of business leaders and executives present at this unprecedented and comprehensive gathering, the aim was to come up with a vision of how the world should look following the crisis. The first proposals centred on the creation of a new multilateral financial institution. This organisation would be responsible for monitoring, advising and identifying countries at risk, in order to prevent a chain reaction. One of the most important features of this international body would be its commitment to ensuring transparency and collective efforts in order to avert future crises. This would require the financial system to be reformed so that all macroeconomic policies adopted could be assessed, regulated and overseen, thus moving towards a model that ensured sustainable development. Another proposal gaining momentum is that world economic policy should be strengthened and its coordination improved through the constant monitoring of all fiscal measures in place. This proposal is linked to the firm rejection of protectionist policies, which could aggravate the current situation. The Executive Chairman of the Davos Forum, Klaus Schwab, also made the important point that economic growth should be based on the needs of the population and the planet, requiring new arrangements to be put in place with regard to water, global warming, clean energy, agriculture and food production. The main challenge is to move from the realms of theory and ensure balance and transparency in practice. The developing world is very sceptical about the elite nature of capitalism, as seen in the world s largest economic powers. It is doubtful that these laudable measures and proposals can be carried out without renouncing the aims inherent to the system (profit at all cost). The developing world s reservations are well founded. According to the Forum s figures, 20% of the world s population accounts for 86% of its GDP, while 80% of exports are in the hands of this minority of people. The United States GDP is larger than the combined GDP of 40 of the world s poorest nations and today more than 950 million people are living in conditions of poverty and exclusion. The World Economic Forum closed its 2009 meeting having had to deal with one of the most serious situations in its history. The most worrying conclusion was the possibility of an outbreak of violence among certain sections of the population in response to the severe economic crisis affecting millions of people around the world. There are also fears that countries will resort to protectionist and nationalist measures, which would cause more yet harm in the form of a slowdown in growth and, consequently, a shortage of jobs. DT\ doc 3/5 PE v02-00

4 World leaders meeting in Davos appealed to people everywhere not to initiate violent protests against capitalism. They also maintained that the adoption of protectionist policies would only bring more problems, signalling a decline in world trade and a loss of commercial confidence. Leaders urged governments to inject confidence into the economy and world markets in order to stabilise the globalisation process and create a way out of the predicament, emphasising that maintaining and improving international cooperation was one of the most important means of overcoming the world crisis. Finally, if anything is certain, it is that, following the present chaos, the overall workings of the market economy will change forever and the rules of international finance will never be the same, because the excesses and absence of all regulation have ultimately infected the finances of the entire world. It is for this reason that a global solution must be found and that international regulation of the financial markets has to be ensured by an international body that will monitor local financial markets and international transactions. The outlook one year on One of the main conclusions reached at the most recent World Economic Forum, held in Cartagena de Indias, Colombia, was that the state of health of the international banking system should be improved, in addition to reviving the economy and stabilising the markets. Indeed, as time has passed, so the international economy has started to recover. However, the notion of financial risk cannot be ignored, especially in the advanced economies. Experts see a need for root-and-branch reform of financial institution accounting and personal consumer credit. It is also important to bear in mind that the rise in public debt worldwide could once again impact on international banking systems. Public finances are therefore increasingly vulnerable and there is concern over possible insolvency in some countries, which may create tensions on the markets if investors start to demand higher returns in order to offset underlying risk. This could lead to a dearth of short-term financing for banks in the advanced countries, which would immediately result in the resumption of private credit. Moreover, the new banking regulations will require the financial system to withhold access to credit while new global rules are being nailed down. In these circumstances, any recovery in private consumption is bound to be slow because demand for credit is weak and its supply limited. Households and enterprises need to cut their debt and clear their balances. Small and medium-sized enterprises are those hardest hit by the credit crunch and political measures may therefore need to be taken in some economies to ease the restrictions on supply. Some developing countries have seen a fresh influx of capital owing to confidence in their economies and a revaluation of their currencies. This can be explained by high liquidity levels and the low interest rates in some of the biggest advanced economies, with some of the emerging countries in Asia and Latin America being the major beneficiaries. Although this is good news for the emerging nations, there may be accompanying inflationary pressures and excessive increases in the price of certain assets, endangering monetary and financial stability. Measures to combat potential risks Transparent fiscal policies are needed to combat economic downturns. The short term poses PE v /5 DT\ doc

5 the greatest challenge since, besides being transparent, stabilisation plans must be flanked by instantaneous measures in the event of public finances deteriorating further than expected. In the long term, reforms of the regulatory framework must be introduced that reflect the prevailing economic and financial conditions. In order to guarantee the reliability of the financial system, more and better capitalisation is required, as well as improved management of liquidity and reserves, both for banks and for countries. Another means of promoting financial stability is by strengthening financial market infrastructure so that it can better cope with problems affecting each financial institution. At a global level, stricter regulatory supervision is needed, as is a set of international guidelines. DT\ doc 5/5 PE v02-00