Month of November, 2008

In an op-ed in the Financial Times’ Economists Forum on November 24th, Growth Commission Chair Michael Spence elaborates on the endogenous nature of the asset pricing problem, and its role in the current global financial crisis. The piece, entitled Balance sheets and income statements: breaking the downward spiral , highlights the uncertainty investors face in determining the intrinsic value of assets, and their consequent reluctance to enter the market.  Dr. Spence discusses the channels underpinning the decline in economic activity, and suggests that government can play a positive role in limiting the negative overshoot in assets and economic activity.  Additionally, he points to the need for a significant stimulus package and a more systematic program of purchasing assets to stem the downward spiral.

As we continue to face extreme volatility in financial markets, the dire economic prospects for the real economy are now also becoming increasingly apparent. Policymaking is rightly focusing on short-term measures to stabilize financial systems. But it is clear that financial stability alone will not be enough to avoid a dramatic global economic slowdown and recessions in many countries. The policy debate is focusing towards measures that can revive the real economy.

The global financial and economic crisis highlights the need for effective means of coordinating complementary national policy responses into workable international action. This seems to me to require in turn an international financial architecture that emphasizes the sustainability of national and cross-border financial institutions, instruments and regulations. The international financial architecture needs a major infusion of transparency and forward-looking regulatory practices. Neither will be simple to conceptualise or implement.  

Some may wonder how the observations of the Growth Report, dealing with sustainable high growth patterns over long periods, can be reconciled with policy choices currently facing government decision-makers.  Clearly the food and fuel price spikes earlier in 2008, followed by the financial meltdown affecting all markets, were dramatic challenges, especially for poorer developing economies, but also for emerging market economies generally. This will inevitably be followed by a global recession in 2009, a slow-down that has already started, even in China, the world’s dominant growth engine in recent years.

Kemal Dervis, head of the UN Development Program, and also a commissioner on the Commission for Growth and Development discussed the need for fairness in the availability of credit for emerging markets. In an op-ed in the Washington Post on Monday, November 3rd, Commissioner Dervis highlighted the dramatic effects the current deleveraging process will have on developing economies. He also points out that if the IMF and reserve-rich countries start implementing a selective lending facility, this will likely create new political tensions that will push vulnerable countries into crisis even faster.  

One of the villains of the current financial crisis is "securitization."  The alphabet soup of securities structures--CMOs, CDOs and SIVs--is roundly blamed for the financial world's current mess.

The irony is that it was not so long ago that emerging countries looked to securitization as a savior for the problems that they faced in developing capital markets.  Specifically, many countries (particularly in Latin America) looked to Fannie Mae/Freddie Mac Mortgage Backed Securities as models for instruments for providing housing finance, and others (such as India) looked at special purpose vechicles as a potential method for getting around the poor financial conditions of local government attempting to finance infrastructure.

So which is it: villain or savior?  Well, of course the answer is neither.  Securitization is just an instrument, and when applied appropriately under appropriate circumstances, is a useful instrument.  So let's begin by dispensing with the notion that securitization is itself a villain, and then talk about why it is not a savior either.