A panel of leading economists grappled with the effects of the financial turmoil triggered by the crisis in the U.S. housing market in a seminar on globalization on October 19, one of three seminars on economic-related issues during the IMF-World Bank Annual Meetings in Washington, D.C.
Others studied the new architecture of international aid and climate change. There were also subsidiary sessions to the main seminars.
First crisis of globalization
Nouriel Roubini, professor of economics and international business at New York University’s Stern School of Business, called the meltdown in the U.S. mortgage market “the first crisis of financial globalization and securitization.” When high-risk borrowers in California or Florida defaulted on their home loans, some investors as far away as Europe, Australia, and Asia who had bought securities backed by pools of U.S. mortgages incurred losses.
The source of the problem, as moderator and Governor of the Bank of Israel Stanley Fischer noted, “is very bad lending by those who originate mortgages.”
The full extent of the losses is still uncertain, as is the location of many of the securities, according to Larry Hatheway, chief economist at UBS AG, who estimated that some $2 trillion in mortgages are at risk and that overall defaults could reach as high as $200 billion.
As the world grapples with globalization and securitization, “we should expect more of what we witnessed this summer,” said Mohamed A. El-Erian, president and CEO of Harvard Management Co.
If the subprime meltdown hits the U.S. economy hard it will be bad for the rest of the world, because the United States still drives the global economy, according to Hiroshi Watanabe, special adviser to the president of the Japan Center for International Finance.
Subsidiary seminars on globalization dealt with the rise of private equity and hedge funds and the need to build support for globalization.
In addition to hedge funds and private equity funds, globalization has spawned other new sources of liquidity, including investors from oil-rich nations, Asian central banks, and sovereign wealth funds. All these players are here to stay, said Tanya Beder, chair of SBCC. She said private equity and hedge funds account for 25 percent of the investments of the world’s pension funds.
Some of these new players are helping emerging market countries benefit from globalization, said Garrett Moran, senior managing director for the Blackstone Group.
Nancy Birdsall, president of the Center for Global Development (CGD), said that the populist backlash against globalization occurs because there are “winners and losers,” mostly because of educational deficiencies.
Multilateral institutions can help by ensuring investment in education, in human capital, and in policy interventions that will enhance the competitiveness of poor countries, said panelist Stephen Roach, chairman of Morgan Stanley Asia.
The new aid architecture
The structure of development assistance has changed dramatically in recent years, reflecting significant increases in the level of aid and the number of development actors.
The scaling up of aid and the proliferation of donors and other players may present some challenges, said World Bank President Robert B. Zoellick, at the main seminar on the new architecture of aid, but fundamentally they open opportunities, bringing fresh ideas, approaches, and innovations, and additional human and financial resources.
The fundamental challenge, said Zoellick, is “to connect all the pieces together in a new aid network,” which would improve the effectiveness and national ownership of assistance programs.
The urgent need to improve the mechanisms for delivering assistance was emphasized by all the participants in the plenary session, which was moderated by Richard Manning, chairman of the OECD’s Development Assistance Committee.
Birdsall called for a new emphasis on impact evaluation, with aid-receiving countries evaluating their development policies and initiatives, rather than donors assessing their projects; a model of output-based aid, to replace conditionality and the carrot-and-stick approach; more donor financing of global public goods in areas such as health, energy, and climate change; and incentives for skilled workers to stay in public service.
Kwadwo Baah-Wiredu, minister of finance and economic planning for Ghana, urged that reform focus on the composition and volatility of aid, noting the frustration of recipient countries about the lack of freely usable aid and the unpredictability of aid flows.
Alan R. Gillespie, CEO of the International Finance Facility for Immunization (IFFIm) and chairman of Ulster Bank (Ireland)—whose facility has raised over $1 billion selling bonds in the capital markets—said that private philanthropy can galvanize the public sector.
“Populist backlash against globalization occurs because there are ‘winners and losers,’ mostly because of educational deficiencies.”
In a follow-on session, the nature and role of foundations in development were examined. These foundations, which guard their independence from governmental bodies, often reflect the priorities and preferences of individual founders and governing boards. Unlike official development agencies, they can more narrowly focus their efforts and can make much longer-term commitments.
They often take more risks in search of innovative approaches, which creates a natural tension with the development community’s desire for evaluation and monitoring.
Is health leading the way?
In the second follow-on session, panelists examined the health sector, where much of the dramatic scaling up of aid has occurred. They cited the need to harmonize aid delivery and manage the unpredictability of aid levels, and the lack of compatibility of aid disbursements with national health plans.
Response to climate change
Panelists agreed that the science of climate change is essentially established: the earth is warming because of human activity caused mainly by the emission of carbon from the burning of fossil fuels.
Yvo de Boer, executive secretary of the United Nations Framework Convention on Climate Change, said the next step is a political response, beginning with the conference in Bali in December to establish formal negotiations for a new climate change accord. All Bali has to do, he said, is “get the process going.” But if it fails to do that, public interest will slip away, which means trouble, because most scientists think there is a 10–15 year window to deal with the emissions issue.
Valli Moosa, president of The World Conservation Union, said nongovernment organizations are frustrated because governments are slow to do “doable things” such as pushing compact fluorescent lighting, encouraging the use of hybrid vehicles, and establishing more environmentally sound building regulations.
Jon Williams, head of group sustainable development for HSBC Bank, said the private sector is willing and able to play an important role. But investors need a global climate change agreement. When we finance projects over a 20–30 year horizon, investors need long-term certainty about such issues as regulation and tax subsidies, he said.
Greenspan Sees Benign Imbalances Outcome
Policymakers have been focusing too narrowly on the U.S. current account deficit, when it is the overall level of debt, not whether it is financed domestically or by foreigners, that influences economic behavior and “can be a cause of system concern,” Alan Greenspan, the former chairman of the U.S. Federal Reserve Board, said October 21.
Greenspan, in a lecture sponsored by the Per Jacobsson Foundation—a regular event for more than 40 years at the World Bank-IMF Annual Meetings—noted that the unwinding of balance of payment imbalances may take some time and will not likely disrupt the real economy, but cautioned that protectionism and a drift towards fiscal instability in the United States and other countries could make the adjustment painful.
Greenspan said that “unless protectionist forces drain the flexibility of the international financial system, I do not view the ultimate unwinding of America’s current account deficit,” about 6 percent of U.S. GDP, “as a cause for undue alarm.”
He said the rapid growth in the U.S. current account deficit in the past 10 to 15 years does not indicate a sudden unhealthy shift in behavior by U.S. borrowers—households, businesses, and governments.
The U.S. deficit should not be viewed in isolation; it is the result of U.S. businesses and the government turning to “foreign sources of deficit funding” in place of domestic sources, “and not predominantly the result of an acceleration in the secular uptrend in economically stressful company or government imbalances.”
In other words, it represents a shift to foreign rather than domestic sources of funding at a time when foreigners were shedding their “home bias” toward investing locally and saw better opportunities in the United States than elsewhere, mainly because of rapid U.S. productivity growth. These two developments in foreign investor behavior are the most “persuasive” explanation for the outsized U.S. current account deficit.