STWR - Share The World's Resources

The bailout burden for the financial crisis will not be equally shared unless there is strong and dedicated mobilisation and campaigning across the world - which makes a common cause across issues such as house repossessions, food price rises, and the unaccountability of the financial system. By Alex Wilks.

26th September 08 -  Alex Wilks, Eurodad

This week was supposed to see a reconfirmation of government commitment to the United Nations Millennium Development Goals. Instead leaders have spent their time in New York and back home discussing the financial crisis, which reached new depths last week. For the last year many commentators have said developing countries were immune (‘decoupled’) from the mayhem affecting financial markets in the North, but this view is being rapidly revised as alarm spreads about the likely impacts on the world's impoverished billions.

Few development analysts realise that under MDG Eight EU governments have committed to develop an “open, rule-based, predictable financial system”. Or that in the Monterrey Consensus on Financing for Development it was agreed that: “Governments should attach priority to avoiding abrupt economic fluctuations that negatively affect income distribution and resource allocation”, to encourage “the orderly development of capital markets through sound banking systems and other institutional arrangements [including] transparent regulatory frameworks and effective supervisory mechanisms”. When they were negotiated in 2002 these clauses were aimed at developing countries – where the 1997-1998 financial crisis broke out – but in the end it is the United States and Europe which have failed to implement these measures, with potentially catastrophic consequences for citizens the world over. 

What is the problem?

A paper by the South Centre, an inter-governmental body of developing country governments said "the cost of crises is immense in terms of lost output and employment, and the associated social strains and political disruption". Mexican economist Nora Lustig also points out that some previous financial crises have been very costly for developing countries in both financial and human terms. In the five years following the start of the 1980s Latin American debt crisis “real wages in Mexico and many other Latin American countries cumulatively fell by between 40 and 50 percent and in many instances real wages did not recover until 10 or 15 years later". She also points out that the incidence of extreme poverty in Mexico was only reduced below its 1984 level some 22 years after the crisis started.”

After a period of commodity price rises and access to international loans, developing countries are facing up to the twin shocks of loss of access to foreign exchange income as well as greater outflows. The income losses for most countries will be because of a slowdown in foreign direct investment, difficulties in refinancing bonds at reasonable rates, and lower workers' remittances and export earnings because of the recession in the richer countries. Global companies may accelerate cash outflows by divesting holdings in Southern countries, and the interest rates which determine how much developing countries pay on their international loans may rise as a result of the lack of confidence between banks.

The impacts on specific countries depend on countries' mix of exports and imports, their dependency on specific types of inflows, and on how much reserves the governments have accumulated. One possible upside is that many investors fear that the dollar will devalue even more than it has in the last year. Jerome Booth, head of research at Ashmore said last week that this sentiment may lead several companies to invest in assets in other currencies, including in emerging markets which have currencies that may appreciate against the dollar. This especially so if they believe that large Southern countries can continue to grow more rapidly than Northern ones even in these difficult times.

While concentration has been focused on the collapse of large US banks such as Lehmann Brothers and Bear Sterns, there is also a possibility that some developing country financial institutions may go to the wall, causing problems for their creditors and drying up finance needed for small businesses, citizens and also governments who are increasingly taking on domestic debt. This could feed a vicious spiral by making finance more expensive. The Financial Times pointed out earlier this week that “emerging markets face battle to roll over $111 billion of debt” by the end of 2009. This to refinance bonds issued by companies and by banks. As many of these are deeply indebted and have few cash reserves to dip into “there will be defaults”, according to David Spiegel of ING, a Dutch bank.

There are some doubts about whether richer countries will use the economic slowdown as an excuse to further slow the growth in official aid levels. The U.S. government has recently nationalised mortgage holding companies Fannie Mae and Freddie Mac in September, taking on their $5,300 billion mortgage debt portfolio (the equivalent of four times the external public debt of all developing countries). The U.S. government has also bailed out insurance giant AIG and is trying to convince Congress to provide another $700 billion or so to buy up further bad debt from banks. Some are asking whether this, combined with likely lower tax takes by governments in the coming recession years, will mean less money available for aid and for social spending in richer countries. This need not be the case, however, as citizens groups are mobilising to make politically unacceptable the idea of diverting public money to bailout financiers' excesses while cutting off money to those who need it most.

A bigger question is whether governments will get away with not changing the model which has led to successive financial crises. This model has allowed a small number of financial institutions and citizens to generate vast wealth, while finding sophisticated ways to avoid regulations and dump risks. The financial system that has emerged in the last twenty years has increased instability and inequality and undermined democracy. In a paper on the issue Peter Wahl, of Eurodad member organisation Weltwirtschaft, Okologie und Entwicklung, comments that: “systemic instability has considerably increased, the new system leads to a constant redistribution from below to above and the transnationalisation of finance prevents the individual nation state from exercising regulation.”

Nicholas Hildyard, in a forthcoming paper for UK think tank the Corner House, argues that hedge funds, private equity funds and other institutional innovations have been created "with the evasion of regulation uppermost in mind". He also points out that these mechanisms, using securities, swaps, derivatives and other instruments has enabled a major concentration of economic power through leveraged buyouts and mergers. The demise of Lehman Brothers and the rapid incorporation of Merrill Lynch, Halifax Bank of Scotland, and Bear Sterns into other banks has now taken this several steps further.

Although it is the North which is the cause and first victim of the current crisis, the effects will be felt worldwide, not least because deregulation has been strongly promoted by international agencies such as the World Bank and International Monetary Fund. The South Centre argues that "the overly rapid opening up by developing countries of their capital accounts and the deregulation of financial markets, and the failure to put in place adequate prudential regulations and monitoring mechanisms, have made developing countries in particular vulnerable to financial crises".

What is to be done?  

Confidence in a pure free market model is now at a lowpoint and there will be long-lasting pyschological effects of this crisis which has erupted in the heart of the financial system. The last few weeks have seen major nationalisations and a political consensus emerging that a re-regulation is necessary. It is unclear how limited these will be, however - will they extend to a push for dramatic new forms of ownership and control over the provision of credit? Will the crisis create space for ideas such as a green new deal, as floated by Eurodad member New Economics Foundation to generate employment while directing investment to reorient the economy onto a sustainable path?

International Monetary Fund Managing Director Dominique Strauss-Kahn agrees that we need: “nothing short of a systemic solution - comprehensive in tackling the immediate fallout and comprehensive in addressing the root causes. This crisis is the result of regulatory failure to guard against excessive risk-taking in the financial system". This is certainly an opportunity for strong action to regulate derivatives, hedge funds and similar financial speculation devices. The regulation, and any bailout, must be done on terms that do not reward company executives or shareholders who have profited excessively from the current lax system, and must protect taxpayers, ordinary homeowners and the people of developing countries. Any company executives who have missold financial products, traded while knowingly insolvent, or broken other laws must face prosecution (the Federal Bureau of Investigations is investigating some 22 companies at present).

Regulatory proposals include:

• more transparency about risks in financial products;

• elimination of tax havens and other secrecy jurisdictions which allow tax evasion and regulatory arbitrage;

• bringing hedge funds and other shadow banks under the same regulatory umbrella as regulated banks;

• requiring banks to hold larger capital reserves;

• standardising derivatives and forcing them to be traded on exchanges;

• introduction of currency transaction and other financial transaction taxes while changing finance company pay and incentive systems;

• stronger coordination of international regulation, including much greater participation of Southern governments and of citizens' representatives in international institutions and fora where financial rules and policies are set.

While it is encouraging that many of these measures are being backed by commentators and politicians who until recently were strong advocates of deregulation, we should not take for granted that the bailout burden will be equally shared or that progressive regulations will be put in place. It will not occur unless there is strong and dedicated mobilisation and campaigning across the world. Citizens are being affected everywhere and it should be possible to make common cause across issues such as house repossessions, food price rises, and the unaccountability of the financial system. Citizens’ action is needed to force government action at home and at United Nations summits this week and in two months time when financing for development will be order of the day.

Alex Wilks is Director for the European Network on Debt and Development.

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