[stop-imf] AS TURMOIL CONTINUES, WEST CONSIDERS MAJOR SUBSIDIES - Martin Khor

[robert weissman]

TWN Info Service on WTO and Trade Issues (Mar08/21)
27 March 2008
Third World Network
www.twnside.org.sg

AS TURMOIL CONTINUES, WEST CONSIDERS MAJOR SUBSIDIES

With the Bear Stearns collapse almost causing a system-wide meltdown and
alarm bells still going off every few days, the Central Banks and
financial authorities in the United States and Europe are now studying
more radical measures to keep the lid on the financial crisis.

The US Federal Reserve, the European Central Bank and the Bank of
England are reportedly studying the possibility of using public funds to
purchase bad mortgage-backed securities from troubled financial
institutions to save them from further losses and write-downs.

Previously, developing countries facing similar financial crises were
ordered by the West-controlled International Monetary Fund not to extend
financial assistance to domestic banks in trouble.

And even today, as the Western governments put up mounting amounts in
subsidized loans to their financial companies, they have been
pressurizing developing countries not to extend subsidies to their
companies.

Below is an analysis of the current developments in the western
financial markets. It was published in the SUNS #6441, Wednesday, 26
March 2008.

With best wishes

Martin Khor

TWN


As Turmoil Continues, West Considers Major Subsidies
By Marin Khor, Geneva, 26 March 2008

With the Bear Stearns collapse almost causing a system-wide meltdown and
alarm bells still going off every few days, the Central Banks and
financial authorities in the United States and Europe are now studying
more radical measures to keep the lid on the financial crisis.

The US Federal Reserve, the European Central Bank and the Bank of
England are reportedly studying the possibility of using public funds to
purchase bad mortgage-backed securities from troubled financial
institutions to save them from further losses and write-downs.



Previously, developing countries facing similar financial crises were
ordered by the West-controlled International Monetary Fund not to extend
financial assistance to domestic banks in trouble.



And even today, as the Western governments put up mounting amounts in
subsidized loans to their financial companies, they have been
pressurizing developing countries not to extend subsidies to their
companies.



The new measures to buy up bad assets from the banks, if carried out,
would be a major departure from the =93normal=94 hands-off policy of the
central bankers, who proclaim that the institutions should be left to
suffer their losses, and the state should not provide a rescue through
public money, on the ground that this would create moral hazard.



Moreover, the use of tax-payers=92 money to rescue financial institutions
that got into trouble because of the bankers=92 greed or ineptitude will
be unpopular, and this measure is still only =93under consideration=94. But
the fact that the policymakers whose ideology is based on =93market
fundamentalism=94 are thinking about it shows the desperate state of affair=
s.



The Fed=92s role in facilitating the takeover of Bear Stearns and its
other moves on the same weekend of 14-16 March already took it many
steps beyond its customary boundary. These included the US$30 billion
guarantee it provided to JP Morgan against losses in the latter=92s
takeover of Bear Stearns and the decision to open loans through the
discount window to all primary dealers (previously made available only
to commercial banks).



If the Central Banks were to purchase the mortgage-backed securities off
the commercial banks, investment banks and perhaps even other
institutions like hedge funds, they would be taking a giant step up from
the recent measures limited to extending credit to mainly the commercial
banks to give them much-needed liquidity.



A senior United Nations official, speaking anonymously, remarked today
that the Western countries were readily providing different types of
subsidies, one larger than the previous, to keep the financial
institutions alive and the system afloat, in an increasing
nationalization of losses of the private financial institutions.



And at the same time, the same developed countries have been pressing
developing countries not to provide subsidies to their industrial
companies, and even proposing new measures to ban them from using more
categories of industrial subsidies at the WTO.



=93The hundreds of billions of dollars of subsidies in loans and
guarantees, and in future through outright purchase of bad loans and
securities used by the Western governments in the current financial
crisis, are something way beyond the millions of dollars of subsidies
that developing countries=92 governments could afford for either their
financial or industrial firms,=94 said the official, stressing the
hypocrisy involved.



On 4 June last year, the US submitted a new proposal in the rules
(anti-dumping and subsidies) group under the Doha negotiations to
prohibit five new categories of subsidies in the industrial sector.



The five types of subsidies are: (1) government payments to companies to
cover operating losses; (2) forgiveness of government-held debt; (3)
government lending to =93uncreditworthy=94 companies; (4) government equity
investments in =93unequityworthy=94 companies; and (5) other financing, suc=
h
as =93royalty-based=94 financing that is not commercially available.



At the time this proposal was introduced, US Trade Representative Susan
Schwab said that stronger WTO rules will rein in the use of industrial
subsidies, and that in an increasingly global economy, foreign
government subsidies provide a distinctly unfair competitive advantage.



=93The subsidies we want to prohibit maintain inefficient production
capacity in industries ranging from steel to semiconductors. Stronger
rules for these types of subsidies would address significant
trade-distorting practices of many of our trading partners that often
lead to unfair trade.=94



The US however was quick to stress that the prohibitions would not apply
to agriculture.



The proposal generated a storm of protests from many developing
countries which argued that such subsidies were necessary for the
evolution of domestic firms and were part of the policy tools for
development, that the now developed countries themselves had made use
of. But these arguments were brushed aside by the US, and its proposal
is still on the table.



The US paper proposed the following five types of subsidies to be added
to the subsidies that are prohibited in the WTO=92s Agreement on Subsidies
and Countervailing Measures:



(a) the direct transfer of funds to cover operating losses sustained by
an enterprise or industry;



(b) forgiveness of debt, i.e. forgiveness of government-held loans or
other instruments of indebtedness, and grants to cover repayment of
government-held loans or other instruments of indebtedness;



(c) loans and other instruments of indebtedness provided directly to
enterprises that are uncreditworthy;



(d) provision of equity capital where the investment decision is
inconsistent with the usual investment practice (including for the
provision of risk capital) of private investors in the territory of that
Member; and



(e) other financing (i. e., =93royalty-based=94 or =93sales-contingent=94
financing or other similar financing) to an enterprise or project that
otherwise would be unlikely to receive such financing from commercial
sources.



The recent measures by the US and some European governments in extending
credit to troubled banks may well fall under the proposed prohibited
subsidy ( c), i. e. providing loans and other instruments to enterprises
that are =93uncreditworthy=94.



And if the governments purchase or nationalize bank equity (such as the
UK government did with respect to Northern Rock bank) or if they
purchase bad loans and securities from financial institutions to save
them from write-downs of capital (as is now being considered), these may
be construed as coming under some of the subsidy categories above, such
as provision of equity capital amounting to an =93unusual investment
practice=94.



The privatization of profits during booms and the nationalization of
private equity and loans gone bad during busts seem to be continuing in
the developed countries in new forms during this financial boom-bust cycle.



The turmoil continued last week following the Bear Stearns episode. On
19 March, Britain=92s largest mortgage lender and fifth largest bank,
Halifax Bank of Scotland (HBOS), came under massive speculative attack
and might have collapsed in similar fashion as Bear Stearns but for
quick action by the UK financial authorities to scorch false rumours
that the bank was in trouble.



HBOS lost 20% of its share value within minutes of the opening of the
stock exchange that day on rumours that it had sought emergency funding
from the Bank of England. The bank was facing a potential run from
depositors, which could have had disastrous effects on the system.



The Bank of England quickly rang up news organizations to deny the
rumours, said to be caused by short sellers that profited from the
sudden fall in HBOS shares. The London financial authorities then
announced that it was investigating market manipulation. By the end of
the day, the bank=92s share was only 7% down.



On 20 March, the Governor of the Bank of England held crisis talks with
the chiefs of Britain=92s five biggest banks, who reportedly pressed him
to take more emergency measures. Central bankers in the UK and Europe
made available billions of dollars more of liquidity in the financial
markets.



As one UK newspaper said, the markets =93stumbled into the long Easter
weekend... as the turbulence of the week finally proved the breadth and
depth of the financial crisis.=94



As shown in the cases of the UK=92s Northern Rock bank (which fell when
there was a run by depositors on the bank) and Bear Stearns (where
investors pulled out their funds), the loss of confidence in a financial
institution can cause it to collapse, and suddenly too. Bear Stearns
fell and was then taken over in only a few days.



A major problem is that trust has been eroded in the West in its
financial institutions, and there is also a lack of openness or clarity
in the real standing of these institutions, thereby making them
susceptible to rumours that threaten to be self-fulfilling.



Two weeks ago, the rumours hit Bear Stearns (which didn=92t survive), last
week, the rumours hit HBOS as well as the Wall Street investment bank
Lehman Brothers (both survived). Many are wondering which other
institution will be hit tomorrow by the rumours.



Many economists and analysts are now commonly talking about =93vicious
cycles=94, for example, how the crises facing banks lead to a squeeze in
credit they give out which in turn causes problems for borrowers like
house buyers and companies, which in turn worsens the banks=92 problems as
well as the real economy.



Lawrence Summers, former US Treasury Secretary, told a seminar earlier
this month that =93we are facing the most serious combination of
macroeconomic and financial stresses that the US has faced in a
generation, and possibly much longer than that.=94



A Financial Times article on 13 March quotes Summers as describing three
vicious cycles going on simultaneously:



     * A liquidity vicious cycle, in which asset prices fall, people
sell and therefore prices fall more;



     * A =93Keynesian vicious cycle=94, where people=92s incomes go down, s=
o
they spend less, so other people=92s income falls and they spend less; and



     * A =93credit accelerator=94, where economic losses cause financial
problems that cause more real economy problems.



Meanwhile, estimates of the losses suffered by the banking institutions
from the mortgage crisis are mounting.



The official estimate is US$400 billion, but Summers calls that
=93substantially optimistic.=94 The economist Nouriel Roubini envisages tha=
t
loan losses could total US$1,000 billion.



But the impact of these bank losses on the real economy will be multiple
times greater.



This was illustrated by the chief economist of Goldman Sachs Jan
Hatzius, who was reported by Financial Times (19 March) as showing a
chart to clients recently, which predicted that major banks and brokers
would suffer US$200 billion sub-prime-linked losses, but the impact on
bank lending would be much greater.



In the calculations, the US$200 billion loss would cut bank capital by
12%. If banks shrank their balance sheets by 12%, the implied reduction
in overall lending would total US$2,300 billion.



This estimation is in line with the =93financial accelerator=94 concept of
the Federal Reserve chairman Ben Bernanke (when he was an academic),
that losses to banks and declines in the value of their loan collateral
cause banks to reduce their lending and thus magnify the scale of an
economic downturn, according to the Financial Times article.



Each week brings new twists and turns in the financial crisis saga of
the Western countries. The effects of the crisis have not yet been much
felt in most developing countries. But it is a matter of time and the
big question is how badly or mildly will these effects be.