SUNDAY, JULY 18, 2010 EZRA KLEIN The drivers of financial crises
The imbalances that led to the financial crisis are likely to escape regulatory solutions. Household debt
Financial sector profit As a share of total corporate profit
50% 34% 40 30 20 10 8.5% 0 1950 1960 1970 1980 1990 2000 ’10
U.S. current account balance In billions of dollars
$100
-600 -500 -400 -300 -200 -100 0
-700 -800
1960 1970 1980 1990 2000 ’10 SOURCES: IMF, Federal Reserve, Bureau of Economic Analysis, Washington Post researcher Dylan Matthews $253.5 billion $6.9 billion
As a percentage of gross domestic product
100 80 60 40 20 0
%
KLMNO
Business
The company has taken responsibility. Would state-owned firms?
by Kyle Thompson-Westra 92.8% 44.8%
’75 ’80 ’85 ’90 ’95 ’00 ’05 ’10 THE WASHINGTON POST
Five places to look for the next crisis klein from G1
regulatory response. The most glaring omission: Fannie Mae, Freddie Mac and the crazed housing market that led to the crash. That issue is slated to go before Congress next year, but here are five that aren’t: “The global glut of savings.” “One of the leading indicators of a financial crisis is when you have a sustained surge in money flowing into the country, which makes borrowing cheaper and easier,” says Harvard economist Kenneth Rogoff. This crisis was no different: Between 1987 and 1999, our current account deficit —the measure of how much money is coming in vs. how much is going out — fluctuated between 1 and 2 percent of the gross domestic product. By 2006, it had hit 6 percent. Ben Bernanke, a man not known for a vivid turn of phrase, called the hundreds of billions of dollars that emerging economies were plowing into our financial system every year “the global glut of savings.” It was driven by emerging economies with lots of growth and few investment opportunities (think China) funneling their money to developed economies with less growth and lots of investment opportunities (think, well, us). The result was cheap money and fast growth that made our economy seem healthy when it really wasn’t. But we’ve gotten out of the crisis without fixing it. China is still roaring forward, accelerating exports and pouring money into the U.S. economy. And we’re happily taking it. With our economy weak and our deficits high, we need it. So after falling to 3 percent after the crisis, our current account deficit is back to 4 percent and rising. Rogoff thinks that’s a problem. “One or 2 percent would be more sustainable,” he says. The indebted American. The fact that money is available to borrow doesn’t explain why Americans borrowed so much of it. Household debt (mortgages, credit card balances, etc.) as a percentage of GDP soared from a bit less than 60 percent in the early 1990s to a bit less than 100 percent in 2006. “This is where I come to income inequality,” says Raghuram Rajan, an economist at the University of Chicago. “A large part of the population saw relatively stagnant incomes over the ’80s and ’90s. Credit was so welcome because it kept people who were falling behind reasonably happy. You were keeping up, even if your income wasn’t.” Incomes, of course, are even more stagnant now that unemployment is bumping up against 10 percent (and underemployment is nearer to 15 percent). And that pain isn’t being shared equally. Inequality has actually grown since before the recession—joblessness is proving sticky among the poor, but recovery has been swift for the rich. Household borrowing is still above 90 percent of GDP, and the conditions that drove it up there are, if anything, worse. The shadow banking market. The Great Depression was visually arresting: long lines of
desperate families trying to get their money in hand before the bank collapsed. The financial crisis started out similarly severe, but aside from some despondent-looking traders, there was little to look at. That’s because this bank run wasn’t started by families. It was started by banks. Regular folks didn’t pull their
money out of the banks, because our deposits are insured. But large investors — pension funds, banks, corporations and others —aren’t insured. They use the “repo market,” a short-term lending market in which they park their money with other big institutions in exchange for collateral, such as mortgage- backed securities. This is the “shadow banking system” — it’s a real banking system, but it’s young, and until now largely unregulated. As such, it’s been vulnerable to the sort of problems we ironed out of the traditional banking system decades ago.
When institutional investors hear that their deposits are endangered, they run to get their money back. And when everyone panics at once, it’s like an old- fashioned bank run: The banks can’t pay off everyone immediately, so they unload all their assets to get capital. The assets become worthless because everyone is trying to sell them at the same time, and the banks collapse. “This is an inherent problem
of privately created money,” says Gary Gorton, an economist at Princeton University. “It is vulnerable to these kinds of runs. It took us from 1857, which was the first panic really about deposits, to 1934 to come up with deposit insurance.” This year, we’re bringing this shadow banking system under the control of regulators and giving them all sorts of information on it and power over it, but we’re not creating anything like deposit insurance, where we simply made the deposits safe so that runs became a thing of the past. The “It’s so little money!” problem. In the 1980s, the financial sector’s share of total corporate profit ranged from 10 to 20 percent. By 2004, it was about 35 percent. That’s a lot of money in a few hands. Simon Johnson, an economist
at MIT, recalls a conversation he had with a hedge fund manager. “The guy said to me, ‘Simon, it’s so little money! You can sway senators for $10 million?’ ” Johnson laughs ruefully. “These guys don’t even think in millions. They think in billions.”
This financial crisis will stick in our minds for a while, but not forever. When it fades, the finance guys will begin nudging. They’ll hold fundraisers for politicians, make friends, explain how the regulations they’re under are onerous and unfair. And slowly, surely, those regulations will come undone. And they’ll have plenty of
money with which to do it. After briefly dropping to less than 15 percent of corporate profits, the financial sector has rebounded to more than 30 percent. Can regulation fix, well, regulation? The most troubling prospect is the chance that this bill, if it had passed in 2000, would not have prevented this financial crisis. That’s not to undersell it: It would’ve given regulators more information with which to predict the crisis. It would have created a consumer financial protection agency that might have intercepted the subprime boom. But plenty of regulators had enough information, and they did not act.
Bubbles always fool the
regulators with the powers to pop them; otherwise they would have been popped. In 2005, with housing prices running far, far ahead of the historical trend, Bernanke said a housing bubble was “a pretty unlikely possibility.” In 2007, he said Fed officials “do not expect significant spillovers from the subprime market to the rest of the economy.”
Alan Greenspan, looking back
at the financial crisis, admitted that regulators “have had a woeful record of chronic failure. History tells us they cannot identify the timing of a crisis, or anticipate exactly where it will be located or how large the losses and spillovers will be.” But this bill leans heavily on
regulators: According to the U.S. Chamber of Commerce, the bill includes 533 rules and calls for 60 studies and 94 reports. Regulators will be in charge of all of them.
Greenspan, in that same speech, expressed a preference for rules that “kick in automatically, without relying on the ability of a fallible human regulator to predict a coming crisis.” The bill contains precious few of those, at least for now. “In history,” Princeton’s
Gorton says, “it always takes us a long time to get financial regulation right, and I expect it will this time, too. Maybe we’re done for this year, or the next couple. But we can’t possibly be done.”
kleine@washpost.com
news just isn’t getting better. Even when there’s hope of a cleanup, an accident sends us back nearly to square one. The American public is incensed, the finger-pointing refuses to end, the U.S.-British “special relation- ship” is straining, an offshore moratorium is declared but over- ruled, and even as the blown-out gulf well was sealed Thursday, anxiety lingered about whether the cap would hold. It’s a mess in ev- ery sense of the word. But this could be far worse. Imagine if BP were a state- owned oil company. Instead of reasoning with an incompetent chief executive, we’d be reasoning with a protectionist prime min- ister. Regarding BP, this is a thought experiment. But there are plenty of state-owned compa- nies drilling in U.S. waters and abroad. The next oil spill could be more than just an economic and environmental crisis. It could be a diplomatic one. As it is, the BP spill has caused tension between the United States and Britain. President Obama has been accused by Brit- ish media and officials of xeno- phobia, waging a campaign of hate, and general “Brit-bashing.” British Prime Minister David Cameron, meanwhile, has been criticized for not taking a stron- ger stance in favor of BP. At a time when some are saying the “spe- cial relationship” is over, a tiff over BP isn’t exactly what the friendship needs. Humor me and picture what would happen if BP were owned by the British government. We would be facing a situation in which a foreign government would be directly responsible for the ever-worsening spill on our domestic shores. The United
T
he Deepwater Horizon oil spill has been with us near- ly three months, and the
States and Britain have had argu- ments before, and the national- istic vitriol coming from both sides would be 10 times worse as issues of blame, recovery costs, national pride, domestic security, and economic competition are endlessly debated between lead- ers, economists, and cable pun- dits.
The Big Money is a financial news and analysis Web site from the Slate Group.
That’s still the rosy scenario, because at least Britain is an ally. There are plenty of countries that are not, and they happen to own their oil companies — Venezuela, China, Iran, and Russia being among the biggest. These petro- leum-rich countries are placing more importance on their nation- alized oil companies as a way to ensure a steady supply to guard against growing do- mestic demand and changing market con- ditions. The oil industry is
dominated by state- owned companies. Multinationals might
have more name recognition with the public — ExxonMobil, Royal Dutch Shell, BP, Chevron — but they have full access to 6 percent of worldwide oil reserves. Eighty- eight percent of reserves are held by national oil companies, which also represent the majority of worldwide production. (It’s un- known the percentage of oil that state-owned companies get from outside their countries’ shores.) Companies such as Aramco, Pe- trobras, Sinopec and Pemex aren’t household names, but they will be as oil becomes scarcer and they can throw around their weight even more due to their dominance of existing oil re- serves. We’re already seeing potential hotspots, and the United States isn’t the only country that should be worried. Chevron and Rosneft (owned by the Russian govern- ment) will begin drilling in the Shatsky Ridge of the Black Sea at the end of 2011. The Black Sea is bordered by Russia, Georgia, Tur- key, Bulgaria, Romania and Ukraine — countries that, to put it lightly, don’t always get along. Any substantial accident would be seen as a Russian oil company contaminating its oft-slighted neighbors. Cue the international
G5 How BP’s mess could be worse
crisis. More potential trouble could happen in the South China Sea, where China-owned CNOOC con- tinues to expand its operations. As many as 10 countries surround the South China Sea, and its im- portance as a major shipping zone and an area of ecological di- versity cannot be overstated. It is already a geopolitical hotspot, and any disaster caused by a state-owned company might un- ravel any diplomatic progress be- ing made. Even the Gulf of Mexico might see trouble again. Brazil’s Petro- bras drills in the gulf, and has been ramping up its operations in the area for several years. Brazil has relatively good relations with its neighbors in the Americas, but a Deepwater Horizon-style dis- aster could significantly change the political dynamics of the re- gion. It doesn’t have to be a blown
offshore platform that changes everything. Accidents can hap- pen at any point in the supply chain. A recent death at the Port Arthur, Tex., refinery (owned by Shell and Aramco) highlights the potential for more tension. A sub- stantially destructive accident at any step of the oil extraction, re- fining or transportation process could stain relations as well. If we can be sure of one thing in
the aftermath of the BP spill, it’s that it won’t be the last. Countries have not used the BP oil spill to stop offshore development: Deep- water production is anticipated to increase by two-thirds within five years, and state-owned oil companies in general are poised to continue their strong growth. Strides in renewable energy
aren’t happening quickly enough to substantially reduce global de- mand of oil. That oil isn’t plenti- ful enough to be extracted as easi- ly anymore, meaning companies are using more and more poten- tially dangerous methods to get at it. As BP has shown, danger can only be averted for so long.
Thompson-Westra is a research assistant at the Center for Strategic and International Studies in Washington. CSIS does not take specific policy positions, and the views expressed are the author’s own.
This announcement is neither an offer to sell nor a solicitation of bids to purchase the Bonds. Under no circumstances shall there be any sale of the Bonds in any jurisdiction in which the offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of such jurisdiction.
PROPOSED NEW ISSUE $200,000,000*
State of Maryland General Obligation Bonds
State and Local Facilities Loan of 2010 Second Series A (Tax-Exempt Bonds)
RETAIL SALE PERIOD—July 23, July 26 and July 27, 2010 (Sale period may be terminated earlier based on demand or market conditions)
• Federal and Maryland State and local income tax-exempt for Maryland residents**
• Expected maturity range of Second Series A: 2013 through 2018
• Confirmed ratings: Aaa (Moody’s) AAA (S&P) AAA (Fitch)
To obtain a copy of the Preliminary Official Statement for the 2010 Second Series A Bonds, please contact an investment professional at:
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