Last Wednesday, the British Prime Minister Gordon Brown gave a speech to Congress, parts of which were very surprising to me. Brown expressed a need for countries to work together to solve the global crisis, and he also suggested two important new measures:
1. A “Global New Deal”, or “Economic Marshall Plan”, and
2. Making the “shadow banking system” illegal
These two suggestions are actually quite radical, but I have not come across many details of these two suggestions. I will nevertheless attempt to speculate around these ideas.
A Global New Deal is hard to imagine ever coming to fruition. What Brown means by this seems to be that countries should come together and inject vast amounts of money in markets, where needed, in order to save and re-build those markets. Brown also seems to be talking about more tangible investments in industries to spur future growth, hence the mention of the Marshall Plan.
I assume that it would involve many different countries putting large amounts of money into a big pot, and then trying to decide where the money would help the most. Alternatively, if the global new deal involves countries simply coordinating financial rescue actions, it’s a little less hard to imagine, but still unlikely.
The issue of “international bailouts” has come up recently in the EU. Eastern Europe has been attempting to free itself from the chains of communism by creating an entire “subprime economy”. They took loans in foreign currencies such as Euros, Swiss Francs and Swedish Crowns. As Easter European currencies plunged in value, the loans skyrocketed in value.
It was thought to be an understanding in the EU that Eastern Europe could act fiscally irresponsibly in order to re-join Europe as equals, and that Western Europe would help them in case they ran in to trouble. When a number of Eastern European countries, such as Hungary, Romania and Bulgaria asked for an actual bailout, Germany said no. Germany feels a lot of resentment for having given up its own financial stability in order to support stability in the Euro and EU zone, and the country has apparently had enough.
When it comes to trying to convince many different countries to act in solidaric ways during a crisis, I believe there must be a system set up in advance. Otherwise, a country will have to choose between international solidarity or feeding its own population, and the former will obviously take a back seat.
Making the shadow banking system illegal, is quite a radical proposal, especially for the economies of the UK and the U.S.. Brown did not specify what he meant by the “shadow banking system”, but it is clear that he was referring to entities such as hedge funds and investment banks that are providing capital for lending in the economy.
In a way, this is a strange proposal, considering the fact that governments around the world have actively been participating in creating the “shadow banking system”, setting up entities like Fannie Mae and Freddie Mac. Brown seems to be saying that the banking system needs to go back to basics, to the way it was before governments started subsidizing mortgage rates (back 60-70 years ago in most cases).
Whether or not you expressly make the shadow banking system illegal, it is in the process of disappearing anyway. Brown’s comments seem to stem from a newly found clarity in terms of the real role of various financial institutions in the U.K. and the U.S., a clarity that he, like U.S. politicians, did not have when he was Chancellor of the Exchequer.
What Brown is suggesting is, in my mind, sound. If entities other than banks would stop providing enormous amounts of capital for all types of speculation, societies would become less reliant on stock markets, and the housing market would experience less swings. Mortgage rates would definitely become higher. Mortgage rates of over 20% were not too uncommon a few decades ago.
With respect to mortgages, I have for a long time advocated a system of covered bonds for the banks, like the one Germany has. I also believe that the Federal Reserve needs to be made into a government-owned Central Bank with a single, inflation fighting, mandate.
Moreover, I advise that the winner-takes-all voting system should be destroyed.