The unprecedented sub-prime crisis in 2007, drastically changed the outlook for the world economy. Banks are always the pivotal institution controlling the flow of credit and when confidence is lost they start to retrench by slowing down their lending. Indeed, it is no secret that confidence among top bosses around the world has plummeted in recent months.
The sour fact is that on the stock markets, the prolonged decline of all major indexes in recent months accelerated to a fast and steep drop. At the end of 2008 there was a despondent note that markets dropped almost 50 per cent on a year-to-year measure. Continued slashing of interest rates and other monetary measures have not cured the patient, although it is a step in the right direction taken by a number of western economies. The downfall is the worst one we faced for the past 60 years and the dotcom crash is dwarfed by sheer comparison. More than 40 heads of state and government, about 35 finance ministers and central bankers and other corporate leaders are attending the World Economic Forum to try to forge a consensus on how to fix the crisis. This is the 39th World Economic Forum annual meeting in Davos, Switzerland, aimed at tackling the worst crisis ever facing its delegates. As can be expected, concrete solutions were hard to find.
Thus, on the agenda were a number of burning questions asking whether capitalism has failed us. Considering the deep recession and the cost of lost jobs, one would be excused to denounce the unfettered capitalism of the past three decades and call for a new era of “social capitalism” in which government intervention and regulation feature heavily. It comes as no surprise that a poll of business leaders suggests any recovery could take three years, even though leaders at the Davos conference all hope for a speedy recovery.
As an example, the British prime minister, Gordon Brown, speaking to a CNN correspondent said that the UK’s low interest rates and low inflation will help the country get out of recession but the recovery needs a concerted effort by all to succeed. More confident was Abhisit Vejjajiva, the new prime minister of Thailand. He feels that his country has turned a corner, with an economic stimulus package making its way through parliament. So does this lead us to punish the bankers who exceeded their remit and run the global economy to its knees or shall we examine in more detail what type of banking regulation is adequate and how effective it works in times of crisis? Those that want to blame the regulators seem to fail to notice that the process can only perform well if there are well trained regulatory people at the helm. It appears that overseas banking regulation particularly in America has come in for a ton of blame for the mess the sub-prime debacle has created. Regulators have had the authority to examine any aspect of a bank’s activities. They had the authority to figure out what was going on at the banks and to limit it. Can we say that in view of what went so wrong the regulators did something too little too late? With this argument in mind does reaching out for a new ‘Sarbanes Oxely’s act in the banking circle mean anything given that the regulators cannot or will not do their jobs. At the World Economic forum in Davos some leaders commented that throughout the various banking scandals of the past 25 years, rogue bankers have proven that they are not to be trusted. Others felt that the anger at the bankers in America is misdirected. If they acted in their self interest, just as anyone else in their position would have, and took advantage of what was made available to them then the blame should be on Congress and regulators. Skeptics disagree about this and lament that central government intervention does not solve anything. In their opinion the crisis has to run its course. Free market solution dictates that the best resolution to this problem is not protectionism or nationalisation of banks but to let the market eliminate the lame ducks through bankruptcy. Typically, the latest attempts in US and Britain to prop up failed credit institutions and businesses is deemed a waste of taxpayers’ monies. It is given that these entities need to fail, otherwise we’ll never have a solid foundation to build upon. Also, they are doubtful about the transparency in regulation and demand a branch and root revision of central bank rules. Armed with past failures, they contend that we can’t have central banks manipulating some of the markets the way they have done unbridled in the sub-prime sector.
Thus, controlling market behavior through artificially low interest rates and currency inflation does not work unless this is buttressed with effective regulation and adequate safeguards. The idea behind the US TARP programme to buy out toxic debts is debatable as it means rewarding failure through bailout policy. Secondly, the policy to reward private sector failure with tax payer monies is questionable unless well controlled and documented. To continue on the theme, one refers to
the dreaded word ‘depression’. This was jealously guarded by commentators at the same time as Bernanke went into overdrive to cool down tensions and continue to slash interest rates.
Another hot topic debated in Davos was unemployment. The German economy is slumping with over two million unemployed and its recovery has so far eluded the party in government. German industries are now seen to be suffering from lack of agility to switch from declining sectors such as mechanical engineering to growing sectors such as biotechnology.
How do we compare in Malta? Laid-off workers and idle factories are becoming a daily feature of the tabloids with the recent announcements on ST Microelectronics’ plans to downsize. Other factories exporting to European economies have suffered a drop in consumer demand and some are working on a four day week. Airmalta is keeping a straight face in not announcing any layoffs against all odds amid mounting costs arising from escalating jet fuel prices, losses on exchange and lease costs. The airline was reported to expect a ‘drastic drop’ in revenue this year as a direct result of a heavy decline in traffic from its key markets. The bright side to the coin is that efforts are in progress to speed up the Smart City project.
The mood in Davos should teach local investors a lesson to refrain from succumbing for the thrilling temptations of fast and short-lived performance hunting.
Certainly SMEs are clamouring for a fiscal stimulus and a cut in fuel tariffs to kick start the domestic economy. Their union, the GRTU has presented a number of practical proposals to government to buck the downturn trend.
To conclude, it is the task of every responsible government to warn citizens of the pitfalls of irrational exuberance that echoed the grave mood in general consensus reached by world leaders in Davos.
Partner at PKF – an audit and business advisory firm