Economy and finances

Main characteristics of the financial crisis
Intense diplomatic activity to curb the crisis
The summit on financial markets and the global economic and its results

1. The about-turn of the American real estate market in 2007 and the increased defaults on payments by households in debt accentuated the fragilities of the financial system, revealed dramatically by several events in September 2008: Lehman Brothers’ bankruptcy, Bank of America’s buyout of Merrill Lynch.

The Fed has intervened extensively, in particular to deal with the drying up of liquid assets on the interbank market.

A rescue plan (State’s assumption of all or part of the doubtful assets) was negotiated with Congress, adopted on 3 October, and then redirected on 12 November (abandoning the buyout of toxic assets in favour of a direct buyout of bank shares [up to 250 billion dollars], extension of the rescue plan to credit related to credit cards, automobile financing and student loans).

2. Many analyses have focused on the causes of this crisis: excessive and unregulated growth in the high-risk mortgage financing market in the United States (subprimes), itself resulting from the growing debt of American households, encouraged by the US Federal Reserve’s expansionary monetary policy and the abundant supply of liquid assets at the international level, a securitization mechanism for these debts through complex financial products on banks’ off-balance sheet and disseminated all around the world, serious failures in terms of financial regulations, risk detection (credit agencies) and warning mechanisms.

3. This crisis, the epicentre of which is in the United States and not in emerging countries, as was the case in the 1990s, has created a considerable shock of confidence in all of the financial markets. It is a new episode of severe turbulence that began during the summer of 2007 (collapse of two Bear Stearns bank hedge funds), which has spread throughout the entire international financial system. Beginning Monday, 15 September, the stock markets have been falling dramatically, threatening the entire financial system. Another very extensive drop began on 6 October (-3.5% in New York, -9% in Paris, -7% in Frankfurt, -6% in Asia, -19% in Moscow), continuing in stages all week long.

Despite a temporary recovery in mid-October, following announcements about the different bank rescue plans, the global stock market situation has continued to deteriorate over the medium term and has remained extremely volatile, with market operators anticipating the effects of the financial shock on the real economy.

4. Beginning in September 2008, the crisis has extended to the European banking sector: emergency rescue of Fortis and Dexia, the Bavarian bank Hypo Real Estate (after the IKB bank), nationalization of the British bank, Bradford and Bingley (after that of Northern Rock), difficulties of the Italian bank Unicredit, and Irish banks (announcement of open-ended government deposit insurance for six banks), partial nationalization of Britain’s largest banks, worth 50 billion pounds (65 billion euros).

In the face of the extent of the liquidity crisis (virtual paralysis of interbank loans) and the risks hanging over the solvency of financial players, a massive European plan was adopted on 12 October 2008 (Eurogroup meeting) with national variations: 1,700 billion euros were mobilized, including 360b in France, comprising funds earmarked for recapitalization of banks in trouble and public interbank loan guarantees.

Two structures have been created in France:
  a Société de Prise de Participations de l’Etat (SPPE, state equity holdings company) tasked with recapitalizing banks at up to 40 billion euros;
  a refinancing company, 66% bank-owned and 34% State-owned, is tasked with providing medium-term refinancing to banks up to 320 billion euros.

In addition, measures to support economic activity have been taken: business tax waivers for new investments, creation of a strategic French investment fund, specific SMB measures for 22 billion euros or for local communities up to 5 billion euros. Finally, measures promoting employment have been adopted (extension of the professional transition contract, 100,000 additional assisted jobs, one-stop shop for job seekers).

5. The impact of the crisis is manifold and has called for several levels of response:

  The impact of the financial crisis on the real economy and its dissemination worldwide: the IMF’s growth forecasts for 2009, revised on 6 November, bring to light the dramatic slowdown in world growth, with this latter being led almost exclusively by developing countries - Asian countries in particular (IMF forecasts in 2009: -0.3% for developed countries, 5.1% for developing countries).

  World trade is also expected to slow dramatically (+2.1% in 2009 against +9.4% in 2006) and unemployment should rise significantly (+20 million in 2009, for a global total of 200 million, according to the ILO). Consequently, many countries have adopted recovery plans (for example, 455 billion euros for China) through the end of 2010 or are planning to do so (the United States, after Barack Obama’s victory, with 800 billion planned for 2009-2010).

  The European Commission presented a community plan for economic recovery on 26 November 2008 (proposing that the Member States and the EU agree on an immediate budget impetus of 200 billion euros, i.e. 1.5% of GDP). Focus is on the possibility of a concerted recovery using the budgetary margins of certain countries (Germany, Japan, and China, specifically).

  The risks of destabilization of countries presenting macroeconomic and financial fragility: withdrawals of international capital and flight to “refuge currencies” (dollar, yen, Swiss franc) put pressure on many emerging countries’ currencies (which increases their debt, often made out in dollars, and which causes their central banks to increase their leading rates to protect their currency, at the risk of damping the economy) and threaten the equilibrium of their balance of payments (in particular for countries with low foreign exchange reserves).

Consequently, the IMF was led to conduct emergency interventions beginning in mid-October 2008: accordingly, Iceland obtained a 2.1 billion dollar loan on 24 October (first European country in this situation since 1976), the terms of which remain under discussion, followed by the Ukraine (16.5 billion dollar loan announced on 26 October) and Hungary on 28 October (12.5 billion dollar loan from the IMF, 1 billion from the World Bank, 6 billion euros from the European Commission under the medium-term financial assistance mechanism). A 7.6 billion dollar bridging loan for Pakistan was announced on 16 November 2008. The financial situation of other States remained fragile in November, with discussions underway with the IMF or support measures being decided on.

In order to deal with these new obligations, the issue of the IMF’s resources (approximately 250 billion dollars) is a focal point (with Japan announcing its availability to provide 106 billion dollars on 13 November).

  In the medium and long terms, the impact of the crisis on the poorest and most vulnerable developing countries: these latter might fall victim to a “scissor effect” between, on one hand, a reduction in financing flows (tensions in terms of the volumes of official development assistance, incoming flows of foreign direct investments and migrant transfers, reduced export revenues), and, on the other hand, the need to provide “social safety nets” for the sectors and populations affected the most.

  The situation of oil-exporting countries hardly appears to be any better (drop in the price of the barrel from 147 dollars to less than 50 dollars in four months, despite OPEC’s strategy aiming to decrease its supply by 1.5 Mb/day, according to the decision made in October), which threatens the fiscal balance for many of them.

1. There have been many international meetings devoted to the financial crisis: at the European level, first, with the G4 format summit on 4 October (European G8 members + commission + ECB + President of the Eurogroup), the ECOFIN Council (7 October), the summit of Euroland countries (12 October), European Council (15 and 16 October), at the international level, G7-Finance (10 October), before the annual IMF/World Bank meetings (11-12 October), ASEM summit (Beijing, 24-25 October), ECOFIN Council of 3 November before an extraordinary European Council on 7 November, G20 Finance in Sao Paolo on 8 and 9 November (presided over by Brazil, before the United Kingdom in 2009), and the United Nations has also mobilized: debate on 30 October at the UNGA on the initiative of Father d’Escoto (Nicaragua) before a debate of the same type at UNCTAD on 13 November, the Doha Conference on Financing for Development (27 November to 2 December), the importance of which was stressed by the UNSG in the “systemic issues”.

2. There are many key elements to the mobilization of the international community during autumn of 2008:
  Adoption of emergency measures coordinated by the States and central banks, focussing on four major groups of measures: States buying toxic assets (Paulson plan), recapitalization of banks in trouble (partial or total nationalization), public interbank loan guarantees in response to the liquidity crisis, public guarantees of - Launching of work on regulation issues (accounting standards, harmonization of rules on deposit insurance, transparency and security of operations in credit derivative markets, credit agencies, executive compensation, and offshore financial centres, etc.);
  Concerted drop in major central banks’ leading rates (the leading rates of six central banks dropped 50 basis points on 8 October, the Fed’s rates dropped again in late October to 1%, the ECB has dropped its rates successively, bringing its leading rate most recently (15 January 2009) to 2%), and commercial banks have received regular injections of liquidities;
  Growing consensus on a complete review of international financial architecture (although the level of ambition of the G20 members varies) and to discuss issues of economic governance (the role of the IMF, the financial stability forum, arenas like the G7/G8/G13/G14/G20, the UN/Bretton Woods institutions connection, etc.).

During the United Nations General Assembly in September 2008, the French President put forward the principle of a summit at the level of heads of state and government, in order to learn from the financial crisis together. This proposal was supported by European countries and the G8 countries (declaration of 15 October). On 18 October, during a meeting with the French President and the President of the European Commission at Camp David, President Bush gave his approval for a “series of summits” at the level of heads of state and government, the first of which would be held in the United States after the US elections, with a view to assessing the emergency measures already taken and defining the principles of a more global reform of international financial architecture.

The summit was held on 15 November 2008 in Washington in the “G20” format, that is, with the G8 countries, the Presidency of the Council of the European Union, and 11 major emerging countries, ie three Latin American countries (Mexico, Brazil, and Argentina), one African country (South Africa), five Asia-Pacific countries (China, South Korea, India, Indonesia, and Australia), as well as Saudi Arabia and Turkey. The United Nations Secretary General, the President of the World Bank, the Director General of the IMF, and the Chairman of the Financial Stability Forum (Mario Draghi) also took part, as well as Spain. This “G20” format at the level of leaders is a first (as a reminder, the G20, which resulted from the 1997-98 Asian crisis in 1999, had until then met only at the level of Finance Ministers annually).

The objectives of this first summit were, in particular:
  to review, depending on the situation, the measures already taken;
  to reach a common understanding of its causes; - to define the principles needed to guide the reforms in the area of architecture and financial regulation;
  to discuss the consequences of the crisis for emerging and developing countries.

Working groups would then be tasked with specific mandates for the following summits. In late October, IMF Director General Dominique Strauss-Kahn put forward a five-point action plan, including the establishment of new IMF instruments (new financing facility intended to respond to liquidity problems), an increase in its resources and strengthening its prevention and warning role. World Bank President Robert Zoellick called for new international economic governance, with variable geometry, bringing the G8 and emerging countries together.

The European members of the G8 showed their ability to weigh in collectively on this meeting, bringing the proposals defined by the European Council:
  subjecting credit agencies to registration, oversight, and governance rules;
  formulation the principle of a convergence of accounting standards;
  deciding that no market segment, no territory, no financial institution is exempt from proportionate and adequate regulations, or at least oversight;
  establishing codes of conduct to prevent excessive risk from being taken in the financial industry; - giving the IMF the overriding responsibility of recommending measures needed to restore confidence and stability.

Finally, the Europeans called for comprehension of the reform of the international financial system in the greater context of the challenges of the 21st century: food safety, fight against poverty, climate change, promotion of free trade through the fast conclusion of the Doha cycle. These proposals were reiterated in part by the G20 Finance, which met in Sao Paulo on 8-9 November. This latter agreed to take “all the measures necessary” to restore confidence shaken in the markets and to give developing countries a bigger voice in global economic affairs.

The summit in Washington made it possible to establish a consensus on a diagnosis and common course of action against this global crisis:

  The seriousness of this crisis, which has resulted in a widespread economic slowdown, calls for a joint response from the world’s main economies;

  This response is based on four principles:

• coordinated and concerted recovery through the use of budgetary measures supporting demand and the mobilization of increased aid for emerging and developing countries:
• new financial market regulation, to prevent such a crisis from happening again. More regulation does not mean an excess of regulations, that would result solely in paralyzing the system;
• global economic governance more open to emerging and developing countries, for increased justice and efficacy;
• refusal of protectionism and the choice of a world open to trade.

  The next summit, which is currently being prepared, is expected to take place on 2 April 2009 in London and has two objectives:

• To assess the action plan adopted on 15 November for new financial market regulation;
• To discuss the new international economic architecture and the issue of recovery.

Updated: January 2009