Options for Dealing with Systemic Banking Crises

Bernard Lietaerblietaer@earthlink.net

WAASHyderabad

Losses Acknowledged to September 2008

• Lehman Brothers (USA) - $17 billion (bankrupt)

• Bear Stearns (USA) - $3.2 billion (bankrupt) • Merrill Lynch (USA) - $46 billion (acquired)• JP Morgan (USA) - $5 billion (reformed to

bank holding company)• Morgan Stanley (USA) - $12 billion (reformed)• Citigroup (USA) - $47 billion • Bank of America - $7 billion • Goldman Sachs (USA) - $3.8 billion • Wachovia (USA) - $6 billion • UBS (Swiss) - $37 billion • Credit Suisse (Swiss) - $6 billion • Northern Rock Bank (UK) – £50 billion +

(went bankrupt) • Royal Bank of Scotland (UK) - $11.8 billion

• Barclays Bank (UK) - $9.9 billion • HSBC (Bank, UK) - $6 billion • HBOS (Bank, UK) - $2 billion • Lloyds TSB Bank (UK) - $1.7 billion • Deutsche Bank (Germany) - $10 billion • BayernLB (Germany) - $3 billion • IKB (Germany) - $2.6 billion • Commerzbank (Germany) - $1.1 billion • WestLB (Germany) - $1.5 billion • Credit Agricole (France) - $7 billion • Societe Generale (France) - $6 billion • Nataxis (France) - $4.3 billion • UniCredit (Italy) - $1.6 billion • National Australia Bank - $1 billion

• Total acknowledged to August 2008: $ 358.7 billion out of a total subprime losses of $ 1200 billion…

In short, our global financial system is in…

Implications?

• “Let's recognize that this is a once-in-a-half-century, probably once-in-a-century type of event.” Alan Greenspan => back to the 1930s?

• “This recession will be long, ugly, painful and deep.” Nouriel Roubini, Prof NY University

• Last time we dealt with a crisis of this size, we “solved it” by creating widespread fascism and WW2– Can we do better this time?

Plan

• Why Save the Banks?

• Symptom Alleviation Options

• Systemic Cause

• Systemic Options

• Pros and Cons

• My Proposal

• Conclusions

Why Save the Banks?

• Lesson from the 1930s: “2d Wave” Crisis– When many banks bankrupt at the same time they

trigger a “2d Wave” recession in the “real economy” – Reason: banks stop financing “real economy”

• Banks have monopoly of issuing legal tender=> Strangulation of all other economic sectors

• Consequence: “Moral Hasard”: – “Too Big to Fail” banks take high risks– If profitable => private winnings– If failed => governments will bail them out…

Costs of Bank Bailouts (% GDP)

• Sweden 1991 3.6%• USA 1988 3.7%• Spain 1977-85 16.8%• Japan 1997 24% • Venezuela 1994-5 18%• Mexico 1994 19.3%• Chili 1981-83 41.2%• Thailand 1997-98 45%• Malaysia 1997-98 45%• Argentina 1980-82 55.3%• South Korea 1997-98 60%

• USA 2008 (so far) 5.8%

Plan

• Why Save the Banks?

• Symptom Alleviation Options

• Systemic Cause

• Systemic Options

• Pros and Cons

• My Proposal

• Conclusions

Symptom Alleviation Options

• Nationalizing the Problem Assets– Preferred by banking system– US approach– Most expensive solution because un-leveraged

• Nationalizing the Banks– European approach– Leverage of bank capital to money creation (minimum

x10)– NB: Actual leverage ratio: Deutsche Bank 1.2%

UBS 2.1%

Barclays 2.4%

Unresolved Problems of Conventional Solutions

• “2d Wave” problem only partially solved– Banks restart lending normally only after their balance sheet is

restored– Even with bailouts, takes minimum 3-6 years

• When large scale problem: 2d Wave vicious circle– Bad bank balance sheet => lending restrictions => recession =>

worsens banks’ balance sheet => more lending restrictions…=> depression?

• Deals only with central institutions problems– Bankruptcy of financial institutions that are not “too big to fail” – Local and State governments in financial trouble…

• Further worsens unemployment and social problems• Example: New York has to cut 2009 budget by US 1.5 Billion…

Plan

• Why Save the Banks?• Symptom Alleviation Options• Systemic Cause• Systemic Options• Pros and Cons• My Proposal• Conclusions

Symptoms of Systemic Cause?

• This is the biggest but not the first such crisis– World bank identified 96 banking crises and 176 monetary crises

in recent 20 year period– Such crisis are a remarkably “hardy perennial” (Kindleberger)

• 48 well documented major crashes between 1637 and 1929.

– Happened under very different regulatory systems, different countries, at different development levels, at very different times…

• My claim: financial system is systemically unstable– “An accident waiting to happen” explains also why huge efforts by

very bright and dedicated people (in central banks and private financial system) repeatedly fail to avoid crashes…

Complexity Theory

• Robert Ulanowicz: 25 years of quantitative modeling of real-life ecosystems using complexity, information and network theory

• Key finding: Sustainability is measurable with a single metric as an optimal balance between “throughput efficiency” and “rebound capacity”.

• NB: Emergent properties from a network structure are independent from what is being processed: biomass in an ecosystem, electrons in electrical circuit, money in an economy…

Sustainability in Natural Ecosystems

Optimum

Rebound capacity ( Throughput Efficiency (A)(Diversity + Interconnections) (Streamlined)

Sustainability

0%

100%

“Window of Vitality” in Natural Ecosystems

Optimum

“Window of Vitality”

Rebound capacity ( Throughput Efficiency (A)(Diversity + Interconnections) (Streamlined)

Sustainability

0%

100%

Application to Monetary System

Effect of MonopolyOf Conventional Money

Current operation of Financial system

Optimum

“Window of Vitality”

Optimum

“Window of Vitality”

Rebound capacity ( Throughput Efficiency (A)(Diversity + Interconnections) (Streamlined)

Sustainability

0%

100%

Application to Monetary System (2)

Effect of Complementary

Currencies

Current operation of Financial system

Optimum

“Window of Vitality”

Rebound capacity ( Throughput Efficiency (A)(Diversity + Interconnections) (Streamlined)

Sustainability

0%

100%

Plan

• Why Save the Banks?• Symptom Alleviation Options• Systemic Cause• Systemic Options• Pros and Cons• My Proposal• Conclusions

Systemic Solution #1 Nationalize the Money Creation Process

• Money is a public good, that was first privatized in favor of banks in 17th century, to finance wars– Anomaly: bailing out banks with bank-debt money reimbursed

with interest by taxpayers?• Governments can spend money into existence

– Banks become simply money brokers – Banks lend out what they receive in deposit End of fractional reserve system => no bank failures anymore (However, will be fiercely resisted by bank system…)

• Risk: politicizing money creation process can lead to hyper-inflation – However, fractional reserve process has also created periodic

hyper-inflation…

Systemic Solution #2Ending Monopoly of Bank-debt money

• Governments (central and/or local) accept in partial payment of taxes carefully selected complementary currencies (other than bank-debt money).– Complementary currencies could be those created by local governments, or

by corporations (b2b such as WIR, Terra), or even local non profits (social purpose currencies).

– Very flexible (choice of currency, time, percent accepted, etc.)– Example of partial precedent: Russia accepted payment of taxes in copper

during rubble crisis.• Doesn’t end privilege of bank-debt money as legal tender, only

temporarily their monopoly...– Doesn’t end the banks’ business model– Complementary currency management can in fact be a new banking service

• Criticism: less efficient…but that is exactly what is recommended

Plan

• Why Save the Banks?• Symptom Alleviation Options• Systemic Cause• Systemic Options• Pros and Cons• My Proposal• Conclusions

Options for Managing Banking Crises

Approach Bankers Taxpayers/

Central Governments

Local

Governments2d Wave Systemic

Cause

ConventionalNationalizing

Problem Assets

Preferred

Most Expensive

(no leverage) Unaddressed delayed Unaddressed

Nationalizing

BanksEquity Dilution

10x leverage Unaddressed delayed Unaddressed

Unconventional

Nationalizing

Money CreationEnd of current business model LT solution (but

inflation?)Unaddressed Governments spend

money into existenceUnaddressed

Complementary Currencies End of

monopoly of money creation

‘

LT solution LT & ST solution

LT & ST solution

Systemic Solution

Plan

• Why Save the Banks?• Symptom Alleviation Options• Systemic Cause• Systemic Options• Pros and Cons• My Proposal• Conclusions

My Proposal

• Bailouts will happen in any case, and my proposal kicks in if and only if the recession or depression of “2d Wave” starts biting…

• Temporarily, while banks can’t fulfill their funding role at appropriate levels, have local and states accept partial payment of taxes in selective and robust complementary currencies– Selection of currencies can be lined up with political objectives– Start with robust B2B currencies (because best auditable)– Implement WIR and Terra type systems…

• Complementary currencies are useful to solve problems even without any crisis– Over time, local and state governments can encourage them in

other ways than acceptance in taxes in the future

Plan

• Why Save the Banks?• Symptom Alleviation Options• Systemic Cause• Systemic Options• Pros and Cons• My Proposal• Conclusions

Conclusions

• Re-regulation is necessary and will be on everybody’s agenda, but it can only make such crises less frequent, not eliminate them.

• We can do better than in the 1930s – avoiding fascism and a World War? – but only if we consider systemic options…

• The systemic option of complementary currency is – within the political decision power of local and state governments – Very flexible in terms of how and for what it is implemented– An acceptable compromise for banking system?

Follow up

Key Points

• Systemic problems in Today’s International Money System “We now have a non-system” Schmidt, Chancellor of Germany “We need a new Global Currency” Paul Volcker, ex-Chairman Federal Reserve

Board “I foresee private currency markets in the 21st century” Alan Greenspan,

Chairman, Federal Reserve Board

• Growing Risk of a Global Recession or Depression

Both problems solved by a business initiative to create Terra, a new Electronic International Complementary Currency

A Complementary Currency is a medium of exchange circulating in parallel with - not replacing - conventional currencies.

Familiar example of complementary currency: Frequent Flier Miles

A better way?

Four Systemic Problems with Today’s Money System

1. Financial Instabilities The current banking crisis is #97 over past two decades World Bank

2. No International Standard of Value Currency Risk now dominant risk in International Business

• When coverage is available hedging costs are incurred.

• When coverage not available (e.g. LDCs), less investments lead to despair and ultimately extremism/terrorism.

3. Pro-cyclical Money Creation amplifies business cycle

Today’s money created as bank-debt• During booms, credit is easy => more boom

• During busts, no credit is available => worse bust

Roller-coaster in sales, payments, staff hiring and firing

4. “Short-termism” Unsustainable strategies • Discounted cash-flow with positive interest rate currency => long-term irrelevant

While effective conventional solutions are…

Presentation Outline

1. The Problems

2. Solution

3. Win-Win Strategy

4. Current Status of Project

Solutions are not to be found within the box

“Never, ever, think outside the box.”

Thinking out of the Box?

Proposed SolutionDefinition

• Terra = reference unit defined as standardized basket of key internationally traded commodities & services

Example: 100 Terra = 1 barrel of oil + 10 bushels of wheat + 20 kg of copper

… + 1/10 of ounce of gold

NB: any standardizable good or service can be included

– Similar stability to gold standard, but with basket instead of single commodity (more stable than any one component)

more stable than today’s national currencies 4 fold reduction of volatility compared to US$ on basis of

9-12 commodity basket– Terra is Inflation-resistant by definition

Proposed Solution (2)

Issuing Mechanism• Terra Alliance (user’s alliance) issues Terra as inventory

receipts for goods sold to it by producers – Example: oil company sells 1 million barrels to Terra Alliance, and

gets credited with Terras at market prices, and can use Terras to pay suppliers…

• Fully backed currency => Robust currency

• Storage costs of basket is paid by the bearer of the Terra = demurrage of 3.5-4.0% per year => Terras pure medium of exchange and contracts, not store of value

• When recession looms => excess inventories of commodities=> more Terras in circulation => activates economy in countercycle with economy

Proposed Solution (3)

Legal/Tax Aspects

- From legal and tax viewpoint: Terra is simply standardized “countertrade” (international barter)

– Volume of countertrade now over $1 Trillion/year, more than 10% of all international trade, growing at 15%/year

– Example: Pepsi-Cola gets paid in Russia with Stolichnaya Vodka

- No need for new international treaty or governmental legislation

Presentation Outline

1. Defining the Problems

2. Solution

3. Win-Win Strategy

4. Current Status of Project

Win-win Strategy

• Reasons for blockage of previous proposals:– They were all trying to replace the official

money system • In contrast, Terra is complementary currency

– They were expensive in implementation• In contrast, Terra operation is completely self-

financing

– They were upsetting substantial vested interest • In contrast, Terra is a win-win for all key parties

Win-win Strategy (2)Advantages for business users

• More stable and predictable international currency – No or less hedging costs– No or less inflation

• Countercyclical – Less roller-coaster of business cycle– Less roller-coaster in finding staff and then firing them

• Less Short-termism– Demurrage charge realigns financial interests with

longer-term thinking– Leaving a better world for our grand-children…

Regulation

Education

FinancialIncentive

How does one convince a corporate elephant to change?

10 years

$ 100

$ 1,000 100 years

Currency with Positive Interest @ 5%/year

Value discounted to today:

Currency with Demurrage @ 5%/year

Demurrage = time-related charge (opposite of interest)

Value discounted to today:

$ 61.39

$7.60

$ 167.02 $ 168,903.82

Financial Viewpoint

Sustainability: The Monetary EngineWhat do we invest in?

Physical Reality (Tree Metaphor)

Costs: 10 $

Costs: 10 $

Short-term thinking is not intrinsic to human nature, but created by today’s money system NB: Historical Precedents: Dynastic Egypt, “Age of Cathedrals”

Win/win Solution (4)Benefits for everybody

• Makes Sustainability a realistic global objective

=>Reversing the hourglass?

Win/win Solution (5)Benefits for everybody

• Makes Sustainability a realistic global objective

• Terra countercyclical less instability in jobs

Main lesson fromthe Euro…

Follow-up

Texts available: • “Terra/TRC Summary” and “Terra/TRC White Paper” on www.terratrc.org

• “Of Human Wealth” (new synthesis book)• “The Future of Money” (London: Random House): www.amazon.co.uk • “The Future of Payment Systems” White Paper for banking sector (available

for free on request via email).

Internet: – www.terratrc.org dedicated website opened today– Email: blietaer@earthlink.net

Two Implicit Hypotheses in Economics

1. Money is “value neutral”– Money is a passive medium of exchange that simply facilitates

exchanges. – The type of money used doesn’t affect the kind of transactions

performed, doesn’t influence the investments made, or the relationships among their users.

2. Our money system is a given, like the number of planets in the solar system…

• Because of hypothesis #1, the monopoly of national money doesn’t matter.

• The monopoly of national money is more “efficient”• 100% of economic theory built on these hypotheses.

– Both hypotheses have been proven invalid!– What becomes possible if we revisit them?=> Addressing systems rather than symptoms…

Win-win Strategy (1)

Advantages for initiators• Co-designing the system

• A way to change illiquid assets (inventory) into working capital

• Now: inventories are a cost item

• With Terra: negligible costs for getting working capital

• New strategic option whenever excess inventories • Now: either store at own costs or dump in market (further value

reduction)

• With Terra: sell to Terra Alliance that will keep it in storage, and storage costs for bearers of Terra

• More cost effective countertrade• Now: typical costs 3-5% of face value

• With Terra: costs approx 0.1% of face value

• + All advantages of other business users

Win/win Solution (3)Benefits to the Banking Sector

• Today, banks don’t play any role in countertrade (up to 10-15% of global trade and fastest growing sector)

– Standardization introduced by Terra enables financial sector to provide its traditional services similar to any foreign exchange transaction (accounts, transfers, advice)

• Terra is only contractual and planning instrument– Financing remains in conventional currency created by banking

system

• Terra is countercyclical stabilizes world economy– Positive impact on banking portfolios

– Makes job of Central Banks easier

Costs:

Currency Risks (Hedging costs)

Opportunity Costs:

Foregone investments (ex: in LDCs)

Misallocation Costs

Costs:

Adaptations to business cycle

Opportunity Costs:

Operational Investments suboptimal

Costs: Regulatory Pressures

Opportunity Costs:Long-term Investments

suboptimal

No Standard of Value

Standard Basket

1. Cost Reductions - reduced storage costs

- reduced hedging costs

2. More Stable Global Trade

3. Realigns financial interest with long-term view

Stable Reference Value

Long-term thinking profitable

“Terra Bridge” Way

Short-termism

Amplification ofBusiness Cycle

Demurrage

AnticyclicalDampening of Business Cycle

Win/win Solution2. Benefits for Corporate Initiators

Today’s Way

Expensive in direct costs and opportunity costs

Poverty

Drop in LDC Investment

s

EcologicalDegradation

Social Adaptation

Costs

“Side Effects”

Political instability

LDC

Terra issued directly

to Producers

Countercyclical

Win/win solution (3)

LDCs

Wealth Creation by and in LDCs

Scarcity of Hard

Currencies

Degradation of Terms of Trades

Debts

in hard FDI

Currencies

Commodity Production Problems

Dumping Storage Costs

IMF

Adjustment Programs

Poverty,

Development Failure

Worldbank

Commercial banks

“Terra Bridge”