Options for Dealing with Systemic Banking Crises

1. Options for Dealing with Systemic Banking Crises Bernard Lietaer blietaer@earthlink.net WAAS Hyderabad

2. 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… Losses Acknowledged to September 2008

3. In short, our global financial system is in…

4. 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?

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

6. 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…

7. 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%

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

9. 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%

10. 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…

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

12. 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…

13. 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…

14. Rebound capacity (F) Throughput Efficiency (A) (Diversity + Interconnections) (Streamlined) 0% 100% Optimum Sustainability Sustainability in Natural Ecosystems

15. Rebound capacity (F) Throughput Efficiency (A) (Diversity + Interconnections) (Streamlined) 0% “Window of Vitality” 100% Optimum Sustainability “Window of Vitality” in Natural Ecosystems

16. Rebound capacity (F) Throughput Efficiency (A) (Diversity + Interconnections) (Streamlined) 0% Current operation of Financial system “Window of Vitality” “Window of Vitality” Effect of Monopoly Of Conventional Money 100% Optimum Optimum Sustainability Application to Monetary System

17. Rebound capacity (F) Throughput Efficiency (A) (Diversity + Interconnections) (Streamlined) 0% Current operation of Financial system “Window of Vitality” Effect of Complementary Currencies 100% Optimum Sustainability Application to Monetary System (2)

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

19. Systemic Solution #1Nationalize 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…

20. 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

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

22. Options for Managing Banking Crises

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

24. 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

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

26. 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?

27. Follow up

29. Key Points • Systemic problemsin 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, FederalReserve Board • Growing Risk of a Global Recession or Depression Both problems solved by a business initiative to create Terra, a newElectronic International Complementary Currency A Complementary Currency is a medium of exchange circulating in parallel with - not replacing - conventional currencies. Familiarexample of complementary currency: Frequent Flier Miles

30. A better way?

31. Four Systemic Problems with Today’s Money System • Financial InstabilitiesThe current banking crisis is #97 over past two decades World Bank • 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. • 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 • “Short-termism”Unsustainable strategies • Discounted cash-flow with positive interest rate currency => long-term irrelevant

32. While effective conventional solutions are…

33. Presentation Outline • The Problems • Solution • Win-Win Strategy • Current Status of Project

34. Solutions are not to be found within the box

35. Thinking out of the Box? “Never, ever, think outside the box.”

36. 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

37. 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

38. 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

39. Presentation Outline • Defining the Problems • Solution • Win-Win Strategy • Current Status of Project

40. 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-winfor all key parties

41. 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…

42. How does one convince a corporate elephant to change? Regulation Education Financial Incentive

43. Sustainability: The Monetary Engine What do we invest in? Physical Reality (Tree Metaphor) 10 years Costs: 10 $ $ 100 100 years $ 1,000 Costs: 10 $ $7.60 Financial Viewpoint Currency with Positive Interest @ 5%/year Value discounted to today: $ 61.39 Currency with Demurrage @ 5%/year Demurrage = time-related charge (opposite of interest) Value discounted to today: $ 168,903.82 $ 167.02 • Short-term thinking is not intrinsic to human nature, but created by today’s money system • NB: Historical Precedents: Dynastic Egypt, “Age of Cathedrals”

44. Win/win Solution (4)Benefits for everybody • Makes Sustainabilitya realistic global objective =>Reversing the hourglass?

45. Win/win Solution (5)Benefits for everybody • Makes Sustainabilitya realistic global objective • Terra countercyclical less instability in jobs

46. Main lesson from the Euro…

48. 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

50. Two Implicit Hypotheses in Economics • 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. • 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…