This is the English transcript of Dr. Sebastien Gay’s interview with BFM, Business&FM newspaper and Business FM radio.
1. The efforts to overcome crisis in all countries where economies have suffered from the global developments involve two major principles - increasing role of the state in strategic industries and large-scale financial support. What are the long-term risks of such approaches?
There are several long-term risks associated with adopting a government-driven strategy to address the emergencies in strategic industries. Most concerning is the incentive structure that is established by such an approach; those large companies that struggle in a weak economy will attempt to hold the country hostage by claiming their necessity. As the responsibility for business mistakes shifts from big companies to the government, the companies’ management teams will be more willing to take greater risks because they will not bear the costs if they fail. It is also important to point out that the term “strategic industries” is a judgment-based term, where “strategic” is based on whether the industry is a significant player in the economy. If government takes a greater role in those industries it considers “strategic” it is, in essence, selecting the winners and losers of the economy and denying the market its role in making that choice. Greater government involvement in strategic industries can also discourage innovation and entrepreneurship, encourage more mergers and acquisitions, and dissuade private investment, particularly in small companies.
Large-scale financial support by the government also bears similar long-term risks; however, the increase in financial support brings an additional factor to consider. For now, the government is supporting its increased spending by printing money (a short-term solution) and borrowing from growing nations like China. International relations may be seriously impacted by the shifting dynamic between the United States as a debtor and other international players as its lenders.
2. Bad assets represent a key problem that has led to the freezing of the markets. How would you assess the idea to create special banks to accumulate such assets, the so-called “bad banks”. What should be the proportion between public and private capital in such banks? And what could be the mechanism to raise private capital for this purpose?
The “bad bank” concept is a good idea so long as the government is able to resell the bundled bad assets on Wall Street. The government should have 100% capital in the bad banks in the beginning. The government can issue bonds to raise capital for the new banks. The mechanism to raise private capital for this purpose is the securities market. The first issue to unpack is the idea of the “bad assets.” These assets, particularly sub-prime mortgages, were always high-risk assets. The reason they were high risk was because (1) the sub-prime mortgage industry was very fragile and (2) there was a chance that significant amounts of money could be made by securitizing them as mortgage-backed securities. Some market players who refrained from selling off the assets on the stock market profited off the short-run fees, but should reasonably have been aware that the long-run result was collapse. What has changed from then until now is the lack of uncertainty; before, there was a chance – however small – that the risky assets could succeed on the stock market and there were investors willing to buy and resell them quickly. In order to restore investor confidence in these so-called “bad assets,” there must be increased uncertainty (i.e. the possibility of positive yields) injected into the securities market. The market player in the best position to do so is the government. The government should work on the other side of the market to make sure there is less certainty about foreclosures so that a positive risk-analysis is put back in the securities market. Whoever grabs the bad assets at their cheapest can potentially make a huge gain. In the long run, however, the problem remains that such markets for risky mortgage-backed securities and other similarly risky assets exist at all. The so-called “bad banks” should be temporary to allow such securities to eventually disappear and greater regulation over such industries must be implemented. There should be no newly created sub-prime mortgage-backed securities, and the existing ones will expire at the final payment of the corresponding loans. Moreover, loan regulations must be put in place to prevent dishonest loan practices from occurring as freely as they have in the past.
3. Are there any dangers in expanding the consumer credit stimulation program, Term Asset-Backed-Securities Loan Facility (TALF)?
The purpose of TALF is to increase the availability of credit to small businesses and consumers. There are many benefits of such a program; namely, it can restore consumer confidence, stave off increasing unemployment, and clean up banks’ balance sheets. Of course, it fails to resolve other pressing concerns. First, there is no guarantee that banks will offer new loans under the program. The brief experience with TARP suggests that banks do not want to use the money provided by the government for the intended purpose of loosening the credit market. Second, the program is only delaying what could be a more dangerous problem down the road if the newly-acquired loans fail, which adds greater burden to the government in the long run.
4. During the last years, there has been much discussion that America “lives beyond means”, that the “world finances the American economy”, etc. If we put aside politics, the new stimulus package to be passed by the Congress requires more than $800 billion. It means the public borrowing will rise. What could be the sources of further borrowing for the administration, particularly - internal or external?
There are not many options available on the borrowing front. The government can issue bonds to raise capital and will certainly borrow heavily from international players, particularly China. It is not a good situation for the US economy. The most the government can hope for is earning tax revenue from new or growing industries in the future.
Find the original interview at: http://www.bfm.ru/news/2009/02/20/sebastien-gay.html