Risky times for abolishing risk-free public debt

Get serious about the threat of a credit collapse
David Ignatius

LONDON What's the chance that credit markets could suffer the kind of bubble-bursting collapse that has afflicted stock markets around the world over the past two years?

Even if the likelihood of such a financial crisis is relatively small, that's the kind of question George W. Bush and his economic advisers should ponder as they think about how to use the mandate the president won in last week's midterm elections. For Bush now has the political power to fix important things that are wrong - not just in Iraq but in the global economy.

Bush should start by finding a serious financial expert to succeed Harvey Pitt as chairman of the Securities and Exchange Commission. This administration has been shamefully weak in financial expertise, fielding what many analysts say is the weakest team at Treasury and the White House in decades. Ideally, Bush will replace Pitt with someone of the stature of Robert Rubin, a former Treasury secretary, or Arthur Levitt, a former SEC chairman.

There's plenty for financial regulators to worry about, according to some new figures, prepared by the investment bank Morgan Stanley, that were presented here last week at the Oil Money 2002 Conference sponsored by the Energy Intelligence Group and the International Herald Tribune.

The Morgan Stanley numbers suggest that there's far more weakness in credit markets than most policymakers recognise. Morgan Stanley's managing director, J. Robert Maguire, noted that bond defaults in 2001 and 2002 have totalled over $180 billion, and that defaults in investment-grade bonds over the past two years have exceeded the cumulative total of the past 20 years. Credit quality has been dropping since 1995, Maguire said.

Overhanging the credit market, meanwhile, are severe weaknesses in the banking sectors of other key countries. "Japan, China and Germany - that's the whole world," said another top banking executive.

The scariest numbers involve those exotic financial instruments known as "credit derivatives," which have exploded in volume over the past several years, largely in response to the weakness in credit markets. According to Morgan Stanley, the value of these credit derivatives has grown from just $50 billion in December 1998 to an estimated $2.4 trillion in December 2002. The dot-com run-up was modest by comparison. It's a big, unregulated circus, and sensible analysts have been scared about the derivatives market for years.

Warren Buffett, the investment guru, sounded the alarm in a long interview in Fortune during the mid-'90s. And while he was Treasury secretary, Rubin often complained privately about the danger of a cascading failure in the derivatives market that could take down the rest of the financial system. And yet, despite all this high-level worry, Washington has done little to address the problem. Wall Street banks headed off regulation by imposing new internal standards for risk management after the August 1998 financial crash. And politicians have had no stomach for challenging the financial institutions whose lobbyists effectively control the key congressional committees. Finally, regulating derivatives would be a bureaucratic nightmare, with the Fed, the Treasury, the SEC, the Commodity Futures Trading Commission and several other agencies all claiming pieces of the action.

After his electoral triumphs, Bush has the clout to impose real regulation on Wall Street and thereby restore confidence in the global financial system. But does he have the will?

David Ignatius, a novelist and former associate editor of The Washington Post, is editor of the International Herald Tribune, where this article was published on 16-17 November 2002. Reproduced with the kind permission of the author.

See also:

Suggested citation
, David Ignatius, 'Risky times for abolishing risk-free public debt', Evatt Journal, Vol. 2, No. 8, December 2002.<https://evatt.org.au/news/risky-times-abolishing-risk-free-public-debt.html>