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Weak Collective Action Threatens Global Credit Crisis

October 7, 2008 at 12:00 AM EST
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The U.S. financial meltdown has become a globalized crisis, spreading to Europe and emerging markets. The managing director of the International Monetary Fund explains the importance of restoring confidence among banks and consumers, coordinating efforts among countries and the IMF's role.
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JIM LEHRER: Now, more on the international dimensions of the financial crisis, and to Jeffrey Brown.

JEFFREY BROWN: And joining me for that is the managing director of the International Monetary Fund. Dominique Strauss-Kahn is an economist and served as minister of finance in France in the 1990s.

Welcome to you.

Your organization issued a report today that was filled with all kinds of dire warnings. So I just want to ask you right simply at the start: How serious is the situation?

DOMINIQUE STRAUSS-KAHN, IMF managing director: Well, obviously, the situation is very serious, not only in the United States, but also in Europe and, perhaps for the first time during the last years, in the emerging market, too.

What we just contemplate now, as the crisis, which originated in the United States, as you see in the housing market of the United States, are now going over Europe and all the problems we have seen in the U.K., in the British banks, for instance, or in the Belgian banks, shows that it’s no more a problem only in the United States, but what is probably more kind of news that emerging markets — Brazil, India, other countries — are just receiving the waves and the shock of the crisis now.

JEFFREY BROWN: Let’s start in Europe, because I know you were in France recently talking with President Sarkozy. In recent days, we’ve seen countries take steps on their own.

And now there’s reports about a possible bailout coming out of Britain maybe as early as tomorrow. But there’s been an inability to do a collective action. Why is that so hard?

Challenges to collective action

DOMINIQUE STRAUSS-KAHN: Well, it's difficult because, you know, the United States is a country. Europe is a construction. It's a set of countries.

And so it's easy to define new rules or new kind of behavior at the European level, but to make a decision at the European level is much more difficult.

So we certainly need -- and that's what I said to President Sarkozy on Saturday -- a kind of comprehensive action by all the European countries, but it's easy to say, not so easy to implement.

JEFFREY BROWN: What should be in any kind of comprehensive plan?

DOMINIQUE STRAUSS-KAHN: Well, I won't talk about a comprehensive plan. A plan can be at the national level, but it has to be comprehensive and not piecemeal at the national level. And coordination has to take place within the different European countries.

When you don't have this kind of coordination, then what you do may hurt the country next to you. Look at what happened when the Irish decided to give a kind of guarantee to the deficit. They give such a big guarantee without any kind of coordination that a lot of money flow out from British banks to the Irish banks.

So beggar my neighbor is a kind of behavior that we have to try to avoid. And that's why more than a comprehensive plan at the European level, I'm asking for more coordination between the European countries.

JEFFREY BROWN: So more coordination, but are there some specific things that have to be in any coordinated plan? We just heard Alan Blinder talking about interest rates, for example.

DOMINIQUE STRAUSS-KAHN: Well, interest rates is one point. And certainly there will be room now for the Europeans to have lower interest rates.

But, you know, when you're in such a crisis, where confidence is so much lacking, then traditional policy don't work so well. And what you need first is to restore confidence.

The main word of the crisis now is confidence, confidence from the household, confidence from the bank. No bank is lending anymore to another bank.

And to restore this kind of confidence, you need more than traditional economic policies. What you need now is strong recapitalization of the banks. You have no other solution than recapitalization.

The IMF has this unique experience of working in 185 countries and having -- be involved in not such a big crisis, but crises like this one in other parts of the world. And always, always the only way to get out is to start with recapitalizing the financial institutions.

The role of the IMF

JEFFREY BROWN: The IMF has experience, particularly in the '90s. We all remember the Asian crisis. What is the role -- what is the IMF's role right now?

DOMINIQUE STRAUSS-KAHN: Well, there are different kinds of roles. The crisis is totally new.

One role is provide advice. And we try to provide advice to governments, including the U.S. government, the European government, and also the emerging countries' governments.

The other role is to provide financing when needed. And it's probably it can be the case, in the coming weeks, for some emerging countries.

But the third rule is it's not exactly today, but it will start the day after today, is to be part of the process to reconsider the way -- the framework, the regulatory framework, the supervisory framework, in which the financial institutions are working, which obviously failed, because this failure is a failure of the regulation system, to rebuild a system in which we can avoid in the future such crises.

JEFFREY BROWN: You're talking about broader reform down the line?

DOMINIQUE STRAUSS-KAHN: Yes. Well, you know, it's needed just because this crisis is the first crisis of the 21st century. It's a globalized crisis. You are asking the question about emerging markets.

Probably 10 years ago, when we had the crisis in Asia, you were just talking about the Asian crisis or the crisis which was localized and contained in Asia. It's no more possible today. A crisis, a big crisis, especially when the epicenter is in the United States, is a globalized crisis.

Far-reaching consequences

JEFFREY BROWN: But explain that for us a little more, because you're working now with many developing countries, part of your organization. How does a housing bubble in the United States affect poorer countries, say, in Africa?

DOMINIQUE STRAUSS-KAHN: Well, the housing -- the foreign prices in the housing market in the United States makes the claims to banks or the financial institutions had on the household are losing part of their value.

But those claims have been securitized in packages who have been sold all over the world, and especially in European banks, who bought them without knowing exactly what kind of risk was in -- they were buying. So the question is transparency, which didn't exist.

And then those prices going down in the housing market and in the United States makes that the European bank or German bank or French bank just realized that what they what they bought hadn't any more the value that they believed.

So they have a problem on their balance sheet. And having a problem on the balance sheet, they're not able anymore to lend money to those who need it. Who needs it? The French household, of course, the French companies, but also the African country you were just talking about, which now see its trade credit line, for instance, just disappearing, because the French bank, or the German bank, or another one say, "OK, I have enough problem at home. I'm not going to lend you anymore."

So starting somewhere in Maryland, because you have a default in a house's capacity to repay their mortgage, and in Africa somewhere, in Nigeria, or in Burkina Faso, where the country is just unable to find any credit anymore.

And that -- the reason for this is that the economies of different parts of the world are so much interrelated that you cannot solve the question only at home. That's why you need coordinated action. And that's probably why you need multilateral institutions like the IMF and others, because it's the only place where everybody is likely to convene and to discuss together the different aspect of the crisis.

Confidence in world leaders

JEFFREY BROWN: Well, and that last question then, you're about to gather for your annual meeting. What is your level of confidence in the world's leaders to be able to come up with a coordinated approach?

DOMINIQUE STRAUSS-KAHN: Well, I think it's very difficult, because they're all concerned mostly by domestic question, which is understandable.

But on the other hand, I think most of the world leaders today, not only in the United States, not only in Europe, but all over the world, are aware of the fact that the crisis is so severe that the consequences can be so devastating.

And so I think that the right time now -- and it will be seen at the end of this week at the meeting we will have in Washington with almost all finance ministers of the world -- it will be seen that they're able to -- I won't say to build something together, because it won't be built in one day, but at least to put the foundation of something which has to be rebuilt. And the first thing which has to be rebuilt is confidence.

JEFFREY BROWN: All right, Dominique Strauss-Kahn of the IMF, thank you very much.

DOMINIQUE STRAUSS-KAHN: Thank you.