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

2. 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…

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 1994-518% Mexico 1994 19.3% Chili 1981-8341.2% Thailand 1997-98 45% Malaysia 1997-9845% 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 betweenthroughput 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. Sustainability in Natural Ecosystems Optimum Rebound capacity ( Throughput Efficiency (A) (Diversity + Interconnections) (Streamlined) Sustainability 0% 100%

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

16. Application to Monetary System Effect of Monopoly Of 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%

17. 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%

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

19. Systemic Solution #1 Nationalize the Money Creation Process Money is a public good, that was first privatized in favor of banks in 17 th 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 #2 Ending 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. Doesnt end privilege of bank-debt money as legal tender, only temporarily their monopoly... –Doesnt 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 ApproachBankers Taxpayers/ Central Governments Local Governments 2d WaveSystemic Cause Conventional Nationalizing Problem Assets Preferred Most Expensive (no leverage)UnaddresseddelayedUnaddressed Nationalizing Banks Equity Dilution 10x leverageUnaddresseddelayedUnaddressed Unconventional Nationalizing Money Creation End of current business model LT solution (but inflation?) Unaddressed Governments spend money into existence Unaddressed Complementary Currencies End of monopoly of money creation LT solutionLT & ST solution Systemic Solution

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 cant 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. Re-regulation is necessary and will be on everybodys 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 problems in Todays 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 21 st 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

30. A better way?

31. Four Systemic Problems with Todays 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 Todays 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

32. While effective conventional solutions are…

33. Presentation Outline 1.The Problems 2.Solution 3.Win-Win Strategy 4.Current Status of Project

34. Solutions are not to be found within the box

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

36. Proposed Solution Definition 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 todays 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 (users 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 1.Defining the Problems 2.Solution 3.Win-Win Strategy 4.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-win for 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. Regulation Education Financial Incentive How does one convince a corporate elephant to change?

43. 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 Engine What do we invest in? Physical Reality (Tree Metaphor) Costs: 10 $ Short-term thinking is not intrinsic to human nature, but created by todays money system NB: Historical Precedents: Dynastic Egypt, Age of Cathedrals

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

45. Win/win Solution (5) Benefits for everybody Makes Sustainability a 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.ukwww.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 todaywww.terratrc.org –Email: blietaer@earthlink.net

50. 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 doesnt affect the kind of transactions performed, doesnt 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 doesnt 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…

51. 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

52. Win/win Solution (3) Benefits to the Banking Sector Today, banks dont 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

54. 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 of Business Cycle Demurrage Anticyclical Dampening of Business Cycle Win/win Solution 2. Benefits for Corporate Initiators Todays Way Expensive in direct costs and opportunity costs Poverty Drop in LDC Investments Ecological Degradation Social Adaptation Costs Side Effects Political instability

55. LDC Terra issued directly to Producers Countercycli cal 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