It's Only Bankruptcy
Putting a Foundation Under the Financial System
In William Saroyan's Depression-era drama "The Time of Your Life," there is a laconic character called "The Arab" who keeps muttering the play's signature line: "No foundation. All the way down the line."
The global economy feels that way this week. No foundation, no liquidity, no safe haven, no exit . . . all the way down the line. That's really the heart of the problem -- global financiers sense that they're standing on quicksand. They don't trust other institutions, so they're hoarding their cash as if it were a lifeline, in the hope they can survive the panic.
The problem is that the sum of all these rational individual decisions, in which each player in the global economy tries to protect his own self-interest, is the collective catastrophe we are witnessing. That's why the answer -- the foundation, if you will -- can come only from public institutions.
If the global economy were a single company, it would be nearing the point of declaring bankruptcy. That sounds scary, but I actually take comfort from the analogy. Bankruptcy doesn't mean a company has run out of good people or ideas, or that it's going to stop making products. It means that it's out of money and must seek the protection of the government to continue operating. Bankruptcy, if properly managed, is a workout process that provides a pathway back to solvency.
A company seeks protection from its creditors through bankruptcy court, which appoints a trustee to supervise an orderly unraveling of its debts and other obligations. Sifting through the claims can take years and creditors often receive less than full value, but there's a reliable process. Companies often reemerge from bankruptcy healthier than before; often, some assets are sold to other companies that can make better use of them.
For the U.S. financial system, the equivalent of the bankruptcy court is the de facto rescue committee headed by the Federal Reserve and the Treasury. That rescue mission so far has focused on pumping liquidity into the system, but it's had little effect -- because terrified banks aren't willing to lend. The rescue committee should move now to a larger task of trusteeship -- of supervising the orderly clearing of debts in an economy where trust has vanished, as is often the case in an ordinary bankruptcy.
Like bankruptcy trustees, Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson should focus on keeping the system operating while it's under government protection. It's not that there's no cash in the system: Trillions of dollars are parked in money-market funds, T-bills and other "safe investments." The problem for our bankruptcy trustees is putting that money to work.
For the global economy, the same metaphor should apply. The bankruptcy trustees in this case will be the global finance ministers and central bankers who are gathering in Washington this weekend for their annual meeting. Hopefully they understand that they must hang together now, or they will all hang separately.
Sadly, the institution that was supposed to protect the global system, the International Monetary Fund -- while issuing some timely warnings about risks to stability -- has been utterly impotent in the crisis. It's time to abolish this bootless institution and create a new one that can help manage the global workout.
What we need now is a Global Clearinghouse, a public-private consortium of the biggest financial institutions and central banks, that can ensure that trades get completed and losses are covered while the system works its way out of bankruptcy. David Smick, whose fine book "The World Is Curved" offered clairvoyant early warnings of disaster, proposes that private financial institutions might finance 60 percent of the cost of this clearinghouse and central banks the remaining 40 percent. To play and get protection, private institutions would have to share all data, which means coming clean about the toxic paper on their books.
What matters is the collective commitment to create a global backstop -- so that there is a foundation for lending and commerce, all the way down the line. "What's happening is the reappraisal of the value of every asset in the world," says Smick. "The solution has got to be global."
This global catastrophe increasingly does resemble a bankruptcy. But take heart in the fact that bankruptcy is an everyday fact of life and that under sensible management it's a process of stewardship rather than a death sentence. We know how to do this job -- how to use public trustees to protect private companies and their workers when markets fail.