Managing Director Dominique Strauss-Kahn
International Monetary Fund
700 19th Street Northwest
Washington, DC 20431
Dear Director Strauss-Kahn:
I am writing today out of deep concern that the global banking bailouts announced this week could backfire.
I am president of Weiss Research, Inc., an independent research corporation, and Chairman of the Sound Dollar Committee, a nonprofit, nonpartisan organization founded by my father in 1959. The Sound Dollar Committee was instrumental in helping President Dwight D. Eisenhower achieve one of the only truly balanced budgets of the past half-century. And in keeping with that tradition, my company continues to promote fiscal responsibility, sound business practices, and prudent investing.
Over the years, we have learned how elusive these goals can be. And by the same token, I recognize the unusual challenges faced by central bankers and economic leaders today.
However, I believe the greatest challenge is this: Since the credit crisis struck global markets over 14 months ago, government interventions to provide ever larger amounts of liquidity and capital have not been successful.
Initially, these efforts did calm investors to a degree. We saw some declines in short-term bank rates, an easing of risk premiums, and a trickle of new lending. But this initial success has consistently been followed by greater market anxiety and even panic.
Therefore, I believe there is good reason to question whether the U.S. and European plans announced this week, committing trillions to recapitalize and guarantee the world’s largest banks, will meet a similar fate.
For example, in August of 2007, when central banks injected hundreds of billions in new liquid funds into the banking system, and again, in March of 2008, when the U.S. Federal Reserve rescued Bear Stearns, the goal was essentially the same as today’s: To boost investor confidence.
In retrospect, however, we can see that the goal was often accomplished in a perverse way: Among other things, investors bought more shares in insolvent banks, invested more in junk bonds of overrated corporations, and placed more bets on shaky derivatives — all despite the fact that bank balance sheets were deteriorating, bond default rates were rising, and derivative models were being proven unsound.
Each time governments intervened, the cost charged for risk came down, but the level of risk continued to rise — a discrepancy that could only be corrected by an explosive market adjustment.
Indeed, before long, investors realized they had erred in taking more risk, they fled in panic, and the debt crisis returned with a vengeance. Instead of restoring realism, the authorities had created a deceptive calm. Rather than bringing stability, they fostered instability. Inadvertently, they helped create conditions for the very panic they sought to prevent.
Meanwhile, the U.S. government is severely strained financially. In its fiscal year 2009 review, the Office of Management and Budget (OMB) projected the 2009 U.S. federal deficit will rise to $482 billion, already a major burden on debt markets. However, that OMB projection was made before the recent bailout commitments were known or even imagined; and since then, U.S. expenditures and liabilities for rescue efforts have easily exceeded $1 trillion.
Therefore, our greatest concern of all centers around the credit and credibility of sovereign governments. If governments continue to commit scarce resources to boundless rescue efforts, we could see a decline in confidence where it would hurt the most — in the government securities of the world’s richest nations.
Investors in U.S. and other government bonds could begin to ask: “Why should I buy government guaranteed bonds when I can invest in government guaranteed banks and get a much better return?” Or worse, some may say: “I bought your bonds because I didn’t trust the banks. Now, you’re giving my money to the banks after all. So perhaps I should not trust you either.”
Unlike some observers, we do not necessarily foresee a wholesale exodus from U.S. and other government securities by China, Japan and other major sovereign investors. We believe it would take a greater level of fiscal and monetary irresponsibility to reach that stage. However, even modest declines in investors’ appetite for government bonds — along with modest increases in supplies due to growing deficit financing — can upset the delicate supply-and-demand balance with a significant negative impact on bond prices and yields; and needless to say, the changes we are witnessing today are far from modest.
Inevitably, given current trends, governments will find it more difficult and more expensive to roll over their maturing debts, to fund their operations, and, ironically, to raise the money they need to finance private-sector rescues. Worst of all, the resulting upward pressure on interest rates and crowding out of already tight private debt markets can only aggravate the debt crisis.
Ultimately, if the contagion of mistrust spreads to government bonds, it will become next to impossible for governments themselves to borrow money, except by selling the shortest-term treasuries at unusually high interest rates.
To prevent that disastrous outcome, we believe governments must cut back drastically their bailout efforts, turning their attention to protecting their own credit and credibility.
At the same time, they must preserve scarce public resources for when they can be of the greatest benefit: For emergency assistance to those that are rendered ill or destitute during a secular global economic decline, and for carefully planned economic stimulus after a decline. If we squander those resources today, a future post-recession recovery will be greatly impaired. If we preserve them, our chances for resumed growth and prosperity will be greatly enhanced.
I trust you will give my expression of deep concern careful consideration. And I hope that, if you convey this view to your colleagues, it does not fall on deaf ears. The future of billions of citizens and their descendents may hang in the balance.
Martin D. Weiss
P.S. For your reference, I am attaching our white paper submitted to the U.S. Congress last month, Proposed $700 Billion Bailout Is Too Little, Too Late to End the Debt Crisis; Too Much, Too Soon for the U.S. Bond Market. The data and research it contains supports the concerns I have expressed here.