ECONOMIC CRISIS RX - VIEW FROM THE CITY

C O N F I D E N T I A L SECTION 01 OF 02 LONDON 002760



SIPDIS



DEPT FOR PDAS NELSON, MSAKAUE

TREASURY FOR MURDEN, CARNES,



E.O. 12958: DECL: 10/30/2015

TAGS: ECON, EINV, UK

SUBJECT: ECONOMIC CRISIS RX - VIEW FROM THE CITY



REF: A. LONDON 2738

B. LONDON 2710

C. LONDON 2683

D. LONDON 2603



Classified By: Economic Minister Counselor Mark Tokola for reasons 1.4

b and d



1. (C) Summary: Political leaders must tackle not only the

liquidity and solvency of financial institutions, but also

must now confront significant currency volatility and a

deepening cross-border contagion. While acknowledging there

are no quick fixes, officials from two leading financial

institutions - Stephen King, Chief Economist, HSBC and

William Chalmers, Managing Director, Investment Banking

Division, Morgan Stanley - identified several possible

policy prescriptions in October 28th meetings with emboffs:

injection of cash into economic systems, full disclosure of

toxic assets, and the creation of a framework for a

supra-national regulatory agent. They also explained why,

in their view, government recapitalization efforts have

failed to stabilize markets. End Summary.



Currency Stability



2. (C) In today's turbulent times, cash is paramount and

governments must ensure that as much money as needed is

available, said King. Political leaders need to indicate

that they are prepared to inject cash into the economy

without limit and regardless of inflationary concerns to

assuage fears of investors and prevent cash hoarding. He

cautioned, however, that no one country should proceed

unilaterally. Coordination among the G7 would limit the

danger of cross-currency contagion. He also noted that

central banks, ability to increase the money supply through

open market operations has been only nominally successful

during the crisis, given the paralysis of inter-bank

borrowing. The European Central Bank (ECB) is also more

hamstrung than the Federal Reserve in terms of increasing

liquidity through cash injections, since the ECB is built to

deal with inflation and has little authority independent of

member state governments in matters of liquidity, King

stated. In his view, governments need to bypass the banking

system and inject liquidity directly into the economy via

increased government project spending.



3. (C) The spillover of currency volatility on trade and the

global de-leveraging process is also of significant

concern, observed Chalmers. The valuation of toxic assets is

more difficult when the currency in which those assets are

denominated is unstable. He also argued that political

leaders need to make both a verbal and concrete pledge to

ensure currency stability. Without such an assurance, the

contagion effect has the potential to cripple European

banks.



4. (C) Governments also have been unable to control the speed

of de-leveraging - the selling of commodities and assets to

reduce risk and raise capital, said Chalmers. The market

panic of recent weeks is evidence that statements by

political leaders have proven to be ineffective in

controlling the pace of de-leveraging.

Political leaders need to issue a coherent, strong and

combined message that measures in place will work and seek

patience from investors and savers, he stated.



Toxic Assets - Fuller Disclosure



5. (C) Many banks have not come clean about the extent of

their toxic assets on their balance sheets, said King.

Political leaders and regulators should underscore the need

for greater transparency and establish mechanisms to force

fuller disclosure, if not voluntarily done by the banks. He

argued that there is a need for an independent authority to

investigate each bank as well as a cross-border evaluation

process.



6. (C) Fuller disclosure about assets is necessary but there

is a potential trade off between greater transparency

and liquidity, said Chalmers. The real value of assets, if

disclosed, could make those assets illiquid. He also argued

that non-regulated instruments - such as hedge funds - also

need to be subject to greater transparency requirements.



Regulatory Framework



7. (C) The industry expects more rigorous regulation,

remarked King. But he warned that regulators need to really



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understand market instruments before developing and imposing

new regulations. Some of these regulators need to

have been market insiders and not just government

technocrats. "Poachers need to become the ranchers," if

governments are to stay ahead of market mechanisms.



8. (C) Going a step further, King said that the architecture

of the global financial system needs to change

so that there is a single global capital market with

sovereign nations managing their individual economies.

This will require a new global framework, a Bretton Woods

Two, he said. He warned however, that if this is not done

skillfully, there is a danger that nations will revert to

capital market protectionism. This would have the same

adverse impact on world economic growth as the Smoot-Hawley

Tariff Act of 1930, but the mechanism would be through the

capital markets rather than trade.



9. (C) Chalmers argued that there is a need for a

supra-national structure in place of the independent,

loosely coordinated responses of sovereign states. He stated

that this could through greater formalized process

of cooperation among national regulators - a "college of

regulator" such as PM Brown has proposed - or through

the ceding of some sovereign authority to a supra-national

organization.



Investors Remain Skeptical



10. (C) The gyrations of the world's financial markets

demonstrate that recent policy decisions have not been

correct, argued King. Interest rate cuts have had negligible

effect since the real root of the crisis is

solvency, not liquidity, he argued. Governments,

recapitalization plans also have had a minimal effect since

the markets are skeptical about whether the amounts will

prove to be sufficient. What is the right amount of money

- USD 700 billion, GBP 500 billion? queried King. The

capital injections were needed to prevent institutions from

going bust, but he warned that there are many Zombie

Banks,, with crippling levels of loans to securitization,

that still haven't come to light. How much could governments

borrow to resuscitate these banks? he asked.

Without an open-ended funding commitment for

recapitalization, the markets will remain skeptical that

there will be enough funding for the distressed banks.



11. (C) The lack of clarity of how and when governments will

divest themselves from the troubled banks also is

sending a negative signal to the market, said Chalmers.

Potential investors in these banks want a timetable - such

a timetable will also show confidence in the markets and that

recovery is attainable, he argued.





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