America was right to look and learn

By John Gapper

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History will record that George W. Bush, the US president, faced two big crises during his term of office: the terrorist attacks of September 11 2001 and the financial meltdown of 2008.

Mr Bush’s response to the first was to tell the rest of the world that “you are either with us or against us” and invade Iraq with the UK in tow. His response to the second was to listen to finance ministers from around the world and fall in line with Europe by buying stakes in banks.

I vote for the second approach.

It is much too early to declare “mission accomplished” on the financial crisis since markets remain extremely nervous and banks are still reluctant to lend to one another. But the latest version of the global bail-out plan at least stands a fair chance of success.

Personally, I have more faith in this plan than I did in the Iraq war, partly because the first draft was discussed with others who wanted to achieve the same end. That helped the US to sharpen up its ideas. Designing things by global committee has flaws but launching a unilateral offensive that lacks credibility is worse.

The new tack clearly tickled Jean-Claude Trichet, president of the European Central Bank, at the Economic Club of New York on Tuesday. Mr Trichet, who gave his speech surrounded by financiers and central bankers, including Tim Geithner of the New York Federal Reserve, looked and sounded as if nothing could be more enjoyable than US-European intercourse.

“I am pleased to have exceptionally intimate relations with the Federal Reserve,” he said, singling out “Ben, Don and Tim” for his warmest regards. It sounded like some kind of racy continental ménage à quatre, but he turned out to be talking about financial policy meetings in Basel with Ben Bernanke, Donald Kohn and Mr Geithner of the Fed.

In fact, Mr Bush and Hank Paulson, the Treasury secretary, had to shift positions, despite their resistance to the idea of nationalising banks. The fact that the UK had taken stakes in banks including Royal Bank of Scotland and HBOS, and would be followed by Germany and France, was force majeure.

It was not so much a victory for multilateralism as a recognition that no nation could afford to go it alone in this global crisis. The forces they were all battling – loss of confidence in banks and other institutions and worries over mortgage-related securities – were too big to be tackled by one country on its own.

Mohamed El-Erian, chief executive of the bond asset management group Pimco and winner of this year’s Financial Times-Goldman Sachs Business Book of the Year award, talks of “correlation rather than co-ordination” among the actions of national governments.

Central banks have, pace Mr Trichet, acted in a co-ordinated fashion – their independence from national electorates gives them the freedom to do so. They have not only cut interest rates together but have set up swap arrangements to allow European banks with a mismatch between assets and liabilities to borrow in dollars.

But governments have mostly made do with correlation, also known as watching what others are doing and copying the things that they like. This has been surprisingly effective for a couple of reasons.

First, since we are in uncharted waters, it has let governments try things out in different countries and see how well they work, or go down with investors. The UK bailed out Northern Rock, the mortgage lender, the US guaranteed money market funds, Germany (sort of) stood behind bank deposits, and so on.

Second, it has provided cover for governments that either did not want to take some steps, or faced resistance among electorates to doing so. The best example is the US, where Mr Paulson initially argued strongly against buying stakes in banks as part of his $700bn bail-out plan.

It is difficult to know exactly what he was playing at. Did he initially abhor taking equity in banks as socialist but then change his mind, did he judge that what had been unnecessary had become necessary, or did he always plan to do so?

You can take your pick from his public statements. Last month, he told a Senate committee that “the right way to do this is not going around and injecting capital”. This Tuesday, he reversed himself, with the excuse that his plan was “not what we ever wanted to do” and was “objectionable to most Americans, me included”.

The fact remains that recapitalising banks was the correct course of action all along. The US gets more bang for its buck by doing this, rather than simply trying to entice private capital into banks by supporting the valuations of bad securities.

Mr Paulson, who did after all insert a clause in the bail-out plan allowing himself to switch course, may have been ruled by realpolitik. It was tough enough to get the plan through Capitol Hill without infuriating House Republicans further by raising the spectre of nationalisation.

In a sense, it does not matter what he was up to because he came to the right conclusion with the aid of foreign partners and market forces. Mr Bush and Mr Paulson were forced to accept that they were either with European governments or the markets would be against them.

That goes for European countries too, which could assess Mr Paulson’s initial, flawed version of his $700bn plan before tweaking it. Gordon Brown, the British prime minister, has rightly gained credit for coming up with the best version but he built on what came before.

Call it a victory for common sense, international co-operation, market discipline or what you will. I believe it will achieve more than Mr Bush could have done by himself.

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