Some commentators have complained that the G7 five point plan is vague and useless. I disagree. The plan has some careful wording that needs a little decoding. Nevertheless, compared to usual drival that is served up as G7 statements, it is a model of clarity.
Lets be clear; this plan is radical. Although some key issues are missing, such as improving financial sector supervision, it is the most comprehensive attempt to solve the credit crisis so far. It marks a significant break from the previous ad hoc "lets wait and see what happens" approach to the credit crunch. Insofar as anything is going to save the global financial system, this is it.
For what it is worth, here is my attempt to add a little clarity to the statement.
1. Take decisive action using all available tools to support struggling financial institutions and prevent their failure.
Meaning: There will be no more Lehmans. Central banks and governments will stand behind systemically important banks. There will be no more destabilizing bank failures. The language here is very strong - "using all available tools" governments will support banks and "prevent their failure."
2. Take all necessary steps to unfreeze credit and money markets.
Meaning: Central banks will guarantee interbank lending. Central banks will also provide unlimited liquidity if needed.
3. Ensure that banks can raise capital from public as well as private sources, in sufficient amounts to re-establish confidence and permit them to continue lending to households and businesses.
Meaning: Troubled banks will be nationalized. This is, in essence, the UK recapitalisation plan. Where possible, the authorities will seek private sources, although, in the short term, this is unlikley to yield significant results. This point also establishes an important objective for the plan; keep the credit flowing to the private sector.
4. Ensure that savers' deposit insurance and guarantee programs are robust so savers have confidence in the safety of their deposits.
Meaning: Individual depositors will be protected by government funds.
5. Take action, where appropriate, to restart the mortgage securitisation markets. Accurate valuation and transparent disclosure of assets and consistent implementation of high quality accounting standards are necessary.
Meaning: This point acknowledges the different US strategy. The US Treasury will continue to buy up mortgage debt in order to clean up US bank balance sheets. It also means that Freddie and Fannie will be restructured and again, begin to issue mortgage backed securities, no doubt without the implicit government guarantees.
It also rules out any funny accounting which provides regulatory forebearance of any insolvent banks. This is an important point, decisively rejecting demands from banks to reduce accounting standards.
What the plan does not say
It doesn't talk about saving equity markets.
Nor does it commit governments to coordinated interest rate reductions, which as we know are a waste of time. The statement only talks about using "macroeconomic policy tools as necessary and appropriate."
The plan has no BS about avoiding a recession or sustaining growth.
There is no mention of moral hazard, explaining the causes of the crisis or apportioning blame. That will be left for later.
There is no mention of improving financial sector regulation. Again, this is a matter kicked out into the future.
There is only passing reference to the taxpayer: - "The actions should be taken in ways that protect taxpayers". The implication is, however, that the taxpayer will be foot the bill for this rescue package.
Will it work?
The plan is designed to incorporate two slightly divergent approaches to the crisis; the British recapitalisation plan and the US balance balance sheet restructuring plan.
My money is on the British plan, which addresses the root problem. Many banks are insolvent and only a major recapitalisation will work. I would have preferred a plan based on full nationalization, but a partial nationalisation is definitely the second best option.
The idea of a systemic banking crisis is just too appalling to contemplate. Let us hope that this plan works.