But they weren’t the only part. What we discovered in late 2008 was that, here in Pakistan, we had our very own liquidity bubble that had produced a very short, very intense and very unsustainable growth spurt for a couple of years in mid-decade, the high water mark of the Musharraf regime. And when the bubble burst, it produced many of the same symptoms here, as it did anywhere else: a credit crunch, collapsing asset values and destruction of bank balance sheets.
For instance, we discovered that we had ‘subprime’ assets of our own, even if they didn’t take the form of exotic mortgage products. We gave them the more dreary name of ‘non performing loans’. But what we discovered when our bubble burst was that almost all our assets were subprime assets, especially given the weak enforcement of contractual obligations that is such an important part of doing business in Pakistan.
A lot of consequences came cascading in the wake of this discovery. A sharp slowdown in investments as banks turned extremely risk averse, a recession as corporates preferred to draw down their debt levels rather than invest and sharp increases in non-performing loans which almost threatened the solvency of the banking system by the summer of 2009, according to State Bank assessments.
Our national debt levels soared in the years that followed as fiscal facts refused to adjust to the new reality created by the bursting of the bubble. Furthermore, the appetite of banks for government debt grew as they swung away from private- sector lending, except to a small group of large corporates and standard bread-and-butter lending, to financing agriculture procurement in sugar, wheat and cotton.
Of course, all this mirrored developments everywhere else in the world, with one important exception. We landed up in that group of countries for whom a fiscal stimulus was not an option. Quite the contrary, shunned by global markets and washed up on the doorstep of the IMF, we had to embark on a programme of ‘structural adjustment’, the very opposite of the fiscal stimulus that many other countries were trying to prime their economies with.
Having prevented a major banking crisis in their economies, the advanced countries in the Eurozone and the US cracked open the textbooks and did what the orthodoxy said you’re supposed to do when the economy slows down: borrow and spend. They embarked on some of the most massive spending plans in their history and boosted these with printing of money and purchases of bad assets from the banking system.
It was a stimulus of breathtaking scope, paid for entirely through debt. But then came the problem: despite the massive infusions of cash, their economies failed to jump-start. Instead what they got was a slow, anaemic, sputtering ‘recovery’. This forced a choice upon the governments of these countries: more spending or austerity.
The choice proved politically too polarising. Austerity meant unemployment, one of the most ghastly afflictions to hit an industrial economy. And that is where they stand even today. Bailouts and stimulus spending, or retrenchment and austerity? What’s the path into the future: to continue trying to jump-start their moribund economies, or salvage what’s left of their sovereign credibility?
In fact, the crisis of 2008 never ended. With their fiscal stimuli, the countries of the West only bought themselves a little time, nothing more. Today, neither of the economic orthodoxies are working: not the monetarist one, nor the Keynesian one. And that’s the lesson we need to wake up to quickly, that the textbook is fast going out of date. The crisis that is upon us now is something new, something different and its still not clear what shape it will take. For a state like ours, living far beyond its means, this is a very serious development.
Published in The Express Tribune, August 25th, 2011.
COMMENTS (5)
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@An_Indian:
Warren Buffet said it best:
"financial instruments of mass destruction".
@Meekal,
Beware aggregate data and look instead at something like this:
http://www.atimes.com/atimes/Global_Economy/MH23Dj04.html
Even with its inbuilt biases, there is much to think about, true?
I would like to congratulate Mr Khurram Husain for choosing to write on such an important topic. The article is very relevant and well written. Actually all this started from the US. There they had this idea of freeing credit even further than ever it was in human history by innovation with financial assets. The intention as stated was novel but what they actually did was a very nasty exercise under the veil of terms like " Financial Innovation ". They created assets that were not creditworthy. When such assets became too many for their comfort the individual lenders sold them of to entities who then clubbed all such sick assets together and sold them off as equal units of asset-backed securities. So this was just an exercise of passing the buck much like the Cuckoo birds the lay their eggs in Crows' nest. These cycles of passing the buck through multiple repetition in the age of globalization soon went beyond anyone's reach. The locus of the risks kind of got lost in the thick mesh ( or should we call mess ) of transactions when the rewards have already been used up. Nobody knew whose assets had what degree and kind of risk. This was a time bomb. The central banks needed to act fast now but they dosed off in cold silence as a huge propaganda was unleashed by the perpetrator of this sorry exercise about how FINANCIAL INNOVATION has distributed and thus taken care of all the risks and that all such risks will now attenuate somewhere deep inside the system. The risks did not fade away, we just lost track on them. Like rabbits we sat with our eyes closed in the face of the adversity hoping against hope that SINCE I CANNOT SEE IT IT WILL ALSO NOT BE ABLE TO FIND ME. It has found us and we are now being hunted by our own creation. These risks are now like terrorists. We do not know where they are, when they come to blast us, how many are they still left. We only see the blast happening and keep collecting the pieces after every devastation has occurred knowing fully well they are somewhere here among us hidden into our collective failure.
However i would not like to end on such a pessimistic note. After all mishaps are nothing new to humankind. I think we should talk about all these more, spread more awareness, debate these issues and develop our understandings. At the end of the day we all are minds capable of innovating. And INNOVATION is what we absolutely need now. Don't we ?
@Adnan:
If you read the real Keynesians (for example Krugman in the NYT), they will say that the Obama stimulus was too small. All it did was prevent a depression. Furthermore, looking at the counterfactual, without the package unemployment would have been 16% and not 9%.
KL, you don't give us any data on NPL's.
As for Pakistan going against the grain, what were we supposed to do with a fiscal and current account deficit of 8% of GDP, headline inflation of 27%, massive capital flight, bubbles popping and an exchange rate falling like a rock (30% before we eventually, but always grudgingly and in bad faith, turned to the fund)?
Other countries, including India and China for example were better positioned to use fiscal policy as a counter-cyclical tool to cushion the downturn. Now they have another problem: over-heating.
As for the global economy, like you I am worried. We seem to have run out of options. But my hope is that in the US at least Obama will come out with a jobs package -- which the Republicans will shoot down.
KL, great piece. I enjoy reading you.
Brilliant article! I fear no one at this stage has the right answers. Keynesians do seem like the better bet, but you are right in saying that their solutions are still not working.