Measuring the Incalculable; Valuing the Intangible!

Tonight, Kerry O'Brien interviewed James Wolfensohn, the former president of the World Bank. I found it quite interesting to hear his views on the subprime fiasco, as well as other matters, but especially the subprime issues and Greenspan. Also very interesting for anyone interested in the "decoupling" theory. Here is the transcript:

KERRY O'BRIEN: After 10 years as World Bank president, and a year as special envoy to the Middle East for the so-called quartet: the UN, the European Union, the US and Russia, Australian-born James Wolfensohn, has scaled back on his career somewhat. And in his 75th year, with a glittering career behind him, why wouldn't he.

But Jim Wolfensohn remains one of the best connected individuals on the planet. Over two decades before his World Bank appointment, he built a legendary reputation on Wall Street, first with Salomon Brothers before building his own firm which ended up with branches as far afield as Europe and Japan.

In an interview with Jim Wolfensohn today, he spoke candidly on several controversial fronts, acknowledging that his close friend, former US central bank president Alan Greenspan, had been blindsided in not seeing the sub-prime crisis coming.

He also says his job as Middle East envoy was made untenable in 2006, when America and the Palestinian faction Fatah, "cooked up a deal" to drive Hamas out of the Gaza strip.

Here's that feature-length interview.

Jim Wolfensohn, from your decades inside Wall Street, how do you assess the seriousness of the sub-prime debacle?

JAMES WOLFENSOHN, FORMER WORLD BANK PRESIDENT: Well, I think it's serious and it's already had its impact in the US markets and it's had its impact in Asian markets and around the world both in anticipation and as the losses have been seen and I think what the Secretary of Treasury was saying yesterday in his remarks is that there is a need to take another look at the methods of control.

KERRY O'BRIEN: That's almost an understatement, isn't it?

JAMES WOLFENSOHN: But after the horse has got out of the yard, and I think what all of us are worried about and concerned about is that obviously the Fed and the authorities are trying to play down and say it's okay and let confidence return but I personally have apprehension. I think it's been such an enormous break in the system that we may have some period ahead of uncertainty. I believe that will happen.

KERRY O'BRIEN: You believed that there will be some further nasty shocks potentially?

JAMES WOLFENSOHN: They may not be shocks but I don't think it's going to be remedied very quickly. We've sustained very substantial losses. The credit market is tightening, the confidence of business is at a low of over 20 years.

So, these are signs that the public, which is heavily borrowed as you know in the United States, and which has been the engine of growth. If you start cutting off credit or tightening credit then you're attacking the very essence of growth in the United States.

KERRY O'BRIEN: Why didn't the smarter minds in banking see this coming or were they all, if I could put it crudely, too busy feeding at the trough?

JAMES WOLFENSOHN: I think it's sad to say they were too busy feeding at the trough. This was, and the people that were running it were a new breed of bankers with PhDs in mathematics to back them up. Trading and securities, which frankly none of the top managers really understood and all they understood was that you had, if you had 20, 30, 50 billion invested in its then it increased your bottom line and they were trading with each other until it's a bit like the story of the emperor has no clothes. One day someone came in and said, "My God, the emperor's naked!" When they did that and they discovered what they were trading then everything happened and it happened very quickly.

KERRY O'BRIEN: Many of those now applying hindsight to what went wrong are blaming Alan Greenspan at least in part for keeping rates for too long during 2003 and '04, keeping money very cheap for longer than necessary and fuelling the house bubble. He says in his defence he was concern about deflation at the type. Do you think his reputation will stand the test of time or having accepted the credit for his years in office should he perhaps face up to some of the deficit?

JAMES WOLFENSOHN: Well I'm in a bit of a problem here because Alan's one of my best friends.

KERRY O'BRIEN: I know.

JAMES WOLFENSOHN: But I happen to think that he was one of the best heads of the Fed that there were. But I think he was blindsided by this. I don't think he had, for whatever reason, any sense of the enormity of the potential disaster that was facing him. I think that traditional economists were looking at the question of interest rates, of inflation, they were prudently going about their business for the other members of the board of governors. They would come into the meetings, they'd move it by 0.25 per cent, they'd move up or down, they'd give some sphinx-like comment to the congressional committee and the markets would move a little bit either way, and that was the game the game was played since Volker. Volker, if you remember, when he was head of the Feds, had this problem of uncertainty in the markets he took rates up to 30 per cent, 35 per cent to try and break the inflationary cycle. Alan didn't see that coming. There was very modest inflation. What was happening was that you had an expansion of credit at a level that was unsustainable because the credit quality was being expanded in a way that the new credits that were being added, as is now clear, were simply not tenable and so when the thing, the house of cards came down, there was no base there and the top, which were all these mortgage bank securities, all of a sudden had no value. You couldn't get a bid for these mortgage bank securities. So, banks were writing off $5 billion, 10 billion, 15 billion and some of the major banks, institutions in New York which were one in particular which was worth $270 billion is if today worth $100 billion in the market and this is not atypical of what's been happening in Europe or in the whole banking system.

KERRY O'BRIEN: Could this have come at a worst time for America in terms of its place and its reputation in the world? China goes ahead economically in leaps and bounds while America tries to recover from the perception, if not the reality, of a foreign policy disaster in Iraq, with serious structural economic problems at home?

JAMES WOLFENSOHN: Well I think the United States is not in its best moment. We've had a period of Bush in which the public deficit has gone from $US6,000 billion to $US9,000 billion. So, if you talk about debt, the national debt in the United States has expanded exponentially partly because of the war but not solely because of the war.

Secondly, you've seen a huge belief in the expansion of India and China and we're now seeing that belief is being materialised as they enter the markets, as China enters and so on but China and India today still have a less than a half in GDP than the United States, maybe it's a third of the GDP of the United States, which is roughly 14 trillion and they together maybe 4. So, in terms of the economic power in the world today, and in terms of the place that China and India need, and the world needs, it's US to import.

Now you can wipe off the United States and you can say, you know, they've managed it badly, but God forbid it really gets tough in the United States because the impact will not allow people in China and India and exporting countries to stand back and say well you see they've screwed up because it will affect them and I think it is the interconnection between the United States and the rest of the world, in a sense, still a dependence on the United States which we yet have to assess.

http://www.abc.net.au/7.30/content/2007/s2205214.htm