Regional Security Implications of the Global Financial Crisis

Council for Security Cooperation in the Asia Pacific

7th General Conference, Jakarta 16-18 November 2009

Charles Wolf, Jr.

Roadmap
Global Financial Crisis (GFC): Sources, Consequences,
Remedies

Regional Security Effects and Implications:

Macroeconomic conditions and security Defense budgets Development budgets Foreign assistance and foreign investment Proliferation Terrorism, piracy, threats to law and order Regional security organizations

Concluding Remarks

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GFC (1): Processes, Participants, Scale; Sub-Prime Mortgages, Lending, Securitizing, Debt Ratings, Undue Diligence, Credit Tightening, and Consequences
Processes & participants

(1)
Motivation of ownership society, Freddie Mac, Fannie Mae, loose monetary policy, low rates, diluted quality of borrowers and of mortgages

(2)
Lending practices of mortgagers, promotional efforts and weak credit scrutiny by lenders, further erosion of mortgage quality

(3)
Packaging, slicing and dicing, derivatives through mixing and matching sub-prime and prime mortgages; collateralizing, securitization of CDOs/SIVs by issuers

(4)
Rating agencies (Moodys, Fitchs, S&P), insurers (AIG, Prudential, etc.)

(5)
Marketers, distributors; leveraging (30:1),and leveraged sellers

(6)
Leveraged buyers

Numbers & questions

107, mainly in U.S., some other countries

104, Countrywide, Home Equity, commercial banks, S&Ls, laxity of credit scrutiny

106, banks, investment banks, Bear Stearns, Merrill, Lehman Bros, Citigroup, erroneous and omitted balance sheet entries due to AAA-ratings, lax FASB rules

102, banks, AAA ratings, conflicts of interest (i.e., clients are rated!), inadequate analytic ability and inherent difficulty of risk assessments

105, banks, investment banks, foreign and U.S. banks, e.g., UBS, Deutsche Bank, Merrill, Citigroup, Goldman

106, U.S. and global banks, central banks, SWFs, bandwagon effects

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GFC (2): Principal Sources and Contributors (Culprits ?)

Macroeconomic policies and imbalances:
Monetary policy (US): loose, permissive Structural imbalances: US (I>S), China (S>I)

Ineffectual regulation in US:

Too little regulation? too much? wrong and confused? Between 2000-2008, full-time US government financial regulatory staff grew by 26%, regulatory budgets by 21% ($2.3 billion) !

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GFC (3):Principal Contributors

Politically-mandated, subsidized (sub-prime)
housing ) mortgages

Securitization, complex derivatives (credit default

swaps, moral hazard)

Rating agencies Leveraging (30-40 times!) Ineffective corporate governance

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GFC: Consequences and Remedies

Coupling between crises in US, Europe, Asia-Pacific
GFC emanating from US, reinforcement by financial institutions, businesses, governments in Europe, Japan, China, & ROW Is coupling generally close, loose, moderate? Factors boosting coupling: trade, foreign investment, equity markets Factors diminishing it: expanded domestic markets, transaction costs, protectionism

Regulatory reform: more, less, or different?

Efficient markets require ample, transparent, timely information Important to reduce information asymmetries Corporate governance: boards, disclosures, procedures Redefining Tier I capital (from 4% to 8%, perhaps with further boost for too-big-to-fail banks?)

Should regulatory focus be national, regional, or international? (IMF,

BIS, World Bank, G-8, G-20. G-77)?

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Roadmap
Global Financial Crisis (GFC): Sources, Consequences,
Remedies

Regional Security Effects and Implications:

Macroeconomic conditions and security Defense budgets Development budgets Foreign assistance and foreign investment Proliferation Terrorism, piracy, threats to law and order Regional security organizations

Concluding Remarks

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Regional Security Effects(1): Macroeconomics and Security

Extensive (inconclusive) literature on relations between
economic conditions and internal/external security (e.g., Marx, Tocqueville, Machiavelli, Hoffer, Deng, Huntington; realists vs.idealists)

Relevant variables include poverty,economic levels and

growth, unemployment, inequality, expectations, informational access, etc.

One familiar model: instability/insecurity likely to increase

if/as economy contracts, unemployment and inequality rise

GFC adversely affects some/all of these variables

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Regional Security Effects (2): External Assistance & Investment

Foreign aid likely reduced: slower growth in donor countries,
larger debt burdens and other fiscal claims: stimulus outlays, health and energy programs,etc.

Foreign investment flows uncertain: entrepreneurial

incentives vs. asset protectionism; resource investments vs. technology investments --Chinas investors (e.g. CIC, CITIC, CNOOC, other banks and companies),likely to be very active for resource security, high tech, other needs

Trade effects also uncertain: protectionism, short- vs. midterm effects

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Regional Security Effects(3): Proliferation

Heightened risks:
Potential sources may be deliberate or inadvertent (e.g., DPRK, Iran, Pakistan??) Potential buyers may be in Asia, or Middle East Dangers from possible links between piracy and proliferation; between proliferation and terrorism

Proliferation Security Initiative: 94 participating countries,

whether to strengthen and how?

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Regional Security Effects(4): Defense Budgets

Asia-Pacific defense budgets: under pressure from GFC But likely different effects within region:
China: +18% (2009), 2010 (?) Japan: 0% change (09). 10 (DPJ uncertainty) Indonesia: -15% (2008), decrease in 09, 2010?? South Korea: +4% (2008), +4% (09), 2010 (?) Australia: + 5% (2008), uncertain 09, 10

GFC effects and A-P political/security conditions

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Regional Security Effects(5): Development Effects

Mixed results from preliminary examination of 2008-2010
health, education, infrastructure budgets of China, Japan, Indonesia, South Korea, Australia

Aggregate government revenues decreased or barely

constant (coupling effects)

But stimulus packages in all 5 countries exceed decreases

of development outlays Chinas stimulus 13% of GDP ! Japans stimulus 3.1% GDP Korea, Australia, Indonesia 1-3% GDP

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Regional Security Effects (6): Multilateral Security Organizations

ARF, CSCAP, SCO, 6-Party Talks, EAS,
bilateral/trilateral links (US-Japan-Korea, USIndonesia)

Is there a useful role for overarching regional

organization? G-20, or subset?

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Roadmap
Global Financial Crisis (GFC): Sources, Consequences,
Remedies

Regional Security Effects and Implications:

Macroeconomic conditions and security Defense budgets Development budgets Foreign assistance and foreign investment Proliferation Terrorism, piracy, threats to law and order Regional security organizations

Concluding Remarks

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Concluding Remarks (1)

Game-changing global trends will affect regional security Enhanced political-economic-security roles of China, India,
Indonesia, Brazil, South Korea, other countries: a pluralistic (rather than multipolar) world power center (e.g. largest global market, but with likely smaller net imports)

US role perhaps diminished (relatively), but still largest

Japan with DPJ may be more active in A-P, (or less? or

unchanged?)

Europes role may be diminished, but perhaps enhanced if

viewed as balancer?

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Concluding Remarks (2)

These game-changers perhaps imply that effective
solutions/management of specific regional security issues (preceding charts), will depend more on A-P institutions, and ad hoc coalitions possessing two characteristics: ---motivation based on priority national interests ---willingness to share burdens (costs) along with decision making

Smart Power as collective, prudent combinations of soft

and hard power

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