Stephen’s Posterous

The Wall Street Journal blog Venture Capital Dispatch interviewed Josh Lerner, a professor at Harvard Business School and a well-known voice in the venture capital industry. Mr. Lerner has signed on as a senior advisor to fund of funds manager Grove Street Advisors LLC.

When asked about the topic of his upcoming book, which addresses the public efforts to boost entrepreneurship and venture capital, Mr. Lerner said that the financial crisis has opened the door to massive public interventions in the West.

Many nations and their governments responded to the threats of illiquidity and insolvency by making huge investments in troubled firms by taking large ownership stakes. There are many concerns can be raised about these investments, from the rushed way in which they were designed by very few people behind closed doors to the design flaws that many experts think will limit their effectiveness.

But one question that should be asked Mr. Lerner says is shouldn't public funds also promote new enterprises and not just prop up troubled entities, especially when the venture industry is on life support, and troubled firms may be beyond salvation.

Silicon Valley, Singapore, and Tel Aviv all bear the marks of government investment, but for every successful public intervention spurring entrepreneurial activity, there are many failed efforts, wasting untold billions in taxpayer dollars.

When Mr. Lerner was asked what one or two changes would provide the biggest boost to venture capitalists, he responded:

There are two sets of changes that could make a big differences. The first is an evolutionary one, which is already underway. Not only have too many groups had mediocre returns for long periods of time, but they have undertaken a lot of "me too" investments that have made it hard for everyone to succeed.

We are now seeing that many second- and third-tier groups are having much greater difficulty raising new capital. While this is of course a frustrating turn of events from an individual perspective, from the point of view of the industry as a while, it cannot help but be seen as a healthy development.

The second relates to public policy. In too many areas, our system has made it hard to be an entrepreneur developing advanced technologies. From a patent system which has been overrun by sham litigation to the many barriers that public companies face, there are a whole variety of policies that create barriers to entrepreneurship.

We need to revisit many of the "reforms" of recent decades—from the strengthening of patent rights to Sarbanes-Oxley—and ask how they could be changed to minimize the harmful effects on entrepreneurs.

The impact of having more private equity and venture capital firms that will have to register as investment advisors with the Securities and Exchange Commission will promote some transparency and only impose a modest cost on the industry, Mr. Lerner says, but some of the proposals emendating from Brussels and Strasbourg, in which some members of the European Commission and Parliament are proposing to micro-manage investment decisions of private equity groups, are troubling.

When asked if private equity firms, including venture capital funds, pose systemic risks to the financial system, Mr. Lerner says that the topic is being researched under the umbrella of the World Economic Forum.

Source.

Wall Street might remember the private-equity boom for the billions in fees it collected along the way. The rest of the country might remember it for a different kind of cleanup: job losses created, in part, by unsustainable debt loads hoisted on thousands of companies across the economy.

So far, the private-equity industry hasn't come to terms with this inevitable bloodletting. That is largely because it has been spending the last two decades trying to reform its image from the 1980s, when buyout artists were branded unrepentant "flippers and strippers."

The makeover can't hide the basic facts: Otherwise-decent companies are being subsumed by debts that simply can't be paid in this brutal recession. There is a certain irony that the Web site of the industry's trade group, the Private Equity Council, highlights three investments, MGM Studios, Univision and Hilton Hotels, that are already struggling mightily.

There are more than reputations at stake. There are big portions of the economy, too. Private-equity research firm Pitchbook Data estimates 7.8 million people are employed by companies owned by private-equity firms.

"Things are bad, and because of the capital structure, it's even more challenging," says Pitchbook's John Gabbert. Private-equity owners are "going to do everything they can to make these companies lean to service that debt." Buyout bosses have for years said they had properly "stress-tested" their numbers, leaving room for a downturn. But they couldn't anticipate a near depression.

Just look at Moody's latest Bottom Rung list, which features the companies it views as most likely to default on debts. The buyout gang's all there: Univision, Harrah's Entertainment, Realogy Corp. and Jacuzzi Brands Corp. among others.

The effect of higher debt payments already has played a big role in the travails of Harrah's. Its debt load increased by some $20.5 billion after it was purchased by TPG's TPG Capital and Apollo Management in 2007. Between 1992 and 2006, the company paid no higher than $728 million in cash interest expense. Last year, the sum was about $2.1 billion.

Harrah's anticipated a "worst-case" of stagant revenues. Last year, they fell 13%, causing Harrah's to post a $5.4 billion loss. So far the company has been vague about job cuts, saying only in a recent conference call that it reduced "labor and marketing costs substantially."

Of course, as the world economy shrinks, it's hard to find a company that's not been cutting workers. The national unemployment rate just pushed over 8% and seems destined to hit 10% or higher by year-end.

There is little doubt that Harrah's would have cut back even without that debt load. Other, less-levered casinos are doing the same. The question for the private-equity industry is just how many incremental jobs were cut because of that incremental debt. In other words, how many jobs were destroyed that didn't have to be?

Harvard Business School's Joshua Lerner has done a lot of research on these questions, some of it commissioned by the World Economic Forum. He says that such layoffs "would be less severe than what we might initially anticipate," but added that they were likely to be "more severe than what we saw during the early 1990s."

One difference is that credit market turmoil is starving troubled companies of the capital they need to emerge from bankruptcy protection. That means that many private-equity backed companies may simply disappear in liquidation. The margin of error is, indeed, shrinking. And who will get caught in the middle?

The worry has certainly hit Joseph Carbon, director of Transport Workers Union Local 721, which represents about 560 card dealers at Harrah's-owned Caesars Palace in Las Vegas.

"We're feeling pretty secure," Mr. Carbon said. "But I don't know how deep this is going to get."

Source.

It is pretty much consensus now that 2009 will be a zero growth year for the world economy. It seems that the major risk for the following years is having a lost decade of Japanese-style stagnation but on a worldwide basis. How are the governments in US and Europe faring so far in their effort to avoid that? Marco, Sao Paulo

Nouriel Roubini: To avoid a Japanese style multi-year L-shaped near-depression or stag-deflation, a deadly combination of stagnation, recession and deflation, the appropriate, coherent and credible combination of monetary easing, traditional and unorthodox, fiscal stimulus, proper clean-up of the financial system and reduction of the debt burden of insolvent private agents, households and non-financial companies) is necessary.

The eurozone is well behind the US in its efforts as: a) the ECB is behind the curve in cutting policy rates and creating non-traditional facilities to deal with the liquidity and credit crunch; b) the fiscal stimulus is too modest as those who can afford it, Germany, are lukewarm about it and those who need it the most, Spain, Portugal, Greece, Italy, can least afford it as they already have large budget deficits; c) there is lack of cross-border burden sharing of the fiscal costs of bailing out financial institutions.

The U.S. has done more, with its aggressive monetary easing and large fiscal stimulus putting it ahead, but two key elements are key to avoid a near-depression and still missing: a proper clean-up of the banking system that may require a proper triage between solvent and insolvent banks and the nationalization of many banks; and a more aggressive and across-the-board solution to the unsustainable debt burden of millions of insolvent households.

Thus, I would say the L-shaped near-depression scenario is possible.

How can Davos, a gathering of the greediest, most avaricious and incompetent people of the planet, ever fix any of the problems they have created in the first place, and hugely benefited from?. Do you agree that when the boom was at its height, you were mistreated there when you tried to draw attention on the looming crisis? Are you now afraid of being now co-opted by the system and losing your independence? Marcel Knecht, Villa Santiago, Mexico

Nouriel Roubini: It is important to keep one’s intellectual rigor and honesty free from any financial conflict of interest. I never trade in markets and so I am never “talk my book” when I present my views. I have kept my balanced and analytically rigorous but bearish view over time and adjusted my outlook only at the margin in light of the evolving circumstances.

But the basic thrust of my analysis and views about the severity of this financial and economic crisis – the worst since the Great Depression - has not changed. I don’t think anyone could suggest that I have been co-opted by the system and lost my independence. If anything my concerns that a severe U-shaped global recession may turn into a worse, L-shaped near-depression have somewhat increased over time.

It seems clear that governments will not allow their banking system to fail altogether and that they will intervene to rescue whenever needed. My question is: The governments will save the banks, but who will save the governments? Is it possible that we are about to see countries default? What does that mean for the global economy? Which countries are the ones who pose the greatest risk?  Jonathan Arad

Nouriel Roubini: In many countries the banks may be too-big-to-fail but also too-big-to-save, as the fiscal/financial resources of the sovereign may not be large enough to rescue such large insolvencies in the financial system. Traditionally only emerging markets suffered – and still suffer - from such a problem. But now such sovereign risk – as measured by the sovereign spread - is also rising in many European economies whose banks may be larger than the ability of the sovereign to rescue them: Iceland, Greece, Spain, Italy, Belgium, Switzerland and, some suggest, even the UK.

The process of socializing the private losses from this crisis has already moved many of the liabilities of the private sector onto the books of the sovereign: banks, other financial institutions and, soon enough possibly, households and some important non-financial corporate companies. At some point a sovereign bank may crack, in which case the ability of governments to credibly commit to act as a backstop for the financial system – including deposit guarantees – could come unglued.

What level of oversight is now appropriate from the financial regulatory authorities? Do they need very large new measures or should they have a light touch? Ashok Soni

Nouriel Roubini:  It is clear that the Anglo-Saxon model of supervision and regulation of the financial system has failed.

It relied on self-regulation that, in effect, meant no regulation; on market discipline that does not exist when there is euphoria and irrational exuberance; on internal risk management models that fail because – as a former chief executive of Citi put it – when the music is playing you gotta stand up and dance.

Furthermore, the self-regulation approach created rating agencies that had massive conflicts of interest and a supervisory system dependent on principles rather than rules. This light-touch regulation in effect became regulation of the softest-touch.

Thus, all the pillars of Basel II have already failed even before being implemented. Since the pendulum had swung too much in the direction of self-regulation and the principles-based approach, we now need more binding rules on liquidity, capital, leverage, transparency, compensation and so on. But the design of the new system should be robust enough to counter three types of problems with rules:

A tendancy toward ‘regulatory arbitrage’ should be bourne in mind, as bankers can find creative ways to bypass rules faster than regulators can improve them. Then there is ‘jurisdictional arbitrage’ as financial activity may move to more lax jurisdictions. And finally, ‘regulatory capture’ as regulators and supervisors are often captured - via revolving doors and other mechanisms - by the financial industry. So the new rules will have to be incentive compatible, i.e. robust enough to overcome to these regulatory failures.

How long will be before we can tell if the US and UK governments’ plans to rescue the banks prove effective or not? If they don’t when do you think lending will recover to near-normal levels? Canh Humphries, Beckenham

Nouriel Roubini:There are three basic approaches to a clean-up of the banking system: recapitalization together with purchase by a bad bank of toxic assets; recapitalization together with guarantees – after a first loss – of the bad assets; outright government takeover, call it nationalization, of insolvent banks to be cleaned after takeover and then resold to the private sector.

Of the three options the first two have serious flaws: in the bad bank model the government may overpay for the bad assets as the true value of them is uncertain; even in the guarantee model there can be such implicit over-payment or over-guarantee that is not properly priced. In the bad bank model the government has the additional problem of having to manage all the bad assets it purchased.

Thus, paradoxically nationalization may be a more market friendly solution: it creates the biggest hit for common and preferred shareholders of clearly insolvent institutions and – possibly – even the unsecured creditors in case the bank insolvency is too large; it provides a fair upside to the tax-payer; it can resolve the problem of government managing the bad assets by reselling most of the assets and liabilities of the bank to new private shareholders after a clean-up of the bank.

This “nationalization” approach was the one successfully taken by Sweden while the current US and UK approach may end up looking like the zombie banks of Japan that were never properly restructured and ended up perpetuating the credit crunch and credit freeze.

To balance the US economy - given the US structural current account deficit - the fiscal deficit needs to balloon. Can the US default on its debt?  And, a related question also addressed in the next answer: What are the possible damaging, unintended consequences of the US stimulus plan? Alessandro Magnoli Bocchi, Kuwait

Nouriel Roubini: While a large fiscal stimulus is necessary to avoid a greater fall of aggregate demand there are also reasons to be skeptical about the effectiveness of such a stimulus: Most infrastructure spending is not ‘shovel-ready’ and its implementation may take too much time.

The tax stimulus may – like the 2008 rebate – be mostly saved or used to reduce credit card and mortgage debt, since, given the credit crunch, the ability of households to leverage the tax rebate to buy durable goods or homes is massively impaired.

Furthermore, the multipliers of fiscal policy are ambiguous and, more importantly, a tsunami of new public debt issuance may lead by the end of 2009 to a significant increase in long government bond rates as most countries in the world will now run budget deficits and thus the global supply of public savings will shrink.

With US fiscal deficits likely to be about $2 trillion in 2009 and $1.5 trillion in 2010; who, outside the US, as most of the financing of US fiscal deficits is done by non-residents, is going to buy such debt and at what dollar value of and level of interest rates? Eventually, large and persistent fiscal deficits may even lead to a downgrade – in a few years – of the AAA rating of the US government.

Do you think investigations and prosecutions should be conducted by the U.S. Government on the naked short selling of equities in the stock market? Should they be? Erich Benner, Blythewood, South Carolina

Nouriel Roubini: The ban on naked short selling of equities was a mistake. Short selling did not cause this crisis: it only reflected the concern about the solvency of many firms. And the ban on naked short selling only transferred the speculative pressure from equities to the credit defualt swaps market creating even greater problems in the credit derivative markets.

When equity markets were in a speculative frenzy of an asset bubble no one requested limits to the ability of investors to go long even if such restrictions in the form of higher margins for leveraged purchases of stocks would have been beneficial.

And when during the same bullish bubble analyst after analyst showed up in the financial media and talked his book up, with no one objecting to this spin cycle. But when investors become bearish and start short selling stocks one hears talk about prosecuting the “evil short sellers”.

This is an outright silly view even if, in the downwards speculative frenzy, market prices can fall below fundamental valuations as cascading effects cause falling prices to lead to margin calls and greater forced selling. But banning short selling is not the proper way to address this disruptive market dynamic. Starting with the excesses of the boom period of a bubble is a more appropriate response, and one that would prevent such bubbles from becoming excessive, limiting the damage from the bursting of such massive bubbles.

Has financial globalization come to an end? Jacques Ergas, Chile

Nouriel Roubini: Financial globalization has not come to an end, but there is certainly a backlash against it. To paraphrase Churchill - capitalist market economies open to trade and financial flows may be the worst economic regime, apart from the alternative, as non-market economy models have failed.

So while this crisis does not imply the end of market economy capitalism it has shown the failure of a particular model of capitalism: the laissez faire unregulated or aggressively deregulated wild-west model of free market capitalism with lack of prudential regulation and supervision of financial markets and with the lack of proper provision of public goods by governments.

It is the failures of ideas such as the “efficient market hypothesis” that deluded itself about the absence of market failures such as asset bubbles; the “rational expectations” paradigm that clashes with the insights of behavioral economics and finance; the “self-regulation of markets and institutions” that clashes with the classical agency problems in corporate governance that are thenselves exacerbated in financial companies by the greater degree of asymmetric information -how can a chief executive or a board monitor the risk-taking of thousands of separate profit-and-loss accounts? Then there are the distortions of compensation paid to bankers and traders.

This crisis also shows the failure of ideas such as the one that securitization reduces systemic risk rather than actually increase it; that risk can properly priced when the opacity and lack of transparency of financial firms and new instruments leads to unpriceable uncertainty rather than priceable risk.

Will the crisis bring about a permanent, significant shift in the economic power balance of the world? Giles Chance, China

Nouriel Roubini: The Anglo-Saxon economic and financial model is wounded and the role of the US as the leading global economic, financial and even geo-strategic superpower is reduced. Even without this crisis, the relative and absolute power of the US would have been reduced by the rise of the fast growing economies of Brazil, Russia India and China and by the emergence of the European Union.

But the policy mistakes of the US that perpetuated twin fiscal and current account deficits and triggered the worst financial and economic crisis since the Great Depression has accelerated this shift in the economic and financial power balance of the world.

Economic and financial superpowers or empires tend to be net creditors and net lenders running current account surpluses such as the British Empire at its peak. But such empires decline - the British pounds role as the world’s leading reserve currency was lost during World War II when the UK became a large net debtor and net foreign borrower running current account deficits and had large domestic fiscal deficits.

The US is now the largest net borrower in the world running huge current account deficits and the largest net debtor in the world while its domestic fiscal deficits are surging too. And unlike the 1980s when the US twin deficits were financed by the its friends and allies, Japan, Germany and the rest of the EU, this time around the largest lenders and creditors of the US are either its strategic rivals, Russia, China, etc, or a bunch or relatively unstable petro-states.

So this balance of financial terror makes the US vulnerable to the kindness of strangers. This growing weakness of the US suggests a paradigm shift in the economic and financial – and eventually even geostrategic - power balance of the world.

Do you believe in the projections made by the Chinese officials predicting a return to steady growth when all the planned stimulus measures have been implemented? Do you expect a reversal in the decisions taken the last 5 years to outsource a majority of the developed economies production to China? Fiorini Mauro, Belgium

Nouriel Roubini: China is now experiencing a hard landing and I predict that Chinese growth in 2009 may not be higher than 5 per cent. For a country that needs a growth rate of about 10 per cent to move millions of poor rural farmers to the modern urban industrial sector, a growth rate of 5 per cent would effectively be a hard landing. Fourth quarter gross domestic product growth in China – measured on a quarter to quarter annualized basis – was closer to 0 per cent than to the 6.8 per cent year-over-year growth reported by the Chinese government.

Other factors also suggest a hard landing: There was a sharp fall in generation of electricity in the fourth quarter. China’s purchasing manager’s index was well below 50 and closer to 40 for six months in a row; there has been a sharp fall in imports, mostly of intermediate inputs and raw materials. And while some of the latest data show a marginal improvement in the second derivative of growth in January, the first derivative still shows contraction. The manufacturing sector is still 40 per cent of GDP and it is clearly shrinking.

Whether the short-run policy stimulus in China will be effective or not is not clear. Instead, consumption levels are still depressed and private savings too high because of structural reasons that will take time to change. The out-sourcing of production to China and other emerging markets was not a mistake. But a model of growth based on cheap exports given an undervalued currency is now in crisis as the US downward adjustment of consumption requires an increase of domestic private and public demand in the surplus countries.

I have read your grave warning about deflation. But, nevertheless, won’t the enormous increases in money supply, out of thin air largely, eventually give rise to serious inflation, possibly hyperinflation? George Todd, Benalmadena, Spain

Nouriel Roubini: In the short run the greatest risks to the global economy are coming from deflationary pressures: slack in goods markets as aggregate demand falls relative to aggregate supply; slack in labor markets as unemployment rises sharply; slack in commodity markets as commodity prices tumble.

Concerns have been expressed that the massive injections of liquidity will be eventually inflationary. But with large output gaps and surging unemployment rates, inflationary pressures are unlikely until such gaps are shrinking sharply.

Also, the injections of liquidity are satisfying a surging demand for liquidity so that the absence of such a large supply of money would lead to spikes in money market rates; while base money is sharply rising other measures of money and credit are flat or shrinking as the money multiplier falls. This signals that the extra liquidity is being hoarded rather than spent or lent out.

It is true that eventually there may be a temptation to use permanent – inflationary - monetization of large fiscal deficits to reduce the real value of public and private debts; indeed the inflation tax may become politically the path of least resistance if government would find it hard and unpopular to raise actual taxes.

But even a relatively dovish central bank such as the Federal Reserve under Ben Bernanke cannot afford to let the inflation genie out of the bottle – if inflation expectations were to rise from low single digits to high single digits or even double digits – because such a surge in inflation would - eventually – cause the need for a harsh Volcker-style recessionary disinflationary policy to bring the inflation- expectations-genie back behind glass.

Also, unexpected inflation can reduce the real value of nominal debts at fixed interest rates. But many liabilities are at variable rates: mortgages, bank deposits, short term debts of households, banks, governments, corporations. So a surge in inflation cannot reduce the real value of such debts as the interest rate on them would rapidly be re-priced to include any increase in expected inflation. So the inflation tax may not even be effective in reducing the liabilities of the private and public sector unless it becomes extremely and dangerously large.

You recently mentioned total credit losses of $3.6 trillion compared to current losses of $1.6 trillion. Will the institutional and geographic distribution of the $2 trillion increase match that of the first $1.6 trillion, or will it be new regions and new institutions, that will get sucked in? Paul Broder

Nouriel Roubini: Our RGE Monitor estimates of $3.6 trillion of peak credit losses refer only to loans and securities that were originally generated by US financial institutions. Of these $3.6 trillion $1.8 trillion will be borne by US banks and broker dealers while the rest by other capital market firms and investors. Since the losses coming from securities are estimated to be $2 trillion and about 40 per cent of them (based on IMF and Federal Reserve estimates) are borne by non-US investors we already have $800 billion of losses that will hit foreign investors/financial institutions, mostly in Europe.

But we have not done yet a systematical analysis of the losses that will hit Eurozone and UK banks or banks in other regions of the world. Losses to these institutions include the $800 billion from US securitized products sold abroad as well as the other losses deriving from loan origination and securitization and issuance of other instruments in areas such as Europe and other parts of the world.

A preliminary analysis suggest that, in the aggregate, the US banking system is insolvent as its capital before the crisis was $1.4 trillion and below expected losses of $1.8 trillion; a good part of the UK banking system appears also to be insolvent.

Is the solution to just keep re-inflating bubble after bubble to recapitalize our consumer driven economy or is it time for a huge systemic paradigm shift away from consumerism? What type of shift would you envision and would it destroy the economy as we currently know it? Robert Singer, Oregon, USA

Nouriel Roubini: For the last 30 years the US has been growing fast only during periods of asset bubbles that eventually burst with significant economic and financial costs.

The 1980s real estate bubble went bust in the late part of that decade leading to a severe banking crisis for the Savings and Loan banks, a credit crunch and a severe recession in 1990-91; next the 1990s tech/internet bubble went bust in 2000 leading to the 2001 recession; massive monetary and credit easing – as well as lax supervision/regulation of mortgages and credit – led to another housing and credit bubble that has now gone bust creating a severe financial crisis and recession.

The current monetary easing may lead to another bubble but we are somehow running out of bubbles to create. Housing, credit, equities, commodities, hedge funds, private equity bubbles: they have all gone bust now. We need to create an economic system that is less prone to bubbles and more likely to lead to sustainable stable growth. For the last few years the US has overinvested in the most unproductive form of capital – residential housing stock that increase utility but not labor productivity – and not enough into physical capital that increases the productivity of labor.

Also we overinvested in the financial sector, a corollary of the housing boom: when the S&P500 market capitalization of financial firms was 25 per cent of the market and when over a third of the profits or earnings of S&P500 constituents came from financial companies, that was an excess of finance.

And having a country where there are more financial engineers than computer engineers or mechanical engineers means a misallocation of human capital as well.

So we need to create a growth model relying less on housing/real estate, less on finance and less on having the brightest minds of the country going into financial services rather than into the production and innovation of new and improved goods and services.

Could any of the weak eurozone countries should be forced out of the single currency because of the effects of the crisis, and if that happened, how is the euro likely to behave? Vincenzo, Italy

Nouriel Roubini: There is now a rising – even if still quite low – risk that some countries will eventually be forced out of the eurozone.

The whole idea of a monetary union was that since member countries would not have independent monetary policy, independent fiscal policy and independent exchange rate policy they would be induced to implement more aggressively structural reforms to ensure convergence of productivity growth and prevent divergence of economic performance.

Germany went through a brutal corporate restructuring that led to rising labor productivity growth with modest nominal wage growth that restored the competitiveness of the country.

In Spain, Portugal, Italy and Greece instead such structural reforms lagged and nominal wage growth outstripped productivity growth leading to increases in relative unit labor cost and real appreciation that reduced competitiveness. And now, on top of this loss of competitiveness some eurozone economies suffer also of a too-big-to-be-saved problem as the potential losses of their banks are larger than the national fiscal resources.

And now, on top of this loss of competitiveness some eurozone economies suffer also of a too-big-to-be-saved problem, as the potential losses of their banks are larger than the national fiscal resources. So the monetary union is under pressure as sovereign spreads are also rising. Two years ago – while still being in the opposition – the current Italian prime minister, Silvio Berlusconi and Mr Tremonti, his exonomic minister, argued that the euro had been a disaster for Italy.

With friends like these who needs enemies in the monetary union? While the risk of a break-up of the eurozone is still distant this financial and economic crisis is the first real test of the monetary union.

Many analysts are now predicting that the bond market is the last and most serious bubble which will burst shortly. Do you agree? Mike, Qatar

Nouriel Roubini: The current fall in government bond yields is justified by economic fundamentals: a severe recession, risks of deflation, risk aversion and move away from risk assets such as equities.

But certainly, over time, large and unsustainable budget deficits in many emerging and advanced economies, may lead to a rise in sovereign risk and a risk in government bond yields. Also the risk – small but rising – that excessive permanent monetization of such deficits will lead to much higher inflation suggests the existence of a minor bubble in government bond yields.

And indeed, in the last two weeks, the back-up in yield on US inflation-linked bonds and traditional 10 to 30 year bonds suggest the concerns of market participants about the sustainability of large fiscal deficits that – over the long run – may lead to solvency concerns.

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Financial markets have a new bogeyman. Economic nationalism, it is argued, will tip the world into a Great Depression, just as America’s Smoot-Hawley Act did 79 years ago.

This is a horrifying but, frankly, also a distant prospect. The disaggregation of global supply chains, the source of the huge efficiencies that companies pass on to consumers, will not be easily undone. The strained bonhomie at the World Economic Forum’s annual get-together was largely a symptom of the high stress levels among mostly elected leaders at a time when half the world’s top 10 economies are in recession and the other half are teetering on the edge.

For now, much of the protectionism is merely rhetorical and is likely to remain so. The controversial Buy American clause in the draft US fiscal stimulus package mandating use of locally produced iron and steel, for example, will be challenged by the EU and is anyway emasculated by a “public interest” opt-out. Actual measures have so far been minor. Take Russia’s 20 per cent increase in duty on imported cars. This has caused the odd street scuffle but is hardly likely to damage GM, Renault or Daimler, which all produce there.

Demagogues cannot dismantle decades-old commitments to freer trade overnight. Tariff protection has fallen consistently in all regions from the mid-1990s. Even if politicians wanted to favour local producers, disentangling national interests would be next to impossible. Witness the squall in England this week over a Lincolnshire refinery built 41 years ago by Total (France/Belgium), now employing Jacobs (America) to subcontract to IREM (Italy), which uses cheap Portuguese labour. 

In this context, state bail-outs are tolerable, provided governments only step in where the usual lenders have shut up shop, thereby compromising otherwise viable companies. Banks may be competing less on foreign rivals’ home patches but that reflects more the unwinding of previous excesses than ugly, government-dictated “national preference” lending policies. The 1930s are vivid enough in memory to stop history repeating itself. Stay short, deglobalisation.

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Wen Jiabao, China’s premier, met for an exclusive interview with the Financial Times. Speaking to Financial Times Editor Lionel Barber, China's Prime Minister discusses the critical year ahead for his country's economy and social stability, and his government's response to the global downturn.

Wen Jiabao: I want to make clear here that I will be most sincere in all my answers, but I may not tell you everything. 

Lionel Barber: Premier, when you were in Davos this week, and everybody was talking about how to restore confidence, there was also some talk about shooting bankers; that certainly will not restore confidence. What can China do today, in this global financial crisis, to restore confidence? 

WJ: Yes, indeed, I attended the Davos WEF Annual Meeting, and paid a visit to the European countries. I want to call this trip a journey of confidence. I have brought with me confidence in tiding over the difficulties caused by the financial crisis. I have brought with me the confidence that China will work closely with the European countries to push forward our strategic partnership. And I have brought with me the confidence that China will work with the international community to get through the difficult times together.

I’m confident that the Chinese economy will be able to get through the difficult times caused by the financial crisis. This confidence has been based on a scientific approach, as well as the realities in today’s world, as well as in China. The source of my confidence is based on the correct judgment we have made of the current situation.

I feel confident, because over the past 30 years of reform and opening up, China has put in place a solid, material and technical foundation, and we have now in place good institutions and mechanisms. I’m confident because China has a stable financial system. And also because China has a big market potential and a large room for manoeuvre.

Most importantly, my confidence is based on the decisive and firm decisions that the Chinese government has adopted. We took these decisions with great intensity and at a proper pace. I think I have given you a sketch of what the Chinese government has done, and if you are interested in any details, I’m ready to answer any question.

LB: Is this stimulus package big enough? Or do you believe further measures will be needed?

WJ: In meeting the financial crisis, it is imperative that governments must adopt a big enough package plan to stimulate the economic development. Such a plan must be comprehensive and complete. It must target both the root causes and symptoms of the issues, and also take into account both immediate difficulties and long term development.

Our package plan has five key components. Number one: we want to stimulate greater domestic demand that will be mainly supported by massive government spending. Number two: we are making adjustment to, and revitalising ten key industries. Number three: we will take steps to advance technical upgrading. Number four: we aim to put in place a fairly comprehensive safety net. And number five: we aim to preserve financial stability to support economic development.

Do you want me to cite some figures, or statistics of that?

We have an investment programme worth Rmb4trillion within two years to stimulate domestic demand, especially consumer demand. We will spend Rmb600bn on scientific and technical innovation and technical upgrading. We will make an investment of Rmb850bn for the improvement of medical and health care system. The financial crisis has not yet hit the bottom, and we will continue to follow very closely the development of the situation. We may take further new timely and decisive measures… All these measures have to be taken pre-emptively before an economic recession, so as to maximise the desirable effect, otherwise our efforts will be wasted.

LB: Did you see, as many economists in Asia witnessed, a very sharp decline in GDP in the fourth quarter in China, like falling off a cliff?

WJ: China’s GDP was at 9% as a whole last year, but in the fourth quarter of 2008 we also had a big decline and it fell to 6.8%. As a result of the international financial crisis we are seeing the diminishing external demand. Our businesses are now experiencing difficulties. We now have over capacity in some industries and also rising unemployment. Our economy is under increased downward pressure and all this means that we are now facing great difficulties. Maybe you will ask how come you still feel confident under such circumstances.

LB: How can you be so confident that you can magically hit that 8% figure? And how can you stop all those statistical experts saying.

WJ: Well, I think this is dependent on four factors. First, we must ensure that all policy measures we have adopted are the right ones as well as the effective ones. So far all these policy measures we have adopted are aimed at stimulating the real economy and also stimulating spending.

Well, actually the major impact of the financial crisis on the Chinese economy has been on its real economy. Secondly, one must act fast. We started to take action from July last year and we started to adopt massive steps from October last year.

During last December the central government took the decision of making an investment of Rmb100bn and I can tell you now that this investment has been put in place in terms of real funds and on what projects the money will be spent. Before the Spring Festival we also made available another investment of Rmb130bn and the funds were disbursed to the necessary projects.

Thirdly, we must take forceful steps. Under special circumstances; necessary and extraordinary measures are required. We should not be restricted by conventions. Success or failure depends on the pace and intensity of those measures. Fourth, we must make sure that these measures are effective ones.

Around the end of last year and early this year we took steps to make the household appliances, agricultural machinery, as well as automobiles more available to the rural areas of China.  From the beginning of January this year we started to undertake the transformation of the value added tax in China, which saved businesses in China Rmb120bn. All these measures have already been implemented.

LB: Consumer spending, Premier Wen, is crucial. Do you agree with the proposition that consumer spending is patriotic?

WJ: We would not put it as simple as that. I think that is a view that is maybe held by some media people or by some individuals. But we do believe that consumer spending is vital in boosting economic development. I don’t think we can know how much a consumer will spend eventually, and whether he wants to spend is not dependant on what kind of slogan we have.

But it is really dependant on how much money he has in his pocket and whether we have those marketable products available. We have actually taken some steps to address this issue. At the beginning of this year we gave lump sum subsidies to 74 million people.

On average each will have Rmb100 to Rmb150. For the fifth time we have raised the pension benefits for enterprise retirees by 10% and each one will have Rmb110. We have also increased the basic cost of liviing for people living in difficult circumstances and increased the special assistance and allowances for the groups who are entitled to them. We have also taken another step that is very difficult.

That is we have increased the wages for the 12m middle and primary school teachers who are in the compulsory education period in the Chinese educational system. We want to bring the wage level of those teachers up to the same level as the public servants.

I think people will be ready to spend when they have the money. We also took the policy that from January 20^th, 2009 to December 31^st, 2009 there will be a policy of halving the purchasing tax of vehicles of 1.6 litre engines or below, and on the first day the policy was introduced it gave such a strong boost to the sales of automobiles on the Chinese market that even the inventories were all gone.

LB: Before I turn to the international aspects of this crisis I have one small question regarding rural China. You visited over 2,000 Chinese counties I understand? What specific measures are you taking to assure social stability as unemployment rises and many, many people are returning to the land? And within that question, one last question on the Agricultural Bank of China. Are you planning to use $800bn to recapitalise it.

TR: The Agricultural Bank of China?

WJ: When I was Vice Premier of the State Council rural affairs in China were already a part of my portfolio, and since I became the Premier of the State Council I have always put rural affairs at the forefront of the government agenda in relation to the development of the Chinese economy. 

As you said, the financial crisis has caused some bankruptcies of businesses and also made the migrant workers return to the countryside. In total we have about 12m migrant workers who have returned to the rural areas. Some western countries may wonder whether this will be a source of social instability.  Well, I want to tell you that in China we have altogether about 200m migrant workers working in the urban areas, and the population of migrant workers searching jobs across provinces is about 120m. 

As I said, about 12m migrant workers have chosen to return to the countryside because of the financial crisis.  As this is a floating population, it is easy to understand that they will come to cities when there are job opportunities there and they will choose to return to the countryside when there aren’t. When they have returned to the countryside you can see that, for most of them, they still have their piece of land in the rural areas.  I think land provides the most important safeguard for the lives of those farmers in China. 

We should thank those Chinese migrant workers because they made an enormous contribution to China’s modernisation drive and, in times of this financial crisis, they have also become a big reservoir of the labour force. With regard to the Agricultural Bank of China, this is the last bank among the five major commercial banks in China who is undertaking reform.

I want to point out one thing here, that it is largely because we started the reform in China’s banking sector about ten years ago that now we have seen the Chinese major banks are now in a fairly healthy condition in terms of the quality and scale of their assets, the profitability of those banks, the proportion of NPLs (non performing loans), as well as the flow of capital in those banks.  We took these measures, including the reducing of non-performing loans in the banks, improving the corporate governance structure in the banks, as well as making them shareholding companies.

There are four key priorities in our reform with regard to the ABC. One is that we must ensure this reform will serve the purpose of agricultural development. Secondly, we must take continued measures to dispose of those non-performing assets. Number three; the government will take steps to inject capital into the bank. Fourthly, we will undertake the reform of putting in place a corporate governance structure. Our decision of this recapitalisation is about US$30bn

LB: You’ve outlined some important measures that China has taken to stimulate its economy but the world expects so much of China, and America in particular.  This past year there was more pressure on China regarding the renminbi and the Treasury Secretary referred to China manipulating its currency.  Have you received assurances from President Obama that America will be more accommodating, and what do you say to those charges that you are manipulating your own money?

WJ: To allege that China is manipulating its currency exchange rate is completely unfounded.  From the second half of 2005 we have started to conduct the reform in China’s exchange rate regime.  With more than three years of the reform, the Renminbi has appreciated by 21% in actual terms against the US Dollar and 12% against the Euro. 

Now we have in place a market based managed floating exchange rate regime with a reference to a basket of currencies.  This regime is consistent with China’s actual conditions and meets China’s actual needs.  I want to make very clear here that it’s to maintain the basic stability of the Chinese RMB on a reasonable and balanced level. 

It’s not only in the interests of China but also the world economy.  It is in the interests of the efforts of the international community in overcoming the financial crisis.  Many people have not come to see this point.  If we have drastic fluctuations in the RMB exchange rate it will only be a big disaster

LB: If I understand you, Premier Wen, you are supporting what the Chinese authorities said ten years ago with the ruling out of a depreciation of renminbi?

WJ: I think I have made my point very clear.  That is we practise a managed floating exchange rate regime and we preserve the basic stability of the exchange rate on a reasonable and balanced level.

LB: Everybody understands that the current financial crisis was manufactured, if you like, in America.  It originated in America. There were many mistakes made in terms of managing risk and regulation but what do you say to those who believe that a part of the problem is the imbalance in the world economy, with China’s $2 trillion of reserves?

WJ: I think such a view is ridiculous.  I think the reason for this financial crisis is the imbalance of some economies themselves. They have for a long time had double deficits and they keep up a high level of consumption on the basis of mass borrowing.

In those economies the financial institutions have not been put under effective regulation and the financial institutions have reaped massive profits with a very high leverage ratio. Once such a bubble bursts, the whole world has been exposed to a big disaster.  China is a very big developing country, with 1.3bn population.

The per capita GDP of China is only 1/16^th of that of the UK. We do need a large pool of financial resources to achieve economic development and improve the people’s livelihood. I think that it is confusing right and wrong when people who have been overspending blame those who lent them the money. In Chinese there is actually a proverb expressing this kind of situation which proves the character in the Chinese novel, Journey to the West, Zhu Ba Jie. 

Second Session 

WJ: … The proverb means to blame those who have actually done you a favour for your own wrongdoing. Well, when I shared this view of mine with the business leaders at Davos, they agreed with me on this.

LB: Premier,  you're still going to buy US Treasury bonds, I hope.

WJ: Well, this is indeed a very sensitive issue.  We do have very big foreign exchange reserves, and these reserves must be well run.  Buying foreign Treasury bonds is one way of running these massive reserves.  But as to whether we will continue to buy the Treasury bonds, and how many we are going to buy, I think we need to take into consideration China's own needs, and also the need that we must maintain the safety and the good value of our foreign exchange reserves. 

We want to see the turnaround, or the recovery of the US economy.  We believe that to maintain a stable international financial market is in the interests of shoring up market confidence, overcoming the financial crisis, and facilitating early recovery of the international markets.

LB: Would China be prepared to support the calls in some quarters for some of the reserves to be recycled through the IMF in return for the necessary award of greater votes for China in the IMF to help to manage this global financial crisis?

WJ: We believe it is imperative that we should first undertake reform in international financial institutions, including the IMF. And through the reform, we should increase the voting share, the representation, and the say of developing countries.  At the same time, the oversight of how the capital at international financial institutions is used should be strengthened.

LB: I asked the question because for 30 years, some people have said capitalism will save China, and now maybe people are saying China must save capitalism.

WJ: Well, I don’t see it this way.  I still have a very clear mind on this particular point.  China remains a big developing country with a 1.3bn population.  We do face arduous tasks, and our way ahead will be a long one. If you have seen the Chinese cities in the coastal areas, maybe you don't see much a difference between those cities and London, but if you have ever been to China's rural areas, particularly the western areas of China, you will see a big gap. 

I firmly believe that running our own affairs well is the biggest contribution to entire mankind.  I think there are three must-dos.  First, we must address both the symptoms and root causes of the problem.  One should not only tend to the head when the head aches, or tend to the foot when the foot hurts.  We must enhance cooperation rather than enter into a confrontational relationship.  We must run our own affairs well respectively instead of shifting troubles to others.

LB: Premier Wen, did President Obama offer some assurances in this respect?

WJ: It has not been long since the inaugural speech of President Obama.  We have been following closely the statements made by the new US administration.  We look forward to early contacts with the new US government, and we believe that to maintain cooperation between China and the United States serves world peace, stability and prosperity.

LB: With respect, Premier Wen, just to press you, so it's not correct; some reports have said that President Obama has given a personal message reassuring China that the renminbi and other matters will not be used in an aggressive way; that America will be more accommodating?  There's no personal message?

WJ: In his telephone conversation with President Hu Jintao the day before yesterday, he expressed his readiness to enhance cooperation with China.  Yet, at the same time, we do see there are different voices within the United States itself.  I hope the FT can convey a message from me to the US side.  We want to enhance cooperation with the United States to meet the financial crisis together as that represents the larger interest, and it serves the fundamental interests of both countries.

LB: Yes, the problem may be even more in Congress than in the administration.  So do you have a message for congress?

WJ: We don't comment on the system of the United States.  I think the US government has a decisive role to play in making the right decisions. The US government should view its relations with China from a long term and strategic perspective, and under the current circumstances, the priority of the two countries should be working together to fight the financial crisis and promote the constructive and cooperative relations between China and the United States.

LB: Just to return to the reserves very quickly, did I understand that the Chinese government may use some of the reserves for spending programmes at home to stimulate the economy?

WJ: Foreign exchanges reserves reflect the economic strength of a country. We are now studying how we can make the best use of the foreign exchange reserves in China.  On this particular topic, you are all experts.  And for banks, I think foreign exchange reserves are liabilities of  the central bank, and if a government wants to make use of the foreign exchange reserves, it has to issue government bonds to buy the foreign exchange reserves.

We are now having discussions about how to make rational and effective use of the Chinese foreign exchange reserves to serve the purpose of economic development in China.  Last year, we issued Rmb1.5 trillion of government bonds in purchasing US$200bn of foreign exchange reserves to inject capital into the China Investment Corporation. Foreign exchange must be spent overseas, and it will be spent mainly on foreign trade and investment.  Therefore, we want to use foreign exchange to buy the much needed technology equipment and products.  That is a quite technical issue.

LB: The world expects so much from China.  China is taking very important steps to increase research and technology on renewable energy.  But later this year, there will be a summit in Copenhagen on climate change.  Is China ready to sign a treaty to cap carbon emissions?

WJ: I had a thorough discussion about this issue with President Barroso of the European Commission in Brussels the day before yesterday.  The Chinese position on this issue is as follows. 

Number one, China supports the Copenhagen conference.  It supports all measures which are playing their roles in meeting the challenge of climate change, and we support the development of a green economy.  We are of the view that to develop a green economy is probably another area in the economy as we meet the international financial crisis. Number two, the Chinese government gives top priority to meeting the challenge of climate change.  We have established a national leadership group on tackling climate change, and I'm head of the group. 

We have formulated a national programme on coping with climate change, and this is not only the first programme of its kind for China, but also the first one of its kind among all developing countries. In China's 11th five-year plan, we have set ourselves obligatory targets in saving energy and reducing pollution.  The target requires us that we must reduce the per unit GDP energy consumption by 4% every year, and in total by 20% in five years.

We failed to meet the targets in the first two years of the five year period, and we succeeded in meeting the target in 2008.  We will continue to make efforts on this front and set targets for ourselves.  I think this can be seen as a way that China is holding itself accountable to the relevant targets. 

Number three, it's difficult for China to take quantified emission reduction quotas at the Copenhagen conference, because this country is still at an early stage of development.  Europe started its industrialisation several hundred years ago, but for China, it has only been dozens of years. 

China has a 1.3bn population, and in terms of per capita greenhouse gas emission, we are certainly not the biggest one, yet we are still very active and positive about our cooperation with Europe in terms of saving energy, reducing pollution, developing a low carbon economy, and developing those environmentally friendly technologies.

LB: Premier Wen, I've been told if I ask a political question, I have to be very careful.

WJ: Ask any question you want.

LB: I have to be careful, because in Mandarin, I will get hat, shoes and gloves.  But looking to the future, could you imagine there being direct elections to the National People's Congress, say, in ten years?

WJ: Well, actually, I think economic life and political life are not separable from each other. Let me address this political question from you from an economic perspective. We are undertaking both economic restructuring and political restructuring, and both are very important. 

Without the successful political restructuring, one can't ensure success in our economic restructuring.  The goal in our political restructuring endeavour is to promote socialist democracy, and better ensure people's rights to democratic election, democratic decision making, democratic management, and democratic supervision. 

The society that we desire is one of equity and justice, is one in which people can achieve all round development in a free and equal environment. That is also why I like Adam Smith's Theory of Moral Sentiments very much. 

In 1776, Adam Smith wrote the Wealth of the Nations. And in the same historical period, he wrote the Theory of Moral Sentiments.  Adam Smith made excellent arguments in his Theory of Moral Sentiments.  He said in the book to the effect that if fruits of a society’s economic development can not be shared by all, it is morally unsound and risky, as it is bound to jeopardize social stability .If the wealth of a society is concentrated in the hands of a small number of people, then this is against the popular will, and the society is bound to be unstable.

Like truth is the primary virtue in thinking, I have always believed that justice and equity are the primary virtue in the socialist system.  In the eyes of the West it seems that the Chinese are afraid of democracy or elections.  Actually, this is not true. 

As I told the press during the press conference of the NPC session early last year, I said that only when people trust you, will they support you in your office.  Now we have direct elections at village level and also direct elections of People’s Deputies at township level.  At the same time, I have always believed that if the people have the ability to run the village affairs well they are capable of running the township affairs and the county affairs and then running the provincial affairs. In this entire process we should take a step by step approach in the light of China’s own conditions and to develop a democracy with Chinese features. 

LB: So there’s a bit more room for democracy and a bit more room for dissent as part of a democracy.

WJ: Well, I don’t think a government should feel afraid of its own people.  I think it should create opportunities for the people to better hold the government accountable.

LB: Premier Wen, I realise we’re running short of time. I had my own quote from the Theory of Moral Sentiments.

WJ: Well, I think for quite some time this book has not attracted due attention or attention that it deserves.  I think it is as important as The Wealth of Nations.  He made a reference to the invisible hand only on two occasions in these books. One, he refers to the market; the other, he talks about the morality. And please go ahead with your quote. 

LB: “How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortunes of others and render their happiness necessary to it, though he derives nothing from it except the pleasure of seeing it.” 

WJ: I think this is very well said, and I have been reading the book and this book I carried with me in my suitcase on the trip. 

LB: Thank you very much for agreeing to talk to the Financial Times.  It’s been very enlightening. 

WJ: Thank you.

Early signs of what the future banking landscape will look like are emerging amid some evidence of improvements in corners of the financial market. For the moment, the main focus for regulators remains fire-fighting in the U.S. and Europe to stave off the nationalization of banks and generate bank lending. Among these emergency measures are sweeping insurance packages for souring bank assets.

British tycoon Richard Branson participates among other people and actors in a "Refugee Run simulation" during the World Economic Forum. Angela Merkel, the chancellor of Germany, speaks at the World Economic Forum in Davos, Switzerland, on Friday. She called for a new 'United Nations-level' economic council to avoid another global financial crisis. 'We need clear-cut rules world-wide,' she said. Against this backdrop, a picture is emerging on how banks will be regulated in the future. The supervision is likely to be vast.

In a speech here Friday, German Chancellor Angela Merkel heaped criticism on what she called an "unfettered" capitalist system. She called for an overhaul of the financial system, suggesting that a new, United Nations-level economic council might be needed to avoid another crisis.

"We need clear-cut rules world-wide," she said. Davos, known in the past as a celebration of profits, this year was more of a cold outpost where attendees, including regulators, bankers, and hedge-fund managers, have been sorting through a raft of back-to-basics strategies for the world's financial system.

"In the end, what we want is a financial industry and banking-sector industry where you have more capital, less debt, more rules and much stronger supervision," said Italian central-bank governor Mario Draghi. He said markets largely remain frozen and that the only thing that would attract investors -- many of which actually serve as lenders because they invest in debt -- is an assurance of safety and transparency.

"The only thing we can do to help restart the market is to tell the world that there are certain kinds of real products that are simple to understand, easy to price and satisfy certain legal conditions," Mr. Draghi added.

Still, there are slight signs that the freeze in lending among banks might be starting to thaw.This month, for example, a critical barometer for the health of the financial sector -- the London interbank offered rate -- showed signs of stabilizing. Libor, which is a measurement of bank borrowing costs, soared last fall after Lehman Brothers Holdings Inc. filed for bankruptcy because banks stopped lending to each other. Though Libor has fallen since start of the year, it has edged higher in recent trading sessions in London. Three-month dollar Libor on Friday was 1.18%, up from 1.08% on Jan. 14.

Among the new rules of the game for banks are likely to be simpler models that rely less on off-balance-sheet vehicles and borrowed funds to drive profits. There also likely to be fewer opportunities for banks to offload risk to third parties -- such as American International Group Inc. -- that then end up unable to insure themselves against losses or exposures to loans.

Regulators are also likely to force banks to be clearer and more transparent about the type of risk that exists on their balance sheets. In recent years, few people knew that big banks used affiliates known as structured investment vehicles to invest in securities underpinned by mortgages. When those vehicles were unable to sell short-term IOUs known as commercial paper, banks had to step in and cover the debt.

Within this new banking landscape, hedge-fund operators face their own changes. At a Credit Suisse Group lunch Thursday, held in what usually serves as a furniture store on a main Davos road, Eric Mindich, chief of hedge fund Eton Park Capital Management, said funds will be consolidating. He also said funds will be forced to better match assets and liabilities in order to ensure liquidity in times of stress.

Making heavy use of debt will no longer be possible to power growth, said several Davos attendees, including Martin Senn, chief investment officer at Zurich Financial Services. "I think the industry will be required to hold more capital, which will lead to less leverage, which will eventually lead to more stable institutions," he said.

Source. More Davos Converage.

Thursday in Davos began with blue sky outside — and more repent-your-sins inside the conference halls which started to resemble tent-revival meetings.

Early morning sessions included “Can the world live with the frugal American,” where Zhu Min, group executive vice president at the Bank of China, and others tackled American credit-card debt. That session ran on a parallel track with one focused on the breakdown in computation modeling.

But the real value assessment was mid-morning as Tony Blair and Shimon Peres along with executives such as Stephen Green, chairman of U.K. bank HSBC Holdings PLC, discussed the disappearance of morals before a standing-room-only crowd in a main conference call.

All seemed to agree that business ethics went off track and that regulation needed a review, too. Mr. Green told the story of how a London train system had prepared for a snowstorm. Yet when the snow arrived, the announcement was made that there would be problems because the train operator had prepared for the wrong form of snow. In other words, there was plenty of regulation. It was just the wrong kind.

PepsiCo chief Indra Nooyi and Mr. Green others did point out that capitalism was needed to power emerging markets and scientific research. Ms. Nooyi also said that the majority of “Main Street” had good values.

“The other part of the economy needs some work,” said Ms. Nooyi, who argued that innovation in the financial world got too far ahead of regulation.  Toward the end, Mr. Blair congratulated Mr. Green for being one of the few bankers courageous enough to appear in daylight hours. But change only comes so fast. Outside the main hall, six silver Audis with drivers waited to ferry passengers away.

Source.

From Gideon Rachman, Financial Times's Chief Foreign Affairs Columnist

There has always been a certain tension between the World Economic Forum’s slogan, “Dedicated to improving the state of the world,” and the fact that many of the delegates are in Davos to network and go to parties. That is particularly awkward in a year when many of the people here have arguably done quite a lot to mess up the state of the world by, for example, flogging toxic debt.

Davos has reacted by toning down the parties this year. The closing gala, which usually features dancing and loud music, has been re-branded as a “cultural event,” which sounds really dismal. The tasting of fine wines is not taking place. The investment banks are keeping a low profile.

I was expounding my theory that this is the party-free Davos to a colleague from The Economist, who then dismayed me by producing a vast folder of party invitations. So it appears there are lots of parties. I just haven’t been invited. My former colleague rather grandly picked out some of the B-list invitations he wouldn’t be using and tossed them my way, a German bank, an Indian newspaper, that kind of thing.

Then he spotted a functionary from the Clinton Global Initiative, called him over and suggested that he invite the FT’s foreign-affairs columnist (me) to the CGI party in the Davos museum. The functionary looked at me for a moment and then said: “I’m afraid it’s a very restricted space.” Oh well, I’m going to a South African jazz party instead, and I won’t even have to gatecrash.

Davos is full of these minor social humiliations. I bumped into the historian Niall Ferguson today, who was a star of the most sought-after dinner this year, on what happened to the investment banks last September. But despite his elevated status, Ferguson is facing the ultimate ignominy, the forum have put him in a hotel room in Klosters, a long drive away from Davos.

“I’m a gloomy Scot”, he remarked cheerfully, “I thrive on these sorts of setbacks.” I was unable to get into the Ferguson dinner, so instead I went to a bizarre-sounding event on “leadership lessons to be learnt from Macbeth,” conducted by Richard Olivier, son of Laurence. The main lessons that I extracted is that it is a bad idea to murder your boss - and beware of your bossy wife.

Source.

The precious few parties hosted by bankers at the World Economic Forum in Davos were so low-key that it was no wonder that a vodka party thrown by Russian prime minister Vladimir Putin last night was deemed to be the hot ticket. Rival dinners were hosted by UK banks Barclays and Standard Chartered. Barclays had London mayor Boris Johnson booked to speak at a shindig hosted by chairman Marcus Agius at the Schatzalp hotel - a former sanatorium known for its pioneering TB research. Standard Chartered, meanwhile, was having its drinks at a chapel, with entertainment provided by Bryn Terfel, the Welsh opera singer.

Goldman Sachs boss Lloyd Blankfein may not be in Davos but he is making important friends in the Middle East instead, where he this week visited young Dubai crown prince Sheikh Hamdan. They had their own mini-forum, discussing the global economic changes and "the role of financial institutions in reviving the global economy though setting up solid strategic partnerships". For his part, according to the Emirates news agency, Mr Blankfein "expressed his confidence in the UAE economy", despite the prevailing pessimism. He also expressed his "willingness" to expand Goldman there. What are bankers for, after all

The penny finally dropped at Barclays that it was more important for US president Bob Diamond and retail and commercial bank boss Frits Seegers to be in the office, as they join the list of last-minute Davos drop-outs. They will miss out on the fresh snow, which is deep and crisp and even, after gentle falls in the scenic mountain town where local kids fill the ice rink.

Alcoa executive Klaus Kleinfeld, ex-Siemens, was in the Café Schneider, going into a room marked 'Tata Consultancy Services'. But there were more no-shows than sightings, with Anglo American boss Cynthia Carroll pulling out of her scheduled panel on the global industry outlook. Among the global corporate celebrities, Google founders Larry Page and Sergey Brin have been inseparable features of Davos, being the toast of the town after they showed up as waiters to a women's dinner in past years. But Eric Schmidt, Google chairman and another regular Davos man, had already decided to stay home and now Sergey has dropped out, leaving Larry to represent Mountain View's views in the Swiss mountains.

This year's Davos gadget was a little blue pedometer. Each delegate was issued with one and invited to "walk the global village". "Be fit, get there quicker and count your steps on the way. Enjoy breathing healthy mountain air. Reduce traffic congestion and contribute to a 'Green Davos'. Be recognised as Walker of the Year 2009." Anyone who walks more than 20,000 steps is entered in a prize draw. With packed snow on the pavements and waist height drifts on the roadside, there will be more broken bones than on the slopes.

Source.