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Former Treasury Secretary Lawrence Summers urges quick US economic stimulus. (Erik Jacobs for the Boston Globe/File 2007) |
LONDON - Jean-Claude Trichet and Lawrence Summers accurately warned investors a year ago about being too complacent. Now they see an erosion of confidence that threatens to paralyze the global economy.
Summers, a former US Treasury secretary, returns to the World Economic Forum in Davos, Switzerland, this week urging quick action in the form of economic stimulus to head off "a cascading loss of confidence" in the US economy since the collapse of its housing market. Trichet, the European Central Bank's president, also traveling to the Alpine retreat, is leading international colleagues in lending emergency cash to banks.
"When you have recessions from bubbles bursting, they tend to be protracted," said Summers, a Harvard economist and the university's former president. "There is the possibility, not yet at all the probability, that a recession could prove long and severe."
As the hubris that Trichet and Summers decried last year is replaced by fear, an aversion to risk-taking may worsen the outlook for the world economy. Europe's Dow Jones Stoxx 600 index yesterday plunged the most since the 2001 terrorist attacks.
"Davos was marked last year by an irrational exuberance," said Josef Ackermann, chief executive of Deutsche Bank AG, Germany's largest bank. "I hope that we don't swing to the opposite this year and give in to an irrational depression."
Bankers are dumping derivatives that drove the credit boom in favor of havens such as gold and US treasuries. At the same time, they're constraining lending and eliminating jobs.
Another indication that investors are losing their appetite for risk is the increase in stock-market volatility, as measured by the Chicago Board Options Exchange's VIX index. The VIX has more than doubled in the past year, after showing little movement for most of 2006.
As investors convert to less-risky holdings, gold reached a record $914.30 last week, and the yield on the benchmark 10-year Treasury note fell to a four-year low.
"We have to pay for the sins of the past," Klaus Schwab, the World Economic Forum's founder and chairman, said in a Jan. 11 interview. "The mood of Davos has changed."
People nursing losses as they try to enjoy the Davos party circuit can't say they weren't warned.
Trichet said at the 2007 forum that a "reappreciation of risk" was likely. Summers compared the confident mood then with the market sentiment that prevailed just before World War I.
Such caution was brushed aside a year ago.
John Thain, then chief executive of NYSE Group, was in Davos then and said "the financial markets, the world economies are all actually in quite good shape."
Thain, returning to Davos this week, knows better now: In December, he became chief executive of Merrill Lynch & Co., charged with reversing the worst losses in the brokerage's 93-year history after it was battered by $16.7 billion in write-downs of failed investments.
On a conference call last week, Thain said that while Merrill "will continue to take risks," they must be "sized appropriately" so they don't have the potential to wipe out profit.
This month, Merrill raised new capital from a group including the Kuwait Investment Authority. Citigroup, the biggest US bank, is getting $14.5 billion from investors including the Singapore government and Saudi Prince Alwaleed bin Talal.
Representatives of such state-run funds may be some of the most sought-after participants among the 2,500 executives, investors, policy makers, and academics at the four-day gathering.
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