Prof. Dr. Hans Tietmeyer: The Banking Crisis is a Crisis of Confidence

The former president of the Bundesbank and chairman of the INSM board of trustees, Prof. Hans Tietmeyer, commented on the current banking crisis in an interview with VDI News. The INSM documents excerpts from this interview.

The currency reform took place in Germany in mid-June 1948, and the Federal Republic began its journey to a social market economy. That is now 60 years ago. Certainly a reason for celebration, if it wasn't for the financial crisis, which critics have even connected with the end of the market economy.

It is true that we are currently confronted with particular challenges as a result of the international financial crisis. Nevertheless, we have good reason to celebrate the 60^th anniversary of the social market economy in postwar Germany this year. Our country was rebuilt after the currency reform in 1948 on the basis of the erection of an economic and social system by Ludwig Erhard using the concept of the social market economy. Dynamic economic development had soon begun, and we achieved significant prosperity. We can be proud of this. And I am convinced that we can and will continue this success story if we fight the current financial crisis correctly and correctly set the stage for the future as well.

I do believe that more care and caution would have been necessary in the financial world in recent years in some products and businesses. Unfortunately, some undesirable developments in the financial markets were also encouraged by problematic macroeconomic developments.

First of all, in my opinion the monetary policies of the United States after September 11, 2001 were too expansive for too long. Second, in recent years there were more and more problematic exchange rate developments, especially among some Asian currencies and the US dollar. The enormous buildup of dollar reserves led to significant expansions of liquidity in countries' own currencies, not only in Asian countries, which artificially boosted these countries' exports. In addition, the dollars were to a large extent reinvested in the United States. Through these dollar purchases and investments, growth was artificially stimulated in the US-along with a high trade balance and budget deficits, as well as sometimes negative savings rates. These exchange rate distortions led not only to excessive expansion of the real economy in the US, but also to excessive financing in the mortgage area, which was also fostered in the US through accelerated deregulation. In dealing with the liquidity, a great number of errors were made in the financial markets, certainly not only in the USA itself, but also in other countries. One would have had to be more cautious overall-especially in the banking world, where too much euphoria took hold in connection with many new products.

Many bankers seem shocked, at least by the extent of the crisis. They were soon calling for government action. And the government has now decided upon a rescue package. Is this behavior in conformity with a market economy?

Here we must differentiate: are we talking about a single business or about the system in general? In the current financial crisis, unfortunately the system itself is at issue. The confidence in markets that has been lost worldwide undermines the markets' ability to function, and that could endanger the market economic system in general if it lasts too long. Thus the markets must be prevented from sliding further and the worldwide blaze must be extinguished. But then we must still develop a system of rules that on the one hand allows the market sufficient leeway, but on the other hand prevents as far as possible the kind of hypertrophies that we are experiencing. That will be difficult, because we not only need international agreement-at least among the larger countries-on a new set of rules; the actual implementation of the rules is naturally also important. Within these rules, however, the banks must continue in the future to act on their own responsibility, and to bear the risks themselves.

Would Ludwig Erhard, the father of the social market economy, have seen things the same way?

I think so, since the current government rescue actions do not serve to protect individual interests, they serve above all to protect and restore the system's ability to function. Erhard was a staunch advocate of the market economy. But he always argued for a framework to maintain the functional ability of the market economy. Given the internationalization of markets, today we also need an international system of rules for the financial sphere. It's not about sealing off national markets; it's about ensuring their ability to function in the long term.