Ambassador's Corner
WEEKLY MESSAGE FROM AMBASSADOR JOHN BRUTON
February 26, 2008
The Economic Report of the President
I have always enjoyed reading the Economic Report of the President, the latest
edition of which was transmitted to Congress earlier this month. Under
successive Administrations of different
parties, this annual report has been
consistently well written, informative and thought provoking. It can be obtained
on the web at www.gpoaccess.gov/eop .
This year’s report, prepared by Chairman Edward P. Lazear and his staff, deals
with every topical economic issue, including healthcare, the nation’s
infrastructure, tax policy and export growth.
The housing market and the world economy
I found the section in the Report on “Credit and Housing Markets” particularly
informative. It explains, in lay person’s language, how the credit markets work
and defines all the terms in current use.
It explains how an expectation that house prices would continue rising
indefinitely, combined with availability of cheap money and intense competition
for business, led lenders to relax their underwriting standards and to offer
products with artificially low initial payment obligations, thereby creating
today’s problems.
Securitization was used to bundle up different types of loans and sell them on
to third parties. In the process, risks were spread, but real exposures became
more and more difficult to quantify. As risk management was increasingly
delegated to younger and mathematically brilliant members of staff, top
management found it harder and harder to keep track of what was really going on,
and to exercise the judgement required.
My own view is that the Government agencies responsible for the supervision of
financial institutions should have seen much earlier that this combination of
low initial rate (teaser) mortgages and bundling risks created a problem for the
system as a whole. Certain practices, like negative amortization and loans made
to borrowers without proof of income, that were inherently unduly risky or
morally hazardous, simply ought to have been banned.
This, of course, would have been highly controversial at the time. A recent
paper entitled
Financing Europe’s Fast Movers, published by the Bruegel
Institute in Brussels, argues that it was the innovativeness of financial
services in the United States that has given emerging US firms an edge over
their European competitors. Securitization, mezzanine debt and other financial
innovations enlarged the pool of investors who could make funds available for
the early phases of development of new firms. That helped new competitors to
break into markets more easily in the US than in Europe.
On balance, America’s deeper and more sophisticated financial markets have
served it well. But as far as personal lending is concerned, especially if the
borrowers were not as financially educated as the lenders and if the lenders
were passing the risks on to someone else and were structuring their employee’s
remuneration to maximize short-term business, there is a real problem.
There must always be a close relationship between power and responsibility, in
finance just as in politics, and it is the financial regulator's job to ensure
that that is so. On both sides of the Atlantic, there are clearly lessons to be
learned from this experience and improvements to be made.
Energy – what do the options really cost?
Another very informative chapter in the Economic Report of the President is on
“Energy Solutions.”
It points out that the US consumes almost three times as much oil per day as
China,
absorbing 25% of the world’s total oil consumption (with only 4% of the
world’s population). The US emits 5.9 billion metric tons of CO2 into the
atmosphere every year (that is 20 tons per person per year). Seventy-three
percent of these
emissions arise from fossil fuel used in transportation and electricity
generation.
The report gives a lucid and readable account of the different ways of reducing
dependency on foreign fuel, and of using fuel more efficiently and with less
damage to the environment. Every approach from solar energy, to wind energy, to
geothermal power is explained and explored.
There is a fascinating table (Table 7.1), which gives the “total system levelized
cost” of each of the options for electric power generation. This calculation
works out the total cost of the option taking into account initial capital
costs, maintenance costs and power transmission costs over the life of
investment.
The cheapest option is conventional coal fired electricity generation, at $60.9
per megawatt hour. Solar thermal power is among the most expensive at $154 per
megawatt hour, and biomass, advanced nuclear and geothermal electricity
generation are all more expensive than conventional coal at $79.8, $69.7 and
$72.9 per megawatt hour respectively. There are also physical limits to these
technologies, so we will keep coming back to coal, whether we want to or not.
How will all this coal fired electricity generation affect our
climate? Will all
the additional CO2 emissions accelerate the crisis?
Carbon sequestration, which would eliminate the CO2 emissions, may be the
answer. As I have said in earlier weekly messages, the technology for carbon
sequestration is available and it is a question of finding geological formations
into which the CO2 can be safely injected, and from which it will not leak.
The problem is that the
Economic Report of the President calculates that the carbon
sequestration option would cost $83.8 per megawatt hour on a total system levelized cost basis, which is much more expensive than the $60.9 per megawatt
hour cost of conventional coal power generation and much more expensive than many
of the other options I have mentioned.
The Chinese are reportedly building a new coal fired power station every week.
If these new power stations are not accompanied by a system for sequestering the
CO2, they will have a dramatic effect on climate change.
But how are the Chinese to be persuaded to adopt a technology that will give
them electricity costing $83.8 per megawatt hour, rather than one costing only
$60.9 per megawatt hour? Who will make up the cost difference? Do we expect them
to make it up out of their own resources? Hardly, given that the extra CO2 they
will otherwise generate will damage everybody, not just themselves.
Therefore, we have got to make it financially worthwhile for companies in both
China and the US to adopt sequestration technology that will eliminate the CO2
emissions from coal burning. The EU’s proposal for global cap and trade systems
would do just that. It would provide a financial pool that could be used to make
up the difference between the $60.9 for heavily polluting conventional coal
fired generation, and the $83.8 for coal fired generation accompanied by carbon
sequestration.
President Bush is right on food aid
President Bush has recently returned from
Africa, where he won well deserved
praise for his commitment to the continent over the past seven years. His action
on HIV/AIDS and malaria complement policies supported by the European Union.
I was pleased to see that, in his State of the Union address, he asked Congress
to agree that some US
food aid be provided to buy crops directly in the
developing world. I applaud this proposal, which is in line with the European
practice of providing cash-only, untied food aid. This is a better policy
because it creates a market for local farmers in the region, encourages them to
invest and avoids the developing world becoming dependent on food imported from
the developed world.
I hope that in 2008 Congress considers President Bush’s proposal favourably, as
it is an important step in the right direction.
Please send me your
comments about this or any of my weekly messages or other EU matters. I
look forward to hearing from you!
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