KEY POINTS:
Double helpings of humble pie must surely have been on the menu in Washington at the weekend, when a clutch of Wall St's richest bankers were hauled in to dinner with finance ministers from the world's most powerful economies to account for their role in unleashing what the International Monetary Fund (IMF) has called "the largest financial shock since the Great Depression".
There was an air of shocked contrition among the ministers and central bankers, many of them new to their jobs, who have found themselves hostage to the forces unleashed by the failures of high finance.
Since the sub-prime crisis began to engulf the global financial system last August, the men and women who run the global economy have jostled to appear decisive and statesmanlike, while cobbling together one costly emergency rescue package after another, to prevent the losses sustained by the banks bringing the entire financial system grinding to a halt. Hardly the stuff of dinner party chat - but the contrite bankers from both sides of the Atlantic who gathered at the US Treasury were asked to give their side of the story.
All the power-brokers gathering for the IMF's spring meetings were faced with a global financial system that bore little resemblance to that of a year ago, when the private equity boom was at its height and markets were awash with unbridled optimism.
At its spring meetings last year, when the US housing downturn was already under way, the IMF, long the cheerleader for unfettered liberalisation and light-touch regulation of financial markets, predicted that the global economy would sail merrily on. It quipped that the "financial tail" would not wag the "economic dog"; in other words, that the losses created among banks and other financial institutions by mass defaults among US homeowners would not derail the strongest expansion in the world economy since the late 1960s. But as Simon Johnson, the IMF's director of research, said last week: "Everyone in the world has learnt a lot about dogs, and their tails, and how that works, over the past year."
Like most of those working in the City or on Wall St, few of the policy-makers gathered in Washington had any first-hand experience of dealing with a crisis. Ben Bernanke, chairman of the Federal Reserve, is two years into the job. He made his reputation by studying what the authorities did wrong during the Great Depression; but he cannot have guessed that he would be faced with the task of avoiding a repeat performance.
Alistair Darling has had nothing but trouble since taking over as Britain's Chancellor last June; Christine Lagarde, the French finance minister, has also been in the job less than a year. And Hank Paulson, the US Treasury Secretary, is a seasoned Goldman Sachs banker, hardly the obvious candidate to sketch out radical solutions to a crisis propagated by the banks themselves.
Around the G7 table at the US Treasury on Friday afternoon, only Mervyn King, chief economist at the Bank of England at the time of Black Wednesday in September 1992 - when the pound was forced out of the European Exchange Rate Mechanism - had any hands-on knowledge of what it was like to be a policy-maker under siege. When the Fund last met in Washington in mid-October, there was still hope that the problems caused by the collapse of the US sub-prime mortgage market could be contained.
The IMF noted the rapid response from the Fed and other central banks and expressed confidence that the American economy was resilient enough to shrug off the impact of its ailing housing market.
At a global level, the consensus was that growth would be barely dented, with the leading developing countries taking over the role of locomotive for the world economy from America.
The mood changed over the northern winter. Financial markets have remained frozen, with credit hard to come by and expensive when available. The poison from the US mortgage market has infected the rest of the economy; consumer confidence has collapsed, unemployment is rising and spending on durable goods has fallen sharply.
Since last summer the Fed, haunted by its policy inaction at the time of the Great Depression, has slashed interest rates by an extraordinary 3 per cent to boost activity, but the impact has been more immediately felt on the world's foreign exchanges, where the dollar has dropped to a record low against the euro. The weakness of the greenback has added to the sense of crisis.
The threat of a global recession traditionally leads to a collapse in the cost of energy; last week the price of crude hit a record $112 a barrel and food prices have risen so fast that Robert Zoellick, the president of the World Bank, warned that growing problems of malnutrition and hunger had set back the fight against poverty by up to seven years.
The bankers' trade body, the Institute of International Finance, issued a rare mea culpa last week, confessing to "major points of weakness in business practices" - including bulging pay packets, awarded in many cases on the basis of short-term performance.
Against this gloomy backdrop, the IMF could hardly be accused of pulling its punches. On Wednesday, it said that the total losses resulting from the sub-prime crisis were likely to be close to $1 trillion; on Thursday, it said the "financial market crisis that erupted in August 2007 has developed into the largest financial shock since the Great Depression, inflicting heavy damage on markets and institutions at the core of the financial system", and warned of a one-in-four chance of a world recession.
Johnson exhorted governments to use all the weapons at their disposal to tackle the crisis. He outlined three "lines of defence" for embattled policy-makers: interest rates, tax policy and, where necessary, more state-backed bailouts.
Next day it was the turn of Dominique Strauss-Kahn, France's former finance minister, to host his first press conference since becoming the IMF's managing director six months ago.
Strauss-Kahn admitted that policy-makers faced a tough task of steering between what he called "ice and fire".
They must balance the risk of a sharp slowdown in their economies with the danger of unleashing rampant inflation. Central bankers are alarmed at the extent to which interest rate cuts have proved almost powerless to reopen the credit markets.
Strauss-Kahn insisted his much-maligned institution was the right body to bring stability to the global economy, saying: "The IMF is back." But his audience could be excused for wondering where it had been since the crisis erupted.
From cash-strapped UK homeowners, to the small businesses in emerging markets that are now finding it harder to raise finance, the crisis has powerfully demonstrated that what happens in the slick institutions of Wall St and the City can have a devastating impact on the world outside.
Demand for radical action is growing, particularly in the US, which many economists believe is already in recession. Paulson admits two million people may lose their homes before the crash is over and basic questions are being asked about the power of global capital.
Presidential candidate John McCain last week joined calls for direct government intervention to help mortgage-holders who cannot pay their bills, outlining a scheme that could cost up to $10 billion.
Yet despite flagging up the crisis as the worst since the Wall St crash of 1929, the IMF had few new recipes to offer the finance ministers it is meant to advise.
Professor Joseph Stiglitz, the Nobel prize-winning economist, says this may reflect another challenge facing policy-makers: not only are they inexperienced and in uncharted waters, they are also unwilling to confront fundamental problems with the philosophy they have pursued for two decades.
"It is all based on a simplistic ideology," he says. "What these leaders are finding is that the heroes of the past 20 years have been the financial market wizards, and all of a sudden it's so obvious that the emperor has no clothes." The lionising of the money men was "ideology - and special interests, cloaked in ideology".
The IMF has been in the vanguard of the drive or deregulated capital markets, urging the removal of restrictions on the activities of banks and other institutions in developed countries, and often insisting on such a policy stance for developing countries seeking financial help.
This "Washington consensus" of liberalisation and deregulation has long been the target of anti-globalisation campaigners and development charities, which blame the fund for imposing free market ideology on the poor. This dogmatic approach was criticised for exacerbating a series of major economic and financial crises. But this time, the IMF and its fellow-travellers are accused of promoting the policies which have created a recession on its very doorstep - in America.
Strauss-Kahn found it impossible to admit last week that the IMF had itself been part of the problem, arguing that its warnings of impending problems from reckless lending had gone unheeded, especially in the US.
But the crisis comes at an unfortunate time.
Morale at the IMF is low after the cost-cutting programme implemented by Strauss-Kahn, and the unwillingness of its big Western shareholders to give up anything more than a fraction of their voting power to developing countries has raised questions about its legitimacy.
Peter Chowla, policy analyst for the Bretton Woods Project, which monitors the World Bank and the IMF, says: "Part of the reason the fund doesn't have the ability to analyse the crisis well is because the major shareholders haven't wanted it to have a role in overseeing financial markets in their countries. The US has been particularly unwilling to cede authority."
Stiglitz agrees: "The IMF is structurally in a difficult position because it is really accountable to the finance ministers and central bankers, and they're really owned by Wall St and the financial markets - and the financial markets are at the root of the problem."
On Friday, Darling called for the IMF to be streamlined and given a stronger role in warning about financial crises. But even when the fund warns of trouble ahead, finance ministers often ignore it, as Darling himself knows well, having spent some time last week rejecting its forecast that the UK faces a deep slowdown over the next two years as a result of its collapsing housing market.
As if sensing that the response of policy-makers to the crisis was weak and confused, the banks last week sought to head off calls for the sort of draconian curbs on their activities imposed by President Roosevelt after the Wall St crash. Josef Ackermann, chief executive of Deutsche Bank and chairman of the Institute of International Finance, said that despite bearing some responsibility, it would be "completely wrong" for the authorities to impose much tougher controls on the banks.
In more normal times, Ackermann's pleas for clemency would find an echo at the US Treasury and the Federal Reserve. The scale of the losses racked up by the banks, the large injections of taxpayers' money to help them through the crisis, and - perhaps most important - the impact on ordinary Americans in an election year means the banks' insistence they can clean up their own mess will be politely ignored in Washington.
The Fed and the Treasury are under strong pressure from Congress to rein in the financial sector. At the very least they are likely to tighten controls on what capital they must hold and demand greater transparency about complex investments such as the mortgage-backed assets at the heart of the sub-prime storm.
For all their huffing and puffing, the banks would probably settle for that. What they fear is the return of the New Deal-style curbs imposed in the 1930s in response to the excesses of Wall St in the 1920s. For the moment, the return of such controls is indeed out of the question.
There is no Roosevelt or Maynard Keynes waiting in the wings with a blueprint for how capitalism could be better managed, and the finance ministers at the weekend meeting appeared to be more interested in using extra public cash to support the banks, than in unpicking the Washington consensus.
Chowla says it will need to get much worse to force a really radical rethink: "The only way you are going to get the oversight you need is in the event of a really major crisis. That gets people to rethink their paradigm about how economies are managed and finance is structured."
The New Deal reforms were the response to a crisis that not only saw a credit crunch and a banking collapse but also 25 per cent unemployment and a 50 per cent drop in industrial production.
The economic fall-out from the sub-prime crisis has not been nearly so damaging - at least not yet.
- OBSERVER
