WASHINGTON -- Bill White is one of the world's leading economists when it comes to figuring out how to deal with trouble.
He's a Canadian in the top ranks of the Bank of International Settlements in Switzerland, and his analysis of global economic events is sought far and wide.
So when Mr. White is asked how the world will sort itself out of the continuing credit crunch, it's disconcerting when he takes a deep breath and a long pause before saying: "I don't know. I don't know."
There's a good chance the credit problems will go away on their own, without too much damage. Trouble with subprime mortgages in the United States will stay confined to the United States. Lenders will get over their risk aversion. Money markets will settle down. Crisis averted.
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But there's also a good chance that financial institutions won't be able to reprice the sophisticated and intertwined credit instruments connected to the subprime meltdown. And there's a chance that housing problems in the United States will deepen, and drag that huge economy down. Lenders will become increasingly risk averse. Jitters spread to emerging markets, and the global economy stalls.
Central bankers, finance ministers, bank executives and top investors from around the world have been meeting for three days to make sure the latter scenario doesn't materialize.
But Mr. White is not optimistic.
In past financial crises, governments and financial institutions scrambled to sort things out, but in the end, monetary authorities usually had to step in and cut interest rates - flooding markets with liquidity and greasing the wheels of the global economy.
But each time, the rate cutting becomes less effective, Mr. White argues. And in today's case, the source of the problem was too much liquidity - which led to easy credit, excessive borrowing and lax standards. For central banks to push markets to the other side of the credit crunch by injecting even more liquidity is questionable at best.
"I think the answer will be that we're going to have to use the traditional kind of tools of easier monetary - and indeed even fiscal - policy, should the economy turn down," Mr. White said in an interview.
"We'll have to use the traditional tools. We'll have to complement them with careful attention to bankruptcies and the appropriate [measures]."
Much of the discussion at the weekend's International Monetary Fund, Group of Seven and private-sector meetings aimed at avoiding such a scenario.
The IMF and G7 both stressed the need for central banks to focus on fighting inflation. In their final communiqués, they stressed the need for financial institutions to take the lead. And financial players, feeling the heat of regulators ready to pounce, are quickly putting forward forceful proposals of their own.
Canada was one of the strongest proponents of letting the market sort things out.
"Many, indeed, perhaps most, of these desired outcomes can, and should, be accomplished through natural market forces responding to these events," said Bank of Canada Governor David Dodge yesterday to the Institute of International Finance, which groups 370 financial institutions from around the world.
"The best route to increased transparency is the use of market forces, rather than detailed, prescriptive, and potentially burdensome regulations."
Finance Minister Jim Flaherty held out hope that the "superfund" forged by key American commercial banks to renegotiate troubled asset-backed commercial paper will be "helpful" in sorting out credit valuations.
For the Canadian commercial paper market, he said he was "cautiously optimistic that ... we'll be able to have an orderly outcome."
Plus, commercial banks and financial players produced a detailed plan to improve risk management, price risk more realistically, make structured finance vehicles more transparent, wean themselves from ratings agencies, and generally improve transparency.
But other leaders warned that regulators and central bankers will have to take a stronger role, if they want to prevent the spread of the credit crunch.
"The issue cannot just be brushed aside because 'markets are always right,' " said Jacques de Larosière, former managing director of the IMF and chairman of BNP Paribas Group. "After all, claiming that the market is the best regulator finds its limits when central banks must intervene to avoid a collapse of liquidity."
Financial-sector regulators should be taking a hard look at whether the reserve ratios that banks are required to hold are sufficient as they move previously off-balance-sheet loans onto their balance sheets, added Charles Goodhart, a former adviser to the Bank of England and now a professor at the London School of Economics.
He likens the follies of the financial markets to people who have built homes on a flood plain.
"When a flood comes, do you rescue them or not?" he asked.
The problem with a full rescue is, "then there's the incentive to build more on the flood plain," he said. "They're putting all the downside risks on to the central banks."
He, like Mr. White, had no answer about whether central banks should play along. In the case of people drowning in a flood, in principle, they should be rescued, he said.
"But it is surely a dangerous game to play," he added. "I don't know of any way to resolve that question."
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