Analysis of the global economy
From BBC News:
People have “every right to be angry” with banks for the UK’s financial crisis, the outgoing Bank of England (BoE) governor Sir Mervyn King says…..”But this crisis wasn’t caused by a few individuals, it was a crisis of the system of banking we had allowed to grow up. “It’s very important we don’t demonise the individuals but we do keep cracking on with changing the system.”
Read more at BBC News – Sir Mervyn King: Public are right to be angry at banks.
Lars Christensen writes of a 2010 lecture by Scott Sumner did at Oxford Hayek Society on the causes of the Great Depression.
Scott does a great job showing that policy failure – both in the terms of monetary policy and labour market regulation – caused and prolonged the Great Depression. Hence, the Great Depression was not a result of an inherent instability of the capitalist system.
Unfortunately policy makers today seems to have learned little from history and as a result they are repeating many of the mistakes of the 1930s. Luckily we have not seen the same kind of mistakes on the supply side of the economy as in the 1930s, but in terms of monetary policy many policy makers seems to have learned very little.
Click to open video on separate page 1:06:12
Read more at Scott Sumner: “It’s Complicated: The Great Depression in the US” | The Market Monetarist.
Interesting pro-bank piece by Sober Look. I have added my comments in italics.
The debate around “too big to fail” of the US banking system is often infused with political rhetoric and media hype. Let’s go through some Q&A on the subject and discuss the facts.
Q: Did large banks take disproportionate amounts of real-estate related risk vs. smaller banks prior to the crisis?
A: No. That’s a myth. Smaller banks were much more exposed to real estate (see discussion).
The issue is not real estate lending, but risky lending.
Q: Who had their snouts in the sub-prime trough, big banks or small banks?
A: Big banks.
Q: Which “too big to fail” banks were directly bailed out by the US federal authorities during the 2008 crisis?
A: While hundreds of banks were forced to take TARP funds, only Citigroup (among US banks) received an explicit bailout to keep it afloat. Note that Bear Stearns (and Lehman), AIG, GM/GMAC, Chrysler, Fannie and Freddie were not banks. Neither was GE Capital and other corporations who relied on commercial paper funding and needed the Fed’s help to keep them afloat. Wachovia may have become the second such large bank if it wasn’t purchased by Wells.
Q: Which “too big to fail” banks were indirectly bailed out by the US federal authorities during the 2008 crisis?
A: All of them
Q: Why did Citi fail in 2008?
A: Citi ran into trouble because of a massive off-balance-sheet portfolio the firm funded with commercial paper. In late 2007, when the commercial paper market dried up, Citi was forced to take these assets onto its balance sheet. The bank was not sufficiently capitalized to absorb the losses resulting from these assets being written down.
Citi was not the only TBTF bank that was inadequately capitalized to deal with losses.
Q: What were the assets Citi was “warehousing” off-balance-sheet?
A: A great deal of that portfolio was the “AAA” and other senior tranches of CDOs that Citi often helped originate (including mortgage related assets). Rating agencies were instrumental in helping banks like Citi structure these assets and keep them off balance sheet in CP conduits.
Q: Who paid the rating agencies?
A: The TBTF banks.
Q: Why did Citi (as well as many other banks) hold so much off-balance sheet?
A: Because they received a significantly more favorable capital treatment by doing so (the so-called “regulatory capital arbitrage” – see discussion from 2009).
Q: Did Citi break any state or federal laws by doing what it did?
A: No. All of this was perfectly legal and federal authorities were aware of these structures.
We need to fix the law so this cannot happen again.
Q: Did derivatives positions play a major role in Citi’s failure? Were other large US banks at risk of failure due to derivatives positions?
A: No. That’s a myth. The bulk of structured credit positions (tranches) that brought down Citi were not derivatives (just to be clear, CDOs are not derivatives).
Q: What has been done since 2008 to make sure the Citi situation doesn’t happen again?
A: The US regulators now have the ability to take over and manage an orderly unwind of any large US chartered bank. Banks are required to create a “living will” to guide the regulators in the unwind process. The goal is to force losses on creditors in an orderly fashion without significant disruptions to the financial system and without utilizing taxpayer money.
Large banking institutions are now required to have more punitive capital ratios than smaller banks.
Capital loopholes related to off-balance-sheet positions have been closed.
Stress testing conducted by the Fed takes into account on- and off-balance sheet assets, forcing banks to maintain sufficient capital to be able to take a hit. US banks more than doubled the weighted average tier one common equity ratio since the crisis (see attached).
Dodd-Frank has been “nobbled” by Wall Street lobbyists. Stress tests by captive regulators are not to be trusted. Increase transparency by supporting the Brown-Vitter bill.
Q: Do large US banks have a funding advantage relative to small banks?
A: Not any longer. According to notes from the meeting of the Federal Advisory Council
and the Board of Governors (attached – h/t Colin Wiles @forteology), “Studies point to a significant decrease in any funding advantage that large U.S. financial institutions may have had in the past relative to smaller financial institutions and also relative to nonfinancial institutions at comparable ratings levels. Increased capital and liquidity, in addition to meeting the demands of many regulatory bodies, has largely, if not entirely, eroded any cost-of-funding advantage that large banks may have had.”
And we should believe them?
Q: Why do TBTF banks dominate the financial landscape?
A: Because of their taxpayer-subsidised funding advantage.
Q: What is the downside of breaking up banks like JPMorgan?
A: Large US corporations need large banks to provide credit and capital markets access/services (Boeing is not going to use Queens County Savings Bank). Without large US banks, US companies will turn to foreign banks and will be at the mercy of those institutions’ capital availability and regulatory frameworks. Foreign banks will also begin dominating US capital markets primary activities (bond issuance, IPOs, debt syndications, etc.) And in an event of a credit crisis foreign banks (who are to some extent controlled by foreign governments) will give priority to their domestic corporations, putting US firms at risk.
Agreed. Large corporations need large banks — or at least syndicates of mid-sized banks. Brown-Vitter does not propose breaking up any TBTF banks, merely requires them to clean up their balance sheets and carry adequate capital against risk exposure.
Q: How large are US largest banks relative to the US total economic output? How does it compare to other countries?
A: See chart below (the chart contrasts bank size as percentage of GDP of Swiss and UK banks to US banks)
Swiss and UK banks have global reach so rather compare absolute size rather than relative to GDP where the bank is headquartered.
So before jumping on the “too big to fail” bandwagon, get the facts.
via Sober Look: Too-big-to-fail Q&A. Get the facts.
I had to smile at the From our Sponsors Google ad at the end of the article, suggesting I open a business account with one of the major banks.
Excellent interview of renowned short-seller Jim Chanos by Jason Zweig. Chanos list three reasons why the average investor is right not to trust the integrity of the financial markets…
First, in recent years financial fraud has rarely been detected and exposed by the people the public might reasonably expect to do so: accountants, regulators and law-enforcement authorities, whom Chanos calls “the normal guardians of the marketplace.” Instead, frauds more often have been rooted out by whistleblowers, short-sellers and journalists.
Second, prosecutions of financial crimes are essential in the minds of investors, but are discretionary in the eyes of government officials….. the so-called too big to jail rationale.
Third, individual investors will never trust the market until these issues are addressed.
To me the list is too short.
Chanos fails to mention the revolving door between Washington and Wall Street where regulators frequently swap sides — working for government the one day and in high-paying jobs on Wall Street the next — and have one eye on their career path rather than focusing on their current job.
Fifth, the massive financial leverage that Wall Street has on Capitol Hill where Congressmen, dependent on fundraisers sponsored by Wall Street lobbyists, allow same lobbyists to write some of the legislation that passes through the house.
Read more at Trust: Easy to Break, Hard to Repair – Total Return – WSJ.
Peter Schiff writes:
The truth is that most buyers cannot afford today’s prices without the combination of government guarantees and artificially low mortgage rates. The Federal Reserve has been conducting an unprecedented experiment in economic manipulation. By holding interest rates near zero and by actively buying more than $40 billion monthly of mortgage-backed securities and $45 billion of Treasury bonds, the Fed has engineered the lowest mortgage rates in generations.
Read more atSCHIFF: The Great Reflation – Business Insider.
Excellent article by Eric Parnell sets out the negative impacts of quantitative easing (QE):
But writing an article such as this is the same as writing 7 Good Reasons Why People Hate Chemotherapy. We all dislike QE. QE is not something that central banks apply through choice. QE is something — like chemotherapy — they apply when they have no choice. QE is the lesser of two evils — the greater evil being a deflationary spiral like the Great Depression of the 1930s.
The important lesson to take from this is: How to Avoid QE. Manage credit growth and the monetary base more conservatively during the good times. Remove the punch bowl just as the party gets going — so we don’t end up with a massive hangover when it’s over.
Read more at The 7 Reasons Why People Hate QE – Seeking Alpha.
Tyler Durden writes:
…….none other than the TBAC warned that the US is suddenly facing a $10+ trillion high quality collateral shortage in the next decade. As we have also explained, this is a major problem for the Fed which at current rates of QEeing, will monetize all Treasury duration exposure in roughly 5 years – at that point there will be virtually no collateral left and the Fed will be finally out of both tools and ammo.
I suspect that fiscal deficits will add sufficient new Treasury bonds to the pile, so that the Fed never has to run out of decent collateral.
Read more at Central Banks’ Central Bank Warns About Rehypothecation Threats | Zero Hedge.
Miles Kimball, Professor of Economics and Survey Research at the University of Michigan, gives a clear summary of Market Monetarism — its strengths and its weaknesses — concluding with these remarks:
Despite the differences I have with the market monetarists, I am impressed with what they have gotten right in clarifying the confusing and disheartening economic situation we have faced ever since the financial crisis triggered by the collapse of Lehman Brothers on September 15, 2008. If market monetarists had been at the helm of central banks around the world at that time, we might have avoided the worst of the worldwide Great Recession. If the Fed and other central banks learn from them, but take what the market monetarists say with a grain of salt, the Fed can not only pull us out of the lingering after-effects of the Great Recession more quickly, but also better avoid or better tame future recessions as well.
Read more at Quartz 21–>Optimal Monetary Policy: Could the Next Big Idea Come from the Blogosphere?.
Market monetarist Lars Christensen gives an insight into rising Japanese (JGB) bond yields:
…..the markets do not think that the Japanese government is about to go bankrupt. In fact completely in parallel with the increase in inflation expectations the markets’ perception of the Japanese government’s default risk have decreased significantly. Hence, the 5-year Credit Default Swap on Japan has dropped from around 225bp in October last year just after Mr. Abe was elected Prime Minister to around 70bp today!
Read more at Two cheers for higher Japanese bond yields in the spirit of Milton Friedman | The Market Monetarist.
By Houses and Holes — cross-posted from Macrobusiness.com.au
It’s fascinating to watch the exit of Ford shake up commentary alliances and ideology.
The loon pond that dominates Australian business media is out in force with soothing words that Australian car manufacturing needs to be let go gently into that good night.
Bill Scales appears at the AFR to argue:
…..while it will be tempting to see this as a sign of the demise of Australian automotive manufacturing, it’s not. This decision is a direct result of the well-recognised, well-understood and deliberate decisions by Ford in Australia and the US.
However it does have important implications for public policy in Australia. This is a good example why governments should not provide company or industry- specific assistance. Governments and bureaucrats can never understand the strategic or commercial imperatives of individual businesses. So they cannot hope to successfully design company or industry-specific assistance programs that make any fundamental difference to the underlying economics of that company or industry. If the strategic direction or intent of a government policy for any company or any industry is not consistent with the strategic or operational direction of that company or industry, and it rarely is, then money provided to them by governments is likely to be wasted.
High priestess of the pond, Jennifer Hewitt, wants outright liquidation:
The national sympathy and attention given to 1200 Ford workers who will be out of a job in three years’ time shouldn’t obscure economic reality. Car manufacturing in Australia has been living on borrowed time – and permanently borrowed tax-payer money for far too long.
That can never be solved by additional government assistance or new industry plans or emotive rhetoric about how car manufacturing in Australia is so special. This only delays the inevitable.
But the response is part of the national semi-panic about the future of manufacturing in Australia. Both Julia Gillard and Tony Abbott stress the need for Australia to be a place that continues to “make” things. Just what new things should be made remains elusive. What is clear is it is will not be cars long term. That is despite the billions of dollars in government subsidies.
…the end of Ford manufacturing shouldn’t in itself be the sort of national crisis suggested by the massive reaction to the company’s announcement.
The Ford Falcon is an iconic loss rather than an economic one, a dream of the past rather than the future.
The AFR editorial and Judith Sloan at The Australian, card carrying members of the pond, are also happy to see Ford go. However, some of the more sane commentators are as well. Alan Mitchell at the AFR, John Durie at The Australian and Bernard Keane at Business Spectator are all for it.
What is missing, as usual, is the only thing that actually matters to the reader and the nation: context.
In 2009, the US faced an analogous decision about whether to let one of its big three auto-makers go to the wall (there were many differences as well). As the GFC tore its GDP to pieces, the government stepped into the breach and saved Chrysler, bankrupted the company, broke its union contracts, reorganised its cost base, sold much of it to FIAT and the company relaunched. Why did the global home of “free market capitalism” bother?
The cheap answer is to save jobs. But there is more to it than that. It is about productivity and not in the way you might think.
We all know that productivity is the key to national standards of living. Only through productivity growth do we sustainably increase our competitive advantage, capital formation, incomes and employment. But, I hear you ask, propping up dud car companies is bad for productivity, right?
Wrong, or at least, overly simplistic.
The issue is this. Manufacturing accounts for a huge slice of productivity potential in all economies. Without it, any economy will struggle to generate long term high productivity growth. Mechanisation, improved processes, innovation and technical progress are the bread and butter of productivity growth. They simply do not exist to the same extent in services, nor, for the most part, in mining (though the runoff in the boom will be good for the next few years). The following chart from McKinsey makes the point. Manufacturing contributes disproportionately to productivity, innovation and exports:
This is the first question that Ford’s departure raises about Australia’s long term economic context. The car industry may or may not survive the shakeout but Australian manufacturing has already declined to only 7% of GDP and is clearly set to plunge further as capex expectations run at levels first seen in the 1980s.
Of the thirty developed economies in the world comprising the OECD, this level of contribution to GDP is last, tied with the tax haven of Luxembourg.
Our elite – the government, mining magnates and the media – have decided that manufacturing will be let go and we will instead rely entirely upon highly priced dirt and houses. Australia’s elite policy makers are engaged in a gigantic experiment that flies in the face of economic history.
The second question is more immediate. What our elite forget or ignore is that selling dirt is a highly cyclical business. Put simply, they never expected the current cycle to end. But it is. Right now. And is about to become a MASSIVE drag on the economy:
Manufacturing is supposed to be one of those sectors picking up the slack along with other exports and more houses. Obviously the departure of Ford will damage any upside for a manufacturing bounce and it will also put a sizable dent in consumer confidence, making it harder for other sectors to rebound as well.
Short term and long, cyclically and structurally, this is a crisis, a crisis of our elite’s own making.
