I came across this ADB paper where my paper on financial education has been included in the reference list as well. (See last page (no 8) of the paper under other publications).
Archive for September, 2008
I had pointed to increasing concerns from the financial channel of the coupling theory. This is just becoming a nightmare for all the authorities. There was a biog concern on ICICI Bank today and the share price was sliding.
RBI had to issue a statement to calm market fears about the company:
There are reports in some sections of the media that based on rumours regarding the financial strength of ICICI Bank, depositors are withdrawing cash at its ATMs and branches in some locations.
It is clarified that the ICICI Bank has sufficient liquidity, including in its current account with the Reserve Bank of India, to meet the requirements of its depositors. The Reserve Bank of India is monitoring the developments and has arranged to provide adequate cash to ICICI Bank to meet the demands of its customers at its branches/ ATMs.
The ICICI Bank and its subsidiary banks abroad are well capitalised
This is actually becoming a nightmare. Irrational exuberance first drives the prices to stratospheric levels across economies and then same irratinal pessimism lead to dramatic correction across economies. What do you do as a policymaker? If you want to intervene during “the rising”, the participants say such intervention is not needed, it is against free markets, markets find their own levels etc. However, in times of ”the fall”, the same logic is defied and interventions are demanded.
FDIC’s latest press releasesays Wachovia has been bought by Citi.
Citigroup Inc. will acquire the banking operations of Wachovia Corporation; Charlotte, North Carolina, in a transaction facilitated by the Federal Deposit Insurance Corporation and concurred with by the Board of Governors of the Federal Reserve and the Secretary of the Treasury in consultation with the President. All depositors are fully protected and there is expected to be no cost to the Deposit Insurance Fund. Wachovia did not fail; rather, it is to be acquired by Citigroup Inc. on an open bank basis with assistance from the FDIC.
Wacovia did not fail?? Then why was it acquired by CIti? Some optimism this.
Citigroup Inc. will acquire the bulk of Wachovia’s assets and liabilities, including five depository institutions and assume senior and subordinated debt of Wachovia Corp. Wachovia Corporation will continue to own AG Edwards and Evergreen. The FDIC has entered into a loss sharing arrangement on a pre-identified pool of loans. Under the agreement, Citigroup Inc. will absorb up to $42 billion of losses on a $312 billion pool of loans. The FDIC will absorb losses beyond that. Citigroup has granted the FDIC $12 billion in preferred stock and warrants to compensate the FDIC for bearing this risk.
Lots of corporate finance and financial structuring going around. I postedon similar transactions to bailout MMMF. Does anybody even understand what is going on? Who is keeping an account of all these exhange of assets and liabilities?
There are just so may discussions over the +ves and -ves of the Treasury plan to purchase USD 700 bn of distressed assets from US Banking system. Krugmandoes not like it, Mankiw is ok with it (see this as well). Robert Shimer doesnt like it and so do Douglas Diamond, Steve Kaplan, Anil Kashyap, Raghuram Rajan, and Richard Thaler. Mankiw also points to numerous other views and Bush’s reason. Rodrik points to another suggestion from Harvard Law Professor Lucian Bebchuk.
Amidst all these discussions, the draft of the plan is out. It is pretty nicely titled as Emergency Economic Stabilization Act of 2008. It has both summary and a skeletal draft of the Act. The summary says, apart from the USD 700 bail out the US Congress is trying to ensure that the funds result in some benefits for taxpayers. Plus there is a penalty if executives are given a golden parachute. They are also setting up an overseer of this plan.
Reading the draft gives some more interesting stuff:
Section 112. Coordination With Foreign Authorities and Central Banks.
Requires the Secretary to coordinate with foreign authorities and
central banks to establish programs similar to TARP.
I didn’t really get this. Have some economies asked for such a plan. Or is US Congress expecting such demand to come and is acting in advance? Time will tell. Then after a ban on short-selling (see this as well), they are considering suspensions on mark to market as well:
Section 132. Authority to Suspend Mark-to-Market Accounting.
Restates the Securities and Exchange Commission’s authority to suspend the application of Statement Number 157 of the Financial Accounting Standards Board if the SEC determines that it is in the public interest and protects investors.
Section 133. Study on Mark-to-Market Accounting.
Requires the SEC, in consultation with the Federal Reserve and the Treasury, to conduct a study on mark-to-market accounting standards as provided in FAS 157, including its effects on balance sheets, impact on the quality of financial information, and other matters, and to report to Congress within 90 days on its findings.
Actually, I had made this suggestion partly in a report written on 5 Feb 2008:
In order to solve the valuation issues, may be the central bankers of the G-20 countries together with FASB, IFRS and BIS should work out a solution whereby the valuation should be frozen as on a particular date for these instruments and a lock-in period given for such valuations. The Central bankers should lend against these securities for a sufficiently longer period that will enable the affected banks to tide over their liquidity problems and start inter-bank and corporate lendings. This will in turn enable the bankers to have sufficient capital adequacy and will not force the bankers to shed their assets or restrict them from fresh lending.
The problem with mark to market was visual long back and why it took so much time to evaluate is a question mark. The problem has largely been lookig for market solutions when the market itself has collpased.
Now this is just the draft. Let us wait for the final release.
I came across this very useful paper from BIS economist Luci Ellis. The basic premise of the paper is that prices had appreciated significantly in most economies, then why did the crisis start at first in US? Though the housing prices had started correcting in many regions like UK, Spain the main questions till remains. Why US and not some other economy. The author answers this question very neatly. The abstract says it all:
The crisis enveloping global financial markets since August 2007 was triggered by actual and prospective credit losses on US mortgages. Was the United States just unlucky to have been the first to experience a housing crisis? Or was it inherently more susceptible to one?
I examine the limited international evidence available, to ask how the boom-bust cycle in the US housing market differed from elsewhere and what the underlying institutional drivers of these differences were.
Compared with other countries, the United States seems to have: built up a larger overhang of excess housing supply; experienced a greater easing in mortgage lending standards; and ended up with a household sector more vulnerable to falling housing prices. Some of these outcomes seem to have been driven by tax, legal and regulatory systems that encouraged households to increase their leverage and permitted lenders to enable that development. Given the institutional background, it may have been that the US housing boom was always more likely to end badly than the booms elsewhere.
Richard Fisher never disappoints with and his speeches are one of the finest to read. They are full of anecdotes, trivia and plain-talk. His recent speech is also superb.
Hong Kong’s Asia Times on Sept. 18, which had this gem of an analysis on the meeting: “Like an old-time cowboy, [Ben Bernanke]’s got all his ‘little doggies’ back into the pen. Dallas Federal Reserve [Bank] president Richard Fisher, the leader of an anti-Bernanke insurgency calling for higher interest rates to fight inflation since spring, fell in line this time with the rate hold [at 2 percent], making the statement unanimous.” To which the writer appended: “… if the choice was between the health of the economy and the restoration of Bernanke’s authority, it seems that the economy got the nasty end of the stick.”
I am not sure what was meant by that last clause about the end of the stick. But I can tell you this: Ben Bernanke, whose authority as chairman has never been in question, is no cowboy. And I am no “doggie” (though our family does own a handsome herd of Longhorns and a fine breeding bull named, incidentally, Irrational Exuberance; I consider these noble animals, so the term in itself is hardly insulting). Nor am I a member of, yet alone a leader within, what some cynical writer imagines is an “anti-Bernanke insurgency.” I am a member of a group of earnest policymakers, which includes the chairman, that places the health of the economy and the proper conduct of monetary policy above any personal interests or intrigue.
It deserves a )) Not many people can take a dig at themselves and come out as winner.
He says he was never sure of using fed funds rate for correcting financial markets.
Since the beginning of the year, I have been worried about the efficacy of reducing the fed funds rate given the problems of liquidity and capital constraints afflicting the financial system. As I see it, the seizures and convulsions we have experienced in the debt and equity markets have been the consequences of a sustained orgy of excess and reckless behavior, not a too-tight monetary policy.
There is no nice way to say this, so I will be blunt: Our credit markets had contracted a hideous STD—a securitization transmitted disease—for which lowering the funds rate to negative real levels seemed to me to be not only an ineffective treatment, but a palliative and maybe even a stimulus that would only encourage further mischief.
He then takes a look at inflation and points some companies have raised the prices. So he is worried on inflation front. He discusses TARP and is not very comfortable with it.
He points to rising off-balance sheet liabilities on US government’s balance sheets:
Even before tackling the task of cementing capital adequacy, we need to bear in mind that the TARP places one more straw on the back of the frightfully encumbered camel that is the federal government ledger. Other off-balance-sheet liabilities were already in place before Washington took on additional burdens from the reorganization of Fannie Mae and Freddie Mac and whatever we realize…
Foremost among the existing liabilities are some $13 trillion in unfunded Social Security benefits and Medicare obligations already promised to the people but as yet unfunded, an obligation that the Dallas Fed staff estimates at a present value of over $80 trillion. The former comptroller general of the United States, David Walker, estimates the Medicare deficit to be less, only $34 trillion, so let’s work with his less-excitable numbers. With everything including Social Security and Medicare properly accounted for, Mr. Walker estimates that “as of September 30, 2007, the federal government was in a $53 trillion fiscal hole, equal to $455,000 per household and $175,000 per person.”
This is a very scary number. It is equal to almost 4 times of US GDP and is nearly equivalent to world GDP in 2007 (as per IMF estimates World GDP in 2007 in current USD was USD 54 trillion) !! I was amazed at the billions being lost in this crisis and now trillions also don’t seem to matter.
Looking at how the world financial markets have responded to the ongoing crisis, this looks like a far bigger problem. Any concerns on such large deficit numbers would surely send markets in a tailspin.
This reminds of the recent events when there were talks of downgrading US sovereign rating from its AAA status. The rating agencies had downgraded other economies in their times of crisis and similar fate was expected of US.
However, Moody’s said US will continue to have AAA status:
The measures that have thus far been implemented and the proposal announced at the end of last week involve a significant expansion of the public sector balance sheet…. despite a considerable degree of financial stress and risk socialisation, the foundations of the US rating remain unshaken.
The same public sector balance sheet expansion would have alone led to lower rating of any other economy. But not for US. The moment you add the off-balance sheet items you are in for a disaster. It is next crisis in making.
Fitch had downgraded India’s currency default rating from Stable to Negative on this reason:
The revision to the local currency Outlook is based on a considerable deterioration in the central government’s fiscal position in 2008-09 (FY09), combined with a notable increase in government debt issuance to finance subsidies not captured in the budget,” said James McCormack, Head of Asia Sovereign ratings.
Why not a similar treatment for US as well?
says LatAm are much better prepared now., Director, Latin America Initiative at Brooking institution
A year ago, most analysts believed that the subprime crisis in the U.S. was not going to have any repercussions in Latin America and other emerging economies. …Even the IMF’s World Economic Outlook predicted that growth in emerging economies was not going to decelerate considerably.
Very few people accept that as a valid assessment today. Markets are moving in tandem everywhere in the world. During the past week stock markets, currencies and sovereign spreads in Latin America and Asia were following U.S. trends almost to the minute. We are going to see more contagion from the U.S. to the rest of the world. With a slower growing U.S. economy, and with lower capital flowing to developing countries, I expect economic growth in the region to be lower than initially expected during the next 18 moths.
He says Brazil is in much better shape though there are concerns over Mexico. He says Latam countries should use the monies from commodoty boom to invest in more productive activities.
Economist has another amusing fact which is actually quite a turnaround for Latam countries this time round:
“THANK God,” said one Latin American finance minister earlier this year. “At least this time it isn’t our fault.”
Though, nothing can be taken for granted.
In a paper I had analysed this decoupling/recoupling issue. There are two channels via which shocks are transmitted- trade flow and financial flow. The trade channel usually impacts with a lag but the financial channel is immediate. This is worrisome as it is a possibility that the crisis has got nothing to do with the economic fundamentals of the economy.
In the paper, I had looked at Indian equity markets and was amazed to see a very high correlation between changes in Indian equity markets and US equity markets. The correlation has increased In recent crisis sharply. One can simply look at the change in US equity markets last night (as per Indian Standard Time) and predict the movement for Indian markets today. If US market closed negative (or positive), so was the case in India and vice-versa. Now corrleation does not imply causation so one can’t really prtedict anything, but the high correlation is worrisome as equity markets should track fundamentals of companies in the markets. If the health is good, the index should reflect that.
The Brookings expert says same has been the case in Latam as well, with most financial varaiables tracking developments in US markets. All this makes policymaking pretty complicated. One is never sure what measures should one take?
Financial markets are considered to be engines of growth. If they react as per foreign developments, what should policymakers do? For instance, we are facing this problem in India. If we just look at domestic conditions, inflation is still very very high, both money supply and credit are still growing at a fare pace. Overall all point to a tight monetary policy stance. Though, the moment you add global conditions to the situation we get a different perspective.
Goldstein discusses Fannie/Freddie, Lehman, AIG and the future of financial regulation. Posen focuses on AIG and damaged US leadership.
Goldstein says we are in the middle of the crisis:
Well, I think you know we’re probably only midway through this crisis. There are various ways you can look at it to see sort of where we are. One way is to look at previous banking crises in industrial countries and large emerging markets. And if you do that, what you see is once you have one of this crises, economic growth usually stays below potential for two or three years after the onset of the crisis.
So if you say that this crisis started last summer, let’s say August 2007, then we’re talking about it not being over until the middle of 2009 or maybe 2010. That’s one indicator. A second one you can look at is, look at the scale of write-downs relative to your estimate of ultimate credit losses. We’ve had about 500 billion written down. And now, it looks like the ultimate credit losses, not just subprime but everything—consumer loans, commercial real estate, et cetera—is going to be perhaps a trillion or so.
His solution for future reform:
One is we need an international quantitative standard for liquidity for banks and investment houses.
we need to overhaul the ball to capital regime for banks. We need to make it countercyclical, not pro-cyclical.
We need to raise capital requirements; that’s very important.
We need to improve the incentives in the securitization model.
The covered-bonds idea is a good idea for the mortgage market.
We’ve got to change Wall Street compensation.
As I mentioned earlier, we got to have a clearing house for our OTC derivatives.
Final words of wisdom:
Well, I think the more serious the crisis, the better the prospects for reform. And I think, by this time, almost everybody is saying, “Never again. We’ve got to have something different. And we’ve got to change the regulatory structure.”
This is true across the world.
Goldstein: I think the level of cooperation has been pretty good. I don’t think that’s the main problem with the crisis. I mean, they all seem to be on the same page. We’ve seen a lot of coordination on liquidity support. So I think unlike in some earlier episodes, I don’t think this is really something we have to worry about too much. Trying to get a common answer on what to do about regulatory reform, which is the longer-term issue, I think is going to be more troublesome.
Posen: The usual reaction to this kind of bailout, although there’s never been one on this scale, is initial relief and long-term worry. Everyone’s initially relieved because this buys time to unwind the positions of AIG so assets don’t get dumped on the market, further cutting off credit and value for everybody else.
But over the long term, people get worried because then this tends to erode the Fed’s credibility, that they’re focused on price stability, that they’re willing to let the market take its slumps…
So short term, everyone breathes a sigh of relief. Long term, everyone worries a little more.
Come October 13, 2008 and we will get to know who will get the Nobel Prize in Economics for 2008. One can see the process of nomination and the nominators here. The picking for a particular year begins as early as September i.e. for 2008 the process began in Sept 2007.
Usually by September of the award year economists and media start discussing the probable candidates. Thomson Scientific, quite successful in its predictions usually starts off the list of probables but so far it has not taken out its list (It has released its 2008 predictions; see below in Addendum) . My previous post tells me it took out its list around Sept 27, 2008. So, the list must be anytime soon. In 2007, the award was given on 15 Oct 2007.
However, some predictions have started. Rediff has a neat presentation saying this time an Indian-born is expected to win the Prize. (pity we can only expect an Indian born economist to win a Nobel Prize as we hardly do any quality research in India) .
The list of probable Indian born economists is well-known and has been there for a long time – Jagdish Bhagwati, Avinash Dixit and Partha Das Gupta (Joseph Stigilitz’s favorite candidate).
It also points economists like Paul Romer, Robert Barro, Paul Krugman, Eugene Fama, Gene Grossman etc are also in the fray.
My pick: Jagdish Bhagwati as he has been on the waiting list for a long time and it might just get the Trade Agenda going.
Also Gene Fama/Kenneth French as most people who have contributed to development of financial economics have been awarded but their name is missing . Two kinds of people have contributed to finance. One who have worked majorly in the field like – Miller, Sharpe, Markowitz, Scholes, Merton and all have been awarded. And there is the second list who have contributed to finance either as a seperate work or indirectly- Samuelson, Tobin, Modgiliani, Akerlof, Stigilitz, Kahneman (his insihghts led to development of behavioral finance) etc. And again they all have been awarded.
However, Fama/French the persons who led to the development of Efficient MArkets Hypothesis, on which most of finance is based is still missing from the list. High time they are rewarded.
But again, I think Fama/French will be given a miss looking at the developments in fin markets. This way they might miss it every time as the financial markets keep collapsing now and then. Though I think it is the right time to award the duo and pass on the message that one can’t make money from financial markets forever, which is what the financial firms keep trying to do.
Markets are efficient and soon find their correct levels. Most markets may not be in the strong EMH category but are surely somewhere in the semi-strong category. Fancy models etc may help you get some returns initially but not always. The problem is all the firms start doing the same thing after seeing returns made by someone and they all end up in a mess.
Most of the people get these basic lessons in their B-Schools but forget the fundamental lesson while in practice.
I will keep you posted on the other predictions.
1. I have a post analysing the Clark Medal and Nobel Prizes. Interested readers can take a look
2. Thomson Scientific has released is predictions for the year 2008. See the list here. This is a very different list from the rediff one. I only have read Martin Feldstein from the list. I have read a bit of Thomas Sargent and Chris Sims as well, but they are just too technical for me.
Martin Feldstein’s nomination is for his contribution in variety of fields where as others are for specific contributions.
Paul Krugman has been given the prize for 2008. See my post here
Mishkin defends inflation targeting in his recent article.
But how can an inflation target remain credible if monetary policy responds to adverse demand shocks when inflation is well above the target, as has happened recently? This is where flexibility comes in.
The modern science of monetary policy argues that it should not try to get inflation to within a tight range over short time horizons. To do so would only result in excessive fluctuations in economic activity. It argues, instead, that when shocks to the economy are sufficiently large, inflation might have to approach the target gradually over time and this could be longer than the two years that is usually assumed as a reasonable time horizon for monetary policy to have its intended effect on inflation.
The problem with this approach is inflation will anyways ease after sometime (unless you are a Zimbabwe). So, how does it help having an inflation targeting central bank.
The main idea behind inflation targets was simple – to anchor inflation expectations and make policy time-consistent. If inflation continues to be up over a shorter period, the public would revise inflation expectations and one expectations go up, it makes the task of bringing it under control later. Eurointelligence points workers of a German firm IG Metal are already claiming the highest wage rise in 16 years. This despite the recent forecasts German economy is expected to slide.
But no one believes in managing inflation as of now. Eurointelligence also has a troublesome news about BIS’ new Chief Economist Stephen Checheeti who says:
in the short-term financial stability must be regarded as the priority, not the fight against inflation. He says the main responsibility of central banks was to protect the real economy from financial sector shocks. Only after that should we have a talk about whether inflation is going to be 2, or 3, or 4 per cent.
Ignore inflation at your own peril.
I had posted that short-selling has been banned in select stocks in US and UK. FT Alphaville posts updates the list and the list includes quite a few countries- Australia, Taiwan, Germany, France, Belgium, Japan, Hong Kong etc.
Morgan Stanley praises the move in its press release. It is pretty amusing the way MS praises the move. As long as you are being shorted, praise the policy; if you short some stock abhor the policy. I am sure if they were on latter side they would have issued an opposite press release.
Meanwhile, Hedgies are not pleased and a group of Hedgies is planning to sue FSA:
A group of the world’s biggest hedge funds are planning to sue the Financial Services Authority for millions of pounds of losses incurred as a result of the regulator’s ban on short-selling last week.
Lawyers are being galvanised on behalf of a raft of hedge funds which claim the financial watchdog has illegitimately extended its powers and caused ‘wide-spread capital destruction.’
One said: ‘The FSA’s remit is to maintain orderly markets – the markets were working fine, only the banks were going bust. With one swoop, the regulators have wiped out perfectly legitimate businesses and have cost some funds millions. They have gone for the big political hit without a thought for the damage they are wreaking. There may be unintended consequences but it’s outrageous and illegal.
What is even more amusing is that some Hedgies even managed to find a way around the short-sale ban. FT Alphaville points:
Managers said they would continue to place bets on their negative views on the banking sector, even as straightforward short sales were no longer possible. However, they face active regulators who are moving to close loopholes in the hurried rules, designed to calm markets by preventing investors from betting on a worsening of the financial crisis. The UK’s FSA watchdog body issued new guidelines to make clear that shorting an index and buying back all but one of the underlying stocks – in effect creating a short position on the one missing company – was forbidden.
FT Alphaville points that some companies want to get into SEC short-sale ban list and some are opting out.
I came across this very useful light read on how various economic news -GDP, inflation, unemployment etc. impact various kinds of financial markets – equity. bond, currency etc.
Exploring how the release of new economic data affects asset prices in the stock, bond, and foreign exchange markets, the authors find that only a few announcements—the nonfarm payroll numbers, the GDP advance release, and a private sector manufacturing report—generate price responses that are economically significant and measurably persistent. Bond yields show the strongest response and stock prices the weakest. The authors’ analysis of the direction of these effects suggests that news of stronger-than-expected growth and inflation generally prompts a rise in bond yields and the exchange value of the dollar.
It also is a nice primer on the way certain financial markets should react to the economic news.
In its 19 Sep daily, Eurointelligence had called the anticipated Treasury support mother of all bailouts.
Looking at the amount involved (around USD 700 billion) it has added Grand to its daily on 22 sep, 2008 – Grandmother of all bailouts. This 22 Sep 2008 daily has a lot of expert views on the step.
The official statement is here. The purpose:
This program is intended to fundamentally and comprehensively address the root cause of our financial system’s stresses by removing distressed assets from the financial system. ….As illiquid mortgage assets block the system, the clogging of our financial markets has the potential to significantly damage our financial system and our economy, undermining job creation and income growth
What will it include:
Treasury will have authority to issue up to $700 billion of Treasury securities to finance the purchase of troubled assets. The purchases are intended to be residential and commercial mortgage-related assets, which may include mortgage-backed securities and whole loans. The Secretary will have the discretion, in consultation with the Chairman of the Federal Reserve, to purchase other assets, as deemed necessary to effectively stabilize financial markets.
The statement is not very clear and it is best kept to the state of the markets when this is enacted. Looking at the current developments, every asset looks distressed and will have to be covered under the program.
The price of assets purchases will be established through market mechanisms where possible, such as reverse auctions. The dollar cap will be measured by the purchase price of the assets. The authority to purchase expires two years from date of enactment. …Cash received from liquidating the assets, including any additional returns, will be returned to Treasury’s general fund for the benefit of American taxpayers.
This is really dubious stuff. How will they be broght through market mechanisms when markets themselves have collapsed. And how will the prices be arrived? Ideally, a distressed asset is sold at a discount. But here, if the prices are kept low, the banks remain undercapitalised and the problem continues. And it cant be sold at a high price as Congress will not pass it as it leads to higher deficit.
Funding for the program will be provided directly by Treasury from its general fund. Borrowing in support of this program will be subject to the debt limit, which will be increased by $700 billion accordingly. As with other Treasury borrowing, information on any borrowing related to this program will be publicly reported at the end of the following day in the Daily Treasury Statement. ..Within three months of the first asset purchases under the program, and semi-annually thereafter, Treasury will provide the appropriate Congressional committees with regular updates on the program.
One good thing about all these mishaps is learning so many concepts. For instance, Treasury’s General Fund is the main account of the US Government. I just checked the recent statement (19 sep 2008) and it says the public debt limit at present is USD 10.6 trillion (actual debt stands at USD 9.6 trillion). So, if this is new USD 700 billion fund is passed the limit will increase to USD 11.3 trillion. Likewise, MMMF funding was done by The Exchange Stabilization Fund. So, Treasury has to now dip into all the funds it is running.
Let us now see whether Congress approves this and modifications if any.