Archive for September 26th, 2008

US spiralling deficit- next crisis?

September 26, 2008

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.

Sample this:

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.”[3]

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.[8] 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?

Impact of subprime crisis on other economies

September 26, 2008

Mauricio Cárdenas, Director, Latin America Initiative at Brooking institution says LatAm are much better prepared now.

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.

Assorted Links

September 26, 2008

1. MR points WAMU  is the biggest banking collapse in history. It has a superb post on interest rate swaps

2. WSJ Blog says distressed assets are likely to be more that the TARP plan

3. Mankiw defends Paulson plan.  Cowen on Mankiw’s views

4. Macroblog says is is a problem of mainstreet as well.

5. Rodrik points to some suggestions for managing the TARP

6. JRV on India vulnerability to the crisis.

7. IDB points to a paper on communication in microfin.

8. ACB onfuture books on current crisis


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