Archive for January 9th, 2009

Eliminate CDS market for a market recovery

January 9, 2009

I have written numerous posts on CDS market. I came across this article by Svetlana Boyarchenko and Sergei Levendorskiĭ where authors say eliminate this market for some recovery. I have come across scathging criticism of this market but nothing as drmatic as this.

Tha authors main point is CDS are prices on the basis of mathematical models and beliefs and both are questionable at the moment. So even if financial market improve banks are still going to have trillions of dollars of CDS on their books which would never result in a complete recovery. 

The authors also offers a lesson for regulators:

For the future, we would like to stress that, each time the “next big thing” grows too large too fast, a crisis is guaranteed because nobody will be able to calculate prices accurately and the price system will depend strongly on the beliefs of the market participants.

Municipal Bond fraud in US!

January 9, 2009

NY Times points to this story which says a fraud has been unearthed in the municipal bond market.

Three federal agencies and a loose consortium of state attorneys general have for several years been gathering evidence of what appears to be collusion among the banks and other companies that have helped state and local governments take approximately $400 billion worth of municipal notes and bonds to market each year.

E-mail messages, taped phone conversations and other court documents suggest that companies did not engage in open competition for this lucrative business, but secretly divided it among themselves, imposing layers of excess cost on local governments, violating the federal rules for tax-exempt bonds and making questionable payments and campaign contributions to local officials who could steer them business. In some cases, they created exotic financial structures that blew up.

I had pointed(read Minneapolis Fed research in the post) that things are not right in Munis bond market as there are no takers in the markets now because of the crisis.  SEC Chief had raised this issue as well and pointed that this market is largely unregulated and has grown to a trillion dollar market.

However, a fraud is a different story altogether. Urbanomics has a discussion as well.

I had posted be ready for financial frauds now. However, it is coming from unlikely sources. First, Satyamand now Munis.

St Louis Fed’s excellent short notes on contemporary economics

January 9, 2009

I am not sure how many visitors have seen this feature from St Louis Fed – Economic Synopses.

Economic Synopses is a series of short essays (generally about 1 page) that provide insight and commentary on timely issues in economics, finance, banking, and other areas. These essays are meant to be clear and accessible for the interested, but not necessarily expert, reader.

It follows its purpose word by word and is a must read. It can be freely subscribed as well. In these times of clutter and confusion it is a welcome relief.

In this A Perspective on the Current Recession: It’s Not the “Worst Case” Yet  it looks at 2 sources of data- industrial production and change in non farm payrolls (a measure for employment). It sees how both looked in the past 10 recessions and compares it with recent recession. Both the data would have to worsen much more to compare with the worst numbers achieved in past 10 recessions.

In this The Current Recession: How Bad Is It?it uses 4 indicators and compares the current numbers with average of past 6 recessions. The 4 indicators are industrial production, employment, real income and retail sales. Only retail sales has fallen much sharper than the average compared to previous 6 recessions’ average.

Excellent resource.


Minneapolis Fed has a research comparing this recession with previous 10 recessions. The large story is the same. US data still has some way to go south.

Swap lines – useful or mere signalling?

January 9, 2009

Central  Banks have set up swap lines mainly with Fed to alleviate dollar liquidity in their home markets. (see this for all swap lines set by different central banks; see this for a nice short primer from Macroblog).

I came across this paper from Maurice Obstfeld, Jay C. Shambaugh and Alan M. Taylor where authors discuss the impact of these  swap lines.

In the first part of the paper they discuss a model for predicting currency reserves. They show that in economies that hold reserves higher than their predicted figures, currency has appreciated. In the second part they relate these reserves with swap lines.

Why are such swap lines needed? Two alternatives for the provision of dollar liquidity in the foreign country would be (a) for the foreign central bank to provide the domestic currency and let the bank sell the local currency for dollars on the open market or (b) for the foreign central bank to use its own dollar reserves to provide the liquidity. The former would put downward pressure on the local currency and the latter would possibly exhaust the central bank’s dollar reserves. Examining current reserve holdings relative to our positive model’s predictions is a useful way to provide some empirical context for these swap lines.

And the analysis says:

The swaps were clearly of very large magnitude for many advanced countries. For every advanced country except Japan, the size of the swap was greater than 50% of actual reserves held and in the case of the U.K., Australia, and the ECB, the swap was larger than the existing level of reserves.

In contrast, the swaps to emerging countries are never larger than 50% of their actual reserves. Further, in most cases, the country already had more reserves than predicted. Korea’s was $30 billion, though the country already had $260 billion. For Singapore the figure was , $30 billion against $162 billion already held, and Brazil received $30 billion versus $180 billion on hand. It is hard to see how these magnitudes could be very meaningful; all three countries already held more reserves than predicted by our model. Instead, these swap lines could be interpreted as signals. For Mexico and Hungary, the swaps are more substantial relative to actual reserves and those two countries were holding fewer reserves than predicted, so the swap lines may have had a more substantive impact beyond mere signaling in those cases.



This is really interesting. Swap lines are useful for advanced economies but are just symbolic for emerging economies. They are mainly used as signalling devices in case of emerging economies. This also throws open the case to hold excess reserves:

The swap lines also have implications for reserve holdings. One could argue that the expectation that such swap lines could be available rationalizes advanced countries’ decisions to hold fewer reserves than other countries. This would suggest EM countries will continue to hold large reserves until they are confident that they will have access to substantial foreign exchange swaps when in need.

Alternatively, these extraordinary measures may have been just that— extraordinary. The advanced countries may now recognize this and increase their reserves stocks (or in some cases adopt the euro to reduce the need for reserves). An increase in IMF resources could also be in the cards.

It will be interesting if developed economies start to maintain higher reserves after this crisis. Where would they invest the reserve monies? US Treasuries?

Fed expands its Money Market facility

January 9, 2009

Fed has expandedits Money Market Investor Funding Facility (MMIFF).

the set of institutions eligible to participate in the MMIFF was expanded from U.S. money market mutual funds to also include a number of other money market investors. The newly eligible participants include U.S.-based securities-lending cash-collateral reinvestment funds, portfolios, and accounts (securities lenders); and U.S.-based investment funds that operate in a manner similar to money market mutual funds, such as certain local government investment pools, common trust funds, and collective investment funds. 

The possibility that the set of eligible investors would be expanded beyond money market mutual funds to include other money market investors was noted when the program was first announced on October 21, 2008.

On October 21, 2008 the press release said:

Eligible investors will include U.S. money market mutual funds and over time may include other U.S. money market investors.

So, the list has been expanded to include mostly all kinds of funds. JohnTaylor recently crticised Fed saying its is running Mondustrial Policy (HT: Marginal Revolution, Also read WSJ Blog)

Taylor said the U.S. Congress has a legitimate right to demand a say in who the Fed lends money to. The outcome would be “radical reform” that would risk monetary policy independence, he said. 

Somewhere down the line, US Govt needs to close all these various open ended schemes Fed is launching. After converting i-banks into commercial banks, auto finance companies weer also added. By simply launching a scheme and adding “over time may include other U.S. ” somewhere in one of the paras is just too dangerous a policy.  It is like those endnotes mentioned on a balance-sheet which hides all the risk.

Bernanke is a student of Great Depression and knows the insights of the game too well. But one needs to draw a line somewhere. You can’t save each and every type of finance firm and financing activity.

Assorted Links

January 9, 2009

1. Krugman continues to be very pessimistic

2.  CMB points why a billionaire venture capitalist is not buying distressed banks

3. WSJ Blog points inflation targeting makes a comeback in Fed

4. MR summarises to Obama’s speech in GMU. WSJ Blog pointsto a draft of the speech.  His speech is going to be more widely and carefully read than Bernanke’s at the moment

5. Mankiw pointsto a new blog from Fama-French. Expect it to be the most widely followed.

6. Bogles’s six lessons for investors

7. WSJ Blog points Obama is going to be really pressed as budget deficit is $ 1.2 tn or 8.3% of GDP.

8. MR points Cass Sunstein to be appointed as administrator of the Office of Information and Regulatory Affairs . He wrote Nudges and expect some behavioral economics being applied in regulation.

9. JRV has couple of postson Satyam episode. TTR on Satyam

10. ACB has a superb post on Raghu Rajan’s flipping ways

11. Urbanomics on policymaking in recessions


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