Are we recreating the problems that led to the crisis?

Donald Kohn of Fed in his recent speech lists 4 policy risks. The first is rise in protectionism, third are various govt programs being done properly and fourth has enough been done. The second risk is quite interesting. He calls it Re-creating the Problems That Got Us Here?

A second risk that we should consider is whether in our efforts to deal with the financial crisis, we are inadvertently re-creating many of the structures and behaviors that contributed to the crisis. For example, the government is providing increased leverage even as markets are calling for deleveraging; some of the government programs make use of credit ratings from the same agencies that so evidently fell short in their assessments of structured financial instruments; some of these programs employ financial structures similar to the off-balance-sheet entities that proved unstable in the crisis; we are trying to keep interest rates very low to support asset prices and spending after an episode in which low long-term rates probably contributed to unsustainable housing prices; and, finally, we are supporting economic activity by further increasing government deficits at a time when the longer-term fiscal outlook is already troubling. So are we just perpetuating the errors and misjudgments that led to the crisis, and thus sowing the seeds of a new crisis in the years to come?

And what do you think his answer is?

I don’t think so. The steps we have taken need to be seen as part of an effort by the government to smooth the transition of our financial sector and economy to a more sustainable situation.

What did you expect??

I don’t think we can say we are not recreating the problems. The spiralling US debt, hugely distressed financial system asking for more and more, non-transparency of the various policies all point to more problems ahead. 

As far as low interest rates and bubbles is concerned, the same was said around 2001 when rates were kept low.  Actually a better way to understand low interest rates and bubbles is this superb post by Mihov. He says what matters more is bubbles develop in which assets?  If it develops in say gold etc it would not lead to a meltdown. However if it again develops say in bond markets it could be a meltdown again. Bubbles would always be there what is important is to monitor which assets? And then make policies accordingly. However, it is all too troublesome as we still don’t know when to call something a bubble, whether we should prick bubbles, who should prick the bubbles, etc etc. The entire issue just goes on and on. Welcome to Economics is all I can say.

How do you resolve a crisis: Theories vs Reality

Phillip Swagel, formerly U.S. Treasury Department has presented a wonderful paper at recent Brooking Conference. The paper title is really fitting – ‘The Financial Crisis: An Inside View’. It is a longish paper (50 pages) and am still reading it. It is so full of insights that skimming does not work at all.

He makes a confession upfront:

Notwithstanding these criticisms with regard to the Treasury, a paper such as this will inevitably be seen as defensive, if not outright self-serving. Since this is unavoidable, I simply acknowledge it at the front.

IMF is baaack!

I was reading this transcript of IMF press conference at G-20 summit.

It was quite amusing to read IMF MD Dominique Strauss-Kahn continuously mentioning how IMF is back to the forefront of policymaking, forecasting, regulating etc. I will just point to some of the main things he says:

Maybe some of you were in the IMF press conference at the end of the Annual Meeting last October. And if some of you were there, then you may remember that what I said at that time is that IMF is back. Today you get the proof when you read the communiqué, each paragraph, or almost each paragraph–let’s say the important ones—are in one way or another related to IMF work.

The IMF is first back as a forecaster, and you may see that IMF forecasts are the reference—of course, there are institutions making forecasts, all very good—but the fact is that the IMF forecasts are the reference for the G-20

What are the right policies (to assure growth will reach levels forecast)? The first one is certainly global stimulus and I must say that I’m really happy to be the head of an institution which more than one year ago—it was last year in January, when we asked for this global stimulus. At this time no institution, nobody was able to see that the crisis would be so deep that it would need a global stimulus. We answered that, and we have been followed, and that’s a very important thing …….

The IMF is also back as a policymaker, and not only is this recognized by the text, when the text says, for instance, in paragraph 6, that this is an “unprecedented and concerted fiscal expansion”. This just explains what I said before, that as a policy advisor the IMF has not been recognized

The IMF is also back in terms of work—of course, forecasts guide our work—but also other kinds of work. I’m thinking especially about the surveillance process. And if you have read the communiqué, you have seen that the surveillance process of the IMF is a central piece in this communiqué, the central piece of what the G-20 is relying on.

And the last point, maybe some of you have listened to me during the last week in a written interviews, or radio, or TV, I always say the same thing, which is that the stimulus will not be effective, or effective enough, if we are not able at the same time to clean up the balance sheets of the banks. The cleansing of the financial sector is obviously today on the minds of all the heads of states and governments. And I was really—I won’t say surprised, but happy to notice that all of them are saying the same thing

Read the whole thing for more details. It is amusing as it is an acknowledgment from IMF itself that it has been ignored by world policymakers. So far other people said IMF needs to be strengthened.  One can just read the excitement on  Dominique Strauss-Kahn’s face while reading this. As I have said in numerous posts, IMF seems to be in an overdrive mode.  Let’s see whether it (overdrive that is) lasts or not.

Assorted Links

1. Krugman points rise of financial sector explains the rising inequality in US quitea  bit.

2. WSJ Blog points to a Richard Fisher speech. It also points to a debate whether it is going to be V or L. It also points ECB member thinks the recent IMF boost is like a global helicopter drop of money

3. Macroblog on forecasting inflation in these times

4. Mankiw points to his primer on DSGE models

5. Rodrik does not agree that making IMF more powerful will work 

6. FCB on active management of indexes

7. Peston asks have we heard a cuckoo?

8. FMB has a superb idea on managing systemic risk

9. ASB pointsto a new article by Eichengreen and Rourke comparing the Depression with this crisis. This crisis is worse!

10. TTR points actual amount committed in G-20 was just USD 100 bn and not USD 1.1 tn as announced