Archive for November 26th, 2008

China cuts rates by 108 bps!

November 26, 2008

Reuters points:

The People’s Bank of China (PBOC) cut benchmark rates for one-year loans and deposits by 1.08 percentage points, lowering the cost of one-year borrowing to 5.58 percent and the rate on 12-month certificates of deposit to 2.52 percent.

Chinese Govt has taken series of measures to restore confidence and keep growth momentum in the economy (see summary of measures here).

 China’s economy forecasts are mixed. IMF in its recent Asia Outlook said it would grow by 9.7% in 2008 and 8.5% in 2009. It has revised its forecasts downwards from October projections by 0.1% and 0.8%.

On the other hand, World Bank in its latest China report (summary here, has forecasted China would grow at 9.4% in 2008 and 7.5% in 2009. So, 2008 forecasts are near same but 2009 forecasts are quite different.

IMF on releasing the Asia Outlook looked confident that China would achieve a growth rate around 8-9%. :

MR. CHALK: I’m Nigel Chalk, Division Chief for the China Division of the Fund. Maybe I’ll talk about the China forecast specifically, and perhaps Jerry can talk a little bit about the impact on the region. For China, we see growth next year around 8-1/2. That incorporates what we expect to be their fiscal stimulus program, although the details of that are still evolving, and also the monetary loosening that they’ve done so far this year. That range of 8 to 9 is a similar range that the government also I think has in mind and we’re fairly comfortable with that range.

World Bank says:

The report’s main author, senior economist Louis Kuijs, added that most of the recently announced ten points for stimulating domestic demand and growth mean higher direct government-influenced spending – in the form of investment or consumption – and should therefore have a measurable impact on output in the short term. ” More than half of our GDP growth forecast of around 7.5 percent for 2009 is coming from government-influenced spending.”

So, much will depend on how fiscal stimulus shapes up in China.

Google develops a eco search engine

November 26, 2008

Harpreet,a  regular reader of Mostly Economics points to a Economics Search Engine by Google.

Thanks Harpreet for the pointer.

Munis next to be included in TALF?

November 26, 2008

Fed has initiated a new facility  – Term Asset-Backed Securities Loan Facility (TALF).

The Federal Reserve Board on Tuesday announced the creation of the Term Asset-Backed Securities Loan Facility (TALF), a facility that will help market participants meet the credit needs of households and small businesses by supporting the issuance of asset-backed securities (ABS) collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration (SBA).

Under the TALF, the Federal Reserve Bank of New York (FRBNY) will lend up to $200 billion on a non-recourse basis to holders of certain AAA-rated ABS backed by newly and recently originated consumer and small business loans.  The FRBNY will lend an amount equal to the market value of the ABS less a haircut and will be secured at all times by the ABS.  The U.S. Treasury Department–under the Troubled Assets Relief Program (TARP) of the Emergency Economic Stabilization Act of 2008–will provide $20 billion of credit protection to the FRBNY in connection with the TALF.

I had seen this support for student loans, auto loans, credit card loans etc coming. This along with Fed’s decision to purchase USD 600 bn of securities of GSE, makes it a USD 800 worth of bailout. And if we include USD 326 billion of Citi’s bailout, it is a trillion dollar support from US authorities in a week. I had pointed in my reportthat original TARP plan of USD 700 bn will not be enough at all. The auto companies might also be bailed out soon. All this makes the already huge US budget deficit bigger and the probability of it being a future disaster increases.

However, a look at the recent Minnepolis Fed research (read the entire report here) tells me another type of security is under trouble – Municipal Bonds (called popularly as Munis). Sec chief Cox had said Munis are facing severe stress is reinfoced in this study. Munis are under trouble We could see Munis being extended to TALF or a separate program to resurrect it.

The total outstading Munis in US is about USD 2.9 trillion, out of which 49% is insured. Maximum bonds are issued by California followed by New York and Texas. So, it is quite big.

What was the main problem?

In the investment world, municipal bonds are often described as plain vanilla, for their simplicity.

Over the past decade, however, financial markets have developed sophisticated variable-rate products that delivered cheap financing for municipal bond issuers. Thanks to recent volatility in financial markets, two of those products—so-called auction-rate securities (ARS) and variable-rate demand obligations (VRDO)—now have their own ice-cream name: rocky road.

Both types of bonds are floating-rate, tax-exempt bonds whose rates reset periodically (usually weekly or monthly, depending on the bond). This design allows the borrower to issue long-term debt at very attractive, short-term interest rates because the bond is repeatedly resold in secondary markets, giving investors high liquidity. In essence, these bonds were advertised as money market funds with better returns.

From virtually zero in the mid-1990s, both ARS and VRDO markets have grown considerably (see chart). In 2007, together they captured better than 20 percent of the municipal bond market, according to data from The Bond Buyer.

And then the problems started in Munis with liquidity crisis, downgrading of bond insurers etc leading to higher interest rates and no takers for the bonds. Read the report for details. Another case of financial innovation gone awry.

Now number of market participants hold these bonds and this has become quite illiquid as well. The states would need monies to finance their programs and the pressure is more to spend as crisis worsens. With dry markets either they pay higher rates or get no takers at all. First leads to higher costs and second leads to no resources. Both being uncomfortable situation for states. Hence, they could ask for help from Centre.

UK Govt warns it could nationalise its Banks

November 26, 2008

FT Aplhaville points that UK Chancellor Alistair Darling has warned that if banks do not open up their credit lines, he could nationalise them!

UK top officials were present at UK Treasury Committee and discussed what to do with UK economy. Mervyn King in a statement at the same meeting (explaining the recent Inflation report and 150 bps rate cut which could have been 200 bps) said bank resuming lending is the biggest concern:

Much though still remains to be done and very significant policy challenges lie ahead. Domestically, the most pressing is to ensure that normal bank lending is resumed. Without that, the downturn in activity could become protracted and extremely damaging. There is also work to do to guard against future financial crises. Given the global nature of our financial system, much of that will need to take place at an international level. In particular, reforms of the international monetary system and improvements to the regulation of banks’ capital and liquidity provisioning are priorities.

As per FT, Chancellor is planning to issue new bank policy:

The chancellor wants regulations that would force banks to give companies more notice of any change in lending practices, including withdrawal of credit lines or sharp changes in interest rates.

He is also looking at ways to extend government guarantees to support new business lending, building on existing proposals designed to release funds for mortgage loans.

Separately, Mr Darling wants to clarify capital adequacy rules to make clear that newly recapitalised banks do not need to sit on a fat cushion of capital and that regulators expect them to lend during the recession.

If these changes fail to reopen credit lines, Mr Darling has a range of options, including a last resort of nationalising the whole banking sector.

However, few banks disagree and say they have been lending:

Banks reject the suggestion that they have reined in lending in spite of the deteriorating economy. Lloyds TSB says its lending to small and medium-sized businesses is up 18 per cent year on year.

Really dramatic times.

Assorted Links

November 26, 2008

1. WSJ Blog points FDIC indicates problem banks grow to 171 in Q3 from 117 at end of Q2!

2. WSJ Blog points Peter Orszag would become Director of the Office of Management and Budget and has quit blogging. I will miss him for his speeches on pushing behavioral economics in policymaking

3. MR points to a pic pointing Krugman shaking hands with Bush and says truce? 🙂

4. Krugman in a post points to the recent Fed move to buy obligations of GSE and says he is confused. This post does suggest that there is nothung like Truce between him and President Bush.

5. Krugman also does not like the new propsal by John Taylor that tax cuts should be permanent. This also suggests that there is nothing like Truce between him and President Bush. Mankiw adds his humor to Taylor’s idea

6. Krugman points Kyoshi Ito died. Ito developed Ito’s lemma which was used by Merton to develop option pricing model.  Fin Prof pays an obituary as well

7. NB points how menu designs can make you spend more

8. CTB points sky is falling

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