Archive for February 26th, 2009

Could this be a global lost decade just like Japan’s lost decade of 1990-2000?

February 26, 2009

Masaaki Shirakawa, Governor of Bank of Japan has given an insightful speech comparing the US situation with Japan’s in 1990s. He points there is a remarkable similarity between the two.

He says:

While the economy of this period is often called as ‘Japan’s lost decade,’ in my view, such a categorization might not be perfectly capturing the nature of the problem and challenges of policy measures taken to cope with a financial crisis.

What were the factors that led to a slump in Japan?

First, there was a delay in recognizing the severity of the impact of massive nonperforming assets on the economy. It was a few years after the burst of the bubble when we recognized how seriously the decline in real estate prices affected financial institutions.

Second, there were imperfections in accounting and disclosure standards. At present, vigorous discussions are going on about how to cover the expected losses over the credit cycle in terms of accounting. At the time, there was a lag in showing the incurred losses of financial institutions on the accounting and disclosure front.

Third, partly as a result of the aforementioned two points, the authorities could not resolve troubled financial institutions in a timely manner, because of the delayed progress in establishing a framework of resolution to cope with troubled and failed large financial institutions. Arguably, the legal framework of resolution, operational procedure, and, above all, public funds to cover a capital shortage are vital in ensuring the smooth resolution of troubled and failed financial institutions. And it was in early 1998 after we experienced a series of failures of large financial institutions that the full-fledged safety net framework was put in place.

He then points similar problems are resurfaced now. So, despite the lessons US (and others) are repeating the same. Why? policymaking comes with a lot of ifs and buts. So, terming it Japan’s lost decade ignores the fact that there was just too much uncertainty. Same is the case now.

He says removing uncertainty is the main problem. It was never a liquidity problem but a solvency problem. Until we solve this, there will be little forward movement. He also adds there are lots of dilemmas for policymakers to solve:

A ‘mirage’ phenomenon is taking place in that, despite public capital injection, concern over additional losses on the assets mounts over time and such concern in turn will heighten concern for a capital shortage of financial institutions.

Under those circumstances, it is of vital importance to remove uncertainty. There are two options to remove uncertainty stemming from financial institutions’ nonperforming assets; the government purchases those assets or provides a loss guarantee to those assets. Nevertheless, even in both cases, uncertainty might not be removed for the assets not covered by the purchases or the guarantees, and investors thus would continue to ask the institutions for high risk premiums.

What Japan faced in the past and what the U.S. is facing now is arguably those difficulties. However, even with such difficulties, it is an indispensable process to promptly identify the amount of losses and to carry out recapitalization to secure financial system stability, if necessary.

All this does not look good at all. It is also not just particular to US but many economies are facing the same  problem. The problem currently looks deeper than Japan’s as despite some aggressive policy responses(though it could still be a lot quicker), nothing has really happened. Things have only gone worse. True, similar mistakes have been made like that of Japan but policy action did not wait as long as seen in Japan.

What is also interesting (and depressing) is that there are many dilemmas to solve. There is no easy way. You infuse capital, it could signal more losses ahead; you try and buy toxic assets, the pricing is an issue etc etc. It does not look good at all and the way things look, it could take a lot longer for economies to recover.  It looks like a long long dark tunnel with light sometime away.

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Economic Forecasters – Hedgehogs or foxes?

February 26, 2009

Philip Tetlock, Professor at the Haas Business School at the University of California-Berkeley, gives an excellent interview in CNN on forecasting (HT: Niranjan’s Blog). Though, I had mentioned about it in assorted links, it deserves a separate post.

What makes some forecasters better than others?

The most important factor was not how much education or experience the experts had but how they thought. You know the famous line that [philosopher] Isaiah Berlin borrowed from a Greek poet, “The fox knows many things, but the hedgehog knows one big thing”? The better forecasters were like Berlin’s foxes: self-critical, eclectic thinkers who were willing to update their beliefs when faced with contrary evidence, were doubtful of grand schemes and were rather modest about their predictive ability. The less successful forecasters were like hedgehogs: They tended to have one big, beautiful idea that they loved to stretch, sometimes to the breaking point. They tended to be articulate and very persuasive as to why their idea explained everything. The media often love hedgehogs.

Excellent. This is so true. Media loves the hedgehogs. It is also important for foxes to remain as one. What usually happens is foxes also become hedgehogs seeing the instant fame.

This actually made me think. Before crisis many experts said we are in era of great moderation and as a result everything will be stable and rising. Quite a few turned hedgehog and stretched the idea to the hilt. And the crisis hit. Now we have a large number of experts saying things are going to be very bad and have stretched this idea as well. We come across new theories nearly every week to justify why the crisis will be worse. Could this be a hedgehog as well and economies will recover sooner than expected.

The entire interview is worth a read.

Did Sweden in its 1990 crisis nationalise the banks?

February 26, 2009

Media is rife with comparisons of today’s crisis with Sweden’s crisis. (However, I think entire Nordic crisis of 1990 is a better parallel). There is a consensus that like Sweden US should also nationalise its banks.

Anders Aslund of IIE turns this Sweden crisis parallel on its head. He says Sweden did not nationalise the banking system as we believe (Norway did). So, we are looking at the wrong country for a solution. Sweden example serves well for buying bad assets but not for nationalisation of banks. Even then, bad banks were set by private banks and not any govt authority.

I also checked a comprehensive paper (see Chapter 3 in paper or page 94 of the entire report) prepared on Nordic Crisis by Norges Bank. It says only 2 banks were nationalised in Sweden – Gota Bank (which Aslund also mentions) and Nordbanken (which was majorly owned by Govt anyways). Norway nationalised three and Finland two.

So it is Norway and not really Sweden we should be looking at. Even in Norway only 3 were nationalised and in US case we are looking at possibly 1000s as President Obama himself noted.

I came across another excellent short note from St Louis Fed on resolving the crisis via Nordic way. It says three lessons:

First, build a bipartisan political consensus to support the actions needed to maintain confidence in the banking system. This includes establishing a new crisis resolution agency to handle both communication with the public and bank restructuring. If successful, such an agency can reduce conflicts of interest or “turf fights” among existing agencies while providing capital and liquidity to banks, even if another agency (such as the central bank) provides funding.

Second, seek private solutions, including mergers and acquisitions; avoid liquidations when possible.

Third, be very transparent regarding support actions. In the Nordic case, public confidence was sustained and bank runs avoided (absent government  deposit insurance) through a highly visible public government guarantee for the obligations of banks, including both deposits and borrowings.

US (and others) have only tried to follow the second lesson. First and Third have been ignored and there is absolutely no clarity with any policy response. I had pointed earlier as well that biggest lesson from Sweden’s crisis was its transparency and communications. Even now, there is much confusion despite both Treasury and Fed trying their best to be transparent. For instance, Treasury has set a website for all its financial stability programs and Fed for its various Programs. They hardly serve any purpose with former having just links to various programs and latter too much information for anyone to digest. What is needed is short primers to tell the public of its intentions.

Anyways, another idea on its head. Hunt for solutions from Norway now.

The focus now moves to pensions

February 26, 2009

BBC reported this shocker:

Sir Fred Goodwin, the former chief executive of Royal Bank of Scotland, is already drawing a pension of £650,000 a year, despite only being 50. The BBC has learned that the pot that generates his pension is worth £16m.

Sir Fred’s strategy and decision to buy ABN Amro is widely seen as making the bank more vulnerable to the credit crunch and having to be bailed out. RBS, which is 70% owned by taxpayers, is expected to announce the UK’s biggest corporate loss on Thursday.

This is simply crazy. Taxpayers now seem to be paying pensions to a guy who is just 50 yrs old!! This has angered the MPs as well:

Michael Fallon, a Conservative MP on the Treasury Committee, said the government should not have allowed the payments to go ahead in the first place.  “Ministers must have known this when they took over the bank back in October,” he said. They must have known what his pension arrangements were. They have had since October to get this sorted out. That pension should have been stopped.

However, Sir Fred is unperturbed:

When giving evidence to the Treasury Committee on 10 February, Sir Fred said: “My pension is the same as everyone else in the bank who is in a defined benefit pension scheme. It is determined in the same way as anyone else.”

Can you believe this!!

Robert Peston of BBC in his blog clarifies that this isn’t just a rumor:

Perhaps unsurprisingly, when I informed the Treasury we were about to run this striking story, I was told that ministers were very unhappy about the generous terms of Sir Fred’s early retirement package.

So UK Financial Investments – the offshoot of the Treasury which manages taxpayers’ stakes in our big banks – is investigating, with RBS’s board, whether there is any way of clawing back some of the pension entitlement (see below for a full copy of a statement given to me by the Treasury).

Peston also points ex- RBS chief fixed this pension arrangement way back:

Now before you pull your hair out, I should mention that Sir Fred didn’t take any money by way of compensation from RBS when he left the bank.  And his entitlement to a pension at 50, in the event that he was asked to leave RBS, was an arrangement put in place some years ago and applied to other directors too. Even so, the disclosure that he’s set up very nicely for life will spark some controversy.

Very smart indeed. Did he understand the risks he had put the bank in and so made a pension plan well in advance?

The authorities would now also have to look at pension accounts as well. How bad can it get?

PS. The latest news tells me RBS has incurred a loss of GBP 34.2 bn in 2008 and is participating in whatever govt plans possible.

Assorted Links

February 26, 2009

1. Krugman points US has not learnt any lessons from Japanese experience. He also says the new measure to stress test banks will not cause much stress 🙂

2. WSJ Blog points Geither says nationalisation is a wrong strategy

3. ASB points BPO path to international finance. Despite all this mess, we still seem to believe in international finance!

4. Nudges has an excellent post on India’s New Penson System scheme

5. Mankiw pointsto an interesting graph on Ricardian equivalence

6. Finprof points index funds wins again

7. TTR points to Taleb article on bank bonuses

8. ACB has a superb post comparing forecasters to hedgehogs and foxes.

9. Urbanomics has a useful post on the benefits of early childhood education


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