Archive for March, 2009

After all this mess, AIG is still distributing bonuses!

March 16, 2009

Just recently Bernanke said if anything, it is developments in AIG that has disturbed him the most. Fed Vice Chairman Kohn was asked to testifyon AIG (haven’t read the details) and he refused to give details of AIG counterparties.

Today, Eurointelliegnce pointed that in its bailout of AIG, the US taxpayers has also saved Deutsche Bank, Societe Generale etc. (the list of counterparties who were paid from public funds is here).  If this was not enough, read this news from NYT:

The American International Group, which has received more than $170 billion in taxpayer bailout money from the Treasury and Federal Reserve, plans to pay about $165 million in bonuses by Sunday to executives in the same business unit that brought the company to the brink of collapse last year.

Word of the bonuses last week stirred such deep consternation inside the Obama administration that Treasury Secretary Timothy F. Geithner told the firm they were unacceptable and demanded they be renegotiated, a senior administration official said. But the bonuses will go forward because lawyers said the firm was contractually obligated to pay them.

The payments to A.I.G.’s financial products unit are in addition to $121 million in previously scheduled bonuses for the company’s senior executives and 6,400 employees across the sprawling corporation.

This is so bad that one needs to find another word for describing these practices. This is just like the RBS story in UK whose ex-chief continues to get his huge pension despite being majorly owned by UK Govt. Another case of taxpayers paying for the bonuses of the people who led to the crisis in the first place.  On top of this, AIG chief says:

In a letter to Mr. Geithner, Edward M. Liddy, the government-appointed chairman of A.I.G., said at least some bonuses were needed to keep the most skilled executives. “We cannot attract and retain the best and the brightest talent to lead and staff the A.I.G. businesses — which are now being operated principally on behalf of American taxpayers — if employees believe their compensation is subject to continued and arbitrary adjustment by the U.S. Treasury,” he wrote Mr. Geithner on Saturday.

Still, Mr. Liddy seemed stung by his talk with Mr. Geithner, calling their conversation last Wednesday “a difficult one for me” and noting that he receives no bonus himself. “Needless to say, in the current circumstances,” Mr. Liddy wrote, “I do not like these arrangements and find it distasteful and difficult to recommend to you that we must proceed with them.”

What skills and talent is he talking about?? Looking at the conditions in employment markets and of AIG, I am sure AIG employees must be more than grateful to have a job. People are struggling to get basic salaries (quite a few don’t even know what was their fault) and here we are talking about a firm barely functional on public funds, distributing bonuses! And what is worse is Government appointed CEO is defending it!! And all this is happening despite President Obama’s criticism of incentive structure.

US policymakers have just messed this entire bailout of AIG (and others). It is a complete confidence crisis in developed world policymakers.


1) I was seeing this presentation on AIG’s website which enforces how important it is to save AIG from collapsing. Really?

2) It also has a arrogant link which is titled as Setting the Record Straight. In this AIG tries to answer all media criticisms. Yes, the record indeed has to be set straight.  We can’t have this situation anymore.


Assorted Links

March 16, 2009

Hi to all. It is nice to be back after a long break. It will take a while to understand the recent developments. Let me start with assorted links.

1. Krugman points to ugly choices for Spain. He says US Govt should guarantee all bank liabilities and buy those that are insolvent

2. WSJ Blog has some superb stuff on financial regulation

3. Mankiw points to Romer speech where she discusses the lessons from Great Depression

4. Fin Prof points to an interesting article that links sales of Ayn Rand Books to govt. interventions

5. FCB points Citito appoint fin experts as board members!

6. Econbrowser on new keynesian models

7. ASB points to some views on G-20 meeting

8. JRV points to a new Bob Barro paper which seems to have solved the equity premium puzzle

9. TTR points to flawed b-school theories. He also points to excesses in consulting firms

10. IDB says high interest rates are not really a problem in Microfinance

11. Urbanomics points to central banks role in asset prices

Revisit Fed-Treasury accord and we are moving to a policy driven crisis

March 10, 2009

Jeff Lacker of Richmond Fed in his speech:

While both the Fed and the Treasury can extend credit, only the Fed issues money. Thus, the Fed’s primary focus should be the management of its monetary liabilities.

Goodfriend advocated an understanding or agreement between Fed and Treasury on credit policy, analogous to the 1951 Accord.

A new “credit accord” that assigns to the Treasury the responsibility for all but very short-term lending to solvent institutions would have a number of advantages, I believe. On a practical level, at some point in the future, the Fed will need to withdraw monetary stimulus to prevent a resurgence of inflation when the economy begins to recover. That time could arrive before credit markets are deemed to be fully enough “healed” to warrant winding down particular credit programs. If monetary policy and credit programs remain tied together, as they currently are, we risk having to terminate credit programs abruptly, or else compromise on our inflation objective. Separating credit programs from monetary policy would make it easier to devise a successful “exit strategy,” and would reduce market uncertainty about how any potential tension between monetary and credit policy will be resolved.

Charles Plosser of  Philadelphia Fed in a speech:

Even more important, credit allocation decisions, in my view, should be under the purview of the fiscal authority, not the monetary authority, since they involve using the public’s money to affect the allocation of resources. The mixing of monetary policy and fiscal policy increases the number of entities that might try to influence Fed decision-making in their favor. Both economic theory and practice indicate that central banks should operate independently from such pressures and resist them when they arise so that their policies benefit society at large over the longer term and not any particular constituency in the near term.

So where should we go from here? One suggestion that would promote a clearer distinction between monetary policy and fiscal policy and help to safeguard the Fed’s independence would be for the Fed and Treasury to reach an agreement whereby the Treasury takes the non-Treasury assets and non-discount window loans from the Fed’s balance sheet in exchange for Treasury securities. Such an accord would offer a number of benefits.

Both mention the need to revisit the Treasury -Fed accord and ensure Fed does only mon policy and credit policy is left to Treasury. Fed may be asked to intervene early in the crisis  but eventually all credit programs should move to Treasury asap.

For more on Treasury-Fed accord see this Richmond Fed Study. This study tells the story of how Fed got its independence and was made responsible for monetary stability in US.

Now, all these are important developments. Till January 2009 all was accepted as ok by Fed members, now we  are seeing dissent (Lacker dissented in the latest Fed meeting) and discomfort. The members are increasingly showing concern with Fed policies and balance sheet. The worries over moral hazard is also increasing . The above  suggestions about revisiting the accord implies they are worried over Fed not being as independent as well.

In another much discussed speech, Kansas Fed President Koenig said (pointed by Krugman):

We have been slow to face up to the fundamental problems in our financial system and reluctant to take decisive action with respect to failing institutions. … We have been quick to provide liquidity and public capital, but we have not defined a consistent plan and not addressed the basic shortcomings and, in some cases, the insolvent position of these institutions.

We understandably would prefer not to “nationalize” these businesses, but in reacting as we are, we nevertheless are drifting into a situation where institutions are being nationalized piecemeal with no resolution of the crisis. 

The crisis is shifting from a financial crisis to a real economy crisis to a policy crisis..

Japan experts on lessons from Japan crisis in 1990s

March 7, 2009

Boston Fed President Eric Rosengren has also done plenty of research on Japanese crisis. He has given a speech in which he points to three main lessons from the Japanese crisis:

  • First, undercapitalized banks behave differently than well-capitalized banks.
  • Second, certain bank-regulatory and accounting policies may amplify the business cycle.
  • Third, troubled assets need to be moved off bank balance sheets as quickly as possible.

This is all too well-known by now. Nevertheless the speech is a great read. It is another evidence that US policymakers despite knowing it all, have not been able to get things going.

Adam Posen, another  Japan expert in a testimony to JEE says 7 things need to be done to solve the crisis. He makes the 7 points drawing his research experiencein Japan. He is a leading advocate of using fiscal stimulus in Japan like problems which US (and others) are facing. He says if we continue to do half measures, we would end up like  Japan.

Taylor says Romer/Bernstein plan too aggressive

March 6, 2009

In January, there was a huge debate about this paper by Romer and Bernstein, advisors to Obama. The paper showed simultations on how Obama plan (the fiscal stimulus plan, there are so many Obama plans) would help the economy.

I was going through this John Taylor paper where he along with other economists shows the projection by Romer/Bernstein is too aggressive and would not stimulate the economy as much as estimated. Taylor says Romer/Bernstein have used old keyensian model but they should have instead used the more advanced and used new keynesian model. The main difference between the two is latter uses expectations more in their models.

Now, this is interesting from two points. One, it is perplexing that why Romer/Bernstein do not show the forecasts using other models as well? They should have based their forecasts on the basis of all possible models to avoid criticism.  

Two, do all these models really matter? I am reading this very good postby Buiter who has criticised all these macro models saying they aren’t good enough. New Keynesian models are used by all central banks and we all know how ineffective they have been. But then we need to understand somethings and move somewhere  and need models. Confusing bit

Anyways, this is another criticism from Taylor on US Govt policies. (See this as well).

Economic Policies to Tackle Crisis Short Run Fix vs Long Term Pain

March 5, 2009

I have written a new paper titled the same. Any comments are welcome.


  1. One should read speech of Hervé Hannoun, Acting General Manager of BIS on the same topic.
  2. ECB Chief Trichet also addresses the same issue

Blogging is going to be weak

March 3, 2009

As I head off to another break, blogging is going to be weak in coming days. I will try and blog but it is not going to be as frequent. Blogging will resume in full from 16 March onwards. Apologies for the inconvenience.  Please keep posting your comments.

Visiting all the viewers A Very Happy and Colorful Holi in advance.

How the crisis impacted Indian shores

March 3, 2009

Though I had coverde the imapct of crisis on India in this paper, here is a nice speech from RBI Governor on the subject. It is a nice primer for anyone wanting to understand how the crisis  impacted Indian shores

Apart from the two channels – trade and finance, he also stresses the role of confidence channel in the crisis. Towards the end come his golden words:

Clearly, there is a period of painful adjustment ahead of us.

Assorted Links

March 3, 2009

1. Y’day, I said expect fireworks from Krugman. MR pointsit  has started (not fireworks as of now)

2. Krugman points capital controls are part of IMF policy in Iceland! He also saysFriedman Shwartz hypothesis that Fed created Great Depression was wrong

3. Krugman points policymakers just refuse to accept the grave situation

4. Stephanomics says policymakers should not say save the world; they should save the banks first

5. Urbanomics points to more research papers on this crisis

Is Universal Banking the way to go?

March 2, 2009

The crisis has killed the standalone i-bank model with all the big names gone. Lehman is no more, Merril takeover by Bank of America, Morgan Stanley and Goldman converted into banks. This has led to the belief that Universal banks (all services under one bank) is the way to go.

I cam across this interesting paperby Asli Demirguc-Kunt of World Bank and Harry Huizinga of Tilburg University. The authors say:

The main contribution of this paper is to provide evidence on what bank income and funding strategies perform well in terms of producing profitable and stable banks. In particular, we examine  how a bank’s income and funding mixes affect the rate of return on its assets and Z-score or distance to default. Our basic regressions suggest that at low levels of non-interest income and non-deposit funding, there may be some risk diversification benefits of increasing these shares, although at higher levels of non-interest income and non-deposit funding shares, further increases result in higher bank risk.

Traditionally a bank funds itself via deposits from public and earns by giving those deposits as loans at a higher interest rate than deposits. In this crisis we saw banks using repo market for funding (non-deposit) and earned via investment in other financial instruments (non-interest income). This paper uses a sample of 1334 banks in 101 countries to show that this strategy leads to higher return on assets but the risk also rises.

They says the collapse of i-bank model is an example of this strategy (non deposit / non income) going wrong:

The collapse of the U.S. investment banking sector shows that the market can weed out banks that have chosen an apparently unviable business model. All the same, there is an important role for policy as well, as bank collapses, such as in the U.S. investment banking case, can have important real side effects and impose high costs on the taxpayers through the financial safety net. The observed variation in policies regarding banking powers and restrictions over time and across countries, also suggests that policy makers are experimenting with different banking models, searching for an optimal model for banks. The evidence presented in paper suggests that traditional banks – with a heavy reliance on interest-income generating and deposit funding – are safer than banks that go very far in the direction of non-interest income generation and funding through the wholesale capital market.

The question is what is the threshold level non deposit / non income where you say – this is enough. This paper also suggest that one needs to look at the financial system holistically once again. The same strategies – non deposit / non income- were considered to be the strategies for banks a while ago. Especially non deposit or wholesale market funding was considered to be very safe.

Finally for U-banking:

However, our results do not suggest that banks with systemic importance should completely eschew non-interest income generating and non-deposit funding, suggesting that universal banking can be beneficial. Nevertheless, evidence of diversification benefits is weak. Hence, while the universal banking model may be the best way to conduct investment banking business in a safe and sound manner, our results also suggest that there may limits to how far banks can steer away from the traditional model of interest income generation and deposit taking.

So, if C-Banks start doing I-banking under its Universal bank umbrella it should ensure that it does not allow non deposit / non income to grow. This is interesting bit and one can see the implications already. There are quite a few U-banks bleeding right now – Citi, UBS etc. All of them seem to have gone too far allowing i-banks within them to get real big on non deposit / non income. This inturn has led all their businesses to bleed. When BoA took over Merill similar thing happened. They underestimated (it is BoA’s fault) the losses from Merrill’s i-banking division.

 Interesting paper with lots of insights. How does a policymaker organise its banking systems? What all should it allow banks to do? These are very important questions especially for emerging markets which still are developing their financial markets.

Fed’s Mondustrial policy

March 2, 2009

John Taylor (of the famous Taylor Rule) has criticised Fed severely in this crisis.

It began with this paper presented in Kansas Fed Symposium in 2007 where he said Fed should have raised rates higher and faster in the period 2002-06 .  This would have minimised the effects of the crisis.

He then presented another paper taking a critical review of Fed’s policies to pump liquidity in the system. He said the crisis was never really a liquidity problem but a solvency problem. The rates in money markets had risen not because of former but because of latter. Fed had got it wrong.

In the next paper he summarises the two above papers and also adds why initial fiscal stimulus die not work, Fed cut rates sharper than Taylor rule suggested etc. This paper was quoted quite a bit in the media.

Taylor has upped his criticism further calling Fed’s Monetary Policy as Mondustrial (Using Monetary Policy for Industrial Policy Goals). This was pointed in WSJ Blog and Taylor has written a new paper on the same which he sarcastically titles  – The need to return to a monetary framework. In this Taylor says monetary policy is being used to help certain sectors and institutions which is the job of a industrial policy. He points to number of questions Fed should answer:

  • What justification is there for an independent government agency to engage in such industrial policy?
  • What is the role of District Bank presidents versus Board members in making such decisions?
  • How can one continue to apply the section 13(3) “unusual and exigent” clause of the Federal Reserve Act when firms and people assisted can get credit but at a rate that seems too high?
  • Will such interventions only take place in recessions, or will Fed officials use them in the future to try to make economic expansions stronger or to assist certain sectors and industries for other reasons?

Very important questions all of them. Like I have said in numeorus posts – central bankers have a long way to go. The crisis will (should) end in sometime but then will begin a series of questions.

How bad is the recession in UK?

March 2, 2009

I had pointedto two research notes from St Louis Fed and Minneapolis Fed comparing this recession with previous recessions in US. In another post I had asked it would be interesting to compare and analyse  the crisis in other economies as well.

Andrew Sentance of Bank of England in a speech helps understand and compare current recession in UK with previous recessions in UK. He only includes post war recessions and so we don’t have great depression stats in UK.

He has a nice table (on page 7 )

  Growth peak Period of Falling GDP Drop in output during recession pre-recession GDP level recovered
Mid-70s 1973Q1 1973Q3-1975Q3 -3.32 1976Q4
Early-80s 1979Q2 1980Q1-1981Q1 -4.61 1983Q1
Early-90s 1988Q1 1990Q3-1991Q3 -2.54 1993Q3
Late-2000s 2007Q3 2008Q3-? ? ?

He says BoE has forecasted4% drop in GDP which is not as bad as early 1980s recession. THis is in line with what research has shown in US as well- the current recession is yet to see negative figures seen in previous recessions.

He also points what is surprising (though common) is that economy has moved from highs to lows in a very quick fashion:

Another similarity between our current experience and the more distant recessions in the mid-1970s and the early-1980s is the speed with which the economy has moved from reasonably healthy growth into recession. Many people have commented that in the current cycle, the economy has moved in less than a year from reasonably healthy growth in late 2007 and early 2008 to outright recession. But that was also very much the pattern we saw in 1973/4 and 1979/80, as Chart 4 shows.

In early 1973, GDP growth peaked at a staggering year-on-year growth rate of 10% – with the Barber boom was in full swing. And yet by the year-end, the UK economy was in recession as the first oil price shock took its toll, a wave of industrial unrest swept the country and workplaces were on a three-day week. Similarly, in 1979/80 it took the economy just a year to move from healthy growth in the first half of 1979 to full-blown recession in early 1980.

He also says that in previous recession there was high inflation (this was actually a case with most previous recessions as well). This was the case with this recession as well but inflation has declined sharply since then.

Nice insight into UK recession history.

Assorted Links

March 2, 2009

1. ASB points to some good stuff on fin regulation

2. ACB points do we need t have a fiscal stimulus target?

3. Urbanomics points to some key economists forecasting when will it end

4. MR points nationalisation of banks is not the answer

5. WSJ Blog summarises the latest BIS quarterly review. It also points that annual treat- Warren Buffet’s annual letter to shareholders – has been released. It also points to a new paper that criticises Fed

6. Mankiw asks what should a deficit hawk do?

7. FCB points to a graph which shows equity markets in the crisis. It also has a nice graph on house prices still too high

8. MIB writesan open letter to Krugman. Expect some fireworks from hereon

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