Archive for September 3rd, 2009

Dont’s of assessing unconventional monetary policy

September 3, 2009

Kiyohiko Nishimura of BoJ has given an insightful speech on unconventional monetary policy. He says:

The topic of this panel, “Monetary Policy Boundaries: Alternative Instruments and Policy Coordination” is particularly timely, since many central banks including the Bank of Japan have already crossed conventional boundaries. They have been conducting unconventional policies since the current crisis erupted a couple of years ago. Some call them credit easing, and others describe them as quantitative easing. This kind of nomenclature is eye-catching, but it is sometimes a distraction, hiding the real picture of what the central banks have done. In fact, if we look at these unconventional policies from a functional viewpoint, they all have this in common: the desire to counteract market dysfunction and confidence erosion.

Straight talking at its best.

He cites 4 principles of  unconventional monetary policy:

  • Select and Concentrate
  • Avoid Further Dysfunction
  • Provide Safety Nets
  • Design Measures to be Self-Fading as Conditions Improve

He says there are 5 dont’s to assess effectiveness of these policies:

  • Don’t Take the Central Bank’s Balance Sheets as a Measure of Monetary Easing
  • Don’t Look only at the Segments of Financial Markets subject to Intervention
  • Don’t Underestimate Safety Nets
  • Don’t Ignore Heterogeneity among Countries and Regions
  • Don’t Assume a Return to the Way It Was

Once again great insights. One has to read the speech for more details.


History of Credit Rating Agencies

September 3, 2009

I came across this wow paper by NYU Financial Historian, Richard Sylla. It gives a historical perspective on credit rating agencies. There is a lot of criticism on role of CRAs in this crisis (and rightly so; see Urbanomics for a discussion) and this blog has occasionally joined in the criticism as well.

What Sylla tells you is how and why CRA came up. As pointed out by several economic history studies, globalization and financial globalisation (see this for some ideas) was pretty alive and kicking before World Wars occurred.

However rating agencies only started in 1907 (Moody’s to be precise) but US already had a kicking bond market. The main cos that issued bonds were railroad companies. So who managed these bond issues then? He said there were three agencies:

One is the credit-reporting (not rating) agency. Another is the specialized financial press. A third is the investment banker. In a sense, the bond-rating agency innovated by Moody in 1909 represents a fusion of functions performed by these three institutions that preceded it.

Read paper for details.

The author then points that just like U shaped curve of fin globalisation history, rating agencies also declined with World Wars. And then as fin glob picked up in 1970s so did rating agencies. They eventually became superpowers and their upgrades and downgrades mattered quite a bit.

He then reviews all the criticisms of the CRAs and says they really need to seriously look at their operations. In the conclusion he summarises:

There is now nearly a century of experience with independent-agency bond ratings in the United States. Many of this issues that arise in recent discussions came up in earlier studies of the U.S. experience. The ones that seem most relevant now have to do with the use of agency ratings for purposes of financial regulation. If ratings are used, for example, to help in determining the capital adequacy of financial intermediaries, the underlying rationale would rest at least in part on thinking that such a use would help to prevent or alleviate financial crises. In that connection, it is worth recalling Braddock Hickman’s concern that such a use conceivably might make a financial crisis worse than it otherwise might have been, or perhaps even cause a crisis when business contractions lead to ratings downgrades.

Partnoy’s complaint that the use of agency ratings for regulatory purposes puts the agencies into the business of selling regulatory licenses also needs to be taken seriously. The U.S. Comptroller of the Currency in 1936 issued a regulation prohibiting banks from purchasing investment securities with characteristics that were “distinctly or predominantly speculative,” and then added that “ the terms employed…may be found in recognized rating manuals, and where there is doubt as to the eligibility of a security for purchase, such eligibility must be supported by not less than two ratings manuals.” The latter phrasing referring to recognized raters was attacked as placing too much authority in the private rating agencies, and on that ground it was deleted from the regulation in 1938, although in a less formal way it remained in effect with regulators. 

The designation of “Nationally Recognized Statistical Ratings Organizations” some four decades later in the United States brought back what had been abandoned in 1938. Should representative governments be in the business of passing out such designations if the designees are thereby allowed to profit from selling regulatory licenses? Or, if ratings are to be incorporated in financial regulations, is it possible that regulatory authorities have a responsibility to come up with, and apply, their own ratings? If the answer is, “No,” then why not contract out other regulatory functions, such as bank examinations, to private contractors?

The same issues are haunting us now. The paper was written in 2001. It was presented at a WB conference on CRA (more papers to read…grrr). We have not done anything at all about the issues raised wrt CRA. Just that they only got bigger and bigger despite conflicts of interest and no real value add (rating agencies mostly follow the events). And the regulatory arbitrage just made them near Gods. As I keep saying in this blog, none of the issues which have beeb raised in this crisis are like out of the blue. They have all been discussed and debated umpteen times but nothing was done.

Citibank chief once (and famouly) said:

When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing. (July 2007)

This applies to all – regulators, economists (the powerful ones who kept ignoring these sort of papers), different kinds of firn firms etc etc.  

It is a great paper and has tremendous insights. Must read.

Are Swedish 1990 crisis lessons relevant today?

September 3, 2009

This is an oldish post by Lars Jonung (March 2009). So those who have not read it could look at it. It has some excellent insights from the Swedish crisis.

He says there are 7 key points of Sweden 1991 crisis model:

  • Political unity
  • Blanket guarantee of bank deposits and liabilities
  • Swift policy action
  • An adequate legal framework based on open-ended funding
  • Full information disclosure
  • Differentiated resolution policy to maintain the banking system and prevent moral hazard
  • The role of macroeconomic policies in ending the crisis

For details see his paper on the same.

What are lessons for today?

On a very general level, the similarities are striking. The two crises are both financial crises driven by identical forces – a boom fuelled by lax monetary policy and negligent financial oversight, later turning into a bust.

On the other hand, there are considerable differences. The Swedish crisis of the early 1990s was primarily a local phenomenon, or – more accurately – a Nordic one, as Finland and Norway also went into crisis at roughly the same time as Sweden. Being a small open economy, Sweden was able to abandon its pegged rate and obtain a significant and lasting depreciation of its currency that contributed to strong recovery. This option is hardly open to an individual country today because the present crisis is global.

The Swedish bank resolution policy was faced with a financial system that was much less sophisticated and much less globalised than the financial systems of today.

In addition, Sweden has a tradition of substantial public confidence in its domestic institutions, political system, and elected representatives. Such social capital made it easy for the government and opposition to reach swift and stable agreements on policy actions.



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