Archive for December 30th, 2009

Future of American Capitalism

December 30, 2009

WSJ Blog has interviews of 2 econs on future of American capitalism:

There is one common question on state of US brand of capitalism and both agree that it is going to be discredited.

Has the decade of the 2000s — with the downfall of Enron, the bursting of the Internet bubble and the Great Panic — discredited the U.S. model of capitalism?

Raghuram Rajan: The rhetoric has changed considerably. People don’t say that the U.S. is the place to emulate any more. The U.S. used to be pretty good at giving lectures in the past, so now of course other countries are taking the chance to thumb their nose at them.

Some people are concluding that capitalism doesn’t work. The problem is that they don’t have anything reasonable to replace it with. To say that we needed more regulation is not to say that markets don’t work.

Jeremy Stein: The risk is that the U.S. model will be discredited more broadly than it ought to be. The lesson that we learn is that we need to do certain things to reform financial markets, but we don’t want to throw out the whole model. Our labor markets are less constrained than European labor markets, we have more IPOs per capita than most other countries. A lot of that stuff remains a strength of the United States.

What is the next best alternative? There are no answers. This crisis is making us rethink on nearly everything in economics…


Teaser Rates offered in India…are any lessons being learnt?

December 30, 2009

Deepak Parikh yet again. He is perhaps the only one who talks about the unfair practices in housing market in India. Mint has an interview of the HDFC Chairman.


Wars and impact on financial markets

December 30, 2009

I didn’t know how to summarise this paper in the title of the post.

I just finished reading this paper from Niall Fergusson. It is such an amazing paper and a must read. He begins the paper saying:

We are living through a paradox—or so it seems. Since September 11, 2001, according to a number of neo-conservative commentators, America has been fighting World War III (or IV, if you like to give the Cold War a number). For more than six years, these commentators have repeatedly drawn parallels between the “War on Terror” that is said to have begun in September 2001 and World War II. Immediately after 9/11, Al Qaeda and other radical Islamist groups were branded “Islamofascists”. Their attack on the World Trade Center was said to be our generation’s Pearl Harbor. In addition to coveting weapons of mass destruction and covertly sponsoring terrorism, Saddam Hussein was denounced as an Arab Hitler. The fall of Baghdad was supposed to be like the liberation of Paris. Anyone who opposed the policy of pre-emption was an appeaser. And so on.

Yet throughout this period of heightened terrorist threats and overseas military interventions, financial markets have displayed a remarkable insouciance. The U.S. stock market was affected only momentarily by the attacks of 9/11. True, between September 10 and September 21, 2001, the Dow Jones Industrial Average declined by as much as 14 per cent. Within just over two months, however, the Dow had regained its pre-9/11 level.

He says it is amazing how financial markets discount geopolitical events and don’t anticipate it. It is only when war events turn true and sour, do markets start chickening out.

History suggests that financial markets do not always anticipate major geopolitical crises. Part II of this paper shows how the majority of investors in London, then the world’s biggest capital market, were caught unawares by the escalation of the conflict in the Balkans in July 1914—so much so that there was a disastrous liquidity crisis in most financial centers even before war had broken out.

However, the markets learn the lessons with certain conditions:

Part III shows how the origins of the First World War have been revealed only with the benefit of hindsight; at the time, they were largely invisible. The same, however, cannot be said of the Second World War. Investors learned from the searing experiences of 1914-23, which saw a wide range of European currencies and securities drastically reduced in value as a result of inflation and outright default. They therefore sought to adjust their portfolios defensively as soon as they saw a renewed risk of world war. Indeed, to judge by securities price data, the City of London (like other markets, notably those in Scandinavia) began positioning itself for another major conflict some years before it actually began. If 1914 was a bolt from the blue, 1939 seemed long overdue.

What are the lessons?

The first point is that it is as hard for investors as for generals to learn lessons from a previous war. Knowing what had happened to various asset classes after 1914 did not make it easier to know when to sell those that had lost out or buy those that had fared well. Nor was there any guarantee that the next war would have the same financial impact as the previous war, because of changes in military technology and government regulation.

As part V argues, these same problems arose again for investors after 1945. Simply because the Cold War never became truly “hot” does not mean that the probability of a nuclear war between the superpowers was always zero. Investors once again tried to learn from history when the Korean War broke out, acting on the assumption that it might have similar effects to World War II (for example on commodity prices).

Twelve years later, by contrast, financial markets evinced only short-lived and mild anxiety at the time of the Cuban missile crisis, reflecting a realization on the part of investors that a world war in the age of the hydrogen bomb would have incalculable consequences against which it would be futile to hedge. In the remaining three decades of the Cold War, the superpowers’ consistent success in settling their disputes by diplomatic means (or proxy conventional wars) reassured investors that their rivalry would not erupt into a hot war, so that markets became progressively less sensitive to international crises.

If financial market data and commentary are reliable guides, then, this is roughly how expectations of war are formed: retrospectively more than prospectively, though with some allowance for changes in the nature of warfare. Excellent stuff. The linkages of war with financial markets is something I hve never read before. What amazing lessons

Super stuff from Ferguson. What insights on thinking about geopolitical risks and impact on financial markets.

What are the risks in current times?

A period such as our own, of sporadic terrorism and small conventional wars, might therefore be expected to encourage the belief that future wars will also be small, with inconsequential financial effects.

The seeming indifference of today’s financial markets to political risk should therefore be regarded not as evidence that the world will likely avoid a major conflict in the foreseeable future, but merely as evidence that the world has avoided a major conflict in the recent past. Given the relative youth of most employees in the financial sector, and the relative shortness of most senior executives’ careers, “recent” may be taken to mean approximately the past twenty-five years.

A major conflict would strike this generation of bankers and fund managers much as the war of 1914 struck their predecessors: like “a bolt from the blue”.

Well, well, well…..

Read the whole thing. Very rich…Is a nice revision of World War History as well.

On reading the paper, I just recalled this previous post where I wondered whether financial markets see the emerging risks in the Indian political system as well? We can see the similarity in Indian situation as well. If you read any India based newspaper politics section would suggest huge risks but financial section would suggest “All is well”. Things in political only look worse going from hereon and still nothing seems to matter financial markets. Can this continue? Will something hit Indian financial markets – a bolt from the blue? I hope not but the possibility cannot be ignored. Atleast Fergusson’s paper tells you why it cannot be ignored.

Prospect magazine’s top 25 brains of the financial crisis

December 30, 2009

Prospect Magazine has named the 25 brains who have contributed to the public conversation in this financial crisis. Let me give away  the winner right away- Simon Johnson.

Who has contributed best to the “public conversation” during these turbulent times?

The financial crisis has destroyed both wealth and received wisdom. The idea that prices are always right and markets self-correct is fatally challenged. Even Alan Greenspan admits that the “whole intellectual edifice” of the efficient market hypothesis collapsed in the summer of 2008. The financial establishment is in a state of deep confusion. As the FT’s Gillian Tett put it in September’s Prospect: it is like “a priest who has lost faith in the Bible, but still has to go to church.” But this is not a bad thing, for it has opened up new ways of thinking about markets, institutions and the all-important cause of financial reform.

Unfamiliar voices have come to prominence, aided by a new wave of financial bloggers eager to push fresh ideas. But who has made the most impact? Prospect assembled a panel of experts to draw up a list of leading “public intellectuals” of the financial crisis in 2009 and then decide on the most important. Our criteria were simple. Anyone who had made an impact on policy with their ideas, or who had changed the “public conversation” was a candidate.

The panel sifted hundreds of names, with an unavoidable bias towards Britain and the US, but felt the most important contributions had been in financial reform—those trying to work out what to do next. The crisis has laid a staggering financial burden on the world, with some $14 trillion propping up US and EU banks. We cannot afford another one. Moreover, we urgently need a new regulatory philosophy. Are liquid markets always good? Is complexity in financial services harmful? Can finance firms stop “herding,” creating wild booms and busts?

After considering so many names, came the final list.

We considered all of this, and gradually whittled the names down to a shortlist of just 25 (see facing page), and then a top three. In reverse order, the bronze medal went to Adair Turner, chairman of Britain’s Financial Services Authority, who bravely questioned the social usefulness of some financial activity, and called for regulators to force banks to hold more capital against risky trades, cutting their profitability. Next, silver went to Avinash Persaud, a respected analyst who spotted nine years ago the dangerous interaction between firms “herding” and new risk management techniques. During 2009 he has been arguing for new “macro-prudential” regulation to stop what he discovered a decade ago.

But there was a clear winner. He is Simon Johnson, an economist at the prestigious Peterson Institute in Washington, DC, who has been leading the argument against overmighty banking. His ideas are well grounded in theory, but he has also done more than any academic to popularise his case: writing articles, a must-read blog, and appearing tirelessly on television.

This is thoroughly deserved. I think Simon Johnson will come tops in most of such lists. I just took a relook at FP’s top 100 thinkers list and am surprised not to find Johnson’s name there at all.

His write up on financial oligarchy has changed the way we think about financial sector completely. He has followed the article with numerous write-ups and follow-ups on how things are only getting worse and unless we reform it, more crisis are going to follow. This coming from a ex-Chief economist of IMF is itself quite revolutionary and has goven it the necessary weight.

Measuring Financial Stability – a literature survey

December 30, 2009

BIS Economists  Blaise Gadanecz and Kaushik Jayaram have written a superb literature survey on measures of financial stability.

This paper is a modest contribution to review the work done towards developing quantitative measures of financial stability and their use in published FSRs. The paper is structured as follows. In Section I, we look at definitions of financial stability and what they mean for identifying key variables, which we discuss in Section II. In Section III, we review how these individual variables might be combined into composite indicators for the purposes of monitoring key sectors of the economy and assigning critical values. In Section IV, we provide a comparative view of the main variables and indicators used in selected FSRs. In Section V we discuss recent attempts to construct a single aggregate measure of financial stability. The final section concludes.

Very useful primer on financial stability measures. Not surprisingly, lots of issues still remain despite loads of work. The concept of financial stability itself is in unstable stages.

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