Why didn’t Canada have a banking crisis in 2008 (or in 1930, or 1907, or…)?

What a paper by the trio – Michael D. Bordo, Angela Redish, Hugh Rockoff (free version here).

Canada’s banking system has always been a case of owner’s pride and neighbor’s envy. It has had this history of having minimal impact of any global crisis on its financial system. And it is never really talked about much except during crisis. You hear about US banks, UK banks and even Europe U-Banks but not much about Canadian banks except when there is a crisis and they escape unscathed.

This paper tracks the reasons for Canada’s fin system. The answer is its history of financial regulation. US struggled to have a unified financial regulation and had multiple regulators and charters with powers divided between states and centre. Canada the federal had powers to regulate the financial sector and hence we have a much better and regulated financial system.

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How about giving Karl Marx a chance to save the world economy?

Move over Smith, Ricardo, Keynes and Friedman…Time for Karl Marx ideology to take over.

George Magnus,  senior economic adviser at UBS opines that we should look at lessons from Karl Marx to solve current economic woes.

Essential Health System Design Innovation

A superb speech by Nachiket Mor. He continues his transition from a banker to a development expert.

There are some interesting facts on healthcare in India:

Two policy reforms for India’s inflation

Here is Inter-Ministerial Group’s (IMG) first paper on inflation. IMG on inflation (apart from several other committees like E-GOM, GOM etc) has been constituted in Feb-11. The first two meetings focused on food inflation and in particular to marketing and retail prices.

This paper says India needs to fix two things to ease food inflation – APMC reform and Allow Multi Product retail.

Why can’t Europe get it right the first time, or the second or the third?

Superb article from Douglas Eliott of Brookings with the same title. He looks at this perplexing question most people are asking.

He says the answer is the cruel set of constraints a European politician faces. The choice is between doing something for Europe and losing the next elections or preferring to make domestic policies which are fine with electorate but damages Europe as a whole. They end up being lost between the two and keep postponing the solutions for their problems. Then problem of coordination of decisions in 17 economies adds further fuel to the fire.

He says the best bet for Europe is to float its Eurobond or Blue Bond which will be guaranteed by the governments and help fund its debt troubles. It is the weakest form of fiscal integration which will not require permissions from electorate and provide market confidence.

How energy (basically coal) helped create industrial revolution?

This is a superb piece from Tony Wrigley. A brilliant take on economic history.

He says both Smith and Ricardo were pessimistic on sustained growth. There are 3 factors of production – land, labor and capital.  While last two were capable of indefinite expansion, the first was limited. Land was limited and so was output that came from land – wool. Cotton, food etc. Then to get things from land like iron, we need huge energy sources which were again limited to wood and animal energy. Even energy from wood was based on process of photosynthesis (it didn’t really occur to me that photosynthesis could be a factor in growth as well) which was limited as well as it captures less that 0.5% of energy in sunlight.

From BoK (Bank of Korea) to Global BoK

This speech from BoK Governor Choongsoo Kim is very interesting. I have not seen any central bank branding itself as a Global Central Bank. BoK in its 61^st anniversary has made an agenda to make itself a world class central bank – from BoK to global BoK.

He says Korea has moved great strides since 60 years from poverty stricken to a G-20 member developed economy.  Central bank has played a great role in this transition and also needs to change itself with changing Korea. It needs to become world class bank of Korea as well along woth world class Korean economy.

It has made changes to its monetary policy framework to look at both price stability and financial stability in a global economic set-up. Along with new framework it is looking at international policy coordination, efficient conduct of currency issuing and payments and settlement systems.

For foreign capital flows, it is implementing Macroprudential stability levy on non-core foreign currency liabilities in coordination with government.

It is also revamping its research department to help it become a world class central bamk. Research forms the core of all this change.

Nice stuff.

Most central banks are introspecting and trying to figure ways to stimulate domestic economies and becoming more domestic. Bernnake defends his policies saying his policies are for US economy and if other countries getting effected by it, they need to make their own policies.

BoK on the other hand is trying to make itself more global. This is a reality and Korea is a small open economy. So making changes accordingly…

Jackson Hole 2011..

The agenda for the much awaited Jackson Hole 2011 conference is out.

It is –  Achieving maximum long run growth. It is nicely balanced with papers from Esther Duflo, Paul Collier, Eswar Prasad etc. apart from many discussions. Of course Bernanke kick starts proceeds with a much awaited speech. It remains the most awaited since 2007.

Keynes and Krugman on looking at the theme would say – in the long run we are all dead. Instead of looking at what to do right now over a short term, we are more interested in long term. The choices made now over a short term now would determine what would happen over long term in future.

 

Why Don’t People and Institutions Do What They Know They Should

David Cutler of Harvard has a nice thought provoking paper on the same.

He says people know many things which work and are useful but still do not implement them. Same stands for institutions and firms:

He begins quoting an example from a hospital which implemented a system which lowered number of deaths. Knowing this evidence, hospitals in US still did not implement the system. It was not expensive and would have saved many lives.

Apart from this many other examples:

Remembering Irving Fisher..

It has been 100 years since Fisher wrote his book The Purchasing Power of Money.

Robert Shiller pays tribute to the book and points Fisher has some important lessons for the crisis.

Undoing lessons from Japanese crisis..

Economists never cease to surprise. You get tons of papers pointing to one set of ideas. And then comes another ton of papers which tells you what you have learnt is questionable.

For instance, we all have taken for granted that Japan made several mistakes in its 1990s crisis and US and others are doing the same. There is so much similarity between US and Japan that US is also expected to have its lost decade. Moreover, we look to Japan to make policies in US and others to revive from the crisis.

John Muellbauer and Keiko Murata dispute these well-accepted findings. They say Japan was different and so are US/UK. The current policies of lower rates might work better in US/UK but were not really effective in Japan.

Monetary transmission via Japan’s household sector is sharply different from that operating in the US and other industrial countries, and hence why monetary policy analogies with Japan should not be taken too far. In recent research with our colleagues (Muellbauer and Murata 2011 and Aron et al forthcoming), we explain why. Indeed, pushing the analogies too far probably contributed to US monetary policy errors in 2002-05, which in turn deepened the crisis that followed.

Our research focuses on the empirical analysis of Japanese consumption and household saving behaviour and explains the role of the household sector in the monetary transmission mechanism in Japan. We find two major differences in Japan compared to the US and the UK.

• First, Japan has not experienced the kind of liberalisation of credit conditions for households seen in the US and the UK.
• Second, the impact on consumer spending in Japan of higher house prices is negative, while in the US and UK it is positive.

Hmmm. Very interesting.

On second they say Japan is different. Unlike US and UK where consumption goes up because house prices go up, in Japan consumption declines. People instead save more to finance future homes in Japan.

in the US and UK, there is an important asset-price channel, which, according to our estimated Japanese consumption function, is not just switched off in Japan, but even works in reverse. Using data going back to 1961, we find that real land prices have a negative effect on consumption in Japan, controlling for income, financial assets and debt, interest rates, and proxies for uncertainty and for income growth expectations. Thus, when real land prices rise, young households and other renters save more, partly because larger down-payments are then needed before a mortgage can be obtained and partly because future rents will be higher. This dominates the wealth effect for older households, which we believe is small partly because of the inheritance tax advantages in Japan of leaving housing assets to their children. For shorter sub-samples in which there is less variation in real land prices, this negative land price effect is weaker than for the full period. Nevertheless, for no period can we find a remotely significant positive effect from physical assets or real land prices on consumption.

Then Japanese have high asset/income ratios. Most assets are in form of bank deposits nad Japanese draw incomes from interest from deposits. As rates declined, people lost incomes and limited consumption as well:

A second reason for the weak, or even perverse, interest-rate transmission mechanism for households in Japan comes from inter-temporal consumption theory. This says that households who are averse to fluctuations in consumption (who have a low elasticity of inter-temporal substitution) and a high asset-to-income ratio will experience positive effects on consumption from a rise in the real interest rate, while the opposite is likely to be true for households with the opposite characteristics.

Japanese households have among the highest asset-to-income ratios in the world, particularly for bank deposits. They may also be particularly cautious, so are more averse to fluctuations in consumption. Indeed, we find a very significant and robust positive real-interest-rate effect in our Japanese consumption function. Thus, the fall in short-term rates after 1993 had a negative direct effect on consumption spending in Japan. However, the later rise in real rates because of falling prices supported consumption. This contradicts the conventional Anglo-centric view that falling prices are a disaster for consumption. Figure 2 illustrates the sizable long-run effect of real interest rates on the consumption-to-income ratio in Japan. It suggests that the rise in real rates induced by price deflation after 1998 actually had a small positiveeffect on the consumption-to-income ratio

However, they add it is not as if interest rate channel has been absent in Japan or lower policy rates will not work in japan. It is just that the overall impact is going to be much weaker than US/UK.

On fiscal policy they say Japanese are more Ricardian as believe higher debts would lead to more taxes in future. Hence do not spend:

We find significant negative effects from fiscal debt-to-GDP ratios in on future growth of GDP and household income, while similar models for the US find far weaker effects. The forecasts from these models are significant in explaining consumption growth, and suggest that there is an important ‘Ricardian’ element in the behaviour of Japanese households. In other words, it appears that Japanese households have some understanding of the fact that high levels of government debt will raise future tax rates or lower future government spending which could have benefitted households.

Hmm.. Interesting pointer on typical Japanese behavior..

So basically, from their research Japan is different and hence struggling. Why are US/UK struggling despite so much policy action? The impact of interest rates etc should be greater in US/UK. They say excesses were much more in US/UK thanks to huge financial liberalisation. Hence, the positives of policy have been diminished by excesses earlier which are getting corrected now:

Credit availability for US and UK households has contracted relative to the excesses before the financial crisis, so that in this respect, differences from Japan have diminished. While this implies that the transmission, via households, to economic activity of the interest rate set by monetary policy in the US and the UK is now somewhat weaker than it was before, the differences from Japan far outweigh the similarities.

Phew…A different perspective altogether…

Based on this not much could be really done in Japan…And US/UK should not slip into Japanesse kind of lost decade trap..Time will tell what will stand true..

It is better to focus on Steve Jobs’ failures

I was taken back by the title of this article. It says instead of looking at Jobs successes we should look at his failures.

We should be celebrating his failures as it helped him become much better over the period of time. He gave us the imacs, ipads, ipods only after his failures taught him some lessons:

Jobs failed better than anyone else in Silicon Valley, maybe better than anyone in corporate America. By that I mean Jobs did what only the greatest entrepreneurs can do: learn from their failures. I don’t mean learn from their mistakes. I mean learn from their abject, humiliating, bonehead, epic fails.  

Jobs was the architect of Lisa, introduced in the early 1980s. You remember Lisa, don’t you? Of course you don’t. But this computer — which cost tens of millions of dollars to develop — was another epic fail. Shortly after Lisa, Apple had a success with its Macintosh computer. But Jobs was out of a job by then, having been tossed aside thanks to the Lisa fiasco.  

Jobs went on to found NeXT Computer, which was a big nothing-burger of a company. Its greatest success was that it was purchased by Apple — paving the way for the serial failure Jobs to return to his natural home. Jobs’s greatest successes were to come later — iPod, iTunes, iPhone, iPad, and more.  

He points how Jobs gave people products which people did not know they neeed:

Jobs is a great entrepreneur for another reason. Lots of ninnies can give customers products they want. Jobs gave people products they didn’t know they wanted, and then made those products indispensable to their lives.  

I didn’t know I needed the ability to read the Wall Street Journal and The Corner on a handsome handheld device at my breakfast table, on the Metro, on the Acela, or in any Starbucks I entered. But Steve Jobs did. I didn’t know I wanted to mix and match my music collection on a computer and take it with me wherever I went, but Steve Jobs did. I didn’t know I wanted a portable multimedia platform that would permit me and my kids to hurl angry birds out of a slingshot at thieving pigs. But Steve Jobs did.  

All those successes were made possible by failure after failure after failure and the lessons learned from those failures.  

Jobs experiences tell you Washington needs to be more tolerant to failures:

There’s a moral here for a Washington culture that fears failure too much. In today’s Washington, large banks aren’t permitted to fail; nor are large auto firms. Next up will be too-big-to-fail hospital systems. Steve Jobs is a reminder that failure is a good and necessary thing. And that sometimes the greatest glories are born of catastrophe.

🙂

Hayek vs. Keynes

Robert Skidelsky, biography of John Maynard Keynes writes this nice article.

He says biggest advantage Hayek enjoyed was he outlived Keynes by nearly 50 years. This allowed Hayek to spread his influence and Keynes to lose out his.

Comparing RBI’s monetary policy with Fed, Bank of England and ECB..

This is a wow speech from Deepak Mohanty of RBI. It is worth a Phd theses by itself..

The speech compares the operating framework of monetary policy of three top central banks with RBI.  We usually look at monetary policy as a policy which changes rates to manage inflation. That is surely the purpose but mechanics of implementing the policy differ vastly across central banks. This mechanics is called the operating framework which includes liquidity facilities, bank reserves, ways to change policy rates etc.  

This is an excellent table to sum up the speech showing differences in three major central banks with RBI:

Ireland’s turbocharged economic history

Patrick Honohan, Governor of the Central Bank of Ireland gives a superb speech on Ireland’s woes. He gives a nice historical perspective and shows how Ireland suffered from crisis before. This 2007 has been most severe but it has had previous moments of turbocharging moments turning into a disaster.

There were three turbocharged situation for Ireland:

• 1970s — which became a crisis after Volcker raised rates in 1979-80
• 1990s — which slowed down/derailed in late 1990s due to both domestic and foreign shocks
• 2000s — again picked up sharply post EMU joining. The interest rates became lower on joining EMU leading to a huge bubble in housing prices. And then the crash

In each of the three the common theme was Ireland was a highly open economy and relied on foreign demand and credit for its growth.

In trade, migration and finance, Ireland had of course been an exceptionally open economy  for a very long time. The large migration flows, especially to the UK and the New World, and  the currency and banking links go back to the early 19th Century at least, with scarcely any overall interruption. Irish banks parked their excess resources in the London money market  right up to the 1960s – a pattern familiar to many African countries today.

Nor is the current crisis the first (O Grada, 2011) – indeed the potentially turbocharged nature  of the globalized economy is well-illustrated by the rapid recovery from the previous severe crisis of less than a generation ago, whose onset coincided with the decoupling – for the first time since just after the Napoleonic Wars – of Ireland’s currency from sterling. The earlier of the two macroeconomic cycles we look at happened at a point where global capital markets were still just beginning to move into the high gear that we see today. We may think of this as Turbocharger Mark 1. It allowed the Irish Government to access foreign  capital to some extent without much by way of credit risk premium..

Then its association with Europe pretty early on also led to Ireland being perceived as a  stable economy:

Ireland’s increasing globalization in the 1980s and 1990s both helped lift the economy from  decades of under-performance and demonstrated its new ability to generate full employment  and compete effectively at the production frontier. One aspect of this was the intimate  engagement with the European Union since membership in 1973 had helped enrich  administrative and political capacity as well as resulting in a vital flow of development funding  through the structural funds especially from the late-1980s to the end of the millennium.

He says open economy managers need to be alert all the time. Globalization works both ways

In this lecture, I will suggest that policymakers in small open economies need to be  especially alert to the fact that globalization can act to accentuate, accelerate and prolong  macroeconomic trends both in the upswing and the downturn. It’s as if  globalization acts as a  turbocharger for the small open economy. 

Just when things seem to be going very well in many dimensions, you can get into trouble  very quickly and at a time when some of the conventional warning indicators are not flashing.  Rapid and quite protracted growth spurts are possible, based not only on expanding exports  to the vast global market for goods and services, but also on the availability from neighboring countries or further afield of additional factors of production, whether material inputs, labour  or capital.

Globalization is a powerful transmitter of economic conditions and know-how, facilitating convergence of living standards. It can also act as a buffer against specific national shocks. But, amplified by globalization, the danger  of the anonymous market overshooting is considerable. National governments can be powerless against consequences of such overshooting. Greater explicit mechanisms of external discipline and co-insurance at the supranational level can help cope with these risks. For Ireland, the European Union already goes some distance in this direction, but more is needed.

Nice stuff. Get good preview on Ireland’s history and its association with the crises. They keep repeating the same mistakes over and over again. It is frustrating how little we learn from history…

Linking US demographics with equity markets

This blog has mentioned couple of times – ignore demographics at your own peril (see my paper on this).

This new paper from FRBSF econs – Zheng Liu and Mark M. Spiegel – says demographics could lead to lower stock market indices in future. As baby boomers become baby busters, they would be moving away from equity as an asset class leading to its decline.

They develop a ratio – middle-age cohort, age 40–49, to the old-age cohort, age 60–69-  and call it the M/O ratio. This M/O ratio depicts P/E ratio of S& P index really closely since 1954:

South Sudan introduced new currency

South Sudan recently become the newest country of the world on 9 Jul 2011 (I was reading this article which said despite 22 years of fall of Berlin Wall, around 28 new border wall have come up since the fall. In 44 years before the fall only 11 new borders came up. Not sure whether South Sudan is included or not).

Biggest threat for urbanisation – earthquakes/natural disasters

Here is another superb article from City Journal. This one is by Claire Berlinski who is a contributing editor.

She says seismic risk poses the biggest risks for cities in the world. There are two reasons for this. One, an earthquake causes more damage than anything else. Two, most big cities end up naturally being in the seismic danger zone. People like to live near water and fertile ground. Over the millennia, seismic activity creates coasts, valleys that channel water, temperate microclimates. So people come and settle at these places and become big cities. As per Claire, 8 of top 10 cities are in seismic zone.

So cities should be working to address this huge risk. And there are some good examples from recent Japanese, NZ and Chilean earthquakes:

How US munis markets were stumped by European crisis?

This note by Gene Amromin and Anna Paulson looks at how municipal bonds are  responding to ongoing economic crisis. There were concerns in 2010 (and even in 2008) over these bonds and fears arose over defaults.

This paper says there can never be a default as munis structure is different. First, they are governed by states and 26 states do not allow municipality bankruptcy:

The bankruptcy process for municipalities is governed by Chapter 9 of the U.S. Bankruptcy Code, which allows local governments to voluntarily seek bankruptcy protection in the federal courts. However, since municipalities are  instrumentalities of states that retain certain sovereign rights under the Tenth Amendment, their eligibility for Chapter 9  protection is controlled exclusively by each state. Presently, Chapter 9 filings are either prohibited or not expressly permitted in 26 states (see fi gure 2). Many of the remaining states further restrict eligibility by requiring explicit authorization by various elected or appointed bodies. For instance, Louisiana requires the governor and the attorney general to pre-approve a bankruptcy petition, while in New Jersey such approval must be granted by a municipal fi nance commission.

Even in 25 startes which allow, the procedures are different:

Chapter 9 fi lings are also substantially different from the more familiar corporate bankruptcy proceedings. The municipality cannot be forced to declare bankruptcy by its creditors. While the municipality is able to restructure its contracts, its assets cannot be liquidated. Furthermore, only the municipality, and not its creditors, can propose an exit plan. The bankruptcy court has very limited authority to force any specific restructuring changes. In fact, unlike with corporate bankruptcies, the court for the most part is a passive observer of the Chapter 9 proces.

Then even if there is bankruptcy, it does not lead to much losses for bond investors. Bonds are backed by assets like toll roads/bridges etc whcih are usually secure

 Municipal bankruptcies do not generally result in any losses for bond investors. In  each of the approximately 300 Chapter 9 filings over the past 40 years, bond investors were repaid in full, if sometimes late. In some cases, the payments were made not by the issuers but by fi nancial institutions that had provided letters of credit or bond insurance. An important reason why municipal bondholders are typically repaid even when a local government defaults is that debt service costs are usually small, averaging just over 4% of revenue flows. In addition, many municipal bonds are backed by dedicated revenue sources, such as toll roads or sewer systems. These sources are considered secured assets in bankruptcy, severely limiting issuers’ ability to divert their cash fl ows away from repaying bondholders.

Then recent financial engineering implies these munis bonds come with a liquidity cover provided by a bank. So in case no takers the whole bond issue becomes a bank owned issue. These are called variable-rate debt obligations (VRDOs). Instead of issuing these bonds for a longer time period at fixed coupon rate they are issued with daily/weekly resets.

A sizable share of long-term municipal debt is funded in variable-rate markets with daily or weekly interest rate resets. A common contract feature of these variable-rate debt obligations (VRDOs) is that investors have the right to return the obligation to the issuer with short advance notice. In other words, an investor can refuse to roll over a VRDO at any given reset date and demand that the issuer buy it back. This clearly presents a significant rollover risk  for the VRDO issuer that is mitigated by obtaining external liquidity support.

So to cover this roll over risk banks provide a liquidity cover. In a way they are undewriters of the issue and if the bond does not roll over, it comes on their balance sheet.

Here comes the interesting part. The composition of banks providing this liquidity cover has changed from US to European banks. So when the European crisis hit these banks, some munis found they are in trouble without any fault of theirs:

Many of these lenders were based in Europe and their expansion into the U.S. municipal market was rather rapid. By some estimates, by the fall of 2008, lenders  like Depfa, Dexia, Allied Irish, and various German landesbanken  (state-owned banks) accounted for about $90 billion in liquidity support. Most of these financial  institutions have been winding down their facilities at a brisk pace, so that by the first quarter of 2011 their commitments had fallen by about one-third. This has been especially true for institutions that found themselves in financial distress.

The Greek debt crisis spurred downgrades in the credit outlook for some European banks with large direct exposure to Greece. Some of these banks, like Dexia, also happen to provide liquidity facilities to U.S. municipal issuers. Thus, when VRDOs backed by Dexia came due for repricing in June 2011, investors demanded sharply higher rates of return. In some cases, they refused to reprice altogether, causing Dexia to take back the VRDOs, convert them to bankowned bonds, and reset loan terms to the issuers. Some small U.S. towns and municipal agencies thus ended up bearing  some of the costs of the European sovereign debt crisis, without ever having participated directly in those markets.  

Superb this. How linterlinked fin markets are and can create spillovers anywhere.

Anyways, the states had to communicate the message to investors that all is well on 201o and explained these features of munis. This settled markets and access to capital markets resumed…

Fed’s New Communication Strategy: Will it Work?

This is the title of my new paper. It looks at the Fed’s new communication strategy of keeping policy rates at near zero till mid-2013.  It compares this with Bank of Canada and Bank of Japan’s communication policies. It ends with comments on recent Fed dissents.

Comments/suggestions/criticisms are welcome..