Hedge funds returned an average 5.2% in May, the best performance in more than nine years, as they drew more money and global markets rallied, said research firm Eurekahedge, reports Bloomberg. The Eurekahedge Hedge Fund Index, tracking more than 2,000 funds, has returned 9.2% this year, according to a preliminary report. The industry recorded net inflows for the first time in 10 months in May, with a $1.5bn gain, while total assets rose by $5bn, it said.
Moody’s comprehensive re-examination of its ratings on the world’s banks continues apace. Here’s an overview of the actions taken since May 21:
- Moody’s reviews five Kazakh financial institutions for downgrade
London, 22 May 2009 — Moody’s Investors Service today placed the issuer and deposit ratings of five government-owned Kazakh financial institutions on review for possible downgrade. Four of the five affected entities are government-related issuers (GRIs — government-controlled financial companies with specific policy mandates), while the other is a bank fully owned by the government.
- Moody’s reviews four banks in Belarus for downgrade
Moscow, May 26, 2009 — Moody’s Investors Service has placed the ratings of four Belarusian banks on review for possible downgrade. The banks affected are Belagroprombank, Belarusbank, Belinvestbank and Belpromstroibank
- Moody’s reviews eight banks in Poland for possible downgrade
London, 26 May 2009 — Moody’s Investors Service has placed the ratings of eight Polish banks on review for possible downgrade. The affected entities are Powszechna Kasa Osczednosci Bank Polski , Bank Polska Kasa Opieki, Bre Bank, Bre Bank Hipoteczny, Bank Zachodni WBK, Bank Gospodarki Zywnosciowej, Lukas Bank, Europejski Fundusz Leasingowy. The outlook for the long-term deposit ratings of ING Bank Slaski was changed to negative from stable.
- Moody’s reviews several Czech banks’ ratings for downgrade
London, 26 May 2009 — Moody’s Investors Service today placed on review for possible downgrade the bank financial strength ratings (BFSRs) and the long- and short-term local and foreign currency deposit ratings of the following banks: Ceska Sporitelna (rated Aa3/A1/P-1/C), Komercni Banka (Aa3/A1/P-1/C) and Ceskoslovenska obchodni Banka (CSOB, Aa3/A1/P-1/C). In addition, Moody’s placed on review for possible downgrade the Aa1 long-term foreign currency issuer and senior unsecured ratings of Czech Export Bank (CEB), the E+ BFSR of J&T Banka and the national scale ratings of the following institutions: J&T Banka (Baa2.cz/CZ-2), Home Credit (HC, A3.cz) and BH Securities (Baa3.cz).
- Moody’s reviews nine Slovak financial institutions for downgrade
New York, May 26, 2009 — Moody’s Investors Service today placed the ratings of nine Slovak financial institutions on review for possible downgrade. The affected institutions are Slovenska sporitelna, Vseobecna uverova banka, Tatra banka, Unicredit Bank Slovakia, Ceskoslovenska obchodna banka, Privatbanka, Tatra leasing and Home Credit Slovakia. OTP Bank Slovakia’s deposit ratings were downgraded to Baa3/Prime-3 from Baa1/Prime-2 following the downgrade of its parent, OTP Bank Hungary (Baa1/P-2/D+) on 19 May 2009, and placed on review for further possible downgrade together with its D- bank financial strength rating (BFSR). The A1/Prime-1 issuer ratings of the government-owned Eximbanka were not
affected by this rating action.
- Moody’s reviews two banks in Uruguay for downgrade
New York, May 26, 2009 — Moody’s Investors Service has placed on review for possible downgrade the local currency deposit ratings of Banco de la República Oriental del Uruguay (República) and Banco Hipotecario del Uruguay (BHU) in both the global and national scales.
- Moody’s reviews four banks in Vietnam for possible downgrade
Singapore, May 27, 2009 — Moody’s Investors Service has placed the deposit and issuer ratings of four Vietnamese banks on review for possible downgrade. The banks affected are Asia Commercial Bank (ACB), Bank for Investment and Development (BIDV), Techcombank (TCB) and Vietnam International Bank (VIB). At the same time, Moody’s has placed the bank financial strength rating (BFSR) of VIB on review for possible downgrade.- Moody’s Changes Outlook for Italian Banks to Negative from Stable
Milan, May 27, 2009 — Moody’s Investors Service today changed the fundamental credit outlook for the rated Italian banks to negative from stable, reflecting the spread of the financial crisis into the real economy and the resultant adverse effect on Italian banks’ asset quality and profitabilityMoody’s places deposit ratings of two Armenian banks on review for possible downgrade
- Moody’s places deposit ratings of two Armenian banks on review for possible downgrade
Limassol, May 27, 2009 — Moody’s Investors Service has today placed on review for possible downgrade the global local currency (GLC) deposit ratings of two rated Armenian banks (ACBA-Credit Agricole and Ardshininvestbank). All other ratings assigned to these banks were not affected by this action.
- Moody’s places deposit ratings of three Lebanese banks on review for possible downgrade
Limassol, May 27, 2009 — Moody’s Investors Service has today placed on review for possible downgrade the global local currency (GLC) deposit ratings of three Lebanese banks (Bank Audi, Blom Bank and Byblos Bank). All other ratings assigned to these banks are not affected by this action.- Moody’s reviews two Pakistani commercial banks for downgrade
Limassol, May 28, 2009 — Moody’s Investors Service has today placed on review for possible downgrade the Ba2 global local currency (GLC) deposit ratings of Habib Bank Ltd and United Bank Ltd in light of its global review of systemic support indicators for the banking systems.
- Moody’s takes rating actions on 13 Indian commercial banks
Limassol, May 28, 2009 — Moody’s Investors Service has today placed the ratings of 13 Indian commercial banks on review for possible downgrade in light of its global review of systemic support indicators for the banking systems.
Related links:
Moody’s global bank review, a roundup - FT Alphaville
Citigroup is in the early stages of negotiating with the SEC to settle an investigation into whether it misled investors by not properly disclosing the amount of troubled mortgage assets it held as the market began to implode in 2007, reports the WSJ. The talks indicate the SEC could be moving toward resolving a number of civil probes that began in late 2007, when mortgage-related losses began mounting on the books of banks and Wall Street firms. Among issues being debated at the SEC is whether Citi, as a recipient of government-rescue funds, should pay a large penalty in the case.
Tim Bond, the Barclays Capital strategist, is having none of this bearish pessimism that has gripped markets since Bill Gross said the US could lose its triple A status and Marc Faber invoked the Z-word when discussing the prospects for American inflation.
From Bond’s latest Global Speculations - “Upside down bulls”:
In the financial markets, interpretation often counts for more than fact. Indeed, after passing through the qualitative and emotional analytical filter, factual inputs can often emerge from the process as anti-facts. At present, many market participants still appear to be afflicted by the mood of depressive pessimism that became pervasive last year. Under this condition, market developments and economic data-points that an impartial analysis would usually construe as positive are being warped into negative signals. Signs of an economic recovery, somehow, end up being interpreted as signs of impending economic doom.
Nowhere, Bond says, is this truer than with the prevailing fuss about the dollar and US treasury yields.
The fact that both asset classes have been losing their safe haven status is an unambiguously positive development, confirming the revival of risk taking and a general acknowledgement that economic life will continue.
Why, the BarCap man asks, if investors are fleeing the US because of its towering debt burden and the threat of hyperinflation, is sterling going up? Frying pans and fires springs to mind. Similarly, why has the Yen been depreciating against the dollar?
The current rumblings of discontent smack more of the avoidance of cognitive dissonance on the part of inveterate bears, than any dispassionate analysis of the situation.
Full takedown of the bears available here.
You've seen the scary charts showing just how bad the Fed's policy of quantitative easing has failed. Although it would love to push long-term interest rates down to 4%, the market was having none of it. And the general consensus is that the uber-steep yield curve is a big nyet vote on both fiscal and monetary policy.
Tim Bond, an analyst at Barclays, says hogwash, taking the Geithner view that the rally in yields is the predictable response to both a recovering economy and the dissipation of the panic premium in US-denominated assets that built up during the bubble. The full report is embedded below (via FT Alphaville). Here's the introduction:
In the financial markets, interpretation often counts for more than fact. Indeed, after
passing through the qualitative and emotional analytical filter, factual inputs can often
emerge from the process as anti-facts. At present, many market participants still
appear to be afflicted by the mood of depressive pessimism that became pervasive last
year. Under this condition, market developments and economic data-points that an
impartial analysis would usually construe as positive are being warped into negative
signals. Signs of an economic recovery, somehow, end up being interpreted as signs of
impending economic doom.
Nowhere is this truer than of the prevailing fuss about the dollar and US treasury yields.
Both asset classes have been losing the save haven and liquidity premiums established
during the market carnage of last year. This is an unambiguously positive development,
confirming a revival in risk appetites, decreased fears about the financial system and a
general improvement in economic expectations. However, after passing through the
prevailing interpretative filter, these positives become negatives. Rather than indicating
an economic recovery, the lower dollar and higher bond yields apparently reflect a crisis
of confidence in US Inc, investors fleeing the prospect of endless budget deficits, a
towering government debt burden and prospective hyperinflation.
Never mind the rather obvious objection that the violent rally in Cable specifically
contradicts this theory – unless of course one assume s that jumping out of the frying
pan into the fire is a rational approach to securing a safe haven. Equally, never mind the
other rather obvious point that the currency of the largest creditor nation – Japan – has
recently been depreciating against the dollar, a development that is not exactly
indicative of rising concerns about US borrowing. Rather, if one starts from the premise
that nothing good is happening in the global economy, any contrary empirical
indications must inevitably be re-interpreted to fit the premise. The current rumblings
of discontent smack more of the avoidance of cognitive dissonance on the part of
inveterate bears, than any dispassionate analysis of the situation.
The appetite for risk in Japan continued to grow on Wednesday, with the benchmark index for the country’s credit default swaps tightening for a seventh consecutive session.
The iTraxx Japan Series 11, which includes the 50 most traded investment-grade entities, ended the day at 165 basis points, ten points lower than late on Tuesday, with some analysts predicting that it could go as low at 150bps on Thursday.
The situation was a lot steadier in Europe, where the cost of insuring against the possibility of corporate default hovered around Tuesday’s closing price, as investors anticipated housing data from the US.
The European iTraxx Crossover index, which tracks the the 45 most liquid names in the junk-rated sphere and had risen above 800bps earlier in the month, was tighter by 1bps at 744bps.
The primary market is likely to see action later in the day, however, with Pfizer, the US pharmaceutical company, following on the heals of a flurry of corporates seeking to raise money.
The world’s largest pharmaceutical group is set to issue a four-part euro and sterling denominated bond, worth €10.6bn.
In the aftermath of S&P lowering its outlook on the UK from stable to negative due to the country’s rising debt levels, there has been a flurry of commentary from analysts, other ratings agencies and (inevitably) political journalists.
And of course, there’s been a market reaction - while the sterling has regained its footing, in late trade in the US on Thursday, the US dollar, bonds and equities were facing severe selling pressure
What hurt sentiment across the pond was the fear that the US, too, is vulnerable to the loss of its triple-A credit rating. As David Rosenberg (formerly of Merrill Lynch, newly of Gluskin Sheff) put it in a note on Thursday morning:
Don’t think for a second that the same cannot happen to the USA at some point judging by the massive runup in government debt and debt guarantees.
Pimco’s Bill Gross told Reuters much the same thing after markets started to slide, i.e. that investors fear the US is “going the way of the U.K. — losing AAA rating which affects all financial assets and the dollar.”
Which is an exaggeration - a negative outlook is hardly a downgrade - but Gross may well have a point.
Analyst Alan Clarke at BNP Paribas noted that in some cases (like Ireland) “the progression from outlook negative to downgrade can still be just a matter of weeks.”
On the other hand (emphasis ours):
The Irish experience reflected a sharp deterioration in conditions over a short space of time. For the UK, it is likely that the bulk of the bad news has largely surfaced; it is now a case of whether or not it looks like the situation will be fixed in a timely manner. That implies a much longer review period than we saw in Ireland. Nonetheless, this week’s news does represent a step closer to a possible downgrade.
Clarke also provides a handy breakdown of the speed with which other countries have moved from a negative outlook or CreditWatch negative to an actual downgrade:
Moreover, in the case of the UK, “the election is the key to reassessment.” As a result, Clarke thinks the base case for the timing of subsequent rating action, “at least from S&P”, is around the time of the election.
However, he argues, there is a risk of a much earlier rating action:
This could be triggered by a failed gilt auction, a run on sterling, even worse than expected data on public finances in the near term or another bailout event.
Of these, he says, a failed auction or another slump in sterling are probably the biggest risks.
Overall, the change in the S&P outlook represents a shot across the bows for both political parties: either plan to get the public finances back in order after the election, or face a downgrade.
They conclude that while is it not inevitable that the UK is downgraded, the possibility remains a threat between now and next year’s election.
In any event, some commentators were little moved by the prospect of a sovereign downgrade for the UK or the US. Arguing for the Brits was Michael Riddell of the Bond Vigilantes blog, who noted:
So does it matter if the UK does eventually get downgraded to AA? Judging by [Thursday morning’s] very successful UK government bond issue, not much. The UK’s Debt Management Office issued £5bn of UK gilts maturing in 2014, and the issue attracted bids for 2.6 times the amount offered. This was impressive considering that, as RBC have pointed out, it was the biggest ever nominal amount of bonds sold in a single operation.
Also, a credit rating downgrade doesn’t necessarily mean government bond yields will rise - Moody’s downgraded Japan to A2 in June 2002, which was lower than the credit rating of Botswana at the time, and that didn’t stop 10 year Japanese government bond yields getting to 0.4% in May 2003.
On the other side of the Atlantic, Felix Salmon postulated that the US triple-A was “nothing to worry about”. Salmon takes the increasingly common approach of dismissing the prognostications of ratings agencies outright:
The most important thing to remember here, however, is that ratings agencies don’t matter any more. They lost their credibility when structured finance blew up, and the number of people buying Treasuries because S&P says that they’re triple-A rated is exactly zero.
And adds:
There are lots of triple-A rated securities; people buy Treasuries because they’re liquid. The US triple-A may or may not disappear at some point, but if and when that happens it’ll be a lagging indicator, and there will already be a select group of alternative securities which are trading at lower yields in dollars. So long as Treasuries have the lowest yields in the dollar-denominated world, they will retain their triple-A, and there are much more important things to worry about.
Which is, in a sense, precisely the stance taken by Her Majesty’s Treasury, one that translates to “move along people, nothing to see here.”
Timothy Geithner, at least, is attempting to dissuade markets of the likelihood of a similar threat to the US, telling Bloomberg Television that reducing the spiralling US deficit was “critically important”:
May 21 (Bloomberg) — Treasury Secretary Timothy Geithner said the Obama administration is committed to reducing the federal budget deficit after concerns rose that the U.S. debt rating may eventually be threatened with a downgrade.
“It’s very important that this Congress and this president put in place policies that will bring those deficits down to a sustainable level over the medium term,” Geithner said in an interview with Bloomberg Television. He added that the target is reducing the gap to 3 percent of gross domestic product or smaller, from a projected 12.9 percent this year.
Nothing to see - until there is.
Related links:
The sovereign ratings on the wall - FT Alphaville
Sovereign stress, UK edition - FT Alphaville
Fitch cuts Ireland to AA+, outlook negative - FT Alphaville
Portugal, Italy, Greece, Spain to S&P slaughter - FT Alphaville
The cost of insuring European corporate debt against default dropped sharply on Tuesday, as credit spreads tightened amid a rally in global equity markets and rising sentiment that the recession may have passed its peak.
The recent spate of companies seeking to tap the bond market gained weight as more investment-grade names lined up to take advantage of the more positive mood sweeping over the financial markets.
Following a host of companies, including the French cement group Lafarge, to announce issues on Monday, Carlsberg Breweries said it plans to sell a five-year eurobond and a 7.5-year sterling bond.By mid-morning the flagship Markit iTraxx Europe, which tracks the 125 most liquid names in the investment-grade class, had clawed back last week’s losses to trade tighter by 10 basis points on the day at 125bps.
Similarly the Markit iTraxx Crossover index, home to the 45 most traded names in the junk-rated sphere, moved sharply tighter. The index, having traded at over 800bps late on Friday, fell by more than 30bps on the day to trade at 757bps, down from 789bps at close on Monday.
The upbeat mood in Europe came on the back of a rally in the US - which later spilled over into Asia - triggered by better-than-expected results from Lowe, the home improvement retailer.
In Japan, spurred on by the bounce in Tokyo shares, the cost of insuring against the possibility of default on the Itraxx Series 11 index fell to 225 bps, compared to 245 at the end of Monday.”The CDS market is following the feel good factor coming from equities outside Europe,” said Mehernosh Engineer, a senior credit strategist at BNP Paribas.
A financial lesson brought to us from way, way, back many centuries ago courtesy of HSBC’s chief economist Stephen King:
In the Bible, you can find everything you need to know about government borrowing. Joseph’s interpretations of Pharaoh’s dreams gave warning that feast would be followed by famine. In response, the Egyptian ruler ordered Joseph — by that stage the Biblical equivalent of a modern-day finance minister — to look after the nation’s grain supplies. Joseph stored enough grain to ensure that, when the inevitable downswing came, no one (his brothers included) would go hungry.
Accordingly, King presents the notion we may all be in for a bit more austerity than perhaps originally planned for. That’s mostly because, whatever the policymakers say, we failed to saved up in the good years and now the numbers don’t add up:At the very least, governments need to pursue a multi-year period of fiscal austerity. Even that, though, may not be good enough to stabilise the fiscal outlook. Credit booms tend to leave countries with permanent activity losses, undermining a government’s ability to raise revenues to support public services. And, even if productive potential were to be untouched by the crisis, governments still face problems. The number of higher rate tax payers will shrink in response to a diminishing financial sector. Ageing populations will place tremendous pressure on some governments to raise healthcare and pension outlays.
Of course, austerity is not the answer most politicians will be looking for; strategies for dealing with the crisis have tended to focus on capital injections, quantitative easing and fiscal easing and not the concept of increased frugality.
As King points out, however, these carry risks in themselves and have in some cases created simply dire fiscal situations:
Unless there is an early, strong and sustained recovery in economic activity — an unlikely scenario in our view — fiscal positions will become intolerable politically, economically and financially.
The worst of these cases is to be seen in the US and the UK, following years of large deficits and government debt levels rising to among the largest in the G6, King says.
Missed opportunities to save-up for rainy days now lead to six possible scenarios (our emphasis):
1) The rosy scenario, where above-trend growth actually transpires after all:
A closure of negative output gaps by 2020 but with no additional fiscal tightening above and beyond what is already spelt out in existing government plans. Above-trend growth persists over the next 10 years. This could be called the “rosy” scenario. Mostly, though, the fiscal numbers continue to deteriorate notwithstanding the faster growth rate.
2) The austerity scenario:
Sufficient fiscal tightening to stabilise government debt/GDP ratios by the end of the period, leaving output lower than in (1). This might be called the “austerity” scenario.
3) The Bad planning scenario:
A lowering of the level of economic activity relative to scenario (2) which, in effect, implies a permanent lowering of the longterm growth rate (a reduction, perhaps, from the “optimistic path” to the “true path”). No additional fiscal tightening is imposed on the model relative to (2). This might be labelled the “bad planning” scenario.
4) A deflation scenario:
A deflation scenario whereby central banks are unable to deliver their mandated goals and where the onset of deflation leads to a permanent lowering of growth through either Fisher-style or Keynesian deflation dynamics. This is an extension of (3) and represents a severe form of Japan’s experience during its lost decade.
5) A default scenario:
A default scenario, where the level of nominal interest rates on outstanding government debt rises sharply because of either the end of quantitative easing benefits, future inflation fears or, alternatively, because governments have no alternative but to suspend payments to existing creditors.
6) And lastly the printing press scenario:
A “printing press” scenario, whereby an increase in money supply used to purchase government debt leads to lower yields and higher inflation, thereby punishing bond holders via negative real interest rates. An overly low hurdle rate for investment, however, leads to inefficient resource allocation, leaving growth weaker over the medium term.
Of these, King says the austerity scenario is probably the best one to aim for. Sustained fiscal tightening for five or six years might just be enough to stabilise the debt/GDP ratio, albeit at a much higher level than it is now at. Pursuing this strategy, however, would have the most severe implications for the UK where the degree of tightening needed is greatest.
The risk, however, is that policymakers focus on the printing press scenario instead — interpreting it as the most helpful from a fiscal perspective in the short term. From all other angles, however, this would be a disaster says King: …on the assumption that capital is increasingly poorly allocated, the mix between growth and inflation steadily deteriorates, threatening a 1970s-style stagflation.
Nevertheless:
For the US and the UK in particular, the incentive to shift the burden elsewhere through monetised government borrowing and, hence, exchange rate depreciation is very high:
Whatever the case, it appears no solution will come with a free lunch:
…any improvement in the fiscal situation is likely to be limited in duration. For the US and, in particular, the UK the likely reduced share of financial services in GDP will limit future revenue growth for a given growth rate of the economy (the financial services industry includes a disproportionate amount of higher rate taxpayers).
Which leads King to conclude:
Yet our projections suggest that, aside from the most optimistic assumptions, the fiscal outlook is now very poor. So many countries are borrowing heavily, and so few were prepared to deliver significant fiscal consolidation during the earlier boom years. Something has to give. Even if output gaps close by 2020, the fiscal numbers for the US, Japan, France and the UK will not add up unless there is a bout of significant fiscal consolidation involving tax increases or public spending constraints. In the process, there are obvious risks, including an outbreak of deflation and an increase in the risk premium on government bonds, both of which would make the fiscal arithmetic even more painful.
Amish-style austerity certainly appears to beckon.
Japan voiced some anti-dollar/US Treasuries remarks and a future preference for samurai bonds late Tuesday.
From the BBC:
Japan’s opposition party says it would refuse to buy American government bonds denominated in US dollars, if elected.
The chief finance spokesman of the Democratic Party of Japan, Masaharu Nakagawa, told the BBC he was worried about the future value of the dollar. Japan has been a major buyer of US government bonds, helping the US finance its Federal budget deficits.
But, he added, it would continue to buy bonds only if they were denominated in yen - the so-called samurai bonds.
Yen-denominated bonds would effectively mean that the US is exposed to the risk of future falls in the value of the USD rather than Japan. That’s a pretty big policy shift for Nippon, which has been a strong buyer of US Treasuries - and, taken with comments coming out of China, hints at a growing unease in Asia over the USD’s supremacy.
But, as the BBC story notes, this is coming from Japan’s opposition party — which isn’t exactly steaming ahead towards victory. Nakagawa’s comments have also been toned down since his interview with the BBC, and there is, as often happens with Japanese politics, undoubtedly a dose of anti-gaijin political rhetoric in the above. BarCap has a good summary:
Masaharu Nakagawa, the “shadow” finance minister of Japan’s largest opposition party, the Democratic Party of Japan, was quoted by BBC on 12 May saying that his party would shun buying US bonds denominated in dollars if his party took the reins of government as a result of Japan’s upcoming lower house election. In an interview with Bloomberg News on 13 May, however, Mr. Nakagawa clarified that it would merely be one option for Japan to propose that the US government issue samurai bonds (US bonds denominated in yen), and that this was strictly his personal proposal and would not necessarily be implemented immediately by the party if it took the helm. The comments, while perhaps reflecting a genuine concern shared by other world leaders, would also serve to boost Mr. Nakagawa’s nationalist credentials ahead of the election and, we believe, should be viewed primarily in that context. Japan’s lower house election must be held by this September, but could be called earlier if the prime minister decides to dissolve the lower house prior to that time.
The samurai will be waiting for a while, it seems.
Related links:
Samurai bond market revives - FT
China to US: We hate you - FT Alphaville
We ‘hate you guys’ even more now… - FT Alphaville
Fox Business reports:
The municipal bond market is in trouble, and Congress wants to grant it a federal guarantee.
Yes, yet another contingent liability foisted upon the US taxpayer.
The House Financial Services Committee is scheduled to consider a series of bills that would provide massive government backing and intervention to the municipal bond market. Draft legislation is expected to be introduced as early as this week. A full committee hearing on municipal bonds is tentatively scheduled for Thursday, May 21, according to an internal staff schedule.
It all makes this op-ed in today’s FT - “America’s triple A rating is at risk” - nothing if not timely:
…exploding healthcare and Social Security costs threaten to engulf the federal government in debt over coming decades. The facts show we’re in even worse shape now, and there are signs that confidence in America’s ability to control its finances is eroding.
And as was reported earlier today - in a portent, perhaps, of such things - the US government experienced its first April budget deficit. April being a month in which the government almost always records a surplus, because of the tax year ending April 15th. The last time April saw a deficit was in 1983. Figures released Tuesday show the excess of government spending over receipts came in at $20.9bn, compared with a surplus of $159.3bn in April 2008.
Sean Corrigan at Diapason securities produced this graph, which rather puts that into perspective.
As Robert Teitelman over at the Deal summarises:to Wolf conservative morphs into cautious, which translates into long-term failure. Much of his larger critique of Obama hinges less on the economics of the situation, and more on a projection about the politics.
One final datapoint worthy of note: just 6 per cent of economic stimulus funds have so far been spent.
This, apparently, is the chart that “shows” the economic recovery will be V-shaped.
That’s from JP Morgan and here’s the accompanying commentary (H/T TJB):
Will the global recovery by V-shaped or L-shaped? That is easy and has been settled. As the chart shows, given the depth of the recession, any return to positive growth will depict a V. The issue is whether the leg up will be as long as the leg down. Here we figure that the V is set to become quite symmetric, with the first few quarters of rebound below trend, and the following ones above trend.
That’s somewhat similar to Barclays’ recommendation to “look for a ‘U’ or a little ‘v’ “, and also Merrill Lynch, which published this tidbit Monday morning:
Some observers seem to be worrying about a “W”, that is, about a relapse into recession after a temporary recovery over the summer. We continue to think that the double-dip scenario has a low probability in, say, the next six quarters. The fiscal stance will remain highly stimulatory at least through to the end of next year. In addition, monetary policy is gaining traction via asset prices. Rather than a short-lived improvement followed by an immediate relapse, we believe it is more likely that economic conditions will improve gradually but the recovery will then gain some strength going into the final months of the year and early 2010.
Perhaps more importantly, the ‘V’ view has been adopted by the Bank of England, according to The Telegraph:
The Bank of England will this week declare that it expects Britain to enjoy a powerful V-shaped recovery as it raises its inflation forecast for the first time since the onset of the economic crisis.
In what many will judge as a landmark moment, the Bank’s Monetary Policy Committee (MPC) will indicate that deflation is no longer the key concern it was only a few months ago, as near-zero interest rates and the £125bn cash infusion from central bank money start to take root.
Ls, Ws, hooks and diminishing sine waves are out of the economic spotlight, then. For now at least.
Related links:
Stop the rot! V for victory - The Long Room
Presenting the ‘hook-shaped’ global economic recovery scenario - FT Alphaville
What shape the US economic recession and recover - FT Alphaville
Alea spotted this statement out from ISDA:
The Mod-r clause in CDS contracts contain provisions whereby the contracts can be triggered by a range of modification or restructuring scenarios beyond the straight-out default of the company.
Had the committee determined that a succession event had occurred, CDS referencing MBIA would have been triggered. In other words, anyone who had bought CDS protection on the bond insurer would be in line for a payout from those who sold protection.
Alas, the ISDA determinations committee has declared there was no succession event under ISDA rules. Which will jar the investor that lodged the determinations request: Austrian hedge fund, Aurelius Capital.In its submission to ISDA, two weeks ago, Aurelius asserted that, by its calculations, “more than 25.7 per cent” of MBIA’s obligations had been succeeded to by MBIA Illinois: at such a level, that would indeed trigger a succession event under ISDA rules. ISDA determines that such an event occurs if more than 25 per cent of “obligations” cede to a new successor entity.
FT Alphaville presumes Aurelius has a CDS position against MBIA (late on a Monday evening, Aurelius could not be reached for comment) - certainly that would explain their activism insofar as doggedly seeking the activation, and arbitration, of the determinations committee.
That being so, will Aurelius seek to appeal the determination decision in court, especially since they are already suing MBIA?
Worth noting seperately: FT Alphaville also understands Aurelius is in a rather uncomfortable position regarding a large CDS contract it entered into with Credit Suisse. Under the contract, Aurelius wrote protection on a basket of structured products, including, but not limited to, CLOs, CDOs and RMBS.
Related links:
MBIA: Transformation or transgression - The Deal
Aurelius Capital
ISDA
The scenarios contained in the US banking stress tests have been much criticised. Now, the type of capital used in the SCAP is coming under scrutiny.
This from RBC Capital Markets’ Gerard Cassidy:
Overall we were pleased with the transparency the level of detail given by SCAP but we have a couple of criticisms of the program. First, we were disappointed the regulators did not use a more stringent form of common equity in their analysis. We would of preferred the regulators used GAAP Tangible Common Equity (TCE) rather than Tier 1 Common Equity. Tier 1 Common Equity deducts Other Comprehensive Income (OCCI) from the calculation of Tier 1 Common which means in this environment of large negative OCCI charges, the unrealized losses are included in Tier 1 Common Equity.
In fact, according to RBC the banks’ capital shortfall would’ve been $68bn greater had the government used TCE instead of Tier 1 Common Equity.
Related links:
Stress tests and the question of converting capital - FT Alphaville
US U-turn on tangible common equity - FT Alphaville
Tangible common equity for beginners - The Baseline Scenario
On paper, the Fed and Bank of England initiated quantitative easing policies to try and keep long-term yields down and to boost the level of aggregate banking sector reserves so as to encourage bank lending. So far, QE appears to be having variable success in achieving these two objectives.
As Stephen Lewis at Monument Securities writes on Thursday, in the UK the 10-year benchmark yield has now risen above the level where it stood when QE was announced. On the banking sector reserves front, meanwhile, there isn’t really enough monetary data for the period since QE began to judge.
But, as Lewis also points out, QE may be having another, perhaps less expected, but nonetheless still very welcome effect - on equities. As he explains (our emphasis):
Possibly, the chief impact of QE will come through the equity market. If ‘other financial institutions’ see their bank deposits increasing, they may be inclined to commit some of these funds to equity investment.
Since QE was initiated, the UK equity market has enjoyed a sharp rally. The Federal Reserve’s purchases of Treasuries may be having a similar effect on US equities. If equity prices are rising, and equity finance is becoming cheaper for companies, this would be a welcome result for UK policymakers. The MPC’s question regarding what happens to capital market values when QE ceases might still be pertinent. However, it might properly relate to equity prices rather than to gilt yields.
Related links:
BoE expands QE - FT Alphaville
The return of the yield? - FT Alphaville
US Treasuries, not treasured by Fed, or Gross - FT Alphaville
CMA reports on Thursday that Norway has been overtaken by Germany as the safest country in terms of sovereign CDS. Here’s the data, as it stands now:
A policy mistake made by some major central bank may bring inflation risks to the whole world. As more and more economies are adopting unconventional monetary policies, such as quantitative easing, major currencies’ devaluation risks may rise.
- People’s Bank of China quarterly report, May 6 (via Bloomberg)
The PBC has been getting gradually more vocal in its criticisms of the Fed and the BoE. Things cant be great if you’ve got a mountain of US Treasuries, of course.
We’ll be watching to see what the BoE has to say about QE - if anything - at noon.
By Sandy Hendry
May 6 (Bloomberg) -- Global central banks risk inflation, currency devaluation and a “big consolidation” in bond markets by pumping cash into their economies, the People’s Bank of China said in its quarterly monetary policy report.
The Federal Reserve and the Bank of England this year started quantitative easing, or printing money to buy government bonds, a policy that the Bank of Japan pioneered to revive its economy at the start of the decade. The European Central Bank’s 22-member board, which meets tomorrow, is split on whether it should buy financial assets to tackle its recession.
“A policy mistake made by some major central bank may bring inflation risks to the whole world,” China’s central bank said in the report today. “As more and more economies are adopting unconventional monetary policies, such as quantitative easing, major currencies’ devaluation risks may rise.”
Chinese Premier Wen Jiabao expressed concern in March that the dollar will weaken, eroding the value of China’s holdings of Treasuries, as the U.S. borrows unprecedented amounts to spend its way out of recession. China’s Treasury holdings climbed 52 percent in 2008 and stood at about $744 billion as of the end of February, according to U.S. government data.
“In the medium and long term, as the financial markets stabilize and economies gradually recover, increasing inflation expectations, rising interest rates and central bank’s liquidity-absorbing operations may cause a ‘big’ consolidation in bond prices,” the central bank’s statement said.
Bernanke
Federal Reserve Chairman Ben S. Bernanke told the congressional Joint Economic Committee yesterday that inflation will “remain low” even as a recovery gets underway because businesses will be slow to build back production and payrolls.
ECB council member Athanasios Orphanides yesterday said the financial crisis needs “drastic” measures. Orphanides and fellow member George Provopoulos from Greece have indicated they may support cutting the target rate to less than 1 percent and buying debt to pump money into the economy.
ECB Executive Board member Lorenzo Bini Smaghi said on April 28 that policy makers should be “wary of the possible side-effects” of unconventional measures.
The euro may rise against the dollar because ECB policy makers will probably decide against introducing so-called quantitative easing when they meet May 7, Bank of Tokyo- Mitsubishi UFJ Ltd. said.
“The failure to move to quantitative easing in the near term should help support the euro, especially against the dollar, given the Federal Reserve’s contrasting aggressive monetary easing approach,” Lee Hardman, a foreign-exchange strategist in London at Bank of Tokyo, wrote in a note yesterday.
To contact the reporter on this story: Sandy Hendry in Hong Kong at shendry@bloomberg.net"
Me:From an FRBSF article, showing funds received vs projected 2010 state budget gaps.
Some states, like New York, appear to be making profits while others, like California and Connecticut, look to be in much tighter spots (H/T Econbrowser).
Via Reuters’ prolific columnist John Kemp, comes this grim reminder of the size of US public debt (emphasis ours):
The chart shows the scale of US federal government debt held by the public as a percentage of GDP since 1939 — with forecasts for the fiscal years 2009-2019 based on the Congressional Budget Office (CBO)’s analysis of the president’s budget proposals.
The cost of the bank rescue plan and fiscal stimulus makes the banking crisis the largest peacetime disaster to overtake the federal budget in the recorded history of the United States. Only the two world wars and war among the states have caused a larger deterioration in the fiscal position and build up of public indebtedness.
Federal debt is set to surge from 37.1% of GDP in 2007 (the last pre-crisis year) to 56.8% in fiscal 2009, the highest level since 1954.
Moreover, federal debt will continue rising thereafter — unless the president and Congress enact further tax rises or spending cuts beyond those already announced. The federal debt is projected to hit 71.4% by 2013 and peak at 79.9% of GDP in 2018.
Without further tax rises or spending cuts, the federal debt will reach levels not seen since 1949 and not much lower than during the 1941-1945 wartime emergency.
Related links:
“The OECD forecasts a jump in US public debt of almost 40 per cent…” - Martin Wolf, FT
US debt puts strain on dollar - FT"
There’s been a slew of (mostly negative) ratings actions on the financial guaranty sector - the bond insurers, mortgage insurers and the like - recently. Here’s a recap.
Subsequent to a warning from FGIC’s auditor that there is substantial doubt over the bond insurer’s ability to “continue as a going concern,” Standard & Poor’s on Wednesday wrote off the company completely:
NEW YORK April 22, 2009–Standard & Poor’s Ratings Services said today that it lowered its counterparty credit, financial strength, and financial enhancement ratings on Financial Guaranty Insurance Co. (FGIC) to ‘CC’ from ‘CCC’ and assigned a negative outlook.
Standard & Poor’s also said that it subsequently withdrew the ratings on FGIC and its ‘CC’ counterparty credit rating on the holding company, FGIC Corp., because of our expectation that timely and comprehensive financial information will no longer be available.
“Recently released GAAP financial statements for both FGIC and FGIC Corp. contain a statement from the independent auditor that there is substantial doubt regarding the company’s ability to continue as a going concern,” noted Standard & Poor’s credit analyst Robert E. Green. “The issuance of this opinion results in an event of default by FGIC Corp. under the terms of the company’s revolving credit agreement.” There is $46 million outstanding under the facility, and FGIC Corp., though it is attempting to secure a waiver, does not have the resources to repay this amount in full if it were to become due on an accelerated basis. In addition, because FGIC is in a negative earned surplus position, it is not able to pay dividends to FGIC Corp.
The negative outlook reflected the possibility that additional losses incurred, as suggested by our RMBS and CDO of ABS loss estimate, could result in capital and surplus below the minimum statutory requirement of $65 million. The negative outlook on holding company FGIC Corp. reflected the independent auditor’s issuance of a going concern opinion, which triggered an event of default on the company’s revolving credit facility.
S&P also downgraded all the major US mortgage insurers, and most by multiple notches. Companies affected include Radian, PMI, Genworth Mortgage Insurance and RMIC.
But - in a rare display of confidence - S&P affirmed the triple-A rating on Financial Security Assurance (FSA) and removed it from credit watch negative.
Over at Moody’s, Ambac was downgraded to Ba3 from Baa1 (deep, deep into junk territory):
The downgrade of Ambac’s ratings primarily reflects weakened risk adjusted capitalization, as Moody’s loss estimates on RMBS securities have increased significantly (particularly with respect to Alt-A transactions). These higher loss estimates increase the estimated capital required to support Ambac’s sizable direct RMBS portfolio (including securities owned as well as securities guaranteed) and also the insurer’s large portfolio of ABS CDO risks. The rating agency noted that the claims-paying resources of Ambac remain above Moody’s expected loss estimates for the firm, though this cushion has been significantly eroded, and losses in more severe stress scenarios would exceed available resources.
Related links:
Moody’s sets its sights on the mortgage insurers - FT Alphaville
2) The rules for LOLR( from here on down this includes any government guarantee ) intervention should be clear, public, and followed, otherwise Moral Hazard is ineffective. All guarantees must be explicit.
3) The terms must be onerous.
"Who can forget the end of "Planet of the Apes" when Charlton Heston, kneeling before the half-buried remains of the Statue of Liberty, slams his fists into the sand and cries, "You maniacs! You blew it up! Ah, damn you ... damn you all to hell!"
Now imagine the same scene, but with a half-buried Morgan Stanley building standing in for Miss Liberty and a time-traveling Walter Bagehot playing the lead and you've got the perfect Hollywood dramatization of the real-life tragedy that, with luck, is having its denouement on Wall Street.
Bagehot? The great Victorian man of letters, best remembered today as the second and most celebrated editor of the British magazine The Economist, wasn't exactly a hunk. But he certainly could have delivered those futile last lines with real conviction, for he was among the first to recognize the vast destructive potential of that newfangled weapon of Victorian finance: the modern central bank.
Bagehot first alerted readers to this potential and offered his suggestions for containing it in an article that appeared in The Economist after the great panic and credit crisis of 1866. That panic witnessed the spectacular collapse of Overend, Gurney & Co., which had long been Great Britain's premier investment house.
Bagehot understood that, during such panics, the Bank of England alone commanded the confidence needed to serve other financial firms as a "lender of last resort." But as Bagehot put it later in his book "Lombard Street: A Description of the Money Market" (1873), the bank's "faltering way" -- its arbitrary and inconsistent use of its unique lending powers -- tended only to make things worse.
"The public," Bagehot wrote, "is never sure what policy will be adopted at the most important moment: it is not sure what amount of advance will be made. ... And until we have on this point a clear understanding with the Bank of England, both our ability to avoid crises and our terror at crises will always be greater than they would otherwise be."
The ultimate source of trouble, Bagehot believed, was the very existence of the Bank of England and the special privileges it enjoyed. But because nothing save a revolution seemed likely to do away with the "Old Lady of Threadneedle Street," as it was called, Bagehot's preferred, practical solution was for the bank expressly to commit itself to lending freely during crises, though on good collateral only, and at "penalty" rates.
The restrictive provisions were supposed to limit aid to otherwise solvent firms panic had rendered illiquid.
Bagehot's recommendation has since become a sort of master precept of central banking -- albeit one that's mainly honored in the breach by central bankers.
To be fair to today's central bankers, there's never been much agreement on how to apply Bagehot's rule in practice. Just what do "good collateral" and "penalty rates" mean in times like these?
While no one might precisely be able to define good collateral -- and one can debate whether the rate at which banks offer to lend unsecured funds to other banks, known as the London Interbank Offered Rate, or LIBOR rate, plus 8 percent constitutes a "penalty" rate -- who even pretends that recent central bank lending has been based on good collateral?
But rescuing insolvent firms is the least of it. The real damage comes from the Treasury's utter lack of any consistent last-resort lending rule. The recently enacted financial institutions bailout bill does little to clarify this.
That's just the sort of thing that troubled Bagehot almost a century and a half ago, when central banks were still in their swaddling clothes. Yet central bankers and governments still don't get it, despite the lip service they pay to this great thinker from our past."
Neither Barack Obama nor John McCain had much of value to say about the financial crisis as it raged through the headlines this fall. Rather than shred their campaign strategies, they played it safe, as most politicians would have. But in the name of justice we ought to recall that there was one candidate who did foresee our predicament with considerable accuracy when it still lay far in the future. Ron Paul, in almost every speech he made during the Republican primaries, spoke of bubbles, reckless credit growth, and the "unsustainability" of present policy. So why isn't there more demand for the common-sense solutions he put forward? Because common sense is not much use in a financial panic. This was the great discovery of Walter Bagehot, the prolific 19th-century essayist and journalist, who was editor of the Economist from 1860 to 1877. (His name rhymes with gadget.) Ninety-nine percent of the time, common sense is a synonym for practicality. But in a serious banking crisis, doing the commonsensical thing--hunkering down and counting your pennies--has proved to be not practical at all. Bagehot's Lombard Street is an insider's look at the Bank of England, and at the principles on which political and financial leaders act when advanced economies come under pressure. Those principles are depressing in the extreme for anyone with an uncomplicated idea of how a democracy works. But they are effective. That is why, in the so-called Anglo-Saxon world, Bagehot's book still provides the bedrock of policy thinking during financial emergencies, including our present one. Lombard Street was published in 1873, seven years after the sudden collapse of Overend, Gurney & Co., a bank that lost £11 million, spread panic among investors, sparked a run, and became "the model instance of all evil in business." The crisis made such a deep impression on British finance and government that the country did not have another bank run for 141 years--not until Northern Rock collapsed in the summer of 2007. (English investors must have longer memories than American ones. Most of our own noxious subprime mortgages were contracted, and the securities built on them concocted, after Enron became our own model instance of evil in 2001.) It was the Bank of England that took charge of averting panic, during the Overend, Gurney crisis and thereafter. It did so by injecting credit into the economy, by bailing people out. Bagehot approved of this. Many ordinary retailers could not pay their suppliers until they got the money for the things they sold. Without credit, they would be ruined, and the ruin would spread to those to whom they owed money. This was not a question of moral failing, it was just the way a modern economy worked. But the modern economic system interacts with the modern political system--democracy--in a rather uncomfortable way. Indeed, at more than one juncture in Lombard Street, Bagehot framed the problem of booms and busts as part of the "increasingly democratic structure of English commerce." People in a democracy are most comfortable when their institutions do the same things that they would do as individuals. In a crisis, banks--like everyone else--reflexively hoard their money. But a central bank must do the opposite. It must lend freely. This was the most basic affront to common sense that the Bank of England presented, but it was not the worst. The worst was that the bank could carry out its necessary duties as a lender of last resort only by breaking the law. The basis of the bank's operating procedure--and of its soundness--was the Bank Act of 1844. We would call it a regime of sound money. It included stringent caps on the ratio of notes issued to reserves held. These caps were hewed to when the economy was running smoothly. Yet at the time Bagehot was writing, a quarter century later, the law had already been suspended three times. Not just that. "No similar occasion has ever yet occurred," Bagehot wrote, "in which it has not been suspended." So the law on which the solvency of the British nation rested was ironclad, except when someone felt a need to break it. Stranger still, never did the Bank of England acknowledge its duty as the lender of last resort. Some of its governors even denied that any such duty existed. Bagehot thought the bank should come clean about what it really was:
But there was a reason for the central bankers' dissembling. If the bank ever acknowledged a duty to rescue banks by generous extensions of credit, it would create a form of moral hazard. Thomson Hankey, a Bank of England director whom Bagehot much admired (and to whom the financial writer James Grant devotes an admiring essay in his new book Mr. Market Miscalculates), called Bagehot's lender-of-last-resort views "the most mischievous doctrine ever broached in the monetary or banking world in this country." In practice, Bagehot was right and Hankey was wrong. The bank was beyond question the lender of last resort. In principle, Hankey was right and Bagehot was wrong. Unless there was a real, credible threat that a bank would be allowed to fail, the guarantee of rescue would simply get priced into any financial bubble that developed, making things worse when the bubble popped. The situation required what we would now call "strategic ambiguity"--both Hankey's doctrine and Bagehot's practice, which contradicts it. The situation today requires the same mix. Central banking is thus often a high-stakes game of chicken. And sometimes, when banks enter the game insufficiently scared, it will be played out to the end. It certainly was in September when the U.S. Treasury terrified the financial world by not coming to the rescue of Lehman Brothers. This was a catastrophe in terms of Bagehot's practice, but it will produce benefits in terms of Hankey's principle. It will discourage people from paying more than is reasonable for assets on the belief that they come equipped with an insurance policy (the promise of a central bank rescue) that has been underwritten by taxpayers. The Republicans who nearly derailed the Treasury's Troubled Assets Relief Program in September played a similar role. A final problem is that there are limits to how accountable a central bank can be. Everyone is always hollering for clear rules and transparency. But a dirty secret of regulation is that it frequently influences conduct most effectively when it is capricious and opaque. Any regulatory system will reveal its vulnerabilities over long use. If it addresses economic problems in a predictable way, savvy investors will find a way to "game" that predictability. You can draw an analogy with antidepressant drugs. There is no permanent right match of medication for a depressive. Antidepressants work only until the mind (or is it the brain?) finds a way around them, at which point a new, unfamiliar drug must be substituted. In the same way, no matter how good the content of a regulatory regime, it must change periodically if big market players are to be kept from profiting off it. As Bagehot outlined his system, he was conscious that the practical realities of banking required him to heap paradox upon paradox. There is a hint of both Andrew Jackson and Thomas Aquinas in the way he referred to central banking as an "unnatural" thing in its very conception. "The business of banking ought to be simple," he wrote. "If it is hard it is wrong." If it is hard, the banker is either delegating poorly or has entangled his institution in complex transactions where it has no business. According to Bagehot, "Adventure is the life of commerce, but caution, I had almost said timidity, is the life of banking." Centralizing a society's cash reserves is complicated, reckless, and artificial:
In his ideas of company size, Bagehot harkened back to the 18th century rather than ahead to our own. To modern eyes, Bagehot is, as a factual matter, simply wrong. The natural tendency under free-market conditions is towards consolidation, and even monopoly. If you want small firms, you must protect them through government--whether this means Teddy Roosevelt-ian trust-busting, French-style subsidies to tobacconists, the EU's hounding of Microsoft, or the NIMBY anti-Wal-Mart campaigns aimed at preserving Mom-and-Pop stores. Bagehot sometimes contradicted himself on this point, noting also that "a large bank always tends to become larger, and a small one tends to become smaller," but his application of the word unnatural to a large central bank was frequent and must be taken as his settled view. It is curious that Bagehot, a contemporary of Marx, came to the opposite (and false) conclusion about how firms evolve. Where Bagehot would agree with Marx is in his belief that there is something predictably destabilizing about modern economies. You don't need banks to have a precarious economy, or one liable to speculation--Bagehot noted that there were no banks, as we would understand them, in 1720, at the time of the South Sea Bubble and the Mississippi Scheme. But modern banking is precarious by design. "In exact proportion to the power of this system is its delicacy," he wrote. "I should hardly say too much if I said its danger." The power, delicacy, and danger all have the same source. In fact they are just different names for the same thing: leverage. At the very opening of the book, Bagehot illustrates with exquisite simplicity how, at least in a boom economy, traders on margin can "harass and press upon, if they do not eradicate, the old capitalist." The old capitalist in question is the poor sap who believes all this stuff about neither-a-borrower-nor-a-lender-be and is foolish enough to be using his own cash:
Later, Bagehot showed that this need for leverage is no different for those selling money than it is for those selling dry goods. The banker can no more choose not to lend than the merchant can choose not to borrow:
In finance, once you can have leverage, you must have leverage. Once you have some leverage, getting more of it than your competitors is a matter of survival. And when governments and central banks debate whether to loosen or tighten up money, they face a constant clamor from the financial world to permit more leverage still. That is why, even in democracies, the instruments of monetary policy tend to be kept far from the influence of voters, and even hidden from view. Otherwise, credit tends to spiral. Bubbles result. Nothing could be more foolish than to assume that this process of spiraling speculation is unleashed by "greed," unless by greed you mean human nature. Credit spirals are a darker aspect of the world Adam Smith described in The Wealth of Nations and Bernard de Mandeville did in the Fable of the Bees. Just as society can be improved by the uncoordinated action of the selfishly motivated, an economy can collapse for reasons having nothing to do with anybody's cupidity. We should be moral in the way we think about money, but a credit system tends to make a mess of moral accounting. Bagehot described London's financial district as "a sort of standing broker between quiet saving districts of the country and the active employing districts." Decent, puritanical Suffolk farmers want to put their money in a safe place; Lancashire entrepreneurs want money to put to work. Thanks to London bankers, both can follow their wishes and make a profit in the process. We have an idea that the Suffolk dairyman is the "moral" party here (he's saving) and the Lancashire speculator the "immoral" one (he's gambling). But, once a banking system intervenes, they are both gambling and they are both saving. In good times you are welcome to mouth the folkloric cliché that holds farmers to be better people than financiers. When depression looms, you had better realize that the rain falls on the just and the unjust. Many Americans who have wound up underwater on their houses and maxed out on their credit cards are greedy, climbing, brand-intoxicated, materialistic shopaholics who thought the world owed them a living. But just as many of them are not. They are trapped, as surely as financial institutions are, in a system based on wild borrowing. Participation in this system is not exactly required, but it is not exactly optional, either. One's quality of life is determined not just by one's purchasing power but also by one's relative economic standing. Chagrin at seeing one's neighbors get richer faster may be a sign of bad character, but do not for a minute assume there is nothing to feel chagrin about! When it comes to the very goods people deem most essential--the proper mate; the schooling of one's children; the size, location, elegance, and comfort of one's house--relative standing is more important than absolute wealth. Those who kept their money in savings banks in the 1990s lost out to those who did things we are supposed to disapprove of, like "spending money they didn't have," borrowing profligately to invest in stocks and even bonds, which appreciated at an average of 15 percent a year over the decade. Among rich people, how one entered the present decade had more to do with how one had done in the stock market than with how one had done in the labor market. Is that just? Of course it's not! It's easy to see now. But while the boom was going on there was all sorts of rationalizing about why it was okay that the social hierarchy should be reordered through stock and housing speculation. One line of argument was that people who did not have a ton of money in stocks, as well as those who rented rather than bought the houses they lived in, were foolish. This line of argument peaked at the turn of the decade, when Americans elected a president who had argued that the public was foolish for not launching its retirement savings onto the open seas of the stock market. Bagehot saw that a speculative mania eventually sweeps up everyone in its path. "Every great crisis reveals the excessive speculations of many houses which no one before suspected," he wrote, "and which commonly indeed had not begun or had not carried very far those speculations, till they were tempted by the daily rise of price and the surrounding fever." Avaricious people get hurt, but it is in the nature of crashes that they are not the ones who get hurt most. A tragic figure present in almost every historic account of speculation and collapse in history is the person who believed, year after year, that the boom was an illusion, and held himself aloof until, at the very last minute, whether out of self-doubt or deference to the opinions of his fellow man, he entered the fray and was (having bought at the top, rather than the bottom, of the market) wiped out. What a wicked irony! His punishment is as much for his long and wise forbearance as for his momentary weakness. So the "cultural contradictions of capitalism" run deeper than we thought. The classic idea, as laid out in their different ways by the economist Joseph Schumpeter and the sociologist Daniel Bell, is that capitalism rewards diligence; diligence produces wealth; wealth begets idleness; and idleness undermines capitalism. But when, as now, push comes to shove, we can ask whether there is really anything particularly capitalist about the virtues of diligence and self-restraint. The real capitalist virtues appear to be optimism and luck. From a central-banking perspective, the cultural contradictions are not results of capitalism but elements of it. The problem with central banking is that it reacts to a system that has been mismanaged by rewarding the managers. That is why objections to central banking, although they can come from the right (Ron Paul, Jim Bunning) or the left (Barney Frank, William Greider), tend to be populist. Bagehot was no populist. He was comfortable with the idea that what some people think should be more important than what other people think:
Although he would surely fault Treasury Secretary Hank Paulson for many things, the criticism most often heard at present--that Paulson is too close to former colleagues on Wall Street, where he worked for years as CEO of Goldman Sachs--would strike Bagehot as misplaced. Because it is on Wall Street, alas, that "the state of credit" is to be determined:
To be blunt, credit is successfully reestablished when financial elites say, "When." Credit is close to a synonym for the mood of the ruling class. To say an economy is based on credit is to say it is based on animal mysteries. Glamour, prestige, élan, sprezzatura, cutting a figure . . . that is what the economy is made of. It is a rather terrifying thought. Viewed as Bagehot viewed it, from the perspective of a central bank in a crisis, an advanced economy looks an awful lot like a primitive economy." |
"Loyal readers, please take a moment to check out Gretchen Morgenson’s column this week. She’s taken a close look at the buyout of Bear Stearns organized by the Federal Reserve, and she has come to an intriguing conclusion: that the Fed not only wanted to prevent financial havoc - it also wanted to deter speculators who were betting on big banks to fail.
Adherents of the Walter Bagehot school of central banking - and I have been among them at times - have cried foul at the sight of big bailouts and the granting of emergency credit at low interest rates. The Bagehot argument is that emergencies that arise from the risks that banks have chosen to take should not be treated with overwhelming sympathy. Emergency credit should be offered, yes, but at rates that will make banks think twice about using the safety net again. That’s not the case this time around (neither in the United States nor in Britain, and probably not in Europe either by the time the folks in Brussels are finished), so the central banks may be telling financial institutions that they can take silly risks without fear of disaster.
But if Morgenson is right, there is a long-term purpose here, too: to reduce the winnings of those who bet on failure, and thus to reduce the incentives to bring that failure to pass. And let’s face it, the speculators aren’t operating in a vacuum; their bets can start to snowball with market sentiment, as they did against Lehman Brothers last week. Still, the Bagehot argument (often called moral hazard) is also a powerful one - which one do you agree with?"
Federal Reserve Chairman Ben Bernanke, who has read his Bagehot and kept a copy in his Princeton office when he was a professor, responded to recent developments first by pumping money into the markets through the New York Fed’s open-market operations and then last week by easing the terms on loans to banks from the Fed’s discount window.
Bagehot (pictured at right) still makes for good reading at times like this.
“What is wanted and what is necessary to stop a panic is to diffuse the impression, that though money may be dear, still money is to be had. If people could be really convinced that they could have money if they wait a day or two, and that utter ruin is not coming, most likely they would cease to run in such a mad way for money. Either shut the Bank at once, and say it will not lend more than it commonly lends, or lend freely, boldly, and so that the public may feel you mean to go on lending. To lend a great deal, and yet not give the public confidence that you will lend sufficiently and effectually, is the worst of all policies; but it is the policy now pursued.”
Robert Feldman, Morgan Stanley’s chief economist for Japan, writes in a note today that it’s key to distinguish between internal discredit — private domestic lenders retreating — and external discredit, which Bagehot defined as a foreign drain on a bank’s money. (Bagehot’s solution to the problem of external discredit is to still lend freely but “at very high rates.”) That doesn’t apply in today’s floating rate system, Feldman says, and exchange rates don’t provide a good substitute, with the dollar’s drop against the yen suggesting we have external discredit while the strengthening against the euro saying we don’t.
Feldman writes: “My view is that the modern counterpart of ‘external discredit’ is moral hazard. The credit of the U.S. IS a problem, since no one knows how big the subprime and related housing market problems really are. Given how poorly banks know their clients, the ‘high rates’ part should come into play. There is no way to re-establish confidence unless those who have made loans to questionable borrowers pay a price for rash lending. Only then will markets regain confidence that risk is under control.
“The next stage of the credit problem — and whether it affects the real economy seriously — depend on eliminating the moral hazard,” Feldman says. “The faster the moral hazard in eliminated, the less impact on the real economy.”
Fed officials are acutely aware of the moral hazard, having resisted action for weeks to not be seen as bailing out risky investments. But they also don’t want a crisis to feed on itself. The Fed stressed its statement, in lowering the discount rate for banks, that it would accept “a broad range of collateral…including home mortgages and related assets.” The central bank sought to reassure a market that had been roiled by risky investments in subprime mortgages.
That’s how the Bank of England halted a panic in 1825, as Bagehot recounts: “A panic, in a word, is a species of neuralgia, and according to the rules of science you must not starve it. The holders of the cash reserve must be ready not only to keep it for their own liabilities, but to advance it most freely for the liabilities of others. They must lend to merchants, to minor bankers, to ‘this man and that man,’ whenever the security is good. In wild periods of alarm, one failure makes many, and the best way to prevent the derivative failures is to arrest the primary failure which causes them. The way in which the panic of 1825 was stopped by advancing money has been described in so broad and graphic a way that the passage has become classical. ‘We lent it,’ said Mr. Harman, on behalf of the Bank of England, ‘by every possible means and in modes we had never adopted before; we took in stock on security, we purchased Exchequer bills, we made advances on Exchequer bills, we not only discounted outright, but we made advances on the deposit of bills of exchange to an immense amount, in short, by every possible means consistent with the safety of the Bank, and we were not on some occasions over-nice. Seeing the dreadful state in which the public were, we rendered every assistance in our power.’ After a day or two of this treatment, the entire panic subsided, and the ‘City’ was quite calm.”
"Bagehot advocated in 1873 that a Lender of Last Resort in a crisis should lend at a penalty rate to solvent but illiquid banks that have adequate collateral. The doctrine has been criticised as having no place in our modern interbank market, but this is wrong. Bagehot’s prescription aims to eliminate the coordination problem of investors at the base of the crisis. It is still a useful guide for action when the interbank market stalls.1 It makes clear that discount-window lending to entities in need may be necessary in a crisis.
Bagehot's doctrine, however, is easy to state and hard to apply. It requires the central bank to distinguish between institutions that are insolvent and those that are merely illiquid. It also requires them to assess the collateral offered. Central banks, because of information limitations, are bound to make mistakes, losing face and money in the process. This doesn’t mean they should not try.
Poor collateral versus massive liquidity
The collateral should be valued under “normal circumstances”, that is, in a situation where the coordination failure of investors does not occur. This involves a judgment call in which the central bank values the illiquid assets. A central bank that only takes high quality collateral will be safe, but will have to inject much more liquidity and/or set lower interest rates to stabilise the market. This may fuel future speculative behavior. Some of this may have happened in the Greenspan era, in the aftermath of the crisis in Russia and LTCM, and after the crash of the technological bubble. The ECB and the Federal Reserve have accepted now partially illiquid collateral that the market would not. This seems appropriate and releases pressure to lower interest rates to solve the problem, something that should be done only if there are signs of deterioration in the real economy. The problem is that central banks are extending the lender of last resort facility outside the realm of traditional banks to entities, like Bear Stearns, that they do not supervise and, therefore, over which they do not have first hand information. How does the Fed know whether Bear Stearns or other similar institutions are solvent? It seems that the Fed is not following Bagehot’s doctrine here.
Finally, if banks and investors are bailed out now, why should they be careful next time? This is the moral hazard problem: help to the market that is optimal once the crisis starts has perverse effects in the incentives of market players at the investment stage. The issue is that only when the moral hazard problem is moderate does it pay to eliminate completely the coordination failure of investors with central bank help. When the moral hazard problem is severe, a certain degree of coordination failure of investors - that is, allowing some crises - is optimal to maintain discipline when investing and, amending Bagehot, some barely solvent institutions should not be helped."
To repeat Bagehot's Rule: "very large (domestic) loans at very high rates are the best remedy for the worst malady of the money market when a foreign drain is added to a domestic drain." The Fed, and the U.S. government more generally, have so far got it only half right."
http://findarticles.com/p/articles/mi_m2751/is_56/ai_55015114/pg_6"In a number of recent blog contributions, we have sketched the role of a modern central bank as ‘market maker of last resort’ (MMLR). This MMLR is the analogue, in a world where intermediation is increasingly through financial markets, to Bagehot’s lender of last resort (LOLR) in a world where most intermediation took place through banks (see e.g. Willem H. Buiter and Anne C. Sibert “The Central Bank as the Market Maker of last Resort: From lender of last resort to market maker of last resort"; Willem H. Buiter “Central banks as market makers of last resort, again”; Willem H. Buiter and Anne C. Sibert “A missed opportunity for the Fed”).
The market maker of last resort function can be fulfilled in two ways. First, the central bank can make outright purchases and sales of a wider range of securities than they currently do. Second, central banks can accept a wider range of securities as collateral in repos, and in collateralised loans and advances at the discount window than they currently do. Following Bagehot’s rule, the MMLR should buy these securities outright or accept them as collateral only on terms that would imply a stiff financial penalty to the owner. The central bank of course already applies a liquidity ‘haircut’ even to liquid instruments offered as collateral in repos or at the discount window. Because the MMLR would have to establish a buying price ‘in the dark’, that is, unaided by recent relevant market prices, and would inevitably take on much more credit risk than central banks have become accustomed to, the ‘haircuts’ should be severe – a financial version of ‘short back and sides’.I doubt a week has gone by since last summer during which I haven't seen some pundit or other trot out Walter Bagehot's dictum that in the event of a credit crunch, the central bank should lend freely at a penalty rate. More often than not, this is contrasted with the actions of the Federal Reserve, which seems to be lending freely at very low interest rates.
Ben Bernanke, in a speech today, addressed this criticism directly:
What are the terms at which the central bank should lend freely? Bagehot argues that "these loans should only be made at a very high rate of interest". Some modern commentators have rationalized Bagehot's dictum to lend at a high or "penalty" rate as a way to mitigate moral hazard--that is, to help maintain incentives for private-sector banks to provide for adequate liquidity in advance of any crisis. I will return to the issue of moral hazard later. But it is worth pointing out briefly that, in fact, the risk of moral hazard did not appear to be Bagehot's principal motivation for recommending a high rate; rather, he saw it as a tool to dissuade unnecessary borrowing and thus to help protect the Bank of England's own finite store of liquid assets. Today, potential limitations on the central bank's lending capacity are not nearly so pressing an issue as in Bagehot's time, when the central bank's ability to provide liquidity was far more tenuous.
I'm no expert on Walter Bagehot, and in fact I admit I've never read Lombard Street. But I'll trust in Bernanke as an economic historian on this one, unless and until someone else makes a persuasive case that Bagehot's penalty rate really was designed to punish the feckless rather than just to preserve the Bank of England's limited liquidity."
"So, we have, what I will call "Grant's Graham For Investing":
1) Decent Size
2) Current Assets Exceed Liabilities By Two Times
3) 10 Continuous Years Of Profit
4) 20 Continuous Years Of Dividends
5) 10 Years Of Earnings Growth Exceeding 33%
6) Price To Earnings Ratio Less Than 15
7 ) Price To Book Ratio Less Than 1.5"The Government will succumb and will lend taxpayers' money to non-financial companies.
In a way, there's no choice, because we'll be hobbled for years as an economy if our few remaining manufacturers and exporters are wiped out."
"Trader's Narrative's Due Diligence":
"The process of investigation undertaken by an party to gather material information on actual or potential risks involved in a financial transaction or relationship."
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"Meanwhile, Reuters reported, "Federal Reserve Bank of Dallas President Richard Fisher said on Thursday it was not clear if the U.S. Treasury yield curve was steepening because of concerns over supply or a more optimistic economic outlook. "Obviously, there is a lot of supply of debt. Another way to interpret the steepening of the yield curve is ... confidence in economy going forward," he told reporters after a speech, adding that both could be happening at the same time. "I think it is probably a little bit of both, discounting the supply of new debt, but I detect...there is a pick up in confidence about the future," said Fisher."
In my book, this is how QE is supposed to work,ie, low short term interests rates and rising longer term interest rates. It's working. Now, of course, at some point, higher interest rates will become a problem, but we're a bit away from that now. So, the negative comments are reasonable, and might turn out to be right. We might, possibly, lose control down the road. I simply disagree.
By the way, haven't we all learned that we're all highly fallible in predicting the future yet?