http://skepticaltexascpa.blogspot.com/2008/12/coming-depression.html
In the long run, a major economic effect of economic globalization is to reduce the income gap between rich and poor countries, by bringing the latter fully into the nexus of the global economy. ...
There is one snag, at least for rich countries such as the [US], Western Europe and Japan. If the world becomes more equal more quickly than it become richer, then living standards in rich countries must decline. If the world were suddenly to achieve equal income levels between countries, without a significant increase in output, U.S. living standards would fall by over three quarters. ...
Tuesday, December 30, 2008
IMF argues for large stimulus packages
http://www.ft.com/cms/s/0/da227bd0-d5d9-11dd-a9cc-000077b07658.html?nclick_check=1Tax cuts needed to concentrate on individuals who were having difficulty getting access to credit rather than those who were saving instead of spending.
As the US Buys Less, Germany Suffers
http://www.cnbc.com/id/28430243
Virtually all economists expect 2009 to be a lost year for Germany, which will pay a heavy price for the downturn
Jacques Cailloux, chief Europe economist at Royal Bank of Scotland in London, has established a strong correlation between Chinese exports to the United States and German exports to China
The American trade deficit in 2007 was $708.5 billion; Germany’s $288.5 billion surplus and China’s $262.2 billion excess represent much of the other side of that equation.
Virtually all economists expect 2009 to be a lost year for Germany, which will pay a heavy price for the downturn
Jacques Cailloux, chief Europe economist at Royal Bank of Scotland in London, has established a strong correlation between Chinese exports to the United States and German exports to China
The American trade deficit in 2007 was $708.5 billion; Germany’s $288.5 billion surplus and China’s $262.2 billion excess represent much of the other side of that equation.
Monday, December 29, 2008
The collapse of financial globalization …
http://blogs.cfr.org/setser/2008/12/29/the-collapse-of-financial-globalization/ Private capital inflows to the US and private capital outflows from the US have collapsed. They have gone from a peak of around 15% of US GDP to around zero in a remarkably short period of time
But even if “private” Treasury purchases since mid-2007 are counted there still would have been a stunning fall in private capital flows. Direct investment flows have continued. Other financial flows though have largely gone in reverse, with investors selling what they previously bought. In the third quarter foreign investors sold about $90b of US securities (excluding Treasuries) and Americans sold about $85 billion of foreign securities. And the reversal in bank flows on both sides (as past loans have been called) has been absolutely brutal.
Note how closely gross inflows and gross outflows move together in the graph
Think of the process this way. Suppose a US bank lends a billion dollars to a bank in London that lends that money to a hedge fund domiciled the Caribbean that buys a billion dollars of US securities. That chain results in an outflow and inflow, but the outflow just financed the inflow — it doesn’t help to finance the current account deficit. By contrast, China’s purchases of Treasuries and Agencies reflect in large part China’s current account surplus — not Chinese banks borrowing from US banks. They certainly help to finance the US current account deficit
It was a largely unregulated system. And it was largely offshore, at least legally. SIVs and the like were set up in London. They borrowed short-term from US banks and money market funds to buyer longer-term assets, generating a lot of cross border flows but little net financing. European banks that had a large dollar book seem to have been doing much the same thing.** The growth of the shadow banking system consequently resulted in a big increase in gross private capital outflows and gross private capital inflows
But even if “private” Treasury purchases since mid-2007 are counted there still would have been a stunning fall in private capital flows. Direct investment flows have continued. Other financial flows though have largely gone in reverse, with investors selling what they previously bought. In the third quarter foreign investors sold about $90b of US securities (excluding Treasuries) and Americans sold about $85 billion of foreign securities. And the reversal in bank flows on both sides (as past loans have been called) has been absolutely brutal.
Note how closely gross inflows and gross outflows move together in the graph
Think of the process this way. Suppose a US bank lends a billion dollars to a bank in London that lends that money to a hedge fund domiciled the Caribbean that buys a billion dollars of US securities. That chain results in an outflow and inflow, but the outflow just financed the inflow — it doesn’t help to finance the current account deficit. By contrast, China’s purchases of Treasuries and Agencies reflect in large part China’s current account surplus — not Chinese banks borrowing from US banks. They certainly help to finance the US current account deficit
It was a largely unregulated system. And it was largely offshore, at least legally. SIVs and the like were set up in London. They borrowed short-term from US banks and money market funds to buyer longer-term assets, generating a lot of cross border flows but little net financing. European banks that had a large dollar book seem to have been doing much the same thing.** The growth of the shadow banking system consequently resulted in a big increase in gross private capital outflows and gross private capital inflows
一场金融危机带来了哪些改变? CNN总结幕后真凶
http://www.6park.com/news/messages/8794.html 于海说，从短期来看，还很难判断美国的社会结构会在这次金融危机中会发生什么新变化，但是美国的产业结构可能会出现一些调整。“上世纪以来，美国服务业一直处于高度发达的水平，然而制造业却在不知不觉中落后。在金融危机的冲击下，第二产业比例或许会有所上升。”
西方经济学诞生之初，节俭是一个重要的命题，美国社会起初也接受了这一观念。但是随着资本主义的繁荣，国家拥有巨大的生产力并积累了雄厚的物质财富后，这种节俭寡欲的心理动力就逐渐枯萎衰竭了。自上个世纪以来，以凯恩斯为代表的一些经济学家所持有的“储蓄增加将导致消费减少，并最终减少投资和社会财富”的观点更是日益成为发达国家的主流，并对美国现代经济和社会产生了深远影响。数据显示，在纽约，20%的市民根本没有任何积蓄，另有45%的人其积蓄只够维持 3个月的生活。复旦大学社会学系教授于海指出，“美国模式”有其文化的原因，即商业资本主义的逻辑。“商业资本主义就是不断地制造出产品，激发消费的欲望，然后再反过来刺激生产。美国是个消费主导的社会，为了拉动消费，美国创造出许多方便消费的手段，如信贷、邮政业务等都是它的首创。而健全的社会保障体制，则让个人无需太多的储蓄”。
前美欧日等发达经济体已相继陷入衰退。对于“寒冬”中的世界经济来说，现在迫切需要一个新的经济引擎。下一轮新经济的增长点在哪里？与前几轮相比，会有哪些不同？ www.6park.com
中国国际经济合作学会副会长陈德照认为，金融危机为何会爆发，与互联网革命后一直没有找到新的经济增长点有关。潘锐向记者进一步解释道：上世纪90年代兴起了新经济革命浪潮，以互联网为主的IT产业是这轮浪潮的龙头。但是到1999年，IT泡沫破灭，美国转而主要推动住房和抵押贷款。当时美国政府选了两批人作为主要对象，一批是大学三、四年级的学生，另一批则是新移民，为了分散风险，遂把金融业务证券化。2000—2001年，这一增长引擎获得了成功。但是 2001年“9·11”事件的爆发，海外移民这块没了，于是美国政府就将目光对准低收入者，次贷风险加大。但是，由于2001—2005年美国房价处于上升阶段，利率也较低，因此没出很大问题。然而，2005年以后房价开始下跌而利率不断上升，最终导致次贷风险爆发。 www.6park.com
如何转“ 危”为“机”，这不仅是一个短期应对问题，还应包含着长期战略性考虑。美国《基督教科学箴言报》曾撰文指出，安全渡过信贷危机将为今后另一些重大工作 ———振兴经济———奠定基础。潘锐认为，新一轮的经济增长点是新能源。“新能源不仅是指新型能源，也指对现有能源技术的改进，如减少耗能，与环保是相关联的。金融危机短期内会影响新能源的投入，而且由于油价下跌，人们会更倾向于利用现有的能源。但是目前这个时候也恰恰是调整能源政策的好时机。” www.6park.com
陈德照则认为，与上一轮不同，新一轮经济增长点的突破口可能不是一两个技术，而是多元的。“能源、环境和生物技术可能比较快一点，成为核心。这些技术之间不是孤立的，彼此成果是可以相互利用的。”陈德照同时指出，从长期来看，由于经济增长与科技创新关系密切，因此，在最困难的时期过去后，有关的投入还是会增加，而且还将成为各国的主要战略考虑。
西方经济学诞生之初，节俭是一个重要的命题，美国社会起初也接受了这一观念。但是随着资本主义的繁荣，国家拥有巨大的生产力并积累了雄厚的物质财富后，这种节俭寡欲的心理动力就逐渐枯萎衰竭了。自上个世纪以来，以凯恩斯为代表的一些经济学家所持有的“储蓄增加将导致消费减少，并最终减少投资和社会财富”的观点更是日益成为发达国家的主流，并对美国现代经济和社会产生了深远影响。数据显示，在纽约，20%的市民根本没有任何积蓄，另有45%的人其积蓄只够维持 3个月的生活。复旦大学社会学系教授于海指出，“美国模式”有其文化的原因，即商业资本主义的逻辑。“商业资本主义就是不断地制造出产品，激发消费的欲望，然后再反过来刺激生产。美国是个消费主导的社会，为了拉动消费，美国创造出许多方便消费的手段，如信贷、邮政业务等都是它的首创。而健全的社会保障体制，则让个人无需太多的储蓄”。
前美欧日等发达经济体已相继陷入衰退。对于“寒冬”中的世界经济来说，现在迫切需要一个新的经济引擎。下一轮新经济的增长点在哪里？与前几轮相比，会有哪些不同？ www.6park.com
中国国际经济合作学会副会长陈德照认为，金融危机为何会爆发，与互联网革命后一直没有找到新的经济增长点有关。潘锐向记者进一步解释道：上世纪90年代兴起了新经济革命浪潮，以互联网为主的IT产业是这轮浪潮的龙头。但是到1999年，IT泡沫破灭，美国转而主要推动住房和抵押贷款。当时美国政府选了两批人作为主要对象，一批是大学三、四年级的学生，另一批则是新移民，为了分散风险，遂把金融业务证券化。2000—2001年，这一增长引擎获得了成功。但是 2001年“9·11”事件的爆发，海外移民这块没了，于是美国政府就将目光对准低收入者，次贷风险加大。但是，由于2001—2005年美国房价处于上升阶段，利率也较低，因此没出很大问题。然而，2005年以后房价开始下跌而利率不断上升，最终导致次贷风险爆发。 www.6park.com
如何转“ 危”为“机”，这不仅是一个短期应对问题，还应包含着长期战略性考虑。美国《基督教科学箴言报》曾撰文指出，安全渡过信贷危机将为今后另一些重大工作 ———振兴经济———奠定基础。潘锐认为，新一轮的经济增长点是新能源。“新能源不仅是指新型能源，也指对现有能源技术的改进，如减少耗能，与环保是相关联的。金融危机短期内会影响新能源的投入，而且由于油价下跌，人们会更倾向于利用现有的能源。但是目前这个时候也恰恰是调整能源政策的好时机。” www.6park.com
陈德照则认为，与上一轮不同，新一轮经济增长点的突破口可能不是一两个技术，而是多元的。“能源、环境和生物技术可能比较快一点，成为核心。这些技术之间不是孤立的，彼此成果是可以相互利用的。”陈德照同时指出，从长期来看，由于经济增长与科技创新关系密切，因此，在最困难的时期过去后，有关的投入还是会增加，而且还将成为各国的主要战略考虑。
Sunday, December 28, 2008
Krugman's "hangover theory", revisited.
http://interfluidity.powerblogs.com/posts/1230410023.shtml
The obvious answer is that when there is a boom, entrepreneurs know into what sector resources must be reallocated, and pull already employed workers from existing jobs into the new big thing. During a bust, from a God's eye view, the same process must occur: resources must be shifted out of some sectors and into others. But entrepreneurs are only human. They do not know to where resources might be productively employed, only that they cannot be productively employed where they are. This is the asymmetry, I think, that explains mass unemployment during busts.
I'll end with an intuition: I think that there's a trade-off between microlevel diversification and macro-efficiency.
If the aggregate portfolio is disproportionately by the decisions of a relatively small group of people, there is no reason to suspect its quality would be better than that decided upon by a bureaucracy of planners. There is reason to suspect, in fact, that it would be worse, because at least the planners know they should at least pretend to serve a broad public interest, while private decisionmakers might quite legitimately think they're just trying to get a piece of next year's bonus pool.
The obvious answer is that when there is a boom, entrepreneurs know into what sector resources must be reallocated, and pull already employed workers from existing jobs into the new big thing. During a bust, from a God's eye view, the same process must occur: resources must be shifted out of some sectors and into others. But entrepreneurs are only human. They do not know to where resources might be productively employed, only that they cannot be productively employed where they are. This is the asymmetry, I think, that explains mass unemployment during busts.
I'll end with an intuition: I think that there's a trade-off between microlevel diversification and macro-efficiency.
If the aggregate portfolio is disproportionately by the decisions of a relatively small group of people, there is no reason to suspect its quality would be better than that decided upon by a bureaucracy of planners. There is reason to suspect, in fact, that it would be worse, because at least the planners know they should at least pretend to serve a broad public interest, while private decisionmakers might quite legitimately think they're just trying to get a piece of next year's bonus pool.
Monday, December 22, 2008
Fed Rate Cuts Dull Perceived Safety of Dollar: Chart of Day
趋势由此而变
http://www.bloomberg.com/apps/news?pid=20601068&sid=aR9Yf.fZy0EM&refer=economy
Dec. 18 (Bloomberg) -- The U.S. dollar is poised to fall against other major currencies as the Federal Reserve’s “aggressive” rate cuts make the greenback less attractive to investors, Credit Suisse Group AG said.
The Fed’s “easing and very low U.S. rates will ultimately undermine the dollar across the board,” analysts Ray Farris and Daniel Katzive wrote in the report. “Perceptions of relative systemic risk” are declining, they said.
“One important implication of this is that the dollar-yen and dollar-euro, which had been inversely correlated throughout the period of deleveraging, have now become positively correlated again,” Farris and Katzive wrote yesterday.
The CHART OF THE DAY shows how the euro and yen have begun to track each other more closely since the beginning of December. The two had been mostly moving in opposite directions between August and November as a global financial crisis prompted investors to sell higher-yielding currencies. The European Central Bank’s benchmark interest rate of 2.5 percent compares with as low as zero in the U.S. and 0.3 percent in Japan.
During the same period, the yen rallied against all of the world’s 16 most-active currencies as credit-market losses and a global stocks rout sparked a reversal in so-called carry trades, where investors get funds in a country with low borrowing costs and buy overseas assets.
“The yen continues to gain support from a repatriation of foreign assets by Japanese investors,” National Australia Bank Ltd. said in a report. “The ongoing narrowing of interest-rate differentials, with spreads between Japan and all major currencies collapsing towards zero, is yen positive.”
There is a 58 percent chance the BOJ will lower borrowing costs when a two-day policy meeting concludes tomorrow, according to calculations by JPMorgan Chase & Co. using overnight interest-rate swaps. The odds were 53 percent yesterday.
http://www.bloomberg.com/apps/news?pid=20601068&sid=aR9Yf.fZy0EM&refer=economy
Dec. 18 (Bloomberg) -- The U.S. dollar is poised to fall against other major currencies as the Federal Reserve’s “aggressive” rate cuts make the greenback less attractive to investors, Credit Suisse Group AG said.
The Fed’s “easing and very low U.S. rates will ultimately undermine the dollar across the board,” analysts Ray Farris and Daniel Katzive wrote in the report. “Perceptions of relative systemic risk” are declining, they said.
“One important implication of this is that the dollar-yen and dollar-euro, which had been inversely correlated throughout the period of deleveraging, have now become positively correlated again,” Farris and Katzive wrote yesterday.
The CHART OF THE DAY shows how the euro and yen have begun to track each other more closely since the beginning of December. The two had been mostly moving in opposite directions between August and November as a global financial crisis prompted investors to sell higher-yielding currencies. The European Central Bank’s benchmark interest rate of 2.5 percent compares with as low as zero in the U.S. and 0.3 percent in Japan.
During the same period, the yen rallied against all of the world’s 16 most-active currencies as credit-market losses and a global stocks rout sparked a reversal in so-called carry trades, where investors get funds in a country with low borrowing costs and buy overseas assets.
“The yen continues to gain support from a repatriation of foreign assets by Japanese investors,” National Australia Bank Ltd. said in a report. “The ongoing narrowing of interest-rate differentials, with spreads between Japan and all major currencies collapsing towards zero, is yen positive.”
There is a 58 percent chance the BOJ will lower borrowing costs when a two-day policy meeting concludes tomorrow, according to calculations by JPMorgan Chase & Co. using overnight interest-rate swaps. The odds were 53 percent yesterday.
Saving Capitalism No Sure Thing as Statism Undermines Economy
http://www.bloomberg.com/apps/news?pid=20601068&sid=aDjmuEpDoctc&refer=economy By Simon Kennedy, Matthew Benjamin and Rich Miller
Dec. 22 (Bloomberg) -- What’s good for General Motors may not ultimately be best for the global economy.
The Bush administration’s $13.4 billion rescue of GM and Chrysler is a fitting finish to a year in which governments around the world expanded their role in the economy and markets after three decades of retreat.
The intervention comes at what may prove to be a steep price. Future investment may be allocated less efficiently as risk-averse politicians make business decisions. Whenever banks decide to lend again, they are likely to find new capital requirements that will curb how freely they can do it. Interest rates may be pushed up by government borrowing to finance trillions of dollars of bailouts.
“We’re seeing a more statist world economy,” says Ken Rogoff, former chief economist at the International Monetary Fund and now a professor at Harvard University in Cambridge, Massachusetts. “That’s not good for growth in the longer run.”
It’s not good for stocks either, says Paola Sapienza, associate professor of finance at Northwestern University’s Kellogg School of Management. Slower economic growth means lower profits. Shares might also be hurt by investor uncertainty about the scope and timing of government intervention in the corporate sector.
“If the rules of the game are changing, people are reluctant to invest in the stock market,” Sapienza says.
Record Lows
The bond market will also be affected as it is forced to absorb ever bigger increases in government debt. While yields on Treasury securities touched record lows last week, they eventually “will go up significantly and dramatically” under pressure from added supply, says E. Craig Coats, co-head of fixed income at Keefe, Bruyette & Woods Inc. in New York.
The increase in the government’s role in the economy has been breathtaking. The U.S. looks set to rack up a budget deficit of at least $1 trillion this fiscal year, while the Federal Reserve has already increased its balance sheet by $1.4 trillion since last December. By way of comparison, U.S. gross domestic product last year was $13.8 trillion.
Winding back the intervention may not be easy, says Sapienza, who has studied the effect of government ownership on bank lending.
When Italy nationalized banks in 1933, “the architects who designed the system envisaged it as temporary,” she says. “It was in place until the end of the 1990s.” More recently, the Japanese government injected capital into banks to get them to lend to big corporations, keeping alive “the zombie companies that economists talk about,” she says.
Investors ‘Gambling’
Already, investors trying to decide where to put their money are “gambling very much on what they think the government will do, not what they think about the company,” Sapienza says. “That’s why there’s so much volatility.”
GM shares plunged as much as 37 percent Dec. 12 after the U.S. Senate failed to pass an emergency loan plan. The shares recovered after George W. Bush said his administration would consider funding a rescue with money already set aside for bank bailouts, then shot up 23 percent on Dec. 19 when he announced the emergency loans.
The auto-industry lifeline is just the latest in an extraordinary year of market interventions that have redefined capitalism. The U.S. government previously seized control of mortgage lenders Fannie Mae and Freddie Mac and insurer American International Group Inc. and took stakes in the nation’s largest banks.
‘Necessary Evil’
Government activism has become a “necessary evil” to help pull the global economy out of recession, says Marco Annunziata, chief economist at UniCredit MIB in London. Even Bush, who ran for the U.S. presidency espousing smaller government, agrees. He told a CNN interviewer last week he has “abandoned free-market principles to save the free-market system.”
Policy makers elsewhere extended their reach, too. The U.K. nationalized mortgage lenders Northern Rock Plc and Bradford & Bingley Plc. French President Nicolas Sarkozy created a 6 billion-euro ($8.7 billion) fund to invest in “strategic” firms. And the European Commission last week relaxed rules on state aid to businesses.
It isn’t inevitable that bigger government will hamstring free enterprise, says William Niskanen, chairman emeritus of the Cato Institute, a Washington research group that generally favors free markets over government solutions. Niskanen predicts that government intervention will prove to be “selective and temporary,” not “a long-term trend.”
Shy Away From Lending
Still, greater government involvement will make businesses less likely to deploy capital in ways that spur growth and profits, says Eric Chaney, chief economist at AXA SA in Paris and a former official at the French finance ministry. Carmakers may be slower to innovate or cut costs, and financiers may shy away from lending to entrepreneurs.
“It’s the job of companies, not governments, to take risk and accept the consequences,” Chaney says. “There is no incentive for governments to take risk, so they won’t.”
The history of public aid to automakers highlights the threat, says Stuart Pearson, an analyst at Credit Suisse Group in London.
While the U.S. rescue of Chrysler in 1979 gave then-Chief Executive Officer Lee Iacocca time to streamline the company and restore profitability, it also sustained an outsized U.S. auto industry, leading to its current woes, Pearson says. The 1975 bailout of British Leyland Motor Corp. ended up costing U.K. taxpayers 11 billion pounds ($16.8 billion) and failed to keep successor MG Rover Group Ltd. from sinking into bankruptcy two decades later.
Help, Obstruction
“Government help has only been an obstruction to getting the car industry into a more economic shape,” Pearson says.
Back in 1953, when the industry was booming, GM Chief Executive Officer Charles Wilson famously observed: “For years I thought what was good for our country was good for General Motors and vice versa.” If the automakers’ importance has declined, so -- until recently -- had the government’s.
Just a dozen years ago, U.S. President Bill Clinton declared that “the era of big government is over.” Sarkozy won election last year promising a “rupture” from France’s history of heavy regulation; these days, the French president has changed his tune. “Laissez-faire, it is finished,” he declared last month.
Role of Government
Until recently, “investors could, broadly speaking, ignore the role of the government when thinking about markets” says Alex Patelis, chief international economist at Merrill Lynch & Co. in London. “This period is over.”
Regulation is back in style as policy makers seek to avoid a repeat of the financial crisis. Leaders from the Group of 20 nations are crafting a plan to require banks to maintain higher capital levels and disclose more about their holdings.
That likely means a lower “speed limit for growth,” as banks have less cash available to lend and invest, says Mohamed el-Erian, co-chief executive at Pacific Investment Management Co., the Newport Beach, California-based manager of the world’s biggest bond fund.
“There will be less lubrication in the form of credit creation,” he says.
Bailouts and economic-stimulus plans are also running up government borrowing. Economists at JPMorgan Chase & Co. estimate the budget deficits of developed economies will more than double next year to 6.3 percent of gross domestic product.
Higher Taxes
Bigger deficits, while necessary now, could spell trouble down the road if they lead to higher borrowing costs or prompt consumers to save more now on the assumption that bigger shortfalls will mean higher taxes later.
“We’ll end a financial crisis with a fiscal crisis,” says Vito Tanzi, former director of fiscal affairs at the IMF. “We’ll get out with very large public debt and very large public spending. That, for sure, will slow down the rate of growth for the next 10 years or so.”
While bigger government is the unavoidable result of dealing with the turmoil, “it makes all of us economists uncomfortable seeing the government doing all these extraordinary things,” says Barry Eichengreen, an economics professor at the University of California at Berkeley.
On the other hand, he says, “I would feel even more uncomfortable if they weren’t doing them.”
Dec. 22 (Bloomberg) -- What’s good for General Motors may not ultimately be best for the global economy.
The Bush administration’s $13.4 billion rescue of GM and Chrysler is a fitting finish to a year in which governments around the world expanded their role in the economy and markets after three decades of retreat.
The intervention comes at what may prove to be a steep price. Future investment may be allocated less efficiently as risk-averse politicians make business decisions. Whenever banks decide to lend again, they are likely to find new capital requirements that will curb how freely they can do it. Interest rates may be pushed up by government borrowing to finance trillions of dollars of bailouts.
“We’re seeing a more statist world economy,” says Ken Rogoff, former chief economist at the International Monetary Fund and now a professor at Harvard University in Cambridge, Massachusetts. “That’s not good for growth in the longer run.”
It’s not good for stocks either, says Paola Sapienza, associate professor of finance at Northwestern University’s Kellogg School of Management. Slower economic growth means lower profits. Shares might also be hurt by investor uncertainty about the scope and timing of government intervention in the corporate sector.
“If the rules of the game are changing, people are reluctant to invest in the stock market,” Sapienza says.
Record Lows
The bond market will also be affected as it is forced to absorb ever bigger increases in government debt. While yields on Treasury securities touched record lows last week, they eventually “will go up significantly and dramatically” under pressure from added supply, says E. Craig Coats, co-head of fixed income at Keefe, Bruyette & Woods Inc. in New York.
The increase in the government’s role in the economy has been breathtaking. The U.S. looks set to rack up a budget deficit of at least $1 trillion this fiscal year, while the Federal Reserve has already increased its balance sheet by $1.4 trillion since last December. By way of comparison, U.S. gross domestic product last year was $13.8 trillion.
Winding back the intervention may not be easy, says Sapienza, who has studied the effect of government ownership on bank lending.
When Italy nationalized banks in 1933, “the architects who designed the system envisaged it as temporary,” she says. “It was in place until the end of the 1990s.” More recently, the Japanese government injected capital into banks to get them to lend to big corporations, keeping alive “the zombie companies that economists talk about,” she says.
Investors ‘Gambling’
Already, investors trying to decide where to put their money are “gambling very much on what they think the government will do, not what they think about the company,” Sapienza says. “That’s why there’s so much volatility.”
GM shares plunged as much as 37 percent Dec. 12 after the U.S. Senate failed to pass an emergency loan plan. The shares recovered after George W. Bush said his administration would consider funding a rescue with money already set aside for bank bailouts, then shot up 23 percent on Dec. 19 when he announced the emergency loans.
The auto-industry lifeline is just the latest in an extraordinary year of market interventions that have redefined capitalism. The U.S. government previously seized control of mortgage lenders Fannie Mae and Freddie Mac and insurer American International Group Inc. and took stakes in the nation’s largest banks.
‘Necessary Evil’
Government activism has become a “necessary evil” to help pull the global economy out of recession, says Marco Annunziata, chief economist at UniCredit MIB in London. Even Bush, who ran for the U.S. presidency espousing smaller government, agrees. He told a CNN interviewer last week he has “abandoned free-market principles to save the free-market system.”
Policy makers elsewhere extended their reach, too. The U.K. nationalized mortgage lenders Northern Rock Plc and Bradford & Bingley Plc. French President Nicolas Sarkozy created a 6 billion-euro ($8.7 billion) fund to invest in “strategic” firms. And the European Commission last week relaxed rules on state aid to businesses.
It isn’t inevitable that bigger government will hamstring free enterprise, says William Niskanen, chairman emeritus of the Cato Institute, a Washington research group that generally favors free markets over government solutions. Niskanen predicts that government intervention will prove to be “selective and temporary,” not “a long-term trend.”
Shy Away From Lending
Still, greater government involvement will make businesses less likely to deploy capital in ways that spur growth and profits, says Eric Chaney, chief economist at AXA SA in Paris and a former official at the French finance ministry. Carmakers may be slower to innovate or cut costs, and financiers may shy away from lending to entrepreneurs.
“It’s the job of companies, not governments, to take risk and accept the consequences,” Chaney says. “There is no incentive for governments to take risk, so they won’t.”
The history of public aid to automakers highlights the threat, says Stuart Pearson, an analyst at Credit Suisse Group in London.
While the U.S. rescue of Chrysler in 1979 gave then-Chief Executive Officer Lee Iacocca time to streamline the company and restore profitability, it also sustained an outsized U.S. auto industry, leading to its current woes, Pearson says. The 1975 bailout of British Leyland Motor Corp. ended up costing U.K. taxpayers 11 billion pounds ($16.8 billion) and failed to keep successor MG Rover Group Ltd. from sinking into bankruptcy two decades later.
Help, Obstruction
“Government help has only been an obstruction to getting the car industry into a more economic shape,” Pearson says.
Back in 1953, when the industry was booming, GM Chief Executive Officer Charles Wilson famously observed: “For years I thought what was good for our country was good for General Motors and vice versa.” If the automakers’ importance has declined, so -- until recently -- had the government’s.
Just a dozen years ago, U.S. President Bill Clinton declared that “the era of big government is over.” Sarkozy won election last year promising a “rupture” from France’s history of heavy regulation; these days, the French president has changed his tune. “Laissez-faire, it is finished,” he declared last month.
Role of Government
Until recently, “investors could, broadly speaking, ignore the role of the government when thinking about markets” says Alex Patelis, chief international economist at Merrill Lynch & Co. in London. “This period is over.”
Regulation is back in style as policy makers seek to avoid a repeat of the financial crisis. Leaders from the Group of 20 nations are crafting a plan to require banks to maintain higher capital levels and disclose more about their holdings.
That likely means a lower “speed limit for growth,” as banks have less cash available to lend and invest, says Mohamed el-Erian, co-chief executive at Pacific Investment Management Co., the Newport Beach, California-based manager of the world’s biggest bond fund.
“There will be less lubrication in the form of credit creation,” he says.
Bailouts and economic-stimulus plans are also running up government borrowing. Economists at JPMorgan Chase & Co. estimate the budget deficits of developed economies will more than double next year to 6.3 percent of gross domestic product.
Higher Taxes
Bigger deficits, while necessary now, could spell trouble down the road if they lead to higher borrowing costs or prompt consumers to save more now on the assumption that bigger shortfalls will mean higher taxes later.
“We’ll end a financial crisis with a fiscal crisis,” says Vito Tanzi, former director of fiscal affairs at the IMF. “We’ll get out with very large public debt and very large public spending. That, for sure, will slow down the rate of growth for the next 10 years or so.”
While bigger government is the unavoidable result of dealing with the turmoil, “it makes all of us economists uncomfortable seeing the government doing all these extraordinary things,” says Barry Eichengreen, an economics professor at the University of California at Berkeley.
On the other hand, he says, “I would feel even more uncomfortable if they weren’t doing them.”
Wednesday, December 17, 2008
Trepidation About Quantitative Easing, Version 2.0
Trepidation About Quantitative Easing, Version 2.0
The Fed made official its move to quantitative easing today, and said it will take no prisoners until it has lowered rates and credit spreads further:
The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability... The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.I (literally) have a very bad feeling in my stomach. This move is a sign of utter desperation. And it is on such a massive scale that if it does not work well, we will have a great deal of difficulty containing its effects.A conventional view of how this plays out comes from Martin Wolf of the Financial Times: the Fed's extreme measures will of course prevail, but at the risk of considerable inflation:
Central banks may soon resort to their most powerful weapons against deflation: the printing press and the “helicopter drop” of money. It is a time for which Ben Bernanke, chairman of the Federal Reserve, has long prepared. Will this weaponry work? Unquestionably, yes: used ruthlessly, it will eliminate deflation. But returning to normality thereafter will prove far more elusive....Once inflation returns, the central bank will need to sell assets into the market, to mop up the excess money it has created in fighting deflation. Similarly, the government must reduce its deficit to a size it can finance in the market. Otherwise, deflationary expectations may swiftly turn into expectations of above-target inflation. This may also happen if the debt sold in efforts to sterilise the monetary overhang is deemed beyond the government’s ability to service.Countries without a credible currency may reach this point early. As soon as a central bank hints at “quantitative easing”, flight from the currency may ensue. As an aside, I had dinner with some well placed Japanese executives this evening (as in the host, for instance, co-authored papers with Eisuke Sakakibara, aka "Mr, Yen." and knows other policy officials personally), and all thought that the dollar would continue to be strong until the US economy started to recover, then investors would be more willing to hold riskier currencies. They dismissed the idea of a dollar crisis (there think there will be no substitute for over 20 years) or of the use of gold or commodities as possible substitutes/stores of value (not a gold standard, but increased monetization of "hard" assets), since those markets are small relative to the currency markets. I found the unwillingness to consider other than "business as usual" scenarios troubling. In addition, one of the executives was interviewing candidates from top schools in China for a US position, and asked what their outlook for the RMB was. To a person, they expect it to fall relative to the dollar. Each had his own reasoning, but the most consistent and compelling theme was that the Chinese government valued preserving employment above all, and was not going to let the RMB appreciate at a time when exports were weak.Now it is important to appreciate the Fed's emphasis in its version of quantitative easing, which we will call QE2. The Wall Street Journal Economics Blog gave additional detail from a press conference after the FOMC meeting:
But the senior Fed official said the central bank’s approach is distinct from quantitative easing and different from what the Japanese did. The Fed’s balance sheet has two sides, the official explained: assets with securities the Fed holds (including loans, credit facilities, mortgage-backed securities) and liabilities (cash and bank reserves). Japan’s quantitative easing program focused on the liability side, expanding cash in the system and excess reserves by a large amount. The Fed’s focus, however, is on the asset side through mortgage-backed securities, agency debt, the commercial paper program, the loan auctions and swaps with foreign central banks. That’s designed to improve credit-market functioning, the official said. By expanding the balance sheet by making loans, the official explained, the focus is not on excess reserves but on the asset side. That securities-lending approach directly affects credit spreads, which is the problem today — unlike Japan earlier, where the problem was the level of interest rates in general, the official said.What is NOT encouraging is the Fed has already made heroic measures in this direction, via the creation of its alphabet soup of facilities, and the results have been underwhelming. The results have been limited and short-lived (consider the successive acute phases of the credit crisis). Now admittedly, we do not appear to be having a year-end squeeze, which is a victory of sorts, but the Fed also expanded the Term Action Facility to massive size. A1/P1 commercial paper seems to be functioning reasonably well too, although the types not supported by the Fed are still under duress. Indeed, a Bloomberg story stresses the limited progress to date:
For all their efforts to liquefy credit markets, the Federal Reserve and the Treasury show no signs of ending the 18-month freeze, as evidenced by the unprecedented gap between what banks and the U.S. government pay to borrow money.The difference between the London interbank offered rate, or Libor, that banks charge each other for three-month loans and Treasury bill rates is six times wider than before markets began to seize up in June 2007. Even though the so-called TED spread narrowed to 1.82 percentage points yesterday from 4.64 percentage points in October, prices of contracts to borrow money months from now show investors don’t expect lending to recover until at least the second half of 2009.“If you take a full assessment of the credit markets, conditions have certainly eased from their worst, but they still are at extraordinary tight levels, which are far from normal,” said Michael Darda, the chief economist at MKM Partners LP in Greenwich, Connecticut. “Short-term funding spreads are all still very wide relative to historical norms. There is a massive pullback going on in the private sector.”Several experts also say they expect the new programs will help in six months, with no explanation as to why.Before we get to the conventional worry, that the Fed will be reluctant to put on the brakes soon enough once the economy starts to recover and wind up with pretty bad inflation. there are other issues that are getting short shrift.The first is that the prescription presupposes that the problem is a liquidity crisis. It does not take seriously the notion that at least part (if not all) of the problem is that a lot of people and companies took on far more debt than they can afford to repay. Anna Schwartz, who was co-author with Milton Friedman of A Monetary History of the US, which is one of the definitive works on the Great Depression. It argued the Fed erred fatally then by not providing enough liquidity, .Schwartz took the Fed to task:
Credit spreads -- the difference between what it costs the government to borrow and what private-sector borrowers must pay -- are at historic highs.......even though the Fed has flooded the credit markets with cash, spreads haven't budged because banks don't know who is still solvent and who is not. This uncertainty, says Ms. Schwartz, is "the basic problem in the credit market. Lending freezes up when lenders are uncertain that would-be borrowers have the resources to repay them. So to assume that the whole problem is inadequate liquidity bypasses the real issue....Today, the banks have a problem on the asset side of their ledgers -- "all these exotic securities that the market does not know how to value."...[H]e's shifted from trying to save the banking system to trying to save banks. These are not, Ms. Schwartz argues, the same thing. In fact, by keeping otherwise insolvent banks afloat, the Federal Reserve and the Treasury have actually prolonged the crisis. "They should not be recapitalizing firms that should be shut down."But the problem goes much further than "toxic securities". Remember the premise of how the Fed's program will work. It will buy various instruments to force spreads lower so as to lower cost to borrowers. The implicit logic is that if you lower rates enough, voila, the debt service cost drops and formerly dud borrowers are now viable. But how do borrowers get their hands on these new, better rates? Quite a few borrowers are up to their eyeballs already in debt, and no way to refinance. Take credit cards. Supporting credit card receivables may allow credit card companies to stop slashing consumer credit lines (although both Meredith Whitney and apparently industry sponsored studies agree that banks will cut credit card availability further due to pro-consumer changes that will make the product less profitable). But it does nothing for consumers carrying balances (unless we see a revival of, say, six month teaser offers). Similarly, for homeowners to get relief, they have to refinance. Now for many, that's a no-brainer. But the ones with no or negative equity have no ready solution, plus starting in 2009 and accelerating in 2010 are the option ARM resets. Even with low rates, many of these mortgages have enough negative amortization that consumers will suffer serious payment shock.But then again, we are assuming that lenders have more or less responsible standards. The powers that be may decide to run roughshod over that. As Accrued Interest noted:
The big wild card is government policy. There is talk that Treasury might allow for no-appraisal refinancing, basically lending based on original loan-to-value as opposed to current loan-to-value. Debate the wisdom of this policy as you might, it would case a massive refinancing wave that would make 2003 look like a a splash in the kiddie pool.And in other areas, stress is starting to get serious in types of debt not yet on the Fed's target list. From Eric Hovde in Institutional Risk Analyst:
One of the problems that is rapidly approaching is commercial real estate mortgages. Res mortgage are the largest asset class in the banking system. Commercial real estate mortgages are the second largest asset class in the banking system. Unfortunately much of the underwriting sins that started in the res market in 2002 crept into the commercial sector as well by 2004 and 2005, plus you never dealt with the massive excess inventory surplus of commercial office space post the Internet boom. Because financing costs became so low, real estate values kept shooting up and builders kept building more. So you have a national vacancy rate of 15%, which is moving higher every quarter. I think you are going to see major losses coming through the commercial real estate books of the banking industry.Commercial real estate is not yet on Bernanke's list. Neither is debtor-in-possession financing, and we and others have lamented that the death of it means that companies that fail and would ordinarily be able to get through Chapter 11 and preserve most of their employment will instead liquidate.Consider further: the Fed assumes it has no constraints, because it can bloat its balance sheet to any size. But it has limits of staff, focus, expertise that restrict what it can do. For it to succeed in its aims, it is going to have to intervene on behalf of every type of troubled credit and make allocation decisions among them. Going on auto pilot (that is, dealing with the "presenting problems", the ones that surfaced first, means that they get priority when that might not be the best use of collective resources (it is not desirable from a competitive standpoint to bloat our housing sector back to status quo ante).Other observers were lukewarm. The Economist questioned whether the Fed could in fact influence credit spreads as much as it hoped to:
....the creation and expansion of an array of lending programmes....have so far no doubt kept the interest rates that are charged to actual private borrowers lower than they otherwise would be, the effect has been difficult to detect, and certainly smaller than what the Treasury achieved through direct injections of public capital into banks.In theory, purchases of longer-term securities could have more impact by pulling down longer-term interest rates. The 10-year Treasury yield, for example, is 2.3%, and the 30-year conventional mortgage-rate is around 5.5%. But whereas the Fed knows more or less just what it has to do to move short-term interest rates up or down, it is in uncharted territory on longer-term interest rates. Indeed, theory suggests that the purchases would have to be spectacularly large to affect such large, globally integrated markets.A senior Fed official, briefing reporters after the FOMC meeting, rejected the notion that the Fed was trying explicitly to target lower long-term rates, and rather framed the Fed’s new actions as an extension of previous efforts at restoring liquidity and normal trading conditions. The official said that yields on Fannie’s and Freddie’s MBS, despite the explicit support of the Treasury, are much higher than Treasury yields because of a lack of liquidity. The Fed can narrow that spread, he said, by providing investors with the confidence that a committed buyer is in the market.Um, MBS have traded at high spreads at least in part due to volatility, which makes the prepayment option worth more, hence higher spreads. No doubt the Fed parsed that bit out. But as I understand it, foreign central banks, which used to be big buyers of agencies, have switched to Treasuries, not comfortable about the lack of a "full faith and credit" guarantee. The statutory authority for the conservatorship extends through the end of 2009, although it is widely assumed it will be renewed, plus Fannie and Freddie are NOT full faith and credit obligations of the US (the Treasury has instead entered into a "no negative net worth" guarantee. The differences may seem semantic, but they are seen as serious in some quarters. If that is the real issue, more Fed buying will not entice the key buyers, central banks, back into the pool.Jim Hamilton is also doubtful, and suggests that the Fed is working at cross purposes:
Will that strategy succeed if we just do it on a sufficiently large scale? I'm not at all convinced that it would. Our standard finance models treat interest rate spreads as governed primarily by fundamentals such as default risk and only secondarily by the volume of buyers or sellers.But while the Fed may have little control over the spreads between different interest rates, it does have a significant degree of control over the inflation rate. The 1.7% drop in headline CPI during November, and the -10% annual deflation rate for the last 3 months, should not be viewed as welcome developments in an environment where our primary concern is whether individuals and institutions are going to repay their debts. The Fed should want to generate enough inflation to pull those short-term interest rates above the zero floor. But to target inflation, the Fed would take exactly the opposite strategy from that outlined by the senior Fed official above. The goal would be to get cash into circulation rather than be hoarded by banks, and have the Fed's assets be ones that could be readily liquidated if the inflation starts to come in higher than desired.
The Fed made official its move to quantitative easing today, and said it will take no prisoners until it has lowered rates and credit spreads further:
The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability... The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.I (literally) have a very bad feeling in my stomach. This move is a sign of utter desperation. And it is on such a massive scale that if it does not work well, we will have a great deal of difficulty containing its effects.A conventional view of how this plays out comes from Martin Wolf of the Financial Times: the Fed's extreme measures will of course prevail, but at the risk of considerable inflation:
Central banks may soon resort to their most powerful weapons against deflation: the printing press and the “helicopter drop” of money. It is a time for which Ben Bernanke, chairman of the Federal Reserve, has long prepared. Will this weaponry work? Unquestionably, yes: used ruthlessly, it will eliminate deflation. But returning to normality thereafter will prove far more elusive....Once inflation returns, the central bank will need to sell assets into the market, to mop up the excess money it has created in fighting deflation. Similarly, the government must reduce its deficit to a size it can finance in the market. Otherwise, deflationary expectations may swiftly turn into expectations of above-target inflation. This may also happen if the debt sold in efforts to sterilise the monetary overhang is deemed beyond the government’s ability to service.Countries without a credible currency may reach this point early. As soon as a central bank hints at “quantitative easing”, flight from the currency may ensue. As an aside, I had dinner with some well placed Japanese executives this evening (as in the host, for instance, co-authored papers with Eisuke Sakakibara, aka "Mr, Yen." and knows other policy officials personally), and all thought that the dollar would continue to be strong until the US economy started to recover, then investors would be more willing to hold riskier currencies. They dismissed the idea of a dollar crisis (there think there will be no substitute for over 20 years) or of the use of gold or commodities as possible substitutes/stores of value (not a gold standard, but increased monetization of "hard" assets), since those markets are small relative to the currency markets. I found the unwillingness to consider other than "business as usual" scenarios troubling. In addition, one of the executives was interviewing candidates from top schools in China for a US position, and asked what their outlook for the RMB was. To a person, they expect it to fall relative to the dollar. Each had his own reasoning, but the most consistent and compelling theme was that the Chinese government valued preserving employment above all, and was not going to let the RMB appreciate at a time when exports were weak.Now it is important to appreciate the Fed's emphasis in its version of quantitative easing, which we will call QE2. The Wall Street Journal Economics Blog gave additional detail from a press conference after the FOMC meeting:
But the senior Fed official said the central bank’s approach is distinct from quantitative easing and different from what the Japanese did. The Fed’s balance sheet has two sides, the official explained: assets with securities the Fed holds (including loans, credit facilities, mortgage-backed securities) and liabilities (cash and bank reserves). Japan’s quantitative easing program focused on the liability side, expanding cash in the system and excess reserves by a large amount. The Fed’s focus, however, is on the asset side through mortgage-backed securities, agency debt, the commercial paper program, the loan auctions and swaps with foreign central banks. That’s designed to improve credit-market functioning, the official said. By expanding the balance sheet by making loans, the official explained, the focus is not on excess reserves but on the asset side. That securities-lending approach directly affects credit spreads, which is the problem today — unlike Japan earlier, where the problem was the level of interest rates in general, the official said.What is NOT encouraging is the Fed has already made heroic measures in this direction, via the creation of its alphabet soup of facilities, and the results have been underwhelming. The results have been limited and short-lived (consider the successive acute phases of the credit crisis). Now admittedly, we do not appear to be having a year-end squeeze, which is a victory of sorts, but the Fed also expanded the Term Action Facility to massive size. A1/P1 commercial paper seems to be functioning reasonably well too, although the types not supported by the Fed are still under duress. Indeed, a Bloomberg story stresses the limited progress to date:
For all their efforts to liquefy credit markets, the Federal Reserve and the Treasury show no signs of ending the 18-month freeze, as evidenced by the unprecedented gap between what banks and the U.S. government pay to borrow money.The difference between the London interbank offered rate, or Libor, that banks charge each other for three-month loans and Treasury bill rates is six times wider than before markets began to seize up in June 2007. Even though the so-called TED spread narrowed to 1.82 percentage points yesterday from 4.64 percentage points in October, prices of contracts to borrow money months from now show investors don’t expect lending to recover until at least the second half of 2009.“If you take a full assessment of the credit markets, conditions have certainly eased from their worst, but they still are at extraordinary tight levels, which are far from normal,” said Michael Darda, the chief economist at MKM Partners LP in Greenwich, Connecticut. “Short-term funding spreads are all still very wide relative to historical norms. There is a massive pullback going on in the private sector.”Several experts also say they expect the new programs will help in six months, with no explanation as to why.Before we get to the conventional worry, that the Fed will be reluctant to put on the brakes soon enough once the economy starts to recover and wind up with pretty bad inflation. there are other issues that are getting short shrift.The first is that the prescription presupposes that the problem is a liquidity crisis. It does not take seriously the notion that at least part (if not all) of the problem is that a lot of people and companies took on far more debt than they can afford to repay. Anna Schwartz, who was co-author with Milton Friedman of A Monetary History of the US, which is one of the definitive works on the Great Depression. It argued the Fed erred fatally then by not providing enough liquidity, .Schwartz took the Fed to task:
Credit spreads -- the difference between what it costs the government to borrow and what private-sector borrowers must pay -- are at historic highs.......even though the Fed has flooded the credit markets with cash, spreads haven't budged because banks don't know who is still solvent and who is not. This uncertainty, says Ms. Schwartz, is "the basic problem in the credit market. Lending freezes up when lenders are uncertain that would-be borrowers have the resources to repay them. So to assume that the whole problem is inadequate liquidity bypasses the real issue....Today, the banks have a problem on the asset side of their ledgers -- "all these exotic securities that the market does not know how to value."...[H]e's shifted from trying to save the banking system to trying to save banks. These are not, Ms. Schwartz argues, the same thing. In fact, by keeping otherwise insolvent banks afloat, the Federal Reserve and the Treasury have actually prolonged the crisis. "They should not be recapitalizing firms that should be shut down."But the problem goes much further than "toxic securities". Remember the premise of how the Fed's program will work. It will buy various instruments to force spreads lower so as to lower cost to borrowers. The implicit logic is that if you lower rates enough, voila, the debt service cost drops and formerly dud borrowers are now viable. But how do borrowers get their hands on these new, better rates? Quite a few borrowers are up to their eyeballs already in debt, and no way to refinance. Take credit cards. Supporting credit card receivables may allow credit card companies to stop slashing consumer credit lines (although both Meredith Whitney and apparently industry sponsored studies agree that banks will cut credit card availability further due to pro-consumer changes that will make the product less profitable). But it does nothing for consumers carrying balances (unless we see a revival of, say, six month teaser offers). Similarly, for homeowners to get relief, they have to refinance. Now for many, that's a no-brainer. But the ones with no or negative equity have no ready solution, plus starting in 2009 and accelerating in 2010 are the option ARM resets. Even with low rates, many of these mortgages have enough negative amortization that consumers will suffer serious payment shock.But then again, we are assuming that lenders have more or less responsible standards. The powers that be may decide to run roughshod over that. As Accrued Interest noted:
The big wild card is government policy. There is talk that Treasury might allow for no-appraisal refinancing, basically lending based on original loan-to-value as opposed to current loan-to-value. Debate the wisdom of this policy as you might, it would case a massive refinancing wave that would make 2003 look like a a splash in the kiddie pool.And in other areas, stress is starting to get serious in types of debt not yet on the Fed's target list. From Eric Hovde in Institutional Risk Analyst:
One of the problems that is rapidly approaching is commercial real estate mortgages. Res mortgage are the largest asset class in the banking system. Commercial real estate mortgages are the second largest asset class in the banking system. Unfortunately much of the underwriting sins that started in the res market in 2002 crept into the commercial sector as well by 2004 and 2005, plus you never dealt with the massive excess inventory surplus of commercial office space post the Internet boom. Because financing costs became so low, real estate values kept shooting up and builders kept building more. So you have a national vacancy rate of 15%, which is moving higher every quarter. I think you are going to see major losses coming through the commercial real estate books of the banking industry.Commercial real estate is not yet on Bernanke's list. Neither is debtor-in-possession financing, and we and others have lamented that the death of it means that companies that fail and would ordinarily be able to get through Chapter 11 and preserve most of their employment will instead liquidate.Consider further: the Fed assumes it has no constraints, because it can bloat its balance sheet to any size. But it has limits of staff, focus, expertise that restrict what it can do. For it to succeed in its aims, it is going to have to intervene on behalf of every type of troubled credit and make allocation decisions among them. Going on auto pilot (that is, dealing with the "presenting problems", the ones that surfaced first, means that they get priority when that might not be the best use of collective resources (it is not desirable from a competitive standpoint to bloat our housing sector back to status quo ante).Other observers were lukewarm. The Economist questioned whether the Fed could in fact influence credit spreads as much as it hoped to:
....the creation and expansion of an array of lending programmes....have so far no doubt kept the interest rates that are charged to actual private borrowers lower than they otherwise would be, the effect has been difficult to detect, and certainly smaller than what the Treasury achieved through direct injections of public capital into banks.In theory, purchases of longer-term securities could have more impact by pulling down longer-term interest rates. The 10-year Treasury yield, for example, is 2.3%, and the 30-year conventional mortgage-rate is around 5.5%. But whereas the Fed knows more or less just what it has to do to move short-term interest rates up or down, it is in uncharted territory on longer-term interest rates. Indeed, theory suggests that the purchases would have to be spectacularly large to affect such large, globally integrated markets.A senior Fed official, briefing reporters after the FOMC meeting, rejected the notion that the Fed was trying explicitly to target lower long-term rates, and rather framed the Fed’s new actions as an extension of previous efforts at restoring liquidity and normal trading conditions. The official said that yields on Fannie’s and Freddie’s MBS, despite the explicit support of the Treasury, are much higher than Treasury yields because of a lack of liquidity. The Fed can narrow that spread, he said, by providing investors with the confidence that a committed buyer is in the market.Um, MBS have traded at high spreads at least in part due to volatility, which makes the prepayment option worth more, hence higher spreads. No doubt the Fed parsed that bit out. But as I understand it, foreign central banks, which used to be big buyers of agencies, have switched to Treasuries, not comfortable about the lack of a "full faith and credit" guarantee. The statutory authority for the conservatorship extends through the end of 2009, although it is widely assumed it will be renewed, plus Fannie and Freddie are NOT full faith and credit obligations of the US (the Treasury has instead entered into a "no negative net worth" guarantee. The differences may seem semantic, but they are seen as serious in some quarters. If that is the real issue, more Fed buying will not entice the key buyers, central banks, back into the pool.Jim Hamilton is also doubtful, and suggests that the Fed is working at cross purposes:
Will that strategy succeed if we just do it on a sufficiently large scale? I'm not at all convinced that it would. Our standard finance models treat interest rate spreads as governed primarily by fundamentals such as default risk and only secondarily by the volume of buyers or sellers.But while the Fed may have little control over the spreads between different interest rates, it does have a significant degree of control over the inflation rate. The 1.7% drop in headline CPI during November, and the -10% annual deflation rate for the last 3 months, should not be viewed as welcome developments in an environment where our primary concern is whether individuals and institutions are going to repay their debts. The Fed should want to generate enough inflation to pull those short-term interest rates above the zero floor. But to target inflation, the Fed would take exactly the opposite strategy from that outlined by the senior Fed official above. The goal would be to get cash into circulation rather than be hoarded by banks, and have the Fed's assets be ones that could be readily liquidated if the inflation starts to come in higher than desired.
Fed May Buy Lower-Rated Assets to Ease Credit Crunch
By Craig Torres
http://www.bloomberg.com/apps/news?pid=20601068&sid=aTmjdz7_Zvno&refer=economy
Dec. 16 (Bloomberg) -- The Federal Reserve is open to the idea of buying lower-rated securities to ease the credit crunch, and plans to discuss possible strategies with President-elect Barack Obama’s Treasury.
Because the Fed must lend only against good collateral, the Treasury would need to take the credit risk of assets that are rated below AAA, a senior Fed official said today in a conference call with reporters in Washington.
Fed officials today shifted to using the size and composition of the central bank’s assets as the main tool of monetary policy after cutting the benchmark interest rate as low as zero. The senior official said that policy makers will make decisions on new lending programs or expanding existing ones based on how housing markets and the overall economy evolve.
The central bank can make a difference in credit markets where yields are higher than they would otherwise be because of a lack of liquidity due to the financial crisis, the official said on condition of anonymity.
The official said that the central bank will collaborate through the Federal Open Market Committee, which includes five presidents of Fed district banks, on policy decisions that grow the central bank’s balance sheet. The Fed’s Board of Governors in Washington has been the key decision-making body for emergency lending programs up to now.
Assets Soar
The central bank has expanded its balance sheet to $2.26 trillion from $868 billion in July 2007 through several facilities designed to ease liquidity in money markets and interbank lending markets.
The U.S. central bank has taken care to limit credit risk by financing only the highest-rated securities, having the Treasury post an equity stake that would take the first loss, or loaning less than the value of collateral when it is of less quality than U.S. Treasuries.
Fed lending programs could become larger, and even more targeted with the aid of the Treasury in the future, the official indicated. The approach will depend on discussions with the new Treasury team after Obama takes office, the person said.
Today’s press briefing by telephone set a new precedent for transparency, after decades of reluctance by Fed officials to explain their moves beyond the FOMC statement.
The official said the FOMC didn’t see deflation as an immediate risk, and added that the current policies of the U.S. central bank are distinct from Japanese-style quantitative easing in that the U.S. central bank is instead focusing on assets.
Asked why the Fed shouldn’t set a target for market rates such as mortgages, the official said that such a step could be dangerous because it might lead to the central bank owning a large part of the market. It’s better to set quantitative indicators and adjust the size of intended purchases as officials take in the markets’ responses, the official said said.
No determination has been made about what maturities of Treasury securities the Fed might buy, the official said when asked to define the FOMC’s reference today to possible purchases of “longer-term” Treasuries.
To contact the reporters on this story: Craig Torres in Washington at ctorres3@bloomberg.net;
Monday, December 15, 2008
Foreign Demand for U.S. Long-Term Assets Weakens
http://www.bloomberg.com/apps/news?pid=20601068&sid=aZlQVDJAUgoo&refer=economyBy John Brinsley
Dec. 15 (Bloomberg) -- International demand for long-term U.S. financial assets weakened in October as foreign investors sold American stocks, corporate bonds and agency debt.
Total net purchases of long-term equities, notes and bonds slowed to a net $1.5 billion in October from $65.4 billion the previous month, the Treasury said today in Washington. Including short-term securities such as stock swaps, foreigners bought a net $286.3 billion, compared with net buying of $142.6 billion the previous month.
Foreigners sold a record amount of debt issued by mortgage- finance companies Fannie Mae and Freddie Mac and other agencies, offsetting demand for Treasuries. The rise in short-term holdings reflected investor demand for dollars as they sold longer-term assets, said Michael Woolfolk, senior currency strategist at Bank of New York Mellon Corp.
“Global investors, whether in the U.S. or not, are selling U.S. assets whether they are stocks or bonds,” Woolfolk said. “The radical swing between the long-term and short-term data reflects investors scared of being long anything and getting into cash.”
Economists predicted international investors would buy a net $40 billion of long-term securities in September, based on the median of five estimates in a Bloomberg News survey.
Stock Selling
Investors abroad sold equities for the fourth month in five, reflecting the biggest decline in stocks in 21 years in October. The Federal Reserve cut its benchmark rate to 1 percent on Oct. 29, its second reduction in three weeks and cited downside risks to growth.
The Standard & Poor’s 500 Index fell 17 percent in October, with the sell-off erasing more than $9.5 trillion in value of stocks worldwide. The dollar rose 4.9 percent in October, the third straight month of increases, according to a trade-weighted index of major currencies.
The Treasury’s reporting on long-term securities captures international purchases of government notes and bonds, stocks, corporate debt and securities issued by U.S. agencies such as Fannie Mae and Freddie Mac, which buy mortgages.
Foreign purchases of Treasury notes and bonds increased by a net $34.6 billion, compared with purchases of $20.7 billion a month earlier. Net foreign official selling of Treasury bonds and notes totaled $1.1 billion, after net purchases of $4.9 billion the previous month.
Treasuries
Two-year securities returned 1.1 percent in October, according to Merrill Lynch & Co.’s Treasury Master Index, for their fifth straight monthly advance.
Foreign demand for U.S. agency debt from companies such as Fannie Mae and Freddie Mac fell from a month earlier. Sales of long-term agency debt totaled a net $50.2 billion, compared with net purchases of $6.2 billion in September.
The Treasury’s figures include both agency debt and mortgage-backed securities and aren’t restricted to Fannie Mae and Freddie Mac bonds. Mortgage-backed securities of Ginnie Mae and corporate debt of the Federal Home Loan Bank System are also included in the report.
U.S. residents sold a net $36.3 billion of long-term foreign securities in October, compared with net sales of $35.4 billion a month earlier, the report showed.
China remained the biggest foreign holder of U.S. Treasuries, after its holdings rose by $65.9 billion to $652.9 billion. Japan, the second-largest holder, increased its holdings by $12.3 billion to $585.5 billion.
U.K., Caribbean
The U.K., which through London acts as a transit point for international investors, especially those in the Middle East, bought $21.9 billion of Treasuries, bringing holdings to $360.2 billion.
Caribbean banking centers, where many hedge funds are based, expanded holdings by $34.2 billion to $219.5 billion, the report showed.
Some economists say the difference between the trade deficit and securities purchased by foreigners is an indicator of how easily the U.S. can finance its external obligations.
The U.S. trade gap unexpectedly widened 1.1 percent in October to $57.2 billion as faltering global demand led to a third consecutive drop in exports, the Commerce Department said on Dec. 11.
Dec. 15 (Bloomberg) -- International demand for long-term U.S. financial assets weakened in October as foreign investors sold American stocks, corporate bonds and agency debt.
Total net purchases of long-term equities, notes and bonds slowed to a net $1.5 billion in October from $65.4 billion the previous month, the Treasury said today in Washington. Including short-term securities such as stock swaps, foreigners bought a net $286.3 billion, compared with net buying of $142.6 billion the previous month.
Foreigners sold a record amount of debt issued by mortgage- finance companies Fannie Mae and Freddie Mac and other agencies, offsetting demand for Treasuries. The rise in short-term holdings reflected investor demand for dollars as they sold longer-term assets, said Michael Woolfolk, senior currency strategist at Bank of New York Mellon Corp.
“Global investors, whether in the U.S. or not, are selling U.S. assets whether they are stocks or bonds,” Woolfolk said. “The radical swing between the long-term and short-term data reflects investors scared of being long anything and getting into cash.”
Economists predicted international investors would buy a net $40 billion of long-term securities in September, based on the median of five estimates in a Bloomberg News survey.
Stock Selling
Investors abroad sold equities for the fourth month in five, reflecting the biggest decline in stocks in 21 years in October. The Federal Reserve cut its benchmark rate to 1 percent on Oct. 29, its second reduction in three weeks and cited downside risks to growth.
The Standard & Poor’s 500 Index fell 17 percent in October, with the sell-off erasing more than $9.5 trillion in value of stocks worldwide. The dollar rose 4.9 percent in October, the third straight month of increases, according to a trade-weighted index of major currencies.
The Treasury’s reporting on long-term securities captures international purchases of government notes and bonds, stocks, corporate debt and securities issued by U.S. agencies such as Fannie Mae and Freddie Mac, which buy mortgages.
Foreign purchases of Treasury notes and bonds increased by a net $34.6 billion, compared with purchases of $20.7 billion a month earlier. Net foreign official selling of Treasury bonds and notes totaled $1.1 billion, after net purchases of $4.9 billion the previous month.
Treasuries
Two-year securities returned 1.1 percent in October, according to Merrill Lynch & Co.’s Treasury Master Index, for their fifth straight monthly advance.
Foreign demand for U.S. agency debt from companies such as Fannie Mae and Freddie Mac fell from a month earlier. Sales of long-term agency debt totaled a net $50.2 billion, compared with net purchases of $6.2 billion in September.
The Treasury’s figures include both agency debt and mortgage-backed securities and aren’t restricted to Fannie Mae and Freddie Mac bonds. Mortgage-backed securities of Ginnie Mae and corporate debt of the Federal Home Loan Bank System are also included in the report.
U.S. residents sold a net $36.3 billion of long-term foreign securities in October, compared with net sales of $35.4 billion a month earlier, the report showed.
China remained the biggest foreign holder of U.S. Treasuries, after its holdings rose by $65.9 billion to $652.9 billion. Japan, the second-largest holder, increased its holdings by $12.3 billion to $585.5 billion.
U.K., Caribbean
The U.K., which through London acts as a transit point for international investors, especially those in the Middle East, bought $21.9 billion of Treasuries, bringing holdings to $360.2 billion.
Caribbean banking centers, where many hedge funds are based, expanded holdings by $34.2 billion to $219.5 billion, the report showed.
Some economists say the difference between the trade deficit and securities purchased by foreigners is an indicator of how easily the U.S. can finance its external obligations.
The U.S. trade gap unexpectedly widened 1.1 percent in October to $57.2 billion as faltering global demand led to a third consecutive drop in exports, the Commerce Department said on Dec. 11.
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