Shots Fired

Posted: November 4, 2010 | Author: | Filed under: Global Financial Crisis | Tags: , , , | 42 Comments

I figured I better start a series of posts on the frontiers of our third war. You probably won’t be thrilled to hear that the General in charge of the theater is none other than Timothy Geithner.   The other general in the war is Ben Bernanke.  Feeling any better year?

Well,  ready or not, we may be in the very first strategic moves set out to wage a currency war and possibly a trade war.  The two superpowers in the battle are China and the U.S. who seem to be in a fight  to see whose currency can go the lowest.   Paul Krugman has written about this quite abit. Naked Capitalism actually had a superb guest post on the topic today. The Economist front paged the entire topic in mid October.

I’ll quote from one of The Economist’s major articles here.

Behind all the smoke and fury, there are in fact three battles. The biggest one is over China’s unwillingness to allow the yuan to rise more quickly. American and European officials have sounded tougher about the “damaging dynamic” caused by China’s undervalued currency. Last month the House of Representatives passed a law allowing firms to seek tariff protection against countries with undervalued currencies, with a huge bipartisan majority. China’s “unfair” trade practices have become a hot topic in the mid-term elections.

A second flashpoint is the rich world’s monetary policy, particularly the prospect that central banks may soon restart printing money to buy government bonds. The dollar has fallen as financial markets expect the Federal Reserve to act fastest and most boldly. The euro has soared as officials at the European Central Bank show least enthusiasm for such a shift. In China’s eyes (and, sotto voce, those of many other emerging-market governments), quantitative easing creates a gross distortion in the world economy as investors rush elsewhere, especially into emerging economies, in search of higher yields.

A third area of contention comes from how the developing countries respond to these capital flows. Rather than let their exchange rates soar, many governments have intervened to buy foreign currency, or imposed taxes on foreign capital inflows. Brazil recently doubled a tax on foreign purchases of its domestic debt. This week Thailand announced a new 15% withholding tax for foreign investors in its bonds.

Currencies are actually  my research area and I’m preparing for a series of papers and presentations on the ASEAN+3 area and the GCC area.  China is one of the +3.  The U.S. dollar is the peg for the GCC because of the influence of Saudi Arabia.  Every one has a stake in this including the European Union.    Anyway, let’s just say this is part of my thing and it’s a complex thing so I’m going to do a series of short posts on this to get every one more or less situated.

This is a quick introduction because I’m going to have to start with what’s happening tomorrow.   This situation is likely to be on the meeting table for APEC Forum starting tomorrow in Japan.  ( That’s the Asian-Pacific Economic Cooperative.)   Geithner’s trying to get the region to shrink their current account imbalances with the U.S. The current accounts are the accounting mechanisms for an open economy that deal with foreign trade.  They are bookkeeping entities where trade payments from exports and imports for goods and services as well as a few other things like any incomes made by citizens who work or invest in other countries are tallied.   The things that most international economists are interested in are the flows of imports and exports (the stuff and services) and the flows of capital (money, plant and equipment for businesses) between countries.  Of course, all this exchange and investing happens with the currency of the country.  It is the country’s medium of exchange.

As you know, the United States is the biggest customer in the world and we buy a lot of things from other countries.  That means we need their currencies to transact business there.  This also means the amount of their money floating around the world and the amount of our money floating around the world is important for trading or exchange of goods and services.  It’s also important because if you don’t buy, you invest, and if you invest, your currency goes into a financial market and earns interest. If that doesn’t happen you sell the currency for another one at the going exchange rate. The market for currencies also influences the levels of interest rates in the world among a few other things.  And, of course, the keepers of the currency–the Central Banks of a country are involved–hence our FED.  So, Bernanke watches exchange rates, amount of money floating around and  interest rates while Tim Geithner’s folks set up terms of trade between countries.  Terms of trade can include free, open markets or things like tariffs, quotas, and capital controls.  These things get set up in trade treaties and are usually negotiated frequently.  All of this stuff determines whether a country will outsource your job some place else and will fund a business someplace else instead of your town. It also determines what you can buy at your favorite store.

So,  what’s up with Geithner?

Geithner aims to use a Nov. 5-6 meeting of Asia-Pacific Economic Cooperation forum counterparts in Kyoto, Japan, to press his case for current-account deficit or surplus targets of less than 4 percent of gross domestic product. The proposal is also on the agenda for a Group of 20 summit in Seoul next week.

The U.S. has cited a glut of Asian savings for helping spark the credit crisis earlier this decade, while Asian officials now counter it’s the American central bank’s liquidity injections that are warping global capital flows. Geithner’s initiative is undermined by complexity in calibrating current accounts and a failure of similar efforts in the past.

“We have the outline routine of an impressive-looking agreement that literally changes nothing,” said Steven Englander, Citigroup’s head of Group of 10 currency strategy in New York. “Nevertheless in the short term investors are likely to be more impressed by the indications that U.S. and China are reconciled than by the underlying content of the reconciliation.”

Geithner’s plan was in part designed to broaden discussions beyond China’s exchange-rate policy, blamed by U.S. lawmakers and companies for keeping the yuan artificially low in a subsidy for local exporters. China may be open to the idea, a central bank adviser indicated last week.

And, what’s up with Brazil, the country that fired the opening salvo in this edition of Currency Wars? Well, according to that link at the FT, it seems that the word is not happy with Timothy Geithner.

Brazilian officials from the president down have slammed the Federal Reserve’s decision to depress US interest rates by buying billions of dollars of government bonds, warning that it could lead to retaliatory measures.
“It’s no use throwing dollars out of a helicopter,” Guido Mantega, the finance minister, said on Thursday. “The only result is to devalue the dollar to achieve greater competitiveness on international markets.”

At a joint press conference with president-elect Dilma Rousseff, outgoing president Luiz Inácio Lula da Silva said on Wednesday he would travel to the G20 summit in Seoul with Ms Rousseff, ready to take “all the necessary measures to not allow our currency to become overvalued” and to “fight for Brazil’s interests”. “They’ll have to face two of us this time!” he said.

Brazil and others are not happy with the Quantitative Easing 2 we talked about earlier today.  This is because it’s an attempt to stimulate the economy and it will cause there to be more dollars floating around the world.  Any one with a first semester class in economics should know that an increased supply means falling prices.  The price of money is on one hand, interest rates and in the open economy, it is also the exchange rate.  This means that U.S. goods will become cheap and every one else’s will look relatively more expensive.  U.S. folks should import less and be able to sell more abroad as exports.  If you’re trying to grow your economy on the back of the U.S. consumer’s appetite for stuff, that will now be more difficult.

Okay, so I’m reaching MABlue’s limit for me blathering on too long.  The links I gave you are pretty wonky and long.  I just wanted to bring up the topic and get you up to speed because this is THE NEXT big THING.  I’m going to try to keep up with what’s going on with the meeting and let you know more about the topic.

If all else fails, you can consider this a way to your good night’s sleep.

Congratulations! You’re an Investment Banker!

Posted: October 15, 2008 | Author: | Filed under: Equity Markets, U.S. Economy, Uncategorized | Tags: , | 1 Comment

Now what? 

Well, I suggest you start looking at the terms and conditions of our new portfolio and clients.  Right now, it’s $250 billion that you and I share with all the other U.S. Tax Payers.  So far, about $125 billion dollars has been divvied up among the major banks. In return for that investment, we get preferred stocks and warrants for common stock.   There are some sweeteners for us and a few for them.  This is the first of the plans that are supposed to ‘inject’ money into banks and ‘unfreeze’ the credit markets.  The release of similar plans by the Europeans on Monday gave us that huge bounce on Monday.  (Remember the one I thought could be a dead cat bounce and possibly is?)

The European plan also provided the structure for the terms of this deal as well as the impetus to move on it.

So, what goodies do our financial intermediaries get from the deal?

1)  The US will guarantee new debt issued by banks for three years. This means any bank that lends to another doesn’t have worry about getting it back.  That also means that they don’t have to hold a large amount in reserve for potential loan losses so it should expand consumer lending.

2)  The Fed will become the buyer of last resort for commercial paper.  This means if a bank is lending to a business in the short run to help it with its working capital needs for things like buying inventory or bridge loans to cover day-to-day business expenses, and the business defaults, the Fed will buy the commercial paper from the bank.  The bank will not suffer the loss.  This is again decreases default risk and means the banks don’t have to worry about upping their reserves for potential loan loses or holding back loans to businesses that may have less than stellar ratings.  A good example of businesses with less than stellar ratings are Ford, GM, and a lot of the airline companies.

3) The FDIC will offer an unlimited guarantee on bank deposits that are not interest bearing.  Since several European banks did this, this is a response to stop the possible flow of business checking accounts and payroll accounts to foreign banks.  There may be some consumer accounts, campaign, or non-profit checking accounts that get protection here also but it is primarily geared to businesses.

What do we get?

1) Bank Equity:  The government will get preferred shares and warrants for common stock with an expectation of a ‘reasonable’ return.   This means that the government gets first shot at any profits and dividends earned by the bank holding company.  No dividends can be given to common stock holders without first paying preferred stock holders.  Preferred stock also has priority in terms of ownership of any assets liquidated in a bankruptcy.  Most preferred stock does not come with voting rights.  A warrant is a security that allows the holder to purchase a share of common stock in that bank holding company at a specified price.  This price is usually higher than the current market price of the common stock. Some warrants stay attached to the preferred stock and basically serve to increase the yield on that stock.  Others can be detached and sold on the side.

The preferred stock that will be issued in this plan will pay special dividends.  At first, it will be at a 5% interest rate that will increase to 9% after five years.  The warrants will be worth 15% of the face value of the preferred stock. (The basic reason for the warrants is that if the stock goes up, the government can exercise the warrant, get the stock from the bank holding company, sell it on the market, and realize a profit.  These profits then go to the Treasury to pay down the Federal Deficit and offset the cost of the program.)

2)  Restrictions on Executive compensation for those institutions that sell shares to the government.  These restrictions include a clawback provision and a ban on golden parachutes as long as the Treasury holds equity issued under this program.

Clawback provisions are written in a way that the government can recover performance-based compensations to CEOs and other executives in the bank to the extent they later determine that performance goals were not actually achieved.  You have to write the specifics into the contract but usually it can be due to a restatement of financial results as well as some other reasons.  The restatement of the financial results usually has to be significant.  It can also kick in if there are determined to be some kind of misconduct. 

Gold parachutes are guaranteed severance compensation packages that  will executives receive if control of a company changes hands that results in a management shift.

Who do we own to date:

$25 billion:  Citigroup, JPMorgan Chase, Bank of America (parent now of Merrill Lynch), Wells Fargo (parent now of Wachovia)

$10 billion: Goldman Sachs, Morgan Stanley

Others with less than that:  Bank of New York, State Street and thousands of yet unannounced little guys.

Other issues:  At this time, the banks will not be asked to eliminate dividends.  CEOs are not required to resign.  All of the banks signed the agreement and entered into the deal so there would not be any stigma based on who needed the program and who did not.  We’ve basically just semi-nationalized the banking system in the U.S. 

Okay, so now we’re all investment bankers.  What I want to know is when do we get our bonus checks?

Just Survive …

Posted: October 12, 2008 | Author: | Filed under: U.S. Economy | Tags: , , , | 2 Comments

I’ve really wanted to talk about the financial crisis more.  It’s been hard to write about because things on the ground are changing so quickly. The deal right now is just to survive the entire thing. Times are odd and the odd are getting odder.

The oddest of the the odds is that there are more than just one economic positions being borrowed from Hillary’s plan by BOTH the surviving presidential contenders.  Both of these guys are completely clueless on the economy and it’s really showing. They are like little boys in a class room cheating off that one little girl with glasses that has all the answers.

This week,  Senator McCain became the liberal by suggesting a plan similar to Hillary’s suggestion of some kind of HOLC like the one that bought up bad mortgages during the depression.    Everything he’s been suggesting is so populist that I keep pinching myself to see if I’m actually awake. The Sunday morning talk shows were filled up with democratic talking heads trying to explain that buying folks’ homes at their underwater positions and renegotiating them is going to help banks more than the home owner.  This program is basically a re-tooled Roosevelt New Deal idea that is geared specifically to folks living in their homes, not the speculators. If you were all for the banks, the agency would bail out ALL mortgages, not just firsts for home owners. As a progressive, I have to say, for Democrats to be taking a stand against this position JUST because McCain introduced  into the debate and Obama just says no, is a little, well, odd, to me.

Another odder than odd policy suggestion is Obama’s idea to let judges work out families’ mortgage problems in bankruptcy court.  This is probably a good long term solution, but wouldn’t it be nice to stop these families from showing up in the bankruptcy court?  I’m actually wondering if prevention of a problem is something a lawyer can even wrap their brains around.  I mean, they make money from exacerbating problems once they’ve gotten huge in a court case, not from problem prevention so is this why he’s stumping for this at a time when short term solutions are required?  Even my first year economic students couldn’t figure out why you’d want to let the bankruptcy court work the foreclosures out.  Why not try to prevent the foreclosures? 

The next thing is the Pelosi hint at yet another stimulus package.  Just about any one ought to realize now that the first one really didn’t do much but hold the recession off a few months and make folks think of other things.  While it’s a nice thing to get $600 in the mail, the government can’t control what that money gets spent on.  It’s one thing if you take the money and buy something American, but most folks either use it to pay down debt which is not the least bit stimulatory or they go buy something that stimulates the Chinese economy. Unless you create a no buying at Walmart rule, this is nothing but another make them feel better while we figure out what to do plan.

 Economists have shown empirically with both the Ford and Bush rebates, that rebates are not the way to stimulate the economy because they don’t have the desired results.  They usually just exacerbate the debt and make folks feel a little better.  They are not game changers.  You need underlying changes to the tax codes to do that or you need the government doing spending on something that might have a chance at creating jobs–like building roads.  This is another Obama suggestion. The problem with infrastructure spending at this point is that it takes a long time to get through the system.  It is needed, but how long will it take to get the program going?  Infrastructure improvements are an important part of both short run economic stimulus and long run economic growth, but it’s a little late to start suggesting these things now that we’re in a full blown financial crisis and down turn in the real economy.  They’d have to be coming OUT of the hopper right now to do any real good; not going into the hopper some time ‘soon’.  Again, this is a preventative type of action once you see things are slowing down.  It wouldn’t be soon enough at this point.  This again leads me to believe that Obama doesn’t seem to grok the concept of preventative and when it’s useful. I was suggesting this a YEAR ago as a way of preventing a recession and slowing job loss when it does happen.  It’s a little futile now.  Hillary was suggesting this a year ago too.  That and her green jobs initiative were great suggestions for the situation at that time.

Which brings me to another odder than odd.  Senator Obama is now wanting some kind of tax credit to home owners for higher energy costs.  What I’m waiting to hear is how this is different from just giving every one a tax holiday from gas taxes except you have to wait until the beginning of the year to file for it.  Again, every time you talk about a one time deal, even if it is a tax thing, every one knows it’s a one time deal and it doesn’t really change their behavior.  Any stimulus that comes from it tends to be very short-lived.  Plus, by the time any tax credits would take effect it will be the spring.  Not one economist will probably stick their head out to say what kind of things will be needed by then.  It doesn’t make sense to try to do that now.

Right now, Henry Paulson is the most important man in Washington.  It’s not the President and it’s not these two candidates.  The second most important man is Ben Bernanke.  Again, odder than odd because neither of these men are elected and both of these men may have very short tenures at the helm. However, I’m just hoping Dubya takes some time off at the ranch.  I know I can’t wish that one for every one up for election right now, but I really would like it.   It is in the hands of Paulson and Bernanke until January.  I’m okay with that because Paulson, btw, is not what the Republicans or the Democrats spin would make him to be. 

Paulson has always been odd for both a Wall Street and Washington insider.  Paulson is a man that grew up on a farm in Illinois and got into Dartmouth the old fashioned way–good grades.  He wasn’t a legacy of any one unlike our current crop of candidates AND the president.  His nickname is “the Hammer” because he’s seen as relentless.  He is also a devout Christian Scientist who does not drink or smoke and goes back to Illinois on the weekends. He did this even when he was on Wall Street.  He lacks ideology and has been criticized by the right of being selling out free-market principles  and on the left for bailing out his Wall Street buddies.  I always consider being criticized by both sides a good thing in a public servant, but then that’s me.

Now we seen a joint effort from G-7 countries to contain the contagion.  Almost all of these plans have to do some with some kind of nationalization of banks.   This includes McCain’s suggestion to get the taxpayer ownership which oddly enough was snuck into the bailout package, unknown to many.  I’m wondering where THAT came from.  Perhaps we’ll find some one taking the credit for that soon, but it seems it might actually be some one like Republican Senator Arlen Specter.  Again, odd, odd and odder.

Meanwhile, my strategy and tactics are just to survive with my job and my loans paid down. I’m also trying to put a little money aside in the bank.   I’m trying not to look at my 401k plan because it’s telling me that I will die at the podium at this point.  I haven’t changed anything about it except all my new contributions are going into bonds.  That’s my suggestion to every one right now, don’t panic, we’ve been here before, we just don’t know how long it’s going to last.  I actually do have faith in Paulson and Bernanke but not so much in ANYONE running for election right now.  Right now,  McCain is sounding like the Roosevelt liberal right now and Obama is sounding very moderate so turning to politics for economics signals right now just has me checking my hands to determine which is left and which is right.  I still know which way up and down are and that we’re in for more downs than ups for awhile.  Other than that, I have NO idea what to say other than it’s an odd time right now and the odd are just getting odder.

Bottom line:  Just try to survive.

Crisis Strategy: Getting it Right the first time

Posted: September 28, 2008 | Author: | Filed under: Uncategorized | Tags: , , | 8 Comments

(Cross-posted at The Confluence)

There are very little details out in the public concerning the supposedly ironed-out terms that will solve the current financial crisis.   Almost every one is worried that the terms of the rescue will involve taxpayers bailing out Wall Street High Rollers and their bonus-loving CEOs.  If you review Financial Economics literature, you will discover that there are several findings in the studies done by economists that can provide guidance to every one on the best way to approach the bail-out.  One of the most recent studies comes from the International Money Fund.  It is by Luc Laeven and Fabian Valencia and was posted this month at the IMF research website.

If you’re not familiar with regression analysis which is the analytical method of choice here, stay away from the last half of this paper.  However, you may find some interesting things in the first section because it includes a huge database that looks at all systematically important financial crises between 1970 and 2007.  This means the database has 42 crises in 37 countries. It looks at steps taken by government to solve these crises and the length and depth of the crisis.

Here’s the link:  http://www.imf.org/external/pubs/ft/wp/2008/wp08224.pdf

Another good source of information for suggestions is the Brit Magazine The Economist.  Many of its articles are also available on line and are not technical in nature.

If you’re not up to looking at the details, let me try to explain some of the things that Financial Economists have learned since the Great Depression.  You should look for some of these dos and don’ts when we finally get to see the details of the plan. Sixty years of study and growing theories has shown us that the tactical approaches–which mostly involve containing the crisis–are very expensive and don’t work too well.  Usually, containment approaches happen while the crisis is unfolding.  As an example of this, I will point to the bail-outs of individual banks and financial institutions that have happened to date.  We’ve seen this containment tactic most of this year.

Governments can respond to these kinds of crises in many ways.  In a lot of cases, we see reallocation of wealth from taxpayers to Banks and other institutions that hold debt. When wealth transfers like this happen, many problems happen in the general economy.  The existing research done in this area shows that providing assistance to banks and their borrowers can actually increase loan losses to banks and in many cases lead to laxes in regulation that can be abused. Study-after-study shows that individual bank bail-out is usually not a good approach.  Other costly and not that efficient tactical steps can include accomodative policies like direct government guarantees of bank liabilities or injecting ‘liquidity’ into the bank itself by lending money to the bank.  The literature shows that none of these steps necessarily lead to a speedier recovery.

So what strategies can our country adopt to staunch the current crisis?  Proposals vary, but a good example of something that worked would be the comprehensive plan we had back under the first Bush administration during the S&L meltdown.  The RTC (Resolution Trust Corporation) was set up in 1989 to deal with the many, many S&L bankruptcies.  The purpose of the RTC was to dispose of failed S&L assets in a way that didn’t drive prices on the properties and assets down.  It put a bottom price on things like farm land or houses that were the underlying assets held by the thrifts.  In the case of situation now, a new ‘agency’ would buy troubled mortgage-backed securities from the market and hold them until there was a turn around in their value.

This new agency could also serve another purpose similar to a depression-era institution called the Home Owner’s Loan Corporation.  Hillary has suggested this type of agency whose purpose would be to buy and restructure existing mortgages.  This would basically keep many folks in their homes with mortgages they could handle.  For this to work, it has to be geared towards folks that can actually follow-through and make their payments.  It could not be a social largess program because that would only create more loan losses in the long run.  It’s purpose would be to keep folks in their homes as well as put faith back into house prices and the mortgage market.  It would also alleviate the downward pressure on home prices.  A new agency would be allowed to hold the loans and troubled securities until the market function agains and the assets once again become valuable.  Many of the assets in some of these securities are fine now and could just be repackaged.  The profits need to be returned to the taxpayer and used to pay down the debt.  We should ensure that the proceeds do not go to any politician’s pet project.

At the same time, we need to look for better oversight of derivatives markets.  The big issue that can be layed squarely at the feet of the Bush Administration and Greenspan is their inability to see the need for regulation of these markets.  The existance of this market (which serves a similiar function to insurance) injected more ‘moral hazard’ into the banking community.  This means if you think you’ve got something insured, you’re more likely to act haphazardly.  We already had banks being encouraged to loosen their underwriting standards for certain borrowers by Fannie and Freddie.  With the invention of these innovations, banks were covered, or so they thought, even if they did practice lax lending standards.  These derivatives were an attempt to manage credit risk.  However, as we have seen, actually placing accurate vales on this contracts just created more uncertainty.  The implied consent and guarantee of the government via Fannie and Freddie exacerbated the misvaluation in a market with no oversight.  We need to re-visit the regulatory responsibilities of the SEC and the FED and update them so that they reflect the existence of these extremely sophisticated and difficult to understand markets.  Also, something has to be done about Fannie and Freddie and how their role to feed loans to creditworthy middle class Americans warped into some social engineering plan that began the lax lending standards and provided opportunities for exploitation.

So, do we need a bail-out?  Yes.  Unfortunately, financial contagions do act as a disease and can create economic downturns that impact everyone.  All you have to do is crack a book on the Great Depression to see how problems in banks and stock markets eventually transfer over to Main Street.  What is needed is the least expensive and most prudent approach.  The literature tells us that it must be systematic and not just tactical.  You need to strengthen the market, not just select players.  I’ve outlined a few things that financial economists have learned about past crises.  I’d hope we get the details out pretty soon so you can look and see if the bailout is consistent with these principles.

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