Month: January 2009

Transparency And Power

Put this morning’s articles on Bank Rescue Plans in the Financial Times and the Washington Post next to each other, and you can see where we are heading.  (Remember: policy announcements need to be bigger than what is leaked, so expect headline numbers larger than floated here – the FT suggests “total buying power” of the initiative will be $1trn; I expect closer to $2trn.)

The foreclosure mitigation steps seem reasonable, although on the small side – with perhaps $80bn of the available $320bn from TARP II being committed here.  The heart of the matter is the banks’ balance sheets, including their toxic assets and presumably deficient capital.  The principles at work seem to be: Continue reading “Transparency And Power” →

Trial Balloons: Insuring The Bad Assets

The Administration is obviously floating ideas to assess potential reactions, particularly from Congress.  Today’s front page WSJ article on banking should be seen in this light.  It’s obviously not a fully-fledged proposal, but the concepts are there to elicit opinions and I don’t think it’s particularly helpful if we hang back.

The article raises the possibility that bad assets from banks will be divided into two parts, (a) bought by an aggregator bank, and (b) insured against further losses by the government.

We’ve covered the general principles of an aggregator bank and good/bad bank splits elsewhere.  Let me focus here on the specific (and credible) permutations in the WSJ article. Continue reading “Trial Balloons: Insuring The Bad Assets” →

Random Observations on the GDP Announcement

By now I imagine you know that GDP contracted at an annual rate of 3.8% in Q4, beating economists’ “consensus” prediction of a 5.4% decrease. (Why do people insist on calling an average of forecasts a “consensus?”) A few thoughts:

  • You can waste a lot of time looking over GDP statistics. Go to the news release page and download the Excel tables in the right-hand sidebar.
  • The “consensus” is that the reason for the positive surprise was an unexpected increase in inventories. (Goods added to inventory count as production, even if they aren’t bought off the shelves.) But . . .
  • With any set of numbers that add up to their totals, you can’t really find true causality. All you can do is point out numbers you think are particularly interesting. Another way to look at it is that the numbers were helped out a lot by short-term deflation, particularly due to falling gasoline prices. Personal consumption expenditures (PCE) , the biggest component of GDP by far, fell at an 8.9% annual rate in nominal terms. But the price deflator for PCE fell by so much – an annual rate of 5.5% – that in real terms PCE only fell at a 3.5% annual rate. That fall in prices was almost entirely due to the fall energy prices, which is highly unlikely to be repeated. But do people consciously reduce their spending in nominal or real terms? Nominal, I would think. So, as I “predicted” in December (I always have so many caveats that it’s not really fair to say that I ever predict anything), Q4 was better than expected, but Q1 is likely to be worse than predicted (before today, that is, since everyone is revising their Q1 forecasts down right now), since people will keep ratcheting down spending in nominal terms, but we won’t be bailed out by such a steep fall in prices.
  • The savings rate climbed from 1.2% to 2.9% – but it still has a long way to go (it was over 10% in the 1980s).
  • Real expenditures on food were down 4% (that’s not an annual rate, that means people spent 4% less on food in Q4 than in Q3). Ouch. I hope that was mainly a shift from restaurants to eating at home.

Back to more useful things.

Global Economic Outlook (Senate Testimony)

My written testimony, submitted to the Senate Budget Committee for today’s hearing is here (in pdf) and after the jump as a post.  This is essentially our new Baseline Scenario, although we’ll likely make a few small changes before putting it out as that.

You can watch the hearing here.  I was struck by how many questions were about what can be done for US housing.  The Senators expressed frustration that substantial further amounts are likely needed to shore up the banking system, yet little has been done for the underlying issues in housing.  They are also quite dubious of any bank recapitalization/clean-up scheme that leaves existing management in place. 

Several expressed a preference for tackling the fiscal stimulus, bank restructuring, and housing refinance together, to get a better handle on what we can and cannot afford.  Personally, I think that’s a sensible approach – as long as we move forward quickly on all three fronts.

Continue reading “Global Economic Outlook (Senate Testimony)” →

What Does “Private” Mean?

Yesterday, Tim Geithner told reporters, “We have a financial system that is run by private shareholders, managed by private institutions, and we’d like to do our best to preserve that system.” On its face, I think most Americans would agree that a private banking sector is better than just having one big government bank. But “private” can still mean a lot of different things. For starters, here are three: (a) day-to-day operations are managed by ordinary corporate managers who are paid to maximize profits, rather than by government bureaucrats; (b) those profits flow to private shareholders, rather than the government; (c) the overall flow of credit in the economy is determined by private market forces, rather than the government.

When people debate “nationalization,” it’s not always clear whether they are talking about ending (a) and (b) or just (b).  The recapitalizations to date under the TARP Capital Purchase Program have bent over backwards to avoid either one. Because the government purchased nonconvertible preferred shares, it has no ability (that I know of, although Robert Reich thinks otherwise in an article I’ll come back to) to turn them into common stock with voting rights that lead to management control; and because the shares pay a fixed 5% dividend, they are a lot like a loan, where any profits after paying off the loan flow to existing shareholders.

Continue reading “What Does “Private” Mean?” →

Senate Testimony Tomorrow

From 10am until about noon on Thursday (January 29th), I’ll be testifying to the Senate Budget Committee on a panel discussing The Global Economy: Outlook, Risks, and Implications for Policy.  I’ll post my testimony here after the session, and – potentially with some edits – this will also serve as the revised version of our Baseline Scenario.

Now would be a good time to tell me if you think there are important developments around the world, big or small, that we have overlooked recently.  And if you have other policy-related points that you think I should consider making, please post those as comments here also.

Long-Term Returns to Stimulus: Education

The fiscal stimulus debate is currently hampered by confusion over its objectives. On the one hand, one purpose of the stimulus is to generate economic activity quickly in order to boost aggregate demand and break the recessionary spiral we seem to be in. On the other hand, people rightly worry about the capacity of the government to spend large amounts of money quickly without wasting it, and argue that the money should be put to productive use, rather than paying people to dig holes and then fill them in again. (This is why you see (at least) two versions of criticism of the stimulus plan: on the one hand, the criticism is that the government is incapable of putting money to productive use; on the other hand, the criticism is that money for things like electronic health records will not be spent in time to have a short-term effect.)

My opinion is that both are valid purposes. There probably is a limit to the number of tens of billions of dollars the government can spend next month without wasting some of it. But given the projected duration of the output gap (the difference between potential and actual GDP, meaning that the economy is performing below its full-employment capacity), I think there is also value in programs that take several quarters to disburse their money – as long as those programs are also good investments.

One major area of spending is education, where the plan includes more than $150 billion in new spending over two years. While politicians (and economists) reflexively cite education as an area where investments can have positive long-term returns (through increases in productivity which increase GDP and our average standard of living), I wanted to see what empirical research there has been on this topic. There has been a lot of research on the impact on individuals’ earnings of additional education (this is a common example used in first-year statistics classes), but somewhat less on the impact on national economic growth.

Continue reading “Long-Term Returns to Stimulus: Education” →

The Scariest Blog Post Ever

Seeking Alpha is perhaps the largest financial blog/blog aggregator around. And for at least a week now, one of their “most popular” posts has been The Scariest Chart Ever. Take a look. Then come back here.

The chart itself isn’t very scary. It shows that the amount borrowed by banks from the Federal Reserve – “Borrowings of Depository Institutions from the Federal Reserve” – has spiked from a trivial level (a few billion dollars) to several hundred billion. It sat at a trivial level because, in ordinary times, there is no reason for a bank to borrow at the discount window when it can borrow instead from another bank at a lower rate (since the Fed funds rate is usually lower than the discount rate). It has spiked up recently as a symptom of the credit crisis; basically, what the chart shows is that the Fed is doing its job of providing liquidity in a crisis.

What’s scary is that the author of the post claims that the chart shows “federal borrowing,” called it “the scariest chart ever,” and concluded, “Anyone still think there are not some rough patches down the road?” . . . and then this became the most popular post on the most popular financial blog in the world. And even though a few people (including me) tried to point out the basic error, the vast majority of the comments pile on to the idea that this chart shows a huge spike in government borrowing.

This is scary (actually, depressing might be a better word) for those of us who think that blogs (and the Internet in general) can serve a valuable purpose in disseminating useful information and allowing constructive discussion. It also points to the importance of financial education, although maybe this example is more about basic verbal education (read the title of the chart) and numerical education (read the numbers on the Y axis: if the chart says that government borrowing was a few billion dollars as recently as 2007, then there’s something wrong).

Update: I should point out that in general I think Seeking Alpha provides a useful service by aggregating information from a wide variety of blogs and using community techniques to filter through them. Among other things, they republish some articles that Simon and I write here. This example just shows that sometimes the community filtering technique produces weird results.

Meanwhile, Elsewhere . . .

All the hubbub about the new Obama Administration and the probably-impending bank rescue plan has diverted my attention a bit from goings-on in the rest of the world. I decided to spend a little time checking in, thanks to the magic of the Internet. And things do not look so good.

  • Japan, in what looks like sign of desperation, announced a plan to buy shares directly in companies (not just banks) that are having trouble raising capital. The idea seems to be that, since companies are having trouble borrowing money from banks, they should get it from the government instead. This looks like a much broader and more direct intervention – deciding who gets capital and who doesn’t – than anything that has been contemplated in the U.S.
  • Germany, the largest economy in the EU and one once thought to be relatively safe in the current crisis (as compared to the U.S. or the U.K., with our overgrown financial sectors), is now projected to see a contraction in GDP of over 3% (composite Bloomberg forecast) – but still struggled to pass a stimulus package of $65 billion – or 2.5% of GDP – over 2 years.  And despite an annual government deficit under 3% of GDP (ours is over 8% by comparison), the political pressure is to reduce the deficit and return to a balanced budget out of fear of inflation. This only highlights the tensions within the Eurozone between countries with different economic situations and priorities.
  • The Institute for International Finance projects that net private sector capital flows (investments, whether direct investment, equity, or debt) to emerging markets will be $165 billion in 2009, a staggering 65% drop from 2008. Commercial banks are expected on balance to withdraw $61 billion from the region. As a result, regions such as Eastern Europe whose recent growth was dependent on foreign lending are likely to contract for some time to come, as companies are unable to refinance their debt.
  • Robert Zoellick, head of the World Bank, estimates that the economic crisis has pushed 100 million people around the world into poverty.

One of the themes of this crisis has been that whatever problems we have here in the U.S., countries with weaker borrowing power, currencies, social safety nets, and financial sectors face much bigger problems. That isn’t changing.

To Save The Banks We Must Stand Up To The Bankers

The Financial Times has just published an op ed by Peter Boone and me, arguing that aggressive bank recapitalization and toxic debt clean-up is essential in the U.S. – and that this can be done with strong protections for taxpayers and without nationalization.  The FT did a great job cutting our draft down to fit their print edition (of Tuesday, January 27th); I don’t think they took out anything crucial.  But, just in case, after the jump is the full article as submitted.

(Note: newspapers usually like to choose their own titles for op eds, and the FT is no exception.  But I like their choice and I’ve used it as the heading for this post.) Continue reading “To Save The Banks We Must Stand Up To The Bankers” →

Sweden for Beginners

For a complete list of Beginners’ articles, see the Financial Crisis for Beginners page.

With the regularity of a pendulum, the focus of discussion has swung back to the banking system (September: Lehman and AIG; November: Citigroup; January: Bank of America, and everyone else). And as everyone waits in anticipation for the Obama team’s first big swing, there has been increased discussion of . . . Sweden, including a recent New York Times article and a fair amount of blog activity, with a broad overview by Steve Waldman. (For other accounts, see this Cleveland Fed paper and a review of the crisis published by the Swedish central bank (which, according to Wikipedia, is also the world’s oldest central bank).)

Why Sweden? Because Sweden had its own financial crisis in the early 1990s, and by many accounts did a reasonably good job of pulling out of it. A housing bubble, fueled by cheap credit, collapsed in 1990, with residential real estate prices falling by 25% in real terms by 1995 and nonperforming loans reaching 11% by 1993, while the Swedish krona fell in value by 30%, hurting a banking sector largely financed by foreign funds. As Urban Backstrom said in a 1997 paper, “[the] aggregate loan losses [of the seven largest banks] amounted to the equivalent of 12 percent of Sweden’s annual GDP. The stock of nonperforming loans was much larger than the banking sector’s total equity capital.” In other words, the banking sector as a whole was broke.

Continue reading “Sweden for Beginners” →

The Emerging Political Strategy For Bank Recapitalization

Here’s a tough problem. 

  1. The nation’s leading banks are short of capital, and only the government can provide the scale of resources needed to recapitalize, clean up balance sheets, and really get the credit system back into shape.  Any sensible approach will put some trillions of taxpayer money at risk.  We should get most of it back but – as we’ve learned – things can go wrong.
  2. Everyone hates bankers right now, and these feelings only deepen as we learn more about how the first part of the TARP was spent and mis-spent.  No one wants to hear about anything that sounds like a bailout to bankers and their careers.

How does the Administration and Congress sort this one out?  This weekend we seeing an approach take shape which, most likely, will work.  There are five closely related moving pieces. Continue reading “The Emerging Political Strategy For Bank Recapitalization” →

Davos World Economic Forum: A Viewer’s Guide

The big annual economic meeting at Davos opens next week (Jan 28-Feb 1 are the official dates), and the discussion there – in both formal and informal interactions – is worth scouring for indications of the current situation around the world and where we all may be heading.

Given the likely composition of the main players this year – world corporate leaders and the non-US policy elite (with the new US policymakers stuck at home, doing real work; update: this is now confirmed by Bloomberg for Summers and Bair) – I would suggest viewers at home and on the ground keep watch for answers to the following.

  1. Are we on the same planet? It is not unheard of for Davos participants to appear as if they are living in their own bubble.  Watch for opulent parties and excessive consumption, particularly if the people involved have nominated themselves for any kind of government handout.  If you meet someone from Merrill, ask if their attendance fees came out of 4th quarter earnings – or if there is still more bad news to come. Continue reading “Davos World Economic Forum: A Viewer’s Guide” →

Protectionism by Another Name?

One thing you can probably get 99% of economists to agree on is that a global trade war in the middle of a global recession is a bad idea. If every country increases import tariffs, hoping to protect its domestic industry from foreign competition, global trade will fall in all directions, hurting everybody. Put another way, increased tariffs are a negative-sum game.

To date, we haven’t seen much in the way of higher trade barriers during this crisis, although you could argue that some bailouts constitute subsidies favoring local over foreign companies. Instead, however, we are seeing friction over currency valuations. If you want to boost your net exports but don’t want to do the obviously unfriendly thing and increase tariffs, the other option is to devalue your currency: a weaker currency increases the price of imported goods and reduces the price of exported goods, hence reducing imports and increasing exports.

Yesterday, Tim Geithner accused China of “manipulating its currency,” something we’ve heard periodically over the last several years but not in much in the last few months. (Of course, Geithner then said that “a strong dollar is in America’s national interest,” whatever that means.)  Switzerland threatened to intervene on foreign exchange markets to suppress the value of the Swiss franc. And the French finance minister criticized the U.K. for letting the pound depreciate. (Hat tip Macro Man for the last two.)

Continue reading “Protectionism by Another Name?” →

The Long Bond Yield Also Rises

The spread between Greek government 10-year bonds and the equivalent German government securities rose sharply this week – Greek debt at this maturity now yields 6.0% vs. German debt at 3.1%.  Other weaker eurozone countries appear to be on a similar trajectory (e.g., Irish 10 year government debt is yielding 5.8%) and if you don’t know who the PIIGS are, and why they are in trouble, you should find out.

We also know East-Central Europe (including Turkey) has major debt rollover problems and most of that region is in transit to the IMF, with exact arrival times determined by precise funding needs relative to the usual political desire to keep the party going through at least one more local election.  Put the IMF down for another $100bn in loans over the next six months, and keep the G20 talking about providing the Fund with more resources.

But the big news of the week, with first-order implications for the US and the world, was from the UK where the prospect of further bank nationalization now looms.  Continue reading “The Long Bond Yield Also Rises” →