Month: October 2008

Insurance Companies Line Up for Treasury Bailout

One of the big stories on Friday and Saturday was the expansion of the Treasury recapitalization program to insurance companies. The Washington Post is acting as if it’s a done deal, while the Times and the Journal said only that it was being considered.

Insurance is one of the industries I know pretty well, as my company made software exclusively for property and casualty insurers, and I must admit I didn’t expect the crisis to show up in insurance so quickly.

Continue reading “Insurance Companies Line Up for Treasury Bailout” →

The Bank Lending Debate

For those who spend too much time reading economics blogs, there was a bit of a stir in the last few days over a paper by three economists at the Minneapolis Fed, which essentially said that bank lending to the real economy had not been affected by the supposed credit crisis. There were articles on the topic by Alex Tabarrok, Free Exchange, Mark Thoma, me, Tyler Cowen, Alex Tabarrok again, Free Exchange again, and Tyler Cowen again, among others. My main issue was that the charts in the paper said nothing about new lending, and my guess was that changes in new lending practices would take time to show up in measures of aggregate lending. (Other people raised more sophisticated issues, for example that companies were racing to draw down lines of credit after September 15 out of fear they might not be around for much longer.)

I want to point out one more source of information that might shed light on this question. Every quarter the Federal Reserve conducts a Senior Loan Officer Opinion Survey which asks how bank lending practices have changed over the past three months. In the July survey, every single measure of either willingness to lend or loan spreads (price of loan, less cost of funding) was at or above the tightest values (least willingness to lend, highest prices) seen in the last twenty years. Granted, these are measures of change in lending practices, but they still show a rapid shift in sentiment at banks. The October survey should be underway now, and it’s hard to see how it won’t look even worse.

Worry Global, Talk Local

The global picture continues to worsen and Friday was a pretty bad day.  I took part in a good summary discussion hosted by Jeff Brown on the Lehrer NewsHour last night. The topics ranged from the rising dollar to falling oil prices to Treasury’s investments in insurance companies to loan modifications for homeowners.

But I don’t think anyone should throw up their hands, abandon their personal strategies, or think that any part of the sky is falling.  Here’s why. Continue reading “Worry Global, Talk Local” →

Hedge Funds, An Impression

I try to read four newspapers before the day really starts, and also look through a couple of on-line sites.  I skim the lead economic stories and randomly dig all the way through the paper to the end of some business/financial stories.

Sometimes the news jumps off the page, and sometimes it seeps through.  Now, about two hours after looking at today’s weekend papers, I realize that something is stuck in my mind, rather like a tune that you can’t get rid of. Continue reading “Hedge Funds, An Impression” →

Financial Crisis 101 … by Paul Krugman

Paul Krugman has a reputation as an angry liberal polemicist. But he’s also very good at giving clear, simple explanations to some basic questions about the financial crisis. His recent interview with Terry Gross on Fresh Air covers a lot of fundamental topics and concepts, such as where the money for the bailouts comes from. Advanced readers probably won’t learn much, but newcomers could find it very helpful.

Smoke in the Eurozone

So far, rising spreads on credit default swaps have accurately predicted what sectors of the global economy would run into trouble next. The sharp rise in spreads on emerging market countries’ debt is old news. But recently, CDS spreads have been rising for countries that are part not only of the EU but of the Eurozone, such as Greece, Portugal, Ireland, and even Italy. The basic fear is that these countries may not be big enough to bail out their banks, so risk has spilled from the private sector into the private sector. The need for flexibility in monetary policy (currently ceded to the European Central Bank), the pain of a severe recession, and the increase in nationalist politics that often accompanies economic misery could lead one or more countries to abandon the euro. The costs of abandoning the euro would be very high, but it is a scenario that has changed from unthinkable to merely unlikely.

There are steps that policy makers can take now to reduce the threats of national defaults and of a fragmentation of the Eurozone. We discuss the situation and our policy proposals in a new op-ed in The Guardian.

Waiting for G7 Currency Intervention: It Won’t Be Long

Major currencies are on the move, big time, since yesterday.  The yen has risen to 91 yen per dollar (from 97) today.  The euro has fallen to nearly 1.25 dollars per euro (from 1.29).  You get the picture.

The G7 needs to slow down the disorderly run into the dollar.  This run is in danger of snowballing into a panic – as people fear further rises in the dollar (and falls in their local currency), they rush to buy more dollars (to cover debts in dollars and also to shift their portfolios), and so on.

Coordinated intervention, announced over the weekend most likely, will involve selling dollars, selling yen, buying euros and pounds.  This can calm things, by showing there are no one way bets.  (Will the Chinese be involved?)

But the global deleveraging (reduction in lending worldwide) will continue.  And this seems to involve more of a move into dollars that we previously thought.  So how long can even the most coordinated intervention hold the line?

Update: Typo fixed to clean up an inconsistency. Sorry for any confusion.

I Like the G20’s Chances, But They Need To Update Their Website

It is pretty common these days, at least in Washington, to pour scorn – or at least cold water – on the idea that a global summit could have much impact on the crisis.  I would count myself among the skeptics with regard to a mega-meeting with 100+ countries around the table, and it does seem like at least one of those meetings is scheduled for December or thereabouts.

But, in addition, President Bush has invited G20 heads of government to meet at one of his places (exact location TBA) on November 15. The G20 convenes the ministries of finance and central banks of 19 countries, and sensibly adds the European Union (represented by both the European Commission and the European Central Bank.) Continue reading “I Like the G20’s Chances, But They Need To Update Their Website” →

“Bailing Out” Homeowners Through Mortgage Restructuring

On Capitol Hill today, attention turned back to where this all started – delinquent mortgages. Sheila Bair of the FDIC is working on a program to encourage lenders and servicers to restructure mortgages by partially guaranteeing post-modification mortgages that meet certain criteria. Christopher Dodd is also considering new legislation in November to help homeowners. Here at the blog, we made intervention into the housing market one the four proposals in our first Baseline Scenario way back when in September, and we are planning to publish something more detailed in the next several days. But first, I wanted to lay out the nature of the problem.

Remember the wave of indignation that accompanied the “bailout of Wall Street” last month? Judging by some emails and comments I’ve seen, it could be even worse when it comes time to “bail out” delinquent mortgage holders. Much as people hate the idea of bailing out Wall Street “fat cats,” for some the idea of bailing out their neighbors – especially the neighbors in the new McMansion – is even worse. I think for some people it’s the idea that someone else is getting away with something that they could have done but chose not to (buying too big a house, in this case); by contrast, most people recognize they had little chance of becoming the CEO of an investment bank. OK, now that I’ve opened myself up to a flood of nasty comments, on to the substance.

Continue reading ““Bailing Out” Homeowners Through Mortgage Restructuring” →

We Have Problems; Emerging Markets Have Big Problems

The increasing damage the global financial crisis is inflicting on emerging markets has been getting a lot of attention lately (those are four separate links, for those with time on their hands), much of it very thoughtful. I would like to immodestly point out that my co-authors Simon and Peter were early to call this one (along with Nouriel Roubini, no doubt), in an op-ed in Forbes.com back on October 12.

That aside, it seems more and more likely that we are witnessing a repeat of 1997-98, just on a grander scale. Credit default swaps on Russian sovereign debt are trading at over 1,000 basis points, which essentially means that investors think the country is more likely to default than not – this just months after the high price of oil seemed to make Russia a dominant regional economic power, and just weeks after Russia was negotiating to lend money to Iceland (as of a couple days ago, it was still possible that Russia would participate in the IMF bailout of Iceland). Argentina, as Simon pointed out earlier, has the honor of being the first country to expropriate private property under the cover of the financial crisis. The Economist published a chart showing CDS spreads on sovereign debt across Eastern Europe showing that Ukraine, the Baltics, Hungary, Romania, and Bulgaria are all at risk. (Many of those spreads are already much higher than in the chart: Ukraine at 2617 bp, Russia at 1038, Turkey at 775, the Baltics between 650 and 1000.) Hungary in particular is showing eerie echoes of 1997-98, as the government takes emergency steps, including increasing interests rates by three full percentage points, to combat speculators betting that the currency will fall – a battle that few countries were able to win a decade ago.

Continue reading “We Have Problems; Emerging Markets Have Big Problems” →

Argentina on My Mind

In the various measures of vulnerability for emerging markets (middle income countries open to capital flows) that are now being examined and re-examined carefully, Argentina does reasonably well.  Its banking system does not appear to be highly exposed to problems in the US and Europe, and its macroeconomy – while not in great shape by any means – is far from being among the most dependent on continued capital inflows from abroad.

Argentina does produce and export a lot of commodities, and these prices are falling, so this creates a potential difficulty for government finances.  Still the government’s proposed response is a stunner: President Cristina Fernandez de Kirchner announced Tuesday that she plans to take over (i.e., nationalize) 10 private pension funds (the Argentine Congress would have to approve this; we’ll know soon how that will go).  The pension funds hold a great deal of government debt, so grabbing them would presumably get the government off the hook for that debt.  But what about people’s pensions?!?

Most importantly, does this indicate that governments around the world feel they can break contracts and expropriate property freely just because all economies have encountered some sort of trouble and many industrialized countries are “recapitalizing” something?  If the global crisis is becoming a smokescreen for confiscation, then our problems just got a lot worse.

Credit Crunch: Did We Make It All Up?

There is a paper by three economists at the Federal Reserve Bank of Minneapolis that is getting a lot of attention on the Internet today. (How often can you write that sentence?) V.V. Chari, Lawrence Christiano, and Patrick J. Kehoe set out to debunk four myths about the financial crisis:

  1. Bank lending to nonfinancial corporations and individuals has declined sharply.
  2. Interbank lending is essentially nonexistent.
  3. Commercial paper issuance by nonfinancial corporations has declined sharply and
    rates have risen to unprecedented levels.
  4. Banks play a large role in channeling funds from savers to borrowers.

In short, they are saying that despite all the hand-wringing about banks not lending to consumers and businesses, it just ain’t true, and even if it were, most lending isn’t done by banks anyway. The implication, to simplify somewhat, is that we are in a media storm of hype that may itself have negative effects.

While I would love to believe this, I don’t think they make the case conclusively. A few quibbles (for this to be understandable, you may have to look at the original paper):

  1. Continue reading “Credit Crunch: Did We Make It All Up?” →

Lehman CDS Settle; World Doesn’t End

Yesterday was the last day for settlement of credit default swaps linked to Lehman debt. One of the fears raised in the dark days of September was that the failure of a bank like Lehman would create hundreds of billions of dollars of liabilities for companies that had sold insurance on Lehman debt, and that market participants had no way of knowing who was good for that money, because many sellers were hedged and might be counting on payment from another seller, who might be counting on …

Well, the financial system is still standing. While we won’t know who lost money until the next quarterly earnings are announced, no one defaulted on the CDS. In part, this was due to the fact that as Lehman bonds fell in value, sellers of CDS had to post collateral to buyers, so a lot of the losses had already been recognized. (I believe AIG was an exception to this, because they had a AAA bond rating and hence did not have to post collateral until they were downgraded.) Perhaps things would have been worse without the many liquidity-increasing steps the Fed took over the last month; if you have to raise cash in a hurry, it is far easier to get it from the Fed now than it was in the past. In any case, it appears we have one less thing to worry about, at least for now.