Author: Simon Johnson

The Inflation Is Coming, The Inflation Is Coming (?)

Citigroup management gets a great deal; you and I not so much.  Consensus on right sizing the fiscal stimulus increases by about $100bn per week.  The rest of the world drags its feet on anything approaching an appropriate set of monetary and fiscal policies (yes, I’m talking about the eurozone again.)  Where does this all point?

It points to inflation.  Inflation has many drawbacks and brings its own serious risks, but inflation is better than the alternative which, as President-Elect Obama said on Saturday, is now a deflationary spiral (falling wages and prices).  The policymakers are going all in and the question now, we argue in a piece on WSJ.com this morning, is whether inflation still lies within their reach.

Dawn of A New Interregnum

According to the official website of the President-Elect, there are 59 days until inauguration. Let’s call it nearly two months.  The good news is that President-elect Obama has begun to name his economic team, the line up looks strong, and they have plenty of time to get their plans in place.  The bad news is that the banking system may not have that much time.

We are now obviously in a delicate political phase, in which the Bush Administration is winding down and the Obama Administration does not yet have real power.  This matters because the US banking system is in a worse than delicate phase.  Contrary to the statements of Mr Paulson earlier this week, core US banks do not appear to be stabilized.  The fall in equity prices this week was a cause of serious concern, and we discussed the causes and potential (unpleasant) cures in our WSJ.com article on Thursday morning.  Since then the situation has only deteriorated, seen most clearly in the credit default swap (CDS) spreads for major banks, which moved up through Friday. 

This increase in CDS spreads means that the market believes the probability of some banks defaulting has gone up.  This is striking because the Federal Reserve at this point can make sure these banks never run out of liquidity.  So what is going on?

Partly people in the market are not sure that all parts of all (global) banks will be saved.  And partly they don’t know where the money for a bailout would come from. This is not just about whether TARP is or is not available to recapitalize banks, it is also about the not-so-good relationship between Congress and the outgoing administration.

Ask yourself this.  If the Bush Administration felt the need to raise, say, $1trn – see this week’s much cited FBR report on the capital needed by the banking system – and sought approval Congress in December, how well or badly would that conversation go at this point?  Could the new Obama team help?  What about when the new Congress arrives in the first week of January – would that make any difference?

We are in an awkward stage, facing major economic problems and with a potentially distracted executive branch.  We need to find some new ways to handle this transition between presidents.  And fast.

To Bail or Not To Bail, Banking Edition

This was a bad day for the market and a very bad day for banking; the credit default swap spread for at least one major bank rose above 400 basis points – a level of implied default probability that we have not seen since mid-October. 

Mr. Paulson suggested earlier this week that the government’s Troubled Asset Relief Program (TARP) take a break from bank recapitalizations, through at least January 20th (listen to today’s NPR story).  After today, I seriously doubt this is a good idea.  And I sincerely hope that the administration is preparing (another) policy U-turn. 

Potentially more sustainable approaches are suggested in my previous post (and the associated WSJ.com article).  Don’t be shy.  Congress in particular needs to hear your suggestions – post them here or call your favorite representative.  Just don’t urge inaction.

Testimony This Morning: Senate Budget Committee

Wednesday morning, starting at 10am, I’m on a panel testifying to the Senate Budget Committee about the need for a fiscal stimulus.  The other witnesses are Mark Zandi and John Taylor.

I’ll post my written testimony after the hearing. I expect to make three main points in my verbal remarks:

1) We are heading into a serious global recession, caused by and in turn causing a process of global leveraging (i.e., reduction in lending and borrowing).  We have never seen this kind of deleveraging – synchronized around the world, fast-moving, and with an unknowable destination.

2) I do not think we can prevent this deleveraging from happening.  Nor do I think we should even try to keep asset prices high (or at any particular level).  But in the United States we have the ability to mitigate some of the short-run effects and to lay the groundwork for a sustainable, strong recovery.  One sensible tool to use in this context is fiscal policy.  I lean towards smart spending programs, but as the economy continues to worsen, I think some kind of temporary tax cut could also help – it can potentially have relatively quick effects.  (Note: contrary to those who think that if tax cuts are saved by consumers, they are somehow “wasted,” I would point out that anything that improves consumers’ balance sheets is both good for them and for the financial institutions that lend to them.)

3) But there is a real limit to how far we can go with fiscal policy (and with other policy measures).  Irresponsible budget policies would not be a good idea – we need to continue a process of fiscal consolidation; it is most vital that people around the world remain confident in the U.S. government’s balance sheet.  Some of the highest numbers now being proposed for a fiscal stimulus are probably too high and a mega-stimulus could be counterproductive if it undermines confidence.

I’m proposing a fiscal stimulus of roughly 3% of GDP, to be spent over several years.  Given the uncertainties involved, this seems like reasonable middle ground – it’s enough to make a difference, but doesn’t promise a miracle; it can be spent sensibly and at an appropriate speed; and it will not undermine our ability to consolidate the U.S. fiscal position (i.e., bring government debt onto a sustainable path) over the medium-term.

Mortgage Restructuring Is Not Enough

Let’s be honest with ourselves.  Even if the outgoing Bush team or the incoming Obama administration can work out a scalable nationwide mortgage restructuring scheme, we will still have a housing problem in the U.S..  Specifically, we should expect a high proportion of restructured mortgages to default again within a year.  In a piece that appeared on Bloomberg this morning, Alex Stricker and I suggest that a more centralized process is needed to manage the flow of foreclosed properties onto the market, and we discuss some alternative ways to implement this idea.

There may be better ways to do this and we are completely open to suggestions – please post as comments here.  We only insist that this is one dimension of U.S housing that needs further careful consideration.

G20 Summit: Just Disappointing or Potentially Dangerous?

Initial reactions to the G20 summit are fairly positive, in the sense that the communique and associated press conferences conveyed (a) there was no open acrimony, (b) the body language was broadly supportive of countercyclical policies, and (c) there may now be a serious international regulatory agenda.

None of this is really new and it could all have been arranged by finance ministers (probably over the telephone), but I agree there is some useful symbolism in having heads of industrialized and emerging market governments convene for the first time (ever?) on these kind of issues.

I will admit to disappointment that no more explicit commitments were made to fiscal stimulus.  I thought the British and the French were heading in this direction, and that they could create some momentum in the right direction.  If Europeans (or anyone else) would like to compete for a “special relationship” with the US after January 20th, they might consider coming to the next summit with substantial fiscal package in hand (as will President Obama). 

If the latest rounds of global economic diplomacy were the Olympics, then China gets gold in the fiscal stimulus category, Germany gets silver, and the UK (so far) is the distant bronze – but the UK does get one more throw next week.  Not the ordering of world economic leadership that one would ordinarily expect, but perhaps that’s a good thing.

In the category of “largest cash contribution designed to save the world from serious disruption”, Japan easily finishes first – their $100bn pledge to the IMF this week was timely, targeted and hopefully not temporary.  Sadly, there were no other entrants in this category.  Perhaps the chemistry and cooking at the White House dinner on Friday will prompt further contributions in the near future?

But there is, unfortunately, another way to read the communique – as a government or international official, for whom this text really is a set of instructions to be implemented.  The whole first part of the document is generic and definitely not new, so – as an official – one’s eye skips through that quickly.  The real issue is the deliverables in the plan of action, with a pressing deadline at the end of March (this is pretty much like saying “do it tomorrow” to an official).  This is where we – an official reader is thinking – must concentrate our immediate attention and efforts.  And most of these specific actions are about tightening regulation on and around credit, or beginning processes that definitely point towards many dimensions for this kind of tightening – accounting standards, hedge funds, risk disclosures, financial sector assessments, credit rating agencies, risk management and stress testing models, international standard setters, sanctions for misconduct, reporting to supervisors in different countries, and more.

There is, of course, nothing wrong with making regulation more effective.  This is surely needed – in both the US and Europe, and probably elsewhere – to help lower the odds of another global financial crisis developing in the future.

But we are still not out of this crisis.  And tightening regulations quickly in the midst of a worldwide credit crunch is one good way to make sure that credit contracts further and faster.  Lending standards naturally tighten in a crisis; the issue to address going forward is how to prevent standards from loosening too much in the next boom – but this is at least several years down the road.  I’m in favor of starting early, but I do not like precipitate action just because you want to look busy and you could not agree on the more pressing issues, such as fiscal policy, support for the IMF, shoring up the eurozone, and so on.

It is true that one (among many) of the stated principles is: “Mitigating against pro-cyclicality in regulatory policy.”  But that is a general statement that is not mapped into operational requirements – except that the IMF and FSF should work together on this, which is a good way to make sure it doesn’t happen.  What officials have to deliver on, by the end of March, is substantive progress with regards to tougher and tighter regulation of credit.  There is a real danger that this action plan – within such a short time frame – can actually make the global downturn dramatically worse.

The G20 Summit: Europe’s Greatest Moment, Or Not? (And a Quiz)

From their pre-meeting, it is reasonably clear what Europeans (except probably the British) want from the G20 summit on Saturday: a road map towards a great deal more regulation, together with agreement that the necessary powers and resources will be provided to implement these new rules at some international level (which could be the IMF or the Financial Stability Forum or the G20, or some combination).

And the Europeans are now apparently saying, on the sidelines, that victory – and a concrete action plan – is within their grasp.  This, of course, raises our expectations and makes us more prone to disappointment.  The White House, on the other hand, has been trying to manage our (and the Europeans’) expectations downwards. 

While we are waiting to learn the outcome of what is probably still a fairly intense conversation, here is a (relevant) pop quiz.

Below is the list of locations for press conferences to be held by participating countries after the conclusion of the summit, kindly provided by Planet Money.  The question is: which of these countries is not actually a member of the G20?  (Answer after the jump)

European Union & France — Willard Hotel
Japan — National Press Club
Italy — Embassy
Australia — National Building Museum
United Kingdon— Ambasssador’s residence
Canada — Embassy
Germany— Ritz carlton Georgetown
South Africa — Park Hyatt Hotel
South Korea –Paloma Hotel
Argentina — Park Hyatt Hotel
Mexico — Embassy of Mexico
Spain — Mandarin Oriental Hotel
Russia — The Washington Club

Continue reading “The G20 Summit: Europe’s Greatest Moment, Or Not? (And a Quiz)” →

MIT Class on GM, G20 and Good News (if any)

Our next MIT class on the global crisis will run Tuesday, 4pm-7pm; live webcast available through a link on this site or directly through MIT Sloan.  Likely topics include:

  • Where do we stand in terms of the overall financial crisis?  Is it over yet?
  • General Motors: to bail out or not bail out?
  • The G20 Summit: good, bad or was it surprisingly ugly?

And we’d be happy to discuss other topics that you suggest here.

The class from last week is available to download (there was no class this week due to the holiday).

Update: you can preview some of the (GM and G20) issues under consideration in my podcast from MIT Sloan today.

China’s Stimulus, the IMF’s Forecast, and France’s G20 Agenda

What exactly is on the table for the G20 heads of government meeting in Washington at the end of this week?  One possibility is some sort of synchronized or joint fiscal policy stimulus in most G20 member countries.  (Yes, I know that the communique from this weekend’s meeting of finance ministers and central bank governors was somewhat on the vague side.)

Continue reading “China’s Stimulus, the IMF’s Forecast, and France’s G20 Agenda” →