Read the BIS report.

I did. They make an interesting case and they’re a very respectable organization.

We are as close to a financial meltdown as we will ever be in our lifetime

We’re 1/2 way through it , Michael. I don’t want to understate it but I think we’ll be Okay as long as there aren’t any really big policy screw ups.

The positive yield curve is a necessary corollary of ensuring we do not spiral out of control.

yes it is, but you also have to be careful not to throw out the baby with the bath water homes. You can have generous liquidity provision without panicking on fed funds.

The US is the worst place hence where most action is needed.

I really don’t know what else they can do except more of the same if the need arises. However they will have to raise rates at some stage too. Certainly not yet, but some time in the middle of next year maybe.

look at headline rates of inflation and then look at core rates.See the LARGE difference.

It seems to be feeding through. In any event almost every indicator including inflationary expectations are rising Homer. This isn’t good.

That means headline inflation is not transmitting into overall prices in the economy

.

Or margins are getting squeezed which you never seem to care about because you don’t think margins are important, do you?

Unsurprising really given how much most economies have been liberalised since the 70s.

Blame Bernanke for taking rates too far down when he may not have needed to. Bear’s failure was not the result of too high interest rates, it was that good old fashioned banking panic that did them in.

credit crunch means either disinflation or deflation.

yes, let’s hope we don’t come to that although it is possible next year.

You read Roubini of RGE. He’s not bad. Actually he excellent. he thinks we’re 1/2 through the damage.

We are as close to a financial meltdown as we will ever be in our lifetime.

The positive yield curve is a necessary corollary of ensuring we do not spiral out of control.

The US is the worst place hence where most action is needed.

look at headline rates of inflation and then look at core rates.See the LARGE difference.
That means headline inflation is not transmitting into overall prices in the economy. Unsurprising really given how much most economies have been liberalised since the 70′s.

credit crunch means either disinflation or deflation.

Can you tell me any Banks the ECB have had to bail out of late.
The worst thing they had to worry their heads about was the covered bond market not working.

At one stage last year they had a bigger requirement at their window than the Fed members, Homer.

Their monetary policy was already tight BEFORE the credit crunch and now it is tighter

.

Ho do you know it was tight in the first place, Homes?

Add that to the credit crunch and you have a guaranteed recession

Why?

You can’t say that. Recession is not guaranteed in the EU although the PIGS are looking shaky…. Portuagal, Italy, Greece and Spain. (that’s what Morgan Stanley call them. Funny hey?

As I said core inflation isnt a problem.

yes it is Homer, it’s a world wide problem at the moment. You’re just ignoring it.

By contrast the Financial system almost went into meltdown in the US.

So what?

That is why you have to produce a very steep yield curve up to three years. we saw Mac and Mae who were quite solvent almost go under because the market goes gaga and they lose liquidity.

So let’s have a permanent artificially engineered steep yield curve forever then and recessions will never happen.

Liquidity is still rare amongst banks and we are now at the stage market participants should be well over their abysmal lack of nerve.

Financial markets go through cycles, Homer and it takes time to clean the balance sheet out and start again. You’re very impatient these days.

The US was always going to have a slowdown/recession whereas Europe could have easily avoided it

And tell us exactly how Europe could have avoided it Homer?

Can you tell me any Banks the ECB have had to bail out of late.
The worst thing they had to worry their heads about was the covered bond market not working.
Their monetary policy was already tight BEFORE the credit crunch and now it is tighter. Add that to the credit crunch and you have a guaranteed recession .Why?
As I said core inflation isn’t a problem.

By contrast the Financial system almost went into meltdown in the US.
That is why you have to produce a very steep yield curve up to three years. we saw Mac and Mae who were quite solvent almost go under because the market goes gaga and they lose liquidity.

Liquidity is still rare amongst banks and we are now at the stage market participants should be well over their abysmal lack of nerve.

The US was always going to have a slowdown/recession whereas Europe could have easily avoided it.

Will you tell Uncle Fyodor or will I? He will only be a litle angry with you homer so don’t be afraid.

Okay fine I will.

Uncle Fyodor, Homes wants to fess up to having defended nazi economics over at Catallaxy for at least 3 months now. He’s very embarrassed and wanted me to tell you.

In case you didn’t know. ” michael K” is Homer wearing a cheap blond wig and black mustache as a disguise (he can’t even color co-ordinate properly). I’ll fisk him first, please.

With respect Fyodor the ECB has not had to deal with the problems imposed by the credit crunch that the Fed has had to.

European banks have also suffered sever losses from the credit crunch homer.

Bernanke simply should have got the FFR down to 1% and so got the yield curve out to 3 years as steep as possible as soon as possible when the full implications became known.

Why 1% then, why not zero with quantative easing like the Japanese? Why is 1% magical Homer? With your solution oil would have got to 200 bucks a barrel a lot sooner. Theres no free lunch, Homer. You should know that.

At present US banks are in the do not make any loans because they might go bad territory.

But they would with a funds rate at 1%?

At some stage they will wake up and realise they have to make money. Make this as easy as possible for them at first because of the consequences.

They are making money for the most part, homer. If you had bothered to look at the last reporting season US banks are making money on ongoing operations. Citigroup made round $6.3 billion for the quarter from on-going operations before write-downs, which isnt to be sneezed at. Write-downs took them to a loss of around 2.5 bill for the quarter.

The Fed essentially had no choice because of how parlous the financial system was.

Yes we know that homes. Markets are suggesting he panicked.

The ECB are fighting yesterdays war in inflation. A credit credit is either disinflationary or deflationary depending on its severity.

I thought you said the ECB didnt have to contend with a severe situation like the Fed? Now you seem to be suggesting the opposite?

No country is showing any signs of headline inflation leading to increased core inflation.

What star constellation are you visiting at the moment, Mr. Hitchhiker?

The time to push interest rates up is when the financial system is back in good health otherwise you give yourself a needless recession which is what will happen to Europe.

Leaving aside a commodity price boom that takes away everything you handed over in interest rate cuts. Theres no free lunch, homes. I keep telling you this and you seem to ignore it.

With respect Fyodor the ECB has not had to deal with the problems imposed by the credit crunch that the Fed has had to.

Rubbish. European banks are in an awful state, and have been hurt by the same dearth of liquidity.

Bernanke simply should have got the FFR down to 1% and so got the yield curve out to 3 years as steep as possible as soon as possible when the full implications became known.

At present US banks are in the do not make any loans because they might go bad territory.

At some stage they will wake up and realise they have to make money. Make this as easy as possible for them at first because of the consequences.
The Fed essentially had no choice because of how parlous the financial system was.

The ECB are fighting yesterdays war in inflation. A credit credit is either disinflationary or deflationary depending on its severity.

No country is showing any signs of headline inflation leading to increased core inflation.

The time to push interest rates up is when the financial system is back in good health otherwise you give yourself a needless recession which is what will happen to Europe.

Homerkles, noone is suggesting that interest rates should be increased. I think it’s apparent that both the USA and Euro-area will experience a major economic slowdown, and probably a recession, regardless of monetary policy over the past year. The difference is that by moving too hard, too early, Bernanke has left himself little leeway to deal with the real-economy crisis that is approaching rapidly. The ECB, in contrast, still has plenty of flexibility – i.e. the capacity to ease aggressively – on this score.

Additionally, it’s not the responsibility of the Fed to improve bank profits by steepening the yield curve. A reckoning is required for the global banking system, and this requires a cleansing of bad assets, bad management and bad banks. Cutting the FFR to 1% or lower precipitously won’t enable the US to avoid that. What it will do, however, is make the job of managing inflation that much harder on the way out of the downturn/recession. The ECB understands this; it appears that the Fed does not.

Bernanke simply should have got the FFR down to 1% and so got the yield curve out to 3 years as steep as possible as soon as possible when the full implications became known.

At present US banks are in the do not make any loans because they might go bad territory.

At some stage they will wake up and realise they have to make money. Make this as easy as possible for them at first because of the consequences.
The Fed essentially had no choice because of how parlous the financial system was.

The ECB are fighting yesterday’s war in inflation. A credit credit is either disinflationary or deflationary depending on its severity.

No country is showing any signs of headline inflation leading to increased core inflation.

The time to push interest rates up is when the financial system is back in good health otherwise you give yourself a needless recession which is what will happen to Europe.

The swap lines between the CB’s has proven to be an excellent decision. It may have saved the Swiss.

Is there a difference any longer (or at the moment) between access to the Fed window and last resort that was once supposed to be at penalty rates?

I think the fed is making a big mistake here. Leaving their short term interest rate policy aside. They are basically allowing (say) Goldman Sachs access to the Fed window that doesnt appear to have any liquidity problems and Wachovia who does. Moreover they seem to be focused on the security being offered as collateral rather than the entity coming to the window.

So in a sense, as far as i see it, their interest policy, last resort and liquidity provision has morphed into one.

If Im right on this then Im pretty sure Bagehot would have taken a pretty dim view. However hindsight is always a better judge.

If you read the first quotation from Bagehot above @ #10, you’ll see that Bagehot wasn’t so concerned about the status of the borrower (from the LLR), but was concerned that their credit should be good (i.e. the collateral is important) and that system panic be avoided. I don’t see a problem with investment banks being given access to LLR facilities at commercial rates, particularly when it is the commercial banks’ exposure to investment banks that is the locus of much systemic risk at the moment. Bear Sterns was too big to fail because its failure would have threatened the likes of BoNY and JP Morgan because of their involvement in tri-party repo facilities that Bear was using to fund itself. The Fed’s opening of liquidity facilities to the investment banks is simply belated recognition that these entities are part of the banking system. That has big consequences for their regulation.

However, back to the original point: providing broader access to LLR facilities is not the same as cutting the Fed Funds Rate – contrast the behaviour of the ECB, which has maintained benchmark interest rates while still pumping liquidity into the Euro-area banking system. My suspicion is that in a couple of years we’ll look back at Bernanke’s actions and conclude that he panicked and cut the FFR too early, particularly given the likely (IMO) scale and duration of the economic downturn the USA is entering.

Patrick, I wonder if theres all that much difference between the dynamics at work in private equity and hedge fund operations vs say listed investment banks. Arent they all mostly playing with OPM and hence (reputation aside), dont they tend to have a great deal more upside than downside?

Yes, I agree with that. It is probably one of the institutional structures you mention.

Youre confusing the provision of liquidity to the market as Lender of Last Resort, and the overall supply of money. These are different issues,

Is there a difference any longer (or at the moment) between access to the Fed window and last resort that was once supposed to be at penalty rates?

I think the fed is making a big mistake here. Leaving their short term interest rate policy aside. They are basically allowing (say) Goldman Sachs access to the Fed window that doesn’t appear to have any liquidity problems and Wachovia who does. Moreover they seem to be focused on the security being offered as collateral rather than the entity coming to the window.

So in a sense, as far as i see it, their interest policy, last resort and liquidity provision has morphed into one.

If I’m right on this then I’m pretty sure Bagehot would have taken a pretty dim view. However hindsight is always a better judge.

You’re absolutely right, JC, the real issue is leverage. I guess part of what I was trying to get at is the role of institutional structures in enabling and encouraging its growth. Skewed financial incentives have played such a destructive role in almost every nook and cranny of this credit boom and it seemed to me the listed investment bank structure has significantly altered the risk/reward balance for their managers compared to the old partnership model. As with the 2/20 hedge fund model, decisions about risk and leverage can so easily end up being made (subconsciously or not) on the basis of heads I win, tails I don’t (or at least, nowhere near as much).

Patrick, I wonder if there’s all that much difference between the dynamics at work in private equity and hedge fund operations vs say listed investment banks. Aren’t they all mostly playing with OPM and hence (reputation aside), don’t they tend to have a great deal more upside than downside?

Anyway, I accept the underlying point I think you’re both making, namely that this end of the street should be a business for consenting adults. Since I’m sufficiently old-fashioned in these matters to have as my ideal a specie based currency and free banking, I’m certainly not in favour of too many rules. Still, neither of those quaint ideas is likely to resurface in our lifetime and so we’re left with the difficult choice of how much (and where) to regulate. From your last comment, Patrick, I guess we’re more or less in the same camp on this one. Either let the risk fall where it may (and make very sure everybody knows this up front) or keep a pretty tight rein on the credit machinery.

Fyodor,

Ive simply reported something someone else has said.

No idea why you feel you can divine my views from my suggesting that people read something.

My mistake, Nicholas – I hadn’t realised you had quoted verbatim. Apologies.

So in a sense you are arguing that the US government has done pretty much what Bagehot suggested.

In terms of providing additional liquidity to the system and the protection of Bear Sterns’ creditors, yes.

The problem as I see it is that Bagehot would obviously have been talking from a gold standard perspective or a gold link (no this isnt a gold thread).

Bagehot was writing at a time when the gold standard was in operation, but it’s not relevant to this discussion.

This runs a little at odds with what the Fed has been up to in terms terms of the massive downward move in short terms interest rates. So weve had a pretty massive monetary stimulus through lower interests and the Fed window is open like a whore house door. In other words its not clear that Bagehot would be think it wise to lower interest rates and maintaining plentiful liquidity at the same time.

You’re confusing the provision of liquidity to the market as Lender of Last Resort, and the overall supply of money. These are different issues, and I agree that Bagehot would not necessarily have been in favour of dropping the cost of money in this circumstance.

What do you make of the Fed and Fannie bailout?

Probably necessary in the circumstances (i.e. massive losses on housing debt), though I’d prefer a clean nationalisation to this bullshit half-pregnancy. The government has no business subsidising shareholders. It’s ridiculous that the GSEs should have been allowed to dominate the market in the way they have. The government created this problem when it set them up in the first place.

How do you rate Bernankes performance?

Ask me again in three years. So far I’m less than whelmed.

Same sort of argument could I think be applied out here to the Macquaries, Allcos and B&Bs of the world.

Well, why? They are about half-owned by their own money. Note also that the private equity houses/hedge funds don’t appear to have been perceptibly better risk managers than Macquarie. Also, isn’t Goldman (also about half-owned by its own money) the industry standard of risk management?

That said, would that this were so, indeed:

The surge of deregulation in recent decades may have produced acceptable outcomes had it been twinned with the explicit removal of all official guarantees.

As an aside, a few people have been saying recently that investment banks (in the American sense) ought never to have been floated, that they should have remained private partnerships. I think thats absolutely right. With their own money (and that of whatever professional lenders they could persuade) on the line, their attitude to risk would probably have been very different.

Why, there have been plenty of shadow banks that were private partnerships that have failed in the past. it’s not the way they structure themselves that is the problem it’s the leverage being used. Bear went out of business leveraged at around 35:1.

And there isn’t much correlation with government support or oversight. Bear had no implied government guarantee and failed at 35:1. Fred and Fannie are running at around 135:1 with an implied government guarantee.

Same sort of argument could I think be applied out here to the Macquaries, Allcos and B&Bs of the world.

The only real bank in that group is Macquarie. Macquarie is a well capitalized bank with a strong balance sheet. All their satellites could fail and it wouldn’t touch their balance sheet. The other two are shadow banks and have no right to go to the RBA window. Investors and lenders should be aware of the risks involved. It’s their problem. If they fail it means there’s a opportunity for others to pick up cheap assets and start again.

Who knows whether Bear Stearns and Northern Rock were in fact solvent at the time of their demise. Simple truth is, I don’t think there’s any way of knowing. Even with the benefit of hindsight a few years down the track, I doubt the answer will be clear cut.

There are deeper issues at stake,I think, not least of which is whether deposit taking institutions in a lender of last resort system should be allowed to gear beyond a certain level or dabble in derivatives except to hedge their book. And yes, I know this is not always the easiest distinction to make.

The surge of deregulation in recent decades may have produced acceptable outcomes had it been twinned with the explicit removal of all official guarantees. That is, had reward been forcefully accompanied by a clear perception of risk. As it is, we ended up with something like the worst of both worlds; innovation and credit ran amuck against a background of sublime confidence in an ever present safety net and the apparent gains were mostly an artifact of a credit induced asset boom and the excessive consumption that progressively followed. Not excessive in any moral sense, by the way, just in relation to savings and investment.

Anyway, it’s a huge topic and there are no longer any easy answers, if ever there were. As an aside, a few people have been saying recently that investment banks (in the American sense) ought never to have been floated, that they should have remained private partnerships. I think that’s absolutely right. With their own money (and that of whatever professional lenders they could persuade) on the line, their attitude to risk would probably have been very different. Same sort of argument could I think be applied out here to the Macquaries, Allcos and B&Bs of the world.

The law (both in the US and here) is clear – there can be no expropriation of assets without due compensation. It is in the Constitutions of most countries.

There could be a case there was with Bear, Andrew. According to a reasonably good piece in Vanity Fair:

http://www.vanityfair.com/politics/features/2008/08/bear_stearns200808

The writer suggests that JP Morgan was prepared to offer 10 bucks a share at the outset but was told by the treasury secretary to pay only 2 bucks. Dunno if thats accurate but it sees the secretary sailed pretty close to the wind on that score if indeed it was true.

The objective of the Lender of Last Resort is to protect the system, not the shareholders of individual banks.

So in a sense you are arguing that the US government has done pretty much what Bagehot suggested.

The problem as I see it is that Bagehot would obviously have been talking from a gold standard perspective or a gold link (no this isn’t a gold thread).

This runs a little at odds with what the Fed has been up to in terms terms of the massive downward move in short terms interest rates. So we’ve had a pretty massive monetary stimulus through lower interests and the Fed window is open like a whore house door. In other words it’s not clear that Bagehot would be think it wise to lower interest rates and maintaining plentiful liquidity at the same time.

I’m not suggesting the Fed shouldn’t be committing to both actions, it’s just what I surmise Bagehot would think.

What do you make of the Fed and Fannie bailout? How do you rate Bernanke’s performance?

I’ve simply reported something someone else has said.

No idea why you feel you can divine my views from my suggesting that people read something.

Anyway, its clearly all about fractional reserve anyway. So your lying.

Heh.

Nicholas, you have the Bagehot “Rule” wrong. It is NOT to bail out failing banks; it is to provide liquidity to the SYSTEM when panic threatens it:

“A panic, in a word, is a species of neuralgia, and according to the rules of science you must not starve it. The holders of the cash reserve must be ready not only to keep it for their own liabilities, but to advance it most freely for the liabilities of others. They must lend to merchants, to minor bankers, to ‘this man and that man,’ whenever the security is good. In wild periods of alarm, one failure makes many, and the best way to prevent the derivative failures is to arrest the primary failure which causes them.” [from "Lombard Street", my emphasis]

Bagehot is also very clear about the “moral hazard” problem you identify but don’t label:

“Nothing can be truer in theory than the economical principle that banking is a trade and only a trade, and nothing can be more surely established by a larger experience than that a Government which interferes with any trade injuries that trade. The best thing undeniably that a Government can do with the Money Market is to let it take care of itself…If the banks are bad, they will certainly continue bad and will probably become worse if the Government sustains and encourages them. The cardinal maxim is, that any aid to a present bad Bank is the surest mode of preventing the establishment of a future good Bank.” [from "Lombard Street"]

The objective of the Lender of Last Resort is to protect the system, not the shareholders of individual banks.

Also, the Swedish and Japanese examples are radically different, precisely because of the accompanying macroeconomic policies and fundamental differences between the two economies. This renders a comparison pretty meaningless.

For those banking nerds (I’m looking at you, Reynolds) with an interest in the subject, the BIS report on the recent history of bank failures is a good primer on the different experiences across countries.

…for the assets they have voluntarily offered up in the hope of a greater reward you mean?

But yes, of course. If there’s money left when the customers have been sorted out, then give the shareholders their due.

If it’s in everyones best interests to keep the bank afloat, likewise fine. Although I suspect it’s most often management pushing this line, for obvious reasons.

Anyway, it’s clearly all about fractional reserve anyway. So your lying.

How is that a bad thing?

I understand the argument about speeding up a return to secure sources of business funds, but if this prevents lessons being learned.

Shorter me – to come down broadly on Willem Buiter’s side does not imply I have not understood the other side.