In case you think you know what to do about the financial crisis

Read this (reproduced below the fold).

Should taxpayers bail out the banking system? One of the worlds leading international macroeconomists contrasts the Larry Summers dont-scare-off-the-investors pro-bailout view with the Willem Buiter they-ran-into-a wall-with-eyes-wide-open anti-bailout view. He concludes that either way, taxpayers are always the losers. The best policy makers can do is to be merciless with shareholders and gentle with bank customers.

Peter Englund, The Swedish Banking Crisis: Roots and Consequences, Oxford Review Of Economic Policy 15 (3): 80-97.

An old and familiar debate is back. Should taxpayers bail out the US banking system, quite possibly the British and European ones as well?

There are two standard views on the multi-trillion dollar question of who pays for getting us out of the financial crisis.

· One view is that the situation has become so desperate that ordinary citizens will in any case be paying a high price for the crisis; throwing money at banks right now might lower the overall burden by preventing a deep, protracted recession.

· The other view is that banks ought to be left hanging to pay for their sins. Governments ought to be worried about their taxpayers, not bank shareholders.

In fact, we dont have that much choice.

Too big to fail: the Bagehot rule

It has long been a poorly hidden secret that large banks cannot be left to go bankrupt. Walter Bagehot, a 19th century economist and editor of The Economist, designed the solution that remains as relevant today as it was then. The Bagehot rule is that the central bank ought to lend freely to a failing bank, against high-quality collateral and at a punitive rate (see Xavier Vives Vox column).

The modern version of the rule adds that shareholders ought to bear serious costs and the managers ought to be promptly replaced. This is exactly what happened with Bear Stearns last March, where another bank, JP Morgan, was used as the conduit for the operation. The cost to the taxpayers was a $1 billion guarantee and a $29 billion loan to JP Morgan guaranteed by Bear Stearns assets. We dont yet know if this was a taxpayer-financed bailout. If JP Morgan redresses the situation within ten years, the taxpayers will make a profit. If not, US taxpayers will have borne the burden. Bear Stearns shareholders were almost completely expropriated.

As the US economy keeps limping and the housing market deteriorates, most observers believe that there will be many more bank failures. Indeed, in early July, a large Californian mortgage lender, IndyMac, went belly up and was also subjected to Bagehots recipe. The possibility that some very large financial institutions, and many smaller ones, will follow provides urgency for the current debate.

The Larry Summers school of thought: Dont scare off the investors

One school of thought lets call it, fairly I think, the Larry Summers School is that the Fed has been far too tough with Bear Stearns. It has scared investors and managers alike. The result is that investors are now unwilling to provide much needed cash to banks that must rebuild their badly depleted balance sheets while bank managers strenuously resist acknowledging their losses and continue selling their toxic assets. As a result, the whole banking system is in a state of virtual paralysis, which means that borrowing is both difficult and costly.

Lowering the interest rate, as the Fed vigorously did, does not even begin to redress the situation. This all leads to a vicious circle where insufficient credit drags the economy down, which leads to more loan delinquencies, which further impair banks ability to lend. Memories of 1929 immediately come to mind, when the Fed made matters considerably worse by clinging to financial orthodoxy.

This school of thought fears that the same fascination with high-minded principles turns a bad crisis into another nightmare of historical proportions. The Larry Summers School wants the Fed to lend freely and more generously with the goal being to reassure potential investors. If that is done, so goes the argument, banks will be able to rebuild their balance sheets and resume their normal activities. This would signal the end of the now 1one-year old financial crisis as a virtuous circle unfolds more loans, a resumption of growth and the end of the housing market decline, healthier banks, and more loans.

The Willem Buiter school of thought: They ran into a wall with eyes wide- open

The other school of thought lets call it, a bit unfairly, the Willem Buiter School sees things in the exact opposite way.

The crisis is the result of financial follies by financial institutions that bought huge amounts of products that they did not understand the infamous mortgage-backed securities and their derivatives parked them off-balance-sheet to avoid regulation, and made huge profits in doing so. In short, they ran into a wall with wide-open eyes.

Once the all-too-well foreseen crisis erupted, these institutions kept hiding the extent of their losses as long as they could they are still playing that game and started to lobby for a bailout from their governments.

The classic credit cycle: lookLook whos crying now

This school notes that the crisis is part of a classic credit cycle that involves excessive risk-taking in good times and ends up in tears. The question is: whose tears?

The challenge is ensure that these are not the taxpayers tears. Indeed banks are in a unique position. They used to call for a bailout to protect their depositors, but deposits are now insured in all developed countries. Still, because bank credit is the bloodline of the economy, we cannot let our banking system sink. But once banks know that they can play the high-risk, high-return game, pocket the profits, and let taxpayers face the risks, bailouts provide a temporary relief but set the ground for the next crisis.

Wilder and wilder parties

Bank of England Governor Mervyn King nicely sums up the situation: ‘If banks feel they must keep on dancing while the music is playing and that at the end of the party the central bank will make sure everyone gets home safely, then over time, the parties will become wilder and wilder. Bagehot principles can be applied when one or two banks fail, but when the whole system is under threat, this is no longer an option.

Which school is winning with policy makers?

Both schools have developed consistent views. The dismaying part of the story is that they lead to radically different policy implications.

So far, the monetary authorities have been closer to the Willem Buiter School view, but things may be changing. The most recent bailout of Fannie Mae and Freddie Mac is clearly a soft rescue operation, with no set limits and, so far at least, no penalty on shareholders and managers. Even though Fannie Mae and Freddie Mac are very special institutions with a federal mandate, the Larry Summers School is right to see some glimmers of hope and therefore must be taken seriously.

In most respects, we have gone through a very classic credit boom- and bust cycle. Two cases from the 1990s are worth pondering.

· Following years of fast bank credit growth accompanied, as should be, by housing price bubbles, bank crises started in 1990 in both Japan and Sweden. The Swedish authorities reacted swiftly, bailing out most banks at a cost to taxpayers estimated at some 4% of GDP, but shareholders were essentially expropriated.

· The Japanese authorities protected their banks with generous loans, even as some banks were serving dividend payments to their shareholders.

Sweden recovered in three years and, nowadays, Swedish banks are not found among those that indulged in mortgage-backed securities. Japan has still not recovered from a nearly twenty-year long lost decade and, nowadays, several Japanese banks have already failed under the weight of the toxic assets that they acquired, once again.

Figure 1: GDP Growth in Japan and Sweden

Source: Economic Outlook, OECD
Conclusions

Of course, there is more to it than this simple comparison, including the accompanying macroeconomic policies. But three unmistakable messages emerge.

1) Be merciless with shareholders and gentle to bank customers. [Except that if Larry Summers is right, you shouldn’t be merciless with shareholders, so you’re damned if you do and damned if you don’t.  Bart Simpson for Central Bank Gov – NG]

2) Either way, taxpayers are always the losers.

3) Bagehot had it all right.


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Ingolf
13 years ago

Nice overview of a very complex issue.

In many ways, I think the relative success of the Scandinavian bailouts argues for the Buiter approach. I’ve previously looked into the Norwegian episode and the official approach is summed up as follows in a research paper from Norges Bank (their central bank):

– Private solutions were explored before the government intervened.
– Share capital was written down to zero before committing public funds.
– The government acted swiftly to limit contagion, but did not provide a blanket guarantee.
– Liquidity support was given to illiquid, but solvent institutions.
– The government did not use an asset management company – as the other Nordic countries did later on.

The clear intent was to ensure enduring public support for the fairly drastic measures taken by explicitly not bailing out shareholders. This approach seems to me not only entirely proper but also vital if appropriate considerations of risk are to be reintroduced to players in the financial system. It also had the great virtue of simplicity and transparency, something that certainly can’t be said about the flurry of acronym laden and often seemingly ad hoc measures currently blossoming like weeds in the US.

P.S. I think it’s easy to come away with the impression the article was written by Peter Englund whereas he’s only referenced in relation to a piece he wrote back in 1999 about the Swedish banking crisis.

FDB
FDB
13 years ago

There’s a missing premise in so many arguments for bailouts. Let it not be glossed over any longer, and let it be refuted thus:

A shareholder takes on risk, for the potential reward of profit. “Protecting shareholders” is code for removing the consequences of poorly made (or informed) investment decisions. The decision of a citizen to pay the taxes asked of them by the government is NOT one of these.

FDB
FDB
13 years ago

Well, I was only putting one (obvious) point in clear terms, not advancing a complete argument. Why should investors in money markets be any less risk exposed than in other sectors?

Andrew Reynolds
13 years ago

Absolutely FDB. If a bank does go under the shareholders should be the first to suffer – or maybe second after the management. The only issue is how and how much.
Most banks go under not because they have a negative net worth, but because of liquidity problems. Both Bear Sterns and Northern Rock are good examples. If you added up the value of all of their assets and deduct all of their liabilities you end up with a positive number – there is still positive net worth in there – i.e. the shares are worth something.
The problem is that the bank cannot satisfy all the demands of the depositors for “their money” now, but could more than do so in a long work out situation.
The shareholders may feel that the demands of the financial system to have operating banks are being put ahead of their right to extract any residual value from their shareholdings – however much that has been hurt by the inability of the bank to pay the depositors out now.
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.
Bear Sterns was an attempt to deal with this.
Obviously, where there is no net worth this does not apply – the bank is truly worthless and there is no shareholder value to argue over.
Where there is net worth, though, the shareholders deserve to recover it. If the government decides that the thing of crucial importance is to keep the bank operating (or transferred to other management) then that is an issue for the government to sort out. The second order issue is to ensure that the shareholders receive appropriate value for the assets they have been deprived of.

FDB
FDB
13 years ago

That not giving taxpayers money to failed business concerns will discourage investment in such concerns?

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.

FDB
FDB
13 years ago

Sorry, #7 was re: #5, and 3rd para should end with an elipsis (and scary chords).

FDB
FDB
13 years ago

“The second order issue is to ensure that the shareholders receive appropriate value for the assets they have been deprived of.”

…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.

Fyodor
13 years ago

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.

JC
JC
13 years ago

Fyodor.

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?

JC
JC
13 years ago

Andrew R

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.

Ingolf
Ingolf
13 years ago

Can’t disagree with the principle of shareholder rights, Andrew, but it becomes a devilishly tricky question with highly geared institutions in an environment of radical uncertainty and opaque pricing.

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.

JC
JC
13 years ago

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.

Patrick
Patrick
13 years ago

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.

Fyodor
13 years ago

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.

Ingolf
Ingolf
13 years ago

JC and Patrick, fair comments both.

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.

JC
JC
13 years ago

Fyodor:

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.

Patrick
Patrick
13 years ago

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.

Fyodor
13 years ago

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.

JC
JC
13 years ago

Yes, the ECB has behaved admirably and has gained a lot of cred over their comportment. It’s something I should have mentioned, but you caught it it time.

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

Michael Kalecki
Michael Kalecki
13 years ago

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

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.

Bring Back "Bring Back Evil Pundit"

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.

JC
JC
13 years ago

fyodor

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.

JC
JC
13 years ago

damn, you got in first.

JC
JC
13 years ago

Homes:

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.

Michael Kalecki
Michael Kalecki
13 years ago

Sorry Fyodor,

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.

JC
JC
13 years ago

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?

Michael Kalecki
Michael Kalecki
13 years ago

Read the BIS report.

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.

JC
JC
13 years ago

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.