Archive for the ‘economy’ Category
The World Economic Forum which has their annual meting later this month have released their Global Risk 2011 report. Here is he summary from the report, and the full report is a free download here.
Most likely and largest risks are those in the upper right as most likely and largest financial impact:
- Fiscal crises
- economic disparity
- energy price volatility
- global governance failure
- climate change as most likely and largest financial impact
This extract from the report is interesting view of the world and nicely summarises the risks.
Three important risks in focus
Beyond these two cross-cutting global risks, three important clusters of risks have emerged in this year’sa nalysis:
The “macroeconomic imbalances” nexus:
A cluster of economic risks including macroeconomic imbalances and currency volatility, fiscal crises andasset price collapse arise from the tension betweenthe increasing wealth and influence of emerging economies and high levels of debt in advanced economies. Savings and trade imbalances within and between countries are increasingly unsustainable while unfunded liabilities create extreme long-term pressure on fiscal positions. One way out of these imbalances would be coordinated global action but this is challenging given the conflicting interests of differentstates.
The “illegal economy” nexus:
This nexus examinesa cluster of risks including state fragility, illicit trade,organized crime and corruption. A networked world,governance failures and economic disparity create opportunities for such illegal activities to flourish. In 2009, the value of illicit trade around the globe wasestimated at US $1.3 trillion and growing. These risks,while creating huge costs for legitimate economic activities, also weaken states, threatening development opportunities, undermining the rule of law and keeping countries trapped in cycles of poverty and instability. International cooperation – both on the supply sideand on the demand side – is urgently needed.
The “water-food-energy” nexus:
A rapidly risingglobal population and growing prosperity are puttingunsustainable pressures on resources. Demand forwater, food and energy is expected to rise by 30-50% in the next two decades, while economic disparitiesincentivize short-term responses in production andconsumption that undermine long-term sustainability. Shortages could cause social and political instability, geopolitical conflict and irreparable environmental damage. Any strategy that focuses on one part ofthe water-food-energy nexus without considering its interconnections risks serious unintended consequences.
A remarkable (if hard to read) piece from Martin Wolf highlights the underlying reason that artificially low interest rates are essential to prevent “uncontrolled collapse .. mass bankruptcy”
Why we have to live with low interest rates | ft.com – Martin Wolf
The deepest question is whether current policy risks generating huge disturbances in future. As both Ms Altmann and Mr Smithers note, encouraging spending by raising asset prices evidently risks creating another round of what Austrian economists label “malinvestment”. Credit may also surge, once more, generating another round of irresponsible behaviour in the financial sector and ultimately another wave of financial and economic crises, quite possibly in emerging economies. It would be foolish to ignore those evident risks.
Yet it would be just as foolish to ignore the just as pressing present dangers. Today, the UK and a number of other economies, including the US, are both excessively leveraged and have weak financial sectors. The low interest rate policy is designed to prevent an uncontrolled collapse of this mountain of leverage into mass bankruptcy and, instead, allow debt to be paid down and the financial system to return to health more gradually.
Thus, we have to choose between low interest rates on current assets or better returns on what would soon be shrunken assets: with higher rates, house prices would fall further, unemployment would rise, more loans would default and banks would fall back into difficulties. Ms Altmann argues that the bubble economy was partly an illusion. So, then, must be a big part of the financial claims on which savers now depend.
The question becomes whether this approach will prevent such events or will merely introduce delay.
Relevance to Bankwatch:
Martin is as close to the ‘powers that be’ as anyone. The fact that there is a low interest rate policy indicates that it is temporary in nature with en eventual end. This is where banks should come in. When that end occurs obviously interest costs will rise and there will be people in a problem. Banks if they were smart and thinking about their customers and also their own future bad debts, should be migrating loan products away from credit cards and lines of credit towards amortised loans. This would take advantage of the low interest environment to pay down debt. The alternative is to require customers to pay down debt when rates are higher – that hardly sounds like a smart alternative.
I really have to call out BMO for irresponsible commentary in this report on Canadian debt. Basically the report says that despite even faster increases in debt of Canadians, that increases in the stock market cover the increase so overall its ok. Does anyone at BMO really believe that]?
“Balance sheet repair is quietly underway among Canadian households thanks to a slight rise in savings and firmer equity markets, while debt growth is poised to slow amid the clear cooling in the housing market,” the report said. “A singular focus on debt portrays an overly negative picture of Canadian household finances, which have proven incredibly resilient this cycle and likely still have enough cushion to provide a soft landing for spending in the year ahead.”
What are they talking about?
- Fast increased debt supported by historically low interest rates is an accident waiting to happen. When rates rise as they inevitably will, it is household income sufficient to make the payments. Bank of Canada does not think so.
- When rates rise, what will the stock market do? It will fall because that’s how it works. So the supposed asset value coverage will disappear. A higher proportion will have insufficient income to service the debt, and by the way, the stock value that could be sold to pay it off has gone.
- The report looks at averages. Are the people with debt the same people that have asset value increases in stock values?
Relevance to Bankwatch:
Banks are worried. They are worried that their franchise is being eroded because in a deleveraging environment, people reduce both Bank assets and liabilities which means reduced income for banks. I get that, and the need to source alternative products and revenue sources is the order of the day.
However to make statements such as “A singular focus on debt portrays an overly negative picture of Canadian household finances” is to turn a blind eye to the lessons of the lasts 1,000 years. Debt bubbles always end badly and are never resolved by asset bubbles. Everything comes back to income and ability to service debt. That’s why I introduced this uncharacteristically negative post on my own alma mater.
There is a statement today …
Statement of John Corston, Acting Deputy Director, Complex Financial Institution Branch, Division of Supervision and Consumer Protection, Federal Deposit Insurance Corporation on Systemically Important Institutions and the Issue of "Too Big To Fail"
that contains some very interesting facts, and side from he bureaucratic commentary there is a real sense of incredulity that this is how big banks are managed.
The overall message is excruciating detail is one of rationalising insufficient regulatory oversight existed to permit the FDIC to adequately monitor the situation. It describes the nature of onsite examiners at FI’s with greater that $10 Bn in assets (news to me) and how they were able to determine in 2008 with limited information that Wachovia was deteriorating do to increased bad debts but also doubts about derivatives which were being traded not as a hedge but for house benefit.
No surprises so far, and sounds like a regulator. Then despite the bureaucracy no sooner than 11 + days before the demise of Wachovia, FDIC got excited that there was a problem despite earlier warnings.
In early September 2008, the FDIC became increasingly concerned with the liquidity condition of Wachovia. During the week of September 15th, following the Lehman bankruptcy, Wachovia experienced significant deposit outflows totaling approximately $8.3 billion, representing a mix of deposit types, but primarily large commercial accounts. On September 23rd, senior executives and staff of the FDIC met to discuss our elevated concerns with the institution, specifically noting liquidity concerns including considerable contingent funding risk and increasingly negative market views on the firm. The institution’s marginal and weakening financial condition made it vulnerable to this negative market perception.
This is the point where the detective work goes from years to minutes in detail. Early September 2008, FDIC met with Wachovia executive regarding ‘elevated concerns’.
Liquidity pressures on Wachovia increased the evening of September 25th when two regular Wachovia counterparties declined to lend to the firm.2 Since the institution was a net seller of Federal Funds this signal was not viewed by the OCC as a catastrophic development. As discussed in the next section, the failure of WaMu was announced late in the evening on September 25th. As of the morning of Friday, September 26, the OCC indicated to the FDIC that Wachovia’s liquidity position remained manageable. During the day, however, market acceptance of Wachovia’s liabilities ceased as the company’s stock plunged, credit default swap spreads widened sharply, and many counterparties advised that they would require collateralization on any transactions with the bank.
So now over a 2 day period from Sept 23rd to Sept 25th Wachovia encounters counterparties to their commercial paper that will no longer lend to Wachovia, yet the OCC (Treasury) signaled all remains well.
Wachovia’s situation worsened as deposit outflows on Friday (26th) accelerated to approximately $5.7 billion, $1.1 billion in asset-back commercial paper and tri-party repurchase agreements could not be rolled over, and $3.2 billion in contingent funding was required on Variable Rate Demand Notes.
Then the final kicker.
On the morning of September 26th, before U.S. financial markets opened for the day, the FDIC Board approved both the systemic risk exception and the acquisition of Wachovia by Citigroup. This proposed acquisition included government assistance in the form of an asset guaranty on a portion of Wachovia’s assets in exchange for $12 billion in Citigroup preferred stock and warrants. The terms of the asset guaranty called for Citigroup to absorb the first $42 billion in losses on a $312 billion segment of Wachovia’s assets with the FDIC covering any additional losses above that amount.
In the end, the Citigroup transaction was superseded by an unassisted bid by Wells Fargo to acquire Wachovia that was announced on Friday, October 3rd.
Relevance to Bankwatch:
The moral of this saga is the speed that a bank can disappear. On September 23rd FDIC determined Wachovia was in serious trouble and September 26th Wachovia’s fate was sealed. The speed of this is astounding and certainly speaks to the inability of the system to determine earlier that a problem was brewing. But the FDIC already ranked Wachovia as being in trouble earlier in September (“FDIC became increasingly concerned with the liquidity condition”). Surely some earlier activity could have occurred, especially since even this blog knew there was a systemic mortgage problem 18 months before Sept 2008!
For me this really speaks to the fragility of the banking system and the banks. It also speaks to the lack of teeth that the regulators have, or are willing to exercise. Its an obvious fact that banks operate at the convenience of government. No legitimate enterprise could otherwise operate with debt to equity of 20 :1 +/- and survive. This occurs by virtue of the money markets and direct connection with the central bank who effectively manage the liquidity positions of banks.
So long as that is the system there must be better co-ordination of information with the regulator so that banks are kept honest and do not get into the kind of house trading that made Wachovia a high risk market maker rather than a market participant. This participation is high risk market activity not associated with basic banking is why Wachovia deserved to disappear. The flip side is that banks create sufficient capital depth that they can operate independently.
Here is one set of regulation that seems to have worked. The article recounts one broker who is down from 85 on staff to 3.
What is intriguing is that the bankrate article seems to suggest this is a bad thing. The reasons provided in the quote below just sound like back to basics banking process that provides lenders and customers protection.
In fact it suggests brokers can only operate in a loose credit/ no diligence environment. I do not believe that and surely there is a model for brokers that involves lending discipline.
Credit histories must be dutifully compiled for all borrowers. And any number of new criteria can lead to a refusal to lend. One new practice closes the door on loans to anyone who’s done a short sale — a way of selling a house when the sale proceeds fall below the balance on the mortgage — in the past three years.
The statistics in this review are quite staggering when we consider in the context of the problems we see in western economies. The growth and accumulation of reserves are the antithesis of what we see.
Key takeaways I got were:
- real estate increases are significant and in bubble territory, but
- little concern for inflation, however
- (my observation) the degree of state-owned enterprises (SOEs) is significant and could herald unintended consequential problems
For economists and data geeks, the World Bank is today releasing an impressive document containing a host of statistics and economic facts covering all the worlds economies and showing shifts in key areas as noted below.
World Development Indicators 2010 | World Bank
WASHINGTON, April 20, 2010 — The World Development Indicators (WDI) 2010, released today, gives a statistical progress toward achieving the Millennium Development Goals (MDGs).
The WDI database, launched along with the World Bank’s Open Data initiative to provide free data to all users, includes more than 900 indicators documenting the state of all the world’s economies. The WDI covers education, health, poverty, environment, economy, trade, and much more.
“The WDI provides a valuable statistical picture of the world and how far we’ve come in advancing development,” said Justin Yifu Lin, the World Bank’s Chief Economist and the Senior Vice President for Development Economics. “Making this comprehensive data free for all is a dream come true.”
WORLD DEVELOPMENT INDICATORS 2010
Complete Report as One File(18mb pdf)
Preface, Acknowledgments, Table of Contents, Partners, Users Guide (1.27 mb
World View (3.14 mb pdf)
People (3.03 mb pdf)
Environment (2.52 mb pdf)
Economy (3.69mb pdf)
States and Markets (2.35mb pdf)
Global Links (2.84mb pdf)
Primary Data Documentation, Statistical Methods, Credits, Bibliography, Index
of Indicators (521k pdf)
The shifts that must be made before recovery is accepted are nicely summarised here including the required reduction in debt. Interestingly this comes after a few introductory cheerleading paragraphs suggesting recovery is already here.
As I have been emphasizing, the transition to full employment and the emergence of this new configuration of spending and production, and borrowing and saving, will take time. This rebalancing involves repairs to balance sheets, the movement of capital and labor across sectors of the economy, and shifts in the global pattern of production and consumption–adjustments that are likely to be gradual under any conditions. Moreover, the re-equilibration may be slower than might otherwise be the case because tight credit will limit the ability of some households and firms to make the necessary adjustments.
Then some additional remarks about the economy in general.
Government policies will be essential to supporting the smooth transition to more-sustainable economic growth with greater investment and exports. We must ensure that changes in taxation and regulation do not blunt incentives for business investment. In addition, although fiscal policy has provided important support for the economic recovery, it will need to be put on a more sustainable path in the medium term. Failure to do so risks a market reaction that could increase longer-term interest rates; economic growth would be hindered if government borrowing boosts the cost of capital and diverts resources away from private investment.
Reducing the deficit and avoiding a continuing buildup in government debt relative to income will be essential for bringing national production and spending into better balance. That balance, in turn, is necessary so that we are no longer so reliant on borrowing from other nations. Heavy dependence on foreign borrowing by the United States is not a solid foundation for long-term economic growth either here or in those countries extending us credit. The actions of U.S. authorities and private parties to bring about a better balance of saving and investment must be matched by action overseas in chronic surplus countries. While we reduce demand relative to our productive potential, the surplus countries must increase their domestic demand if the global economy is to thrive.
Finally, as has been so painfully demonstrated over the past few years, sustained growth requires a financial system that is much more resilient and thus better equipped to continue to supply funds to creditworthy borrowers when the unexpected happens. To this end, banks and other lenders must hold capital and liquidity to cover more of the risks they are taking, and they must have the capability to know what those risks are and to manage them effectively. Critically, the financial regulatory structure needs to be modernized to bring oversight and market discipline to bear much more effectively on our rapidly evolving financial system and to give regulators more tools to deal with problems as they arise. At the Federal Reserve, we are improving our supervision and regulation to incorporate a broader view of emerging risks in the financial system and to become more effective at translating identified risks to supervisory oversight and, if required, remedial actions by the banks.
The video and the pdf record the discussion moderated by McKinsey. This quote summarises for me and the longstanding position of this blog that Government is wrong to speak about recovery. While the debate is US centric, the characteristics broadly apply to US, Canada, UK, and Euro countries such as Spain.
Brian is the General Counsel of the SEC.
Brian Cartwright: When you look at the leveraged nature of, let’s say, the consumer, it’s about 70 percent of the economy. So, if we’re going to have an economic recovery—and I would say the liquidity crisis is over, but the economic crisis is far from over—the consumer has got to come back.
But US households are carrying debt that’s about equal to the GDP. Put that another way, just unpack it: that means all of our households in aggregate have borrowed an entire year’s worth of the production of the entire economy. When I was growing up—that was a while ago, but still—it was about half that. And I’m not sure where the right number is, but it would seem quite plausible that we now need to do a good deal of deleveraging, which means people have to save rather than consume. That would seem to be a big negative for an economic recovery.
Relevance to Bankwatch:
The implication for banks and their competitors is that products must be re-defined to reflect a saving and de-leveraging consumer marketplace.
Whether its Greece, Portugal and the EU financial issues, or the ongoing housing saga in the US, we are clearly not yet out of the woods relative to the 2008 banking crisis.
The Obama administration will announce on Friday a broad new initiative to help troubled homeowners, potentially refinancing several million of them into fresh government-backed mortgages with lower payments.