Posts Tagged ‘niall ferguson’
I recently covered Mervyn Kings proposal for Utility Banking; a banking business model that separates banking banking services from high risk investments. For example utility banking as I see it, would cover day to day chequing, savings, loans and mortgages, ATM’s, and online banking. It would have traditional FDIC type deposit insurance, and utility banks would be subject to capital requirements and would not be permitted to participate in off balance sheet banking, nor securitisation. Think James Stewart and ‘Its a Wonderful Life’.
In this piece Niall Ferguson takes it further suggesting that the Utility Banking approach still leaves the potential for Too Big Too Fail (TBTF’s) institutions that would inevitably be bailed out by governments, and therefore taxpayers.
Thus, Glass-Steagall and narrow banking treat only a part of our financial tumour, leaving the rest to metastasize. Limited purpose banking (LPB) is the only credible cure. It transforms all financial companies with limited liability, including insurance corporations, into pass-through mutual fund companies. Limited purpose banks would process securities and sell them to mutual funds. They would not be permitted to borrow to invest. Hence, they would never face a run and never fail. Risk-taking would be done by us, the people, via our purchase of more or less risky mutual funds.
Mutual funds are, effectively, small banks, with a 100 per cent capital requirement under all circumstances. Thus, LPB delivers what many advocate – small banks with more capital.
Under LPB people would be able to use cheques, debit cards and ATMs to draw on their cash mutual funds. Insurance mutual funds would permit people to diversify individual and share aggregate risks
This model of Limited Purpose Banking (LPB) would convert all banking to Mutual Funds. The different types of banking and investment requirements would be accommodated by alternative Mutual Fund types, from cash Mutual Funds to more speculative investment Mutual Funds. The Utility bank would be replaced by a cash Mutual Fund.
Niall makes the point that the dollar for dollar nature of Mutual Funds would solve the capital problem, and the ultimate risk would always be absorbed by the investor, ergo no bailouts required.
Relevance to Bankwatch:
It remains clear that the current banking model is not sustainable, and is prone to catastrophe. It is also clear that despite the stock market growth in 2009 that banking is not anywhere close to recovery. The banking results have reflected high investment returns, and mask the poor performance of retail banking. Consumers are retrenching and will be doing so for some time.
Further the need to solve the matters of transparency, and effective risk assessment has not been addressed in debt markets. Banks are continuing to operate as in pre 2007 times in those markets.
There is a potential for alternative banking models and it may be surprising where and when they begin to appear.
[categories profitability, business models]
US deficit is now in Botswana and Russia territory in terms of record levels relative to GDP. The argument that this is not inflationary sounds to me like pushing water uphill.
WASHINGTON — The Obama administration said Friday that the federal budget deficit for the fiscal year that just ended was $1.4 trillion, nearly a trillion dollars greater than the year before and the largest shortfall relative to the size of the economy since 1945.
A summary in NYT of the fascinating Ferguson/ Fallows debate at Aspen on the economic relationship between China and US.
Ferguson: US and China are divorcing economically. China will focus on internal consumption, not exports. “Depreciation (of US $) is inevitable and the Chinese are working to end the dollar’s role as the world’s reserve currency.”
Fallows: “… doesn’t know what the future will hold, but he believes that Chinese officials still see the dollar as their least risky investment. Domestically, China will not turn democratic, but individual liberties will expand. He agreed that China and the U.S. will dominate the 21st century, but he painted the picture of a more benign cooperation.”
I came to the debate agreeing more with Fallows and left the same way, but I was impressed by how powerfully Ferguson made his case. And I was struck by their agreement about what to do. This conversation, like many conversations these days, gets back to America’s debt. Until the U.S. gets its fiscal house in order, relations with countries like China will be fundamentally insecure.
This is just plain fun. Some of my own economist hero’s (Roubini, Ferguson) and others debating the blame for the crisis. The result was a vote in favour of for the motion, that Washington is to blame, but the humour and the threads are fascinating for those interested – particularly the Ferguson / Minow, (Government is corrupt / Government are victims) bits. I highlighted summary points, and full transcript is here. financial-crisis-031709
For the motion: Niall Ferguson, John Steele Gordon, Nouriel Roubini
Against the motion: Alex Berenson, Jim Chanos, Nell Minow
The full transcript of this debate is available online at this link; the debate will also be broadcast in a few days on National Public Radio. Here is below a press release on this debate and its main themes and results followed by a brief commentary on the debate by John Fund of the WSJ:
As Ferguson eloquently puts it:
Not only were the bankers greedy, we would agree. They were also, in many cases, incompetent. But I and my colleagues are not here to praise them, or to defend them. We blame them for much of what has gone wrong. It’s just that we blame the politicians…more. [LAUGHTER, APPLAUSE]
It’s just too easy. And if you noticed, that’s exactly what the politicians do. I couldn’t help but notice, in President Obama’s inaugural
address, an allusion to greed, and irresponsibility. And only yesterday, he was denouncing, and I quote, “The recklessness and greed of the bonuses paid to executives at the insurance company AIG.” It was just the same in the last Great Depression, [I think of this as the Slight Depression].
[LAUGHTER] FDR in his inaugural address, heaped scorn on the rulers of the exchange and the unscrupulous money-changers. Ladies and gentlemen, you have to ask yourselves…why do the politicians always wax so indignant about finance at times like these? Could it just possibly be that they’re trying to divert our attention away from Washington’s own responsibility for the debacle?
He goes on to cite the actions of the:
- Federal Reserve’s expansionary activities on interest rates while house price inflation ran between 15% and 17%
- Securities and Exchange Commission (SEC) which allowed banking leverage to increase from some 12 : 1 to some 20 and 30 : 1.
- Congress who “wholly failed to supervise Fannie Mae, and Freddie Mac. Those two essential institutions, which underpin the United States mortgage market” – On the eve of their destruction, Fannie and Freddie had core capital, as defined by their regulator, of $83 billion, and supported around $5.2 trillion of debt and guarantees. In other words they were leveraged 65-to-1.
- White House “We want everybody in America to own their own home,” declared President George W. Bush, in October in 2002. Everybody, in America. He challenged lenders to create 5.5 million new minority homeowners, by the end of the decade. He signed the American Dream Down Payment Act, in 2003.
He makes these points while humourously noting the address for the four culprits is in fact Washington. Seriously worth the read for a fairly light yet insightful view of how we got to where we are today.
Next best quote is Alex Berenson:
And I have to say I’m at a great disadvantage because, Niall Ferguson has
that accent, he could read the phone book to you and it would sound a lot smarter than I do. [LAUGHTER]
He continues to make the point in that regulation cannot improve on individual decision making.
if you think about your own life, if you think about your own business as you know, whether you’re a lawyer or a doctor or whether you work in retail, whether you—a landlord, whatever it is that you may do, you probably have a better idea where the opportunities are, but also where
the problems are, where you can take advantage of your customers, where you can cut corners, than any regulator could no matter closely they monitored you. It’s your business, it’s your life. And so the regulator needs to set the rules, but in the end—you succeed or fail on your own.
… Compensation is a crucial, crucial part of understanding what went wrong on Wall Street in the last 10 years. When you can make a million or 10 million or in some cases $100 million for a year’s work, you don’t have very much incentive to run your business for the long term.
… Could we and should we have had a much more robust regulatory system? Absolutely. Regulation is vital, regulation sets the playing field, it sets the rules. But in the end, you have to put blame where blame is due. And, blame is due on the firms. It’s due on the owners, it’s due on the managers, it’s due on the executives, it’s due on the employees.
John Steele Gordon in favour:
we have had panics on Wall Street roughly every 20 years. Now
the Constitution came into effect in April of 1789, we had the first crash on Wall Street in April of 1792. Then we had another one 1819, 1837, 1857, 1873, 1893, 1907, 1929, 1987, and now 2008. It seems to be just part of the beast, I mean could any of these panics have been prevented by Wall Street?
… So, blaming Wall Street is like blaming the atmosphere for thunderstorms
There’s still one great big player in the financial world in the United States, that is not subject to these commonsense rules. It’s called the government. For instance, you remember those budget surpluses in the later years of the Clinton administration between 1998 and 2001?
They amounted to $558 billion. So the national debt went down by $558 billion, right? Uh, no, it went up by $400 billion. The reason is that Social Security was put on budget. And that means that the revenues that flow into Social Security over and above what is paid out to recipients of Social Security becomes part of the government revenue, it’s called an intra-governmental transfer. Of course the money that’s taken out of the Social Security trust fund is replaced with newly minted federal bonds.
Which is why the debt went up. Now, if a private company or publicly-traded company, tried to take employee contributions to the company pension fund, and call it revenue in order to perk up the bottom line, the managers of that corporation would all this very minute be playing volleyball in Club Fed. [LAUGHTER]
Nouriel Roubini from RGE is the last I will summarise here. He argued in favour:
Zero down payment, no verification of income, assets and jobs, they
called them ninja loans or liar loans. Interest-only mortgages, negative amortization, teaser rates, all this toxic stuff or subprime, near-prime, prime. The Fed and Greenspan actively said was the best thing that have happened to mortgages. Free market, they could control it, they had the law, the power to do it, they didn’t do it.
… Big McMansion can give you utility but doesn’t increase the stock of capital in the real way of productivity of capital and labor, like, physical capital does. We have subsidized housing in 20 different ways. That has led to the bubble as well. There was an ideology for the last decade in Washington, that was critical to this financial crisis. Was an ideology of laissez-faire, Wild West unregulated capitalists. The base of this ideology was the idea that banks and financial institutions will self-regulate. And as we know, self-regulation means no regulation. It was the ideology of relying on market discipline, and we know when there is irrational exuberance, there is zero market discipline.
… So every element of our regulatory system, has failed, you know, this Basel accord that relied on this principle, has failed even before it was implemented. Relying on principle rather than rules, relying on light touch, rather than tough rules, a light touch means no touch at all.
… Shareholders are gonna be able to control the behavior of bankers and so on. This was the belief in deregulation. Elements of it, actions were taken. The repeal of Glass-Steagall that separated investment banking from commercial banking. Now we let them essentially, use deposit insurance and deposits to do 30 times leverage prop trading, that’s what was allowed. Essentially deregulation of credit derivatives and derivatives, over the counter with systemic risk. Things of that sort were going on. The SEC deciding the level ratios, 30 to 1 was okay.
And the final quote de jour goes to Nell Minow:
Past performance is no guarantee of future performance. And who is it that requires them to say that? That is Washington. Wall Street has expected us to bet on them for a long time. They have not lived up to our trust in them and they are more responsible than Washington for this mess. Thank you. [APPLAUSE]
And the result:
the results of the final vote, 60 percent of you are for the motion, 31 percent against… [APPLAUSE] 9 percent undecided, the side for the motion wins… congratulations to them
James Baker of all people sums up precisely why the current government approaches to fixing banks’ problems is flawed. As you will have gathered I fall in the Niall Ferguson/ Martin Wolf camp that says this situation is not just worse than we think but more importantly it is different than the prevailing wisdom. We risk fixing the wrong problem in other words.
‘How Washington can prevent ‘zombie banks’ | Financial Times
Beginning in 1990, Japan suffered a collapse in real estate and stock market prices that pushed major banks into insolvency. Rather than follow America’s tough recommendation – and close or recapitalise these banks – Japan took an easier approach. It kept banks marginally functional through explicit or implicit guarantees and piecemeal government bail-outs. The resulting “zombie banks” – neither alive nor dead – could not support economic growth.
A period of feeble economic performance called Japan’s “lost decade” resulted.
Unfortunately, the US may be repeating Japan’s mistake by viewing our current banking crisis as one of liquidity and not solvency. Most proposals advanced thus far assume that, once confidence in financial markets is restored, banks will recover.
To prevent a bank run, all depositors of recapitalised banks should be fully guaranteed, even if their deposit exceeds the Federal Deposit Insurance Corporation maximum of $250,000 (€197,000, £175,000). But bank boards of directors and senior management should be replaced and, unfortunately, shareholders will lose their investment. Optimally, bondholders would be wiped out, too. But the risk of a crash in the bond market means that bondholders may receive only a haircut. All of this is harsh, but required if we are ultimately to return market discipline to our financial sector.
Baker suggests quick and decisive action, and I agree.
This is a crisis of debt and bubble asset values. The asset values are being re-stated in the equity markets and housing markets as we see evey day. That horse has left the barn, as they say. The result is a set of debt around the world on the balance sheets of companies and consumers that is too high relative to the asset base.
The prevailing theme of government and therefore consumer belief is that government stimulus plans will address the economic shortfalls, and return us to growth later in 2009. But what does that mean, even if successful?
The key is to define “growth” and what that means. That would mean GDP, that mix of consumer, government and businesss expenditures and investments is no longer dropping. There are two key points that have to be said here. Even if growth in GDP returns, that does not mean asset values will return to 2007 levels – no-one can believe that now. Despite a return to normal patterns of consumer, business and government expenditures sometime in the next 2 years, house prices will not rise by the 25 – 50% that would be required to attain 2007 levels, nor is it likely that the stock markets will grow the 100% + that will be required to return to 2007 levels. Those things are possible, but we have to believe unlikely in the near term (5 – 7 years)
As Baker states clearly above, this is a crisis of solvency. A liquidity crisis merely means value is tied up in assets that are not quickly useable as cash. Solvency means debt exceeds asset values. The banks have a solvency crisis. That brings be back to Niall’s point. This is a crisis of debt.
The delusion that a crisis of excess debt can be solved by creating more debt is at the heart of the Great Repression. Yet that is precisely what most governments propose to do. (Niall Ferguson/ LA Times Feb 6th, 2009)
A crisis of solvency has requires help for debtors and there is some relief coming on that for US people mortgages, although the plans are not yet completed.
But the worry is the banks. As Baker says above, and Wolf said yesterday on the Fareed interview on CNN banks are frozen in a state of inaction by virtue of potential asset value losses that exceed their capital base. They also cannot generate new assets, ie lend, because they do not have an adequate capital base to support. Enter, what I have been calling financial utilities, and Baker calls zombie banks. Banks that are moribund and merely exist to provide very basic functions under the guidance and auspices of their bureaucrat overseers. This does not bode well for innovation, nor new and better services.
Relevance to Bankwatch:
The good news is that the opportunity remains for those that choose to accept it. This timing of this economic mess is not co-incidence and although few predicted the precise date, many knew a day of reckoning was to come [link to The Upside of Down]. When Thomas Homer-Dixon wrote that book in 2005 the characterisations of stress in the world he saw were these.
Homer-Dixon contends that five “tectonic stresses” are accumulating deep underneath the surface of today’s global order:
- energy stress, especially from increasing scarcity of conventional oil;
- economic stress from greater global economic instability and widening income gaps between rich and poor;
- demographic stress from differentials in population growth rates between rich and poor societies and from expansion of megacities in poor societies;
- environmental stress from worsening damage to land, water forests, and fisheries; and,
- climate stress from changes in the composition of Earth’s atmosphere.
With the benefit of hindsight it is easy to see he was correct in the assessment. More imporantly though these stresses point to a systemic shift in the world that requires different and better solutions, if we are to mitigate future crises, economic and otherwise. For example it is all very well to point to the Keynesian approach of replacing consumer spending with government spending to address the problem, but what ought the government spend its money on, if the target is a different and better system than we have today?
Going back to the banks’ – the information we have just summarised strongly suggests they are not going back to the way things were before. What better opportunity to rethink strategy. We are now in a period of an experential economy, powered by customer empowerment. Internet has seen to that and that change is also systemic.
If a big bank can really, and I mean really, grasp the power of internet, and the associated cost benefits associated with customer empowerment, ie, customers willingly doing the work for them, in return for better value, and banking on their terms. just perhaps a bank could join in the disruption for banking that is surely upon us.
This is much talk these days of the decline of the United States and a fundamental reshaping of relative world economic clout.
It is worthwhile to reflect on the current size of economies before such claims are made. This rambling piece from Richard Florida that I thought was going to deal with the decline of America, actually ends up making the case that the impacts on US cities will be significant. Of that there is little doubt, but the example of Detroit may not be the best to make the point (the Phoenix example is a better one).
Detroit has had and survived at least four sets of signifcant rioting with manufacturing issues at the core, amplified by race issues.
This from the Pittsburgh News in Oct 1933 during the depression.
Indeed it is worth clicking through and reading of this particular event.
“A factory manager at one plant fired several shots as the mob approached the place, but said he aimed over the heads of the rioters”
What can I say. The history of the US is all about survival and moving ahead despite setbacks – but I digress. America cannot be “mis’underestimated.
Here is the GDP ranking of the world. Bear in mind that 2% shifts in GDP are considered gigantic. If the US economy reduced by an impossible 50% it would remain 50% larger than the next largest. [I am aware that there has recently been reported a shift in the top 4 rankings, but the point I am making does not change]
Gross domestic product 2007 | World Bank
Ranking Economy US dollars [000's]
1 United States 13,811,200
2 Japan 4,376,705
3 Germany 3,297,233
4 China 3,280,053
5 UK 2,727,806
6 France 2,562,288
7 Italy 2,107,481
8 Spain 1,429,226
9 Canada 1,326,376
10 Brazil 1,314,170
There will be serious impacts, the economies of the world will be dramatically different after this event we are all part of, but i maintain the ability of the US to come back is unfathomable compared to the rest of the world. The nearest hope would be the EU if only by size, but while they try to re-architect using 20th century thinking, the US has little to fear.
I do worry about the debt levels in the world [The Great Unwinding], reflected in the banking system. The pending impact of revaluation of that debt to accomodate new asset values will be enormous, and not seen since some of the events in the 17th and 18th centuries. When the dust settles on that score there will be impacts on countries, exchange rates, and inflation/ deflation within those countries – impacts I am not qualified to predict, but they will come.
On the topic of Bank capital this chart embedded in Greenspans article shows just how much banks business model has evolved. In economic terms this is the corollary to extreme business and personal debt.
In the years following 1840 when bank capital was approaching 60%, as banks made loans, the borrower bought things that resulted in bank deposits which can then be lent again, and again. The velocity of capital as it is know increased dramatically until 1940 and largely remained there – till now. As banks re-capitalise the preachings of government to lend more is the ultimate paradox.
Banks need more capital | Alan Greenspan | The Economist
On the other hand this piece from Niall Ferguson takes the opposite view that we may have reached a point with consumer debt that is irreversible, requiring a Jubilee (debt forgiveness). Niall writes:
Excessive debt is the key to this crisis; it is the reason we are confronting no ordinary recession, curable by a simple downward adjustment of interest rates. It is the reason we still have to fear, if not a second Great Depression, then very likely the biggest recession since the 1930s. We are living through the painful end of an age of leverage which saw total private and public debt in the US rise from about 155 per cent of gross domestic product in the early 1980s to something like 356 per cent by the middle of this year.
With estimates of total losses on risky assets now ranging from $2,800bn (£1,850bn, €1,960bn) to $6,000bn, a chain reaction is under way that will leave no sector of the world economy untouched. The American economy is contracting at an annualised rate of 5 per cent. Commercial property is following the residential market into freefall. The Standard & Poor’s 500 index is down 43 per cent since its peak in October last year. The market for credit default swaps is pointing to a surge in defaults on corporate bonds. The automotive industry is already (against the will of Congress and the original intention of the Treasury) on life support. The US is at the centre of the crisis but Europe and Japan may suffer even larger aftershocks. As for the much feted emerging market “Brics” – Brazil, Russia, India and China – their stock markets have been dropping like, well, bricks.
He develops the case for debt forgiveness as the only way to break the logjam. He mentions this option:
…. as recently suggested by Harvard’s Martin Feldstein. (In his scheme, the government would offer any homeowner with a mortgage the option to replace 20 per cent of the mortgage with a low-interest loan from the government, subject to a maximum of $80,000. The annual interest rate could be as low as 2 per cent and the loan would be amortised over 30 years.
The Greenspan article is generally positive while the Ferguson one is more pragmatic. More and more it is clear that the state of the economy, GDP and the matters of recession/ depression/ growth/ inflation/ deflation lie in Government hands.
Relevance to Bankwatch:
Despite all this, Banks have an opportunity to get creative and innovative in how they participate in the development of the new economy. They must do more than merely become financial conduits funnelling government policy to the proletariat. The opportunity lies in development of new models of service that are more reflective of the new economy as we dither between welfare state (old and unaffordable) and market state. (my latest study)