Monthly Archives: January 2009

In its January Global Financial Stability Report Market Update (published January 28, 2009), the IMF has raised their estimate of credit losses from bad assets originated in the US and held by US and European banks to $2.2 trillion (from $1.4 trillion estimated in November).  It also estimates the combined need of US and European banks for new capital at $0.5 trillion. Finally, the Fund recommends that the authorities take the distressed assets from the banks’ balance sheets through ‘bad bank’ arrangements.

Note that we are no longer just talking of ‘toxic’ assets, that is, assets whose value cannot be assessed with any degree of certainty because of their complexity.  We are now talking about bad or impaired assets that include the toxic stuff but also a large chunk of plain vanilla assets (real estate loans, simple mortgage products, consumer loans, corporate debt) that have become impaired because the borrowers/issuers are at risk of going belly-up the old-fashioned way.  With a long and deep recession still ahead of us, the quantity of ‘conventional’ bad assets on the books of the banks will escalate. 

In a letter to the Editor in today’s Financial Times (28 January 2009), the Director-general of the Bank of Italy, and my esteemed former colleague at the EBRD, Dr Fabrizio Saccomanni, objects to some of the things I wrote in my post The Banca d’Italia and the re-nationalisation of cross-border banking on 24 January 2009, about the Bank of Italy’s new initiative in creating a collateralised inter-bank market or MIC (for Mercato Interbancario Collateralizzato).

I reproduce his letter here:

Timothy Geithner, the nominee for US Treasury Secretary, has risked damaging the global economy even before his confirmation by the full Senate.  In a written answer to questions from US senators, Geithner said: “President Obama – backed by the conclusions of a broad range of economists – believes that China is manipulating its currency”.   In the US, the words “currency manipulation” are fighting words.  If the US administration were to formally name China as a currency manipulator, a range of trade sanctions could be imposed by the US government.

The threat to world trade comes from the Omnibus Trade and Competitiveness Act of 1988.  The section dealing with the exchange rate, bilateral current account balances and the overall current account balance is a monument to economic illiteracy.

There is growing financial protectionism.  This is happening even within the Eurozone – in violation of the Treaty.  For instance, the Italian central bank (Banca d’Italia) has just created a Collateralised Interbank Market, where the Banca d’Italia will serve as the universal counterparty, guaranteeing settlement in case of default.  The arrangement is, however, only open to Italian banks (one per group).  In the current turmoil, the Banca d’Italia may be able to get away with an arrangement that clearly violates the Eurosystem’s principle of “equal treatment of institutions across the euro area”, but the ECB will want to get rid asp of anything that hints at balkanisation of the eurosystem and preferential treatment offered by NCBs to their national counterparties. The ECB asserts indeed that the general eligibility criteria for counterparties to national central banks “are uniform throughout the euro area”.

This finanancial protectionism is to a large extent the unavoidable consequence of the rediscovery, during the current financial crisis, that although banks and other financial institutions have become global, regulation and the fiscal capacity to bail out banks and other tottering financial institutions have remained national.  Consequently, we have seen two forms of re-nationalisation of banking and finance.

From Reykjavik

Late last night I returned from a four-day visit to Iceland with Professor Anne Sibert, co-author of a report anticipating the collapse of the Icelandic banking system and joint carer for our cats and children.

Iceland’s largest three banks with border-crossing activities collapsed last fall, as did its currency.  The three banks are in administration and new state-owned banks with a purely domestic focus have been set up.  Strict capital controls make external borrowing all but impossible and discourage foreign investment.  The country now has an IMF program.  Strangely enough, the programme does not impose any fiscal pain until 2010.  This year the fiscal automatic stabilisers are allowed to work freely, although no further discretionary expansionary fiscal measures are being proposed.  Starting in 2010, under the programme, discretionary fiscal tightening of more than 8 per cent of GDP is envisaged between now and 2013.  That number could be higher if the external indebtedness of the state turns out to be higher than the 110 per cent of annual GDP estimate of the IMF.

The true state of the gross and net external indebtedness, including contingent off-balance sheet exposure, of the Icelandic state is a mystery even now.  In addition to sovereign debt and sovereign-guaranteed debt, there are credit lines and possibly other contingent external liabilities whose take-up has to be estimated/guessed to get an accurate view of the state’s external obligations.  It is possible that the IMF figures include an offset against the sovereign’s external liabilities in the form of an estimate of the recovery value of some of the external assets of the sovereign (e.g. its share in the assets of the UK subsidiaries of Kaupthing and Landsbanki). Assigning any positive value to these assets is an act of faith.  In any case, it would be helpful to have the hard external liabilities and the soft external assets reported separately.

Iceland’s government had to let the country’s three main banks go into administration because it did not have the fiscal capacity to bail out financial institutions with balance sheets amounting to 600-700 per cent of annual GDP.  Any attempt to commit further government resources to the rescue of the banking system would have precipitated a sovereign default.

With each day that passes, estimates of the recovery value of the assets of the three  ‘bad banks’ melts away like snow in April.  The decision not to guarantee the liabilities or the assets of the banks (other than retail deposits, including retail deposits with foreign branches for amounts up to €20,000) was the only wise thing the Icelandic authorities have done in this whole sorry mess.  It isn’t even clear that the Icelandic authorities came up with this sensible idea themselves.  More likely the IMF opened their eyes.  The creditors of the banks, which include Commerzbank and Bayerische Landesbank will have to explain to their own shareholders and taxpayers why they now in effect own large chunks of three defunct Icelandic banks.

…to London

Returning to London from Reykjavik last night was like coming home from home.  Allowing for the differences in the scale of the Icelandic economy and the British economy (the UK population is more than 200 times larger than Iceland’s Coventry-sized population), there are disturbing economic parallels.  The excesses in Iceland during the past decade were greater than in the UK, but not qualitatively different. 

The Irish government just nationalised the third largest Irish bank, Anglo Irish Bank.  Even an Irish government guarantee of all the liabilities of the Irish banks was not enough to keep Anglo Irish afloat.  Bank of America has just received a second injection of capital from the US government -  $20bn this time.  It has also received a guarantee from the US Treasury, the FDIC and the Fed on all but the first $10bn of $118bn of potential losses on toxic assets.

Governments all over the world (including the British government with Northern Rock and Bradford & Bingley, the Dutch government with ABN-AMRO) seem to resort to full nationalisation only after everything else has been tried and has failed. Looking ahead it seems likely that all British high street banks, RBS, HBOS, Lloyds Banking Group, Barclays and HSBC will end up in (temporary) public ownership within the next year or so.  RBS is already 57 percent government-owned and the soon-to-be-merged HBOS and Lloyds Banking Group are 43 percent publicly owned.  All three need additional capital.  None of the three is likely to be able to get it from the market.

Today saw the publication of a pamphlet titled Ten years of the Euro: New Perspectives for Britain.  It is published by John Stevens and edited by Graham Bishop, Brendan Donnelly, Will Hutton and myself.

In the preface, John Stevens writes:

“These papers are the result of a discussion convened by Peter Sutherland on the 4th of November 2008. Their publication is intended to help place the case for Britain joining the Euro back upon the political agenda and to provide the beginnings of an ongoing forum for its promotion. Additional papers addressing further aspects of the matter and more detailed analyses will follow over the coming months in the hope of creating a rallying point for more weighty interests to find the courage of their convictions.”

There are 31 essays in the volume.  The longest one is (unfortunately but not surprisingly)  by me. I did not have the time to write a shorter contribution.

The entire volume can be downloaded as a pdf file here.

A recent (January 13, 2009)  column in the Financial Times by John Authers provides a good example of a logical slip on the banana peel of an alleged link between the external value of the euro, the likelihood of the eurozone breaking up and sovereign default by a eurozone national government.  Versions of this fallacy can be found all over the place, even in the writings of those who ought to know better.

The relevant passages from Authers’ The Short View follow in full:

“Greece has always been treated as a peripheral eurozone member, not only in geography. Even before last year’s civil unrest, its bonds traded at a significantly higher yield than those of Germany – showing a higher perceived default risk.

The market is nervous about other nations on the eurozone’s periphery, notably Ireland and Spain, which grew overextended during the credit bubble.

A eurozone country defaulting and leaving the euro is close to an unthinkable event. But Friday’s news from Standard & Poor’s that Greece and Ireland were on review for a possible downgrade, followed yesterday by Spain, left many thinking the unthinkable.

The spread of Greek bonds over German bunds is 2.32 percentage points, almost 10 times its level of two years ago. Spanish spreads yesterday rose above 90 for the first time. An Intrade prediction market future puts the odds on a current eurozone member leaving the euro by the end of next year at about 30 per cent.

The euro dropped more than 1 per cent against the dollar within minutes of the Spanish news, and is down 9.8 per cent in the last few weeks.”

Three issues are being linked in this passage.  The emergence of high levels of sovereign default risk premium differentials between different eurozone member states, the external value of the euro and the likelihood of the eurozone breaking up. There is no self-evident link between these three issues.  The first is neither necessary nor sufficient for the second or the third.  More than that, the threat or reality of sovereign default by a eurozone member state is much more likely to reduce that country’s incentive to leave the eurozone than to increase it.

The moral turpitude and ethical spinelessness of the Bush administration over the Guantánamo Bay detention camp have also infected president-elect Barack Obama.  The offshore detention and torture camp still holds 248 detainees.  During his election campaign, Obama promised to close it.  His proposed time table does not impress, however.  While Obama is now expected to issue an executive order during his first week in office closing down Guantanamo Bay, the measure will not be implemented, that is, the camp won’t actually be closed, during the first hundred days of his administration.

Barack Obama’s lack of moral fibre on this issue is manifest from his own words.

“It is more difficult than I think a lot of people realise”.  Indeed, doing the right thing is often difficult and can be personally or politically costly.  Difficult decisions should not come as a surprise to the president-elect.  It’s what you expect to get on your plate when you run for president of the United States of America, rather than for dog catcher.

The UK Chancellor, Alistair Darling, has been busy repudiating the notion that the British government was planning to ‘print money’ to prevent deflation and stimulate the economy.  He was reported in the  Financial Times (January 9th, 2009) as saying :“Nobody is talking about printing money. There’s a debate to be had about what you do to support the economy as interest rates approach zero, as they are in the US.  But for us that is an entirely hypothetical debate”.

This statement of the Chancellor either represents a major manifestation of profound ignorance about what central banks do and how monetary policy is conducted, or a deliberate denial of an obvious fact, perhaps because the words “printing money” have unfortunate Weimar or Zimbabwe connotations.  Yet ‘printing money’  – that is, creating base money, either through the issuance of currency or by increasing the stock of commercial bank reserves held with the central bank –  is what central banks do in a fiat money world. They do this not just in Zimbabwe, but also in the US, in the Eurozone and in the UK.

Maverecon: Willem Buiter

Willem Buiter's blog ran until December 2009. This blog is no longer active but it remains open as an archive.

Professor of European Political Economy, London School of Economics and Political Science; former chief economist of the EBRD, former external member of the MPC; adviser to international organisations, governments, central banks and private financial institutions.

Willem Buiter's website