Daily Archives: January 7, 2010

By John Cassidy, author of How Markets Fail and a staff writer at the New Yorker

ehind his white beard, Federal Reserve chairman Ben Bernanke has a wry sense of humour. On reading his recent speech to the American Economic Association, in which he defended the Fed’s actions during the housing bubble, I initially suspected it was a practical joke. Rather than conceding that he and his predecessor, Alan Greenspan, made a hash of things between 2002 and 2006, keeping interest rates too low for too long, he said the Fed’s policies were reasonable and the main cause of the rise in house prices was not cheap money but lax supervision.

Searching in vain for a punch line, I was reminded of Talleyrand’s quip about the restored Bourbon monarchs: “They have learned nothing and forgotten nothing.” Mr Bernanke is far smarter than Louis XVIII and Charles X, two notorious boneheads, and has done a good job of firefighting. But his unwillingness to admit the Fed’s role in inflating the housing and broader credit bubble raises serious questions about his judgment. Read more

Krishna Guha

Very hawkish speech from Tom Hoenig today. He worries that staying too low for too long will generate financial stability risks and misallocation of resources as well as inflation risks.

In doing so he more or less explicitly rejects Bernanke’s weekend claim that keeping rates low after the dotcom bust had little or nothing to do with the housing and credit bubbles. Read more

The current disagreement does not concern whether or not Iceland will repay. They have already agreed to repay €20,887 to the British and Dutch governments per head (the governments have already repaid depositors, in full and to a maximum of €100,000, respectively).

Indeed, the President has just reaffirmed this on Newsnight. No, the disagreement concerns the maximum liability and state guarantee of repayments. A potted history follows.

Two loan agreements were signed on 5 June 2009 between Iceland’s Depositors’ and Investors’ Guarantee Fund and the Icelandic state on the one hand, and the UK and Dutch governments on the other. In addition, a special settlement agreement was concluded between the British Financial Services Compensation Scheme and the Icelandic Guarantee Fund. These loan agreements were meant to conclude the Icesave issue.

The deal, agreed under English law, arranged loans from the UK and Holland, agreeing Iceland would repay them in 32 equal instalments starting on 5 June, 2016 and ending 5 June, 2024. Repayments would be fixed at 5.55 per cent. Maximum annual payments would be based on the growth of the Icelandic economy, fixed at a baseline year (effectively £2.35bn to the UK and €1.33bn to the Netherlands). The minimum deposit guarantee of €20,887 was in accordance with EU directive 94/19/EEC. Read more

Krishna Guha

Sharp-eyed observers are zeroing in on a chart (below) used by Ben Bernanke in his address to the American Economic Association at the weekend that appears to show the optimal interest rate based on a forward looking Taylor rule with a PCE measure of inflation was zero in early 2009 – and not a negative number.

This appears to conflict with earlier studies – including an internal Fed staff analysis I wrote about last year – that used modified Taylor rules to show that the optimal interest rate in early 2009 was well below zero – for instance, minus five per cent. Such analysis supported the case for large scale asset purchases as a proxy for negative rates. Read more

Export-dependent Japan wants the carry trade back, apparently. A carry trade involves borrowing in a cheap currency to invest in one with a decent rate of return. The cheap currency of choice has been, for years, Japan. Recently there was much excitement that the mantle was passing to the USA. But Gillian Tett says Japan is fighting back.

The Japanese want the yen to be borrowed because it increases the quantity of yen and decreases its price. A lower yen means Japanese exports become more attractive internationally. Read more

Clearly they are not, in fact, risk-free (Argentina proved this). But government bonds are nonetheless viewed as the sole risk-free asset, and banks are required to hold certain amounts of them in their portfolios. The risk-free (read: government) rate is also the basis for valuing almost all assets.

Whether this should be the case is a question posed today by Michael Gordon, former CIO of Fidelity. He argues corporate bonds might be a safer bet; some corporate bonds, after all, come with an implicit government guarantee. (Perhaps corporate bonds could be split into regular and TBTF bonds.) If the view caught on, a revolution would lie ahead for markets, involving mass revaluations and financial remodelling.

But his argument assumes all types of bond issuer are equivalent financial actors. I’m not convinced of this. Read more

UPDATE at 18.53: Icelandic timeline

UPDATE at 17.23: The Icelandic President talks to Newsnight

An avoidance of responsibility, or democracy in action? Analysis of the Icelandic President’s declaration to the people suggests the latter, with the words “people”, “passed”, “referendum” and “nation” occurring frequently. Conversely, the terms “international”, “British”, “Dutch” and indeed “Icesave” are rare.

The President has vetoed a second round of legislation to repay British and Dutch governments for their (advance) reimbursements to Icesave account holders in their countries. (NB. Terms had largely been agreed on 5 June, 2009, under which the Icelandic Guarantee Fund would repay depositors €20,887.) The President has asked for a referendum on the issue, saying: “The people are the supreme judge of the validity of the law”.

This is perhaps unsurprising. But three things stand out. Read more

Ralph Atkins

The top news from today’s European Commission confidence indicators is the surge in economic optimism at the end of last year, which seemed widespread across the continent. The British mood brightened particularly sharply. With even Spain – where unemployment is dire – reporting a steady improvement, the survey offers suport for the “tide-lifts-all-boats” theory.

The other good news for the European Central Bank is that the eurozone public may be starting to believe in inflation again. Read more

As expected, the Bank of England has just kept interest rates on hold at 0.5 per cent and left the target of asset purchases at £200bn.

There was no statement from the Monetary Policy Committee. This was as everyone expected – the first of many boring rates meetings at the start of 2010 (with the possible exception of next month).

The banks in the United Arab Emirates do not have any liquidity problems, but enjoy high liquidity and are not in need of additional support, the central bank governor said on Wednesday.

In remarks made on the sidelines of an opening ceremony of the Sharjah Islamic Bank’s new headquarters, Al Suwaidi also said the global economic crisis has stabilized to some extent, which reflected positively on the UAE, according to the official news agency WAM. “The economic growth in the UAE will not be enormous in the coming period and we will not have to talk about inflation as its rate will be very low,” he added. Read more

OK, two datapoints doesn’t make a trend. But it’s two datapoints this week and the list will grow.

President Cristina Fernandez is trying to oust the (nominally independent) central bank governor, who is last reported sitting at his desk, refusing to go. She has neither legal nor moral authority to fire him. After all, he is refusing to spend Argentina’s foreign exchange reserves, and he might well be right. Read more

The Chinese central bank has today sold three-month bills at a yield of 1.3684 per cent, up 4.04 basis points from 1.3280 percent last week, the level it has kept over the past four months. The move makes the prospect of an interest rate rise more likely.

The yield increase expands the Chinese policy of liquidity mop-up: two significant draining operations have already taken place this week (1, 2). Read more

Krishna Guha

Fed minutes show doves are still worried about the sustainability of the recovery. They fear renewed weakness in housing as the central bank winds down its MBS purchases and want to keep open the option of buying more MBS if a) the economic outlook deteriorates b) mortgage rates spike.

That option is still open, but I suspect it would take a big forecast downgrade and/or a large mortgage rate spike to persuade the majority of the committee to buy more MBS. Read more