Monthly Archives: October 2010

Still fresh after his performance as the lone dissenting dove on the UK’s Monetary Policy Committee, Adam Posen has now used the expertise for which he is perhaps best known — Japan’s lost decade(s) — to argue in a speech that easy monetary policy doesn’t lead to asset bubbles. Not inevitably, anyway.

Posen’s targets in the speech are the world’s surplus countries, which he believes should embrace more accomodative monetary policy to stimulate domestic demand.

We’ll give you his conclusion first, and then work back through some the argument:

In particular, I want to argue that accommodative monetary policy does not cause asset price bubbles. This argument is based on the empirically supported premise that it is private capital flows and differences in productivity that determine current accounts (and asset prices) for the most part. Barring the self-destructive subjugation of all macroeconomic goals to a fixed exchange rate, the instruments available to central banks of short-term interest rates and bank reserves are of little lasting impact on current accounts …

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New research suggests – perhaps unintentionally – that leverage ratios are a poor indicator of impending severe bank stress or failure, casting doubt on the heavy reliance placed upon them in stress tests and efforts to make the banking system safe.

As part of a broader study, a BIS working group looked at data on 117 banks, and tried to find levels of key leverage ratios that could be used to separate the ultimate fortunes of the bank. For example, did banks with a Tier One ratio below 4 per cent always fail? Did banks with Tier One ratios above 10 per cent always succeed?

The short answer is that these levels were not very instructive. One level the paper suggests is 4 per cent for the Tier One ratio. But the actual finding is that in 50 per cent of cases, banks with more than 4 per cent did not go on to suffer severe stress, and banks with less than 4 per cent, did. Fifty per cent is rather low, however: could one similarly ‘identify’ the fate of banks by tossing a coin?

The paper says that there is no “correct” method to identifying these levels, though it seems that this should have called for a classic regression analysis. Read more

We have already identified the new rules and tools required for financial stability and should move on to prioritising our options. This was the implicit message in a speech given last night by Mervyn King, as he said we would need several options working together, and proposed a criterion by which to rank them:

The guiding principle of any change should be to ensure that the costs of maturity transformation – the costs of periodic financial crises – fall on those who enjoy the benefits of maturity transformation – the reduced cost of financial intermediation. All proposals should be evaluated by this simple criterion.

There are no silver bullets, says Mr King. Key suggestions – such as a permanent bank levy or limits on leverage – each add something, but are insufficient alone to prevent another crisis. Additional capital requirements, special resolution regimes and contingent capital also get a mention, underscoring the variety and breadth of proposed solutions.

More radical solutions – such as ‘limited purpose’ banking or functional separation – receive a more cautious treatment Read more

UK output rose by 0.8 per cent in the third quarter, according to a preliminary estimate from the Office for National Statistics. The rise is smaller than the surprise 1.2 per cent increase in the second quarter, but substantially above expectations of 0.4 per cent, and the ONS argues that underlying growth in the two quarters is essentially unchanged: “Allowing for the recovery in Q2 following the bad weather at the start of the year, the underlying growth in Q3 is broadly similar to that in Q2.” The UK’s output, or gross domestic product, rose 2.8 per cent between Q309 and Q310.

Output is likely to be restricted in the coming quarters as the spending cuts start to bite, but one of the benefits of the austerity programme has been underlined as S&P raised the UK’s outlook to stable from negative. They said: “In our opinion, the decisions reached by the United Kingdom coalition government in its 2010 Spending Review reduce risks to the government’s implementation of its June 2010 fiscal consolidation program. Moreover, the coalition parties have shown a high degree of cohesion in putting the U.K.’s public finances onto what we view to be a more sustainable footing.”

The Riksbank has raised Sweden’s repo rate 25bp to 1 per cent, citing a rapidly growing economy. Inflationary pressures remain low but are expected to rise. The country’s central bank has said, however, that the repo rate will not “need to be raised so much in the coming years.”

For a statement announcing this expected rate rise, it was pretty bearish: Read more

The central bank of Holland might soon be able to take over troubled financial companies, and sell their shares, assets or liabilities without shareholder approval. Bloomberg says the Dutch Finance Minister is preparing a draft bill, which would provide an alternative to the “financial reorganization option” in the emergency procedure, which has “proven ineffective” according to central bank governor Nout Wellink.

From Bloomberg: Read more

A speech just made by an ECB board member illustrates perfectly the divergent fortunes of the ECB, Bank of England and the Fed.

In the UK and US – where the recovery is more fragile – markets, economists and journalists are increasingly looking to their central banks for a monetary solution. Not in Europe. The economy is on a “good recovery track”, which can be ensured by fiscal responsibility and structural reform, says the ECB. So, no monetary solution here: responsibility is firmly back with the state. Read more

Ben Bernanke, chairman of the US Federal Reserve, said on Monday that regulators were “intensively” probing banks’ foreclosure practices and expected to produce results next month. Some of the largest US banks have halted moves to claim back homes from borrowers after it emerged that they had cut corners in preparing paperwork; state attorneys general are investigating allegations of fraud.

The Fed chairman told a conference on the future of housing finance that regulators were “looking intensively at the firms’ policies, procedures, and internal controls … and seeking to determine whether systematic weaknesses are leading to improper foreclosures”. Read more

Want to buy RUB/CNY directly? May soon be a possibility, the Russian central bank has told Chinese ambassador Li Hui. Xinhua reports a statement of intent from deputy head, Victor Melnikov, to the effect that Bank Rossii is willing to co-operate with China to effect a direct currency exchange between rouble and yuan.

Both countries are keen to deepen “financial co-ordination and mutual investment”, according to state-run media Xinhua. Dr Melnikov noted the economic and strategic significance of a direct exchange between the two currencies; the Chinese ambassador echoed these sentiments, and was keen to support Sino-Russian co-operation in economic, energy and science projects.

Robin Harding

The final part of any Fed announcement of a new programme of asset purchases would be some indication of its future intentions: its willingness to increase or decrease the size of the programme and the conditions under which it might do that. Once again, the Fed will not decide anything until the FOMC meets and I don’t know any details, but I can set out some considerations.

How conditional is conditional?

If you look back to the Fed’s March 2009 statement there was an attempt to make asset purchases conditional.

“by purchasing up to an additional $750 billion of agency mortgage-backed securities”

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Robin Harding

In a previous post I suggested that a plausible estimate for the amount of asset purchases the Fed may initially consider for a new round of quantitative easing is about $500bn. I’d emphasise again that this is informed speculation because if I had any definite information it would have been in the newspaper this morning.

The next important question is how fast it would buy those assets. Again, I have no definite knowledge, but I can set out some of the considerations.

In the piece I wrote in Thursday’s paper I said that the Fed could either set out a rate of buying (Xbn a month until a total of X) or a timeframe (a total of Xbn over X months). Given that Distance = Speed x Time it is just a question of which of the latter two parameters you choose to define. Read more

Robin Harding

I don’t have a reportable number for the size of the new programme of asset purchases that the Fed will consider at its November meeting – it is even possible that the meeting will tweak whatever the staff propose somewhat – but I can manage some informed speculation on the likely order of magnitude.

As I have reported, the Fed is not planning to go totally meeting-by-meeting, and there will be some medium-term guidance at least on the amount of purchases that are very likely to be completed. $500bn seems about right for that initial number.

There are several reasons to think this: Read more

Record high rates charged by banks on unsecured debt are not justified by default and write-down rates, as banks claim.

News broke yesterday that five-year debt in the UK is at its cheapest since the 1980s. Great news for banks; even politicians were probably pleased. But of little help to consumers – and by extension, the real economy. Until banks drop their rates, and pass through some of the savings, they remain a bottle-neck in the transmission of cheap debt. And that means that monetary policy tools – such as making debt cheaper – cannot effectively flow through to stimulate a debt-fuelled recovery.

The problem is simple: banks are borrowing ever more cheaply but lending at ever higher rates. Take overdrafts. In August the average overdraft rate offered by banks hit a record high of 19.08 per cent, and it stayed there through September. The banks’ cost of debt shouldn’t be causing this: we don’t know the composition of their funding, but we do know that government and corporate debt rates are falling. So, why the high rates?

When asked by the Bank of England, banks said increasing default rates were the problem:

…spreads between effective interest rates and Bank Rate and Libor for consumer credit — particularly for interest-bearing credit card balances — remained significantly wider than in late 2008, which lenders reported as partly reflecting heightened credit risk on this form of lending.

Why, then, did banks report falling defaults for ‘other unsecured’ loans in the latest credit conditions surveyRead more

French daily La Tribune reports that President Nicolas Sarkozy is opposed to Axel Weber taking the helm of the ECB next year. Citing sources close to the president, the paper says Mr Sarkozy has never agreed to Mr Weber’s appointment with German chancellor Angela Merkel. To underline the point, the paper points out that Mr Sarkozy has only recently received Bank of Italy governor Mario Draghi, widely considered Mr Weber’s chief rival.

The appointment of an ECB president needs approval by the EU’s political leaders, so Mr Sarkozy’s views will carry some weight. But this might just be political horse-trading. Automated Trader reports rumours that Mr Sarkozy has pledged to support Mr Weber’s candidacy in reward for Ms Merkel’s co-operation on EU fiscal rules. Plus it might be politically unpalatable to have ‘Southerners’ holding both key positions at the ECB (the ECB VP, Vitor Constancio, is Portuguese). Read more

From Bloomberg:

Norway’s Finance Ministry named Oeystein Olsen as central bank governor starting on Jan. 1 in an appointment that may lead to a slower pace of interest-rate increases in the world’s seventh-largest oil exporter. Read more

Sweden is forecast to raise rates next week by 25bp, taking the repo rate to 1 per cent. If this happens, Sweden will have the honour of being the only European serial rate-raiser – an exclusive club spread across the globe, including Israel, Taiwan and Chile. Other rate-raisers have paused. From Citi:

We expect the Riksbank to continue its policy normalization, hiking by another 25bp to 1.0% at the upcoming October 25-26 meeting. Such a move would echo the September conditional interest rate path and also be in line with current market pricing (discounts about a 92% chance of such an outcome)…

We see compelling reasons building, though, for a downgrade of the longer-term part of the Riksbank’s rate path. There is little sign of inflationary pressures building and, combined with an uncertain global economic outlook and lower global interest rate expectations, the Riksbank should be in no hurry to hike, once the policy rate has reached more normal recessionary levels (of around 1.25-1.5%, in our view).

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James Politi

Conventional wisdom in Washington is that Ben Bernanke, Federal Reserve chairman, is pretty much alone in his quest to deliver a jolt to the US recovery.

With concerns about the deficit running rampant, Congress is unlikely to push through any significant fiscal stimulus anytime soon, particularly if there is a shift in power with strong Republican gains in the midterm congressional elections. As much as the Obama administration may want to move forward with new economic programmes, it is clearly hamstrung by the headwinds on Capitol Hill.

But not all may be lost…..

A research note by Michael Feroli, economist at JPMorgan, just highlighted some interesting ways in which fiscal policy could achieve what Charles Evans, president of the Federal Reserve Bank of Chicago, recently described as a crucial policy objective: lower short term real interest rates. Read more