De donde sale la cifra de USD700 millardos?

Según Bernanke los 700 millardos (billions) de dólares son el 5% de los USD14 billones (trillions) que hay colocados en hipotécas. La idea es que el gobierno compre el 5% de los activos hipotecarios a un precio más cercano a los fundamentos de largo plazo (por ejemplo al valor presente del par value), es decir a un precio mucho más alto que el precio de mercado actual. Eso hace que ese precio sea el precio mínimo o base, no solo del 5% sino de la totalidad de papeles hipotecarios colocados; pues nadie va a vender a un valor menor porque preferiría venderle al gobierno. El punto acá es la arbitrariedad del 5%: quien dice que si se le pone un piso al 5% de esos activos el 95%% restante va a reaccionar igual?. No hay teoría económica para eso, es un asunto de lo que piensen los agentes. Puede ser que se necesite menos del 5% o mucho más. Lo que tienen que percibir los agentes es que el gobierno va a poner lo que sea necesario para defender ese precio mínimo. O sea, lo necesario para que nadie quiera vender a menor precio porque sabe que le puede vender al gobiero si no encuentra otro comprador. Si eso se sabe, los activos hipotecarios suben de precio y eso aumenta los activos de las empresas quebradas.

De modo que, pasado este asunto de si son USD 700 o 3000 millardos, lo importante es lo que hablamos antes:quien debe asumir el riesgo de comprar unos papeles que no valen nada esperando que a largo plazo se valoricen? El plan del ejecutivo (diseñado por Paulson, el secretario del Tesoro, quien es un hombre de Wall Street) es que ese riesgo lo corran exclusivamente quienes no originaron el problema, es decir los contribuyentes. Al Congreso eso no le gusta, quieren que ese riesgo sea compartido por los bancos que originaron el problema. Por eso han propuesto que los bancos que van a vender los titulos hipotecarios aseguren al gobierno contra el hecho de que el precio futuro de esos titulos no sea superior a lo que el gobierno va a pagar. Propuesta que se suma a la propuesta de la mayoría des economistas en el sentido de que el gobierno sea dueño de esos bancos en proporción a lo que invierta para salvarlos. Estas dos ultimas propuestas son más eficientes a largo plazo porque evitan los problemas de riesgo moral en Wall Street, una industria que genera una crísis grave cada diez años.

Está claro que economicamente las dos segundas propuestas (la del congreso y la de los economistas) son mejores, está claro que la propuesta del gobierno (o sea la de Wall Street) es la peor. Lo que queda ahora es un debate dentro del congreso, con los poderosos lobbies de Wall Street empujando la propuesta gubernamental y algunos senadores y académicos tratando de defender a los contribuyentes. Los grandes intereses en juego hacen prever que ese debate no va a ser solamente un debate económico. Y la decisión tiene que ser rápida, lo cual juega a favor de un free ride de Wall Street.

Blog Real Time Economics   |  September 24, 2008, 12:42 pm

Does Treasury Need $700 Billion All At Once?

Congress is balking at the stunning size of the Treasury market-bailout plan and the request to do with the money what administration officials see fit. Treasury Secretary Henry Paulson has resisted suggestions from lawmakers that it should be anything less than that. Fed Chairman Ben Bernanke today, by not insisting on that figure as strongly, may have given congressional leaders a bit more standing to push their case.

Sen. Charles Schumer (D., N.Y.), chairman of the Joint Economic Committee, opened the questioning at today’s hearing asking Mr. Bernanke why a smaller authorization — perhaps $150 billion — wouldn’t be enough to start. Installments would ensure that taxpayers’ interests are protected and allow officials to evaluate the success of whatever program is used to buy mortgage assets. “This is just an idea, one of many that we in Congress are considering as we try to responsibly respond to this dire situation,” Mr. Schumer explained.

“Probably $1 trillion would be better than $700 billion,” he said. “Do you think that $150 billion is insufficient to assure the markets that Congress is serious and the government is serious about addressing this problem?”

Mr. Bernanke noted that he isn’t part of the legislative or executive branches, and therefore has “no standing to negotiate this proposal.” (Mr. Paulson wasn’t at the committee hearing but is scheduled to testify Wednesday afternoon before the House.) But Mr. Schumer wanted the perspective from Mr. Bernanke, the economist.

“Senator, you asked me my opinion as an economist,” Mr. Bernanke replied. “Unfortunately, this is a matter for psychology.”

The key issue, Mr. Bernanke explained, is that “markets need to have confidence” the problem will be addressed. The government is essentially sending a signal to financial markets. An insufficient amount could be seen as “dribs and drabs” to solve the issue, he said. “It is a very big problem and we don’t want to undershoot it.”

How did the $700 billion figure come about? “It’s not science to figure out how much is going to be needed to stabilize the firms and the markets,” Mr. Bernanke said. The amount is roughly 5% of outstanding mortgages. “It seems like an appropriate size” given the scale of the numbers, he said.

Mr. Bernanke urged continuous oversight by lawmakers over the program as a key way to ensure that its goals are achieved. –Sudeep Reddy

Do not abandon inflation targets

Por Frederic Mishkin

Financial Times, 28 de septiembre del 2008

Inflation targeting is now facing its greatest challenge from a series of fundamental shocks. High energy and other commodity prices have led to inflation rates well above the inflation target – nearly 5 per cent in the UK versus the 2 per cent inflation target, for example – at the same time that the financial markets are reeling from the worst financial crisis since the Great Depression. Some critics of inflation targeting have argued that under the present circumstances, such targeting should be abandoned.

Frederic Mishkin

Is inflation targeting an idea that worked well in the past, but cannot cope with the stress of the present environment? How can monetary policy respond to the negative shock to the economy from the financial crisis, when inflation targeting requires a commitment to reduce inflation back to its target? Would the need to hit the inflation target not require tighter monetary policy that will just kick the economy when it is down?

To the contrary. I believe that inflation targeting, with some flexibility built in, is exactly what is needed right now. Inflation targeting establishes a transparent and credible commitment to a specific numerical inflation objective that provides a firm anchor for long-run inflation expectations, thereby directly contributing to the objective of low and stable inflation.

Additionally, the presence of a firm nominal anchor gives the central bank greater flexibility to respond decisively to adverse demand shocks. Such a commitment helps ensure that an aggressive policy easing – which might be needed to counteract the blow to the economy from the current financial crisis – is not misinterpreted as signalling a shift in the central bank’s inflation objective and thereby minimises the possibility that inflation expectations could move upward. A continuing, strong commitment to retain the same inflation target is exactly what is needed at the current juncture.

But how can an inflation target remain credible if monetary policy responds to adverse demand shocks when inflation is well above the target, as has happened recently? This is where flexibility comes in.

The modern science of monetary policy argues that it should not try to get inflation to within a tight range over short time horizons. To do so would only result in excessive fluctuations in economic activity. It argues, instead, that when shocks to the economy are sufficiently large, inflation might have to approach the target gradually over time and this could be longer than the two years that is usually assumed as a reasonable time horizon for monetary policy to have its intended effect on inflation.

Trying to get inflation down to the target too quickly will impose an unnecessary cost on the economy, and is actually likely to weaken the credibility of the central bank. Both the public and the central bank know that the central bank is unable to sustain an overly tough policy stance because if it did so the government might very well take steps to weaken its independence. An overly tough policy stance could then undermine the support for the inflation targeting policy and unhinge longer-run inflation expectations, actually leading to worse outcomes, both on economic activity and inflation. Instead, the central bank should articulate a desired path for inflation that gets to the target over a reasonable time horizon, thereby promoting the joint objectives of price stability and maximum sustainable employment. This kind of public communication can build the support that makes this policy sustainable.

The approach outlined here is actually representative of where best practice in inflation targeting is heading. The Norges Bank and Riksbank, the central banks of Norway and Sweden, have moved exactly in this direction. They have both made clear that they are pursuing more flexible inflation targeting regimes in which the horizon over which inflation returns to its target might have to vary, depending on the shocks to the economy.

Inflation targeting has been a significant step forward in improving the conduct of monetary policy. The challenging environment that central banks are facing today, however, suggests that inflation targeting practice needs to keep evolving in a more flexible direction, with a focus on what should be the best path for inflation that moves it towards a longer-run inflation objective, but not necessarily over a fixed time period.

Indeed, a more flexible approach to inflation targeting might make it more attractive to countries that have not adopted this monetary policy strategy, such as the US, where there is a fear that inflation targeting might promote too much of a focus on controlling inflation in the short run and not enough on financial stability or the dual objectives of promoting stability and maximum sustainable employment.

The author is a professor of finance and economics at the Graduate School of Business, Columbia University, a former member (governor) of the Board of Governors of the Federal Reserve and the author of ‘A Monetary Policy Strategy’ (MIT Press, 2007)

What Are the Other Bailout Options? An Explainer

By Catherine Rampell in the Economix blog

Treasury Secretary Henry M. Paulson Jr. has emphasized the urgency of his bailout plan by warning that inaction would be disastrous. But are there other options besides total inaction on the one hand, and Mr. Paulson’s $700 billion bailout on the other hand?

Let’s start with the fundamental problem that the bailout is trying to solve. To function, Wall Street firms cannot have too much debt relative to their underlying assets. If they do, other banks won’t do business with them – much as your local bank won’t give you a $100,000 loan unless you have some collateral behind it. In recent years, banks went deeper and deeper into debt, in an effort to turbo-charge their returns. Now they are discovering that their assets are not worth what they thought. The combination of high debt levels and falling asset values has paralyzed the financial markets. In econ-speak, the firms have too much debt relative to their assets.

The government could reduce that debt-to-assets ratio either by decreasing the numerator (debt) or increasing the denominator (assets). The first option would involve reducing the debt obligations of these institutions. The Treasury Department’s $700 billion plan to buy mortgage-backed securities and other contracts from the banks falls into this category. Proponents argue that this plan can be executed quickly and that the government will end up making back a significant chunk of the $700 billion, if not all of it, when it sells the assets down the road.

The second option would be to increase the firm’s assets. Several economists, as well as a number of Democratic lawmakers, are advocating the second approach (or at least some combination of the two strategies).

One way to do this would be to have the government invest in the firms. In other words, the government would give Wall Street institutions more capital, presumably also from taxpayer funds, in exchange for a cut of the firms’ profits down the road. Douglas W. Elmendorf, Paul Krugman and various others have advocated this. Luigi Zingales has put forth a proposal for the banks to raise capital without taxpayer money by having creditors forgive some of the banks’ debt in exchange for partial ownership of the same banks. These and other critics say it is not fair to make taxpayers spend hundreds of billions of dollars rescuing these companies without also giving them a stake in the upside.

Other ideas – including conditions on oversight authority and executive pay, which could theoretically be combined with either approach – have also been pitched.

For example, Robert Reich, the former labor secretary, recommended that the bailout be replaced with a regular ol’ bankruptcy, organized by the government.

A number of critics say the bailout plan pays too little attention to homeowners and to “Main Street.” Dean Baker recommended that the bailout should give priority to keeping people in their homes — i.e., reducing the amount of money people owe on their mortgages — instead of maximizing the returns the government can get from mortgage payments. Nouriel Roubini suggested creating a government body in charge of helping Americans find debt relief, modeled on the Home Owners’ Loan Corporation established during the Great Depression. Mark Thoma proposed the creation of a “worker bailout fund” for those afflicted by layoffs nationwide.

It’s not totally clear to me that helping people keep their homes will resolve the larger liquidity problems that are afflicting the financial system and, in the process, putting the economy at risk of falling into a deep recession. My colleague David Leonhardt will discuss this later in a separate post.

An Emerging Consensus Against the Paulson Plan: Government Should Force Bank Capital Up, Not Just Socialize the Bad Loans

From Jeffrey Frankel’s Weblog | Sep 23, 2008

In time of war, there is a tendency for both political parties to rally around the president, as we saw (all too well) in Iraq after September 11.    In time of financial panic, there is often a similar inclination.  The two presidential candidates, for example, are being very careful in their statements.   I don’t blame them.  The issues are too complex to be taken on inside the context of a political campaign.   Both candidates realize that the danger of a verbal misstep that the other side can try to blame for worsening the crisis is far greater than the likelihood that either one will come up with a brilliant solution that will gain widespread support or will solve the problem, let alone both.

Having said that, opposition to the $700 billion plan proposed by Treasury Secretary Henry Paulson September 19  has coalesced quickly, from both ends of the political spectrum.    Sebastian Mallaby pursues the Iraq analogy in “A Bad Bank Rescue” in the Washington Post, September 21:   “…in buying bad loans before banks fail, the Bush administration would be signing up for a financial war of choice.  It would spend billions of dollars on the theory that preemption will avert the mass destruction of banks.

The explicit lack of oversight or checks and balances in the Treasury proposal is very worrisome – and it worries Congressional Democrats.

But the nature of the bailout, how the money is to be used, is what bothers me most of all.   As Mallaby says, “Within hours of the Treasury announcement Friday, economists had proposed preferable alternatives.  Their core insight is that it is better to boost the banking system by increasing its capital than by reducing its loans.”  Examples are not tied to economists from a particular political viewpoint or party.   He mentions the proposals of Ragu Rajan (FT.com) and Luigi Zingales (Vox) that the government could tell banks to cancel all dividend payments;   and proposals by Charlie Calomiris  (Ft.com) and Doug Elmendorf (Brookings) that the government could buy equity stakes in banks themselves, rather than just buying their bad loans.

Similarly,  in today’s New York Times opinion page, Paul Krugman on the left side of the page and Bill Kristol on the right side of the page.  What Mallaby calls the core insight is also the crux of Krugman’s logic (“Cash for Trash”):  “…the financial system needs more capital.  And if the governments is going to provide capital to financial firms, it should get what people who provide capital are entitled to – a share in ownership, so that all the gains if the rescue plan works don’t go to the people who made the mess in the first place.”  Sounds right to me.   Don’t socialize the losses without socializing the gains.

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Panic grips credit markets

Financial Times | September 17 2008 21:38

The panic in world credit markets reached historic intensity on Wednesday, prompting a flight to safety of the kind not seen since the second world war.

Barometers of financial stress hit record peaks across the world. Yields on short-term US Treasuries hit their lowest level since the London Blitz. Lending between banks in effect halted and investors scrambled to pull their funding from any institution or sector whose future had been called into doubt.

The $85bn emergency Federal Reserve loan for the troubled insurance group AIG, announced on Tuesday night, failed to curb the surge in risk aversion. Instead, markets were hit by a fresh wave of anxiety.

Speculation mounted that the Federal Reserve, which refused to cut rates on Tuesday, could be forced into an embarrassing U-turn. Amid the financial chaos, traders were pricing in 32 basis points of rate cuts by the end of the month – essentially betting that there was a 60 per cent chance the Fed would cut rates by half a percentage point in the coming days.

One cause for fear came when shares in a supposedly safe money market mutual fund fell below par value – or “broke the buck” – owing to losses on Lehman Brothers debt. This raised the risk that retail investors in other such funds could panic and pull out their money.

All thought of profit was abandoned as traders piled in to the safety of short-term treasuries, with the yield on three-month bills falling as low as 0.03 per cent – rates that characterised the “lost decade” in Japan. The last time they were this low was January 1941.

Shares in the two largest independent US investment banks left standing – Morgan Stanley and Goldman Sachs – fell 24 per cent and 14 per cent respectively as the cost of insuring their debt soared, threatening their ability to finance themselves .

Repercussions were felt far beyond the US. There was turbulent trading in HBOS, a leading UK mortgage lender, which was forced – at the prompting of the British government – to enter into merger talks with fellow retail bank Lloyds TSB after drastic falls in its share price.

Lending between banks in Europe and the US in effect halted. The so-called Ted spread – the difference between three-month Libor and Treasury bill rates, which measures fear over banks – moved above 3 per cent, higher than the record close after the Black Monday crash of 1987.

The authorities fired back, with the Treasury announcing it would borrow money to give to the Fed to use for its emergency lending – in essence removing any balance sheet constraint on the size of this assistance.

The Securities and Exchange Commission, the regulator, announced new curbs on short selling that traders called draconian. Short sellers, who profit from share price declines, were widely blamed for the trouble at AIG. But these efforts failed to avert heavy selling, particularly of US financial stocks.

Many analysts criticised the US authorities for adopting an arbitrary approach to rescues – saving AIG but not Lehman – that was impossible for investors to predict and therefore did nothing to boost confidence.

The S&P 500 fell 4.7 per cent, led by a 8.9 per cent slump in financials. Equity volatility was near its highest level since March. The dollar weakened slightly, while the Japanese yen rallied as risky currency funding trades were unwound.

Gold benefited from safe-haven buying, with prices at their biggest one-day precentage gain, up 11.2 per cent to a three-week high of $866.47 a troy ounce.

Andrew Brenner, co-head of structured products and emerging markets at MF Global, said: “It feels like no one wants to take anyone’s credit . . . it feels like we are on a precipice.”

Mercados mundiales se desploman por segundo día consecutivo; IGBC cayó 2,02%

Portafolio, 17 de septiembre del 2008

En la Bolsa de Nueva York, el Índice Dow Jones descendió en 4,06% (449,3 puntos), y el Índice tecnológico Nasdaq se derrumbó en 4,94%. Eso, pese al intento de la FED de evitar la quiebra de AIG.

Hacia la media sesión en el índice industrial, las acciones de AIG se desplomaban en 44,33 por ciento, y se negociaban a 2,08 dólares, después de que su rescate por parte de la Reserva Federal no lograra tranquilizar a los inversores, que se preguntan quién será la próxima víctima de la crisis financiera.

En el mercado de valores de Colombia, el IGBC acumula un descenso de 15,75 por ciento durante lo corrido del año. Este miércoles se negociaron 166.643,88 millones de pesos en 2.959 operaciones.

La especie con el volumen más alto de negociación fue Ecopetrol, con 115.815,80 millones de pesos. También se destacaron en este aspecto, Suraminv ($8.360,07 millones, con cambio negativo en su precio del 1,06 por ciento a $16.820,00) junto con Pfbcolom ($6.754,20 millones, con cambio negativo en su precio del 4,41% a $15.620,00).

Por su parte, Mineros logró el ascenso más importante durante la sesión. El precio de este título creció un 8,00 por ciento, con cierre de 2.430 pesos. Otros títulos destacados por su apreciación fueron; Socbolivar, cuyo precio creció en 2,03 por ciento a 97.500 pesos; y Coltejer, que ascendió 1 por ciento a 1,20 pesos.

 

 

Posible venta de HBOS influye en bolsas del mundo

El HBOS, el mayor proveedor de hipotecas británico, anunció el miércoles que está en negociaciones avanzadas que podrían culminar en una oferta de compra de Lloyds TSB.

La bolsa de Londres cerró con una fuerte pérdida de 2,25 por ciento; Francfort, la mayor plaza financiera de la Eurozona, perdió 1,75 por ciento al cierre y París cayó un 2,14 por ciento para ubicarse en su menor nivel desde mayo de 2005.

En Madrid, el Ibex-35 perdió 2,29 por ciento hasta situarse en los 10.661,40 puntos, su nivel más bajo desde enero de 2006, arrastrado a la baja por los valores financieros.

Los bancos sufrieron una nueva sesión negativa con una caída del 3,97 por ciento a 10,41 euros para el Banco Bilbao Vizcaya Argentaria (BBVA) y unas pérdidas del 5,58 por ciento a 9,99 euros para su principal competidor y líder de los bancos españoles, Santander.

“El rescate de AIG ha tranquilizado a los mercados de que algunas instituciones financieras son demasiado grandes como para permitirles que quiebren, después de todo”, dijo el analista Julian Jessop, de Capital Economics.

La próxima víctima de la crisis “subprime” podría ser el banco estadounidense Washington Mutual. Según el diario New York Post, las autoridades bancarias estadounidenses buscan un comprador para esta institución, hasta ahora sin éxito.

En Asia, algunas bolsas cayeron bastante en medio de temores sobre la salud de las instituciones financieras estadounidenses.

La bolsa de Hong Kong perdió al cierre un 3,6 por ciento, mientras Shanghai retrocedió un 2,9% por preocupaciones sobre el impacto de la tormenta financiera estadounidense en la economía china.

Rusia permanecía inmersa en plena tormenta bursátil y financiera el miércoles, y la cotización de sus dos bolsas estaba suspendida tras derrumbes de 17,5 por ciento y 11,5 por ciento el martes, mientras el gobierno y el banco central siguen inyectando sumas colosales de dinero en los tres mayores bancos del país.

Los mercados rusos fueron sacudidos además por el rumor de una próxima quiebra del banco de inversiones nacional Kit Finance, que podría ser rescatado por el Estado.

La bolsa de Tokio terminó el miércoles la sesión con un alza de 1,21 por ciento, un día después de hundirse casi 5 por ciento a su menor nivel en más de tres años.

Los bancos centrales de Asia inyectaron el miércoles otra vez efectivo en los mercados monetarios. El Banco de Japón inyectó unos tres billones de yenes (28.000 millones de dólares).

La bolsa de Seúl terminó en alza de 2,7 por ciento tras un derrumbe de 6,1 por ciento el martes.

 

E.U. elevará emisión para financiar inyecciones de liquidez

El departamento del Tesoro de Estados Unidos anunció, este miércoles, que aumentará temporalmente la emisión de bonos públicos para financiar las inyecciones de capital de la Reserva Federal en los mercados.

En un comunicado, el Tesoro señaló que realizará las subastas mediante el llamado “Programa de Financiación Suplementario”, que se añadirá a su programa actual de captación de fondos, muy voluminoso por el repunte del déficit federal en Estados Unidos.

El Tesoro entregará el dinero en efectivo a la Reserva Federal, que se ha visto obligada a aumentar sus intervenciones en los mercados financieros para impedir que se desestabilicen.

La primera operación tendrá lugar este miércoles y en ella el Tesoro ofrecerá bonos a 35 días de vencimiento por valor de 40.000 millones de dólares.

Al hacer el anuncio de la inyección de capital, la Reserva Federal argumentó que el colapso de la gigante aseguradora American International Group Inc. golpearía más los mercados y amenazaría aún más a la frágil economía.

A cambio, la FED recibirá un 79,9 por ciento de participación en AIG y el derecho de despedir a la directiva, señaló la Fed.

La medida fue similar a la del 7 de septiembre, cuando el gobierno se hizo cargo de las gigantes hipotecarias Fannie Mae y Freddie Mac. El Departamento del Tesoro informó que estaba dispuesto a inyectar hasta 100.000 millones en cada una de las compañías, en caso necesario, para evitar su quiebra.

Ambas medidas generarían cuestionamientos sobre si se debe usar el dinero de los contribuyentes para rescatar firmas privadas. Aunque es poco conocida fuera de Wall Street, AIG hace negocios casi con todas las instituciones financieras del mundo, y asegura activos por 88.000 millones de dólares, incluyendo préstamos hipotecarios y corporativos.

Su caída también ”llevaría a mayores costos de los préstamos, menor valor de las viviendas y a un desempeño económico más débil”, informó la Fed en un comunicado.

La intervención de la Fed “es considerada como el primer paso para una estabilización del mercado financiero, y ello provoca la compra” de acciones, explicó Masatoshi Sato, de Mizuho Investors Securities.

Pero “los principios que guían a las autoridades financieras siguen siendo poco claros”, deploró, indicando que el mercado se pregunta por que la Fed y el Tesoro norteamericanos salvan AIG, Freddie Mac y Fannie Mae y dejan hundirse a Lehman Brothers.

“Los riesgos siguen siendo elevados y el mercado va a seguir inestable probablemente por un tiempo”, predijo.

“Es razonable que los inversionistas piensen que si una gigantesca institución como AIG se encuentra en la actual situación, debe haber muchas otras empresas, más pequeñas, cuyos problemas están aún por conocerse”, declaró Akira Ishida, gerente en Chuo Securities, interrogado por Dow Jones News Wires.

Se pronuncia la Casa Blanca

La Casa Blanca defendió, este miércoles, su nacionalización de la aseguradora AIG, al indicar que la iniciativa busca proteger la economía en general, y expresó su preocupación por otras empresas.

En su rueda de prensa diaria, la portavoz de la Casa Blanca, Dana Perino, indicó que el riesgo de un colapso de AIG, la mayor aseguradora de EE.UU., representa una amenaza mucho mayor que el coste de la nacionalización.

“Algunas de estas compañías son tan grandes que dejarlas caer hubiera causado un daño aún mayor a la economía”, sostuvo la portavoz, que no descartó la posibilidad de otras intervenciones.

“Seguimos preocupados por otras compañías, y por eso el secretario del Tesoro y el equipo (de la Casa Blanca) examinan si podemos detener otras pérdidas”, según Perino.

Cualquier otra intervención se decidirá caso por caso, puntualizó la portavoz, que no mencionó nombres precisos de empresas y reconoció que en la actualidad la economía estadounidense presenta datos “muy mezclados”.

Investment banks’ future questioned

By Peter Thal Larsen and Francesco Guerrera in London

Financial Times | September 15 2008 20:26

When Chase Manhattan bought JPMorgan in the autumn of 2000, many thought the deal would trigger a series of mergers in the investment banking business. Senior bankers predicted that other Wall Street firms such as Bear Stearns, Lehman Brothers and Merrill Lynch would have to join forces with larger lenders or risk being marginalised.

Eight years on, those predictions are finally coming true. After an extraordinary weekend on Wall Street, Lehman on Monday filed for bankruptcy protection while Merrill Lynch rushed into the arms of Bank of America, its larger rival. Combined with the collapse of Bear Stearns earlier this year, the ranks of the Wall Street banks have been cut in half. Among the so-called “pure” investment banks, only Goldman Sachs and Morgan Stanley remain.

Not surprisingly, the crisis has once again raised serious questions about the viability of investment banks that are not part of a larger institution. “Merrill has been a strong and respected competitor in the marketplace,” Ken Lewis, BofA’s chairman and chief executive said on Monday. “But the market continues to question the viability of a stand-alone investment bank.”

That process continued on Monday. Shares in Morgan Stanley were down almost 9 per cent by early afternoon in New York on Monday, and have lost almost half their value in the past 12 months. Goldman Sachs, which has survived the credit crunch in better shape than any of its direct competitors, was down 7 per cent. The cost of buying protection on a default of both banks also jumped sharply on Monday as traders absorbed the consequences of the decision by Hank Paulson, the US Treasury Secretary, not to support Lehman. “What’s got everyone on edge is that Paulson has effectively declared that the broker-dealer model has no backstop,” one banking executive said, referring to the fact that there is no regulator standing behind it.

For executives at larger universal banks – which combine deposit-taking activities with their investment banking operations – the turmoil is long-awaited proof of the vulnerabilities of Wall Street banks, which tend to have smaller balance sheets and rely entirely on the wholesale markets for their funding. They believe the recent takeovers are merely a delayed consequence of the 1999 repeal of the Glass-Steagall Act – the depression-era legislation that separated commercial banks from Wall Street broker-dealers.

“This is a tough time to be an investment bank,” a senior executive at a US commercial bank said on Monday. “Given the events of the past few months, it is difficult to argue that it is better to be monoline at anything, be it investment banking, credit cards or insurance.”

Vikram Pandit, the former Morgan Stanley banker who now heads Citigroup, made a similar point in an internal memo aimed at reassuring the financial giant’s 360,000-plus employees of the company’s ability to weather, and even profit, from the current turmoil.

“Our industry is in a state of change, but I am confident that this should be an opportunity for Citi,” Mr Pandit wrote. “Citigroup continues to boast a strong deposit base that is diversified across products and regions.”

But others dismiss the idea that the business model of investment banks such as Goldman Sachs and Morgan Stanley, is broken and that they are doomed to merge with a deposit-taking institution as too simplistic.

They argue that the disappearance of three fierce competitors in the space of a few months would benefit the two surviving firms.

“Capital markets are not going to disappear, the investment banking business is still going to be there and you will only have two companies exclusively focused on it: that does not sound like a recipe for disaster,” a senior investment banker said on Monday.

With Goldman considered a notch above the rest due to its trading prowess and enviable client base, much of the spotlight will be trained on Morgan Stanley, which reports third-quarter results on Wednesday. John Mack, the firm’s chief executive, on Monday was at pains to stress that Morgan Stanley’s solid capital position and healthy revenues put it in a good position to benefit from the industry’s re-shaping.

However, stand-alone investment banks face two fundamental challenges: capital and liquidity. The bursting of the credit bubble and the drying up of the securitisation market favours banks that can put large balance sheets to work in support of their clients.

The turmoil has also highlighted the vulnerabilities in the investment banks’ dependence on the short-term repurchase market for secured funding. Wall Street banks, which have historically been overseen by the Securities and Exchange Commission, are also set to be brought under the supervision of the Federal Reserve, leading to tighter regulation of the risks the banks can take.

“The brokers may not be broken, but in future we expect the financial system in general – and the brokers in particular – to become shadows of their former selves,” Matt King, a strategist at Citigroup, wrote in a recent note.

None of this means Goldman or Morgan Stanley will be forced to surrender their independence. In the past, Wall Street banks have proved adept at reinventing themselves and adapting to a changing market. For the time being, however, the Wall Street banks must be feeling increasingly lonely.

SOBRE EL MISMO TEMA:

Downgrades deepen AIG woes – Sep-16

Stocks sink amid Wall St crisis – Sep-16

Full coverage: Crisis on Wall Street - Sep-12

Shocked City braced for more hits – Sep-15

Exodus of employees told to ‘move on’ – Sep-15

Angry staff point finger at management – Sep-15

Central banks try to lift markets

Financial Times, last updated: September 16 2008 12:32

By Ralph Atkins in Frankfurt and Chris Giles in London 

Central banks across Europe intervened heavily on Tuesday morning, after much higher than usual volatility in money markets as banks scrambled for cash following the collapse of Lehman Brothers.

The European Central Bank reported a sharp rise in eurozone banks’ demand for liquidity and pumped €70bn of emergency funds into the overnight market – significantly higher than on Monday.

The Bank of England followed Monday’s injection of £5bn of cash until Thursday, with an additional £20bn on Tuesday.

The Federal Reserve Bank of New York said on Tuesday it would “shortly”’ arrange a “large” injection of funds into money markets after overnight interest rates surged.

Many commercial banks will be short of cash because they have exposures to Lehman Brothers that are now tied up in bankruptcy proceedings.

The signs of stress in unsecured bank funding markets were extreme. On Tuesday the overnight sterling Libor fix jumped to a seven-year high of 6.79 per cent as banks hoarded cash. The short term OIS market, more closely watched by the Bank, was also extremely volatile with short term interest rates trading well above the Bank’s 5 per cent policy rate.

The share prices of banks lurched lower on Tuesday as the signs of strain in the financial system increased. HBOS, the UK’s largest mortgage lender, was the biggest faller – down 28 per cent at 167.4p. That helped push the FTSE 100 index of blue-chip shares briefly below 5,000 for the first time since June 2005.

Other banks were also sharply lower. Barclays, which earlier on Tuesday said it was interested in buying parts of Lehman, was down 6.1 per cent at 296¾p and Royal Bank of Scotland was 11 per cent weaker at 187p.

Bids for overnight funds in the latest ECB special operation launched since the collapse of Lehman Brothers at the weekend exceeded €100bn, the Frankfurt-based institution reported. That pointed to rising financial market tensions in the wake of the US financial crisis.

In the end, the ECB allocated €70bn at an average interest rate of 4.4 per cent. But that was significantly higher than the €30bn it allocated on Monday, when the bank pledged, “to contribute to orderly conditions in the euro money market”. Its policy rate is currently 4.25 per cent.

Bids were equally high in London, with banks seeking £58bn compared with the £20bn on offer. In London the interest rate on the cash offered by the Bank of England was the 5 per cent policy rate as the Bank uses such operations to tide commercial banks over until their regular weekly refinancing operation on Thursday.

Then the Bank of England will estimate how much extra cash it needs to pump into financial institutions in the short term to ensure that overnight interest rates stay at its desired level of 5 per cent.

At the same time, the ECB reported the strongest demand this year for funds in its regular offer of seven-day funds. Some 533 banks bid for a total of €328.7bn – the highest since the special liquidity-boosting operations launched by the ECB at the end of last year. The ECB allotted €150bn.

Throughout the unfolding global financial market turmoil, the ECB and the Bank of England have drawn a clear distinction between such financial market operations, aimed at easing tensions in money markets and ensuring overnight interest rates stay close to their policy rates, and their main interest rate strategy designed to control demand and inflation in the economy.

So far there has been no sign of the ECB weakening its hard-line stance in combating inflation, which was confirmed at 3.8 per cent in August, by Eurostat, the European Union’s statistical unit. That was only modestly lower than the record 4 per cent reported in July.

The ECB aims to keep inflation “below but close” to 2 per cent. The ECB’s monetary policy stance is unlikely to change even if the US Federal Reserve cuts US official borrowing costs tonight, analysts said.

Mervyn King, the Bank of England’s governor, had to write a letter to the chancellor on Tuesday, explaining why UK inflation was so high at 4.7 per cent. He struck a tough tone insisting the Bank was even “firmer” in its belief now that the economy had to weaken significantly to bring inflation down.

When the dust settles…

Models and Agents, posted: 14 Sep 2008 11:04 AM CDT …the sky opens… the light comes down… Lehman is history… and Fannie and Freddie are happily snuggled in the Federal government’s coffer… what happens to the dollar? One of the most mystifying developments in recent weeks has been the dollar’s audacity in the face of tremendous and persistent upheavals in America’s financial markets. Upheavals that, somehow, don’t seem to rhyme well with the customary verse that “dollar = safe haven.” Yet, the dollar has been relentless, rising by double-digits against most major currencies—partly the result of a widespread stampede out of risky assets, be it commodities or emerging market stocks. There are two ways one could proceed here. One is to spend endless sleepless nights, twisting and turning, trying to fathom investors’ psychology at times of generalized panic. Another is to keep cool and try to figure out instead what investors might do with their stack of repatriated dollars once the dust settles and the US Treasury opens the tap to support Fannie, Freddie and their debt/mortgage holders. Not that the latter is an easier problem to tackle. If history is any guide, larger fiscal deficits have had a mixed impact on exchange rates: For example, the dollar strengthened during the early 1980s, when America’s fiscal deficit increased. Ditto for Japan, in the early 1990s. But other industrialized countries had the opposite experience, seeing their currencies depreciate as deficits widened: France in the early 1980s, Canada in the mid-80s or Finland and Sweden in the early 1990s. But then, is there anything we can say about the future of the dollar? The good old story: Standard economic textbooks give us the story as first told by economists Robert Mundell and Marcus Fleming. Accordingly, when Hank at the US Treasury raises the budget deficit (say by giving out tax rebates or a fat bailout for Freddie), Americans will likely spend more—be it Heinz ketchup or a new home. Aggregate demand will go up, putting pressure on prices, and forcing Ben at the Federal Reserve to raise interest rates to keep inflation at bay. Suddenly, American bonds look more attractive, so foreign money floods in to take advantage of the higher yield. Mind you, not only foreigners; Americans too, from pensioners in Topeka, KS, to teachers in St Paul’s, MN might decide that those exotic Japanese bonds they own are not longer as appealing as their American equivalents. And as the money flows in, the dollar goes up. So a larger fiscal deficit should be good for the dollar, right? Ce n’est pas la vie: Life is not as simple as that… First of all, the story assumes that Ben will play it tough, rather than letting monetary policy loose to accommodate a rise in prices. But if he doesn’t, the higher inflation should be bad for the dollar, eventually. Importantly, the framework set by Messrs Mundell & Fleming makes a number of brave assumptions (for simplicity’s sake). First, expectations are supposed to be static—meaning that the value of the dollar today will not be affected by how you, the Topekans or the Chinese expect future government policies to evolve. That’s kind of hard to buy—if you thought Hank or Ben might “blow” it at some point down the road, by letting public debt swell or inflation spike, you might want to sell your dollars today and send your money back to Japan… Read “larger deficit bad for the dollar.” Secondly, the Mundell-Fleming model does not take into account any changes in investors’ perceptions of how risky are American assets compared to assets elsewhere in the world. What could prompt such changes? Uncertainty over future government policies, among other things. For example, if our foreign lenders suddenly feared that a larger deficit (and thus debt) might prompt the government to inflate its way out (i.e. allow higher inflation so that the value of its debt falls in real terms), they might decide to get out today. Read: “larger deficit bad for the dollar.” How will it play in Beijing? But think of another scenario: What if investors bought US assets like Fannie and Freddie debt and MBSs precisely because they expected the US government to bail these companies out, if they failed? What a terrible disappointment it would be, if Hank let them down! I mean, who cares about the larger deficit (at least for the moment)? “Either you keep your (implicit) promise, Hank, or we get out!” Read: “larger deficit, good for the dollar!” Arguably, Hank’s bailout of Fannie and Freddie was partly aimed at maintaining the appeal of US assets. For good reason, you might think. With foreigners holding 2.6 trillion of America’s debt, and a hefty chunk of Fannies and Freddies, it’s kind of hard to tell the Chinese “we don’t need you!” (Although… I can’t help thinking of the old motto that “if I owe you 100 dollars, it’s my problem. If I owe you 2.6 trillion, it’s yours!”) So Hank delivers, bond markets rally, mortgage rates drop… and the dollar? Ultimately, persistently large budget deficits raise America’s foreign debt. So either the dollar has to fall to boost American exports and help us grow out of our debt (read: “deficit bad for the dollar”); or interest rates will have to rise to keep luring foreigners into buying US debt (read: “bad for mortgage borrowers,” defeating the purpose of the bailout in the first place!). True, some foreign creditors (like the Chinese government) seem to be “infatuated” with US debt assets for their own growth-policy reasons, even if expected returns are negative. But even those guys are sending subtle signals they are considering alternative options. Importantly, if I am a private, profit-maximizing investor, there is little to stop me from cashing in my gains from last week’s bond rally and get out of dollar assets—until I see interest rates rising again to levels that compensate me for the risk of higher government debt issuance in the future. Read: “larger deficit bad for the dollar!” So there you go. A bailout providing short-term respite but building up pressures for both long-term interest rates and the dollar. Hard to see how Hank could stop these… well, unless of course he took out a real, M20B1 Super Bazooka! Glossary: Mundell-Fleming model, deficit vs. debt, bailout, super bazooka.

Financial Russian Roulette

By PAUL KRUGMAN

 

New York Times | September 14, 2008

Will the U.S. financial system collapse today, or maybe over the next few days? I don’t think so — but I’m nowhere near certain. You see, Lehman Brothers, a major investment bank, is apparently about to go under. And nobody knows what will happen next.

Paul Krugman

To understand the problem, you need to know that the old world of banking, in which institutions housed in big marble buildings accepted deposits and lent the money out to long-term clients, has largely vanished, replaced by what is widely called the “shadow banking system.” Depository banks, the guys in the marble buildings, now play only a minor role in channeling funds from savers to borrowers; most of the business of finance is carried out through complex deals arranged by “nondepository” institutions, institutions like the late lamented Bear Stearns — and Lehman.

The new system was supposed to do a better job of spreading and reducing risk. But in the aftermath of the housing bust and the resulting mortgage crisis, it seems apparent that risk wasn’t so much reduced as hidden: all too many investors had no idea how exposed they were.

And as the unknown unknowns have turned into known unknowns, the system has been experiencing postmodern bank runs. These don’t look like the old-fashioned version: with few exceptions, we’re not talking about mobs of distraught depositors pounding on closed bank doors. Instead, we’re talking about frantic phone calls and mouse clicks, as financial players pull credit lines and try to unwind counterparty risk. But the economic effects — a freezing up of credit, a downward spiral in asset values — are the same as those of the great bank runs of the 1930s.

And here’s the thing: The defenses set up to prevent a return of those bank runs, mainly deposit insurance and access to credit lines with the Federal Reserve, only protect the guys in the marble buildings, who aren’t at the heart of the current crisis. That creates the real possibility that 2008 could be 1931 revisited.

Now, policy makers are aware of the risks — before he was given responsibility for saving the world, Ben Bernanke was one of our leading experts on the economics of the Great Depression. So over the past year the Fed and the Treasury have orchestrated a series of ad hoc rescue plans. Special credit lines with unpronounceable acronyms were made available to nondepository institutions. The Fed and the Treasury brokered a deal that protected Bear’s counterparties — those on the other side of its deals — though not its stockholders. And just last week the Treasury seized control of Fannie Mae and Freddie Mac, the giant government-sponsored mortgage lenders.

But the consequences of those rescues are making officials nervous. For one thing, they’re taking big risks with taxpayer money. For example, today much of the Fed’s portfolio is tied up in loans backed by dubious collateral. Also, officials are worried that their rescue efforts will encourage even more risky behavior in the future. After all, it’s starting to look as if the rule is heads you win, tails the taxpayers lose.

Which brings us to Lehman, which has suffered large real-estate-related losses, and faces a crisis of confidence. Like many financial institutions, Lehman has a huge balance sheet — it owes vast sums, and is owed vast sums in return. Trying to liquidate that balance sheet quickly could lead to panic across the financial system. That’s why government officials and private bankers have spent the weekend huddled at the New York Fed, trying to put together a deal that would save Lehman, or at least let it fail more slowly.

But Henry Paulson, the Treasury secretary, was adamant that he wouldn’t sweeten the deal by putting more public funds on the line. Many people thought he was bluffing. I was all ready to start today’s column, “When life hands you Lehman, make Lehman aid.” But there was no aid, and apparently no deal. Mr. Paulson seems to be betting that the financial system — bolstered, it must be said, by those special credit lines — can handle the shock of a Lehman failure. We’ll find out soon whether he was brave or foolish.

The real answer to the current problem would, of course, have been to take preventive action before we reached this point. Even leaving aside the obvious need to regulate the shadow banking system — if institutions need to be rescued like banks, they should be regulated like banks — why were we so unprepared for this latest shock? When Bear went under, many people talked about the need for a mechanism for “orderly liquidation” of failing investment banks. Well, that was six months ago. Where’s the mechanism?

And so here we are, with Mr. Paulson apparently feeling that playing Russian roulette with the U.S. financial system was his best option. Yikes.