Posted on Sunday, October 12th, 2008 by bsetser
Words no Managing Director of the International Monetary Fund ever wants to utter:
“Intensifying solvency concerns about a number of the largest US-based and European financial institutions have pushed the global financial system to the brink of systemic meltdown.”
(source: FT)
Lehman’s default – and the resulting $400 billion run on money market and “prime” funds – precipitated the current, intense crisis. Van Duyn, Brewster and Tett of the FT report:
As word of the Reserve Fund’s predicament spread, investors fled. By that weekend, more than $200bn had been pulled from money market funds, by both retail and institutional investors. When other short-term funds, such as prime funds, are included, the amount that was taken out of short-term investments quickly reached $400bn. That shift brought the funds under heavy pressure to sell into an illiquid market, simply to ensure they had enough cash to pay investors withdrawing their money. For banks, heavily reliant on these investors for their funding needs, it created a spiral of liquidity crises. “It was the straw that broke the camel’s back,” says Joe Lynagh, a portfolio manager at T. Rowe Price, an investment company. …
The run on money markets created problems for a host of institutions that relied on the money markets rather than deposits for dollar financing. Think European banks – and the large former investment banks. It turns out that American money market funds were financing the large European purchases of US corporate debt. That explains why less risk was dispersed than the regulators thought – and why Europe was providing less financing to the US than the TIC data indicated. Van Duyn, Brewster and Tett:
The impact of the investor pullback is borne most heavily by banks that are predominantly reliant on wholesale funding, a group that includes many European banks,” says Alex Roever, analyst at JPMorgan. “This investor pullback from the secured dollar bank commercial paper market is a contributing factor in the recent wave of liquidity issues at European banks.”
Lehman’s default clearly triggered the run. But the ultimate cause of the crisis is more troubling: a large number of large commercial and investment banks seem to have been borrowing not on the strength of their own balance sheets but rather on the expectation that they were too big and too systematically important to fail.
“Prior to Lehman, there was an almost unshakable faith that the senior creditors and counterparties of large, systemically important financial institutions would not face the risk of outright default,” notes Neil McLeish, analyst at Morgan Stanley.”
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Posted in Systemic Risk | 19 Comments »
Posted on Friday, October 10th, 2008 by bsetser
Central banks with lots of reserves have not been running away from the dollar. But they do seem to be running away from any dollar asset with a hint of risk. Right now, it is hard not to focus on the relentless slide of the stock market (the FT is calling this week a global crash), the enormous daily moves in the foreign exchange market or oil’s sharp slide. But New York Fed’s latest custodial data is stunning in its own way.
Since September 10, central banks have added close to $100 billion to their custodial holdings of Treasuries. Custodial holdings of Treasuries reached $1537.6b on Wednesday — up from $1513.1b last Wednesday, and up from $1438.1b on September 10.
Some of the increase in Treasury holdings is explained by a slight fall in Agency holdings — which fell from $956.6b on September 10 to $944.8b on October 8. But the roughly $8b fall in Agency holdings cannot explain the huge increase in Treasury holdings.
Solid data on global reserve growth in September doesn’t yet exist - China and Saudi Arabia matter, and they don’t release data quickly. But the reserves of nearly every country that reports data quickly fell in September. I have no doubt that the Fed’s custodial holdings are increasing far more rapidly than global reserves.
That either means that:
a) Central banks are shifting from euros to the dollar, adding to their dollar holdings;
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Posted in Systemic Risk, central bank reserves | 56 Comments »
Posted on Thursday, October 9th, 2008 by bsetser
The authors of the IMF’s World Economic Outlook have a difficult job. They have to forecast the trajectory of the global economy — itself not an easy task. Their forecast will be judged and evaluated in real time. But the work according to a schedule set by the need to consult the IMF board and the demands of physical rather than virtual publication. In practice, that means that the forecast never fully reflects the most recent data. “IMF Board” time, “internet” time and “market” time are all very different things.
Sometimes that doesn’t matter. But right now is one of the times when it does. A lot happened this September. And I suspect that much of what has happened isn’t reflected in the IMF’s forecasts.
Specifically, I now expect a larger fall in US output and a larger fall in the US current account deficit — and for that matter, the combined current account deficit of the US and the EU — than the IMF currently forecasts (see the WEO’s data tables).
In the past I have argued that the IMF has had a tendency to forecast problems like the US current account deficit away, and in effect assume that the US current account deficit would tend to shrink even if neither China nor the US adjusted their policies. The IMF has also tended to downplay the role the official sector has played in financing the US.
Now I suspect that there will be more adjustment than the IMF expects.
Specifically, the IMF now forecasts that the 2009 US current account deficit will fall to $485b in 2009 (around 3% of US GDP)– well below its 2006 peak of $790b, and down from an estimated $665b in 2008. The deficit has been running at around $700b, so the IMF is forecasting a fall in the deficit in the second half of the year (see Table A10).
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Posted in China, Europe, U.S. trade deficit and external debt | 61 Comments »
Posted on Wednesday, October 8th, 2008 by bsetser
Really crazy.
Just read Macro man.
The kind of moves in the Brazilian real and Mexican peso that Macro man describes are not exactly normal.
But nothing much has been normal recently.
One last note: The demands on my time have increased recently, as the number of people looking for insights into what is going on has increased even as I struggle myself to try to understand all that is happening. I haven’t been able to respond to some calls and emails quite as promptly as I would like. My apologies.
Posted in Exchange Rate | 23 Comments »
Posted on Tuesday, October 7th, 2008 by bsetser
A few years ago, analysts looking at the same data that Dr. Krugman highlighted started to call the US a hedge fund. It borrowed short-term in dollars, providing the world wit a safe liquid asset (or it was said) and used the proceeds to buy risky assets abroad — collecting a risk premium in the process.
That kind of hedge fund is has had a bad run recently. The US — viewed as a hedge fund — is structurally “short” the dollar and “long” global equities, as it borrows in dollars to buy assets abroad. It consequently did well when the dollar fell and global equity markets rose, and correspondingly did poorly when the dollar rises and global equities fall. Unless something changes, the United States net international investment position will deteriorate quite sharply this year.
The US as hedge fund metaphor actually never quite worked for the US — as the US was borrowing as much to finance a current account deficit (current consumption) as to finance the purchases of assets abroad. It actually was a better description of Europe (which also is having a bad week) in general and the Eurozone in particular. The Eurozone attracted large inflows and used the resulting inflows to finance equally large outflows, not a large current account deficit.
But no national resembled a high-living hedge fund quite as much as Iceland. Its big banks and big firms had enormous international liabilities and enormous international assets — at least in relation to Iceland’s small economy. And for a while, Iceland used the profits from its intermediation to live very well, running a large current account deficit. In that sense, it also resembled the US.
Suffice to say it is a very troubled hedge fund.
And it has apparently turned to Russia — yep, Russia — for emergency financial support. Iceland’s prime minister claimed to have no choice. Iceland’s friends, he claimed, all turned Iceland down (maybe they were too busy rescuing their own banks). The FT reports
Geir Haarde, Iceland’s prime minister, said on Tuesday that the country’s “friends” had not offered financial assistance to his country, forcing it to seek a capital injection from Russia.
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Posted in Sovereign Wealth Funds, Systemic Risk | 61 Comments »
Posted on Monday, October 6th, 2008 by bsetser
I think it is fair to say that we have reached, for all intents and purposes, step 12 of Nouriel Roubini’s 12 steps to financial disaster — i.e. “a cascading and mounting cycle of losses and further credit contraction.”
Macro-man, speaking of the currency market, says crash.
John Jansen is a bit more verbose:
“The movements in the FX market are incredible. One friend just read me something which he has received from an fx trader which said that the only things that anyone desires to own are the US dollar,the Japanese Yen, gold, bottled water and bullets”
If 1998 is any guide, these kind of dislocations in currency markets won’t do wonders for the aggregate returns of the hedge fund industry. A host of high carry currencies (i.e. the currencies of countries with high interest rates) have sold off sharply. Look at the euro and Australian dollar v the yen, the Brazilian Real against the dollar and the Icelandic krona against pretty much anything. To facilitate comparison, I set all these currencies at 100 at the end of 2005.
Looking back to 2003 paints only a slightly less ugly picture.
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Posted in Exchange Rate, Systemic Risk | 45 Comments »
Posted on Monday, October 6th, 2008 by bsetser
This week’s Economics focus notes “Last year just over $2 trillion of capital—direct investments in firms or purchases of bonds, equities and other loans—came from investors outside America, mostly private ones. This was more than enough to cover the $730 billion current-account deficit and leave enough over to finance $1.3 trillion of investments by Americans overseas.”
That is true. But a lot has changed since the end of 2007. The Economist’s argument is based on out-of-date data. Gross inflows to the US over the last four quarters of data were only $1130b. That is down from $2.6 trillion in the four quarters before the crisis, i.e. q3 06 to q2 2007. The strong data for 2007 largely reflects pre-crisis flows.
The US data indicates that official flows accounted for $475b of the $1130b in total flows over the last four quarters of data. But that data hasn’t been revised to reflect the survey data – and it consequently understates official flows from China in particular. If past patterns hold, the official sector will end up accounting for most of the $260b of “private” purchases of Treasuries, bringing total official flows up to around $735 billion.
Looking ahead, I expect official flows to fall — largely because the US trade deficit is now liekly to fall rapidly start. And the sale of US assets abroad may provide much more financing for the US deficit than in the past. But over the past four quarters, the scale of official inflows truly cannot be understated. Personally I think $735b is on the low side, given the likely scale of dollar reserve growth.
One fact that hasn’t gotten as much attention as it should is that gross private capital flows – both inflows and outflows – have absolutely collapsed over the past year. The crisis has led to an enormous contraction in private flows – with less interbank lending and far smaller foreign purchases of US corporate bonds and equities.
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Posted in U.S. trade deficit and external debt, central bank reserves | 10 Comments »
Posted on Sunday, October 5th, 2008 by bsetser
We aren’t there quite yet. At least not on an annual basis. The oil exporters foreign asset growth in 2008 will likely top their 2007 foreign asset growth.
But we may not be that far away.
On a quarterly basis, the foreign asset growth of the oil exporters probably peaked in either q2 or q3 2008.
The oil exporters certainly aren’t feeling quite as flush as they once did. Somehow an import bill that can be covered — without dipping into existing assets — if oil is above $70 and a $90 a barrel market price doesn’t feel quite as secure as an import bill that can be covered if oil is above $20 a barrel and a $40 a barrel market price.
Three things have combined to put a bit of pressure on the oil exporters — and the portfolio managers of their central banks and sovereign funds:
1/ Oil prices are no longer rising faster than domestic spending and investment. Instead oil prices are falling as domestic spending and investment (and associated imports) rise. That means the oil exporters have a smaller monthly surplus, as a higher fraction of their oil export revenue is spent on the imports associated with higher levels of domestic spending and investment. Rachel Ziemba and I believe that the oil exporters will “break even” (neither adding to their foreign assets or dipping into their external savings) this year if oil is around $70 a barrel. That break even price though has been rising quickly — and it isn’t inconceivable that the break even price might be $75 or $80 a barrel next year (unless some folks with ambitious plans cut back in the big way; with rents up 65% this year in Abu Dhabi there is certainly a bit of froth in the market) and, well, the market price of oil could potentially be lower than that.
2/ Any sovereign wealth fund that invested heavily in equities has been hurt by the global sell-off. Anyone who shifted from the US to Asia (remember all the talk of a new silk road?) has been hit particularly hard. Hedge funds haven’t been a safe haven either. Global equities indexes are down 25% on the year. I don’t think the Abu Dhabi Investment Authority is quite as large as some people think, so I don’t think it started the year with a $400b equity portfolio. But even it didn’t have a big enough equity portfolio to be in position to see a $100b loss on its equity portfolio, it clearly is down substantially. Indeed, Rachel and I now suspect that SAMA will have more foreign assets than ADIA by the end of the year. Holding a conservative portfolio has paid dividends this year.
3/ The oil exporters are increasingly using their reserves (and sovereign funds) to stabilize their own markets. Russia has indicated that it will lend up to $50 billion from its reserves to domestic banks having trouble rolling over their external credit lines. The UAE has announced a similar $13.5b facility, a facility that is considered to be a “quiet” bailout of Dubai by the much richer sheiks of Abu Dhabi. Dubai itself has indicated that one of its funds — DIFC Investments — will support the local market. Kuwait’s central bank is lending domestically as well — and the KIA has been intervening to support Kuwait’s domestic stock market.
A lot of the oil exporters had very large fiscal surpluses from oil — as the foreign exchange from oil sales was held in foreign currency at the central bank or invested through a sovereign fund. But a lot of private (or quasi-private, as the dividing line between public and private often isn’t clear) banks and firms in the oil exporters were borrowing heavily from banks abroad. That flow has dried up. And the state is being called on to step in to stabilize things — much as the state in the US and Europe is trying to offset a collapse in private intermediation.
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Posted in Sovereign Wealth Funds, oil | 17 Comments »
Posted on Saturday, October 4th, 2008 by bsetser
The dollar hasn’t fallen along with the US stocks, US Treasury yields or US employment. There is now a broad consensus that the US is currently in a recession, something that might be expected to lead to a fall in the dollar.
But the dollar, instead, has rallied. Against the euro. But also against a host of Asian currencies and commodity plays like Brazil and Russia. And it is soaring against the Icelandic Krona …
Some have called this a flight to quality. That though doesn’t seem quite right. The US is the source of much of the bad debt that has brought the world’s financial system to a near-standstill. The default of a US institution — Lehman — triggered the current panic in the shadow financial system. The price of “insurance” against the risk of a US government default suggest that US government debt is now considered a bit more risky than German government debt.
Rather this seems to be a flight away from risk.
Remember, the dollar rallied last August too, for the exact reason jck of Alea highlights.
Of course, there is now a new dynamic at play as well — namely mounting evidence of a broad global slowdown, and a sharp slowdown in Europe. That is quite different from last August, when the US slowed and the world didn’t. The dollar has to have something to depreciate against … and right now there aren’t many good candidates.
But there is also reason to think that the dollar’s current strength reflects something other than the United States relative economic fundamentals. A recent research piece from Sophia Drossos and Yilin Nie of Morgan Stanley argues that global deleveraging is a major current source of support for the dollar.
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Posted on Thursday, October 2nd, 2008 by bsetser
For holding things together. Barely. Bad as things are, they could be worse. Really.
By my count, the Fed is now providing about $1.25 trillion in liquidity support to the global financial system.
The Fed’s latest balance sheet data shows: $80b of repos; $150b of term auction credit, $410b in other loans, $30b in portfolio investment with “Maiden Lane” (the Bear Stearns vehicle), $320b in “other assets,” and $260b in securities lent to dealers.
Do the math. It is a huge number. Or look at my CFR colleague Paul Swartz’s updated chart. I wouldn’t believe these numbers could possibly be true if I hadn’t been watching the data for a while. Frankly the TARP is now starting to look small relative to the Fed’s balance sheet.
The $1.25 trillion total likely includes the swap lines that have allowed other central banks to provide dollar liquidity to their financial institutions.** (This sentence has been edited after my initial post: see the note below, it is important)
I have long thought that sovereign funds, which provided equity capital to support banks’ existing management in the early stages of this crisis, have gotten too much credit for helping to stabilize the financial system and the Fed and other central banks have gotten too little, in part because there isn’t as obvious a set of beneficiaries.
The latest data release should settle the question; absent enormous liquidity support from the Fed, a much broader set of financial institutions — including some that received equity investments from sovereign wealth funds — would have failed.
What are sovereign investors from the emerging world doing? We don’t know much about what sovereign wealth funds are doing — and in any case, the set of sovereign funds and big state firms from the emerging world is sufficiently diverse that it makes little sense to try to paint a single picture. But we do know a little bit about what the world’s central banks are doing from the New York Fed’s custodial data.
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