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Brad Setser: Follow the Money

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Too much of a good thing? Should global capital flows be pumped back up to their boom levels?

by Brad Setser
May 5, 2009

I tend to agree with the FT’s leaders – especially their leaders on the world’s macroeconomic imbalances — more often than naught. But not always. On Friday an FT leader warned about the risk of financial deglobalization:

“Finance is deglobalising out of fear and because of national policies. Neither will be fully undone without political choices that look unlikely, at least for now …. But unless policymakers come up with better global regulation that works we may have to settle for permanently less globalised finance.”
(emphasis added)

That didn’t ring true to me. At least not fully. The tone of the leader seemed to long for a return of the pre-crisis world, one where huge quantities of funds flowed across borders, albeit one with better global regulation. Yet just as trade probably rose to a level that could only be supported if US households continued to run up an unsustainable level of debt, cross-border financial flows likely reached levels that could only be sustained if the global financial system remained over-leveraged.

The goal shouldn’t be to return the boom years, but rather to return to a more sustainable level of cross-border flows — or at least a system without the excesses that contributed to the current crisis. Remember, the rise in cross-border capital flows prior to the crisis was associated with a rise in the amount of leverage in the system, as a host of institutions tried to support bigger balance sheets without increasing their equity. That rise in leverage sustained a lot of cross border flows.

To be concrete:

US financial institutions sponsored offshore special investment vehicles (SIVs) that often borrowed short-term from American investors to buy longer-term US debt. They were offshore largely because they were off balance sheet. If the same activity had been performed on the banks domestic balance sheet – with more short-term wholesale borrowing to support a larger securities book – cross-border flows would fall. But regulators also would have had a lot more information about the build-up of risks in the global system. Taxpayers might not think that is a bad thing.

European institutions seem to have been supporting bigger dollar balance sheets than they could finance entirely in the offshore “euro-dollar” market. Some were borrowing large sums from US money market funds – and then using the proceeds to invest in longer-term US paper. Sometimes securities insured by AIG’s now notorious credit products group, a little trick that allowed the banks to minimize the amount of capital that they had to hold against their dollar book. A bit less of this wouldn’t necessarily be a bad thing. AIG hasn’t worked out so well for the US taxpayer, and the big dollar books of European banks haven’t worked out so well for European taxpayers.

And then, of course, there are the cross-border flows associated with tax avoidance.

The huge rise in transatlantic flows over the past several years produced by the expansion of the cross-border operations of leveraged intermediaries ultimately didn’t produce a more stable financial system — only a more opaque system. Far less risk from the U.S. housing boom was transferred off the financial sector’s books that most expected. Even some of the risk theoretically shifted to European banks ended up coming back to the US through AIG.

The main reason why cross-border exposure fell in the fourth quarter, incidentally, was a fall in lending among the major economies – not a fall in lending from the major economies to the emerging world. To be sure, lending to the emerging world fell – but the $300 billion fall in exposure to developing countries in the fourth quarter cannot explain the $4800 billion overall fall.

The large two-way global flow between the emerging world and the advanced economies also — at least in its old guise — also didn’t necessarily result in a more stable global system.

Take the surge in private money flowing into China. That rise in private inflows was offset by a rise in state outflows. Private money wanted to finance more investment in China, yet China’s government was trying to damp down investment by suppressing domestic credit growth (through the high reserve requirement) and pulling money out of China to invest abroad (through the CIC and other state institutions). Fewer inflows and fewer outflows would result in less total capital flows — and somewhat slower growth in China’s reserves/ state assets. But that might not be the worst thing in the world, particularly if it was the result of an adjustment in China’s exchange rate that reduced the incentive for speculative inflows into China. A huge rise in private inflows that leads to an offsetting rise in official outflows doesn’t accomplish much, economically speaking — even it pushes up total global capital flows.

Indeed, smaller aggregate outflows from China wouldn’t necessarily be a bad thing. The large aggregate outflow from China over the past few years hasn’t been driven, generally speaking, by private Chinese demand for the rest of the world’s securities, or even a desire on the part of Chinese savers to diversify their portfolios. Rather Chinese demand for the rest of the world’s financial assets was driven by China’s government, as it bought foreign securities as a byproduct of its effort to hold China’s exchange rate down. Call it subsidized financial globalization: China’s government pulled money out of China and invested it abroad on terms that imply likely financial losses to achieve its policy goals.

Back when money was flowing into China in early 2008 and late 2007, reserve growth and other government outflows were close to 20% of China’s GDP. The gross capital outflow from China then — almost all a government flow — was comparable in scale to total gross inflow to the US in the boom years before the August 2007 subprime crisis. Gross inflows to the US peaked in early 2007, incidentally …

The huge flows of the pre-August 2007 reflected a world where lot of too-big-to-fail financial firms were able to gear up in large part because they were perceived to have a government backstop. These financial flows were in a sense larger than could be supported in a truly unfettered market, as key institutions were operating with a level of leverage and balance sheet opacity that we now know only worked with implicit (and now explicit) government support.

And in other cases, the high level of flows reflected large government-driven flows that were in some sense unnatural. The outflow from China wasn’t a market flow.

A total collapse of global capital flows wouldn’t be a good thing. But returning to the frothy flows of the bubble years — an era where I think a strong case can be made that a set of distortions pushed aggregate global flows above their natural level — would not necessarily be a good thing. Not unless cross-border flows rest on a stronger foundation than they do now. The goal should be a happy median, one where a high level of cross-border flows doesn’t reflect a high level of leverage — -and one where emerging economies don’t just recycle private inflows back into demand for US Treasuries.

The FT leader assumes that absent government pressure more money would be lent across borders, and thus attributes the recent fall in cross-border flows to government intervention. I would start with the opposite presumption: absent government intervention in the third and fourth quarter – the bailout of AIG, big swap lines and the G-7′s commitment to avoid another Lehman – more large global institutions would have collapsed, leading to an even sharper fall in cross-border exposure. A set of financial institutions that were operating globally lacked enough capital to buffer themselves against what should have been a fairly predicable shock;* their near-collapse –not government intervention to prevent their total collapse — is the main reason why cross-border flows have come to a standstill.

* A large fall in US home prices after a large run up in those prices shouldn’t have been a total surprise.

UPDATE: I edited out a section of the original post that focused on two-way flows to the oil exporters. The post was too long, and the subject is a complex one worth its own post.

32 Comments

  • Posted by guest

    http://www.bis.org/publ/bppdf/bispap45.pdf

    Interestingly this paper and meeting took place under the theme

    The global capital flows is more capital intensive for some countries than for others.Money markets centers are global capital consuming, a direct investment in industry or trade is not.

  • Posted by FollowTheMoney

    we wont return to the boom years because the boom years were built on fraud. although the banks earnings appear to hint that the crisis is over, my question is where would we be without FASB changes to mark and market?

    the truth, in my opinion is that mark to market was changed because AIG could no longer cover the billions and billions of upcoming losses had assets remained booked market to market. So policy makers forced FASB to re-structure m2m. There is no question that all green shoots hyping another bull market fail to understand that the last run was built through the illusion AIG backed collateral on it’s loans, this allowed the banks to make risky bets without worry.

    Now there is no AIG that allowed all sorts of exotic credit innovation and there won’t be for some time. The boom was unfortunately built on false trust, and immense fraud and it is therefore we won’t return to prosperous times any time soon.

    Sure the mark to market changes help paper over the future losses (for some time) at AIG and other large institutions. But the problem has not been solved, only delayed.
    Until the root of the crisis has been resolved, there will eventually be more red flags.

    In the end , the U.S. will need to restructure and produce. The U.S. will have to move away from a finance driven economy, and one that’s main fuel is service. Again, for a true global economy, China will have to pick up internal consumption and structure more trade agreements with a basket of countries.

    As the author puts it, sustainable levels, degress of ‘moderation’ will be a key. No we should not return to a cycle of booms and busts, but focus on new form of living. A standard of moderation.

  • Posted by DJC.

    From Asia Times:

    The U.S. Economy melts, China grows

    The statistics speak for themselves. The International Monetary Fund (IMF) predicts the world’s gross domestic product (GDP) will shrink by an alarming 1.3% this year. Yet, defying this global trend, China expects an annual economic growth rate of 6.5% to 8.5%.

    Beijing has decided to play an active, interventionist role in the international financial arena. Backed by China’s US$2 trillion in foreign exchange reserves, its industrialists have gone on a global buying spree in Africa and Latin America, in neighboring Russia and in Kazakhstan, to lock up future energy supplies for its economy. At home, the government is investing heavily not only in major infrastructure, but also in its much neglected social safety net, its healthcare system, and long overlooked rural development projects – partly to bridge the increasingly wide gap between rural and urban living standards.

    The secret of China’s success

    What is the secret of China’s continuing success in the worst of times? As a start, its banking system- state-controlled and flush with cash – has opened its lending spigots to the full, while bank credit in the US and the European Union (EU) remains clogged, if not choked off. Therefore, consumer spending and capital investment have risen sharply.

    http://www.atimes.com/atimes/China_Business/KE06Cb01.html

  • Posted by DJC.

    All signs are that Washington will be unable to restore the status quo ante after the present “great recession” has finally given way to recovery. In the coming years, its leaders will have to face reality and concede, however reluctantly, that the economic tectonic plates are shifting – and that it is losing financial power to the thriving regions of the Earth, the foremost of which is China.

    http://www.atimes.com/atimes/China_Business/KE06Cb01.html

  • Posted by jonathan

    I read the FT piece and shook my head. It was one of those cri de couers we’re daily getting from the financial world. These are mostly fear based: don’t cut our pay because then only idiots will want to work for what is still very high pay, don’t regulate us because then there will be no innovation, don’t force us to disclose because then we won’t be able to do all those neat things that let us make so much money when things were going well. They want the world as it was but with a light butter cream frosting of regulation.

    In retrospect, isn’t it amazing that “we” let major institutions move so much off balance? That we let massive capital flows go unreported? That we had no idea how banks were financing themselves?

    These heart-rending cries are essentially adolescent yearnings: I want the freedom to do what I want but I want you, Daddy & Mommy, to help me out when I get in too much trouble.

  • Posted by Twofish

    bsetser: US financial institutions sponsored offshore special investment vehicles (SIVs) that often borrowed short-term from American investors to buy longer-term US debt. They were offshore largely because they were off balance sheet.

    This largely isn’t true because most SIV’s are not offshore entities. The accounting regulations regarding offshore SIV’s are the same as onshore ones, and there are very good regulatory reasons to have SIV’s on-shore. If there is a dispute, it gets handled in a court in Manhattan or in Delaware, and you need an ironclad legal system to make the SIV’s work, which you get in Delaware but not the British Virgin Islands.

    Since the purpose of SIV’s is to securitize a basket of loans, it’s much, much easier to do a listing of a security if the entity is US based.

    The main reasons for putting something offshore are tax reasons (i.e. you don’t want to pay US taxes for people not living in the US).

    The other thing is that all financial stuff is not the same. The legal needs for setting up an SIV are *completely* different from one setting up an emerging market private equity fund or hedge fund.

  • Posted by Twofish

    djc: What is the secret of China’s continuing success in the worst of times? As a start, its banking system- state-controlled and flush with cash – has opened its lending spigots to the full, while bank credit in the US and the European Union (EU) remains clogged, if not choked off.

    But the reason China has a good banking system now is because it had a awful one in the 1990′s, and fixed it. Today’s success leads to tomorrow’s failure, and today’s failure leads to tomorrow’s success.

    It’s possible, even likely, that the banking mess today in the US today will get cleaned up, and that the relative success in Chinese banking will lead to overconfidence, causing everything to be different when the next crisis comes. Right now, the US financial system is under-regulated. What is likely to happen is that things will get regulated to the point where things get over-regulated, at which point we have a crisis in which we need to tear up a lot of Obama’s changes.

    History doesn’t end, because today’s solutions are tomorrow’s problems.

  • Posted by Twofish

    jonathan: They want the world as it was but with a light butter cream frosting of regulation.

    Heavy regulation, but pro-business regulation. If the banks were heavily regulated so that none of the crap of the last few months had happened, my bonus would have likely been much larger.

    And whether or not that happens depends on how the economy goes in the next year. If things get better, then the public will forgive and forget and we go back to more or less business as usual. If things totally fall apart, and we still have 15% unemployment a year from now, then this just will won’t work.

    jonathan: In retrospect, isn’t it amazing that “we” let major institutions move so much off balance?

    Don’t blame me. I voted for Gore in 2000, Kerry in 2004, and Obama in 2008. Part of the reason I voted for Obama is that I knew that he would behave pretty much as he has over the last few months. I also believe that pro-banking, stiff regulation, and high taxes are the way to go.

    In any case, the general approach has been decided, we are now in the process to see how it will work. If my view of the world is correct, then we’ll be in good shape by the 2010 election.

    jonathan: That we let massive capital flows go unreported? That we had no idea how banks were financing themselves?

    There is what I think is a shocking lack of curiosity. I bet that no more than one person in five really knows what a bank does, and most people just don’t care, until something goes wrong.

    jonathan: These heart-rending cries are essentially adolescent yearnings: I want the freedom to do what I want but I want you, Daddy & Mommy, to help me out when I get in too much trouble.

    Which is really how most people behave.

    Really, you shouldn’t help bankers out. You really shouldn’t. Your main concern in making these sorts of decisions is to help yourself out, and that involves learning about how money, power, and finance really work.

    It’s really tricky here, because if you are angry at bankers, there are lots and lots of people that will use that anger to get you to do things that really aren’t in your best interests.

    One sign that you are being taken for a ride is if someone appeals to your vanity or sense of moral superiority. The classic line that politicians use is *YOU* are good, *THEY* are evil, give me power and I will crush them because I am one of *YOU*.

    Whenever any politician says that they are one of you or are looking out for your interests, they are lying. This includes politicians I support as well as those I oppose.

  • Posted by jonathan

    Twofish, on this matter, I believe we’re on the same side.

    BTW, one note, it doesn’t matter who is curious or knowledgeable about how banks finance operations, etc. What matters, of course, is that the people who need to know have the information they need. We all agree that has been a stunning lack.

    Also BTW, I see London’s future as compromised but how much I don’t know. They built an edge by allowing dodgy things to happen under a veil.

  • Posted by Twofish

    FollowTheMoney: we wont return to the boom years because the boom years were built on fraud.

    I think we will because the boom years weren’t build on fraud. Yes there was a lot of fraud, that’s what happens in a boom, but there was also a lot of real wealth production.

    Compare television sets and laptops today on television sets and laptops in 2001. Think about the process for buying an airplane ticket.

    FollowTheMoney: In the end , the U.S. will need to restructure and produce. The U.S. will have to move away from a finance driven economy, and one that’s main fuel is service.

    And move to what? Manufacturing? The reason that so few people work in manufacture is the same reason few people work in agriculture. The more efficient something is, the less you have to have people work in it.

    Finance is notoriously inefficient. Try this. Take $10,000 in cash, and leave it in the cash machine to do a bank deposit. Do you feel comfortable putting cash in a box. Probably not. You want to stare someone in the eye when you hand over the money.

    You can get a robot to build a car. You can’t get one to sell a car. This means that as robots do more of the work, more of us are going to be car salesman. Once all the cars are built by robots, then we will have endless meetings about what types of cars to build, what color, do you want pine scented air fresheners or lemon scented ones.

    This meetings will be basically about finance. As technology advances, you’ll see fewer factory workers, and more finance and sales people.

    FollowTheMoney: As the author puts it, sustainable levels, degress of ‘moderation’ will be a key. No we should not return to a cycle of booms and busts, but focus on new form of living. A standard of moderation.

    This is just not going to happen, because that would involve a change in how people behave that I don’t think will happen, and is probably not desirable. People will be moderate for a few years (or even a few months), then go crazy and we’ll have another boom/bust cycle.

  • Posted by FollowTheMoney

    @ Twofish,

    manufacture what? Thats the question Obama will face, and face much sooner than most expect.

    The circles of NY-D.C. are indeed very creative! In Feb. they knew they’d have a difficult time of coming back to Congress/Senate asking for Tarp2, well then came the time and in my opinion it looks like there was an agreement between banks/govt that since Taxpayers were at the highest level of banker rebillion, what soother way to smooth things over than paper over the gaps with the removal of FASB standards we’ve had the last 2 years. Although most of the banks, in my opinion still have serious troubles the inevitable is now delayed.

    NOTHING HAS BEEN FIXED, NOTHING HAS BEEN SOLVED. We are Trillions in debt as a nation, and AIG is still a DEEP DARK black hole. That’s until banks, in my opinion come to grips that they still have hundreds of billions if not trilions of toxic assets on their books.

    So we’re in deflation, and will be for some time. Housing is nowhere near it’s lows, and momentum traders are running up the dow on low volume.

    Once the market realizes that the 2nd half blockbuster recovery will fizzle and banks come crying back to congress for additional funds thats when people will be shocked. Meanwhile our deficits are ballooning, and China should start to ask itself if 30 year tbills at 3% worth the return when compared to the returns of commodities/equities, etc the last 3 months.

    The U.S. is in a horrible position. The policy makers have refused to acknowledge the problem. For all we know Geithner will come out on THURSDAY and say all the banks are just fine and will be able to raise plenty of capital privately.

    THE THING IS NONE OF THIS ADDS UP. A few months back , i believe everyone in the administration from Volker to Geithner were pretty certain the banks would need an additional Trillion.

    THE ONLY THING THAT ADDS UP is AIG could no longer get additional government funds to cover it’s losses and it’s therefore government had to force FASB to adjust M2M accounting.

    The truth is, nobody really knows whats on the banks books. The best thing allowed to let happen would have been to leave mark to market (as soros has mentioned) and cleaned out these banks once and for all.

    SO WHY NOT?

    In my opinion it’s obvious that the gov’t was getting concerned, with a Dow approaching 5000, Citibank at below $1, and taxpayers/congress/senate furious over Tarp1, there was only 1 solution. Despite calls from Volker and Geithner that banks would likely need FAR MORE $$$ for capital (up to a trillion ) in feb (if i’m correct) they just weren’t in a place to get it. With a BIG NO FROM CONGRESS/SENATE and the TAXPAYER at the time THE ONLY SOLUTION WAS to gap the holes by removing FASB mark to market. In my opinion, this now allows for the setup of what could be the largest Enron like scenario in U.S. history. This being the U.S. Financial Sector.

    I’m not buying this rally! i’ll let Geithner come out and say all the banks are just fine, but i can do the math, i can look through the puzzle, it’s not hard. Study the way politics and economics go hand and hand and you’ll learn.

    It’s easy to see how the game is played, and for now the game has been surely fixed to avoid the fans (taxpayers) from erupting.

    But all games come to a close, my advice? be prepared for the outcome.

  • Posted by ReformerRay

    Brad is right – forget trying to reproduce the boom years.

    I say to Obama, forget trying to use the U.S. government to pick the future industry for the U.S.

    Instead, arrange tax and import controls such that any thinking person who is trying to manufacturing something using the most advanced technology will want to try to find a location in the U.S.

    Machines don’t require many tenders, but the benefits that shed for the nation in which they exist are very large.

  • Posted by Phillip Huggan

    All these bank bailouts will kill USD eventually. So why not make banking industry lend to actors that would benefit from low USD environment. Making wind turbines and biosensor domestically would be ideal (and any staph fighting medical products too), but any manufacturing for export would work. Phase in Rajan`s banking industry asshole insurance fee and give exemptions for lenders to manufacturing for export industries. I`m ignoring flight-to-quality here. If USA defaults on debt does that now mean USD goes to infinity. IDK anymore.
    Forget targetting inflation. It is used politically to keep interest rates too low. Target lagging global GERD basic R+D indicator to guess present and near future productivity gains. And instead, focus upon targetting an optimal GDP size of the finance industry.

  • Posted by Twofish

    Follow the Money: NOTHING HAS BEEN FIXED, NOTHING HAS BEEN SOLVED

    Lots of things have been fixed, and lots of things have been solved. Six months ago, the world financial system was about to collapse, and everyone was running for the exits. People aren’t running for the exits any more.

    Follow the Money: That’s until banks, in my opinion come to grips that they still have hundreds of billions if not trilions of toxic assets on their books.

    No they don’t. We are looking in the tens of billions range. The banks haven’t come to grips with the fact that they don’t have that much toxic asset, because in fact, they don’t have that much toxic asset on their books if the economy improves.

    Follow the Money: THE THING IS NONE OF THIS ADDS UP. A few months back , i believe everyone in the administration from Volker to Geithner were pretty certain the banks would need an additional Trillion.

    No. A few months ago, people were worried that the banks would all die, and so everyone was running for the exits. The irony is that when people all run for the exits, then it becomes a self-fulfilling prophecy.

    People are looking at what the damage really is right now, and it doesn’t look that bad. Some pain and agony over the next few months as things get flushed out of the system, but nothing that will kill the system.

    Crisis is over. We are in the clean up phase.

    FollowTheMoney: The truth is, nobody really knows whats on the banks books. The best thing allowed to let happen would have been to leave mark to market (as soros has mentioned) and cleaned out these banks once and for all.

    I think that everyone that cares to know pretty much knows exactly what is on the bank’s books. We’ve had a few months to find out.

  • Posted by Twofish

    Also getting rid of MTM really hurts AIG. Think about it, AIG sells credit insurance to the banks. If the banks can value that credit insurance above market, this means a bigger loss for AIG.

    I do think that AIG has gotten rid of most of the time bombs from its balance sheet. What do you think all those tens of billions was for? It was to pay off the CDS so that wouldn’t go boom at a bad time.

    The other thing is that derivatives are mark to market. Ordinary real estate loans are not mark to market and never were.

    The reason the market is looking up is pretty simple. A few months ago, people were expecting a great depression, and all of the stocks were valued as if we were going to have one. Now, the number of people that are betting on a depression are fast decreasing. Once people think that there isn’t going to a depression, then everything gets revalued.

  • Posted by Twofish

    jonathan: What matters, of course, is that the people who need to know have the information they need. We all agree that has been a stunning lack.

    I don’t. Just turn on your late night TV show and watch people talking about flipping real estate, and it would pretty obvious to anyone that cared that we were in a middle of a real estate bubble.

    If the key decision makers were unable or unwilling to do anything with the information that they had, I don’t see how more data would have helped things.

  • Posted by Howard Richman

    Brad,

    You are correct to question the Financial Times folks’ desire to go back to the old system of huge international capital flows. I would go much further than you. I would argue that financial capital inflows should be discouraged by the receiving country.

    A 2007 study discovered a major truth. Three International Monetary Fund economists (Eswar S. Prasad, Raghuram G. Rajan, and Arvind Subramanian) found that the more a nonindustrial country was importing financial capital, the slower its growth. They concluded that the deleterious effect of the foreign capital inflows is due to the resulting higher exchange rate that makes the recipient country’s exports less competitive in world markets.

    The United States has experienced the same loss of competitiveness as a result of the international capital that has flowed into our country.

  • Posted by djc

    From Asia Times:

    US Dollar Debt on Default Path

    Big government rescues on Wall Street and elsewhere, domestic stimulus plans, toxic asset replacement plans, and new government programs to address a wide range of other longstanding problems are causing the United States budget deficit to skyrocket.

    More than US$12 trillion has already been committed and/or spent in this crisis, with the current year’s budget deficit projected to reach, or exceed, nearly $2 trillion. The US Treasury is flooding the market with new issuance of debt, while the chances appear increasingly slim that the huge and ballooning deficit will be brought under control anytime soon. With all this spending, we’re guaranteeing that huge and persistent tax increases will beenacted down the line to pay for it all. That will trounce economic growth and is an enormously ugly prospect.

    The US dollar will inevitably bear the full and ferocious brunt of the decidedly hyper-inflationary policies of Washington, notwithstanding the Federal Reserve’s empty promises to reverse such policies swiftly to protect the currency.
    All the while, the strongest evidence indicates that when economic recovery finally arrives, it will be feeble at best for years to come. So the financial and economic sectors won’t be able to withstand any promised rapid reversal of Washington’s hyper-inflationary policies. But nor will the dollar be able to withstand the option of leaving such policies in place. Washington is therefore setting up the most colossal catch-22 imaginable for the dollar and for the US economy. With the Fed then hamstrung by its own shortsighted and reckless policies, we could well see the arrival of hyper-stagflation. The dollar cannot survive such a scenario intact.

    Unless you’ve been hiding out in a cave somewhere, you know that the big financiers of the US Treasury, namely China and its Eastern partners in Asia and the Middle East, have soured on the dollar’s future beyond the short to medium term. They’ve entirely lost faith in the ability of the US to really get its monetary, financial and economic houses in order before the repercussions of shortsighted policy come home to roost with a vengeance. They’re preparing new solutions that will take two or three more years to fully enact but which will shove the dollar aside toward the margins of international finance and international monetary policy. The handwriting is therefore on the wall for dollar-denominated financial assets.

    http://www.atimes.com/atimes/Global_Economy/KE07Dj02.html

  • Posted by jimspassion

    Twofish: The reason the market is looking up is pretty simple. A few months ago, people were expecting a great depression, and all of the stocks were valued as if we were going to have one. Now, the number of people that are betting on a depression are fast decreasing. Once people think that there isn’t going to a depression, then everything gets revalued.

    The market hadn’t priced in a depression – I didn’t see many blue chips for pennies in the dollar nor did I see very low multiples either the S & P is not even trading at a cheap level relative to earnings.

    I think that everyone that cares to know pretty much knows exactly what is on the bank’s books. We’ve had a few months to find out.

    So tell us all what is on the banks books??? What is it that you know that smart academics and professional investors don’t know???

    So we don’t have a shadow banking system, we have house price deflation ( refinancing for consumption the great HOUSING/ATM OECD dream smashed ) mounting unemployment, available credit from credit cards being yanked from the system, auto industry in tatters, commercial real estate ready to implode ( shopping malls not profitable and under increasing pressure from tenants ) revenues down, future liabilities mounting, ballooning debt, Under utilization of capacity, over leverage bubble inflated balance sheets in ruin, take all this into account and then add up the cost to the OECD economies of a lock down in consumer spending because quite simply we gambled on everything going up forever we paid so called smart people to calculate the risk and then we spent the money ( Don’t count your chickens before they hatch )

  • Posted by a

    “European institutions seem to have been supporting bigger dollar balance sheets than they could finance entirely in the offshore “euro-dollar” market. Some were borrowing large sums from US money market funds – and then using the proceeds to invest in longer-term US paper. ”

    I’m not privy to European institutions’ investment strategies, but it seems that you are implying that the Europeans were doing this unhedged. Maybe. Still I think it’s more likely that the Europeans’ were hedging their short-term borrowing and long-term lending with swaps, with one leg short-term Libor. So the Europeans should have been fine; a crisis on the short-end had them losing on out their loans (costs more money to finance), but gaining on their hedges.

    Unfortunately, the other side of those swaps was effectively held by American households. The Fed was desparate to keep Libor down to help them, and this caused the Libor system to break down (the effective rate of financing for European banks skyrocketed over Libor). The Fed’s solution was to offer swaps to the ECB, so that European banks could get cheap USD financing and thus not borrow in the interbank market effectively keeping Libor down.

    It’s working now, but let’s wait to see what happens when the Fed’s swaps are withdrawn.

  • Posted by Twofish

    jimspassion responds: So tell us all what is on the banks books???

    You can look start by looking at the banks books.

    jimspassion responds: What is it that you know that smart academics and professional investors don’t know???

    Nothing really, but academics and professional investors know lots of stuff that the average person on the street doesn’t bother look at. Have you actually gone through Citigroups balance sheets? It’s on their website.

    The big fear was that the banks were hiding something people didn’t already know about, and the point of the Geithner report was to reassure people that the bad stuff that people already know about/suspect is going on, is pretty much the only bad stuff that is there.

    Now the big question is, do you trust Geithner, and personally I do, and my money is where my mouth is.

    jimspassion: So we don’t have a shadow banking system, we have house price deflation ( refinancing for consumption the great HOUSING/ATM OECD dream smashed ) mounting unemployment, available credit from credit cards being yanked from the system, auto industry in tatters, commercial real estate ready to implode ( shopping malls not profitable and under increasing pressure from tenants ) revenues down, future liabilities mounting, ballooning debt

    All of which is pretty standard stuff for a credit bust, and most of which can be solved by printing money, which is what the Fed has been doing. Too much debt…. Well, (types a few commands into the computer), debt is gone.

    Looking at the Chinese banking system (which was a total mess in 1998), it’s amazing how quickly things improve if you do the right things, and we have about two centuries of experience in credit busts, to figure out what to do.

    jimpassion: Under utilization of capacity, over leverage bubble inflated balance sheets in ruin, take all this into account and then add up the cost to the OECD economies of a lock down in consumer spending because quite simply we gambled on everything going up forever we paid so called smart people to calculate the risk and then we spent the money.

    If the problem is that consumers aren’t spending because they don’t have money, then the answer is simple. Print money. You get people screaming inflation and moral hazard, but for the most part you should ignore them, because listening to them causes the crisis to get worse.

    If the problem is deflation, then inflate.

  • Posted by Howard Richman

    It’s not just US government debt that is skyrockinging at the moment. Don’t miss our commentary, US Foreign Debt jumps to 35% that appeared in the American Thinker this morning!

  • Posted by a

    “If the problem is that consumers aren’t spending because they don’t have money, then the answer is simple. Print money. You get people screaming inflation and moral hazard, but for the most part you should ignore them, because listening to them causes the crisis to get worse.

    If the problem is deflation, then inflate.”

    And if the problem is that asset holders (stock investors, bank depositors, workers with pensions) were expecting to receive future payments, in the form of goods or services, that cannot or won’t be delivered by debtors?

  • Posted by Twofish

    a: And if the problem is that asset holders (stock investors, bank depositors, workers with pensions) were expecting to receive future payments, in the form of goods or services, that cannot or won’t be delivered by debtors?

    Then we have a situation that is very, very different than the current one.

    If you have an economy that is operating at it’s capacity limits, then printing money is a bad thing. However with unemployment at 8% and rising and with everyone cutting output, printing money will push the economy back to normal capacity. You print money, you give it to the debtors, who use it to exercise unused capacity create goods and services to pay back the creditors. It’s exactly what the Fed did in 2001 and in every credit bust in the last fifty years.

    The hard part is cutting back *after* you’ve gotten the economy out of the ditch. Free money is very addictive so people still want it after it becomes harmful.

  • Posted by Twofish

    bsetser: These financial flows were in a sense larger than could be supported in a truly unfettered market, as key institutions were operating with a level of leverage and balance sheet opacity that we now know only worked with implicit (and now explicit) government support.

    The problem here is that an unfettered market is this abstraction that doesn’t work in reality. If the capital flows are large enough, then they will have implicit government support even if the government denies it.

    I really don’t think that the issue is lack of data. The big problem is that the decision makers in 2003-2005 were operating under very flawed economic principles, one of which is that governments should minimally intervene in markets. If you threw more data at Greenspan, it wouldn’t have made a difference.

    Citigroup’s SIV exposure is listed right there in its 2006 10-K report on page 142. Now you might argue that putting those numbers in an obscure footnote on one page of a 180 page report just buries the information.

    You’d be right, and adding more data is going to help this problem, how? More data sometimes makes this more opaque, not less.

    Personally, I think that people are saying “we didn’t know” to avoid saying “we were wrong.”

  • Posted by a

    “Then we have a situation that is very, very different than the current one.”

    Nah, it’s exactly the right one.

  • Posted by Cedric Regula

    ROBOTS !!!!

    I’ve actually toured an automotive assembly plant, so it’s obvious to me that it would be far easier(and even necessary) to have robots run the financial industry than it would be to have robots replace humans in manufacturing. The Japanese were the most zealous early adopters of robotic manufacturing systems and concluded that this is useful for quality control of processes and also doing hazardous processes, but they don’t do away with human workers. In fact the necessary skill level goes up in the factory since people now need to run, program, manage, and maintain the automated equipment.

    But in the finance sector, I see far fewer hurdles. I have actually liked dealing with ATM machines, though I’m sure the brick and mortar banking system would like to convince their customers that we really want a personal touch. But I think it would be rather easy to convince bank CEOs that ATM machines should be made in their own image! We could have 8ft tall Ken Lewis, et all, robotic neighborhood ATM machines. They would wave at passing customers, wearing a big idiotic grin on their faces and customers would drive up and deposit their paychecks in iBankermanATM’s pocket. We may anticipate a range of customer inquiries at this point, such as…”Can I get cash back?”…”Can I get a loan and does it matter what it’s for?”… “What’s my interest rate?”…etc.

    iBankermanATM would respond at that point with the same grin, then ask “what’s your identity today?”. Upon getting the customer response, iBankermanATM’s speech recognition software embosses a credit card with the information and iBankermanATM hands it to the customer and waves goodbye. The credit card says “3% Interest Rate” in large letters on the front side. The backside has the “change in terms notification” already laser printed on it and states the interest rate is 20% and there is an annual $50 card fee.

    So it’s not that difficult in my view. Also Isaac Asimov did a lot of the preliminary work with his Three Laws of Robotics. This was necessary to head off the scenario we saw with Terminator, where we had a too big to fail Arnold and his sentient weapons of mass destruction attempt to wipe out the human race.

    Bankers are of course much too wimpy for us to fear this scenario, and I’m sure most people could take an axe or a sledgehammer and reduce their neighborhood iBankermanATM to rubble. Though it probably wouldn’t occur to them to do this until after they realize their deposited paychecks disappeared into thin air and their new paychecks have a tax increase to cover some of the cost of their old paychecks disappearing.

    But obviously Three Laws of Robotics are not enough and we need more to safeguard the system. Some candidates are:

    4)Thou shalt not get Congress to change the Laws of Robotics
    5)Thou shalt not pretend to be an insurance company and sell phony insurance, with no reserve cash, to cover near certain losses of your customers.
    6)Thou shalt not put bad investments off balance sheet, only to mention later that off balance sheet losses are still causing you a problem.
    7) Thou shalt not run 30-1 leveraged hedge funds by borrowing in overnight money markets.
    8) Handbags do not cost $4000
    9) You are NOT Masters of the Universe…see Laws One thru Three.

    That’s a start, but I’m sure there are many more.

  • Posted by Phillip Huggan

    “No they don’t. We are looking in the tens of billions range. The banks haven’t come to grips with the fact that they don’t have that much toxic asset, because in fact, they don’t have that much toxic asset on their books if the economy improves.”

    Whew. Was worried it was two orders of magnitude larger.

    “Heavy regulation, but pro-business regulation. If the banks were heavily regulated so that none of the crap of the last few months had happened, my bonus would have likely been much larger.”

    The USA finance sector gives bonuses for covering up toxic asset exposure?! I guess the non-finance employed American people voted for pocket Change.

  • Posted by Phillip Huggan

    A cheapshot I know. But if you ignore my tone I’m trying to be helpful here. Anyone in the USA finance industry who for some stupid reason is still getting a bonus should probably be quiet about it.

  • Posted by Twofish

    Huggan: A cheapshot I know. But if you ignore my tone I’m trying to be helpful here. Anyone in the USA finance industry who for some stupid reason is still getting a bonus should probably be quiet about it.

    The way that my compensation works is that I get about two-thirds of my pay via my monthly paycheck and about one-third as a lump sum at the end of the year. Last year that lump sum was much smaller than in previous years, and so I ended up with a 25% pay cut, and I was lucky because I kept my job, and missed the 25% layoffs.

    I don’t work for AIG or Lehman and the people that I work for strike me as generally competent, and largely stayed away from doing crappy things. Still, I got a 25% pay cut for AIG’s mess.

    No I don’t make a million dollars, and if you want to punch the executives at Lehman or AIG in the face, be my guest. But do you think that it is fair for people who aren’t AIG to be compensated the same than people who are.

  • Posted by Phillip Huggan

    You don’t have to worry about me; just won’t see my witty comments around the blogosphere if I soon go back to casual labour. *I* (a Canadian whose criticisms of our banks for not lending to Indian Reserves or for not offering free savings accounts are muted) can take an illegal Mexican immigrant standard of living; don’t know any other.

  • Posted by don

    Brad: “cross-border financial flows likely reached levels that could only be sustained if the global financial system remained over-leveraged.”
    I agree as to the gross flows, but i don’t think the statement can be applied to the net flows, which in my mind are the seeds of tomorrow’s real problems.
    2fish: “The big fear was that the banks were hiding something people didn’t already know about, and the point of the Geithner report was to reassure people that the bad stuff that people already know about/suspect is going on, is pretty much the only bad stuff that is there.”
    My fear (and belief) is that the currently-recognized losses are based on over-rosy expectations for the future and that the bulk of the bank holding companies are insolvent (and I, too, have my money where my mouth is).

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