Posted on Friday, August 22nd, 2008 by bsetser
Russia’s reserves fell by $16.4 billion last week.
Data released by Russia’s central bank showed a drop in foreign currency reserves of just over $16.4bn in the week beginning August 8. This was one of the largest absolute weekly drops in 10 years, according to Ivan Tchakarov at Lehman Brothers.
Some of that reflects the fall in the dollar value of Russia’s existing rubles, but Russia’s central bank still likely sold close to $10 billion of foreign exchange to limit the rubles slide.
No one though is that worried that Russia is going to default — or run out of cash. It still has well over $550 billion left in the bank. And with oil trading between $115 and $120 a barrel, Russia should be able to replenish its coffers quickly.
To be sure, capital outflows have put some pressure on Russia’s domestic market, and domestic borrowing costs are up. That may constrain the Kremlin a bit. Charles Clover of the FT writes:
global market sentiment … could end up being an important check on Kremlin decision-making. “The million-headed hydra of the bourgeoisie has sent a signal: ‘change your course, comrades!’” wrote the popular internet columnist Dmitry Oreshkin on www.ej.ru in a joking reference to the communist background of Russia’s leadership.
But it isn’t anything like 1998.
At the end of June 1998, Russia only had around $11 billion in the bank — almost all borrowed from the IMF. The United States decision not to support the disbursement of a $5 billion installment on Russia’s IMF loan was enough to leave Russia effectively bust, and to force a default.
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Posted in Systemic Risk, central bank reserves | 8 Comments »
Posted on Sunday, August 17th, 2008 by bsetser
A well-deserved one too. Nouriel stuck to his core views — housing was massively over-valued, the financial system was heavily exposed to a fall in home prices and the fall out from a fall in US home prices wouldn’t be contained either nationally or globally – when those views were decidedly unpopular.
Back in early 2007, there was a great deal of complacency among America’s financial leadership. Many thought macroeconomic volatility had been vanquished, and as a result financial volatility was justly low. High levels of leverage consequently made sense — and a range of asset market prices reflected this. In the language of the time: credit markets weren’t over-valued, equity markets were under-valued. Recessions - or at least severe recessions and financial crises – were things that happened to other countries, not the US. The US had survived the .com bubble with only a shallow downturn. The 2003-2006 rise oil prices hadn’t put a big dent in the US economy. The large US current account deficit reflected high savings abroad and the attractiveness of the US financial assets; the US, after all, had a comparative advantage in financial-engineering. The IMF wrote that “innovative US fixed income markets [provided] many assets which simply aren’t available elsewhere” (see p. 12). There wasn’t much too worry about.
Read Michael Lewis’ argument that Davos man spent too much time worrying. He wrote in 2007:
Oil prices double, the U.S. housing market tanks — no matter what happens, financial markets adjust quickly and without hysteria. There are obviously a few things to worry about just now in the world, but the inability of traders to find a sensible price for the spread between European junk and European Treasuries isn’t one of them. So why do these people waste so much of their breath and, presumably, thought, with their elaborate expressions of concern?
Even the IMF – which is paid to worry – was tired of worrying. In late January of 2007, Chris Giles of the FT ran an article, based on an interview with the IMF’s Deputy Managing Director, that was titled “Big risks to global economy receding.” I thought that captured the mood of those times well.
Nouriel didn’t waver then. Others (myself included) did. Standing apart from the herd can be hard.
Over time, the focus of Nouriel’s concerns has shifted over time from the United States’ external deficit to the housing market and the financial system. But there has been a core consistency to his views: he never thought that it was healthy for the US to borrow heavily from the rest of the world to finance large fiscal deficits, high levels of consumption and lots of investment in suburban housing. And he thought this borrowing binge would end badly. Very badly.
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Posted in Systemic Risk, housing | 20 Comments »
Posted on Thursday, August 14th, 2008 by bsetser
Not only do we live in a new “age of authoritarianism,” but we live in a world where autocratic governments increasingly finance democratic governments.
Consider a chart that shows the increase in the foreign assets of the world’s more authoritarian governments v the increase in the foreign assets of the world’s democratic government.
Right now, autocratic governments generally don’t finance other autocracies. China’s capital account is closed to Gulf sovereign funds (nearly) as tightly as it is closed to private hedge funds. China’s government is no more able to buy a stake in the Gulf’s national oil companies than private investors. China, Russia and the Gulf are all building up large financial claims on the United States and Europe far faster than they are building up financial claims on each other.
In the first chart, I included Russia and Venezuela alongside the world’s authoritarian governments. That can be debated. Both Putin and Chavez have authoritarian sides, but both have also put their governments up for a vote. But separating Russia and Venezuela out doesn’t change the story much. The rise in the foreign assets of the world’s less-than-perfectly-democratic government is driven overwhelmingly by the rise in the foreign assets of the People’s Republic of China and the Gulf monarchies.
Both graphs, incidentally, are drawn from a paper that I have been working on over the summer, so stay tuned. The graphs include estimates for new inflows into sovereign funds (and the increase in the foreign assets of Chinese state banks) as well as the growth in central bank reserves. And yes, they indicate that the increase in the foreign assets of the world’s governments - particularly governments in the emerging world — over the last four quarters has been truly extraordinary.
Earlier this week Gerald Seib noted — quite correctly — that high oil prices have increased the financial power of the world’s less-than-democratic oil exporters. Throw in the fact that high oil prices have yet to put a dent in China’s current account surplus or the accumulation of China’s foreign assets, and the shift in financial power away from from democratic governments is even more pronounced.
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Posted in Systemic Risk, US politics, central bank reserves | 64 Comments »
Posted on Thursday, July 24th, 2008 by bsetser
Emerging market financial crises in the 1990s followed a fairly consistent pattern.
The country lost access to external financing.
The sector of the economy that had a large need for financing – firms in Asia, the government elsewhere – had to dramatically reduce its need for financing. Asian investment collapsed. Argentina swung from a fiscal deficit to a fiscal surplus (helped along by its default on its external debt). Turkey began to run large primary surpluses.
Financial balance sheets shrank; credit dried up.
The country’s currency fell sharply. And its current account swung into balance, if not a surplus.
That process was incredibly painful. Falls in GDP of 5% or more were not unknown. It also meant that after a year or so, most emerging markets had reached bottom. Their economies had adjusted, as had their currencies.
A year – almost – after its crisis, the US economy hasn’t endured a similar period of adjustment. Economic activity has slumped, but not fallen off a cliff. US households are pinched (and unhappy), but spending hasn’t collapsed. The US current account deficit has fallen, but not by much – the rise in the oil deficit has offset the fall in the non-oil deficit. Banks have depleted their capital, but I don’t think that they have – in aggregate – shrank their balance sheets. Then again some of the expansion of their balance sheets may not have been entirely voluntary, as off-balance sheet assets and liabilities moved on to the formal balance sheet.
Residential investment has fallen significantly as a share of GDP.
But in other ways, the US hasn’t adjusted.
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Posted in Systemic Risk, U.S. trade deficit and external debt, housing | 72 Comments »
Posted on Monday, July 14th, 2008 by bsetser
My post over the weekend attracted a bit of attention. I thought I would clarify a few points that came up in the discussion, refine a few calculations and try to put central banks’ Agency purchases into context.
One key point that I didn’t initially emphasize is that that different central banks hold slightly different Agency portfolios. China holds a lot of Agency “MBS” (also called Agency pass-throughs). These are mortgage backed securities that the Agencies guarantee, as opposed to the debt the Agencies issue in their own name to finance their retained portfolio. Other central banks, by contrast, tend to own the debt the Agencies issue themselves, not the debt they guarantee.
There are a couple of ways of seeing this. Compare for example the “Agency” portfolios of China, Russia and Korea (using the data released in the Treasury survey).
In June 2007, the US data indicates that China had $11 billion of short-term Agency debt, $170.1b of long-term Agency debt and $206.2b of Agency MBS.
In June 2007, the US data indicates that Russia had $38.6b of short-term Agency debt, $75.3b of long-term Agency debt, and $0.001 billion of Agency MBS.
Here I want to note that my initial $155 billion estimate for Russia’s current Agency holdings is significantly higher than the $100 billion the Russian central bank claims to hold. That may reflect a reduction in the central banks’ holdings since April (the last data point), or the limits of methodology. My estimate makes two key assumptions: first, Russia’s central bank accounts for almost all of Russia’s total holdings of Agencies (i.e. private holdings are minimal) and second, almost of all of Russia’s holdings of short-term negotiable securities, CDs and other custodial liabilities are short-term Agencies. That was true in June, 2005, in June 2006 and in June, 2007 (the survey showed $38.6b of Agencies, v $42.1b in short-term custodial holdings). But it is possible that things have changed since then. I assumed that all of Russia’s 66.6b in short-term custodial holdings are in Agencies, which is a big assumption.
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Posted in Systemic Risk, central bank reserves | 43 Comments »
Posted on Saturday, July 12th, 2008 by bsetser
The epicenter of the US financial crisis now seems to have shifted to Fannie Mae and Freddie Mac — the government sponsored enterprises that dominate the market for US housing finance. Few institutions matter more for the US economy. They currently buy or guarantee an astonishingly high fraction of all new mortgages in the US. Absent that financing, home prices would fall further — dragging down the value of a lot of the “private” mortgage-backed securities issued at the height of the crisis, and health of a lot of (troubled) private financial institutions.
But Fannie and Freddie aren’t just “too-big-to-fail” US financial institutions. Not anymore. They are now global financial institutions. They have been central to the process that has turned US mortgages into securities held by the world’s central banks. Official — meaning central bank — holdings of Agencies have soared over the past two years. The US “TIC” and survey data suggests that central banks now have at least $925 billion in “Agency debt.” That is almost certainly an understatement: the monthly TIC data tends to understate official purchases, leading to large revisions when the more accurate survey data is released in June. Total official holdings are likely above a trillion — or about 20% of the $5 trillion or so in Agency debt outstanding.
As a result, the governments of China and Russia are now almost as exposed to the “Agencies” as the US government.
* This graph makes use of data collected by the CFR’s Arpana Pandey.
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Posted in Systemic Risk, central bank reserves, housing | 73 Comments »
Posted on Wednesday, July 2nd, 2008 by bsetser
International institutions usually put out reports filled with turgid and overly-qualified prose.
But not the BIS. At least not this year. The introduction and conclusion of its 78th annual report are a pleasure to read. The prose is clear and direct. An example:
“If asset prices are unrealistically high, the must eventually fall. If savings rates are unrealistically low, they must rise. If debts cannot be serviced, they must be written off. Trying to deny this through the use of gimmicks or palliatives will only make things worse in the end.” (p. 145)
Outgoing Chief Economist William White’s is unsparing in his criticism of both the big private banks and the major central banks. Central banks, in White’s view, held rates too low for too long after the equity bubble burst – creating asset bubbles that fueled excessive demand growth to offset what he views as the natural fall in prices associated with the integration of large new pools of labor into the world economy. Private banks ignored the risks building on their balance sheets
And central banks and private bankers alike failed to appreciate the risks created by the new world of securitized mortgage finance – particularly a world where a lot of exposure was held off-balance sheet in “vehicles” of various kinds.
“Recent innovations such as structured finance products were originally thought likely to produce a welcome spreading of risk-bearing. Instead the way in which they were introduced materially reduced the quality of credit assessments in many markets and also led to a marked increase in opacity. The result was the eventual generation of enormous uncertainty about the size of losses and their distribution. In effect, through innovative repackaging and redistribution, risks were transformed into higher-cost and, for a while at least, lower-probability events.”
It isn’t hard to get the impression that White thinks innovation increased the both the cost and probability of a crisis by contributing – along with low policy rates – to reduced credit standards and asset bubbles. He clearly thinks that the credit losses that followed the bursting of the bubble cannot be “cleaned up” easily.
“It is not clear where the losses [on “new financial instruments”] are, how they should currently be valued or how large they might grow given ongoing declines in the prices of underlying assets.”
The solution? In the first instances, the banks who originated and distributed (sometimes to their own treasury or internal hedge) the bad loans should take their losses.
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Posted in Monetary policy, Systemic Risk | 75 Comments »
Posted on Friday, May 30th, 2008 by bsetser
Peter Fisher (Blackrock, formerly of the Treasury and the New York Federal Reserve) as quoted by the Wall Street Journal’s David Wessel:
“The idea of risk dispersion is nice in theory, but in practice it depends on who risk gets dispersed to. It turns out that we dispersing risk it into strong hands who could hold it through volatility. Rather we were dispersing it to weak hands who couldn’t hold it, and ended up adding to the volatility.”
So true.
Who were those weak hands?
Some credit hedge funds – whose use of leverage left them exposed to volatility.
Broker dealers like Bear.
And stronger – but not quite-as-strong as advertised – hands like UBS..
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Posted in Systemic Risk | 21 Comments »
Posted on Monday, April 21st, 2008 by bsetser
Back in 2005, Ragu Rajan warned that the banks were taking on the hard-to-sell leftovers from the securitization process. As a result, he argued that the banks were becoming less liquid – and that the process of risk transfer was incomplete. I assumed that this meant that the banks were holding small amounts of the most risky tranches that emerged from bundling a lot of different loans and securities together. That assumption seems to have been off. The risky bits carried high yields, and seem to have been easy to move. Instead the banks were holdings large quantities of the safest (and lowest yielding) securities – the “super-senior” tranches.
Gillian Tett:
The concept of super-senior debt was essentially invented by creative bankers about four years ago to refer to the chunk of debt that sits at the very top of the capital structure of a collateralised debt obligation. It is the bit that gets paid off first, before other investors, if the CDO ever defaults. In theory, it makes this debt super-safe; indeed, so secure that rating agencies have been happy to give super-senior CDO debt a triple-A tag, irrespective of what lay inside the CDO.
When I first heard about this asset class a couple of years ago I initially assumed this stuff might appeal to risk-averse institutions such as pension funds. But nothing could be further from the truth. In fact, key buyers for super-senior in recent years have been banks such as Merrill Lynch and UBS. Most notably, as these banks have pumped out CDOs, they have been selling the other tranches of debt to outside investors - while retaining the super-senior piece on their books. Sometimes they did this simply to keep the CDO machine running. But there was another, far more important, incentive: regulatory arbitrage.
Most notably, because super-senior debt carried the triple-A tag, banks were only required to post a wafer-thin sliver of capital against these assets - even though this debt has typically offered a spread of about 10 basis points over risk-free funds. Thus, banks such as UBS and Merrill have been cramming their books with tens of billions of super-senior debt - and then booking the spread as a seemingly never-ending source of easy profit. It is not just the CDO desks that have been playing this game; treasury departments have been playing along. So have many hedge funds, including those financed by . . . er . . . the major investment banks
It turns out that the super-senior tranches carried a lot more risk than many thought – Combing a bunch of CDOs composed of subprime securities into a new security didn’t make the underlying risk go away. Plus these instruments were illiquid and thus hard to sell.
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Posted in Systemic Risk | 67 Comments »
Posted on Sunday, April 6th, 2008 by bsetser
A ton, according to Morgan Stanley’s Stephen Jen and a host of Wall Street investment banks
Not all that much, according to Milken Institute’s Christopher Balding (as reported by Bob Davis in the Wall Street Journal’s economics blog). The Gulf – which is home to the big sovereign funds has only about $300b in reported US assets. Its reported reserves aren’t that big. And its supposedly big sovereign funds haven’t stepped up to inject more capital into the US financial system since January.
The truth, I suspect, lies in the middle. Some Wall Street numbers sometimes are a bit too high for my taste. But Felix is also right: Christopher Balding’s estimate seems significantly too low.
The most likely reason why sovereign funds haven’t made more investments in US financial firms is that they lost a ton of money on their investments, not a lack of cash. Their losses (unrealized) haven’t escaped notice in their home countries. They may feel like they were, to paraphrase Landon Thomas’ reporting in the New York Times “made fools of.” It probably didn’t escape sovereign funds notice that a lot of banks paid out record bonuses right after securing big commitments from sovereign funds – and that some of the same firms looking for capital last fall are still short of capital now ….
Thomas also notes that the Gulf investors aren’t happy with the criticism that their investment has received in the US. They believe the US government should be thanking them, not asking them to more transparent. Thomas’ reporting appeared in the Deal Journal “Leveraged Planet” special from last week — it is well worth reading.
Why am I confident that Balding’s estimate is too low? Simple: the US data understates the financial holdings of the Gulf. There is a relatively well-known reason for this too – as Rachel Ziemba explains – the big Gulf funds and the Saudi Monetary Agency have effectively outsourced the management of much of their wealth. They put their money in the hands of a Swiss bank or a London asset manager. And the Swiss bank or London asset manager invests on their behalf. The US data only sees the investment from Switzerland or London, not the source of the money. And frankly the UK facilitates all of this by refusing to publish any detailed data on capital flows in and out of the UK. I titled one of my early papers on petrodollars “disappearing into London”
There is another reason why I am confident that the Gulf has large assets that don’t show up in the US data: the IMF’s balance of payments data. Read the rest of this entry »
Posted in Sovereign Wealth Funds, Systemic Risk | 9 Comments »
