by Alex Evans | Jan 21, 2008 | Cooperation and coherence, Influence and networks, UK
Adam Boulton at Sky News, travelling with the PM in India, gives us a heads-up of another speech on multilateral reform:
The Prime Minister believes that the world has changed so much since then that we need to rewrite the rules. He is particularly interested in the growing might of the so-called BRICs – Brazil, Russia, India and China – the last two of which he is visiting on this tour. Mr Brown cheered his hosts by repeating Britain’s longstanding view that India should join Britain, France, the US, Russia and China with a permanent seat on the United Nations Security Council. But in return he wants India to do more in the global conflict against fundamentalist terrorism. The Prime Minister also wants the UN to establish a standing rapid response team of judges, police, and civilian experts who can be deployed immediately to stabilize countries immediately following violent conflicts.
He seems to have the sub-prime mortgage crisis and the knock on collapse of Northern Rock on his mind in his ideas for the IMF. Mr Brown says it shoud become the “early warning system for financial turbulence”, with the powers to intervene as soon as potential financial crisis are identified. He wants the World Bank to focust on the environment as well as it’s existing mission of poverty reduction. He wants to set up a global climate change fund (Britain has already earmarked $1.6 billion for a similar project). This would be the carrot for poor countries to do something about their carbon emissions complementing the stick of rich nation threats.
Hang on, you say, isn’t there a slight sense of deja vu here? Why yes: it’s the same as his last speech on multilateral reform – and as I observed at the time, that speech in turn read like a re-run of the 2004 UN High Level Panel on threats, challenges and change. To be fair, it’s hard to find fault with the content. But it would be welcome to hear more about how the PM plans to achieve all this, given the snail’s pace of multilateral reform discussions over the last few years.
by Alex Evans | Jan 10, 2008 | Global system
The latest report of the Global Risks Network at the World Economic Forum is just out – here it is if you fancy a look. The report begins with the words:
Over the last year, a series of risk issues – from the liquidity crisis in the financial markets to the emerging concerns over the long-term security of food supply – have focused global attention on the fragility of the global system.
So it is a pleasant irony indeed that one of the sponsors of the report is none other than – Citigroup!
Nor does the irony stop there. Last time the Global Risks Network met in London, on 10 July, the participants (of whom David and I were two) were treated to a quite fantastically complicated presentation by two Citigroup staff – the gist of which was “innovative financial instruments are great because they reduce risk in the global financial system”.
Who knew? And it gets better still.
For as you’ll all recall, 10 July is of course the very same day that then-CEO of Citigroup Chuck Prince made his infamous comment in the FT that
When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.
Oh dear. A couple of us did ask the Citi staff at the time how their sophisticated presentation on risk management squared with their boss’s snappy dance moves; but hey, benefit of hindsight and all that. As the introduction to the WEF report continues,
Under conditions of global stress, one core questions of global risk management will become more salient than ever: who owns the risk?
How true, how true – and never more so than in the case of all those pesky CDOs that Mr Prince has left us with. Anyway, the report is excellent, and well worth a look.
by Alex Evans | Jan 2, 2008 | Global system
So says Ambrose Evans-Pritchard in the Telegraph, so it must be true. He writes: “As the credit paralysis stretches through its fifth month, a chorus of economists has begun to warn that the world’s central banks are fighting the wrong war, and perhaps risk a policy error of epochal proportions.” And what might that policy error be?
Buckets of liquidity are being splashed over the North Atlantic banking system, so far with meagre or fleeting effects … “Liquidity doesn’t do anything in this situation,” says Anna Schwartz, the doyenne of US monetarism and life-time student (with Milton Friedman) of the Great Depression.
Peter Spencer of York University continues:
“The central banks are rapidly losing control. By not cutting interest rates nearly far enough or fast enough, they are allowing the money markets to dictate policy. We are long past worrying about moral hazard … [The global financial authoritie] still have another couple of months before this starts imploding. Things are very unstable and can move incredibly fast. I don’t think the central banks are going to make a major policy error, but if they do, this could make 1929 look like a walk in the park”.
I’m not sure that the ‘chorus of economists’ saying that it’s an insolvency crisis rather than just a liquidity crunch is really so new – Nouriel Roubini was saying so back in mid-August, as we observed at the time – but let’s let that pass. Here are three interesting, if controversial, thoughts that emerge from E-P’s piece:
1. Remember what happened to Japan in the 1990s:
In theory, Japan had ample ammo to fight a bust. Interest rates were 6 per cent in February 1990. In reality, the country was engulfed by the tsunami of debt deflation quicker than the bank dared to cut rates. In the end, rates fell to zero. Still it was not enough. When a credit system implodes, it can feed on itself with lightning speed. Current rates in America (4.25 per cent), Britain (5.5 per cent), and the eurozone (4 per cent) have scope to fall a long way, but this may prove less of a panacea than often assumed. The risk is a Japanese denouement across the Anglo-Saxon world and half Europe.
2. E-P’s outlook for Britain:
The risk for Britain – as property buckles – is a twin banking and fiscal squeeze. The UK budget deficit is already 3 per cent of GDP at the peak of the economic cycle, shockingly out of line with its peers. America looks frugal by comparison. Maastricht rules may force the Government to raise taxes or slash spending into a recession. This way lies crucifixion. The UK current account deficit was 5.7 per cent of GDP in the second quarter, the highest in half a century. Gordon Brown has disarmed us on every front.
3. Something you may not have considered vis-a-vis the European Central Bank:
The ECB’s little secret is that it must never allow a Northern Rock failure in the eurozone because this would expose the reality that there is no EU treasury and no EU lender of last resort behind the system. Would German taxpayers foot the bill for a Spanish bail-out in the way that Kentish men and maids must foot the bill for Newcastle’s Rock? Nobody knows. This is where eurozone solidarity stretches to snapping point. It is why the ECB has showered the system with liquidity from day one of this crisis.
In other news, Nouriel Roubini finds that in 2007, cash (in short term Treasuries or money market funds) outperformed the stock market.
by Alex Evans | Dec 5, 2007 | Climate and resource scarcity, Cooperation and coherence, Global system
Amid the torrent of news about (a) ongoing turmoil in financial markets and (b) rocketing prices in the real economy for energy and food, it’s fascinating to watch two worlds – the financial economy and the real economy – colliding. All of a sudden, various of globalisation’s chickens are coming home to roost – energy security, food security, hedge funds and financial innovation, to name just a few. And the worrying thing is that as policymakers play catch-up with these esoteric, highly specialised issues, it’s becoming increasingly clear that no-one has a clear strategic overview of what’s happening.
Start , for instance, with a quick snapshot of the financial markets situation from NY Times columnist Paul Krugman:
How bad is it? Well, I’ve never seen financial insiders this spooked — not even during the Asian crisis of 1997-98, when economic dominoes seemed to be falling all around the world. This time, market players seem truly horrified — because they’ve suddenly realized that they don’t understand the complex financial system they created.
Chip Mason, founder of Legg Mason (one of the world’s largest money managers, with $1 trillion of assets under management) says that credit markets are the worst he’s seen in 47 years in the business: “It is a very unusual situation. I have not seen anything like this, where nothing is traded.” Nor is the UK proving immune to the crunch. As Nouriel Roubini notes, two days ago the one month Libor inter-bank interest rate spiked 60 basis points from its Friday levels – to its highest level in nine years.
Already, a kind of inquest on financial innovation is opening up in some quarters. Krugman quotes Bill Gross – the managing director of Pimco, a leading bond manager – thus: “What we are witnessing is essentially the breakdown of our modern-day banking system, a complex of leveraged lending so hard to understand that Federal Reserve Chairman Ben Bernanke required a face-to-face refresher course from hedge fund managers in mid-August.” (See also Gross’s more detailed – and very downbeat – assessment on Pimco’s own website.) Krugman’s own view: “The bottom line is that policy makers left the financial industry free to innovate — and what it did was to innovate itself, and the rest of us, into a big, nasty mess.”
But there’s disagreement over how much the current turmoil matters for the real economy. Not much, says former Bank of England Monetary Policy Committee member Willem Buiter: “The good news in all this is that much of the financial sector has become quite detached from the real economy. The implosion of much of this formerly privately profitable but never socially productive financial intermediation will have little if any adverse macroeconomic effect.” A lot, says Nouriel Roubini: “it does not make sense to avoid bailing out the real economy – and preventing a massive global loss of incomes and jobs – just in order to punish reckless lenders and investors in the financial market and thus avoid moral hazard.”
There’s disagreement too over what needs to happen on interest rates. Roubini thinks it’s urgent, but Wolfgang Munchau begs to differ: “The inflation outlook would justify a neutral policy stance at best. A bias towards low interest rates got us into this mess. Low interest rates will not get us out of it. Central banks should keep their cool.”
The question of inflation brings us neatly over to the real economy, and to prices for energy, crops and other commodities (another issue that we’ve been following here in recent months). If the financial turmoil does present a serious downside risk for growth, at the same time as energy and food prices – for which demand is relatively inelastic – proceed inexorably upwards, does that herald a return to 1970s-style stagflation?
Krishna Guha did a handy analysis piece on that question in the FT on Monday, and concluded that there was indeed at least “a whiff” of the s-word in the air, but that over a 1-2 year time horizon, “the world may see low growth or high inflation – but probably not sustained stagflation in any large economy”.
(I’m not so sure. The more I look at energy and food trends, the more it looks like we may have seen a structural shift towards long term higher prices for both. True, a slowdown in emerging economies would let off some steam. But it would take a very hard landing in China and India to eradicate the massive growth in their demand for energy and agricultural products of recent years. And it will still take a very large amount of investment – in energy infrastructure, in agricultural acreage expansion- to keep up with even lower end demand projections for these commodities.)
But here’s the thing. I know more or less enough about energy and agriculture to form my own views about what’s happening on that front. But I’m completely reliant on interpreters (like the ones I’ve quoted above) to explain the credit crunch to me. And I have no real way of evaluating which of them is right and which of them is wrong.
As the various worlds of the economy continue to collide, an integrated perspective of all of these issues is becoming increasingly urgent. And here’s what should really worry all of us: who the hell does understand both worlds? Almost certainly not any one policymaker, central banker or committee. Yet these are the people we trust to make crucial decisions on this tangled web. Increasingly, we’re going to come to see this perfect storm above all as a crisis in our ability to take and implement effective decisions. More on that in a future post…
by Alex Evans | Nov 7, 2007 | Global system
Time to take stock of the credit crunch. Nouriel Roubini, a professor of economics and international business at NYU’s Stern School of Business, is decidedly downbeat:
It is now clear that the delusional hope that the severe credit and liquidity crunch that hit US and global financial markets would ease has been shattered by the events of the last few weeks. This credit crunch is getting much worse and its financial and real fallout will be severe.
And, he goes on, we need to stop calling this a subprime crisis. It’s far broader than that: not only has the contagion sread to near-prime and prime mortgages, it’s also well advanced into subprime and near-prime credit cards and car loans, and heading off into broader pastures still. “Every corner of the securitization world is now under severe stress, including so called highly rated and “safe” (AAA and AA) securities.”
And there appears to be the potential for it all to get a lot worse on November 15th, when a new accounting standard, FASB 157, comes into effect. FASB 157 is all about the valuation of illiquid assets – i.e. those assets where there isn’t necessarily a ready buyer and hence the asset is less readily convertible into cash. What it says, essentially, is that financial institutions will be much more limited in their ability to put these ‘illiquid’ assets into so-called “level 3” securities – a category of securities where the lack of market prices allows banks to use highly dubious models to price the securities instead. In English – until now, banks have basically been able to make up whatever estimate they like for the value of illiquid assets. And now that party looks set to come to an end.
Quite how bumpy a hangover there might be is illustrated by some back of an envelope calculations provided on Roubini’s blog, which look at various financial institutions and divide their level 3 assets – the ones vulnerable to this new valuation standard – by their overall equity capital base. As one of Roubini’s contributors puts it, “this will give us a better idea as to which of them may really remain solvent at the end of the day”.
Start then with Merrill Lynch, which has had to write down $7.9 billion of debt and seen the loss of its CEO, Stan O’Neal. Here, the totals were $16 billion in level 3 assets, and $42 billion in equity – a ratio, in other words, of 38%. Then look at Citigroup, which lost its CEO Chuck Prince on Sunday. Here, the figures are $135 billion in level 3 assets, against an equity base of $128 billion – a ratio of 105%. Ouch. But now look at a few other firms:
- Bear Stearns: $20 billion level 3, $13 billion equity base = 154%
- Lehman Brothers: $35 billion in level 3, $22 billion equity base = 159%
- Goldman Sachs: $72 billion in level 3, $39 billion equity base = 185%
- Morgan Stanley: $88 billion in level 3, $35 billion equity base = 251%
In other words, most of the media attention so far, and the two highest profile corporate scalps, are actually among the institutions with lowest exposure. Roubini’s summary: “Thus, you can expect that the ongoing credit crunch will get much worse in the year ahead and its fallout spread from the US to Europe and throughout Asia and the globe. Trillions of dollars of securitized assets that were sliced and diced in the long food chain of securitization are now at some risk. The first crisis of financial globalization and securitization is thus only at its beginning stage.”
It looks pretty likely that the current turmoil will lead on swiftly to a discussion about global financial regulation – this was apparently the clear consensus at a seminar on financial market turmoil held at the IMF / World Bank annual meetings last month. Commentators from the left like Will Hutton are already sharpening their claws (and, one suspects, rubbing their hands with glee) in preparation for such a discussion:
To get through this crisis, the American and British governments are going to have to think what hitherto has been unthinkable. Already the Americans are cutting interest rates careless of the inflationary consequences. Britain may have to follow suit. Both governments will have to devise new forms of regulation and control. Banks may have to be taken into public ownership.
Governments, though, so far seem reluctant to engage in such a debate. Here in the UK, Alistair Darling has admitted that the global banking industry is facing “an unparalleled period of financial uncertainty”, but he added that “I believe that we can get through that…our banking system is basically strong and…we have a very strong economy”. He must be hoping so.
