We discussed the burgeoning European debt crisis with details on the problems in Greece and Spain, the growth of public debt, the euro, high leverage levels in the private banks, the asset bubbles that formed in the Eurozone countries, how the low interest rates of the ECB and the overvalued exchange rates which fueled the asset bubbles, and unemployment in these countries.
We are late in writing this post, because the week following was filled with the unfolding of the pan-European debt crisis.
We did not get to these items during the show.
On February 10, FINRA will hold a closed meeting to discuss charges that the former chairman of FINRA and now the chairman of the SEC, Mary Shapiro, acted negligently and incompetently in failing to warn investors about Lehman, Bear Stearns, and Merrill Lynch as well as about Auction Rate Securities, despite liquidating FINRA's own ABS holdings in mid-2007 and in not taking action against the Ponzi schemes of Bernard Madoff and Robert Stanford. Under her administration FINRA suffered almost $700 million in investment losses and paid its senior executives nearly $30 million dollars. Mary Shapiro has never been able to comprehend that her job was --- and is --- to protect the American public. She has always ended up representing her perceived salesmen constituency.
The TARP Inspector General, in his quarterly report to Congress, stated the government's concerted efforts to support housing prices risk re-inflating the housing bubble and the government has effectively taken over
the housing market, directly or implicitly, through purchases and guarantees of nearly all residential mortgages.
The TARP Inspector General is reported to be investigating insider trading not only on the lower foot soldier level but the executive level of eight of the largest banks with respect to TARP information and actions. He is also investigating gaming of the Public Private Investment Partnerships, such as selling a security form a non-PPIP fund and buying it back at a slightly higher price with a tax payer supported PPIP fund minutes later.
The FHA and Fannie May are pushing foreclosure sales with the FHA lifting bans for one year and allowing investors to buy a home and then flip it within 90 days, but their profits will limited to 20% and transactions must be arms length. Fannie May will offer 3.5% seller assistance for buyers of its Homepath properties, which are properties Fannie May already owns. There have been approximately 2.8 million foreclosures in 2009.
Fannie May and Freddie Mac both face an uncertain future with many, including Barney Frank, wanting to do away with them as the financial community has long sought to extinguish the competition which some advocates still maintain made owning a house a legitimate reality for more middle class citizens. It is amazing how the forces which seek to destroy Fannie and Freddie rather than reform the GSE concept conveniently forget it was the mortgage and banking interests that lobbied to get Fannie and Freddie to lower their standards and take on more mortgages, which the financial community could then bundle into derivative securities, from which the profits drove the greed which propelled the housing market into an asset bubble.
Mortgage insurers, such as MGIC Investment, have rescinded or refused to pay approximately $6 billion in claims from banks on delinquent home loans since January 2008 and the bond insurers are also trying to recover more than $4 billion for breaches of representation and warranties on residential mortgage-backed securities they guaranteed. Bank of America and Wells Fargo may be particularly exposed, but all of the large banks are increasing their reserves for the potential costs of being forced to repurchase these troubled home loans. J. P. Morgan's first quarterly loss in two years was partially the result of these reserves.
Italy seized $102 million of Bank of America assets in a police investigation of the losses from derivatives linked to the sale of 870 million euro of bonds sold by regional governments in 2003 and 2004 on the grounds the bank mislead the municipalities on the economic advantages of the transactions and concealed their fees. The police have also segregated and sequestered another 30 million euro Bank of America would have managed for one municipality. Swap derivatives arranged to create funds to repay the bonds were skewed to the the advantage of the bank and to hide their fees.
Trim Tabs has reported that the mysterious large volume buyer of S&P 500 futures has dropped 6.6% in eleven trading days starting the day before President Obama announced he wanted to restrict the proprietary trading of banks. There has been speculation the buyer could have been the Federal Reserve or the U. S. Treasury. The question now has the mysterious buyer stopped buying?
It has been suggested that the UK and Netherlands demands on Iceland for repayment of their reimbursement of their citizen's for investment losses on interest bearing deposits in Icelandic banks are unreasonable. The UK has even put Iceland on the list of international terrorists. It would be in the interest of all three countries to compromise and agree for Iceland to compensate the UK and Netherlands for any shortfall in recovery from the assets of Landsbanki when it is wound down. Iceland cannot afford to pay now with their economy in deep recession.
A Swiss administrative court has ruled that data belonging to an UBS client cannot be given to the United States, although UBS must provide information on at least 10,000 of 14,700 US clients to the IRS. However, the IRS has also refused to give any indication how many UBS client information it has received. The Swiss Justice Minister said that the Swiss economy and job market would be adversely impacted if UBS lost its US license. UBS shares fell on those comments.
St. Louis Fed President Bullard said deflation is no longer a worry and it is too early to tighten monetary policy, although the Fed could increase the discount rate.
At Davos, Roubini said the outlook for US growth is dismal and more than half of the current growth has been from replenishing inventory while consumption was dependent on monetary and fiscal stimulus. Stiglitz again reiterated that the prior stimulus was not enough, although in the right direction, and there has to be a second stimulus focusing on investment
In a public presentation of his new book Freefall, Stiglitz asserted the US botched the economy over the last eight years.and that is the reason we got into this mess was banks. Banks misallocated capital, took on excessive risk, and charge transactions fees which were so high that financial service companies accounted for more than 40% of US corporate profits in 2007. The financial system failed and the regulators, the Fed and government, failed to constrain them. Regulatory reform has failed to materialize and the banks are free to destabilize the global economy again. The need for a second, better targeted stimulus is urgently needed. Stemming the tide of foreclosures by addressing the 25% of mortgages which are underwater is necessary.
Paul Volcker, citing the conflicts of interest in commercial banks being involved in proprietary trading, said the risks taken by banks need to be curbed and there needs to be international consensus that banks should be regulated to avoid being treated as too big to fail.
Rather than have banks increase risk retention from 5% to 10%, the Comptroller of the Currency said regulations should be formulated requiring minimum underwriting standards which would apply to all loan originators. While he supports the return of securitizations to balance sheets properly aligned with risk, he is worried it will impair the development of a robust securitizattion market.
Primary dealers (big banks and investment firms) are complaining that the increase in direct purchasers at Treasury auctions hurts their margins, because it drives up the price and spreads and hurts their margin in subsequent resale.
The FDIC has proposed to change the requirements for a securitization to be treated as a true sale, which means investors could not go back to the originator for recourse. The FDIC proposed mortgages must be seasoned 12 months before they can be securitized, the originator must retain at least 5% interest in the credit risk, the interests of all parties must be clearly disclosed, resecuritizations, i.e., CDOs, are not permitted, and compensation to servicers will include incentives for loss mitigation. The FDIC also made various proposals to insure transparency for investors.
Oil supplies up 2.3 million barrels, gas down 1.3 million, distillate down 1.0 million.
Personal consumption up 2 tenths of a percent; income up 4 tenths; disposable income up 4 tenths; real; PCE (after adjustment for revenue changes) up 8 tenths; savings up to 4.8% December (4.5% in November).
January ADP private survey -- large business down 19,000 jobs; small business down 12,000 jobs; non-farm service sector up 38,000; total private sector down 22,000 but businesses plan to layoff 71,482, which is largest since August 2009.
ISM non-manufacturing index service sector up to 50.5 (below estimates) from 49.8.
ISM manufacturing index up to 58.4 in January from 54.9, construction down 1.2%.
Weekly jobless claims up 8000 to 480, 000; 4 week moving average up 11,750 to 468,750; continuing claims up 2000 to 4,602,000.
December factory new orders up 1%, shipments up 1.6%, unfilled orders down 1%, inventory down 1 tenth.
Consumer credit down to annualized rate of 4.75% January -- 12 months off 4% -- consumer credit dropped $1.8 billion in January.
German factory orders down 2.3% in December.
Bank of England did no asset purchases for the first time in 11 months but reserved the possibility to resume.
Russian GDP 2009 was <7.9%>; -- for largest contraction in 15 years.
IMF said it would help Greece if asked while saying it is confidant Greece will take steps to head off the debt crisis.
NY Fed President Dudley is worried the recovery is weak but sees double dip chances as low.
Kansas City Fed President Hoenig said interest rates cannot remain low as the economy recovers.
GMAC wrote down bad mortgage assets for $5 billion Q4 loss -- $10.3 billion loss for year.
While the S&P 500 rose 63%, S&P 500 earnings (inflation adjusted) have fallen below 10% while the financial sector is up 173%.
Bankruptcy filings are up 15% vs year ago January.
Pending home sales were up 1% in December but empty, privately owned houses up 2.7% in Q4. Home ownership rate is 67.2%, which is the lowest since 2000. This suggests there are over 1.8 million excess housing units.
UK manufacturing activity was up to 56.7 in January from 54.0 -- fastest pace in 15 years.
Greece will need to refinance 50 billion euro of debt in 2010.
Portugal reduced 500 million euro Treasury bill offer to 300 million and still had a poor sale with yield 50 basis points higher than two weeks ago.
ECB holds interest rate at 1%. Trichet is looking to 2nd Quarter for exit strategy.
Bank of England holds interest rate at 5 tenths.
Investors have turned bearish on the euro.
European producer prices (factory gate) fell 2.7% in December vs year ago -- 12 months of monthly decline.
UK producer prices rose 4 tenths in January, wholesale costs up 3.8% vs year ago.
French economy is estimated to be up 3 tenths - 4 tenths in first half of 2010.
German industrial output down 2.6% December vs November.
China GDP estimated to rise 11.5% Q1 (10.7% Q4 2009).
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Sunday, February 14, 2010
Thursday, February 11, 2010
Denial and the Pan-European Debt Crisis
As if the euro Trojan Horse was not being prominently offered, the European Union today issued a statement offering solidarity with Greek austerity measures but with no commitment to a solution to the pan-European debt crisis which is unfolding. And the European and US stock markets went whistling along as if no solution was the shadow of a solution. Hope driven stock markets which ignore reality are very unhealthy signals.
In fact, the solidarity but no commitment statement implied that if there is any assistance to Greece it will not be in any form which acknowledges the euro as a multi-national currency which inhibits its euro nations from exercising a complete sovereign fiscal policy within their nations and the failure to provide the ECB with the economic tools, available to any national central bank with its own currency, to respond to the economic conditions of individual euro nations. The design failures of the euro and the ill-conceived economic restrictions imposed by the Stability and Growth Pact were destined to yield a financial crisis.
German sentiment continues to be very divided, because it has enjoyed a positive euro exchange rate in comparison to other countries, such as Greece, Spain, and Portugal. The Frankfurter Aligemeine today editorialized that Germany should return to the deutschmark and denies any European Union responsibility for the economic stability of its members. This is a position which denies the reality of German banks exposure to the euro nations with significant leverage problems: "German exposure to the region amounts to €43bn in Greece, €47bn in Portugal, €193bn in Ireland, and €240bn in Spain, according to the Bank for International Settlements. German lenders are already vulnerable, with the world's lowest risk-adjusted capital ratios bar Japan."
It is estimated that two-thirds to 77% of Greek debt is held outside of Greece: France with $75 billion, Switzerland with $64 billion, and Germany with $43.2 billion. The contagion has already affected Greek banks ability to roll over repo debt. On the European banking scene, the exposure risks also include those of the Baltic states who have their own currencies, but the currencies are pegged to the euro.
It appears if any patchwork assistance is provided to Greece, it may well require a further surrender of national sovereignty rather than creating a European bond as I and others, such as Marc Chandler, have suggested. Brussels is proceeding down the road of political compromise rather than seizing the problem by its causes and solidifying a core Eurozone with a currency and an ECB that acknowledges the exchange rate competitiveness gaps, the need for a European bond, the need of individual member nations to exercise sovereign fiscal policies, and the need of an ECB with the economic tools to assist individual member nations and coordinate within the European Union. At the present time we have a 20 billion euro liquidity problem, but the Eurozone will need to finance approximately 1.6 trillion euro of debt in 2010. Ineffectual political compromise will engender a pan-European debt crisis which would ripple across Europe and around the world.
In discussing Greece, which has a relatively small economy, Spain, which has a much larger economy, is often mentioned as a possible next focus of the pan-European debt crisis, but Italy and Ireland are right up there with Spain with significant public and private bank debt. They all have excess leverage and are suffering from public fiscal problems which have been facilitated by a negative euro exchange rate and inhibited by the Stability and Growth Pact. Which will be next? Greece could just be the training exercise as the derivatives traders hone their skills to wind the deficit hawks up and harvest larger CDS trading profits.
The rest of the world should not be waiting. The UK had a failed bond auction in March of 2009 and has recently stated it may need to inject more cash into its economy. Germany had a failed bond auction in January. The 30 year United States treasury auction with its high yield and 24% direct buyers is considered by many as a weak failed auction today.
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In fact, the solidarity but no commitment statement implied that if there is any assistance to Greece it will not be in any form which acknowledges the euro as a multi-national currency which inhibits its euro nations from exercising a complete sovereign fiscal policy within their nations and the failure to provide the ECB with the economic tools, available to any national central bank with its own currency, to respond to the economic conditions of individual euro nations. The design failures of the euro and the ill-conceived economic restrictions imposed by the Stability and Growth Pact were destined to yield a financial crisis.
German sentiment continues to be very divided, because it has enjoyed a positive euro exchange rate in comparison to other countries, such as Greece, Spain, and Portugal. The Frankfurter Aligemeine today editorialized that Germany should return to the deutschmark and denies any European Union responsibility for the economic stability of its members. This is a position which denies the reality of German banks exposure to the euro nations with significant leverage problems: "German exposure to the region amounts to €43bn in Greece, €47bn in Portugal, €193bn in Ireland, and €240bn in Spain, according to the Bank for International Settlements. German lenders are already vulnerable, with the world's lowest risk-adjusted capital ratios bar Japan."
It is estimated that two-thirds to 77% of Greek debt is held outside of Greece: France with $75 billion, Switzerland with $64 billion, and Germany with $43.2 billion. The contagion has already affected Greek banks ability to roll over repo debt. On the European banking scene, the exposure risks also include those of the Baltic states who have their own currencies, but the currencies are pegged to the euro.
It appears if any patchwork assistance is provided to Greece, it may well require a further surrender of national sovereignty rather than creating a European bond as I and others, such as Marc Chandler, have suggested. Brussels is proceeding down the road of political compromise rather than seizing the problem by its causes and solidifying a core Eurozone with a currency and an ECB that acknowledges the exchange rate competitiveness gaps, the need for a European bond, the need of individual member nations to exercise sovereign fiscal policies, and the need of an ECB with the economic tools to assist individual member nations and coordinate within the European Union. At the present time we have a 20 billion euro liquidity problem, but the Eurozone will need to finance approximately 1.6 trillion euro of debt in 2010. Ineffectual political compromise will engender a pan-European debt crisis which would ripple across Europe and around the world.
In discussing Greece, which has a relatively small economy, Spain, which has a much larger economy, is often mentioned as a possible next focus of the pan-European debt crisis, but Italy and Ireland are right up there with Spain with significant public and private bank debt. They all have excess leverage and are suffering from public fiscal problems which have been facilitated by a negative euro exchange rate and inhibited by the Stability and Growth Pact. Which will be next? Greece could just be the training exercise as the derivatives traders hone their skills to wind the deficit hawks up and harvest larger CDS trading profits.
The rest of the world should not be waiting. The UK had a failed bond auction in March of 2009 and has recently stated it may need to inject more cash into its economy. Germany had a failed bond auction in January. The 30 year United States treasury auction with its high yield and 24% direct buyers is considered by many as a weak failed auction today.
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Tuesday, February 9, 2010
The Unfolding Pan-European Debt Crisis
The stock market, desperate for any irrational exuberance, is trading up today on the "hopes" of a European solution to the Greek economic troubles, while the actual information is extremely conflicted and indicative that a European solution is not yet nascent.
Trichet is returning early from the Australian conference of central bankers fueling speculation that the EU would have a special meeting, although ECB governors were again reaffirming the ECB does not have clear bail out authority and any decision to help Greece must be a political one. The constant refrain is Greece must carry out its EU austerity plan. In the meantime, a new EU economic team has been formed and there is speculation that the ECB unannounced exit plan may have to be delayed if it threatens to further destabilize market concerns about Greece, Spain, and other euro monetary countries.
We have previously documented that the banking problems in Greece, Spain, Portugal, and Ireland have all led to budgetary deficit problems and called for the EU and ECB to create Euro bonds to help solve the problem, because we do not think the IMF possible solution will be acceptable to the EU or Greece, because it also does not address the problem of a multi-national currency with no monetary policy to correct national competitiveness gaps which significantly limits national fiscal policies. Greece has publicly said an IMF solution would send the worst possible signal.
The global debt controversy, which swings between deficit hawks and the efficiency of targeted economic spending, is overplayed even to the extent of what would be a proper Keynesian action plan. German sentiment clouds both economic debate and what is best for the EU as a whole.
The EU needs to get its member nations to put the problems in perspective. It is an opportunity for the EU to stand up and directly address the problems caused by a multi-nation currency in individual euro countries, who no longer have monetary policy options available to coordinate with fiscal policy. The fact that the Eurozone is not an optimum currency area is obvious, but the creation of a two-currency European Monetary Union does not solve the multi-nation individual country economic problems relative to the multi-nation currency; it would only be a synthetic end run around a crumbling bridge.
Joseph Stiglitz is calling for national authorities to teach the derivatives speculators a lesson. As Stiglitz has documented, another part of the problem is how Goldman Sachs helped the prior Greek government hide debt. Yet, the primary hedge funds involved in driving the derivatives attack on Greece and Spain, which also drives the CDS costs of other nations up globally, are those of Goldman Sachs, J. P. Morgan, and three other hedge funds. These attacks on sovereign debt for transitory profit are an example of a systemic risk which could throw the global economy into a double dip and depression.
While the myths and facts of this Eurozone debt crisis are many and not being fully debated and addressed for long term solutions, the final analysis is that failure to deal effectively and efficiently with the debt crisis risks sovereign debt contagion fueled by derivatives speculators and a global double dip into recession of unknown length. The banks in each of these euro countries are intimately involved in the creation of this debt crisis which was facilitated by the euro and its effect on each individual country's economy in creating either asset bubbles or negative competitiveness gaps requiring public spending to pick up the slack of private spending or both. The excess leverage in the banking systems of these countries, and Ireland is the large powder keg in the background, is symptomatic of the difficult balancing act which must be done if a multi-national monetary policy is to work for the benefit of all member nations. The leveraged banking problem is deep and significant; it is the problem which should be addressed urgently and is being masked by European Union monetary policy and the sovereign debt issues. The creation of Euro bonds would be a step towards putting some flexibility in EU monetary policy and providing some teeth in individual member nation's ability to properly control their fiscal policy. The alternative is a pan-European debt crisis which spreads from nation to nation around the world. Ireland's bank debt dwarfs Iceland and the United Kingdom's debt level is even higher with government guarantees. The EU and ECB need to come up with an end game that acknowledges the banking and sovereign debt as economic problems requiring monetary, regulatory, and fiscal coordinated responses, which facilitate fiscal policy responses appropriate for each member nation, and effectuate the euro as a true multi-nation currency.
Attempts to provide loan guarantees or otherwise put a thumb in the dike will not protect other EU nation's banks from the fundamental leverage problem and how it is acerbated by the euro. Until a real, substantive coordinated plan actually emerges, the rumor mills will grind away.
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Trichet is returning early from the Australian conference of central bankers fueling speculation that the EU would have a special meeting, although ECB governors were again reaffirming the ECB does not have clear bail out authority and any decision to help Greece must be a political one. The constant refrain is Greece must carry out its EU austerity plan. In the meantime, a new EU economic team has been formed and there is speculation that the ECB unannounced exit plan may have to be delayed if it threatens to further destabilize market concerns about Greece, Spain, and other euro monetary countries.
We have previously documented that the banking problems in Greece, Spain, Portugal, and Ireland have all led to budgetary deficit problems and called for the EU and ECB to create Euro bonds to help solve the problem, because we do not think the IMF possible solution will be acceptable to the EU or Greece, because it also does not address the problem of a multi-national currency with no monetary policy to correct national competitiveness gaps which significantly limits national fiscal policies. Greece has publicly said an IMF solution would send the worst possible signal.
The global debt controversy, which swings between deficit hawks and the efficiency of targeted economic spending, is overplayed even to the extent of what would be a proper Keynesian action plan. German sentiment clouds both economic debate and what is best for the EU as a whole.
The EU needs to get its member nations to put the problems in perspective. It is an opportunity for the EU to stand up and directly address the problems caused by a multi-nation currency in individual euro countries, who no longer have monetary policy options available to coordinate with fiscal policy. The fact that the Eurozone is not an optimum currency area is obvious, but the creation of a two-currency European Monetary Union does not solve the multi-nation individual country economic problems relative to the multi-nation currency; it would only be a synthetic end run around a crumbling bridge.
Joseph Stiglitz is calling for national authorities to teach the derivatives speculators a lesson. As Stiglitz has documented, another part of the problem is how Goldman Sachs helped the prior Greek government hide debt. Yet, the primary hedge funds involved in driving the derivatives attack on Greece and Spain, which also drives the CDS costs of other nations up globally, are those of Goldman Sachs, J. P. Morgan, and three other hedge funds. These attacks on sovereign debt for transitory profit are an example of a systemic risk which could throw the global economy into a double dip and depression.
While the myths and facts of this Eurozone debt crisis are many and not being fully debated and addressed for long term solutions, the final analysis is that failure to deal effectively and efficiently with the debt crisis risks sovereign debt contagion fueled by derivatives speculators and a global double dip into recession of unknown length. The banks in each of these euro countries are intimately involved in the creation of this debt crisis which was facilitated by the euro and its effect on each individual country's economy in creating either asset bubbles or negative competitiveness gaps requiring public spending to pick up the slack of private spending or both. The excess leverage in the banking systems of these countries, and Ireland is the large powder keg in the background, is symptomatic of the difficult balancing act which must be done if a multi-national monetary policy is to work for the benefit of all member nations. The leveraged banking problem is deep and significant; it is the problem which should be addressed urgently and is being masked by European Union monetary policy and the sovereign debt issues. The creation of Euro bonds would be a step towards putting some flexibility in EU monetary policy and providing some teeth in individual member nation's ability to properly control their fiscal policy. The alternative is a pan-European debt crisis which spreads from nation to nation around the world. Ireland's bank debt dwarfs Iceland and the United Kingdom's debt level is even higher with government guarantees. The EU and ECB need to come up with an end game that acknowledges the banking and sovereign debt as economic problems requiring monetary, regulatory, and fiscal coordinated responses, which facilitate fiscal policy responses appropriate for each member nation, and effectuate the euro as a true multi-nation currency.
Attempts to provide loan guarantees or otherwise put a thumb in the dike will not protect other EU nation's banks from the fundamental leverage problem and how it is acerbated by the euro. Until a real, substantive coordinated plan actually emerges, the rumor mills will grind away.
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Monday, February 8, 2010
Links in Fast Moving Times 2/8/2010
The European debt problem could turn into contagion with immediate global impact.
Greece: The Eu needs to develop an anti-crisis policy, a monetary endgame, and act as a cohesive unit.
Do we want a global margin call?
Who are the derivative traders attacking Greece?
Portugal, Spain, and US Deficits: How it all weaves together with Greece, Germany's desire to profit, and the lack of European Monetary Union response to the economic needs of member nations.
Do not forget Ireland and the effect of the EMU.
China: Loan defaults within China are increasing.
Systemic Risk: We have discussed the concept of a Tobin tax to penalize and control systemically risky behavior in the the financial industry. Why should banks not be taxed in order to discourage systemic risks?
In each of the countries above, the banks in those countries have contributed directly to the current problems and they need to be regulated. Derivatives trading needs to be regulated on a transparent recording market.
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Greece: The Eu needs to develop an anti-crisis policy, a monetary endgame, and act as a cohesive unit.
Do we want a global margin call?
Who are the derivative traders attacking Greece?
Portugal, Spain, and US Deficits: How it all weaves together with Greece, Germany's desire to profit, and the lack of European Monetary Union response to the economic needs of member nations.
Do not forget Ireland and the effect of the EMU.
China: Loan defaults within China are increasing.
Systemic Risk: We have discussed the concept of a Tobin tax to penalize and control systemically risky behavior in the the financial industry. Why should banks not be taxed in order to discourage systemic risks?
In each of the countries above, the banks in those countries have contributed directly to the current problems and they need to be regulated. Derivatives trading needs to be regulated on a transparent recording market.
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Sunday, February 7, 2010
Links - What Others Are Saying in Fast Moving Times 2/7/2010
I normally use links to substantiate or provide other views in my posts, but events are moving very fast and I want to follow up to my last post on Greece and Spain, China, AIG/Goldman, and the need for financial regulatory reform.
China: This past week saw the US and China butting heads over trade restrictions and the whether the yuan should be allowed to appreciate or remain pegged to the US dollar. Just recently, President Obama said he wanted to double US exports within five years. Just which other countries of the world would have to contract their exports to accommodate the United States? China is the obvious target. Given labor costs and other competitive cost constraints, the United States cannot possibly double its exports in five years, but it can initiate international protectionist trade wars.
On China's asset bubbles, inflation expectations, and cash reserves.
On China's currency.
On China's price pressures and tightening of bank reserve requirements.
On China's loan rate's and new loan restrictions.
What to watch for in China -- the risks.
As I said on the Radio Show yesterday, you have to have been watching China for some time. The connection to Latin America, particularly Brazil, is obvious and Latin American mutual funds and ETFs are showing the danger. The recent refusal of the Australian central bank to raise interest rates a fourth time citing a need to evaluate the past raises and what is going on in China was significant. Australia has developed China as an Australian export market. Even if China does everything right going forward and does it slowly, the global impact of even that soft landing will be shuddering, just as we have begun to witness in the last two weeks of China's preliminary tightening moves.
Greece and Spain will continue to come under derivative trading attack and it will continue to be a potentially larger European problem. Our last post, "Greece, Spain, and the Euro Trojan Horse", documented the multiple causes, the need for financial reform, a more effective monetary policy, and the need for the EU and ECB to formulate a program of EU bonds.
Greece and why the IMF will not be the answer.
While the failure of Greece to provide accurate economic data in the past and its corruption are widely known, the problem of the losses on Spanish banks books has been relatively muted.
The market pressure will continue.
While bailout doomsday scenarios abound and demands for budgetary cuts grow, the real problem is the need for financial regulatory reform and the economic impact of the euro on the 16 countries which use the euro.
While budget cuts are necessary to remove ineffective accumulation of public debt, targeted spending and the effective accumulation of public debt to spur economic growth and job creation is the most fiscally responsible governmental path, but the 16 EU countries which use the euro do not have the monetary and fiscal policy options of countries which have their own currency.
The risk remains that the speculative attack of the derivative traders could create a European and global debt contagion.
Meanwhile 10 billion euro have been pulled out of Greece.
The connection between Goldman Sachs and AIG continue to simmer and escalate, because it goes straight to what was wrong with the bank bailouts and how that bailout actually made the sources of the current global financial crisis larger, more powerful, and more systemically dangerous.
How Goldman Sachs pushed AIG to the edge and profited.
Just how much did AIG not understand the true market values, credit rating, and risks of its CDOs?
If the relationship between AIG and Goldman Sachs been fully disclosed publicly, should the United States government have nationalized AIG and then dealt with Goldman Sachs?
Economic Solvency: What we do now will have a direct impact on whether we have an economic crisis twenty or thirty years from now. When you look at China, Japan, Australia, the United States and other countries with respect to population growth and immigration, some have started to ask if there is a population growth solution to sovereign solvency.
Another example is the relation of savings in China to population growth and the one child family.
Economics to be properly applied needs a very multidisciplinary approach.
Financial regulatory reform: We have in the past listed the failure of the US Congress to move real financial regulatory reform forward and the role of financial lobbyists in neutering, gutting, and making proposed "reforms" actually less effective than the one's currently on the books. Greece, Spain, etc have shown the need for financial reform in their countries also. Some have tried to delay financial regulatory reform by calling for coordinated global financial reform regulations. Each country needs to act now. Global coordination should be pursued, but it is not an acceptable excuse to delay needed reforms in individual countries. One only has to look at Canada to see how financial regulations there significantly controlled the impact of the current global financial crisis. In fact, a case could be made that past global coordination agreements are directly inhibiting financial regulatory reform.
I have repeatedly stressed that these, as well as other, macroeconomic issues not only have a direct effect on economic and political decisions but investment decisions and portfolio management.
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China: This past week saw the US and China butting heads over trade restrictions and the whether the yuan should be allowed to appreciate or remain pegged to the US dollar. Just recently, President Obama said he wanted to double US exports within five years. Just which other countries of the world would have to contract their exports to accommodate the United States? China is the obvious target. Given labor costs and other competitive cost constraints, the United States cannot possibly double its exports in five years, but it can initiate international protectionist trade wars.
On China's asset bubbles, inflation expectations, and cash reserves.
On China's currency.
On China's price pressures and tightening of bank reserve requirements.
On China's loan rate's and new loan restrictions.
What to watch for in China -- the risks.
As I said on the Radio Show yesterday, you have to have been watching China for some time. The connection to Latin America, particularly Brazil, is obvious and Latin American mutual funds and ETFs are showing the danger. The recent refusal of the Australian central bank to raise interest rates a fourth time citing a need to evaluate the past raises and what is going on in China was significant. Australia has developed China as an Australian export market. Even if China does everything right going forward and does it slowly, the global impact of even that soft landing will be shuddering, just as we have begun to witness in the last two weeks of China's preliminary tightening moves.
Greece and Spain will continue to come under derivative trading attack and it will continue to be a potentially larger European problem. Our last post, "Greece, Spain, and the Euro Trojan Horse", documented the multiple causes, the need for financial reform, a more effective monetary policy, and the need for the EU and ECB to formulate a program of EU bonds.
Greece and why the IMF will not be the answer.
While the failure of Greece to provide accurate economic data in the past and its corruption are widely known, the problem of the losses on Spanish banks books has been relatively muted.
The market pressure will continue.
While bailout doomsday scenarios abound and demands for budgetary cuts grow, the real problem is the need for financial regulatory reform and the economic impact of the euro on the 16 countries which use the euro.
While budget cuts are necessary to remove ineffective accumulation of public debt, targeted spending and the effective accumulation of public debt to spur economic growth and job creation is the most fiscally responsible governmental path, but the 16 EU countries which use the euro do not have the monetary and fiscal policy options of countries which have their own currency.
The risk remains that the speculative attack of the derivative traders could create a European and global debt contagion.
Meanwhile 10 billion euro have been pulled out of Greece.
The connection between Goldman Sachs and AIG continue to simmer and escalate, because it goes straight to what was wrong with the bank bailouts and how that bailout actually made the sources of the current global financial crisis larger, more powerful, and more systemically dangerous.
How Goldman Sachs pushed AIG to the edge and profited.
Just how much did AIG not understand the true market values, credit rating, and risks of its CDOs?
If the relationship between AIG and Goldman Sachs been fully disclosed publicly, should the United States government have nationalized AIG and then dealt with Goldman Sachs?
Economic Solvency: What we do now will have a direct impact on whether we have an economic crisis twenty or thirty years from now. When you look at China, Japan, Australia, the United States and other countries with respect to population growth and immigration, some have started to ask if there is a population growth solution to sovereign solvency.
Another example is the relation of savings in China to population growth and the one child family.
Economics to be properly applied needs a very multidisciplinary approach.
Financial regulatory reform: We have in the past listed the failure of the US Congress to move real financial regulatory reform forward and the role of financial lobbyists in neutering, gutting, and making proposed "reforms" actually less effective than the one's currently on the books. Greece, Spain, etc have shown the need for financial reform in their countries also. Some have tried to delay financial regulatory reform by calling for coordinated global financial reform regulations. Each country needs to act now. Global coordination should be pursued, but it is not an acceptable excuse to delay needed reforms in individual countries. One only has to look at Canada to see how financial regulations there significantly controlled the impact of the current global financial crisis. In fact, a case could be made that past global coordination agreements are directly inhibiting financial regulatory reform.
I have repeatedly stressed that these, as well as other, macroeconomic issues not only have a direct effect on economic and political decisions but investment decisions and portfolio management.
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Friday, February 5, 2010
Greece, Spain, and the Euro Trojan Horse
We have written and commented on Greece and Spain as well as Iceland, Italy, Ireland, and Portugal. This week saw a rash of sovereign debt credit default swap speculation driving the costs of CDS for Greece, Spain, and Portugal higher as well as other countries, including the United States. The speculation is another example of the need for derivatives regulation and a transparent trading and recording market. The fear of sovereign debt default by a European Union Euro currency nation is a wasted exercise, unless you are profiting from the same type of unregulated speculation which helped bring Bear Stearns and Lehman down and drove Merrill Lynch and Morgan Stanley into larger, more systemically dangerous relationships.
The problems in Greece and Spain are vastly different, but both are derived from the Euro. Greece and Spain both suffer from a competitiveness gap in that their Euro exchange rate is overvalued while surplus exporting countries, like Germany, have an undervalued exchange rate. Greece has tourism, shipping, agriculture, and banking, with an aggressive exposure to emerging Eastern Europe, as economic engines combined with an aging demographic population and falling birth rate. The immediately prior Greek government also soured relations with the EU by supplying economic information which was not correct leaving the current Greek government with testy EU demands. Given the lack of industrial economic growth and exports, Greece has less immediate but longer term problems.
Spain has more immediate problems. The Euro caused negative interest rates in Spain from 2002 to 2006, which caused massive economic overheating during which Spain became the largest issuer of covered bonds in Europe driven by the mortgage market. These Cedulas are secured by mortgage loans on domestic properties issued by any Spanish bank or savings institution. In some instances, they are participation securitizations in which the holder is entitled to only a percentage participation. Under Spanish law, unlike the Phandbriefe in Germany, Spain undertook the largest departure from the German bond model and it is less demonstrable that investors could lay hands on the assets in the event of issuing institution insolvency. When the current global financial crisis caused lending to cease in Spain in August of 2008, it was as if the whole financial system had seized up. The question has become to what extent the government may have to act if the individual issuing institutions do not have the ability to make these covered bonds good in the future. This would be a serious European problem, because, in over 200 years no Phandbriefe has ever defaulted. The financial seizure in the financial sector and the bursting of the mortgage asset bubble has created significant unemployment. Nationally, unemployment is in excess of 19% and youth unemployment (16+) is 44.5%. The unemployment situation places a much more immediate pressure on the Spanish problem.
If Spain or Greece had their own currency, they would have more ability to apply fiscal and monetary policies to stimulate their economies and create employment. The speculative attack on their ability to issue bonds at reasonable yields is an unwarranted attack on their sovereignty, because the actual target of the attack is the Euro and is fueled by EU rules which require member nations to have only 3% debt to GDP without respect to the Euro competitiveness gap or internal national economic conditions. Both countries should be increasing public spending to target economic growth and job creation, but they are being forced by the EU to reduce their budget deficits. These enforced budget austerity programs are both reducing public sector wages. This will fuel deflation. Prior to the global financial crisis, Spain had a surplus. The 2010 deficit estimate is 9.8% of GDP. 7.5% in 2011, 5.3% in 2012 with an austerity program which will cut $70.1 billion. Despite the high unemployment, the people of Spain have not yet realized the fate to which the EU is consigning them.
In Greece, it is another story. General strikes are already planned for February 10 and 24. It is estimated that the EU enforced austerity program will accelerate the decline in Greek GDP from <1.7%>; to <7%>;. Greek unemployment, presently 8.3%, will increase by another 300,000 as a direct result. Does the EU really want to promote social disturbances in Greece and have them spread to Spain and then to Portugal, with its politically divided government? Greece is raising its fuel tax. Lower public spending, higher taxes, lower wages, and increasing unemployment are not the economic drivers the EU should be forcing on these countries. Greece needs more budgetary control given the historical level of corruption which means spending should be efficiently targeted to spur economic growth and jobs. Despite those deficit hawks who would drive countries into depression, public debt is not the same as private debt and it is private debt fueled by unregulated derivatives speculation which has caused this global financial crisis. To turn our focus away from needed financial regulatory reform to an an unwarranted sovereign debt default fear which has been promoted by derivatives speculators is intolerable. Are we to allow the derivatives speculators to become the new terrorist overlords?
There has been much gratuitous talk of bailing out Greece and how the EU will not bail out any member nation. In fact, the legal authority exists for the EU to bail out a member nation, but it is not necessary. All that is required is that the EU provide loans which will target economic growth and jobs and revise its monetary policies to more appropriately take into consideration the competitiveness gap of the Euro exchange and the actual internal economic conditions of each member country. To force a debt to GDP rule down a countries throat when it needs to increase public spending is asking for economic turmoil. To the extent, that some countries budget deficits have been inefficiently expanded by corruption or incompetence is an issue which needs to be addressed by targeted, efficient public spending. The problem with the EU providing loans is the surplus EU countries, like Germany , who benefit from the Euro competitiveness gap, are not going to want to share in the risk.
Yet, there are European rumors that large French and German banks have significant exposure to Greek debt. Greek banks have used Greek debt as collateral on loans from (repos) the ECB, but the ECB, at the end of 2010, will no longer accept collateral with less than an A credit rating, which Greek bonds no longer have. Currently, there is every expectation that market pressures will continue and, perhaps, grow. All of this makes it all the more important for the EU and ECB to quickly formulate a loan plan for targeted spending in Greece and Spain, as well as any other Euro competitiveness gap country with similar problems, such as Portugal and Italy.
Much has been made of the IMF providing money to Greece as the preferred process and the IMF has indicated it would be willing to work with Greece, but Greece has not approached the IMF. In as much as these problems in Greece and Spain have been at least partially caused by the Euro, I do not see the EU wanting the IMF to help Greece. Additionally, the EU and the ECB need to face up to the need of the Euro to be responsive to the economic conditions of the member nations and the need to address the Euro competitiveness gap. The EU has studied the possibility of issuing EU bonds since at least 2000 and this current situation is just the reason the EU and ECB should quickly develop an EU bond program and begin issuing EU bonds.
If EU member nations using the Euro are not able to apply fiscal and monetary policy, because they no longer have a national currency, then the EU and the ECB need to develop the monetary policy tools to allow their member nations to apply appropriate fiscal policies to best serve their citizens.
The possibility of default is speculative hoopla and deficit hawk destructiveness. While deficits need to be controlled, targeted public spending grows an economy and the withdrawal of public spending constricts an economy. At the present time, Greece and Spain need targeted spending and financial regulatory reform. Default is not a plausible option given the domino effect.
Note: I am aware that the EU currency is spelled euro and not capitalized, but I have chosen to capitalize it to emphasize that it is a currency of 16 nations and, as such, it faces the problems a global currency would have to resolve.
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The problems in Greece and Spain are vastly different, but both are derived from the Euro. Greece and Spain both suffer from a competitiveness gap in that their Euro exchange rate is overvalued while surplus exporting countries, like Germany, have an undervalued exchange rate. Greece has tourism, shipping, agriculture, and banking, with an aggressive exposure to emerging Eastern Europe, as economic engines combined with an aging demographic population and falling birth rate. The immediately prior Greek government also soured relations with the EU by supplying economic information which was not correct leaving the current Greek government with testy EU demands. Given the lack of industrial economic growth and exports, Greece has less immediate but longer term problems.
Spain has more immediate problems. The Euro caused negative interest rates in Spain from 2002 to 2006, which caused massive economic overheating during which Spain became the largest issuer of covered bonds in Europe driven by the mortgage market. These Cedulas are secured by mortgage loans on domestic properties issued by any Spanish bank or savings institution. In some instances, they are participation securitizations in which the holder is entitled to only a percentage participation. Under Spanish law, unlike the Phandbriefe in Germany, Spain undertook the largest departure from the German bond model and it is less demonstrable that investors could lay hands on the assets in the event of issuing institution insolvency. When the current global financial crisis caused lending to cease in Spain in August of 2008, it was as if the whole financial system had seized up. The question has become to what extent the government may have to act if the individual issuing institutions do not have the ability to make these covered bonds good in the future. This would be a serious European problem, because, in over 200 years no Phandbriefe has ever defaulted. The financial seizure in the financial sector and the bursting of the mortgage asset bubble has created significant unemployment. Nationally, unemployment is in excess of 19% and youth unemployment (16+) is 44.5%. The unemployment situation places a much more immediate pressure on the Spanish problem.
If Spain or Greece had their own currency, they would have more ability to apply fiscal and monetary policies to stimulate their economies and create employment. The speculative attack on their ability to issue bonds at reasonable yields is an unwarranted attack on their sovereignty, because the actual target of the attack is the Euro and is fueled by EU rules which require member nations to have only 3% debt to GDP without respect to the Euro competitiveness gap or internal national economic conditions. Both countries should be increasing public spending to target economic growth and job creation, but they are being forced by the EU to reduce their budget deficits. These enforced budget austerity programs are both reducing public sector wages. This will fuel deflation. Prior to the global financial crisis, Spain had a surplus. The 2010 deficit estimate is 9.8% of GDP. 7.5% in 2011, 5.3% in 2012 with an austerity program which will cut $70.1 billion. Despite the high unemployment, the people of Spain have not yet realized the fate to which the EU is consigning them.
In Greece, it is another story. General strikes are already planned for February 10 and 24. It is estimated that the EU enforced austerity program will accelerate the decline in Greek GDP from <1.7%>; to <7%>;. Greek unemployment, presently 8.3%, will increase by another 300,000 as a direct result. Does the EU really want to promote social disturbances in Greece and have them spread to Spain and then to Portugal, with its politically divided government? Greece is raising its fuel tax. Lower public spending, higher taxes, lower wages, and increasing unemployment are not the economic drivers the EU should be forcing on these countries. Greece needs more budgetary control given the historical level of corruption which means spending should be efficiently targeted to spur economic growth and jobs. Despite those deficit hawks who would drive countries into depression, public debt is not the same as private debt and it is private debt fueled by unregulated derivatives speculation which has caused this global financial crisis. To turn our focus away from needed financial regulatory reform to an an unwarranted sovereign debt default fear which has been promoted by derivatives speculators is intolerable. Are we to allow the derivatives speculators to become the new terrorist overlords?
There has been much gratuitous talk of bailing out Greece and how the EU will not bail out any member nation. In fact, the legal authority exists for the EU to bail out a member nation, but it is not necessary. All that is required is that the EU provide loans which will target economic growth and jobs and revise its monetary policies to more appropriately take into consideration the competitiveness gap of the Euro exchange and the actual internal economic conditions of each member country. To force a debt to GDP rule down a countries throat when it needs to increase public spending is asking for economic turmoil. To the extent, that some countries budget deficits have been inefficiently expanded by corruption or incompetence is an issue which needs to be addressed by targeted, efficient public spending. The problem with the EU providing loans is the surplus EU countries, like Germany , who benefit from the Euro competitiveness gap, are not going to want to share in the risk.
Yet, there are European rumors that large French and German banks have significant exposure to Greek debt. Greek banks have used Greek debt as collateral on loans from (repos) the ECB, but the ECB, at the end of 2010, will no longer accept collateral with less than an A credit rating, which Greek bonds no longer have. Currently, there is every expectation that market pressures will continue and, perhaps, grow. All of this makes it all the more important for the EU and ECB to quickly formulate a loan plan for targeted spending in Greece and Spain, as well as any other Euro competitiveness gap country with similar problems, such as Portugal and Italy.
Much has been made of the IMF providing money to Greece as the preferred process and the IMF has indicated it would be willing to work with Greece, but Greece has not approached the IMF. In as much as these problems in Greece and Spain have been at least partially caused by the Euro, I do not see the EU wanting the IMF to help Greece. Additionally, the EU and the ECB need to face up to the need of the Euro to be responsive to the economic conditions of the member nations and the need to address the Euro competitiveness gap. The EU has studied the possibility of issuing EU bonds since at least 2000 and this current situation is just the reason the EU and ECB should quickly develop an EU bond program and begin issuing EU bonds.
If EU member nations using the Euro are not able to apply fiscal and monetary policy, because they no longer have a national currency, then the EU and the ECB need to develop the monetary policy tools to allow their member nations to apply appropriate fiscal policies to best serve their citizens.
The possibility of default is speculative hoopla and deficit hawk destructiveness. While deficits need to be controlled, targeted public spending grows an economy and the withdrawal of public spending constricts an economy. At the present time, Greece and Spain need targeted spending and financial regulatory reform. Default is not a plausible option given the domino effect.
Note: I am aware that the EU currency is spelled euro and not capitalized, but I have chosen to capitalize it to emphasize that it is a currency of 16 nations and, as such, it faces the problems a global currency would have to resolve.
Print Page
Tuesday, February 2, 2010
Krugman and Canada
In my last post, I said Canada was one of the developed countries that weathered the current global financial crisis better than the United States, because Canada had a more effective financial regulatory system. Yesterday, Paul Krugman, in an op-ed column entitled "Good and Boring", said Canada is a country which did it right and is an important role model of stability from which we need to learn.
Canada has an independent Financial Consumer Agency and Canada sharply restricted sub-rime lending. Krugman characterizes the Canadian banking system as boring, because they kept banking safe by strictly limiting banks' leverage while the United States, since Reagan, has lived dangerously on the path of deregulation. Canada limited the process of securitization. In the United States the process of securitization was unfettered and became a cash cow for banks to make ever increasing risky bets with other people's money rather than a means to reduce risk by spreading it.
Krugman takes issue with Paul Volcker's assertion that the "... crisis lay in the scale and scope of our financial institutions --- in the existence of banks 'too big to fail' ", because there are only five banking groups in Canada and they are all "too big to fail". Krugman is not correct in his assessment of Volcker. Volcker has consistently said derivatives were not only misused but possibly unnecessary financial innovations. He has called for regulatory reform and breaking up banks which inappropriately combine commercial retail banking with investment/trading banking. In that Volcker has used the phrase "too big to fail", he is as sloppy as most commentators and media. As Joseph Stiglitz has repeatedly said and which I have explained for months, the issue is not size or just banks but whether any financial institution of any size without respect to whether it is a big bank, small bank, insurance company, mortgage company, hedge fund, equity investment group, or some other shadow banking firm is systemically dangerous.
In as much as the so-called currently proposed "Volcker" Rule uses the phrase "too big to fail" while keeping the financial system, in actuality, just as it is, Mr. Krugman would be correct in his criticism. "Too big to fail" is a bogus , if not purposefully misleading, concept which deflects the public from the need to regulate systemically dangerous financial institutions of any size. In 1998, a single hedge fund, Long-Term Capital Management, came very, very close to causing a systemic failure. And the United States made no attempt to correct that crisis with financial regulatory reform.
Krugman also is not correct in his assertion that Canada proves that keeping low interest rates over a long period of time does not aggravate and lengthen the recession (I also believe it keeps unemployment high). In fact, Canada has had a more active intervention with the use of their overnight rate and it has been at a higher rate, 25 basis points as opposed the US federal funds rate of zero to 25 basis points, for a shorter period of time. Krugman does not believe the Fed lowered interest rates too low too fast. I do not agree.
Here is a comparison of the Federal Funds Rate and the Canadian Overnight Rate:
6/30/05 3.25 2.50
7/9/05 2.75
8/9/05 3.50
9/20/05 3.75
10/18/05 3.00
11/1/05 4.00
12.6/05 3.25
12/13/05 4.25
1/24/06 3.50
1/31/06 4.50
3/28/06 4.75
4/25/06 4.00
5/10/06 5.00
5/24/06 4.25
6/29/06 5.25
7/3/06 3.75
7/10/07 4.50
9/18/07 4.75
10/31/07 4.50
12/4/07 4.25
12/11/07 4,25
1/22/08 3.50 4.00
1/30/08 3.00
3/4/08 3.50
3/18/08 2.25
4/22/08 3.00
4/30/08 2.00
10/8/08 1.50 2.50
10/21/08 2.25
10/29/08 1.00
12/9/08 1.50
12/16/08 0 - .25
1/20/09 1.00
3/3/09 .50
4/21/09 .25
The Fed has made its quantitative easing nest and will have a much more difficult series of exit strategies to execute if they are to sustain even a slow recovery which is why the recession will be long and drawn out and unemployment will remain high. How difficult will it be to exercise monetary policy to control inflation and output gaps in a slow recovery with high unemployment?
The United States must learn from Canada as well as Australia and France. The United States needs an independent Consumer Financial Protection Agency, transparent derivatives markets, regulation of securitizations, a modern version of Glass-Steagall separating commercial retail banking from investment/trading banking, and financial regulations which limit, if not prevent, the existence of systemically dangerous financial institutions of whatever size and regardless of whether they operate in transparent daylight or the shadows.
Print Page
Canada has an independent Financial Consumer Agency and Canada sharply restricted sub-rime lending. Krugman characterizes the Canadian banking system as boring, because they kept banking safe by strictly limiting banks' leverage while the United States, since Reagan, has lived dangerously on the path of deregulation. Canada limited the process of securitization. In the United States the process of securitization was unfettered and became a cash cow for banks to make ever increasing risky bets with other people's money rather than a means to reduce risk by spreading it.
Krugman takes issue with Paul Volcker's assertion that the "... crisis lay in the scale and scope of our financial institutions --- in the existence of banks 'too big to fail' ", because there are only five banking groups in Canada and they are all "too big to fail". Krugman is not correct in his assessment of Volcker. Volcker has consistently said derivatives were not only misused but possibly unnecessary financial innovations. He has called for regulatory reform and breaking up banks which inappropriately combine commercial retail banking with investment/trading banking. In that Volcker has used the phrase "too big to fail", he is as sloppy as most commentators and media. As Joseph Stiglitz has repeatedly said and which I have explained for months, the issue is not size or just banks but whether any financial institution of any size without respect to whether it is a big bank, small bank, insurance company, mortgage company, hedge fund, equity investment group, or some other shadow banking firm is systemically dangerous.
In as much as the so-called currently proposed "Volcker" Rule uses the phrase "too big to fail" while keeping the financial system, in actuality, just as it is, Mr. Krugman would be correct in his criticism. "Too big to fail" is a bogus , if not purposefully misleading, concept which deflects the public from the need to regulate systemically dangerous financial institutions of any size. In 1998, a single hedge fund, Long-Term Capital Management, came very, very close to causing a systemic failure. And the United States made no attempt to correct that crisis with financial regulatory reform.
Krugman also is not correct in his assertion that Canada proves that keeping low interest rates over a long period of time does not aggravate and lengthen the recession (I also believe it keeps unemployment high). In fact, Canada has had a more active intervention with the use of their overnight rate and it has been at a higher rate, 25 basis points as opposed the US federal funds rate of zero to 25 basis points, for a shorter period of time. Krugman does not believe the Fed lowered interest rates too low too fast. I do not agree.
Here is a comparison of the Federal Funds Rate and the Canadian Overnight Rate:
6/30/05 3.25 2.50
7/9/05 2.75
8/9/05 3.50
9/20/05 3.75
10/18/05 3.00
11/1/05 4.00
12.6/05 3.25
12/13/05 4.25
1/24/06 3.50
1/31/06 4.50
3/28/06 4.75
4/25/06 4.00
5/10/06 5.00
5/24/06 4.25
6/29/06 5.25
7/3/06 3.75
7/10/07 4.50
9/18/07 4.75
10/31/07 4.50
12/4/07 4.25
12/11/07 4,25
1/22/08 3.50 4.00
1/30/08 3.00
3/4/08 3.50
3/18/08 2.25
4/22/08 3.00
4/30/08 2.00
10/8/08 1.50 2.50
10/21/08 2.25
10/29/08 1.00
12/9/08 1.50
12/16/08 0 - .25
1/20/09 1.00
3/3/09 .50
4/21/09 .25
The Fed has made its quantitative easing nest and will have a much more difficult series of exit strategies to execute if they are to sustain even a slow recovery which is why the recession will be long and drawn out and unemployment will remain high. How difficult will it be to exercise monetary policy to control inflation and output gaps in a slow recovery with high unemployment?
The United States must learn from Canada as well as Australia and France. The United States needs an independent Consumer Financial Protection Agency, transparent derivatives markets, regulation of securitizations, a modern version of Glass-Steagall separating commercial retail banking from investment/trading banking, and financial regulations which limit, if not prevent, the existence of systemically dangerous financial institutions of whatever size and regardless of whether they operate in transparent daylight or the shadows.
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