Financial Stability News

Flashing news about financial stability and central banking

Monthly Archives: April 2012

Making finance servant, not master of the economy

This heading seems like a good companion post to the previous one on hedge funds speculation against the euro countries. It is the title of a presentation by Ann Pettifor at a conference on Just Banking (for program, see here). She gives a good overview of the problems in Europe and then draw extensively on Keynes in her proposal for a radical alternative to the current austerity approach:

Keynes’s six tools for recovery:

First, independent monetary policy: liquidity created by both public and private financial institutions should be directed towards sound public and private investment in productive, job creation activity. Any attempt to divert liquidity/credit into speculation had to be curtailed.

Second, fiscal policy: Keynes understood that it was not enough simply to create liquidity. That money had to be spent, and spent wisely. Today economists and politicians like David Cameron (“.. a fiscal conservative and a monetary activist”) rely simply on monetary policy to inject liquidity into zombie banks. This helps the banks, but does precious little to direct lending to firms and to stimulate recovery.

Third, managing debt de-leveraging: Keynes understood that the vast bubble of debt had to be de-leveraged in a managed way. Some debts inevitably have to be written off, with debtors granted a jubilee – as Steve Keen argues – simply because a high proportion of private debts are ultimately unpayable.

Fourth: regulation of credit creation. To ensure that credit created by the private banking system was aimed at the real economy, and not speculation, Keynes advocated wise regulation of the credit creation powers of private banks (‘tight money’). In other words loans had to be carefully assessed for their ability to generate income to finance repayment; and for their ability to generate sound employment and economic activity.

Fifth: permanently low interest rates. This was one of the central pillars of the Keynesian revolution. It was also the one that invited the greatest hostility from private bankers – whose profits and capital gains depend on exacting high rents from the effortless activity of creating new loans, and from speculative activities.

Six: capital controls are important for a number of reasons. One of the most important reasons for control over the mobility of capital is that management of financial flows gives democracies the freedom and autonomy to conduct their economic policies in the interests of society and the economy as a whole. In the absence of capital control, democracies are subject to the whims and interests of unaccountable global financial elites.

Hedge funds bet against eurozone – again

While unemployment is heading for 25 % in Spain, the FT report today (Hedge funds get against eurozone) that hedge funds are now betting against the core euro countries as well. With Hollande predicted to win the election in France and German growth weakening, Poulson and the other big macro funds are taking directional bets against the key euro bonds, including the German Bunds. A bet against Germany is currently “cheap”, since the cost of hedging the credit risk through a CDS is “only” 86 basis points compared with 660 bp for Spain.

For how long can this game go on, with euro countries imposing austerity to please the markets, just to be undercut with additional speculation? S&P’s downgrade last week of Spain shows that there is not much reward to be gained from austerity programs. And as Marin Wolf observed in the FT today: small contractions bring recessions and big contractions bring depressions. “Since a large number of countries are expected to tighten their fiscal positions substantially in coming years, their economies are likely to contract. How long the political glue will hold in these circumstances is a really interesting question.”

MF Global Customer Funds Were Not “Vaporized”

Todays hearing in the Senate Banking committee on the MF Global bankruptcy were supposed to deal with how we can avoid a similar debacle in the future. Much of the action was still on where the money went and how this could happen. Not so much new information during a short two hour session, but obvious that the relevant rules (1.25 &30) could be used in a quite flexible way as a result of previous strong lobbying by Goldman Sachs (for rule making proposal to straighten up this loophole, see here, and for the objections from MF global, see here). Unbelievable that CFTC let them continue with investing client money in European debt and in-house repos! Gensler, chairman of CFTC and former colleague of Corzine at GS obviously has a problem with this case (he has left it to his commissioner Sommers to handle the case on the Hil)

This post from January capture the angry (and probably correct) mood among the MF Global clients, when it comes to lack of fair treatment. And nobody should believe that the money just “vaporized”. They were stolen twice!

Brad DeLong on Bagehot

This paper by Brad DeLong  – This time, it is not different – argues that Bagehot’s book on Lombard Street is still relevant for understanding the current crisis, and that mainstream economics for years have failed to pick up the interesting research topics that Bagehot discussed back in the 1870.

Whereas I agree with deLong’s view that Bagehot is still relevant (for my take on the story, see this paper on “Terms and conditions of central bank liquidity support”, ), I think DeLong dismisses a long and relevant theory tradition rather summarily when he in the beginning of his paper dismisses Minsky’s book and articles as irrelevant. This is unfortunate, as Minsky and Keynes (and all the others on which they built, including Henry Simons, Minsky’s teacher at Chicago University) had a pretty good grip on the theory of financial crises.

For more on this and the need for a new understanding of banking in macroeconomics, see my working paper on “Shadow banking and the limits to central bank liquidity support“, where I discuss many of the same issues that DeLong raises.

Paul Krugman promotes Katzenjammer

Recent post from Krugman in NYT recommends the Norwegian band Katzenjammer as the right music “to cheer me up after a cold, very rainy day”. Great band and great PR!

Money and Collateral

A new IMF WP by Singh and Stella has already attracted a lot of comments on FT Alphaville and Zero Hedge blogs. They note that thee is a shortage of safe capital instruments out there, and suggest that Governments should issue more Treasuries to accommodate the shadow asking systems demand for safe and liquid assets over and  beyond what they can get inguaranteed bank deposit accounts. However, you can as well argue atshe size of he shadow banking should be reduced, for further arguments see my WP on shadow banks and the limits to central bank liquidity support

The Financial System Five Years from Now

The IMF hosted a one day conference end of March on the structural challenges in banking and on shadow banking. Some of the presentations and papers have now been posted (unfortunately not all). See in particular presentation by Arnoud Boot, which gives an interesting overview of the issues, but provides more questions than answers. Andrei Shleifer et al. have a paper on shadow banking where they show how vulnerable the financial system becomes if tail risk is ignored and securitization allowed. They support some form of regulation, preferably through a leverage ratio.

Shadow banking and central bank liquidity support

Global liquidity provision is highly pro-cyclical. The recent financial crisis has resulted in a
flight to safety. Severe strains in key funding markets have led central banks to employ highly unconventional policies to avoid a systemic meltdown. Bagehot’s advice to “lend freely at high rates against good collateral” has been stretched to the limit to meet the liquidity needs of dysfunctional financial markets.  As the eligibility criteria for central bank borrowing have been tweaked, it is legitimate to ask how elastic the supply of central bank currency should

I address this question in a new Working Paper from Levy Institute: Shadow banking and the limits of central bank liquidity support. The paper review the recent expansion in central bank liquidity support, including their collateral polices, and then suggests that central banks should not unconditionally supply liquidity to a banking system that is growing uncontrolled. Stricter controls are required unless central banks again will have to underwrite dysfunctional markets.

The paper also provides input to the ongoing Krugman – Keen discussion on banking. See especially section 6 on excessive global credit and section 7 on A new view of banking.