Financial Stability News

News about financial stability, central banking and theory of money

Monthly Archives: May 2012

Swiss Government issues debt at negative interest rates

Investors are paying the Swizz to take care of their monies in these uncertain times. Read this post from Zero Hedge to get the rest of the story.


Bank of England will be subject to 3 reviews

According to FT today, the Bank of England will be subject to three independent reviews, of its LLR role during the crisis, of its current liquidity policies and of the MPC inflation forcasets.

This is not surprising, as pressure has been building for some time to subject the BoE’s crisis performance to scrutiny. Also, there has been reports of too much group-think within the bank, and too much hierarchy within the Court of King Mervyn.

The reviews are welcome, but one wonder why their Financial Stability Reviews are not subject to review as well. After all, it was that part of the bank that was supposed to take appropriate measures to guard financial stability.

SEC officials oppose money fund reform report

It looks like Mary Schapiro at SEC will have problems getting her proposals for money market reform through her own board. According to this Reuter report three of five members are currently opposed to new changes to regulation of MMF. This reform package is by many considered the most important remaining element of the changes needed to stabilize the financial system. But the industry is dead against any changes, not surprisingly since they are up against the wall of low returns and high costs. In the meantime MMF continue to provide banks with unstable funding, so we will have to wait for the next big crisis to hit and MMF will withdraw their funding again. Not a terrible stable system this!

For the industry view, see the IOSCO report

End of central bank independence?

Former PIMCO economist Mc Culley has issued a new WP with former IMF economist Poszar called Does Central Bank Independence Frustrate
the Optimal Fiscal-Monetary Policy Mix in a Liquidity Trap? Well worth reading! (50 pages)

Martin Wolf  devoted a long blog post to the paper in April, and the issue is sure to be high on the policy agenda as the discussion of economic policy in Europe continues.

Randall Wray has an interesting reflection on Wolfs post here, and you can read here for a very opposite view form Bundesbank chief Weidmann.

One thing is sure, as Ron Paul noted, central bank management and policy will surely be hot topics ahead.

You can watch a Bloomberg interview with Mc Culley here

Should the Fed be abolished?

Interesting hearing in the Congress yesterday headed by the one and only Ron Paul on The Federal Reserve System: Mend It Or End It?

Quite interesting panel with Professor Jaime Galbraith, former Fed Governor Alice Rivlin and Professor John Taylor. They discussed a wide range of issues related to the dual mandate, ruled based policy, the size of the Fed’s balance sheet, the relations with the Treasury and whether the Fed should be abolished or not.

Key issue that came up was current relation between Fed and Treasury and the unhealthy situation where the Fed purchases most of the new issuance of treasury paper. It will be hard for the fed to increase rates when the time comes for a more restrictive policy. Huge impact on financing costs of Treasury.

Despite wide differences, few on the panel wanted to abolish the Fed. But management and nature of central bank will certainly be a hot topic as we move forward, according to closing statement by Chairman Ron Paul.

I have posted some notes from the hearing here.

You can watch the hearings here

MF Global – Why has there not been more prosecution of fraud?

This interesting but somewhat technical post discusses an important issue: Why has there not been more prosecution of financial fraud in this crisis? This is i large part due to the tradition of appointing trustees for the failed institution, instead of appointing receivers. This again is related to the US Bankruptcy law and legal tradition, which mistakenly has avoided appointing receivers when there are clear signs of fraud against unsecured creditors. As the post notes …

There are a number of examples where a receiver function plays an important role in fighting fraud. In case of The Stanford Group, an Article III receiver was appointed by a federal District Court without any bankruptcy to pursue a wide ranging investigation, which included efforts to conserve customer funds and pursue third parties via criminal and civil means.

He goes on to note that the FDIC is a good example of who such receiver powers could be used …

The FDIC is another excellent example of how receivership powers enable that bank agency to limit losses to the mutual insurance fund supported by insured banks and also pursue claims against bank officers, directors and other parties. Unlike a trustee in a bankruptcy, the FDIC acting as receiver has broad authority to seize assets, sue officers and directors, reject contracts and even make criminal referrals related to a failed bank.

More frequent appointments of receivers whenever fraud is suspected should restore some of the balance for unsecured creditors and lead to more prosecution in obvious fraud cases.

IMF calls for fiscal austerity and lower real wages

This recent speech from IMF Managing Director Lagarde confirms the austerity for growth paradigm that has taken hold recently. She notes that to get growth

The most important element is to lay out a credible medium-term plan to lower debt. Without such a plan, countries will be forced to make an even bigger adjustment sooner.

The current reduction of budget deficits with about 1 % of GDP on average is at a “prudent pace”, according to Lagarde.

As for the southern European countries that has lost competitiveness, the choice is between increased productivity or lower wages. But since labor market reform takes time, “wage will have to adjust” (read: fall).

It is remarkable how the IMF has changed since Mr. Strauss Kahn provide strong leadership out of the 2008 financial crisis. I just quote from one of his many press releases, this one from November 15, 2008 commenting on the G-20 Action Plan:

Mr. Strauss-Kahn noted the G-20 leaders’ commitment to act together to meet global macroeconomic challenges, using both monetary and fiscal policy. Lower inflation risks provide room to ease monetary policy, he said, adding that this will be important, but will not be enough.

I welcome the emphasis on fiscal stimulus, which I believe is now essential to restore global growth,” Mr. Strauss-Kahn said. “Each country’s fiscal stimulus can be twice as effective in raising domestic output growth if its major trading partners also have a stimulus package.”

He noted that the Summit Declaration recognizes that some countries have more room for maneuver than others. “We believe that those countries-advanced and emerging economies-with the strongest fiscal policy frameworks, the best ability to finance fiscal expansion, and the most clearly sustainable debt should take the lead,” he said.

Negative money multiplier

My old friend Peter Stella and IMF colleague M. Singh has a new VOX post based on their IMF WP Money and Collateral. They argue that we should not fear inflation due to excess reserves, since the money multiplier is not working anyway. The shadow banking system is now creating much of the credit, but also need support in the crisis from central bank liquidity support. But since the shadow banking system is based on repo financing in government paper, central banks should support the system by doing QE in other undervalued papers, like asset based securities.

Whereas I liked their IMF WP, this post needs some discussing. First of all, the money multiplier is long dead anyway. For a good discussion of whether excess reserves will create inflation, this see blog post by McAndrews of NY Fed. Second, they correctly note the huge size of financial market assets relative to very little reserves, but do no discuss further the advisability of operating a financial system of private credit with so little official backing.

As I have noted earlier in my Levy WP “Shadow banking and the limits to central bank liquidity support” there is probably a limit to how far central banks should accommodate the endogenous expansion of shadow credit. Unless credit creation is somehow constrained, central banks cannot simply go on to support private liquidity markets with endlessly new QEs.

If you are interested in the FT’s view on the issue, Isabelle Kaminska of Alphaville devotes two long posts to their paper.


Central Bankers Under Siege

Raghu Rajan has a new post out with this dramatic title. The essence is really that Chairman Bernanke is doing his best to revive the economy, but getting blamed whatever he does. Rajan is negative to further measures, and explicitly rejects the proposal by some economists for a higher target for the inflation rate. With a household savings rate of barely 4 %, the best we can do, according to Rajan, is

improving the capabilities of the workforce across the country, so that they can get sustainable jobs with steady incomes. That takes time, but it might be the best option left.

Not very encouraging for the 10 %  + unemployed (including those who have given up looking for work)!


Brad DeLong on FT’s call for austerity

The FT’s editorial today with a balanced call for austerity in Europa was surprising and disappointing, given all the writings of Martin Wolf and others in the paper before. Today Brad de Long take charge at the ed and discuss why it is that people who should know better fall in the “austerity trap”. He points out that even Milton Friedman would have to to stabilize nominal GDP and buy stuff for until inflation and growth are reestablished on a sustainable path.Well written.

Also included are the response from Paul Krugman which is even better, and probably well to the mark (still scary):

My best theory here is that it’s political and sociological: conservative-leaning economists who should know better are driven by peer pressure to suppress their better instincts.

Think about Greg Mankiw and inflation. Early on in the Lesser Depression Greg came out for inflation — fairly high inflation! — as the solution, to give us negative real interest rates. But he encountered a firestorm of criticism from his political allies — and went silent.

The point is that even among academics with tenure and established reputations, there is apparently enough leverage in the hands of the enforcers of right-wing orthodoxy that they end up bowing to the reign of error.

As for Rachman: I think this is a subtler form of peer pressure. And for what it’s worth, Ryan Avent has already written the devastating reply to Rachman I haven’t had time for because I’m on Reddit!