Financial Stability News

News about financial stability, central banking and theory of money

Category Archives: Banking crisis

On Covered Bonds, Collateral Crunches, And The Circular Logic Of Central Banks

This post by Zero Hedge gives a subjctive interpretation of the current rush of covered bonds by Europeans banks, some of them soon approaching the limits for such issuance. Many banks retain large portion of the new bonds themeselves; which raises the interesting question if you can own your own debt!

The post goes on to argue that central banks are painting themeselve into a corner, where lack of collateral and requirement of collateralized lending (from CBs to banks) will finally meet.

If, however, the covered bond bridge is pushing up against its very real statutory and quality limitations, that might mean the ECB is now fighting a two-front funding war – retail deposit flight and collateral diminishment at the same time. 

At that point the system will collapse or central bank will be force to relax collateral requirements, ref. Tuckers discussion of this problem under the heading of “central banks’ time inceonsistency problem”, for a discussin of this dillemma see my Levy WP here on The Collateral Squeeze, p. 17

Alternatively (and better), central banks should let failing banks go into resolution and stop the collateral chasing. Better to start on this process before it becomes too late.

Debuty Governor Paul Tucker on how to avoid a new banking crisis

Somewhat old interview (August 1), but still interesting points about central bank lending to CCPs, how to solve the TBTF problem, and the need for more liquidity for trading activities:

Since then, I have wanted trading book positions to incorporate an element of capital against illiquidity risk, because these books get marked to market so even if there is no change in fundamentals but the market suddenly dries up, values will fall as a result and the net worth of the dealer or bank falls sharply.

And also about how to prevent a new “blow-out” of the financial system:

Risk: Do you see any danger in a more prescriptive approach to capital modelling?

PT: This is a genuine consultation by the Basel Committee, but I would point out that there are something like 15 million people unemployed in the western world because finance imploded, and finance imploded because the rules of the game in finance were inadequate. That’s a terrible price to pay. So this business of debating exactly how to calibrate things, this is for grown ups. It’s not about whether we – if the following rich assumptions hold – can optimise capital levels. It’s about whether we can avoid having a financial system that is fragile in ways that have very high social costs.

Agree fully with Tucker!

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

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)!


Money, Power and Wall Street

PBS has made a four episode documentary about the crisis on Wall Street. The first two (on the build-up to the crisis and the crisis itself can be seen online). The next two will air today in the US and can be seen online afterwards. The two first were really good. Despite a wealth of reporting on the crisis, including numerous well researched books, they manage to recreate the suspense and also be quite analytical. Conclusion: Nothing much has changed since the crisis – are we heading for another one?

Reading-list on the financial crisis

Gorton and Metric has just submitted a review (for the Journal of Economic Literature) on the essential readings about the financial crisis. They start with this observation:

The first financial crisis of the 21st century has not yet ended, but the wave of research on the crisis has already exceeded any single reader’s capacity, with the pace of new work only making this task harder. Many professional economists now find themselves answering questions from their students, friends, and relatives on topics that did not seem at all central until a few years ago, and we are collectively scrambling to catch up.

Some would argue that these missed topics have been around for years, and that they in fact was the centerpiece of the theories to Keynes and Minsky, just to name two.

For an overview of those that saw the crisis coming, you can read these two short blogs, from Matias Vernengo from Utah University and Gerald Epstein from University of Massachusetts – Amherst. They both give a nice overview and a different perspective.

Epstein reflects on why mainstream goes from crisis to crisis without learning, and notes that

As Economist Phil Mirowski pointed out to me, the problem is that, like the protagonist in the movie Memento , who has no memory but is trying to solve the mystery of his wife’s murder, and has to remind himself every minute about what happened the minute before by writing notes and even tattooing himself , mainstream macro-economists’  write themselves articles and books after every crisis and they then promptly forget what they wrote (no tattoos as far as I know).

A good illustration of this effect is the latest speech (very good one) by deputy governor in Bank of England Paul Tucker, who readily admits that the lessons he and Mario Draghi learned after the Asian crisis (and wrote down in a report then), that balance sheets matters and should be closely monitored, was forgotten and need to be re-learned. At least he is honest enough to admit it.

The beauty of being TBTF

Sometimes in the US you get these angry blog post with “jail the bankers”. There are obvious some folks out there who are angry if their house has been foreclosed, but this attitude is spread much wider, and not just with “radicals”. The financial crisis commission and the Senate Investigative Committee Report (and many others) have documented tons of evidence of fraud and malpractice. But despite all this,  few bankers have gone to jail. The Justice department and SEC has preferred to settle cases, and only the opposition by some brave judges have prevented a clean bill of health for the financial industry after the crisis.

The latest development is the settlement with the banks over “robo-signing”, a practice used in the heydays of the property boom, to make quick loans with little documentation. Now the Obama administration has signed an agreement with the industry that settles all claims and nobody goes to jail.

Simon Johnson is upset by this and discusses why the administration consistently avoids confrontation with the financial industry. A good read and it also gives some insight into the politics around the financial sector in the US.

ECB’s heavy haircuts

FT Alphaville gives further details today on the regional variations in collateral requirements for the upcoming LTRO . As noted by Draghi yesterday, ECB will apply a hefty haircut of 2/3 on all pledged collateral. But national central banks have discretion within the new collateral rules to accept local assets depending on circumstances. Generally, the new guidelines imply that NCB’s will accept assets with ratings down to BB- instead of previously BBB-. But there are variations between NCBs as noted in this report, e.g. CB of Spain will accept mortgages, while the Irish CB will not.

The Germans think the ECB is giving away “easy money”. That can be debated, with such a heavy haircut.

Private liquidity is highly endogenous

It is official: According to Mr Benoît Coeuré, Member of the Executive Board of the European Central Bank,

In normal times, private liquidity dominates official liquidity. But private liquidity is highly pro-cyclical
and highly endogenous to the conditions that prevail in the global financial system.
The inherent endogeneity of private liquidity means that it can easily evaporate in times of
financial stress.

This is something Hyman Minsky noted a long time ago, but it’s nice to see the ECB now endorsing his views.

However, Mr. Coeuré doesn’t quite follow through in this dinner speech from the recent ECB – BIS conference on Global liquidity, as he explains the crisis with “excessive sovereign borrowing”, “gaps in regulation and supervision” and “insufficient fiscal discipline”. Nothing there about excessive bank lending or rehypotecation in the shadow banking system. But at least the belated insight that private credit is endogenous is something.

EU moving towards political union

According to Monti, who spoke at the Peterson Institute in Wash DC today …

“We are moving perhaps even without being aware towards some form of political union”, Mr Monti said, adding that the Greek crisis has helped this along.

Interestingly, Monti is in the US while all his colleagues are in Brussels for tonight’s EU Council meeting. The distance allowed Monti to plead for flexibility for Greece. According to this WSJ story he urged the Trokia to award Greece an expanded loan package even with “a minimum of compliance”