Friday, August 26, 2011

Today's links

1--Thinking about the liquidity trap, Paul Krugman, (from the archive)

Excerpt: Expectations: Finally, we return to the issue of inflation targeting. The basic point, once again, is that a credible commitment to expand the future money supply, perhaps via an inflation target, will be expansionary even in a liquidity trap. There are two problems, however, with this view. One is that it is not enough to get central bankers to change their spots; one must also convince the market that the spots have changed, that is, actually change expectations. The truth is that economic theory does not offer a clear answer to how to make this happen. One might well argue, however, that one way to help make a commitment to do something unusual credible is to do a lot of other unusual things, demonstrating unambiguously that the central bank does understand that it is living in a different world. Market participants are pretty much unanimous in their belief that unsterilized intervention would have a much bigger effect than sterilized, essentially because it would convey news about future BOJ policy; the same could be said of other actions, including quantitative easing. My personal view is that a country deep in a liquidity trap should try everything, even if careful analysis says that some of the actions should not matter; if, in the precise if annoying phrase I used in my first paper on the liquidity trap, a central bank must "credibly promise to be irresponsible", it should waste no opportunity to demonstrate its new spirit.

The other problem is that the policy shift must not only be credible but sufficiently large. A too-modest inflation target will turn into a self-defeating prophecy. Suppose that the central bank successfully convinces everyone that there will henceforth be 1 percent inflation – but that a real interest rate of minus 1 percent is not low enough to restore full employment. Then despite the expectational change, the economy will remain subject to deflationary pressure, and the policy will fail. Half a loaf, in other words, can be worse than none.

2--Fallout from the Fed’s secret $1.2 trillion bank bailout, Marketwatch

Excerpt: Did you know the Federal Reserve secretly loaned up to as much as $1.2 trillion to U.S. and foreign banks? This information has now been released and we even know the institutions that got the bulk of the funds. Can you say, Morgan Stanley (MS), Citigroup (C), Bank of America (BAC). Due to the inflammatory nature of this information, the Fed has been reluctant to share it with Americans, but now it has now come out due to a lengthy Freedom of Information Act (FOIA) investigation by Bloomberg.

This blog post by Barry Ritholtz gives details about a secretive $1.2 trillion bailout program by the Federal Reserve [emphasis added]:

...We knew that Citigroup (C), who borrowed $99.5 billion, and Bank of America (BAC), who took loans of $91.4 billion, were in trouble. I’ve been saying for the better part of 3 years now that they were, and likely still are mostly insolvent. But the surprise data point was Morgan Stanley (MS), got as much as $107.3 billion in loans, with no strings attached.

...Imagine if the government and the Federal Reserve were run not by knaves and fools and Wall Street sycophants, but instead, were run honestly for the benefit of the taxpaying voter. Imagine the goal was saving the banking system (not the banks), and the financial rescue was for the benefit of the taxpayers, not the bondholders…

3--4th UPDATE: Banks Borrow More Euros From ECB, Dollar Supply Seen Tighter, Wall Street Journal

Excerpt: Euro-zone commercial banks Tuesday borrowed a far larger amount of euros from the European Central Bank than the day before, which isn't helping to allay worries that the region's banking system could be heading for a liquidity shortage.

Banks didn't tap the ECB for dollars Wednesday, which came as a relief after one bank borrowed $500 million from the ECB last week, for the first time in 23 weeks. But comments from Bundesbank executive board member Andreas Dombret made it clear that market tensions could be just around the corner as U.S. banks have become more selective with their lending policies to euro-zone banks.

"Without doubt, unsecured dollar funding markets have tightened somewhat recently...But let me emphasize that we are very far away from the situation we witnessed in 2008," Dombret said in a speech in New York Wednesday.

Many market watchers worry that conditions on money markets are worsening to levels not seen since the second half of 2008, when the global credit crisis first hit.

Banks borrowed Tuesday EUR2.822 billion from the ECB's overnight lending facility--which charges a punitive interest rate of 2.25%--up from EUR555 million in the previous trading session, the ECB data showed Wednesday.

Liquidity fears grew when Rabobank Group, one of Europe's best-capitalized lenders, said it has become more careful in providing loans to banks in fiscally-troubled euro-zone countries, another sign that the sovereign debt crisis threatens to disrupt the bank funding market.

4--Europe's Banks in Lending Squeeze, Wall Street Journal

Excerpt: Commercial banks boosted their reliance on the European Central Bank, borrowing €2.82 billion ($4.07 billion) from an emergency lending facility on Tuesday, while other banks continue to park unusually large amounts with the central bank, according to data released Wednesday.

While the amount of borrowing is tiny relative to the multitrillion-euro European banking system, it, and the increase from €555 million a day earlier, nonetheless suggest that some lenders are struggling to borrow from traditional funding sources, such as the capital markets or other banks.

The ECB charges a punitive 2.25% interest rate to borrow from its facility, well above what a healthy bank typically would pay to borrow via other channels and Tuesday's total is well above normal....

All told, the evidence points to an environment when even strong European banks are finding it harder to obtain affordable long-term funding. Banks are being forced to pay more to borrow for shorter periods of time.

The troubles come against the backdrop of Europe's broad and intensifying financial crisis. Already, three euro-zone countries have needed international bailouts, and investors and others fear that larger countries like Spain and Italy could get sucked into the vortex. That is bad news for Europe's banks, which hold large sums of those governments' bonds that could then lose value.

As a result, a growing number of investors are balking at lending money to banks for any longer than just overnight.

"We are not seeing a lack of funding, but we are seeing a shortening of maturities," said a senior executive at a U.K. bank that is generally a borrower in the interbank market....

The ECB doesn't specify why its emergency facility is being used or by whom, but analysts say it is usually tapped for unexpected funding shortfalls that can occur for technical reasons such as insufficient borrowing at the ECB's regular one-week loan offerings. Banks can borrow an unlimited amount at those regular facilities at a lower rate that at the emergency window, which is why spikes in the emergency facility are usually temporary.

Although Tuesday's use of the ECB's emergency facility is much higher than usual, it has been exceeded several other times this year, most recently on Aug. 10, when banks borrowed more than €4 billion.

At the same time, European banks, wary of lending to one another, have been stashing above-average amounts of deposits at an ECB overnight facility. The facility pays a paltry interest rate, and banks could earn more by lending out the funds on the interbank market.

5--Money Markets: Dollar funding costs on the rise, Reuters

Excerpt: European bank funding pressures remained high on Tuesday as the cost of short-term interbank dollars continued to rise, while U.S. banks' debt costs also came under pressure in the unsecured bond markets.

European banks are facing higher dollar funding costs as U.S. money fund investors, nervous over bank exposure to peripheral euro zone countries, reduce the length and amount of loans to the companies.

U.S. banks have largely, thus far, been spared short-term funding stress, though a dramatic share price drop at Bank of America (BAC.N) in the past two days has raised concern that the firm will need to raise new capital at the same time as big investors are increasingly risk averse. For details, see [ID:nN1E77M0FC]

"There are definitely issues in funding affecting banks across the board," said Abdullah Karatash, head of U.S. fixed-income credit trading at Natixis in New York.

6--The Cost Of Insuring European Bank Debt Has Doubled Since April, Business Insider

Excerpt: The cost of insuring junior and senior bonds at 25 European banks has doubled since April, according to a Bloomberg report.

Such numbers appear to confirm fears that funding problems are threatening to cripple European banks.
The report also cited the highest Euribor-OIS spread since 2009 as indicative of banks' reluctance to lend to one another.

"The banks seem to prefer to deposit cash with the ECB rather than lend it out to others that need it," John Raymond, an analyst at CreditSights, Inc., in London told reporters. "In itself, that's a sign of stress in the interbank market."

A retreat in the availability of bank funding could further slow growth in Europe, particularly in the south where bank problems are most severe. Poor economic conditions could aggravate the already unsteady political positions of governments in the PIIGS and erase hopes that austerity measures will fix their sovereign debt problems.

7--Weekly Initial Unemployment Claims increased to 417,000, Calculated Risk

Excerpt: The DOL reports:

In the week ending August 20, the advance figure for seasonally adjusted initial claims was 417,000, an increase of 5,000 from the previous week's revised figure of 412,000. The 4-week moving average was 407,500, an increase of 4,000 from the previous week's revised average of 403,500.
The following graph shows the 4-week moving average of weekly claims since January 2000

The four-week average of weekly unemployment claims increased this week to 407,500.

Weekly claims have increased for two consecutive weeks and the 4-week average is still elevated.

8--How Much More Can the Fed Help the economy, New York Times

Excerpt: Interest rates are already at zero, though (and have been for a while), so the Fed cannot lower them any further. That’s why the Fed has engaged in more unusual — in some cases, unprecedented — measures....

After two rounds of quantitative easing, long-term interest rates are already quite low. It is not clear that lowering them further with a third round of quantitative easing (QE3) would do a whole lot more to encourage investment in riskier assets, or to increase lending. Many companies are choosing not to borrow primarily because demand is so weak, and not because credit is expensive.

Additionally, if investors do start increasing their investments in assets with higher returns, they may pour more money into commodities like oil. And commodity prices are already higher today than they were a year ago; pushing energy and food prices further up could actually discourage consumers from spending.

And many economists are still debating whether the last round of quantitative easing was terribly useful.

“It’s hard to make the argument that QE2 was a rousing success or we wouldn’t be on the verge of seeing QE3,” the economists at RBC Capital Markets wrote in a client note. “The market may very well get what it seems to desire, but we believe there is no magic bullet here.”...

Many economists have suggested that the most powerful tool the Fed might employ would be an announcement that it is raising its medium-term target for inflation.

If prices are expected to rise, banks, businesses and consumers will be more eager to spend their money before it loses value. That could have positive effects throughout the economy, since spending means more demand for goods and services, which means companies need to hire more employees, which means more spending, and so on. That is the much-sought-after virtuous cycle.

Additionally, inflation would lower the value of many people’s debt burdens and so help with the painful process of deleveraging.

The problem, though, is that inflation has some major downsides too — especially if coupled with sluggish growth, as seen during the “stagflation” of the 1970s. Not having a good sense of how much your next gallon of milk or gas will cost is stressful, particularly if your wages aren’t rising to match the higher prices.

9--Fiscalization Watch, Paul Krugman, New York Times

Excerpt: A correspondent informs me that Wolfgang Schaeuble, the German finance minister, has just given a speech asserting that excessive public debt caused the 2008 crisis. In fact, I’m told, he said that

It’s actually undisputed among economists worldwide that one of the main causes – if not the main cause – of the turbulence – not just now, but already in 2008 – was excessive public debt everywhere in the world.

OK, we can prove that wrong immediately: I dispute it, Brad DeLong disputes it, Christy Romer disputes it, and I think we fall into the category of “economists worldwide”.

But more seriously, let’s look at the full list of countries that got into trouble because of high debts accumulated before the crisis, as opposed to those that have developed large deficits as a consequence of the crisis. Here’s the full list:


Spain and Ireland had low debts and budget surpluses on the eve of the crisis. The US financial crisis represented a collapse of confidence in private debt, not public debt. So Schaeuble is just making stuff up, inventing a crisis that didn’t happen rather than dealing with the crisis that did happen.

Unfortunately, he’s not alone. The fiscalization of the crisis story — the insistence, in the teeth of the evidence, that it was about excessive public borrowing — has become an article of faith on both sides of the Atlantic. And that faith has done and will do untold damage.

10--Five Trillion Dollars, Paul Krugman, New York Times

Excerpt: A couple of notes on the most recent Congressional Budget Office Projections:

1. They offer a portrait of an economic catastrophe. Here’s the CBO estimates of potential real GDP — the amount the economy could produce without causing inflationary pressure — and actual GDP, in trillions of 2005 dollars per year:

No, I don’t know where that recovery in 2015 is supposed to come from; my guess is that it’s basically the CBO unwilling to project a depressed economy more or less forever. But even with that bounceback assumed, the projection says that we’ll have a cumulative output gap of $5.1 trillion, with $2.8 trillion of that having already happened.

Surely it would have been worth making an extraordinary effort to avoid this outcome. In particular, an $800 billion stimulus, a significant fraction of which was stuff that would have happened anyway (like extending the patch on the alternative minimum tax) looks ludicrously underpowered. Yet policy has been timid and conventional.

2. The CBO also projects unemployment staying above 8 percent until late 2014 — again, with no clear explanation of why it should fall sharply in 2015. This translates into a human catastrophe for the long-term unemployed. It also says that there will be no good reason to raise interest rates for the foreseeable future.

I think if you had told people back in, say, 2007 that this would happen, they would have asserted with confidence that generating a faster recovery would be at the top of the political agenda. The fact that it isn’t — that deficits are still dominating the conversation, even as interest rates plumb record lows — is truly remarkable.

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