Thursday, September 22, 2011

Today's links

1--Asia Stocks Tumble Toward Lowest in Year on Mounting Financial System Risk, Bloomberg

Excerpt: Asian stocks tumbled, sending the regional benchmark index toward its lowest close in more than a year, after the U.S. Federal Reserve warned of “significant downside risks to the economic outlook” and Moody’s Investors Service cut its debt ratings on some American banks.

HSBC Holdings Plc (5), Europe’s No.1 lender by market value, plunged 3.4 percent in Hong Kong as the currency union’s risk watchdog said threats to the financial system have increased “considerably.” BHP Billiton Ltd.

(“The Fed delivered exactly what had been expected,” said Angus Gluskie, who manages more than $300 million at White Funds Management in Sydney. “All underlying measures of credit risk are rising and there are numerous examples of banks having to resort to unusual measures to obtain funding. Under the surface, we are moving quickly into a secondary credit crisis.”

2--How to save the euro, The Economist

Excerpt: SO GRAVE, so menacing, so unstoppable has the euro crisis become that even rescue talk only fuels ever-rising panic. Investors have sniffed out that Europe’s leaders seem unwilling ever to do enough. Yet unless politicians act fast to persuade the world that their desire to preserve the euro is greater than the markets’ ability to bet against it, the single currency faces ruin. As credit lines gum up and outsiders plead for action, it is not just the euro that is at risk, but the future of the European Union and the health of the world economy.

It is a sobering thought that so much depends on the leadership of squabbling European politicians who still consistently underestimate what confronts them (see article). But the only way to stop the downward spiral now is an act of supreme collective will by euro-zone governments to erect a barrage of financial measures to stave off the crisis and put the governance of the euro on a sounder footing....

A rescue must do four things fast. First, it must make clear which of Europe’s governments are deemed illiquid and which are insolvent, giving unlimited backing to the solvent governments but restructuring the debt of those that can never repay it. Second, it has to shore up Europe’s banks to ensure they can withstand a sovereign default. Third, it needs to shift the euro zone’s macroeconomic policy from its obsession with budget-cutting towards an agenda for growth. And finally, it must start the process of designing a new system to stop such a mess ever being created again.

3--Lessons from the history of fiscal federalism, Pragmatic Capitalism

Excerpt: Our survey of the evolution of the five federal states in our sample leads to the following conclusions:

First, all the fiscal unions have evolved in close interaction with the political unions forming the ultimate basis for their fiscal cooperation. Federalism is not a static pattern, characterised by a precisely defined division of powers between governmental levels. It is a continuous process by which a number of separate political communities enter into arrangements for working out solutions and making joint decisions on common problems. Thus, each federation is an evolving entity shaped by economic and political events.

In particular, fiscal policy arrangements are driven by exceptional events, often by deep economic crises. The most prominent example is the Great Depression of the 1930s which affected in a fundamental way the institutions of the five federal states. During and after the Great Depression, the American, Canadian, Argentine, and Brazilian federations underwent a process of centralisation. This centralisation made it easier for the federal governments to either introduce (as in the Canadian case) or extend (as in the US example) measures aiming at equalisation of incomes across regions. Such measures were part of the stabilisation process, since the regions which were more harmed by the recession received larger financial transfers. Thus in case of a major negative shock the federal state learned to implement measures to improve the conditions of the most harmed regions.

History also suggests that the most appropriate way to finance interregional transfers in distressed times is by a national (union-wide) bond market. After the American War of Independence, Alexander Hamilton, the first Secretary of the Treasury, introduced a stabilisation plan to get the new Republic on its feet. The war had been largely financed by the issue of paper money and the resulting hyperinflation plus the default by the states on their debt left the new nation in a fiscal shambles.

Hamilton consolidated the state and federal debt in a new national bond which was to be serviced by customs duties and excise taxes. The new bond issue was a success which allowed for the financing of future wars and secured tax revenue at the national level.


The history of fiscal federations provides us with a number of conditions necessary for a fiscal union to function smoothly and successfully and thus also the monetary union on which the fiscal union is based. The first and probably the most important condition is a credible commitment to a no-bailout rule for the members of the fiscal union. The second one is a degree of revenue and expenditure independence of the members of the fiscal union reflecting their political preferences. The third condition is a well-developed transfer mechanism to be used in episodes of distress. This transfer mechanism can be facilitated by the establishment of a common bond. The fourth condition is a capacity to learn from past mistakes and adapt to new economic and political circumstances.

The Eurozone was created without an effective fiscal union. The institutions that were established to serve as the foundation for the fiscal union (the Maastricht Treaty and the Stability and Growth Pact) – to discipline domestic fiscal policies – did not function as planned as revealed by the crises and recession from 2007-2009 and onwards. The lessons from the historical experience of the five federal states surveyed by us could be helpful for the Eurozone to avoid disintegration.

4--Three-Month Dollar Libor Rises for Eighth Day to 0.355 Percent, Bloomberg

Excerpt: The rate at which London-based banks say they can borrow for three months in dollars rose for the eighth straight day, reaching the highest level since August 2010.

The London interbank offered rate, or Libor, for dollar loans climbed to 0.35500 percent from 0.35250 percent yesterday, according to data from the British Bankers’ Association. That’s the biggest daily increase in a week and the highest rate since Aug. 16, 2010.

The dollar Libor-OIS spread, a gauge of banks’ reluctance to lend, was at 29.00 basis points as of 11:53 a.m. in London, from 28.95 basis points yesterday, the widest on a closing-price basis since July 27, 2010, according to data compiled by Bloomberg.

The TED spread, or the difference between what lenders and the U.S. government pay to borrow for three months, rose for a 12th day. It widened to 35.50 basis points from 35.25 basis points yesterday.

5--Euribor rates inch up after Italy downgrade, Reuters

Excerpt: Key euro-priced bank-to-bank
lending rates edged up on Tuesday, reflecting growing concern
about the future of the euro zone after a downgrade of Italy's
credit rating and in spite of high amounts of excess money
market liquidity.

Standard and Poor's cut Italy's sovereign ratings by one
notch overnight and traders said the European Central Bank was
in the market buying Italian bonds in small amounts and of
targeted maturities of between five and 10 years.

EU finance ministers made clear to Greece over the weekend
that it must meet targets to get fresh funds, but they broke no
new ground in dealing with the debt crisis shaking the euro

The three-month Euribor rate -- traditionally
the main gauge of unsecured interbank euro lending and a mix of
interest rate expectations and banks' appetite for lending --
ticked up to 1.537 percent from 1.536 percent....

Last week five major central banks teamed up to cooperate in
offering three-month dollar loans to commercial banks to prevent
money markets from freezing up in the wake of Europe's debt
crisis. The move came after downgrades to some of Europe's major
banks and after two undisclosed banks tapped the ECB for dollar
funding, the second time in a month the normally expensive
facility has been called upon.

The worsening euro zone debt crisis has seen many banks
stock up on ECB euro funding. They took 164 billion euros in
one-week funds last week, well above the 135 billion traders had
expected, and added an extra 54 billion in one-month liquidity.

The deepening crisis has already forced the ECB back into
emergency mode. Last month it reintroduced six-month euro
funding, a measure it had previously mothballed, and extended
limit-free funding in all its lending operations up until

It has also signalled a shift in its interest rate policy,
indicating further rate rises were off the agenda for now.

6--Euro Stability Fund Will Pass: German Minister, CNBC

Excerpt: Angela Merkel's coalition partner, whose party has formed the main political opposition to the extension of the European Financial Stability Facility within Germany, told CNBC Wednesday that he believes the new EFSF measures will pass next week...

Roesler struck a more conciliatory tone in his interview with CNBC, and stated that a preliminary poll of his party's members of parliament indicated that the majority would back the measures.

"We want to make sure that all countries that are inside the euro zone will stay in it," Roesler said. "We also want to make sure that these countries will regain their economic strength."

As the biggest economy in the euro zone, Germany also faces the biggest bill for the EFSF. Its recovery from the 2008 crisis has been stronger than much of the rest of the euro zone.

7--Stocks slide as Fed's outlook deepens gloom, Reuters

Excerpt: Asian stocks tumbled on Thursday, following a slide on Wall Street, as investors took fright at a warning by the Federal Reserve that the United States faced a grim economic outlook with "significant downside risks."

The dollar rose on the prospect of higher short-term interest rates after the Fed said it would sell $400 billion of short-term Treasury bonds to buy longer-dated debt in a widely predicted move known as "Operation Twist," aimed at stimulating the economy by forcing down long-term borrowing costs.

But it was the central bank's bleak assessment of the world's biggest economy that preoccupied markets, with oil and copper falling alongside stocks on fears of weakening demand, while some were disappointed that there were no bolder stimulus moves, given the extent of the Fed's pessimism.

"To be honest, I'm surprised to see so much risk aversion after the Fed," said Teppei Ino, a currency analyst at Bank of Tokyo-Mitsubishi UFJ in Tokyo.

8--Economists React: Fed Is ‘Doing What It Can’, Wall Street Journal

Excerpt: Economists and others weigh in on the Federal Reserve’s decision to embark on Operation Twist.

– The Fed didn’t disappoint market expectations, but initial equity market reaction was still negative, probably because the Fed statement referred to “significant downside risks to the outlook”. The Fed is doing what it can to address those risks – and we think that sooner or later it will do more quantitative easing – but it doesn’t have any tools that can magically re-ignite economic growth. The “twist” might keep ten-year rates 10-20 basis points below where they otherwise might have been, but interest rates are already extremely low. A few more basis points lower does not transform the outlook. And the biggest risks right now, in Europe, are ones that only European policy-makers can address. –Nigel Gault, IHS Global Insight

–The three dissents (same as in August) mean nothing for policy at this point, and it means nothing for QE down the road if Bernanke wants it. Consensus is nice, not necessary. This is Bernanke’s Fed, his legacy, and he intends to make good on his pledge that the Japanesification “cannot happen here.” This meeting provided more proof of that. If he fades his colleagues, trust me, he will fade the Republicans. He doesn’t want another term, he wants to control his legacy. We suspect we will get even more proof down the road. –Eric Green, TD Securities

Skeptics will argue that structural issues will prevent lower long-term interest rates from being stimulative. Indeed, Fed officials generally agree that the economy’s interest sensitivity has been impaired by the lingering effects of overbuilding in housing and excessive private sector debt growth, diluting the potential impact. However, most officials also believe the recovery would have been even weaker than it has been had monetary policy been less accommodative. In turn, further declines in rates will likely be at least modestly stimulative. The challenge, of course, is the degree to which growth is also being restrained by various headwinds, including some new ones stemming from “strains in global financial markets” recently. –James F. O’Sullivan, MF Global

Nothing the Fed has left in its arsenal, including today’s moves, will have a large effect on real economic growth. The level of interest rates has never been an impediment to growth in the current recovery, and it certainly is not at the moment. Moreover, creditworthy borrowers have ready access to credit, and it is doubtful that anything the Fed may do is going to encourage banks to lend in great quantities to less creditworthy borrowers (nor should it). –Joshua Shapiro, MFR Inc.

9--The Fed Twists in the Breeze, Naked Capitalism

Mr. Market so far is not at all impressed with the announcement today that the Fed will be changing the composition of its portfolio by selling $400 billion of near-dated Treasuries and buying the same amount of longer maturity Treasuries. Since the Fed will maintain the same Fed funds target rate, the Fed’s intent is to keep short term rates low and also reduce longer term rates.

The fallacy with the Fed approach, as our Marshall Auerback has pointed out repeatedly, is that targeting a quantity means the central bank has no idea what result it will achieve. An analysis by Jim Hamilton showed that $400 billion of QE in the past would have moved rates by all of 17 basis points, which is bupkis (and that’s assuming you think lowering of longer term rates further is a worthy goal when long term rates are already at historic low levels). From his 2010 paper:

We can summarize the implications of that forecast in terms of the following scenario. Suppose that the Federal Reserve were to sell off all its Treasury securities of less than one-year maturity, and use the proceeds to buy up all the longer term Treasury debt it could. For example, in December of 2006, this would have required selling off about $400 B in bills and notes or bonds with less than one year remaining, with which the Fed could have effectively retired all Treasury debt beyond 10 years. The figure below summarizes the implied average change in forecast for the 1990-2007 period as a result of this change for interest rates of various maturities. Yields on maturities longer than 2-1/2 years would fall, with those at the long end decreasing by up to 17 basis points.

Yields on the shortest maturities would increase by almost as much. While our estimates imply that the Fed could make a modest change in the slope of the yield curve, it would not make any difference for the average level of interest rates. As we said, results may (as in will) vary, but the broader point is the last experiment of this sort produced underwhelming results.

And of course, to the extent the Fed is successful in flatting the yield curve, even modestly, this reduces the profitability of the basic operation of banking, which is maturity transformation (borrowing short and lending long).

No comments:

Post a Comment