Showing posts with label monetary system. Show all posts
Showing posts with label monetary system. Show all posts

Monday, September 08, 2008

The System is Down

Volcker Says Finance System `Broken,' Losses May Rise (Update2)
By Steve Matthews and Doug Alexander

Sept. 5 (Bloomberg) -- Former Federal Reserve Chairman Paul Volcker said the U.S. financial system, dependent upon securitization rather than traditional bank loans, is broken, and may contribute to the weakest expansion since the 1930s.

``This bright new system, this practice in the United States, this practice in the United Kingdom and elsewhere, has broken down,'' Volcker said today at a banking conference in Calgary. ``Growth in the economy in this decade will be the slowest of any decade since the Great Depression, right in the middle of all this financial innovation.''

The former Fed chief projected ``a lot'' more losses from the collapse in the mortgage-backed debt market, after the more than $500 billion tallied so far, should the U.S., European and Japanese economies fail to pick up. He urged changes in financial regulations, echoing calls among sitting officials and legislators.

``It is the most complicated financial crisis I have ever experienced, and I have experienced a few,'' said Volcker, who has endorsed Democratic presidential candidate Barack Obama. Volcker ran the Fed from 1979 to 1987, and engineered an increase in interest rates to 20 percent to quell inflation that exceeded 10 percent.

U.S. growth has averaged 2.3 percent so far this decade, down from 3.4 percent in the 1990s. The current growth rate is the weakest since at least the 1940s, when the government began compiling figures on quarterly gross domestic product.

Volcker's comments came after a government report today showed the U.S. unemployment rate rose to a five-year high as the economy lost more jobs than forecast in August. The report underscored concerns that U.S. consumer spending will weaken and push the American economy into a recession.

Economists expect annualized rates of growth of 1 percent in the third quarter and 0.4 percent in the fourth quarter, according to the median estimate in a Bloomberg Survey in early August.
Fed Chairman Ben S. Bernanke said on Aug. 22 that financial turmoil has ``not yet subsided,'' and is contributing to weaker growth and higher unemployment. Policy makers will ``continue to review'' the Fed's measures to ensure liquidity to determine ``if they are having their intended effects,'' Bernanke said.

``Changes are going to have to be made'' to the global financial system, Volcker said. Banks three decades ago accounted for about 60 percent of U.S. credit; that later declined to about 30 percent as securitization -- where financial firms package assets into bonds and other instruments and sell them on to investors and other companies -- spread.

Volcker said he agreed with descriptions of the current financial system as ``dysfunctional. That is a polite way of saying it failed.'' The U.S. government, not the Fed, should take the lead in rescuing any financial institutions when ``push comes to shove,'' he said, echoing comments by former Fed Chairman Alan Greenspan.

The Fed rescued Bear Stearns Cos. from bankruptcy in March, facilitating the firm's merger with JPMorgan Chase & Co. by loaning against $29 billion of Bear securities. Bernanke has also made central bank loans available to nonbanks for the first time since the 1930s and lowered the rates at which banks can borrow from the Fed.

Monday, July 14, 2008

US Mortgage Bailout

Fannie Plan a `Disaster' to Rogers; Goldman Says Sell (Update2)
By Carol Massar and Eric Martin

July 14 (Bloomberg) -- The U.S. Treasury Department's plan to shore up Fannie Mae and Freddie Mac is an ``unmitigated disaster'' and the largest U.S. mortgage lenders are ``basically insolvent,'' according to investor Jim Rogers.

Taxpayers will be saddled with debt if Congress approves U.S. Treasury Secretary Henry Paulson's request for the authority to buy unlimited stakes in and lend to Fannie Mae and Freddie Mac, Rogers said in a Bloomberg Television interview. Goldman Sachs Group Inc. analyst Daniel Zimmerman predicted the mortgage finance companies' shares may fall another 35 percent.

``I don't know where these guys get the audacity to take our money, taxpayer money, and buy stock in Fannie Mae,'' Rogers, 65, said in an interview from Singapore. ``So we're going to bail out everybody else in the world. And it ruins the Federal Reserve's balance sheet and it makes the dollar more vulnerable and it increases inflation.''

The chairman of Rogers Holdings, who in April 2006 correctly predicted oil would reach $100 a barrel and gold $1,000 an ounce, also said the commodities bull market has a ``long way to go'' and advised buying agricultural commodities.

Rogers, a former partner of hedge fund manager George Soros, predicted the start of the commodities rally in 1999 and started buying Chinese stocks in the same year. He traveled the world by motorcycle and car in the 1990s researching investment ideas for his books, which include ``Adventure Capitalist'' and ``Hot Commodities.''

Stocks Rise
Fannie Mae and Freddie Mac each surged more than 20 percent in pre-market trading today after Paulson moved to stem a collapse in confidence in the two companies that purchase or finance almost half of the $12 trillion in U.S. home loans.

``These companies were going to go bankrupt if they hadn't stepped in to do something, and they should've gone bankrupt with all of the mistakes they've made,'' Rogers said. ``What's going to happen when you Band-Aid and put some Band-Aids on it for another year or two or three? What's going to happen three years from now when the situation's much, much, much worse?''

Freddie Mac rose 22 cents, or 2.8 percent, to $7.97 at 10:13 a.m. in New York Stock Exchange trading, while Fannie Mae rose 73 cents, or 7.1 percent, to $10.98. Paulson's proposal, which the Treasury anticipates will be incorporated into an existing congressional bill and approved this week, signals a shift toward an explicit guarantee of Fannie Mae and Freddie Mac debt.
The Federal Reserve separately authorized the firms to borrow directly from the central bank.
Last Week's Slump

Washington-based Fannie Mae slid 45 percent last week, while McLean, Virginia-based Freddie Mac sank 47 percent on concern they may require a bailout that would wipe out shareholders.
Former St. Louis Federal Reserve President William Poole last week said in an interview that Freddie Mac is technically insolvent under fair value accounting, which measure a company's net worth if it had to liquidate all its assets to repay liabilities. Poole said Fannie Mae may also become insolvent this quarter.

Goldman's Zimmerman said today the U.S. government's plan to rescue Fannie Mae and Freddie Mac won't benefit shareholders. He lowered his share-price estimate for Fannie Mae to $7 from $18 and for Freddie Mac to $5 from $17.

Rogers said he had not covered his so-called short positions in Fannie Mae and would increase his bet if it were to rally. Short sellers borrow stock and then sell it in an effort to profit by repurchasing the securities later at a lower price and returning them to the holder.

The U.S. economy is in a recession, possibly the worst since World War II, Rogers said.
``They're ruining what has been one of the greatest economies in the world,'' Rogers said. Bernanke and Paulson ``are bailing out their friends on Wall Street but there are 300 million Americans that are going to have to pay for this.''

Friday, April 18, 2008

Behind the Food-Price Riots

From the Wall Street Journal: By VINCENT REINHART, April 18, 2008

With a dramatic rise in the prices of foodstuffs, riots have flared up in dozens of hotspots around the world. Panicky politicians are responding with precisely the wrong policies, including production subsidies and trade controls.

The problem is clear enough: According to the International Monetary Fund, food and beverage prices have risen 60% in the past three years, and more than doubled since 2001. Even in the U.S., increases in the food-price component of producer- and consumer-price indexes over the last 12 months have been in the neighborhood of 5%.

What is going on? We can discern four forces at work today pushing up food prices – forces that were also at work in the 1970s, the last time food prices increased so rapidly on a sustained basis:

- Monetary policy in overdrive. Consider the real federal funds rate – that is, the nominal funds rate less inflation. A low real fed funds rate both encourages interest-rate sensitive spending, such as business investment, and discourages global investors from supporting the dollar on foreign exchange markets. At 2.25%, the nominal fed funds rate is now below the prevailing rate of consumer price inflation.

The last time the real fed funds rate was negative for a prolonged period was the mid-1970s. This was also a period when overstimulated demand pushed food prices up and the dollar depreciated sharply. In the end, economic growth suffered as well. Remember stagflation?

- Exchange-rate arrangements in disarray. The 1970s were also noted for turmoil in exchange markets, following the breakdown of the Bretton Woods system. The schism today is that some exchange rates move too little and others too much.

The exchange rates that are moving too little are those of emerging market economies and oil producers. China, India, Korea and Taiwan, and key oil producers such as Saudi Arabia, have been preventing their exchange rates from appreciating significantly by rapidly accumulating international reserves.

They've also effectively adopted the monetary policy of the Federal Reserve by keeping their domestic interest rates close to the fed funds rate. That way, no interest-rate wedge opens between their markets and our own that would otherwise put pressure on their exchange rate. As a consequence, they are following an accommodative monetary policy strategy totally unsuited to their already overheated domestic economies. Higher inflation has followed.

With exchange-rate movements capped by policy makers in so many parts of the world, the burden of adjustment falls more heavily on the nations that allow their currencies to float freely, such as Canada, those in the Euro area, and Japan. The depreciation of the dollar against these currencies is yet another reminder of the 1970s. As a result of these exchange-rate changes, the purchasing power of these regions for any internationally traded good denominated in dollars has gone up. Hence, it is no accident that the dollar price of food is up sharply.

- Unsound market interventions. Policy makers flailed about in the 1970s, enacting environmental legislation without due deference to the costs imposed on industry. They also tried to impede market forces with gasoline rationing and a brief flirtation with outright price controls.

This time round, our government has been force-feeding the inefficient production of ethanol. The result: Corn prices have more than doubled over the past three years, adding to price pressures on commodities that are close substitutes, or which use corn as an input to production.
Meanwhile, policy makers in emerging market economies have bent under the weight of popular unrest to raise food subsidies. This strains their budgets. They are also imposing restraints on exports, thereby losing gains from trade.

- Oil prices on the rise. The lines stretching around filling stations in the 1970s should remind us that large energy-price increases are disruptive. And we have had a large one: Crude prices have more than quadrupled since 2001. Any industry dependent on energy will feel those cost pressures, and modern agriculture, with its oil-based fertilizers and large machinery, is no exception.

But there is an important difference between our troubles today and those of the 1970s. In that decade, aggregate supply sagged as oil producers scaled back production and anchovies disappeared off the coast of Peru. The 2000s have been about demand expansion. Millions of workers in China, India and Vietnam, among others, have joined the world trading system. Beginning from a point close to subsistence, most of their additional income is being spent on food. Thus, the price of food relative to other goods and services has risen.

The good news is that producers respond to relative prices, although it can take some time. Already, the acreage in which corn is planted in the United States is back to levels of the 1940s. More of a production response should follow in other areas as well.

Challenges abound as supply catches up with higher global demand. The Federal Reserve has to be sensitive not to stoke inflation pressures, and to monitor inflation expectations closely. The subsidies proffered to corn producers have to be trimmed, in part to set a new standard for emerging market economies to emulate. And the gains from an open trading system have to be protected to keep our economy efficient.

Mr. Reinhart, a resident scholar at the American Enterprise Institute, was director of the Division of Monetary Affairs at the Federal Reserve.

Here is a Canadian perspective on inflation.

Wednesday, December 12, 2007

Cash Injection - Hello Inflation


By HEATHER SCOFFIELD Globe and Mail Update December 12, 2007 at 12:29 PM EST

OTTAWA — The world's major central banks, including the Bank of Canada, are launching a rare coordinated action to calm global credit markets and smooth out transactions over the end of the year.

The Bank of Canada, the U.S. Federal Reserve, the European Central Bank, the Bank of England and Switzerland's central bank made a joint announcement Wednesday, saying they were taking coordinated measures “designed to address elevated pressures in short-term funding markets.”

Investors applauded what was yet another step to deal with a severe credit crunch stemming from the tightening of bank lending standards. The Dow Jones industrial average was up by more than 100 points in midday trading, after rising more than 270 points in early trading, while the S&P/TSX composite index gained more than 120 points.

“At the very least these measures should tide the markets over the potentially awkward New Year period, and hopefully well into 2008 as well,” Capital Economics said in a research note. “They do not address the underlying imbalances threatening the world economy – notably the impact the U.S. housing slump will still have via conventional economic channels – but they should at least reduce the risk that the credit crunch tips economies into recession.”

For its part, the Bank of Canada will inject liquidity into short-term money markets, something it has resisted doing over the past few months despite widening spreads in short-term debt markets.

To date, the Canadian central bank has only concentrated on injecting liquidity into the overnight market to defend its target interest rate, which stands at 4.25 per cent. But spreads on credit for terms longer than overnight have been high and widening recently.

The central bank will enter into purchase and resale agreements with banks Thursday to the tune of $2 billion, followed by a minimum of $1 billion next Tuesday.

The Bank of Canada will also expand its list of collateral, something financial institutions have been begging the central bank to do for months.

Acceptable collateral for the term liquidity includes Government of Canada bonds and bonds guaranteed by the government, such as Canada Mortgage Bonds and securities backed by provincial governments, and bankers' acceptances and bearer deposit notes.

The Bank of Canada also said it would begin in March to accept some kinds of asset-backed commercial paper, or ABCP, as collateral for borrowing from its standing liquidity function, a pool from which banks can borrow at the bank rate, on an overnight basis, to help deal with temporary liquidity problems in their settlements.

To be accepted as collateral, the ABCP can not be the type that froze Canadian markets in August. Rather, it must be backstopped under global rules, not looser Canadian rules, the central bank said.

The fact that the Canadian central bank is taking measures it has resisted to date — making plans to accept ABCP as collateral, getting involved in term lending, and being more lenient in the collateral it accepts – suggests grave and urgent concern on the part of the central bank.

And the fact that it is coordinating credit-oriented action with other central banks suggests problems are deep and widespread, heading to a climax as the year draws to a close and demand for liquid cash spikes.

The liquidity measures are aimed at flooding money markets with extra readily-available cash at a price lower than the market is demanding now. The measures are meant to drag spreads back to more normal levels, and instill confidence in the markets.

While each central bank's measures may seem modest taken on their own, they are impressive if taken together and should be effective, said Mark Chandler, fixed income strategist at RBC Capital Markets.

“It's coordinated with monetary policy and it's coordinated with central banks, and it shows that they're listening,” he said.

Markets balked yesterday when the U.S. Federal Reserve cut its key rate by just a quarter of a percentage point, feeling the Fed was not sufficiently recognizing the pain felt from the credit crunch.

The Fed's response makes more sense now, with the news that it is coordinating with central banks to inject liquidity, Mr. Chandler said.

The action comes alongside interest rate cuts by the Fed, the Bank of Canada and the Bank of England, he pointed out, and as a package should ease problems in debt markets.

Mr. Chandler said it is wise for central banks to work together, since the problem of widening spreads in credit markets is globalized – more expensive borrowing conditions in one country has sent borrowers scurrying to other countries in search of better rates. But the pressure of their demand made for more expensive borrowing in other countries too.

So a problem in England quickly became a problem in Canada and the United States.
“We've all been fighting for the same thing, which is a pool of liquidity,” Mr. Chandler said.
That pool is now larger and easier to access.

In a statement timed to occur before the start of trading, the Fed said it planned to offer $40 billion (U.S.) in emergency funds to banks next week through an auction process.

The Fed said that it was creating a temporary auction facility to make funds available to banks and was also setting up lines of credit with the European Central Bank and the Swiss Central Bank that could be used for additional resources.

The first two auctions of $20 billion each will be next week on Dec. 17 and Dec. 20.
Analysts said the use of auctions to try to get more money into the banking system was an acknowledgment that efforts to spur direct loans from the Fed to banks through the Fed's discount window had not worked as well as hoped because of banks' fears that investors could become worried if they started utilizing the Fed's discount window to any large extent.

The Fed said it was also setting up lines of credit with the European Central Bank and Swiss Central Bank that could be used for additional resources.

The Fed said the new auction process should “help promote the efficient dissemination of liquidity” when other lines of credit were “under stress.”

It said that the temporary swap arrangements being set up would provide up to $20 billion in reserves for the European Central Bank and up to $4 billion for the Swiss National Bank. The reserves would be available for up to six months.

Since the global credit crunch hit with force in August, central banks have been injecting massive amounts of money into the banking system in an effort to keep credit flowing.

However, those efforts have only been partially successful. Many businesses and consumers report rising trouble in obtaining loans as banks become more fearful about extending credit in the wake of a surge in bad loans stemming from the U.S. housing crisis.

But I thougth these problems were contained to the United States and only affected a few deadbeat borrowers called subprime!?!?!

Check out Calculated Risk on this topic.
Or Floyd Norris' comments at the NY Times.

Monday, September 17, 2007

Greenspan alert on US house prices

Hello Everybody,

Sorry for having fallen off the face of the Earth lately. I'll try to be more reliable now that the rain seems to have come back.

This is a slightly cheap post, but I think an important one. In yesterday's Financial Times Alan Greenspan had some of the following choice comments:


US house prices are likely to fall significantly from their present levels

...the decline in house prices “is going to be larger than most people expect”.


He said the price of risk had fallen to unsustainably low levels beforehand, with investors addicted to asset-backed securities that offered some additional yield over Treasury bonds as if they were “cocaine”.


Interesting that Greenspan is finally acknowledging a situation he helped create. We also pick up this tidbit:

As Fed chairman, Mr Greenspan had talked about “froth” in the housing sector, but never said there was a bubble in the market as a whole. His successor Ben Bernanke has also avoided the word “bubble”.


But Mr Greenspan told the FT that froth “was a euphemism for a bubble”.


He said he still thought froth – a collection of bubbles – was a better description, because of the variation in house price appreciation in different local housing markets. But he said “all the froth bubbles add up to an aggregate bubble”.

Friday, August 10, 2007

Credit Crunch



By credit crunch I don't mean some new breakfast cereal or chocolate bar, I mean the sudden unwillingness of people to buy junky mortgage debt thus causing a 'liquidity problem.'

It sure looks like I have missed an interesting week in the markets. My vacation will be nice for a couple more days though so I'll provide more next week. Thanks for that interesting post on construction quality M-, very insightful.

Tuesday, July 17, 2007

Inflation - Different Schools of Thought

Inflation, as most people generally interpret it, is "a persistent rise in the general price level, as measured against a standard level of purchasing power." This is currently the way that inflation is measured in North America and subsequent attempts on controlling it are based on these measurements. In Canada, when referring to inflation, we reference CPI, or Consumer Price Inflation. The Bank of Canada attempts to keep CPI in a range of between 2% and 3% through controlling the overnight lending rate or "prime rate" and this policy meets with some success.

"Mainstream economists' views of the causes of inflation can be broadly divided into two camps: the "monetarists" who believe that monetary effects dominate all others in setting the rate of inflation, and the "Keynesians" who believe that the interaction of money, interest and output dominate over other effects. Keynesians also tend to add a capital goods (or asset) price inflation to the standard measure of consumption goods inflation. Other theories, such as those of the Austrian school of economics, believe that inflation is caused by an increase in the supply of money by central banking authorities."

The thought I wanted to put forward today is this: What if the current Keynesian view and approach is faulty? What if inflation is more accurately termed as the Austrian school view it as an increase in the supply of money by central banking authorities? If this is true, what would we observe?


To illustrate I've put together a chart comparing recent Consumer Price Inflation with the Bank of Canada M3 total Money Supply. The question I have is: Where does the money go once it is created? Consumer goods? Homes? Cars? Stocks? Equipment?

Sunday, July 15, 2007

Why does micro-credit work?



If you have never heard of micro-credit and its current impact around the world I suggest you watch the video. Let us know what you think and if you think it works - get involved. Mohican supports http://www.opportunityinternational.ca/ and so does Bill Gates. Here is a letter from Bill and Melinda Gates.

Every day, more than 1,000 children die because they didn’t get a 15-cent measles vaccine. Almost 3 billion people around the world live on less than $2 per day. Here in the United States, only one-third of the students who start the ninth grade will graduate from high school with the skills they need to succeed in college and work. A disproportionate number of those who fall behind will be African American and Hispanic.

Our foundation and our partners are trying to solve these problems because we believe that all lives have equal value, no matter where they are being lived—in rich countries with high-quality health care or poor countries with almost none; in well-off suburbs with shiny new high schools or in disadvantaged communities where most kids drop out.

We also believe that from those to whom much is given, much is expected. We benefited from great schools, great health care, and a vibrant economic system. That is why we feel a tremendous responsibility to give back to society.

Starting from these core values, our foundation is guided by some key principles.

First, we concentrate on a few areas of giving so we can learn about the best approaches and have the greatest possible impact. We choose these issues by asking: which problems affect the most people, and which have been neglected in the past?

Our Global Health Program focuses on diseases and health conditions that cause the most illness and death and receive the least attention and resources—diseases such as tuberculosis and malaria that barely exist in rich countries but still kill millions in the developing world. And AIDS, which infects 5 million new people every year, the vast majority of them in poor countries.

We also believe in the power of science and technology to improve people’s lives. In recent years, the world has made tremendous advances in fields ranging from biology to information technology, and yet not everybody is benefiting from these innovations. Our goal is to help apply science and technology to the problems of the neediest people.

As an example, our Global Development Program works with an organization called Opportunity International on a relatively simple technology that is helping women in Malawi save their children from destitution. In Malawi, life expectancy is about 37 years. When a man dies, his parents and siblings often seize his possessions and his money, leaving his wife and children with nothing.

Opportunity International helps by distributing “smart cards.” These cards are similar to our ATM cards, and they let women keep money in super-secure savings accounts that are protected by a thumbprint scanner. Only the cardholder herself can access the account, using her unique thumbprint. Smart cards have become so popular in Malawi that they’re now regularly given as gifts at wedding showers.

Finally, our foundation is deeply committed to the importance of partnerships. All of the issues we’re tackling will require the talents and resources of many people and many different organizations.

To effect lasting change, we must collaborate with governments, business, and other nonprofit organizations. Our work with high schools in the United States, for instance, involves dozens of partners, from grass-roots community organizations all the way up to national policymakers. Changing high schools will require the efforts of parents, teachers, school administrators, school districts, a range of organizations devoted to school reform, and government leaders at every level. We need this kind of coordinated approach to make sure we prepare every child for college, work, and citizenship.

These are just some of the ways we think about the work we do. We are optimistic about the future. We were deeply gratified by the gift Warren Buffett gave our foundation in June 2006, which will allow us to roughly double our grantmaking starting in 2009. Warren’s incredible gift inspires us and makes us even more aware of the opportunity and deep responsibility we have to make a lasting impact for people in need.

Some of the problems we work on already have solutions, and our focus needs to be on getting those solutions into the hands of the people who need them most. Other problems have never been given the attention they deserve, and we believe focused efforts can lead to amazing advances. The challenges we face are great, but so is the opportunity to improve people’s lives.

Bill Gates
Melinda French Gates