Lessons from Iceland’s Economic Recovery?

The Rocky Road to Globalization

Iceland recovered from the 2008 financial crisis by taking certain measures.  Is there anything to be learned from their example?

Karen Hammer writes:  Iceland has rebounded after the 2008/9 crisis and will soon surpass pre-crisis output levels with strong performance in tourism and fisheries. Debt ratios are on a downward path and balance sheets have broadly been restored. The financial sector is back on track though with some important items remaining on the docket.

In an interview with IMF Survey, Peter Dohlman, IMF Mission Chief for Iceland, explained what sets Iceland apart from other countries having experienced the financial crisis.

IMF Survey: Iceland was in a state of collapse in 2008 but is now back on its feet and has become a success story. Can you give us a sense of Iceland’s economic picture today?  

Dohlman: Overall, macroeconomic conditions in Iceland are now at their best since the 2008/9 crisis. Iceland has been one of the top economic performers in Europe over the past several years in terms of economic growth and has one of the lowest unemployment rates. A particular bright spot for Iceland has been the booming tourism industry, which has also contributed to a strong current account surplus.

Other indicators of Iceland’s successful trajectory are its low inflation, stable exchange rate, and ready market access. Iceland’s strong balance of payments has allowed it to repay early all of its Nordic loans and much of its IMF loans while maintaining adequate foreign exchange reserves.

There are of course some important remaining vulnerabilities and risks. Public and external debt ratios are still high, though on a downward sustainable path. The prospect of funds exiting quickly and disrupting external stability in the absence of capital controls is still a potential and important vulnerability. Downside risks emanate from significant wage pressures and an uncertain external environment, including risks of slower demand and deflationary pressures from trading partners.  IMF Survey Iceland’s Recovery

Iceland's Recvoery

 

Bank Equity Requirements Up. Size of Banks May Be Up Too

Equity requirements upped for banks and questions about the size of banks subject to US Fed regulation.

The largest U.S. banks would face a $120 billion total shortfall of long-term debt under a Federal Reserve proposal aimed at ensuring their failure wouldn’t hurt the broader financial system.

Banks such as Wells Fargo & Co. and JPMorgan Chase & Co. will be required to hold enough debt that could be converted into equity if they were to falter, according to a Fed rule that was approved by a unanimous vote on Friday. The Fed’s proposal, which applies to eight of the biggest U.S. banks, requires debt and a capital cushion equal to at least 16 percent of risk-weighted assets by 2019 and 18 percent by 2022.

Ian Katz writes: The broad strokes of the proposal, including the lengthy phase-in period and the 18 percent target instead of what some bankers thought could be as high as 20 percent, are easier than many in the industry expected.

The proposal, along with other measures regulators have taken to avoid chaotic bank failures, “would substantially reduce the risk to taxpayers and the threat to financial stability stemming from the failure of these firms,” Fed Chair Janet Yellen said in a statement. The plan “is another important step in addressing the ‘too big to fail’ problem,” she said.

The rule on total loss-absorbing capacity, or TLAC, is a key part of regulators’ efforts to avoid another financial crisis. If U.S. banks were to fail, investors in their stock would lose everything, but the debt would be converted into equity in a new, reconstituted bank under the plan. It’s an element of the so-called living wills banks must submit to the Fed and Federal Deposit Insurance Corp. each year to map out their hypothetical demise.

The reason for the provision: When a bank fails, regulators want it to have a war chest to fund a new, healthy version of the company — hopefully without a dime from taxpayers.

Wells Fargo had been perceived as facing the toughest road under the rule because of its reliance on deposits rather than debt.

Jaret Seiberg, an analyst at Guggenheim Securities LLC, said in a research note that the Fed “passed up several opportunities to be even more onerous.”

The Financial Stability Board, a group of global regulators that makes recommendations to the Group of 20 nations, plans to phase in a TLAC rule requiring long-term debt of at least 16 percent of risk-weighted assets starting in 2019 and 18 percent by 2022.

The Fed also approved mandatory levels of minimum long-term debt, which vary depending on how large and complex the banks are.

Since the financial crisis, the Fed has consistently written rules that have been more stringent than global regulatory accords on capital and liquidity.

Banks are now subject to regulation if they have $50 billion in assets.  Banks have asked to up this to $500 billion.  The Fed set new requirements to help protect against bank failures;  “The final rule establishes a number of enhanced prudential standards for large U.S. bank holding companies and foreign banking organizations to help increase the resiliency of their operations. These standards include liquidity, risk management, and capital. It also requires a foreign banking organization with a significant U.S. presence to establish an intermediate holding company over its U.S. subsidiaries, which will facilitate consistent supervision and regulation of the U.S. operations of the foreign bank. The final rule was required by section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.”  from the US Fed.

Bank Regulation?

 

Balance Between Criminal Charges in Banking and Fines?

The Rocky Road to Globalization

French companies are complaining that they pay huge fines to the US government when they do not comply with American law, but that France is not benefitting by reciprocal fines.  In the US, the policy has been to exact fines, big by the ordinary citizen’s standards, but the cost of doing business for most corporations.  There are no crimes charged.

Only when Credit Suisse was forced to plea one criminal charge as citizens and some lawmakers joined the hue and cry against big banks’ seeming immunity.  Promises made by the SEC and the Department of Justice helped the Swiss bank accept the charge.  They must have been told that the bank would not loose its 2 billion dollar pension business in the US if they pleased guilty.

US Representative Maxine Waters and Senator Elizabeth Warren demanded that the US Labor Department justify its exemption for Credit Suisse, enabling the bank to continue its pension business in the US despite its criminal status.

Hearings were held last January 15th.  Testimony about Credit Suisse’s corrupt culture was given by important people in finance around the globe.

The outcomeL  Instead of granting the ten-year exemption Credit Suisse had applied for, they were given a five-year exemption.  The criminal plea counted for almost nothing.

Do we want laws on the books that are not enforced?  Why exact a criminal plea if it is not enforced?   ANd where do these monies the government collects go?

Jail Bankers?

 

 

Special Drawing Rights for Renminbi?

The IMF will add the renminbi to its Special Drawing Rights basket today.

Matt Levine writes about how China fulfilled the IMF’s two requirements:
The staff’s findings hinged on the renminbi meeting two criteria. The first is that China and the renminbi have a significant role in global trade, a bar which Beijing passed years ago. But the second — that the renminbi be both widely used and “freely usable” internationally — has proved more contentious.

In a number of the measures that ascertain how widely it is used — such as its use in central bank foreign exchange reserves and in international debt markets — the renminbi fell below the Australian and Canadian dollars, neither of which is a member of the SDR basket.

Operational and free-usability issues remain, but on the other hand I suppose nothing will encourage Chinese currency liberalization like SDR inclusion. That

The inclusion puts new pressure on Beijing to change everything from how it manages the yuan, also known as renminbi, to how it communicates with investors and the world. China’s pledges to loosen its tight grip on the currency’s value and open its financial system will come under new scrutiny.

A working group that includes former Treasury secretaries Henry Paulson and Timothy Geithner hopes to build a framework for the trading and clearing of the Chinese currency in the U.S., the Wall Street Journal reported Monday, citing a statement from Michael Bloomberg, who will chair the group.

Remninbi

 

Iceland’s Economic Recovery?

Islandic Horse ToltSabina Zawadzki writes:  Iceland, whose spectacular 2008 meltdown came to symbolize the greed and mismanagement of the global financial system, is expected to begin unwinding the bankruptcies of its three main banks and lifting controls on the movement of capital in and out of the island within months.

For Iceland, these moves will signal rehabilitation and a return to the international financial community after the collapse of a banking system which at one time held assets worth a staggering ten times the nation’s gross domestic product.

The collapse infuriated some European countries which were left on the hook for billions of dollars in compensation to depositors in failed Icelandic banks, and left Iceland shunned by Western nations in its hour of need.

At the low point in October 2008, Britain used anti-terrorism legislation against the country – forcing international bankers to pick up their bags in the middle of crisis meetings and head to the airport.

Now, Iceland hopes that by finally lifting capital controls it can draw a line under the crisis, restore its credit rating, lower its borrowing costs, boost its economy and revive the living standards of its 330,000 people. But to do so, it must find a way to let investors withdraw funds without provoking a catastrophic stampede.

Officials say they will put rules in place to ensure a managed, not free, float of the currency. The government is considering taxing the removal of cash to prevent an exodus. And it will clip the wings of domestic banks to make sure a similar crisis can never happen again.

“We’re talking here about the third largest bankruptcy in the history of mankind being unwound in one of the smallest countries,” the country’s central bank governor, Mar Gudmundsson, told Reuters in a recent interview in Reykjavik.

“That is just a huge complication in its own right so we shouldn’t be surprised that it is taking some time,” he said.  Iceland’s Economic Recovery

Iceland's Economic RecoveryCentral Bank of Iceland

Emerging from Low Interest Rates: US 1994

How does a central bank normalize monetary policy after a long spell of unusually low interest rates? This may seem like a question very much of the present, as Fed leaders ponder interest-rate policy following the Great Recession of 2007- 2009 and the tepid U.S. recovery. But it’s also a challenge the Fed confronted two decades ago. In 1994, the Federal Open Market Committee (FOMC) wrestled with a similar dilemma as it considered emerging from a sustained period of low interest rates, amid signs of a reviving economy, growing aggregate demand, and no obvious signals of inflation.

The Richmond Fedeal Reserve reports Emerging from Low Interest Rates

Low Interest Rates

Esteves, Better Than Goldman, Gets a CarWash

The Petrobras scandal has widened to indict Andre Esteves, who claims he is better than Goldman Sachs bankers.

The chief executive of Brazil’s largest independent investment bank and a powerful ruling party senator were arrested early Wednesday as part of an investigation into a massive corruption scandal at state-controlled oil company Petróleo Brasileiro SA.

Authorities in Brasília arrested Sen. Delcídio do Amaral, a member of the governing Workers’ Party and the Senate whip, whose help is seen as critical for President Dilma Rousseff to pass unpopular austerity measures to shore up Brazil’s shaky finances.

Prosecutors say the two men were conspiring to pay millions in bribes to a key witness in the Petrobras investigation, then spirit him out of Brazil on a private jet to prevent him from turning state’s evidence that could implicate them in the sprawling graft scheme.

The arrests were stunning even by the standards of Brazil’s biggest-ever corruption probe, which has toppled elites at the highest levels of the nation’s business and government. The developments are yet another blow to Ms. Rousseff, whose popularity has plummeted as Brazil’s economy has deteriorated and her party, known as the PT, has become mired in the scandal.

Through his attorney, Mr. Esteves denied wrongdoing. Mr. Amaral’s lawyer said his client is fighting the charges against him.

Messrs. Esteves and Amaral were taken into custody on suspicion they were trying to stop a former Petrobras executive, Nestor Cerveró, from cutting a plea bargain with prosecutors and providing testimony that would link the men with the corruption scandal, according to Brazil’s Supreme Court, which authorized the arrests.

Mr. Cerveró is accused of taking bribes in exchange for awarding supplier contracts as part of a massive graft ring that operated at Petrobras for more than a decade. Court documents portray the efforts by Messrs. Esteves and Amaral to free Mr. Cerveró from custody.

At a November meeting at an upscale Brasília hotel, Mr. Amaral met with Mr. Cerveró’s son, Bernardo Cerveró and two other men to discuss ways to free Mr. Cerveró from prison and have him flee the country, according to the documents.

According to the documents, Mr. Amaral proposed using a legal maneuver to secure Mr. Cerveró’s release from prison while he awaits trial.

Supreme Court Justice Teori Zavascki said that Mr. Amaral “is part of a criminal organization,” citing the senator’s alleged participation in “an escape plan” that could jeopardize the corruption probe known as Operation Car Wash.

The court documents didn’t expressly indicate a link between BTG and the investigation.

But Brazilian authorities have been investigating BTG’s $1.5 billion purchase of a 50% stake in the African operation of Petrobras in 2013 following allegations that the price paid the bank may have been too low.

BTG also is a major investor in troubled oil rig supplier Sete Brasil Participações SA, which also was ensnared in the Operation Car Wash investigation.

Mr. Esteves’s arrest is a dramatic setback for one the nation’s best-known financial executives. One of Brazil’s richest men, Mr. Esteves, 46, has a net worth estimated at $2.1 billion, according to Forbes.

Mr. Esteves quickly developed a reputation for innovative deal making and built BTG into Brazil´s largest independent investment bank, with 245 partners and 3,500 employees. The bank manages about $112 billion and has offices in 20 countries.

 

Curbing the Tentacles of the Big Banks

The Federal Reserve is on the verge of relinquishing the tools it used to rescue American International Group Inc. and Bear Stearns Cos. That probably won’t appease lawmakers who’ve said they’re still concerned the central bank might abuse its powers as the lender of last resort.

After the Fed released an initial proposal almost two years ago, a bipartisan group of lawmakers including Democratic Senator Elizabeth Warren complained that it didn’t go far enough and left regulators too much wiggle room to orchestrate a backdoor bailout that violates the intent of Congress. Yellen, testifying before a House panel this month, rejected the idea that the Fed should relinquish its role as potential savior in a crisis.

Warren and other lawmakers argue the expectation that the Fed will rescue failing banks, incentivizes reckless behavior on Wall Street. Lawmakers also are trying to shrink the number of banks that receive heightened supervision from the Fed and are threatening to boost Congress’ authority over the Federal Reserve Bank of New York, which oversees giant U.S. lenders such as JPMorgan Chase & Co. and Citigroup Inc.

Before Dodd-Frank, the central bank had the authority “in unusual and exigent circumstances” to lend to virtually any company or person, thanks to section 13(3) of the Federal Reserve Act. In March 2008, the Fed, then led by Ben S. Bernanke, used that power to extend credit to Bear Stearns through JPMorgan, which acquired the failing securities firm. Six months later the Fed began a bailout program to keep insurer AIG afloat.
Now the Fed is prohibited from rescuing individual firms, but Dodd-Frank permits the central bank to provide “broad-based” liquidity to the financial system if it gets the approval of the Treasury secretary. Though Dodd-Frank laid out the basic emergency lending restrictions, the Fed has to write the policies and procedures.

The lawmakers urged the Fed to revise its proposal to establish both clear time limits for how long banks could receive emergency lending and procedures for the orderly unwinding of such programs. They asked Yellen to improve how the Fed defines terms such as insolvent and broad-based. To prevent the so-called moral hazard associated with the Fed’s lending authority, the group requested that any emergency loans be made at unfavorable, or penalty, interest rates.

Yellen has indicated that she might partly, but not entirely, appease the politicians. The Fed expects to release the final rule by the end of November and will address “concerns about the definition of broad-based eligibility, insolvent borrowers, and penalty rates,” she told the House panel. She didn’t discuss the lawmakers’ other requests.  Yellen also must contend with Republican efforts led by Shelby to limit the Fed’s authority. Legislation he drafted that would reduce Fed oversight of regional banks, including eliminating stress tests for many of them, was added to a spending bill that Congress must pass next month to avert a federal government shutdown.

Tentacles of the Big Banks

US Fed and Interest Rate Liftoff

Is the US Fed making accurate assessments of its interest rate policies?


Barry Eichengreen writes: For much of the year, investors have been fixated on when the Fed will achieve “liftoff” – that is, when it will raise interest rates by 25 basis points, or 0.25%, as a first step toward normalizing monetary conditions. Markets have soared and plummeted in response to small changes in Fed statements perceived as affecting the likelihood that liftoff is imminent.

But, in seeking to gauge changes in US monetary conditions, investors have been looking in the wrong place. Since mid-August, when Chinese policymakers startled the markets by devaluing the renminbi by 2%, China’s official intervention in foreign-exchange markets has continued, in order to prevent the currency from falling further. The Chinese authorities have been selling foreign securities, mainly United States Treasury bonds, and buying up renminbi.

This is the opposite of what China did when the renminbi was strong. Back then, China bought US Treasury bonds to keep the currency from rising and eroding the competitiveness of Chinese exporters. As a result, it accumulated an astounding $4 trillion of foreign reserves.

And what was true of China was also true of other emerging-market countries receiving capital inflows. These countries’ foreign reserves, mainly held in US securities, topped $8 trillion at their peak last year.

The effects of these purchases attracted considerable attention.  Although no one outside official Chinese circles knows the exact magnitude of China’s foreign-exchange intervention, informed guesses suggest that it has been running at roughly $100 billion a month since mid-August. Observers believe that roughly 60% of China’s liquid reserves are in US Treasury bills. Given that reserve managers prefer to avoid unbalancing their carefully composed portfolios, they probably have been selling Treasuries at a rate of roughly $60 billion a month.

The effects are analogous – but opposite – to those of quantitative easing. Menzie Chinn of the University of Wisconsin has examined the impact of foreign purchases and sales of US government securities on ten-year Treasury yields. His estimates imply that foreign sales at a rate of $60 billion per month raise yields by ten basis points. Given that China has been at it for 2.5 months, this implies that the equivalent of a 25-basis-point increase in interest rates has already been injected into the market.

Some would object that the renminbi is weak because China is experiencing capital outflows by private investors, and that some of this private money also flows into US financial markets. This is technically correct, but it is already factored into the changes in interest rates described above.

Another objection is that QE operates not just through the so-called portfolio channel – by changing the mix of securities in the market – but also through the expectations channel. It signals that the authorities are seriously committed to making the future different from the past. But if Chinese intervention is just a one-off event, and there are no expectations of it continuing, then this second channel shouldn’t be operative, and the impact will be smaller than that of QE.

The problem is that no one knows how long capital outflows from China will persist or how long the Chinese authorities will continue to intervene.

Interest rates?

What Pressures Are Suppressing Inflation?

Stephen S. Roach writes:  Fixated on inflation targeting in a world without inflation, central banks have lost their way. With benchmark interest rates stuck at the dreaded zero bound, monetary policy has been transformed from an agent of price stability into an engine of financial instability. A new approach is desperately needed.

The US Federal Reserve exemplifies this policy dilemma. After the Federal Open Market Committee decided in September to defer yet again the start of its long-awaited normalization of monetary policy, its inflation doves are openly campaigning for another delay.

For the inflation-targeting purists, the argument seems impeccable. The headline consumer-price index (CPI) is near zero, and “core” or underlying inflation – the Fed’s favorite indicator – remains significantly below the seemingly sacrosanct 2% target. With a long-anemic recovery looking shaky again, the doves contend that there is no reason to rush ahead with interest-rate hikes.

The Fed’s presumption that the US will soon approach full employment has caused the so-called dual mandate to collapse into one target: getting inflation back to 2%.

Here, the Fed is making a fatal mistake, as it relies heavily on a timeworn inflation-forecasting methodology that filters out the “special factors” driving the often volatile prices of goods like food and energy.

This approach failed spectacularly when it was adopted in the 1970s, causing the Fed to underestimate virulent inflation. And it is failing today, leading the Fed consistently to overestimate underlying inflation. Indeed, with oil prices having plunged by 50% over the past year, the Fed stubbornly maintains that faster price growth – and the precious inflation rate of 2% – is just around the corner.

Missing from this logic is an appreciation of the new and powerful global forces that are bearing down on inflation.  Rather than recognize a seemingly chronic shortfall of global aggregate demand amid a supply glut and a deflationary profusion of technological innovations and new supply chains – the Fed  would rather attribute low inflation to successful inflation targeting, and the Great Moderation that it presumably spawned.

Unable to disentangle the global and domestic pressures suppressing inflation, a price-targeting Fed has erred consistently on the side of easy money.

This is apparent in the fact that, over the last 15 years, the real federal funds rate – the Fed’s benchmark policy rate, adjusted for inflation – has been in negative territory more than 60% of the time, averaging -0.6% since May 2001. From 1990 to 2000, by contrast, the real federal funds rate averaged 2.2%. In short, over the last decade and a half, the Fed has gone well beyond a powerful disinflation in setting its policy interest rate.

Over the same 15-year period, financial markets have become unhinged, with a profusion of asset and credit bubbles leading to a series of crises that almost pushed the world economy into the abyss in 2008-2009. But rather than recognize, let alone respond to, pre-crisis excesses, the Fed has remained agnostic about them, pointing out that bubble-spotting is, at best, an imperfect science.

That is hardly a convincing reason for central banks to remain fixated on inflation targeting.

Today’s enemy is financial instability. On that basis alone, the case for monetary-policy normalization has never been more compelling.

FederalReservePrintingMoney1