Category Archives: Finance

Bail in or Bail Out: That is the Question?

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Ken Workman discusses reaction to the true but politically incorrect remark of Jeroen Djisselbloem.  The fact—and the fear—is that the Eurogroup is changing expectations again: When they bailed out Greece, creditors got restructured, but Europe promised it was a one-time only thing. The ECB bailout of Spain was different: You guys recapitalize the banks, creditors stay whole, and the ECB provides the financing. When Cyprus, and its role as Russia’s offshore bank came along,  European leaders responded by reverting to the Greek model: Creditors got “bailed-in” and had to take losses.

Customers at banks in Spain and Italy and France now realize that if their countries and banks end up in need of further financial assistance to stay in the euro zone, the private sector might have to take losses. This is already causing bank stock prices to drop, prompting a quick walk-back (pdf) that left everyone confused.

Customers at banks in Spain and Italy and France now realize that if their countries and banks end up in need of further financial assistance to stay in the euro zone, the private sector might have to take losses.

The problem is that while Cyprus is special, it’s not that special. Germans don’t want to bailout Russian depositors, but they also don’t want to bail out anyone. The Spain model isn’t working and the expectation that it will means disappointment. A euro zone mired in recession is not going to be able to out-grow its debt problem with a weak financial system.  The EU needs a banking union, something the Eurogroup has already begun work on. Recognizing reality may make markets nervous, but to solve the crisis, public and private creditors will have to pay up.

That doesn’t make Cyprus ideal by any stretch of the imagination. Cypriots would probably be better off leaving the euro altogether. And the haphazard assembly of its bailout has left only two real principles intact: the euro will not be allowed to fail, and creditors will likely need to help with that. Balancing crisis management (stopping bank  runs) with reform (recapitalizing banks) is never easy, but after four years it might be worth thinking more clearly about the tensions between the two.

Bail-Ins

Common Energy Policies in the EU

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Nick Butler writes: An intriguing process has begun in the EU, almost unnoticed outside the small world of Brussels and the shrinking circle of those who believe in an ever-closer European Union. The EU is asserting its role in the energy market.

No country is forced to give up the power to set its own energy mix. The French will not be told to start fracking for shale gas or the extensive volumes of tight oil that
exist in the Paris basin. Germany will not be required to change its policy of phasing out nuclear power. There is no proposal to unify taxation on energy production or consumption.

What changes is simply but crucially that a new level of policy making is established above the nation states.  Focus is on energy security, particularly for gas but potentially also for electricity.  Completing the internal market in energy means removing the national barriers which at present create a patchwork quilt of supply systems and prices.

In truth, the likelihood is that in the classic European way one thing will lead to another. Many of the proposals for energy network linkages — for instance between Spain and France, or through Italy into central and northern Europe — won’t be built because it is not in the interests of particular national suppliers whose business depends on limiting open competition. But once there is a European-level policy, the momentum to open the market and to sweep away the blockages of national borders will be very strong.

In the days when Europe was at war with itself, those systems were protected nation assets. Now we are in many ways, and by legal agreement, a single economic space why not unify the system?

Energy security is a matter of national security and in the end governments carry a responsibility to ensure that the lights stay on. Given market failures around the impact of carbon emissions, only the state can ensure that externalities are priced in. But state control of the market can be costly, destructive to innovation and narrowly inward looking. The new European energy union virtually ignores technical and scientific progress and has very little to say about trade links with other parts of the world, even though those links could in many cases give Europe lower cost supplies. At a first reading you would get the idea that Mr Sefcovic and his colleagues would be very happy if Europe were completely self-sufficient in energy.

 

Is the American Dream Over?

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Richard Reeves writes about the Horatio Alger awards:  Twelve new members (11 men, one woman) were honored for having risen from childhood poverty to positions as captains of commerce or celebrated public servants. Colin Powell, a 1991 award recipient, was among those in the audience. The new members’ speeches were brief, striking a balance between pride and humility, and all hewing to the rags-to-riches theme.

The climax of the evening came with the arrival on stage of more than 100 students from poor and troubled backgrounds to whom the Society had awarded college scholarships. . The ceremony had the feel of an act of worship and thanksgiving before the altar of the society’s namesake. It was a genuinely moving experience, even for me—and I’m a Brit.

Vivid stories of those who overcome the obstacles of poverty to achieve success are all the more impressive because they are so much the exceptions to the rule. Contrary to the Horatio Alger myth, social mobility rates in the United States are lower than in most of Europe. There are forces at work in America now—forces related not just to income and wealth but also to family structure and education—that put the country at risk of creating an ossified, self-perpetuating class structure, with disastrous implications for opportunity and, by extension, for the very idea of America.

In his second inaugural address in 2013, Barack Obama declared: “We are true to our creed when a little girl born into the bleakest poverty knows that she has the same chance to succeed as anybody else, because she is an American; she is free, and she is equal, not just in the eyes of God but also in our own.”

Strive and Succeed cover

The United States was to be a self-made nation comprised of self-made men. Alexis de Tocqueville—the first of many clever Frenchmen to wow the American reading classes—suffused his Democracy in America with admiration of the young nation’s “manly and legitimate passion for equality,” while Abraham Lincoln extolled his countrymen’s “genius for independence.”

There is a simple formula here—equality plus independence adds up to the promise of upward mobility.   Hence the toddlers who show up at daycare centers in T-shirts emblazoned “Future President.” Hence Americans’ culture of competitiveness, their obsession with sports, their frequent and all-purpose references to “the rules of the game” and to “fairness.” Hence the patriotism-tinged pride of the successful, exulting not only in their own grit and prowess, but also in the meritocratic system that gave them scope and opportunity.   Can Americans Still Dream

Warren: Rules and Market Go Together

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Elizabeth Warren writes:  For too long, the opponents of financial reform have cast the debate as an argument between the pro-regulation camp and the pro-market camp. They generally put Democrats in the first camp and Republicans in the second.

But that so-called “choice” gets it all wrong.

Rules are not the enemy of markets. Without some basic rules and accountability, financial markets don’t work. People get ripped off, risk-taking skyrockets, and markets fall apart. Rolling back the rules or firing the cops can be profoundly anti-market.

Republicans claim – loudly and repeatedly – that they support competitive markets, but their approach to financial regulation is pure crony capitalism. It helps the rich and the powerful protect and expand their wealth and their power – and leaves everyone else behind.

This week, I gave a big policy speech which boils down to two principles:

First, financial institutions shouldn’t be allowed to cheat people. Markets work only if people can see and understand the products they are buying, only if people can reasonably compare one product to another, only if people can’t get fooled into taking on far more risk than they realize just so that some fly-by-night company can turn a quick profit and move on. That’s true for families buying mortgages and for pension plans buying complex financial instruments.

Second, financial institutions shouldn’t be allowed to get the taxpayers to pick up their risks. That’s true for using insured deposits for high-risk trading, and it’s true for letting Too-Big-to-Fail banks get a wink-and-a-nod guarantee of a government bailout.
We know what changes we need to make financial markets work better. Strengthen the rules to prevent cheating. Make the cops do their jobs. Cut the banks down to size.  Change the tax code to promote more long-term investment. Tackle shadow-banking done by non-bank firms and subsidiaries.

Changes like these can make a real difference. They can help protect hard-working families from cheats and liars. They can help rein in the lawless practices that are still too common on Wall Street. They can end Too Big to Fail.

The secret to better markets isn’t turning loose the biggest banks to do whatever they want. The secret is smarter, more structural regulation that forces everyone to play by the same rules and doesn’t let anyone put the entire economy at risk.

Warren the Warrior.

World Bank and IMF Spring Up

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Homi Kharas writes:  This weekend, finance ministers, economists, and others from around the world will convene on Washington for the annual World Bank-International Monetary Fund Spring Meetings. The IMF released dramatic new global growth projections yesterday, and these will set the tone as other issues surface throughout this year’s meetings.So what’s going on in the world economy today?

Global growth drivers aren’t who they used to be: The Millennium Development Goals will expire this year, and in July, countries will meet in Addis Ababa to discuss how the U.N. will finance development efforts for the next 15 years. Financing for development is expected to be a principal topic for the development committee this year, and one that finance ministers are starting to take seriously. I’ve already written my thoughts on what we need from the Addis meeting, as well as on the worthiness of crafting a set of Sustainable Development Goals that work. But what can we expect from the Addis meeting? And how is it different from what we’ve seen before?
New funding sources have to be leveraged for effective future development
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Finally, the Asian Infrastructure Investment Bank will continue to make news. Almost every country but the U.S. and Japan has now joined China in its setting up of the AIIB. And everyone has an opinion—from Larry Summers proclaiming it’s time for the U.S. to wake up to a new economic era, to my Brookings colleague Raj Desai who welcomes the bank and thinks the U.S. will suffer from its lack of participation. So what exactly is the AIIB and why has the U.S. sought to keep its allies from participating?
The AIIB could be a new channel for much-needed infrastructure investment.

Finance Wizards Meet

Is the Revolving Door from Government to Finance Dangerous?

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Ben Bernanke, the former chairman of the US Federal Reserve, has joined Citadel as an adviser on monetary policy, arriving as the Chicago hedge fund recovers from a $1bn loss trading government bonds.

The ex-central banker, who stepped down from the Fed in January 2014, said he would be adding his “perspective on a range of issues affecting our global economy” in his new role.

The move may fan criticism of the revolving door between the Fed and other wings of government and powerful financial firms.

Alan Greenspan, Mr Bernanke’s predecessor as Fed chairman, took up positions including acting as a consultant for Deusche Bank and hedge fund Paulson & Company after leaving the central bank.

Last month, Jeremy Stein, a former Fed governor, said he would start advising BlueMountain Capital Management, another fund.

Mr Bernanke said he was sensitive to anxieties about the “revolving door” and had chosen Citadel, rather than a position at a bank, in part because it is not regulated by the Fed. He said he would not be doing “lobbying of any sort”.

Ken Griffin, the founder and chief executive of Citadel, which has $26bn in assets under management, said Mr Bernanke has “extraordinary knowledge of the global economy and his insights on monetary policy and the capital markets will be extremely valuable to our team and to our investors.”

The appointment was announced on Thursday, hours before it emerged that Citadel’s head of fixed income, Derek Kaufman, had resigned after suffering $1bn of losses in his portfolio of developed market sovereign bonds.

People familiar with the situation said a series of macro bets went awry in 2014, dragging down the overall performance of Mr Kaufman’s 20-person team.

After a weak start to trading in 2015, he resigned two weeks ago.  A former JPMorgan proprietary trader, Mr Kaufman was recruited by Citadel in 2008.

Mr Kaufman’s team was responsible for a $4bn global fixed income fund, which managed only a 0.75 per cent gain last year, and for portions of Citadel’s flagship Kensington and Wellington funds. The fixed income team will now report directly to Mr Griffin.

“Citadel is a dynamic firm with tremendously talented people and a rigorous approach to research and investing. I look forward to adding my perspective on a range of issues affecting our global economy,” said Mr Bernanke in a statement released by Citadel.

Since leaving the Fed, Mr. Bernanke’s views have been solicited by hedge fund managers and other market participants at exclusive dinners and speaking engagements. He will be a speaker at next month’s SALT conference for hedge fund managers in Las Vegas.

Mr Bernanke served as chairman of the Fed from February 2006 to January 2014, putting him at the helm of the central bank in the midst of the financial crash. Before his appointment as chairman, he chaired the president’s council of economic advisers from June 2005 to January 2006.

Revolving Door

What’s Draghi Up To?

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Mohamed El-Erian writes: European Central Bank President Mario Draghi painted a dovish and hopeful picture and was also realistic about what euro zone governments need to do to enable the ECB’s full success.

Draghi left no doubt the ECB is committed to the implementation of its “non-standard” monetary policy. He reiterated that the central bank “intends” to intervene in markets until the end of September 2016, regardless of concerns about negative nominal yields and a possible shortage in securities to purchase. And it would continue beyond that date if the bank doesn’t obtain the macroeconomic outcome the quantitative easing program is designed to achieve.

To make this point even more forcefully, Draghi dismissed concerns about QE’s inadvertent collateral damage. These include accentuating the future risks of financial instability and enabling governments to be less responsible.

Turning to the impact of QE, Draghi was optimistic about the initial results. He pointed to the improvement in credit flows and other monetary indicators; and he took comfort from the stronger momentum of the euro zone economy, notwithstanding substantial variations among countries. In doing so, he played down concerns that ECB policy was encouraging financial bubbles, though he only seemed focused on bank leverage.

What Draghi didn’t make clear is that the euro zone’s experience of QE closely resembles those of other countries that had previously undertaken such efforts, particularly Japan and the U.S.

As was the case elsewhere, the first stages of the ECB’s program were immediately met with a helpful response in financial markets, including higher equity prices, lower bond yields and a depreciated currency. This response boosted sentiment more broadly and partially spilled over into economic activity. That was the easy part, which I previously described as the first third of the QE journey.

The remaining two-thirds will be much harder. Success requires sustaining economic progress while, simultaneously, containing the “costs and risks” associated with artificially boosted asset prices and possible resource misallocations. To navigate that artfully, the ECB will need a lot of help from other institutions.

As noted by Draghi, the ultimate success of the ECB’s unconventional policy approach will require governments to implement deeper structural reforms — including in labor and product markets — as well as encourage business investment and expansion. It will need much more pronounced balance-sheet healing, including overcoming increasingly entrenched debt overhangs. And, in my opinion, it also needs aggregate demand within Europe to be higher and more evenly spread across countries.

Europe is still quite a distance from achieving any of this. The celebration of the encouraging start of the euro zone’s QE should be tempered by the lessons of similar policies elsewhere.

Draghi

Wolfgang Schäuble on Sensible Finance Policy

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WOLFGANG SCHÄUBLE, finance minister of Germany, writes: The immediate sting of the global financial crisis has faded in much of the world.  Unfortunately, however, the world economy is not yet out of the woods. It still faces very concrete challenges. We are as badly as ever in need of a common understanding of what needs to be done

Complaints that the European response to the crisis has been ineffective at best, or even counterproductive — are simply not accurate. There is strong evidence that Europe is indeed on the right track in addressing the impact, and, most importantly, the causes of the crisis.

First, it has often been said that German insistence on fiscal austerity meant that Germany, the largest economy in the European Union, has “punched below its weight” — and thereby pushed the eurozone more deeply into crisis — by not stimulating more demand. This misses the point. The crisis in Europe was first and foremost a crisis of confidence, rooted in structural shortcomings. Investors started to realize that the member countries of the eurozone were not as economically competitive or financially reliable as the uniform bond yields of the pre-crisis years had suggested. These investors began to treat the bonds of certain countries with much more caution, causing interest rates for those bonds to rise.

Germany has consistently advocated an approach of structural reforms and reducing public debt without throttling growth. This is not blind “austerity.” It is about setting a reliable framework for private-sector activity, preparing aging societies for the future and improving the quality of public budgets.

In Germany, this approach has shown tangible success: The economic recovery since 2009 has been broad-based, with domestic demand as the main driver of growth. Investment — both public and private — is increasing. We are speeding up debt reduction, in line with the I.M.F.’s recent call for “symmetric stabilization” (reducing deficits in good times, to offset deficits in bad times).

Many European countries are reaping the rewards of reform and consolidation efforts. Countries like Ireland and Spain, which put far-reaching reforms into effect when they hit financial trouble a few years ago, now boast some of the highest growth rates in Europe.

Some make the absurd claim that Germany — being a creditor nation— is actually profiting from the crisis.  It is true that the German government now enjoys historically low borrowing costs. But so do almost all other eurozone members. Unconventional monetary policies pursued by the independent European Central Bank seem to have fulfilled their part there. Low interest rates help all borrowers — but they come at ever-increasing costs to savers and pension funds.

Some say the answer to the crisis in Europe has been ever-greater liquidity and ever-lower interest rates. Now that we have both, we are finding that these policy tools are no panacea, but create problems of their own. More and more experts on both sides of the Atlantic warn of dangerous bubbles in asset prices and risks to financial stability from ever-increasing leverage (financing by borrowing). And it is clear that the debt burden in many countries cannot be solved by incentives to take on even more debt.

On the fiscal side, we need to prepare government budgets for an eventual normalization of monetary policy and capital markets.

The European Central Bank has warned many times that monetary policy cannot substitute for fiscal and structural reforms in member countries. Christine Lagarde, the managing director of the I.M.F., has also called for further structural reforms.

The priorities for Germany, as the current president of the Group of 7 nations, are modernization and regulatory improvements. Stimulus — both in fiscal and monetary policy — is not part of the plan. When my fellow finance ministers and the central bank governors of the G-7 countries gather in Dresden at the end of next month we will have an opportunity to discuss these questions in depth, joined — for the first time in the G-7’s history — by some of the world’s leading economists.

Wolfgang Schäuble


Reform the IMF?

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Paolo Noguiera Batista and Hector R. Torres write:   More than four years have passed since an overwhelming majority of the membership of the International Monetary Fund agreed to a package of reforms that would double the organization’s resources and reorganize its governing structure in favor of developing countries. But adopting the reforms requires approval by the IMF’s member countries; and, though the United States was among those that voted in favor of the measure, President Barack Obama has been unable to secure Congressional approval.

The delay by the US represents a huge setback for the IMF. It stands in the way of a restructuring of its decision-making process that would better reflect developing countries’ growing importance and dynamism.

In our view, the best way forward would be to decouple the part of the reforms that requires ratification by the US Congress from the rest of the package. Only one major element – the decision to move toward an all-elected Executive Board – requires an amendment to the IMF’s Articles of Agreement and thus congressional approval.

The other major element of the reform package is an increase and rebalancing of the quotas that determine each country’s voting power and financial obligation. This change would double the IMF’s resources and provide greater voting power to developing countries. Congress would still need to ratify the measure before the US’s own quota increased, but its approval would not be required for this part of the reform package to take effect for other countries.

The connection between the two parts of the reforms has always been unnecessary; the measures are independent, require different approval processes, and can be delivered separately. Removing the link between them would require the support of the US administration, but not ratification by Congress.

This separation could be implemented smoothly. A simple majority of the IMF’s Executive Board would recommend it to the Board of Governors, where a resolution separating the reforms into two parts would require 85% of the votes.

The changes to the quotas could then quickly become effective.

The key obstacle to this proposal is the requirement of congressional approval to increase America’s quota share. This opens the possibility that the US’s voting power could temporarily fall below the 15% threshold needed to veto decisions that require the support of 85% of IMF members’ votes.

In order to secure US support, the Board of Governors could commit not to consider any draft decision requiring 85% backing without America’s consent. This guarantee could be included in the resolution dividing the reform package into two parts. It would remain valid until the US was in a position to increase its quota and recover its voting share.

The agreement could also act as an incentive for ratifying the reforms. The power to reinstate the US’s formal veto power would lie entirely in the hands of Congress – making it unlikely that another four years would pass before the matter is finally resolved.

Criminals on Trial and at Large

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Matt Levine deliciously balances his take on financial matters.  One story he tells is of an information security director at the Multi-State Lottery Association who won a $14.3 million jackpot after he allegedly accessed the secure room housing the computer and infected the random number generator with software that allowed him to control the number generated. He goes on trial next week.

For your edification, Mr. Tipton changed the settings of the cameras so that they only filmed one second of every minute, so he had 59 seconds to break in, insert his thumb drive and watch the progress bar crawl across the screen as the klaxons rang in the distance.

image015Mr. Levine also notes that Jesse Drucker went to Switzerland to visit with 21 financial advisors who remain under US indictment and are at large.  He reports they have adapted well to fugitive life.

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