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Fundamentally: Fiscal Impasse Now Takes Center Stage for Investors

November 10, 2012 by Leave a Comment

The conventional wisdom is that the fight over this so-called fiscal cliff “may cause investors to sell, and contribute to more volatility in the coming month or two,” said Jeffrey N. Kleintop, chief market strategist at LPL Financial.

History shows only that the markets tend to be volatile and unpredictable in the aftermath of close national elections. In election years since 1976, between Election Day and Dec. 31, the Standard Poor’s 500-stock index has lost as much as 9.6 percent and gained as much as 7.6 percent.

Still, despite the real possibility of economic peril — the Congressional Budget Office predicts that gross domestic product will shrink next year if Congress and the White House can’t reach an agreement — a recession and bear market aren’t the only possible outcomes that investors should brace for.

For starters, many economists think that while certain items may be allowed to lapse, like the payroll tax holiday and extended emergency unemployment benefits, they doubt that Congress and the White House would allow the economy to go completely a full fall. In fact, the consensus among forecasters surveyed by Blue Chip Economic Indicators is that the economy will avoid recession and grow modestly in 2013.

Earlier this year, the budget office predicted that the full possible effects of the situation — including the expiration of the so-called Bush tax cuts and automatic spending reductions put in place in last year’s contentious debt-ceiling debate — could shave as much as $800 billion off gross domestic product in 2013.

But Mike Dueker, chief economist for Russell Investments, says he thinks policy makers may ultimately reach a fiscal-tightening agreement that will result in a much smaller drag on G.D.P.

Marie M. Schofield, chief economist at Columbia Management Investment Advisers, agrees that a moderate tightening is likely. “The question in my mind is if this is going to be a fiscal cliff or a fiscal bunny hill,” she said. Rather than let everything expire and kick in, she said, Congress could find a way to postpone certain important decisions.

If Congress were to stretch out the crisis over several months, it could mute these problems enough to make them manageable in investors’ minds, said James W. Paulsen, chief investment strategist at Wells Capital Management.

Mr. Paulsen notes that, like the European debt crisis this year, the situation might turn out to be a series of chronic problems that are dealt with sequentially, not as a single financial disaster.

There is some evidence, he says, that the market views the problem in these terms. Despite growing concerns this year, he notes that the CBOE Volatility Index, or VIX, a closely watched gauge of investor fear, remains below 20, after having approached 50 last summer.

“To me, this is evidence that the financial markets are desensitized to this doomsday thinking,” he said.

He notes that many elements of the economy are healing in the meantime.

The labor markets, for instance, are slowly but surely improving. Consumer confidence is at a five-year high. And the housing market shows clear signs of a rebound. The latest reading of the Case-Shiller Home Price Index, for instance, found that home values in the 20 largest metropolitan markets gained 0.9 percent in August over July.

G. Scott Clemons, chief investment strategist of Brown Brothers Harriman, says the nascent housing recovery is significant.

“The real engine of economic activity is still personal consumption,” he said. “So the housing and labor markets are the canaries in the coal mine for the economy. As long as those parts of the economy are still chirping, we’re fine.”

Henry B. Smith, chief investment officer at Haverford Trust, sees another script to consider.

While it’s not the most likely outcome, there is a possibility that the debate in Washington will eventually lead to major tax and spending reforms.

Under this bullish alternative, he said, the lame-duck Congress finds a way to postpone spending cuts for at least a couple of quarters. Then, beginning next year, the president and Congress tackle spending, taxes and entitlements not in piecemeal fashion, but through a comprehensive tax reform and deficit reduction plan.

“If that were to happen, in our view, you’d see everyone’s 2013 G.D.P. estimates come up,” he said, adding that it would unleash pent-up demand both in the economy and the markets.

Paul J. Lim is a senior editor at Money magazine. E-mail: fund@nytimes.com.

Article source: http://www.nytimes.com/2012/11/11/your-money/fiscal-impasse-now-takes-center-stage-for-investors.html?partner=rss&emc=rss

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Economix Blog: Simon Johnson: Introducing the Latin Euro

September 13, 2012 by Leave a Comment

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Peter Boone is chairman of the charity Effective Intervention and a research associate at the Center for Economic Performance at the London School of Economics. He is also a director of Salute Capital Management Ltd. Simon Johnson is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and former chief economist at the International Monetary Fund.

The verdict is now in. Traditional German values lost and the Latin perspective won. Germany fought hard over many years to include “no bailout” clauses in the Maastricht Treaty (the founding document of the euro currency area) and to limit the rights of the European Central Bank to lend directly to national governments.

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But last week, the bank’s governing council – over German objections – authorized the purchase of unlimited quantities of short-term national debts and effectively erased any traditional Germanic restrictions on its operations.

The finding this week by the German Constitutional Court that intra-European financial rescue funds are consistent with German law is just icing on this cake, as far as those who support bailouts are concerned.

With this critical defeat at the E.C.B., Germany is forced to concede two points. First, without the possibility of large-scale central-bank purchases of government debt for countries such as Spain and Italy, the euro area was set to collapse.

And second, that “one nation, one vote” really does rule at the E.C.B.; Germany has around one-quarter of the population of the euro area (81 million of a total of around 333 million), but only 1 vote of 17 on the bank’s governing council – and apparently no veto.

The balance of power and decision-making has shifted toward the troubled periphery of Europe. The “soft money” wing of the euro area is in the ascendancy.

This is not the end of the crisis but rather the next stage. The fact that the European Central Bank is willing to purchase unlimited debt from highly indebted nations should not make anyone jump for joy. The previous rule forbidding this was in place for good reason; the German government did not want investors to feel they could lend freely to any euro-area nation and then be bailed out by Germany.

Now investors know they can be bailed out by Germans, both directly through fiscal transfers and through credit provided by the European Central Bank. How does that affect the incentives of borrowers to be careful?

Prime Minister Mariano Rajoy of Spain has now opened the next front in the intra-European credit struggle. Despite the announcement of E.C.B. support, Mr. Rajoy remains elusive regarding whether he would seek the money.

His main concern is that the E.C.B. is insisting that the International Monetary Fund, along with the European Union commission and perhaps the central bank itself, negotiate an austerity program with any nation that needs funds. Such an austerity program is the “conditionality” that the E.C.B. had to assert would exist in order to justify the large bailouts they are promising.

So the battleground moves from whether the European Central Bank can bail out nations to whether austerity programs should be required for bailouts. The peripheral countries will fight this issue tooth and nail, and they will win.

Unemployment in Spain is now around 24.6 percent; in Greece it is 24.4 percent (with unemployment for those 14 to 24 at 55 percent). Both Portugal and Ireland have made progress with their austerity programs, but they are not growing, and their debts remain very large (gross general government debt is projected by the I.M.F.’s Fiscal Monitor to be 115 percent of gross domestic product next year in Portugal and 118 percent of G.D.P. in Ireland).

The current Italian government is well regarded, but large political battles loom, and it is also burdened with big debts (to reach 124 percent of G.D.P. in 2013).

At the same time, European countries outside the euro – including Britain, Sweden, Poland and Norway – are all seen as faring much better.

The Germans will be increasingly drawn toward one plausible conclusion: perhaps the euro area is simply the wrong system. If tough austerity programs do not wrest nations free from high unemployment and overindebtedness, then how are they to get back on the path to growth?

If a one-time devaluation could help release nations from their troubles rather more quickly, perhaps Germany should instead acknowledge – or insist – that the single currency is a failed exchange-rate regime.

The European Central Bank is now fighting for its survival as an organization. Its president, Mario Draghi, and his colleagues have stretched the rule book in order to open the money spigots to purchase troubled nations’ debts. The leaders of troubled nations will fight hard to get all they can with as few promises in return as possible. Elected officials must do this, or they will lose elections.

Europe has strong institutions, including good property rights and vibrant democracy. An independent central bank was long seen as an important manifestation of such institutions. But powerful interests have shifted toward wanting easy credit above all else. And the more the E.C.B. provides such credit, the more powerful those voices on the periphery will become.

We’ve seen such a dynamic operate time and again around the world. When strong regional governments are fighting for resources against national governments, there is a tendency for regions to accumulate large debts, then demand new bailouts at the national level. These battles often end in runaway inflation, messy defaults or both (think Argentina many times or Russia in the 1990s).

The European Central Bank has handed the euro zone’s peripheral governments a great victory at the expense of those who hoped to keep the euro area a solvent, “hard currency” zone through disciplined public finance.

It may be difficult to imagine that wealthy European nations could follow the tragic path to inflation and defaults seen for so long in Latin America. Yet with each “step forward” in this euro crisis, Europe moves further along that same route.

Article source: http://economix.blogs.nytimes.com/2012/09/13/introducing-the-latin-euro/?partner=rss&emc=rss

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Pace of Home Sales Quickened in December

January 21, 2012 by Leave a Comment

Home sales in the United States rose in December to the highest pace in nearly a year, the National Association of Realtors reported. The gain coincided with other signs that show the troubled housing market improved at the end of 2011.

Still, sales remain depressed and ended the year well below healthy levels.

The Realtors group said home sales increased 5 percent last month to a seasonally adjusted annual rate of 4.61 million.

“The pattern of home sales in recent months demonstrates a market in recovery,” said Lawrence Yun, the group’s chief economist. “Record low mortgage interest rates, job growth and bargain home prices are giving more consumers the confidence they need to enter the market.”

For the year, home sales totaled only 4.26 million, up from 4.19 million the previous year. Since the housing bust four years ago, home sales have slumped under the weight of foreclosures, tighter credit and falling price.

Article source: http://feeds.nytimes.com/click.phdo?i=d8e8b4cc2391d8fbcade23ec5eacf7ca

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World Bank Predicts Slower Growth and Urges Precautions

January 18, 2012 by Leave a Comment

In a report released Tuesday, the Washington-based bank lowered its growth forecasts for high-income and low-income countries, saying it expected the world economy to expand an aggregate 2.5 percent in 2012, down from about 2.7 percent in 2011. In its previous estimate, in June, it forecast growth of 3.6 percent in 2012.

The bank also warned of the continued threat of a global financial shock “similar in magnitude to the Lehman crisis,” because of the possibility that a major European economy could be shut out of the global debt markets. In that case, the bank estimated the damage to the world’s economic growth would rival the recession of 2008 and 2009.

“The largest economy in the world is weakening,” Justin Yifu Lin, the bank’s chief economist, said in an interview, referring to the European Union. “The message for developing countries is to start preparing now.”

The report was issued as forecasters warned of slower growth in the United States. Estimates of the nation’s annual pace of growth reached as high as 4 percent in the final months of 2011. But economists contend the strength came in part from temporary measures, including wholesalers restocking their inventories and consumers saving less and spending more over the holidays.

Economists say they expect many headwinds in early 2012: rising oil prices as the United States and European countries confront Iran; the risk of a tax cut for American wage earners expiring; a strong dollar rendering American exports less competitive; and continued repercussions from the sovereign debt crisis in Europe.

In the report, the biannual Global Economic Prospects, the bank predicted that high-income countries, including the United States, France, Japan and Germany, would grow 1.4 percent in 2012. It forecast a mild contraction of 0.3 percent in the 17 countries that use the euro. Developing countries will grow 5.4 percent, down from a forecast of 6.2 percent in June, the bank said.

The reason for the global slowdown is twofold, said Andrew Burns, head of global macroeconomics at the World Bank and the main author of the report. First, developing countries like Turkey, India, Russia and Brazil were “overheating” in the rebound after the recession and have tightened monetary policy to help curb inflation, he said. Second, he added, the euro zone crisis has frightened investors, and austerity budgets adopted in countries, including Italy and Greece, have weighed on growth.

Mr. Burns said those trends created a “dangerous dynamic,” with the slowdown in emerging economies sapping growth from advanced economies, and the downturn in advanced economies worsening prospects for emerging markets. “The events are feeding off of one another,” he said.

A worst case in Europe could lead to significant hardship for emerging economies, the report said. Commodity prices could fall as much as 24 percent, hurting government revenue in export-dependent nations. Global trade volumes could fall by more than 7 percent. Countries in Central Asia and Eastern Europe would be hit hardest, the bank said.

But even if catastrophe does not occur, growth looks weaker, the bank said. For instance, the World Bank estimates world trade will expand only 4.7 percent in 2012, down from 12.4 percent in 2010.

Last summer, the World Bank noted significant “contagion from Europe to developing countries,” Mr. Burns said. Risk-averse investors slashed financing to emerging markets, with gross capital flows falling to $170 billion in the second half of 2011 from about $309 billion in the same period in 2010. In addition, borrowing costs began to rise in developing countries.

The bank said developing economies should prepare for declining investment from abroad, less-robust exports, and reduced remittances. Governments should rigorously stress test their financial institutions, plan major infrastructure projects to help support demand and ensure the viability of their social safety nets, the report said.

Mr. Lin said advanced economies should consider more immediate fiscal stimulus to support growth, locally and globally. “They need to carry out structural reforms in the long-term,” he said. “But in the short term, they need an intervention to provide a short-term boost to demand.”

He warned that emerging markets have less room for fiscal and monetary stimulus than they did in 2008 and 2009, even though they have more capacity than many developed countries. Many high-income countries, including the United States, are already struggling with heavy debt loads, limiting the possibility of fiscal stimulus. And central banks have already overextended their balance sheets and pushed interest rates close to zero, limiting monetary stimulus, Mr. Burns said in an interview.

The International Monetary Fund, the World Bank’s sister organization, echoed its warnings about the dangers slowing trade and uncertainty about Europe pose to emerging markets.

In a speech Monday, David Lipton, the fund’s first deputy managing director, said there was reason for optimism, given the lessons learned in the 2008 crisis. But, he warned: “Europe could be swept into a downward spiral of collapsing confidence, stagnant growth and fewer jobs. And in today’s interconnected global economy, no country and no region would be immune from that catastrophe.”

The fund is expected to update its World Economic Outlook on Jan. 24. It said it would cut its growth forecast from predictions it issued last September.

World Bank officials emphasized the importance of confidence, given uncertainty about Europe and worries about slowing growth. Mr. Burns said investor sentiment “could have an enormous impact cumulatively.”

Article source: http://feeds.nytimes.com/click.phdo?i=03edb72c48cdd211d1033157208e7071

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Economix Blog: Simon Johnson: Where Is the Volcker Rule?

December 15, 2011 by Leave a Comment

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Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”

Three years ago, a financial crisis threatened to bring down the United States economy and to spread economic disaster around the world. How far have we come in preventing any kind of recurrence? And will the much-discussed Volcker Rule – attempting to limit the risks that big banks can take – play a positive role as we move forward?

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Bad loans were the primary cause of the 2007-8 financial debacle. When the full extent of the problems with those loans became apparent, there was a sharp fall in the values of all securities that had been constructed based on the underlying mortgages – and a collapse in the value of related bets that had been made using derivatives.

The damage to the economy became huge because these losses were not dispersed throughout the economy or around the world. Rather, many of the so-called toxic assets were held by the country’s largest banks. Financial institutions that used to lend to consumers and businesses had instead become drawn into various forms of gambling on the booming mortgage market (as well as on commodities, equities and all kinds of derivatives). “Wall Street gets the upside and society gets the downside” was the operating principle.

And what a downside that proved to be.

Henry M. Paulson Jr., Treasury secretary at the time, said the Troubled Asset Relief Program, or TARP, was needed to buy those troubled assets from the banks. But this quickly proved unwieldy, so TARP pumped roughly half a trillion dollars into bank equity. The Federal Reserve backed this up with an enormous amount of liquidity through more than 21,000 transactions.

The additional government debt as a direct result of this finance-induced deep recession is estimated by the Congressional Budget Office at around 50 percent of gross domestic product, roughly $7 trillion.

These are staggering numbers. And this system of big banks taking outsize risks, failing and imposing huge damage on the rest of us has to stop. This ball is now firmly in the regulators’ court.

Whatever your broader issues with the Dodd-Frank Act of 2010, one point about legislative intent in this law is clear: The regulators have the authority to cut banks down to size and return them to their historical role of intermediary between savers and borrowers.

As for size, the regulators have long ignored the existing guidelines and allowed the biggest banks to get bigger. We need to go in the opposite direction, and that includes cutting down to size the private megabanks, as well as Fannie Mae and Freddie Mac. It also means taking advantage of the resolution authority and all associated provisions that Sheila Bair, the former chairwoman of the Federal Deposit Insurance Corporation, worked so hard to put into the Dodd-Frank Act.

As Jon Huntsman is arguing on the Republican campaign trail, too-big-to-fail banks simply need to be forced to break themselves up.

But we also need to make the megabanks less likely to fail. The easiest way to do that would be to require banks to have enough common equity to absorb losses.

But the bankers have pushed back hard, with Jamie Dimon, head of JPMorgan Chase, leading the way with statements like this on capital requirements, which are known loosely as the Basel Accords: “I’m very close to thinking the United States shouldn’t be in Basel any more. I would not have agreed to rules that are blatantly anti-American.”

Dan Tarullo, responsible for this issue on the Federal Reserve Board, seems to support the idea of requiring significantly more equity in big banks, perhaps moving in the direction recommended by Anat Admati and her colleagues. But Mr. Tarullo appears to have lost that battle for now.

If we are not breaking up banks and if we are not requiring them to have reasonable levels of capital (thus limiting how much they can borrow relative to their equity), we must use all other available tools to stop the too-big-to-fail banks from taking excessive and ill-conceived risks.

This is where the Volcker Rule becomes so important. Named for Paul A. Volcker, former chairman of the Federal Reserve, and adopted as part of Dodd-Frank at the insistence of Senators Jeff Merkley, Democrat of Oregon, and Carl Levin, Democrat of Michigan, the Volcker Rule directs the regulators to get banks out of the business of betting on the markets.

The regulators are now determining how they plan to carry it out. Draft proposals are currently open for comment.

But the latest news on this front is not encouraging, as crucial regulators seem stuck in a “bigger is better, and anything goes for the biggest” mind set.

The Volcker Rule has some good points, including a requirement that trader compensation not be tied to speculative risk-taking, and that firms collect and report some essential data to regulators. But the current draft does too little to actually stop the banks’ risky practices.

The main problem is that the rule as drawn does not set out the clear, bright lines that banks and regulators need, nor does it provide for meaningful enforcement. Instead of drawing the lines, the proposed rule mandates that firms write many of the rules themselves.

There is some good news. At this point, it is only a proposed rule, and the public is able to comment. Organizations like Better Markets that promote the public interest within the regulatory process will be in there fighting to strengthen the proposed rule and make the final rule better.

Everyone who cares about real financial reform should do the same, but the regulators’ draft rule has made it harder to uphold the public interest than should have been the case. For example, the regulators ignored the breadth of the Volcker statute and focused instead on only a narrow slice of the bank’s balance sheet – just what the bank says is for “trading” purposes. Much else of what big banks do seems likely to escape scrutiny.

The regulators also have given very little guidance on conflicts of interest, on what should be considered high-risk assets or on what high-risk trading strategies should be permitted.

During a Senate hearing at which I testified last week, Senator Bob Corker, Republican of Tennessee, focused on another important problem – the lack of any restrictions on trading in the enormous Treasury securities market. The regulators will create a lot more paperwork for the banks, but if the current draft is adopted, the too-big-to-fail banks are not likely to be forced to stop doing much.

Last year Senator Levin said:

We hope that our regulators have learned with Congress that tearing down regulatory walls without erecting new ones undermines our financial stability and threatens our economic growth. We have legislated to the best of our ability. It is now up to our regulators to fully and faithfully implement these strong provisions.

From what we’ve seen so far, our regulators have not yet understood this message. They seem instead more in tune with Mr. Dimon, who insisted this year that regulators should back away from any effective implementation of the Volcker Rule:

The United States has the best, deepest, widest, most transparent capital markets in the world, which give you, the investor, the ability to buy and sell large amounts at very cheap prices. I wish Paul Volcker understood that.

Mr. Dimon — who is on the board of the Federal Reserve Bank of New York — seems to have forgotten the financial crisis, its impact on ordinary Americans and the utter fiscal disaster that ensued. Or perhaps he never noticed.

Article source: http://feeds.nytimes.com/click.phdo?i=550db65e33b09bc4701892f384902cc0

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Russian Tycoons Find Tougher Times as Money Flees

December 10, 2011 by Leave a Comment

NIKOLAI MAKSIMOV, one of the richest men in Russia, was sitting in a grimy jail cell in the Ural Mountains.

Through the murk, Mr. Maksimov saw his cellmate — a man, he says, who appeared ill with tuberculosis, a scourge in Russian prisons. “I had the feeling that I was put in this cell on purpose,” Mr. Maksimov, now free on bail, recalled recently.

Mr. Maksimov, who was arrested in February on suspicion of embezzling hundreds of millions of dollars, is hardly the only Russian tycoon who has run into trouble. Among the six men who have topped the Forbes rich list here in the last decade, one, Mikhail B. Khodorkovsky, is in prison, and another, Boris A. Berezovsky, is in exile. They, like Mr. Maksimov, maintain their innocence.

Even before the authorities here acted last week to quash protests against the government and Prime Minister Vladimir V. Putin, Russia’s rich were growing agitated, too. Evidence is mounting that conditions are deteriorating for the maintenance and investment of their vast wealth — and while this development may gladden populists, it may become an economic threat.

Post-Soviet privatizations shifted state-owned factories into the hands of a coterie of well-connected businessmen — the oligarchs. Partly as a result, Russia has 101 billionaires, behind only China, with 115, and the United States, with 412, according to Forbes.

Only now, capital flight, a problem in the 1990s, has re-emerged. Money is flowing out of Russia faster than it is flowing in. The net outflow is expected to reach $70 billion by year-end, and the figures suggest that the bulk of that will be from large investors.

Yaroslav Lissovolik, chief economist for Deutsche Bank here, notes that “the scale of capital flight has more than compensated for the rise of oil prices.”

Even if oil output is maintained and crude prices stay relatively high, according to Russian finance ministry estimates, the nation’s current account will slip into deficit by 2014. Then Russia’s economy, like that of the United States, will depend on an inflow of investment, economists say.

The Russian government has recently made modest gains in attracting foreign investment. The problem is that for every foreign company that invests — from Exxon on the Russian Arctic Shelf to Cisco Systems in a high-technology park going up outside Moscow — far more Russian entrepreneurs head for the exits, gauging the risks too great.

Officials understand that oil can take Russia only so far and are eager to lure investment from all quarters. “The amazing thing is that they are doing far better with the foreign investors than the locals,” says Clemens Grafe, chief economist at Goldman Sachs here.

It’s hard to know how big a role cases like Mr. Maksimov’s have played. Mr. Maksimov, 54, is withering in his criticism of the authorities. The suggestion is that his business enemies enlisted the police to try to persuade him to resolve a dispute.

“I was on the Forbes list; now I’m going to jail,” he says. “It’s normal. It’s Russia.”

His troubles began three years ago, when he sued Vladimir S. Lisin, another steel tycoon, touching off the dispute that eventually led to Mr. Maksimov’s arrest.

The two had made a deal, which quickly soured, for Mr. Lisin to buy 50 percent plus one share of Mr. Maksimov’s company, the Maxi Group. Maxi was estimated at the time to be worth $1.2 billion after debts. Mr. Lisin’s company, Novolipetsk, paid Mr. Maksimov an advance of $317 million. It was to pay the remainder after an outside auditor estimated the extent of the company’s debt, within 90 days.

Executives of Novolipetsk declined to pay. In an interview at its headquarters here, lawyers for Novolipetsk accused Mr. Maksimov of transferring large sums out of the Maxi Group to the bank account of his girlfriend. He denied the accusation, saying he had been buying out shares that his girlfriend, who was also a business partner, owned in business subsidiaries.

Article source: http://feeds.nytimes.com/click.phdo?i=985d3b9a39dc500f5b4f4c396ee95cd7

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Economix Blog: Simon Johnson: The Huntsman Alternative

December 1, 2011 by Leave a Comment

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Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”

The euro zone financial situation continues to worsen. The latest idea from the euro group of finance ministers is apparently to have the European Central Bank make a huge loan to the International Monetary Fund, which would then turn around and lend to countries like Italy. This is a bizarre notion.

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If the monetary fund takes the credit risk of a megaloan to Italy — e.g., an amount around $600 billion, greater than the fund’s current lending capacity — this would represent an unprecedented and unacceptable risk to the fund’s shareholders, which include the American taxpayer. If the monetary fund does not take this credit risk, what’s the point?

The European Central Bank should provide financial support directly to Italy, if that is the goal.

But that goal increasingly seems to be both the only idea of officials and the last failed notion of a fading era. More bailouts and the reinforcement of moral hazard — protecting bankers and other creditors against the downside of their mistakes — is the last thing that the world’s financial system needs.

Yet this is also the main idea of the Obama administration. Treasury Secretary Timothy Geithner told The Fiscal Times this week that European leaders “are going to have to move more quickly to put in place a strong firewall to help protect countries that are undertaking reforms” – meaning more bailouts. And the new swap lines of easier credit provided by the Federal Reserve and other central banks, announced Wednesday, appear to be just another way to shore up European (and perhaps American) banks with no strings attached.

This week we also learned more about the underhanded and undemocratic ways in which the Federal Reserve saved big banks last time around. (You should read Ron Suskind’s book, “Confidence Men: Wall Street, Washington, and the Education of a President.” To understand Mr. Geithner’s philosophy of unconditional bailouts, remember that he was president of the Federal Reserve Bank of New York before becoming Treasury secretary.)

Is there really no alternative to pouring good money after bad?

In a policy statement released this week, Jon Huntsman, the former governor of Utah who is seeking the Republican presidential nomination, articulates a coherent alternative approach to the financial sector, which begins with a diagnosis of our current problem: too-big-to-fail banks:

To protect taxpayers from future bailouts and stabilize America’s economic foundation, Jon Huntsman will end too-big-to-fail. Today we can already begin to see the outlines of the next financial crisis and bailouts. More than three years after the crisis and the accompanying bailouts, the six largest U.S. financial institutions are significantly bigger than they were before the crisis, having been encouraged by regulators to snap up Bear Stearns and other competitors at bargain prices.

Mr. Geithner feared the collapse of big banks in 2008-9, but his policies have made them bigger. This makes no sense.

Every opportunity should be taken to make the megabanks smaller, and plenty of tools are available, including hard size caps and a punitive tax on excessive size and leverage (with any proceeds from this tax used to reduce the tax burden on the nonfinancial sector, which will otherwise be crushed by the big banks’ continued dangerous behavior).

The goal is simple, as Mr. Huntsman said in his recent Wall Street Journal opinion piece: make the banks small enough and simple enough to fail. “Hedge funds and private equity funds go out of business all the time when they make big mistakes, to the notice of few, because they are not too big to fail,” he wrote. “There is no reason why banks cannot live with the same reality.”

The path we are on leads to more state ownership of banks in Europe — not a good idea — and, in the United States, huge open-ended subsidies to private banks. Executives in those banks get the upside and American taxpayers and workers get the downside — a huge recession, damage to millions of lives and a huge run-up in government debt because of lost tax revenue.

Everything else Mr. Huntsman wants is also eminently sensible, including full transparency in the derivatives market. Who will argue with that proposal as we watch the European financial sector spiral downwards — driven partly by the fear of what lurks in prominent opaque transactions and balance sheets?

Mr. Huntsman has also spotted the fatal flaw in Basel III: “The Basel III Accord primes the pump for the next financial crisis by putting its thumb on the scale of sovereign debt, making it less expensive for banks to invest in those instruments without making a realistic risk assessment.” Again, in the light of recent developments in Europe, who can dispute this?

These are not fringe or unproven ideas. When I talk with sensible people in and around the financial sector, these are exactly their views. These are also natural Republican ideas — what we have now is not a market but a huge, unfair and dangerous subsidy scheme.

Such points are made by top academics like Gene Fama (University of Chicago) and Alan Meltzer (Carnegie Mellon), by the former Treasury Secretaries Nicholas Brady and George Shultz, and by top Federal Reserve officials, like Richard Fisher (president of the Dallas Fed) and Tom Hoenig (recently retired from being president of the Kansas City Fed and currently nominated for the No. 2 post at the Federal Deposit Insurance Corporation). (See my coverage of this strong current of Republican thinking in past Economix columns.)

Only Theodore Roosevelt could take on the industrial and railroad monopolies in 1901, only Richard Nixon could go to China in 1972, and only Jon Huntsman seems prepared to face down the too-big-to-fail banks today.

Article source: http://feeds.nytimes.com/click.phdo?i=c7a2db20ffea61f871b1a92e9c7ca3cb

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Europe’s Two Years of Denials Trapped Greece

November 6, 2011 by Leave a Comment

THE warning was clear: Greece was spiraling out of control.

But the alarm, sounded in mid-2009, in a draft report from the International Monetary Fund, never reached the outside world.

Greek officials saw the draft and complained to the I.M.F. So the final report, while critical, played down the risks that Athens might one day default, with disastrous consequences for all of Europe.

What is so remarkable about this episode is that it wasn’t so remarkable at all. The reversal at the I.M.F. was just one small piece of a broad pattern of denial that helped push Greece to the brink and now threatens to pull apart the euro. Politicians, policy makers, bankers — all underestimated dangers that seem clear enough in hindsight. Time and again over the last two years, many of those in charge offered solutions that, rather than fix the problems in Greece, simply let them fester.

Indeed, five months after the I.M.F. made that initial prognosis, Prime Minister George Papandreou of Greece disclosed that, under the previous government, his nation had essentially lied about the size of its deficit. The gap, it turned out, amounted to an unsustainable 12 percent of the country’s annual economic output, not 6 percent, as the government had maintained.

Almost all of the endeavors to defuse this crisis have denied the overarching conclusion of that I.M.F. draft: that Greece could no longer pay its bills and needed to drastically cut its debt.

Until October, when European leaders conceded that point, the champion of the resistance was Jean-Claude Trichet, who stepped down this month as president of the European Central Bank. It was he who insisted that no European country could ever be allowed to go bankrupt.

“There is simply no excuse for Trichet and Europe getting this so wrong,” said Willem Buiter, chief economist at Citigroup. “It is fine to make default a moral issue, but you also have to accept that outside of Western Europe, defaults have been a dime a dozen, even in the past few decades.”

If leaders had agreed earlier to ease Greece’s debt burden and moved faster to protect the likes of Italy and Spain — as United States officials had been urging since early 2010 — the worst might be behind Europe today, experts say.

The turning point came at a late-night meeting last month when Angela Merkel, the German chancellor, pushed private creditors to accept a 50 percent loss on their Greek bonds. Mr. Trichet had long opposed such a move, fearing that it could undermine European banks. Instead, at his urging, European leaders initially promoted painful austerity for Greece, prompting a public backlash that pushed Mr. Papendreou’s government to the brink of collapse and could force Athens to abandon the euro.

Many view the latest rescue plan as too little, too late.

“Because of all this denial and delay, Greece will need to write down as much as 85 percent of its debt — 50 percent is not enough,” Mr. Buiter said.

It was never going to be easy to turn things around in Greece, particularly given European politics. In countries like Germany and the Netherlands, many people oppose bailing out their southern neighbors. Policy makers and, indeed, many financiers believed that they could buy enough time for Greece to solve its problems on its own.

“It was quite obvious, by the spring of 2010, that Greek debt could not be paid off,” said Richard Portes, a European economics expert at the London Business School. “But in good faith, policy makers felt that Greece could grow out of its debt problem. They were wrong.”

BOB M. TRAA is no one’s idea of a radical. A Dutchman, he labors at the I.M.F., among the arcana of global debt statistics. He wrote the 2009 report.

Immediately after that bulletin, he produced another, more damning analysis, which concluded that if Greece were a company, it would be bankrupt. The country’s net worth, he concluded, was a negative 51 billion euros ($71 billion).

But because Greece had a high-enough credit rating at that time, it could keep borrowing money and skate by. Once again, the Greek government objected to the I.M.F. analysis, although this time, the report was not amended.

Attention has only recently been drawn to these early I.M.F. studies. The Brussels research group Bruegel, which conducted an analysis at the I.M.F.’s behest, concluded the fund should have done more to draw attention to Greece’s troubles.

By early 2010, banks and bond investors were growing reluctant to lend Greece money. The country’s finance minister, George Papaconstantinou, delivered a blistering message to his European partners.

Stephen Castle reported from Brussels.

Article source: http://www.nytimes.com/2011/11/06/business/global/europes-two-years-of-denials-trapped-greece.html?partner=rss&emc=rss

Filed Under: Global Business Tagged With: , ,

Economix Blog: Simon Johnson: The European Debt Crisis and the G-20 Summit

November 4, 2011 by Leave a Comment

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Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”

The April 2009 London summit meeting of the Group of 20 is widely regarded as a great success. The world’s largest economies agreed on an immediate coordinated approach to the global financial crisis then raging and promised to work together on banking reforms that would support growth. President Obama got high marks for his constructive engagement.

Today’s Economist

Perspectives from expert contributors.

The G-20 heads of government have met twice a year since then, and in Cannes this week they meet again. Could this meeting help stabilize the world economy? Can President Obama again play a leading role? The answer to both questions is likely to be no.

In 2009, the primary problem was slumping economies in the United States and Western Europe. It was in the perceived individual interest of those economies to engage in some fiscal stimulus – and they were happy to present this as a joint approach. China was also willing to stimulate its economy, as its policy makers feared that slowing global trade would reduce Chinese exports. President Obama’s appeal for fiscal stimulus around the world was pushing on an open door.

Now the issue is quite different. We have a sovereign debt crisis within the euro zone, in which countries that have borrowed heavily are facing the prospect of restructuring their debts. The euro zone summit meeting last week established that privately held Greek debt would fall by about half (relative to face value), although this does not clearly put Greece onto a sustainable debt path. Prime Minister Andreas Papandreou announced a plan on Monday for a referendum on the plan, a move with the potential to build political support for the needed reforms, and on Wednesday his cabinet offered its full support. But another outcome — if the government does not fall in the meantime, making the referendum plan moot — could be a Greek exit from the euro and a default on its debts in disorderly fashion, without any kind of international framework or outside financial support.

But the real issue is Italy, as it has been at least since the summer. The Europeans are only beginning to come to grips with the centrality of Italy in the European debt web – glance at Bill Marsh’s recent graphic to get the point. Italy has more than 1.9 trillion euros in debt outstanding; this is the third-largest bond market in the world. In the aftermath of the Greek referendum announcement, the yield on Italian debt rose above 6.1 percent. The standard view is that if this reaches 6.5 percent, Italy will need to seek assistance in the form of a backstop fund to guarantee there will be no default.

But the International Monetary Fund does not have enough resources available and the existing European Financial Stability Facility is also likely to be too small. People in the know talk of the need for more than two trillion euros in a “stabilization fund,” and while a lot of fuzzy math is involved in contemporary international financial rescues, the I.M.F. and the stability facility combined would be hard pressed to provide more than a third of that.

This might seem like a good time for a summit meeting – so the hat can be passed around among world leaders. And some people do hope that China can provide an enormous loan, either directly or working with the I.M.F. China, after all, has more than two trillion euros’ worth of reserves (not all in euros, of course; much of this is in dollars).

But it’s not clear China that wants to take the credit risk of lending directly – the Europeans might not repay, after all. And the United States is not keen to have China funnel such a large amount through the I.M.F.; this would undermine the traditional American predominance there. In today’s budgetary environment, there is no way that the United States can come up with anything like matching funds at a level that would make a difference – would you like to ask the House of Representatives for $100 billion right now to help keep Silvio Berlusconi in power?

And the heart of the problem is really European, not global. Specifically, the euro zone needs to address its underlying fiscal structure, which has become severely dysfunctional. It needs a proper fiscal union, with the right to tax and to issue debt – backed ultimately by the European Central Bank. And the ability of member governments to issue debt must be severely curtailed.

The United States faced a similar problem, long ago. The original Articles of Confederation proved inadequate, largely because there was no centralized fiscal authority. The Constitutional Convention convened in 1787 in large part because the United States had defaulted on its debts, incurred during the War of Independence – and there was no way forward without a new agreement among the original 13 states and greater fiscal powers (and more) for the federal government.

Europe needs the equivalent of a constitutional convention. But today’s financial markets move so much faster than 200 years ago, and the delay in Europe has already been excessive. The Europeans need to move fast. Will the Cannes summit meeting speed them up?

Article source: http://economix.blogs.nytimes.com/2011/11/03/the-european-debt-crisis-and-the-g-20-summit/?partner=rss&emc=rss

Filed Under: Global Business Tagged With: , ,

Shares Skittish on Greece Fears

October 4, 2011 by Leave a Comment

At the close, the Standard Poor’s 500-stock index was up 2.25 percent, after spending much of the day in bear market territory, defined as a 20 percent drop from the previous peak. The S. P. 500, considered a broad measure of stock performance, last peaked in April.

The Dow Jones industrial average closed with an increase of 1.44 percent, and the Nasdaq composite index gained 2.95 percent.

Analysts differed on the significance of a bear market label. Some believed that it could serve as a psychological blow that could fuel a further sell-off. But others said it was little more than another day in five months of trouble on Wall Street.

“Today will not be the driving force,” said Richard J. Peterson of Standard Poor’s Capital IQ.

Federal Reserve Chairman Ben S. Bernanke voiced his own concern about the American economy when he addressed a Congressional committee Tuesday morning. Mr. Bernanke called on Congress to take action on jobs, but also said that the Fed was prepared to take further moves to stimulate the economy. He said the turmoil in the markets was acting as a drag on the American economy.

The market’s downslide eased during Mr. Bernanke’s appearance, then slipped in late afternoon before its move into positive territory right before the close of trading. Analysts noted the negative tone of his remarks.

“We’re no longer comparing it to what you would be expecting in a recovery — it’s that we’re not as bad as we were in 2008. He talks about the limits of what he can do,” said Eric Green, chief economist at TD Securities.

In economic data, new factory orders were down slightly in August, but not as bad as most analysts had predicted, according to figures from the Commerce Department. Andrew Wilkinson, chief economic strategist for Miller Tabak Co., said that the numbers were the latest in a series of economic indicators showing that the American economy was not slipping into recession. Still, he said, the economy remained vulnerable.

“It’s moving in the right direction, but it’s moving at a very slow pace,” he said.

Earlier in Europe, stocks declined sharply. In London, the FTSE 100 index closed down 2.6 percent, the DAX in Frankfurt was 3 percent lower and the CAC 40 in Paris was down 2.6 percent.

Finance ministers from the 17 European Union nations that use the euro postponed moves to release the next installment of aid to Greece, which means that Greece is now unlikely to receive 8 billion euros ($10.6 billion) before November.

European banking shares fell sharply, led by Dexia, whose value has plunged this week because of its exposure to Greek debt.

The price that European governments pay for credit default swaps, which serve as insurance against default for their sovereign debt, rose sharply across Europe, with the largest increases coming in France and Germany, two countries that may be called to bail out weaker nations in the case of a financial crisis. European banks also had to pay more to insure their debt.

In Asia, the Nikkei 225 in Japan fell 1.1 percent, while the Hang Seng index in Hong Kong lost 3.4 percent to close at its lowest level since 2009.

American crude oil fell 2.51 percent to $75.66 a barrel. Gold prices were down 3.51 percent. Yields on 10-year U.S. Treasury bonds were up to 1.786 percent.

The dollar rose to a fresh nine-month high against the euro, which fell as low as $1.3144, a nine-month low, before recovering to $1.3293.

Since World War II, there have been 10 bear markets, according to JPMorgan Chase, with the market dropping an average of 35 percent. The most recent bear market came between October 2007 and March 2009, when the market fell by 56.8 percent.

Overall, stocks for American companies valued at more than $100 million have lose $4.03 trillion in value since the market’s peak, according to an analysis by Mr. Peterson. Worldwide, the loss has been $13.5 trillion since the end of May.

Banks have been hit particularly hard. Bank of America has lost 56 percent of its market value since April, while Citigroup has lost 51 percent.

Article source: http://feeds.nytimes.com/click.phdo?i=b02472c93d5267a8027ea415e7e9bbe2

Filed Under: Economy News Tagged With: , ,
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