AIG - Aiaargh - tuneless music - miss-timing PR!

Economics and the markets are not unlike music, fingering the notes (yes, banknotes too) and knowing when to pluck, plonk, suck or blow (yes, the dealers' too and their coke habits). What we see are institutions that look like they have forgotten how to play, or are learning for the first time. Government responses have not yet played a tune. They are still getting the fingering positions right and learning to read Keynes notes. It is now time we heard some coherent tuneful music, but we may have to wait until April when the newly re-formed G20 orchestra gathers with all its instruments and sheet music in London. We hope they will agree to play the same classical pieces and agree on a new symphony.
Meanwhile, a good day is merely one without a Greek chorus of bad news like yesterday. Yesterday, world stock markets were expected to fall anyway, but had the added excuse of a flurry of badly-timed news, especially $30bn more government funding for AIG, the world's largest insurer, and an $18bn rights issue by one of the world's strongest banks, HSBC (see further discussion on this in my other blogs here).
Debate in the USA about all all this, AIG especially, is focusing on whether had more clarity been produced earlier, about firms' true balance sheets and about government response measures, then some major financial firms could have been allowed to 'fail' where failure means rescuing 'Main Street' but letting 'Wall Street' take the hits? AIG's 'Main Street' is over 70 million policy holders including 100,000 business entities employing 100 million Americans in domestic USA alone. Could they have been secured by AIG's insurance reserve funds and government support until all the accounts could be transferred and sold to other insurers? The idea is that if the main weight of government intervention had occurred say in the winter of 2007-08, then banks and others might have been better secured to support the economy in 2008 and 2009 to work with government positively and ant-cyclically. Now the burden is almost entirely on government and we have to wait for fiscal stimulus to trigger recovery before banks will return to their 2003 solvency level,and this reuires a 5% plus boost to the economy from Government. But, Government did not know until mid-2008 that it had the economy had been in recession already for 6 months! Once that was clear the stock market began steadily falling (short-sellers' heaven). In the UK, recession arrived six months later and was also only noticed when figures had been revised six months later. And the UK stocks fell steeply from mid-year. Various forward indicators now are looking more positive, and short-sellers are nervous. Certainly stock out on loan has fallen from 8-10% level in the S&P down to under 5%. But, the media response was in any case over-shocking; the media never balks at a 'good story' and good stories are not about what makes precise sense, not about talking up only talking down. The media is a short-seller of the news. Is that being irresponsible or just being news-professionals?
AIG had an $80bn infusion that included $60bn draw-down. The £30bn is half of that being drawn on (from Oval Office TARP) and remaining drawdown is $25bn after a $5bn loan. It would have been far better for the drawdown to have progressed gradually, not in one big hit notified to, and thereby spooking, the markets! One of the abiding lessons of this crisis is the damaging lack of a crisis-sensitivity in how press-releases are managed, and here I include Lloyds Bank interims and HSBC's rights issue along with many others where a pro-forma procedure is followed without context information to mitigate against panic-reactions!
AIG's $30bn is not a change in terms of the federal support as the markets assumed. The draw-downs are triggered by requirements that the “AAA” rating be maintained on AIG’s counterparty risk instruments. The policy behind federal support thus seems reducible to merely avoiding another Lehman-scale failure and wholesale-credit market meltdown. The devastation caused by Lehman’s failure was in wholesale funding (counterparty risk and liquidity risk). This is the complex market risk structure that is one of the main concerns of Basel II called double-default risk in which opposing parties of derivative instruments are dependent upon the credit worthiness of each other and where, for example, if the instrument requires a “AAA” credit rating, loss of the credit rating can become an element of default. The £30bn is therefore required as standby liquidity (like capital reserves) to further insure the assets so that at least the senior tranches retain AAA and contractual default-trigger thresholds are not crossed when investors can insist on liquidating the investments.
US federal policy is driven by the need to avoid another “Lehman” as we can see in support for AIG and Citigroup, while trying to stop short of the 80% stock ownership by government at which point the balance sheets of these come on-budget, onto the federal budget, adding to its deficit and debt. The international standards practice is for current debts to be added to national debt but not offset by current assets, hence the fear of a misinterpreted cost to taxpayers. This is the circle of the argument, how much do taxpayers stand to lose one way or the other, and this looms far larger than the offsetting question of how much do taxpayers stand to gain one way or the other? This is of course a biased argument driven forward politically by net taxpayers and not by net recipients of government transfers, and hence the divide here also appears in party politics. The Democrats accuse the Republicans of risking economic disaster by holding on to monetarist thinking and caring less about the systemic roundabouts. The Republicans accuse the democrats of bankrupting the country, by which they mean government finances at an enormous cost to future taxpayers. Ditto, between Labour and Conservatives in the UK and between centre-left and centre-right in all OECD countries.
We will spend years examining the many decisions, about Bear Stearns or Fannie Mae, lehman, other banks, fiscal or monetary responses, shareholder value protection or not, off-market, on-market, off-budget, on-budget, and many other such questions as exercises that will occupy students, economists, historians, and other analysts and academics for decades. But are those the relevant questions for banks, governments and other portfolio managers today? Decisions made today and tomorrow come down to (1) will government intervention via equity ownership, and or (2) huge expansion and fiscal stance on central banks and governments balance sheets, and or (3) trillions of contingent guarantees combine prevent prolonged depression and hasten recovery?
Economic history says the answer is yes. There are no limits to government credit that can be extended in support of this, whatever it takes, in whatever amounts necessary and with whatever tools needed. And this is especially, some say uniquely, true of the USA, which is the major counterparty via the US$ to the whole of the rest of the world. If you believe as I do, that the OECD economies will find some bottoming in 2009 or early 2010, then all the model and accounting calculations will find a new level for clearing between creditors and debtors that is economically affordable whereby taxpayer risks are much reduced and in prospect of earning profits.
Some would add that inflation will help and deflation massively hinder recovery. Whichever is more true, governments believe the former view and this too is what bailouts like AIG or RBS and many others are also all about. G20 in April should, for the first time, and on an international or global scale, issue clarifying plans that should take much of the anxiety that feeds off uncertainty out of the markets. This must especially include far less uncertainty with Western Europe’s approach including the deteriorating situation in Eastern Europe that is raising the bar with major questions for the whole EU and whether it can deliver a financial aid plan for the region. If not, then the EU project is seriously discredited and will take a long time to recover.
The Euro is just shy of its lowest level vs the $ since November, one reason for the low £ oil price. Global bond markets are the main beneficiary of the equity weakness today but these cannot recoup the credit weakness in all other credit sources.
In the US and other OECD countries consumers are shifting focus to saving from spending. Private saving will soar as Governments flood in with bond issues. How this translates in higher transmission mechanism flow-through to the economy is what is exercising government political-economists. For example, in the USA, the President's economic teams will be extrapolating from the following recent data:
In the US, January Income unexpectedly rose 0.4% vs expectations of a decline of 0.2%. Income was boosted by “special factors” such as COLA increases and more pay to goverment workers and military personnel. Excluding these and other special factors, Income rose 0.2%, still better than estimates. Spending rose 0.6%, 0.2% more than forecast and with a 0.2% gain in the PCE, REAL spending rose 0.4%. As a result of the income rise, savings rate rose to 5% from 3.9%, and is now at the highest since April ‘95 and would still be in the 4%+ range even after taking out the one time adjustment boosts to income. The savings rate is likely headed towards the 8-10% range and roughly speaking, for every 1% pt increase, there is about $100b less consumption spending. This will be a painful process of zig-zag adjustments on the path of the economy's credit and economic cycle.
FOR THE FULLEST ACCOUNT OF AIG's PROBLEMS AND CREDIT DEFAULT SWAPS AND HOW THEY SELL-SHORT THE MARKETS SEE: CRUNCH IMAGES BLOG VIA CLICK ON 'VIEW PROFILE'

EU KETTLE BOILS OVER BY $24 TRILLIONS OR 0VER 40% OF EU BANK BALANCES - DON'T BELIEVE IT!

This essay follows on from that of the third one below this.
This week just gone saw explosive estimates in a secret 17 page document seen by the press. A bail-out of the toxic assets held by European banks' could plunge the European Union into crisis, according to a confidential Brussels document. European Council meetings are immensely secure - it is very rare for key documents to be leaked. Our Contintental partners will be asking themselves whether UK oficials deliberately leaked the secret document? It says things like: “Estimates of total expected asset write-downs suggest that the budgetary costs – actual and contingent - of asset relief could be very large both in absolute terms and relative to GDP in member states,” as seen by The Daily Telegraph. I smell a rat - a con-job? And, "It is essential that government support through asset relief should not be on a scale that raises concern about over-indebtedness or financing problems.”
The "secret 17-page paper" was discussed, it is claimed, by finance ministers, including UK Chancellor Alistair Darling in brussels on Tuesday. National leaders and EU officials fear that a second bank bail-out in Europe will raise government borrowing at a time when investors - particularly those who lend money to European governments - have growing doubts over the ability of countries such as Spain, Greece, Portugal, Ireland, Italy and Britain to pay it back. I don't doubt some that is reasonable to state, but scarcely news or at all alarming, not until the numbers that The Telegraph reports were in the paper (later removed from the website?)
The Commission's figures, if that is what they are, are significant because of the role EU officials will play in devising rules to evaluate “toxic” bank assets by the end of this month when new moves to bail out banks will be discussed at an emergency EU summit. The EU is also very concerned by widening spreads on bonds sold by member state countries. In line with perceived default risk, and the weak performance of some EU economies compared to others, investors are demanding increasingly higher interest to lend to countries such as Italy instead of Germany or Greece instead of France. Ministers and officials fear that the process could herald a spiral that threatens the EU's wider, and Eurozone's narower, integrity. The secret paper supposedly says, "Such considerations are particularly important in the current context of widening budget deficits, rising public debt levels and challenges in sovereign bond issuance.” And the Teleraph says, Toxic debts of European banks risk overwhelming a number of EU governments and pose a “systemic” danger to the broader EU financial system.“ If I may digress for a moment - It is not inappropriate for an organisation such as the UN, IMF or in this case, the EU, set up to provide the economic cooperation needed to secure long term peace, to remind ourselves of why Versailles failed in 1919 after WW1. The two greatest economists of the age, J.M.Keynes and A.A.Young both resigned in protest, and Keynes wrote the best-seller "The Economic Consequences of the Peace." The argument was that seeking proportional reparations would prolong the economic mess that led to war and one could not predict what extremities people would go to to get out of their misfortunes. His advice was taken thorough account of after WW2 and the world experienced exceptional growth and rising prosperity. Of course, wars were not banished and enormous problems persisted. But, similarly again now, when G20 is in effect setting up a system for a new financial world order, both to get out of the crisis and then to create a sustainable world economy, great care has to be taken to ensure conditions are not created for future extreme crises much as WW1's Versailles led to WW2. There are already, in Europe and the USA and in many other parts of the world extreme assumptions of the total collapse of the financial system, of the EU, of the economies of China, Africa and so on. The secret 17-page paper appears in how it has been characterized by The Telegraph to fit that anxiety-bill.
It says that estimates of total expected asset write-downs suggest that the budgetary costs of asset relief could be very large both in absolute terms and relative to GDP in member states to the extent that the ability of the EU to survive is threatened! It supposes that for some member states, it may be the case that asset relief for banks is no longer an option, due to their existing budgetary constraints and/or the size of their banks’ balance sheet relative to GDP. Ireland, for example, where voters are still expected to vote against the new EU Constitution despite the fact that the main banks are all sucking on the liquidity teats of the ECB for survival. Yet, if the UK was to allow the Irish banks access to its liquidity window the cost would be a relatively trivial addition to the asetts for treasuries it is already doing for UK banks. Unfortunately in the Eurozone, only the ECB can issue short term roll-over treasury bills off-budget from a national debt point of view. The situation demonstrates a valuable monetary lever available to the UK that would be much less so had the UK joined the Euro system. The UK is also enjoying no deflation threat due to its exchange rate having fallen by about 30% and its persistent inflation (currently about 3%) is an additional help in paying down debts.
The extent of any risks to the EU banking system as a whole from an inadequate response in these member states needs to be considered, particularly in the case of cross-border banks. No country is named in the so-called 'secret paper', but obvious candidates might be Greece, Ireland, Luxembourg, Belgium, the Netherlands, Austria, Sweden, Spain, and UK, and non-EU member Switzerland, which have large banking sectors relative to GDP or have sold proportionately large amounts of asset-backed securities. EU banks hold balance sheet assets of €41.2 trillion (£36.9 trillion). But, it seems to me that the toxic assets are a market price problem, not yet a problem of low income, not credit risk defaults to the extent that these assets are not paying substantial yields. The problem is more that of accounting for the market price writedowns on banks' books - so take them off into the Bank of England or bad bank entities, leaving the real cash-flow problem being funding the banks' funding gaps between customer deposits and customer loans. This gap is well within the financial means of EU governments and the ECB. Brussels refused to comment on the paper, but it is clear that officials are concerned about default risk in the weaker states where interest spreads on government bonds are widening most. The IMF has questioned the lack of a proper 'lender of last resort' in the eurozone, although it is more so than the current G20 plan for the IMF's similar role globally. The European Central Bank (ECB) is, however, not allowed to bail out individual states. National goverments' 'central banks' within the Eurozone (Euro single currency) countries do not control national monetary levers given that treasury bills, repos etc. (open market liquidity operations) and central bank interest rate are an ECB responsibility. The concern about the ECB being less than a full central bank because it lacks a less than full political master, i.e. a less than full federal government, is an old saw that is unlikely to be resolved anytime soon. Therefore, the ECB is especially sensitive to how well it and the Euro financial system are seen to survive its first full recession test.
The IMF says C.European and UK banks have 75% as much exposure to US toxic debt as US banks, yet have been slower to book write-downs ($738bn in the US, $294bn in Europe, $260bn short?) Global banks have so far written down half of the $2,200bn losses estimated by the IMF. On top of this, EU banks have another $1,600bn depreciating asset exposure to Central and Eastern Europe, viewed by some as Europe’s sub-prime over-indebted poor. EU corporate debts are said to be 95% ratio to EU GDP compared to 73% ratio in the US, a mounting concern (as default rates reach 6.7% in the US, with S&P forecasting 23% by 2011 and the fear this may be repeated in Europe). But, these are default rates for speculative grades only and will only be experienced in the bottom 25% of corporate debts. The EU secret document also highlights the “real danger of a subsidy race between member states” if countries start to under-cut each other in the way they value toxic debts in their `bad bank’ rescue programmes. Whenever the word "race" appears in a communitaire economy context it means "race to the bottom". The fears is that of covert state aid, undermining the single 'fair' market integrity of the EU. Actually, it pays no country to seek to under-cut or outpace the others since the benefits leak out via the external account. Therefore, commonsense should dictate that all countries coordinate their economic recovery reflation measures at roughly the same pace, the same ratio proportions to GDP. But, no-one wants to risk going at the pace of the least fiscally Keynesian, except the least fiscally Keynesian, Germany and Austria!
An explosion of budget deficits and national debts ratios are also feared. The budget deficit will hit 12% of GDP in Ireland next year and almost 10% in Spain and UK, no doubt others too. Therefore the secret paper says, “It is essential that government support through asset relief should not be on a scale that raises concern about over-indebtedness or financing problems. Such considerations are particularly important in the current context of widening budget deficits, rising public debt levels and challenges in sovereign bond issuance.”
It is not surprising that European Union finance ministers looked ashen faced in Brussels on Tuesday and will do so again today in Berlin where EU leaders have agreed the agenda for their contributions to the London G20 conference and this turns on a global financial regulator authority - something many of us imagined existed in the BIS, bu is to be backed by the IMF in the role of a central authority with substantial funds. Last Tuesday's coffee & croissents or madelaines with confitures Anglaises breakfast meeting discussed how EU governments should deal with "toxic" banking assets that all accept triggered the economic crisis, but by Sunday, today, this has transmuted more towards regulatory supervision and transparency. The figures in the secret EU Ecofin Commission paper, are startling. The dodgy financial assets are estimated, according to The Daily Telegraph, to total £16.3 trillions (€15 trillions, $20 trillions) in banks across the EU. The "impaired assets" may amount to an astonishing 46% of EU banks' loan-assets, which is in reality wholly as improbable as it is astonishing. Who produced these estimates, digging a deep ditch for bankers, regulators and friends in government to stumble into.
The secret 17 page paper, according to The Daily Telegraph, warns that government attempts to buy up or underwrite this scale of assets could plunge the EU into a Union-threatening deep crisis. This is equivalent to saying that the EU and Eurozone are equivalent to Iceland or Ireland in having a banking sector dispoportionate to what the economy can afford? It is like saying we cannot afford our banking system, much as has been said for years by anti-welfare state ideologues, about social services, state health and education (typically all three added together being 60% of government spending budgets). The anti-welfare state economists were just as piss-poor at macro-economics as the the authors of the secret paper appear to be - in fact I am forced to seriously doubt its authenticity, maybe another Hitler's diaries scam?
The Telegraph says everyone is terrified that a second bank bailout will push up government borrowing at a time when bond markets have growing doubts over the ability of countries such as Spain, Greece, Portugal, Ireland, Italy and Britain, to service and repay their borrowings. This is so ludicrous, worst kind of scare-mongering, based on upticks in government bond spreads that reflect the cost of capital elsewhere more than genuine perceptions of government solvency! This is typical of interpretations invented when mathematically-minded, economically-ignorant, analysts are forced to explain a number! The 'secret document' says, "Estimates of total expected asset write-downs suggest that the budgetary costs - actual and contingent - of asset relief could be very large both in absolute terms and relative to GDP in member states." These adjectives are relative terms and have to be sized over time, over the credit and economic cycle. There are no known actual absolutes involved. War economies showed us that much; cost is a matter of spreading over time time against present emergency urgency. Spread yields are widening on bond markets as investors apparently judge it riskier to buy the debt of a country like Italy than the debt of another like Germany. The fact is that these securities are a seller's market and there is a juggling of perceptions going on to dissuade governments from appreciating this. Such juggling is a time-honoured tactic ahead of known large government bond issues.
In line with the risk, and the low performance of some EU economies compared to others, the markets have demand a higher premium on government bonds issued to raise the cash - so says the Telegraph and others. Well, when banks are forced to buy and hold more than the 50% they usually buy this time round an desperately need the 'gilt-edged' bonds to rectify their capital quality - governments need take no notice and need not cave in to discounting face values. As Sarkozy might say "nul points". The secret paper is fuelling this concern, "Such considerations are particularly important in the current context of widening budget deficits, rising public debt levels and challenges in sovereign bond issuance."
Reasons for doubting the report is that it had its numbers removed after first appearing on the Telegraph website. What began as a secret 17-page report circulating among European Union finance ministers warning EU governments that toxic assets still held by EU banks and investment firms could total a massive £16.3 trillions or $24.4 trillion, and that Commission officials estimated as "impaired assets" = 44% of total EU bank balance sheets, was later sanitised by removed the numbers calling them merely "massive". I suspect this figure of £16tn/$24tn is a funding gap figure (not toxic assets at all) and a transposition from the 40% funding gap of UK banks to EU banks. One reason for disbelieving the numbers, quite apart from their rediculous scale, is that last week numbers circulated in Wall Street estimated U.S. bank toxic assets at $9 trillions. Frankly, also rediculous. $2 trillions each (my calculations) is the realistic ballpark figure on both sides of the Atlantic, with $2.8tn booked as impaired credits by October 2008, according to the Bank of England. Writedowns by Nov 2008 were over $710bn by banks worldwide and capital raising was $760bn roughly both aligned by world-region distribition (ECB Stability Review). Deleveraging by Euro Area banks required is estimated at €560bn (3% of all assets, 9% of customer loans, €19tn), of which the ECB has mitigated so far by half by providing liquidity to banks. Euro Area bank funding gap is roughly €4.5 trillions. The ECB is perplexedly not brilliantly specific about this. The banks' funding gap of Central and Eastern Europe supplied by EU banks is about €1.2tn only, not insupportable. I reckon that the Telegraph's figure of £16.3tn for toxic assets is actually 16.3% ratio to all of Europe's gross banking assets that are European banks' funding gap, that portion of their liabilities that are interbank borrowings, €1tn for UK banks, €4.5tn for Euro Area banks, €1.2 tn for C&E Europe and others. This makes me even more convinced the Telegraph story as originally put out is some kind of anti-EU malevolent concoction?
I got back late from Berlin today with my head full of figures only to find that Number 10's website had the story in its least quantitiative version: "European leaders meeting in Berlin today, ahead of next months G20 Summit in London, have agreed to the need for fundamental changes in the world’s economic systems. At a joint press conference following the meeting the Prime Minister called for a “global new deal” to aid the recovery of the world economy and provide a set of principles for a sound future. The “grand bargain” would involve global economic and fiscal stimulus, global financial control mechanisms and be based on sound banking principles. It would require the strengthening of international financial institutions and help deliver a low carbon economy, he added. The PM said: “We are resolved that global problems need global solutions. And we will work together over these next few weeks to make sure that by our co-operation and our determination to act together we can not only inject the confidence that is necessary in the world economy but also build anew the economic activity that is necessary for the jobs, for the security that the people of the world want.”
"The Prime Minister will travel to the United States next week to discuss the world economy with President Obama. On 1 April world leaders will meet in London for the G20 Summit to continue the work begun in Washington last year."

PRICE THE STOCK BY THE FLOW?

On both sides of the Atlantic Cable that first tied UK and USA financial markets and stock exchanges and then Continental Europe's too, that today has somehow determined that systemically important banks (economically vital), from that of Fifth Third Bancorp to Lloyds Banking Group, to Royal Bank of Scotland, Unicredit, Fortis, and others, the banks' share prices are the price of postal stamps and bank capitalisation is a mere fraction of book value; in effect the shares are more like 'options' and the actual 'options' must therefore be the best market bets going, so good in fact that short-sellers like UK hedge fund Odey (up 42.5% in $ terms last year) is now going long on such banks. Maybe they are anticipating a change about to be permitted to mark-to-market pricing standards, something probabilistically determined using the forward-looking dimensions of the new accounting standard IFRS7?
What does marking assets to market prices mean. It means pricing the stock far below the valuation that can be justified by net income to the asset just as in the case of major banks. For example, the prices of assets on the books of Washington Mutual, when it was bought by J.P. Morgan at a fire-sale price, were cited as a reason to mark-down the assets on the books of Wachovia. This, some say, forced the FDIC /Federal Deposit Insurance Corporation) to arrange Wachovia´s sale to Citibank even though these banks are cash-flow positive. Similarly,Fannie Mae and Freddie Mac, had positive cash flow when they were nationalized by the US Treasury. Fannie Mae and Freddie Mac have not yet actually had to draw down a dime from the Treasury's $200 billion facility that was created to bail them out. It was the use of mark-to-market accounting that allowed Treasury to declare them bankrupt when on a cash flow basis, they are solvent. Mark-to-market accounting causes mayhem for tried and tested accounting standards reasons, but with the awkward and often devastating proviso that financial firms are forced to treat all potential losses as if they were current cash losses, and indeed this is how the general public, including many shareholders, perceives all loss announcements. Even if the firm does not sell at the excessively low price, and even if the net present value of current cash flows of these assets is above the market price, the firm must run the loss through its capital account and into its P/L bottom line statement for loss provision, hitting dividends and tax provision. If the loss is large enough, then the firm can find itself in violation of capital requirements. This, in turn, makes it vulnerable to closure, nationalisation or forced sale. My stamp is my bond? Some large banks' shares are the price of postage stamps and their stock market trade-price is close to one year's net profit, even with G20 governments guaranteeing the banks' long term solvency! The news media informs and reflects widely held opinions of bank bonds (backed by assets comprising our loans and repayment schedules) that they're worth even less than postage stamps, certainly less than gold or diamonds that also pay zero income. It is possible to joke that postage stamps are rising in value: buy now and they are good to 'hold' for an annual 8% return? Are bank shares good to 'hold'? Medium to long term they must be.
In the short term now too maybe, if further dilutions by rights issues are avoided, and certainly if cash-flows can be decoupled from mark-to-market asset write-downs. This is the idea of assets valuations based on 'hold to maturity', and shifting assets from trading book to banking book, or the idea again (now called 'bad bank') of getting assets with below book value prices off the balance sheet, and so on, such as swapping toxic assets into bad banks or at central bank liquidity windows via SIVs or any form of medium to longer term warehousing, i.e. de-coupling cash-flow P/L so that banks share price valuations can move closer to banks book value (even if the latter is written-down, short or medium-term discounted by recession, cyclically) and if solvency is considered on a cash-flow basis, then bank shares must have tremendous up-side. But, the political authorities are reluctant to permit massive shareholder 'regains' (unless government or perhaps pension fund shareholders only?) If fiscal measures by US, UK and other governments deliver firm signs of recovery by 2010 (maybe with advance indicators in 2nd half of 2009) then the 'upside' potential of bank share prices becomes a powerful certainty!

FUNDING OF FISCAL RESPONSES TO THE CRISIS

Solving the combination of credit & economic cycle recessions together amounts to doubling of our recent past experience of economic recessions. The solution has to be about restoring confidence as much as about restoring solvency. Trying to do just enough to win through may be foolish risk-taking. We can see this to be more like a war-economy situation where the only sensible risk-taking is to do as much as can be done and therefore much more than enough to win through.
Just as in wartime, it is essential that when trust in all else fails we do not lose trust in democratic governments too! There are far worse consequences than trusting in government, however flawed their efforts might be. It is my considered view, however, that remarkably our governments are doing a surprisingly intelligent and good job. Any of you luxuriating in angst and anger who wish to strike blows in all directions - you're being dangerously wrong-headed!
I task you with the quesion: what is the importance of not losing trust in what governments are doing and can do? I suggest that when trust is lost in banks and so much else, we have to be able to trust in government actions in this crisis for fear of far worse consequences when all trust is lost! In this respect is it not unlike wartime conditions where however flawed the Churchillian or FDR leaderships might have been, for example, they pulled together the national effort? While I don't want to make a party-political point, this is where the UK Conservative front benchers are mistaken in playing yah-boo politics. Would Labour Party have done the same in WW2 had it not been part of a National Unity government? I don't think so? But, it is undoubtedly with such thoughts that Obama is trying in the US to "reach across the aisle".
Overwhelming much else, more and more, is the immensely dramatic change to the pattern of world trade and financial flows, and this is also why Governments need to over-shoot in their measures. We could say we (Governments, and banks too) need to attempt a 'shock recovery', almost shoot first, ask questions later. And that means forcefully countering those who either emotionally or for carpet-bagger vested interest reasons oppose trying to restore as much as possible the map of how matters stood before the crisis. We can assess how much and where we can risk a clean break with the immediate past? In solving the banks liquidity risks, Governments can supplant as counterparty (and then as market intermediary) all of interbank wholesale funding of banks 'funding gaps' and also eventually bring credit and money markets on-market into regulated transparent credit and money markets. Part of the problem undoubtedlky was that these were off-mnarket, in 'over-the-counter' trading. This is not beyond governments financial resource to do so and would leave the previous sources of wholesale funding begging to get back into this profitable market - a good result for restoring balance to money and credit markets.
But, it cannot be accomplished if governments liquidity and SLS type measures are not transparent (e.g. The UK 2009 Banking Bill that permits non-disclosure for at least 6 months of precise details of government funding of the banks).
A related matter is that even the FT as well as all other media have failed to pick up that by law government holdings of commercial banks when over 50% are outside of regulatory supervision laws (CRD Basel II, Solvency II, IFRS etc.) and outside of the Companies Act and codes of conduct etc. This is clearly established at EU law by the Irish nationalisation of Anglo-Irish Bank and now applies to NR, B&B and RBS. (And similar is true of Fortis, ABN AMRO, and in USA of AIG, FM&FM etc.) Some assurances are needed here that regulatory supervision will continue in these cases!
Above all, the public want the reassurance of a clear statement of the game-plan. It is not enough that this game-plan is now diverted into the G7 and G20 agendas.
In my analysis of what's happening is as follows: banks generally in both UK and USA, and elsewhere, are losing twice their reserve capital, once to the credit crunch, once to the recession. Governments are replacing one times capital reserves and so far one quarter to one third of 'funding gaps' plus guarantees of deposits & bondholders. Banks have to recover one times capital reserve from recoveries and one times capital reserves from selling off business assets from which they can redeem government bank share investments (and will be anxious to do so before their share values rise sharply sometime in the medium term).
But, where are government measures in this to assure that banks will not endanger recovery by deleveraging, acting powerfully pro-cyclically? That, I believe, is to be found in the now long-run (not temporary) liquidity funding by central banks of banks 'funding gaps' - the reason why securitisation of bank assets has gone up dramatically in 2008 and will continue to be historically high in 2009!
This, so as to pledge the bond collateral with central banks as 40-50 year maturity paper (as in the UK, where this collateral after 25% discounting is pledged for 3 years holding periods in exchange for Treasury Bills, but this is likely to be prolonged beyond 3 years, and 3 years is now the US holding period too, up from 1 year) i.e. these are very long term Covered Bond, MTN and SIV funding programs under which the underlying loans are topped-up continually, replenished, rolled over. On this basis lending levels by the banks should be restored and maintainable.
In fact, we can envisage that insofar as all this government liquidity infusion is off-budget, the dividend & coupon revenues to Government are of sufficient size to balance US Federal and UK General Government budget deficits after 2009! Thus, there is a shift from private financial sector profit to Government profit to pay for the fiscal impulses.
If this framework is publicly recognised and managed intelligently that is a prudential way out of the mess.

EU emergency anti-crisis summits

The EU has scheduled two emergency anti-recession summits ahead of the London G20 and G7 in an effort to suppress protectionism, sustain employment and prevent the bloc’s political fragmentation into old and new member states. EU heads of state and government will convene in Brussels on March 1 to discuss their latest steps to counter the financial sector crisis. They will meet again in Prague in May after the G20 to consider the recession’s impact on the 27-nation bloc’s labour market. This is in addition to a previously scheduled summit of EU leaders on March 19-20 in Brussels that will also deal mainly with economic issues from the G20 agenda for which the Commission has a large number of high priority tasks to progress.
“Only by co-ordinated and united action will we overcome the crisis. The internal market is the vehicle that will drive us out of it,” said Mirek Topolanek, the Czech PM, after talks with José Manuel Barroso, EU Commission President. The two announced the summits to limit the fall-out from a clash between French (outgoing 6 month Presidency) and Czech leaders (incoming 6 month presidency) that exposed cracks in EU unity just as the EU has to find a common united voice for the G7 and G20 about how to usher in a new financial world order and the most serious global economic difficulties in EU history.
The not at all plain fact is that while financial flows in most of history followed trade flows, and then were decoupled when major currencies all freely floated post end of Bretton Woods, there followed the fast growth but severely unbalanced trade patterns of the past 20 years requiring financial flows to be provided as packaged up financial assets (commercial bank securitisations etc.). Half of US structured products were bought by its foreign trade counterparty surplius countries such as China, Japan, Korea, and the EU, about $1.2 trillions.
The collapse of these securities, dramatic changes in exchange rates and energy prices over the past year, recessions etc. all have caused a massive re-orientation of world trade patterns. Most countries are totally lost in knowing what their extrnal accounts are going to be. We see this for example recently in Russia where a large fiscal stimulus was abandoned as the Government could see its foreign exhcnage reserves rapidly falling and the necessity to support its banking sectors external obligations with the necessity of buying in toxic debts!
The Czech views reflect to some extent that of central Europe where trade and investment flows with the EU have dramatically worsened. “My feeling is that this is something that’s very damaging to both of us,” Mr Topolanek said of his row with Nicolas Sarkozy. “We haven’t dealt with it in person because, frankly, it wasn’t worth it. Now I’ve learnt a lesson. It’s better to call each other up.” The dispute broke out last week when Mr Sarkozy suggested that French car manufacturers operating in new EU member-states, such as the Czech Republic and Slovakia, should switch production to France and protect French jobs. Tensions rose on Tuesday when Mr Topolanek accused unnamed eurozone governments of “deforming” the project of European monetary union with misguided responses to the financial crisis. The quarrel will become a broader conflict between the EU’s older, western European countries, most of which use the euro, and the newly admitted states of central and eastern Europe. This is a problem with a long history. The EC/EU has been traditionally weak or less effective than it should and could have been in addressing economies across its borders compared to the USA and Mexico for example, though mjatters can be strained there too. In the past this was explicable given that across EC/EU borders were either Soviet states or Muslim states which each had obstacles to capitalist development. Aid was more effective in sub-sahara Africa and in trade with OPEC and further afield.
Now within the EU there is a large group of central European states, most outside the eurozone and more vulnerable to severe financial disruption the longer the crisis persists. “Already we can see small countries entering into problems with liquidity, as the price of their bonds decreases and they are not able to sell them,” said Mr Topolanek, whose Czech Republic took over the EU’s rotating presidency from France on January 1. The Czech Republic is also angry and frustrated at the disapproving noises heard in certain western capitals about its weak leadership in the financial crisis. France's €6bn aid plan for the French car industry with attaching non-communitaire conditions is in breach of the free market, and Mr Topolanek's presidency has a right to reprimand France for this - hence the row - saying the real division in the EU was between “those who think it’s possible to violate the rules right now, and those who think it’s not, and I’m one of the latter”. Mr Barroso, striking a balance between support for France and defence of the EU single market’s integrity, said: “We must not let our industries perish because of a temporary downturn ... But we will need to scrutinise very carefully the details of the [French] subsidies.” He added: “All over the world there’s a real threat to the global economy from economic nationalism and narrow protectionism. We must resist this temptation. If one country decided to go it alone and take unilateral measures, others might decide to do likewise. But I reject the idea that it is a specifically European problem.”

WELFARE AS AN ENTERPRISING NECESSITY?

Fiscal policy in the recession has been described by many on both sides of the Atlantic by reference to John Maynard Keynes' analogy or metaphor of £5 notes to be earned and paid for by cost of getting unemployed people to first bury and then exhume them. Keynes (according to a very good recent piece by Nick Fraser in The Independent saw this as an alternative to dole money (welfare checks)! http://www.independent.co.uk/news/business/analysis-and-features/john-maynard-keynes-can-the-great-economist-save-the-world-994416.html)
There is a current debate in the UK about whether to tax savings (or unearned income generally) or otherwise TO end any public subsidy of savings. This may be based on Keynes' comment that 'One man's saving is another man's unemployment'. As savings and borrowings are equal, the only way to reduce borrowing is to reduce saving. The purpose is to make those with money spend, so that the poor can earn instead of borrow. The originator of the idea was Silvio Gesell, who advocated a system of depreciating cash by 2.5% a year. In fact this idea persists in the idea of steady long run non-inflationary, optimal productive capacity, growth, by seeking a long run inflation rate of about 2-2.5%. Gesell's system was not comprehensive enough, but his present day followers have tried to deal with the defects. The view that some have come to now is that tax assisted saving should end. Others are advocating the exact opposite. Hidden behind this is the fear that the transmission mechanism by banks which converts savings into loans for productive enterprise is not working, and that Government dispersion of spending power would be more effective i.e. a shift from private to public money 'transmission mechanism'.
There are many ways of achieving such a shift that I will not rehearse here. But, looking at the matter more broadly, or philosophically, there is also a protestant, conservative as well as Marxist, work ethic here that money has to be a value for (and valued by) hard labour. Before the 'hungry thirties', the second 'great depression' (today's may become the third) there had been a century of poor law, public and private relief works etc. For example, in Ireland during the 1840s famine and in the depression of the 1880s and other times (and in Scotland and many parts of England and Wales too, if less so) relief work was proscribed to being non-commercial i.e. not producing anything that could be for sale! Hence, the work was building estate walls (private relief) or roads (public relief) but not anything that might furnish commercial exchange and thereby compete with or displace private enterprise. Similarly, in public housing provision, once it became a state activity, the dimensions and quality had to be to the lowest minimum standard i.e. less than that of private commercial housing - though ironically private homes and sub-divisions of townhouses etc. had presaged these low standards, and subsequently emulated these minima often at lower standards! The difference between private and public housing quality was usually in quality of location and often only superficially in building quality and design for living.
Also, this general bias of social provision being of minimalist quality also explains the city- or town scape cultural desert of council housing estates (or ghettos) e.g. having minimal or zero shops, post office, church, culture spaces, village hall, fire, medical or police stations. Imagine if the enormous benefit and ethos if the design had been more that of Prince Charles's Poundbury than Glasgow's Easterhouse (note that the 1998 social exclusion policy in the UK began rectifying this - http://news.bbc.co.uk/1/hi/uk/171530.stm ) Today, in the UK,there are 1.7m on the council waiting lists in the UK, nearly one third in Scotland
(which is only 10% of UK population) where last year 5,700 new social homes were built after 10 years of zero new builds.
The prejudices (by or, often spuriously so, on behalf of 'taxpayers') about the dole (public welfare) now extends in the credit crunch to governments baling out (or bailing?- joke) bankers' losses only so that private bankers can take all the profit again in the upturn. We have also had over a decade of prejudicial fear that the growth in pensioner numbers (in addition to all other welfare claimant's etc.) are becoming an insupportable burden on enterprise and on 'working families' (the beloved constituency of both US major parties).
A modern Keynesian way of seeing these is quite different, and possibly not one Keynes would have instinctively supported, that welfare safety nets and pensions are not external to the 'real' or 'productive' economy, but more of an essential central engine of the 'real economy'. Welfare system safety nets encourage entrepreneurship in business and the arts (and if also their close relative, crime) by taking away some of the downside fear of taking commercial risks. It also recycles spending from savings to incomes in ways that are more equitable (including geographically) to act as a very useful complementarity to the banks' transmission mechanism and thereby increases everyone's income i.e. 'the welfare state multiplier'.
The idea of welfare (and public infrastructure and services) as a beneficial economic necessity (benefiting general economic growth) as much as, or more than as merely a moral obligation (socialistic view) or a national security requirement (liberal conservative view) or as charity (caring conservative and religious view), has never caught on, not in the public imagination anyway - and that is a gross failure by economists and of all leading thinkers (philosopher politicians and academics).
Similarly, there is no history yet written to show or extol how the design of public provision has been variously innovative and leading (something socialists would love to be able to believe) and/or the very opposite (as neo-liberals firmly believe), a stifler of productive innovation and of 'free markets'.
In my view, political-economy philosophy would have had a very different development if Adam Smith had written some years later than he did and the dominant capitalist model would then have been based on productive growth of cities, as much or more than on the productivity of factories. Cities express the overall system of all transactions (goods and services) mediated by money and self-financing by increasing the velocity of capital (now 250 times GDP in the UK, world's highest), and not based on theories of value (whether on essential resources such as food and shelter production, labour-value, or gold standard and its variants, including Malthusian and Shumpeterian theories, physiocrats, mercantilism etc.). We are still at sea largely in understanding market price values in economics as a basis for fundamental models (except in physiocrat and mercantilist-based philosophy theories).
We also have dysfunctional thinking in relating short term to longer term and working life to total lifetimes. This was part of the debate around Keynes as Davis describes.
As a sub-note to some of my readers: I think it was a major calamity that Prof. Alan Abbott Young (Prof. Nicholas Kaldor's teacher at the LSE) died when he did (1928) before writing and publishing broader philosophical texts about economics, who I think might have more than marginally exceeded Keynes (who was inspired by AA Young) in our estimation today had he lived?

Save more or spend more?

Echoing a similar debate in the USA, the UK debate about getting savers to spend more, or to tax them, the prudish comments about a false economy based on credit boom, how our priority should be more savings, UK having highest household debt in EU etc. - this is angst-ridden baloney! The only important issue about our credit boom economy was the external account (net of our high FDI inflows) that had to be funded by selling financial asets to forewignors (exporting bank asset securitisations) and at some point this had to collapse necessitating severe changes in our terms of trade; lower net imports and lower pound (for a while anyway).
The viability quality of the economy is not given by how much we save or borrow. Export-led economies are not in better shape. Anyway, the definition of 'savings' is wrong - too narrowly conceived. When households pay mortgages they also believe themselves to be saving, similarly in life and pension schemes. Household debt did rise to highest in EU (among the bigger nations) but so too did assets and therefore UK households net position remained merely at the average for the EU. Even today with average loan to value ratios of mortgages at about 55% these loans are more than fully secured despite the 20% fall in house prices (even if likely to fall another 10%). Even defaulting mortages average about 67% LtV also in aggregate within the discounted collateral value of house prices. So far all defaults are likely to be at least 60% recoverable. When Government borrowing rises or falls, so too does private saving rise or fall and by exactly the same ratio to GDP. This is an accounting identity; these are not separate unconnected observations. Japan's high savings ratio was the counterpart of the Government's high borrowing. The low domestic consumption was caused by lack of Government domestic stimulis and the multi-generational household debt overhang from the heady property values of the late 1980s.
More serious an accusation is that following a major shift in lending to mortgages and consumer cards (In UK, Eire, Greece, Spain, USA) that lending to non-financial businesses suffered (when measured absolutely and not just in ratio to GDP) and net imports grew phenomenally - financed by foreign acquisition of net financial assets. There is a strong case for shifting bank lending to more loans for business sectors.
Lending to customers by UK banks is 2-3 times GDP (and not all this is UK specific). UK customers possess 3 times this again in assets at current market prices, i.e. one third at most is debt, probably only one quarter. Household savings in bank deposits alone are about one times GDP and this covers 80% roughly of loans to households. Therefore, the idea that UK households cash savings are perilously low based on reported annual 'savings ratios' is wrong, and wrong again when other savings are considered out of income i.e. pension, life, property equity net of mortgages and other private or personal assets. Taxing cash savings when expenditure is richly taxed and given recession circumstances is truly mad! Taxing unearned income (interest on cash savings and other) at source could be relieved and recovered in income tax returns is possible, but this gives non-doms a bonus.
Hence I prefer the idea of more money for the poor among whom in greatest number are poor state pensioners getting half of what state pensions were worth 50 years ago and almost half what French pensioners get for example. Rich pensioners are the fastest rising tax payer segment and pay more than enough to fund doubling of state pension to poor pensioners, whose net cost is low given that the poor spend domestically and can't save whatever they get.
Of course, household consumption is important to GDP, but too much attention is focused on the consumption side of GDP (a conservative choice) nd not on the output side of the same double-entry account. Output GDP is public and private earned income and profits. The ratio between earnings and profits varies over the cycle, but the total of the two has to equal public and private (households and businesses) consumption + fixed investment. Government counter-cyclical actions operate on both sides, but it should be fairly clear (before considering the external account, which is also very important) that action to maintain employment income is just as important or more important than consumer spending. If people save more in bank deposits or similar than they would spend at other times, this is merely a matter for the banks' transmission mechanism to extend more loans to productive industry and/or to buy and hold more gilts from new issues - something the Government is keen to enforce on banks in which it has shareholdings.
When household saving fell dramatically in the few years this coincided with 186% rise in house prices and fall in government borrowing. When sterling deposits at UK banks fell over a long period as a % of their assets this was also because of the international expansion of UK banks including wholesale business.
The media dogs, like Anatole Kaletsky recently in The Times, responding to the simple-minded statements by messrs Osborne and Cameron, and absurd questions about whether to tax household savings, have got their teeth on a meatless and hollow bone.