MERKEL MICROSCOPE

As a foretaste of next year's UK general election, we have Germany's, Europe's biggest economy. Germany could be nearing the bottom of its sharp economic downturn, Chancellor Angela Merkel suggested in a bullish speech at the Hanover trade fair. This is not just political hubris, but is in German politics the equivalent of saluting the flag, of expressing modern German'ness, of what German means in the world, it means exports!
Everyone knows Germany's growth has for three decades been far too exposed to exports, to being export-led, while the domestic economy has languished in high unemployment for lack of domestic fiscal stimuli, but the german politicians won't stand up and say that. Arguably, it was China, Japan and Germany's joint failure to do little to secure domestic-led growth despite their generous external account surpluses that is as responsible as anything else for the global crisis, such that the US and UK and other major deficit countries were 'forced' to rely overmuch on credit-boom growth. Export supluses are seen as virtuous and responsible, conservative and prudential, and in the case of the world's three biggest non-oil trade-surplus countries net exports is their brand, their sinature tunes, their self-identity that they are extremely reluctant to abandon or dilute. German industry representatives also predict that the worst could be over by the middle of the year viz. collapse in demand for German exports.
One thinks of the "it'll all be over by Christmas" propaganda thinking, and maybe that is only to be expected in election politicking. But is a global crisis a fit subject for domestic politics? I this not being globally irresponsible and one-eyed about the the comprehensive picture.
In a general employers and conservative poltiicians touching of 'bottoms', the VDMA federation of equipment manufacturers (the mainstay of german exports dependent on foreign countries' upping investment in industrial capital, which seems a vain hope) backed the optimistic assessment, saying the steep drop in orders for German industrial products could be over by mid-2009. Hannes Hesse, MD of the VDMA, said the sharp reduction in inventories and government fiscal stimuli being implemented around the world (but much less so in Germany itself?) would have a positive impact on orders in the second half. This is a great example of lauding fiscal stimuli anywhere else but at home?
The fond notion that Germany’s steepest economic downturn since the terrifying '30s could soon too be history is not widely shared, either at home or abroad. Economists think industrial inventories are too high for the German economy to turn around in the near term, despite continued drops in machinery and vehicle production. Hans-Peter Keitel, president of the BDI industry federation, said even a rebound in orders in the second half would not prevent Europe’s largest economy from shrinking by 4-5 per cent this year, which is twice the shrinkage expected in the UK and USA.
Forty top business representatives, bankers, economists and trade unionists are today airing their much more negative opinions about the state of the German economy at a meeting hosted by Ms Merkel in Berlin, but probably doing so mostly in private, any chance to try and turn the Merkel telescope around and to take a proper look below decks and recognise that domestic fiscal stimulus (Interne Wachstumsimpuls, bitte, und mach schon, schnell damit!).
One of Merkel's top table guests, Frank Bsirske, head of the services trade union Verdi, is urging Berlin to spend €300bn ($387bn, £266bn) over the next three years to prevent a full-blown depression. This amount seem parsimoniously weak. Yet, that is several times the €80bn pledged by Berlin so far to kickstart the economy, and puts the union at odds with the CDU party and closer to its rival SPD. Merkel's CDU rejected a third stimulus package. The SPD and unions agree that he federal government policy led by the CDU systematically underestimates the magnitude of this crisis and its measures to combat it are too small. Verdi’s proposals, he said, would create or protect 2m jobs. In my view the government should be aiming to double this impact. But, if politicians have a weakness it is the belief that new facts should not change or alter whatever they have said from one year or decade to the next as a matter of firm principle even when only on the matter of not if or when but merely 'how much?' Such crises demand that governments should fear far more doing too little than doing too much;the latter is easier to deal with in hindsight than the former.
Verdi's union wants the government to spend €75bn annually until 2011 on public infrastructure and services, such as schools, hospitals, transport and broadband networks, plus €25bn each year for labour market measures; extension of unemployment benefits, more support for short-time working and introduction of a minimum wage. Berlin could fund the measures through new taxes but also by the measures own self-financing effects.
To those of us schooled in 3-dimensional economics, the codespeak means 'Keynesian multipliers' and they have been political anathema, banned, gulag'ed,under house-arrest, considered deeply un-German, missing-in-action from German politics for four decades! It remains to be seen whether the SPD has the wit and ofrtitude to run that flag up the glagpole and see how many will salute it at the polls?

Quantitative Easing, Asset Protection Scheme, and bank nationalisations

QUANTITATIVE EASING IS ABOUT MONEY SUPPLY AND IN DIFFERENT WAYS ABOUT INSURING BANKS' 'BAD BANK' ASSETS, BUT ALSO ABOUT BANK FUNDING AND WHAT MAKES MOST PRACTICAL SENSE TO CENTRAL BANKS.
QE is a possible replacement (not just supplement to) for asset swaps at Central Banks' liquidity windows for banks in central banks money market operations (of the 'less open' sort). For those of you who don't read all the financial pages, the world-model for this is the Bank of England's Special Liquidity Window, SLS. This closed on 19th January, having operated since April 2008, since when it swapped about £245bn of UK banks' Asset-backed Bond Securities, ABS, (mainly mortgage loans. packaged into bond structures, and sold in Special Investment Vehicle companies, SIVs, that are firms only set up, and managed by agents, just to handle the payments and standby liquidity between banks and investors so that all of this is now 'off-balance sheet').
The £245bn or so ABS was swapped (after heavy margin write-downs and haircut fees) for £185bn of treasury bills (government bonds with less than 1 year maturity) that can then be used to replace private sector funding (and redemption of banks' maturing medium term notes and 'covered bonds' they issued) to re-fund the 'funding gap' between customer loans and customer deposits. The swapped bonds are worth far more than all the gold in the Old Lady's bottom drawer (as in our Bank of England vault pictured above). Assuming you have got that, now let's move on.
Next stop, "son of SLS", the UK HM treasury and Bank of England Asset Protection Scheme, APS.
APS is alongside, and arguably also part of the permanent "son of SLS" liquidity window at the Bank of England (BoE) that for an additional fee is available to UK banks any business day, not just periodically. The BoE might have continued with an exact repeat-copy of SLS, but it had some second thoughts - intelligent ones. The way SLS was heading was that £500bn would be swapped by end of 2009. But, was this enough if it only provides 3-year roll-over compensation for UK banks' credit crunch asset write-downs, even when that will exceed the total of the UK big banks' total equity capital? As much again would be needed. But should this still be done via treasury bills?
The problem with SLS is that the assets swapped are held as collateral to support the T-bills. The assets are held for 3 years and therefore the T-bills must be rolled-over. But, what if the banks that got the bills sell them or run into any difficulty such that the bills fall in other hands and are presented back to the BoE for payment on maturity date and not for roll-over (paid for with some new bills)? The difference between collateral held after swapping for bills also backed capitalisation investments in UK banks' preference and ordinary shares, off the Government budget, and if UK banks did not hold their bills to maturity for any reason, which in theory and for accounting purposes they did not have to do, then those capitalisation investments could be disrupted.
This then brings us to QE, Quantitative Easing.
In QE, a UK bank's bonded assets are swapped for a BoE cheque that is paper cash (just as a Bank of England banknote is a bearer's cheque) but to be held on deposit as part of the UK bank's liquid deposits (reserves) at the BoE. That way the central bank has direct liabilities (deposits) to balance-off against its bought-in assets (3 year collateral). The press comment noted, however, that the BoE will swap cheques for assets with non-banks! That's just a technicality, 'non-banks' only means from SIVs that UK banks set up to process their ABS off-balance-sheet; it does not mean 'shadow-banks' like hedge-funds (unless we count SIVs as parts of shadow-banking - and why not?). The cheques have to end up remaining at the BoE as part of UK banks' deposits there, which is not something for any actual non-banks to be able to do! The media also imagine that the BoE's MPC Committee must approve this? Well yes, but only because the academic literature defines Quantitative easing as a sort of 'printing money', actually signing cheques, which means boosting the money supply and thereby risking an inflation-response in the economy! This is just a pro-forma idea, more supposition than reality. The money supply is global as well as domestic and inflation is not currently a threat or undesirable. A dose of inflation, like negative real interest rates, or even if imported inflation, could speed up debt repayments and debt rec-cycling and might put a floor under property price falls. Property is involved in everything and banks accounts (unlike inflation-adjusted GDP growth numbers) are unconcerned about inflation so long as not making credit risks worse or squeezing net interest income. Inflation might help to draw a line under the number of banks to be saved. Why also QE is attractive is because under liquidity windows, the BoE SLS-type, the t-bills received by banks, bought with off-balance-sheet bonded loan-assets) could be sold, traded, to get cash, when BoE need the banks to hold the T-bills in capital reserves where they can then be rolled-over so the debt issuance doesn't have to appear on the Government budget like Government bonds (gilts) do. Then, if banks sold their t-bills, there is a theoretical fear of short-term crowding-out of private capital by government capital (actually the opposite happens, but no mind this is more than half-respectable Monetary Theory)- but it's not that really anyway; that's just very hard to prove theory, Keynesians say unproven and wrong because treasury bills and bonds are nearly 100% liquid instruments. Worth repeating: the BoE (ECB too in Euro zone) fear that if sold on (possibly by forced-sale due to cash-flow embarassment or takeovers) these t-bills reappear to be presented for payment, when central banks want to be sure they can simply roll them over i.e. not redeem them, not for 3 years, the period they will hold the swapped assets. The central banks don't want to redeem the t-bills until they've made money from the collateral assets, and from the difference between the face and write-down values that they've used to back other treasury spending on capitalisation of banks. Hence the safest way to proceed from BoE (ECB and Federal Reserve too) perspective with "son of SLS" is QE. And, yes, having fully liquid deposits at BoE means the UK banks have that as backing for 'cash' payments i.e. so-called 'printing money', but actually no different than t-bills except t-bills have to be sold on, or borrowed against as short=term collateral, to get the money and could come back to embarrass the BoE. Cash-flow support via QE does not come back to haunt the BoE i.e. like people demanding gold for their grubby notes. And, yes, there is a money supply and inflation aspect, but also consumption spending and higher imports and wider trade deficit. BoE might like to be telling the banks to use the money to support loans to infrastructure, fixed investment customers e.g. property developers, to keep the building of new housing stock built, or better to assist industrial manufacturers to make exportable products, even if only building inventory ahead of recovery? I spoke about all this on Sky News today. The same is true, however, in the USA.
What is happening in the USA is also so in the UK. An important context for the Lloyds deal is the rise in CDS spreads this month that echo the jump in spreads in September when Lehman Brothers crashed that led in the USA, UK and other countries to bank bailouts. CDS spreads are risk price indicators for the cost of interbank funding, but also reflect risks within the net CDS exposures of banks because of the huge $50tn size of the CDO and Synthetic CDO markets that greatly exceed the underlying assets to be insured. Got that?
What was the lesson of Lehman Brothers? It followed from Bear Stearns, Northern Rock, and other reminder lessons that the most important asset a bank has is confidence, just as the most important lesson of a whole market is also confidence, direct confidence, not just confidence about the underlying assets or the underlying economy. If people are confident in a bank, it can continue to do business; if not, it can’t. For the last six months, where has that confidence been won or lost? Not in banks’ balance sheets, which is a big concern for audit firms as well as banks. The balance sheets are mistrusted when they absolutely should not be! Is confidence won or lost in the various bouts of capital and targeted asset guarantees provided by Treasury and the Fed, HM Treasury and Bank of England, ECB and others? These support a widespread assumption that the government will not let the creditors of large banks lose money, out of fear of repeating the Lehman debacle; only shareholders are at high or near-absolute risk.
Let’s say that AIG, Citigroup, RBS, or LBG are restructured (less ruthlessly than say Fortis) via government conservatorship so that creditors did not get all their money back (Unlike the 100% guranatee in Ireland or as applies to FDIC-insured deposits in the US or to recently-issued senior debt explicitly guaranteed by the government), they may be forced to convert debt for equity, higher risk/higher return, or be stiffed! A concern is that this could undermine further confidence in banks. According to the FT, bank bonds are one quarter of all U.S. investment-grade corporate bonds. I suspect the % in Europe is similarly high. Losses would be spread far and wide, hitting other banks, pension funds, insurance companies, hedge funds, and so on. If banks cannot support their derivatives exposures, then institutions that bought CDS protection from face further losses. (Banks were net buyers of CDS protection i.e. they invested in them for speculative gain more than just for default insurance.) The fear is that it will be impossible to predict how these losses will be distributed and who else might be dragged under. I'm indebted here to 'Contrahour' from seekingalpha.com
Lehman did not seem to force any other major firms into bankruptcy, although it may have severely wounded AIG since it was counterparty to a dominant share of CDS contracts. Once investors figure out that bank debt is not safe generally, they will refuse to lend to banks, and we are back in September all over again, and this is what CDS spreads are now telling us is the case today. But, now, this is despite governments' massive delivery of liquidity into their banking systems to keep banks functioning? So what changed this week?
One theory is that the semi-forced conversion of Citigroup, RBS and LBG of preferred into common shares is a sign that government may try to force creditors to exchange their bonds for common stock in future bailouts. Preferred shares are not, technically speaking, debt. But they are a lot like debt (fixed coupon dividends), and once you finish converting preferred into common, the next layer of the capital structure is subordinated debt. So the markets are left wondering, and we know markets don’t like large uncertainty. Another possibility is more people are thinking that the government may end up restructuring bank debt. In the FT, for example, Martin Wolf and Willem Buiter, both very serious and globally influential opinion-formers, question whether government should be protecting bank creditors. Wolf, I believe, favours yes for now, but Buiter says no.
Each time the lines on CDS charts, as above, spike up, government has to be seen taking action to imply that creditors will be protected, without making severely testable promises. Hence the bad bank APS in the UK implemented this week. Chances are we’ll see more along these lines. At some point, though, the government may lose credibility and then, disastrously, no source of confidence remains. But, next stop G20 in early April for a global confidence-building inter-government conference.
In June, Sweden takes over the EU's 6 month Presidency. One of the steps in Sweden’s sometimes-heralded bank rescue program was an explicit government guarantee on all bank liabilities, as per Ireland's response too and its nationalisation of Anglo-Irish. But, if any country could wholly-guarantee its banks, you would think it would be the U.S. But the real barrier to taking such a step is probably political - the accusation that this is the road to communistic socialist control of the commanding heights etc. No-one should underestimate US concern, sometimes bordering on paranoia, about the Federal tax-dollar, one reason why EU fiscal centralisation has not proceeded further. Usefully, to understand the technicalities of governments' current initiatives is Morgan-Stanley bank's definition of QE as follows (extract): "Unlike the Asset Purchase Facility already in operation, these asset purchases won’t be funded by the issuance of Treasury securities (which effectively withdraws money from the economy, offsetting the injection of money from the purchase of the assets). The Bank of England will buy assets in exchange for, effectively, a cheque from the Bank of England. The seller then deposits the cheque at its bank which (assuming it banks directly with the Bank of England) results in that amount being added to the commercial bank’s reserves at the Bank of England. The seller of the asset has less of one type of asset (e.g. gilts) and more cash. The commercial bank has more deposit liabilities and increased assets at the Bank of England. The Bank of England has increased liabilities in the form of commercial bank reserves and increased assets in the form of the securities it has purchased. Money has been created (‘printed’)." For ,ore see: http://www.asymptotix.eu/node/115#comment-8
Additionally, it is a moot point that the bonds and bills are actually HM Treasury property via the DMO (Debt management Office), not exactly Bank of England's and therefore aspects of that can alter the accounting in respect of national debt and budget deficits. By shifting to BoE cheques instead of treasury bills we get a build-up of liabilities at BoE that can then build assets in the banks itself and take the pressure of HM Treasury! This is politically neat.
The context for QE includes an agreed deal already for over £325bn between RBS and BoE. Another deal is being negotiated for £258bn Lloyds Banking Group, LBG. A problem has arisen here though, it seems? The swap requires fees upfront, writedown and haircut plus interest payments. If the assets are of the riskiest sort, then the coupon and standby first-loss liquidity protection can be quite heavy and may require 'paper losses' reported in the P/L which then further postpones coupon payments on preference shares and so on. The problem may be that LBG feels suitably cash-flow liquidity constrained that it wishes to make the payments to the BoE (in effect actually to HM Treasury's DMO which manages Government bonds and bills) in shares, preference, or given the scale ordinary full-voting shares. This could then take the Government's share of LBG above 50% and possibly to 70%! What happens then if almost half of the UK mortgage market is government-owned and more than half of everybody is doing financial savings and borrowings with government-owned banks, and so on, and maybe on to a degree of government control and knowledge about everyone, directly or by cutouts such as UKFI, Big Brother state, actual or potential, just imagine the leader writers of the press starting to write "know what, good citizens, we have asked our panel of professors are we or aren't we... and they have all agreed... the UK is now a fully-fledged, centrally-controlled Camminist State in all but name, Long Live Comrade Brown!" It is bade enough that Private Eye magazine devotes a whole page fortnightly to precisely this amusing idea. Imagine all this belonging to the Party of "hard-working families" (Chairman Brown's acclaimed constituency today), the party of hard-working taxpayers and the poor, but not of course of bonus-earners, non-doms, and unearned-income shareholders. This, as much as anything else, is what lies behind deep resistance by Government/s to nationalise the banks, because it means effectively, and variously, nationalising most of everything else. banks are that important, truly the commanding heights of the economy, Clause 4 risen from the dead and straight into power! Lloyds shares were up 6% in mid-morning trade and remained over 5% up at end of day, while oddly other major UK banks' shares fell? The oddity is that ordinary shareholders in LBG are about to be diluted. Perhaps they have calculated that on balance the bank will be worth that much and more, and that the long negotiation suggests that outright nationalisation, as Vince Cable MP says seems now only sensible, will not happen and the long term faithful shareholders will not be wiped out. Short-sellers too must be steering clear, or no-one is prepared for once at this sensitive time to lend out LBG shares only to get them trashed. Both the government and Lloyds said nothing had been agreed by mid-morning, after the BBC broke the story at 9am, and silence persisted.
The BBC reported that under the plan the government "would insure" up to £258bn of assets, and would get non-voting shares in return, which actually means that the preference shares would back the standby liquidity reserve for the SIV assets. The amounts are also significant in that for both banks, RBS and LBG, they virtually cover 100% of their current year 'funding gap' re-funding requirement. But what the experts and public may not know is that in fact the assets are not just those of the two banks, but very likely will include securitised assets from other smaller banks and building societies that included large dollops of theirs in RBS and LBG (LTSB and HBOS) securitised assets in SIVs and covered bonds such as the HBOS rolling $125bn program or Lloyds other SIVs, but not including the well-known SIVs, Grampian and Cancara.
The BBC speculation is that the deal could also mean the bank swapping some of the government's existing non-voting preference shares, on which the bank currently pays 12% interest, for ordinary shares and that it is believed the interest on these shares costs Lloyds about £480m a year. One can only suppose that there is a price for converting fixed coupon shares for zero dividend shares and this will be paid for in more shares too? I find it very hard to believe the bank is so cash-flow sensitive! But, although the numbers are large in ratio to GDP, they are not if we just consider that what is happening is the public sector displacing the private sector from what in reality is lucratively good business, bank-financing. The swapping of preference shares for ordinary shares would be seen as important for Lloyds' cashflow says BBC political correspondent Reeta Chakrabarti, who added that an agreement between Lloyds and the government should have been reached a week ago, but both sides confirmed discussions remain ongoing. A spokesman for Lloyds Banking Group said conversations had not yet concluded because there was still "a good deal of detail to be worked through", and actually this is as much to do with legal drafting paperwork as it is to do with spread-sheeting the financials and doing some risk modeling. Of course, had they asked me I'd have modeled it all before lunch and structured a call-off contract arrangement with an algorithm for quarterly revisions so that a provisional agreement could be announced and let the lawyers and investment bankers turn their clocks off. A HM Treasury spokesman said in almost perfect Rumsfeldian: "Discussions are ongoing. A deal will be announced at the conclusion of those discussions." Do we take this to mean that "no deal" is "no option"? [Agreement was announced next day, Friday, resulting in government shareholding in the bank growing from 43% to 65% voting shares and 75% overall, just under the 80% threshold.]
Meanwhile, across all channels, Liberal Democrat Treasury spokesman Vince Cable, a most honourable Member of Parliament, described full nationalisation of Lloyds as being, not just in his view, but somehow according to some Golden Calf god, "inevitable" and has called on the government to bring the whole banking sector under public control. I don't see it as technically or otherwise inevitable, whether desirable or simpler or cleaner is another matter. BBC political correspondent Carole Walker said Vince Cable is not alone in believing full nationalisation will restore confidence in the banks more quickly, saying, "There are a number of people in Westminster who believe we are getting closer and closer to full nationalisation... [They think] it would be simpler and easier for the government to nationalise the banks and that in the long-term it would save the taxpayer a lot of money." Sorry, but they are dead wrong there. Simple does not mean easier and this is about medium term not long term. Gordon brown wants to clean out the banks, but nationalisation means beginning with cleaning out the shareholders, but what problem are they, and how much less is the prospect of a profitable return for taxpayers if the banks shares are no longer quotable or able to rise on the good news in April from the G20 and possible GDP turnaround in late 2009 and in 2010?
Restoring confidence should extend to share values as a proxy signal to bondholders and potential bond investors who would profitably redeem the Government's stakes. Nationalisation removes some market signaling that in other improved future circumstances are useful, valuable. It also brings in some other problems of what is or is not in the national debt and on-budget and what is or is not in or outside regulatory supervision as well as competition issues. The Euro zone is operating on 2 year bailout timescale. The UK government is on a 3 year timeline. What happens then to level-playing field EU political-economy laws and markets? The deal is part of the Treasury's taxpayer-backed Asset Protection Scheme, APS,to "insure" banks' riskiest assets against further losses - actually much more than that and really funding gap funding and general balance sheet protection too. It was put forward by Chancellor Alistair Darling, no doubt with Mervyn King, to "restore confidence in the banking sector", which while true is a care-worn somewhat threadbare mantra after a year or more of endless repeating. the problem seems to be that Ministers cannot speak out authoritatively about banking in any detail, because who'd believe their professional credentials for doing so, and bankers cannot do so either, not even central bankers and regulators, because they are all disgraced and discredited publicly and no-one trusts them or their motives! This is why international coordination on bank regulation and fiscal responses is politically important apart from being economically important. The last bastion it is assumed where voters might venture trust and belief is when governments across the world all seem to agree. Gordon brown and his government is therefore hugely depending on the success of the G20 London Conference on 2 April. This was the essence of his speech today at the Scottish labour Party Conference in Dundee, which in turn repeated much of what he had been saying earlier this week in Washington and in addressing the Congress and Senate. He is truly a global statesman hero, Flash Gordon, and I truly hope, and believe, he can, and is, playing that role fully, with integrity, and most successfully. Conservative Shadow chancellor George Osborne, less than artlessly, continues to deliberately fail to get it, believing still that his best best is to undermine the last bastion of public trust, government handling of global economic crisis, by sniping in true ya-boo political bad-form that government efforts to get the banks funding each other again may be likened to "insuring the car after it has crashed". He is keeping pace with the Republican Party minority leader in the US senate who also says this is a time for government belt-tightening not taking the belt off! In my view both have their trousers round their ankles and should be thinking about how to restore some dignity to their politics in this time of crisis! This is absolutely not the time to be undermining confidence in governments' economic or political authority! Opposition parties should envisage the crisis as if we are in a wartime economy and value the importance of all loyally pulling together. Normal service in politics may stick with non-economic policy matters and otherwise wait until more normal political-economy conditions return.

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.”