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IMF Puts Financial Losses at $4,100bnThe deteriorating global economy means financial institutions now face total losses of $4,100bn on loans and other assets, the International Monetary Fund said on Tuesday, urging governments to take “bolder steps” to shore up institutions – including nationalising them where necessary. The IMF said in its Global Financial Stability Report that many loans sitting on institutions’ balance sheets were eroding in value, not just the toxic sub-prime securities which first triggered the crisis. The IMF estimated that total writedowns on US assets would reach $2,700bn, up from the $2,100bn estimate it made in January and almost double what it forecast in October last year. Including loans originated in Japan and Europe, the writedowns would hit $4,100bn, it added. Banks would bear about two-thirds of the losses, it said, with insurance companies, pension funds, hedge funds and others taking the rest. Efforts to cleanse these bad assets from balance sheets and replenish viable institutions with capital had so far been “piecemeal and reactive”, the IMF said, calling for more decisive government action. “The current inability to attract private money suggests the crisis has deepened to the point where governments need to take bolder steps and not shrink from capital injections in the form of common shares even if it means taking majority, or even complete, control of institutions,” it said. The report is likely further to unnerve investors, even though the writedown estimates are lower than those of some private economists. On Monday traders were so alarmed by news of rising delinquencies on consumer and business loans at Bank of America that they triggered a stock market sell-off. US banks have so far taken about half of the writedowns they face, while European banks – particularly vulnerable because of their exposure to emerging European markets – have only taken one-fifth. But if banks took all the writedowns they face immediately, the IMF calculates it would wipe out their common equity altogether. That highlights the urgent need to inject more capital into many banks and other institutions. To restore their balance sheets to the state they were in before the crisis – defined by the IMF as a tangible common equity to tangible asset ratio of 4 per cent – US banks need $275bn in capital injections, euro area banks need $375bn and UK banks $125bn. But the IMF expressed concern that taxpayers were becoming weary of supporting the financial sector. “There is a real risk that governments will be reluctant to allocate enough resources to solve the problem,” the report said. One possible step would be for governments to convert their preferred shares in banks into common equity, the IMF suggested. This is something that the US government is considering, a senior official has told the Financial Times, though some have criticised such measures as “nationalisation by the back door.” Even if governments do take bold action to shore up the system, the credit crisis will be “deep and long-lasting”, the IMF warned. It said that deleveraging and economic contraction would cause credit growth in the US, the UK and the eurozone to contract and even turn negative in the near future, and only recover after a number of years. The IMF was also gloomy about the prospects for emerging markets as foreign investors and banks withdraw funds. It estimated the refinancing needs of emerging markets are around $1,800bn, while net private capital will flow out of such economies this year. Reshaping global financial regulation was another major topic in the IMF report. It suggested creating two tiers of regulatory oversight: one to gather information, and a smaller one for systemically important institutions with “intensified” regulation. It also mooted the idea of levying an extra capital surcharge as a way to deter companies from becoming “too-connected-to-fail” in the first place. Building Castles of SandBANKERS, frauds, predatory insurers: there has been a stampede to punish the villains of the global meltdown. Yet one culprit is not only rarely seen as an offender, but is also being cosseted and protected. Governments’ obsession about home ownership has contributed as much to the meltdown as any moustache-twirling financier. The bust began in America’s housing market and soon spread to government-sponsored institutions created to increase home ownership, Fannie Mae and Freddie Mac. Part of the problem came about because of policy. In most rich countries the state subsidises private housing. Some places (America, Ireland and Spain) give tax relief on mortgage-interest payments. Others, such as Britain, eliminate or lower the tax on capital gains from sales of someone’s main house. Still others use state-backed outfits to direct credit to housing or to make it easier for first-time buyers or the poor to buy their own homes. Subsidies are not to blame for everything—the housing bubble affected a range of markets regardless of how much they were subsidised—but the distortions aggravated the boom and bust by making housing artificially attractive. Governments subsidise home ownership because they think it encourages stable, more law-abiding neighbourhoods. The children of homeowners do better at school than the children of renters do. Homeowners are more engaged in local democracy. And, because homeowners must pay off their mortgages, housing supposedly encourages people to save more than they otherwise would. Yet as our article argues, the benefits of subsidies have proved smaller than expected and the costs much greater. Home ownership may indeed instil neighbourly stability (though Germany with its high levels of stability and renting suggests the two need not go together). But who said local stability was so desirable? A stable neighbourhood may be one in which people refuse to move in search of jobs. Government backing sucked money into housing, boosting prices. Since millions use their homes as collateral for general loans, the house-price boom also exaggerated the consumer boom while it lasted, and amplified the bust when that came. Perversely, public policy even undermined the very things governments were trying to encourage. Housing policy aims at boosting savings. Yet home-equity loans and “negative amortisation” mortgages boosted spending. In their efforts to stem the financial crisis, governments have thrown money at everything, including housing. Some of this is justified, but they are making their ultimate task harder. The state should in the medium term be aiming to slash subsidies for housing. That means, in America, cutting the size of the loan on which people can deduct mortgage interest from $1m now to, say, $300,000 and ideally to zero. There is no argument for a tax break worth, in practice, ten times as much to the rich as to the poor. Countries should start phasing out the unlimited capital-gains tax advantages given to houses—which people treat partly as an investment. And any government weighing whether to create institutions to boost home-ownership should take note of the disasters elsewhere. A homeowning democracy is a bulwark against an overmighty state. Yet all those subsidies produce not just bloated home ownership, but dependence on public handouts. Nationalizing the Banks? Stock Conversion May BackfireThe Obama Administration wants to convert the preferred shares the government got from banks in the bank bailout into common shares. In theory, it could help expand lending, but in practice, it could politicize the banks, harm the economy, and waste taxpayer money. Common shares, unlike preferred shares, vote on who manages the company. The Government could use its votes to make banks waste money on ideological causes — the way it recently did with Freddie Mac, in order to promote mortgage relief for even high-income borrowers, and is now attempting to do with banks that lent to automakers, in order to bail out the UAW union. Or it could use its new power over corporate management to bail out politically connected Wall Street firms — as it did with the AIG bailout, gave billions of dollars to wealthy customers of AIG like Goldman Sachs, a wealthy Wall Street firm which was in little danger of going bankrupt, but which gave millions to liberal politicians, and which was formerly headed by Bush’s last Treasury Secretary. On the other hand, preferred stock gets paid dividends before common stock. One of the ideas behind conversion is to increase banks’ cushion of common stock, and thus dilute future losses by common shareholders. The theory is that this will make bank managers less reluctant to lend money for fear of losses. Conversion could also reduce troubled banks’ burden of paying preferred dividends, and give the government more incentive to make banks profitable. For this reason, some banks apparently like the idea of conversion. But there are big pitfalls in practice, since common shares, unlike preferred shares, vote on who manages the company. The Government could use its votes to make banks waste money on ideological causes — the way it recently did with Freddie Mac, in order to promote mortgage relief for even high-income borrowers, and is now attempting to do with banks that lent to automakers, in order to bail out the UAW union. Or it could use its new power over corporate management to bail out politically connected Wall Street firms — as it did with the AIG bailout, gave billions of dollars to wealthy customers of AIG like Goldman Sachs, a wealthy Wall Street firm which was in little danger of going bankrupt, but which gave millions to liberal politicians, and which was formerly headed by Bush’s last Treasury Secretary. It’s not clear whether the government will negotiate with banks, or follow normal contractual provisions, as to the rate of conversion, or whether it will use financial pressure. Many healthy banks were strong-armed into accepting TARP bailout funds in the first place, so that banks that really needed a bailout would not be stigmatized by accepting the funds. Now, the government doesn’t want them to be allowed to return the unnecessary funds in order to escape micromanagement of their business practices. Nor does the Administration seem to have an exit strategy to sell shares when the economy recovers, to keep banks from being subject to destructive political meddling and corruption, the way parastatal companies long were in Italy. As the New York Times notes, after converting its preferred stock into common, “The Treasury would also become a major shareholder, and perhaps even the controlling shareholder, in some financial institutions. That could lead to increasingly difficult conflicts of interest for the government, as policy makers juggle broad economic objectives with the narrower responsibility to maximize the value of their bank shares on behalf of taxpayers.” Freddie Mac offers a cautionary tale of what happens when the federal government takes over a financial institution. After federal regulators took over failing mortgage giant Freddie Mac, they didn’t stop its risky lending practices. Instead, they ramped up its risk-taking, making it run up even bigger debts at taxpayer expense to try to artificially pump up the economy. They made Freddie buy countless risky mortgage loans. Recently, the Obama Administration forced it to incur $30 billion in losses as part of the administration’s bailout for irresponsible mortgage borrowers, which caps mortgage payments for even high-income borrowers at a ridiculously low level. The Obama Administration tried to prevent Freddie Mac from even disclosing these losses in the financial disclosures it must make to investors under the securities laws. I was a huge critic of GSEs like Freddie Mac and Fannie Mae. CEI President Fred Smith publicly criticized their risky practices for years. Congress ignored his prophetic warnings about the risk they posed to taxpayers. But federal regulators have been so reckless that they have managed to make matters even worse at Freddie Mac. Obama’s car czar, Steven Rattner, is pressuring banks to satisfy the Administration’s costly political goals at the expense of shareholders and taxpayers. As Michael Barone notes, “The banks that have received federal TARP funds—some unwillingly—were told by government car czar Steven Rattner that they must accept 15 cents on the dollar on some $7 billion (face value) of Chrysler bonds. They professed shock and refused.” The reason for this demand is that absent such concessions, Chrysler won’t be taken over and bailed out by Italian carmaker Fiat unless the UAW union is willing “to give up some of the supergenerous health care benefits and supergenerous pension arrangements that the UAW has extracted from the U.S.-based automakers over the years.” Rattner, a major liberal donor, wants to keep such cost-cutting from happening at all costs, in order to benefit the staunchly liberal UAW — even though doing so will cost U.S. taxpayers billions. Given its poor track record of financial management, such as record deficits, there is little reason to believe that the Administration can run banks better than their current managers, however mediocre. The Administration is spending $800 billion on a stimulus package designed to revive the economy, but the Congressional Budget Office says the “stimulus” will actually shrink the economy “in the long run.” And Treasury Secretary Geithner has a history of bungling responses to past economic crises, such as his role in the destruction of Indonesia’s economy in the Asian Financial Crisis of the 1990s. It May Be Time for the Fed to Go NegativeWITH unemployment rising and the financial system in shambles, it’s hard not to feel negative about the economy right now. The answer to our problems, however, could well be more negativity. But I’m not talking about attitude. I‘m talking about numbers. Let’s start with the basics: What is the best way for an economy to escape a recession? Until recently, most economists relied on monetary policy. Recessions result from an insufficient demand for goods and services — and so, the thinking goes, our central bank can remedy this deficiency by cutting interest rates. Lower interest rates encourage households and businesses to borrow and spend. More spending means more demand for goods and services, which leads to greater employment for workers to meet that demand. The problem today, it seems, is that the Federal Reserve has done just about as much interest rate cutting as it can. Its target for the federal funds rate is about zero, so it has turned to other tools, such as buying longer-term debt securities, to get the economy going again. But the efficacy of those tools is uncertain, and there are risks associated with them. In many ways today, the Fed is in uncharted waters. So why shouldn’t the Fed just keep cutting interest rates? Why not lower the target interest rate to, say, negative 3 percent? At that interest rate, you could borrow and spend $100 and repay $97 next year. This opportunity would surely generate more borrowing and aggregate demand. The problem with negative interest rates, however, is quickly apparent: nobody would lend on those terms. Rather than giving your money to a borrower who promises a negative return, it would be better to stick the cash in your mattress. Because holding money promises a return of exactly zero, lenders cannot offer less. Unless, that is, we figure out a way to make holding money less attractive. At one of my recent Harvard seminars, a graduate student proposed a clever scheme to do exactly that. (I will let the student remain anonymous. In case he ever wants to pursue a career as a central banker, having his name associated with this idea probably won’t help.) Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10 percent. That move would free the Fed to cut interest rates below zero. People would be delighted to lend money at negative 3 percent, since losing 3 percent is better than losing 10. Of course, some people might decide that at those rates, they would rather spend the money — for example, by buying a new car. But because expanding aggregate demand is precisely the goal of the interest rate cut, such an incentive isn’t a flaw — it’s a benefit. The idea of making money earn a negative return is not entirely new. In the late 19th century, the German economist Silvio Gesell argued for a tax on holding money. He was concerned that during times of financial stress, people hoard money rather than lend it. John Maynard Keynes approvingly cited the idea of a carrying tax on money. With banks now holding substantial excess reserves, Gesell’s concern about cash hoarding suddenly seems very modern. If all of this seems too outlandish, there is a more prosaic way of obtaining negative interest rates: through inflation. Suppose that, looking ahead, the Fed commits itself to producing significant inflation. In this case, while nominal interest rates could remain at zero, real interest rates — interest rates measured in purchasing power — could become negative. If people were confident that they could repay their zero-interest loans in devalued dollars, they would have significant incentive to borrow and spend. Having the central bank embrace inflation would shock economists and Fed watchers who view price stability as the foremost goal of monetary policy. But there are worse things than inflation. And guess what? We have them today. A little more inflation might be preferable to rising unemployment or a series of fiscal measures that pile on debt bequeathed to future generations. Ben S. Bernanke, the Fed chairman, is the perfect person to make this commitment to higher inflation. Mr. Bernanke has long been an advocate of inflation targeting. In the past, advocates of inflation targeting have stressed the need to keep inflation from getting out of hand. But in the current environment, the goal could be to produce enough inflation to ensure that the real interest rate is sufficiently negative. The idea of negative interest rates may strike some people as absurd, the concoction of some impractical theorist. Perhaps it is. But remember this: Early mathematicians thought that the idea of negative numbers was absurd. Today, these numbers are commonplace. Even children can be taught that some problems (such as 2x + 6 = 0) have no solution unless you are ready to invoke negative numbers. Bank of Canada Lowers Overnight Rate by 1/4 to a Record Low of 1/4Bank of Canada lowers overnight rate target by 1/4 percentage point to 1/4 per cent and, conditional on the inflation outlook, commits to hold current policy rate until the end of the second quarter of 2010 OTTAWA – The Bank of Canada today announced that it is lowering its target for the overnight rate by one-quarter of a percentage point to 1/4 per cent, which the Bank judges to be the effective lower bound for that rate. The Bank Rate is correspondingly lowered to 1/2 per cent. The deposit rate - the rate paid on deposits held by financial institutions at the Bank of Canada - is left unchanged at 1/4 per cent and provides the floor for the overnight rate. Details of the Bank's operating framework at the effective lower bound can be found here. In an environment of continued high uncertainty, the global recession has intensified and become more synchronous since the Bank's January Monetary Policy Report Update, with weaker-than-expected activity in all major economies. Deteriorating credit conditions have spread quickly through trade, financial, and confidence channels. While more aggressive monetary and fiscal policy actions are underway across the G20, measures to stabilize the global financial system have taken longer than expected to enact. As a result, the recession in Canada will be deeper than anticipated, with the economy projected to contract by 3.0 per cent in 2009. The Bank now expects the recovery to be delayed until the fourth quarter and to be more gradual. The economy is projected to grow by 2.5 per cent in 2010 and 4.7 per cent in 2011, and to reach its production capacity in the third quarter of 2011. Given significant restructuring in a number of sectors, potential growth has been revised down. The recovery will be importantly supported by the Bank's accommodative monetary stance. The Bank expects core inflation to diminish through 2009, gradually returning to the 2 per cent target in the third quarter of 2011 as aggregate supply and demand return to balance. Total CPI inflation is expected to trough at -0.8 per cent in the third quarter of 2009 and return to target in the third quarter of 2011. While the underlying macroeconomic risks to the projection are roughly balanced, the Bank judges that, as a consequence of operating at the effective lower bound, the overall risks to its inflation projection are tilted slightly to the downside. With monetary policy now operating at the effective lower bound for the overnight policy rate, it is appropriate to provide more explicit guidance than is usual regarding its future path so as to influence rates at longer maturities. Conditional on the outlook for inflation, the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010 in order to achieve the inflation target. The Bank will continue to provide such guidance in its scheduled interest rate announcements as long as the overnight rate is at the effective lower bound. To reinforce its conditional commitment to maintain the overnight rate at 1/4 per cent, the Bank will roll over a portion of its existing stock of one- and three-month term Purchase and Resale Agreements (PRAs) into six- and twelve-month terms at minimum and maximum bid rates that correspond to the target rate and the Bank Rate, respectively. These longer-term PRAs will be issued according to the schedule released today. Today's decision to lower the policy rate by 25 basis points brings the cumulative monetary policy easing to 425 basis points since December 2007. It is the Bank's judgment that this cumulative easing, together with the conditional commitment, is the appropriate policy stance to move the economy back to full production capacity and to achieve the 2 per cent inflation target. The Bank retains considerable flexibility in the conduct of monetary policy at low interest rates. |
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