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October 14, 2010

Will QE2 sail...or sink?

A second round of quantitative easing in the US economy is not required, probably won't work, and may prove counter-productive.

 

Past weeks have seen the US (and world) financial media aflutter with talk that the US Federal Reserve will initiate a second round of Quantitative Easing (QE) aimed at boosting economic growth. This QE2 is generally expected to consist of open market operations such as purchasing financial assets - government bonds, mortgage-backed securities and corporate bonds. QE2 will be a bad idea.

 

Why would QE2 be a bad idea?

  • QE2 will weaken the dollar and hence raise oil prices (which are denominated in dollars). Costlier oil will act as a drag on growth. The Fed believes that the positive effects of a weaker dollar (such as cheaper exports) will outweigh negative effects, but this belief is not sufficiently grounded in empirical experience. 
  • Economists don't know enough about how QE affects inflation; such a policy may well cause inflation to surge. 
  • Easy funds arising out of QE2 will chase higher returns outside the US; the wall of liquidity already descending on emerging markets in the past few months is thus likely to grow even bigger. This will not only cause QE2's effects to leak out of the US economy, but will also lead to asset price bubbles in emerging markets. QE2 may well thus cause the US to export financial instability to the emerging world.
  • The biggest reason why QE2 will be a bad idea, however, is that there just isn't enough evidence to show that such a policy would work. Prior uses of QE include Japan during the early 2000s and the financial stimulus used in the US and Eurozone in the aftermath of the 2008-09 crisis (i.e., QE1). The Japanese experience was hardly edifying, failing to achieve either higher growth or deliverance from chronic deflation. In any case any extrapolation from Japan to the US would be inappropriate - the US is a far larger economy (almost 3 times the size of Japan), and is a far more diversified, open and vibrant economy, with a currency that is also the world's reserve currency.
 
Of course, it may be argued that QE1 should have been stopped owing to similar misgivings. However the situation was very different then, with most experts believing that economic armageddon was looming. It was a desperate measure, but the desparate situation called for it. And QE1 perhaps did work, at least in some measure (although there are many divergent opinions on this). Things are very different now. The US (and world) economies have been on the mend since the recession officially ended in June 2009 , and the dreaded "double dip" has receded to not much more than a theoretical possibility. As outlined above, quantitative easing in the current situation may well prove ineffective or even a setback. Today, the risks of further easing outweigh any possible benefits.

Prolonged easy monetary policy (in the US and elsewhere) in the aftermath of the early 2000s recession sowed the seeds of the 2008-09 financial crisis; easing monetary policy now may well sow the seeds of the next crisis.
 
 

Posted by Dr. Vivek P Kochikar at 10:46 AM | | Comments (0) | TrackBacks (0)

The recession: a "surprise" ending

Neither the recession nor its end should have come as a surprise

 

I had written on this very blog in April 2009  that the US and global economies would begin their recovery from recession in July 2009. This opinion was based on five factors, all publicly known.

 

The opinion was considerably at odds with that of eminent economists and world leaders at the time: Uber-gurus such as Nobel Laureate Paul Krugman  and Robert Reich (a member of President Clinton's cabinet and ranked among America's Top Ten Business Thinkers) were predicting another Great Depression; the IMF and OECD were in March 2009 foreseeing a recovery for the world economy starting only in 2010  . President Bush said in his final press conference that his economic advisors believed that "the economic situation could be worse than the Great Depression". The US Federal Reserve warned in February 2009 that "the crippled U.S. economy would deteriorate throughout 2009".

 

Now comes heartening news: The US National Bureau of Economic Research (NBER)'s Business Cycle Dating Committee (which certifies the start and end of recessions in the US economy) said three weeks ago  that the recession ended in June 2009, and a recovery began that month. It also said the basis for this decision was "the length and strength of the recovery to date".

 

My analysis and opinion on the end of the recession have thus been proven remarkably accurate, despite having appeared outlandish, over-optimistic and contrary to prevailing expert wisdom in April 2009 when they were written.

 

Sadly however, it appears that in matters economic, we must continue to stumble from one surprise to another. Earlier too, in March 2007 and August 2005, I had written forewarning of an impending implosion of financial markets - here I wasn't alone but among an unheeded minority that had forewarned of such an eventuality.

 

A guest column I've written in CEO World magazine in February 2010 analyzes recent economic events and shows that neither the recession nor its end should have come as a surprise.

 

Of course many people don't believe a recovery has begun even now (some reasons in this blog post). Also, the above only means that the recession ended mid-2009 and the recovery began then - it certainly doesn't mean the US or world economies are perfect as can be. 

 

A few thoughts on longer-term structural changes (some rocky, some benign) in store for the world economy in coming years are this blog post. They include:

 

v      No lessons have been learnt from the recent financial crisis, and so there will be more crises.

v      As the world rebalances, global wealth distribution is shifting inexorably. In 2025 the world will look more like it did in the late 19th century (in terms of relative apportioning of wealth, not in terms of absolute standards of living or technological advancement) ! 

 

 

Posted by Dr. Vivek P Kochikar at 10:43 AM | | Comments (0) | TrackBacks (0)

February 19, 2010

Wanted: Lucid, clearheaded thinking

Muddleheadedness can be costly, particularly when it obscures a clear view of the economy.

Consider this: Most business- and world- leaders, eminent economists and thought leaders failed to foresee correctly the recent upheavals in the global economy - the financial crisis of late 2008, the recession and the subsequent recovery.

However, neither the recession nor its end should have come as a surprise. I've presented detailed evidence of this claim, in a guest column in CEO World magazine last week. As I show there, the surprises happened because signals in plain sight were resolutely and repeatedly ignored !

Considering the overriding importance of the macroeconomy - it affects the livelihood of millions of people, the business prospects of thousands of companies, and often the survival of governments - this collective foresight failure is puzzling and quite unforgivable.

The good news is that, I believe, improving on this foresight deficit needs neither magic nor math (as in complex mathematical models). It doesn't need clairvoyance or crystal ball gazing. Most often a crystal clear view of what's happening in the real world, and a clear eye to discern relevant signals that are often in plain sight are good enough. But those are precisely what's lacking - obscured by siloes of professional specialization, cognitive biases, flawed 'conventional wisdom', predilections of various kinds and so forth.

I will present a more detailed analysis of the reasons behind this lack of foresight, and how a more clearhead view of the economy can be fostered in a future post.

Read the guest column, The recession has ended and other surprises.

Posted by Dr. Vivek P Kochikar at 8:30 AM | | Comments (2) | TrackBacks (0)

May 15, 2009

Bank Stress Tests - Not so Stressful?

Released last week, the long-awaited results of the “Stress Tests” conducted under the direction of the  US Treasury Secretary, Timothy Geithner,  have since been picked, prodded, lauded and criticized.  Pundits from the right, left and the center have unleashed a torrent of mixed opinions into the media and blogosphere.  With a week gone by, I thought I would table a few questions which I envisioned might strike up a lively debate:
·         Were the Stress Tests stringent enough?
·         Rather than a true test of bank health, were the Stress Tests instead a means to boost confidence in the banking system?  
·         Will the U.S. Stress Test model be emulated by other countries, especially in Western Europe?

Continue reading "Bank Stress Tests - Not so Stressful?" »

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April 16, 2009

The World Economy: Clear Skies Ahead?

Why we should be optimistic about the prospects for an economic recovery

Note: This piece was written on April 16th, 2009. Subsequent developments in the world economy have substanitally borne out the assertion made here that "there will be concrete signs of recovery as early as July". See details in the July 19th update at bottom of this piece.

How soon should we expect the world economy to be back on a growth trajectory? I've been following statements from a varied set of economic gurus and masters of world destiny, and have found the overall sense of pessimism quite remarkable.
Jan 13th, 2009: President Bush said in a press conference that his economic advisors believed that the economic situation could be worse than the Great Depression.
Jan 23rd, 2009: Steve Ballmer, Microsoft CEO said, “The economy could remain in the doldrums for "a year, two years..”.
Feb 14th, 2009: the G7 meeting of the Finance Ministers of the world’s most powerful countries in Rome declared that "the severe downturn will persist through 2009".
Feb 18th, 2009: The US Federal Reserve warned that “the crippled U.S. economy is even worse than thought, and would deteriorate throughout 2009”.
Mar 16th, 2009: Federal Reserve Chairman Dr. Ben Bernanke, in carefully hedged remarks on CBS 60 Minutes, said the recession will “probably” end in 2009, provided the US government’s efforts to stabilize the financial markets bore fruit.
Mar 19th, 2009:  the IMF said the world economy will shrink by 1 percent in 2009, lowering its own forecast of 0.5 percent decline made in January 2009.  It said recovery would begin only in 2010. 

While the above assertions come from people and institutions with gold-plated credentials, I believe they are overly gloomy – far more so than warranted by the evidence. There have been ample reasons to believe at least since late December that the US (and world) economy will be on a strong recovery path well before the end of 2009, and there will be concrete signs of recovery as early as July. What are the reasons for this optimism, which appears at odds to much of the expert opinion expressed by the Gurus above?

To be sure, enormous problems remain - imbalance between savings rates in the US and other countries notably China, continuing insolvency in major industries including banking and automobiles, some divergence of opinion between major powers as to how the financial crisis is to be tackled. Yet a clear-headed look at the world economy today shows a wide array of factors that give much cause for hope:

Continue reading "The World Economy: Clear Skies Ahead?" »

Posted by Dr. Vivek P Kochikar at 10:25 AM | | Comments (3) | TrackBacks (0)

January 18, 2009

Good Bank - Bad Bank

What a turbulent three weeks of the New Year it has been! It began with the hope that major stock markets around the world (led by the US Dow Jones Index), were beginning to thaw. But what promised to be a sneak preview to a turn-around, rapidly changed course; over the past week, the US Banking system teetered on the brink of collapse for the third time in four months. Citi finally accepted the fait accompli that its days as a Universal Bank  were numbered. Bank of America’s much vaunted acquisition of Merrill Lynch almost came unstuck!

The US Treasury and Federal Reserve (along with the FDIC) have made multiple attempts at resuscitating the credit markets. After the TARP approach of investing in Banks’ preferred stock and (subsequently) using the back-stop guarantee mechanism, the latest thinking among US Government bureaucrats is to segregate the “bad” assets on Banks’ balance sheet from the good ones or what is popularly being termed the "Good Bank – Bad Bank" model.

Sheila Bair, Chairperson of the US FDIC , has mooted the idea of a “Bad Bank”, which would aggregate and consolidate the toxic assets on all US Banks’ balance sheets (read here) - an idea that was earlier espoused by US Federal Reserve Chairman, Ben Bernanke and is also gaining support among President-elect Obama’s economic advisors. Across the Pond, the UK Treasury Chief, Alistair Darling and his team of policy makers have been discussing a similar option, in the face of Bank stocks getting hammered on the London Stock Exchange.  UBS actually put the concept to test in November 2008, when it spun off about $ 60 Bn in toxic assets into a separate entity with $ 6 Bn in equity (the jury is still out on the efficacy of such a move – write back to me if you have more insights).

Is creating a Bad Bank the solution to the crisis? Will this help focus Government recovery efforts like the Resolution Trust Corporation (RTC), which helped tackle the US Savings and Loans (SnL)  crisis in the late ‘80s? The Washington Post has a very interesting article on the subject and suggests adopting the Swedish Bank rescue model of 1991.

Personally, I am not a very enthusiastic supporter of the Bad Bank proposition. The Swedish Bank crisis or even the US SnL disasters were events of much lesser magnitude. The US ultimately lost only about $ 150 Bn in the RTC led SnL rescue. As of today, about $ 350 Bn of TARP funds have already been deployed in battling the credit crisis, not counting the Citi and Bank of America asset guarantees of almost $ 400 Bn!

Nobel Prize winner and Economics professor at Princeton University, Paul Krugman, who is also a noted columnist for the New York Times, has made a good point about the lack of clarity around the proposition (read here). 

I am keen to hear your views, as this debate livens up next week, even as the US is preparing for a historic Presidential inauguration amidst an even more historic and unprecedented economic crisis!    

 

Posted by Balaji Yellavalli at 4:18 AM | | Comments (1) | TrackBacks (0)

December 21, 2008

Madoff with Ponzi - Twin Devil on the Wall

We are yet to digest the sub-prime horror, international terrorism after Mumbai massacre and suddenly the trans-atlantic media is buzzing about a man and his master weapon- that's right, Mr Madoff & his schemy scheme , "Ponzi". With Wall Street reeling under $50 billion collateral damage, losses pouring in from Europe & parts of asia, some of the brightest investors' money under drain, this scandal has opened up the pandora's box of plight of super-free capitalist market. As the whole story yet to unfold, the big question that comes first- "What went wrong? Who is this Madoff? What is this Ponzi scheme? How come big names in the losser list got stumped by this NY man?"

Continue reading "Madoff with Ponzi - Twin Devil on the Wall" »

Posted by Suvendu Samantaray at 5:37 PM | | Comments (2) | TrackBacks (0)

November 30, 2008

Mark-to-Market Rules - Worsening the Credit Crisis?

With Citi being forced to seek the help of the U.S. government once again, it is apparent that banks will continue to feel the effects of a deteriorating housing market for some time to come.  While the viability of Citi’s Universal Banking model is being debated, it is becoming increasingly clear that, regardless of Bank-type, mortgage-backed securities are drowning our financial institutions in a sea of red ink. 

Many question whether this deluge of losses is actually necessary.  Bankers are pressuring regulators and lawmakers to make adjustments to FAS 157, the mark-to-market accounting rule in the US.  Put in place in response to the Enron crisis (Enron overvalued its assets to the point of bankruptcy) mark-to-market accounting requires corporations to value assets at their "fair value"; the price the asset would command on the open market. 

Continue reading "Mark-to-Market Rules - Worsening the Credit Crisis?" »

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November 8, 2008

Now Showing: Government vs. Free Market (Part 2)

As the financial crisis reverberates thru the world economy, redrawing the lines between government and free markets, here are some objective principles that define the role regulators should play in the new world financial order. 

The extent of regulation in general, and financial regulation in particular, plays a large role in defining the business landscape. In addition to determining the broad business environment in an economy, it has several micro, firm-level implications in areas such as governance, risk management and the use of Information Technology. In the first part of this essay we asked the question, How much financial regulation is "just right"? Or, where do we draw the line between government and free markets?

This admittedly difficult question has taxed the finest financial brains over the years, and we must clearly not expect any easy answers. People will approach it differently depending on their personal predilections, ideology, historical experience with regulation, current economic conditions and so forth. However, I believe it is possible to lay down a few principles that should help provide an objective basis for arriving at the "right" level of regulation, or at least to evaluate a regulatory regime once it has been devised. Here they are.

Continue reading "Now Showing: Government vs. Free Market (Part 2)" »

Posted by Dr. Vivek P Kochikar at 10:02 AM | | Comments (2) | TrackBacks (0)

October 31, 2008

Now Showing: Government vs. Free Market

In the aftermath of the financial crisis, the lines between government and free markets are being fundamentally redrawn. As a new world financial order emerges, laying down some objective principles will help.

On November 15th, leaders of the world's top 20 economies will meet in Washington, D.C. to decide what financial regulation will look like in future. The creation of this new world financial order is at once a historic opportunity and a task of immense responsibility. People are already referring to the Nov. 15th summit as Bretton Woods II, thus equating it with the conference that created the post-war world financial order that endures to this day.

With the notable exception of the US, almost all the leaders who will be in attendance have already weighed in in favor of greater regulation of the financial markets (see, for example, here, here, here, here and here ) and so we are inevitably entering an era of increased regulation. In this 2-part essay I will analyze past trends in financial regulation, and outline some principles that a financial regulatory regime must adhere to. I will revisit this topic after mid-Nov. and evaluate the outcomes of the Nov. 15th summit in the light of these principles.

 

Continue reading "Now Showing: Government vs. Free Market" »

Posted by Dr. Vivek P Kochikar at 7:46 AM | | Comments (4) | TrackBacks (0)

October 19, 2008

Do we need Basel III to curb current market dynamics?

Sub-prime led credit crunch, failure of some of the leading players in capitalist market have definitely brought the question back on risk management practiced in financial world. If closely observed the demise of some of these institutions, the root cause points to single major factor - “Too much exposure to single market downplaying consequences of correlation & concentration”. Before I pin-point individuals, let’s look at the market dynamics for last 8 years till culminating to present crisis. It clearly articulates how the risk taking corporations forgot to understand the implications of traps in each step. If we closely observe each of these leading debacles – Lehman, AIG, Bear Stearns, Wachovia, Washington Mutual & plenty more mortgage providers- the reason for crisis stems from the very greed & exuberance portrayed by these players to spike their profit by exposing to unrealistic level of mortgage business & its structured products without entangling the underlying risk. Some pundits might argue that some of these investment banking units have failed due to unbelievable leverage since they do not come under banking regulatory purview and not reined by the risk based regulatory capital regime of central banks,  but the failure of commercial banks at the same time questions that very conjecture. Basel II driven risk management philosophy in banks is the talk of town for last 7 years; however we see so much financial disturbance within banking fraternity globally. What went wrong then? Does that mean Basel II has its inherent weakness or not capable of answering present crisis? 

Continue reading "Do we need Basel III to curb current market dynamics?" »

Posted by Suvendu Samantaray at 2:37 AM | | Comments (5) | TrackBacks (0)

October 15, 2008

Bail Out Blues

I was teaching my 6 year old a new nursery rhyme the other day, in keeping with the times…!

Baa, baa, Paulson, have you any bail out?

Yes Sir, Yes Sir, 700 billion of tax payer loot

Some for the Big Banks, some for Wall Street

And some for the Congressmen (and women)’s gravy train

But none for the poor man (and woman) who foreclosed down the lane!

Seriously speaking, the US Treasury-led bail out has generated very lively debates across academics, economists, columnists and the entire political spectrum. The fact that there is a Presidential election looming in less than 3 weeks adds to the fireworks!

When the Emergency Economic Stabilization Act of 2008 (a.k.a the "bailout plan") was signed into law on October 3rd, reaction was mixed.  Various opinion leaders (notably Warren Buffett and George Soros) had differing viewpoints—many of them critical of the plan’s ability to achieve the intended goals.  The market didn’t react as hoped and what followed was a massacre that the global stock markets had not witnessed (especially, the Dow Jones Industrial Average in the US) in a generation  

Following UK Prime Minister Gordon Brown’s lead, on Tuesday October 14th, the Bush Administration changed course and announced what was tantamount to a partial nationalization of large U.S. banks - essentially forcing nine of America’s largest banks to accept funds in exchange for an equity stake.  The markets around the world anticipated this coordinated action and responded by opening the week with one of the highest single day gains in history.

I think that the biggest conflict facing the implementation of any bail out plan is really the toss-up between protecting tax payers’ interest and the need to thaw the credit markets by freeing up the Banks’ tangle of toxic assets! I am probably reducing the challenge to a very simplistic proposition, hence I am keen to hear your views.

I have also put together a links page, polling opinions of noted economists, columnists and academics.  If you have the time, click to read the extended entry below and let me know what YOU think about the bailout plan, the nationalization of banks around the world and the future of the global economy. Of noteworthy mention is Economics Nobel Prize winner, Paul Krugman’s column in The New York Times on Gordon Brown’s "equity injection" plan.

Continue reading "Bail Out Blues" »

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September 30, 2008

The Shotgun Wedding Planner on Wall Street!

Subsequent to my post couple of weeks back on the subject of Universal Banks, rapidly unfolding events in the US have catapulted JP Morgan Chase, Citi and Bank of America as the top 3 banking institutions in the country. With a leadership position across business parameters like Branch network, Deposit base, Credit Cards issued and hmm, Mortgages originated and serviced, these Banks carry an onerous responsibility on their balance sheets now and cover almost the entire US population in their collective footprint! 

The unsung hero of all the hectic parleys that culminated in the Universal Bank proposition is the FDIC! This venerable 75 year old institution, a by product of the Depression-era legislation, has played a critical catalyst role in averting a banking crisis for the person on the street. While the more high profile Treasury and Federal Reserve arms of the Government have been publicly making attempts to get consensus on the bail out proposition, the FDIC has been proactively working behind the scenes to identify fissures in the banking system and diligently negotiating with the larger banks to take over their weaker brethren in what the market terms as "shotgun weddings"!

Bank failures can be very expensive, apart from causing an irreparable crisis of confidence in the economy; the ripple effects can cause immense stress to small businesses and individuals, by putting their lifetime earnings at risk!

Read more about the FDICs round-the-clock efforts (and the final 4 am Monday morning deal!) in the most recent Citi - Wachovia merger here.

And do you realize that, in this deal, there is already an implicit bail out package? The Federal Government, through the FDIC has agreed to absorb any losses beyond $42 Bn in Wachovia's $312 Bn asset portfolio, in return for preference shares in Citi. So much for the "noise" around bail outs! 

Posted by Balaji Yellavalli at 4:55 PM | | Comments (0) | TrackBacks (0)

September 23, 2008

A Firewall for Wall Street

When death-defying daredevilry goes awry

What happens when you neglect an engine that is long overdue for an overhaul? Answer: It breaks down, perhaps bringing an aircraft crashing down to earth.

And in recent days Wall Street, the engine of the world financial economy, has sadly shown that it is far from immune to the banal real-world constraints that the rest of the world is routinely accustomed to living with.

Owing to a heady and overpowering mixture of high expectations and sheer exuberance, many financial industry players were convinced they could defy the mundane aspects of the real world, such as gravity. But magic wands and pixie dust did turn out to be the stuff of fairy tales, after all.

As I wrote 18 months ago in The Long Arm of the Laws of Economics, risk in world financial markets has been underpriced by hiding it away, using increasingly arcane, complex and innovative instruments* such as Credit Default Swaps and Collateralized Debt Obligations. As I wrote,

"While underpriced (Cheap) risk is good for borrowers in the short term, in the long term it can undermine  the health of the entire financial system. Thus there are good grounds for apprehension as to the robustness of the world's financial markets."

Continue reading "A Firewall for Wall Street" »

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September 19, 2008

Three Cheers to the Universal Bank!

On April 7, 1998 CitiCorp and Travelers merged, forming Citigroup.  Operating in both the investment and commercial banking spheres, Citigroup represented the reemergence of the Universal Bank, a Financial Services supermarket that was rendered extinct by the Glass-Steagall act of 1933. 

The Glass-Steagall Act was enacted in response to the Crash of 1929.  Large, deposit-holding commercial banks had waded into the booming stock market, underwriting issues and making risky loans (sounds familiar?).  When the market crashed and banks failed, deposits were wiped out (there was no FDIC, back then!), kick-starting the Great Depression.

 

Continue reading "Three Cheers to the Universal Bank!" »

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September 9, 2008

Fannie Mae and Freddie Mac - Flattened by the Credit Crunch?

Life used to be very simple in small towns across the US before the so called "Credit Crunch" came forth…

Joe Buyer and his wife Kim Buyer have a kid and want a new house to raise a family.  On a Tuesday afternoon they meet with their local bank’s loan officer, who stamps his approval on a mortgage that Joe and Kim may or may not be able to afford.  The loan officer forwards the loan to his bank’s treasury department, which eventually flips the loan to the Federal National Mortgage Association (affectionately known as Fannie Mae).  The cash proceeds from the sale of the loan are used to make more loans to other Joes and Kims.  The profits from all of these loans are used to purchase “safe and stable” investments—like Fannie Mae preferred stock.

Continue reading "Fannie Mae and Freddie Mac - Flattened by the Credit Crunch?" »

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