Saturday, September 27, 2008

Follow the money

How They Stack Up. Since am clearly enjoying it, take a look at the visualisation I made on how much money are central banks across the world pouring into to give life support to the financial system.

Mutual Fund Assets in the World.

Click here to see the visualisation I created on Many Eyes.

Source: Investment Company Factbook

Monday, September 22, 2008

Behind the motives of The Bail-Out

Authors of the book of Too Big To Fail: The Hazards of Bank Bailouts (2004) - Gary H. Stern, Ron J. Feldman of the Federal Reserve Bank of Minneapolis had this to say -
Many of the existing pledges and policies meant to convince creditors that they will bear market losses when large banks fail are not credible and therefore are ineffective. Blanket pledges not to bail out creditors are not credible because they do not address the factors that motivate policymakers to protect uninsured bank creditors in the first place. The primary reason why policymakers bail out creditors of large banks is to reduce the chance that the failure of a large bank in which creditors take large losses will lead other banks to fail or capital markets to cease working efficiently. Other factors may also motivate governments to protect uninsured creditors at large banks. Policymakers may provide protection because doing so benefits them personally, by advancing their career, for example. Incompetent central planning may also drive some bailouts.

For the history of bank bail-outs in the US, read here.

Do we see the return of the ‘essentiality doctrine’ of the 1980s? Authorities then forged a criteria to deal with various bank failures. The doctrine was also an explanation to the public on why the government was doing what it was doing. It feels strange now that officials then were overwhelmed by "lightening-fast removal of large deposits from around the world by electronic transfer."

Sunday, September 21, 2008

State of the Fisc

We just finished living through history this week. Seven days that changed the contours of American capitalism as it were. The American economy came to a tipping point - close to a credit freeze. Even as Treasury's desperate proposal of a $700 billion bail-out that essentially seeks to raise the ceiling on national debt to $11.3 trillion, awaits ratification, the crippling impact it will have on government finances is yet to be fully known.

How will this impact the expenditure of the government. Will this move see many justifiable social expenditure taking a back seat? After all, the headroom available for expenditure has now been squeezed because of the massive bail-out for financial institutions at large.

US government fiscal deficit :
2005-06 - $248 billion
2006-07 -$162.8 billion
2007-08 -$161 billion
2008-09- $407 billion (estimates)
2009-10- $438 billion (this figure will now balloon)

According to a report by the Congressional Budget Office dated September 9, the deficit is expected to rise from 1.2% of GDP in 2007 to 2.9% in 2008. The projected deficit for this year is more than twice as large as the deficit recorded for 2007, which was $161 billion, or 1.2 percent of GDP. After the final bail-out figures are frozen, the new bill may cost upto $1 trillion or 7% of the GDP.

Cost of wars - $858 billion
Cost of bail-out-$600 billion (Bear Stearns, AIG, F&F, money market funds)
Cost of total clean up - $500 billion to $1trillion (estimated)
Impact per capita $2000 (estimated)

A lot will depend on how the mechanism of the bail-out will manifest on government's balance sheet. Governments resorting to off-balance sheet exposures as an effort to keep fiscal deficit in check is common to developed and developing countries alike. But then, as one commentator, the fiscal profligacy of third world countries is childs play compared to what is unravelling around us. Also, bailing out poor farmers under a populist scheme may be less harmful than protecting greedy bankers who precipitated this systemic risk.

Monday, September 15, 2008

Economy in slow motion

Even as economists agree to disagree on the definition of recession, for America recession is here, or is it?

The problem is there are no broad measures that estimate industrial production. The rate of GDP is the only measure and that’s too broad. Smaller number of industries were responsible for a larger output. Today the economy is much more diversified. Even if some of the industries were performing slower it did not impact the overall economy too much. When the financial services industry is in recession like today, it is generally leads to a multiplier effect and there is an decline overall output. The National Bureau of Economic Research may declare this as a recession with a lag (like it did last time). We do not need two continuous quarters of negative growth to have recession.

In a conversation with Markus Schomer of AIG investments last week, he pointed out something interesting. He said the way recessions manifest themselves has changed. It is hard to see. There are no people crowding at employment exchanges! He had a different point of view for recession catch-words like “job losses” and “credit crisis”.

Excerpts -
In the case of an industry like the auto sector, a slowdown has been going on for years. But processes around this industry has been able to adjust itself to this pace. So does it not stand out. Nobody says it is a dying sector, although there has been sustained job losses over the years.

Manufacturing is laying off people. But today companies are far more nimble in managing inventories than before. For example, companies like Wal-Mart for example monitor the demand and adjust inventories real-time. There is no sudden build-up of inventory, that leads to a decrease production and even job losses. There is a more calibrated approach.
Earlier recessions were really brutal. Companies are now getting better at managing expectations and human resources. There are actually not many companies laying off employees as before. The American economy is largely driven by the services sector, so there is not much scope for laying off people.

On credit crisis -
The test now is how well corporate America does under the current circumstances. There is a problem with access to financing. The companies that are facing difficult financing conditions are dependant on their banking relationships. Default rates are going up. There is finance, but the traditional ways of accessing finance have become difficult. Companies can still manage to get access the public market through bond issuances. And there are been cases where such issuances have been oversubscribed.

Official Unemployment Rate : 6.1%
This rate does not take into account illegal migrants that work in sectors like construction which has been laying off people. This means that the actual unemployment rate can be much higher.

Wednesday, September 10, 2008

Changing Risk Profile

In the previous post, we spoke about the risk of sovereign debt. The risk profiles of various countries forecast by the Economist Intelligence Unit (EIU) throws up some interesting results. For countries such as China and India, though fairly high, the risk rating has been consistently decreasing, the reverse is true for the U.S. On most parameters the risk profile for the US has increased. The same holds true for UK as well. Look at the table below -

Country overall currency sovereign debt banking political economic structure
Brazil 40 38 41 41 38 35
China 41 38 31 54 54 35
India 39 37 36 44 39 38
UK 23 25 17 28 7 18
US 24 28 15 30 14 23

While the table above does not show the risk rating over a period of years, EIU data shows that on most accounts, the risk profile of the US has increased in the last decade. For sovereign debt risk, the rating jumped from 3 to 15 in a decade. For China, banking sector and political risk has remained almost constant for a decade.

(For a long-term forecast like this one, EIU develops a framework based on supply side indicators. In such a case output is determined "by availability of labour and capital equipment and the growth in productivity," the EIU states.)

The Wall Street Journal says Asian investors, including the Chinese prevailed upon Treasury officials.

Monday, September 8, 2008

When should the state step in?

Although the mega F&F bail-out package spread cheer in most economies, there was unmistakable cautiousness that it will not keep the markets bouyant for long. Banking stocks in general rose, but scrips of those Asian banks that have a higher exposure to the F&F debt are faring better than the others.

That it was inevitable for the US government to intervene is taken, but the practice of governments (UK-Nothern Rock) of bailing big firms raises questions. Is it a good regulatory practice to bail out ailing financial institutions (FIs)? A decision like this one will have to be done keeping in mind the consequences of not bailing out those FIs that could pose a systemic threat.

The broader point still emerging out of all discussions in print and on-line how soon should government get out of playing an active role in the mortgage business. And how healthy is sovereign debt? Should there be a more comprehensive policy that lays down conditions under which governments are authorized to step in. The short term goal of giving the markets a shot in the arm will be served by this bail-out, but what remains to be seen is the long-term impact on the U.S. exchequer and world in general.

p.s. Its funny, we live in times where there are sponsored links that say "Is your bank in trouble? Click here to check out the list of banks doomed to fail" and so on. Well as they say, there is a season for everything.

Sunday, September 7, 2008

The Perfect Storm

We are on a rather slippery stretch now! The Mobius Strip was born on a landmark day in the history of United States - on a day when the two biggest mortgage companies were taken over by the U.S. government. The Financial Times, ( painted a picture of a hurricane ready to wreac havoc in its way, as it spreads to other parts of the global economy. The way Americans and American banks bought and sold homes, has just become history.

Tax-payers will be called on to pay for massive capital injections into Fannie and Freddie. Credit rating company S&P has already downgraded F&F stock to junk after the government took over. As United States goes to sleep after the largest government bailout that made the treasury secretary Henry Paulson a hero, rest of Asia wakes up to tumbling US treasuries and rallies in its stock exchanges.

At a time when there is very little leeway for central bankers across the world to devise a truly autonomous monetary policy, this blog will try to explore the pressure points for economies. While its too early to speak about the death of decoupling, we will try to understand how connected economies truly are. In short it will try and answer the question of how rising prices in one part of the world, can lead to higher cost of money elsewhere?

Welcome to The Mobius Strip.