Archive for the ‘economics’ Category

Too little bank capital forces taxpayers to act as equity

March 28 2013 1 comment

Euromoney is bizarrely adamant that British banks should have as little capital as possible.

“It’s all too easy to be seduced into fear over the capital positions of UK banks,” it rightly says, while clearly resisting the temptation itself. Indeed, Euromoney isn’t worried at all. It seems to think that a vague 7% equity buffer is more than enough capital to protect taxpayers from ever having to foot another bail-out — or perhaps it just doesn’t care.

As long as bank investors earn a return for risking none of their capital and bankers get overpaid on the subsidised spread, all is for the best in the best of all possible worlds. Though it’s unclear what journalists get from the deal. Free banker love?

The situation is much simpler than is often portrayed in the press, as described in a book called The Bankers’ New Clothes by Anat Admati and Martin Hellwig, which does an excellent job of explaining why banks should fund themselves with a lot more equity, just as every other type of company on the planet does.

Admati and Hellwig have done the research (published in previous academic papers), and it shows that the funding mix a business chooses — the ratio of debt and equity — has little to no effect on its operations.

Bankers often make it seem as though equity is somehow set aside for a rainy day and thereby restricts their lending ability, but this is nonsense. Beware bankers whose lips move. The difference between equity and debt is that equity doesn’t have to be repaid. The proceeds from both end up in the same pot.

Because debt has to be paid back, businesses that are too dependent on it can quickly become swamped if the value of their assets depreciates. And this is as true for Citi as it is for Apple (which has almost zero debt).

To put that in terms that all homeowners will understand: the financial crisis caused the banks to fall into negative equity because they were mortgaged to the hilt. And the response to the crisis has only made things worse — they continue to be heavily mortgaged because their borrowing costs are so cheap due to an implied taxpayer guarantee through too-big-to-fail.

The only beneficiaries of this are the bankers and the investors. It makes no positive difference to bank customers or to the financial system. In effect, taxpayers are the equity.

Needless to say, this is not an efficient way to run the financial system. The discipline imposed by funding with equity is almost completely removed, yet the safety cushion is still in place thanks to the captive equity unwittingly provided by taxpayers.

This blatant moral hazard is cause for celebration over at Euromoney: “Importantly, there is no trigger for any fresh equity issuance, with a new recommended end-2013 capital target of ‘7% of RWAs’.”

Hurrah! That’s a 93% mortgage on the entire banking system — assuming that the banks don’t cheat, which they obviously do.

Does anyone outside The City think that’s a prudent margin of safety for the most important sector of our economy? Seven percent. Would people be surprised to find out that their home enjoys more secure funding than the bank that’s providing it? I think so.

When it comes to the national economy, politicians love to draw comparisons with small businesses and households and common-sense notions of thrift. But what happens to those sentiments when it comes to discussing the banks? The plain wisdom of the greengrocer is quickly forgotten and, instead, we’re treated to mind-boggling banker gibberish that is ultimately a lesson in the benefits of maximum leverage.

Given the level of deliberate obfuscation, it’s perhaps not surprising that some people misinterpret what’s really being said. “Equity is expensive,” they wail, as if bank investors are somehow a different breed of animal to the people buying Apple stock. They are not, of course.

Bank equity is only expensive when compared to taxpayer-subsidised bank debt, but the cost of that subsidy is very real. Bankers can safely ignore those costs because they’re not on the banks’ balance sheets, but from a national perspective it doesn’t make any sense to say that bank equity is expensive — because the nation does bear the cost of guaranteeing the debt.

So, the question is really about choosing a capital structure that maximises the safety and the utility of the banking system, rather than the current arrangement that simply maximises compensation for the bankers themselves.

Categories: banking, economics Tags: , ,

British Conservatives forget their own history

February 27 2013 Leave a comment

Andrew Lilico is a true believer in the logic of austerity and took to the Conservative Home blog recently to argue for bigger, faster cuts.

He was kind enough to respond to my comment and I’ve posted the exchange below.

oblivia: No, no, no. And no.

Lilico reckons Britain could face the same fate as Ireland and Spain. “It is not a “’purely theoretical’ concern,” he assures us.

Err, did I miss the UK joining the euro? If not, then Lilico is talking nonsense. It’s a “purely theoretical” concern that Britain will be forced by the Germans to take the same medicine as Ireland and Spain.

As long as we have our own currency, it’s impossible that we could run out of money and have to go begging to Europe for a bailout. Doesn’t Lilico know this? Is he deliberately cultivating groundless fears or just being ignorant?

It’s bizarre that people who railed against giving up the pound now behave as though we joined the euro anyway. What’s the point of currency sovereignty if you don’t take advantage of the huge power it gives us? We could have spent the past couple of years sprinting past the rest of Europe, but instead we’ve just joined them.

Hard to think of anything stupider.

Lilico: Yeah, yeah, cos countries that print their own currencies *never* have sovereign debt crises, do they? How could anyone have thought that the UK in 1976 had a gilts crisis, or that Angola is anything other than AAA today. And *obviously* the Irish recession and bank failures came *after* the ECB intervened, not before – how could I have been so silly as to think things had occurred in the opposite order.

I am no longer able to be polite about this utterly ridiculous meme that has spread that countries that print their own currencies can never have sovereign bond problems. It’s garbage.

oblivia: There are indeed parallels between Britain in 1976 and the PIIGS in 2009 — they were beholden to others. Britain was dependent on funding from the IMF, while Ireland and Spain had devolved monetary policy under the euro.

News flash: We are no longer indebted to the IMF and we didn’t join the euro. These aren’t accidents. They were the product of deliberate Conservative efforts to protect our independence.

Now you argue that this independence is an illusion. Forget all the arguments of the past, you say, we are in just as much peril today as we were in 1976. Be afraid.

I say this is nonsense.

ps Andrew Lilico is a director and principal at Europe Economics, a consultancy specialising in economic regulation, competition policy and the application of economics to public and business policy issues. You can find him on Twitter as @AndrewLilico, though you do so entirely at your own risk.

pps Martin Wolf also has a good piece in today’s FT that slays a few austerity dragons and makes the point that the problems in the PIIGS were caused by the ECB’s ill-advised austerity (which was forced on them after they gave up their independence to join the euro): “Eurozone countries’ debt crises resulted from European Central Bank policy failures. Because of its refusal to act as lender of last resort to governments, they suffered liquidity risk – borrowing costs rose because buyers of bonds lacked confidence they would be able to resell easily at all times. That, not insolvency, was the immediate peril.”

Helicopters can go up as well as down

February 18 2013 Leave a comment

I commented on Gavyn Davies’ much-discussed article: Helicopters can be dangerous.

This line in particular struck me as odd: “The increase in the monetary base is temporary in the case of QE, and permanent in the case of OMF.”

OMF is overt monetary finance, which is apparently a “less inflammatory” term for helicopter money. I’m not exactly sure why Davies thinks helicopter money would be dropped permanently, or why he thinks anyone is arguing that this would be a good idea.

But what I find particularly obnoxious is how the City is now back to calling for common sense and fiscal restraint. Ha!

Remember, it was bankers who demanded the initial increase in the monetary base (through bailouts) as a way of preserving their bonuses, and it was bankers that drove monetary expansion in the years before the financial crisis as they earned fat margins from cavalier lending, but when someone suggests a monetary expansion that might actually benefit ordinary people… heaven forbid!

Of course, neither MMT nor modern monetarism are concerned with a permanent expansion of the monetary base anyway. The point is to take control of the money supply away from the banking cartel and using a rule-based system instead. Outside of the banking industry, this is not a remotely controversial idea.

The only restriction on what a sovereign nation can or cannot do is determined by the available resources, rather than some made-up limit on the amount of money (which can be created at will).

Fear of currency wars is, like, so 2009

February 6 2013 Leave a comment

I responded to a comment underneath this article: Currency Wars, What Are They Good For? Absolutely Ending Depressions – Matthew O’Brien – The Atlantic.


There seems to be one big problem with this argument. Unlike in the 30s, trade has not collapsed. Thus, the likelihood of a trade war, and consequent ill effects, are quite a bit higher. The effects on the American consumer of sudden price increases on Chinese imports, or their disappearance altogether due to a collapse in trade, could be quite severe.


This comment (and article) would have been timely in about December 2008, when there were some legitimate reasons to fear a trade war (however irrational it might have been). Today, we already know the answer. It didn’t happen.

Instead, China printed massive amounts in 2009, as did most other large economies. And, after considerable strengthening of the yen, Japan is now benefiting from unorthodox monetary policy through Abenomics, and even India seems to be joining the party. But none of these countries are doing it to beggar their neighbours, which is the key point to understand. They are addressing problems in their domestic economies, which happens to have an effect on exchange rates (or not, in a world where everyone is doing the same thing).

Talk of “currency wars” is just marketing for a book of the same name. And best ignored.

Categories: economics Tags:

Japan: No longer a basket case?

January 16 2013 Leave a comment

America’s political right is obsessed with the notion of a debt crisis, even in the face of inconvenient truths that have a habit of appearing out there in the real world.

As some lobbyist writes in the FT today, this is how debt crises are supposed to happen:

What happens when an economy runs out of fiscal space? The presumption is embodied in the image of “hitting the wall”. Under this assumption, public debt exceeds a certain limit and financial confidence collapses. As a result, interest rates rise, the currency falls and panic ensues.

Unfortunately, this has never really been observed. And the best possible example of an indebted, developed economy — Japan — completely refutes it. Japan’s ballooning debt has not led to higher interest rates, a falling yen or panic.

Even so, Adam Posen manages to fill an article with evidence-free reasons why the US should not indulge in a new New Deal.

I have no idea if he’s right or not (though I certainly don’t like the way he says it), but it seems to me that people are starting to re-assess Japan’s response to its long economic slump.

After all, in 20 years of depressed growth, Japanese unemployment never reached levels that the US has suffered since 2009. And when you factor in the past few years of recession and weak recovery in the west, Japanese growth during the past decade is actually not that bad.

Of course, Shinzo Abe isn’t an enlightened figure. He’s doling out cash to his cronies for political reasons, but coordinated easing from the BoJ and fiscal stimulus from the government seem like a much more sensible approach than what’s happening in the US right now.

China’s problem of plenty

January 16 2013 Leave a comment

Someone posted an interesting comment on Simon Rabinovitch’s article about Chinese banks in the FT today, which describes a thorny problem facing mainland lenders: too much cash.

Rabinovitch sums up by saying:

There are some glimmers of hope that money in China is beginning to flow away from banks. Non-bank sources of credit, including bonds, exceeded bank loans in the second half of 2012, an important step towards a diversified financial system.

And attracts this neat retort:

Rabinovitch totally misses the point here. In a country where there is too much ‘private’ debt, and you’re coming off of three years of the world’s largest expansion of debt ever, the last thing you want is for the controls on new debt issuance to ‘flow’ away from banks. That prevents the government from full control over the expansion of credit, and allows for bad ‘WMPs’ to flourish (insuring that more malinvestment occurs and that creative destruction is not allowed to start). As noted by the head of the Bank of China, nothing more than “Ponzi schemes.”

Banks aren’t lending because there’s too many NPLs and they cannot expand their balance sheets anymore. So, the PRC government is letting ‘non-bank’ lenders continue to fuel the expansion of debt. While it may be necessary to some small extent (the country is running pretty much on empty as far as real growth), the reality is that 1/3rd of the total savings in China is now invested in these ‘non-bank’ debt instruments (or, nearly 1/2 of annual GDP). That’s not good at all, and not a source of “hope”…

Categories: economics, money

The lobby for the status quo

January 9 2013 Leave a comment

Paul Krugman is a Nobel prize-winning economist, right?

He went to Stockholm and rubbed shoulders with the world’s leading scientists, novelists and peacemakers — fellow members of this elite community. Right?

Wrong, kind of. Alfred Nobel was a Swede who, as everyone knows, made his fortune in the explosives business. On his death, he bequeathed that fortune to the endowment of five awards in the fields of physics, chemistry, medicine, literature and peace. Not economics.

The prize that Krugman won is officially known as the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, and has been sponsored by the Swedish central bank since it created the award in 1968.

It is the only other prize awarded by the Nobel Foundation, and some of Nobel’s descendants actively protest the association of the economic prize with their name.

Discussions about nominations cannot be disclosed for 50 years, so we have a few years to wait to find out how the selection process works, but one thing is clear, according to Bernard Lietaer, an economist who once worked at the Belgian central bank: there must be no discussion of the monetary system.

“Didn’t they tell you? Never touch the money system,” Krugman once told him, apparently. “You’re killing yourself academically if you touch the money system.”

Mainstream economists disagree over many things, but they rarely differ much over the money system. Whether in the Soviet Union or the USA, bank-debt money was the only game in town for both communists and capitalists.

“We have been blind ideologically to what is common between them,” says Lietaer in an interesting presentation on “monetary blind spots and structural solutions”:

This video is the first of five parts, in which Lietaer challenges assumptions about how our money system works the way it does. And why.

“At Belgian central bank, they told me: ‘We exist, the central banks exist, the IMF, the World Bank exist for one purpose: to keep the system going as it is, not to improve it.’ It is the lobby for status quo. At the time, in the 1920s, the banks got the best deal they could ever get, so they created a reality that froze it forever. There’s an active lobby that nobody sees as a lobby, because central banks are different from the banks, right? But there’s one thing they agree on, the money system.”

They also agree that anyone who challenges the status quo doesn’t get a “Nobel Prize”.

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