The mother of all bailouts
The financial markets were obviously unimpressed by AIG bailout, but rallied on reports last night that the US government was working on a plan which effectively bails the entire financial sector. The Wall Street Journal has the story there is a now a plan for a “comprehensive solution” rather than continue ad-hoc bail-outs. This could take the form of a mechanism to take bad assets off the balance sheet of financial institutions, similar to the Resolution Trust Company that rescued the savings and loans in the 1980s. Another complimentary proposal is an insurance for investors in money market mutual funds similar to deposit insurance of savings accounts. The Security and Exchange Commission is also considering a temporary ban of short-selling (what about a temporary ban on long-selling during booms?) The FT reports that the UK authorities already banned short-selling of financial stocks.
The planned new government will be different from the RTC in one respect, as the Calculated Risk blog finds. The RTC bought up assets from failed S&Ls, while this new institution will buy up assets from solvent institutions at a steep discount in the hope to sell them later. The blog says the government is considering in addition an equivalent of President Hoover’s Reconstruction Finance Corporation, created in 1932, which bought preferred stocks in banks to strengthen their capital position.
The reports of another RTC/RFC type bailout triggered a massive rally on Wall Street, with stocks up some 4%. The rally continued overnight in Asia.
In another development yesterday central banks pumped in $180bn in fresh liquidty for non-US banks, which succeeded to bring down 1-week of $ Libor from 5.03% to 3.84%. FT Alphaville reported earlier that a large money market fund hit acute trouble.
Yves Smith, writing in Naked Capitalism, makes the point that the fundamental problem with the RTC idea is that we are now living in a world of mark-to-market capitalism. RTC depends to a large extent on the ability to sell assets. “Perhaps the biggest shortcoming of this idea is it assumes the US has the wherewithal to pull this off without the tacit support of our friendly foreign funding sources.”
This touches on the question, raised by Kenneth Rogoff the day before, for how long foreign investors are going to put up with this. And there are signs that the exodus may already have started. Menzie Chinn, writing in Econbrowser, quotes an interesting article from the Internatinoal Herald Tribune, according to which Asian investors are beginning to have second thoughts about investing in US assets, and, what’s more, some have already started to diversify.
Firefighting vs moral hazard considerations
The Financial Times says in an editorial that the follies of a generation of irresponsible financiers will fall on future generations of taxpayers. The price will come in the formed of “fundamentally transformed and tightened financial regulation”. But moral hazard is not the priority now. “Today is about survival. Lenders of last resort must lend freely and they must do so right now.” Charles Goodhart is making a similar point in a comment in the paper.
Brad Delong on the Fed
We usually summarize here, but there is simply no way you could improve on Brad Delong’s on comparisons between today and previous crises.
“Is 2008 Our 1929? No. It is not. The most important reason it is not is that Bernanke and Paulson are both focused like laser beams on not making the same mistakes as were made in 1929.
They are also focused, but not quite as much, on not making the mistakes made by Arthur Burns in the 1970s.
And they are also focused, but not quite as much, on not making the mistakes the Bank of Japan made in the 1990s.
They want to make their own, original, mistakes...”
The markets expect ECB to cut rates earlier
It is fun watching the implied rate cut probabilities from futures prices, as the Wall Street Journal economic blog does. And so the financial markets now think the ECB will cut rates in February 2009, as opposed to may, and traders even attach a 25% chance of a rate as early as October – which is a very brave call considering what Jean-Claude Trichet said at the last press conference.
Russia’s crisis to affect German economy
The FT has an article look at the effect of the Russian crisis on German exporters, as Russia is one of Germany’s most important trading partners. Export to Russia were an important stabiliser of German growth, and this is now weakening considerably, and it could prove to slow down Germany’s eventual recovery, according to some analysts quoted.
KfW crisis gets even worse
Remember the scurrilous story that KfW, the state-owned German development bank, inadvertently transfer lots of money to Lehman Brothers after it went bankrupt. It turn out that the sum in question was not €300m, as reported, but ooops, €350m, and there is even more exposure to Lehman, totalling over €500m. Germany’s economics and finance minister blew a fuse yesterday, and suspended two board members, plus the head of risk management. The payment on Monday was part of a Swap arrangement, and KfW was merely honouring its commitment. According to FT Deutschland, KfW stands to lose large parts, or all, of this money, while the bankers are still praying to get 50% back. (Dream on!)
Italian property market downturn
Il Sole 24 ore has new of a sharply than previously throught down in the Italian property market. Now, Italy is not quite in the bubble league of the US or Spain, with property prices falling by an average 2.7% in the big cities during the first quarter this year, according to Il Sole 24 ore, citing figures from the Bank of Italy. Florence bucks the trend, but prices fell sharply in Genova (-4.5%) and Bologna (-3%), while price in Milan and Rome were down 2.2% each. Italian property experts say that this trend is likely to have continued.
The growth in global derivatives markets
The Angry Bear blog has a very useful piece about the growth of the derivatives market, which went up from a total annual turnover of well under $100 trillion to $600 trillion. The three big growth segments in this market are commodity contracts, credit default swaps and interest rate swaps. The blog also makes a reference to the AIG rescue, which was apparently motivated by AIG’s exposure to CDS, some $57bn worth.
An interesting suggestion, and an interesting statistic
Thomas Fricke, writing in FT Deutschland, cites recent research showing that bubbles are mainly created by young financiers without experience of previous bubbles. A long-term solution to financial market instability is therefore not better regulation, but a minimum age for brokers or traders, say 40. He also has an interesting statistic. The total, gross, bailout of the US financial institutions is so large that it would German welfare benefit (known there as Hartz IV after the reforms) would last some 500m months. (There might be a reform of a system before then).
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