Moody’s to Review $302.6 Billion in Commercial Debt (Update2)
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By Sarah Mulholland
Feb. 5 (Bloomberg) -- Moody’s Investors Service is reviewing the ratings of $302.6 billion in commercial mortgage-backed securities as real-estate values drop and property owners fall behind on payments.
The review encompasses 52 percent of outstanding U.S. commercial mortgage-backed debt ranked by Moody’s, the New York- based ratings company said today in a statement. The ratings of so-called senior and mezzanine AAA bonds, the top two classes of CMBS accounting for about 72 percent of the securities being reviewed, probably won’t be affected, Moody’s said.
The U.S. recession is crimping consumer spending and hurting business growth, making it harder for commercial property owners to make their payments. Should Moody’s decide to cut the ratings, investors including banks and insurers may need to sell CMBS holdings to maintain required levels of capital.
“Property values declined sharply in 2008, and we anticipate further declines over the next 12 to 24 months,” Moody’s analyst Nick Levidy said in the statement. “Delinquencies on CMBS loans are also on the rise, and we expect the pace to accelerate as macroeconomic pressures take a toll on property cash flows.”
Moody’s said it may downgrade the lowest levels of the securities by an average of four to five levels. Many of the securities are trading at levels that already suggest their ratings were lowered.
The gap, or spread, on commercial mortgage-backed bonds relative to benchmark interest rates has soared in the past year on concern that defaults will rise. Top-rated commercial real estate securities are trading at about 10.3 percentage points more than the swap rate, compared with 1.8 percentage points a year ago, Bank of America Corp. data show. The swap rate is currently 3.154 percent.
Fait Accompli
“This was already a fait accompli in the market,” said David Castillo, a senior trader of structured-finance bonds at Further Lane Securities in San Francisco.
Sales of the securities plummeted to $12.2 billion last year, compared with a record $237 billion in 2007, according to JPMorgan Chase & Co. data.
To contact the reporter on this story: Sarah Mulholland in New York at smulholland3@bloomberg.net Last Updated: February 5, 2009 16:09 EST
Here we go. Review, Downgrade, Markdown, Bailout. Yee haw! The banks are insolvent dammit. Nationalize them and get this over with. Ofcourse game theory dictates that uncertainty on one hand makes things worse for the economy and on the other hand makes Treasury debt popular. Right now, the Treasury is focused on raising money for the Fed at cheap rates and therefore they'll try to keep certainty from coming back into the market. For now. At some point Obama has to make an executive decision here and say enough with the uncertainty - the damage that is being caused to "animal spirits" in the economy is unacceptable.
Showing posts with label Credit Crisis. Show all posts
Showing posts with label Credit Crisis. Show all posts
Friday, February 6, 2009
Monday, February 2, 2009
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Big Risks for U.S. in Trying to Value Bad Bank Assets
As the Obama administration prepares its strategy to rescue the nation’s banks by buying or guaranteeing troubled assets on their books, it confronts one central problem: How should they be valued?
Not just billions, but hundreds of billions of taxpayer dollars are at stake.
The Treasury secretary, Timothy F. Geithner, is expected to announce details of the new plan within weeks. Administration and Congressional officials say it will give the government flexibility to buy some bad assets and guarantee others in an effort to have a broad impact but still tailor the aid for different institutions.
But getting this right will not be easy. The wild variations on the value of many bad bank assets can be seen by looking at one mortgage-backed bond recently analyzed by a division of Standard & Poor’s, the credit rating agency.
The financial institution that owns the bond calculates the value at 97 cents on the dollar, or a mere 3 percent loss. But S.& P. estimates it is worth 87 cents, based on the current loan-default rate, and could be worth 53 cents under a bleaker situation that contemplates a doubling of defaults. But even that might be optimistic, because the bond traded recently for just 38 cents on the dollar, reflecting the even gloomier outlook of investors.
The bond analyzed by S.& P. is just one of thousands that the government might buy or guarantee should it go forward with setting up a “bad bank” that would acquire $1 trillion or more of toxic assets from banks.
The idea is that, free from the burden of carrying these bad assets, banks would start lending again and bolster the faltering economy. The bad bank set up by the government would, over time, sell the assets and recover some or most of what it had paid.
While the government is considering several approaches to helping the banks, including more capital injections, buying or insuring toxic assets is likely to be a centerpiece. Determining the right price for these assets is crucial to success. Placing too low a value would force institutions selling and others holding similar investments to register crushing losses that could deplete their capital and make it harder for them to increase lending.
But inflated values would bail out the companies, their shareholders and executives at the expense of taxpayers, who would swallow the losses if the government could not recoup what it had paid.
Some critics of the plan warn that the government should not buy the assets, because banks will try to get too high a price and leave taxpayers holding the bag.
“To date, the banks have stuck their heads in the sand,” said Lynn E. Turner, a former chief accountant for the Securities and Exchange Commission, “and demanded that they be paid the price of good apples for bad apples.”
But many believe that, given the depth of the problem and the fact that it keeps getting worse, the government has little choice.
Finance experts from Wall Street and academia are advising the administration on other options. To sidestep the thorny valuation problem, some have suggested that the bad bank acquire only assets that have already been marked down significantly and guarantee other assets, but officials would have just as difficult a task in determining how much to charge for insuring risky assets.
Economists predict that the cost of the program will most likely exceed the $350 billion remaining in the $700 billion Troubled Assets Relief Program that Congress approved in October.
They say the Obama administration may need upwards of $1 trillion in additional aid for banks — on top of the more than $800 billion the administration is seeking in an economic stimulus measure moving through Congress.
Many in Washington question whether the rescue has achieved its goal of stabilizing the financial markets. A report by the Government Accountability Office on Friday concluded that whether the bailout program had been effective might never be known.
“While the package helped avoid a financial collapse, many are frustrated by the results — and rightfully so,” President Obama said in hisweekly address on Saturday. “Too often taxpayer dollars have been spent without transparency or accountability. Banks have been extended a hand, but homeowners, students, and small businesses that need loans have been left to fend on their own.”
Mr. Obama and many lawmakers have expressed anger that banks that received the first batch of aid money do not appear to have increased their lending significantly, even as some firms have spent billions on bonuses, corporate jets and other perks. In two weeks the House will hold a hearing to ask chief executives of the eight largest banks about their spending controls.
As early as this week, the Treasury Department may impose new limits on the executive pay of companies receiving financial assistance. The Oversight Panel created by Congress to monitor the program is also expected to publish a report this week looking at whether the government paid too much to the large banks that they have provided with assistance.
A frequent refrain in Washington and on Wall Street is that there are no current market prices for toxic securities. But people who buy and sell these investments say that is a simplistic reading of the problem. They say most kinds of securities can be valued and are being traded, but trading has slowed as sellers and buyers disagree about what that the price should be.
The value of these securities is based on the future cash flow they provide to investors. To determine that, traders have to make assumptions about the housing market and the economy: How high will the unemployment rate go in the coming years? How many borrowers will default? What will homes be worth?
The Standard & Poor’s group, Market, Credit and Risk Strategies, which operates independently from the company’s credit ratings business, has been studying troubled securities for investors and banks. The bond that is trading at 38 cents provides a vivid illustration of the dilemma in valuing these assets.
The bond is backed by 9,000 second mortgages used by borrowers who put down little or no money to buy homes. Nearly a quarter of the loans are delinquent, and losses on defaulted mortgages are averaging 40 percent. The security once had a top rating, triple-A.
Michael G. Thompson, a managing director at the S.& P. group, says his computer models can easily calculate what the bond is worth under different situations. “This is not rocket science, this is straight bond math,” he said. But determining what the future holds is much harder. “We are not masters of the universe who can predict the macroeconomic environment,” he added
Some would-be buyers of these assets fear that a deep recession could drive up default rates and push down home prices much further. They also worry that a cataclysm like the failure of a big bank could send prices tumbling again, just as the collapse of Lehman Brothersdid in September. Others see no reason to bid up prices because those who need to sell are desperate.
Big banks and other owners of mortgage investments have argued that the low market prices reflect fire sales. Many have classified such securities as level-three assets, for which accounting rules allow them to determine values using computer models rather than the marketplace. Mr. Thompson estimates that at the end of September financial firms had $600 billion in such hard-to-value assets.
But critics like Mr. Turner say that the banks’ accounting for these assets cannot be trusted because they have an incentive to use optimistic assumptions.
In some instances, the government has guaranteed losses on certain assets for big, systemically important companies like Citigroup andBank of America.
Policy makers have found such arrangements appealing because they do not require upfront payments and they can be customized for each bank, Douglas J. Elliott, a fellow at the Brookings Institution, wrote in a recent paper.
Still, government guarantees need to be based on sound valuations, Mr. Elliott and others say. If the government underestimates the risks of default, taxpayers could eventually lose tens of billions of dollars. The cost of insuring such assets in the private market is often several times greater than the price the government is charging banks.
Whatever approach the Obama administration takes, investors and policy makers say it should provide more and clearer information about the health of banks and the risks that the government is taking.
Many analysts do not trust what they are told about the quality of the securities and loans held by banks and other financial firms. Most banks provide only a very general description of their holdings, because they consider the information privileged.
But the government, using its power as a big investor, could compel the banks to divulge more specific data, without giving away the names of individual bonds or loans, analysts said. The market could then do its own analysis on what the assets are worth.
“At least it would give the government one objective measure of the value of these assets,” said Anthony Lembke, co-head of investments at MKP Capital Management, a hedge fund firm that is a big investor in mortgages. “In the absence of transparency and clarity, investors are going to assume a value that will be conservative and then add a risk premium.”
Tuesday, January 27, 2009
Roubini: Nowhere to Hide and Nationalize
Roubini Sees ‘Nowhere to Hide’ From Global Slowdown (Update2)
By Betty Liu and Eric Martin
Jan. 27 (Bloomberg) -- Global stock market declines are increasingly correlated and emerging economies will follow developed nations into a “severe recession,” according to New York University Professor Nouriel Roubini.
Roubini said economic growth in China will slow to less than 5 percent and the U.S. will lose 6 million jobs. The American economy will expand 1 percent at most in 2010 as private spending falls and unemployment climbs to at least 9 percent, he added.
“There is nowhere to hide,” Roubini, an economics professor at NYU’s Stern School of Business who predicted the financial crisis, said from Zurich in an interview with Bloomberg Television. “We have for the first time in decades a global synchronized recession. Markets have become perfectly correlated and economies are also becoming perfectly correlated. This is not your kind of traditional minor recession.”
Roubini said the U.S. government should nationalize the biggest banks because losses will exceed assets, threatening to push them into bankruptcy. The banks could be privatized again in two or three years, Roubini said. The professor reiterated his prediction that U.S. financial losses will more than triple to $3.6 trillion and that global equities will fall 20 percent this year from current levels.
‘Zombie Banks’
“Nobody’s in favor of long-term ownership of the U.S. banking system by the government, but if you don’t do it this way, you end up like Japan where you kept alive for a decade zombie banks that were never restructured,” he said. “That’s going to be much worse. It’s better to clean it up, nationalize it and sell it to the private sector.”
Japanese policy makers hesitated in addressing a banking crisis in the 1990s and then struggled to revive growth and fight deflation in what is known as the “Lost Decade.”
Roubini recommended holding cash or short-term government debt and said high-yield bonds are cheap relative to U.S. stocks.
In July 2006, Roubini predicted the financial crisis. In February of last year, he forecast a “catastrophic” meltdown that central bankers would fail to prevent, leading to the bankruptcy of large banks with mortgage holdings and a “sharp drop” in equities. Since then, Bear Stearns Cos. was forced into a sale and Lehman Brothers Holdings Inc. went bankrupt, prompting banks to hoard cash and depriving businesses and households of access to capital.
Deeper Into Recession
The world’s biggest economies are sliding deeper into recession as the fall-out from the global financial crisis hobbles manufacturing output and punctures consumer spending from New York to Beijing. The U.S. economy probably contracted at 5.5 percent pace in the fourth quarter, the fastest in 26 years, a survey of economists showed.
Caterpillar Inc., Sprint Nextel Corp., Home Depot Inc. and ING Groep NV led companies announcing at least 77,000 job cuts yesterday as sales withered while U.S. jobless claims touched a 26-year high of 589,000 in the week ended Jan. 17. President Barack Obama is pushing congress to approve an $825 billion stimulus package to create 3 million to 4 million new jobs.
In China, the urban unemployment rate, which doesn’t include millions of migrant workers, rose for the first time since 2003 in the fourth quarter. The government is targeting a rate of 4.6 percent for the year, which would be the highest since 1980. The slowdown may destabilize the country’s communist government, Albert Edwards, a strategist at Societe Generale in London, said in a Jan. 15 research note.
To contact the reporters on this story: Betty Liu in New York atbliu17@bloomberg.net; Eric Martin in New York atemartin21@bloomberg.net.
Last Updated: January 27, 2009 14:00 ESTGeithner sworn in as Treasury Secretary
Timothy Geithner takes on the mantle of Treasury Secretary for the Obama Administration
Monday, January 26, 2009
"Nationalization" now in the mainstream press
January 26, 2009
News Analysis
Nationalization Gets a New, Serious Look
By DAVID E. SANGER
WASHINGTON — Only five days into the Obama presidency, members of the new administration and Democratic leaders in Congress are already dancing around one of the most politically delicate questions about the financial bailout: Is the president prepared to nationalize a huge swath of the nation’s banking system?
Privately, most members of the Obama economic team concede that the rapid deterioration of the country’s biggest banks, notably Bank of America and Citigroup, is bound to require far larger investments of taxpayer money, atop the more than $300 billion of taxpayer money already poured into those two financial institutions and hundreds of others.
But if hundreds of billions of dollars of new investment is needed to shore up those banks, and perhaps their competitors, what do taxpayers get in return? And how do the risks escalate as government’s role expands from a few bailouts to control over a vast portion of the financial sector of the world’s largest economy?
The Obama administration is making only glancing references to those questions. In an interview Sunday on “This Week” on ABC, the House speaker, Nancy Pelosi, alluded to internal debate when she was asked whether nationalization, or partial nationalization, of the largest banks was a good idea.
“Well, whatever you want to call it,” said Ms. Pelosi, Democrat of California. “If we are strengthening them, then the American people should get some of the upside of that strengthening. Some people call that nationalization.
“I’m not talking about total ownership,” she quickly cautioned — stopping herself by posing a question: “Would we have ever thought we would see the day when we’d be using that terminology? ‘Nationalization of the banks?’ ”
So far, President Obama’s top aides have steered clear of the word entirely, and they are still actively discussing other alternatives, including creating a “bad bank” that would nationalize the worst nonperforming loans by taking them off the hands of financial institutions without actually taking ownership of the banks. Others talk of de facto nationalization, in which the government owns a sizeable chunk of the banks but not a majority, with all that connotes.
That has already happened; taxpayers are now the biggest shareholders in Bank of America, with about 6 percent of the stock, and in Citigroup, with 7.8 percent. But the government’s influence is far larger than those numbers suggest, because it has guaranteed to absorb the losses of some of the two banks’ most toxic assets, a figure that could run into the hundreds of billions of dollars.
Many believe this form of hybrid ownership — part government, part private, with the responsibilities of ownership unclear — will not prove workable.
“The case for full nationalization is far stronger now than it was a few months ago,” said Adam S. Posen, the deputy director of the Peterson Institute for International Economics. “If you don’t own the majority, you don’t get to fire the management, to wipe out the shareholders, to declare that you are just going to take the losses and start over. It’s the mistake the Japanese made in the ’90s.”
“I would guess that sometime in the next few weeks, President Obama and Tim Geithner,” he said, referring to the nominee for Treasury secretary, “will have to come out and say, ‘It’s much worse than we thought,’ and just bite the bullet.”
So far the Obama administration has signaled that it is trying to avoid that day, and members of its economic team — among them Mr. Geithner and the president’s top economic adviser, Lawrence H. Summers — made the case during the Asian financial crisis in the 1990s that governments make lousy bank managers.
Indeed, the risks of nationalization they warned about then apply equally to the United States now. The first is that nationalization can prove contagious. If the Obama administration took over Bank of America and Citigroup, two of the largest banks in the United States, private investors could decide to flee from the likes of JPMorgan Chase and Wells Fargo, or other major banks, fearing they could be next.
Moreover, Mr. Obama’s advisers say they are acutely aware that if the government is perceived as running the banks, the administration would come under enormous political pressure to halt foreclosures or lend money to ailing projects in cities or states with powerful constituencies, which could imperil the effort to steer the banks away from the cliff.
“The nightmare scenarios are endless,” one of the administration’s senior officials said.
The argument in favor of nationalization, even a brief nationalization of a few months or years, is straightforward: It might be the only way to pull America’s largest financial institutions out of the downward spiral that makes it enormously difficult to raise the capital they need to keep operating.
Right now, many banks are reluctant to write off their bad debts, and absorb huge losses, unless they can first raise enough capital to cushion the blow. But they cannot attract that capital without first purging their balance sheets of the toxic assets. Japan’s experience proved the dangers of that downward swirl; the economy stagnated, new lending ground to a halt and the country’s diplomatic clout shrank with its balance sheets.
Nationalization could pull the banks out of that dive, at least temporarily, as the government injected capital, hired new managers and ordered a restart to lending. But some Republicans who bit their tongues when President George W. Bush ordered huge interventions in the market would charge that Mr. Obama was steering America toward socialism.
Nationalization, said Charles Geisst, a financial historian at Manhattan College “is just not a term in the American vocabulary.”
“We think of it,” he continued, “as something foreigners do to us, not something we do.”
It is also something foreigners do to themselves: the British have recently taken a majority stake in the Royal Bank of Scotland.
Some of Mr. Obama’s advisers have asked who the government would get to run the banks. Many of the most experienced executives are tainted by the decisions they made during the age of excess. And how would the government attract the best talent if it demanded that they take minimal pay — a political reality in the current environment?
Another option is for the government to buy the banks’ most toxic assets either through a giant fund, or, more likely, a federally supported bad bank designed to buy up troubled investments. But in that case, taxpayers might well be the losers: They would have all of the banks’ worst assets and none of their performing loans. And unless a deal is worked out to take a larger share of the banks whose bad loans are shuffled off to the government, the taxpayers would not have the chance to benefit by selling the shares back to private investors.
Moreover, cleaning up the banks’ bad assets, without extracting a heavy price for the bank managers, shareholders and their lenders, is exactly what Mr. Summers and Mr. Geithner warned against during the Asian financial crisis.
“We told the Asians that they had to be willing to let banks and companies fail,” said Jeffrey Garten, a professor at the Yale School of Management and a top official in the Clinton administration. “We warned that there was great moral hazard if governments just bailed them out.”
“And now,” he said, “we are doing the polar opposite of our advice.”
Eric Dash contributed reporting from New York.
I have been calling for a Nationalization since the middle of last year. It is obvious to everyone why banks have NO CAPITAL available. Where is all the private money - its on the sidelines (a lot of it is probably in Zurich) because everyone knows the king has no clothes. But here we are - hemming and hawing our way to a Global Depression because we dont have the balls to say yes we need to Nationalize these insolvent institutions. Even at this late hour - it is not too late. Declare a Bank Holiday and Nationalize these insolvent institutions. Wipe out the shareholders and their lenders. NOW. The Global Depression clock is now ticking. Tick, Tock.
News Analysis
Nationalization Gets a New, Serious Look
By DAVID E. SANGER
WASHINGTON — Only five days into the Obama presidency, members of the new administration and Democratic leaders in Congress are already dancing around one of the most politically delicate questions about the financial bailout: Is the president prepared to nationalize a huge swath of the nation’s banking system?
Privately, most members of the Obama economic team concede that the rapid deterioration of the country’s biggest banks, notably Bank of America and Citigroup, is bound to require far larger investments of taxpayer money, atop the more than $300 billion of taxpayer money already poured into those two financial institutions and hundreds of others.
But if hundreds of billions of dollars of new investment is needed to shore up those banks, and perhaps their competitors, what do taxpayers get in return? And how do the risks escalate as government’s role expands from a few bailouts to control over a vast portion of the financial sector of the world’s largest economy?
The Obama administration is making only glancing references to those questions. In an interview Sunday on “This Week” on ABC, the House speaker, Nancy Pelosi, alluded to internal debate when she was asked whether nationalization, or partial nationalization, of the largest banks was a good idea.
“Well, whatever you want to call it,” said Ms. Pelosi, Democrat of California. “If we are strengthening them, then the American people should get some of the upside of that strengthening. Some people call that nationalization.
“I’m not talking about total ownership,” she quickly cautioned — stopping herself by posing a question: “Would we have ever thought we would see the day when we’d be using that terminology? ‘Nationalization of the banks?’ ”
So far, President Obama’s top aides have steered clear of the word entirely, and they are still actively discussing other alternatives, including creating a “bad bank” that would nationalize the worst nonperforming loans by taking them off the hands of financial institutions without actually taking ownership of the banks. Others talk of de facto nationalization, in which the government owns a sizeable chunk of the banks but not a majority, with all that connotes.
That has already happened; taxpayers are now the biggest shareholders in Bank of America, with about 6 percent of the stock, and in Citigroup, with 7.8 percent. But the government’s influence is far larger than those numbers suggest, because it has guaranteed to absorb the losses of some of the two banks’ most toxic assets, a figure that could run into the hundreds of billions of dollars.
Many believe this form of hybrid ownership — part government, part private, with the responsibilities of ownership unclear — will not prove workable.
“The case for full nationalization is far stronger now than it was a few months ago,” said Adam S. Posen, the deputy director of the Peterson Institute for International Economics. “If you don’t own the majority, you don’t get to fire the management, to wipe out the shareholders, to declare that you are just going to take the losses and start over. It’s the mistake the Japanese made in the ’90s.”
“I would guess that sometime in the next few weeks, President Obama and Tim Geithner,” he said, referring to the nominee for Treasury secretary, “will have to come out and say, ‘It’s much worse than we thought,’ and just bite the bullet.”
So far the Obama administration has signaled that it is trying to avoid that day, and members of its economic team — among them Mr. Geithner and the president’s top economic adviser, Lawrence H. Summers — made the case during the Asian financial crisis in the 1990s that governments make lousy bank managers.
Indeed, the risks of nationalization they warned about then apply equally to the United States now. The first is that nationalization can prove contagious. If the Obama administration took over Bank of America and Citigroup, two of the largest banks in the United States, private investors could decide to flee from the likes of JPMorgan Chase and Wells Fargo, or other major banks, fearing they could be next.
Moreover, Mr. Obama’s advisers say they are acutely aware that if the government is perceived as running the banks, the administration would come under enormous political pressure to halt foreclosures or lend money to ailing projects in cities or states with powerful constituencies, which could imperil the effort to steer the banks away from the cliff.
“The nightmare scenarios are endless,” one of the administration’s senior officials said.
The argument in favor of nationalization, even a brief nationalization of a few months or years, is straightforward: It might be the only way to pull America’s largest financial institutions out of the downward spiral that makes it enormously difficult to raise the capital they need to keep operating.
Right now, many banks are reluctant to write off their bad debts, and absorb huge losses, unless they can first raise enough capital to cushion the blow. But they cannot attract that capital without first purging their balance sheets of the toxic assets. Japan’s experience proved the dangers of that downward swirl; the economy stagnated, new lending ground to a halt and the country’s diplomatic clout shrank with its balance sheets.
Nationalization could pull the banks out of that dive, at least temporarily, as the government injected capital, hired new managers and ordered a restart to lending. But some Republicans who bit their tongues when President George W. Bush ordered huge interventions in the market would charge that Mr. Obama was steering America toward socialism.
Nationalization, said Charles Geisst, a financial historian at Manhattan College “is just not a term in the American vocabulary.”
“We think of it,” he continued, “as something foreigners do to us, not something we do.”
It is also something foreigners do to themselves: the British have recently taken a majority stake in the Royal Bank of Scotland.
Some of Mr. Obama’s advisers have asked who the government would get to run the banks. Many of the most experienced executives are tainted by the decisions they made during the age of excess. And how would the government attract the best talent if it demanded that they take minimal pay — a political reality in the current environment?
Another option is for the government to buy the banks’ most toxic assets either through a giant fund, or, more likely, a federally supported bad bank designed to buy up troubled investments. But in that case, taxpayers might well be the losers: They would have all of the banks’ worst assets and none of their performing loans. And unless a deal is worked out to take a larger share of the banks whose bad loans are shuffled off to the government, the taxpayers would not have the chance to benefit by selling the shares back to private investors.
Moreover, cleaning up the banks’ bad assets, without extracting a heavy price for the bank managers, shareholders and their lenders, is exactly what Mr. Summers and Mr. Geithner warned against during the Asian financial crisis.
“We told the Asians that they had to be willing to let banks and companies fail,” said Jeffrey Garten, a professor at the Yale School of Management and a top official in the Clinton administration. “We warned that there was great moral hazard if governments just bailed them out.”
“And now,” he said, “we are doing the polar opposite of our advice.”
Eric Dash contributed reporting from New York.
I have been calling for a Nationalization since the middle of last year. It is obvious to everyone why banks have NO CAPITAL available. Where is all the private money - its on the sidelines (a lot of it is probably in Zurich) because everyone knows the king has no clothes. But here we are - hemming and hawing our way to a Global Depression because we dont have the balls to say yes we need to Nationalize these insolvent institutions. Even at this late hour - it is not too late. Declare a Bank Holiday and Nationalize these insolvent institutions. Wipe out the shareholders and their lenders. NOW. The Global Depression clock is now ticking. Tick, Tock.
Tuesday, January 13, 2009
Bernanke update: Jan 13th (London School of Business)
Speech
Chairman Ben S. Bernanke
At the Stamp Lecture, London School of Economics, London, England
January 13, 2009
The Crisis and the Policy Response
For almost a year and a half the global financial system has been under extraordinary stress--stress that has now decisively spilled over to the global economy more broadly. The proximate cause of the crisis was the turn of the housing cycle in the United States and the associated rise in delinquencies on subprime mortgages, which imposed substantial losses on many financial institutions and shook investor confidence in credit markets. However, although the subprime debacle triggered the crisis, the developments in the U.S. mortgage market were only one aspect of a much larger and more encompassing credit boom whose impact transcended the mortgage market to affect many other forms of credit. Aspects of this broader credit boom included widespread declines in underwriting standards, breakdowns in lending oversight by investors and rating agencies, increased reliance on complex and opaque credit instruments that proved fragile under stress, and unusually low compensation for risk-taking.
The abrupt end of the credit boom has had widespread financial and economic ramifications. Financial institutions have seen their capital depleted by losses and writedowns and their balance sheets clogged by complex credit products and other illiquid assets of uncertain value. Rising credit risks and intense risk aversion have pushed credit spreads to unprecedented levels, and markets for securitized assets, except for mortgage securities with government guarantees, have shut down. Heightened systemic risks, falling asset values, and tightening credit have in turn taken a heavy toll on business and consumer confidence and precipitated a sharp slowing in global economic activity. The damage, in terms of lost output, lost jobs, and lost wealth, is already substantial.
The global economy will recover, but the timing and strength of the recovery are highly uncertain. Government policy responses around the world will be critical determinants of the speed and vigor of the recovery. Today I will offer some thoughts on current and prospective policy responses to the crisis in the United States, with a particular emphasis on actions by the Federal Reserve. In doing so, I will outline the framework that has guided the Federal Reserve's responses to date. I will also explain why I believe that the Fed still has powerful tools at its disposal to fight the financial crisis and the economic downturn, even though the overnight federal funds rate cannot be reduced meaningfully further.
The Federal Reserve's Response to the Crisis
The Federal Reserve has responded aggressively to the crisis since its emergence in the summer of 2007. Following a cut in the discount rate (the rate at which the Federal Reserve lends to depository institutions) in August of that year, the Federal Open Market Committee began to ease monetary policy in September 2007, reducing the target for the federal funds rate by 50 basis points.1 As indications of economic weakness proliferated, the Committee continued to respond, bringing down its target for the federal funds rate by a cumulative 325 basis points by the spring of 2008. In historical comparison, this policy response stands out as exceptionally rapid and proactive. In taking these actions, we aimed both to cushion the direct effects of the financial turbulence on the economy and to reduce the virulence of the so-called adverse feedback loop, in which economic weakness and financial stress become mutually reinforcing.
These policy actions helped to support employment and incomes during the first year of the crisis. Unfortunately, the intensification of the financial turbulence last fall led to further deterioration in the economic outlook. The Committee responded by cutting the target for the federal funds rate an additional 100 basis points last October, with half of that reduction coming as part of an unprecedented coordinated interest rate cut by six major central banks on October 8. In December the Committee reduced its target further, setting a range of 0 to 25 basis points for the target federal funds rate.
The Committee's aggressive monetary easing was not without risks. During the early phase of rate reductions, some observers expressed concern that these policy actions would stoke inflation. These concerns intensified as inflation reached high levels in mid-2008, mostly reflecting a surge in the prices of oil and other commodities. The Committee takes its responsibility to ensure price stability extremely seriously, and throughout this period it remained closely attuned to developments in inflation and inflation expectations. However, the Committee also maintained the view that the rapid rise in commodity prices in 2008 primarily reflected sharply increased demand for raw materials in emerging market economies, in combination with constraints on the supply of these materials, rather than general inflationary pressures. Committee members expected that, at some point, global economic growth would moderate, resulting in slower increases in the demand for commodities and a leveling out in their prices--as reflected, for example, in the pattern of futures market prices. As you know, commodity prices peaked during the summer and, rather than leveling out, have actually fallen dramatically with the weakening in global economic activity. As a consequence, overall inflation has already declined significantly and appears likely to moderate further.
The Fed's monetary easing has been reflected in significant declines in a number of lending rates, especially shorter-term rates, thus offsetting to some degree the effects of the financial turmoil on financial conditions. However, that offset has been incomplete, as widening credit spreads, more restrictive lending standards, and credit market dysfunction have worked against the monetary easing and led to tighter financial conditions overall. In particular, many traditional funding sources for financial institutions and markets have dried up, and banks and other lenders have found their ability to securitize mortgages, auto loans, credit card receivables, student loans, and other forms of credit greatly curtailed. Thus, in addition to easing monetary policy, the Federal Reserve has worked to support the functioning of credit markets and to reduce financial strains by providing liquidity to the private sector. In doing so, as I will discuss shortly, the Fed has deployed a number of additional policy tools, some of which were previously in our toolkit and some of which have been created as the need arose.
Beyond the Federal Funds Rate: The Fed's Policy Toolkit
Although the federal funds rate is now close to zero, the Federal Reserve retains a number of policy tools that can be deployed against the crisis.
One important tool is policy communication. Even if the overnight rate is close to zero, the Committee should be able to influence longer-term interest rates by informing the public's expectations about the future course of monetary policy. To illustrate, in its statement after its December meeting, the Committee expressed the view that economic conditions are likely to warrant an unusually low federal funds rate for some time.2 To the extent that such statements cause the public to lengthen the horizon over which they expect short-term rates to be held at very low levels, they will exert downward pressure on longer-term rates, stimulating aggregate demand. It is important, however, that statements of this sort be expressed in conditional fashion--that is, that they link policy expectations to the evolving economic outlook. If the public were to perceive a statement about future policy to be unconditional, then long-term rates might fail to respond in the desired fashion should the economic outlook change materially.
Other than policies tied to current and expected future values of the overnight interest rate, the Federal Reserve has--and indeed, has been actively using--a range of policy tools to provide direct support to credit markets and thus to the broader economy. As I will elaborate, I find it useful to divide these tools into three groups. Although these sets of tools differ in important respects, they have one aspect in common: They all make use of the asset side of the Federal Reserve's balance sheet. That is, each involves the Fed's authorities to extend credit or purchase securities.
The first set of tools, which are closely tied to the central bank's traditional role as the lender of last resort, involve the provision of short-term liquidity to sound financial institutions. Over the course of the crisis, the Fed has taken a number of extraordinary actions to ensure that financial institutions have adequate access to short-term credit. These actions include creating new facilities for auctioning credit and making primary securities dealers, as well as banks, eligible to borrow at the Fed's discount window.3 For example, since August 2007 we have lowered the spread between the discount rate and the federal funds rate target from 100 basis points to 25 basis points; increased the term of discount window loans from overnight to 90 days; created the Term Auction Facility, which auctions credit to depository institutions for terms up to three months; put into place the Term Securities Lending Facility, which allows primary dealers to borrow Treasury securities from the Fed against less-liquid collateral; and initiated the Primary Dealer Credit Facility as a source of liquidity for those firms, among other actions.
Because interbank markets are global in scope, the Federal Reserve has also approved bilateral currency swap agreements with 14 foreign central banks. The swap facilities have allowed these central banks to acquire dollars from the Federal Reserve to lend to banks in their jurisdictions, which has served to ease conditions in dollar funding markets globally. In most cases, the provision of this dollar liquidity abroad was conducted in tight coordination with the Federal Reserve's own funding auctions.
Importantly, the provision of credit to financial institutions exposes the Federal Reserve to only minimal credit risk; the loans that we make to banks and primary dealers through our various facilities are generally overcollateralized and made with recourse to the borrowing firm. The Federal Reserve has never suffered any losses in the course of its normal lending to banks and, now, to primary dealers. In the case of currency swaps, the foreign central banks are responsible for repayment, not the financial institutions that ultimately receive the funds; moreover, as further security, the Federal Reserve receives an equivalent amount of foreign currency in exchange for the dollars it provides to foreign central banks.
Liquidity provision by the central bank reduces systemic risk by assuring market participants that, should short-term investors begin to lose confidence, financial institutions will be able to meet the resulting demands for cash without resorting to potentially destabilizing fire sales of assets. Moreover, backstopping the liquidity needs of financial institutions reduces funding stresses and, all else equal, should increase the willingness of those institutions to lend and make markets.
On the other hand, the provision of ample liquidity to banks and primary dealers is no panacea. Today, concerns about capital, asset quality, and credit risk continue to limit the willingness of many intermediaries to extend credit, even when liquidity is ample. Moreover, providing liquidity to financial institutions does not address directly instability or declining credit availability in critical nonbank markets, such as the commercial paper market or the market for asset-backed securities, both of which normally play major roles in the extension of credit in the United States.
To address these issues, the Federal Reserve has developed a second set of policy tools, which involve the provision of liquidity directly to borrowers and investors in key credit markets. Notably, we have introduced facilities to purchase highly rated commercial paper at a term of three months and to provide backup liquidity for money market mutual funds. In addition, the Federal Reserve and the Treasury have jointly announced a facility that will lend against AAA-rated asset-backed securities collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration. The Federal Reserve's credit risk exposure in the latter facility will be minimal, because the collateral will be subject to a "haircut" and the Treasury is providing $20 billion of capital as supplementary loss protection. We expect this facility to be operational next month.
The rationales and objectives of our various facilities differ, according to the nature of the problem being addressed. In some cases, as in our programs to backstop money market mutual funds, the purpose of the facility is to serve, once again in classic central bank fashion, as liquidity provider of last resort. Following a prominent fund's "breaking of the buck"--that is, a decline in its net asset value below par--in September, investors began to withdraw funds in large amounts from money market mutual funds that invest in private instruments such as commercial paper and certificates of deposit. Fund managers responded by liquidating assets and investing at only the shortest of maturities. As the pace of withdrawals increased, both the stability of the money market mutual fund industry and the functioning of the commercial paper market were threatened. The Federal Reserve responded with several programs, including a facility to finance bank purchases of high-quality asset-backed commercial paper from money market mutual funds. This facility effectively channeled liquidity to the funds, helping them to meet redemption demands without having to sell assets indiscriminately. Together with a Treasury program that provided partial insurance to investors in money market mutual funds, these efforts helped stanch the cash outflows from those funds and stabilize the industry.
The Federal Reserve's facility to buy high-quality (A1-P1) commercial paper at a term of three months was likewise designed to provide a liquidity backstop, in this case for investors and borrowers in the commercial paper market. As I mentioned, the functioning of that market deteriorated significantly in September, with borrowers finding financing difficult to obtain, and then only at high rates and very short (usually overnight) maturities. By serving as a backup source of liquidity for borrowers, the Fed's commercial paper facility was aimed at reducing investor and borrower concerns about "rollover risk," the risk that a borrower could not raise new funds to repay maturing commercial paper. The reduction of rollover risk, in turn, should increase the willingness of private investors to lend, particularly for terms longer than overnight. These various actions appear to have improved the functioning of the commercial paper market, as rates and risk spreads have come down and the average maturities of issuance have increased.
In contrast, our forthcoming asset-backed securities program, a joint effort with the Treasury, is not purely for liquidity provision. This facility will provide three-year term loans to investors against AAA-rated securities backed by recently originated consumer and small-business loans. Unlike our other lending programs, this facility combines Federal Reserve liquidity with capital provided by the Treasury, which allows it to accept some credit risk. By providing a combination of capital and liquidity, this facility will effectively substitute public for private balance sheet capacity, in a period of sharp deleveraging and risk aversion in which such capacity appears very short. If the program works as planned, it should lead to lower rates and greater availability of consumer and small business credit. Over time, by increasing market liquidity and stimulating market activity, this facility should also help to revive private lending. Importantly, if the facility for asset-backed securities proves successful, its basic framework can be expanded to accommodate higher volumes or additional classes of securities as circumstances warrant.
The Federal Reserve's third set of policy tools for supporting the functioning of credit markets involves the purchase of longer-term securities for the Fed's portfolio. For example, we recently announced plans to purchase up to $100 billion in government-sponsored enterprise (GSE) debt and up to $500 billion in GSE mortgage-backed securities over the next few quarters. Notably, mortgage rates dropped significantly on the announcement of this program and have fallen further since it went into operation. Lower mortgage rates should support the housing sector. The Committee is also evaluating the possibility of purchasing longer-term Treasury securities. In determining whether to proceed with such purchases, the Committee will focus on their potential to improve conditions in private credit markets, such as mortgage markets.
These three sets of policy tools--lending to financial institutions, providing liquidity directly to key credit markets, and buying longer-term securities--have the common feature that each represents a use of the asset side of the Fed's balance sheet, that is, they all involve lending or the purchase of securities. The virtue of these policies in the current context is that they allow the Federal Reserve to continue to push down interest rates and ease credit conditions in a range of markets, despite the fact that the federal funds rate is close to its zero lower bound.
Credit Easing versus Quantitative Easing
The Federal Reserve's approach to supporting credit markets is conceptually distinct from quantitative easing (QE), the policy approach used by the Bank of Japan from 2001 to 2006. Our approach--which could be described as "credit easing"--resembles quantitative easing in one respect: It involves an expansion of the central bank's balance sheet. However, in a pure QE regime, the focus of policy is the quantity of bank reserves, which are liabilities of the central bank; the composition of loans and securities on the asset side of the central bank's balance sheet is incidental. Indeed, although the Bank of Japan's policy approach during the QE period was quite multifaceted, the overall stance of its policy was gauged primarily in terms of its target for bank reserves. In contrast, the Federal Reserve's credit easing approach focuses on the mix of loans and securities that it holds and on how this composition of assets affects credit conditions for households and businesses. This difference does not reflect any doctrinal disagreement with the Japanese approach, but rather the differences in financial and economic conditions between the two episodes. In particular, credit spreads are much wider and credit markets more dysfunctional in the United States today than was the case during the Japanese experiment with quantitative easing. To stimulate aggregate demand in the current environment, the Federal Reserve must focus its policies on reducing those spreads and improving the functioning of private credit markets more generally.
The stimulative effect of the Federal Reserve's credit easing policies depends sensitively on the particular mix of lending programs and securities purchases that it undertakes. When markets are illiquid and private arbitrage is impaired by balance sheet constraints and other factors, as at present, one dollar of longer-term securities purchases is unlikely to have the same impact on financial markets and the economy as a dollar of lending to banks, which has in turn a different effect than a dollar of lending to support the commercial paper market. Because various types of lending have heterogeneous effects, the stance of Fed policy in the current regime--in contrast to a QE regime--is not easily summarized by a single number, such as the quantity of excess reserves or the size of the monetary base. In addition, the usage of Federal Reserve credit is determined in large part by borrower needs and thus will tend to increase when market conditions worsen and decline when market conditions improve. Setting a target for the size of the Federal Reserve's balance sheet, as in a QE regime, could thus have the perverse effect of forcing the Fed to tighten the terms and availability of its lending at times when market conditions were worsening, and vice versa.
The lack of a simple summary measure or policy target poses an important communications challenge. To minimize market uncertainty and achieve the maximum effect of its policies, the Federal Reserve is committed to providing the public as much information as possible about the uses of its balance sheet, plans regarding future uses of its balance sheet, and the criteria on which the relevant decisions are based.4
Exit Strategy
Some observers have expressed the concern that, by expanding its balance sheet, the Federal Reserve is effectively printing money, an action that will ultimately be inflationary. The Fed's lending activities have indeed resulted in a large increase in the excess reserves held by banks. Bank reserves, together with currency, make up the narrowest definition of money, the monetary base; as you would expect, this measure of money has risen significantly as the Fed's balance sheet has expanded. However, banks are choosing to leave the great bulk of their excess reserves idle, in most cases on deposit with the Fed. Consequently, the rates of growth of broader monetary aggregates, such as M1 and M2, have been much lower than that of the monetary base. At this point, with global economic activity weak and commodity prices at low levels, we see little risk of inflation in the near term; indeed, we expect inflation to continue to moderate.
However, at some point, when credit markets and the economy have begun to recover, the Federal Reserve will have to unwind its various lending programs. To some extent, this unwinding will happen automatically, as improvements in credit markets should reduce the need to use Fed facilities. Indeed, where possible we have tried to set lending rates and margins at levels that are likely to be increasingly unattractive to borrowers as financial conditions normalize. In addition, some programs--those authorized under the Federal Reserve's so-called 13(3) authority, which requires a finding that conditions in financial markets are "unusual and exigent"--will by law have to be eliminated once credit market conditions substantially normalize. However, as the unwinding of the Fed's various programs effectively constitutes a tightening of policy, the principal factor determining the timing and pace of that process will be the Committee's assessment of the condition of credit markets and the prospects for the economy.
As lending programs are scaled back, the size of the Federal Reserve's balance sheet will decline, implying a reduction in excess reserves and the monetary base. A significant shrinking of the balance sheet can be accomplished relatively quickly, as a substantial portion of the assets that the Federal Reserve holds--including loans to financial institutions, currency swaps, and purchases of commercial paper--are short-term in nature and can simply be allowed to run off as the various programs and facilities are scaled back or shut down. As the size of the balance sheet and the quantity of excess reserves in the system decline, the Federal Reserve will be able to return to its traditional means of making monetary policy--namely, by setting a target for the federal funds rate.
Although a large portion of Federal Reserve assets are short-term in nature, we do hold or expect to hold significant quantities of longer-term assets, such as the mortgage-backed securities that we will buy over the next two quarters. Although longer-term securities can also be sold, of course, we would not anticipate disposing of more than a small portion of these assets in the near term, which will slow the rate at which our balance sheet can shrink. We are monitoring the maturity composition of our balance sheet closely and do not expect a significant problem in reducing our balance sheet to the extent necessary at the appropriate time.
Importantly, the management of the Federal Reserve's balance sheet and the conduct of monetary policy in the future will be made easier by the recent congressional action to give the Fed the authority to pay interest on bank reserves. In principle, the interest rate the Fed pays on bank reserves should set a floor on the overnight interest rate, as banks should be unwilling to lend reserves at a rate lower than they can receive from the Fed. In practice, the federal funds rate has fallen somewhat below the interest rate on reserves in recent months, reflecting the very high volume of excess reserves, the inexperience of banks with the new regime, and other factors. However, as excess reserves decline, financial conditions normalize, and banks adapt to the new regime, we expect the interest rate paid on reserves to become an effective instrument for controlling the federal funds rate.
Moreover, other tools are available or can be developed to improve control of the federal funds rate during the exit stage. For example, the Treasury could resume its recent practice of issuing supplementary financing bills and placing the funds with the Federal Reserve; the issuance of these bills effectively drains reserves from the banking system, improving monetary control. Longer-term assets can be financed through repurchase agreements and other methods, which also drain reserves from the system. In considering whether to create or expand its programs, the Federal Reserve will carefully weigh the implications for the exit strategy. And we will take all necessary actions to ensure that the unwinding of our programs is accomplished smoothly and in a timely way, consistent with meeting our obligation to foster full employment and price stability.
Stabilizing the Financial System
The Federal Reserve will do its part to promote economic recovery, but other policy measures will be needed as well. The incoming Administration and the Congress are currently discussing a substantial fiscal package that, if enacted, could provide a significant boost to economic activity. In my view, however, fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system. History demonstrates conclusively that a modern economy cannot grow if its financial system is not operating effectively.
In the United States, a number of important steps have already been taken to promote financial stability, including the Treasury's injection of about $250 billion of capital into banking organizations, a substantial expansion of guarantees for bank liabilities by the Federal Deposit Insurance Corporation, and the Fed's various liquidity programs. Those measures, together with analogous actions in many other countries, likely prevented a global financial meltdown in the fall that, had it occurred, would have left the global economy in far worse condition than it is in today.
However, with the worsening of the economy's growth prospects, continued credit losses and asset markdowns may maintain for a time the pressure on the capital and balance sheet capacities of financial institutions. Consequently, more capital injections and guarantees may become necessary to ensure stability and the normalization of credit markets. A continuing barrier to private investment in financial institutions is the large quantity of troubled, hard-to-value assets that remain on institutions' balance sheets. The presence of these assets significantly increases uncertainty about the underlying value of these institutions and may inhibit both new private investment and new lending. Should the Treasury decide to supplement injections of capital by removing troubled assets from institutions' balance sheets, as was initially proposed for the U.S. financial rescue plan, several approaches might be considered. Public purchases of troubled assets are one possibility. Another is to provide asset guarantees, under which the government would agree to absorb, presumably in exchange for warrants or some other form of compensation, part of the prospective losses on specified portfolios of troubled assets held by banks. Yet another approach would be to set up and capitalize so-called bad banks, which would purchase assets from financial institutions in exchange for cash and equity in the bad bank. These methods are similar from an economic perspective, though they would have somewhat different operational and accounting implications. In addition, efforts to reduce preventable foreclosures, among other benefits, could strengthen the housing market and reduce mortgage losses, thereby increasing financial stability.
The public in many countries is understandably concerned by the commitment of substantial government resources to aid the financial industry when other industries receive little or no assistance. This disparate treatment, unappealing as it is, appears unavoidable. Our economic system is critically dependent on the free flow of credit, and the consequences for the broader economy of financial instability are thus powerful and quickly felt. Indeed, the destructive effects of financial instability on jobs and growth are already evident worldwide. Responsible policymakers must therefore do what they can to communicate to their constituencies why financial stabilization is essential for economic recovery and is therefore in the broader public interest.
Even as we strive to stabilize financial markets and institutions worldwide, however, we also owe the public near-term, concrete actions to limit the probability and severity of future crises. We need stronger supervisory and regulatory systems under which gaps and unnecessary duplication in coverage are eliminated, lines of supervisory authority and responsibility are clarified, and oversight powers are adequate to curb excessive leverage and risk-taking. In light of the multinational character of the largest financial firms and the globalization of financial markets more generally, regulatory oversight should be coordinated internationally to the greatest extent possible. We must continue our ongoing work to strengthen the financial infrastructure--for example, by encouraging the migration of trading in credit default swaps and other derivatives to central counterparties and exchanges. The supervisory authorities should develop the capacity for increased surveillance of the financial system as a whole, rather than focusing excessively on the condition of individual firms in isolation; and we should revisit capital regulations, accounting rules, and other aspects of the regulatory regime to ensure that they do not induce excessive procyclicality in the financial system and the economy. As we proceed with regulatory reform, however, we must take care not to take actions that forfeit the economic benefits of financial innovation and market discipline.
Particularly pressing is the need to address the problem of financial institutions that are deemed "too big to fail." It is unacceptable that large firms that the government is now compelled to support to preserve financial stability were among the greatest risk-takers during the boom period. The existence of too-big-to-fail firms also violates the presumption of a level playing field among financial institutions. In the future, financial firms of any type whose failure would pose a systemic risk must accept especially close regulatory scrutiny of their risk-taking. Also urgently needed in the United States is a new set of procedures for resolving failing nonbank institutions deemed systemically critical, analogous to the rules and powers that currently exist for resolving banks under the so-called systemic risk exception.
Conclusion
The world today faces both short-term and long-term challenges. In the near term, the highest priority is to promote a global economic recovery. The Federal Reserve retains powerful policy tools and will use them aggressively to help achieve this objective. Fiscal policy can stimulate economic activity, but a sustained recovery will also require a comprehensive plan to stabilize the financial system and restore normal flows of credit.
Despite the understandable focus on the near term, we do not have the luxury of postponing work on longer-term issues. High on the list, in light of recent events, are strengthening regulatory oversight and improving the capacity of both the private sector and regulators to detect and manage risk.
Finally, a clear lesson of the recent period is that the world is too interconnected for nations to go it alone in their economic, financial, and regulatory policies. International cooperation is thus essential if we are to address the crisis successfully and provide the basis for a healthy, sustained recovery.
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Footnotes
1. A basis point is one-hundredth of a percentage point. Return to text
2. Board of Governors of the Federal Reserve (2008), "FOMC Statement and Board Approval of Discount Rate Requests of the Federal Reserve Banks of New York, Cleveland, Richmond, Atlanta, Minneapolis, and San Francisco," press release, December 16. Return to text
3. Primary dealers are broker-dealers that trade in U.S. government securities with the Federal Reserve Bank of New York. The New York Fed's Open Market Desk engages in trades on behalf of the Federal Reserve System to implement monetary policy. Return to text
4. Detailed information about the Federal Reserve's balance sheet is published weekly as part of the H.4.1 release. For a summary of Fed lending programs, see Forms of Federal Reserve Lending to Financial Institutions (229 KB PDF). Return to text
Chairman Ben S. Bernanke
At the Stamp Lecture, London School of Economics, London, England
January 13, 2009
The Crisis and the Policy Response
For almost a year and a half the global financial system has been under extraordinary stress--stress that has now decisively spilled over to the global economy more broadly. The proximate cause of the crisis was the turn of the housing cycle in the United States and the associated rise in delinquencies on subprime mortgages, which imposed substantial losses on many financial institutions and shook investor confidence in credit markets. However, although the subprime debacle triggered the crisis, the developments in the U.S. mortgage market were only one aspect of a much larger and more encompassing credit boom whose impact transcended the mortgage market to affect many other forms of credit. Aspects of this broader credit boom included widespread declines in underwriting standards, breakdowns in lending oversight by investors and rating agencies, increased reliance on complex and opaque credit instruments that proved fragile under stress, and unusually low compensation for risk-taking.
The abrupt end of the credit boom has had widespread financial and economic ramifications. Financial institutions have seen their capital depleted by losses and writedowns and their balance sheets clogged by complex credit products and other illiquid assets of uncertain value. Rising credit risks and intense risk aversion have pushed credit spreads to unprecedented levels, and markets for securitized assets, except for mortgage securities with government guarantees, have shut down. Heightened systemic risks, falling asset values, and tightening credit have in turn taken a heavy toll on business and consumer confidence and precipitated a sharp slowing in global economic activity. The damage, in terms of lost output, lost jobs, and lost wealth, is already substantial.
The global economy will recover, but the timing and strength of the recovery are highly uncertain. Government policy responses around the world will be critical determinants of the speed and vigor of the recovery. Today I will offer some thoughts on current and prospective policy responses to the crisis in the United States, with a particular emphasis on actions by the Federal Reserve. In doing so, I will outline the framework that has guided the Federal Reserve's responses to date. I will also explain why I believe that the Fed still has powerful tools at its disposal to fight the financial crisis and the economic downturn, even though the overnight federal funds rate cannot be reduced meaningfully further.
The Federal Reserve's Response to the Crisis
The Federal Reserve has responded aggressively to the crisis since its emergence in the summer of 2007. Following a cut in the discount rate (the rate at which the Federal Reserve lends to depository institutions) in August of that year, the Federal Open Market Committee began to ease monetary policy in September 2007, reducing the target for the federal funds rate by 50 basis points.1 As indications of economic weakness proliferated, the Committee continued to respond, bringing down its target for the federal funds rate by a cumulative 325 basis points by the spring of 2008. In historical comparison, this policy response stands out as exceptionally rapid and proactive. In taking these actions, we aimed both to cushion the direct effects of the financial turbulence on the economy and to reduce the virulence of the so-called adverse feedback loop, in which economic weakness and financial stress become mutually reinforcing.
These policy actions helped to support employment and incomes during the first year of the crisis. Unfortunately, the intensification of the financial turbulence last fall led to further deterioration in the economic outlook. The Committee responded by cutting the target for the federal funds rate an additional 100 basis points last October, with half of that reduction coming as part of an unprecedented coordinated interest rate cut by six major central banks on October 8. In December the Committee reduced its target further, setting a range of 0 to 25 basis points for the target federal funds rate.
The Committee's aggressive monetary easing was not without risks. During the early phase of rate reductions, some observers expressed concern that these policy actions would stoke inflation. These concerns intensified as inflation reached high levels in mid-2008, mostly reflecting a surge in the prices of oil and other commodities. The Committee takes its responsibility to ensure price stability extremely seriously, and throughout this period it remained closely attuned to developments in inflation and inflation expectations. However, the Committee also maintained the view that the rapid rise in commodity prices in 2008 primarily reflected sharply increased demand for raw materials in emerging market economies, in combination with constraints on the supply of these materials, rather than general inflationary pressures. Committee members expected that, at some point, global economic growth would moderate, resulting in slower increases in the demand for commodities and a leveling out in their prices--as reflected, for example, in the pattern of futures market prices. As you know, commodity prices peaked during the summer and, rather than leveling out, have actually fallen dramatically with the weakening in global economic activity. As a consequence, overall inflation has already declined significantly and appears likely to moderate further.
The Fed's monetary easing has been reflected in significant declines in a number of lending rates, especially shorter-term rates, thus offsetting to some degree the effects of the financial turmoil on financial conditions. However, that offset has been incomplete, as widening credit spreads, more restrictive lending standards, and credit market dysfunction have worked against the monetary easing and led to tighter financial conditions overall. In particular, many traditional funding sources for financial institutions and markets have dried up, and banks and other lenders have found their ability to securitize mortgages, auto loans, credit card receivables, student loans, and other forms of credit greatly curtailed. Thus, in addition to easing monetary policy, the Federal Reserve has worked to support the functioning of credit markets and to reduce financial strains by providing liquidity to the private sector. In doing so, as I will discuss shortly, the Fed has deployed a number of additional policy tools, some of which were previously in our toolkit and some of which have been created as the need arose.
Beyond the Federal Funds Rate: The Fed's Policy Toolkit
Although the federal funds rate is now close to zero, the Federal Reserve retains a number of policy tools that can be deployed against the crisis.
One important tool is policy communication. Even if the overnight rate is close to zero, the Committee should be able to influence longer-term interest rates by informing the public's expectations about the future course of monetary policy. To illustrate, in its statement after its December meeting, the Committee expressed the view that economic conditions are likely to warrant an unusually low federal funds rate for some time.2 To the extent that such statements cause the public to lengthen the horizon over which they expect short-term rates to be held at very low levels, they will exert downward pressure on longer-term rates, stimulating aggregate demand. It is important, however, that statements of this sort be expressed in conditional fashion--that is, that they link policy expectations to the evolving economic outlook. If the public were to perceive a statement about future policy to be unconditional, then long-term rates might fail to respond in the desired fashion should the economic outlook change materially.
Other than policies tied to current and expected future values of the overnight interest rate, the Federal Reserve has--and indeed, has been actively using--a range of policy tools to provide direct support to credit markets and thus to the broader economy. As I will elaborate, I find it useful to divide these tools into three groups. Although these sets of tools differ in important respects, they have one aspect in common: They all make use of the asset side of the Federal Reserve's balance sheet. That is, each involves the Fed's authorities to extend credit or purchase securities.
The first set of tools, which are closely tied to the central bank's traditional role as the lender of last resort, involve the provision of short-term liquidity to sound financial institutions. Over the course of the crisis, the Fed has taken a number of extraordinary actions to ensure that financial institutions have adequate access to short-term credit. These actions include creating new facilities for auctioning credit and making primary securities dealers, as well as banks, eligible to borrow at the Fed's discount window.3 For example, since August 2007 we have lowered the spread between the discount rate and the federal funds rate target from 100 basis points to 25 basis points; increased the term of discount window loans from overnight to 90 days; created the Term Auction Facility, which auctions credit to depository institutions for terms up to three months; put into place the Term Securities Lending Facility, which allows primary dealers to borrow Treasury securities from the Fed against less-liquid collateral; and initiated the Primary Dealer Credit Facility as a source of liquidity for those firms, among other actions.
Because interbank markets are global in scope, the Federal Reserve has also approved bilateral currency swap agreements with 14 foreign central banks. The swap facilities have allowed these central banks to acquire dollars from the Federal Reserve to lend to banks in their jurisdictions, which has served to ease conditions in dollar funding markets globally. In most cases, the provision of this dollar liquidity abroad was conducted in tight coordination with the Federal Reserve's own funding auctions.
Importantly, the provision of credit to financial institutions exposes the Federal Reserve to only minimal credit risk; the loans that we make to banks and primary dealers through our various facilities are generally overcollateralized and made with recourse to the borrowing firm. The Federal Reserve has never suffered any losses in the course of its normal lending to banks and, now, to primary dealers. In the case of currency swaps, the foreign central banks are responsible for repayment, not the financial institutions that ultimately receive the funds; moreover, as further security, the Federal Reserve receives an equivalent amount of foreign currency in exchange for the dollars it provides to foreign central banks.
Liquidity provision by the central bank reduces systemic risk by assuring market participants that, should short-term investors begin to lose confidence, financial institutions will be able to meet the resulting demands for cash without resorting to potentially destabilizing fire sales of assets. Moreover, backstopping the liquidity needs of financial institutions reduces funding stresses and, all else equal, should increase the willingness of those institutions to lend and make markets.
On the other hand, the provision of ample liquidity to banks and primary dealers is no panacea. Today, concerns about capital, asset quality, and credit risk continue to limit the willingness of many intermediaries to extend credit, even when liquidity is ample. Moreover, providing liquidity to financial institutions does not address directly instability or declining credit availability in critical nonbank markets, such as the commercial paper market or the market for asset-backed securities, both of which normally play major roles in the extension of credit in the United States.
To address these issues, the Federal Reserve has developed a second set of policy tools, which involve the provision of liquidity directly to borrowers and investors in key credit markets. Notably, we have introduced facilities to purchase highly rated commercial paper at a term of three months and to provide backup liquidity for money market mutual funds. In addition, the Federal Reserve and the Treasury have jointly announced a facility that will lend against AAA-rated asset-backed securities collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration. The Federal Reserve's credit risk exposure in the latter facility will be minimal, because the collateral will be subject to a "haircut" and the Treasury is providing $20 billion of capital as supplementary loss protection. We expect this facility to be operational next month.
The rationales and objectives of our various facilities differ, according to the nature of the problem being addressed. In some cases, as in our programs to backstop money market mutual funds, the purpose of the facility is to serve, once again in classic central bank fashion, as liquidity provider of last resort. Following a prominent fund's "breaking of the buck"--that is, a decline in its net asset value below par--in September, investors began to withdraw funds in large amounts from money market mutual funds that invest in private instruments such as commercial paper and certificates of deposit. Fund managers responded by liquidating assets and investing at only the shortest of maturities. As the pace of withdrawals increased, both the stability of the money market mutual fund industry and the functioning of the commercial paper market were threatened. The Federal Reserve responded with several programs, including a facility to finance bank purchases of high-quality asset-backed commercial paper from money market mutual funds. This facility effectively channeled liquidity to the funds, helping them to meet redemption demands without having to sell assets indiscriminately. Together with a Treasury program that provided partial insurance to investors in money market mutual funds, these efforts helped stanch the cash outflows from those funds and stabilize the industry.
The Federal Reserve's facility to buy high-quality (A1-P1) commercial paper at a term of three months was likewise designed to provide a liquidity backstop, in this case for investors and borrowers in the commercial paper market. As I mentioned, the functioning of that market deteriorated significantly in September, with borrowers finding financing difficult to obtain, and then only at high rates and very short (usually overnight) maturities. By serving as a backup source of liquidity for borrowers, the Fed's commercial paper facility was aimed at reducing investor and borrower concerns about "rollover risk," the risk that a borrower could not raise new funds to repay maturing commercial paper. The reduction of rollover risk, in turn, should increase the willingness of private investors to lend, particularly for terms longer than overnight. These various actions appear to have improved the functioning of the commercial paper market, as rates and risk spreads have come down and the average maturities of issuance have increased.
In contrast, our forthcoming asset-backed securities program, a joint effort with the Treasury, is not purely for liquidity provision. This facility will provide three-year term loans to investors against AAA-rated securities backed by recently originated consumer and small-business loans. Unlike our other lending programs, this facility combines Federal Reserve liquidity with capital provided by the Treasury, which allows it to accept some credit risk. By providing a combination of capital and liquidity, this facility will effectively substitute public for private balance sheet capacity, in a period of sharp deleveraging and risk aversion in which such capacity appears very short. If the program works as planned, it should lead to lower rates and greater availability of consumer and small business credit. Over time, by increasing market liquidity and stimulating market activity, this facility should also help to revive private lending. Importantly, if the facility for asset-backed securities proves successful, its basic framework can be expanded to accommodate higher volumes or additional classes of securities as circumstances warrant.
The Federal Reserve's third set of policy tools for supporting the functioning of credit markets involves the purchase of longer-term securities for the Fed's portfolio. For example, we recently announced plans to purchase up to $100 billion in government-sponsored enterprise (GSE) debt and up to $500 billion in GSE mortgage-backed securities over the next few quarters. Notably, mortgage rates dropped significantly on the announcement of this program and have fallen further since it went into operation. Lower mortgage rates should support the housing sector. The Committee is also evaluating the possibility of purchasing longer-term Treasury securities. In determining whether to proceed with such purchases, the Committee will focus on their potential to improve conditions in private credit markets, such as mortgage markets.
These three sets of policy tools--lending to financial institutions, providing liquidity directly to key credit markets, and buying longer-term securities--have the common feature that each represents a use of the asset side of the Fed's balance sheet, that is, they all involve lending or the purchase of securities. The virtue of these policies in the current context is that they allow the Federal Reserve to continue to push down interest rates and ease credit conditions in a range of markets, despite the fact that the federal funds rate is close to its zero lower bound.
Credit Easing versus Quantitative Easing
The Federal Reserve's approach to supporting credit markets is conceptually distinct from quantitative easing (QE), the policy approach used by the Bank of Japan from 2001 to 2006. Our approach--which could be described as "credit easing"--resembles quantitative easing in one respect: It involves an expansion of the central bank's balance sheet. However, in a pure QE regime, the focus of policy is the quantity of bank reserves, which are liabilities of the central bank; the composition of loans and securities on the asset side of the central bank's balance sheet is incidental. Indeed, although the Bank of Japan's policy approach during the QE period was quite multifaceted, the overall stance of its policy was gauged primarily in terms of its target for bank reserves. In contrast, the Federal Reserve's credit easing approach focuses on the mix of loans and securities that it holds and on how this composition of assets affects credit conditions for households and businesses. This difference does not reflect any doctrinal disagreement with the Japanese approach, but rather the differences in financial and economic conditions between the two episodes. In particular, credit spreads are much wider and credit markets more dysfunctional in the United States today than was the case during the Japanese experiment with quantitative easing. To stimulate aggregate demand in the current environment, the Federal Reserve must focus its policies on reducing those spreads and improving the functioning of private credit markets more generally.
The stimulative effect of the Federal Reserve's credit easing policies depends sensitively on the particular mix of lending programs and securities purchases that it undertakes. When markets are illiquid and private arbitrage is impaired by balance sheet constraints and other factors, as at present, one dollar of longer-term securities purchases is unlikely to have the same impact on financial markets and the economy as a dollar of lending to banks, which has in turn a different effect than a dollar of lending to support the commercial paper market. Because various types of lending have heterogeneous effects, the stance of Fed policy in the current regime--in contrast to a QE regime--is not easily summarized by a single number, such as the quantity of excess reserves or the size of the monetary base. In addition, the usage of Federal Reserve credit is determined in large part by borrower needs and thus will tend to increase when market conditions worsen and decline when market conditions improve. Setting a target for the size of the Federal Reserve's balance sheet, as in a QE regime, could thus have the perverse effect of forcing the Fed to tighten the terms and availability of its lending at times when market conditions were worsening, and vice versa.
The lack of a simple summary measure or policy target poses an important communications challenge. To minimize market uncertainty and achieve the maximum effect of its policies, the Federal Reserve is committed to providing the public as much information as possible about the uses of its balance sheet, plans regarding future uses of its balance sheet, and the criteria on which the relevant decisions are based.4
Exit Strategy
Some observers have expressed the concern that, by expanding its balance sheet, the Federal Reserve is effectively printing money, an action that will ultimately be inflationary. The Fed's lending activities have indeed resulted in a large increase in the excess reserves held by banks. Bank reserves, together with currency, make up the narrowest definition of money, the monetary base; as you would expect, this measure of money has risen significantly as the Fed's balance sheet has expanded. However, banks are choosing to leave the great bulk of their excess reserves idle, in most cases on deposit with the Fed. Consequently, the rates of growth of broader monetary aggregates, such as M1 and M2, have been much lower than that of the monetary base. At this point, with global economic activity weak and commodity prices at low levels, we see little risk of inflation in the near term; indeed, we expect inflation to continue to moderate.
However, at some point, when credit markets and the economy have begun to recover, the Federal Reserve will have to unwind its various lending programs. To some extent, this unwinding will happen automatically, as improvements in credit markets should reduce the need to use Fed facilities. Indeed, where possible we have tried to set lending rates and margins at levels that are likely to be increasingly unattractive to borrowers as financial conditions normalize. In addition, some programs--those authorized under the Federal Reserve's so-called 13(3) authority, which requires a finding that conditions in financial markets are "unusual and exigent"--will by law have to be eliminated once credit market conditions substantially normalize. However, as the unwinding of the Fed's various programs effectively constitutes a tightening of policy, the principal factor determining the timing and pace of that process will be the Committee's assessment of the condition of credit markets and the prospects for the economy.
As lending programs are scaled back, the size of the Federal Reserve's balance sheet will decline, implying a reduction in excess reserves and the monetary base. A significant shrinking of the balance sheet can be accomplished relatively quickly, as a substantial portion of the assets that the Federal Reserve holds--including loans to financial institutions, currency swaps, and purchases of commercial paper--are short-term in nature and can simply be allowed to run off as the various programs and facilities are scaled back or shut down. As the size of the balance sheet and the quantity of excess reserves in the system decline, the Federal Reserve will be able to return to its traditional means of making monetary policy--namely, by setting a target for the federal funds rate.
Although a large portion of Federal Reserve assets are short-term in nature, we do hold or expect to hold significant quantities of longer-term assets, such as the mortgage-backed securities that we will buy over the next two quarters. Although longer-term securities can also be sold, of course, we would not anticipate disposing of more than a small portion of these assets in the near term, which will slow the rate at which our balance sheet can shrink. We are monitoring the maturity composition of our balance sheet closely and do not expect a significant problem in reducing our balance sheet to the extent necessary at the appropriate time.
Importantly, the management of the Federal Reserve's balance sheet and the conduct of monetary policy in the future will be made easier by the recent congressional action to give the Fed the authority to pay interest on bank reserves. In principle, the interest rate the Fed pays on bank reserves should set a floor on the overnight interest rate, as banks should be unwilling to lend reserves at a rate lower than they can receive from the Fed. In practice, the federal funds rate has fallen somewhat below the interest rate on reserves in recent months, reflecting the very high volume of excess reserves, the inexperience of banks with the new regime, and other factors. However, as excess reserves decline, financial conditions normalize, and banks adapt to the new regime, we expect the interest rate paid on reserves to become an effective instrument for controlling the federal funds rate.
Moreover, other tools are available or can be developed to improve control of the federal funds rate during the exit stage. For example, the Treasury could resume its recent practice of issuing supplementary financing bills and placing the funds with the Federal Reserve; the issuance of these bills effectively drains reserves from the banking system, improving monetary control. Longer-term assets can be financed through repurchase agreements and other methods, which also drain reserves from the system. In considering whether to create or expand its programs, the Federal Reserve will carefully weigh the implications for the exit strategy. And we will take all necessary actions to ensure that the unwinding of our programs is accomplished smoothly and in a timely way, consistent with meeting our obligation to foster full employment and price stability.
Stabilizing the Financial System
The Federal Reserve will do its part to promote economic recovery, but other policy measures will be needed as well. The incoming Administration and the Congress are currently discussing a substantial fiscal package that, if enacted, could provide a significant boost to economic activity. In my view, however, fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system. History demonstrates conclusively that a modern economy cannot grow if its financial system is not operating effectively.
In the United States, a number of important steps have already been taken to promote financial stability, including the Treasury's injection of about $250 billion of capital into banking organizations, a substantial expansion of guarantees for bank liabilities by the Federal Deposit Insurance Corporation, and the Fed's various liquidity programs. Those measures, together with analogous actions in many other countries, likely prevented a global financial meltdown in the fall that, had it occurred, would have left the global economy in far worse condition than it is in today.
However, with the worsening of the economy's growth prospects, continued credit losses and asset markdowns may maintain for a time the pressure on the capital and balance sheet capacities of financial institutions. Consequently, more capital injections and guarantees may become necessary to ensure stability and the normalization of credit markets. A continuing barrier to private investment in financial institutions is the large quantity of troubled, hard-to-value assets that remain on institutions' balance sheets. The presence of these assets significantly increases uncertainty about the underlying value of these institutions and may inhibit both new private investment and new lending. Should the Treasury decide to supplement injections of capital by removing troubled assets from institutions' balance sheets, as was initially proposed for the U.S. financial rescue plan, several approaches might be considered. Public purchases of troubled assets are one possibility. Another is to provide asset guarantees, under which the government would agree to absorb, presumably in exchange for warrants or some other form of compensation, part of the prospective losses on specified portfolios of troubled assets held by banks. Yet another approach would be to set up and capitalize so-called bad banks, which would purchase assets from financial institutions in exchange for cash and equity in the bad bank. These methods are similar from an economic perspective, though they would have somewhat different operational and accounting implications. In addition, efforts to reduce preventable foreclosures, among other benefits, could strengthen the housing market and reduce mortgage losses, thereby increasing financial stability.
The public in many countries is understandably concerned by the commitment of substantial government resources to aid the financial industry when other industries receive little or no assistance. This disparate treatment, unappealing as it is, appears unavoidable. Our economic system is critically dependent on the free flow of credit, and the consequences for the broader economy of financial instability are thus powerful and quickly felt. Indeed, the destructive effects of financial instability on jobs and growth are already evident worldwide. Responsible policymakers must therefore do what they can to communicate to their constituencies why financial stabilization is essential for economic recovery and is therefore in the broader public interest.
Even as we strive to stabilize financial markets and institutions worldwide, however, we also owe the public near-term, concrete actions to limit the probability and severity of future crises. We need stronger supervisory and regulatory systems under which gaps and unnecessary duplication in coverage are eliminated, lines of supervisory authority and responsibility are clarified, and oversight powers are adequate to curb excessive leverage and risk-taking. In light of the multinational character of the largest financial firms and the globalization of financial markets more generally, regulatory oversight should be coordinated internationally to the greatest extent possible. We must continue our ongoing work to strengthen the financial infrastructure--for example, by encouraging the migration of trading in credit default swaps and other derivatives to central counterparties and exchanges. The supervisory authorities should develop the capacity for increased surveillance of the financial system as a whole, rather than focusing excessively on the condition of individual firms in isolation; and we should revisit capital regulations, accounting rules, and other aspects of the regulatory regime to ensure that they do not induce excessive procyclicality in the financial system and the economy. As we proceed with regulatory reform, however, we must take care not to take actions that forfeit the economic benefits of financial innovation and market discipline.
Particularly pressing is the need to address the problem of financial institutions that are deemed "too big to fail." It is unacceptable that large firms that the government is now compelled to support to preserve financial stability were among the greatest risk-takers during the boom period. The existence of too-big-to-fail firms also violates the presumption of a level playing field among financial institutions. In the future, financial firms of any type whose failure would pose a systemic risk must accept especially close regulatory scrutiny of their risk-taking. Also urgently needed in the United States is a new set of procedures for resolving failing nonbank institutions deemed systemically critical, analogous to the rules and powers that currently exist for resolving banks under the so-called systemic risk exception.
Conclusion
The world today faces both short-term and long-term challenges. In the near term, the highest priority is to promote a global economic recovery. The Federal Reserve retains powerful policy tools and will use them aggressively to help achieve this objective. Fiscal policy can stimulate economic activity, but a sustained recovery will also require a comprehensive plan to stabilize the financial system and restore normal flows of credit.
Despite the understandable focus on the near term, we do not have the luxury of postponing work on longer-term issues. High on the list, in light of recent events, are strengthening regulatory oversight and improving the capacity of both the private sector and regulators to detect and manage risk.
Finally, a clear lesson of the recent period is that the world is too interconnected for nations to go it alone in their economic, financial, and regulatory policies. International cooperation is thus essential if we are to address the crisis successfully and provide the basis for a healthy, sustained recovery.
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Footnotes
1. A basis point is one-hundredth of a percentage point. Return to text
2. Board of Governors of the Federal Reserve (2008), "FOMC Statement and Board Approval of Discount Rate Requests of the Federal Reserve Banks of New York, Cleveland, Richmond, Atlanta, Minneapolis, and San Francisco," press release, December 16. Return to text
3. Primary dealers are broker-dealers that trade in U.S. government securities with the Federal Reserve Bank of New York. The New York Fed's Open Market Desk engages in trades on behalf of the Federal Reserve System to implement monetary policy. Return to text
4. Detailed information about the Federal Reserve's balance sheet is published weekly as part of the H.4.1 release. For a summary of Fed lending programs, see Forms of Federal Reserve Lending to Financial Institutions (229 KB PDF). Return to text
Friday, January 9, 2009
Calculated Risk: On Roubini's 2 yr recession
Thursday, January 08, 2009
Roubini: Two Year Recession
by CalculatedRisk on 1/08/2009 04:30:00 PM
From Rex Nutting at MarketWatch: Roubini forecasts recession will last 2 years
The U.S. recession will last two full years, with gross domestic product falling a cumulative 5%, said Nouriel Roubini, ... For 2009, Roubini predicts GDP will fall 3.4%, with declines in every quarter of the year. The unemployment rate should peak at about 9% in early 2010 ...
Roubini is forecasting a pretty serious recession, but far short of a "depression" which is usually defined as a 10% decline in real GDP.
The concensus (and the Fed forecast) is that the economy will bottom in Q2 2009 with a sluggish recovery in the 2nd half of this year.
The recession started officially around Dec 06 - Jan 07. Roubini is prediciting that the recession will last through Jan ' 09 ish. This is exactly my prediction as well (read earlier posts) and I believe Calculated Risk has come up with similar projections himself. Its worth bearing in mind that my projection is based on the following "givens": Obama's Stimulus plan being over 800B and that the US will nationalize major banks QUICKLY. Both of these are policy responses and may not happen in Q1 of 2008 and if there is a substantial delay by the Obama Administration - the recession may drag out further into 2010. I am making my business plans on the assumption that Q1 of 2010 will see the end of the recession.
Roubini: Two Year Recession
by CalculatedRisk on 1/08/2009 04:30:00 PM
From Rex Nutting at MarketWatch: Roubini forecasts recession will last 2 years
The U.S. recession will last two full years, with gross domestic product falling a cumulative 5%, said Nouriel Roubini, ... For 2009, Roubini predicts GDP will fall 3.4%, with declines in every quarter of the year. The unemployment rate should peak at about 9% in early 2010 ...
Roubini is forecasting a pretty serious recession, but far short of a "depression" which is usually defined as a 10% decline in real GDP.
The concensus (and the Fed forecast) is that the economy will bottom in Q2 2009 with a sluggish recovery in the 2nd half of this year.
The recession started officially around Dec 06 - Jan 07. Roubini is prediciting that the recession will last through Jan ' 09 ish. This is exactly my prediction as well (read earlier posts) and I believe Calculated Risk has come up with similar projections himself. Its worth bearing in mind that my projection is based on the following "givens": Obama's Stimulus plan being over 800B and that the US will nationalize major banks QUICKLY. Both of these are policy responses and may not happen in Q1 of 2008 and if there is a substantial delay by the Obama Administration - the recession may drag out further into 2010. I am making my business plans on the assumption that Q1 of 2010 will see the end of the recession.
Tuesday, December 30, 2008
2009 - In the land of the blind a one eyed man is king WINK
from www.ft.com (Financial Times)
Published: December 27 2008 00:23 | Last updated: December 27 2008 00:23
An imaginary retrospective of 2009
By Niall FergusonPublished: December 27 2008 00:23 | Last updated: December 27 2008 00:23
It was the year when people finally gave up trying to predict the year ahead. It was the year when every forecast had to be revised – usually downwards – at least three times. It was the year when the paradox of globalisation was laid bare for all to see, if their eyes weren’t tightly shut.
On the one hand, the increasing integration of markets for commodities, manufactures, labour and capital had led to great gains. As Adam Smith had foreseen in The Wealth of Nations, economic liberalisation had allowed the division of labour and comparative advantage to operate on a global scale. From the 1980s until 2007, the world economy had enjoyed higher, more widespread growth and fewer, less severe crises – hence Federal Reserve chairman Ben Bernanke’s hubristic celebration of a “great moderation” in 2004.
On the other hand, the more the world came to resemble an intricate, multi-nodal network operating at maximum efficiency – with minimal inventories and just-in-time delivery – the more vulnerable it became to a massive systemic crash.
That was the true significance of the Great Repression which began in August 2007 and reached its nadir in 2009. It was clearly not a Great Depression on the scale of the 1930s, when output in the US declined by as much as a third and unemployment reached 25 per cent. Nor was it merely a Big Recession. As output in the developed world continued to decline throughout 2009 – despite the best efforts of central banks and finance ministries – the tag “Great Repression” seemed more and more apt: although this was the worst economic crisis in 70 years, many people remained in deep denial about it.
“We assumed that we economists had learned how to combat this kind of crisis,” admitted one of President Barack Obama’s “dream team” of economic advisers, shortly after his return to academic life in September 2009. “We thought that if the Fed injected enough liquidity into the financial system, we could avoid deflation. We thought if the government ran a big enough deficit, we could end a recession. It turned out we were wrong. So much for [John Maynard] Keynes. So much for [Milton] Friedman.”
The root of the problem remained the US’s property bubble, which continued to deflate throughout the year. Many people had assumed that by the end of 2008 the worst must be over. It was not. Economist Robert Shiller’s real home price index in 2006 had stood at just under 206, nearly double its level just six years earlier. To return to its pre-bubble level, it therefore had to fall by 50 per cent. Barely half that decline had taken place by the end of 2008. So house prices continued to slide in the US. As they did, more and more families found themselves in negative equity, with debts exceeding the value of their homes. In turn, rising foreclosures translated into bigger losses on mortgage-backed securities and yet more red ink on banks’ balance sheets.
With total debt above 350 per cent of US gross domestic product, the excesses of the age of leverage proved difficult to purge. Households reined in their consumption. Banks sought to restrict new lending. The recession deepened. Unemployment rose towards 10 per cent, and then higher. The economic downward spiral seemed unstoppable. No matter how hard they saved, Americans simply could not stabilise the ratio of their debts to their disposable incomes. The paradox of thrift meant that rising savings translated into falling consumer demand, which led to rising unemployment, falling incomes and so on, ever downwards.
“Necessity will be the mother of invention,” Obama declared in his inaugural address on January 20. “By investing in innovation, we can restore our faith in American creativity. We need to build new schools, not new shopping malls. We need to produce clean energy, not dirty derivatives.” Commentators agreed that the speech was on a par with Franklin Roosevelt’s on his inauguration in 1933. Yet Roosevelt had spoken after the worst of the Depression was over, Obama in mid-tailspin. The rhetoric flew high. But the markets sank lower. The contagion spread inexorably from subprime to prime mortgages, to commercial real estate, to corporate bonds and back to the financial sector. By the end of June, Standard & Poor’s 500 Index had sunk to 624, its lowest monthly close since January 1996, and about 60 per cent below its October 2007 peak.
The crux of the problem was the fundamental insolvency of the major banks, another reality that policymakers sought to repress. In 2008, the Bank of England had estimated total losses on toxic assets at about $2.8 trillion. Yet total bank writedowns by the end of 2008 were little more than $583bn, while total capital raised was just $435bn. Losses, in other words, were either being massively understated, or they had been incurred outside the banking system. Either way, the system of credit creation had broken down. The banks could not contract their balance sheets because of a host of pre-arranged credit lines, which their clients were now desperately drawing on, while their only source of new capital was the US Treasury, which had to contend with an increasingly sceptical Congress. The other credit-creating institutions – especially the markets for asset-backed securities – were all but paralysed.
There was uproar when Timothy Geithner, US Treasury secretary, requested an additional $300bn to provide further equity injections for Citigroup, Bank of America and the seven other big banks, just a week after imposing an agonising “mega-merger” on the automobile industry. In Detroit, the Big Three had become just a Big One, on the formation of CGF (Chrysler-General Motors-Ford; inevitably, the press soon re-christened it “Can’t Get Funding”). The banks, by contrast, seemed to enjoy an infinite claim on public funds. Yet no amount of money seemed enough to persuade them to make new loans at lower rates. As one indignant Michigan law-maker put it: “Nobody wants to face the fact that these institutions [the banks] are bust. Not only have they lost all of their capital. If we genuinely marked their assets to market, they would have lost it twice over. The Big Three were never so badly managed as these bankrupt banks.”
In the first quarter, the Fed continued to do everything in its power to avert the slide into deflation. The effective federal funds rate had already hit zero by the end of 2008. In all but name, quantitative easing had begun in November 2008, with large-scale purchases of the debt and mortgage-backed securities of government-sponsored agencies (the renationalised mortgage giants Fannie Mae and Freddie Mac) and the promise of future purchases of government bonds. Yet the expansion of the monetary base was negated by the contraction of broader monetary measures such as M2 (the measurement of money and its “close substitutes”, such as savings deposits, that is a key indicator of inflation). The ailing banks were eating liquidity almost as fast as the Fed could create it. The Fed increasingly resembled a government-owned hedge fund, leveraged at more than 75 to 1, its balance sheet composed of assets everyone else wanted to be rid of.
. . .
The position of the US federal government was scarcely better. By the end of 2008, the total value of loans, investments and guarantees given by the Fed and the Treasury since the beginning of the financial crisis had already reached $7.8 trillion. In the year to November 30 2008, the total federal debt had increased by more than $1.5 trillion. Morgan Stanley estimated that the total federal deficit for the fiscal year 2009 could equal 12.5 per cent of GDP. The figure would have been even higher had President Obama not been persuaded by his chief economic adviser, Lawrence Summers, to postpone his planned healthcare reform and promised spending increases in education, research and foreign aid.
Obama had set out to construct an administration in which his rivals and allies were equally represented. But his rivals were a good deal more experienced than his allies. The result was an administration that talked like Barack Obama but thought like Bill Clinton. The Clinton-era veterans, not least Secretary of State Hillary Clinton, had vivid memories of the bond-market volatility that had plagued them in 1993 (prompting campaign manager James Carville to say that, if there was such a thing as reincarnation, he wanted to come back as the bond market). Terrified at the swelling size of the deficit, they urged Obama to defer any expenditure that was not specifically targeted on ending the financial crisis.
Yet the world had changed since the early 1990s. Despite the fears of the still-influential former Treasury secretary Robert Rubin, investors around the world were more than happy to buy new issues of US Treasuries, no matter how voluminous. Contrary to conventional wisdom, the quadrupling of the deficit did not lead to falling bond prices and rising yields. Instead, the flight to quality and the deflationary pressures unleashed by the crisis around the world drove long-term yields downwards. They remained at close to 3 per cent all year.
Nor was there a dollar rout, as many had feared. The foreign appetite for the US currency withstood the Fed’s money-printing antics, and the trade weighted exchange rate actually appreciated during 2009.
Here was the irony at the heart of the crisis. In all kinds of ways, the Great Repression had “Made in America” stamped all over it. Yet its effects were more severe in the rest of the world than in the US. And, as a consequence, the US managed to retain its “safe haven” status. The worse things got in Europe, in Japan and in emerging markets, the more readily investors bought Treasuries and held dollars.
. . .
For the rest of the world, 2009 proved to be an annus horribilis. Japan was plunged back into the deflationary nightmare of the 1990s by yen appreciation and a collapse of consumer confidence. Things were little better in Europe. There had been much anti-American finger-pointing by European leaders in 2008. The French president Nicolas Sarkozy had talked at the G-20 summit in Washington as if he alone could save the world economy. The British prime minister Gordon Brown had sought to give a similar impression, claiming authorship of the policy of bank recapitalisation. The German chancellor Angela Merkel, meanwhile, voiced stern disapproval of the excessively large American deficit.
By the first quarter of 2009, however, the mood in Europe had darkened. It became apparent that the problems of the European banks were just as serious as those of their American counterparts. Indeed, the short-term liabilities of the Belgian, Swiss, British and Italian banks were far larger in relation to those countries’ economies, while the German, French and Danish banks were much more dangerously leveraged. Moreover, in the absence of a European-wide finance ministry, all talk of a European stimulus package was just that – mere talk. In practice, fiscal policy became a matter of sauve qui peut, with each European country improvising its own bailout and its own stimulus package. The result was a mess. Currencies outside the Euro area were afflicted by severe volatility. Inside the Euro area, the volatility was in the bond market, with spreads on Greek and Italian bonds exploding relative to German bunds.
The picture was even worse in most emerging markets. Especially hard hit in eastern Europe were Bulgaria, Romania, Ukraine and Hungary. Of the Brics (Brazil, Russia, India and China), Brazil had the best year, Russia the worst. It was a terrible year for oil and gas exporters, as prices plunged, taking currencies such as the rouble down with them. The Indian stock market, meanwhile, was battered by escalating tensions between New Delhi and Islamabad in the wake of the Mumbai terrorist attacks.
Political instability also struck China, where riots by newly redundant workers in Shenzhen and other export centres provoked a heavy-handed clampdown by the government, but also a renewed effort by the People’s Bank of China to prevent the appreciation of the yuan by buying up yet more hundreds of billions of dollars of US Treasuries. “Chimerica” – the symbiotic relationship between China and America – not only survived the crisis, but gained from it. Although Obama’s decision to attend the first G-2 summit in Beijing in April dismayed some liberals, most recognised that trade trumped Tibet at such a time of economic crisis.
This asymmetric character of the global crisis – the fact that the shocks were even bigger on the periphery than at the epicentre – had its disadvantages for the US, to be sure. Any hope that America could depreciate its way out from under its external debt burden faded as 10-year yields and the dollar held firm. Nor did American manufacturers get a second wind from reviving exports, as they would have done had the dollar sagged. The Fed’s achievement was to keep inflation in positive territory – just. Those who had feared galloping inflation and the end of the dollar as a reserve currency were confounded.
On the other hand, the troubles of the rest of the world meant that in relative terms the US gained, politically as well as economically. Many commentators had warned in 2008 that the financial crisis would be the final nail in the coffin of American credibility around the world. First, neo-conservatism had been discredited in Iraq. Now the “Washington consensus” on free markets had collapsed. Yet this was to overlook two things. The first was that most other economic systems fared even worse than America’s when the crisis struck: the country’s fiercest critics – Russia, Venezuela – fell flattest. The second was the enormous boost to America’s international reputation that followed Obama’s inauguration.
. . .
If proof were needed that the US constitution still worked, here it was. If proof were needed that America had expunged its original sin of racial discrimination, here it was. And if proof were needed that Americans were pragmatists, not ideologues, here it was. It was not that Obama’s New New Deal – announced after the Labor Day purge of the Clintonites – produced an economic miracle. Nobody had expected it to do so. It was more that the federal takeover of the big banks and the conversion of all private mortgage debt into new 50-year Obamabonds signalled an impressive boldness on the part of the new president.
The same was true of Obama’s decision to fly to Tehran in June – a decision that did more than anything else to sour relations with Hillary Clinton, whose supporters never quite recovered from the sight of the former presidential candidate shrouded in a veil. Not that the so-called “opening to Iran” produced a dramatic improvement in the Middle East region. Nobody had expected that either. It was more that, like Richard Nixon’s visit to China in 1972, it symbolised a readiness on Obama’s part to rethink the very fundamentals of American grand strategy. And the downfall of the Iranian president Mahmoud Ahmedinejad – followed soon after by the abandonment of the country’s nuclear weapons programme – was a significant prize in its own right. With their economy prostrate, the pragmatists in Tehran were finally ready to make their peace with “the Great Satan”, in return for desperately needed investment.
Meanwhile, al-Qaeda’s bungled attempt to assassinate Obama – on the eve of Thanksgiving – only served to discredit radical Islamism and to reinforce Obama’s public image as “The One”. Another of the many ironies of 2009 was that the mood of religious reawakening triggered by the economic crisis benefited the Democrats rather than the deeply divided Republicans.
By year end, it was possible for the first time to detect – rather than just to hope for – the beginning of the end of the Great Repression. The downward spiral in America’s real estate market and the banking system had finally been halted by radical steps that the administration had initially hesitated to take. At the same time, the far larger economic problems in the rest of the world had given Obama a unique opportunity to reassert American leadership, particularly in Asia and the Middle East.
The “unipolar moment” was over, no question. But power is a relative concept, as the president pointed out in his last press conference of the year: “They warned us that America was doomed to decline. And we certainly all got poorer this year. But they forgot that if everyone else declined even further, then America would still be out in front. After all, in the land of the blind, the one-eyed man is king.”
And, with a wink, President Barack Obama wished the world a happy new year.
Niall Ferguson is a contributing editor of the FT and the author of ‘The Ascent of Money: A Financial History of the World’ (Penguin)
On the one hand, the increasing integration of markets for commodities, manufactures, labour and capital had led to great gains. As Adam Smith had foreseen in The Wealth of Nations, economic liberalisation had allowed the division of labour and comparative advantage to operate on a global scale. From the 1980s until 2007, the world economy had enjoyed higher, more widespread growth and fewer, less severe crises – hence Federal Reserve chairman Ben Bernanke’s hubristic celebration of a “great moderation” in 2004.
On the other hand, the more the world came to resemble an intricate, multi-nodal network operating at maximum efficiency – with minimal inventories and just-in-time delivery – the more vulnerable it became to a massive systemic crash.
That was the true significance of the Great Repression which began in August 2007 and reached its nadir in 2009. It was clearly not a Great Depression on the scale of the 1930s, when output in the US declined by as much as a third and unemployment reached 25 per cent. Nor was it merely a Big Recession. As output in the developed world continued to decline throughout 2009 – despite the best efforts of central banks and finance ministries – the tag “Great Repression” seemed more and more apt: although this was the worst economic crisis in 70 years, many people remained in deep denial about it.
“We assumed that we economists had learned how to combat this kind of crisis,” admitted one of President Barack Obama’s “dream team” of economic advisers, shortly after his return to academic life in September 2009. “We thought that if the Fed injected enough liquidity into the financial system, we could avoid deflation. We thought if the government ran a big enough deficit, we could end a recession. It turned out we were wrong. So much for [John Maynard] Keynes. So much for [Milton] Friedman.”
The root of the problem remained the US’s property bubble, which continued to deflate throughout the year. Many people had assumed that by the end of 2008 the worst must be over. It was not. Economist Robert Shiller’s real home price index in 2006 had stood at just under 206, nearly double its level just six years earlier. To return to its pre-bubble level, it therefore had to fall by 50 per cent. Barely half that decline had taken place by the end of 2008. So house prices continued to slide in the US. As they did, more and more families found themselves in negative equity, with debts exceeding the value of their homes. In turn, rising foreclosures translated into bigger losses on mortgage-backed securities and yet more red ink on banks’ balance sheets.
With total debt above 350 per cent of US gross domestic product, the excesses of the age of leverage proved difficult to purge. Households reined in their consumption. Banks sought to restrict new lending. The recession deepened. Unemployment rose towards 10 per cent, and then higher. The economic downward spiral seemed unstoppable. No matter how hard they saved, Americans simply could not stabilise the ratio of their debts to their disposable incomes. The paradox of thrift meant that rising savings translated into falling consumer demand, which led to rising unemployment, falling incomes and so on, ever downwards.
“Necessity will be the mother of invention,” Obama declared in his inaugural address on January 20. “By investing in innovation, we can restore our faith in American creativity. We need to build new schools, not new shopping malls. We need to produce clean energy, not dirty derivatives.” Commentators agreed that the speech was on a par with Franklin Roosevelt’s on his inauguration in 1933. Yet Roosevelt had spoken after the worst of the Depression was over, Obama in mid-tailspin. The rhetoric flew high. But the markets sank lower. The contagion spread inexorably from subprime to prime mortgages, to commercial real estate, to corporate bonds and back to the financial sector. By the end of June, Standard & Poor’s 500 Index had sunk to 624, its lowest monthly close since January 1996, and about 60 per cent below its October 2007 peak.
The crux of the problem was the fundamental insolvency of the major banks, another reality that policymakers sought to repress. In 2008, the Bank of England had estimated total losses on toxic assets at about $2.8 trillion. Yet total bank writedowns by the end of 2008 were little more than $583bn, while total capital raised was just $435bn. Losses, in other words, were either being massively understated, or they had been incurred outside the banking system. Either way, the system of credit creation had broken down. The banks could not contract their balance sheets because of a host of pre-arranged credit lines, which their clients were now desperately drawing on, while their only source of new capital was the US Treasury, which had to contend with an increasingly sceptical Congress. The other credit-creating institutions – especially the markets for asset-backed securities – were all but paralysed.
There was uproar when Timothy Geithner, US Treasury secretary, requested an additional $300bn to provide further equity injections for Citigroup, Bank of America and the seven other big banks, just a week after imposing an agonising “mega-merger” on the automobile industry. In Detroit, the Big Three had become just a Big One, on the formation of CGF (Chrysler-General Motors-Ford; inevitably, the press soon re-christened it “Can’t Get Funding”). The banks, by contrast, seemed to enjoy an infinite claim on public funds. Yet no amount of money seemed enough to persuade them to make new loans at lower rates. As one indignant Michigan law-maker put it: “Nobody wants to face the fact that these institutions [the banks] are bust. Not only have they lost all of their capital. If we genuinely marked their assets to market, they would have lost it twice over. The Big Three were never so badly managed as these bankrupt banks.”
In the first quarter, the Fed continued to do everything in its power to avert the slide into deflation. The effective federal funds rate had already hit zero by the end of 2008. In all but name, quantitative easing had begun in November 2008, with large-scale purchases of the debt and mortgage-backed securities of government-sponsored agencies (the renationalised mortgage giants Fannie Mae and Freddie Mac) and the promise of future purchases of government bonds. Yet the expansion of the monetary base was negated by the contraction of broader monetary measures such as M2 (the measurement of money and its “close substitutes”, such as savings deposits, that is a key indicator of inflation). The ailing banks were eating liquidity almost as fast as the Fed could create it. The Fed increasingly resembled a government-owned hedge fund, leveraged at more than 75 to 1, its balance sheet composed of assets everyone else wanted to be rid of.
. . .
The position of the US federal government was scarcely better. By the end of 2008, the total value of loans, investments and guarantees given by the Fed and the Treasury since the beginning of the financial crisis had already reached $7.8 trillion. In the year to November 30 2008, the total federal debt had increased by more than $1.5 trillion. Morgan Stanley estimated that the total federal deficit for the fiscal year 2009 could equal 12.5 per cent of GDP. The figure would have been even higher had President Obama not been persuaded by his chief economic adviser, Lawrence Summers, to postpone his planned healthcare reform and promised spending increases in education, research and foreign aid.
Obama had set out to construct an administration in which his rivals and allies were equally represented. But his rivals were a good deal more experienced than his allies. The result was an administration that talked like Barack Obama but thought like Bill Clinton. The Clinton-era veterans, not least Secretary of State Hillary Clinton, had vivid memories of the bond-market volatility that had plagued them in 1993 (prompting campaign manager James Carville to say that, if there was such a thing as reincarnation, he wanted to come back as the bond market). Terrified at the swelling size of the deficit, they urged Obama to defer any expenditure that was not specifically targeted on ending the financial crisis.
Yet the world had changed since the early 1990s. Despite the fears of the still-influential former Treasury secretary Robert Rubin, investors around the world were more than happy to buy new issues of US Treasuries, no matter how voluminous. Contrary to conventional wisdom, the quadrupling of the deficit did not lead to falling bond prices and rising yields. Instead, the flight to quality and the deflationary pressures unleashed by the crisis around the world drove long-term yields downwards. They remained at close to 3 per cent all year.
Nor was there a dollar rout, as many had feared. The foreign appetite for the US currency withstood the Fed’s money-printing antics, and the trade weighted exchange rate actually appreciated during 2009.
Here was the irony at the heart of the crisis. In all kinds of ways, the Great Repression had “Made in America” stamped all over it. Yet its effects were more severe in the rest of the world than in the US. And, as a consequence, the US managed to retain its “safe haven” status. The worse things got in Europe, in Japan and in emerging markets, the more readily investors bought Treasuries and held dollars.
. . .
For the rest of the world, 2009 proved to be an annus horribilis. Japan was plunged back into the deflationary nightmare of the 1990s by yen appreciation and a collapse of consumer confidence. Things were little better in Europe. There had been much anti-American finger-pointing by European leaders in 2008. The French president Nicolas Sarkozy had talked at the G-20 summit in Washington as if he alone could save the world economy. The British prime minister Gordon Brown had sought to give a similar impression, claiming authorship of the policy of bank recapitalisation. The German chancellor Angela Merkel, meanwhile, voiced stern disapproval of the excessively large American deficit.
By the first quarter of 2009, however, the mood in Europe had darkened. It became apparent that the problems of the European banks were just as serious as those of their American counterparts. Indeed, the short-term liabilities of the Belgian, Swiss, British and Italian banks were far larger in relation to those countries’ economies, while the German, French and Danish banks were much more dangerously leveraged. Moreover, in the absence of a European-wide finance ministry, all talk of a European stimulus package was just that – mere talk. In practice, fiscal policy became a matter of sauve qui peut, with each European country improvising its own bailout and its own stimulus package. The result was a mess. Currencies outside the Euro area were afflicted by severe volatility. Inside the Euro area, the volatility was in the bond market, with spreads on Greek and Italian bonds exploding relative to German bunds.
The picture was even worse in most emerging markets. Especially hard hit in eastern Europe were Bulgaria, Romania, Ukraine and Hungary. Of the Brics (Brazil, Russia, India and China), Brazil had the best year, Russia the worst. It was a terrible year for oil and gas exporters, as prices plunged, taking currencies such as the rouble down with them. The Indian stock market, meanwhile, was battered by escalating tensions between New Delhi and Islamabad in the wake of the Mumbai terrorist attacks.
Political instability also struck China, where riots by newly redundant workers in Shenzhen and other export centres provoked a heavy-handed clampdown by the government, but also a renewed effort by the People’s Bank of China to prevent the appreciation of the yuan by buying up yet more hundreds of billions of dollars of US Treasuries. “Chimerica” – the symbiotic relationship between China and America – not only survived the crisis, but gained from it. Although Obama’s decision to attend the first G-2 summit in Beijing in April dismayed some liberals, most recognised that trade trumped Tibet at such a time of economic crisis.
This asymmetric character of the global crisis – the fact that the shocks were even bigger on the periphery than at the epicentre – had its disadvantages for the US, to be sure. Any hope that America could depreciate its way out from under its external debt burden faded as 10-year yields and the dollar held firm. Nor did American manufacturers get a second wind from reviving exports, as they would have done had the dollar sagged. The Fed’s achievement was to keep inflation in positive territory – just. Those who had feared galloping inflation and the end of the dollar as a reserve currency were confounded.
On the other hand, the troubles of the rest of the world meant that in relative terms the US gained, politically as well as economically. Many commentators had warned in 2008 that the financial crisis would be the final nail in the coffin of American credibility around the world. First, neo-conservatism had been discredited in Iraq. Now the “Washington consensus” on free markets had collapsed. Yet this was to overlook two things. The first was that most other economic systems fared even worse than America’s when the crisis struck: the country’s fiercest critics – Russia, Venezuela – fell flattest. The second was the enormous boost to America’s international reputation that followed Obama’s inauguration.
. . .
If proof were needed that the US constitution still worked, here it was. If proof were needed that America had expunged its original sin of racial discrimination, here it was. And if proof were needed that Americans were pragmatists, not ideologues, here it was. It was not that Obama’s New New Deal – announced after the Labor Day purge of the Clintonites – produced an economic miracle. Nobody had expected it to do so. It was more that the federal takeover of the big banks and the conversion of all private mortgage debt into new 50-year Obamabonds signalled an impressive boldness on the part of the new president.
The same was true of Obama’s decision to fly to Tehran in June – a decision that did more than anything else to sour relations with Hillary Clinton, whose supporters never quite recovered from the sight of the former presidential candidate shrouded in a veil. Not that the so-called “opening to Iran” produced a dramatic improvement in the Middle East region. Nobody had expected that either. It was more that, like Richard Nixon’s visit to China in 1972, it symbolised a readiness on Obama’s part to rethink the very fundamentals of American grand strategy. And the downfall of the Iranian president Mahmoud Ahmedinejad – followed soon after by the abandonment of the country’s nuclear weapons programme – was a significant prize in its own right. With their economy prostrate, the pragmatists in Tehran were finally ready to make their peace with “the Great Satan”, in return for desperately needed investment.
Meanwhile, al-Qaeda’s bungled attempt to assassinate Obama – on the eve of Thanksgiving – only served to discredit radical Islamism and to reinforce Obama’s public image as “The One”. Another of the many ironies of 2009 was that the mood of religious reawakening triggered by the economic crisis benefited the Democrats rather than the deeply divided Republicans.
By year end, it was possible for the first time to detect – rather than just to hope for – the beginning of the end of the Great Repression. The downward spiral in America’s real estate market and the banking system had finally been halted by radical steps that the administration had initially hesitated to take. At the same time, the far larger economic problems in the rest of the world had given Obama a unique opportunity to reassert American leadership, particularly in Asia and the Middle East.
The “unipolar moment” was over, no question. But power is a relative concept, as the president pointed out in his last press conference of the year: “They warned us that America was doomed to decline. And we certainly all got poorer this year. But they forgot that if everyone else declined even further, then America would still be out in front. After all, in the land of the blind, the one-eyed man is king.”
And, with a wink, President Barack Obama wished the world a happy new year.
Niall Ferguson is a contributing editor of the FT and the author of ‘The Ascent of Money: A Financial History of the World’ (Penguin)
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