Investing Curiouscatblog

Category: Economics

  • Greenspan Says He Was Wrong On Regulation

    Greenspan Says He Was Wrong On Regulation

    Greenspan alternately defended his legacy and acknowledged mistakes. Waxman asked whether the former chairman was wrong to consistently oppose regulating the multitrillion dollar derivative market that has contributed to the financial crisis. “Well, partially,” said Greenspan, before stressing the difference between credit-default swaps and other types of derivatives.
    …
    Even Greenspan seemed genuinely perplexed yesterday by all that had happened, hard-pressed to explain how formerly fundamental truths about how markets work could have proved so wrong.
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    “When bubbles cause huge problems is when they cause the financial sector to seize up,” said Frederic S. Mishkin, a Columbia University economist and, until recently, Fed governor. “The right way to deal with that kind of bubble is not with monetary policy,” but with bank supervision and other regulatory powers.
    …
    While endorsing some expanded regulation yesterday, such as requiring the companies that combine large numbers of loans into securities to hold on to significant numbers of those securities, he also repeatedly retreated to his libertarian-leaning roots, and warned of the dangers of overreacting.
    …
    “I made a mistake,” Greenspan said, “in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms.”

    The key is to strive for properly functioning markets. Unfortunately that does not mean allowing those that give large payments to politicians to foist huge risks on the economy by exempting themselves from sensible regulation. I guess some people get confused that the benefits of “free markets” are not the same as standing back and allowing powerful interests to manipulate markets and risk economies. The benefits of a free market are provided to the economy when the market is free not when large, powerful organizations are allowed to exert undue influence on markets.

    I don’t really understand how people could think “free markets” are about letting special interests be free to manipulate markets. It is not really something that should be confusing to people that have thought enough to have an opinion on the benefits of free markets. The dangers of monopolies and business people conspiring to extract benefit (for those in the cartel, trust, conspiracy…) by manipulating the market was well know from the initial minds putting together capitalist theory. And the obvious method to allow the benefits of the free market to be maintained was regulation to prevent those that sought to manipulate the market for their benefit.

    And the dangers of overly leveraged financial institutions should be obvious to anyone with a modicum of understanding of financial history. Then make those overly leveraged financial institutions large (too be to fail) types and you really are asking for disaster. Add in a extremely large use of debt by the public and private sectors (living beyond your means). Then throw in encouraging reckless short term thinking by providing enormous cash bonuses for paper potential profits and you really have to wonder how anyone could think this was not a perfect design to assure a financial meltdown.

    Related: Too Big to Fail, Too Big to Exist – Fed to Loan AIG $85 Billion in Rescue – 2nd Largest Bank Failure in USA History

  • Treasury Now (1987) Favors Creation of Huge Banks

    Treasury Now Favors Creation of Huge Banks, New York Times, 1987:

    Top officials at the Treasury Department have concluded that the Government should encourage creation of very large banks that could better compete with financial institutions in Japan and Europe.

    The Treasury plan, which would permit the acquisition of banks by large industrial companies, was also endorsed by Alan Greenspan, in an interview before President Reagan nominated him this week to be chairman of the Federal Reserve Board.
    …
    Mr. Gould acknowledged that any policy promoting the creation of very large financial institutions encounters deep-seated sentiments that date from the founding of the Republic. But he thinks the nomination of Mr. Greenspan could provide an important stimulus for change. Mr. Greenspan contends that many of the laws restricting commercial banks severely limit their ability to adapt to a changing marketplace.

    The Reagan Administration has met frustration in its efforts to lessen regulation of banking, largely because Paul A. Volcker, the current Federal Reserve chairman, has firmly opposed any move that would begin to break down the barriers that prohibit large nonbanking companies from owning banks. Mr. Volcker has also been rather grudging in his support of changes that would allow interstate banking and the underwriting of securities by banks.
    …
    ”We have been the beneficiaries of living in a relatively insulated big economy, and only recently have we found out that the Japanese can make automobiles better than we do,” said Hans Angermueller, vice chairman of Citicorp. ”We are discovering that the same thing may apply in the financial services area, and to meet that challenge, we need to get leaner, meaner and stronger. We don’t do this by preserving the heartwarming idea that 14,000 banks are wonderful for our country.”

    The New York Times web archive is a great resource for viewing the historical trends to turn away form the capitalist ideas of free market competition and instead move toward large market dominating banks. You get the impression from people talking about “free markets” that they have never actually read Adam Smith, Ricardo, Mills…

    Related: Ignorance of What Capitalism Is – Not Understanding Capitalism – Canadian Banks Avoid Failures Common Elsewhere – Monopolies and Oligopolies do not a Free Market Make – Estate Tax Repeal
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  • Will Americans Actually Save and Worsen the Recession?

    Americans need to save much more money. This is true for people’s personal financial health. And it is true for the long term health of the economy. Of course the credit card immediate gratification culture doesn’t put much weight on those factors. And if Americans actually do reduce their consumption to save more that will harm the economy in the short term. But since those reading this are people (the economy can’t read) the smart thing for most readers is to save more to create a stronger financial future for themselves.

    Turmoil May Make Americans Savers, Worsening ‘Nasty’ Recession

    U.S. retail sales fell in September for the third straight month, the longest slump since the government began keeping records in 1992.
    …
    From 1960 until 1990, households socked away an average of about 9 percent of their after-tax income, Commerce Department figures show. But Americans got out of the saving habit starting in the 1990s
    …
    “Consumers are starting to realize that they’ve been living in a fantasy world,” says Lyle Gramley, a former Fed governor who is now senior economic adviser at Stanford Group Co. in Washington. “They will have to begin salting away money for retirement, their children’s education and other reasons.”

    Americans have a way to go to catch up with their counterparts in other countries. The 0.4 percent of disposable income that U.S. households saved last year compares with 10.9 percent for Germany and 3.1 percent for Japan

    Related: Americans are Drowning in Debt – Too Much Stuff – Financial Illiteracy Credit Trap

  • MicroFinance Currency Risk

    I have been curious how Kiva deals with currency risk. Kiva is a great resource for providing micro-lending and the opportunity to engage in choosing who you will lend to. But my transactions are all in US$ and the loans in the field are in the local currency. This creates an issue of what happens when currency values fluctuate. I asked a question on the Kiva LinkedIn group (an excerpt is shown here):

    A lender takes out a loan of $100 with 10 months to repay. If the loan is in the local currency, what if the value of that currency during the 10 months declines by 20%? Then the bank has received all their money back but they owe Kiva $100 but they only have $80 worth of the local currency (again ignore that the payments are made monthly – since it doesn’t effect the issue at hand – currency rates). Hows does Kiva deal with this currency risk? Do the local partner banks take the risk…?

    I was directed to a great slideshow showing Kiva’s lending policies. It turns out Kiva does have the local banks take the currency risk. So they have to pay back $100, if the local currency value is now $80, they would have a loss, of course the local currency value could also have risen, then the local bank has a gain.

    They have a chart showing the cost of capital to local Kiva lenders at 0-1% plus currency exchange risk (which they say some banks choose to hedge and others just take the risk), which is about the lowest cost of capital around. Kiva charges no interest on the loans to the local banks. The costs come from the requirements (the cost of adding a profile – the time of staff of the bank to add the information…) of using the Kiva website.

    Updates
    1) Kiva updated their policy to put any currency loss greater than 20% on the lenders (up to 20% losses are taken by the bank, above 20% are taken by those lending through Kiva). But the banks can chose to take the currency risk, which they could do to encourage lenders to select their loans to fund.
    2) They updated it again to make it a decision by the bank, which means often the lenders bear the risk (it is stated on each loan how the risk is assigned)

    Curious Cat Kiva connections: Curious Cats Kiva lending team – Curious Cat Kivans – Funding Entrepreneurs in Nicaragua, Ghana, Viet Nam, Togo and Tanzania – Kiva Fellows Blog: Nepalese Entrepreneur Success – Kiva related blog posts

  • FDIC Doubling Bank Fees to Pay for Increased Takeovers

    FDIC to double bank fees in face of $40bn loss

    The Federal Deposit Insurance Corporation yesterday proposed doubling the fees it charges US banks, as it warned that it faced about $40bn in losses from bank failures in the coming years.

    About 90 per cent of US banks will see their basic deposit insurance fees double in the first quarter of 2009, from between 5 cents and 7 cents for each $100 of deposits to between 12 cents and 14 cents, according to a plan laid out yesterday by the FDIC, a government-backed agency that insures consumer deposits up to $250,000. From the second quarter that range would widen to from 10 to 14 cents per $100.
    …
    Banks with the riskiest profiles could end up paying fees as high as 77.5 cents for every $100 of insured deposits under the plan, compared with a maximum of 43 cents under the current structure.

    The FDIC insures bank deposits with fees charged to banks. The recent increase of the FDIC Limit to $250,000 seems to indicate that taxpayers will now pay for any costs for covering above $100,000 per account-holder (which I think is a mistake – the fund should be self supporting). But this increase in fees is to restore the fund to the minimum capital requirements of the insurance fund.

    Related: posts on banking – Avoid Getting Squeezed by Credit Card Companies – Where to Keep Your Emergency Funds?

  • Jim Rogers on the Financial Market Mess

    Jim Rogers webcast: Fannie Mac and Freddie Mac should not have been bailed out. Jim Rogers is one of the most successful investors in the last 50 years. He and George Soros (together with the Quantum Fund) and then separately along with Warren Buffett have made the most as investors (that I know of – I could easily be wrong).

    How you want to accept their opinions on the current crisis is up to you. I believe they are worth listening to – more than anyone else. That does not mean I believe they are totally right. To me the long term track record of each is very impressive. Especially Jim Rodgers and George Soros have been making big investment gains largely on macro economic predictions in the last 20 years.

    In The Dollar is Doomed (July 2008) Jim Rogers predicts the United States Federal Reserve is so badly run it will be gone in a decade or two. I disagree with that sentiment. He certainly has much more expertise than I do but in evaluating such a comment you need to look at what really matters to him. He doesn’t need the Federal Reserve to actually cease to exist to make profitable trades based on his prediction that the Federal Reserves policies are dooming the dollar.

    Another thing to note with Rogers and Soros is they will make strong statements and take huge positions but will change their mind when conditions change (often quickly). So you can’t assume what they said awhile back is still their belief today.

    Related: Jim Rogers: Why would anybody listen to Bernanke? – investment books – Rodgers on the US and Chinese Economies – A Bull on China

  • Crisis May Push USA Federal Deficit to Above $1 Trillion for 2009

    Cost of U.S. Crisis Action Grows, Along With Debt

    The global financial crisis is turning into a bigger drain on the U.S. federal budget than experts estimated two weeks ago, ballooning the deficit toward $2 trillion.
    …
    The 2009 budget deficit could be close to $2 trillion, or 12.5 percent of gross domestic product, more than twice the record of 6 percent set in 1983, according to David Greenlaw, Morgan Stanley’s chief economist. Two weeks ago, budget analysts said the measures might push deficit to as much as $1.5 trillion.
    …
    The financial health and earnings prospects of Fannie Mae and Freddie Mac — seized by the government on Sept. 7 to prevent them from failing — worsened in the second and third quarters, the companies’ government regulator said this week.
    …
    On top of all that, budget watchdogs say the sheer size of the interventions is making Washington more profligate than usual. To attract votes in Congress, leaders added several costly items to the $700 billion rescue, including extensions of some tax credits and tax breaks for makers of wooden arrows and stock- car racetrack owners.

    Under normal circumstances, there would have been more resistance to such expenses, said Robert Bixby, executive director of the Concord Coalition, a non-partisan budget watchdog.

    The news sure is not yet getting better. And our failure to act responsibly in good times now seriously increase risk. Just as someone that lived far beyond their means, with excessive debt, debt on multiple credit cards… we have continually elected politicians that had our government live beyond our means for decades. And that means we don’t have the resources to pay for the measures we are talking. For now the world markets are willing to give the USA government more credit cards to finance more spending. But at some point that stops.

    At some point the loans have to be paid back. The only options are large reductions in spending, large increases in taxes or just printing more and more money people don’t want to pay off loans (which will cause massive inflation). There is also the possibility of growing our way out of the problems (the equivalent of yes, I have $40,000 in credit card debt but when I make $150,000 a year paying that off will be easy). To some extent this will happen (unless things get very very bad) but the level of economic growth needed is unlikely to fix the problem we make worse every year (as we fall further and further behind). We are now spending huge amounts to money we didn’t save in the good times. That means we are mortgaging even more of our future than we already had before this mess.

    Related: Financial Market Meltdown – Warren Buffett Webcast on the Credit Crisis – FDIC Limit Raised to $250,000 – Financial Markets Continue Panicky Behavior – USA Federal Debt Now $516,348 Per Household

    Plan Pushed for Government to Buy Bank Stocks

    Bank nationalization would be a more extraordinary move for the US, but in a recent interview former FDIC Chairman William Isaac provided some rare insight into the matter. He said that during the Latin American debt crisis of the 1980s when major money center banks were facing possible loan payment defaults by sovereign governments, the US “had a contingency plan in place to nationalize [the banks].”

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  • Soros on the Financial Market Collapse

    George Soros published his most recent book in May 2008 – The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means. Yesterday Bill Moyers Interviewed George Soros:

    Markets have the ability to adjust and they’re very flexible. There is this invisible hand. But it is also prone to be mistaken.
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    This current economic disaster is self-generated. It was generated by the market itself, by getting too cocky, using leverage too much, too much credit. And it got excessive.
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    The financial system is teetering on the edge of disaster. Hopefully, it will not go over the brink because it very rarely does. It only did in the 1930s. Since then, whenever you had a financial crisis, you were able to resolve it.
    …
    the sort of period where America could actually, for instance, run ever increasing current account deficits. We could consume, at the end, six and a half percent more than we are producing. That has come to an end.
    …
    Right now you already have 10 million homes where you have negative equity. And before you are over, it will be more than 20 million.

    Related: Soros Says Credit Crisis Will Worsen Before Improving (April 2008) – Warren Buffett Webcast on the Credit Crisis – Rodgers on the US and Chinese Economies – – Personal Investment Failures

  • Canadian Banks Avoid Failures Common Elsewhere

    Canada’s banking system kept high and dry by strict regulation: Flaherty

    High banking standards have kept Canada’s financial institutions afloat and out of the kind of trouble that has sunk many of their international peers, Finance Minister Jim Flaherty said Wednesday.
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    Some of the fundamentals credited with keeping Canada’s banks in the safe zone were put in place nearly a decade ago by the Liberal government of Jean Chretien, including a refusal to approve any Canadian bank mergers.
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    The finance minister said Canada is in a strong position to deal with the global crisis, with a strong banking system, a stable housing market and a federal budget surplus. “Other countries have been increasing their deposit standards, but they’re still for the most part below the high Canadian standard,” he said.

    Related: Monopolies and Oligopolies do not a Free Market Make – Too Big to Fail – What Should You Do With Your Government “Stimulus” Check? – The Budget Deficit, the Current Account Deficit and the Saving Deficit – 2nd Largest Bank Failure in USA History

  • Corporate and Government Bond Rates Graph

    graph of 10 year bond rates

    Over the last 3 months the yields on corporate bonds have increased while treasury bonds have decreased. The chart shows the move away from lower quality bonds to higher quality though probably not as dramatically as actually has taken place as it is just an average for each month (and in September the flight to quality became extreme at the end of the month). While the Fed did not announce a formal cut in the discount rate, the average rate for overnight loans from the Fed last month was 1.81%.

    The spread between 10 year Aaa corporate bond yields and 10 year government bonds increased to 196 basis points. In January, 2008 the spread was 159 points. The larger the spread the more people demand in interest, to compensate for the increased risk. The spread between government bonds and Baa corporate bonds increased to 362 basis points, the spread was 280 basis point in January. The rate on government bonds has barely change (decreasing from 3.74% in January to 3.69% now) so the change has nearly all been in increased corporate bond rates.

    Data from the federal reserve – corporate Aaa – corporate Baa – ten year treasury – fed funds

    Related: Bond Yields 2005 to June 2008 – 30 Year Fixed Mortgage Rates versus the Fed Funds Rate – Curious Cat Investing and Economics Search – posts on interest rates