Bob Carlson

January 19, 2015

The ECB’s Coming Announcement

Filed under: Economy,Financial crisis — Bob @ 1:38 pm

The European Central Bank is expected to announce this week that it will begin its version of quantitative easing. Here’s a good compilation of viewpoints, pointing out what we still don’t know about the program, what the different issues are, and discussing whether it can be as effective as the programs in the U.S. and U.K.

There are plenty of rumors that Greece will indeed be excluded from any QE program, unless you imagine they settle things with the Troika rather more quickly than they are likely to.  Yet a bond-buying program without Hellenic participation doesn’t seem so far from hurling an “eurozone heraus!” painted brick through their front window in the middle of the night.

Overall, shuffling assets and risk profiles between national monetary authorities and national fiscal authorities would seem to accomplish…nothing.  Not buying up the debt of your biggest problem country also seems to accomplish nothing, in fact it is worth than doing nothing.

Taming the Urge for Stimulus Spending

Filed under: Economy,Emerging stock markets,Financial crisis — Bob @ 9:20 am

Economies around the globe are slowing, so naturally a number of advisers and analysts are recommending that government spending increase. Here’s a piece (subscription might be required) urging that before developed governments take this advice, they look at the recent experience of emerging economies. China, Russia, Brazil, and others ramped up spending to boost their economies during the financial crisis. It worked in the short run, but now these economies are slowing rapidly, and some are in trouble. Those that resisted the urge to spend to stimulate are doing better.

Since 2010, the growth rate in China has fallen by a third and is headed below 7%. Brazil is in recession. Russia, which spent a staggering 10% of GDP on stimulus, is now contracting sharply.

What happened? Emerging nations borrowed from the future to produce that flash of growth in 2010, and now they face the bills. Their government budgets have fallen into the red, from an aggregate surplus of 1.5% of GDP in 2007 to a deficit of nearly 2% of GDP in 2014.

To pay for this deficit spending, public debt has risen significantly, throwing the books out of balance. Excluding oil-rich Saudi Arabia and Russia, the average current-account balance of emerging nations has deteriorated from a slight 2007 surplus to a 2014 deficit of 1.7% of GDP.

January 14, 2015

The Housing Crisis Reviewed

Filed under: Economy,Financial crisis — Bob @ 6:39 pm

People still debate what caused the financial crisis and the related housing crisis in the U.S. Peter Wallison of AEI has a new book out in which he argues that it was U.S. housing policies that were the primary cause. Other significant causes were the contradictory treatments of Bear Stearns and Lehman Brothers in 2008 and mark-to-market accounting. You can read an interview with Wallison here.

The Federal Reserve provided $29 billion in financial support when Bear Stearns was sold to JPMorgan Chase. However, to the surprise of market participants, the government then let Lehman Brothers fail. This shook market confidence. Would letting Bear Stearns fail have changed how other major banks and financial firms reacted to the unfolding financial crisis and the eventual bankruptcy of Lehman?

Yes, if the government had allowed Bear Stearns to fail, everything would have been different. First of all, we know now—after the Lehman Brothers failure—that no other firms would have failed if Bear Stearns had been allowed to fail. We know this because when Lehman failed no other firms failed because of exposure to Lehman. This showed that the fears of Secretary Paulson and others – that Bear’s failure would bring down other “interconnected” firms – were completely unfounded.

Yes, of course, there was chaos after Lehman’s bankruptcy, but that was because the market—which had thought the government had established a policy of rescuing large firms—was shocked and panicked when Lehman was allowed to fail. Still, despite the chaos and panic, no other significant firm anywhere failed because Lehman failed, and Lehman was about 50% larger than Bear. So if Bear had been allowed to fail we can be reasonably sure that nothing significant would have happened.

However, because Bear was rescued, everything changed. Firms that should have raised more equity to shore up their capital positions decided not to do so; they thought their creditors would be protected by the government, so the creditors did not need the assurance of additional equity.

January 7, 2015

Greece: Back in the News

Filed under: Economy,Financial crisis — Bob @ 1:26 pm

The European Central Bank’s pledge in 2012 to do “whatever it takes” calmed markets about Europe’s problems for a few years. But all the remedies were only temporary, mere bandages when major surgery was needed. Now, it’s time for a new treatment, and no one is willing to do what needs to be done. So, the talk again is about when Greece will leave the currency union and what effect that will have on the markets and global economy. Read this brief but thorough summary to get up to date.

Leaving the euro would make Greece a pariah in international markets, enforce a devaluation that probably would require capital controls and make banks fresh targets. The economy would probably contract again and the government would be pushed off the deleveraging and deregulatory policies that euro membership demands and which, while painful, have begun to bear some fruit.

To Holger Schmieding of Berenberg, such a backdrop would leave Greece as “Venezuela without oil,” a nod to the Latin America nation already skidding toward default.

After Greece, speculators would immediately size up the next potential victim — from Cyprus to Spain and on to Italy.

December 23, 2014

The Next Turn in the Greek Drama

Filed under: Emerging stock markets,Financial crisis — Bob @ 9:30 am

There’s an election coming up in Greece. Because of the severe depression in the country, there’s political and social unrest. The situation is so bad that a fringe party has a shot at winning and taking over the government. This post is a good review of the situation and possible scenarios after the election.

The bailout by the Troika (ECB/IMF and EU) is set to end in February 2015. After that, the current centre-right coalition led by Antonis Samaras faces the need to borrow 22bn euros in fiscal years 2015 and 2016.

Eurobank analysts say the solution being discussed is for the EU to extend an “enhanced conditions credit line” from the ESM bailout fund of 9.5bn euros over two years; and for the IMF to lend 12.5bn euros,  meeting Greece’s needs.

But since the original bailout only postponed crunch-time on repaying this massive 319bn euro debt, most observers think there will have to be a further writedown of the debt.

December 18, 2014

The Next Rumble in Europe

Filed under: Economy,Financial crisis — Bob @ 1:20 pm

The depression in much of Europe raises two concerns. One is that poor economic growth there will reduce growth in other countries. The other is more longlasting and dangerous. Economic conditions are so poor in Europe that they are likely to lead to political and cultural upheavals if they endure for long. We’ve seen the fringe parties gain strength in the polls and even some recent elections. With so many youth unemployed with no hope of finding jobs, they are susceptible to appeals from the fringe parties. Here’s a news article discussing some recent demonstrations by extremists in Germany. Without economic improvement in Europe, these events are likely to increase.

Lutz Bachmann, the head of Pegida, a nascent anti-foreigner campaign group, led the crowds, either waving or draped in German flags, in barking chants of “Wir sind das Volk”, or “We are the people”, the slogan adopted by protesters in the historic “Monday demonstrations” against the East German government in the runup to the fall of the Berlin Wall.

Associating themselves with the freedom demonstrations has given Pegida protests an air of moral respectability even though there are hundreds of rightwing extremists in their midst, as well as established groups of hooligans who are known to the police, according to Germany’s federal office for the protection of the constitution.

“The instigators are unmistakably rightwing extremists,” a federal spokesman said.

Geopolitics and the Markets

Filed under: Economy,Financial crisis — Bob @ 9:20 am

The markets are affected at least as much by international affairs these days as by economics. There are a couple of pressing situations. One is Russia, especially regarding Ukraine.

Russia is beset right now by a combination of falling commodity prices and economic sanctions imposed by western countries. This analysis from indicates that Russia is prepared to endure these problems. They won’t change Russian behavior or lead to the demise of Vladimir Putin. It’s a view most of us haven’t heard or considered and is worth reading.

Russians’ strength is that they can endure things that would break other nations. It was also pointed out that they tend to support the government regardless of competence when Russia feels threatened. Therefore, the Russians argued, no one should expect that sanctions, no matter how harsh, would cause Moscow to capitulate. Instead the Russians would respond with their own sanctions, which were not specified but which I assume would mean seizing the assets of Western companies in Russia and curtailing agricultural imports from Europe. There was no talk of cutting off natural gas supplies to Europe.

If this is so, then the Americans and Europeans are deluding themselves on the effects of sanctions. In general, I personally have little confidence in the use of sanctions. That being said, the Russians gave me another prism to look through. Sanctions reflect European and American thresholds of pain. They are designed to cause pain that the West could not withstand. Applied to others, the effects may vary.

December 15, 2014

The Scoop on the Dodd-Frank Revision

Filed under: Economy,Financial crisis — Bob @ 1:09 pm

The omnibus spending bill pushed through Congress at the last minute contained a change in the Dodd-Frank financial regulation law. Opponents of the change called it a gift to Wall Street and big banks, and people on both the left and the right were united in opposition. But does it really matter? Here’s a post that downplays the significance of the change. The post also includes a roundup of other interesting financial news during the week.

I have my biases, but I have a hard time believing equity derivatives will bring down a bank. Uncleared CDS, I’ll grant you, has a rough track record, though the market is slowly moving away from it in general. But the big derivatives risks, by notional, were going to be allowed to remain in the depository banks anyway. “Oh but no one could be blown up on interest rate swaps,” you say, as the Fed discusses the timing of rate increases.

December 11, 2014

Warning Signs in Europe

Filed under: Economy,Financial crisis — Bob @ 1:17 pm

The European economy is deteriorating, and that’s a risk to global economic growth. More importantly, the European economy is so bad that the political and social structure in many parts of the continent is at risk. has a clear-eyed assessment of the situation, touching on events and conditions in four key countries. There’s a lot more to know about what’s going on in Europe. Fringe parties and extremists that were popular jokes a few years ago now have realistic chances of doing well in elections and becoming either the dominant parties or key players in coalitions. But the linked article is a good place to start.

When the European Central Bank promised to intervene in financial markets almost two years ago, the European Union lost the sense of urgency it had in the early stages of the crisis. The European Union, and particularly Germany, chose caution instead of action. Should Greece generate financial turmoil in Europe again, the Europeans will have to go back to the negotiating table and discuss all the issues that have so far been avoided.

November 25, 2014

A Dark View of Europe

Filed under: Economy,Financial crisis — Bob @ 9:20 am

For some time, the biggest risk to the U.S. and global economies has been from Europe. Policymakers managed to halt the downward spiral in 2011 and 2012, but they haven’t generated anything close to the growth needed to restore employment to decent levels. Recent data indicate the continent is at risk of losing what growth it has and slide back into negative growth.

People became more optimistic recently after European Central Bank President Mario Draghi indicated the ECB would begin a QE-like program in coming months. But significant actions haven’t been taken, and there are those who doubt they will be, at least as long as Germany is part of the ECB. Here’s a very pessimistic report on the situation that’s probably very accurate. The political situation in Europe is very difficult. The most likely scenario is that Germany leaves the ECB or the weaker economies (Greece, Italy, and others) leave and establish their own monetary policies. And here’s a report of fresh German opposition to Draghi’s plans.

Although the Bundesbank has been careful not to close the door to QE, it is very hard to imagine the circumstances under which it would ever give its consent—and what makes the Bundesbank such a formidable opponent for Mr. Draghi isn’t the formal power that it possesses, which is limited, but the extent to which it shapes and reflects German public opinion.

By the same token, German officials have made it abundantly clear to me that if Mr. Draghi ever tries to buy government bonds, the ECB should be under no illusions that it will face multiple legal challenges from Germany and that the finance ministry will come under intense pressure to mount a challenge itself. If Mr. Draghi didn’t know it before, he must now realize that the political firestorm that would surround any decision to launch QE would be so destabilizing and do such damage to the ECB’s credibility that it would undermine whatever good he hoped to achieve.

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