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.
There was a lot of debate in 2009 after some economists published research concluding that economic growth always is slower after a financial crisis and that it takes a long time for the economy to return to its old high. Some people disputed the data and conclusions. Now, the Federal Reserve has published new research concluding that indeed growth is much slower after a severe recession and that the economy isn’t capable of higher growth for some time. But the surprise conclusion is that perhaps the Fed shouldn’t keep interest rates low for a long time. It’s possible that inflation could spike up despite all the unused capacity if the Fed stimulates for a long time after the recovery begins.
Fed officials have held their short-term interest rate near zero for nearly six years, in part because they believe the difference between the economy’s output and its potential—the so-called output gap—is large, and should therefore hold down inflation pressures. But if the economy’s potential rate of growth is lower than they thought, that would mean the output gap is smaller than estimated and inflation price increases could start picking up sooner than expected. That would argue for raising interest rates sooner than currently envisioned.
The government’s been busy touting the multi-billion dollar settlements it obtained against major banks for fraudulently selling mortgage securities before the real estate crash. Rolling Stone tells a different story. It interviews an attorney for Chase bank who says the fraud was deliberate and rife, and that the government colluded with the banks to keep the facts under wraps and avoid criminal prosecutions.
Back in 2006, as a deal manager at the gigantic bank, Fleischmann first witnessed, then tried to stop, what she describes as ”massive criminal securities fraud” in the bank’s mortgage operations.
Thanks to a confidentiality agreement, she’s kept her mouth shut since then. ”My closest family and friends don’t know what I’ve been living with,” she says. ”Even my brother will only find out for the first time when he sees this interview.”
Six years after the crisis that cratered the global economy, it’s not exactly news that the country’s biggest banks stole on a grand scale. That’s why the more important part of Fleischmann’s story is in the pains Chase and the Justice Department took to silence her.
She was blocked at every turn: by asleep-on-the-job regulators like the Securities and Exchange Commission, by a court system that allowed Chase to use its billions to bury her evidence, and, finally, by officials like outgoing Attorney General Eric Holder, the chief architect of the crazily elaborate government policy of surrender, secrecy and cover-up. ”Every time I had a chance to talk, something always got in the way,” Fleischmann says.
The European Central Bank concluded its recent meeting by keeping interest rates unchanged. But it didn’t announce a big policy to boost monetary policy, despite signs of falling inflation and growth. But ECB President Mario Draghi said the staff is preparing a policy to implement when needed. That promise continues to drag the euro down against the dollar but it isn’t inspiring confidence yet that it will help the European economy. Read a roundup here.
To keep the euro zone from slipping into deflation, the ECB has started pumping more money into the banking system through purchases of private debt and offers of long-term loans, aiming to boost its balance sheet by up to 1 trillion euros.
There is growing doubt whether these measures will be enough, but the ECB is expected to wait until it gets a clearer view of the impact of its asset purchases and four-year loans to banks before moving further.
Sources close to the ECB have told Reuters that its plan to buy private-sector assets may fall short and pressure is likely to build for bolder action early next year, firstly moving into the corporate bond market.
During the depths of the financial crisis, debate was ignited by the publication of This Time is Different, a book that argued, among other things, that after a financial crisis it takes a long time for economic growth to return to normal. Though questions arose about some of the data later, most analysts accept the data, arguments, and conclusions. Now, a couple of economists weigh in on the other side. This article provides a good summary of both sides of the debate.
Their finding: Declines in economic output, as measured by gross domestic product and industrial production, following crises were on average moderate and often short-lived. There was a lot of variation in outcomes, so there was nothing cut and dried about how economies respond to crises.
The Romers further point out that, in some cases, financial crises are set off by weakness in the economy. That makes it difficult to determine what counts as crisis-related declines in output and what doesn’t. “Thus, our estimates are, if anything, likely to be an overestimate of the impact of financial distress,” they write.
Mr. Rogoff says that he and Ms. Reinhart have “some fundamental areas of disagreement” with the Romers’ work “that I’m sure will be sorted out over time by further discussion, further revisions, further research and further papers.”
Some of you might remember back to the stock market crash of October 1987, when major indices fell about 25% in one day. There was a lot of finger pointing at the time about the cause, but I remember a number of people saying that a major mutual fund company decided to unload a lot of stocks quickly. That crash of 1987 happened and reversed quickly, partly because stock markets are so big and liquid. But what about other markets, such as high-yield and distressed bonds.
New attention is being drawn to the fact that a few large mutual fund companies control major positions in some asset classes and even in the bonds of some companies. There are several potential concerns. One is that all this mutual fund buying gives a false picture of how liquid and efficient the market is. Another concern is that if these funds suffer large redemptions they’ll have to sell the bonds quickly and at whatever price they can. It could be like the fall of 2008 again. Read the linked article for more.
The chief risk officer of Goldman Sachs, Craig W. Broderick, warned at the I.M.F. meetings last week that the asset management firms that now hold the bulk of these bonds had not yet been tested in terms of how they would react to a market shock.
“Now there is plenty of liquidity,” Mr. Broderick said. “But when things are different, the alternative providers will not be there.”
The term of art for this scenario is a liquidity mismatch, with some going so far as to call it a systemic liquidity mismatch. If, for example, there is a sustained emerging-market crisis and a fund wants to liquidate these bonds to meet redemption demands, the manager will be required to provide cash immediately even though it may take several days to sell the securities in question.
The big stock slide Monday generated a lot of discussion about its causes, especially since the market indices seemed solid the first part of the day. I think a big reason investors are concerned is the impasse among policymakers in Europe, especially the monetary policy of the European Central Bank. Take a look at this Bloomberg.com article. It details the back and forth between ECB President Mario Draghi and German Finance Minister Jens Weidmann. I suspect Draghi has the votes to do what he wants. The questions are how long it will take and how will Germany react? Will it consider leaving the European Union if it doesn’t continue to get its way?
“There’s an enormous conflict within the Governing Council on what the ECB should do,” said Joerg Kraemer, chief economist at Commerzbank AG in Frankfurt. “Clearly, it’s Draghi against Weidmann once again. In the end, Draghi will get his way and we will see quantitative easing next year.”
The ECB is swelling its balance sheet as it seeks to revive inflation of 0.3 percent, the lowest in almost five years. By buying private-sector assets, as it plans to do from this month, or continuing to accept collateral from banks in return for cheap loans, it is pushing liquidity into the economy. Still unresolved is if it will ultimately buy sovereign debt, a taboo subject in Germany where politicians worry it amounts to financing governments and removing pressure on them to act.
I’ve pointed out recently that the European economy is nearing a turning point. Actions of the last few years arrested the downward spiral. But the economy is losing momentum and is close to entering a new deflationary depression spiral. Major policy changes are needed. But European policymakers don’t seem able or willing to do what needs to be done. Here’s the latest summary of where things stand.
RBS estimates that the inflation rate has already dropped to below 0.1pc in the eurozone if one-off tax rises and fees are stripped out, and this measure may turn negative in October. “Deflation is already knocking on the door. We think it could happen as soon as next month given the latest fall in food prices,” said Mr Roberts.
“We are reaching the end game in Europe. If they don’t launch real QE and start reflation by the end of the year or soon after, the consequences are too awful to contemplate,” he said.
Recently there’s been a lot of discussion about the financial crisis of 2008. Earlier this week The New York Times published a report stating that the government probably could have bailed out Lehman Brothers if it wanted to. I linked to that report previously. This seems to have generated a lot of second-guessing and third-guessing of the second-guessers. Here’s an essay arguing that in the long run it was a good thing that Lehman Brothers went bankrupt. I don’t find this compelling, primarily because it says several times that the Dodd-Frank financial regulation law wouldn’t have passed without the crisis, and that the law is a good thing. I don’t see much good in Dodd-Frank.
Here’s an interesting essay by Andrew Ross Sorkin asserting that people shouldn’t be mad that the bailout of AIG actually was a bailout of Wall Street, because that’s what was intended. No one should be surprised that saving the rest of Wall Street was the reason for bailing out AIG or believe that the government was deceptive about it. I find that commentary refreshing, and I think that is accurate. My concern always has been that the government confused saving the system with saving the individual players and firms in the system. Bailouts could have been structured and managed so that the system didn’t collapse but people who helped cause the chaos didn’t profit from it.
The government sought to save A.I.G. for only one reason: because it was “systemically important,” which is not-so-hard-to-decipher code for a company whose failure would have had a ripple effect on large swaths of the industry — in this case, dozens of banks. To pretend that the rescue of A.I.G. was anything but an effort to make sure the rest of the industry didn’t go under is to misunderstand history. The entire point of the A.I.G. bailout was to bail out Wall Street and reinstall confidence in the system so that it didn’t collapse under even more uncertainty.
The government never sought to couch A.I.G.’s lifeline as a way to push money into the hands of Goldman Sachs, Deutsche Bank, Société Générale and the dozens of other banks around the world that were the beneficiaries. That idea was never going to win a popularity contest. But that was the effect of the assistance to A.I.G. And that was the point.
The sudden bankruptcy of Lehman Brothers in 2008 turned a difficult situation into a deep global financial crisis. For years, government officials involved in the process at the top levels said that they had no legal authority to bail out the firm, as it did for others before and after the Lehman bankruptcy. The firm’s assets were too highly leveraged to provide a loan or other assistance.
But a new report in The New York Times provides new, anonymous sources that claim that wasn’t the case. They say the government lawyers never said a bailout wasn’t allowed and also that a team of analysts at the New York Federal Reserve had concluded that the firm had enough equity to qualify for a bailout. But they say they never presented their information to the top decision makers.
Whether the Fed should have tried to save Lehman is still a subject of heated debate. And it is unclear whether the firm could have been rescued at all.
What happened that September was the culmination of circumstances reaching back years — of ordinary people too eager to borrow, of banks too eager to lend and of Wall Street financial engineers reaping multimillion-dollar bonuses. Even so, saving Lehman from complete collapse might have shielded the economy from what turned out to be a crippling blow. And as the subsequent rescue of A.I.G., the insurance giant, demonstrated, a rescue could have included substantial protections for taxpayers.