SECRETARIA DE ESTADO DE ECONOMÍA,

MINISTERIO SECRETARÍA GENERAL DE POLÍTICA ECONÓMICA DE ECONOMÍA Y ECONOMÍA INTERNACIONAL Y HACIENDA SUBDIRECCIÓN GENERAL DE ECONOMÍA INTERNACIONAL

CUADERNO DE DOCUMENTACION

Número 89º ANEXO II

Alvaro Espina Vocal Asesor 31 de Julio de 2009

BACKGROUND PAPERS:

1. Obama present bill to create consumer finance Watchdog, , by David Cho and Michael D. Shear…10 2. Don’t celebrate too early Germany’s constitutional court has given a stinging judgment on European integration, Collegio Carlo Alberto…12 3. Too early for triumph in Brussels, Spiegel online by Hans-Hurgen …14 4. Germany cannot ratify Lisbon-yet, Spiegelonline …16 5. SF Fed president yellen on the Economy, CalculatedRisk …18 6. In 2nd quarter, stocks gained, but for how long?, by Jack Healy…21 7. A Real free lunch, SpiegelOnline…24 8. woes deepening in Europe, The New Yor Times by Landon Thomas Jr…30 9. Retired from GM at 54 pensionless at 74?, The New York Times, by Mary Williams Walsh…33 10. How much money inflation? Mises Daily…37 11. The savings glut. Controversy guaranteed, Brad Setser Follow the Money…41 12. How sale are prime and jumbo mortgages amid falling home prices? RGE Monitor…46 13. Is the decline in US home prices easing? RGE Monitor…50 14. Landes banken consolidation off the agenda, Collegio Carlo Alberto…49 15. BIS wants financial products ranked like drugs, Forbes by Huw Jones…52 16. BIS Annual report: Rescue, recovery, reform the narrow path ahead, Bank International Settlements…54 17. How a Loophole benefits GE in Bank Rescue, The Washington Post by Jeff Gerth and Brady Dennis…56 18. BIS criticizes governments over bank policies, Collegio Carlo Alberto…61

1 19. Bis Toxic assets still a threat by CalculatedRisk…64 20. Recapitalising the through enhanced credit support: quasi-fiscal shenanigans in Frankfurt, , by Willem Buiter…65 21. Merkel’s tax cut pledge is Hollow, wrong, implausible, Spiegel online…67 22. Germany and France need to sing in tune, FT.com by Wolfgang Munchau…69 23. The Fed must reassure markets on inflation, FT.com by Martin Feldstein…71 24. The evolution of the external balance sheet in the last decade (wonky), Brad Setser follow the money by bsetser…73 25. The dirty war against clean coal, The New York Times by Gregg Easterbrook…79 26. Betraying the planet, The New York Times by Paul Krugman…81 27. Health care is not a bowl of cherries, The Conscience of a Liberal…82 28. Kenneth arrow and the birth of health economics, Bulletin of the World health organization by William D Savedoff…83 29. Los mercados se están equivocando, El País, by Alicia González…86 30. La corrección del déficit exterior supera lo previsto, El País, by Angel Laborda…89 31. Adivina qué crisis viene esta noche, El País by Juan Ignacio Crespo…91 32. China,s super-sovereign reserve currency idea: could the SDR a reserve currency?, RGE Monitor…94 33. Japan Back in Deflation? …96 34. Not enough audacity, The New York Times, by Paul Krugman…99 35. Exporters face credit crunch, Collegio Carlo Alberto…101 36. Inflation - the real threat to sustained recovery, by Alan Greenspan…103

2 37. Even with 465 million of freshly minted taxpayer funds, the spunky US startup faces a steep road to develop and market its electric cars, Businessweek by David Welch…106 38. US delinquencies/charge offs at record highs: lenders step in, RGE Monitor …109 39. For release at noon EDT, …111 40. Another half trillion, Collegio Carlo Alberto…114 41. Near record growth in the custodial holdings at the Fed ongoing angst about the dollar’s role as a reserve currency, Brad Setser follow the money by Bsetser…117 42. The rise and apparent fall of macroprudential regulation Vox by Avinash Persaud…120 43. Restoring financial stability: book review, Vox by Charles AE Goodhart…122 44. The macroprudential approach to regulation and supervision, Vox by Claudio Borio…125 45. More on the New and existing homes sales gap, Calculated Risk …129 46. Distressing gap: ratio of existing to new home sales by CalcultadRisk…130 47. New home sales:record low for may by Calculated Risk…132 48. American institute of architects:recovery has stalled by Calculatd risk…134 49. MBA: mortgage rates decrease slightly by Calculated Risk…135 50. Housing bust and mobility by Calculated Risk…136 51. The next fed chairman? And 1930 by Calculad Risk…136 52. Does demand in the US housing sector show prolonged sluggishness?, RGE Monitor…137 53. Federal reserve press release…139 54. Agencies announce notice of proposed rulemaking for community reinvestment act, Board of governors or the Federal Reserve System…140 55. RGE Monitor’s newsletter RGEMonitor, 24/06/2009 …141

3 56. Most want health reform but fear its side effects, The Washington Post by Ceci Connoly and Jon Cohen…144 57. Despite recession, high demand for skilled labor, The New York Times by Louis Uchitelle…146 58. Reform of regulation has to start by altering incentives, FT.com by Martin Wolf…149 59. Sec and CFTC share derivatives oversight responsibility: who does what? RGE Monitor…152 60. Yes Virginia there was an international financial crisis in 2007 and 2008 Brad Setser follw the money …154 61. The good and bad news in the ’s China Quartely, Brad Setser Follw the Money…157 62. Frictions in the US China relations…160 63. No podemos ver el trabajo de los chinos desde un punto de vista europeo. Allí ganarían 50 euros, El País, by Jesús García…162 64. Un centenar de empresarios chinos reivindica su buen nombre ante Interior, Qué…162 65. Trabajadores chinos niegan haber sido explotados por los detenidos en la macrorredada de los Mossos, LaVanguardia…165 66. Cerca de 30 detenidos por explotar a trabajadores chinos en Mataró en la mayor redada de los Mossos…166 67. La macroperación contra la mafia china en Mataró se salda con mas de 20 detenidos y 72 registros, Europapress.cat…167 68. Los empresarios piden más inspecciones, la expansión del comercio chino preocupa gravemente a los empresarios pacenses, Hoy.es, por J López Lago…169 69. Broad agreement reached on derivative oversight, The Washington Post, by Zachary A Goldfarb…171 70. Making work:a systemic risk regulator, The Washington Post…172 71. On regulating credit-default swaps, RGE Monitor…174 72. From Versailles a message of no austerity, Eurointelligence …176

4 73. 4 People and firm sued in Madoff case, The New York Times by Diana B Henriques…179 74. How to get the fed out of its Box, by Frederic S Mishkin…182 75. Health care showdown, The New York Times, by Paul Krugman…184 76. Small countries outside G20 defenseless in global economic crisis, ShanghaiDaily.com by Michale Spence…186 77. Bini-smaghi criticizes EU leaders’ failure to tackle supervisory reform, Eurointelligence…190 78. China will not save the world economy, FT.com…190 79. European-wide financial regulation:leaders give backing, RGE Monitor…191 80. A thin outline of regulatory reform, FT.com by Clive Crook…193 81. Berlin waves a deficit hair-shirt for us all, by Wolfgang Munchau…195 82. Towards a Fiscal Constitution, Economicprincipals.com…198 83. The Obama light touch will be a bit heavy handed, Times Online, by Irwin Stelzer…192 84. The risks of a double-dip, W-shaped recession may be growing, Taipei Times, by Nouriel Roubini…201 85. Better broth, still too many cooks, Economist.com…203 86. An interview with Paul Samuelson, Part One, The Atlantic Home, by Conor Clarke…208 87. An Interview with Paul Samuelson, Part Two…212 88. Re-Interpreting the blin der numbers in the light of new trade theory…216 89. International finance and macroeconomics, NBER Reporter by Jeffrey A Frankel…220 90. The supply side of housing markets, NBER Reporter:research summary 2009 number 2 by Joseph Gyourko…228 91. ¿Cambio de rumbo en la política fiscal?Tribuna: Economía global coyuntura nacional by Angel Laborda…233

5 92. ¿Un problema potencial? Tribuna economía global Rafael Domenech El País by Rafael Domenech…235 93. Hay que reequilibrar las relaciones EU China, El Pais by Kenneth Rogoff…237 94. Asalto al reinado del dólar, El País by Sandro Pozzi…238 95. España, cantera de talento, El País by Javier Santiso…241 96. El socialismo para ricos de Estados Unidos, El País, by Joseph Stiglitz…244 97. Produciendo parados … y precariedad, El País by Manuel V Gómez…246 98. Dos visiones frente a 10 preguntas, El País…249 99. Los sindicatos movilizan a 700 expertos contra la rebaja del despido, El País by Manuel V Gómez…257 100. Vender viviendas, cada vez más caro, El País by Luis Doncel…259 101. El AVE paga los platos rotos, El País…261 102. De cómo arruinar el mundo dos veces, El País by Javier Moreno…262 103. Out of the shadows, The New York Times by Paul Krugman…265 104. Salir de las sombras, El País by Paul Krugman…267 105. It is now up to the EP to decide the timetable of Barroso’s renomination, Collegio Carlo Alberto…269 106. Where housing will be in 2012, Housing special report, by Peter Cov…271 107. In Poll, Obama is seen as ineffective on the economy, The New York Times, by Jeff Zeleny and Dalia Sussman…274 108. A transatlantic divide: while America reforms its regulatory system, Europe waits, Collegio Carlo Alberto …276 109. Regulatory reform in the US systemic regulators and receivership back on the radar screen, RGE Monitor…279 110. Moral hazard and the crisis, TWSJ…281 111. The three steps to financial reform, FT.com by Geoge Soros…283

6 112. IEA warns about futher oil price hikes and inflation, Eurointelligence…285 113. Blueprint deepens federal role in markets, The Washington Post by Binyamin Appelbaum and David Cho…288 114. With blackrock’s reach set to expand, CEO defends money manager’s stability, The Washington Post by Tomoeh Murakami Tse…291 115. Stalking a weaker wall street, The New York Times by Graham Bowley…294 116. Obama sought to enlist a wide consensus on finance rules , The New York Times by Stephen Labaton…296 117. Stress tests in Europe: ECB expects additional US 283 billion and securities losses among Eurozone Banks, RGE Monitor…299 118. Spanish banks: Government announces EUR 99 Billion rescue fund, RGE Monitor…302 119. US housing starts rise sharply from record lows in April: more volatility ahead, RGE Monitor…304 120. Regulatory revamp targets securities at heart of crisis, The Washington Post, by Binyamin appelbaum…305 121. Recession and revolution, The New York Times, by Ross Douthat…307 122. ECB gloomy about banking sector, Eurointelligence…309 123. Moody’s recorta el rating de 25 banos españoles, Cinco Días…312 124. Credit issuers slashing card balances, The New Yorke Times, by David Streitfeld…314 125. Nobody is prepared for a double clip recession, Financial Times by Wolfgang Munchau…317 126. Stay the course, The New Yorke Times by Paul Krugman…319 127. Stimulus history lesson, The Conscience of a Liberal…321 128. No conundrum, again, Credit bubble bulletin by Doug Noland…324 129. Counter cyclical or counterproductive by Doug Noland…327

7 130. The core to periphery dynamic by Doug Noland…329 131. German finance minister scared about inflation, Eurointelligence…332 132. The healthty decoupling by Angel Ubide…334 133. Global imabalances and the accumulation of risk, Vox…336 134. The economic consequences of the grand coalition in Germany, Eurozone Watch, by Sebastian Dullien…340 135. Optimism is not enough for a global recovery, FT.com by Wolfgang Munchau…341 136. Insurance giant AIG takes ex-chief to court, The New York Times by Mari Williams Walsh …343 137. Mises as we knew him, Mises Daily by Friedrich A Hayek…345 138. For inmediate release, Federal Reserve…351 139. The monster returns, Euorintelligence…352 140. How to lose on a sure-fire bet, Econbrowser…354 141. The big hate, The New York Times, by Paul Krugman…355 142. Night the reread Minsky, The Conscience of a Liberal…357 143. US Recovery could outstrip Europe’s pace, The New York Times by Nelson D Schawartz…358 144. Executives unruffled by proposed compensation rules, The Washington Post, by Tomoeh Murakami Tse…360 145. Spending stimulus money takes money, The Washington Post by Alec Macgillis…362 146. Spike in interest rates could choke recovery, The Washington Post, by Neil Irwin…364 147. Federal reserve press release, For release at noon EDT…366 148. Goals shift for reform of financial regulation, The Washington Post by David Cho…367 149. Michigan works to remake itself without king auto, The New York Times, by Bill Vlasic and Nick Bunkley…370 150. 10 large banks allowed to exit US aid program, The New York Times by Eric Dash…373

8 151. Is eastern Europe on the brink of an Asia-Style crisis?, RGE Monitor…376 152. Em Equities:does the bear rally have bull legs?, RGE Monitor…379 153. Ni funcionarios ni precarious, El País, by Ariadna Trillas…382 154. Nobel winner krugman sees US recession ending son (update1) bloomberg.com by Courtney Schlisserman…386 155. Banks may need new stress tests, panel says, The Washington Post by Amit R Paley…388 156. Hang on in there Gordon we really need you until January, Eurointelligence …390 157. Why Germany’s export model will no longer work after the crisi, Eurointelligence by Wolfgang Munchau…392 158. For inmediate release, Federal Reserve press release…394 159. A tale of two depressions, Vox by Barry Eichengreen…395 160. EU split over lessons of crisis, Spiegel on Line by Hans-Jurgen Schlamp…404 161. Irwing Fisher’s debt deflation theory and its relevance today…408 162. Hire Irving Fisher, Vox by Enrique G Mendoza…408 163. Out of Keyne’s shadow, Economist.com by Irving Fisher…413 164. The hicks-hansen is lm model…418 165. Modelo IS-LM, de Wikipedia…428 166. Webappendix 10: The mundell-Fleming model by Michael Burda …432 167. Box A10.1 Exogenoues? Endogenous? What Determines What…436 168. Three whiz kid economists of the 90’s pragmatists all, The New York Times by Silvia Nasar…437 169. The sveriges riksbank prize in Economic sciences in Memory of Alfred Nobel 1972, Nobelprize.org…442

9

Obama Presents Bill to Create Consumer-Finance Watchdog New Agency's Broad Scope Draws Stiff Industry Resistance By David Cho and Michael D. Shear Washington Post Staff Writers Wednesday, July 1, 2009 The Obama administration sent a detailed proposal to Congress yesterday for creating an agency to oversee nearly all facets of consumer lending, but the breadth of its powers is setting the stage for a fierce clash on Capitol Hill. The bill aims to establish a Consumer Financial Protection Agency to guard Americans from the abusive lending practices that contributed to the financial crisis, such as undocumented mortgage applications, the poor disclosure of loan terms and deceptive ads. Administration officials proposed that the new regulator have a broad mandate to cover the spectrum of consumer financial products and to fill gaps in current regulations. The agency would have the power to probe any lender, impose penalties of up to $1 million a day in cases of wrongdoing, limit the compensation even of loan officers and mortgage brokers, and check if banks have been acting discriminatorily by forcing them to disclose the race, age and gender of their customers. An intense lobbying effort has already begun to win over the few undecided lawmakers who will be critical in deciding which details will be included in the final bill. Industry groups say they are forming a coalition to persuade members of Congress to scale back the bill. "I think when people read this, they will be shocked about the incredibly broad delegation of power," said Edward L. Yingling, chief executive of the American Bankers Association. "It basically can do almost anything it wants. . . . I think there will be opposition simply on the breadth of it, on the balance of power between Congress and an agency." Some critics warn that lawmakers may be afraid to oppose parts of the bill because of appearances. "If you argue against the agency, then you could be incorrectly painted as arguing against consumer protection," said Scott Talbot, senior vice president of government affairs at the Roundtable. Industry representatives say they are particularly concerned that the agency could intervene in the daily business practices of lenders -- for instance, how they design , or how much they pay employees. An official at one of Wall Street's largest banks said the new agency, for example, could compel lenders to offer loans to poor consumers who have shaky credit histories even if this could jeopardize the firms' health. In a briefing with reporters, Michael Barr, assistant secretary for financial institutions at the Treasury Department, said yesterday that the bill represents a return to deeper regulation of a sector that had shed much federal oversight in recent years. He added that

10 the new rules will "level the playing field" by standardizing regulations that apply to different loan products. "I don't think that it's a surprise that big banks . . . that benefited from the status quo want to keep it that way," he said. "It's a very hard argument for a big bank to make that the status quo on consumer protection was enough. . . . We have the view that the market, left to its own devices, isn't always going to result in an optimal result for consumers." Rep. Barney Frank (D-Mass.), chair of the House Financial Services Committee, said that he would take quick action and that he aims to approve the committee's version of the bill before Congress's summer recess begins on Aug. 3. "The federal regulatory system has clearly failed to provide adequate protection for consumers and that failure contributed to the broader economic crisis," he said. "That is why I have made the creation of the agency one of our highest priorities." But Frank would have to overcome resistance from the other side of the aisle. "The proposed CFPA appears to be premised on the idea that Washington is better at making financial decisions for all Americans than leaving that choice up to individual Americans," said Rep. Spencer Bachus (R-Ala.), the ranking member on the committee. "The best way to protect consumers is not through the creation of another bureaucracy accountable to no one but by consolidating the regulatory system and holding regulators accountable." Some consumer groups said the bill does not go far enough. John Taylor, chief executive of the National Community Reinvestment Coalition, which advocates for affordable housing, said he generally supported the measure, particularly disclosure requirements that force small-business lenders to reveal whether they have been holding back credit from minority- or women-owned businesses. But Taylor said he has lobbied the White House to give the agency the authority to approve or deny mergers of financial firms based on whether these would benefit consumers. Some matters have yet to be resolved. The administration did not specify how the agency will be funded, other than stating that some money will come from the financial services industry. In addition, the measure says the president can appoint four commissioners but does not detail what criteria he should use. The fifth and final commissioner would be the head of a new banking regulatory agency. http://www.washingtonpost.com/wp- dyn/content/article/2009/06/30/AR2009063004187.html?wpisrc=newsletter

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01.07.2009 Don’t celebrate too early – Germany’s Constitutional Court has given a stinging judgment on European integration

Germany’s Constitutional Court has spoken, and it is quite a bombshell. You would not have noticed if you had read non-German newspapers, or only listened to Commission president Barroso, who within minutes of the judgement declared victory for the Lisbon Treaty – obviously not having read the 147 page judgement, or probably not even the 10 page summary, as Der Spiegel pointed out, commenting on the “hasty statements of jubilation” from Brussels. The incoming Swedish presidency reaffirmed the ratification timetable, and it seemed that everybody was relieved that the Court did not make a decision that could have delayed Germany’s ratification beyond this year. The Constitutional Court found the Treaty to be in line with the German constitution, but not a German bylaw, which governs the rights of the two chambers of the German parliament. This will have to be redrafted in the summer. The Court has ruled the Bundestag and the Bundesrat need to have a full vote before the government agrees to extension of powers of the EU, for example a shift from unanimity to qualified majority voting. Furthermore, and this is probably the most sensational aspect of the ruling, the Court ruled explicitly on the question of the finality of European integration, by stating that ultimate sovereignty must rest with the member states. German newspapers and various constitutional experts quickly interpreted this statement as marking the finality of European integration. In addition, the Court did not only strengthen parliament but also itself, by insisting that it will continue to oversee cases that touch on democratic rights of German citizens. Frankfurter Allgemeine said in a comment that the Court had already granted itself the right in his judgement on the Maastricht Treaty, but the present judgement goes much further. It will not be limited to a few isolated cases, but there are already a number of issues where European law and German constitutional law seem to conflict. (We have not read the 147 pages either, only the summary, but we feel that this judgement deserves further and detailed analysis. We would also caution against thinking that the verdict has no implication for the Lisbon ratification process. Of course, Germany will ratify, but as one of Germany’s constitutional experts predicted yesterday,

12 the judgement will be studied very closely by those who have not yet ratified the Treaty, including the Czech president, who may be inspired to find additional procedural reasons for a delay.) Verhofstadt liberal leader in EP Guy Verhofstadt, former Belgian prime minister, was elected president of the liberal ALDE group in the European parliament, reports Le Soir. None of the two large parties have a majority in the EP, which gives the liberals a pivotal role. Verhofstadt has been canvassed as a possible alternative to José Manuel Barroso as European Commission president until Barroso's endorsement by all 27 member states at the recent EU summit. European Voice writes that he may still be in line for one of the other senior EU posts that will become available if and when the Lisbon treaty comes into force next year. In search for a council president FT Deutschland has an article on the possible future line-up of top posts in the EU, as Tony Blair seems to be a frontrunner for the Council presidency, possibly also Filipe Gonzales, the articles says. The article also had a long list of names for the office of EU foreign minister, with names like Bildt, Kouchner, Steinmeier and also Solana. What happens to national investment projects? Le Monde looks at what happens to large investment projects, such as TGV fast train connections throughout France, once they get off the drawing board. Six months after the announcement, the TGV projects are stuck. About ten local governments, mistrusting financial engagements from the state, used their position to attach conditions to their participation. Local governments are concerned about the abolition of the local business tax, their main income resource, and effective in 2010, and are ready to stand up against the state. [If this is an omen for the latest of Sarkozy’s national investment projects, it’s a bad one. Everybody is defending his own stake rather than uniting behind the big national effort, as Sarkozy and his entourage like to advertise it. ] Vittori on economists and diner parties Jean Marc Vittori in Les Echos writes that economists have a hard time on diner parties today, forced to defend themselves and their failure to predict and explain the crisis. Vittori argues that their failure is due to the fact that many economists abandoned economic reasoning and are instead hyperspecialised, supported by rising computation capacity for vast data bases. But the search for causes of this crisis will require that the economists take once again a big angle rather than focussing on aspects of it. Otherwise we will be stuck with studies proving that one asset was more toxic than another. Spanish house prices fall and fall… The latest official data on Spanish house prices show a 10% year-on-year fall in prices, which is still relatively moderate, compared to the sharper price declines in the US and the UK, El Pais notes, but the article quotes experts as saying that there is no reason to expect that the decline in Spain should be any more contained than in the US, where prices have fallen by more than 30%. El Pais says Madrid and Catalonia are among the regions with the steepest decline, but this should soon spill over into the rest of the country. … and so do US prices

13 The Case-Shiller house price index fell by 0.6% on a non-seasonally adjusted basis in April – and by 0.9% on a seasonally adjusted basis – which suggests that the second derivative of house prices is improving. This means prices are still falling, but at a slower speed. Calculated Risk has everything you need to know about this, including a reference to a statement by Prof. Shiller, who says that the situation may be slowing improving, and a good discussion about the tail-end of a housing bust, which consists of a long series of small price declines. The overall conclusion is that the decline in US house prices still has further to go. …but not UK prices The UK has seen three month of house price increases over the last four months, which has led some commentators to declare, probably prematurely, that the crisis is over. Edward Harrison has a discussion of UK house prices in RGE Europe Economonitor, where he quotes an analyst who says that this may be mostly an inventory situation, due to abnormally low supply levels, which won’t last forever, and which might presage another round of price decreases. A disturbing pattern Wolfgang Munchau, writing in FT Deutschland, finds a common pattern in Germany’s attitude to debt. The government is heading for a zero level of debt, on the assumption that the economy will not be growing much in the future. And on a micro level, prospective students do not want to take on debt either on the grounds that future expected earnings will be insufficient to repay the loan. The country’s debt aversion is based on a premise of no future. The debt aversion itself, however, contributes to that outlook significantly, as Germany’s, in terms of economic policy, is now embracing the ideal of Ceausescu’s Rumania. Yellen on inflation The Wall Street Journal has a good discussion of Janet Yellen’s recent comments on inflation. She said the Fed would find it relatively easy to unwind its positions, but then goes on that the real risk is a long period of stagnant growth. She says the weak economy is, if anything, putting downward pressure on wages and prices, and consumers will continue to retrench as they repair their household balance sheets.

07/01/2009 01:57 PM TOO EARLY FOR TRIUMPH IN BRUSSELS What Lisbon Ruling Really Means for the EU By Hans-Jürgen Schlamp in Brussels The political elite in Brussels are breathing a sigh of relief. The fact that Germany's highest court has set very strict conditions on the ratification of the Lisbon Treaty doesn't seem to be bothering anyone: The main thing is that the treaty doesn't have to be reworked again. It didn't take anytime at all for the windbags in Brussels to start furiously sending out celebratory messages after Germany's highest court in Karlsruhe ruled on Tuesday that the Lisbon Treaty to reform the European Union doesn't directly violate the country's

14 constitution. "I welcome the decision of the German Federal Constitutional Court," Jose Manuel Barroso, the president of the European Commission, the EU's executive branch, immediately announced, probably before he had had a chance to read through the 147- page ruling -- or even the 10-page press release. That's because Barroso is currently in Greece, near Athens, as a guest at a working conference of German members of the European Parliament for the conservative Christian Democrats. They're currently working on more important things -- namely a plan to secure Barroso's re-election as the Commission's president. And one can't really say that the Karlsruhe judges recognized the Lisbon Treaty because of its "strengthening of the democratic legitimacy of the European Union," as Barroso sought to spin it. German Checks and Balances for EU Laws In fact, the exact opposite is true. The guardians of the German constitution are concerned about the EU's "democratic deficit" -- shortcomings it also sees in the Lisbon Treaty. On page after page, the justices formulate strict legal limits, stating that any future "Community law or Union law" deemed to violate those principles can be "declared inapplicable in Germany." Somehow, though, the threatening verdict from Germany's highest court doesn't seem to be bothering anyone in Brussels. Hans-Gert Pöttering, president of the European Parliament, "warmly welcomes" it. The Greens "welcome it." Even members of parliament for the far-left Left Party "welcomed" a "part of the ruling," even though their political bosses in Berlin were parties in the case seeking a blanket rejection of Lisbon at the Constitutional Court. Klaus Hänsch, a longtime German Social Democrat in Brussels, described the development as a "good day for Germany." His colleague Alexander Lambsdorff, also a member of the European Parliament, warned his colleagues in Germany's Bundestag that the parliament must fulfil "its obligation" to make ratification of Lisbon possible by drafting domestic legislation demanded by the high court, so that the EU could be made "more democratic through the treaty." Further Hurdles Remain Swedish Foreign Minister Carl Bildt, whose country takes over the six-month rotating EU presidency on Wednesday, said that the time table for the coming half year would not be changed by the ruling. According to the current time plan, the Lisbon Treaty, which aims to make the union more transparent, is intended to go into force by the end of the year. Jan Fischer, the prime minister of the Czech Republic, which just completed its EU presidency, also welcomed Wednesday's ruling. "I see today's decision as an important step towards the ratification of the Lisbon Treaty and towards institutional stability of the European Union," he said in a statement. Still, it's difficult to pinpoint what is feeding all this Euro-euphoria. Many EU champions are just happy that the guardians of the German constitution didn't reject the Lisbon Treaty and that the worst-case scenario could be averted. Now, the complicated ratification process for this complicated treaty can continue. But that alone is already going to be plenty of work. The next step in the process is an expected second referendum in Ireland in October that will see the Irish voting on Lisbon

15 again after rejecting it last year. The euroskeptic presidents of Poland and the Czech Republic must also be cajoled into signing the treaty. Still, the treaty -- forged out of what was originally planned as a European constitution that failed in referenda in France and the Netherlands -- has cleared one more hurdle. Everything that the Constitutional Court has rejected, criticized and noted, will initially have more impact on German domestic democratic institutions than European. That's why the pro-Lisbon faction is celebrating. At the same time, its opponents don't want to be seen as the losing party -- that wouldn't come across well with their supporters. So everybody's happy -- at least judging by outward appearances. Even the Europe grumps in Bavaria with the Christian Social Union, the sister party to Chancellor Angela Merkel's conservative Christian Democratic Union, who sued to stop Lisbon, are pleased with the Karlsruhe decision. But their pleasure is more schadenfreude than true joy. Markus Ferber, the leader of the CSU's party group in the European Parliament in Brussels, is less pleased about the development -- he would have preferred to see Lisbon fail the German legal review. But he's still happy that the court is forcing the German parliament to change the domestic laws pertaining to the ratification of the treaty and require greater participation from Germany's legislative bodies in the European decision-making process. Now, he says, there will finally "be more parliamentary control before governments make decisions in Brussels." He says he has often told his colleagues in the German parliament that they give their chancellor and their ministers "too much freedom" in handing over competencies to Brussels and in passing new laws. In the future it won't be as easy as it often has been up until now for representatives of the 27 EU member states in Brussels to fiddle around and push through important decisions on a wide range of topics including personal or social security, cultural and legal questions or even military deployments involving German soldiers. Before such decisions can be made, Germany's two legislative bodies, the Bundestag and the upper house of parliament, the Bundesrat, will have to give their approval. That might make the EU's work a little bit more cumbersome, but it will also be more democratic. URL: http://www.spiegel.de/international/europe/0,1518,633691,00.html

http://www.spiegel.de/international/europe/0,1518,druck-633414,00.html 06/30/2009 11:58 AM YELLOW LIGHT FROM CONSTITUTIONAL COURT Germany Cannot Ratify Lisbon -- Yet Germany's highest court has ruled that the Lisbon Treaty is not fundamentally incompatible with the country's constitution. However, it has called a halt to the ratification process until the German parliament changes a domestic law to strengthen the role of the country's legislative bodies in implementing European Union laws. With the process of ratifying the Lisbon Treaty hitting one speed bump after another, many would have expected that at least Germany would have given the treaty safe

16 passage. However, an attempt by some German legislators to block its ratification has led to delays even in the European Union's biggest country.

AP The judges of Germany's Constitutional Court on Tuesday. On Tuesday, Germany's highest court rejected a petition by a group of around 50 lawmakers seeking to stop the treaty, with the judges arguing that the Lisbon Treaty is compatible with the country's constitution, the so-called Basic Law. Nevertheless, the Federal Constitutional Court laid one final hurdle before it can be ratified: A domestic law must be changed in parliament. According to the court, based in the western city of Karlsruhe, the law which regulates the German parliament's involvement in the implementation of European law, needs to be strengthened before the ratification process can continue. The ruling applies to both parliament, the Bundestag, and Germany's upper legislative chamber, the Bundesrat. "The Basic Law says 'yes' to Lisbon, but demands a strengthening of the parliament's responsibilities on a national level," Andreas Vosskuhle, the presiding judge, said on Tuesday. Ratification Could Come in September Germany is one of four countries that has still not ratified the Lisbon Treaty, which is supposed to streamline European Union institutions, increase their powers and responsibilities and make the bloc more democratic. Ireland rejected the treaty in a referendum last year and euro-skeptic presidents in the Czech Republic and Poland have refused to rubber-stamp the reform despite the fact that it has been approved by their respective parliaments. The European Union's star-crossed attempt to ease decision-making among the now 27 member states began back in 2005 when French and Dutch voters rejected a proposed EU constitution. It was then replaced with a new watered-down version, stripped of most of the trappings that might be perceived as an EU state. Even Germany, one of the powerhouses of the European Union hasn't made things easy. Although the German parliament voted in favor of the treaty last year, a number of members from across the political spectrum petitioned the Constitutional Court to reject the treaty. While most are from the far-left Left Party, Peter Gauweiler, a member of Bavaria's Christian Social Union -- the sister party to Chancellor Angela Merkel's Christian Democratic Party -- led the challenge. He argued that the Lisbon Treaty would enable the EU to circumvent national parliaments and thus undermine Germany sovereignty.

17 President Horst Köhler had refused to sign the treaty until after the Karlsruhe court had made its ruling. The parliament will now be under pressure to rapidly bring in new legislation so that the ratification process can continue. The Lisbon Treaty is supposed to be implemented by the beginning of 2010 at the latest. Vosskuhle said on Tuesday that he was sure that the "last hurdles" would soon be overcome. The German parliament is to gather for a special sitting on August 26 for a first reading of the new law, a spokesperson for the Social Democrats parliamentary party announced on Tuesday. The vote in the lower house would then take place on Sept. 8, just weeks before Germany's national election. Chancellor Merkel welcomed the court's decision, saying that it was "a good day for the Lisbon Treaty." She told journalists that the treaty had "passed another important hurdle" and that she was happy that Berlin's ruling grand coalition of her conservatives and the Social Democrats (SPD) had been able to agree on a rewording of the law on the rights of the parliament. German Foreign Minister Frank-Walter Steinmeier, who is the SPD's candidate for chancellor in the Sept. 27 election and was in Karlsruhe for the ruling, said that he was pleased that the court had found the treaty to be "completely compatible" with the constitution. He predicted that the Lisbon Treaty would come into force by early 2010 at the latest. If the German Constitutional Court had ruled against Lisbon, it would likely have killed the treaty. It would have given the Czech Republic and Poland a reason not to ratify it and it also could have derailed plans to hold a second referendum on the EU reform in Ireland in early October. European Commission President Jose Manuel Barroso welcomed the German ruling. "I am confident we can complete the process of ratification of the Treaty of Lisbon in all countries by the autumn," he said.

TUESDAY, JUNE 30, 2009 SF Fed President Yellen on the Economy by CalculatedRisk on 6/30/2009 09:05:00 PM San Francisco Fed President Janet Yellen has been rumored to be one of the front runners to replace Chairman Ben Bernanke (although most consider Larry Summers the front runner, assuming Bernanke isn't reappointed). Tonight Dr. Yellen spoke in San Francisco: A View of the Economic Crisis and the Federal Reserve’s Response. Here are some excerpts on her views going forward: I expect the recession will end sometime later this year. That would make it the longest and probably deepest downturn since the Great Depression. ... I don’t like taking the wind out of the sails of our economic expansion, but a few cautionary points should be considered. I expect the pace of the recovery will be frustratingly slow. It’s often the case that growth in the first year after a recession is very rapid. That’s what happened as we came out of a very deep downturn in the early 1980s. Although I sincerely wish we would repeat that performance, I don’t think we will. In past deep recessions, the Fed was able to step on the accelerator by cutting the federal funds rate sharply, causing the

18 economy to shoot ahead. This time, we already have our foot planted firmly on the floor. We can’t take the federal funds rate any lower than zero. I believe that the Fed’s novel programs are stimulating the flow of credit, but they simply aren’t as powerful levers as large rate cuts, so this time monetary policy alone can’t power a rapid recovery. History also teaches us that it often takes a long time to recover from downturns caused by financial crises. In particular, financial institutions and markets won’t heal overnight. Our major banks have made excellent progress in establishing the capital buffers needed to continue lending even through a downturn that is more serious than we anticipate. But they are still nursing their wounds and credit will remain tight for some time to come. I also think that a massive shift in consumer behavior is under way—one that will produce great benefits in the long run but slow our recovery in the short term. American households entered this recession stretched to the limit with mortgage and other debt. The personal saving rate fell from around 8 percent of disposable income two decades ago to almost zero. Households financed their lifestyles by drawing on increasing stock market and housing wealth, and taking on higher levels of debt. But falling house and stock prices have destroyed trillions of dollars in wealth, cutting off those ready sources of cash. What’s more, the stark realities of this recession have scared many households straight, convincing them that they need to save larger fractions of their incomes. In the long run, higher saving promises to channel resources from consumption to investment, making capital more readily available to retool industry and fix our infrastructure. But, in the here and now, such a rediscovery of thrift means fewer sales at the mall, and fewer jobs on assembly lines and store counters. A fourth factor that could slow recovery is the unprecedented global nature of the recession. Neither we nor our trading partners can count on a boost from strong foreign demand. Finally, developments in the labor market suggest it could take several years to return to full employment. During this recession, an unusually high proportion of layoffs have been permanent as opposed to temporary, meaning workers won’t get called back when conditions improve. Also, we’ve seen an unprecedented level of involuntary part-time work, such as state workers on furlough a few days per month. Those workers are likely to return to full-time status before new workers are hired. To summarize, I expect that we will turn the growth corner sometime later this year, but I am not optimistic that the economy will spring back to normal anytime soon. What’s more, I expect the unemployment rate to remain painfully high for several more years. That’s a dreary prediction, but there is also some risk that things could turn out worse. High on my worry list is the possibility of another shock to the still-fragile financial system. Commercial real estate is a particular danger zone. Property prices are falling and vacancy rates are rising in many parts of the country. Given the weak economy, prices could fall more rapidly and developers could face tough times rolling over their loans. Many banks are heavily exposed to commercial real estate loans. An increase in defaults could add to their financial stress, prompting them to tighten credit. The Fed and Treasury are providing loans to investors in securitized commercial mortgages,

19 which should be a big help. But a risk remains of a severe shakeout in this sector. emphasis added Yellen also discusses Fed policy, the Fed balance sheet, the fiscal deficit and inflation: "I think the predominant risk is that inflation will be too low, not too high, over the next several years."

20 Business July 1, 2009 Stocks and Bonds In 2nd Quarter, Stocks Gained, but for How Long? By JACK HEALY The good news is that Wall Street finished its best quarter in years on Tuesday — part of a dizzy spree that lifted the broad market 35 percent since early March. The not-so-good news? It would take almost three more rallies like that to push the Dow Jones industrial average back to 14,000 and return markets to where they were before the financial crisis. On Wall Street — where exuberance, irrational and otherwise, is usually an art form — there is a nagging fear that the market is again losing its footing.

Despite signs that this downturn is easing, many Americans are more downbeat about the economy now than they were when the stock rally began. Unemployment is rising. Home prices are falling. Many corporate earnings are still weak. “Less-worse isn’t the same as better,” said Barry Ritholtz, chief executive of FusionIQ, a research firm. “We want to see ‘good.’ In order to grow profits, in order for earnings to increase, in order for corporate America to start hiring and spending, we need to see greener shoots. So far that hasn’t really happened.” If consumers continue to guard their money and banks sustain more losses from foreclosures, credit card defaults and losses in commercial real estate, analysts say that

21 stock markets will face huge obstacles to growth that could keep investors in the doldrums for many more months. Yet by almost any measure, the second quarter was one for the record books. The Standard & Poor’s 500-stock index was up 15.2 percent in the second quarter. The Dow Jones industrials gained 11 percent in the quarter, while the Nasdaq composite index soared 20 percent. Many blue-chip stocks posted spectacular gains. Bank of America soared 94 percent. American Express gained 71 percent. Microsoft was up 29 percent. But some analysts sense the euphoria is tempered. Markets ended basically flat for the month of June, pulled in different directions by economic figures showing improvement and those revealing unexpected weakness. Trading on Tuesday underscored those wobbles. The Dow Jones average fell 82.38 points, or 0.97 percent, to 8,447. The broader S.& P. 500 slid 7.91 points, or 0.85 percent, to 919.32. Gains in some technology shares kept losses on the Nasdaq to 9.02 points, or 0.49 percent. It declined to 1,835.04. The Treasury’s 10-year note fell 14/32, to 96 20/32. The yield, which moves in the opposite direction from the price, rose 3.53 percent, from 3.48 percent Monday. Bullish forecasters say the S.& P. 500, which is up 1.8 percent for 2009, will continue to rise as the economy bottoms out, and close the year at 1,050 or 1,100. But bears say that taxpayer aid is still holding up the financial system, and they warn that investors who expect better returns may be in for a bitter disappointment.

“We feel like we’re entitled to go back up again,” said David Tice, a prominent Wall Street bear. “We went from the telecom bubble to the Internet bubble to the bubble to the real estate bubble. Now each of those has broken. We have never been more convinced that the worst is not yet over.”

22 Some analysts say that stocks may simply rise and fall fitfully in the months — or years — to come without making broader progress, as they did from the mid-1960s to the mid- ’70s. And they say that investors who once bought and held stocks or pieces of index funds and rode them higher will need to devise different investment strategies. “The market is going to be range-bound for this year and going into next year,” said Mary Ann Bartels, head of technical and market analysis at Bank of America/Merrill Lynch. “Is the market still investable? Our answer is yes.” Some investors say energy companies and basic-materials producers will lead the markets as commodity prices rise. Others like technology firms, emerging markets or any company that offers a dividend and is not steeped in debt. Unemployment is at 9.4 percent, and economists expect it will rise to 9.6 percent when the Labor Department releases its June employment figures on Thursday. Private wages and salaries are continuing to fall, and Americans are saving more money as they try to hedge against job losses. All of which, say some analysts, could mean slower growth in consumer spending, corporate earnings and stock prices in the months to come. “We’d all like our stocks to go up,” said Mr. Tice, the bear. “But now’s the time to defend ourselves.” Following are the results of Tuesday’s Treasury auction of four-week and 52-week bills: http://www.nytimes.com/2009/07/01/business/01markets.html?_r=1&th&emc=th

23

07/01/2009 01:09 PM 'A REAL FREE LUNCH' How German Banks Are Cashing In on the Financial Crisis By Beat Balzli, Armin Mahler and Wolfgang Reuter Central banks are making trillions in unusually cheap money available to banks in a bid to restore liquidity to the financial system. But institutions are not passing on the cash to their customers, choosing instead to invest it and make a fat profit. These days, bankers are used to bad press and being scolded by politicians. There's been no shortage of either in the past week. Getty Images

Frankfurt skyline: German banks are hoarding money at the expense of their customers. "Banks Hoard Money," was the headline on the cover of the Financial Times Deutschland, while the tabloid Bild sharply condemned the "Outrageous Overdraft Interest Rates." Consumer Protection Minister Ilse Aigner railed: "It is unacceptable that the financial industry takes months to pass on reductions in the key interest rate, when it only takes a few days to pass on key interest rate increases." The new attacks on banks have been prompted by the fact that base rates are at a historic low and that central banks are injecting money into the market like never before. In the last week alone, the European (ECB) allocated the record sum of €442 billion ($619 billion) to 1,100 financial institutions -- at a paltry 1 percent interest rate. And yet the money is not going where the central banks want it to go, namely into the pockets of businesses and consumers -- at least not at reasonable interest rates. Instead, many companies are struggling to survive because their loans and credit lines are not being extended. Meanwhile, citizens are outraged that they are still expected to pay double-digit interest rates on their overdrafts. It seems clear that the banks would rather invest the cheap money they can borrow from central banks in safe investments, such as German government bonds offering 2.5 percent interest, than lend it to companies whose prospects, in the middle of a recession, are anything but rosy. And they are also lining their pockets with the fees they charge customers who are forced to go overdrawn as a result of the crisis. Are the banks taking advantage of the crisis to turn a profit -- at the expense of the very citizens to whom they owe their survival? Previously Unimaginable Sums It is now almost two years since the financial crisis began in Germany with the government's dramatic bailout of IKB Deutsche Industriebank. IKB was one of the many banks around the world who had speculated unwisely, investing billions and even

24 trillions in new, supposedly safe securities that were essentially nothing but repackaged and securitized loans to so-called subprime borrowers. When the bubble burst, the financial world teetered on the brink of collapse. If the government had not come to their rescue with previously unimaginable sums, many banks would no longer exist today. The German government has already spent a total of €760 billion ($1.06 trillion), in the form of loan guarantees and bailouts, and it even took a 25 percent stake in Germany's second-largest bank, Commerzbank. To limit the consequences for the real economy, the government also spent billions on economic stimulus programs. The bill for taxpayers is equally enormous. In the coming year, the federal government will have to borrow €86 billion ($120 billion) -- as opposed to the €6 billion ($8.4 billion) figure that was planned before the crisis. Politicians, as well as central bankers, business owners and, most of all, citizens, expect something in return: a functioning financial system -- and low-interest loans. This is especially true now that the banks seem to have survived the worst of the crisis. In the United States, many banks have started to repay the money they received from the government under the Troubled Asset Relief Program (TARP). After last year's record losses, many institutions have reported respectable profits for the first few months of 2009, and the banks' share prices, which had fallen to all-time lows in January, have since doubled. Nevertheless, the economic crisis threatens to get even worse, because the credit system is still not working the way many politicians specializing in financial issues believe it needs to, if greater damage is to be prevented. DER SPIEGEL Graphic: Comparison of selected interest rates Ilse Aigner has asked officials in her ministry to carefully examine and document the behavior of financial institutions. She plans to release the results of the study to the public. In her view, banks that do not pass on interest rate reductions to their borrowers are operating in legally shaky territory. Her position is based on an April ruling by the German Federal Court of Justice, according to which banks cannot set variable interest rates and fees at their own discretion. Even Axel Weber, the chairman of Germany's central bank, the Bundesbank, is relying on public pressure. He knows that banks have steadily tightened their requirements for the creditworthiness of borrowers in recent weeks and months. And he also knows that much of the money the banks have borrowed from the ECB is not reaching businesses and bank customers. In a startling move, Weber called upon the banks to pass on interest rate reductions. Otherwise, he said, "central banks will be forced to circumvent the banks and take direct measures to support the economy." That's something they will in fact probably have to do, should politicians fail in their attempts to stabilize the financial sector. Despite the current profits and rising share prices, the banking crisis is far from over.

25 Toxic Assets and Hidden Losses Banks still have unimaginable amounts of toxic securities on their balance sheets. The International Monetary Fund (IMF) estimates that potential global write-downs resulting from the financial crisis could be over $4 trillion (€2.85 trillion). Crisis-related write- downs to date amount to only about $1.5 trillion (€1.1 trillion). Although new, more generous write-down rules have eased the problem, they have not solved it. And the real solution, the establishment of functioning bad banks, is something the German government has been struggling with for months. So-called "bad" banks are companies into which banks can deposit their toxic securities. This removal of troubled assets from balance sheets frees up equity capital otherwise needed as a buffer against risk. It also prevents banks from being further downgraded by the rating agencies, which would mean that they would have to establish even larger buffers. In return for relieving the banks of their toxic assets, Germany's center-left Social Democrats, and some members of the center-right Christian Democrats, have pushed through strict rules that would hamper the banks for years should they participate in the bad bank program. Under one of these rules, the banks are required to immediately pay the federal government 10 percent of the book value of the transferred securities. Exceptions are only permitted if such a payment would reduce a bank's capital base to such an extent as to sharply curtail its ability to compete. All other potential losses are estimated and must be paid in installments over a 20-year period. A bank is only permitted to pay a dividend if its profits exceed the payment it owes the federal government. But a bank that is restricted in this way would be unable to raise money on the capital markets -- and therefore would have no capital to invest. In the worst case scenario, the bank would exist in a comatose state for decades. More generous rules were not feasible, for political reasons. Bank bailouts are unpopular -- especially at the moment, when parties are campaigning in the run-up to Germany's Sept. 27 national election. It is difficult to convince voters that such aid averts far more serious consequences, especially when banks are reporting profits and their share prices are rising sharply. The current debate over an amendment of the law governing Germany's ailing state- owned regional banks, the Landesbanken, is even more strongly marked by partisan interests. Ironically, it was precisely these publicly owned banks that enthusiastically snapped up the exotic high-yield securities that have since proven to be toxic during the boom years. Should they be written down, some of the state-owned banks would be forced into bankruptcy. And should a Landesbank go bust, the state that owns it could also go bankrupt, a scenario which currently looms over the northern state of Schleswig- Holstein, for example. Hence the state-owned banks are in particularly urgent need of a way to dispose of their toxic assets. Finance Minister Peer Steinbrück is aware of this, and he is demanding something in return. He wants the governors of the states in question to finally move forward on a long-overdue consolidation of the Landesbanken. But the governors, who perceive the pressure from Berlin as unreasonable intervention, want to be allowed by law to establish their own bad banks -- while at the same time wanting the federal government to take on much of the risk associated with those institutions.

26 It is unclear how the dispute will end. If the legislation is not passed, the German parliament, the Bundestag, will be forced to convene during the summer recess to save one or perhaps several of the state-owned banks from bankruptcy. The Capital Trap Two years since the start of the financial crisis, many banks are still on the brink of disaster -- with devastating consequences for the real economy. Hans-Werner Sinn, the president of the influential Munich-based Ifo Institute for Economic Research, sees the "under-capitalization of the banking system and the high levels of hidden losses that have not yet been disclosed" as the main obstacle to Germany's further economic development. DER SPIEGEL Graphic: A flood of cheap money No matter how much additional liquidity ECB President Jean-Claude Trichet and his staff pump into the market, banks' capital ratios remain a limiting factor when it comes to issuing credit. The core capital ratios of German banks have declined in the wake of the crisis, but many are reluctant to bolster their capital base with the help of the government's special Stabilization Fund, known as Soffin. The program has significant strings attached, including restrictions on bankers' salaries. Other countries, like the United States, have taken a more rigorous approach, forcing their banks to accept an injection of government capital. A bank is only permitted to lend money or sell debt securities if a certain portion of the underlying funds is backed by bank capital. The riskier a loan or customer, the more capital the bank is required to keep in reserve as collateral. The credit ratings of US subprime mortgages or corporate borrowers are now declining faster and faster. The repackaged and resold mortgages on houses in low-income neighborhoods in the United States often lose their entire value at one go. A similarly disastrous development is beginning to emerge among companies. According to Creditreform, a German company that collects creditworthiness data, 16,650 companies with a total of 250,000 employees have had to file for bankruptcy since the crisis began. Experts predict German banks will be hit by up to €170 billion ($238 billion) in recession-related loan defaults by the end of next year. The effect on bank balance sheets is devastating. Their relatively thin equity capital reserves are either evaporating or suddenly being tied up as mandatory reserves -- thanks to Basel II, an international set of regulations which banks agreed to in 2005 and which came into force at the beginning of 2007. Basel II was created to make it more difficult for banks to issue loans recklessly, in a bid to prevent crises. Now it is only making the current crisis worse. A Gift to Gamblers Under Basel II, banks are permitted to set aside fewer reserves for loans to customers with strong creditworthiness than to those with lower credit ratings. In a crisis, however, the solvency of almost all customers declines. As a result, banks in a downturn must

27 constantly increase their equity reserves to be able to satisfy the requirements for existing loans. In many cases, they can only do so by not extending expiring loans. The formula used to compute the required equity reserve for a security with a face value of €1 million ($1.4 million), with US mortgages as collateral, demonstrates how brutal the mechanism is. If the US rating agency Moody's issues its highest rating, Aaa, the bank only needs to keep €5,600 ($7,840) of its capital in reserve for the security. But if Moody's lowers its rating by 10 levels to Ba1, the required reserve increases to €200,000 ($280,000). And if the rating drops even lower, to B1, the bank must keep the full value of the security, €1 million ($1.4 million), in reserve. A different computation factor applies to corporate loans, but the logic remains the same. Politicians have been up in arms over these balance-sheet restrictions for weeks. Two Sundays ago, the SPD's state floor leaders from Hesse, Bavaria and Baden-Württemberg called for a temporary suspension of Basel II for banks. According to the three politicians, Thorsten Schäfer-Gümbel, Franz Maget and Claus Schmiedel, the rules only exacerbate the difficulties companies face in securing loans at favorable terms. Senior government officials in Berlin are all too familiar with the sensitive nature of the issue. But they also know that it is impossible for a country to go its own way when it comes to Basel II. The German Finance Ministry is currently examining options to "provide banks with short-term relief regarding the capital requirements during this severe economic crisis," according to a letter Karlheinz Weimar, the finance minister of the state of Hesse, received two weeks ago. But the federal Finance Ministry officials also pointed out that any such efforts would have to reflect the fact that the capital requirements that apply in Germany are based, for the most part, on international and European rules "that are difficult to change in the short term." Weimar wrote to German Finance Minister Peer Steinbrück in late May, pointing out a specific German accounting problem. In Germany, unlike most other EU countries, so- called revaluation reserves are included as part of equity capital. This doesn't present a problem as long as the stock markets are booming and security portfolios are showing high returns. Reserves increase, the capital base virtually grows by itself and bankers are perfectly happy. But in the current situation, German banks must either record the reduction in the value of assets on their profit and loss statements or see their revaluation reserves rapidly shrink -- together with their capital base. This clearly benefits competing banks in France and Great Britain. The government-supported Commerzbank, for example, showed more than €22 billion ($31 billion) in equity capital on its Dec. 31, 2008 financial statement. But because of the bank's negative revaluation reserve of €2.2 billion ($3.1 billion), CEO Martin Blessing was forced to book only €19.9 billion ($27.9 billion). The difference at rival Deutsche Bank, on the same date, was €882 million ($1.23 billion), while at Postbank, which Deutsche Bank acquired, it was €724 million ($1 billion). If Weimar has his way, this mechanism will be eliminated, a move Steinbrück supports. He has told Weimar that the federal government is "fundamentally open" to adjustments, and that the appropriate authorities would "intensively expedite" the necessary efforts. A Finance Ministry spokeswoman confirmed, however, that the banking industry will be consulted before any final decisions are reached.

28 Relief is urgently needed, or else equity capital will continue to shrink and banks will have to restrict lending even further -- with the consequence that even more companies will go out of business and even more business loans will have to be written off, causing capital bases to shrink even further. In other words, the crisis will become self- perpetuating. For many business customers, this means that they don't stand a chance of getting any money from banks, regardless of the interest rate or how much liquidity the central bank makes available. This makes it all the more tempting for banks to invest the money to turn a profit. "This is a real free lunch," comments one Frankfurt banker who did not want to be named. It is also a gift to gamblers and speculators within the banks, who are apparently prepared to put up with a bit of public outrage for the sake of such a profitable opportunity. Besides, the banks are largely immune to criticism of their behavior. For instance, consumer advocates have been outraged for decades over the banks' practice of inadequately passing on base rate changes to customers. They have sharply criticized this behavior again and again -- unsuccessfully, as is still evident today. Since last October, the average interest rate for overdraft loans to private households has declined by about one percentage point, from 12.1 to 11.0 percent, according to the German Bundesbank. Rates on consumer loans have dropped by 0.5 points to 5.3 percent, while rates on mortgages with a maturity of up to five years have declined by 1.4 percentage points to 4 percent, meaning that rate is almost at a historic low for Germany. But the ECB's key interest rate has been reduced much further, falling by 3.25 percent in the last 12 months. In other words, this crisis is not that bad for banks after all. Provided, that is, they have enough capital to survive. Translated from the German by Christopher Sultan

URL: http://www.spiegel.de/international/business/0,1518,633690,00.html

29 Global Business

July 1, 2009 Bank Woes Deepening in Europe By LANDON THOMAS Jr. When the financial crisis struck the global economy last autumn, European governments moved swiftly to keep their biggest banks from falling into an abyss — never mind fears over nationalization. But now, as big banks on this side of the Atlantic show signs of recovery, a number of their counterparts overseas are sinking into a spiral of deepening losses that has prompted the European Union to consider a more aggressive approach to cleaning up its banking system. Few people outside Belgium have ever heard of KBC Bank. But the travails of this lender, based in Brussels, highlight the broader challenges Europe is facing by not having more fully confronted the deteriorating health of its financial institutions. Since October, KBC Bank has had to seek government relief three times. In all, it has received $41.5 billion in financing and guarantees to recover from disastrous mortgage bets that its financial engineers and traders made when times were good. For a bank with a balance sheet of just $425 billion, it is an astounding sum, exceeding the bailout of the Royal Bank of Scotland. KBC is not alone. Souring loans and festering portfolios of securitized mortgages still plague a number of national banks. Moody’s, the rating agency that recently issued a warning about the credit risk at 30 Spanish banks, is expected to lower its outlook for the Greek banking sector because of a sharp rise in nonperforming loans. In Ireland, the nationalized Anglo-Irish Bank still has a contaminated loan book that has emerged as threat to the country’s sovereign credit rating. Nonperforming loans at Russian banks are even more worrisome, composing about 10 percent of the average bank’s books, a figure expected to balloon to 25 percent by the end of the year, forcing banks to raise as much as $80 billion in new capital. And in Sweden, the imploding Latvian economy has hobbled Swedbank, a huge provider of loans in the Baltics. Scott Bugie, a European bank analyst at Standard & Poor’s, said it would be “a multiyear process” for these and other European banks to improve their capital positions and return to sound financial footing. He predicted that bad loan write-offs at Europe’s 50 largest banks would double next year. The growing losses have raised calls for several new approaches, including a more aggressive approach by the European Union to diagnose banks’ creditworthiness. Now, regulators are debating whether to impose a regionwide stress test for banks, like the ones the United States required of its 19 largest banks. But the European proposals have raised questions bordering on incredulity with some critics.

30 “This has the feel of a Magritte painting,” said Karel Lannoo, chief executive of the Center for European Policy Studies in Brussels, comparing the European Commission’s approach with the surrealism of the Belgian painter. “This is Belgium’s third-largest bank,” he said of KBC, “and it has had three successive rounds of aid, and they still can’t target the problem.” KBC does not fit the profile of the classic overreaching bank. Its core business is serving Belgian corporations and individual investors. But as the credit boom approached its zenith, a small team of designers of exotic securitized investments pushed the envelope much further. Whether it was manufacturing high-yielding collateralized debt obligations, leveraged lending to hedge funds or buying up life insurance policies and securitizing them, these bankers, based in London and New York, cultivated an anything-goes aura that was at odds with the bosses in Brussels. So eager were KBC salesmen to sell high-reward products like collateralized debt obligations that they effectively promised risk-free returns, which lured a number of nonexpert investors. A group of European companies that said it was told that the investments were marketed as risk-free is suing the bank. Luc Philips, the chief financial and risk officer of KBC, said, “the decisions made by KBC FP were preapproved and vetted by the market and credit risk committees at the KBC Group headquarters in Brussels.” As for the lawsuits, Viviane Huybrecht, a spokeswoman, said the bank was examining them on a case-by-case basis. The financial products team leaders, Darren Carter and Thomas Korossy, came to KBC in 1999 when the bank bought the equity derivatives business from D. E. Shaw, an American hedge fund. The atmosphere was loose and geared toward risk-taking. Employees would come to meetings dressed in shorts and flip-flops, and if a business proposal did not meet the internal standard of a 22 percent return, it was discarded, former executives say. Angry investors claim the unit was unsupervised. They point to the bank’s unusual practice of combining the roles of chief financial and chief risk officer, a policy that is in stark contrast to the most basic of corporate governance standards. In an interview, Mr. Carter said the bank’s collateralized debt obligations were of the highest quality, and were insured by the bond insurer MBIA. When the mortgage market collapsed in late 2007, KBC, which had one of the highest ratios of collateralized debt obligations to bank capital of any institution in Europe, soon found itself close to insolvency. In October 2008 and again this January, KBC received 7 billion euros in public funds. When MBIA said in February that it could not pay off on its riskier positions, KBC was suddenly responsible for another 14.5 billion euros in collateralized debt obligations. In May, André Bergen, the chief executive, turned to the government again, this time for a bailout of 22.5 billion euros. The week before the latest infusion was announced, Mr. Bergen, 60, was rushed to the hospital for open-heart surgery. Late Tuesday, the bank said it was splitting the role of chief financial officer and chief risk officer, and that Mr. Bergen would step down permanently to recover, to be replaced by the interim chief Jan Vanhevel. Another crucial

31 player, Guido Segers, resigned as the head of merchant banking, and traders and bankers have left as part of the inevitable downsizing. Still, the executives behind the collateralized debt obligation strategy remain in charge. Ms. Huybrecht said the bank was trying to put the past behind it. But in two and a half years, if its investment is converted into KBC stock, the Belgian government could end up owning as much as 25 percent of the bank. http://www.nytimes.com/2009/07/01/business/global/01eurobanks.html?ref=business

32 Business July 1, 2009 Retired From G.M. at 54. Pensionless at 74? By MARY WILLIAMS WALSH General Motors is using its huge pension fund in a way it never intended. It had planned — and put money aside — for a steady march of retirees over time. But instead, tens of thousands of blue-collar workers, most in their 40s and 50s, are all becoming eligible for retirement benefits now, as the company rapidly downsizes. And even as its pension fund faces this giant bulge in payouts, G.M. is not putting any new money in — the company is not required to make any contributions to the fund until 2013. The longer this goes on, the weaker the fund will be and the more uncertain its long-term viability.

Allison V. Smith for The New York Times Dwayne and Brenda Humphries at home in Mansfield, Tex. After 30 years’ service, he receives $3,150 a month, including G.M. retirement pay and a G.M. payment in lieu of Social Security. For now, the pension payments to its younger “retirees,” part of a deal G.M. negotiated with the United Automobile Workers union in 2007, allow the company to drastically shrink its work force without having to come up with the cash to pay severance. The payments also relieve some of the burden on social service programs in the countless factory towns and counties around the country with large numbers of G.M.’s newly jobless.

33 “G.M. basically raided the pension plan, by having a lot of these severance benefits paid through it,” said Douglas J. Elliott, a fellow with the Brookings Institution who specializes in financial institutions and policy. What G.M. has done is perfectly legal. Nor is this the first time an employer has used a pension fund to pay for pruning its ranks. Well-subsidized early retirements are a time- honored practice in the public sector, where teachers often retire after 30 years and police officers can sometimes claim rich pensions after working as few as 20 years. Many corporations once offered sweetened pensions to people in their 50s and early 60s as well, but they have generally stopped the practice because it locked them into making payments indefinitely. G.M. never stopped. To the contrary. The question now is whether the plan will run short of money and what effect that might have on the company, its workers and retirees, and the federal government, which insures pensions and is now G.M.’s majority owner. In the short term, G.M.’s newly minted retirees, those in their 40s and 50s, have the most to lose if the plan is rapidly depleted and fails. But over time, the risk will shift to the government and the dwindling number of active U.A.W. workers still building cars at G.M. For those workers, a secure pension is already becoming an increasingly distant dream. “They could find that they don’t get their full pensions when they retire, because the plan has had to be terminated because of the payments to current retirees,” Mr. Elliott said. “There are definitely these intergenerational transfer issues with underfunded pensions.” G.M. declined to discuss the situation, although it has said it intends to keep the plan going when it emerges from bankruptcy. For decades, G.M.’s blue-collar workers have earned pensions with two components. The first is the “basic benefit,” currently about $1,590 a month, or $19,000 a year, for an auto worker with 30 years’ service. The U.A.W. won this “30-and-out pension” after a strike at G.M. in 1970, and still considers it something close to an inalienable right. In a 30- and-out plan, someone can go to work at 18, work nonstop for 30 years and retire at 48. The second part is a supplement, worth what each worker’s Social Security benefit will be on the earliest date he or she can start drawing the benefits, currently age 62. (Even then, the workers are joining Social Security three years early, so they qualify for just 80 percent of the full benefits they would get at 65.) Even in the days when G.M. was healthy, years ago, most of its 30-and-out retirees were too young to qualify for Social Security. The supplements were supposed to make up the difference until the retiree became eligible for Social Security. The total dollar amounts are not eye-popping. Unlike many pension plans in the public sector, G.M.’s U.A.W. plan cannot be “spiked” by working insane amounts of overtime just before retirement. Nor is it indexed for inflation. “What we’re getting isn’t enough to live on,” said Dwayne Humphries, a 54-year-old G.M. retiree in Arlington, Tex., who completed his 30 years last year, retired, and is now getting the standard $3,150 a month, or $37,500 a year. Roughly half of the total, $19,000 a year, is the basic benefit. The rest duplicates Social Security. “It’s tight,” said Mr. Humphries, who was earning $50,000 to $60,000 a year before his retirement. “It takes a different way of living than what you were used to.”

34 To make ends meet, he helps out with his son’s small business, cleaning swimming pools. When a G.M. retiree turns 62, he joins Social Security, and the pension fund stops paying him the supplement. So eight years from now, Mr. Humphries will still be getting $37,500 a year, but only about $19,000 will come from the G.M. pension fund. The rest will come from Social Security. That will greatly lighten the load on the pension fund. But thousands of G.M. workers have taken early retirement in the last few years, and each of those workers’ total benefits come from the fund. So while the benefits may seem inadequate to individual workers like Mr. Humphries, they add up to hundreds of millions of dollars being pulled out of the fund every year. When a reorganization began to loom at G.M., in 2007, the company faced the choice of offering people cash buyouts or sweetening their pensions, letting them collect their 30- and-out benefits even if they had not yet worked the requisite 30 years. Mr. Elliott called the decision “a no-brainer,” thanks to the federal rules for funding pensions. “When you have an increase in benefits in a pension plan, you’re given quite a number of years to fund the increase,” he said. “So by doing it through the pension plan, they could defer paying any cash for this for years.” How long the fund can sustain this is a mystery. G.M.’s financial reports combine the U.A.W. pension plan with the company’s other big plan, for salaried employees. (It was frozen in 2006 and cannot undergo a sudden increase in benefits.) The U.A.W. plan’s own annual reports, on file with the Labor Department, provide no fresh financial information because they stop at 2006. At that point, the fund had roughly $67 billion in assets — more than enough to cover the $59 billion in benefits it had promised to pay. The plan was then paying out a little more than $5 billion a year to retirees. Now the assets are almost sure to be smaller, thanks to the market losses of 2008 and the growing payouts. “My guess is, they can probably go for 20 years before they run out of cash,” Mr. Elliott said. That may sound like a long time, but with so many retirees and spouses still in their 50s, the plan needs resources for at least 50 years. “If you’re supposed to be paying people for 50 years, it’s actually not that comforting that they have enough cash to pay people for 20,” Mr. Elliott said. The Pension Benefit Guaranty Corporation declined to comment, but officials there have long worried privately that the collapse of one big automaker pension plan would be the end of the whole federal system of insuring pensions. Normally, federal law would require G.M. to put fresh money into the pension fund. But G.M. has not had to make any contributions since 2003, when it issued bonds and put the proceeds — $15.2 billion — into the fund. That was more than the required amount, and the pension law allows companies that make bigger-than-required contributions to use the excess to offset the contributions they will owe in subsequent years. That, and earlier contributions, are allowing G.M. to halt contributions until 2013. By then, the plan may have a significant shortfall. The law gives G.M. seven years to catch up, which could be difficult if the company is not performing well.

35 Ron Gebhardtsbauer, head of the actuarial science program at Pennsylvania State University, said G.M. and its government stewards could reduce the risk by raising the retirement age in the future. “They’re a bankrupt company and they shouldn’t be giving overly generous benefits,” he said. “It’s sort of like the banks giving out bonuses when they’re not profitable.” http://www.nytimes.com/2009/07/01/business/01pension.html?pagewanted=print

36

How Much Money Inflation? Mises Daily by Howard S. Katz | Posted on 7/1/2009 12:00:00 AM The Federal Reserve is lying about the nation's money supply (M1). The current figure for money supply is being given as $1.6 trillion. The actual number is $2.34 trillion. The reported number is equivalent to an increase of 16% over the past year. The actual number is equivalent to an increase of 70% over the past year. This compares with the nation's high money-supply increase of 16.9% in 1986. Astute observers of the Federal Reserve have noticed that, since the large infusion of money of last autumn, the monetary base has exceeded the money supply: Figure 1

reported monetary base ($1.8 trillion) Figure 2

reported money supply ($1.6 trillion)

37 These figures are from Federal Reserve releases H-6 and H-3. However, the monetary base is a part of the money supply. How can the part exceed the whole? (Money is created in 2 basic steps. First, the Federal Reserve prints up paper money. This is called special money and is usable by private banks as reserves. It is treated in the system in the way gold used to be. This money is measured by Federal Reserve credit, or Reserve Bank credit. With a few adjustments, this becomes the monetary base, which can be thought of as the special money that is available to the banking system for the second step. In the second step, the private banks create money in the form of demand, and other checkable, deposits. They do this in the process of making loans. Essentially, the nation's money supply is cash — the special money — plus bank deposits.) In pursuit of the answer to how the monetary base got to be bigger than the money supply itself, I called the St. Louis Federal Reserve, and they were good enough to send me the following reply: Half of all transaction deposits do not appear in M1 [the money supply] due to retail deposit sweeping. Adding these back into M1 causes M1 to be larger than the monetary base. (In retail deposit sweeping, banks reclassify checkable deposits as savings deposits so as to reduce statutory reserve requirements. Within certain legal bounds, such behavior is acceptable to the Fed. Bank customers are unaware that such reclassification is occurring.) Plus the FOMC has increased the Fed balance sheet to levels never before seen. Banks are holding deposits at the Fed and not making a great deal of new loans (they are making some, but it is a recession after all). If the banks made new loans, that would generate more deposits to be included in M1. Transactions deposits are simply demand deposits plus other checkable deposits. That is, they are total bank deposits and, as such, are an important part of the money supply. Immediately prior to the crisis of last autumn and the massive creation of over one trillion dollars out of nothing by the Federal Reserve, total bank deposits were about 40% of the money supply, with the monetary base as the other 60%. According to the St. Louis memo, half of these deposits are "swept," that is, they are reclassified as time deposits. (The memo did not say, but probably it is done overnight or over the weekend.) This process of reclassifying bank demand deposits as time deposits is the fraudulent part of the new procedure. Despite the fact that both are called deposits, time deposits are fundamentally different from demand deposits as follows: • A is money given to a (banking) institution that does not earn interest and can be withdrawn by the person who gives it (the depositor) whenever he wants (on demand). • A is money given to a (banking) institution that earns interest but cannot be withdrawn except after giving notice for a defined period of time (usually 90 days). A time deposit at a bank should be thought of as similar to a . You can't get your money out for a certain period of time, but while it is there, it earns you interest. Because of these differences, economists, for many centuries, have classified demand deposits as money but have said that time deposits are not money. A simple example will

38 illustrate the point. Money is that economic good which can be used to buy things. Suppose you go to the store and see an item that you want. If you pull out your checkbook, which is a demand deposit, it will be accepted as money. But if you pull out your passbook to the , then you will politely be told to take the passbook to the bank and get money for it. The passbook is not money (because of the time restriction on it), and you cannot buy things with it. Notice that the St. Louis memo tiptoes around the question of telling a depositor that he has a demand deposit while telling the rest of the country that he has a time deposit. It states, "Within certain legal bounds, such behavior is acceptable to the Fed." Well, since the Fed is trying to lie to the American people, I imagine that it certainly would be acceptable. The question is not whether the banks' behavior is acceptable to the Fed; the question is whether the Fed's behavior is acceptable to the nation. At least the memo is candid when it concludes, "Bank customers are unaware that such reclassification is occurring." According to the June 1, 2009, Federal Reserve release H-6 (table 3), demand deposits plus other checkable deposits are equal to $740 billion. But, according to the memo, this reported figure is only half of the real deposits. Thus the true number for bank deposits is $1,480 billion. Adding back the missing $740 billion gives us a money supply of $2.34 trillion (1.6 + .74). Calculating from the end of May 2008 to the end of May 2009, the US money supply has grown from $1.37 trillion to $2.34 trillion. This is an increase of 70%. To put this figure into context, the previous high one-year growth in US money supply was 16.9% in 1986. The money supply figures for the late '70s, which gave us a 13.3% rise in the consumer price index, were in the range of 8%–9% per year. Barack Obama has projected a budget deficit for the coming year of $1.8 trillion. (To be honest, it seems strange to me to be using the T-word.) There is something that is not understood about budget deficits. We are always told that this is bad because it is borrowing from the future and that our children will be responsible for our debts. This, however, is an earlier-day lie. No government in history has ever been able to borrow the money for any sizable spending program from the people. The government's deficits are simply too big and would overwhelm the credit markets of the nation. What every government has done when it faces sizable deficits is to simply print the money. If America is facing a $1.8 trillion deficit later this year, then it will probably print (another) trillion dollars to finance this. And then, as a political reality, it will be impossible to significantly cut the deficit for the next year, and the year after, etc., etc., etc. In this way, our children do not get poorer in the future. We get poorer, here and now. But we get poorer by having our dollars worth less. We have a bigger quantity of dollars but a smaller quantity of goods. This means printing of money (the Fed prints the money and then "lends" it to the Treasury) of $500 billion to $1 trillion addition to the money supply, each year for the next several years. A few years down the road, we could easily be looking at a money supply of $4 trillion to $5 trillion.. This is 3–4 times the level of a year ago. Last year practically every newspaper in the country was telling you that the problem we faced was "deflation." That was a gigantic piece of propaganda designed to frighten you into holding cash. Remember the flight to "safety" into T-bills and T-bonds? Most people fled from hard assets. These are the victims. They believed the propaganda of the

39 establishment. When the debris of our collapsing society starts to come down, they will be its victims. Their assets will be "safe" in the US dollar as it loses its place as the world's reserve currency. [VIEW THIS ARTICLE ONLINE]

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The savings glut. Controversy guaranteed. Posted on Tuesday, June 30th, 2009 By bsetser Few topics are quite as polarizing as the “savings glut.” The very term is often considered an attempt to shift responsibility for the current crisis away from the United States. That is unfortunate. It is quite possible to believe that the buildup of vulnerabilities that led to the current crisis was a product both of a rise in savings in key emerging markets, a rose that with more than a bit of help from emerging market governments – produced an unnatural uphill flow of capital from the emerging world to the advanced economies, and policy failures in the U.S. and Europe. The savings glut argument was initially put forward to suggest that the United States’ external deficit was a natural response to a rise in savings in the emerging world – and thus to defuse concern about the sustainability of the United States’ large external deficit. But it was equally possible to conclude that the rise in savings in the emerging world reflected policy choices* in the emerging world that helped to maintain an uphill flow of capital – and thus that it wasn’t a natural result of fast growth in the emerging world. This, for example, is the perspective that Martin Wolf takes in his book Fixing Global Finance. Wolf consequently believed that borrowers and lenders alike needed to shift toward a more balanced system even before the current crisis.

41 From this point of view, the savings glut in the emerging world — as there never was much of a global glut, only a glut in some parts of the world — was in large part a result of product of policies that emerging market economies put in place when the global economy — clearly spurred by monetary and fiscal stimulus in the US — started to recover from the 2000-01 recession. China adopted policies that increased Chinese savings and restrained investment to try to keep the renminbi’s large real depreciation after 2002 – a depreciation that reflected the dollar’s depreciation – from leading to an unwanted rise in inflation. The governments of the oil-exporting economies opted to save most oil windfall – at least initially. Those policies intersected with distorted incentives in the US and European financial sector – the incentives that made private banks and shadow banks willing to take on the risk of lending to ever-more indebted households (a risk that most emerging market central banks didn’t want to take) to lay the foundation for trouble. On one point, though, there really shouldn’t be much doubt: savings rates rose substantially in the emerging world from 2002 to 2007. Consider the following chart – which shows savings and investment in emerging Asia (developing Asia and the Asian NIEs) and the oil exporters (the Middle East and the Commonwealth of independent states) scaled to world GDP. Investment in both regions was way up. But savings was up even more. It is unusual for Asia and the oil exporters to show large surpluses at the same time. In 98 the fall in oil prices helped Asia and hurt the oil exporters; in 2000 the rise in oil prices helped the oil exporters and hurt Asia. And way back in 1980, Asia ran a deficit that helped offset the oil exporters’ surplus.

The main reason for the rise in emerging Asia’s savings is simple: China’s GDP rose relative to world GDP, and China’s savings rate rose relative to China’s GDP The result was a very large increase in the aggregate savings of the emerging world – especially after 2003. The rise in the combined surplus of Asia and the oil exporters that

42 followed the Asian crisis was around 0.5% of world GDP. The post 2003 “China boom” pushed the combined savings rate of the oil exporters and emerging Asia up another 1% of world GDP.

The chart is from Stephen Green of StanChart; used with permission All my data, incidentally, comes straight from the IMF’s WEO data tables. All I did was to multiply the data on savings rates by regional GDPs and then scale the resulting dollar figure to world GDP in dollars. That disaggregated data is almost as striking. It shows, for one, that the “investment drought” argument applies far more to the Asian NIEs (Korea, Taiwan, Singapore, Hong Kong) than to the rest of Asia. Investment in some countries may not have recovered from the 1998 crisis, but the overall data is dominated by the huge rise investment in developing Asia (read China). Plotting the rise in billions of dollars – rather than as a share of global GDP – makes the scale of the rise in investment in developing Asia over the past few years clear. Savings and invesment in India both rose. And China went from a $1 trillion economy investing 30 to 35% of its GDP to a $4 trillion plus economy investing close over 40% of its GDP … It is also striking that investment in the Middle East was essentially stagnant, in dollar terms, from say 1980 on. That meant that is was falling as a share of world GDP – and certainly falling relative to the Middle East’s population. Comparisons with the “boom” level of 1980 is a bit unfair, but it still isn’t hard to see why the region stagnated when oil prices stagnated.

43 And it also isn’t hard to see why the region boomed when oil prices soared, as the rise in oil revenue financed a boom in investment. The scale of that boom – in dollar terms – is rather impressive. The net result: the global economy prior to the crisis was characterized both by high levels of both savings and investment in Asia and the oil exporters and by high levels of consumption and low levels of savings in the US.

44 In a global economy, a rise in savings relative to investment in one part of the world necessarily implies a fall in savings relative to investment in the rest of the world; sorting out why key macroeconomic variables change is always difficult. Maybe this equilibrium was a function of excessive demand stimulus by the advanced economies in the aftermath of the last recession – and lax financial regulation that allowed households to over-borrow. High US and European demand allowed the emerging world to save more. Maybe it was a function of policies in the emerging economies, policies sometimes put in place to support undervalued exchange rates. That would explain why the growing US savings deficit didn’t put upward pressure on global interest rates and why the rise in the US external deficit didn’t lead to a rise in US real interest rates — something would have short-circuited the housing boom. Probably it was a mix of both. Emerging market savers (really their governments, as private savers weren’t exactly seeking out depreciating dollars) helped to provide Wall Street and the City the rope they (almost) used to hang themselves. No matter. We don’t need to assign responsibility for the imbalances that marked the pre- crisis global economy to know that the chain of risk-taking that allowed emerging market savers to finance heavy borrowing by US households didn’t result in a stable system. * Policies that increased savings in China include a tight fiscal policy and the reforms that increased the profitability of the SOEs, creating a new source of business savings. No comparable reform was put in place to have the SOEs pay dividends (or to use the dividends to support say a social safety net), so the rise in business savings in effect freed up household savings to be lent abroad (with a lot of help from the state banks and the PBoC). Policies that reduced investment include the rise in the banks’ reserve requirement — which meant that Chinese banks had one of the lowest loan to deposit ratios in the emerging world going into the global slump — and more generally the restraints on bank lending. The governments of most oil-exporting economies also saved a large fraction of the oil windfall, especially in 2004 and 2005. Over time discipline waned a bit, but the rise in spending and investment didn’t quite keep pace with the rise in oil prices. http://blogs.cfr.org/setser/2009/06/30/the-savings-glut-controversy-guaranteed/#more- 4700

45 Jul 1, 2009 How Safe Are Prime And Jumbo Mortgages Amid Falling Home Prices? Overview: Prime-jumbo and prime mortgage securities issued in 2006 and 2007 experience record delinqencies as the surge in U.S. foreclosures spreads beyond only subprime loans. Falling house prices and negative equity promote 'jingle mail' among prime borrowers who are also increasingly exposed to a deteriorating labor market. About $500 billion of prime-jumbo bonds exist, according FTN Financial. o OCC Q1 Mortgage Metrics report: "Prime mortgages (incl. for the first time mortgages serviced for Fannie&Freddie ), which represented two-thirds of all mortgages in the portfolio as of Q1, had the highest percentage increase in serious delinquencies, climbing by more than 20 percent from the prior quarter to 2.9 percent of all prime mortgages (1.1 percent one year ago)." The report covers the performance of 34 million loans totaling more than $6 trillion in principal balances from the beginning of 2008 through the end of the first quarter of 2009. o Guiso/Zingales/Sapienza (NBER/CEPR): Study on strategic defaults shows that " 26% of the existing defaults are strategic. We also find that no household would default if the equity shortfall is less than 10% of the value of the house. Yet, 17% of households would default, even if they can afford to pay their mortgage, when the equity shortfall reaches 50% of the value of their house. Besides relocation costs, the most important variables in predicting strategic default are moral and social considerations." o Doms/Furlong/Krainer: It is now standard to model the mortgage default decision as an option model. If the value of the house is less than the value of the mortgage, then the default option is “in the money” and the borrower is predicted to exercise that option. o April Fitch: Prime Loans with multiple risk attributes, such as limited income documentation and second liens, are defaulting at very high rates. A growing percentage is losing all home equity due to declining home prices. The percentage of borrowers with negative equity in some recent vintage mortgage pools is approaching 50%. In addition to high default rates, recovery rates on defaulted loans are also trending downward. o April Foote (Boston Fed): "Our research suggests that “unaffordable” loans, defined as those with high mortgage payments relative to income at origination, are unlikely to be the main reason that borrowers decide to default. Rather, the typical problem appears to be a combination of household income shocks and an unprecedented fall in house prices." o Feb 19: The President's New Homeowner Affordability and Stability Plan has no provision to help jumbo mortgage borrowers facing negative equity.--> see also Market-Based Approaches to Deal With Upside Down Mortgages

46 o Krugman: The spread between conventional 30-year mortgages and 10-year Treasuries (10-year because most mortgages get paid off early, when houses are sold, and the average duration is about 10 years) itself has been constantly increasing to 3% compared to an average of 1.5% pre-crisis. At this point the Fed announced its MBS purchase plan. o San Francisco Fed: "Despite the superior credit quality of the prime borrowers, the correlation between the prime and subprime delinquency rates reported by the MBA is surprisingly high—.94 in 2006. Prime delinquency rates tend to be higher in states where subprime interest rates were higher, and where overall subprime lending activity was higher. We also see that economic conditions and recent changes in house prices explain a large part of the variation in prime delinquency rates, although the estimated coefficients on all of these variables are much smaller than was the case in the subprime regressions." o Nouriel Roubini: With a 30% fall in home prices 21m households (40% of the 51m with a mortgage) would be underwater. http://www.rgemonitor.com/687/Real_Estate_and_Mortgage_Finance?cluster_id=12859

47 Is the Decline in U.S. Home Prices Easing? Jun 30, 2009 o April 2009: The S&P/Case-Shiller 20-City Composite Index fell 18.1% y/y in April 2009 after declining 18.7% y/y in March. The m/m pace of decline in April was slower than in March for 19 cities, while 13 of 20 cities covered in the survey showed an improvement in the y/y return in April. (S&P) o As of April 2009, average home prices are at similar levels to what they were in mid-2003. From the peak in mid-2006, the 10-City Composite is down 33.6% and the 20-City Composite is down 32.6%.(S&P) o Blitzer: "We are entering the seasonally strong period in the housing market, so it will take some time to determine if a recovery is really here." (S&P) o Q1 2009: The S&P/Case-Shiller U.S. National Home Price Index recorded an 19.1% decline in Q1 2009, largest in the series' history. This has increased from the annual declines of 18.2% and 16.6%, reported for the Q4 and Q3 2008, respectively. (S&P) o March 2009: The FHFA Monthly Home Price Index fell 1.1% in March after unexpectedly rising in January and February. The index is down 7.3% y/y and 11% below it's peak in April 2007. The FHFA purchase-only Home Price Index fell 0.5% in Q12009, after falling a record 3.3% in Q42008 and is down 7.1% y/y.(FHFA) o RGE Monitor: based on a range of indicators (real home price index by Shiller 2006, price rent ratio and price/income ratio) the fall in home prices from their peak will reach 44%. Inventories persist at an all time high, while starts might be close to a bottom and will likely move sideways for some time, it is the demand side that has to pick up to reabsorb inventories. As long as demand remains weak and inventories high, downward pressures on prices will continue o Fitch (via Calculated Risk): expecting home prices to decline by an average of 25 percent in real terms at the national level over the next five years, starting from the Q2 2008 o Wachovia:the S&P/Case-Shiller 10-city composite index will fall 28.6% on a peak-to-trough basis. OFHEO purchase only index will decline around 22% o IMF: the baseline scenario for the U.S. economy assumes a 14–22% drop in house prices during 2007–08 o PMI Group: U.S. home price declines will probably double to a national average of 20 percent by next year, with lower values most likely in metropolitan areas in , Florida, Arizona and o Krugman: My preferred metric is the ratio of home prices to rental rates. By that measure, average home prices nationally got way too high. We'll probably basically retrace all that. So that's about a 25% decline in overall home prices (CNN) o Davis, Lehnert and Martin: prices would have to fall 15% over five years - assuming rents rose 4% a year - to bring rent/price ratio back to its long-term average o Goldman Sachs (Calculated Risk): Home prices to fall 15% w/o recession and 30% in case of a recession o Shiller: home prices to fall up to 50% in some areas o The FHFA HPI covers both purchase and refinance transactions, while the S&P Case Shiller Indexes only use purchase transactions. The HPI only includes conventional mortgages sold/ guaranteed by GSEs while the S&P Case Shiller indexes also include non-agency mortgages. http://www.rgemonitor.com/80/Housing_Bubble_and_Bust?cluster_id=6077 Véase John Y. Campbell, Stefano Giglio y Parag Pathak, “Forced Sales and House Prices”, NBER Working Paper 14866, : http://www.nber.org/papers/w14866

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30.06.2009 Landesbanken consolidation off the agenda

Some bad, but unsurprising news from Germany. The country’s state premiers seemed to have prevailed with their insistence to allow each Landesbank to set up its own “bad bank”, which if agreed by the Grand Coalition would deprive the finance ministry of the quid-pro quo deal they had proposed earlier, under which the seven Landesbanken should be allowed to offload their toxic assets in exchange for future consolidation into one or two institutions. If every state is now able to pursue its own solutions, the pressure for consolidation is off the agenda. Germany’s constitutional court will decide on Lisbon Treaty today FT Deutschland has a nice portrait/analysis piece on German constitutional justice Udo di Fabio, a known eurosceptic, who is the leading justice in the case brought by a group of parliamentarian against the Lisbon Treaty. The issue is whether the treaty possibly reduces liberties for German citizens in the long run. The article says if the court could declares essential passages anti-constitutional, it would require a new round of negotiations (and probably the death of the project). Alternatively (and more likely in our view), the court could impose some conditions, which could be inserted as a protocol, and which do not require new negotiations. Di Fabio has already stated publically in a previous hearing that he had deep reservations about this treaty, so that the outcome of the case is genuinely uncertain. Der Spiegel has a detailed scenario analysis. It says a simple approval is most unlikely, but so is a simple No. The most probable outcome would be a conditional Yes. BIS wants to subject financial products to “prescriptions” An interesting proposal came from the Bank for International Settlements yesterday, which suggested that the trade in financial products should be regulated similarly to the trade in pharmaceuticals. Certain products should be freely available, other should be limited through an equivalent of a pharmacy, while others again should be outlawed, FT Deutschland reports.

Euro area confidence is up

49 Euro area economic confidence recovered more than expected this month, the FT writes, citing a survey from the European Commission, which reported that its eurozone “economic sentiment indicator” rose 3.1 points to 73.3 in June, the highest since last November. Optimism rose among consumers, in the service sector and to a lesser extent in industry. It was the third consecutive increase from the low reached in March, but the Commission pointed out that the indicator remained below the level reached at the end of the last trough in late 1992. Jury still out on ECB’s repo action The FT writes that Euro Libor has fallen to new lows after the ECB’s €442bn cash injection last week, but the jury is still out. Most of that money - €236bn – was parked back at the ECB’s deposit facility, which suggests that the banks are hoarding a large part of the funds. It is still not clear whether this new money will ultimately lead to more lending, which is the goal of this exercise. Why is the oil price rising? Oil future hit $70pb, the Wall Street Journal noted, but why? It surely is not demand. The International Energy Agency has cut its forecast for world oil demand over the next five years to an an average of 87.9m bpd in 2013, 7% fewer than it expected last July. Oil consumption is forecast to by 3% this year, the sharpest decline in a quarter-century. But if it is not demand, then the reason may be a lot more sinister, the Journal noted. Two possibilities are supply constraints, and speculation. 7% fiscal deficit in France The government expects the French deficit to reach €125bn-€130bn (7% of GDP) in 2009, reports Les Echos. Two third is a consequence of the crisis, says the government note for the Parliamentary budget debate this week. For 2008 the budget is €56.3bn, €14.6bn more than in the initial budget, and €4.8bn more than forecasted last December. Black economy to boost Greek economy When it comes to raising GDP growth, Greeks become inventive. Kathemerini recommends the government to use the black economy to stimulate economic growth and reduce the fiscal deficit. In particular the article proposes the government to permitthe purchases of homes without requiring ‘pothen eshes,’ the proof from buyers of where they found the money. It is said that the underground economy looks for alternatives to stocks, government bonds and other investments. Deposits at banks are growing at a satisfactory single-digit rate, partly due to money from non-reported activities. The article calls on the government to dare such an unorthodox devise because it has no choice. The end of the Arts, Sports and Tourism ministry? A leaked report from the “cost-cutting committee” headed by the University of Dublin recommends prime minister Brian Cowen to axe 4 minister posts, reports the Irish Independent. The government is asked to “review” the entire operation of the Department of Arts, Sport and Tourism and the Department of Community, Rural and Gaeltacht Affairs. The article goes on saying if Cowen doesn’t accept the recommendations, it sends the dangerous signal of lack of courage. Latest statistics

50 show that average weekly earnings in the public sector (excluding health) rose by 3.4% in the 12 months to March despite the worst recession in living memory.

51

Reuters BIS wants financial products ranked like drugs 06.29.09, 6:00 AM ET By Huw Jones BASEL, Switzerland, June 29 (Reuters) - Financial products should undergo registration like drugs to curb investor access until safety is proven, the Bank for International Settlements said on Monday. Policymakers were alarmed at how opaque and complex securitised products collapsed in value as the credit crunch began unfolding from mid-2007, despite being highly rated. This sparked huge writedowns by banks that shattered investor confidence. "In a scheme analogous to the hierarchy controlling the availability of pharmaceuticals, the safest securities would, like non-prescription medicines, be available for purchase by everyone," the BIS, which acts as a forum for the world's central banks, said in its annual report. "Next would be financial instruments available only to those with an authorisation, like prescription drugs; another level down would be securities available only in limited amounts to pre-screened individuals and institutions, like drugs in experimental trials," the BIS said. "Finally, at the lowest level would be securities that are deemed illegal." A new instrument would be rated or an existing one moved to a higher safety category only after successful tests. "Such a registration and certification system creates transparency and enhances safety ... This will mean that issuers bear increased responsibility for the risk assessment of their products," the BIS said. Access to some products is already restricted in some countries, such as to hedge funds. DERIVATIVES, RISK CHARGE Policymakers are tightening financial rules in a process spearheaded globally by the Group of 20 industrialised and emerging market countries. The BIS endorses many of the pledges the G20 made in April such as the need to monitor all parts of the financial market, particularly system-wide risks, to limit tendencies to amplify rather than counter the prevailing trend, and to insist on the clearing of off- exchange traded derivatives. Policy interventions should combine outright bans with regulations that bump up the cost of risky activities, it said. The BIS goes a step further than the G20 by suggesting shifting off-exchange traded instruments onto exchanges. "The primary advantage of taking this step is that it ensures price transparency with less reliance on market-makers," the BIS said.

52 It proposed a bespoke "systemic capital charge" on each bank to reflect the risk it posed to the wider financial system as well as a minimum leverage ratio, another regulatory tool other policymakers have aired. The BIS also backed calls for all financial institutions to have a bankruptcy contingency plan. The G20 wants banks to build up buffers of capital during good times for tapping when markets turn sour, thereby lessening the likelihood of more taxpayer funded bailouts. The BIS cautioned that one difficulty was knowing when banks should start building up a buffer, which would make lending more costly, and when reserves can be tapped to promote lending. "Yet another problem with implementing a countercyclical charge is that it is not 'one size fits all'," the BIS said. Central bankers also needed to adopt a more "activist stance" to booms in both credit and asset prices. "The issue is how monetary policymakers should expand their frameworks to make room for property prices, equity prices and amounts of debt outstanding," the BIS said. (Reporting by Huw Jones; Editing by Ruth Pitchford) http://www.forbes.com/feeds/reuters/2009/06/29/2009-06- 29T100047Z_01_LAG003542_RTRIDST_0_BIS-REGULATION.html

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BIS Annual Report: Rescue, recovery, reform – the narrow path ahead 29 June 2009 In its 79th Annual Report, released today, the Bank for International Settlements (BIS) looks at the narrow path ahead leading out of the financial crisis. The Report underlines the need to focus clearly on the medium term and on sustainability when designing both macroeconomic and financial policy responses. The crisis had both macroeconomic and microeconomic causes: large global imbalances; a protracted period of low real interest rates; distorted incentives; and an underappreciation of risk. There were market failures, and regulation failed to prevent the build-up of excessive leverage. In September and October 2008, the financial crisis intensified, forcing monetary, fiscal and regulatory authorities both to expand their fight to restore the health of the financial system and to counter the threats to the real economy. The scale and scope of the monetary and fiscal policy measures are unprecedented. Nevertheless, the balance sheets of many financial institutions have still not been repaired. Further steps are needed to address this. A healthy financial system is a precondition for the effectiveness of expansionary policies and for stable long-run real growth. It is “essential that authorities … repair the financial system”, notes the Annual Report, and “persevere until the job is done”. And they should resist financial protectionism, sometimes an unintended consequence of national support for the financial sector, as this would moderate growth and development. Implementing the rescue is a complex task that is fraught with risks. Policies should aid, not hinder, orderly adjustment. They need to strike a balance between short-term stimulus and well articulated exit strategies that ensure long-term sustainability. They need to allow the financial sector to shrink as borrowers reduce their leverage. And they need to promote a shift in production patterns away from export- and leverage-led growth models towards more balanced ones. Governments and the private sector have to work together to build a more resilient financial system. Addressing the broad failures revealed by the crisis means that systemic risk in all its guises must be identified and mitigated, adopting a macroprudential perspective – a core theme of the BIS’s work for many years. Guillermo Ortiz, Chairman of the BIS Board of Directors, noted that “the work will have to be coordinated internationally across a wide range of countries. In particular, institutions with expertise in the field – including the Financial Stability Board and standard-setting committees – will need to play a leading role”. The BIS Annual Report argues that financial instruments, markets and institutions all require reform if a truly robust system is to emerge. For instruments, it means a mechanism that rates their safety, limits their availability and provides warnings about their suitability and risks. For markets, it means encouraging trading and clearing through

54 central counterparties and exchanges. For institutions, it means the comprehensive application of enhanced prudential standards that integrate a system-wide perspective. Above all, regulators and supervisors must adopt a macroprudential orientation. By focusing on the stability of the system as a whole, as much as on the viability of individual institutions, it would reduce the probability of joint failures that arise from common exposures and at the same time moderate the procyclicality inherent in the financial system. Speaking today, BIS General Manager Jaime Caruana stressed that “there are several projects under way to make the macroprudential approach operational, building on the new-found international consensus supporting it. The BIS is actively involved in all of these initiatives”. But better regulation is not enough. Macroeconomic policies can and must play a role in promoting financial stability. For monetary policy, this means taking better account of asset prices and credit booms; for fiscal policy, it means putting a premium on medium- term fiscal discipline and long-term sustainability. The 79th Annual Report was presented at the Bank’s Annual General Meeting, held today in Basel, Switzerland, and chaired by Guillermo Ortiz. The Bank reported a balance sheet total of SDR 255 billion (USD 381 billion) at end-March 2009, a decrease of SDR 56 billion over the past year. Net profit was 18% lower than for the previous financial year, amounting to SDR 446 million (USD 666 million). Currency deposits by customers represent some 4% of the world’s total foreign exchange reserves. The BIS’s 55 shareholding central banks will receive a dividend of SDR 265 per share, unchanged from the previous financial year. http://www.bis.org/press/p090629.htm

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How a Loophole Benefits GE in Bank Rescue Industrial Giant Becomes Top Recipient in Debt-Guarantee Program By Jeff Gerth and Brady Dennis ProPublica and Washington Post Staff Writer Monday, June 29, 2009 General Electric, the world's largest industrial company, has quietly become the biggest beneficiary of one of the government's key rescue programs for banks. At the same time, GE has avoided many of the restrictions facing other financial giants getting help from the government. The company did not initially qualify for the program, under which the government sought to unfreeze credit markets by guaranteeing debt sold by banking firms. But regulators soon loosened the eligibility requirements, in part because of behind-the- scenes appeals from GE. As a result, GE has joined major banks collectively saving billions of dollars by raising money for their operations at lower interest rates. Public records show that GE Capital, the company's massive financing arm, has issued nearly a quarter of the $340 billion in debt backed by the program, which is known as the Temporary Liquidity Guarantee Program, or TLGP. The government's actions have been "powerful and helpful" to the company, GE chief executive Jeffrey Immelt acknowledged in December. GE's finance arm is not classified as a bank. Rather, it worked its way into the rescue program by owning two relatively small Utah banking institutions, illustrating how the loopholes in the U.S. regulatory system are manifest in the government's historic intervention in the financial crisis. The Obama administration now wants to close such loopholes as it works to overhaul the financial system. The plan would reaffirm and strengthen the wall between banking and commerce, forcing companies like GE to essentially choose one or the other. "We'd like to regulate companies according to what they do, rather than what they call themselves or how they charter themselves," said Andrew Williams, a Treasury spokesman. GE's ability to live in the best of both worlds -- capitalizing on the federal safety net while avoiding more rigorous regulation -- existed well before last year's crisis, because of its unusual corporate structure. Banking companies are regulated by the Federal Reserve and not allowed to engage in commerce, but federal law has allowed a small number of commercial companies to engage in banking under the lighter hand of the Office of Thrift Supervision. GE falls in the latter group because of its ownership of a Utah savings and loan. Unlike other major lenders participating in the debt guarantee program, including Bank of America, Citigroup and J.P. Morgan Chase, GE has never been subject to the Fed's stress tests or its rules for limiting risk. Also unlike firms that have received bailout money in the Troubled Assets Relief Program, or TARP, GE is not subject to restrictions such as limits on executive compensation.

56 The debt guarantee program that GE joined is administered by the Federal Deposit Insurance Corp., which was reluctant to take on the new mission, according to current and former officials who were not authorized to speak publicly. The FDIC also initially resisted expanding the pool of eligible companies, fearing it would add more risk to the program, the officials said. Despite those misgivings, there have been no defaults in the loan guarantee program. It has helped buoy confidence in the credit markets and enabled vital financial firms to raise cash even during the darkest days of the economic crisis. In addition, the program has raised more than $8 billion in fees. "The TGLP program has been a moneymaker for us," FDIC chairman Sheila C. Bair has said. "So I think there have been some benefits to the government and the FDIC." For its part, GE said that it properly applied for and qualified for the program. "We were accepted on the merits of our application," company spokesman Russell Wilkerson said. The Cash Cow The current good fortune of General Electric, ranked by Forbes as the world's largest company, has roots in the Great Depression, when it created a consumer finance arm so that cash-starved families could buy its appliances. What grew from those beginnings is now a powerful engine of profit, accounting for nearly half of its parent's net earnings in the past five years. GE may be better known for light bulbs and home appliances, but GE Capital is one of the world's largest and most diverse financial operations, lending money for commercial real estate, aircraft leasing and credit cards for stores such as Wal-Mart. If GE Capital were classified as a banking company, it would be the nation's seventh largest. Unlike the banking giants, GE Capital is part of an industrial company. That allows GE to offer attractive financing to those who buy its products. At the height of last fall's financial crisis, GE's cash cow became a potential liability. As credit markets froze, analysts feared that GE Capital was vulnerable to losing access to cheap funding -- largely commercial paper, or short-term corporate IOUs sold to large investors. Company officials projected confidence. "While GE Capital is not immune from the current environment," Immelt said in October, "we continued to outperform our financial- services peers." Behind the scenes, they urgently sought a helping hand for GE Capital. One key hope was a rescue plan taking shape at the FDIC. The program emerged during a hectic weekend last October as regulators scrambled to announce a series of rescue efforts before the markets opened. They found a legal basis for the program in a 1991 law: If a faltering bank posed "systemic risk," then the FDIC, the Fed, the Treasury secretary and the president could agree to give the FDIC more authority to rescue a failing institution. The financial regulators applied the statute broadly, so it would cover the more than 8,000 banks in the FDIC system. The FDIC hurried to approve the program Oct. 13. "This was crisis management on steroids," said a person familiar with the process. "A lot was made up on the fly." The author of the systemic-risk provision, Richard Carnell, now a law professor at Fordham University, says it was intended to apply to a single institution, and that in their

57 rush to find legal footing for unprecedented new programs, regulators "turned the statute on its head." The FDIC launched the program Tuesday, Oct. 14, the same day Treasury officials announced large capital infusions into nine of the country's banking giants under TARP. That day, the FDIC also expanded its deposit guarantees to a broader range of accounts. Within days, the FDIC held conference calls with bankers to explain the program. Agency officials explained that not all companies that owned banks were eligible. "The idea is not to extend this guarantee to commercial firms," David Barr, an FDIC spokesman, said during one of the calls. A Broader Program GE was watching closely. Though GE Capital owned an FDIC-insured savings and loan and an industrial loan company, they accounted for only 3 percent of GE's assets. Company officials concluded that GE couldn't meet the program's eligibility requirements. So the company requested that the program "be broadened," GE's Wilkerson said. GE's main argument was fairness: The FDIC was trying to encourage lending, and GE Capital was one of the country's largest business lenders. GE deployed a team of executives and outside attorneys, including Rodgin Cohen, a banking expert with the New York firm Sullivan & Cromwell. "GE was among the parties that discussed this with the FDIC," along with the Treasury and Fed, according to FDIC spokesman Andrew Gray. He said the details about eligibility "had not been specifically addressed" in the beginning. Citigroup, the troubled banking giant, also was pressing for an expansion of the FDIC program. Though Citigroup was included in the debt guarantee program, its main finance arm, Citigroup Funding, appeared ineligible. Fed Vice Chairman Donald L. Kohn wrote to the FDIC's Bair on Oct. 21, arguing that debt issued by Citigroup Funding should be covered "as if it were issued directly by Citigroup, Inc." Two days later, the FDIC announced a new category of eligible applicants -- "affiliates" of an FDIC-insured institution. Bair explained that "there may be circumstances where the program should be extended" to keep credit markets flowing. That meant "certain otherwise ineligible holding companies or affiliates that issue debt" could apply, she said. GE Capital now was eligible. Raising Billions GE Capital won approval to enter the FDIC program in mid-November with support from its regulator, the Office of Thrift Supervision. The company used the government guarantee to raise about $35 billion by the end of 2008. By the end of the first quarter of 2009, the total reached $74 billion, helping to cover the company's 2009 funding needs and about $8 billion of its projected needs for 2010. Despite government support, GE lost its Triple-A rating for the first time in decades this year and was forced to sharply cut its dividend. But the outlook could have been much worse. The debt guarantee program has "been of critical importance" to the fiscal health of GE Capital, said Scott Sprinzen, who evaluates GE's finance arm for the Standard & Poor's

58 credit-rating company. He said the FDIC program enabled GE to "avoid an exorbitant price" for its debt late last year. GE has not disclosed how much the company has saved because of TLGP backing. Like other companies in the program, GE pays the FDIC fees to use the guarantees -- a little more than $1 billion so far. But as Bair explained to bankers last fall, the fees, while "healthy," are "far below certainly what the cost of credit protection is now in the market." Not every finance company has had that peace of mind. One of GE's competitors in business lending markets, CIT Group, a smaller company, has had a harder time raising cash. It has been unable to persuade the FDIC to allow it into the debt-guarantee program, at least in part because of its lower credit ratings. A recent Standard & Poor's analysis cited CIT's "inability to access TLGP" as a factor in the company's declining financial condition. The 'Cliff' Ahead Two weeks ago, the Obama administration said it would seek to eliminate the Office of Thrift Supervision and force companies like GE to focus on commerce or banking, but not both. That could require the industrial giant to spin off GE Capital. Last week, Immelt said GE had no intention of doing that. "GE is and will remain committed to GE Capital, and we like our strategy," he said in a memo to staff. In its proposal to overhaul financial regulation, the Treasury Department pointed out that some firms operating under the existing rules, including collapsed companies such as American International Group, "generally were able to evade effective consolidated supervision and the long-standing policy of separating banking from commerce." GE's Wilkerson said the company generally supports regulatory reform but thinks that it should be permitted to retain its structure. "Bank reform has historically included grandfathering provisions upon which investors have relied," he said, "and there is no reason this settled principle should not be followed here." He said the company "didn't have any choice" but to have OTS as its regulator. The company also objects to the Treasury's proposal to force firms to separate banking and commerce because that issue "had nothing to do with the financial crisis," Wilkerson said. Wilkerson said GE has remained profitable and avoided some of the exotic financial products that contributed to losses at other institutions. He also said that GE performed an internal stress test this year and found that its capital position was "quite strong by comparison to the banks." The FDIC has been working to wean financial institutions off the program. The TLGP originally was slated to end in June, but at the Treasury's request the FDIC agreed to extend it until Oct. 31. Some participants have stopped using the program, but GE Capital continues to do so for the overwhelming majority of its debt. Much of the $340 billion in debt will come due in 2012, the year the FDIC guarantees expire. At that point, known in banking circles as the "cliff," the agency will have to make good if companies such as GE are unable to honor their obligations. FDIC officials say they are comfortable that the agency has collected more than enough money to cover potential losses. ProPublica is an independent, nonprofit newsroom that produces investigative journalism in the public interest.

59 http://www.washingtonpost.com/wp- dyn/content/article/2009/06/28/AR2009062802955_pf.html

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29.06.2009 BIS criticises governments over bank policies

The Guardian (hat tip Calculated Risk) has a preview of tomorrow’s BIS annual report, which does not mince its words about the crisis resolution. The BIS, which has been an early and persistent voice of warning in the run-up to the crisis, said that the failure to sort out the banking system would threaten the global recovery. The Guardian quotes from the report: “The lack of progress threatens to prolong the crisis and delay the recovery because a dysfunctional financial system reduces the ability of monetary and fiscal actions to stimulate the economy.” The BIS said governments had not acted quickly enough to unload the toxic assets from bank balance sheets, while blanket guarantees of bank lending have exposed the taxpayer to potentially large losses. Buiter on the ECB’s 12-month repo Willem Buiter makes the point that the ECB’s decision last week to supply the banking system with a 12-month repo at 1% interest, totally €442bn, is a gift, as it gives banks access to excessively cheap money. He says it is inefficient and unfair to recapitalise the banking system via cheap money. In that sense the ECB is conducting fiscal policy, not monetary policy. He accuses the ECB of pandering to section interest, and urges the ECB to act in the public interest again. Merkel promises lower taxes, higher spending, and lower deficits It’s election time in Germany. The Christian Democrats have decided yesterday on a gravity-defying, and probably unconstitutional package of tax cuts, coming only weeks after the same Christian Democrats voted in favour of a constitutional debt ceiling. Merkel has concluded that she needed to promise tax cuts – totalling about €15bn – in order to win the next elections, but her programme does not say anything how this will be financed. Merkel categorically ruled out tax increases, as this would stifle economic growth. But she said nothing how Germany is going to cut the cyclically-adjusted deficit to 0.35% of GDP from 2016, which is now stipulated by the constitution, and which requires deficit cuts as from 2010 onwards. Der Spiegel, which has the story, quotes economists and legal experts as

61 saying that Merkel’s election programme was unconstitutional. FT Deutschland, which also has this story on its front page, says some CDU state premiers favour tax increases to meet the constitutional debt ceiling, for example a rise in VAT on food. Munchau on intra-euro area imbalances In his FT column Wolfgang Munchau asks what will happen if Germany heads towards a zero budget deficit and if Sarkozy continues to expand the budget, which is likely in the runup to the 2012 French presidential elections. Munchau concludes that this might drive German investors, who face a shortage of domestic bonds, into the French government bond market. For as long as Germany produces masses in excess savings, France should have no difficulty in financing an expansion of its deficits. This imbalance has some parallels with the financial relationship between China and US. Germany will be trapped in the French bond market, just as China is trapped in the US capital markets today. In the long-run, imbalances unwind one way or the other. Unless Germany abandons its balanced- budget policies, or unless France abandons its expansionary fiscal policies, there is a huge disintegration risk to EMU in the long run. Draghi calls for exit strategy coordination It is too early for an exit strategy now, Mario Draghi told the Financial Stability Board, according to La Repubblica. But when the time has come it is important that exit strategies are co-ordinated globally, especially between the US, the EU and Japan. The second precondition is a resolution to the banking crisis, meaning that credit flows have normalised again. How to spend it Francois Fillon reunited his reshuffled cabinet to make one point clear: the new debt issuance should finance only investments that are financially profitable with a clear socio- economical goal, reports Les Echos. The debt is not to finance a third stimulus package, not buildings or social expenditures. It’s more for long term growth such as environment projects, research and key industries such as biotechnology or ecotechnology to secure competitiveness (!). Earlier, some ministers had floated ideas on how to spend the money with proposals such as additional places in prisons. Bank of Spain wants consolidation El Pais leads its economic section with the story that the Bank of Spain called for the consolidation of Spanish savings banks in a meeting two weeks ago. The paper says the Bank of Spain did not say who should merge with whom, nor did it give any concrete instructions, but added that the statement was significant nevertheless, given the Bank of Spain’s influence in the banking sector. Spain approved a €9bn fund to support mergers for banks to avoid that solvency problems of small banks compromise confidence into large banks reports Le Monde. Spain’s black economy is swelling El Pais has an interesting story about the Spanish black economy, as 800,000 immigrants, about a third of the total, are now outside the official sector. This number is the gap between the total number immigrants, as establish by a nationwide labour market survey, which is 2.6m, and the number of immigrants on the social security register, which is 1.8m. The rise in the black economy is a direct consequence of the economic crisis in Spain. Most of those

62 immigrants are believed to have worked in construction, tourism and domestic services. Emergency mood in Ireland The Irish Independent calls on the government for immediate cost cutting actions. No more postponing of unpleasant decisions, no more excuses like the European elections or the Lisbon Treaty. The public sector needs to shrink and the government should take action before the summer pause not afterwards. Property tax should be introduced immediately, even if the charging mechanism is not yet properly understood. “April's emergency budget was a baby step in the right direction but there has been slippage since then. We are in a national emergency. We need to see action every day and every week. But instead, all we are getting is silence.” Keenan on cost cutting and bus drivers Brendan Keenan picks up the looming strike of Irish bus drivers - one of the best paid and well protected in Europe, to highlight what he considers to be the most striking argument from the IMF report on Ireland: ”Just fixing the arithmetic of budget deficits and bank losses may not be enough. It must be done,..., in a way which inspires confidence in the outcome and persuades people to join in the national effort, rather than protecting their own patch. If we could somehow get that with the bus drivers, we would be half-way there.”

Blame game This is a story to show just how unreal some debates are: Der Standard reports that a recent study from Deloitte accuses the former board of Kommunalkredit Austria to be not properly informed about the risks taken. The risk management was criticised as low professional. Member of this board was Claudia Schmid, current education minister, who defended her position by saying that she was in charge with “Financing, environment and ICT” and not with the treasury. She accused the other side of trying to make political capital out of this story. Quatremer on Schulz Jean Quatremer has an excellent commentary on Martin Schulz, the Socialist parliamentary leader in the European Parliament, whose refusal to put a Socialist candidate for the Commission presidency has caused much consternation. Quatremer hints that personal reasons may have played a role in this. He also mocks Schulz’ assertion that this was a battle the Socialists could not win, and made the valid that politicians would never apply the same logic to national elections. Martin Feldstein on inflation Writing in the FT, Martin Feldstein says that the recent rise in 10-year yields signifies an increase in investors’ fears of inflation and a higher US budget deficit. Analysising the difference between yields on ordinary bonds and those on inflation-protected bonds suggests that the entire rise in the yield can be explained by changing inflationary expectations. He says the US government should not withdraw the stimulus now, but it is important nevertheless that the US authorities reassure investors that they do not allow inflation to rise. Setser on the Net International Investment Position Once again, Brad Setser offers a deep insight into global financial flows with an analysis of

63 the latest US net international investment position. He remarks that the debate about the dollar’s reserve currency status rests too much on market share, not on market size. Emerging countries have seen a huge increase in their total reserves in the last few years, while holding the dollar share constant. This leaves the US hugely exposed to a sudden withdrawal of funds, should the reserve position reverse.

SUNDAY, JUNE 28, 2009 BIS: Toxic Assets Still a Threat by CalculatedRisk on 6/28/2009 09:52:00 PM The Bank of International Settlements (BIS) will release their annual report tomorrow. The Guardian has a preview: Recovery threatened by toxic assets still hidden in key banks ... Despite months of co-ordinated action around the globe to stabilise the banking system, hidden perils still lurk in the world's financial institutions according to the Basle-based Bank of International Settlements.

"Overall, governments may not have acted quickly enough to remove problem assets from the balance sheets of key banks," the BIS says in its annual report. "At the same time, government guarantees and asset insurance have exposed taxpayers to potentially large losses."

... As one of the few bodies consistently sounding the alarm about the build-up of risky financial assets and under-capitalised banks in the run-up to the credit crisis, the BIS's assessment will carry weight with governments. It says: "The lack of progress threatens to prolong the crisis and delay the recovery because a dysfunctional financial system reduces the ability of monetary and fiscal actions to stimulate the economy."

It also expresses concern about the dilemma facing policymakers on when to start reining in the recovery. "Tightening too early could thwart the recovery, whereas tightening too late may result in inflationary pressures from the stimulus in place, or contribute to yet another cycle of increasing leverage and bubbling asset prices. Identifying when to tighten is difficult even at the best of times, but even more so at the current stage," it says. Also, the WSJ has an article on the incredibly shrinking PPIP: Wary Banks Hobble Toxic- Asset Plan

I think the stress tests showed that the U.S. should have pre-privatized BofA, Citigroup and GMAC. Oh well ...

64 ft.com/maverecon Recapitalising the banks through enhanced credit support: quasi-fiscal shenanigans in Frankfurt Willem Buiter June 28, 2009 8:04pm Last week the Eurosystem performed a €442bn injection of one-year liquidity into the Euro Area banking system. They did this at the official policy rate - the Main refinancing operations (fixed rate) - of 1.00 percent, against the usual collateral accepted for Longer Term Financing Operations, effectively anything euro-denominated, not based on derivatives and rated at least BBB-. It was a fixed-rate tender, that is, the ECB was willing to meet any demand at the 1 percent interest rate, as long as eligible collateral was offered; 1121 banks participated in the operation. You will not be surprised to hear that this was the largest one-day ECB/Eurosystem operation ever. Even more remarkable than its scale are the terms on which the one-year funds were made available. There can be no doubt that this operation represents both a subsidy and a gift from the Eurosystem to the banks that participated in the operation. I hope to clarify the distinction between a subsidy and a gift in what follows. First, it is clear that a 1.00 percent interest rate for collateralised borrowing at a one-year maturity is well below the cost at which the participating banks could have funded themselves at a one-year maturity. Twelve-month Euribor averaged 1.64% in May. This is, of course, an unsecured interbank rate. Secured rates would be lower. On the other hand, Euribor is a ‘cheap talk rate’, based on what up to 43 panel banks believe a typical prime bank can borrow at from another prime bank. Citing the Euribor website, “A representative panel of banks provide daily quotes of the rate, rounded to two decimal places, that each panel bank believes one prime bank is quoting to another prime bank for interbank term deposits within the euro zone.” A prime bank is a bank that is not yet insolvent. Although the Euribor procedure is less likely to lead to an understatement of the true cost of unsecured borrowing than Libor, which, according to the Libor website “is calculated each day by asking a panel of major banks what it would cost them to borrow funds for various periods of time and in various currencies, and then creating an average of the individual bank’s figures.”, neither measure is a substitute for the only meaningful measure- one based on borrowing rates charged and paid on actual loans or deposits rather than on a panel bank’s guess at the rates at which that bank or some other bank might be able to borrow. Why any contracts are based on ‘cheap talk’ rates like Libor and Euribor is a mystery to me, but that is a subject for another post. Other measures of private source borrowing costs for banks include deposits. Interest rates on new household deposits up to 1 year maturity were 2.24%, new deposits from non- financial corporations with agreed maturity up to 1 year averaged 1.39% in March 2009. Household deposits up to the deposit insurance limit are ’safe rates’, guaranteed by the government. The rate on German government bonds at a one-year maturity was around 0.80% at the time of the Eurosystem’s mega-operation. You may think that this implies that the cost to the banks of borrowing from the Eurosystem for a year - 1.00% - does not imply a subsidy, as the banks’ borrowing from the Eurosystem is secured against collateral. You would be right if the collateral consisted of German government bonds. My guess (I don’t have hard information) is that this was not the

65 case, and that instead the borrowing banks stuffed the Eurosystem with the worst quality collateral they could put their hands on, subject to the constraint that a rating agency had rated it at least BBB-. Given the well-established practice of Eurozone banks that are eligible counterparties of the Eurosystem in repos and at the discount window, to carefully structure collateral packages that just meet the letter of the ECB’s collateral eligibility requirements, I am happy that I am not responsible for vetting and verifying the credit risk present in the portfolio of that increasingly speculative, highly leveraged entity known as the Eurosystem. What can the banks do with the €442 that they have borrowed at 1.00 % for up to a year from the Eurosystem? They could invest it in secured loans to households, e.g. mortgages. New floating rate and up to one year fixed mortgages in the Eurozone paid 3.66% interest on average in March 2009. Or they could put it into government debt. At least as regards German one-year central government securities, there is no ‘money machine’ allowing one- year funds borrowed at 1.00% to be invested in a safe asset yielding more than 1.00 percent. But if you are willing to bet that repo rates will not rise above above1. 5% over the next year, and not above 2.5% over the next two years, you have something close to a money machine. The Euro Area yield curves, based on AAA-rate Euro Area central government bonds showed spot rates at one year maturity of 0.93 percent, at two years maturity of 1.53 percent and at three years maturity of about 2.5% (eyeballing Chart 26 on page S45 in the ECB’s June 2009 Monthly Bulletin for this last figure). The instantaneous forward rates at one-year maturity were 1.43% in May 2009 and 2.77% at two years maturity. When is there a subsidy? It is possible for the ECB/Eurosystem to provide Euro Area banks with funds at a rate well below the rate at which the banks could have funded themselves elsewhere, without this implying a subsidy from the ECB/Eurosystem to the banks. There is a subsidy only if the rate charged by the ECB to the banks is less than the ECB’s risk-adjusted opportunity cost of funds. Let i(b) be the banks’ risk-adjusted cost of borrowing, i(l) the banks’ risk-adjusted lending rate, i(ecb)the Eurosystem’s lending rate to the banks and ithe Eurosystem’s risk- adjusted opportunity cost of funds. Then the subsidy provided by the ECB per € lent out is i(ecb)-i . The joy of the borrowing banks is measured by i(b) - i or by i(l) - i. But i(b)-i- both risk-adjusted rates, is not a subsidy from the Eurosystem to the banks. It is financial manna-from-heaven, reflecting the superior risk-sharing capacities of central bank and the sovereigns behind it (one hopes). Assume that, in May, the ECB’s opportunity cost of funds (other than through base money issuance) at a one-year maturity equals the average Eurozone AAA-rate sovereign borrowing rate - 0.93 percent. If the banks’ collateral is safe, there is no subsidy but a slight tax, 0.93 - 1.00= -0.07 or seven cents per € borrowed. If instead the collateral offered by the banks is without value, their secured borrowing is equivalent to unsecured borrowing. The one-year Euribor rate, 1.64%, provides a lower bound on the true unsecured borrowing rate of the banks. I believe it is safe to assume that most of the collateral offered to the ECB in this operation was rubbish. The supply of one-year funds was open-ended (demand-determined) and it is plausible to assume that the banks did not demand more than €442bn because they ran out of collateral and exhausted their capacity to transform pig’s ear securities into silk purse collateralisable assets. The risk-adjusted rate of return to the Eurosystem on its lending to the banks can hardly be more than 0.70%, given the poor quality of the collateral offered and the dreadful state of

66 the balance sheets of many Euro Area banks. In that case there is a subsidy from the ECB to the banks of just over 0.25 percent, say € 1 bn. While this is a small number, on the gargantuan scale on which bank losses and bailouts are measured these days, it is clearly inappropriate for the central bank to engage in quasi-fiscal operations of this nature. Subsidies should be voted by the appropriate parliaments, not distributed by unelected technocrats. The total increase in profits to the Euro Area banks from this operation is a multiple of the subsidy, and can be measured by the difference between the safe lending rate of the banks and the rate charged by the ECB. Depending on which use of funds you consider, this could amount to 1.5% of the €442 bn (if the money is invested in 3-year government instruments and nothing too nasty happens to short rates over the next 3 years) or 2.5% (minus a discount for default risk) one-year housing loans, that is, around €6bn or €10bn. While most of that is not a subsidy, it is a gift from the Eurosystem to the banks. If the ECB wants to play Santa Claus, I know of more deserving recipients of their largesse than the banks. Interest subsidies and gifts are a slow, inefficient and inequitable way to recapitalise the banks. Japan pursued this strategy and created zombie banks that brought the country a lost decade. The right way to recapitalise banks is to have a mandatory conversion of unsecured bank debt into equity. If there is insufficient unsecured debt, the tax payer can come in as recapitalisor of last resort, but only in exchange for equity or some other claim on any future upside. When the ECB’s enhanced credit support is mainly a slow and inefficient mechanism for recapitalising the banks - the ECB recently estimated short-term capital needs in the banking system of the Euro Area at about €280bn - without giving the taxpayers and other citizens of the Eurozone a claim on the banks in exchange, it turns the ECB into an agent of the banks (or more precisely of those in control of the banks and of the banks’ unsecured creditors) rather than of the 340 mn citizens of the Euro Area. The ECB should avoid such capture by narrow sectional interests and opt to act in the public interest instead. http://blogs.ft.com/maverecon/2009/06/recapitalising-the-banks-through-enhanced-credit- support-quasi-fiscal-shenanigans-in-frankfurt/

International 06/29/2009 Merkel's Tax Cut Pledge is 'Hollow, Wrong, Implausible' Chancellor Angela Merkel's conservatives are wooing voters by pledging tax cuts in their policy program for the September election. Commentators say that at a time of record public debt, it's an unrealistic promise that could damage her. German Chancellor Angela Merkel almost lost the 2005 election because she decided to be honest and announced she would hike the value added tax to cut the budget deficit if she got into power. That pledge, combined with her lackluster performance in the campaign, whittled down her respectable lead in opinion polls and ended up forcing her conservatives to share power with the rival center-left Social Democrats for the last four years.

67

DPA Merkel is rummaging around for €15 billion in tax cuts as she prepares for the September 27 election. Merkel has learned her lesson and is now pledging to cut taxes by €15 billion if she wins a second term in the September 27 election. Her conservative Christian Democrats (CDU) and their Bavarian sister party, the Christian Social Union (CSU), agreed on Sunday to put tax cuts in their joint campaign manifesto, and to rule out tax hikes, in a move that makes her re-election even more likely. But media commentators say the manifesto, which is due to be passed at a joint party congress of the CDU and CSU on Monday, risks denting Merkel's credibility at a time when the federal budget deficit has ballooned to its highest level since World War II as a result of the financial crisis. The draft budget for 2010 envisages a deficit of €86.1 billion, more than twice the previous record reached in 1996, because of massive stimulus programs, bank rescue initiatives, state-sponsored corporate bailouts, falling tax revenues and surging welfare payouts in the country's deepest recession since the 1930s. But legal experts say tax cuts could be in breach of the German constitution, which sets a limit on government debt. And economists say it will be impossible to get the burgeoning government deficit under control without hiking taxes at some stage, and that tax cuts are barely feasible. "I think what's being promised by the conservatives now is unrealistic," Stefan Homburg, an economics professor at the University of Hanover, told Deutschlandfunk radio on Monday. "We have just received a financial plan from the federal government that estimates public spending in the years through 2013 will be far higher than last year and that revenues won't rise in that period. That will result in gigantic deficits and something will have to be done to deal with those deficits." The conservatives' 63-page manifesto says nothing about how the planned tax cuts, which include cutting the bottom level to 12 percent from 14 and lifting the tax threshold for the top tax bracket from €52,552 to €60,000, are to be financed. Merkel and CSU leader Horst Seehofer made plain at Sunday's meeting that they were prepared to run up fresh debt to ensure taxes could be cut. Merkel said economic growth mustn't be stifled and added: "There won't be a tax increase with me in the next term."

However, the conservatives have refrained from setting a date for the cuts. Merkel's comments were intended to silence recent calls for tax hikes from two senior CDU members, Baden-Württemberg state governor Günther Oettinger and Saxony-Anhalt governor Wolfgang Böhmer, who both stayed away from Sunday's meeting of the party

68 leadership. Media commentators from left and right said on Monday that Merkel was risking her credibility with the tax cut pledge. Center-left Süddeutsche Zeitung writes: "She has chosen tax policy as a focus and thereby thrown the spotlight on an issue that is bound to make her look dubious. She spent more than three years opposing tax cuts by arguing that the federal budget couldn't cope with it. Consolidation became the trademark of the coalition. And now of all times, when public debt is soaring to immeasurable levels, she's promising billions in tax cuts. "In the 2005 election campaign Merkel talked about hiking value added tax because she wanted to remain credible. Today she has to live with the fact that her pledge to cut taxes doesn't make her look particularly convincing." "The Americans distinguish between two types of politicians. Barack Obama is the type who takes the lead, who tries to shape the future of his country and fights to rally the majority behind his plan. The other type tests the waters -- examining the public mood and adjusting policy accordingly. Angela Merkel is that type. If the Germans remain a people of 'water testers', Merkel will have really good chances in the autumn." Left-wing Berliner Zeitung writes: "The tax-cutting mantra now being written into the election manifesto originates from a time before the crisis and the record debt, it now sounds hollow, wrong, implausible. What would be interesting now would be to hear creative answers to the question of how Germany can get over the crisis and emerge stronger from it, as Merkel keeps promising. But these answers aren't forthcoming." Business daily Handelsblatt writes: "We shouldn't pretend that the huge budget deficits will disappear of their own accord. The necessary consolidation of the state finances won't succeed without increasing the public burden either through increasing taxes or cutting public services at all levels. That's why promising general tax cuts in the coming four years seems deeply dishonest to politically aware citizens." Conservative Frankfurter Allgemeine Zeitung writes: "It's true that honesty didn't pay off for Angela Merkel last time around. Her announcement that she planned to hike value added tax to consolidate the budget almost cost her the election victory four years ago. But the reverse conslusion that she'll get any further with unconvincing pledges could really backfire." David Crossland, 1 p.m. CET

COLUMNISTS: Wolfgang Münchau Germany and France need to sing in tune Published: June 28 2009 19:20 | Last updated: June 28 2009 19:20 I never expected a message of austerity to emerge from the Palace of Versailles, where Nicolas Sarkozy, France’s president, spoke last week to outline his economic strategy for the rest of his term. He left no doubt that he is not prepared to follow Angela Merkel,

69 Germany’s chancellor, in the direction of a balanced budget. Instead, he distinguished between “good” and “bad” government deficits, went on to explain that a good deficit is cyclical, a bad deficit structural, and then produced yet another category: a temporary deficit that would be brought down through higher economic growth in the future. In theory, this is all fine. In practice we have reason to doubt whether he will make an earnest effort to get rid of the deficits, good or bad. One can have endless debates about the relative benefits of Germany’s legalistic approach or Mr Sarkozy’s alternative version. Whatever side of the debate you support, you will probably agree that it is not a good idea for the two largest members of the eurozone to move in opposite directions. In fact, it could prove highly destabilising to the eurozone. Germany, as I argued last week, is heading in the direction of a zero level of government debt in the long run as a consequence of a new constitutional balanced-budget law. It is perhaps not intuitive that a balanced budget, pursued indefinitely, would eventually lead to a complete eradication of public debt. But this is what will happen. In fact, Germany’s new law imposes an upper deficit ceiling of 0.35 per cent of gross domestic product over the economic cycle. But remember this is a ceiling. There is no floor. If the cyclically adjusted deficit came in exactly at that ceiling, year after year, and assuming a nominal rate of output growth of 4 per cent, this would stabilise Germany’s debt-to-GDP ratio at just under 10 per cent. So if this constitutional law sticks, Germany’s debt-to-GDP ratio will settle somewhere between zero and 10 per cent in the long run. Now, Germany is a country with a large current account surplus, or excess of domestic savings over domestic investments – 6.6 per cent of GDP in 2008 and 7.6 per cent the year before. It is no surprise therefore that German banks have been hit so heavily by the securitisation crisis. They had to channel masses of surplus savings abroad. In the event, they bought US subprime mortgages and their derivative products. They will not repeat the same mistake, but they will still be facing a problem. If Germany’s national debt converges towards zero, Germany’s surplus savers will have to invest huge amounts of their savings outside the country, since the supply of German government bonds will diminish over time as the outstanding stock of debt is depleted. Now this is where Mr Sarkozy’s bad deficits come in. Most German savers, especially pension funds, will want to invest in euro-denominated government debt, which, for practical purposes in this scenario, means French debt, because no other domestic European bond market is sufficiently large and mature. As a result France may enjoy a version of America’s exorbitant privilege. If Germany unilaterally goes down the road of deficit reduction, and if France unilaterally goes the opposite way, the result will be a serious imbalance. France will find it progressively easy to finance its public sector deficit, as German savers have no choice but to buy French debt instruments. They will get trapped in French debt, just as the Chinese got trapped in US debt. This means that Germany will suffer two successive blows. The first is a sacrifice of economic growth as a result of the pro-cyclical policies needed to do away with the deficits for ever. We got a taste of that last week, when Klaus Zimmermann, president of the German Institute for Economic Research, advocated an increase in value added tax from 19 to 25 per cent. Such action would obviously be disastrous for economic growth. It would throw Germany into a full-scale depression. But he is right in a narrow technical sense. If Germany is hell-bent on eliminating its structural deficit by 2016, some drastic measures are inevitable. Ms Merkel has said she will not raise VAT, but she will either have to raise

70 other taxes or cut spending. Politically, the first will be easier than the second. Once budgetary balance is achieved, at huge economic cost, German savers will then suffer the second blow in the form of poor returns on investment, as their surplus savings will be financing Mr Sarkozy’s good, bad and ugly economic policies. How long can this go on? Imbalances can last a long time, but they do not last for ever. Something will have to give. It could be that future generations of German politicians find ingenious ways around the balanced budget law. Or that they find a two-thirds majority to overturn it. Or that Mr Sarkozy or his successors follow Germany into a future of austerity. But as long as one of those three events fails to happen, Germany may discover that unilateral fiscal rigour in a monetary union could prove extremely costly. For the sustainability of the euro, you surely do not want to get into a position where a large member state has a rational economic reason to quit. So if Germany and France really do what they both promise, you may as well start the egg timer. Germany and France need to sing in tune, FT, 28/6/2009: http://www.ft.com/cms/s/0/f0cccffc-640e-11de- a818-00144feabdc0.html?ftcamp=rss&nclick_check=1

COMMENT The Fed must reassure markets on inflation By Martin Feldstein Published: June 28 2009 19:27 | Last updated: June 28 2009 19:27 The interest rate on 10-year US Treasury bonds almost doubled in six months, rising from 2.26 per cent last December to 3.98 per cent in mid-June, before decreasing slightly in recent days. This sharp rise happened despite the Federal Reserve’s quantitative easing policy aimed at lowering long-term rates by buying $300bn (€21bn, £18bn) of Treasuries and promising to buy more than $1,000bn of mortgage securities. The higher Treasury bond interest rates have pulled up mortgage rates, especially since April. That has weakened aggregate demand by depressing home-buying and reducing house prices. The fall in house prices in the past six months cut household wealth by some $1,500bn, leading to lower consumer spending. The lower home prices also caused more defaults and weakened bank balance sheets. There is no single reason for the sharp rise in rates, and what matters is not just how investors see the economic future but also what they think other investors will come to believe. Someone may sell long-term Treasuries because he believes inflation will rise, or because he thinks others will soon sell bonds because they think inflation will rise. The simplest explanation for the higher 10-year rate is that many investors now expect inflation to rise. Although economic weakness and excess capacity are keeping current inflation low, the explosive rise of bank reserves created by Fed policy provides fuel for future inflation. The prospective decline of the dollar is also a potential source of inflation. Comparing the interest rates on 10-year Treasuries with the interest rates for 10-year Treasury inflation protected securities (Tips) supports this inflation explanation for the rise in long-term nominal rates. In mid-December, the 10-year Treasury yield was 2.26 per cent and the yield on 10-year Tips implied a 10-year expected inflation rate of just 0.19 per cent. By mid-June Treasury yields were up to 3.98 per cent and the yield on Tips was slightly

71 down, implying that 10-year expected inflation had jumped to 2.07 per cent. Analysed this way, the entire increase of the interest rate was due to the rise in investors’ expectations of 10-year inflation, or to that plus an increase in their willingness to pay for protection against a rise in the risk of inflation. But such an explanation is deceptively easy. The changing spread between the yields on Treasury bonds and Tips reflects not only changes in inflation expectations but also the response to investors seeking safety. Those scared by Lehman Brothers’ collapse wanted the safety and liquidity of ordinary Treasury bonds, causing their yields to fall sharply while yields on Tips rose slightly. Treasury yields rose by this month to their level a year earlier because improving market conditions meant investors were no longer willing to pay for the extreme liquidity of Treasuries. Inflation was thus not the only, and perhaps not even the main, reason for the rise in rates. Why did the Fed’s massive buying of long-term Treasury bonds not hold down the bond rate? The answer is that bond markets are less impressed by the $300bn of Fed purchases than by the official projection of $10,000bn of government borrowing over the next decade, with a deficit in 10 years’ time above 5 per cent of gross domestic product. The resulting crowding out of private investment will require higher future interest rates, and that is reflected in current long-term rates. A further reason long rates remain high is a fear that foreign buyers may not be willing to continue buying dollar bonds to finance a large US current account deficit. In short, higher long-term interest rates reflect investors’ concern about future inflation, future fiscal deficits and the future willingness of foreign investors to purchase US bonds. These long-term concerns can have adverse effects on the prospects for recovery during the coming year. The immediate challenge to the US government is to reassure investors about both the risks of inflation and the projected growth of fiscal deficits. It would be wrong for the Obama administration and Congress to reduce the fiscal stimulus in 2009 or 2010, since there is no clear evidence of a sustained upturn. But it would be equally wrong to allow the national debt to double to 80 per cent of GDP a decade from now. Increasing taxes even more than proposed would weaken demand in the near term and hurt economic incentives in the long run. The fiscal deficit should therefore be reduced by curtailing the increases in social spending that the president advocated in his election campaign. The Fed must also be careful not to tighten too soon. But it needs to reassure markets that it will prevent the excess reserves of the banks from financing a surge of inflationary lending when the economy begins to expand. It must make clear now that it will be willing to do so even if that involves big rises in short-term rates.

The writer is professor of economics at Harvard University http://www.ft.com/cms/s/0/6f7526a0-6410-11de-a818-00144feabdc0.html?ftcamp=rss

The evolution of the United States’ external balance

72 sheet in the last decade (wonky) Posted on Sunday, June 28th, 2009 By bsetser On Friday I tried to show why the US net international investment position deteriorated in 2008 – and also why it didn’t deteriorate in the previous years. Even after the market and currency gains of the past evaporated in 2008, the US net debt isn’t quite as big as an analyst who looked at the United States large cumulative current account deficit would expect. Some of the debt that the financial assets that the US sells the world seem to disappear when the US goes out at tries to count how much debt it owes the world – and how much equity in US companies have been sold to the rest of the world.* Yet even if the US data doesn’t show quite as much debt as it probably should, it still tells a lot going about what was on in the US – and the global – economy in the run up to the crisis. It is consequently tempting to try to do a bit of forensic accounting to help understand how vulnerabilities built up. One thing quickly becomes clear. The US was piling up external debts in the run-up to the crisis even if the United States’ net international investment position wasn’t deteriorating. The data in the NIIP can be disaggregated into debt and equity fairly easily. It is also fairly easy to separate out net official and net private claims. There isn’t a separate breakout for “official” investments in equities – as central bank and sovereign funds’ equity investments are aggregated together with their investments in US corporate bonds. But the US survey data indicates that official holds of equities were over three times official holdings of corporate bonds in the middle of 2008, so I don’t feel too bad considering “other official assets” a proxy for central bank and sovereign funds’ investment in US equities. But don’t get bogged down in the details. There is no doubt that the US was clearly racking up debts to both official and private creditors in the run up to the crisis. Net US external debt (US borrowing from the world, net of US lending to the world) is now close to 40% of US GDP — a fairly high level for a country with a modest export sector.

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The steady buildup of US external debt though was long offset by the rise in the value of US equity investment abroad. In my calculations I valued FDI at cost; valuing it at its market value would have pushed net US equity holdings (US equity investment abroad – foreign equity investment in the US) up even faster and, of course, produced an even bigger fall in 2008. Looking at the net data alone can be misleading. In some cases gross positions offset; it is useful to know if a stable net position reflects a symmetric rise in gross positions (or a symmetric fall). Look at the data on “gross” official flows. In 2008, for example, a rise in US “official” lending to the world – essentially the Fed’s swap lines – offset an ongoing rise in gross official claims on the US. This data helps to clarify the debate on the dollar’s status as a global reserve currency – a debate that I often feel misses a key point. The dollar was a reserve currency in the 70s, 80s and 90s too. But total central bank claims on the US generally were under 10% of US GDP. They jumped a bit in the mid-1990s, when a surge in capital inflows to the emerging world allowed many countries to rebuild their reserves. They dipped a bit during the Asian crisis, as many countries few on their reserves to finance capital outflows. But they only started to soar in 2003, when the dollar started to depreciate against the euro and Japan and a host of emerging economies resisted pressure on their currencies to appreciate.

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Somehow the usual debate on the dollar’s status as a global reserve currency suggests that little has changed over the past few years – the question is only whether countries will continue to want the dollar to be world’s leading reserve currency. But the debate over “market share” ignores the real issue: the size of the market. The dollar’s share of global reserves didn’t rise over the past several years. Rather countries holdings of reserves soared, and a constant (or even slightly falling) share and much larger stock produced a big rise in central bank holdings of US debt. That shift mattered: It left many emerging economies with a lot of exposure to the dollar, and left the US exposed to the risk that key countries might lose their appetite to continue to hold dollars. What of private debts? I plotted gross bank claims on the US against US bank claims on the world, and US holdings of debt securities against foreign holdings of US debt securities. Gross banks soared in the late 1970s. Petrodollar recycling. It actually was more than just recycling though. US bank claims on the world increased faster than foreign bank claims on the US; in aggregate, US banks were using US deposits to provide financing to the rest of the world. That has changed. Gross flows have generally trended up, but foreign claims on the US and US claims on the world rose together. The pace of increase though did pick up just prior to the crisis – probably because of the expansion of the shadow financial sector. But I am just guessing. Setting 2005 though, US banks weren’t a net source of financing to the rest of the world. Foreign and US holdings of debt securities have both increased over time. Foreign holdings of US debt soared in the 1990s. That makes sense. A rising dollar made dollar-denominated US debt an attractive asset. And US firms were borrowing heavily to finance a lot of tech related investment; think of it as the US borrowing to build the information super highway (and no doubt to consume a bit too). The big rise in foreign holdings of US debt from 2002 on is a bit harder to understand. It obviously provided a lot of financing to the US household sector – as foreign demand shifted from “straight” corporate bonds to US asset-backed

75 securities. But these inflows came in the face of a declining dollar. They presumably were done by investors with access to dollar financing – so the investors were taking the credit risk but not the currency risk. The US banking system though wasn’t in aggregate providing credit to the rest of the world, so it wasn’t in a position to finance these purchases. Someone else was supplying a lot of dollar financing in the world’s offshore financial centers (London especially). Figure out who, and I suspect that you have figured out a lot.

A disaggregated plot of the different components of the US net debt position shows that the deterioration in the last decade reflects a rise in (net) official claims on the US, and a rise in (net) private holdings of US debt securities. The mechanics of the rise in official holdings are well known (China, China, China and to a lesser degree Japan, Russia, Saudi Arabia and Brazil). The mechanics of the rise in net private holdings of dollar securities less so. Who wanted to take US dollar risk as well as US credit risk? And how was the dollar risk of say European banks buying US ABS shed? A small point: some of the rise in private holdings may reflect disguised official flows, or at least official flows intermediated v private intermediaries. The US data shows that “official” investors had $3.5 trillion in “safe” US assets (I am setting aside official holdings of corporate equities, as those could be held largely by sovereign funds). Counting the PBOC’s other foreign assets and SAMA’s non-reserve foreign assets, the global pool of reserves was around $7.3 trillion at the end of 2008. If 60% of all reserves (a low end estimate) were in dollars, total central bank dollar holdings should be around $4.4 trillion; if 70% of all reserves (a high end estimate) are in dollars, the total rises to $5.1 trillion. That is a gap of between $900 billion and $1.6 trillion — a sizeable sum. Net private holdings of US debt are around $2.4 trillion, though gross holdings are obviously much larger.

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At least $300 billion of that is in offshore dollar deposits ($300 billion is the gap between the US data and the BIS data in table 5c), and quite possibly more. Some of the $350 billion in official holdings of “risk” assets shown in the US data is in central bank hands. But between $500b and $1000b is missing – perhaps because it is managed by private fund managers. Central banks handing dollars over to private managers thus could be one explanation for persistent private demand for dollar debt even as the dollar fell. But there are clearly others.

What of equities, and specifically portfolio equities?

77 The story here is simple. The value of US investment in foreign portfolio equities doubled, as a percent of US GDP, from 2003 to 2007. That isn’t primarily a reflection of large purchases of foreign equities by US residents. Cumulative purchases of foreign equities by US investors from the end of 2003 to the end of 2007 totaled $560 billion, implying valuation gains accounted for about $2.6 trillion of the $3.17 trillion total rise in US holdings of foreign equities. Rather it reflects the dollars’ depreciation, which pushed up the dollar value of US investments abroad – especially in Europe. And it reflects the fact that foreign stock markets dramatically outperformed the US stock market during this period. Foreign investors bought nearly as many US equities as US investors bought foreign equities ($520b v $560b); the rapid rise in the value of US equity investment abroad relative to foreign investment in the US reflects the underperformance of US equity markets. That in some sense is the great puzzle of the last six years. The US ran large deficits – and necessarily attracted large financial inflows – during a period when US markets consistently performed worse than foreign markets. Sure, that changed in the crisis. But the out- performance of the US then (US markets fell less than foreign markets) in the crisis hardly explains the persistence of inflows when returns on both safe and risky investments in the US lagged returns on comparable investments abroad. Foreign investors presumably weren’t buying US assets because they anticipated a US financial crisis. The ability of the US to finance large deficits – and run up a large debt stock – during a period when returns on US investments lagged is the central puzzle of the global flow of funds. And it seems to me that one at least has to consider the possibility that the financing that supported these deficits weren’t entirely a “market” outcome. * Some discrepancy between the stock and cumulative flows is to be expected — especially as the stocks get bigger. Things like the repayment of principal on Agency MBS and asset- backed securities make proper calculation of the flow difficult. The presence of a gap in the data isn’t a surprise. The surprise is that the revisions consistency work in the United States favor. http://blogs.cfr.org/setser/2009/06/28/the-evolution-of-the-united-states%e2%80%99- external-balance-sheet-in-the-last-decade-wonky/

78 Opinion

June 29, 2009 OP-ED CONTRIBUTOR The Dirty War Against Clean Coal By GREGG EASTERBROOK Washington WHILE President Obama’s cap-and-trade proposal to reduce greenhouse gases has been the big topic of recent environmental debate, the White House has also been pushing a futuristic federal project to build a power plant that burns coal without any greenhouse gases. Sounds great, right? Except the idea is a rehash of a proposal that went bust the first time around. More important, the technology already exists to make huge reductions in greenhouse emissions from coal, allowing power companies to begin cutting the carbon footprint of coal today. Instead, advanced-technology coal power sits on the shelf while regulators wait to see what happens with a project that may be just an expensive boondoggle. The big project, a public-private partnership called FutureGen, was first announced by George W. Bush in 2003. Dreading facing up to the problem of greenhouse gases from electricity generation, the Bush White House suggested that decisions should wait while FutureGen developed a coal-fired power with no emissions. FutureGen’s administrators spent five years on studies, proposals and studies of studies, but never broke ground for a test installation. Then, in a fit of integrity, the Department of Energy decided the project should be put in Illinois, a Democratic state — Midwestern coal is high in carbon, making this a logical choice — rather than in Republican Texas, which the White House preferred. The administration promptly canceled financing for FutureGen. But this month, Energy Secretary Steven Chu announced he was reviving the project, hinting that the ultimate cost may run to billions of dollars. FutureGen was better off canceled. Government is good at basic research, poor at commercial-scale applied energy technology. The Synthetic Fuels Corporation, a heavily subsidized attempt begun by the Carter administration to manufacture gasoline substitutes, flopped without ever producing a marketable gallon. The Energy Department has also financed such overpriced, unrealistic projects as the MOD-5B, a wind turbine that weighed 470 tons and stood 20 stories tall: it looked like a gigantic propeller intended to push the earth to a new star system. It ended up being sold for scrap. The Obama administration’s FutureGen plan calls for yet another year of study before any actual action; test runs may not begin for a decade. No wonder the project’s nickname is “NeverGen.” This is part of a Washington tradition — beginning pie-in-the- sky projects that create an excuse to avoid forms of conservation and greenhouse-gas reduction that are possible immediately. Companies including General Electric have already perfected technology to reduce emissions substantially, called “integrated gasification combined cycle” power. (Yes, it needs a better name.)

79 Current coal-fired power plants burn pulverized coal using a combustion process that hasn’t changed in a half a century. The new approach turns coal into a gas similar to natural gas, which runs through a device similar to a jet engine. Such plants can achieve near-zero emissions of toxic material and chemicals that form smog, and they require about a third less coal than regular coal-fired power plants to produce an equal amount of energy, which means about a third lower greenhouse gases. Beyond that, the promising technology of “sequestering” carbon dioxide — pumping it back into the ground to keep it out of atmosphere — appears for technical reasons to be impractical for conventional pulverized-coal power plants. But gasification plants have technical characteristics that should make “sequestration” of carbon feasible. A gasification power plant with sequestration would have around two-thirds lower greenhouse gases than a conventional coal-fired generating station. The first commercial gasification power plant, designed by General Electric for Duke Energy, is being built in . Yet, absurdly, most state public-utility commissions have denied requests to construct these environmentally friendly systems. Last year, Virginia denied a major utility’s request to build a coal-fired power plant that would have sequestered nearly all its carbon output. One reason Virginia gave for the denial was the higher up-front cost of a gasification plant. Yet, once greenhouse gases are regulated (and President Obama’s cap-and-trade plan would in effect tax carbon), the economics of gasification plants may become attractive, with low-emission plants costing less to run. Another reason for the denials is that utility commissions are waiting for the outcome of the FutureGen experiment. This is a classic instance of the best being enemy of the good. Rather than starting to cut coal-caused carbon emissions right now, we are waiting to see if a hypothetical system could achieve perfection decades from now. Meanwhile, emissions continue willy-nilly. FutureGen is politically appealing: contractors get subsidies, politicians get to hand out money in their districts and astonishing breakthroughs are promised at unspecified future dates. Why aren’t progressives fighting for an immediate embrace of gasification power? Much of the environmental movement clings to a fairyland notion that coal combustion can soon be eliminated, and therefore no coal-fired power plant of any kind, even an advanced plant, should be built. Reflecting this mindset, Senate Majority Leader Harry Reid has said he opposes integrated gasification plants — only new solar, wind and geothermal facilities should be allowed. Environmentalists who correctly point out there can never be absolutely “clean coal” thus end up in the position of opposing coal that’s far cleaner than what we are using. Yet coal use is a future certainty. Half of our power comes from coal, versus about 2 percent from solar and wind: in the next few decades, green power simply cannot grow quickly enough to eliminate the need for coal. We have two choices: do nothing and wait for FutureGen while coal-caused carbon emissions continue unabated; or start building improved coal-fired plants that reduce the problem. Which seems more forward- thinking? Gregg Easterbrook is the author of “The Progress Paradox” and the forthcoming “Sonic Boom.” Gregg Easterbrook The Dirty War Against Clean Coal June 29, 2009: http://www.nytimes.com/2009/06/29/opinion/29easterbrook.html?th=&emc=th&pagewanted=print

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Opinion

June 29, 2009 OP-ED COLUMNIST Betraying the Planet By PAUL KRUGMAN So the House passed the Waxman-Markey climate-change bill. In political terms, it was a remarkable achievement. But 212 representatives voted no. A handful of these no votes came from representatives who considered the bill too weak, but most rejected the bill because they rejected the whole notion that we have to do something about greenhouse gases. And as I watched the deniers make their arguments, I couldn’t help thinking that I was watching a form of treason — treason against the planet. To fully appreciate the irresponsibility and immorality of climate-change denial, you need to know about the grim turn taken by the latest climate research. The fact is that the planet is changing faster than even pessimists expected: ice caps are shrinking, arid zones spreading, at a terrifying rate. And according to a number of recent studies, catastrophe — a rise in temperature so large as to be almost unthinkable — can no longer be considered a mere possibility. It is, instead, the most likely outcome if we continue along our present course. Thus researchers at M.I.T., who were previously predicting a temperature rise of a little more than 4 degrees by the end of this century, are now predicting a rise of more than 9 degrees. Why? Global greenhouse gas emissions are rising faster than expected; some mitigating factors, like absorption of carbon dioxide by the oceans, are turning out to be weaker than hoped; and there’s growing evidence that climate change is self- reinforcing — that, for example, rising temperatures will cause some arctic tundra to defrost, releasing even more carbon dioxide into the atmosphere. Temperature increases on the scale predicted by the M.I.T. researchers and others would create huge disruptions in our lives and our economy. As a recent authoritative U.S. government report points out, by the end of this century New Hampshire may well have the climate of North Carolina today, Illinois may have the climate of East Texas, and across the country extreme, deadly heat waves — the kind that traditionally occur only once in a generation — may become annual or biannual events. In other words, we’re facing a clear and present danger to our way of life, perhaps even to civilization itself. How can anyone justify failing to act? Well, sometimes even the most authoritative analyses get things wrong. And if dissenting opinion-makers and politicians based their dissent on hard work and hard thinking — if they had carefully studied the issue, consulted with experts and concluded that the overwhelming scientific consensus was misguided — they could at least claim to be acting responsibly.

81 But if you watched the debate on Friday, you didn’t see people who’ve thought hard about a crucial issue, and are trying to do the right thing. What you saw, instead, were people who show no sign of being interested in the truth. They don’t like the political and policy implications of climate change, so they’ve decided not to believe in it — and they’ll grab any argument, no matter how disreputable, that feeds their denial. Indeed, if there was a defining moment in Friday’s debate, it was the declaration by Representative Paul Broun of Georgia that climate change is nothing but a “hoax” that has been “perpetrated out of the scientific community.” I’d call this a crazy conspiracy theory, but doing so would actually be unfair to crazy conspiracy theorists. After all, to believe that global warming is a hoax you have to believe in a vast cabal consisting of thousands of scientists — a cabal so powerful that it has managed to create false records on everything from global temperatures to Arctic sea ice. Yet Mr. Broun’s declaration was met with applause. Given this contempt for hard science, I’m almost reluctant to mention the deniers’ dishonesty on matters economic. But in addition to rejecting climate science, the opponents of the climate bill made a point of misrepresenting the results of studies of the bill’s economic impact, which all suggest that the cost will be relatively low. Still, is it fair to call climate denial a form of treason? Isn’t it politics as usual? Yes, it is — and that’s why it’s unforgivable. Do you remember the days when Bush administration officials claimed that terrorism posed an “existential threat” to America, a threat in whose face normal rules no longer applied? That was hyperbole — but the existential threat from climate change is all too real. Yet the deniers are choosing, willfully, to ignore that threat, placing future generations of Americans in grave danger, simply because it’s in their political interest to pretend that there’s nothing to worry about. If that’s not betrayal, I don’t know what is. http://www.nytimes.com/2009/06/29/opinion/29krugman.html?_r=1&th&emc=th

June 28, 2009, 3:04 pm Health care is not a bowl of cherries Or a carton of milk, or a loaf of bread. Both George Will and Greg Mankiw basically argue that we don’t need a government role because we can trust the market to work — hey, we do it for groceries, right? Um, economists have known for 45 years — ever since Kenneth Arrow’s seminal paper — that the standard competitive market model just doesn’t work for health care: adverse selection and moral hazard are so central to the enterprise that nobody, nobody expects free-market principles to be enough. To act all wide-eyed and innocent about these problems at this late date is either remarkably ignorant or simply disingenuous.

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Bulletin of the World Health Organization Print version ISSN 0042-9686 Bull World Health Organ vol.82 no.2 Genebra Feb. 2004 doi: 10.1590/S0042-96862004000200012 PUBLIC HEALTH CLASSICS

Kenneth Arrow and the birth of health economics William D. Savedoff Health Financing and Stewardship, Evidence and Information for Policy, World Health Organization, Geneva, Switzerland (email: [email protected])

Forty years ago, Kenneth Arrow published "Uncertainty and the welfare economics of medical care" in The American Economic Review (1). This paper became not only one of the most widely cited articles in the field of health economics — indeed, it marked the creation of the discipline — but also a source of reference in other fields. A search on the ISI Web of Knowledge generated 771 citations that include journals in all parts of the world and in fields as varied as public choice, sociology, banking, education, environment, law and clinical practice, and even space policy. Furthermore, the article's relevance is far from diminishing over time: citations between 1991 and 2000 were five times more numerous than those between 1963 and 1972 (2). The first reason for this article's continuing popularity is its intellectual elegance and insight. The second is that it touches on a core feature of public health policy debates: the extent to which market or non-market institutions play fundamental and socially desirable roles in the provision and distribution of health care services. In 1963, Arrow was already well established as a leading economist, having published (with Debreu) seminal work on competitive equilibrium that provided the foundation for modern economic thinking about the extent to which markets can or cannot reach welfare-maximizing equilibria. Previously, he had developed the impossibility theorem for which he later won the Nobel Prize. In that work, he demonstrated the difficulty of finding any collective decision-making process that can provide consistent ordering of social preferences. Arrow had not previously written about health and rarely returned to the subject in his subsequent work. The article extracted here resulted from an invitation from the Ford Foundation to promote greater exchange between economists and other professions in the areas of health, education and welfare. Arrow therefore had to learn about health care and health insurance services before he could apply himself to the question. The article begins with reference to the desirable properties of perfectly competitive markets, using concepts from Arrow's general welfare theorems. He then explores how the existence of "uncertainty in the incidence of disease and in the efficacy of treatment" leads competitive markets to generate an inefficient allocation of resources and

83 contributes to the emergence of non-market institutions (such as trust and norms) that compensate for these market failures. In demonstrating the kind of market failure that derives from uncertainty and related problems of information, Arrow helped to generate a vast literature dealing with problems in markets ranging from health insurance to used cars (3, 4). He also opened the way for agency models to be applied to studies of physician behaviour (5). By developing the implications of uncertainty on markets and market equilibria, Arrow established principles that have been found useful in subjects other than health. His insight applies to any analysis in which costly information compromises a system's ability to generate preferred aggregate outcomes from decentralized actions. It is this generalized applicability that accounts for the article's wide range of citations across various fields. The article was written, however, specifically about health care (Arrow is careful to stipulate that he is discussing only medical services and not health per se), and its longevity also derives from its comprehensive treatment of the central issue in most public health policy debates: what roles are effectively played by markets and what roles are best left to non-market institutions. The article is sometimes cited to demonstrate that health care is not as exceptional as many people claim and that market mechanisms can play an effective role in the medical care industry in the same way as they do in other economic activities (including sectors with an effect on health, such as food and housing). In contrast, it is also cited to demonstrate that market failures in health care justify the creation or preservation of non-market institutions. Arrow writes that non-market institutions can (but not necessarily do) enhance the efficiency of the medical care system. In this respect, he cautions against viewing all efforts by physicians to ration entry to medical schools or to require professional licensing as mere ruses to raise their incomes. He goes further to conjecture that, in situations where markets fail, societies will create non-market institutions to correct the resulting inefficiencies. This conjecture has proved controversial, yet it provides fertile ground for developing theories on the formation of social institutions. To follow Arrow, such a theory would have to take account of conditions under which different interest groups find ways to cobble together social institutions that are mutually beneficial, even when such institutions may require some degree of self-restraint or compromise on the part of those same groups. In many ways, it is remarkable that "Uncertainty and the welfare economics of medical care" has stood the test of time. In 1963, medicine still consisted largely of a single physician treating a single patient with relatively rudimentary remedies and medications. Since that time, medicine has been revolutionized by technological advances in the understanding and treatment of illnesses, and rising incomes have stimulated high and increasing levels of spending. In the United States of America in the early 1960s, government involvement with medical care was limited; insurance covered less than half of all medical expenditures, compared with about 85% today. Since then, health care has been transformed by, among other things, Medicare and Medicaid, malpractice, and managed care. The non-market institutions that Arrow had observed, such as trust that physicians would not be motivated by profit and beliefs that the medical profession could regulate itself, have eroded.

84 Elsewhere, changes in health care have been no less remarkable. Spending on health services has increased dramatically in all of the world's high- and middle-income countries, leading to increased concerns about cost-containment, quality and responsiveness. Many of these countries, even if they have predominantly public systems, have introduced more market elements to relieve pressure on public services or to encourage greater productivity and allocative efficiency. Tensions in developing countries run high, as rising aspirations continue to outstrip the local resources available to meet them. Countries in Latin America — which had hoped to follow the western European models of social insurance expansion — have been blocked by the slow expansion of the formal labour market and low productivity in public institutions. In most of Asia, private fee-for-service arrangements continue to dominate, with few insurance products emerging. The former communist nations of eastern Europe and central Asia are dealing with the collapse of national health services and turning to social insurance arrangements, while African countries are struggling under extremely limited resources and increasing disease burdens, notably from the spread of HIV/AIDS. In fact, no country today appears to be happy with its health system. Few health systems resemble those of the world Arrow wrote about in 1963. Instead, they now encompass, to varying degrees, highly specialized, interrelated and costly services funded by complex financial and insurance mechanisms. Today's struggles over public policy for health services are really efforts to develop a new set of non-market institutions adequate to manage this rapidly changing industry. The resulting debates over the boundary between individual decisions in market settings (for example, choice of a physician or insurance plan) and collective decisions in non market settings (for example, global budgets or mandatory insurance coverage) will continue to motivate polemics, movements and studies. Thus the main messages of Arrow's article and his approach to understanding the health service sector will remain relevant for a long time to come.

References 1. Arrow KJ. Uncertainty and the welfare economics of medical care. The American Economic Review 1963;53:941-73. 2. Kenneth Arrow and the changing economics of healthcare (special issue). Journal of Health Politics, Policy and Law 2001;26:823-1214. 3. Rothschild M, Stiglitz J. Equilibrium in competitive insurance markets: an essay on the economics of imperfect information. Quarterly Journal of Economics 1976;90:629- 49. 4. Akerlof G. The market for lemons: qualitative uncertainty and the market mechanism. Quarterly Journal of Economics 1970;84:488-500. 5. Evans R. Supplier-induced demand: some empirical evidence and implications. In: Perlman M, editor. The economics of health and medical care. London: MacMillan; 1974. p. 162-73.

This section looks back to some of the ground-breaking contributions to public health, reproducing them in their original form and adding a commentary on their significance from a modern-day perspective. William D. Savedoff reviews the 1963 paper by Kenneth

85 Arrow that launched the discipline of health economics; extracts from the original article are reproduced by permission of the American Economic Association.

ENTREVISTA: Econonía global STEPHEN ROACH Presidente de Morgan Stanley Asia "Los mercados se están equivocando" ALICIA GONZÁLEZ 28/06/2009 A su paso por Madrid, antes de dar una conferencia en la Fundación Rafael del Pino, Stephen Roach lamenta no haber podido disfrutar de alguna corrida de toros. "He estado en varias, en México, en Francia...". El toro, en economía, es el símbolo de un mercado alcista y el oso el de un mercado a la baja. En su etapa como economista jefe de Morgan Stanley era considerado el "más pesimista entre los osos". Algo de eso queda.

Stephen Roach, durante su visita a Madrid esta semana.- SAMUEL SÁNCHEZ Pregunta. Después de años de recibir críticas, ¿se siente vengado con la crisis? Respuesta. Absolutamente. Las advertencias que he hecho durante años se referían a la preocupación por la acumulación de burbujas de activos en todo el mundo y por los desequilibrios globales creados entre países con déficit de ahorro, como EE UU, y los países con superávit, el caso del sureste asiático y en especial China. Pero mientras duran las burbujas nadie escucha porque las burbujas son seductoras, parece que todo sube. Mi teoría era que cuanto más esperáramos peor final tendría ese juego. Aunque para ser honesto nunca pensé que ese final fuera tan catastrófico. P. ¿Hay todavía hoy razones para el pesimismo? R. Lo peor de la crisis, en cuanto al funcionamiento de los mercados y de las instituciones financieras, ya ha quedado atrás pero todavía hay mucho que purgar. Se ha llevado a cabo el 60% y queda otro 40%. Pero lo más importante es que el tamaño real de la economía mundial se ha visto seriamente afectado por las burbujas de activos y los desequilibrios y sus consecuencias van a durar varios años. P. ¿Qué pasa entonces con los tan publicitados brotes verdes? R. Es una metáfora muy superficial hecha por gente desesperada. La tasa de caída era enorme y ahora se ha reducido ¡pero la economía sigue cayendo! ¿Dónde están los brotes verdes ahí?

86 P. ¿Y cuándo serán reales? R. Va a ser un proceso muy, muy lento. Esta recuperación va a ser muy débil durante varios años, tanto en EE UU como en el resto del mundo. Así que nadie espere verlo pronto o va a quedar muy decepcionado. P. ¿Cómo será la recuperación? R. Claramente no va a tener forma de V, la que quiere todo el mundo, que después de una caída brusca se salga rápidamente y con fuerza. Ésa es por la que están apostando sin duda los mercados, pero se están equivocando. Tampoco creo que se produzca en forma de L, donde en realidad no hay ningún tipo de recuperación. Creo que tendrá más bien forma de sierra, con pequeñas recuperaciones y recaídas. P. Es decir, con forma de W. R. No me gusta emplear esa letra porque me recuerda al peor presidente de EE UU pero sí tendría ese tipo de característica aunque más prolongada. Un poco al estilo japonés, que tuvo periodos de crecimiento del 1% durante los años terribles de la década perdida. P. ¿Cree que hay una alternativa real al dólar? R. Por el momento no. Hay muchos riesgos en un sistema que se basa en el dólar como moneda de reserva, que depende de las autoridades que lo dirigen y del comportamiento de sus consumidores. El mundo parece que, finalmente, se da cuenta de esa concentración de riesgos. Pero cuando China, a través del gobernador del banco central, apuesta por una alternativa al dólar debería tener cuidado con sus deseos, no sea que se hagan realidad. No creo que la amenaza de las autoridades chinas de reducir la compra de deuda estadounidense tenga ninguna importancia inmediata. Su economía se basa en las exportaciones y con una moneda alternativa al dólar, la divisa china -el yuan o renminbi- se disparará y minará la competitividad de sus exportaciones. Así que hasta que el resto del mundo esté dispuesto a reducir su dependencia de EE UU, el dólar va a seguir siendo la divisa predominante. P. ¿Cómo está China? R. A finales del año pasado, China parecía muy débil pero el Gobierno ha sido agresivo en sus acciones de estímulo del crecimiento, aunque más del 70% del mismo se ha centrado en el sector más desequilibrado de su economía: la inversión fija. Éste representa el 40% del PIB, un porcentaje demasiado elevado, nunca ha sido tan alto en ningún país. Es sólo un estímulo temporal que sirve para ganar tiempo hasta que el resto del mundo retome el crecimiento y las exportaciones chinas vuelvan a crecer. Pero esta vez los consumidores de EE UU no van a volver así que el sector exterior chino va a tener mucha presión y estará más débil el próximo año. P. ¿Es más optimista con el resto de Asia? R. Soy muy optimista con el futuro de India pero el resto de Asia depende mucho de China. India es la historia prometedora en este momento, especialmente después de las elecciones que echaron a los comunistas fuera del Gobierno. Si India saca adelante las reformas -veremos cómo son los presupuestos que presenta el 7 de julio-, las perspectivas económicas del país son de lo más alentadoras. Cruzaremos los dedos... P. Hablando de reformas ¿qué le parece el plan de Obama? R. Es necesario pero no suficiente para sanear el sistema. Elude la cuestión principal: durante años EE UU llevó a cabo una política imprudente e irresponsable que provocó una burbuja de activos y de crédito y que permitió que se trasladaran a la economía real.

87 Todo el plan refuerza el poder de la institución que creó todo este monstruo con más poderes, que es la Reserva Federal, sin exigirle responsabilidades por sus actos. P. Hay quien dice que estamos sentando las bases de una nueva crisis... R. Si no abordamos todos estos problemas, sin duda veremos una nueva crisis. Eso seguro. P. ¿También en Europa? R. Europa fue la más lenta en dar respuesta a la crisis, el BCE mantuvo los tipos altos demasiado tiempo, no ha mostrado ninguna intención de ver el estado real del sistema, no ha hecho test de resistencia a sus bancos. La UE no contaba con un colchón de crecimiento cuando estalló la crisis, como EE UU o Asia, así que la recesión es bastante pronunciada. Además, va a verse perjudicada por los efectos de una moneda fuerte, que mina la competitividad de sus exportaciones. Las perspectivas no son maravillosas, aunque tampoco lo son para el resto del mundo. P. ¿Debería bajar tipos el BCE? R. Sí y creo que además debería abandonar el objetivo de inflación como su única misión. P. ¿Y cómo ve la economía española? R. Era yo el que le iba a preguntar por eso, ¿qué pasa?, ¿no es éste el lugar del milagro? P. Usted es el experto... R. España ha tenido su propia burbuja inmobiliaria. Hace unos cuantos años me decían "nosotros somos diferentes, estamos recibiendo muchos inmigrantes, nuestros bancos están bien gestionados". Pero la verdad es que el país vivía una burbuja, que ha acabado afectando a la economía real. Y ahora se está pagando un precio terrible. P. ¿Cómo se superan sus consecuencias? R. España no tiene la opción de la política monetaria pero sí de medidas drásticas contra los excesos del crédito hipotecario. Y, por supuesto, las recetas clásicas: la política fiscal, el gasto, las infraestructuras. Todo eso es muy importante. -

88

TRIBUNA: ECONOMÍA GLOBAL - coyuntura nacional ÁNGEL LABORDA La corrección del déficit exterior supera lo previsto ÁNGEL LABORDA 28/06/2009 Entre los datos más interesantes sobre la coyuntura española publicados en la semana última se sitúan los del comercio exterior de abril y la ejecución presupuestaria del Estado y del Sistema de la Seguridad Social hasta mayo. En el ámbito internacional la OCDE publicó sus Perspectivas Económicas de primavera, que incluyen previsiones para España. La OCDE pronostica una caída del PIB del 4,1% en 2009 para el conjunto de la treintena de países miembros y una modesta recuperación del 0,7% en 2010. Dicha recuperación estará liderada por EE UU y, en menor medida, por Japón, mientras que la zona del euro tendrá que esperar a 2011 para ver tasas medias anules positivas. Es curioso que el terremoto de la crisis se esté sintiendo con menos fuerza allá donde se situó su epicentro. El fuerte ajuste a la baja del gasto interno en el país americano y la depreciación del dólar, con la consiguiente mejora de la aportación de su sector exterior al crecimiento, explican esta paradoja. Algo parecido a lo que está sucediendo en España, aunque aquí sin devaluación y con mucho más ajuste del gasto interno. La OCDE estima en un 4,2% la caída del PIB español en 2009, seis décimas menos que el conjunto de la zona euro, si bien, la salida de la crisis será más lenta, pues en 2010 aún se registrará una tasa negativa de -0,9%, mientras que en la zona euro el PIB se mantendrá estable. Es éste un escenario bastante cercano al contemplado por el consenso de analistas privados españoles. Los datos del comercio de abril mostraron una intensificación de las caídas de las exportaciones e importaciones en volumen. No obstante, hay que tener en cuenta que estos datos se publican sin corregirlos de calendario laboral, por lo que sus tasas de variación están sesgadas por el efecto de la Semana Santa, que este año se celebró en abril mientras que en 2008 se hizo en marzo. Lo más adecuado, por tanto, es hacer la media de los dos meses. En estos términos, se observa una sorpresa positiva en el comportamiento de las exportaciones de marzo y abril, ya que su nivel, corregido de estacionalidad, ha repuntado notablemente respecto a los meses de enero y febrero. Como se observa en el gráfico superior izquierdo, las exportaciones medias de los dos primeros meses del año se redujeron nada menos que un 12% respecto a la media del cuarto trimestre, mientras que la media de marzo y abril ha registrado un aumento de casi el 9% respecto a enero-febrero, aunque aún se sitúa un 17% por debajo de un año antes. Si en mayo y junio se mantienen las cifras de los dos últimos meses, el segundo trimestre del año puede dar una sorpresa en el comportamiento de las exportaciones, que podrían registrar una aportación positiva al crecimiento trimestral del PIB tras tres trimestres de aportaciones negativas. Este comportamiento se observa también en otros países, lo que parece indicar que los efectos más devastadores del terremoto financiero sobre el comercio internacional ya han quedado atrás. No obstante, estos datos hay que tomarlos con cautela y deben ser confirmados en los próximos meses.

89 En cambio, las importaciones de marzo y abril continuaron descendiendo a un ritmo similar al que registran desde el segundo trimestre de 2008. Su nivel medio en estos dos meses fue casi un 6% inferior al de enero-febrero, el cual había sido también un 6% inferior al del cuarto trimestre del pasado año. Respecto al mismo periodo del año anterior, las importaciones medias de marzo y abril han caído casi un 28%. Combinando el crecimiento de las exportaciones con la caída de las importaciones, la aportación del saldo exterior de mercancías al crecimiento del PIB en estos dos meses ha sido muy considerable. Si a este mejor comportamiento de las exportaciones respecto de las importaciones en términos reales unimos la menor caída de los precios de las primeras respecto de las segundas, el resultado es una intensa corrección del déficit comercial con el exterior, que en marzo-abril ha sido un 59% inferior al de un año antes y en los cuatro primeros meses del año, un 49%. Continúa, por tanto, la corrección de los desequilibrios de la economía española, y a un ritmo superior al previsto, lo cual es un signo positivo ante la esperada recuperación.

90 Negocios TRIBUNA: Laboratorio de ideas JUAN IGNACIO CRESPO Adivina qué crisis viene esta noche JUAN IGNACIO CRESPO 28/06/2009 En una crisis financiera de las dimensiones de la actual sorprende que aún no se haya producido algo que suele ir inevitablemente asociado a esta clase de situaciones: las convulsiones en los mercados de divisas. Efectivamente, haciendo un repaso de los momentos más delicados por los que pasó la economía mundial a lo largo del siglo XX, siempre la crisis de una moneda más importantes (o de todo el sistema de relaciones entre ellas) aparece como uno de los elementos más destacados. Así, los años setenta, tan problemáticos, antes que con sus dos crisis energéticas se inauguraron con la decisión del presidente de EE UU Richard Nixon de declarar el dólar no convertible en oro a partir del 15 de agosto de 1971 (hasta entonces tal conversión era posible y, de hecho, el General De Gaulle amenazó a los EE UU con exigirla para los dólares en poder del Banco de Francia). Después vendrían las dos crisis energéticas, la inflación y el estancamiento. Más reciente está en el recuerdo de los europeos en general y de los españoles en particular el que la recesión económica de los primeros años noventa coincidiera con un fuerte deterioro de la relación entre las monedas que formaban el Sistema Monetario Europeo; tan fuerte, que la libra esterlina y la lira se vieron obligadas a abandonarlo, mientras que la peseta pasaba por el calvario de sufrir tres devaluaciones diferentes entre 1992 y 1993. A pesar de las enormes diferencias, la tendencia a comparar la crisis actual con la Gran Depresión de los años treinta ya casi ha adquirido carta de naturaleza. Uno de los elementos distintivos de aquella crisis, que no han tenido su correlato en ésta, es el desmoronamiento primero y la desaparición después de lo que entonces era la base de las políticas monetarias y de las relaciones de cambio internacionales, el patrón oro. Desde comienzos de la década de los treinta y a pesar de haber sido restaurado tras la I Guerra Mundial, todos fueron abandonándolo paulatinamente. Nada comparable ha sucedidoen esta ocasión. Es decir, en cada una de esas tres grandes crisis, las dudas sobre la conveniencia de mantener el patrón oro, sobre la capacidad del dólar de continuar siendo el pivote del nuevo orden monetario internacional nacido de Bretton Woods, o sobre la estabilidad del Sistema Monetario Europeo acompañaron a los problemas económicos del momento. ¿Va a ser diferente esta vez? - Añoranza de una crisis Parece, pues, sorprendente el que esta vez los problemas no se hayan trasladado al mercado de divisas. De hecho, solo han apuntado en esa dirección los comentarios de algunos responsables políticos o monetarios que, so capa de expresar alguno de sus deseos o temores, parecen estar convocando unos cambios que, cuando lleguen, no se producirán sin traumas.

91 En efecto, durante los tres últimos meses, desde el gobernador del Banco de China (Zhou Xiaochuan) hasta el Presidente ruso (Dmitry Medvedev) pasando por el gobernador del Banco de Inglaterra (Mervyn King) todos han apuntado, abiertamente o no, a un problema, imaginario por ahora, que un buen día podría hacerse realidad: la crisis del dólar. La inquietud proviene de que sus respectivos bancos centrales mantienen, como todos, una enorme porción de sus reservas de divisas en dólares, buena parte de las cuales están invertidas en deuda pública norteamericana (las de China, que ascienden a un contravalor en dólares de dos billones, son las más importantes del mundo). ¿Por qué una crisis del dólar? Es verdad que tras la experiencia de las décadas de los setenta y ochenta la crisis en los mercados de divisas se identificaba con las crisis del dólar. Incluso cuando éste mostraba su mayor fortaleza, a mediados de la era Reagan, esa misma fuerza se consideraba un problema que necesitaba corrección y se hacían cumbres internacionales para alcanzar acuerdos (entonces del G-5) para acordar la manera de debilitarlo. Sin embargo, desde hace casi 25 años, el dólar ha evolucionado de manera natural, fortaleciéndose o debilitándose en ciclos más o menos largos y sin que en los mercados de divisas se produjeran sustos inesperados. Es más, el principal argumento para justificar una crisis del dólar, el desmesurado gasto del gobierno USA, podría aplicarse también a las demás monedas importantes. La explicación de la ausencia de una "crisis del dólar" no es demasiado compleja: las grandes crisis en los mercados de divisas se producían en los tiempos en que los sistemas que las ligaban eran rígidos, con lo que la presión sobre alguna de ellas terminaba produciendo saltos o discontinuidades en las fechas en las que se devaluaban o revaluaban; o en las que una de ellas perdía su cualidad más apreciada (como ser convertible en oro), o en que resultaba imposible mantenerlas dentro de unos límites prefijados (caso del Sistema Monetario Europeo). - Los ciclos del dólar Desde Desde que, tras la II Guerra Mundial, el dólar se convirtiera en el pivote del sistema financiero internacional, podría decirse que inició su declive secular. Probablemente ese declinar había comenzado un poco antes, con la devaluación decretada por el Presidente de los EEUU Franklin Delano Roosevelt en 1933 (haciéndolo pasar de 20,67 a 35 dólares/onza) y fue profundizándose con la aparición de economías potentes que competían con la norteamericana, fundamentalmente Alemania y Japón, y el fortalecimiento de sus monedas respectivas, el marco y el yen. Ese declive secular del dólar ha continuado durante las últimas décadas, acentuado por el papel que como moneda de reserva ha ido adquiriendo el Euro y también por la potencia creciente de las economías del Sudeste Asiático. Y si bien no es la primera vez que se cuestiona su papel como moneda de reserva para los bancos centrales, hasta ahora ese cuestionamiento parecía cosa más bien propia de servicio de estudios que de declaraciones de responsables de primeras potencias mundiales. Los ciclos de fortaleza y debilidad del dólar hacen que los argumentos a favor y en contra de estas tesis parezcan exagerados unas veces y timoratos otros. Desde 1971 el dólar ha tenido tres grandes movimientos: de debilidad hasta 1980; de fortaleza, durante los 22 años siguientes, y de debilidad desde 2002 de nuevo. Todo ello compatible con sub-períodos alternativos de debilidad o fortaleza dentro de cada una de las fases más largas.

92 Ahora, en mitad de la crisis, el dólar parece estarse comportando como lo hizo durante las recesiones económicas de los años setenta y ochenta en las que entró con relativa fuerza, para debilitarse posteriormente y, finalmente, salir de la crisis reforzado. Este patrón de comportamiento es perfectamente compatible con su declive secular o de largo plazo. - No será una crisis del dólar Cuando hace unos meses el gobernador del Banco Central chino mostró la desazón que le provocaba la futura evolución del dólar propuso la utilización de los Derechos Especiales de (o SDR, por sus siglas en inglés) como alternativa. Los SDR son una cesta de diferentes monedas (dólar, euro, yen y libra en diferentes proporciones) que emite el FMI, se utilizan para el comercio y las finanzas internacionales y hoy por hoy no existen más que en cantidades muy limitadas. Es tanto como proponer que el FMI juegue un papel mucho más importante en el sistema financiero internacional. La expresión de semejante deseo por parte de las autoridades chinas apunta de manera involuntaria a dos hechos que probablemente no desean tanto: la inclusión del yuan en ese grupo de monedas que forman los Derechos Especiales de Giro (quizá tan pronto como el año que viene) y la presión para que el yuan sea declarado convertible. Con una economía como la china, en vías de convertirse en la segunda más importante del mundo, y si el yuan quiere jugar el papel que le corresponde en el comercio internacional, todo eso sería la evolución más natural. Para ello el yuan tendría que abandonar antes el corsé que lo mantiene ligado al dólar y que le impide flotar libremente en los mercados de cambio. Y ese momento, cuando llegue, será la discontinuidad en el mercado de divisas que aún no ha tenido lugar en esta crisis ya que, probablemente cursará con una gran apreciación del yuan frente al dólar, primero, y una apreciable depreciación después (cuando el incremento del consumo interior en China lleve al incremento de las importaciones y a la disminución de sus reservas de divisas). La crisis que aún no se ha producido será pues, si llega, una crisis del yuan (aunque en algún momento pueda parecer que es una crisis del dólar). Con independencia de que ambos vayan a jugar un papel dominante en el futuro, disputándose, si la transición política en China no lo desbarata todo, la hegemonía mundial. -

93 Jun 28, 2009 China's Super-Sovereign Reserve Currency Idea: Could the SDR Be a Reserve Currency? o Chinese officials have been suggesting that the international monetary system be revised, with a particular focus on alternatives to the US dollar in its role as the key global reserve currency. They have also suggested the reserve currencies should not be subject to major exchange rate moves to minimize volatility to other economies. o In March 2009, Zhou Xiaochuan, the Chinese Central Bank governor proposed an overhaul of the global monetary system, suggesting that the U.S. dollar could eventually be replaced by the IMF's Special Drawing Right (SDR) as the world's main reserve currency as it might reduce the pro-cyclicality in the international system. o PBoC Financial Stability Report (June 2009) To avoid intrinsic shortcomings in using a sovereign currency as a reserve currency, we need to create an international reserve currency that is divorced from sovereign states and can maintain a stable value over the long term (via Reuters) It also suggested that the IMF step up its review of the economic and monetary policies of reserve currencies to encourage stability, a view previously expressed by finance ministry officials o Roubini: The process that will lead - in the medium-long term - to a challenge of the US dollar as the major global reserve currency has started. The US creditors - the BRICs, the Gulf states and others - are becoming increasingly alarmed that the US will deal with its unsustainable fiscal path via inflation and debasement of the value of the dollar via depreciation. So they will not sit idly waiting for this to happen: they are already diversifying into gold, into resources (as China purchases mines and energy, mineral and commodity resources all over the world). o Zhou: The frequency and intensity of financial crises following the collapse of the Bretton Woods system suggests costs of the dollar-based system may have exceeded its benefits and that that the SDR could take on a key global role. Issuing countries of reserve currencies are constantly confronted with the Triffin dilemma, either failing to adequately meet the demand for global liquidity as they try to ease inflation pressures at home, or create excess liquidity in the global markets by overly stimulating domestic demand. Furthermore, member countries reserves could be entrusted to the IMF, pooling their reserves o Russian President Medvedev has proposed regional reserve currencies as part of the drive to address the global financial crisis, shifting away from the U.S. dollar however many of the underlying currencies are not convertible. (Ziemba)

94 About the SDR o Pettis: As the key of the reserve currency, the liquidity of SDR and other alternatives cannot match the US dollar. o Humpage: The IMF created SDRs as an international reserve currency in the late 1960s to solve problems, similar to Dr. Zhou’s concerns, which rose out of the Bretton Woods. Adopting the SDR as an official international reserve asset may be technically feasible, but substituting the SDR for the dollar more broadly as the world’s key international currency will not happen anytime soon. People reap substantial economies from conducting cross-border commerce in dollars, and until the SDR matches these benefits, central banks will still need dollars. In the interim, countries that want to limit their exposure to credit-based reserve currencies, like the dollar, might simply allow their currencies to appreciate. o According to Zhou: Necessary preconditions for a greater global role for the SDR - increase settlement between other currencies and SDR, promote its use in trade, create SDR denominated securities, expand currencies used in the SDR's basket, perhaps weighted by GDP o Several emerging market economies including the BRICs, Korea and Saudi Arabia plan to buy SDR denominated bonds issued by the IMF. These bonds would not only allow them to diversify their reserve assets but also provide limited duration funding for the IMF as it expands its mandate. o Accominotti: French experiences in the early 1930s, when the bank of France acquired large stock of GBP reserves are a reminder that when there is growing risk on reserves currencies, foreign reserves can be both a source of instability for the international monetary system, and a burden for large holders. o Foley: In the short term the costs to the US of losing its role as the reserve currency would be significant as it would lose seignorage benefits and ability to borrow in its own currency. In the longer term, the U.S. would benefit as it would regain some control over its currency. A central currency would make it harder for one country to get into so much debt to another. If the currency was increased along with global GDP it could provide a steady store of value. China and the IMF/Global Role o Chinese Article IV consultation has been delayed for several years, reportedly on differences on the RMB and the results of the IMF's multilateral exchange rate surveillance. o Setser: China has tended to argue that it had no choice but to build up dollar reserves so long as the dollar occupied a central place in the global financial system. But China didn’t have to peg to the dollar and keep its peg to the dollar unchanged as the dollar fell from 2002 to 2005 http://www.rgemonitor.com/26/China?cluster_id=13652

95 Jun 28, 2009 Japan Back in Deflation? Japan, which underwent deflation from 1999 to 2005, is back in deflation and may be facing a protracted period of falling prices due to anemic demand growth. CPI excluding fresh food fell 1.1% y/y in May, the steepest decline since records began in 1970 and the third consecutive month of negative growth. Core CPI inflation was negative for the fifth consecutive month in May. Wages slid 2.5% y/y in April 2009, extending their longest losing streak since 2003. The negative output gap is at its widest since records began in 1980. How Severe Will Deflation Be?

o IMF: With considerable slack in the economy, inflation is projected to remain mildly negative until 2011

o BNP: The low point for the core CPI will probably be in July-October 2009, when the index could plunge by more than 2% in reaction to crude oil-led gains posted the year earlier, but even after that a minus inflation rate of more than 1% is likely to take root for a while due tointensifying deflationary pressures

o Japan Center for Economic Research: Expect deflation to worsen to -2.9% by Q1 CY2011, which would be the worst figure seen since the collapse of Japan's economic bubble and indicates Japan teeters on the brink of a deflationary spiral

o Mary Stokes of RGE: Japan's slide into deflation could be longer-lasting than the 2010 recovery forecast by a number of economists, primarily because anemic domestic demand and real wages look unlikely to pick up anytime soon Inflation Trends

o Headline CPI inflation was -1.1% y/y in May 2009 o CPI excluding fresh food fell 1.1% y/y, the steepest decline since records began in 1970

o Core CPI (excluding food and energy) fell 0.5% y/y in May 2009 after March posted the first year-over-year decline (-0.1%) since late 2007, raising concerns of a potential deflationary spiral

o The fall in the 'core core' CPI underlines that deflation might become an issue in Japan with the output gap opening up massively and the labor market getting weaker

o The meager inflation of recent years was predominantly from cost-push sources, like rising energy and material costs, rather than increasing domestic demand

o CGPI, or Corporate Goods Price Index, dropped a record 5.4% y/y May 2009 - the steepest fall since 1987 - led down by raw materials

96 o Japanese wages fell 2.5% in the year to April 2009, the 11th decline in a row, but a moderation from March when wages fell 3.9% y/y - the largest decline in nearly seven years

o The output gap fell 8.5% in Q1 2009, the biggest decline since the government started tracking the data in 1980, according to the Cabinet Office (Bloomberg) Deflation Drivers

o 1) Spare capacity - Falling machinery orders indicates increasing slack in the economy

o 2) Falling commodity prices since July 2008 o 3) Strength of yen vis-a-vis other major currencies o 4) Loss of export growth engine due to global downturn o 5) Anemic domestic demand o 6) Sluggish wages and employment Core CPI Forecasts

o FY 2008 CPI Inflation (excl. perishables): 1.2% (BoJ), 1.3% (MUFJ), 1.4% (Citigroup), 1.5% (JRI)

o FY 2009 CPI Inflation (excl. perishables): -1.5% (BoJ), -0.6% (MUFJ), -0.4% (Citigroup), -0.3% (JRI), less than -1% (BNP)

o FY 2010 CPI Inflation (excl. perishables): -1.0% (BoJ), 0.2% (MUFJ), -0.2% (Citigroup), 0.3% (JRI) http://www.rgemonitor.com/404/Japan?cluster_id=4062 Japanese Labor Market: Why Are Wages So Sluggish? Jun 27, 2009 Real wages have stagnated in Japan over the past decade. While labor income shares have declined in many advanced economies, wages in Japan have grown at an unusually slow pace (IMF). Japan now has one of the largest shares of 'working poor' - wages have fallen by around 10% (in nominal terms) over the past decade (Economist). EIU forecasts real wages will decline in 2009 for 3rd consecutive year. Wages are likely to keep falling; companies are responding to a sharp demand drop by retrenching overtime working hours (Morgan Stanley via Bloomberg) Explanations For Sluggish Wage Growth

o Deregulation/Growth in Part-Time Workers: Legal changes in late 1990s expanded the list of industries allowed to hire part-time and short-term workers (Economist). Since 2001, the proportion of Japan's workforce categorized as part- time workers has increased from 38% to 44% (Worsley). Average hourly wage of part-time employees is only 40% of that of regular workers, and they are exempt from some social insurance systems (OECD)

o Impact of Foreign Competition: Competitive pressures from emerging economies of inexpensive labor have become a major factor restricting increases in wages (IMF, Nishimura)

97 o Pay for Tenure is Weakening: Japanese employment system has traditionally been characterized by a strong relationship btwn a worker’s tenure (number of years the worker has worked at a firm) and higher wages. Numerous researchers have found the tenure and age wage curves in Japan are steeper than in other countries (Sparks) o Fiscal Situation: Severe fiscal conditions forced central as well as local govts to restrain wages of government and related agencies' employees, which had a spill-over effect on other service industries (Nishimura) Going Forward Labor force in Japan will continue to age in coming years and population age groups that will be coming into the labor force will likely be much smaller than currently. Consequently, there may be more competition for young labor and an increase in relative wages for younger workers (Sparks) http://www.rgemonitor.com/404?cluster_id=12605

98

Opinion

June 26, 2009 OP-ED COLUMNIST Not Enough Audacity By PAUL KRUGMAN When it comes to domestic policy, there are two Barack Obamas. On one side there’s Barack the Policy Wonk1, whose command of the issues — and ability to explain those issues in plain English — is a joy to behold. But on the other side there’s Barack the Post-Partisan, who searches for common ground where none exists, and whose negotiations with himself lead to policies that are far too weak. Both Baracks were on display in the president’s press conference earlier this week. First, Mr. Obama offered a crystal-clear explanation of the case for health care reform, and especially of the case for a public option competing with private insurers. “If private insurers say that the marketplace provides the best quality health care, if they tell us that they’re offering a good deal,” he asked, “then why is it that the government, which they say can’t run anything, suddenly is going to drive them out of business? That’s not logical.” But when asked whether the public option was non-negotiable he waffled, declaring that there are no “lines in the sand.” That evening, Rahm Emanuel met with Democratic senators and told them — well, it’s not clear what he said. Initial reports had him declaring willingness to abandon the public option, but Senator Kent Conrad’s staff later denied that. Still, the impression everyone got was of a White House all too eager to make concessions. The big question here is whether health care is about to go the way of the stimulus bill. At the beginning of this year, you may remember, Mr. Obama made an eloquent case for a strong economic stimulus — then delivered a proposal falling well short of what independent analysts (and, I suspect, his own economists) considered necessary. The goal, presumably, was to attract bipartisan support. But in the event, Mr. Obama was able to pick up only three Senate Republicans by making a plan that was already too weak even weaker. At the time, some of us warned about what might happen: if unemployment surpassed the administration’s optimistic projections, Republicans wouldn’t accept the need for more stimulus. Instead, they’d declare the whole economic policy a failure. And that’s exactly how it’s playing out. With the unemployment rate now almost certain to

1 http://en.wikipedia.org/wiki/Wonk_(character): Wonk is a character from The Adventures of Wonk by Muriel Levy with illustrations by Kiddell-Monroe. Published by Ladybird Books in the 1940s, these children's classics are now extremely rare. Wonk is a creature best described as a cuddly Koala-like bear who gets himself into all sorts of trouble. He is the constant companion of a little boy called Peter.

99 pass 10 percent, there’s an overwhelming economic case for more stimulus. But as a political matter it’s going to be harder, not easier, to get that extra stimulus now than it would have been to get the plan right in the first place. The point is that if you’re making big policy changes, the final form of the policy has to be good enough to do the job. You might think that half a loaf is always better than none — but it isn’t if the failure of half-measures ends up discrediting your whole policy approach. Which brings us back to health care. It would be a crushing blow to progressive hopes if Mr. Obama doesn’t succeed in getting some form of universal care through Congress. But even so, reform isn’t worth having if you can only get it on terms so compromised that it’s doomed to fail. What will determine the success or failure of reform? Above all, the success of reform depends on successful cost control. We really, really don’t want to get into a position a few years from now where premiums are rising rapidly, many Americans are priced out of the insurance market despite government subsidies, and the cost of health care subsidies is a growing strain on the budget. And that’s why the public plan is an important part of reform: it would help keep costs down through a combination of low overhead and bargaining power. That’s not an abstract hypothesis, it’s a conclusion based on solid experience. Currently, Medicare has much lower administrative costs than private insurance companies, while federal health care programs other than Medicare (which isn’t allowed to bargain over drug prices) pay much less for prescription drugs than non-federal buyers. There’s every reason to believe that a public option could achieve similar savings. Indeed, the prospects for such savings are precisely what have the opponents of a public plan so terrified. Mr. Obama was right: if they really believed their own rhetoric about government waste and inefficiency, they wouldn’t be so worried that the public option would put private insurers out of business. Behind the boilerplate about big government, rationing and all that lies the real concern: fear that the public plan would succeed. So Mr. Obama and Democrats in Congress have to hang tough — no more gratuitous giveaways in the attempt to sound reasonable. And reform advocates have to keep up the pressure to stay on track. Yes, the perfect is the enemy of the good; but so is the not- good-enough-to-work. Health reform has to be done right.

100

26.06.2009 Exporters face credit crunch

The FT reports that Germany’s BGA exporters’ association have forecast a “dramatic deterioration” in credit conditions in coming months, which would result in “massive financing squeeze”. It quotes the president of the association as saying that there are already difficulties for middle- and long-term credit. And the banks are now beginning to squeeze out short-term credit. The FT said the reality down on the ground is very different from politicians say who have argued that the export-dependent country is not facing problems in the supply of credit to business or households. French car industry in trouble Wreckage premium and moral-boosting words from the president were of little help: the French car industry is going down with 20000-30000 job losses expected this year in France, more than 10% of the workforce in the car industry, reports Les Echos. The insurer Euler Hermes estimates that more than 400 suppliers could go out of business. At Renault, the production is running at 50% of capacity. Hermes recommends more presence in emerging markets and new alliances to cut costs, nothing of which is about to happen. Defining the future The French government started its search for what could be priority investment projects worth to be debt financed. Les Echos reports that it already looks like the ideas are all over the place. Francois Fillon named biotechnology , energy, and electric cars while Sarkozy’s entourage listed ecology, research, education, training, industrial policy (!) and SMEs. Eric Woerth meanwhile starts by defining the projects as those that bring a return to future generations. Statistics tell us that France spends 6% of its budget on investment, against 34.5% on civil servants’ pay and 53.9% for consumption. But the statistical definition of investment is narrow, as it measures only infrastructure. Most of the priority

101 ideas would never be counted statically as investment but as consumption. Short term money market rates fall European short-term money market rates have fallen massively after the ECB’s €442bn 12-month repo which had the effect to oversupply the banking sector with new liquidity. The FT Deutschland reports that one-day money market rates fell to 0.25 to 0.5%, from previously prevailing levels of between 1 and 1.25%. A stimulus for a bureaucracy FT Deutschland leads with the story that Germany’s stimulus money is stuck in the local and land administration, and does not get through to industry. Of the €13bn earmarked for infrastructure and schools, only €11bn have been spent, as applications are getting stuck in local administrations, and this despite the fact that they have agreed to breach EU public procurement rules, so that for order up to €1m, the local administration is free to channel the money to local companies, without having to subject to EU-wide tenders. (This shows that infrastructure investments, necessary as they may be, are not well suited to stimulus programmes, given the long time it takes for such programmes to be shovel- ready). Von Hagen on taxes and debt rules In an interview with FT Deutschland, Jurgen von Hagen said Germany’s fiscal policy has been totally misguided, as it persistently ignored the inter-relationship between deficits and growth. He explicitly rejected calls for tax increases for the same reason, as they would reduce Germany’s potential growth rate. He said debt ceilings, such as the recently agreed constitutional change, do not work as they are too mechanistic, and lead to policy mistakes. He opposes the de-politicisation of fiscal policy, as fiscal policy is in its nature political. Spain Interrupted League tables are big in southern Europe. When Spain overtook Italy in terms of GDP- per-capita in 2006, it was headline news, and subject to mutual discriminations. The latest data, as reported by El Pais, are showing that Spain is falling back relative to the eurozone, a gap which it has been steadily close for 13 years until in 2008 the trend was reversed. In 2007, Spanish per capita GDP was 94.3% of the eurozone average. In 2008 it fell to 93.6% (and we would guess that 2009 and 2010 are going to be pretty years as well). Draghi warns of premature exit Il sole 24 ore quotes Bank of Italy governor Mario Draghi as saying that to overcome the global economic crisis two fundamental conditions have to be met, maintenance of consumer spending and continued strength of the labour market. He said it was far too early to put in place exit strategies at a time when the banking system is not yet repaired, and when the credit flows have not been restored. Well-being through balanced budget The Belgian Prime minister Herman Van Rompuy calls on regions and communities to work towards a balanced budget,” not as a federal dictate but because there is a general

102 interest to preserve our well being”, quotes Le Soir. No more foreign currency credits in Austria Foreign currency credits should come to an end in Austria, reports Der Standard. The National Supervisor FMA said that foreign currency credits should no longer be a standardised product; exceptions are subject to restrictive rules, i.e. for those, whose income or wealth is also in the same foreign currency. FMA leaves the detailed regulation to the banks, but announced tight controls in the next year. Greenspan on balance sheets This is an interesting comment from Alan Greenspan in the FT about the interrelationship between equity prices and the economy. He starts of saying that March-to mid-June rise in equity prices was the main reason for the green shoots, as the $12 trillion of new corporate equity value added to the capital buffer that supports the issue of debt. He says he accords a much larger economic role to equity prices than is the conventional wisdom. He says they are not merely an important leading indicator of global business activity, but a major contributor to that activity, operating primarily through balance sheets.

ft.com/economistsforum

Inflation - the real threat to sustained recovery June 26, 2009 4:57am by FT By Allan Greenspan The rise in global stock prices from early March to mid-June is arguably the primary cause of the surprising positive turn in the economic environment. The $12,000bn of newly created corporate equity value has added significantly to the capital buffer that supports the debt issued by financial and non-financial companies. Corporate debt, as a consequence, has been upgraded and yields have fallen. Previously capital-strapped companies have been able to raise considerable debt and equity in recent months. Market fears of bank insolvency, particularly, have been assuaged. Is this the beginning of a prolonged economic recovery or a false dawn? There are credible arguments on both sides of the issue. I conjectured over a year ago on these pages that the crisis will end when home prices in the US stabilise. That still appears right. Such prices largely determine the amount of equity in homes – the ultimate collateral for the $11,000bn of US home mortgage debt, a significant share of which is held in the form of asset-backed securities outside the US. Prices are currently being suppressed by a large overhang of vacant houses for sale. Owing to the recent sharp drop in house completions, this overhang is being liquidated in earnest, suggesting prices could start to stabilise in the next several months – although they could drift lower into 2010. In addition, huge unrecognised losses of US banks still need to be funded. Either a stabilisation of home prices or a further rise in newly created equity value available to US financial intermediaries would address this impediment to recovery.

103 Global stock markets have rallied so far and so fast this year that it is difficult to imagine they can proceed further at anywhere near their recent pace. But what if, after a correction, they proceeded inexorably higher? That would bolster global balance sheets with large amounts of new equity value and supply banks with the new capital that would allow them to step up lending. Higher share prices would also lead to increased household wealth and spending, and the rising market value of existing corporate assets (proxied by stock prices) relative to their replacement cost would spur new capital investment. Leverage would be materially reduced. A prolonged recovery in global equity prices would thus assist in the lifting of the deflationary forces that still hover over the global economy. I recognise that I accord a much larger economic role to equity prices than is the conventional wisdom. From my perspective, they are not merely an important leading indicator of global business activity, but a major contributor to that activity, operating primarily through balance sheets. My hypothesis will be tested in the year ahead. If shares fall back to their early spring lows or worse, I would expect the “green shoots” spotted in recent weeks to wither. Stock prices, to be sure, are affected by the usual economic gyrations. But, as I noted in March, a significant driver of stock prices is the innate human propensity to swing between euphoria and fear, which, while heavily influenced by economic events, has a life of its own. In my experience, such episodes are often not mere forecasts of future business activity, but major causes of it. For the benevolent scenario above to play out, the short-term dangers of deflation and longer-term dangers of inflation have to be confronted and removed. Excess capacity is temporarily suppressing global prices. But I see inflation as the greater future challenge. If political pressures prevent central banks from reining in their inflated balance sheets in a timely manner, statistical analysis suggests the emergence of inflation by 2012; earlier if markets anticipate a prolonged period of elevated money supply. Annual price inflation in the US is significantly correlated (with a 3½- year lag) with annual changes in money supply per unit of capacity. Inflation is a special concern over the next decade given the pending avalanche of government debt about to be unloaded on world financial markets. The need to finance very large fiscal deficits during the coming years could lead to political pressure on central banks to print money to buy much of the newly issued debt. The Federal Reserve, when it perceives that the unemployment rate is poised to decline, will presumably start to allow its short-term assets to run off, and either sell its newly acquired bonds, notes and asset-backed securities or, if that proves too disruptive to markets, issue (with congressional approval) Fed debt to sterilise, or counter, what is left of its huge expansion of the monetary base. Thus, interest rates would rise well before the restoration of full employment, a policy that, in the past, has not been viewed favourably by Congress. Moreover, unless US government spending commitments are stretched out or cut back, real interest rates will be likely to rise even more, owing to the need to finance the widening deficit. Government spending commitments over the next decade are staggering. On top of that, the range of error is particularly large owing to the uncertainties in forecasting Medicare costs. Historically, the US, to limit the likelihood of destructive inflation, relied on a large buffer between the level of federal debt and rough measures of total borrowing capacity. Current debt issuance projections, if realised, will surely place America precariously close to that notional borrowing ceiling. Fears of an

104 eventual significant pick-up in inflation may soon begin to be factored into longer-term US government bond yields, or interest rates. Should real long-term interest rates become chronically elevated, share prices, if history is any guide, will remain suppressed. The US is faced with the choice of either paring back its budget deficits and monetary base as soon as the current risks of deflation dissipate, or setting the stage for a potential upsurge in inflation. Even absent the inflation threat, there is another potential danger inherent in current US fiscal policy: a major increase in the funding of the US economy through public sector debt. Such a course for fiscal policy is a recipe for the political allocation of capital and an undermining of the process of “creative destruction” – the private sector market competition that is essential to rising standards of living. This paradigm’s reputation has been badly tarnished by recent events. Improvements in financial regulation and supervision, especially in areas of capital adequacy, are necessary. However, for the best chance for worldwide economic growth we must continue to rely on private market forces to allocate capital and other resources. The alternative of political allocation of resources has been tried; and it failed.

The writer is former chairman of the US Federal Reserve

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Autos June 24, 2009, 12:01AM EST text size: TT Can Tesla Become a Real Automaker? Even with $465 million of freshly minted taxpayer funds, the spunky U.S. startup faces a steep road to develop and market its electric cars By David Welch Once again, the federal government is handing billions of dollars to auto companies. The last round of loans raised the question of whether General Motors and Chrysler could shake off their creaky ways and survive to pay the money back. The question this time: Can Tesla Motors become enough like one of those old car companies? The latest round of handouts is coming from U.S. Energy Dept. funds to boost development of greener vehicles. The department issued $8 billion in loans on June 23, granting Ford Motor (F) $6 billion, Nissan Motor (NSANY) $1.6 billion, and tiny electric-car startup Tesla $465 million. While it's fair to say that Ford and Nissan have staying power, Tesla is a riskier bet. The Silicon Valley company faces a massive challenge to generate the kind of cash needed to develop new cars that will sell in sufficient volume to make real money eventually. While Tesla is racing to lower costs and hone the development of its first- generation Roadster—along with a fleet of less expensive, more mainstream cars—it's tough for any company to make a significant profit on low-volume cars. "The business model is wrong," says James N. Hall, principal of 2953 Analytics, a Detroit-area auto consultancy. "The prices of their cars are too low for the kind of technology they want to sell. You have to sell a lot of them. As production goes up, they will realize how undercapitalized they are." Greenbacks to Help Create Green Jobs Tesla plans to use $365 million of its loans to develop the Model S, a five-passenger, $50,000 sedan that is scheduled to go on sale in late 2011. The rest of the money will be used to build an electric-battery plant to sell Tesla's electric-drive technology to other carmakers. For their parts, Nissan says it will build an electric car in Tennessee and Ford will use the money to help fund a $14 billion push into advanced-technology vehicles. The financing fits the Obama Administration's goal of creating green jobs. "We have an historic opportunity to help ensure that the next generation of fuel-efficient cars and trucks are made in America," said President Barack Obama in a statement. Tesla's final loan repayment to taxpayers would be made in 2022, CEO Elon Musk said in a conference call with journalists. Musk says the company has lowered the cost of its $101,500 roadster to $80,000 per car, not including overhead. He says Tesla should start making money in July. The margins will be scant—even when the Model S comes out or if Tesla manages to realize Musk's dream of selling an affordable third-generation electric car that will sell

106 more than 100,000 units annually. "The goal is to make margins relatively lean to make the price of the cars as affordable as possible," Musk said. A Scramble for Money and Management Tesla's technology is impressive. From scratch—on less than $200 million in investment capital—the company delivered the Roadster, a battery-powered sports car with a body based on the Lotus Elise that's capable of going from zero to 60 mph in 3.9 seconds. The company claims to have sold 1,200 of them, and Tesla Chief Financial Officer Deepak Ahuja says the company has taken deposits for 1,200 Model S sedans. But since opening its doors in 2004, Tesla has been woefully unstable. The company has gone through four chief executives. The first, now-deposed Martin Eberhard, sued Tesla on June 11 for breach of contract and libel. Musk has spent the last year scrambling for cash. Late last summer the credit crunch undercut Tesla's attempts at a new round of private funding, so Musk had to pony up more of his own funds. As the company kept burning cash, it sold a 10% stake to German carmaker Daimler (DAI) for $50 million. Another challenge is the unpredictability of demand for electric cars. After 10 years, even such hybrid-electric cars as Toyota's (TM) Prius make up less than 5% of the U.S. car market. And when Tesla's Model S hits the market, Nissan, GM, Chrysler, and Toyota will either be selling electric cars or plug-in hybrids that appeal to the same tech-savvy, green buyers. "Tesla will find more and more competition," Hall says. If Tesla does come up with hit technology, a big player like Toyota could use its financial strength and technological prowess to develop a competing car very quickly, Hall points out. Having Daimler as a partner helps. Musk says Daimler can assist in developing big mechanical systems such as suspensions and can use its purchasing muscle to lower costs. Tesla also has a deal to supply electric-drive systems for Daimler's tiny Smart cars. If Tesla can sell other carmakers on the electric-drive systems from its planned battery- pack plant, it would gain an additional revenue stream to help defray its investment costs. But it won't be an easy road for the startup—and it's far from a sure thing for taxpayers. Return to the Auto Bailout Special Report Table of Contents GM looks to China, the UAW looks to the Feds Posted by: David Welch on May 14 General Motors said this week that the company has plans to build more cars in China and other low-cost countries for sale in the U.S. And out came the drama. Some critics argue that if GM is getting government loans to stay afloat, it shouldn’t be cutting jobs here and adding work in China. The United Auto Workers have had their say, as well. UAW Vice President Bob King has already criticized GM for its decision to build more cars in the China, Korea and Mexico while cutting workers here. And the union asked the U.S. Treasury Department to reject the company’s restructuring plan because it closes plants here while building more overseas. GM CEO Fritz Henderson then buckled to the pressure and told Bloomberg that GM could cut planned imports from China to keep help secure union concessions. Unless GM was just using import talk as a bargaining chip to pressure the union—which is possible—this is problematic. For sure, the government and the UAW are playing a

107 role in building a new GM, with Uncle Sam loaning money and taking an interest in GM while the union concedes thousands of jobs and cuts benefits. All that said, GM management has to be allowed to run the company. And there are two cold hard realities to business these days that support building cars in other countries and selling them here. One is cost. Not even the Japanese and Koreans make fat profits on small cars in the U.S. The pricing isn’t there and the total cost isn’t that much different for making some larger models. Many carmakers lose money on their compacts. The other is the very global nature of the car business. Plants and workers are expensive. If one market goes soft, a company needs to be able to sell the production elsewhere. Toyota has done this for years, toggling between selling the production from its Japanese plants in the U.S. or Japan to keep those plants running near full tilt. GM should be allowed to do the same thing. Of course, there is a slight problem, and one that the UAW will argue with plenty of merit. The Chinese government requires local partnerships and local parts content in the vehicles sold there. American imports get taxed at a fat 25% rate. So while GM could sell Chinese-made Buicks in the U.S. easily, sending American cars made by union hands over there is a lot more costly. GM does sell some American-made Cadillac models and the Buick Enclave suv in China. But with that tax rate, not to mention higher American labor rates, it only makes sense to export expensive luxury models from the U.S. to China. That won’t keep the union happy because that won’t translate into many jobs. So here’s a solution: The Treasury Department should ignore the bleating from labor about building more cars in China and let GM make its own business decisions. So far, Treasury has mostly been willing to do that. But the government needs to get China to level the playing field so that our cars can sell over there.

108 Jun 25, 2009 U.S. Credit Card Delinquencies/Charge-Offs At Record Highs: Lenders Step In Overview: Moody's credit card index charge-off rate, the write-down of uncollectable debt, advanced to a record high 9.97% in April. Moody's expects the credit-card charge- off rate to reach 12% by mid-2010 with unemployment peaking at 10%. RGE (Kruettli) estimates that the credit-card charge-off rate could reach 13% (or $146bn) with 10% unemployment rate. Meredith Whitney estimates that over $2 trillion out of $5 trillion of credit-card lines will be cut in 2009 and $2.7 trillion by the end of 2010. Research shows that unemployment is one of the most important drivers of credit card and auto loan loss rates.

o June 25 Moody's (via ZeroHedge): "Credit-card charge-off rates for May have now surpassed 10%. "This trajectory is consistent with our revised expectation for the charge-off rate index to peak in the second quarter of 2010 at about 12 percent, assuming an unemployment rate peak close to 10 percent in the first half of 2010," the report said."

o June 25 FT: Banks such as Citigroup, JPMorgan Chase and Bank of America have come to the rescue of the off-balance-sheet vehicles that help them to fund credit card loans. While most credit card securitizations are still well above loss triggers that force early repayment of investors, banks have a strong incentive to provide support before accelerating credit-card losses put the trusts in a danger zone.

o Meredith Whitney (via WSJ) March 10: "Currently, there is roughly $5 trillion in credit-card lines outstanding in the U.S., and a little more than $800 billion is currently drawn upon. Just six months ago, I estimated that at least $2 trillion of available credit-card lines would be expunged from the system by the end of 2010. However, today, that estimate now looks optimistic, as available lines were reduced by nearly $500 billion in the fourth quarter of 2008 alone. My revised estimates are that over $2 trillion of credit-card lines will be cut inside of 2009, and $2.7 trillion by the end of 2010." See also Credit Card Reform: What Impact On Consumers? On Banks? On Investors? Currently five lenders dominate two-thirds of the market.

o SIFMA: Q4 2008 marked the first time ever that four of the major sectors (home equity, credit card, student loan, and equipment leases) had no issuance. The asset-backed securities (ABS) market revived in the first quarter of 2009, spurred by the start of the Federal Reserve Board’s Term Asset-Backed Loan Facility (TALF) program. TALF-backed issuance from March to end-May amounts to 29 deals worth over $50billion (see William Dudley speech).

o Graef (Deutsche Bank): "Credit card debt grew strongly in absolute terms but was comparatively stable in relation to disposable income. In light of the virtually unchanged ratio of credit card debt to disposable incomes, we cannot detect a credit card bubble. This is why we do not expect an above-average increase in credit

109 card defaults, particularly in view of substantially lower credit card interest rates compared with earlier years."

o White (NBER/UCSD): Ratio of consumer debt to median income increased to 4.5 in 2007 from 1 in 1980 compared to a ratio of 3 for mortgage debt/median income. "High debt/misuse of credit cards" is the primary reason for increase in bankruptcy filings since the mid-1980s.

o Wieting (Citigroup): "Households shifted expensive credit-card debt to less expensive, tax-deductible mortgage credit in the early/mid 2000s. Revolving credit grew at an average 4.3%y/y pace in 2002-2007 vs 12.4% for mortgage debt. As such, credit-card delinquencies have been closer to “cyclical norms,” unlike housing. However, we believe the employment downturn will now drive cyclical delinquencies in cards too. Expect unemployment to rise to 8-10%."

o Mathias Kruettli (RGE): "Given that lending standards are being tightened across the board, a jump in the unemployment rate is likely to increase the default rate on credit card debt, which might lead to higher write-downs on the banks' credit-card portfolios."

o Kruettli (RGE): "The paper comes to the conclusion that write-downs in 2009 are likely to be significantly higher than in 2008 (US$50 billion). In the worst case scenario the credit card receivable write-downs could be as high as US$146 billion in 2009. In the best case the write-downs will be around US $64 billion. Currently, there are about $2.5T ABS receivables outstanding, including credit cards, auto loans, home-equity loans (Securities Industry and Financial Markets (SIFMA) estimate as of Q2 2008)."

o Fitch, DBRS: Report addresses the sensitivity of auto and credit-card transactions to unemployment, one of the most important macroeconomic indicators for consumer finance. Conclusions: - Changes in the unemployment rate are strongly correlated with changes in auto loan losses and credit-card chargeoffs; - Auto loan and credit-card asset-backed securities (ABS( loss rates are expected to increase in proportion to the increases in the unemployment rate; - Prime credit card chargeoffs are expected to increase on a 1:1 basis with respect to unemployment. Accordingly, a 100% increase in the base unemployment rate, from 5% to 10%, would lead to a 100% increase in the prime credit-card chargeoff index, from 6.18% (April 2008) to 12.36% over the next 12 months; - Subprime credit-card chargeoffs and prime and subprime auto loan net losses are expected to increase at a rate closer to 1.2−1.3:1, meaning a 100% increase in unemployment could lead up to a 130% increase in losses; - Consumers are more likely to default on credit cards more immediately than they default on auto loans following shocks to the labor markets; - While, on average, the ‘BBB’ or ‘AAA’ bonds could withstand an unemployment rate of up to 11% or 20% respectively before a default occurs, downgrades during these stresses would be inevitable http://www.rgemonitor.com/691/Securitization,_Structured_Finance,_and_Derivatives?cl uster_id=13338

110 Press Release

Release Date: June 25, 2009 For release at noon EDT The Federal Reserve on Thursday announced extensions of and modifications to a number of its liquidity programs. Conditions in financial markets have improved in recent months, but market functioning in many areas remains impaired and seems likely to be strained for some time. As a consequence, to promote financial stability and support the flow of credit to households and businesses, the Federal Reserve is extending a number of facilities through early 2010. At the same time, in light of the improvement in financial conditions and reduced usage of some facilities, the Federal Reserve is trimming the size and changing the terms of some facilities. Specifically, the Board of Governors approved extension through February 1, 2010, of the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF), the Commercial Paper Funding Facility (CPFF), the Primary Dealer Credit Facility (PDCF), and the Term Securities Lending Facility (TSLF). The expiration date for the Term Asset-Backed Securities Loan Facility (TALF) currently remains set at December 31, 2009. The Term Auction Facility (TAF) does not have a fixed expiration date. The extension of the TSLF also required the approval of the Federal Open Market Committee (FOMC), as that facility is established under the joint authority of the Board and the FOMC. In addition, the temporary reciprocal currency arrangements (swap lines) between the Federal Reserve and other central banks have been extended to February 1. The Federal Reserve action to extend the swap lines was taken by the FOMC. The Federal Reserve also announced changes to certain liquidity programs in light of the improvement in financial conditions and the associated reduction in usage of some facilities. Specifically, the Federal Reserve trimmed the size of upcoming TAF auctions, because the amount of credit extended under that facility has been well below the offered amount. In view of very weak demand at TSLF Schedule 1 auctions and TSLF Options Program auctions over recent months, auctions under these programs will be suspended. The frequency of Schedule 2 TSLF auctions will be reduced to one every four weeks and the offered amount will be reduced. The authorization for the Money Market Investor Funding Facility (MMIFF) was not extended, and an additional administrative criterion was established for use of the AMLF. If necessary in view of evolving market conditions, the Federal Reserve will increase the size of TAF auctions and resume TSLF operations that have been suspended. The Board and the FOMC will continue to monitor closely the condition of financial markets and the need for and effectiveness of the Federal Reserve's special liquidity facilities and arrangements. Should the recent improvements in market conditions continue, the Board and the FOMC currently anticipate that a number of these facilities may not need to be extended beyond February 1. However, if financial stresses do not

111 moderate as expected, the Board and the FOMC are prepared to extend the terms of some or all of the facilities as needed to promote financial stability and economic growth. The public will receive timely notice of planned extensions, discontinuations, or modifications of Federal Reserve programs. TAF and Swap Lines In recent months, conditions in wholesale funding markets have improved, and partly as a result, usage of the TAF and the dollar facilities provided by foreign central banks has declined notably. For some time, amounts bid at TAF auctions have fallen short of the amounts auctioned. In view of the decreasing need for TAF funding, the Board has reduced the amounts auctioned at the biweekly auctions of TAF funds from $150 billion to $125 billion, effective with the auction to be held on July 13. The Federal Reserve anticipates that, if market conditions continue to improve in coming months, TAF funding will be reduced gradually further. The extension of the dollar liquidity swap arrangements through February 1 currently applies to the swap lines between the Federal Reserve and each of the following central banks: the Reserve Bank of Australia, the Banco Central do Brasil, the Bank of Canada, Danmarks Nationalbank, the Bank of England, the European Central Bank, the Bank of Korea, the Banco de Mexico, the Reserve Bank of New Zealand, Norges Bank, the Monetary Authority of Singapore, Sveriges Riksbank, and the Swiss . The extension of the foreign currency swap arrangements currently applies to the swap lines between the Federal Reserve and the Bank of England, the European Central Bank, and the Swiss National Bank. The Bank of Japan will consider extensions of the dollar liquidity swap and the foreign-currency liquidity swap arrangements with the Federal Reserve and will announce its decision following its next Monetary Policy Meeting. TSLF and PDCF The Federal Reserve extended the TSLF, with certain modifications, and the PDCF through February 1. In view of the considerable progress to date in deleveraging by primary dealers and dealers' improved access to funding in the market for repurchase agreements, activity at the TSLF has fallen notably. In response, the Board and the FOMC approved certain modifications to the TSLF. In particular, TSLF auctions backed by Schedule 1 collateral (Treasury, agency debt, and agency-guaranteed mortgage-backed securities) will be suspended, effective July 1. Also, the Federal Reserve suspended the TSLF Options Program (TOP), effective with maturity of outstanding June TOP options. TSLF auctions backed by Schedule 2 collateral (Schedule 1 collateral and investment-grade corporate, municipal, mortgage-backed, and asset-backed securities) will now be conducted every four weeks, rather than every two weeks, and the total amount offered under the TSLF will be reduced to $75 billion. The Federal Reserve anticipates that the amounts auctioned under the TSLF will be scaled back further over time as permitted by market conditions. However, the Federal Reserve is prepared to resume Schedule 1 TSLF operations and TOP auctions and to increase the frequency and size of Schedule 2 auctions if warranted by evolving market conditions. Although the amount outstanding under the PDCF is currently zero, the Board believes it appropriate to continue to provide the PDCF as a backstop liquidity facility for primary dealers in the near term, while financial market conditions remain somewhat fragile. AMLF, CPFF, and MMIFF

112 The Board extended the authorizations for the AMLF and the CPFF through February 1, 2010. The authorization for the MMIFF, which expires on October 30, 2009, was not extended. Usage of the AMLF has declined considerably as market conditions have improved. Nonetheless, in view of the continued fragility in market conditions, the Board judged it appropriate to extend the authorization for the AMLF. To help ensure that the AMLF is used for its intended purpose of providing a temporary liquidity backstop to money market mutual funds (MMMFs), the Federal Reserve established a redemption threshold whereby a MMMF would have to experience material outflows--defined as at least 5 percent of net assets in a single day or at least 10 percent of net assets within the prior five business days--before it can sell asset-backed commercial paper (ABCP) that would be eligible collateral for AMLF loans to depository institutions and bank holding companies. Any eligible ABCP purchased from a MMMF that has experienced redemptions at these thresholds could be pledged to AMLF at any time within the five business days following the date that the threshold level of redemptions was reached. The Board similarly judged that market conditions warranted the extension of the CPFF through February 1 in order to help ensure the access of U.S. businesses to short-term funding. Interest rates posted on the CPFF are at levels that are increasingly unattractive for many borrowers as market conditions improve, and accordingly usage of the CPFF is declining fairly steadily. In these circumstances, the Board judged that modifications to the CPFF were not necessary at this time. Given the overall improvement in market conditions and the continued availability of the AMLF and the CPFF, the Board believed that it was not necessary to extend the authorization for the MMIFF. http://www.federalreserve.gov/newsevents/press/monetary/20090625a.htm

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25.06.2009 Another half trillion

The big news this morning everywhere was the ECB’s €442bn 12-month repo auction, the largest and longest-dating ever, through which 1100 European banks have obtained new liquidity. FT Deutschland cites finance minister Peer Steinbruck, once again displaying his full misjudgment of the financial crisis, as saying that the banks would no longer have an excuse to refuse credits. The article points out that the banks have a very good reason to withhold credit, as the rating of its customers has deteriorated due to the deep recession. The article also quotes Bundesbank president Axel Weber as saying there is no generalised credit crunch, but there are credit constraints especially for small companies. The article also cites a survey according to which the credit crunch has become the main reason for insolvencies of SMEs. Insolvency administrators complain that banks with whom the companies had long-standing relationships now refuse credit. (So much for “not a generalised credit crunch”). Weber was also quoted as saying that the German government’s forecast of a 0.5% growth next year was too optimistic. He expects zero growth. The Federal Reserve Open Market Committee, meanwhile, ended speculation that it may raise interest rates soon with a statement saying: “The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time.”

OECD expects recovery, but not over here In its latest forecast, the OECD expects recovery for 2010 everywhere except in Europe. Eurozone forcasts were revised downwards for 2009 to -4.8% (rather than -4.1%) while the US was revised upwards to -2.8% (rather than -4%), reports Les Echos. General Secretary Angel Gurria said the the Eurozone and the US are different with respect to the magnitude of the stimulus package, the flexibility of their economy and the transparency about the capital needs of their banking sector. For the eurozone he recommends further interest cuts, and to continue the unconventional monetary policy as well as the stimulus policies. Countries with margins of

114 manoeuvre should even increase their efforts. He warned in particular Germany, not to end stimulus measures prematurely. The OECD warned Austria that continued turbulences in Eastern Europe could threaten Austria’s financial and fiscal stability, reports Der Standard. IMF and Ireland clash over bank strategies... Karl Whelan of the Irish Economy blog dug up some interest bits from the IMF Article IV consultations on Ireland, which shows some serious disagreements about bank resolution policy. IMF staff noted that bank nationalisation could become necessary, while that was disputed by the Irish government, who also disagreed with the fund’s view that pricing of bad assets would be easier under nationalisation. The staff made the point that nationalisation would need to be accompanied by a clear commitment to operate the banks in a transparent manner and on a commercial basis. IMF also wants Ireland to cut public sector pay, employment, and to raise property tax The Irish Independent summarises the main points of the report. In particular, the IMF calls for more reductions in the public pay bill and government employment; broadening the tax base, including the introduction of a "long overdue" property tax; and a better targeted social welfare payments. The report also warns that Ireland has become the most expensive place to do business in the eurozone. After Berlusconi No, he is not going to resign soon, the FT writes, but notes that there are a lot people in the government who shuffling to and fro, hoping to take over soon. There is no clearly designated successor, the article notes. Berlusconi has no incentive to quit either, since his immunity from prosecution lasts only for as long as he is in office. (talk about bad incentives!) Tremonti on debt In a feisty speech, Giulio Tremonti yesterday declined to raise Italy’s debt to deal with this crisis, according to La Repubblica. He said it is quite frightening during a crisis to have the world’s third largest mountain of debt, without being the third largest economy . The government has to walk a tightrope to secure solid public finances and social peace.

Greece national stress tests The Bank of Greece conducted stress tests together with the IMF on Greek lenders and concluded that the fundamentals of Greece’s banking system are healthy and that the banking sector could withstand further severe economic shocks, reports Kathemerini. [We believe that stress tests need to be transparent and Europe wide to convince the markets. Assurances of this sort are simply not enough.] Brad Setser on dollar reserve growth Brad Setser has another excellent discussion of the latest global financial flow data which shows that custodial holding at the Fed (investment the Fed is administering on behalf of others, mostly foreign central banks and state funds) have risen to record level. As Setser explains in great detail, one cannot simply extrapolate from this information, but his take is that if central bank reserves are up, and if the custodial holdings are up, global central banks should be adding

115 to their dollar reserves. But interestingly, they are mostly buying at the short end of the market – Treasury Bills – rather than longer term notes, as they fear inflation down the road. So this is not exactly comforting for the US. The paradox of macro-prudential regulation Avinash Persaud has an interesting column in Vox, in which he writes about the paradox of macroprudential regulation, which consists of encouraging behaviour that a prudent firm would otherwise follow – which he compares to the paradox of savings. He said a good macroprudential tool would be counter-cyclical capital adequacy requirements, but not the type of proposals for macroprudential regulation that recently came out of the US (and the EU), which suggest more micro-prudential regulations of the sort that already failed. Why are leading indicators doing so well – when the real economy is not? James Hamilton has an interesting post in his blog looking at the Conference Board Leading Economic Index, which has increased by more than 1% in both April and May. He looked at the components and finds that the largest positive contributors are stock prices and yield spreads. In other words this is self-feeding mechanism, in which markets race ahead, which in turn produces a spike in leading indicators. (Unfortunately now, the rally seems to be over, which will bring the leading indicator a little closer to reality.)

116 Near-record growth in the custodial holdings at the Fed; ongoing angst about the dollar’s role as a reserve currency … Posted on Wednesday, June 24th, 2009 By bsetser Central banks haven’t lost their appetite for Treasuries. At least not shorter-dated notes. John Jansen noted before yesterday’s 2-year auction “the central banks love that sector [of the curve].” And the auction result certainly didn’t give him cause to backtrack. Indirect bids — a proxy for central banks — snapped up close to 70% of the auction. Jansen again: The Treasury sold $ 40 billion 2 year notes today and the bidding interest from central banks was frantic. The indirect category of bidding ( which the street holds is a proxy for central bank interest) took 68 percent of the total. That leaves about $ 13 billion for the rest of us. Central banks also seem increasingly interested in five year notes. Indirect bids at today’s five year auction were quite high as well.* Strong central bank demand for Treasuries shouldn’t be a real surprise. Reserve growth picked up in May: look at Korea, Taiwan, Russia and Hong Kong. There are even rumblings - based on the data that the PBoC puts out — that Chinese reserve growth picked up as well. The rise in reserve growth fits a long-standing pattern: emerging markets tend to add more to their reserves — and specifically their dollar reserves — when the euro is rising against the dollar. A fall in the dollar against the euro often indicates general pressure for the dollar to depreciate — pressure that some central banks resist (Supporting charts can be found at the end of a memo on the dollar that I wrote for the Council’s Center for Preventative Action). And the Fed’s custodial holdings (securities that the New York Fed holds on behalf of foreign central banks) have been growing at a smart clip. Recent talk about a shift away from a dollar reserves by a few key countries actually coincided with a surge in the Fed’s custodial holdings. Over the last 13 weeks of data, central banks added $160 billion to their custodial accounts, with Treasuries accounting for all the increase.

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$160 billion a quarter is $640 billion annualized — a pace that if sustained would be a record. Of course, $640 billion in central bank purchases of Treasuries would still fall well short of meeting the US Treasuries financing need. The math only works if Americans also buy a lot of Treasuries. That is a change. Still, most emerging economies seem to have concluded that the risks associated with holding too few dollar reserves exceed the risks of holding too many dollars. That doesn’t seem to have changed. China may be in a different position, but it likely will find that scaling back its dollar exposure is hard so long as it wants to maintain a dollar peg … The rise in the Fed’s custodial holdings isn’t a perfect indicator of dollar reserve growth. If a reserve manager pulls dollars out of a bank and invests the proceeds in Treasuries, that can show up as a rise in the Fed’s custodial holdings. A reserve manager that shifts a Treasury bond from a private custodian to the Fed can produce a similar result. Both no doubt happened last fall and early this winter. Conversely, central banks can — and do — hold Treasuries with private custodians. From mid 2005 to mid 2006 the rise in central banks holdings of Treasuries (according to the survey) exceeded the rise in the Fed’s custodial holdings. But the Fed’s data is the best high-frequency data we have got. And if central banks reserves are up and the Fed’s custodial holdings are up, Occam’s razor suggests that central banks are adding to their dollar reserves. That isn’t to say all is well so long as central banks are adding to their dollar reserves. On one hand, there is a risk that a return to excessive reserve growth will keep the United States trade deficit from continuing to adjust. They could make it harder for exports to spur US growth. A depreciating dollar is once again producing a depreciating RMB.

118 And on the other, central bank reserve managers are a lot more comfortable holding short-term US notes than longer-term US notes. There consequently is a potentially a gap between what central bank reserve managers want to buy and what the US wants to issue. That is a more subtle version of the argument that central banks won’t finance the US deficit. Central banks might finance the deficit but not by buying the tenors the US really wants to sell. Central banks could be clustered at the short-end of the curve because they fear that US inflation will rise — and they don’t want to be stuck with longer-term US bonds then. Or they could just worry that they will buy a bond that yields 3.5% only to see yields rise to 4.5%, producing a mark-to-market loss. Or it could just be a mechanical result of central banks aversion to the risk of any (mark-to-market or accounting) loss. More volatility means a high probability that a longer-term Treasury portfolio might lose value. That mechanically might lead some central banks to shorten the maturity of their holdings. But there is a limit to how far central banks can go. Bills don’t produce any income, and most central banks need some income from their reserve portfolio. When the yield curve is steep, that generates pressure to hold something that has a slightly longer maturity. The two year note seems to be hitting central bank reserve managers’ sweet spot — and today’s auction suggests that central bank demand for somewhat longer tenors could be picking up as well. * One caveat: the recent rise in indirect bidding may be — in part — a function of changes in auction rules. “Guaranteed bid arrangements” through the primary dealers have been eliminated. See Jansen (and ultimately the reporting by Min Zeng of Dow Jones) http://blogs.cfr.org/setser/2009/06/24/near-record-growth-in-the-custodial-holdings-at- the-fed-ongoing-angst-about-the-dollars-role-as-a-reserve-currency/

119 vox Research-based policy analysis and commentary from leading economists The rise and apparent fall of macro- prudential regulation

Avinash Persaud 24 June 2009

Policymakers embraced the rhetoric of macro-prudential regulation in response to the crisis, but most of their proposals have just suggested more micro-prudential regulations of the sort that already failed. This column criticizes those proposals and outlines what real macro-prudential approaches would look like. An early consensus to emerge from the wreckage of the global financial system was that in addition to the old regulation, we needed a new type – macro-prudential regulation. This became so readily accepted, at a time when policy makers were ready to accept almost anything that appeared to be affirmative action, that the term “macro-prudential regulation” quickly became a cliché – overused and poorly understood. So poorly understood, it now appears, that despite much talk of the need for macro-prudential regulation and its cousin, systemic risk regulation, it is actually hard to find any detailed macro-prudential regulation in http://financialstability.gov/docs/regs/FinalReport_web.pdf (the US administration’s white paper.) Bank of England Governor Mervyn King has also pointed out that despite being given broader responsibility for systemic risk by the UK Government, he has not yet been given any macro-prudential tools to achieve it. The term macro-prudential regulation was probably first used in the late 1980s by Andrew Crockett, former General Manager of the Bank of International Settlements. In more recent years his colleagues at the Basel-based BIS, in particular, Bill White and Claudio Borio, championed the idea along with some policy officials – it may be unhelpful to them to identify these by name – and macroeconomists like Charles Goodhart, John Eatwell, Jose-Antonio Ocampo, me and others. The point of macro- prudential regulation is that financial firms acting in an individually prudent manner may collectively create systemic problems. Macro-prudential regulation is a response to a failure of composition problem – we cannot make the financial system safe merely by making every and product safe. Proposals to improve the regulation of firms, products and markets – contained in the Obama administration’s white paper – are generally a good thing, but they are not macro-prudential. Moreover, these proposals neglect the critical observation that we have spent the last 20 years tightening up micro-prudential regulation and yet financial crashes are just as deep if not more so, and they do not occur randomly, which a failure of a rogue firm might imply, but always follow booms. The cycle of financial boom and crash implies there is something “macro” going on we need to address separately. A common source of macro-prudential risk is common behaviour by financial firms –

120 often as a result of close adherence to micro-prudential rules. During booms, asset prices rise and measured risks fall. Acting prudently, financial firms will feel it is safe to expand lending. All financial firms expanding together will lead to a scramble for assets that will lead to unsustainable valuations and lending. During the resulting crashes, asset prices collapse temporarily and measured risks soar. In “Sending the herd off the cliff edge” (Persaud 2000), I showed how all financial firms responding to common, prudential, market-based risk controls would lead them all to want to sell the same assets at the same time, creating a liquidity black hole. Macro-prudential regulation is about encouraging different behaviour than a prudent firm would follow, wherever this prudential behaviour could undermine the financial system if followed by everyone. It is rather like the paradox of saving. Individually saving is good; collectively we can have too much of it. A classic macro-prudential tool that Charles Goodhart and I have advocated is to raise capital adequacy requirements, not for all times, but specifically when aggregate borrowing in an economy or a sector is above average in an attempt to put sand in the systemically dangerous spiral of rising asset prices leading to rising borrowing to buy assets, leading to rising asset prices. This will not end boom-bust cycles, but it will help to reduce their amplitude. Another macro-prudential tool would be to take a holistic approach to financial regulation and encourage certain risks to flow to places with a capacity for that risk. When the crash comes, firms that can absorb short-term liquidity risks, perhaps because they have long-term funding, are not forced to join the selling frenzy in the name of common prudential rules for all, but are more able to buy and diversify liquidity risks across time. This would forestall the implosion of the financial system that would occur if there are no buyers, only sellers. Buried beneath the Obama Administration’s proposals are hints at counter-cyclical provisioning, extra capital for liquidity risks at banks, and differentiated accounting, but the paper essentially gives too much to those carrying the pitch forks in Congress who argue that what was wrong was that we didn’t have enough regulation. The brave observation is that we had too much of the wrong regulation. Doubling up existing regulation will satisfy the justifiable moral outrage against bankers that many voters feel; but it will lead to more of the same in financial boom and bust because it is insufficiently macro-prudential. References Persaud, Avinash (2000). “Sending the herd off the cliff edge: The disturbing interaction between herding and market-sensitive risk management practices,” World Economics, Vol. 1, Nº 4, pp. 15-26. Avinash Persaud , “The rise and apparent fall of macro-prudential regulation”, 24 June 2009, http://www.voxeu.org/index.php?q=node/3694

Sending the Herd off the Cliff Edge The disturbing interaction between herding and market-sensitive risk management practices Avinash Persaud World Economics Volume 1, Number 4, 2000, pages 15 - 26

In the international financial arena, policy makers chant three things: market-sensitive risk-management, transparency and prudential standards. The message is we do not need a new world order, just to improve the workings of the existing one. While many believe this is an inadequate response to the financial crises of the past two decades, few argue against this line. Perhaps more should. There is compelling evidence that in the short run, markets find it hard to distinguish between the good and the unsustainable, market players herd and contagion is common. In this environment, market- sensitive risk management and transparency can destabilise markets.

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vox Research-based policy analysis and commentary from leading economists Restoring Financial Stability: Book review

Charles A.E. Goodhart 24 April 2009

The crisis has spawned a handful of books on how to fix the world’s financial system. This column reviews the NYU Stern book edited by Viral Acharya and Matthew Richardson. It says that the book’s prologue on “The Financial Crisis of 2007-8: Causes and Remedies” is the best single paper yet written on the background and development of the crisis. The production of this book has been a remarkable and praiseworthy enterprise. At the end of 2008, following an initiative by Tom Cooley and Ingo Walter, the Dean and Vice- Dean, its main authors and organisers, Viral Acharya and Matthew Richardson, realised that the faculty of the Stern School of Business at New York University were optimally placed to comment on and analyse the many facets of the on-going financial crisis. They got 33 colleagues to contribute to the 18 chapters, from Acharya to Zemel, in record time, (I wonder if any promised contributions had to be scratched because of lateness), and then had Wiley’s, to whom praise is also due, publish it within a couple of months – with no shortfall in quality – by the end of March. So the book represents a comprehensive and up-to-date account of almost all the main features of the crisis, despite the latter’s rapid evolution and metamorphoses. Only in the instance of Chapter 15, on “The Financial Sector Bailout”, did I feel that events had moved on significantly since the authors had stopped writing. Moreover, despite the speed of the exercise, the quality was generally very high. This book is the best available on this extraordinary and fascinating subject. Indeed, I would rank the Prologue, on ‘The Financial Crisis of 2007-8: Causes and Remedies’, (which is the longest chapter in the book, pp 1-56), as the best single paper yet written on the background and development of the crisis. The book is worth buying for this one chapter alone. For the rest, the book is divided into seven parts, generally starting with a brief introductory and summary note, followed by some two, or three, somewhat longer chapters developing the themes involved. These cover: • Causes, with chapters on securitisation, leverage, and rating agencies (Chapters 1-3). • Institutions, with chapters on government-sponsored enterprises, large complex financial institutions, and hedge funds (Chapters 4-6).

122 • Governance and Structure, with chapters on corporate governance, remuneration, and fair value accounting (Chapters 7-9). • Derivatives, with chapters on derivatives, centralised clearing, and short selling (Chapters 10-12). • The Role of the Fed, with chapters on regulating systemic risk and lenders of last resort (Chapters 13, 14). • The Bailout, with chapters on bailout mechanisms, the housing market, and General Motors (Chapters 15-17). • International, with a single chapter (18) on international regulation. Given that the authors are from a School of Business and Finance, the best Sections were those that focussed on their professional expertise, Sections 1-4 and 6, which I heartily recommend. There are, however, two huge gaps. First, outside the housing market, there is really nothing on the macroeconomy, nothing on the move of the USA and the rest of the world into deep recession, nor on the official responses to this in the shape of interest rate cuts, quantitative easing, and fiscal policy. The introductory note on “The Role of the Federal System” was insufficient and did not cover the ground properly. Second, this is an almost entirely US-focussed book. There is little or no mention of events abroad; thus, Northern Rock, IKB, Iceland and Ireland do not appear in the index. Again the one chapter on international regulation was also insufficient and did not cover the subject matter adequately. It is a US-centric book – anyone wanting a more global perspective will have to look elsewhere. Even in the regulatory arena, there was hardly anything on the crucial issue of the balance between “home” and “host” supervisory authority responsibilities. The authors are not shy about coming out with their own proposals for remedying and restoring the financial system. For the most part, I found their suggestions attractive, for example on securitisation, hedge funds, remuneration, centralising clearing, short selling, mortgage reorganisation, and support for GM. The authors rather hedged their bets on ratings agencies. Views on Fair Value Accounting (FAS 157) tend to be polarised; the author here (Stephen Ryan) is one of the supporters. It is all too rare to get a balanced view. Perhaps because I have a personal position myself on many of the issues involved in financial regulation, I found several of their proposals in the field misguided. These are: • Have a separate regulator/supervisor for large complex financial institutions (Chapter 5). But US financial regulation/supervision is already too Balkanised into separate fiefdoms. The US needs consolidation along the lines of the Paulson plan instead. • Make lending of last resort conditional on previous good behaviour (Chapter 14). As is surely obvious from the current crisis, the threat of denial of liquidity assistance in a crisis is just not credible, and rightly so. We need to devise sanctions that penalise banks misbehaving in normal (good) times, not deny liquidity assistance when the crisis hits. • Have a joint public/private insurance scheme to guard against systemic risk

123 (Chapter 18). I should, however, add both that much of the chapter on the need to guard against, and to measure, systemic risk is excellently done, (although there is no discussion about trying to introduce counter-cyclical regulatory measures), and that their proposed scheme in this respect is much better thought out, and superior to, most other proposals along these lines. That said it still suffers from the defects – pointed out by behavioural economists – that people and markets suffer from disaster myopia in good times, and excessive aversion just after disaster strikes. The authors, like most US economists, believe that markets are always better at pricing risk than the authorities. When it comes to an assessment of tail risk, I am not in that camp, but in this case I admit that there is a fair argument to be made and that the authors have made the best case to date for a partially private insurance scheme. So I do have a few niggles here and there, but overall the book was a brilliant idea, superbly executed, and has first-class content. Buy it. References Viral Acharya and Matthew Richardson (eds), New York University Stern School of Business (2009) Restoring Financial Stability: How to Repair a Failed System, Wiley, March

This article may be reproduced with appropriate attribution. See Copyright (below).

Recent contributions by Charles A.E. Goodhart

• Restoring Financial Stability: Book review

• Credit rating agencies

• Two goals, one instrument: How can central banks tackle financial crises?

• Yield curves and recessions

124 vox Research-based policy analysis and commentary from leading economists The macroprudential approach to regulation and supervision

Claudio Borio 14 April 2009

There is now a growing consensus among policymakers and academics that a key element to improve safeguards against financial instability is to strengthen the “macroprudential” orientation of regulatory and supervisory frameworks. This column explains the approach and various issues that regulators must address to implement it.

There is now a growing consensus among policymakers and academics that a key element to improve safeguards against financial instability is to strengthen the “macroprudential” orientation of regulatory and supervisory frameworks. Paraphrasing Milton Friedman, one could even say that “we are all macroprudentialists now”. And yet, a decade ago, the term was hardly used. An old idea whose time has come In fact, the term is not new. At the Bank for International Settlements (BIS), its usage goes back to at least the late 1970s, denoting a systemic or system-wide orientation of regulatory and supervisory frameworks and their link to the macroeconomy. It was already recognised then that focusing exclusively on the financial strength of individual institutions could miss an important dimension of the task of securing financial stability. The term’s appearance in public documents is of more recent vintage (e.g., BIS 1986). And it was not until the beginning of the new century that efforts were made to define it more precisely, so as to derive specific implications for the architecture of prudential arrangements. This was first done in a speech by the then-BIS General Manager (Crockett 2000) and elaborated in subsequent research (e.g., Borio 2003). In those days, the usage of the term was already becoming more common (e.g., IMF 2000). Subsequently, the macroprudential perspective slowly gained further ground, as described in Knight (2006), White (2006), and BIS (2008), until the current financial crisis gave it an extraordinary boost. What does it mean? At the same time, the usage of the term remains ambiguous. What does “macroprudential” really mean? What are its implications for policy? Drawing on the long BIS tradition, this column provides a specific characterisation of the macroprudential approach and highlights some policy implications. In the process, it brings together strands of analysis that may appear as unrelated. The macroprudential approach has two distinguishing features. It focuses on the financial

125 system as a whole, with the objective of limiting the macroeconomic costs of episodes of financial distress. And it treats aggregate risk as dependent on the collective behaviour of financial institutions (in economic jargon, as partly “endogenous”). This contrasts sharply with how individual agents treat it. They regard asset prices, market/credit conditions and economic activity as independent of their decisions, since, taken individually, they are typically too small to affect them. In turn, the macroprudential approach is best thought of as consisting of two dimensions. • How risk is distributed in the financial system at a given point in time – the “cross-sectional dimension”. • How aggregate risk evolves over time – the “time dimension”. The key issue in the cross-sectional dimension is how to deal with common (correlated) exposures across financial institutions. These arise either because institutions are directly exposed to the same or similar asset classes or because of indirect exposures associated with linkages among them (e.g. counterparty relationships). Common exposures are critical because they explain why institutions can fail together. Just as an asset manager, who cares about the loss on her portfolio as a whole, focuses on the co-movement of the portfolio’s securities, so a macroprudential regulator would focus on the joint failure of institutions, which determines the loss for the financial system as a whole. The main policy question is how to design the prudential framework to limit the risk of losses on a significant portion of the overall financial system and hence its “tail risk”. The key issue in the time dimension is how system-wide risk can be amplified by interactions within the financial system as well as between the financial system and the real economy. This is what pro-cyclicality is all about (e.g., Crockett 2000, Borio et al 2001, BIS 2001, Brunnermeier et al 2009). Feedback effects – the endogenous nature of aggregate risk – are of the essence. During expansions, declining risk perceptions, rising risk tolerance, weakening financing constraints, rising leverage, higher market liquidity, booming asset prices, and growing expenditures mutually reinforce each other, potentially leading to the overextension of balance sheets. The reverse process operates more rapidly, as financial strains emerge, amplifying financial distress. As a result, actions that are rational and compelling for individual economic agents may result in undesirable aggregate outcomes, destabilising the whole system. The main policy question is how to dampen the inherent pro-cyclicality of the financial system. Monitoring A macroprudential approach has implications for the monitoring of threats to financial stability and for the calibration of prudential tools. Monitoring should not consider institutions on a stand-alone basis or be limited to peer- group analysis. Rather, it should pay special attention to the sources of non-diversifiable, or “systematic”, risk in the financial system. Hence the importance of common exposures across institutions and of possible symptoms of generalised overextension in balance sheets during economic expansions and macro risks. Notable examples are unusually rapid increases in credit and asset prices and unusually low risk premia. The build-up to the current crisis has hammered home the importance of all of these factors. In the cross-sectional dimension, the guiding principle for the calibration of prudential tools is to tailor them to the individual institutions’ contribution to system-wide risk. Ideally, this would be done in a top-down way. One would start from a measure of system-wide tail risk, calculate the contribution of each institution to it and then adjust

126 the tools (capital requirements, insurance premia, etc.) accordingly. This would imply having tighter standards for institutions whose contribution is larger, contrasting sharply with the microprudential approach, which would have common standards for all regulated institutions. In turn, that contribution will depend on features that are either specific to the institution itself (e.g., its size and probability of failure) or relevant for the system as a whole (its direct and indirect common exposures with other institutions). In the time dimension, the guiding principle is to calibrate policy tools so as to encourage the build-up of buffers in good times so that they can be drawn down as strains materialise. By allowing the system to absorb the shock better, this would help to limit the costs of incipient financial distress. Moreover, the build-up of the buffers, to the extent that it acted as a kind of dragging anchor or “soft” speed limit, could also help to restrain the build-up of risk-taking during the expansion phase. As a result, it would also limit the risk of financial distress in the first place. The gathering consensus The growing consensus on the need to strengthen the macroprudential approach is easily apparent in both policy and academic communities (e.g., Mayes et al 2009, Brunnermeier et al. 2009). The importance of monitoring threats to financial stability on a system-wide basis has been recognised for some time. Hence the proliferation of central bank financial stability reports and the efforts made to develop tools such as early warning indicators and macro stress-tests (e.g., Borio and Drehmann 2008, 2009). More recently, the cross- sectional dimension of the macroprudential approach has attracted considerable attention. Academic work has been seeking to estimate the contribution to system-wide risk of individual institutions (e.g., Acharya and Richardson 2009) and there have been calls for policymakers to extend official oversight to all financial institutions that are “systemic”, regardless of their legal form (e.g., De Larosière et al 2009, G20 2009). Above all, however, it is the time dimension that has been in the limelight. Dampening the pro- cyclicality of the financial system is now widely regarded as a priority (e.g., Brunnermeier et al 2009, Calomiris 2009, Mayes et al 2009, De Larosière et al 2009, G20 2009, FSF 2009). Several work streams under the aegis of the Financial Stability Forum are examining how this might be done. The BIS is actively working in all of these areas. Future challenges Looking ahead, the challenges involved in implementing a macroprudential approach to regulation and supervision should not be underestimated (Borio and Drehmann 2008). Some of these are analytical. Both measuring system-wide risks and calibrating policy tools are far from straightforward. For example, what size of capital buffers are needed so that they can be credibly run down without markets insisting on much higher ones at times of potential stress? And how far can their build-up and release be based on rules rather than discretion? Other challenges are of a more institutional and political economy nature. For instance, it is essential to align authorities’ objectives with control over instruments and the know-how to use them. This means that careful thought should be given to mandates, to the composition of the bodies in charge of implementing the approach, and to the necessary insulation from political pressures, which might inhibit attempts to “take away the punch bowl as the party gets going”. Whatever the specifics, this is bound to call for closer cooperation between supervisory authorities and central banks. Note: The views expressed are those of the author and do not necessarily reflect those of the BIS.

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References Acharya, V and M. Richardson (eds) (2009). Restoring financial stability: How to repair a failed system, Wiley, March 2009. Bank for International Settlements (1986) Recent innovations in international banking, Report prepared by a Study Group established by the central banks of the Group of Ten countries, Basel, April. Bank for International Settlements (2001) 71st BIS Annual Report, Basel, June. Bank for International Settlements (2008) 78th BIS Annual Report, Basel, June. Borio C (2003) “Towards a macroprudential framework for financial supervision and regulation?”, CESifo Economic Studies, vol 49, no 2/2003, pp 181–216. Also available as BIS Working Papers, no 128, February. Borio, C and M Drehmann (2008) “Towards an operational framework for financial stability 'fuzzy' measurement and its consequences”, 12th Annual Conference of the Banco Central de Chile, Financial stability, monetary policy and central banking, Santiago, 6–7 November. Borio, C and M Drehmann (2009) “Assessing the risk of banking crises – revisited”, BIS Quarterly Review, March, pp. 29-46. Borio, C, C Furfine and P Lowe (2001) “Procyclicality of the financial system and financial stability issues and policy options” in “Marrying the macro- and micro- prudential dimensions of financial stability”, BIS Papers, no 1, March, pp 1–57. Brunnermeier, M, A Crockett, C Goodhart, M Hellwig, A Persuad and H Shin.(2009): “The fundamental principles of financial regulation,” Geneva Reports on the World Economy 11 (Preliminary Conference Draft). Calomiris, C (2009) “Financial innovation, regulation, and reform”, Cato Journal, forthcoming. Crockett, A (2000) “Marrying the micro- and macroprudential dimensions of financial stability”, BIS Speeches, 21 September. De Larosière et al (2009) De Larosière Report, various authors. Financial Stability Forum (2009) Report of the Financial Stability Forum on addressing procyclicality in the financial system, Basel, April. Group of Twenty (2009) G20 Working Group 1: Enhancing sound regulation and strengthening transparency, 25 March. International Monetary Fund (2000) “Macroprudential indicators of financial system soundness”, various authors, Occasional Paper No 192, April. Knight, M (2006) “Marrying the micro and macroprudential dimensions of financial stability: six years on”, speech delivered at the 14th International Conference of Banking Supervisors, BIS Speeches, October. Mayes, D, R Pringle and M Taylor (2009) (editors) Towards a new framework for financial stability, Central Banking Publications. White, W (2006) “Procyclicality in the financial system: do we need a new macrofinancial stabilisation framework?”, BIS Working Papers, no 193, January.

Claudio Borio, “The macroprudential approach to regulation and supervision”, 14 April 2009 http://voxeu.org/index.php?q=node/3445

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WEDNESDAY, JUNE 24, 2009 More on the New and Existing Homes Sales Gap by CalculatedRisk on 6/24/2009 08:51:00 PM Earlier today I posted some analysis of the gap between existing and new home sales: Distressing Gap: Ratio of Existing to New Home Sales (see the post for several graphs - including the ratio between new and existing home sales)

Professor Brian Peterson has more (including some thoughts prices): House Prices and New versus Existing Homes Sales To get a feel for how the two series [New and existing home sales] move together, figure 2 plots the percentage deviation for each series from its mean from 1975-2008. We see clearly that from 1975 to 2006 (the solid lines) that new home sales and existing homes sales move around together, with a correlation of 0.944 over the the time period up to 2006. However, as shown by the dashed lines, a gap has developed post 2006, resulting in the correlation for the sample from 1975-2008 falling to 0.876. There seems to be some type of a shock that is driving existing homes sale up relative to new homes sales.

I find it strange that most analysts are looking at existing home sales for stability in the housing market. I think the new home market is the place to look. Posted by CalculatedRisk on 6/24/2009 08:51:00 PM http://www.calculatedriskblog.com/2009/06/more-on-new-and-existing-homes- sales.html

129 WEDNESDAY, JUNE 24, 2009 Distressing Gap: Ratio of Existing to New Home Sales by CalculatedRisk on 6/24/2009 11:47:00 AM For graphs based on the new home sales report this morning, please see: New Home Sales: Record Low for May Yesterday, the National Association of Realtors (NAR) reported that distressed properties accounted for one-third of all sales in May. Distressed sales include REO sales (foreclosure resales) and short sales, and based on the 4.77 million existing home sales (SAAR) that puts distressed sales at about a 1.6 million annual rate in April. All this distressed sales activity has created a gap between new and existing sales as shown in the following graph that I've jokingly labeled the "Distressing" gap. This is an update including May new and existing home sales data.

This graph shows existing home sales (left axis) and new home sales (right axis) through March. As I've noted before, I believe this gap was caused by distressed sales - in many areas home builders cannot compete with REO sales, and this has pushed down new home sales while keeping existing home sales activity elevated.

The second graph shows the same information, but as a ratio for existing home sales divided by new home sales.

130 Although distressed sales will stay elevated for some time, eventually I expect this ratio to decline - probably with a combination of falling existing home sales and eventually rising new home sales.

The third graph shows the ratio back to 1969 (annual data before 1994). Note: the NAR has changed their data collection over time and the older data does not include condos: Single-family data collection began monthly in 1968, while condo data collection began quarterly in 1981; the series were combined in 1999 when monthly collection of condo data began. http://www.calculatedriskblog.com/2009/06/distressing-gap-ratio-of-existing-to.html

131 WEDNESDAY, JUNE 24, 2009 New Home Sales: Record Low for May by CalculatedRisk on 6/24/2009 10:00:00 AM The Census Bureau reports New Home Sales in May were at a seasonally adjusted annual rate (SAAR) of 342 thousand. This is essentially the same as the revised rate of 344 thousand in April.

The first graph shows monthly new home sales (NSA - Not Seasonally Adjusted). Note the Red columns for 2009. This is the lowest sales for May since the Census Bureau started tracking sales in 1963. (NSA, 32 thousand new homes were sold in May 2009; the record low was 36 thousand in May 1982). As the graph indicates, sales in May 2009 were substantially worse than the previous years.

The second graph shows New Home Sales vs. recessions for the last 45 years. New Home sales have fallen off a cliff. Sales of new one-family houses in May 2009 were at a seasonally adjusted annual rate of 342,000 ... This is 0.6 percent (±17.8%)* below the revised April rate of 344,000 and is 32.8 percent (±10.9%) below the May 2008 estimate of 509,000.. And another long term graph - this one for New Home Months of Supply.

132 There were 10.2 months of supply in May - significantly below the all time record of 12.4 months of supply set in January. The seasonally adjusted estimate of new houses for sale at the end of May was 292,000. This represents a supply of 10.2 months at the current sales rate.

The final graph shows new home inventory. Note that new home inventory does not include many condos (especially high rise condos), and areas with significant condo construction will have much higher inventory levels. It appears the months-of-supply for inventory has peaked, and there is some chance that sales of new homes has bottomed for this cycle - but we won't know for many months. However any recovery in sales will likely be modest because of the huge overhang of existing homes for sale. This is another weak report. I'll have more later ... Posted by CalculatedRisk on 6/24/2009 10:00:00 AM http://www.calculatedriskblog.com/2009/06/new-home-sales-record-low-for-may.html

133 WEDNESDAY, JUNE 24, 2009 American Institute of Architects: Recovery has stalled by CalculatedRisk on 6/24/2009 08:38:00 AM From Reuters: Architecture billings index steady in May - AIA A leading indicator of U.S. nonresidential construction spending held steady for a second month in May, suggesting an economic recovery has stalled, an architects' trade group said on Wednesday. The Architecture Billings Index edged up a tenth of a point to 42.9 last month after a slight decline in the prior month, according to the American Institute of Architects. .. A measure of inquiries for projects dipped to 55.2, the third straight month that inquiries have held at a similar level but have not led to improved billings. The data indicated recovery has stalled, the AIA said. "Numerous firms (have) bid for the same project, which is why the high level of inquiries is not necessarily translating into additional billings for project work at many firms," AIA Chief Economist Kermit Baker said in a statement.

This graph shows the Architecture Billings Index since 1996. The index is still below 50 indicating falling demand. Historically there is an "approximate nine to twelve month lag time between architecture billings and construction spending" on commercial real estate (CRE). This suggests further dramatic declines in CRE investment later this year. Posted by CalculatedRisk on 6/24/2009 08:38:00 AM http://www.calculatedriskblog.com/2009/06/american-institute-of-architects.html

134 WEDNESDAY, JUNE 24, 2009 MBA: Mortgage Rates Decrease Slightly by CalculatedRisk on 6/24/2009 08:25:00 AM The MBA reports: The Market Composite Index, a measure of mortgage loan application volume, was 548.2, an increase of 6.6 percent on a seasonally adjusted basis from 514.4 one week earlier. ... The Refinance Index increased 5.9 percent to 2116.3 from 1998.1 the previous week and the seasonally adjusted Purchase Index increased 7.3 percent to 280.3 from 261.2 one week earlier. ... The average contract interest rate for 30-year fixed-rate mortgages decreased to 5.44 percent from 5.50 percent ...

This graph shows the MBA Purchase Index and four week moving average since 2002.

Note: The increase in 2007 was due to the method used to construct the index. Since the MBA surveyed mostly the major lenders, when lenders like New Century went under - this pushed more borrowers to lenders included in the survey. As smaller lenders went out of business, the remaining lenders saw more applications. Plus a number of borrowers started submitting multiple applications. Both factors distorted the index. That increase in 2007 fooled many people, like Alan Greenspan. See, from Bloomberg: Greenspan Says `Worst' May Be Past in U.S. Housing (Oct 6, 2006) Although we can't compare directly to earlier periods because of the changes in the index, this shows no significant pick up in overall sales activity. Posted by CalculatedRisk on 6/24/2009 08:25:00 AM http://www.calculatedriskblog.com/2009/06/mba-mortgage-rates-decrease- slightly.html

135 TUESDAY, JUNE 23, 2009 Housing Bust and Mobility by CalculatedRisk on 6/23/2009 10:52:00 PM From the SF Gate: Housing, unemployment woes leave movers shaken Sinking home prices and a weak job market have forced normally restless Americans to stay put in an uncharacteristic shift that has, among other things, clobbered the moving industry. "Property values have dropped so much people can't pick up and move the way they used to," said Michael Hicks, a demographer at Ball State University in Indiana who has tracked the nationwide slowdown using data from several sources, including moving companies. That industry data mirrors a Census Bureau report that looked at moves in 2008, said William Frey, a demographer at the Brookings Institution in Washington, D.C. "The annual migration rate has gone way down to historic low levels," Frey said. "This includes long distance moves and moving across town." During the 1950s and 1960s, Frey said, as many as 20 percent of Americans moved in any given year. Mobility rates slowed to 15 percent to 16 percent during the 1990s. But in 2008, only 11.9 percent of Americans moved, he said. A few previous mobility posts: Housing Bust Impacts Worker Mobility April 2008, Housing Bust Impacting Labor Mobility, Dec 2008, Housing Bust and Geographical Mobility, April 2009

Posted by CalculatedRisk on 6/23/2009 10:52:00 PM http://www.calculatedriskblog.com/2009/06/housing-bust-and-mobility.html TUESDAY, JUNE 23, 2009 The Next Fed Chairman? And 1930 ... by CalculatedRisk on 6/23/2009 08:48:00 AM A couple of morning stories ... From Bloomberg: Bernanke Set to Defend Record as Reappointment Debate Begins Besides keeping Bernanke, Obama’s options include appointing Summers or Janet Yellen [San Francicso Fed President] Summers, 54, a former Treasury secretary who heads Obama’s National Economic Council, is considered the front-runner should the president want a change. San Francisco Fed President Yellen, 62, was previously a Fed governor and chairman of the Council of Economic Advisers .... Summers wants the job, Senator Robert Bennett of Utah [said]. Asked if he would support Summers for Fed chairman, Bennett said: “I am told that Larry would very much like me to. I would have no objection to Larry.”

136 And Paul Krugman directs us to a site tracking the news from 1930 day by day. A couple quotes from June 23, 1930: Col. Ayres, VP Cleveland Trust, predicts an abrupt recovery in stock and commodity prices by Labor Day due to current consumption exceeding production. Distinguishes between two types of depression, “V”-shaped and “U”-shaped. And heard on the Street: “'Things are getting back to normal,' remarked the head of a Broadway house. 'Again the main topic of discussion among our customers is the 18th amendment.'” [Prohibition] Posted by CalculatedRisk on 6/23/2009 08:48:00 AM 87 Comments http://www.calculatedriskblog.com/2009/06/next-fed-chairman-and-1930.html

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Jun 24, 2009 Does Demand in the U.S. Housing Sector Show Prolonged Sluggishness? Overview: A sustained rebound in housing demand is vital for bringing down record levels of inventories and stabilizing prices in the U.S. housing sector. With housing affordability at an all time high, first time buyers are responding positively to falling prices and historically low rates on mortgages. However, home sales and purchase mortgage applications remain depressed year over year. An uptick in demand for housing may be delayed as the worsening unemployment rate will prolong consumer retrenchment. May 2009: New home sales fell by 0.6% m/m in May to an annualized rate of 342,000, after April sales were revised downwards to 344,000. New sales are down 32.8% y/y in May and down 75% from the peak of July 2005. The median sale price rose to $221,600, 3.4% below last May's level. Unsold new homes equal 10.2 months' worth supply at the current sales rate, down from 10.4 months in April. May 2009: Existing home sales rose 2.4% to an annual rate of 4.77 million units in May from 4.66 million units in April, with first time buyers accounting for 29% of sales. Distressed sales accounted for about 33% all sales, keeping the national median home price down 16.8% y/y. The number of previously owned unsold homes on the market by the end of May represented 9.6 months’ worth supply at the current sales pace, down from 10.1 months in April. Resales of single-family homes rose 1.9% to an annual rate of 4.25 million in May. Sales of condos and co-ops rose 6.1% to an annual rate of 520,000 units.(NAR) Yun: The increase in sales is less than expected because poor appraisals are stalling transactions- Pending home sales indicated much stronger activity. (NAR) Weekly Mortgage Applications composite index rose by 6.6% to reach 548.2 from 514.4 in the week ending June 19, after falling 15.8% last week. The refinance index rose 5.9% while the purchase index rose 7.3%. The share of refinance activity was 54% of total applications, compared to 36.3% for the same period last year. (MBA) Refinancing activity is up 74% y/y while purchase activity remains depressed by 16% y/y. Mortgage rates, which fell to record lows in April 2009, have risen in June due to rising treasury yields- for the week ending June 12, the average 30 year fixed mortgage rate was 5.44% (MBA). This is likely to bring down refinancing activity in the coming weeks and also impact housing affordability. . April 2009: The Pending Home Sales Index- a forward-looking indicator based on contracts signed in April 2009, rose 6.7% to 90.3 from 84.6 in March, as housing affordability conditions remained high. The index is up 3.2% since April 2008 when it was 87.5 (NAR) April 2009: The Housing Affordability Composite Index rose to 174.8 in April, 29.2% higher than April 2008 (NAR).

138 May 2009: The Housing Market Index, an indicator of builder perceptions of current and future home sales fell 1 point to 15 in June from 15 in May.(NAHB) January is the worst month for sales in the annual housing cycle and the improvement in February is largely due to seasonality. Sales remain depressed y/y, though house prices dropping faster than home sales y/y indicates sales may near stabilization. (Barry Riholtz) The $8000 first time home buyer tax credit is unlikely to have an effect on the current market as renting remains the better option to buying due to falling prices. (Dean Baker) With banks raising lending standards, policy makers have a very critical task ahead of keeping the mortgage credit pipeline flowing by keeping the GSE’s very active in purchasing and guaranteeing new home loans (BNP Paribas) http://www.rgemonitor.com/80/Housing_Bubble_and_Bust?cluster_id=13699 Press Release

Release Date: June 24, 2009 For immediate release Information received since the Federal Open Market Committee met in April suggests that the pace of economic contraction is slowing. Conditions in financial markets have generally improved in recent months. Household spending has shown further signs of stabilizing but remains constrained by ongoing job losses, lower housing wealth, and tight credit. Businesses are cutting back on fixed investment and staffing but appear to be making progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability. The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time. In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage- backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve will buy up to $300 billion of Treasury securities by autumn. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in

139 financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted. Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen. http://www.federalreserve.gov/newsevents/press/monetary/20090624a.htm Board of Governors of the Federal Reserve System Federal Deposit Insurance Corporation Office of the Comptroller of the Currency Office of Thrift Supervision June 24, 2009 For immediate release

Agencies Announce Notice of Proposed Rulemaking for Community Reinvestment Act

The federal bank and thrift regulatory agencies today proposed revisions to regulations implementing the Community Reinvestment Act (CRA) to require the agencies to consider low-cost education loans provided to low-income borrowers when assessing a financial institution's record of meeting community credit needs. This proposal, which is being proposed jointly by the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, and Office of Thrift Supervision, incorporates provisions of the recently enacted Higher Education Opportunity Act, which revised the CRA. The proposal also would incorporate into the CRA rules statutory language that allows the agencies, when assessing an institution's record, to consider, as a factor, capital investments, loan participations, and other ventures by nonminority- and nonwomen- owned financial institutions in cooperation with minority- and women-owned institutions and low-income credit unions. This language codifies guidance in the Interagency Questions and Answers on Community Reinvestment, published on January 6, 2009. Although the agencies seek comment on all aspects of the proposal, they are focusing on the following questions: • How "education loans" should be defined, including whether private loans not governmentally insured or guaranteed and loans for elementary and secondary education should be covered, as well as loans for education expenses associated with unaccredited institutions; • Whether the proposed definition of "low-cost" is appropriate; and • Whether "low-income" should be defined differently from the way it is currently defined in the CRA regulations, including how the agencies should treat the student's family income or expected contribution. Public comments are due 30 days after the proposal is published in the Federal Register, which is expected shortly. The Federal Register notice is attached. Attachment (238 KB PDF)

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RGE Monitor's Newsletter 24/06/2009 8:00

As decided at the latest G20 meeting, authorities around the world are devising micro- and macro-prudential reforms in order to strengthen the resilience not only of single financial institutions but of the entire financial system by extending oversight to all important financial institutions, products, and activities. The United States In the U.S., the Obama administration introduced its widely anticipated regulatory reform proposal on June 17. Its five main components include: 1. The establishment of the Fed as systemic risk regulator and supervisor of “too- big-to-fail” institutions in return for Treasury permission requirement for extraordinary liquidity programs. The plan proposes creation of a “Council of Regulators” (formerly the President’s Working Group) chaired by Treasury but with advisory powers only; 2. The creation for the first time of a regulatory regime for all financial derivatives, as well as a requirement that the originator, sponsor or broker of a securitized vehicle retain “skin in the game” – i.e., a financial interest of at least 5% in its performance; 3. The creation of a new Consumer Financial Protection Agency with rules against predatory lending and transparency standards at the retail level; 4. A new resolution mechanism that allows for the orderly divestiture of any non- bank financial holding company whose failure might threaten the stability of the financial system, including investment banks, large hedge funds and major insurers such as AIG; 5. Adopting a leadership role in the effort to improve and coordinate global regulation and supervision.

The main points of contention in Congress are likely to include the scope of the new regulatory powers conveyed to the Federal Reserve in view of the arguably minimal use it made of its already existing regulatory powers in the run-up to the crisis. Equally controversial are the need and the powers of the new Consumer Financial Protection Agency. Furthermore, some policymakers and market participants are equally worried about the potentially stifling effect of too much regulation on financial innovation. The European Union and Switzerland Two days after the Obama plan’s introduction, on June 19, EU leaders reached agreement on a new framework for coordinated (rather than unified at EU-level) macro- and micro-prudential supervision along the lines proposed by Jacques de Larosiere and endorsed by the European Commission on June 9. Regarding the macro-prudential authority, the new European Systematic Risk Council (ESRC) will comprise EU central bank governors and will most likely be chaired by the ECB president. The Council will issue financial stability risk warnings and macro-prudential recommendations for action

141 to supervisors and monitor their implementation. In contrast to the U.S. Federal Reserve, however, EU central bankers will not oversee and regulate systemic cross- border institutions directly. ECB vice president Lorenzo Bini Smaghi, in a June 19 speech, deplored this discrepancy. The EU agreement also establishes a new micro-prudential authority at EU-level. In particular, the European System of Financial Supervisors, comprising three new European Supervisory Authorities, will help ensure consistency of national supervisio n and strengthen oversight of cross border entities. This will be accomplished by setting up supervisory colleges and establishing “a European single rule book applicable to all financial institutions in the Single Market.” Importantly, the new EU-level supervisory authority will have binding decision powers in the case of disagreement between the home and host state supervisors, including within colleges of supervisors. EurActiv cites the following example: “If Italian and Polish supervisory authorities disagree regarding recapitalization of an Italian bank operating in Poland, for example, it would be the new EU-level authority that would settle the issue with binding decisions.” However, EU leaders are clear in their agreement that “decisions taken by the European Supervisory Authorities should not impinge in any way on the fiscal responsibilities of Member States.” This precludes any ex ante burden-sharing provision, a very controversial issue. As EurActiv explains: “Should a major financial institution fail, there will be no European competence to establish which countries will have to foot the bill and by what means. National interests are likely to prevail again on this issue.” Up until now, then, an EU-wide resolution regime for cross-border banks remains unaddressed. While this is welcome news for Britain, which worked hard to confine any EU interference to a minimum, smaller EU countries as well as non-EU countries with large banking sectors have a problem. Not by coincidence, Philipp Hildebrand, vice president of the Swiss National Bank, noted on a June 18 speech: "The lac k of any clearly defined and internationally coordinated wind-down procedure contributes to a de facto obligation on the part of the state to provide assistance to these institutions." Small countries, in particular, will need to develop wind-down rules for crisis situations. One possible consideration, according to Hildebrand is to "split off those units of a bank that are important for the functioning of the economy and wind down the rest." ‘The rest,’ of course, might include foreign EU operations in need of domestic backing. In terms of pro-active regulatory interventions, the Swiss have been at the forefront with an overall leverage cap for their large institutions, an innovative ring-fencing framework for bad assets at UBS, and a risk-adjusted remuneration scheme at Credit Suisse (i.e., to pay top bankers based on the per formance of the toxic waste they originated or acquired on behalf of the bank). The UK established new resolution powers for national institutions in the Banking Act 2009 in the aftermath of Northern Rock. Large and complex financial institutions, however, still await a comprehensive solution, a fact noted in Mervyn King’s June 17 speech. He noted that “one important practical step would be to require any regulated bank itself to produce a plan for an orderly wind down of its activities,” i.e. akin to making a will. That kind of information would also be a valuable input for the new EU cross-border regulators.

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Alternative Investment and Derivatives Regulation In the U.S., the President’s plan requires all advisers to hedge funds and other private pools of capital, including private equity funds and venture capital funds whose assets under management exceed some modest threshold, to register with the SEC under the Investment Advisers Act and provide sufficient information for effective systemic risk supervision. Similarly, under the EU Commission draft regulation, managers of hedge funds and similar ‘alternative investment funds’ that handle at least €500m (€100m for those using borrowed money) would have to be registered in trade repositories and provide information about leverage. For now, the draft law applies only to managers, rather than funds, because many funds are based offshore. After three years, the rules will get tougher for funds based outside the EU. Although the EU plan was under heavy attack by the industry, the latest U.S. backing should put any hope of a reversal to self- regulation to rest. New rules in major financial centers also require all financial derivatives to be brought under the regulatory umbrella. As part of the U.S. plan, standardized credit default swaps (CDS) and other over-the-counter (OTC) derivatives will be required to clear through a central counterparty and trade on exchanges and other transparent trading venues. More customized products will be required to register with a central registry that makes aggregate data available to the public and detailed positions for regulators. In the European framework, the UK secured that the new EU supervision will not cover clearing houses for derivatives – an important objective for the City of London who is global leader in terms of trading volumes of derivatives.

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Most Want Health Reform But Fear Its Side Effects By Ceci Connolly and Jon Cohen Wednesday, June 24, 2009 A majority of Americans see government action as critical to controlling runaway health- care costs, but there is broad public anxiety about the potential impact of reform legislation and conflicting views about the types of fixes being proposed on Capitol Hill, according to a new Washington Post-ABC News poll. Most respondents are "very concerned" that health-care reform would lead to higher costs, lower quality, fewer choices, a bigger deficit, diminished insurance coverage and more government bureaucracy. About six in 10 are at least somewhat worried about all of these factors, underscoring the challenges for lawmakers as they attempt to restructure the nation's $2.3 trillion health-care system. Part of the reason so many are nervous about future changes is a fear they may lose what they currently have. More than eight in 10 said they are satisfied with the quality of care they now receive and relatively content with their own current expenses, and worry about future rising costs cuts across party lines and is amplified in the weak economy. President Obama, in a news conference yesterday, sought to leverage that apprehension. "Premiums have been doubling every nine years, going up three times faster than wages," he said. "So the notion that somehow we can just keep on doing what we're doing, and that's okay, that's just not true." Debra Matherne, a 43-year-old lawyer in Pennsylvania, agreed, saying she is contemplating leaving a job she loves because health insurance premiums for her family have jumped to $2,000 a month. "That's just a crazy figure," she said. The midday news conference was part of an orchestrated attempt by the White House to draw public attention to the need for landmark health legislation. Earlier in the day, Health and Human Services Secretary Kathleen Sebelius released a report documenting the growing financial burden that medical bills are placing on families. On Wednesday, Obama will host a health-care meeting with a bipartisan group of governors and later participate in a televised town hall session dedicated to the issue. Obama also used yesterday's news conference to rebut criticism of one of the more contentious ideas being considered: creation of a government-sponsored health insurance program that would compete with private firms. Insurers and many Republicans warn that the "public option" included in bills filed in the House and Senate "would dismantle employer-based coverage, significantly increase costs" and add to the federal deficit. "If private insurers say that the marketplace provides the best quality health care; if they tell us that they're offering a good deal, then why is it that the government, which they

144 say can't run anything, suddenly is going to drive them out of business?" Obama said. "That's not logical." After months of cordial relations between the industry and the White House, Obama's comments were the sharpest to date and come at a time when there is widespread debate and confusion over what the public wants. One of the reasons is the complexity of the issue, something not easily captured in a poll question. Survey questions that equate the public option approach with the popular, patient-friendly Medicare system tend to get high approval, as do ones that emphasize the prospect of more choices. But when framed with an explicit counterargument, the idea receives a more tepid response. In the new Post-ABC poll, 62 percent support the general concept, but when respondents were told that meant some insurers would go out of business, support dropped sharply, to 37 percent. Support for an "individual mandate," requiring every American to carry health insurance, ranges from 44 percent to 70 percent depending on the specific provisions. "The president needs to understand that this is about patients and preserving their options," said Sen. Mike Enzi (R-Wyo.), a key player in bipartisan negotiations in the Senate. "Losing their health insurance is not the kind of change Americans were hoping for." Even as Obama and the insurers ratcheted up the tenor of the discussion, both sides made clear there is still plenty of room for compromise. "We are still early in this process, so we have not drawn lines in the sand," Obama said. Karen Ignagni, head of America's Health Insurance Plans, said that she sensed an opening in the president's enthusiasm to create a government-sponsored plan modeled after the private-market plans from which federal workers choose. In the poll, 58 percent said they see government reform as necessary to stall skyrocketing costs and expand coverage for the uninsured, while 39 percent said they fear any federal action would do more harm than good. The numbers split sharply along partisan and ideological lines: Ninety-two percent of liberal Democrats said they see government intervention as essential, compared with 19 percent of conservative Republicans. Beyond general backing for governmental action, a few specific provisions under consideration on Capitol Hill receive significant levels of public support, including higher taxes on households with incomes above $250,000, a limit on medical malpractice amounts and, under certain conditions, a law requiring all Americans to carry health insurance. A large majority, 70 percent, opposes a new federal tax on employer-paid health insurance benefits that exceed $17,000 a year. Majority support for certain new government action, however, does not come with high hopes: Half of all Americans said they think the quality of their health care will stay about the same if the system changes, and 31 percent expect it to deteriorate. "We're spending a lot and not necessarily getting the bang for our buck," Philip Arms, 58, of Northwest Washington, said in a follow-up interview. Despite his desire for reform, "I'm not necessarily convinced it won't make things worse." The poll was conducted by telephone June 18 to 21, among a national random sample of 1,001 adults; results have a margin of sampling error of plus or minus three percentage points. Polling analyst Jennifer Agiesta contributed to this report.

145 Business

June 24, 2009 Despite Recession, High Demand for Skilled Labor By LOUIS UCHITELLE Just as the recession began, Chris McGrary, a manager at the Cianbro Corporation, set out to hire 80 “experienced” welders. Only now, 18 months later, is he completing the roster. With the unemployment rate soaring, there have been plenty of applicants. But the welding test stumped many of them. Mr. McGrary found that only those with 10 years of experience — and not all of them — could produce a perfect weld: one without flaws, even in an X-ray. Flawless welds are needed for the oil refinery sections that Cianbro is building in Brewer, Me. “If you don’t hire in a day or two, the ones that can do that,” Mr. McGrary said, “they are out the door and working for another company.” Six million jobs have disappeared across the country since Mr. McGrary began his quest. The unemployment rate has risen precipitously to 9.4 percent, the highest level in nearly 30 years, and most of the jobs that do come open are quickly filled from the legions of seekers. But unnoticed in the government’s standard employment data, employers are begging for qualified applicants for certain occupations, even in hard times. Most of the jobs involve skills that take years to attain. Welder is one, employers report. Critical care nurse is another. Electrical lineman is yet another, particularly those skilled in stringing high-voltage wires across the landscape. Special education teachers are in demand. So are geotechnical engineers, trained in geology as well as engineering, a combination sought for oil field work. Respiratory therapists, who help the ill breathe, are not easily found, at least not by the Permanente Medical Group, which employs more than 30,000 health professionals. And with infrastructure spending now on the rise, civil engineers are in demand to supervise the work. “Not newly graduated civil engineers,” said Larry Jacobson, executive director of the National Society of Professional Engineers. “What’s missing are enough licensed professionals who have worked at least five years under experienced engineers before taking the licensing exam.” While these workers might be lured away by higher offers in a robust economy, they should be more plentiful when overall business demand is as slack as it is now. For these hard-to-fill jobs, there seems to be a common denominator. Employers are looking for people who have acquired an exacting skill, first through education — often just high school vocational training — and then by honing it on the job. That trajectory, requiring years, is no longer so easy in America, said Richard Sennett, a New York University sociologist.

146 The pressure to earn a bachelor’s degree draws young people away from occupational training, particularly occupations that do not require college, Mr. Sennett said, and he cited two other factors. interrupts employment before a skill is fully developed, and layoffs undermine dedication to a single occupation. “People are told they can’t get back to work unless they retrain for a new skill,” he said. None of this deterred Keelan Prados from pursuing a career as a welder, one among roughly 200,000 across the nation. At 28, he has more than a decade of experience, beginning when he was a teenager, building and repairing oil field equipment in his father’s shop in Louisiana. Marriage to a Canadian brought the Pradoses to Maine, near her family. And before Mr. Prados joined Cianbro, an industrial contractor, he ran his own business, repairing logging equipment out of a welding and machine shop on the grounds of his home in Brewer. The recession dried up that work, and last December, he answered one of Mr. McGrary’s ads. “I welded a couple of pieces of plate together for them and two pipes, and they were impressed,” Mr. Prados said. In less than two weeks, he was at work on Cianbro’s oil refinery project, earning $22 an hour and among the youngest of Mr. McGrary’s hires, most of whom are in their mid-30s to early 40s. The Bureau of Labor Statistics does not track how often Mr. Prados’s experience — applying for a job and quickly being offered it — is repeated in America in the midst of huge and protracted unemployment. A bureau survey counts the number of job openings and the number of hires, but the data is not broken down by occupation. The Conference Board, a business organization in New York, comes closer. In a monthly count of online job openings — listed on Monster.com and more than 1,200 similar Web sites — it breaks the advertised openings into 22 broad occupational categories and compares those with the number of unemployed whose last job, according to the bureau, was in each category. In only four of the categories — architecture and engineering, the physical sciences, computer and mathematical science, and health care — were the unemployed equal to or fewer than the listed job openings. There were, in sum, 1.09 million listed openings and only 582,700 unemployed people presumably available to fill them. The Conference Board’s hard-to-fill openings include registered nurses, but the shortage is not as great as it was before the recession, particularly in battered states like Michigan and Ohio, said Cheryl Peterson, a director of the American Nurses Association. “Until the downturn, it was easy for experienced registered nurses to find employment right in their communities, in whatever positions they wanted,” Ms. Peterson said. “Now it is a little more difficult because the number of job openings has fallen and we have more retired nurses, in need of income, coming back.” That does not hold for nurses who have a decade of experience caring for critically ill people, particularly in hospital recovery rooms, said Dr. Robert Pearl, chief executive and chairman of the Permanente Medical Group, a big employer of medical professionals. “There are probably more nurses recently trained than there are jobs for them,” he said, “but for those with the highest level of skill and experience, there are always openings.” And at $100,000 in pay. That is also the case for geological engineers like Diane Oshlo, who was hired last month by Kleinfelder, a professional services firm headquartered in San Diego that takes on big projects, like the environmental cleanup work Ms. Oshlo is doing in

147 Corpus Christi, Tex., at the site of an inactive oil refinery. Engineers like her, skilled in petroleum, are in short supply, and those who are also professional geologists are even rarer. That made Ms. Oshlo, 50, a hot prospect when she decided to relocate from Chicago, where she had lived for years, doing similar work for a similar firm. Margaret Duner, a Kleinfelder recruiter, spotted her résumé when it arrived in the spring in response to a job ad, and quickly brought her into the hiring process. “Diane stood out,” Ms. Duner said. Two other firms to which Ms. Oshlo sent résumés also quickly offered work. What swayed her was not the $65,000 salary — there will be raises and bonuses soon, Ms. Duner said — but Kleinfelder’s willingness to pay to move her to Corpus Christi. “I told the two others I couldn’t wait,” Ms. Oshlo said. “They offered roughly the same pay, but they weren’t sure about the relocation package.”

148 COLUMNISTS: MARTIN WOLF Reform of regulation has to start by altering incentives By Martin Wolf Published: June 23 2009 20:16 | Last updated: June 23 2009 20:16

Martin Wolf: This crisis is a moment, but may not be a defining one - May-19 Martin Wolf: Why Obama’s conservatism may not prove good enough - May-12 Economists’ forum - Oct-01 Martin Wolf: Tackling Britain’s fiscal debacle - May-07 Proposals for reform of financial regulation are now everywhere. The most significant have come from the US, where President Barack Obama’s administration last week put forward a comprehensive, albeit timid, set of ideas. But will such proposals make the system less crisis-prone? My answer is, no. The reason for my pessimism is that the crisis has exacerbated the sector’s weaknesses. It is unlikely that envisaged reforms will offset this danger. At the heart of the financial industry are highly leveraged businesses. Their central activity is creating and trading assets of uncertain value, while their liabilities are, as we have been reminded, guaranteed by the state. This is a licence to gamble with taxpayers’ money. The mystery is that crises erupt so rarely. The place to start is with the core of modern capitalism: the limited liability, joint-stock company. Big commercial banks were among the most important products of the limited liability revolution. But banks are special sorts of businesses: for them, debt is more than a means of doing business; it is their business. Thus, limited liability is likely to have an exceptionally big impact on their behaviour.

149 Lucian Bebchuk and Holger Spamann of the Harvard Law School make the big point in an excellent recent paper.* Its focus is on the incentives affecting management. These are hugely important. Still more important, however, is why a limited liability bank, run in the interests of shareholders, is so risky. In a highly leveraged limited liability business, shareholders will rationally take excessive risks, since they enjoy all the upside but their downside is capped: they cannot lose more than their equity stake, however much the bank loses. In contemporary banks, leverage of 30 to one is normal. Higher leverage is not rare. As the authors argue, “leveraged bank shareholders have an incentive to increase the volatility of bank assets”. Think of two business models with the same expected returns: in one these returns are sure and steady; in the other the outcome consists of lengthy periods of high returns and the occasional catastrophic loss. Rational shareholders will prefer the latter. This is what one sees: high equity returns, by the standards of other established businesses, and occasional wipe-outs. Profs Bebchuk and Spamann add that four features of the modern financial system make the situation even worse: first, the capital of banks is itself partly funded by debt; second, the role of bank holding companies may further increase the incentives of shareholders to underplay risk; third, managers are rewarded for aligning their interests with those of shareholders; and, fourth, some of the ways managers are rewarded – options, for example – are themselves a geared play on rewards to shareholders. So managers have an even bigger economic interest in “going for broke” or “betting the bank” than shareholders. As the paper notes, the fact that some managers lost a great deal of money does not demonstrate they were foolish to make these bets, since their upside was so huge. A solution seems evident: let creditors lose. Rational creditors would then charge a premium for lending to higher-risk operations, leading to lower levels of leverage. One objection is that creditors may be ill-informed about the risks being run by banks they are lending to. But there is a more forceful objection: many creditors are protected by insurance backed by governments. Such insurance is motivated by the importance of financial institutions as sources of credit, on the asset side, and suppliers of money, on the liability side. As a result, creditors have little interest in the quality of a bank’s assets or in its strategy. They appear to have lent to a bank. In reality, they have lent to the state. The big lesson of the current crisis is just how far such insurance may go in the case of institutions deemed too big or interconnected to fail. Big banks rarely get into trouble in isolation: they often make very similar errors; moreover, the failure of one impairs the actual (or perceived) solvency of others. Thus, creditors are most at risk in a systemic crisis. But a systemic crisis is precisely when governments feel compelled to come to the rescue, as they did at the end of last year. According to the International Monetary Fund’s latest Global Financial Stability Report, support offered by the US, UK and eurozone central banks and governments has amounted to $9,000bn (€6,400bn, £5,500bn), of which $4,500bn are guarantees. The balance sheet of the state was put behind the banks. This does not mean creditors bear no risk at all. But their risk is attenuated. The well-known solution is to regulate such insured institutions very tightly. But an enormous part of what banks did in the early part of this decade – the off-balance-sheet vehicles, the derivatives and the “shadow banking system” itself – was to find a way round regulation. The obvious question is whether it will be “different this time”.

150 Sensible people must doubt it. Indeed, it must be particularly unlikely when the capitalisation of banks is so small. This is the time to go for broke. In a speech delivered just last week, Mervyn King, governor of the Bank of England, made clear why finding a better approach matters so much: “The costs of this crisis are not to be measured simply in terms of its impact on public finances, the destruction of wealth and the number of jobs lost. They are also to be seen in the lost trust in the financial sector among other parts of our economy ... ‘My word is my bond’ are old words. ‘My word is my CDO-squared’ will never catch on.” Such a crisis is not only the result of a rational response to incentives. Folly and ignorance play a part. Nor do I believe that bubbles and crises can be eliminated from capitalism. Yet it is hard to believe that the risks being run by huge institutions had nothing to do with incentives. The unpleasant truth is that, today, the incentive to behave in this risky way is, if anything, even bigger than it was before the crisis. Regulatory reform cannot end with incentives. But it has to start from incentives. A business that is too big to fail cannot be run in the interests of shareholders, since it is no longer part of the market. Either it must be possible to close it down or it has to be run in a different way. It is as simple – and brutal – as that.

* Regulating Bankers’ Pay, Harvard Law and Economics Discussion Paper No. 641, May 2009 http://www.ft.com/cms/s/0/095722f6-6028-11de-a09b-00144feabdc0.html

151 SEC and CFTC Share Derivatives Oversight Responsibility: Who Does What? Jun 23, 2009 Overview: On May 13, the U.S. Treasury announced comprehensive OTC derivatives trading reform. In particular, the OTC derivatives markets must be moved “onto regulated exchanges and regulated transparent electronic trade execution systems" ($684 trillion OTC derivatives market). Four main gaps are to be closed: 1) systemic risk (see GAO report); 2) price and counterparty transparency: aggregate data must be made available to the public and detailed positions to regulators. 3) regulators need authority to limit market abuse e.g. naked shorts; 4) need implement stronger consumer and investor protection. Emerging consensus: If a clearinghouse accepts to clear a derivative, it is standardized and must trade through a central counter party.

o June 23 Senate Hearing results (via WSJ): SEC Chairman Mary Schapiro proposed that her agency oversee derivatives linked to stocks, bonds (including corporate CDS) and securities ,and that the Commodity Futures Trading Commission (CFTC) oversee all other derivatives including derivatives related to interest rates, foreign exchange, commodities, energy and metals. At the hearing, Gary Gensler pushed for more aggressive regulation than the Obama administration had requested: He wants to require that standardized derivatives be traded on electronic exchanges which includes a central counterparty as well as price and volume transparency.

o June 4: Gary Gensler, the new CFTC chairman, also proposes strict policing of derivatives that are too non-standard to be moved onto an exchange or cleared centrally by instituting strict documentation and practices requirements and by preventing regulatory arbitrage between instruments.

o May 14 Bloomberg: Regulators at the SEC are considering price reporting standards similar to TRACE for the OTC derivatives market. Mind that the switch to TRACE reduced bank profits by almost half seven years ago.

o June 23 Reuters: Craig Donahue, chairman of Chicago Mercantile Exchange (CME): "We have to be careful to manage the risk profile of what we clear and there will be a range of things that we would not be comfortable clearing." Illiquid CDS trading infrequently are difficult to assess from a risk-management perspective. Moreover, enforcing margin requirements on CDS could be more challenging than for other derivatives as the value of the contracts can rapidly change if a borrower is suddenly deemed near default. In some cases, defaults can occur before sufficient collateral payments can be made (jump risk). See: Has the fight for market share begun?

o May 18 Figlewski/Roy/Walter (NYUStern): Credit is not like market risk. Require 100% margin on largest position on any day because if a default occurs, payout requirement can jump to 100%.

o Cass (breakingviews): Focus on standardized OTC products dangerous unless the truly toxic bespoke products are not addressed as well in new regulations.

o Sen. Tom Harkin, D-Iowa, introduced in November 08 the Derivatives Trading Integrity Act to eliminate the distinction between derivatives traded over the counter and on an exchange, and thus bring the massive over-the-counter (OTC)

152 derivatives market under federal regulation. Sen. Peterson circulates draft bill that would require all CDS to be processed by a clearing house. More significantly, it would ban “naked” CDS trading - i.e. any trades in which protection buyers did not own the underlying bond referenced by the contract. Naked CDS trades account for about 80 per cent of the market. (FT Alphaville) o Industry, academia (via FTAlphaville): Outright ban of naked CDS naked shorts is too extreme. To the extent the committee is concerned about speculation in CDS, they should consider giving the CFTC or the Fed Board the right to establish margin requirements for CDS exchange trades that are not ‘bona fide hedges’ or the like, similar to the rules governing futures contracts. As a result, the bill has no chance to pass in this form. (Reuters) o SIFMA and ISDA industry groups agree to central counterparty but don't want to lose flexibility and fees from OTC trading. Moreover, on and off-exchange trading are not perfect substitutes. Investors appreciate customized products; banks earn fees and have the advantage of back-office infrastructure vis-a-vis securities exchanges. o Jan 30 Bloomberg: Faced with tougher regulation dealers overhaul CDS trading by March 2009 with 'Big Bang' reform: 1) For the first time, the market will have a committee of dealers and investors making binding decisions about the event of default and potential recovery value; 2) In one of the most noticeable changes for traders, those who buy protection will pay an upfront fee depending on current market prices, and then a fixed $100,000 or $500,000 annual payment for every $10 million of protection purchased. (Now, upfront payments are only required for riskier companies whose spread exceed 10%.) o May 6 Bloomberg: The New York Fed is concerned that credit-default swap clearinghouses lack a common feature of their counterparts for futures, allowing customers to segregate their trading from bank accounts: in the run-up to Bear Stearns and Lehman troubles, there were large outflows due to investors that feared for their posted collateral (with good reason as the case of Lehman showed.) o Stephen Cecchetti: Amaranth and LTCM impact comparison shows that regulated exchange trading should be the norm. Advantages: smaller counterparty risk with centralized clearing house and margin calls; asset valuation certainty; standardized products. o see BIS H2 2008 OTC Derivatives Survey

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Yes Virginia, there was an international financial crisis in 2007 and 2008 Posted on Tuesday, June 23rd, 2009 By bsetser Now that the markets have lost a bit of their froth, it seems fitting to note just how sharply trade — and private financial flows — have contracted over the past year. The US q1 balance of payments data is rather stunning.

Trade (as we all know) contracted far more rapidly during this cycle than in the past. But the fall in private financial flows — outflows as well as inflows — has been even sharper than the fall in trade flows. US private investment in the rest of the world rebounded a bit in the first quarter, but private demand for US financial assets remained in the doldrums. Private investors were still pulling funds out of the US in the first quarter. A close examination of the graph indicates that demand for US financial assets by private investors abroad actually peaked in the second quarter of 2007 — a peak that came after gross private flows (inflows as well as outflows) rose strongly in 2005 and 2006. That surge was — in my view — linked to the chain of risk associated with a world where central banks took the currency risk associated with financing the US external deficit and private intermediaries took the credit risk associated with financing ever more indebted US households.

154 Any interpretation of what caused the crisis has to explain this surge. But any interpretation of the crisis also needs to explain why US imports and exports continued to rise — and the US trade and current account deficit remained large — even after private inflows collapsed. I suspect that part of the answer is that a lot of private inflows were linked to private outflows — as special investment vehicles operating in say the US could only buy long-term US mortgage bonds if someone in the US bought their short-term paper. The fact that private outflows collapsed along with private inflows meant that net private flows didn’t fall at the same rate. Indeed, at times - notably in q4 2008 — the fact that US investors pulled funds out of the rest of the world faster than foreign investors pulled funds out of the US provided the US with a significant amount of net financing. And part of the answer is that private investors never were the only source of financing for the US current account deficit. Strong central bank demand — especially in late 2007 and early 2008 — offset a fall in private flows. One thing though is sure: the scale of the collapse in private financial flows the experienced during this crisis is entirely unprecedented. There were a few instances in the past when private flows (excluding flows into Treasuries) were slightly negative. But outflows of 5% of GDP in a quarter are entirely unprecedented. And now that the US data has been revised to reflect the survey, adding private purchases of Treasuries back in doesn’t change all that much … Net private demand for long-term US financial assets - that is purchases of US securities and foreign direct investment in the US, net of US purchases of foreign securities and US direct investment abroad — has been weak for some time now.

There is more to say on the details of the balance of payments data, but I’ll live it for another post.

155 13 Responses to “Yes Virginia, there was an international financial crisis in 2007 and 2008” June 23rd, 2009 at 4:15 am 1. D Gross responds: Very interesting charts (again). A couple of quick observations/questions Doesn’t the capital flow chart from 2000 onward look like an amplified version of the chart from 1995-2000? This seems to be what US bubbles look like. Are you sure that % of GDP is the right measure? Global capital flows have been growing much faster than GDP for decades as the world becomes more interconnected (and leveraged) and capital controls come down. Hence, I would expect any pro-cyclical changes in capital flows to look a lot bigger now as a % of GDP than back in the 70s, 80s or even 90s. Would also be interesting to see the changes as a % of capital stock. As you point out, international finance has gotten more complex, with hedge funds and US-controlled SIVs and trusts in the Caymans and London, so it is hard to nail down exactly who is a foreign and who is a domestic investor. In any case the mid-2007 peak on your charts was well timed with the start of the mortgage crisis. Many London/Cayman-based hedge funds blew up and liquidated portfolios (including Bear and UBS). At that same time, the Fed and the ECB started taking dodgy collateral directly from investment banks in order to finance their holdings. Public funding replaced private funding in the repo markets. The economy didn’t start slowing immediately because the consumer did not appear to be affected by these early collapses (though foreclosures were already picking up). The drop in US consumption seemed to occur only after Lehman failed and a more widespread crisis in confidence crushed the stock markets. We seem to have gotten over much of that crisis in confidence, but as your charts indicate, cross-border capital flows are far from normal, central banks still run the repo markets and few private investors are buying mortgages. I wonder if the return in confidence we have seen this quarter in 2009 (stocks up, EM up, commodities up) is as misplaced as consumer confidence was in 2007? I can see hundreds of small to mid-sized US banks going down over the next year due to commercial real estate troubles, and we could see some US municipal defaults as well. The US Federal government will step into the breach with more bailouts but the patience on the part of US taxpayers and foreign investors for bailout upon bailout coincident with huge healthcare, energy and stimulus spending initiatives may be limited. The US is far from “out of the woods”, as your charts show. June 23rd, 2009 at 6:50 am 1. June 23rd, 2009 at 6:50 am 2. DJC responds: The US government is set to provoke a new international crisis with a trade War targeting China. Will the China PBoC still be purchasing hundreds of billions of US Treasury bonds?

156 http://www.cnbc.com/id/31496975 U.S. Trade Representative Ron Kirk is expected to launch a WTO case against China on Tuesday when he holds what his office called a major news conference regarding U.S.- China trade. “If the U.S. does indeed file a WTO case against China on raw material export restrictions, we welcome this action,” said Tom Gibson, president of the American Iron and Steel Institute. “U.S. and NAFTA steel producers have long believed that this government of China policy is a WTO violation and that it is benefiting Chinese manufacturers artificially while disadvantaging manufacturers everywhere else,” he said. http://blogs.cfr.org/setser/2009/06/23/yes-virginia-there-was-a-financial-crisis-at-the- end-of-2008/#more-5717

The good and bad news in the World Bank’s China Quarterly Posted on Sunday, June 21st, 2009 By bsetser The good news in the latest World Bank China Quarterly: One. China is growing, thanks to China’s government. The World Bank estimates that the government’s policy response will account for about 6 percentage points of China’s 7.2% forecast growth (p. 8). That’s good. There is a big difference between growing as 7% and growing at 1%. This was the right time for China’s government to “unchain” the state banks. Ok, it would have been better if China had allowed its currency to appreciate back in late 2003 and early 2004 to cool an overheated economy instead of imposing administrative curbs on bank credit and curbing domestic demand. Then China might not have ever developed such a huge current account surplus and avoided falling into a dollar trap. But better late than never: this was the right time to lift any policy restraints on domestic demand growth. China has, in effect, adopted its own version of credit easing. It just works through the balance sheets of the state banks rather than through the balance sheet of the central bank. Andrew Batson: By some indicators, credit in China is even looser than in the U.S., where the Federal Reserve has extended unprecedented support to private markets. … China’s methods for pumping cash into the economy are quite different from those of other major economies. Its banks, almost all of which are state-owned, made more than three times as many new loans in the first quarter as a year earlier. Central banks in the U.S., Europe and Japan lack such control over lending, and have instead used extremely low interest rates and direct purchases of securities to support credit. Two. China’s fiscal deficit will be closer to 5 percent of GDP rather than 3 percent of GDP. That’s cause for celebration in my book. Last fall I was worried that the desire to limit the fiscal deficit to three percent of GDP would mean that there was less to

157 China’s stimulus than met the eye (or hit the presses). I was wrong. If the likely future losses on the rapid expansion of bank credit are combined with the direct fiscal stimulus, China almost certainly produced a bigger stimulus program than any other major economy. Three. China’s current account surplus is now projected to fall in 2009. Exports still haven’t picked up — and we now have data through the first five months of the year. Imports by contrast are starting to pick up. That shows up clearly in a chart of real imports and real exports, a chart that draws on data that that the World Bank’s Beijing office generously supplied me:

Some of that is commodity stockpiling and thus not a reflection of underlining demand. And some stockpiling sounds a lot like simple speculation. But let’s set those debates aside for a bit. In dollar terms, China’s 2009 current account surplus will be a bit smaller than its 2008 surplus (The World Bank assumes that China’s trade surplus in the last half of 09 to be significantly smaller than its surplus in 08, as the surplus was up in the first five months of 09). And since the fall in commodity prices would be expected to push the surplus up, all other things being equal, that indicates a real shift in net exports. Net exports, according to Dr. Kuijs of the Bank’s Beijing office, will subtract about 2.5% from China’s overall GDP growth in 2009. The not-so-good news: One. It isn’t clear that China has put in place policies that will bring about a sustained rise in domestic consumption. The stimulus has worked by pumping up investment, especially state investment. And investment already loomed large in the national accounts. Olivier Blanchard: “In response to the crisis, China has embarked on a major fiscal expansion, with a focus on investment rather than on consumption. This was the right policy given the need to increase spending quickly, but this increase in investment can only last for a

158 while. The question is whether, as time passes, China will allow an increase in consumption.” Two. The negative drag from net exports stems from a faster fall in real exports than in real imports, not a rise in real imports that exceeds the rise in real exports. For the year, real exports are forecast to fall by 10% and real imports by almost 5%. If China’s exports fall faster than global demand, that opens up space that allows others to cut back less. The alternative — fast Chinese export growth amid a shrinking global economy — would be a sure source of trouble. But China still isn’t really acting as a locomotive for overall global demand growth. Three: Real imports of manufactured goods are still down 16% y/y. The rebound in Chinese imports has been driven entirely by the rise in commodity imports; real imports of primary products were up 17% (y/y) in April.

Back in 2003, when China was going through another lending boom, real imports of all kinds were up way more than they are now. Of course, back in 2003, China’s export sector was also booming and that pulled in imports for the “processsing trade.” The comparison isn’t perfect. But it does highlight how different China’s current lending and investment boom is from past lending and investment booms. Part of the explanation for the weak rebound in Chinese demand for manufactures is no doubt weak demand for exports, and thus weak demand for imported components. And part of it is that there is plenty of spare capacity in China to meet a surge in Chinese demand. For say cars. Chinese auto sales may top US auto sales this year – and China seems able to meet that rise in demand without importing a lot of finished cars or auto parts. But part of it seems to be that Chinese consumers are less interested in Western — or even Korean and Japanese– brands. Maybe Chinese consumers concluded that if foreign

159 banks weren’t better than Chinese banks, they shouldn’t assume that foreign goods were better than Chinese goods. And China’s government also seems particularly keen on making sure China’s stimulus is spent in China. Jamil Anderlini reports: “Beijing said government procurement must use only Chinese products or services unless they were not available within the country or could not be bought on reasonable commercial or legal terms.” Kind of risky for a country that still exports way more than it imports. But it shouldn’t be a total surprise. The usual argument for why China would keep its exchange rate undervalued even though the undervalued exchange rate meant that China was overpaying for foreign assets and thus would eventually take losses was that China needed to keep up Chinese employment, and this was a way to do so. And don’t forget, the undervalued renminbi has encouraged jobs through import substitution – not just the expansion of China’s export sector. China’s hasn’t been interested in undistorted trade; it has been interested in using trade to support domestic activity in China. It isn’t a huge jump then to see why China might want to make sure that its domestic stimulus creates, in the first instance, as many Chinese jobs as possible. But it does suggest that China’s commitment to say the G-20 is limited. Just giving China a seat at the international negotiating table won’t necessarily change China’s policies. All in all, I would say the good trumps the bad. But real problems will come if China’s buy China policy is still holding down Chinese demand for the world’s goods when global demand for Chinese goods returns; rising exports and still stagnant manufacturing imports from the world’s biggest surplus country wouldn’t be terribly popular globally. http://blogs.cfr.org/setser/2009/06/21/the-good-and-bad-news-in-the-world-banks-china- quarterly/ Frictions in the U.S-China Trade Relations

Jun 23, 2009 o June 2009: U.S. and E.U. filed their third joint WTO complaint against Chinese export restrictions on raw materials, which they say provide domestic manufacturers with inexpensive access to raw materials. China recently lost an appeal at the WTO over Chinese duties on auto parts after the U.S. and E.U. complained (Bloomberg) o Trade tensions have risen during the financial crisis as exports contract and job losses mount on both sides o China has not signed the WTO Agreement on Government Procurement, and its National Development and Reform Commission issued a decree in May requiring that Chinese companies should receive contracts for government stimulus projects unless Chinese companies cannot deliver certain technical goods at a reasonable price or time frame

160 o The U.S. stimulus package included a similar "buy American" provision for construction projects as long as they do not violate WTO trade agreements. Because China has not signed the relevant WTO agreement, Chinese firms can be restricted from stimulus contracts o Brookings: The U.S. has engaged the formal WTO dispute settlement mechanism to manage its bilateral trade tensions with China since 2006. While this avenue has worked well with U.S.-E.U. trade tensions, it remains to be seen if China and the U.S. will be able to similarly use the WTO to avoid self-destructing political landmines o A U.S. Treasury report in April declined to label China as a currency manipulator, although it believes the Renminbi is undervalued o During the campaign, Obama proposed higher import duties on Chinese imports to compensate for its undervalued currency and dumping, greater scrutiny of its investment in U.S. o U.S-China earlier agreed to cooperate on inspection and certification of food and other products; China to allow foreign firms to invest in securities JVs/issue debt, shares in domestic market; eliminate tax benefits to foreign-invested enterprises in Jan-08 after cutting/removing export-tax rebates on several categories in Jul-07 o China says it is strengthening product supervision and quality but U.S. politicizing trade o Upsides for U.S.: Rising exports to China on improving Chinese domestic demand, Chinese financing of U.S. deficit, use of China as a countervailing force against North Korea and Iran o Other contentious issues remain: Trade deficit with U.S. (China surpassed Canada to become top exporter to the U.S.), policy on climate change, violation of IPR; Trade with China may lead to cheaper import of goods but also higher commodity prices; U.S. blames China’s undervalued currency, subsidies for job loss, wage pressure and trade deficit

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"No podemos ver el trabajo de los chinos desde un punto de vista europeo. Allí ganarían 50 euros" Los empresarios asiáticos de Mataró se concentran ante la Generalitat para exigir la reapertura de sus talleres textiles JESÚS GARCÍA | Barcelona 23/06/2009 Unos 200 empresarios chinos acaban de concentrarse delante de la sede del Departamento de Interior, en Barcelona, para protestar por la operación policial que hace una semana se saldó con el cierre de 72 talleres de confección y la detención de 77 propietarios. Los empresarios han entregado una carta dirigida al consejero Joan Saura, en la que piden "recuperar la buena imagen legal" de la comunidad china y su "armonía" con los mossos. "Llamamos a los empresarios catalanes a que confíen en nosotros. Estamos preocupados porque dejen de hacernos los encargos", ha manifestado el presidente de la Unión de Asociaciones Chinas de Cataluña, Lam Chuen Pin, minutos después de reunirse con el jefe de gabinete de Saura, Xavier Rius. Lam, que ha sido recibido con aplausos por los empresarios, ha reclamado la reapertura de los locales. Al menos, de los que cuentan con licencia municipal de actividad (24, o sea una tercera parte de los registrados). Lam ha resaltado que los 450 operarios de los talleres de Mataró "quieren volver al trabajo". Eso, a pesar de que trabajaban en condiciones duras: 12 horas al día por 20 euros, en habitaciones insalubres y con poca luz. "No tenemos que verlo desde un punto de vista europeo, porque en China esa misma gente no pasa de los 50 euros al mes". A la protesta han acudido algunos de los amos de los talleres de Mataró, que han permanecido dos días detenidos y están en libertad con cargos, acusados de un delito contra los derechos de los trabajadores. También han asistido empresarios de grandes almacenes y locales de venta al por mayor de Badalona, Santa Coloma de Gramenet y otras localidades del área metropolitana. Han expresado su preocupación por la "imagen" del colectivo chino y porque las operaciones policiales puedan golpear también a sus negocios. http://www.elpais.com/articulo/espana/podemos/ver/trabajo/chinos/punto/vista/europeo/ganarian/euros/elpe puesp/20090623elpepunac_7/Tes

Un centenar de empresarios chinos reivindica su buen nombre ante Interior Barcelona, 23 de junio de 2009 (EFE). Un centenar de empresarios chinos del área de Barcelona se ha concentrado hoy ante la sede de la conselleria de Interior para reivindicar el buen nombre de la comunidad china

162 en Cataluña y defender la legalidad de su actividad, tras la redada en talleres ilegales de Mataró (Barcelona). Un grupo de ciudadanos de origen chino escuhan las palabras de Lam Chuem presidente de la Federación de Asociaciones Empresariales Chinas en Barcelona en las inmediaciones de la consellereia de Interior donde un centenar de empresarios chinos del área de Barcelona se han concentrado para reivindicar el buen nombre de la comunidad china en Cataluña y defender la legalidad de su actividad, tras la redada en talleres ilegales de Mataró (Barcelona). EFE En la redada, que los Mossos d'Esquadra llevaron a cabo la semana pasada por orden judicial en un total de 72 talleres de Mataró, se detuvo a 77 empresarios chinos -que ya han quedado en libertad con cargos- y se liberó de la explotación a 450 trabajadores, también chinos. Una semana después de la actuación policial, un centenar de empresarios chinos se ha concentrado ante la sede de Interior, donde una representación, con el apoyo de la patronal catalana de pequeñas y medianas empresas (Pimec), ha sido recibida por el jefe de gabinete del conseller Joan Saura, Xavier Rius. En la reunión, los empresarios le han entregado al jefe de gabinete de Saura sendas cartas dirigidas al conseller y al jefe de los Mossos d'Esquadra, reclamando una reunión para analizar en profundidad su situación y abogando por recuperar la "buena imagen legal" de la comunidad china. Al término de la reunión, el presidente de la Federación de Empresarios Chinos en Barcelona, Lin Chuan Ping, ha asegurado que su interés no era buscar el enfrentamiento sino reivindicar el "buen nombre" de los empresarios chinos, ya que estima que el "99,9%" de ellos respeta siempre la legalidad. Chuan Ping ha hecho además un llamamiento a los empresarios catalanes para que "sigan confiando" en los empresarios chinos y les sigan encargando pedidos, ya que, sino, cree que se corre el riesgo de que muchos comercios tengan que cerrar y que centenares de trabajadores se queden en el paro. Este empresario ha destacado que la comunidad china en Cataluña está integrada por 33.000 personas censadas, de las que 28.000 cotizan en la Seguridad Social y un tercio del total son autónomos, según datos facilitados por Chuan Ping. Al ser preguntado por las condiciones infrahumanas en las que trabajaban algunos de los empleados de los talleres clausurados por los Mossos, Chuan Ping ha insistido en que él sólo defiende los talleres legales, que estima que son mayoría, y ha recordado que los empleados cobraban en Mataró entre 20 y 30 euros al día y que en cambio en China ganan como máximo 50 euros al mes. "Trabajando en estos talleres están mejor y más tranquilos que en China y además no están ni robando, ni pidiendo en el metro o en la calle, sino trabajando", ha remarcado. En la misma línea, el representante de Pimec Alejandro Goñi, que también ha acudido a la reunión con la conselleria de Interior, ha destacado que casi la totalidad de los empresarios chinos trabajan dentro de la legalidad. Según Goñi, estos empresarios se han sentido ahora "humillados" por la actuación de los Mossos d'Esquadra, que cree que han dejado a mucha gente en el paro y en la calle y a muchos talleres precintados, sin poder atender pedidos y con el material encerrado en los talleres.

163 Cuando se le ha preguntado por las condiciones de los trabajadores, Goñi ha rehuido la respuesta y se ha escudado en que su organización se limita a defender la legalidad de los talleres y que "otra cosa son las condiciones de los trabajadores", que no ha querido valorar porque cree que no es tarea de Pimec.

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Trabajadores chinos niegan haber sido explotados por los detenidos en la macrorredada de los Mossos Unas 200 personas se concentran en Mataró para reivindicar la inocencia de sus compatriotas acusados de 'esclavizar' personas en talleres ilegales y piden que éstos se reabran | Entre los manifestantes, hicieron acto de presencia la cónsul de China en Barcelona, Wang Quing Ping, y el alcalde de Mataró, Joan Antoni Barón 18/06/2009 | Actualizada a las 18:43h | Sucesos Mataró (Barcelona). (EFE).- Unas 200 personas de origen chino se han concentrado en Mataró para reivindicar la inocencia de sus compatriotas detenidos en la macrorredada llevada a cabo anteayer por los Mossos d'Esquadra en talleres ilegales de esta ciudad y han negado que fueran esclavos de la economía sumergida. MÁS INFORMACIÓN Los cuatro jueces de Mataró iterrogarán a los 77 detenidos en la macrorredada de los Mossos La macrorredada en talleres ilegales de Mataró libera de la explotación a 450 chinos Cerca de 30 detenidos por explotar a trabajadores chinos en Mataró en la mayor redada de los Mossos Libertad con cargos para los 77 detenidos en la operación contra la mafia china

La operación policial de los Mossos d'Esquadra en talleres textiles ilegales de Mataró, que se ha saldado con 77 detenidos acusados de un delito contra los derechos de los trabajadores, ha permitido liberar de la explotación laboral a 450 personas, todas ellas de nacionalidad china, que en muchos casos vivían en condiciones infrahumanas. La cónsul de China en Barcelona, Wang Quing Ping; el presidente de la Unión de Asociaciones Chinas, Lam Chen Ping, y el alcalde de Mataró, Joan Antoni Barón, también han asistido a la concentración, que ha tenido lugar en la plaza Aneto de la capital del Maresme. Lam Chuen Ping ha asegurado que los trabajadores "no estaban obligados a trabajar" y ha añadido que la china es una sociedad "muy trabajadora" y que "si querían ganar más dinero y querían trabajar veinte horas, están en su derecho". El objetivo del Consulado de la China en Barcelona es que las autoridades catalanas resuelvan con rapidez el conflicto. La cónsul Wang Qing Ping ha señalado: "Necesitamos la comprensión y la tolerancia de esta tierra. China y Mataró, así como con Barcelona, Catalunya, y en todas partes tenemos buenas relaciones, tanto políticas como comerciales". El alcalde de Mataró, Joan Antoni Baron, ha manifestado que cuando la situación judicial lo permita se trabajará para legalizar los talleres que sea posible y clausurar los ilegales. Baron ha reiterado el apoyo de los servicios sociales del Ayuntamiento a los afectados por la operación policial. Uno de los concentrados este mediodía, Jin, ha explicado que se trata de una actuación policial "injusta" y ha denunciado el trato que recibieron por parte de los agentes de los

165 Mossos d'Esquadra algunos de sus compañeros. "No somos ninguna mafia china, somos trabajadores", ha dicho el ciudadano chino. Algunos familiares o amigos de los detenidos han empezado una recogida de firmas contra la actuación de los Mossos d'Esquadra. Cerca de 30 detenidos por explotar a trabajadores chinos en Mataró en la mayor redada de los Mossos 16/06/2009| Actualizada a las 19:55h | Sucesos La policía autonómica ha efectuado entradas simultáneas a un total de 72 pisos y locales que servían de talleres, donde al parecer trabajan y vivían en condiciones infrahumanas ciudadanos de origen chino Barcelona. (EFE).- Los Mossos d'Esquadra han detenido hoy a una treintena de personas acusadas de explotar a trabajadores en condiciones infrahumanas en talleres ilegales de Mataró (Barcelona), en la que ha sido la mayor redada de la policía catalana, que ha movilizado durante todo el día a unos 750 agentes. La operación policial se ha iniciado hacia las 09.30 horas, cuando los Mossos han efectuado entradas simultáneas en un total de 72 pisos y locales de Mataró que servían de taller textil clandestino, donde al parecer trabajan y vivían en condiciones infrahumanas ciudadanos de origen chino. En las entradas a estos talleres de confección, los Mossos han detenido al menos a una treintena de personas, también de origen chino, acusados de integrar una red que atentaba contra los derechos de los trabajadores. La operación policial sigue abierta, por lo que no se descarta que el número de detenidos pueda aumentar en las próximas horas. Cuando los agentes han entrado en los locales han encontrado a numerosas víctimas de la organización, que han sido liberadas. La operación, que ha llenado de furgonetas y agentes de la policía catalana la comarca barcelonesa del Maresme, ha estado dirigida por la unidad central de tráfico de seres humanos de la División de Investigación Criminal de los Mossos d'Esquadra, en estrecha colaboración con la Fiscalía de crimen organizado. El conseller de Interior, Joan Saura, ha desvelado que hasta el mediodía ya se habían detenido a entre veinte y treinta personas, algunas en firme y otras pendientes de identificar. En sus declaraciones a los periodistas, Saura ha destacado la importancia de este operativo -que es el más grande que han desplegado hasta ahora los Mossos, sin tener en cuenta los dispositivos de orden público-, ya que en total se han movilizado a 750 agentes de diversas comisarías y unidades policiales. "Es una muestra clarísima de la eficiencia y la profesionalidad de los Mossos para combatir el crimen organizado", ha remarcado Saura, que ha felicitado a los agentes por el operativo, que ha calificado como "el más importante que se ha hecho en Catalunya contra la explotación laboral y el tráfico de seres humanos". Los talleres textiles clandestinos que han sido inspeccionados y precintados por los Mossos están situados en diferentes calles de los barrios de Cerdanyola, Pla d'En Boet, Eixample y La Habana de Mataró. Los Mossos han inspeccionado, además, pisos particulares de ciudadanos de origen chino que también los utilizaban como taller textil.

166 En algunos casos, los agentes han encontrado en los locales y pisos altillos donde se hacinaban varios de los trabajadores que eran víctimas de la red. El dispositivo, denominado "Operativo Wei", se ha organizado para detener a los responsables de una red acusada de cometer delitos contra los derechos de los trabajadores. En los registros, los agentes se han hecho con material y documentación para proseguir con las pesquisas.

La investigación la instruye el juzgado de instrucción número 2 de Mataró, que ha decretado el secreto del sumario. El subjefe de la División de Investigación Criminal de los Mossos, el inspector Josep Monteys, tiene previsto comparecer mañana para dar más detalles de este operativo. El amplio despliegue policial ha provocado revuelo y curiosidad entre los vecinos de Mataró, poco acostumbrados a una operación policial de tanta envergadura. Algunos vecinos se han quejado de que los talleres clandestinos estaban en funcionamiento de día y de noche, por lo que les molestaban a la hora de dormir, y que de los locales salían continuamente bolsas llenas de artículos de confección. europapress.cat | Cataluña La macroperación contra la mafia china en Mataró se salda con más de 20 detenidos y 72 registros BARCELONA, 16 Jun. (EUROPA PRESS) - Unos 750 agentes de los Mossos d'Esquadra detuvieron esta mañana al menos a 20 ciudadanos chinos y efectuaron 72 registros en locales y pisos de forma simultánea en el barrio de Cerdanyola y la Llàntia de Mataró (Barcelona), en la mayor operación contra la mafia china efectuada en Catalunya. Según informaron a Europa Press fuentes cercanas al caso, localizaron a más de un centenar de ciudadanos chinos que eran explotados en talleres ilegales, la mayoría textiles, que trabajaban en condiciones "infrahumanas", en muchos casos vivían allí mismo, y registraron una decena de naves industriales en el polígono de Pla d'en Boet. El dispositivo 'Wei' se ha realizado en colaboración con la Fiscalía de Crimen Organizado, y a las 18.00 horas todavía seguían los registros en pisos y locales, que empezaron a las 9.30 horas, la mayoría en domicilios y locales, muchos de ellos propiedad de ciudadanos chinos, en los que presuntamente la organización explotaba a trabajadores. La investigación está bajo secreto de sumario, y las diligencias las instruye el Juzgado número 2 de Mataró, aunque en los registros participaron una veintena de secretarios judiciales de varios juzgados, también de fuera de la localidad. En declaraciones a Europa Press, un concejal del PP del Ayuntamiento, Juan Carlos Ferrando, que estaba en el lugar de los registros, calificó la operación de "desproporcionada" ya que, según él, se hubiera podido hacer con inspectores de trabajo, y puntualizó que no todos los ciudadanos chinos "son ilegales".

167 ESCUCHABAN LAS MÁQUINAS Una vecina de la calle Montcada de Mataró explicó a Europa Press que en los bajos del número 8 --que estaban siendo registrados por los Mossos-- había un taller y que "por la noche se escuchaban las máquinas de coser", ya que trabajaban "de día y de noche". Cada día iba una furgoneta para llevarles bolsas de ropa, aunque no veían si allí había hacinada mucha gente porque siempre "salían de noche", y en los tres años que el presunto taller llevaba allí nunca presenciaron peleas ni discusiones, por lo que, si no se vivía en la esa misma calle, no era fácil enterarse de su presencia. Entre otras calles, en el número 21 de la calle València la policía también efectuó un registro, donde los propietarios, de nacionalidad china, llevaban viviendo dos o tres años. Durante la intervención policial, se concentraron decenas de vecinos frente al portal, entre ellos varios ciudadanos chinos que criticaron la actuación policial. Una de ellas explicó que "China trabaja mucho para España" y recalcó que lo único que quieren "es trabajar", por lo que lamentó que la policía "siempre coja a los chinos". Otro registro se efectuó en el número 40 de la calle Pere III el Cerimoniós, en el que salió un ciudadano chino salió detenido ante la presencia de periodistas, vecinos y curiosos. Una vecina del bloque contiguo relató a Europa Press que sí que a veces "escuchaba ruido", aunque se quedó "alucinada" al percatarse de que los agentes habían entrado en el domicilio, donde vivían dos matrimonios chinos, uno en cada vivienda. Unas vecinas de un inmueble del 73 de la calle Rosselló --también registrado-- señalaron a Europa Press que cada día "llegan furgonetas y coches con género" y dijeron que en los siete años que llevaban no había habido problemas excepto una pelea entre dos mujeres. Una dependienta del estanco de enfrente afirmó que se sabía que "dentro había muchas personas que trabajaban día y noche", pero que cuando venía la policía "no encontraban nada porque el taller se encontraba en una terraza". http://www.europapress.es/catalunya/noticia-macroperacion-contra-mafia-china-mataro- salda-mas-20-detenidos-72-registros-20090616185849.html

168 22 Ago 2007 Los empresarios piden más inspecciones La expansión del comercio chino «preocupa gravemente» a los empresarios Pacenses El presidente de la Federación de Comerciantes de la Provincia dice que hay muchas dudas por despejar y pide a las autoridades que investiguen J. LÓPEZ-LAGO/BADAJOZ Daijun es una joven china de 20 años que llegó a Badajoz hace cinco meses. Trabaja en el inmenso Bazar Elefante de la avenida Fernando Calzadilla, una de las arterias comerciales de Badajoz y donde los caracteres chinos ya destacan entre los rótulos. Hay cola para pagar, pero hace un hueco para explicar que ella llegó a España porque aquí gana mucho más dinero y que así hay muchas compatriotas suyas. Volverá a Pekin en el 2008 para ver los Juegos Olímpicos y regresará para trabajar en éste o en otro bazar: «No sé si en Badajoz, en Barcelona, ... no lo sé, perdona, mi jefe prefiere que no hable con periodistas». El recelo es lógico, pues el desembarco asiático en el comercio está transformando muchos pueblos y ciudades y afectando directísimamente a los negocios tradicionales. Balanza descompensada De hecho, la relación comercial con España arroja números impresionantes. Según estadísticas de la Casa de Asia en Madrid, si en 1995 las importaciones desde China a España sumaron 1.757 millones de Euros, ocho años después la cifra subió a 6.682 millones. A la inversa, las exportaciones de España al gigante asiático fueron de 680 millones en 1995 y 1.098 millones en el 2003. Mientras, las tiendas multiprecios y bazares que han reemplazado a los 'todo a cien' se multiplican en Badajoz. «Este teléfono inalámbrico viene sin instrucciones», se quejaba ayer una ama de casa en uno de estos bazares. El encargado apenas pudo explicarle el funcionamiento porque casi no habla español. «Coja otro», es capaz de decirle mientras sigue cobrando artículos de todo tipo -desde una manguera a una libreta- a sus clientes de la barriada de Santa Marina, dicen que la más boyante de la ciudad. Más inspecciones José María Reino, presidente de la Federación de Comercio de la Provincia de Badajoz (Fecoba), reconoce abiertamente que «estamos gravemente preocupados». Aunque no hay estadísticas públicas de cuántos son, es fácil detectar que en los dos últimos años ha habido un incremento muy importante de establecimientos asiáticos en la provincia, asevera el representante del pequeño comercio pacense. Dice que «no podemos evitar que la gente se establezca aquí porque hay que respetar la libertad de mercado, pero sí alertar de que ocurren cosas extrañas que deberían tener en cuenta las autoridades». Por esta razón, la junta directiva de Fecoba que él preside ha enviado cartas a los responsables de Trabajo de la junta de Extremadura, a la Delegación del Gobierno, la Delegación de Hacienda y el Ayuntamiento de Badajoz «para que vigilen de dónde viene el capital, ya que yo llevo toda la vida de comerciante y resulta sospechoso que lleguen de la noche a la mañana e inviertan miles de euros en los mejores locales con cientos de metros cuadrados»

169 Según Reino, «la situación ha llegado a un punto en que establecimientos del mismo área de influencia tienen que cerrar, que existan naves rotuladas como mayoristas (en Badajoz están en el polígono el Nevero) que en realidad venden a todo el mundo a precios muy bajos. Y no olvidemos que hay artículos que venden y que carecen de instrucciones u homologación o que los responsables no saben hablar español. Por no hablar de que se ven niños de 10 y 12 años trabajando». Almacenes en el polígono de El Además -prosigue- se emplean a ellos mismos, por lo que Nevero. Cada vez hay más y los no generan empleo. Respecto a los horarios y si respetan empresarios locales se quejan derechos de los trabajadores como pagar horas extras de que muchos venden al por cuando abren los festivos, el presidente de Fecoba pide a mayor a particulares. / los inspectores que vigilen el cumplimiento de la ley para EMILIO PIÑERO detectar posibles anomalías. Pero sobre todo, un factor que subraya los recelos de los El negocio asiático ocupa las empresarios hacia ellos es que, en Badajoz, Reino no mejores calles conoce ningún interlocutor o asociación de comerciantes HAZTE OIR: ¿Compra asiáticos, como sí existen en otras comunidades. De habitualmente en comercios momento, la próxima reunión -en septiembre en chinos? Zaragoza- de la Confederación de Asociaciones de Comercio tratará este asunto gracias a un próximo informe del Ministerio de industria, comercio y turismo que explica cómo está afectando estos negocios al comercio español.

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Broad Agreement Reached on Derivative Oversight By Zachary A. Goldfarb Washington Post Staff Writer Tuesday, June 23, 2009 As Congress prepares to debate new rules for governing financial markets, federal regulators are taking steps to keep their turf wars from getting in the way of regulation. The two agencies responsible for overseeing financial trading have reached broad agreement over how, for the first time, to regulate the vast market in derivatives -- complex investments that last year magnified the problems spreading among financial firms. At a congressional hearing yesterday, Securities and Exchange Commission Chairman Mary L. Schapiro proposed that her agency oversee derivatives linked to stocks, bonds and securities and that the Commodity Futures Trading Commission oversee all other derivatives. CFTC Chairman Gary Gensler, sitting beside her, didn't offer his own proposal, but a spokesman said Gensler agrees with Schapiro, except on one outstanding issue. The multitrillion-dollar derivatives market, which currently isn't regulated, enables financial firms to speculate on whether stocks, bonds, currencies and natural resources, among other things, will rise or fall in value. A particular type of derivative called a credit-default swap exacerbated the financial crisis and contributed to the collapse of American International Group, which made bets on derivatives it could not afford. Credit-default swaps, which are linked to the value of bonds, would be overseen by the SEC under the proposed agreement. The accord between the SEC and CFTC awaits action by Congress, which a decade ago exempted derivatives from regulation. In a plan for retooling financial regulation announced last week, the Obama administration proposed new rules and heightened oversight for derivatives and the firms that trade in them. But the administration left the division of labor up to the SEC and CFTC, both independent agencies. In the past, the two agencies have clashed over which body had the best claim to oversee this market. The Obama administration had discussed a proposal to merge the two agencies but backed off the idea in part because of opposition on Capitol Hill, where different committees have jurisdiction over the SEC and CFTC. The derivatives market, valued at more than $400 trillion, is important both because so many financial firms participate in it and because the trading can affect the underlying assets. For example, trading in a credit-default swap linked to a corporate bond can influence the interest rate a company has to pay to borrow money. Schapiro, Gensler and others testified before the securities, insurance and investment subcommittee of the Senate Banking Committee. Still being negotiated between the SEC and CFTC is oversight of derivatives linked to indexes -- for instance speculating on whether the Dow Jones industrial average will rise or fall.

171 At the hearing, Gensler pushed for more aggressive regulation than the Obama administration has requested. Obama's proposal calls for derivatives to be traded through "central clearinghouses," which would collect data about the market and require that buyers and sellers allocate enough money to cover any trades. Gensler wants to go a step further and require that derivatives be traded on electronic exchanges, just as stocks are traded on the New York Stock Exchange and the Nasdaq. A derivatives exchange would offer the advantages of a clearinghouse but also provide public information about the pricing and volume of trades. Non-standard derivatives would be exempt from much of this regulation. These are derivatives linked to highly complex investments, such as securities composed of mortgages and other kinds of debt. But Gensler and Schapiro said it would be important to be vigilant about policing this market.

TODAY'S NEWSPAPER June 22, 2009;

Making Financial Regulation Work: A Systemic Risk Regulator This is part of a series on The Hearing called "Making Financial Regulation Work." The guest post is from Dean Baker, co-director of the Center for Economic and Policy Research. One of the major debates around President Obama’s plan for reforming the financial system is over who should be given the job of regulating systemic risk. This debate is fundamentally misguided. We already have an unofficial systemic risk regulator, or SRR: the Federal Reserve Board. The problem is that it did not do its job when it allowed an $8 trillion housing bubble to grow unchecked. The Fed has always perceived addressing problems of systemic risk as part of its job description. How else can we explain Alan Greenspan’s decision to support the stock market following the crash in 1987 or to intervene in the collapse of the Long-Term Capital Management hedge fund in 1998? Can these interventions be described as the conduct of monetary policy? We are not experiencing this crisis because no one had the job of dealing with systemic risk. The economy collapsed because Alan Greenspan and his successor, Ben Bernanke, both insisted that everything was just fine, even as the housing bubble grew to ever-more- dangerous levels. Their failure to recognize the risks posed by the housing bubble and to take steps to rein it in is the root cause of our economic problems. Suppose we rerun history and envision that our systemic risk regulator did its job over the past decade. Would anything have been different? If the Fed were officially designed as our SRR, the answer almost certainly is no. AIG’s issuance of trillions of dollars of credit default swaps almost certainly would have survived Greenspan’s scrutiny. After all, Greenspan insisted that there was no housing bubble. In the absence of a nationwide housing bubble, the prospect of a large number of mortgage-backed

172 securities going bad simultaneously is infinitely small. Why would Greenspan have been concerned? Suppose the SRR were someone else. If Alan Greenspan (formerly known as “the Maestro”) had said everything was okay, would that person have had said that he was wrong and there is a dangerous housing bubble? That is not the way things generally work in Washington. Most people in public agencies are worried first and foremost about advancing their careers. And picking a fight with a Fed chairman who enjoys the support of the financial industry, the media and most academic economists is not how to advance your career. In short, there is little reason to believe things would have been different even if there were a formally designated SSR. If the problem is the regulators rather than the regulations, then the goal should be to change the behavior of the regulators. There is one obvious way to do this: Fire them. The point is simple. If the regulators fail to do their jobs, as happened with disastrous consequences in this case, and do not see their careers suffer, then they have no incentive to do anything besides go along. In other words, we have to restore some symmetry to the incentive structure. The regulators know they take risks when they confront the financial industry. They must also know that they take risks if they fail to confront the industry. Simple economics tells us that if regulators risk consequences only when they confront the financial industry, then they will never confront the financial industry, even if we give them the title of “Systemic Risk Regulator.” --Dean Baker is co-director of the Center for Economic and Policy Research. He is the author of books including "Plunder and Blunder: The Rise and Fall of the Bubble Economy" and editor of "Getting Prices Right: The Debate Over the Consumer Price Index." He blogs at Beat the Press. By Terri Rupar | June 22, 2009;

173 On Regulating Credit-Default Swaps This afternoon, the Senate Banking Committee will be holding a hearing on over-the- counter derivatives. This is what I would be asking about: One part of the Obama administration's financial reform plan is tighter regulation of credit- default swaps -- those previously unregulated derivatives that brought down AIG and nearly the entire financial sector with it. One of the problems with AIG was that its regulators were apparently unaware that it had amassed a huge, one-sided portfolio of credit-default swaps that amounted to a massive bet that the economy would do just fine; another problem was that because credit default swaps were "over the counter," custom transactions between individual private parties, they created a large amount of counterparty risk -- the risk that the party you were trading with might not be there to honor the trade. In response, the administration proposes to "require clearing of all standardized OTC derivatives through regulated central counterparties (CCPs)." In addition, "regulated financial institutions should be encouraged to make greater use of regulated exchange-traded derivatives." Major players in the market will also be subject to conservative capital requirements (making sure they have enough money in case their trades go badly) and reporting requirements. These provisions aim to increase regulatory oversight and minimize the chances that a derivatives dealer will fail and take its counterparties down with it, and as far as they go they are a good thing. However, there is one potential loophole that, according to UCLA law professor Lynn Stout (on Friday's "Morning Edition"), is "potentially big enough to put the state of Texas into." The loophole is that "customized bilateral OTC derivatives transactions" would remain out of the reach of both exchanges and CCPs. Custom derivatives would still have to be reported to regulators, so what's the problem? The small problem is that unnecessary customization of financial products is a great way for derivatives dealers to jack up unnecessary transaction fees. The big problem is that custom derivatives are by their nature harder to oversee. Regulators want to be able to estimate a firm's potential exposure across all its tranactions under various scenarios; the more complex those transactions, the more difficult this becomes. Regulators already had the power to demand access to banks' books before the financial crisis; the problem was that they lacked the staff and skills to understand the complex structured products those banks were manufacturing and trading. As a result, custom products become a way for market participants to hide risks from oversight, and a potential means for systemic risks to build up out of sight. The conventional wisdom is that some firms have unique needs and therefore there have to be customized derivatives contracts. But the real question to ask is why we need customized derivatives in the first place. For example, you can buy only U.S. Treasury bills and bonds that mature on specific dates and in specific denominations. (Although perhaps there are banks that will custom-manufacture a Treasury-like security for you, and charge you a transaction fee -- while throwing in counterparty risk for good measure.) What's wrong with a world where you can buy a credit-default swap on any fixed-income instrument, but only for certain maturities (including the maturity of the underlying instrument) and on standard terms (such as the definition of a credit event and how the swap will be settled)? I know the high-level answer (in fact, I already said it): Firms have unique hedging needs. But I want to hear some good examples. On that same "Morning Edition" segment, Cory Strupp, a lobbyist at the Securities Industry and Financial Markets Association, gave this example: "If you have a company that wants to hedge a credit exposure in an odd amount of money -- $156,217.25 -- they can enter into a credit default swap that covers exactly that

174 amount of credit risk, to the penny." This is a terrible example, because if I'm a company of any size, and I have a credit exposure of $156,217.25 but I can only buy credit default swaps in multiples of $10,000, that's perfectly fine with me. Strupp must know it's a terrible example, but must have decided the better examples were too complicated for NPR. And once we know what the good examples are, the question is whether the benefits they provide to the parties involved outweigh their costs. And by costs, I don't mean just the transaction costs; I mean the fact that customized derivatives make regulation harder and increase the risks of a costly failure. This is an externality, pure and simple, and it should be deterred or taxed. (I'm guessing someone will point out that the Constitution limits the ability of the government to interfere in the freedom of contract. But remember, this is a regulated industry. Custom derivatives increase the cost of regulation; it would be perfectly constitutional to say that firms that trade in custom derivatives must pay a hefty tax on those products to offset the increased regulatory cost. If the tax is big enough, that would deter banks from using custom derivatives when standardized ones would do.) There's an interesting point behind this question. Felix Salmon said that the real problem wasn't that firms weren't perfectly hedged; it's that they believed they could be perfectly hedged. Risk never goes away; if you think you've eliminated it, it's just gone someplace else to hide. Instead of a system where companies think they can hedge their risks perfectly because financial products are infinitely flexible -- and therefore don't manage their risks effectively -- it would be better to have a system where companies can't hedge their risks perfectly, and know that, and behave accordingly. By James Kwak | June 22, 2009; 6:23 AM ET

175

23.06.2009 From Versailles a message of no austerity

Nicolas Sarkozy addressed a joint session of parliament at the palace of Versailles outlining his priorities for the second half of his presidency. It is the first time since 134 years that a president addresses parliament directly, only possible after a constitutional change. Sarkozy focused mostly on cushioning the effects of the recession rather than presenting a reinvigorated reform agenda. No tax rise and no austerity policies (“since these have always failed,”) but more investment into the future: Reindustrialisation, support for the young and unemployed, universities and schools, etc., as the way out of the crisis. In his speech Sarkozy distinguished between “good” (cyclical and “bad” (structural) deficits and a third type of deficit that would be “reabsorbed by allocating the proceeds of growth” He announced a new public bond to raise money for “priority investments”. In the next three months the government will hold vast consultations with different stakeholders to identify priority investments ( Les Echos has more details) Jean Francis Percresse writes that such a public bond could reunite the nation behind a growth strategy while at the same time accepting reforms such as the rise in the pensions age. But this was not a new strategy for France. The old policies had led to the present accumulation of debt. Sarkozy said “bad” deficits are to be reduced by spending cuts and “courageous reforms”. Health reform and overhauling the structure of local government in France are mentioned here. A reform of France’s pay-as-you-go pension system is scheduled for mid 2010, including the controversial issue of the pension age. Interestingly, the FT and El Pais picked up the rejection of austerity policies as a main confrontational issue with the Germans and the ECB, while the German press focussed on the pompous setting (see FTD or FAZ). ECB about to swamp the market with record liquidity Tomorrow is liquidity day in Europe, the FT reports, when the ECB will for the first time provide the banks with unlimited funds for a 12 month securities repurchase operation.

176 Many banks are said to be interested because they calculate that the interest rates have reached their bottom, and that this refinancing offer is as good as it will get, especially since the ECB said it might raise the 12-month repo rate independent of the ordinary repo rate. The paper quotes experts as saying that the estimated volume of liquidity injections will be in the order of several hundred of billion euros. The markets say goodbye to the green shoots The spring has ended, and so has the talk about green shoots. After the green shoot rally, global equity markets continued their retreat, but yesterday also saw sharp falls in commodities and emerging market currency amid rising risk aversion, the FT reports. Here are some important indicators: • iTraxx Crossover ( a measure of credit risk in Europe): up 27bp to 765bp • Gold down 1.2% at $920 • Russian Micex index – down 7.8% • Brazilian real down 3% at R$2 per US dollar IFO index rebounds, but... A picture is sometimes worth more than a thousand words. If you think that German industry is headed for a recovery on the grounds of the third consecutive increase in the Ifo index, this is the main index’ chart.

All it shows that after a steep decline, confidence has stabilised close to the bottom , while it is not even close to return to the levels prevailing before the crisis (when it was over 100, compared with 85.9 in June). This is still consistent with a U-shaped recovery, and even a L-shapen non-recovery, but it is not like a V-shaped recovery because the Ifo would have climbing much faster. The FT quotes an analyst as saying that German companies seem to be too optimistic about the prospect that the world economy is going to come to their rescue yet again. FT Deutschland points out that it is yet unclear whether the stabilisation of the Ifo index, and also of industrial orders, is based on a genuine recovery of demand, or on an inventory correction. If it is only the latter, it would not be stable. Oil again There seems to be more evidence that the oil price shock in 2008 may have been at least in part responsible for the recession. FT Deutschland quotes from a Bundesbank study that apart from the financial crisis, the sharp rise in oil prices was an important contributing factor for the recession. For Germany, the costs of energy imports to from 1.8% of GDP in 2004 to 3.4% in 2008. The shock would have been much harder had it

177 not been for the appreciation of the euro and the increase in energy saving and efficiency. The Bundesbank report also explained that the auto crisis in the US was caused in part by an oil-price induce switch to smaller and medium sized cars, which are mostly produced outside the US. Lucas Zeise on the EU’s banking regulation The criticism of the European approaching to banking regulation is getting louder. In his FT Deutschland column, Lucas Zeise says the US banking regulation is insufficient, while the European attempts are grotesque. All we do is to create new committees, such as the new risk council, which essentially consists of the same people – national central bank governors – who have failed to foresee the current crisis. Zeise is also deeply critical of what the US are doing, or rather not doing, especially in respect of credit derivatives. Exit strategies for Latvia Writing in Vox, Eduardo Levy-Yeyati says Latvia has been hard hit by the global crisis and faces an unsustainable currency peg. Should the country float its currency, adopt the euro, or try a contained devaluation? Assessing the options he concludes the latter is most realistic, in that it will address the concerns of the EU, IMF, and Latvia.

178 Business

June 23, 2009 4 People and Firm Sued in Madoff Case By DIANA B. HENRIQUES Three lawsuits filed on Monday provided new details about what regulators say went on inside Bernard L. Madoff’s long-running Ponzi scheme, including information about who might have helped perpetuate the fraud for so long. No one but Mr. Madoff and his accountant have faced criminal charges so far. But in two civil fraud cases filed Monday, federal regulators contend that a prominent investor and a small brokerage firm both helped Mr. Madoff sustain the Ponzi scheme by steering billions of dollars into it, in exchange for hundreds of millions of dollars in fees and profits. Taken together, the new lawsuits expand on what regulators have previously disclosed about Mr. Madoff’s swindle, which wiped out customer account balances totaling almost $65 billion.

In one lawsuit, the Securities and Exchange Commission filed civil fraud charges against Stanley Chais, a prominent California money manager and one of Mr. Madoff’s earliest investors, with accounts dating to 1970.

179 The lawsuit accused Mr. Chais of deceiving his clients and ignoring obvious signs of fraud. Some of those signals, regulators say, included Mr. Madoff’s ability to comply with a request from Mr. Chais that none of the Chais accounts should ever report a single losing trade. The second civil fraud case, also filed by the S.E.C., contended that three senior executives at the Cohmad Securities Corporation, a small brokerage firm co- founded by Mr. Madoff, knowingly helped finance the Ponzi scheme and conceal it from regulators for years. The third suit, filed in federal bankruptcy court by the trustee seeking assets for Madoff victims, also named Cohmad and its three senior executives, along with more than a dozen of its current or former employees. It seeks to recover millions of dollars in fees and profits the defendants received from Mr. Madoff over the years. Cohmad, which rented space in Mr. Madoff’s Manhattan offices, was little more than a stealth marketing arm that allowed Mr. Madoff to maintain his aura of exclusivity, the S.E.C. contended. In each case, the defendants deny that they knew about Mr. Madoff’s fraud. They also emphasized that they, like other Madoff victims, lost enormous sums of money when the scheme collapsed with Mr. Madoff’s arrest in December. For the most part, the S.E.C. case mirrors accusations in a lawsuit the Madoff trustee, Irving H. Picard, filed against Mr. Chais last month. However, it adds the claim that Mr. Chais demanded that Mr. Madoff never incur losses in his accounts. Eugene R. Licker of Loeb & Loeb, a lawyer for Mr. Chais, denied the S.E.C. accusations. “Like so many others, Mr. Chais was blindsided and victimized by Bernard Madoff’s unprecedented and pervasive fraud,” Mr. Licker said in a statement. “Mr. Chais and his family have lost virtually everything — an impossible result were he involved in the underlying fraud.” He added that his client “has faith that the judicial system will allow him to fight these reckless charges and restore his hard-earned good name.” The Cohmad executives named in the suits were Maurice J. Cohn, its co-founder and chairman; his daughter Marcia Beth Cohn, its president and chief operating officer; and Robert M. Jaffe, its vice president. The two new lawsuits against Cohmad and the executives included new accusations about the firm’s role in the fraud. Both lawsuits asserted that Mr. Madoff paid fees to Cohmad executives and brokers based on the amount of cash they steered into his hands. But according to the lawsuits, those fees were based on records that showed only the actual cash status of customer accounts — the amounts of cash invested and withdrawn — without including the fictional profits shown in the statements provided to customers. When a customer’s withdrawals exceeded the cash invested, Cohmad’s employees no longer earned fees on that account, even though the customer’s statements still showed a substantial balance, according to the suits. This unusual arrangement indicated that Cohmad and its representatives knew that the profits that investors were supposedly earning were bogus, according to the trustee’s lawsuit complaint. The S.E.C. complaint also asserted that Mr. Jaffe — who is the son-in-law of Carl Shapiro, a philanthropist whose family reported losing hundreds of millions in the

180 scheme — personally brought more than $1 billion into Mr. Madoff’s investment business. According to regulators, Mr. Jaffe was rewarded with outsize profits of more than 40 percent in his personal Madoff accounts. Some of those profits were generated after the fact to comply with Mr. Jaffe’s requests for specific long-term gains on particular days, the lawsuits contend. Mr. Jaffe “knew or recklessly disregarded” that these trades were fictitious and continued to raise cash for Mr. Madoff from other investors, according to the S.E.C. complaint. Steven R. Paradise of Vinson & Elkins, representing Cohmad and the Cohn family, denied any link between his clients and Mr. Madoff’s fraud. “Our clients continue to be as shocked as anyone at the revelations” about Mr. Madoff, Mr. Paradise said. “We look forward to the opportunity to challenge both the S.E.C.’s and Mr. Picard’s allegations in court.” Mr. Jaffe’s lawyers, led by Stanley S. Arkin, released a statement saying that the S.E.C. complaint “smacks of impulsiveness and efforts at self-justification. It is unfair, baseless in the law, and is inaccurate in its understanding of the facts and of Mr. Jaffe.” Although Cohmad’s offices were on the 18th floor of the three-floor suite that housed Mr. Madoff’s business, Ms. Cohn also had a key card for the 17th floor, where the fraudulent investment management operations was located, and records show that she used it regularly, according to the trustee’s lawsuit. Exhibits filed with the trustee’s case showed that someone had used Ms. Cohn’s card to enter that area more than five dozen times during 2008, including two occasions on the morning of Dec. 11, the day Mr. Madoff was arrested. According to the trustee’s lawsuit, all the individual Cohmad defendants “knew or had access to facts” that raised serious doubts about the legitimacy of that money management business and “had strong financial incentives to participate in, to perpetuate and to keep quiet about Madoff’s fraudulent scheme.” http://www.nytimes.com/2009/06/23/business/23madoff.html?_r=1&th&emc=th

181 The Wall Street Journal JUNE 22, 2009 How to Get The Fed Out Of Its 'Box' A commitment to fiscal discipline could enable expansionary monetary policy. By FREDERIC S. MISHKIN

When the Federal Open Market Committee meets this Tuesday and Wednesday, the Federal Reserve will face a serious dilemma. Since the last committee meeting six weeks ago, the 10-year U.S. Treasury yield has risen by around 70 basis points (0.70%), with the result that the interest rate on 30-year mortgages has risen by a similar amount. The rise in long-term interest rates is particularly worrisome, because it has the potential to choke off economic recovery and lead to further deterioration in the housing market. That would put an already weakened financial system under stress. Does the situation call for the Fed to expand its purchases of Treasury bonds to lower long-term interest rates? To answer this question, we need to look at why long-term interest rates have risen. Here, there is good news and bad news. One cause of the rise in long-term rates is the more positive economic news of the past couple of months, particularly in financial markets. The bad news is that long-term interest rates are higher because of concerns about the deteriorating fiscal situation, with massive budget deficits expected for the indefinite future. To fund these budget deficits, the Treasury has to sell large quantities of bonds both now and in the future, causing bond prices to fall and interest rates to rise. The increased supply of Treasury debt puts pressure on the Fed to buy it up. Although an expansion of Treasury bond purchases by the Fed would have the benefit of lowering long-term interest rates temporarily to stimulate the economy, in the current environment it could be dangerous for two reasons. First, it might suggest that the Fed is willing to monetize Treasury debt. The Fed does not, and should not, want to make it easy for the Treasury to sell its debt and thereby be an enabler of fiscal irresponsibility. Second, if the Fed loses its credibility to resist pressures to monetize the debt it could cause inflation expectations to shift upward, thereby leading to a serious problem down the road. The Fed is boxed in. The slack in the economy that is likely to persist for a very long time suggests the need for stimulative monetary policy to lower long-term interest rates through the purchase of Treasurys. The fiscal situation argues against this policy action, because it would weaken the Fed's inflation-fighting credibility. How can the Fed get out of the box and pursue the expansionary monetary policy that is needed right now? The answer is that the Obama administration and Congress have to get serious about long-run fiscal sustainability. Large budget deficits naturally occur during severe recessions when tax revenue undergoes a substantial decline. In addition, fiscal stimulus to promote economic recovery when the economy is in a severe recession is a sensible prescription. However, the failure to take steps to get future budgets under control is a recipe for disaster. Not only does it make it difficult for the Fed to take the actions needed to promote economic recovery, but it may even make the fiscal stimulus package less

182 effective. After all, if you know that the government is issuing a lot of debt that has to be paid back someday you can expect to pay much higher taxes in the future. With the prospect of higher taxes, you will be less likely to spend today. How can the Obama administration and Congress help the Fed do its job and help the fiscal stimulus package work? It needs to address exploding spending on entitlements -- Social Security and particularly Medicare -- which are causing future deficit projections to be so bleak. One possibility is to establish a nonpartisan commission on entitlement reform, along the lines of the National Commission on Social Security in the early 1980s. It produced recommendations that for a time helped put Social Security on a more solid footing. Another is taxing health-care benefits as part of any package to reform health care. Taxing health-care benefits would not only generate large amounts of revenue. It would also increase the incentive for people to lower the costs of their health care. There are surely many other ways to promote more fiscal responsibility. The Fed can assist this process. It could indicate that implementing measures that would promote fiscal sustainability will be rewarded with Federal Reserve actions to bring long- term Treasury rates down. Deals like this have been successfully made in the past. In the current extremely difficult economic environment, we surely need such a deal now. Mr. Mishkin, an economics professor at Columbia University, is a former member of the Board of Governors of the Federal Reserve and the author of "Monetary Policy Strategy" (MIT Press, 2007). Printed in The Wall Street Journal, page A15

183 Opinion

June 22, 2009 OP-ED COLUMNIST Health Care Showdown By PAUL KRUGMAN America’s political scene has changed immensely since the last time a Democratic president tried to reform health care. So has the health care picture: with costs soaring and insurance dwindling, nobody can now say with a straight face that the U.S. health care system is O.K. And if surveys like the New York Times/CBS News poll released last weekend are any indication, voters are ready for major change. The question now is whether we will nonetheless fail to get that change, because a handful of Democratic senators are still determined to party like it’s 1993. And yes, I mean Democratic senators. The Republicans, with a few possible exceptions, have decided to do all they can to make the Obama administration a failure. Their role in the health care debate is purely that of spoilers who keep shouting the old slogans — Government-run health care! Socialism! Europe! — hoping that someone still cares. The polls suggest that hardly anyone does. Voters, it seems, strongly favor a universal guarantee of coverage, and they mostly accept the idea that higher taxes may be needed to achieve that guarantee. What’s more, they overwhelmingly favor precisely the feature of Democratic plans that Republicans denounce most fiercely as “socialized medicine” — the creation of a public health insurance option that competes with private insurers. Or to put it another way, in effect voters support the health care plan jointly released by three House committees last week, which relies on a combination of subsidies and regulation to achieve universal coverage, and introduces a public plan to compete with insurers and hold down costs. Yet it remains all too possible that health care reform will fail, as it has so many times before. I’m not that worried about the issue of costs. Yes, the Congressional Budget Office’s preliminary cost estimates for Senate plans were higher than expected, and caused considerable consternation last week. But the fundamental fact is that we can afford universal health insurance — even those high estimates were less than the $1.8 trillion cost of the Bush tax cuts. Furthermore, Democratic leaders know that they have to pass a health care bill for the sake of their own survival. One way or another, the numbers will be brought in line. The real risk is that health care reform will be undermined by “centrist” Democratic senators who either prevent the passage of a bill or insist on watering down key elements of reform. I use scare quotes around “centrist,” by the way, because if the center means the position held by most Americans, the self-proclaimed centrists are in fact way out in right field.

184 What the balking Democrats seem most determined to do is to kill the public option, either by eliminating it or by carrying out a bait-and-switch, replacing a true public option with something meaningless. For the record, neither regional health cooperatives nor state-level public plans, both of which have been proposed as alternatives, would have the financial stability and bargaining power needed to bring down health care costs. Whatever may be motivating these Democrats, they don’t seem able to explain their reasons in public. Thus Senator Ben Nelson of Nebraska initially declared that the public option — which, remember, has overwhelming popular support — was a “deal-breaker.” Why? Because he didn’t think private insurers could compete: “At the end of the day, the public plan wins the day.” Um, isn’t the purpose of health care reform to protect American citizens, not insurance companies? Mr. Nelson softened his stand after reform advocates began a public campaign targeting him for his position on the public option. And Senator Kent Conrad of North Dakota offers a perfectly circular argument: we can’t have the public option, because if we do, health care reform won’t get the votes of senators like him. “In a 60-vote environment,” he says (implicitly rejecting the idea, embraced by President Obama, of bypassing the filibuster if necessary), “you’ve got to attract some Republicans as well as holding virtually all the Democrats together, and that, I don’t believe, is possible with a pure public option.” Honestly, I don’t know what these Democrats are trying to achieve. Yes, some of the balking senators receive large campaign contributions from the medical-industrial complex — but who in politics doesn’t? If I had to guess, I’d say that what’s really going on is that relatively conservative Democrats still cling to the old dream of becoming kingmakers, of recreating the bipartisan center that used to run America. But this fantasy can’t be allowed to stand in the way of giving America the health care reform it needs. This time, the alleged center must not hold.

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Small countries outside G20 defenseless in global economic crisis Created: 2009-6-22 Author:Michael Spence WHAT can we expect as the world's economy emerges from its most serious downturn in almost a century? The short answer is a "new normal," with slower growth, a de-risked and more stable core financial system, and a set of additional challenges (energy, climate, and demographic imbalances, to name a few) with varying time horizons that will test our collective capacity to improve management and oversight of the global economy. Lower growth is the best guess for the medium term. It seems most likely, but no one really knows. The financial crisis, morphing quickly into a global economic downturn, resulted not just from a failure to react to growing instability, risk, and imbalance, but also from a widespread pre-crisis inability to "see" the rising systemic risk. These defining characteristics will condition the responses and the results in coming years. There are countervailing forces. The high-growth countries (China and India) are large and getting larger relative to the rest. That alone will tend to elevate global growth compared to the world where industrial countries, and the US in particular, were in the growth driving seat. The current crisis has come to be called a "balance-sheet recession" of global scope and tremendous depth and destructive power because of its origins in the balance sheets of the financial and household sectors. Extreme balance-sheet destruction is what made it distinctive. In the future, central banks and regulators will not be able to afford a narrow focus on (goods and services) inflation, growth, and employment (the real economy) while letting the balance-sheet side fend for itself. Somewhere in the system, accountability for stability and sustainability in terms of asset valuation, leverage, and balance sheets will need to be assigned and taken seriously. Financial re-regulation should and will emphasize capital, reserve, and margin requirements; limiting systemic risk buildup by constraining leverage; eliminating fragmented and incomplete regulatory coverage and regulatory arbitrage (a huge challenge internationally); and a focus on transparency. American consumers will save more and spend less, abandoning the pattern of the last few years. The large hole (on the order of US$700 billion or more) in global aggregate demand will have to be filled over time by a compensating increase in consumption in surplus economies, such as China and Japan. The longer this takes, the greater the incentives at the national level to capture a share of global demand via protectionist measures.

186 The recent increase in protectionist measures is an understandable political price for a range of stimulus packages in advanced and developing countries. But such measures may increase - and will be harder to phase out over time - in the context of a shortfall in aggregate demand. This is the forward-looking version of the global imbalance issue. Its resolution via coordinated policy action (or a failure to resolve it through such action) will have a huge impact (for good or ill) on the multinational incentive structure surrounding the global economy - and hence on its likely growth. Responsibility for overseeing the global economy is passing rapidly from the G7/8 to the G20, as it should. The latter accounts for 90 percent of global GDP and two-thirds of the world's population. But there is a risk that the interests of the remaining one-third of the world's people (and the majority of the small countries) will not be adequately represented. In the current crisis, a substantial fraction of countries outside the G20 are essentially defenseless: small relatively poor economies, no fiscal capacity for stimulus, and inadequate reserves to offset the capital outflows that occurred to shore up damaged balance sheets in advanced markets. Within the G20 countries, there are mechanisms that attend to the interests of the most vulnerable citizens. There is no magic bullet for today's crisis. Pragmatic, steady progress at the national and international levels in improving the regulatory architecture and increasing our collective ability to avoid non-cooperative behavior and suboptimal equilibria, is the best course to follow. (The author is a Nobel laureate in economics (2001) and chairman of the Commission on Growth and Development. Copyright: Project Syndicate, 2009. www.project- syndicate.org.) Published on ShanghaiDaily.com (http://www.shanghaidaily.com/) http://www.shanghaidaily.com/sp/article/2009/200906/20090622/article_404858.htm

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22.06.2009 Bini-Smaghi criticises EU leaders’ failure to tackle supervisory reform

Lorenzo Bini-Smaghi of the ECB has criticised the EU summit’s footdragging over De Larosiere, especially the decision to insist that national fiscal authorities remain autonomous. (This was done at the behest of the UK and supported Germany, and it means that you can essentially bin those reforms.) Writing in the FT, Bini-Smaghi supports the essential argument by Lord Turner (in his recent review) that you either do this properly at the European level, or that you dismantle the single market and do it at national level. Bini-Smaghi says there is a fundamental clash between three objectives: financial integration, financial stability, and national supervisory autonomy. Ultimately, you have to choose. The financial crisis has shown that it is impossible to protect the national taxpayer from events in other countries. Burden sharing is much more likely to be acceptable if the decision was taken by a joint supervisor, than by a national supervisory of a foreign country. The legal basis FT Deutschland picks up on the question of the legal basis for the decision about De Larosiere. This subject was also sidelined at the summit. The Commission wants to bring its proposals under qualified majority voting while some member states, notably the UK, prefer unanimity as it increases their own leverage over the process. This alone will in practice severely constrain the De Larosiere process, as the ultimate power over the banking system remains with the member states. Klaus wants a new ratification It is going to be interesting to watch whether Vaclav Klaus political rhetoric will match his action. He said the summit’s declaration of assurances to the Irish ahead of their

188 referendum constituted a change in the Treaty, and this would require a new round of ratification. FT Deutschland says that not many people agree with his legal interpretation, but what if he uses this argument to delay the ratification of the Treaty beyond January 1, and until the British Conservative when the UK election, which must be held by early June 2010? French deficit will rise to more than 7% Les Echos reports that the French 2009 deficit will come in at 7% of GDP, much higher than expected, higher than the 1993 record of 6.4%, and higher than the previous forecast of 5.6%. The reason is a massive decline in tax receipts as a result of this crisis. For 2010, the French finance minister envisages a deficit of between 7 and 7.5%, while the Court of Auditors envisages a much sharper deterioration next year. The article said that France has a massive structural deficit problem, as even under the assumption of a strong rebound in growth, and planned budgetary cuts, the deficit would still be 5% in 2010. World Bank sees subdued recovery Bloomberg reports on the latest World Bank forecasts according to which the global economy will contract 2.9% this year, to be followed by a 2% expansion next year. The report said that while the recovery would start in the second half of this year, its pace it much more subdued than might normally be the case. Unemployment and poverty levels will continue to increase during the early stages of the recovery. China will not save the world economy The FT has a good editorial on China, based on the World Bank’s latest quarterly update. It shows that China will manage a decent rate of growth this year, thanks to its stimulus plan, but the impact of the stimulus on the rest of the world is going to be small. The net stimulus will be some 0.1% of global GDP. The FT said the big challenge for China is to shift demand from investment to consumption, and from the state to the private sector, from capital-intensive manufacturing to labour-intensive services, and from a reliance on exports to reliance on the domestic market. This shifts require reforms. Munchau on the German constitution In his FT column, Wolfgang Munchau argues that Germany’s constitutional budget law, which effectively forces the government to run a balance budget from now on, is hugely problematic. As this budget law implies a zero level of debt in the long run, Germany is very likely to underinvest and thus settle on a path of low growth in a procyclical fiscal environment. This unilateral law was not co-ordinated at EU level, and means an increasing gap between Germany and France, which could prove highly destabilising. There exists no economic argument for a zero debt level (which is what a structural deficit of 0.35% implies for a country under normal circumstances). It seems that Germany is running a moral crusade. Grunberg on the French Socialists Writing in Telos, Gerard Grunberg says the French Socialists, after each successive loss, promise internal reform, but then nothing of substance happens. The party leadership has refused to open the party to society, and focused on gimmicks instead, such as the primary elections of the party’s presidential candidate. For Martine Aubrey it would be very difficult now to change course. She would have to give her presidential ambitions,

189 and focus entirely on the programmatic side of politics, with a party apparatus that prefers a suicidal status quo to change.

COMMENT China will not save the world economy Published: June 21 2009 19:04 | Last updated: June 21 2009 19:04 Both too much and too little are expected of China’s response to the economic crisis: too much, because the Asian giant can play only a modest role in rescuing the world economy; too little, because few believe the economy will be radically changed. The stimulus programme is helpful, for China and the world. But the real challenge is structural transformation. As the World Bank’s June quarterly update shows, China’s response to the crisis has been a success. It forecasts economic growth at 7.2 per cent in 2009. This is a long way down from the 11.9 per cent in 2007. But it would be viewed as a triumph anywhere else. For such an open economy to cope with a fall in the rate of real export growth from 20 per cent in 2007 to 8 per cent last year and a forecast of minus 10 per cent this year is remarkable. Nevertheless, the impact of China’s stimulus on the rest of the world will be modest: the country generates only 7 per cent of global output, at market prices; more-over, the bank also forecasts a decline of 5 per cent in real imports this year. The net stimulus China will give to the rest of the world will only be around 0.1 per cent of global output in 2009. Certainly, China needs to sustain demand. It can also afford to do so: the fiscal deficit is forecast at a mere 5 per cent of GDP in 2009 and the risk of an upsurge in inflation is quite small. Yet there is a danger. It is that what is needed in the short term makes required longer- term reform more difficult. As the World Bank notes, this stimulus is dependent on “government-influenced spending”. That can only be a stop-gap. Both the opportunity created by the crisis and the time given by the stimulus must be used to shift the pattern of growth, instead. The rapid past expansion of gross and net exports is not going to return. China must move, instead, towards an economy led by private rather than public demand, towards consumption rather than investment, towards labour-intensive services rather than capital-intensive industry and towards reliance on domestic rather than foreign markets. These shifts demand a number of linked reforms: opening more sectors to private competition; raising interest rates paid by privileged borrowers and to hard-pressed savers; forcing state-owned enterprises to pay dividends and using the proceeds to support public services; and introducing a decent social safety net. For China, this crisis is a golden opportunity. It must be seized.

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Jun 19, 2009 European-wide Financial Regulation: Leaders Give Backing Overview: European heads of state have come to an agreement over the European Commissions proposed overhaul of Europe’s system for supervising banks and insurers. The Commission's proposals draw heavily on the two-tier approach suggested by Jacques de Larosiere (see de Larosiere Report). In particular, the commission is advocating the creation of a European Systemic Risk Council, to assess and warn about threats to financial stability in the region. Not all parties were in favour initially with the UK were especially concerned about ceding binding authority to non-national bodies (FT)

o June 19: Following a two-day European Council, EU leaders reached a compromise over the Commission's financial supervision proposals. The agreed text provides more power to the General Council comprised of EU central bank governors. It also allows for a significant concession of national powers "in case of disagreeement between the home and host state supervisors".

o Fiscal Responsibilities: Following a meeting on June 9, a EU finance ministers suggested to the European Commission that it make sure, when presenting proposals on financial supervision in coming months, that they did not infringe on the fiscal responsibilities of governments. A view strongly supported by the UK. This View was maintained by the European Council in its recent agreement.

o "The European Council stresses that decisions taken by the European Supervisory Authorities should not impinge in any way on the fiscal responsibilities of member states."

o Euractiv: The EU supervision will not cover cleaing houses for derivatives which was a previous concern of the UK government and the city of London.

o European Commission Proposal: Two-tiered - 1) European Systematic Risk Council (ESRC): To monitor and assess risks to the stability of the financial system as a wholeand provide an early warning syste. 2) European System of Financial Supervisors (ESFS): supervision of individual financial institutions consisting of a robust network of national financial supervisors working in tandem with new European Supervisory Authorities

o Three EU co-ordinating bodies for banking, insurance and securities will be given more powers and become a European Banking Authority, and European Insurance and Occupational Pensions Authority and a European Securities Authority.

o FT Editorial: The de Larosière group wisely did not suggest a single European regulator to oversee individual financial firms. Instead, it lays out a step-by-

191 step plan to develop existing EU-level bodies into a European Banking Authority, an Insurance Authority and a Securities Authority. These would combat regulatory arbitrage by: deciding compulsory minimum EU-wide standards; providing binding mediation between disagreeing national authorities; and coordinating international “colleges of supervisors”. But national bodies would remain in charge of day-to-day supervision and could go beyond the common standards. o CEPS: A crisis is a terrible thing to waste. The EU has failed to learn lessons of the crisis - the core of its proposals fail to offer a fully integrated system of financial supervision.It needs to make new proposals empowering a strong centre which can act on behalf of the European interest. It is reality that the level of European market integration achieved in recent years could recede. See also --> Pros and Cons of a Single European Regulator o Professors Brinkhorst, Louis & Smits (via EurActive): The de Larosière report fails to tackle the main fault lines that the credit crisis has shown to exist in the EU supervisory landscape. An EU-wide fund to finance pay-outs is exactly what should be considered to prevent 'passing the buck' problems. See also --> Is Fiscal Coordination Essential? o Buiter: There is a fear of 'over-regulation'. What is clear is that a lot more regulation, and regulation different from what we have had in the past, will be required to reduce the likelihood of future systemic failures and to better align private and public interests. If over-regulation, indeed destructive over-regulation is the immediate result, then so be it. It is easier to negotiate sensible modifications to a framework characterised by over-regulation than it is to add sensible regulation from a framework characterised by under-regulation. o Gordon Brown: "A strong step in the direction of regulation" is needed. "Complex products like banking derivatives which were supposed to disperse risk around the world have instead spread contagion" - Brown called for the creation of "global standards". o Spiegel: London and Dublin, in particular, are blocking anything that could create problems in their respective financial industries. Great Britain and Ireland have very few other industrial sectors. But this path is immensely dangerous for Europe.

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A thin outline of regulatory reform By Clive Crook Published: June 21 2009 18:43 | Last updated: June 21 2009 18:43

The Obama administration’s proposals for US financial regulation are pretty good, as far as they go. The problem is they do not go far enough. Great care and intelligence went into the plan announced last week. It makes no stupid suggestions; recall Sarbanes-Oxley, a recent instance of unguided regulatory backlash, and you see this is no small achievement. But the plan’s comprehensiveness is a bit of an illusion. It ignores many issues, and has more loose ends and suggestions for further review than actual innovations. Also, as in other areas, the White House is unwilling to confront the political barriers to fuller reform. You can call this pragmatism, or you can call it timidity. A crisis of this order demands big new ideas, and the leadership to push them through. In finance, if not now, when? The administration asks Congress, which will have to write new laws for the plan to work, to fill some of the biggest holes in the existing structure. Systemically important financial institutions, whether or not they are banks in the old-fashioned sense, should be more tightly regulated by the Federal Reserve, says Mr Obama. In addition, a new intervention regime should cover all such firms, modelled on the scheme run by the Federal Deposit Insurance Corporation for ordinary banks, says the plan. The idea is to wind up a failing bank early and in an orderly way, rather than facing the choice of bailing it out or letting it collapse and maybe drag others down with it. The administration is right: these are big and necessary changes. But the details are vague. How exactly the tighter regulation of these “tier one financial holding companies” will work – what their capital and liquidity requirements will be, for instance – is for further study. Firms in this category will pay a regulatory surcharge, as they should. And the plan seems to favour counter-cyclical capital requirements too, which would brake lending growth in credit booms. Again this is right; again there are no specific proposals.

193 The plan calls for tighter regulation of securities markets. It proposes, for instance, that issuers of credit-risk securities should retain a share of the risk. It wants many over-the- counter derivatives to be traded on exchanges, which is safer, and proposes to bring “all OTC derivatives and asset-backed securities into a coherent and co-ordinated regulatory framework”. Quite right. But what about Fannie Mae and Freddie Mac, the vast “government sponsored enterprises” that were instrumental in stoking the subprime boom? The plan bravely calls for a “wide-ranging initiative to develop recommendations”. What about the credit-rating agencies, and the measurement of risk for regulatory purposes more generally? There is no point in telling financial institutions to set aside more capital if they are free to pump up their risks at the same time. The plan is thin. It wants better regulation of the rating agencies. Who doesn’t? But what would better regulation of the agencies look like? That needs further study. “The financial crisis highlighted the problems associated with compensation structures that do not take into consideration risk and firms’ goals over the longer term,” says the plan. Indeed it did. The report says little on what to do about it, and next to nothing about wider bank corporate governance. Fair-value accounting? Further review. These are all complicated issues, and wide consultation is doubtless required to design the rules. So in a way it is unfair to complain about loose ends. It would be easier to feel that way if the administration had got things right at the organisational level. Unfortunately it has not. Perhaps the biggest disappointment in the plan is that it fails to address the bewildering complexity of the regulatory apparatus. Unlikely as it may seem, the plan suggests a net increase in regulatory agencies. In the US, this requires real ingenuity. Recognising the issue of “jurisdictional disputes among regulators” – a problem that is going to get worse under these plans – it calls for a new Financial Services Oversight Council, chaired by the Treasury. This would advise the Fed on which firms should be regarded as systemically significant, and “facilitate information sharing and co-ordination”. Regulation by committee, atop a system of overlapping agencies unsure of their responsibilities, with financial firms still free to shop around for a regulator they like, does not inspire. Crucially, it also militates against effective international co-ordination. Aside from poor oversight of the shadow banking system and the system-wide failure to account properly for risk, the biggest weakness in the existing regulatory scheme has been lack of cross- border co-operation by national regulators. The more complicated the domestic regulatory structure, the harder it will be for US regulators to work with their counterparts abroad. Why no effort to streamline the structure? The answer seems to be that Congress would object. A simpler organisation chart would strip its oversight committees of responsibility, and their members of influence. The White House apparently regards this as too much to ask. On health reform, the administration has given control of the entire project to Congress. On financial regulation, it is still trying to direct the policy – but from the outset within limits that respect the legislature’s preferences, however ill advised. That is a pity.

http://www.ft.com/cms/s/0/f436b22e-5e88-11de-91ad-00144feabdc0.html

194 Berlin weaves a deficit hair-shirt for us all By Wolfgang Münchau Published: June 21 2009 18:49 | Last updated: June 21 2009 18:49 A decision was taken recently in Berlin to introduce a balanced-budget law in the German constitution. It was a hugely important decision. It may not have received due attention outside Germany given the flood of other economic and financial news. From 2016, it will be illegal for the federal government to run a deficit of more than 0.35 per cent of gross domestic product. From 2020, the federal states will not be allowed to run any deficit at all. Unlike Europe’s stability and growth pact, which was first circumvented, later softened and then ignored, this unilateral constitutional law will stick. I would expect that for the next 20 or 30 years, deficit reduction will be the first, second and third priority of German economic policy. Anchoring the stability law at the level of the national constitution is an extreme measure – like locking the door, and throwing the keys away. It can only ever be undone with a two-thirds majority – and even a future Grand Coalition may not be able to deliver this as both of the large parties are in a process of secular decline. It means that future fiscal policy will be in the hands of the justices of Germany’s Constitutional Court. The new law replaces a much softer constitutional clause – a golden investment rule that said deficits can only be used to finance investments. It was not a satisfactory rule, but at least it allowed structural deficits in principle. The new law not only sets draconian deficit ceilings, it also provides a detailed numerical toolkit to implement the rules over the economic cycle. I can foresee two outcomes. First, Germany might end up in a procyclical downward spiral of debt reduction and low growth. In that case, the constitutionally prescribed pursuit of a balanced budget would require ever greater budgetary cuts to compensate for a loss of tax revenues. To meet the interim deficit reduction goals, the new government will have to start cutting the structural deficits by 2011 at the latest. There is clear danger that the budget consolidation timetable might conflict with the need for further economic stimulus, should the economic crisis take another turn for the worse. There is still economic uncertainty. Bankruptcies are rising, and the German banks are just about to tighten their credit standards again. I simply cannot see how Germany can produce robust growth in such an environment, not even in 2011. If that scenario prevails – as I believe it will – the new constitutional law will produce a pro-cyclical fiscal policy with immediate effect. One could also construct a virtuous cycle – the second outcome. If Germany were to return to a pre-crisis level of growth in 2011, and all is well after that, the consolidation phase would then start in a cyclical upturn. Either of those scenarios, even the positive one, is going to be hugely damaging to the eurozone. In the first case, the German economy would become a structural basket case, and would drag down the rest of Europe for a generation. In the second case, economic and political tensions inside the eurozone are going to become unbearable. Over the past 25 years, France has more or less followed Germany’s lead at every turn, but I suspect this may be a turn too far. Deficit reduction has not been, nor will it be, a priority for Nicolas Sarkozy, the French president. On the contrary: he has listened to bad advice from French economists who told him that budget deficits are irrelevant, and that he

195 should focus only on structural reforms. Budget deficits and debt levels matter in a monetary union. But a zero level of debt is neither necessary nor desirable. I am a little surprised not to hear howls of protests from France and other European countries. Germany has not consulted its European partners in a systematic way. While the Maastricht treaty says countries should treat economic policy as a matter of common concern, this was an example of policy unilateralism at its most extreme. What is the rationale for such a decision? It cannot be economic, for there is no rule in economics to suggest that zero is the correct level of debt, which is what a balanced budget would effectively imply in the very long run. The optimal debt-to-GDP ratio might be lower for Germany than for some other countries, but it surely is not zero. While the balanced budget law is economically illiterate, it is also universally popular. Average Germans do not primarily regard debt in terms of its economic meaning, but as a moral issue. Der Spiegel, the German news magazine, had an intriguing report last week on the country’s young generation. One of the protagonists in its story was a young woman who had borrowed a little money to set up her own company. The company turned out to be a success, and she had began to repay the loan. And yet she said she had not felt proud of having taken on debt. This general level of debt-aversion is bizarre. Many ordinary Germans regard debt as morally objectionable, even if it is put to proper use. They see the financial crisis primarily as a moral crisis of Anglo-Saxon capitalism. The balanced budget constitutional law is therefore not about economics. It is a moral crusade, and it is the last thing, Germany, the eurozone and the world need right now.

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June 21, 2009, David Warsh, Proprietor Towards a Fiscal Constitution It was fifty years ago that a young assistant professor named Leland Yeager organized a series of lectures meeting at the University of Virginia in Charlottesville. The topic was money – oddly enough a neglected topic in university economics in those days. Eleven authors, including Milton Friedman, James Buchanan, Jacob Viner, Benjamin Graham and Murray Rothbard, described how the basic character of a monetary system might be shaped from, as it were, the ground up. Fractional central banking? Or one hundred percent reserves? A commodity standard? A gold standard? Free banking? Open market operations to steady the price level? Rules? Discretion? Independence? Or political control? Their lectures, with an introduction by Yeager, were published in 1962 by Harvard University Press as In Search of a Monetary Constitution. In the ensuing decades of high inflation, the book became something of a modern classic, anticipating many of the abstruse debates to come in accessible literary form. Last week, Yeager, now 84, spoke as part of a panel at the Summer Institute for the Preservation of the Study of the History of Economics at the University of Richmond on the US response to the economic situation. He wasn’t sanguine. “Although a short-run consequence of the overspending-fueled boom and its collapse, this deficiency [of demand] is what politicians emphasize as they call for economic stimulus…. The supposed remedy increases the burden of the national debt and worsens the danger of money-supply and price inflation.” Still less sanguine was Buchanan, who also spoke. The Keynesian revolution in the middle third of the twentieth century had produced a solid advance in economic understanding, Buchanan said, teaching people to think about aggregate economics in terms of the measurements by which the economy today is understood – national product, income, rates of growth and so on. But no comparable advance has occurred since. Now the panic of 2008 has precipitated a threat to the monetary system more serious than any other, Buchanan said; the temptation to inflate away the burden of the national debt by printing money may prove irresistible. He recalled his proposal of 1962 for a commodity standard based on the money price of a common building brick (a notion proposed years before by C.O. Hardy, an expert on monetary affairs between the wars, but never published). “The Federal Reserve Board has no incentive to economize on something that costs nothing to produce,” he said. The whole central bank idea has “no constitutional basis, however.” There is another possibility – that the commitment to an informal monetary constitution has actually become stronger in the last thirty years, not weaker. At one point in the discussion, Michal Lehuta, a young Slovak analyst, piped up, “But haven’t we basically got just that that? With inflation targeting? And independent central banks?” Maybe. It ‘s possible, after all. The hard-won battles against high inflation rates of the 1970s gave way in the 1990s to a great deal of self-congratulation. “The Great Moderation” of the twenty-five years after 1982 was born of a new appreciation of the

197 importance of relatively stable money, and of an enhanced understanding of the tools by which central banks had brought it about. If only a little of that turns out to be true – if monetary policy proves to be adequate to ending the current recession without producing a divisive and demoralizing burst of inflation – then the “credibility revolution” of the last thirty years may turn out to be another intellectual advance of the first magnitude in economics.

It cannot happen, though, unless the first tentative steps are taken towards the creation of an informal fiscal constitution – a widely-shared and broadly-measurable consensus about how the goods and services of the economy as a whole are to be spent in the coming decades, collectively and privately, which is the only way of insuring that those choices are compatible with monetary stability. On the surface of it, that is no more complicated than balancing the budget – so much harder than it sounds because so much of the national debt, in the form of commitments to Social Security and medical care, is omitted from the official measures. No wonder, then, that back-of-the-envelope calculations abound to show it simply can’t be done – that the US has no choice other than – at best – a short burst of inflation, rather like (in golfer’s parlance) a wedge shot from a bunker onto the green. There is nothing simple about the diaphanous idea of a fiscal constitution, that’s for sure. A start was made in the 1990s with global spending caps and various “pay-go” provisions requiring Congress to identify and authorize revenue streams to pay for any and all spending programs. Matters get more complicated when the near-term rate of growth may be affected. Could the sudden imposition of a cap-and-trade system for limiting greenhouse-gas emissions slow the economic recovery? Perhaps, but that doesn’t mean a modest program is a bad idea. Things become even more difficult to gauge when long- term growth rates are involved. Would the creation of a new healthcare system be expensive? Certainly. But what if it succeeded in slowing the rate of increase in the cost of healthcare even a little? Then it might actually begin to trim the overall deficit faced by those off-balance-sheet Federal spending programs, Social Security and Medicare, in the years to come – a tax increase that wouldpay for itself. “The last thing the US needs is to be viewed as one giant California, rich but unwilling to pay enough taxes to fund the services its citizens demand,” Harvard’s Kenneth Rogoff wrote in the Financial Times last week And, indeed, a sharp increase in healthcare taxes might raise doubts about government’s willingness to make good on its other commitments. So some combination of higher taxes and diminished entitlement claims in the years again ahead – none of the losses such as to cause great pain among the generation of the Baby Boom, which must, by simple arithmetic, bear the greatest cost – might trigger a virtuous circle of steady growth and stable money for decades ahead. This is the province of a fiscal constitution — an overall set of rules by which the nation’s commitments to taxing and spending are to be arranged. If the past is any guide, somewhere there is a group working on it in relative harmony, with high seriousness of purpose, just as fifty years ago a group at the University of Virginia was laying some part of the groundwork for the present day. http://www.economicprincipals.com/issues/2009.06.21/487.html

198 June 20, 2009 The Obama light touch will be a bit heavy handed Irwin Stelzer: American Account

The US is not the UK. So the first thing to keep in mind when appraising President Barack Obama’s new regulatory scheme for the financial sector is that it is merely the administration’s wish list, with Congress yet to be heard from. The second is that the blurb on the jacket of an Obama oeuvre — in this case his Guide to Light-handed Regulation — is never an accurate description of its contents. There is a reasonable chance Obama will get much, although not all, of what he wants. For two reasons: the recent near-meltdown of the financial sector has revealed weaknesses in the regulatory structure, and the president knows that politics is the art of the possible. He knows that every regulator reports to some congressional committee or other, and that congressional barons are reluctant to give up power, which they must if the agency they oversee is eliminated. So, few agencies are to be merged — and not the most important ones. The president has gone to great lengths to calm fears that he is unleashing draconian restrictions on the freedom of action of financial institutions — reform, yes; revolution, no. “No” to those who argue in favour of the status quo, and “no” to those who want him to go further, perhaps as far as separating commercial banking from and shrinking banks that are too big to fail. He cannily labels his programme as the most far-reaching since Franklin Roosevelt’s New Deal, and as an example of light-handed regulation. “You set up some rules of the road, ensure transparency and openness, guard against huge systemic risk that will lead . . . government potentially having to step in to avoid a depression, and then let entrepreneurs and individual businesses compete and do what they do,” he said on Wednesday. Start with the securitisation process, which many believe converted a problem in the mortgage markets into a threat to the entire financial system. Treasury secretary Tim Geithner is eager to get the securitisation process restarted, so that credit will flow more readily to the business community and consumers. So, rather than outlawing the process, he persuaded the president to take the sensible step of requiring those selling these securities to have some skin in the game — retain 5% of the value of such securities. This means the issuer/peddler remains at risk, and is less likely to push dicey paper out into the market, as he had an incentive to do when he profited from issuance fees but did not share in any losses. Here, the administration followed the first principle of good regulation: get the incentives of the private-sector players aligned with the broader public interest. The administration is also right to call for reform of the rating system to eliminate the conflict of interest inherent in the fact that the agencies get paid by the issuers of securities only if the deal gets done. No surprise, then, that the holy water of AAA ratings was sprinkled liberally over a great deal of paper that proved to be

199 toxic, in some cases fatally so — perverse incentives in action. My calls to the leading rating agency, Standard & Poor’s, were rewarded with a press release professing the agency’s “commitment to working with policymakers and market participants around the world to help get the capital markets back on track”. Whether that includes developing a new system of payment is unclear. Then there is the Securities and Exchange Commission (SEC), an agency that did not cover itself with glory in the boom years. Obama proposes to transfer the SEC’s power to regulate financial products sold to small customers, including credit cards, student loans and home mortgages, to a new Consumer Financial Protection Agency, and to a beefed-up Federal Trade Commission. Inter-agency squabbles will follow. Most important, the previously independent Federal Reserve Board will have new powers but will now have to cope with a political overseer. Obama wants the Fed to have broad powers to prevent systemic risk by regulating not only banks, but any financial institutions the failure of which would create such risk. Caught in the net would be GE Capital, the finance arm of GE, which is larger than many banks, and any hedge funds and private-equity groups that might become large enough to fall into the “too big or interconnected to fail” category. But like other agencies, the Fed would report to a new super co-ordinator, the Financial Services Oversight Council, housed at the Treasury, with “a permanent full-time staff” to provide the several regulators with the information they need to do their jobs and, if Congress approves, powers Obama would prefer to reside in the Fed. There is a lot more, including a proposal that regulators be allowed to seize failing institutions. The net effect will be an increase in capital requirements — which means lower profit margins for banks; new regulation of non-bank financial institutions; greater power for the Treasury and the politicians who approve its key personnel; and a flood of new regulations as the regulators churn out specific rules to put flesh on the president’s skeletal outline — a fact of which Obama is well aware, and why his attempt to present his proposals as minimally intrusive and “light handed” should be taken with the output of a large salt mine. Obama claims all of this will allow America “to lead the global economy” down a new path to better regulation. Other nations, however, have different sorts of reforms in mind. The EU has made it clear that it favours tighter regulation of hedge funds and private equity than Obama contemplates, and international oversight of banks, partly to reduce the competitive advantage Britain now enjoys in the provision of financial services. One thing is certain: international differences in the scope and nature of regulation will remain, presenting opportunities for regulatory arbitrage. Not a bad thing: that will prevent regulators in individual countries from over- reaching, lest they lose business to other, more welcoming jurisdictions. - Irwin Stelzer is a business adviser and director of economic policy studies at the Hudson Institute [email protected]

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The risks of a double-dip, W-shaped recession may be growing By Nouriel Roubini

Saturday, Jun 20, 2009, Page 9 In the past three months, global asset prices have rebounded sharply: Stock prices have increased by more than 30 percent in advanced economies and by much more in most emerging markets. Prices of commodities — oil, energy, and minerals — have soared; corporate credit spreads (the difference between the yield of corporate and government bonds) have narrowed dramatically, as government-bond yields have increased sharply; volatility (the “fear gauge”) has fallen; and the dollar has weakened as demand for safe dollar assets has abated. But is the recovery of asset prices driven by economic fundamentals? Is it sustainable? Is the recovery in stock prices another bear-market rally or the beginning of a bullish trend?

While economic data suggests that improvement in fundamentals has occurred — the risk of a near depression has been reduced; the prospects of the global recession bottoming out by year end are increasing; and risk sentiment is improving — it is equally clear that other, less sustainable factors are also playing a role. Moreover, the sharp rise in some asset prices threatens the recovery of a global economy that has not yet hit bottom. Indeed, many risks of a downward market correction remain. First, confidence and risk aversion are fickle, and bouts of renewed volatility may occur if macroeconomic and financial data were to surprise on the downside — as they may if a near-term and robust global recovery (which many people expect) does not materialize.

Second, extremely loose monetary policies (zero interest rates, quantitative easing, new credit facilities, emissions of government bonds and purchases of illiquid and risky private assets), together with the huge sums spent to stabilize the financial system, may be causing a new liquidity-driven asset bubble in financial and commodity markets. For example, Chinese state-owned enterprises that gained access to huge amounts of easy money and credit are buying equities and stockpiling commodities well beyond their productive needs.

CORRECTION

The risk of a correction in the face of disappointing macroeconomic fundamentals is clear. Indeed, recent data from the US and other advanced economies suggest that the recession may last through the end of the year. Worse, the recovery is likely to be anemic and sub-par — well below potential for a couple of years, if not longer — as the burden of debts and leverage of the private sector combine with rising public sector debts to limit

201 the ability of households, financial firms and corporations to lend, borrow, spend, consume and invest. This more challenging scenario of anemic recovery undermines hopes for a V-shaped recovery, as low growth and deflationary pressures constrain earnings and profit margins and as unemployment rates above 10 percent in most advanced economies cause financial shocks to re-emerge, owing to mounting losses for banks’ and financial institutions’ portfolios of loans and toxic assets. At the same time, financial crises in a number of emerging markets could prove contagious, placing additional stress on global financial markets. The increase in some asset prices may, moreover, lead to a W-shaped, double-dip recession. In particular, thanks to massive liquidity, energy prices are now rising too high too soon. The role that high oil prices played last summer in tipping the global economy into recession should not be underestimated. Oil above US$140 a barrel was the last straw — coming on top of the housing busts and financial shocks — for the global economy, as it represented a massive supply shock for the US, Europe, Japan, China and other net importers of oil. DEFICITS

Meanwhile, rising fiscal deficits in most economies are now pushing up the yields of long-term government bonds. Some of the rise in long rates is a necessary correction, as investors are now pricing a global recovery. But some of this increase is driven by more worrisome factors: the effects of large budget deficits and debt on sovereign risk, and thus on real interest rates; and concerns that the incentive to monetize these large deficits will lead to high inflation after the global economy recovers from next year to 2011 and deflationary forces abate. The crowding out of private demand, owing to higher government-bond yields — and the ensuing increase in mortgage rates and other private yields — could in turn endanger the recovery. As a result, one cannot rule out that by late next year or 2011, a perfect storm of oil above US$100 a barrel, rising government-bond yields and tax increases (as governments seek to avoid debt-refinancing risks) may lead to a renewed growth slowdown, if not an outright double-dip recession. The recent recovery of asset prices from their March lows is in part justified by fundamentals, as the risks of global financial meltdown and depression have fallen and confidence has improved. But much of the rise is not justified, as it is driven by excessively optimistic expectations of a rapid recovery of growth toward its potential level and by a liquidity bubble that is raising oil prices and equities too fast too soon. A negative oil shock, together with rising government-bond yields — could clip the recovery’s wings and lead to a significant further downturn in asset prices and in the real economy. Published on Taipei Times http://www.taipeitimes.com/News/editorials/archives/2009/06/20/2003446613

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Reforming financial regulations in America

Better broth, still too many cooks Jun 18th 2009 From print edition

FINANCIAL regulation in America has two problems: there is both too much of it and too little. Multiple federal agencies oversee the financial system: five for banks alone, and one each for securities, derivatives and the government-sponsored mortgage agencies. They share these duties with at least 50 state banking regulators and other state and federal consumer-protection agencies. Yet all these regulators failed to anticipate and prevent the worst financial crisis since the Depression, because risk-taking flourished in the cracks between them. Toxic subprime mortgages were peddled by lenders with little federal oversight and shoved into off-balance-sheet vehicles. The greatest leverage accumulated in firms that avoided the capital requirements of banks. On June 17th Barack Obama took aim at these weaknesses (see article). His financial white paper gets much right. First, it does not pursue what Dan Tarullo, one of the governors of the Federal Reserve, has called “reform by nostalgia”. Rolling back the deregulation of the past three decades would have wiped out the genuine benefits that innovation and competition have brought to Americans. Second, it recognises that many remedies do not require new regulators, but simply better regulations, such as beefed-up capital and liquidity buffers for banks and shifting much of the “over the counter” trade in derivatives to regulated exchanges and clearing houses. In other respects the plan does not go far enough. It does too little to reduce the multiplicity of regulators that has long undermined their effectiveness. To be sure, regulatory competition is not all bad: it can check government overreach and nourish experimentation. Nor is a unified regulator a cure-all: Britain’s Financial Services

203 Authority failed to do anything about British banks’ excessive dependence on short-term, wholesale funding. But most of America’s overlap is a useless holdover from the days when commercial and investment banks, thrifts, government-sponsored enterprises and commodity dealers did different things. This overlap encourages dodgy firms to shop around for the friendliest regulator, which is how the Office of Thrift Supervision (OTS) ended up overseeing so many big, failed companies. It slows down implementation of new rules, breeds turf wars, corrodes accountability and increases costs. But under the new proposals only one agency, the OTS, will disappear. A new agency to protect consumers will take this area over from the bank regulators. But it will not assume similar duties now held by the Securities and Exchange Commission or Commodity Futures Trading Commission, and have little enforcement authority over thousands of state-regulated finance companies and loan brokers—a glaring shortcoming given that such firms were responsible for originating a large share of toxic mortgages and abusive loans. The plan also complicates the role of the Federal Reserve, which has already been exposed to political attack by its unprecedented interventions in markets and the economy. The Fed should certainly revisit how it does its job. The financial crisis has amply demonstrated that maintaining low inflation does not guarantee economic stability. This has fired up interest, in Europe as well as America, in “macroprudential regulation”: the notion that regulators must supplement “micro” supervision of individual firms by looking across entire markets and industries for risks that threaten the whole system. This is much harder in practice than in theory. By its very nature, risk-taking thrives in the shadows and crises take regulators by surprise. But if macroprudential regulation is to be done, the central bank is the logical body to do it. As lenders of last resort central banks pick up the bill in systemic crises, so they deserve a role in preventing them. The European Union is also proposing that European central bankers work with bank supervisors to detect and prevent systemic risk. Unlike the EU proposals, however, Mr Obama’s plan also makes the Fed directly responsible for the supervision of all firms deemed too big to fail in addition to its existing responsibility for bank holding companies and some banks. That introduces conflicts of interest and risks of regulatory capture: might the Fed be tempted to bail out a firm to save jobs, for example, or refrain from raising interest rates to stop a big firm from failing? If the Fed is to receive this expanded macroprudential role, it should be stripped of its microprudential duties. Don’t let a crisis go to waste Mr Obama’s aides have concluded that a more ambitious overhaul of America’s sprawling regulatory system would expend too much political capital with too little benefit. That bodes poorly for their willingness to face down special interests over the details of even this limited proposal. Who will have to hold more capital, and how much? Which firms will be designated as systemically important, and how will they pay for their implicit government backing? How to prevent banks shopping around for laxer rules abroad? Mr Obama’s aides are famously fond of saying that crises create opportunities. But the best opportunity in years for a complete redesign of America’s regulatory apparatus seems to be going to waste. http://www.economist.com/opinion/PrinterFriendly.cfm?story_id=13862497

204 So Mark Thoma wrote a piece saying “The development of the shadow banking system is important because the troubles we are seeing today are not the result of problems in the traditional, regulated sector of the financial industry. The problems began in the unregulated shadow banking system.” The Atlantic Business Dr. Manhattan responded: the systemic breakdowns we have been experiencing over the past 18 months have been caused by problems at the major banks (even the former investment-only banks which weren’t regulated by the Fed or FDIC cannot be called part of the “shadow banking system”), AIG (regulated by the state insurance commissioners, even if they’d rather you didn’t remember) and let’s not forget Fannie and Freddie, which had their own regulator.

Brad Delong declares it a “crash and burn” with some fun Watchmen allusions. When people mention “The Unregulated Shadow Banking System” (TUSBS) they are often talking about different things and thus past each other, so let’s refocus. In general, I hear three things people invoke when they mention TUSBS. 1) Subprime lenders, who were not subject to the same regulatory burden as depository institutions. 2) A market that trades “informationally insensitive” debt as the result of the repo market and securitized debt as collateral. Where depositors are corporations and money market funds and where lenders are financial firms. 3) Traditional firms who took big bets in the investment markets while their regulators were not present or asleep at the wheel. Mark Thoma is talking about #2. The Atlantic is referring to #3, and later to #1. Let’s work them backwards. 3) Arnold Kling is correct. Most of the firms doing crazy things with their portfolios had some sort of regulator. Fannie/Freddie had Congress, who were unwilling to regulate the firms. AIGFP had the OTS, who I believe were simply unable to regulate the firm. OTS may be good at some things, but they are not the SEC and they are not qualified to assess the credit risk of large out of the money puts on the market. If The Coast Guard and The League of Women Voters were put in charge of regulating AIGFP and their large concentrations of tail risk we could also say they were ‘regulated.’ But is that fair assessment? Why was the OTS in charge of monitoring capital reserves on large portfolios of CDS contracts? As a result of deregulatory measures put in in the late 1990s, firms like this

205 that could shove a thrift into their business could then pick-and-choose the weakest regulators. Maybe if we reform this finance sector, we might want to consolidate some of these regulatory agencies. But the point stands. And Thoma made it too: “Today’s problems could have been eased or perhaps even avoided entirely if regulators would have simply enforced regulations already in place, or called for new ones when existing tools were inadequate.” 2) Ok, let’s do this carefully: A bank is, in abstract, an institution that borrowers short and lends long. Your local bank borrowers short deposits and lends long investments. If it needs liquidity it can always go to the central bank’s discount window. The central bank’s discount window is the market maker of last resort for this banking system. This prevents bank runs. In exchange it is regulated by the government. Your local shadow bank took in money in the repo market as deposits, and used senior tranches of debt as the collateral. Now what happens when it needs liquidity? There is no market maker of last resort who the system as a whole could turn to. Repeat that again. It exists in the shadows, there is nowhere to turn to for emergency liquidity. There is no regulation/liquidity tradeoff here. This is what is meant by being unregulated – not that there weren’t any government agents in sight. As such it was only a matter of time before a bank run of epic proportions happened. Checkout this chart:

That’s what a 21st century bank run looks like. This narrative is influenced by Gary Gorton’s “Slapped in the Face by the Invisible Hand” (Ezra Klein is FTW with his writeup of it). That this issue is newly broken and needs to be fixed is echoed by Robert Lucas: The regulatory problem that needs to be solved is roughly this: The public needs a conveniently provided medium of exchange that is free of default risk or “bank runs.” The best way to achieve this would be to have a competitive banking system with government-insured deposits. But this can only work if the assets held by these banks are tightly regulated. If such an equilibrium could be reached, it would still be

206 possible for an institution outside this regulated system to offer deposits that are only slightly more risky but that also pay a higher return than deposits at the regulated banks. Some consumers and firms will find this attractive and switch their deposits. But if everyone does, the regulations will no longer protect anyone. The regulatory structure designed in the 1930s seemed to solve this problem for 60 years, but something else will be needed for the next 60. When Robert Lucas and Brad Delong are both in agreement against your point, you may want to reconsider. I also want to point out this excellent Review of a Review of Tett’s Fool’s Gold by Anthropologist Anush Kapadia: When the banks need liquidity, they go to the interbank market and borrow/lend at LIBOR. When they all run out, they go to the central bank’s discount window. As Tett points out, shadow banks had only one liquidity backstop: the absolutely vital “liquidity puts” with the banks themselves, (MacKenzie makes no mention of them at all. See Tett pg. 205-6). Insurance sellers on the ABX were also providing a kind of backstop, and those backing up AAA risks were in effect backing up systemic risk, really the only kind of risk that is expressed in that coveted rating. By making AAA insurance contracts liquid, insurance market makers were implicitly acting as systemic risk providers. Cheap liquidity led them to underprice systemic risk and help create an unsustainable credit boom. When this became clear and everyone ran for the doors, there was no market maker of last resort who the system as a whole could turn to. The system itself melted because the systemic watchdogs were private, profit-driven entities (AIG and the monolines) who, when it comes to systemic risk, are by definition under-capitalized. With the backstops blown out, even the safer-than-safe risks looked unsafe. Read that again, it is fantastic. When Robert Lucas and an Anthropologist of Markets are both in agreement against your point, you may want to reconsider. It may turn out that this narrative is bunk, or that it is a sideshow to a much more central narrative – but I don’t feel that Thoma’s critics are getting his point, much less providing a counter-narrative. Now granted, there were government agents hanging around all these firms. So correct me if I’m wrong, there were no mechanism to handle this liquidity- backstop-for-regulation prior to the crisis. And that’s a problem that we all need to deal with.

207 The Atlantic Home Jun 17 2009, 1:20PM Conor Clarke An Interview With Paul Samuelson, Part One [Update: I've posted part two here.]

I've spent the last six months, off and on, trying to interview Paul Samuelson. Samuelson has a long list of accomplishments -- A John Bates Clark Medal, a Nobel Prize -- that I won't try to recap here. But by most accounts he is responsible for popularizing Keynesian economics in Post-Second World War America, and I wanted his thoughts on the current administration's fiscal policies and the modern Keynesian resurgence. I finally spoke with Dr. Samuelson yesterday morning. (Then my crummy RadioShack recorder -- caveat emptor -- spent yesterday afternoon trying to destroy the file.) Sameulson is an energetic 94 years old and the conversation ran for about an hour, so I've decided to break the transcript into two parts. I'll publish part two tomorrow morning. The first part of the conversation is mostly economic history -- the rise and fall (and rise) of Keynes, the influence of Milton Friedman, and the era of Alan Greenspan. Part two covers current events -- the need for a more stimulus spending and how his nephew (one Larry Summers) is doing running the economy. My questions are in bold. So is it time for the Keynesians to declare victory? Well I don't care very much for the People Magazine approach to applied economics, but let me put it this way. The 1980s trained macroeconomics -- like Greg Mankiw and Ben Bernanke and so forth -- became a very complacent group, very ill adapted to meet with a completely unpredictable and new situation, such as we've had. I looked up -- and by the way, most of these guys are MIT trained; Princeton to MIT or Harvard to MIT -- Mankiw's bestseller, both the macro book and his introductory textbook, I went through the index to look for liquidity trap. It wasn't there! Oh, I used those textbooks. There's got to be something in there on liquidity traps. Well, not in the index. And I looked up Bernanke's PhD thesis, which was on the Great Depression, and I realized that when you're writing in the 1980s, and there's a mindset that's almost universal, you miss a lot of the nuances of what actually happened during the depression.

208 I am regarded as a Keynesian. My book, which over a period of about 50 years sold millions of copies, for the first time brought home -- not only to advanced Ivy League places but also to community colleges and high schools -- the gist of the Keynesian macroeconomic system. I thought it would be a success because it was one Keynesian book by Lorie Tarshis, which for reasons I've never understood got completely tarred by a kind of a fascist group, and by Bill Buckley, as unsound and so forth. And unfairly that book never got a good chance. He had actually been a student of Keynes. And my book came along and swept the field, and set a pattern so that every time somebody -- this is just scuttlebutt -- so that every time some economics textbook writer sued another textbook writer for plagiarism, it never got anywhere because the judge would just say, 'it's all Samuelson lite,' so to speak. Anyway. Things swept so badly that I had distrust -- after 1967, let's say -- of American Keynesianism. For better or worse, US Keynesianism was so far ahead of where it started. I am a cafeteria Keynesian. You know what a cafeteria catholic is? I think so. Someone who picks and chooses the bits of the doctrine that they find agreeable. Yeah. I might go to mass every week, so I'm a good catholic, but I don't regulate my family size the way the Pope would like to. So which bits of the Keynesian doctrine do you not take out of the cafeteria? Well, let me give you a bit of boring autobiography. I came to the University of Chicago on the morning of January 2, 1932. I wasn't yet a graduate of high school for another few months. And that was about the low point of the Herbert Hoover/Andrew Mellon phase after October of 1929. That's quite a number of years to have inaction. And I couldn't reconcile what I was being taught at the university of Chicago -- the lectures and the books I was being assigned -- with what I knew to be true out in the streets. My family was well off but not rich. I spent the four years I was an undergraduate working on the beach. And it wasn't because I was lazy; it was because my freshman class would go to a hundred different employers and wouldn't get a nibble. That was a disequilibrium system. I realized that the ordinary old-fashioned Euclidean geometry didn't apply. And I applauded when the major members of the Chicago faculty -- maybe even a few years before Keynes's general theory -- came out with a petition to have a deficit-financed spending without taxation in order to create a new increment of spending power. And I was for that. And Franklin Roosevelt, who was not a trained economist, and who experimented and made a lot of mistakes, in his first days, by good luck or good advice got the system moving. It was in a sense an easier problem because the pathology was so terrible. He would go to Warm Springs Georgia. And that county -- a pretty sizeable one, this is the old south -- there were maybe three to ten people with enough income to file an income tax return. So, when along came the WPA, the PWA, and a little later the Reconstruction Finance Corporation, you could be very sure that those monies spit out by government-- not from airplanes in the air, sending newly printed greenbacks, but essentially the equivalent of that -- would be spent. I don't know if you know the name, the professor E. Cary Brown wrote kind of the definitive article in the American Economic Review on what had been accomplished by deficit spending that was sustained. And his numerical findings were that there were no

209 miracles -- it was about what you'd expect -- but it worked. And so I developed I guarded admiration for Keynes. And I say guarded because I don't think he understood his system as well as some of the people around him did. Anyway, this swept the field for a number of decades. And then, when the 1970s came, with very heavy supply side shocks -- the quadrupling of OPEC oil prices overnight, a rash of bad harvests, and the terrible price/wage control system contrived by Arthur Burns and Nixon 17 months before the election in order to ensure that they won. All these things added up. And Keynesianism, if it was thought to promise perpetual prosperity, became disparaged. When the king dies you need a new king. Guess what? Milton Friedman? Milton Friedman. Friedman had a solid MV = PQ doctrine from which he deviated very little all his life. By the way, he's about as smart a guy as you'll meet. He's as persuasive as you hope not to meet. And to be candid, I should tell you that I stayed on good terms with Milton for more than 60 years. But I didn't do it by telling him exactly everything I thought about him. He was a libertarian to the point of nuttiness. People thought he was joking, but he was against licensing surgeons and so forth. And when I went quarterly to the Federal Reserve meetings, and he was there, we agreed only twice in the course of the business cycle. That's asking for a question. What were the two agreements? When the economy was going up, we both gave the same advice, and when the economy was going down, we gave the same advice. But in between he didn't change his advice at all. He wanted a machine. He wanted a machine that spit out M0 basic currency at a rate exactly equal to the real rate of growth of the system. And he thought that would stabilize things. Well, it was about the worst form of prediction that various people who ran scores on this -- and I remember a very lengthy Boston Federal Reserve study -- thought possible. Walter Wriston, at that time one of the most respected bankers in the country and in the world fired his whole monetarist, Friedmaniac staff overnight, because they were so off the target. But Milton Friedman had a big influence on the profession -- much greater than, say, the influence of Friedrich Hayek or Von Mises. Friedman really changed the environment. I don't know whether you read the newspapers, but there's almost an apology from Ben Bernanke that we didn't listen more to Milton Friedman. But anyway. The craze that really succeeded the Keynesian policy craze was not the monetarist, Friedman view, but the [Robert] Lucas and [Thomas] Sargent new-classical view. And this particular group just said, in effect, that the system will self regulate because the market is all a big rational system. Those guys were useless at Federal Reserve meetings. Each time stuff broke out, I would take an informal poll of them. If they had wisdom, they were silent. My profession was not well prepared to act. And this brings us to Alan Greenspan, whom I've known for over 50 years and who I regarded as one of the best young business economists. Townsend-Greenspan was his company. But the trouble is that he had been an Ayn Rander. You can take the boy out of the cult but you can't take the cult out of the boy. He actually had instruction, probably

210 pinned on the wall: 'Nothing from this office should go forth which discredits the capitalist system. Greed is good.' However, unlike someone like Milton, Greenspan was quite streetwise. But he was overconfident that he could handle anything that arose. I can remember when some of us -- and I remember there were a lot of us in the late 90s -- said you should do something about the stock bubble. And he kind of said, 'look, reasonable men are putting their money into these things -- who are we to second guess them?' Well, reasonable men are not reasonable when you're in the bubbles which have characterized capitalism since the beginning of time. But now Greenspan admits he was wrong. Because we had, instead of three standard deviations storm, a six standard deviation storm. Well, we did have something unprecedented. I think looking for scapegoats and blame can be left to the economic historian. But, at the bottom, with eight years of no regulation from the second Bush administration, from the day that the new SEC chairman -- Harvey Pitt -- said 'I'm going to run a kinder and gentler SEC,' every financial officer knew they weren't going to be penalized. Self regulation never worked as far as macroeconomic events -- whether we're talking about post-Napoleonic War business cycles or the big south sea bubble back in Isaac Newton's time, up to today's time. The pendulum just swings back in the other direction. About that pendulum. Has macroeconomics learned anything in the past 30 or even in the past 70 years? Well, I will say this. And this is the main thing to remember. Macroeconomics -- even with all of our computers and with all of our information -- is not an exact science and is incapable of being an exact science. It can be better or it can be worse, but there isn't guaranteed predictability in these matters. What has pleasantly surprised me is that because of the Obama political sweep we've got some very rapid interventions beyond anything that the Eccles Federal Reserve even dreamed of in Franklin Roosevelt times, and that's why I think we're a little bit ahead o the European Union in the state of our recovery. On the other hand, I think the popular view -- if I count noses -- is that by the end of this year even, or by 2010, recovery will have set in. That's a very ambiguous thing. Things could get better -- things could even get better such that the National Bureau committee that officially dates these recessions will say that the recession officially ended in something like December 2010. That could be misleading, because it could be completely consistent with continuing decreases in employability, an adverse balance of payments, and a move of both the consumer section and the investing section towards non-spending -- towards saving and hoarding. I don't think we would enjoy a lost decade, like the two lost decades the Japanese had. However, if you need a framework for these things, then you can't do better than the 1965 Hicks/Hansen version of the Keynesian system, which is pretty clear cut on how a central bank can, by diddling its discount rate up and down judiciously, lead toward a period of great moderation rather than the terrible ups and downs of the 20th century. Part two of the interview is here. Samuelson image via MIT economics page. Thanks to Brad DeLong. http://correspondents.theatlantic.com/conor_clarke/2009/06/an_interview_with_paul_sam uelson_part_one.php

211 Jun 18 2009, 9:30AM An Interview With Paul Samuelson, Part Two

This is the second part of my interview with Paul Samuelson. I posted part one yesterday. Part two is a little more all over the place. We discuss fiscal stimulus, the current administration, behavioral economics, the risk of inflation, and Dr. Samuelson's relationship with Larry Summers. Skim milk makes an appearance, and so does Greg Mankiw's textbook (again). I have very lightly edited the transcript for clarity, but otherwise it is an exact rendering of our conversation. My questions in bold. I have a couple of questions about the current debate. Do you think large fiscal stimulus should be controversial? And would you like to see more of it? Would you like to see a second or third stimulus, depending on where you start counting? Well, in the first place, the E. Carey Brown analysis stressed that one shot spending gives you only one-shot response. It's gotta be sustained. The way we got out of the 1929 Great Depression in the US -- and this happened not only in the US but also in Germany and each place in which there was almost a third unemployed --- was heavy deficit spending. It was not clever Federal Reserve policy, because early on the Federal Reserve had shot its bolt when we came near to liquidity trap. I'll speak from some experiences. My father in law was president of a national bank in Vernon, Wisconsin, population 4,100 as of the last Census. His was the only bank in the first week after Roosevelt's bank holiday that was allowed to reopen. Why? Well, he knew every borrower and he knew better than they did what they could afford and what they couldn't afford. And so he came into the situation with a clean balance sheet. You think 'Great, because we preserve the monetary supply in the system, right?' Not great. Because the average person did not go out spending and lending freely. He bought treasury bills for as little as half a percent per annum. So the system was frozen without these supplementary expenditures, where the WPA competed with the PWA and with the reconstruction finance corporation. For really depressed situations, unorthodox central banking is needed.

212 We're almost getting there. In one of Greg Mankiw's articles, he said that maybe when the interest rate gets down to zero and it's threatening to be negative, you should give a subsidy with it. Well, that's what fiscal policy is! By the way, I don't want you to think that I think that everything for the next 15 years will be cozy. I think it's almost inevitable that, with a billion people in China wide awake for the first time, and a billion people in India, there's going to be some kind of a terrible run against the dollar. And I doubt it can stay orderly, because all of our own hedge funds will be right in the vanguard of the operation. And it will be hard to imagine that that wouldn't create different kind of meltdown. Last thing. Mea culpa, mea culpa. MIT and Wharton and University of Chicago created the financial engineering instruments, which, like Samson and Delilah, blinded every CEO -- they didn't realize the kind of leverage they were doing and they didn't understand when they were really creating a real profit or a fictitious one. There 's a lot of causality in economics, even though it's very far from an exact science. A question about the exact science stuff before going back to policy questions. One of the things for which you are most famous is for writing the Foundations of Economic Analysis, which as I understand it attempted to bring a kind of mathematical uniformity to the field – Well, I would say a mathematical searchlight – Okay, what's the distinction there? I'm curious what you think about some recent developments in economics, some of the movements that are hot right now -- like behavioral economics, part of which wants to challenge the notion of humans as utility maximizing rational agents. In my view behavioral science describes an extremely large and important part of the modern picture. However, whenever the economy turns in a very irrational way, that can create opportunities for very rational speculators to make a profit. So you can still get some approximation on the micro level of an efficient market. But there never has been a true macro efficient market. You just have to look at the record of economic history the ups and downs. Bubbles are self-generating. And I'm not sure most of the people that get caught up in the middle of a bubble can be described as irrational. It seems pretty rational to buy a house and flip it in the next few weeks at a profit when that's been happening for along time. It works both ways. The crowd mentality is maybe not rational. Well, let's put that differently. It's not optimal. It's what it is. You have to cope with people. Now, if all the people had gone to the Wharton School and become very sophisticated that doesn't mean the society in which they lived and operated would be incapable of having a business cycle or bubbles. They're self generating. So are people utility maximizing and rational and can we make sense of interpersonal comparisons of utility in a mathematical way? No. But you know, people say, 'greed has suddenly increased.' But it isn't that greed's increased. What's increased is the realization that you've got a free field to reach out for what you'd like to do. Everybody would still like to retire with a satisfactory nest egg in real terms. And the tragedy of this unnecessary eight-year interlude is that much of what has been accumulated is gone and gone forever. And no amount of pumping is going to

213 bring back into reality what were ill-advised overextensions of bridges to nowhere and housing developments for which there was no effective demand. With the Foundations, I looked around for the best bicycle in town. It wasn't perfect, but it was better than what had been assigned previously. Back to some middle-term and long-term policy questions. Even if it makes sense to think about deficit-financed government demand stepping in and replacing a drop off in household demand, do you worry about the rising deficit and the potential risk of inflation? There's been a lot of articles on this in the past two weeks -- Paul Krugman and Niall Ferguson and others. I think it would be surprising if, down the road -- not in the long long run but in the somewhat short run -- we don't have some return of inflation. On the other hand, I'm of the view that if we come out of this with some kind of temporary stabilization at least, and the price level is let's say 10-12% above what it was before we got into the meltdown, I think that's a price I would be willing to pay! Unfortunately, after World War One -- in 1925 when the British tried to put the pound back to the 1914 level against Keynes advice -- it turned out that Keynes was very right and a lot of the subsequent grief in the British empire traces to that wrong decision. I'm against inflation, but what I worry about is continuing, galloping, self-reinforcing inflation. I would not try to roll things back to some sacred earlier price level. And China .. You've written some about that. How real do you think the threat of a run on the dollar is? Some people, like your nephew Larry Summers has said that there's kind of "balance of financial terror" there -- that it's not in China's interest to see a big decline in the value of dollar denominated assets. Well first let me say that I have big admiration for Larry Summers as an economist. However, when he was at MIT as an undergraduate, he never took a course of mine! But I think he was wise. If he had people could always say, 'well, he's traveling on someone else's steam.' There's a Chinese wall between him and me. Any view he expresses and any view I express -- there might be some overlap, but there's nothing synchronized. So you're not in touch with him now? No. Certainly, some of the reasons the Chinese have stuck with huge amounts of reserves in very low interest rate US assets has been to keep the export led program that they espouse in existence. They can still succeed there by taking the reserves out of prime zero-interest stuff and putting it in our general stock market and so forth, the way Dubai and some of the other countries are beginning to do. So I think we've got -- in the long term -- a lull in our favor, but it's a lull in our favor that, rationally, is probably not going to persist. I just have two more questions. First, when I told people that I was going to talk to you this morning, the question that came up most had nothing to do with economics and was usually some variation of "how are you still doing stuff at 94?" What's the secret? Well, I'll tell you! Luck. My female genealogy is very favorable. My aunts and so forth all lived into their 90s. My male genealogy was deplorable. And for the first 35 years of my life there was no treatment for hypertension. So part of my brashness was probably, "If I'm going to do something I better do it early." But my very good internist at MIT said

214 'hey, we can do something about that now.' And luckily I picked someone at the very good lab at Boston University Medical where some of the original anti-hypertensives and anti cholesterol medication and so forth was developed. So I'm a tribute to the advance of modern medicine. However, I'll take a little credit for helping it along. I switched to skim milk when everyone said it was crazy. And I was always pretty well off. You know what happiness is: 'Having a little more money than your colleagues.' And that's not so tough in academic life. Very last thing. What would you say to someone starting graduate study in economics? Where do you think the big developments in modern macro are going to be, or in the micro foundations of modern macro? Where does it go from here and how does the current crisis change it? Well, I'd say, and this is probably a change from what I would have said when I was younger: Have a very healthy respect for the study of economic history, because that's the raw material out of which any of your conjectures or testings will come. And I think the recent period has illustrated that. The governor of the Bank of England seems to have forgotten or not known that there was no bank insurance in England, so when Northern Rock got a run, he was surprised. Well, he shouldn't have been. But history doesn't tell its own story. You've got to bring to it all the statistical testings that are possible. And we have a lot more information now than we used to. Are you happy with the way economics is being taught now? You've mentioned Greg Mankiw's textbooks. Well to say that I've read them would be an exaggeration. I looked into them, and I was disappointed that they were so bland. [Laughs] No, he's a gifted writer. But an economist with a facile pen isn't necessarily an overnight expert on the likelihoods in our inexact science. http://correspondents.theatlantic.com/conor_clarke/2009/06/an_interview_with_paul_sam uelson_part_two.php

215 Jun 16, 2009 Re-Interpreting the Blinder Numbers in the Light of New Trade Theory According to this, "the US is actually a net insourcer" of jobs: How many jobs are onshorable? Re-interpreting the Blinder numbers in the light of new trade theory, by Richard Baldwin, Vox EU: Before the global crisis hit, offshoring was one of the scarcest things on rich nations’ economic radar screens – especially the offshoring of “good” service sector jobs. Alan Blinder was one of the first to point out the threat in his 2006 Foreign Affairs article “Offshoring: The Next Industrial Revolution?” He wrote: “constant improvements in technology and global communications virtually guarantee that the future will bring much more offshoring of ‘impersonal services’’— that is, services that can be delivered electronically over long distances with little or no degradation in quality.” Blinder has more recently produced some estimates of the size of the revolution. And they make it look like “the big one”. Blinder (2009): "I estimated that 30 million to 40 million US jobs are potentially offshorable." This sort of media-friendly statement is part of what I consider to be very confused thinking by non-specialists – not that the economists involved are necessarily confused, but tacitly or not, they are allowing the media to misinterpret the numbers. Let me start off by saying that I consider Alan Blinder to be one of the world’s leading macroeconomic policy specialists. Moreover, I greatly appreciate the way he uses his knowledge of economics to make this a better world (rather than focusing entirely on impressing the other inhabitants of academe). This time, however, I’m not sure it has worked out right. I don’t wish to take issue with his numbers or methods. I wish to question the implications of those numbers. The trouble is that his numbers are being interpreted in the light of the “old paradigm” of globalisation – the world of trade theory that existed before Paul Krugman, Elhanan Helpman, and others led the “new trade theory” revolution in the 1980s. The new trade theory: Micro, not macro, determinants of comparative advantage Krugman’s contribution, which was rewarded with a Nobel Prize in 2008, was to crystallise the profession’s thinking on two-way trade in similar goods.[1] This was a revolution since the pre-Krugman received wisdom assumed away such trade or misunderstood its importance. In 1968, for example, Harvard economist Richard Cooper noted the rapid rise in two-way trade among similar nations and blamed it for the difficulty of maintaining fixed exchange rates. Using the prevailing trade theory orthodoxy, he asserted that this sort of trade could not be welfare-enhancing. And since it wasn’t helping, he suggested that it should be taxed to make it easier to maintain the world’s fixed exchange rate system – a goal that he considered to be the really important thing from a welfare and policy perspective (Cooper, 1968). Trade economists back then took it as an article of faith that trade flows are caused by macro-level differences between nations – for example, national differences

216 between the cost of capital versus labour. Nations that had relatively low labour costs exported relatively labour intensive goods to nations where labour was relatively expensive. This is the traditional view that Blinder seems to be embracing. What Krugman (especially Krugman 1979, 1980) showed was that one does not need macro-level differences to generate trade. Firm-level differences will do. In a world of differentiated products (and services are a good example of this), scale economies can create firm-specific competitiveness, even between nations with identical macro-level determinants of comparative advantage. Krugman, a pure theorist at the time, assumed that nation’s were identical in every aspect in order focus on the novel element in his theory (and to shock the “trade is caused by national differences” traditionalists). His insight, however, extends effortlessly to nations that also have macro-level differences, like the US and India. This brings us to interpreting Blinder’s 30 to 40 million offshorable jobs. Blinder’s calculations Blinder’s approach is easy to explain – a fact that accounts for much of its allure as well as its shortcomings. • Step 1 is to note that Indian wages are a fraction of US wages. • Step 1a is to implicitly assume that Indians’ productivity-adjusted wages are also below those of US service sector workers, at least in tradable services. • Step 2, and this is where Blinder focused his efforts, is to note that advancing information and communication technology makes many more services tradable. The key characteristic, Blinder claims, is the ease with which the service can be delivered to the end-user electronically over long distances. • Step 3 (the critical unstated assumption, if not by Blinder, at least by the media reporting his results) is that the new trade in services will obey the pre- Krugman trade paradigm – it will largely be one-way trade. Nations with relatively low labour costs (read: India) will export relatively labour-intensive goods (read: tradable services) to nations where labour is relatively expensive (read: the US). The catch This last step is factually incorrect, as recent work by Mary Amiti and Shang-Jin Wei (2005) has shown. They note: “Like trade in goods, trade in services is a two- way street. Most countries receive outsourcing of services from other countries as well as outsource to other countries.” The US, as it turns out, is a net “insourcer”. That is, the world sends more service sector jobs to the US than the US sends to the world, where the jobs under discussion involve trade in services of computing (which includes computer software designs) and other business services (which include accounting and other back-office operations). The chart shows the facts for the 1980 to 2003 period. We see that Blinder is right in that the US importing an ever-growing range of commercial services – or as he would say, the third industrial revolution has resulted in the offshoring of ever more

217 service sector jobs. However, the US is also “insourcing” an ever-growing number of service sector jobs via its growing service exports. The startling fact is that not only is the trade not a one-way ticket to job destruction, the US is actually running a surplus.

Source: Author’s manipulation of data from Amiti and Wei (2005), originally from IMF sources on trade in services. Conclusion None of this should be unexpected. The post-war liberalisation of global trade in manufactures created new opportunities and new challenges. To apply Blinder’s logic to, say, the European car industry in the early 1960s, one would have had to claim that since the German car industry (at the time) faced much lower productivity-adjusted wages, freer trade would make most French auto jobs “lose- able” to import competition. Of course, many jobs were lost when trade did open up, but many more were created. As it turned out, micro-level factors allowed some French firms to thrive while others floundered, and the same happened in Germany. Surely the same sort of thing will happen in services, as trade barriers in that sector fall with advancing information and communication technologies. In short, what Blinders’ numbers tell us is that a great deal of trade will be created in services. Since services are highly differentiated products, and indivisibilities limit head-to-head competition, my guess is that we shall see a continuation of the trends in the chart. Lots more service jobs “offshored” and lots more “onshored”. What governments should be doing is helping their service exporters to compete, not wringing their hands about one-way competition from low-wage nations. Footnotes 1 Full disclosure: Krugman was my PhD thesis supervisor and we have coauthored a half-dozen articles since 1986. References Amiti, M. and S.J. Wei (2005), “Fear of Service Outsourcing: Is it Justified?”, Economic Policy, 20, pp. 308-348.

218 Blinder, Alan (2006). “Offshoring: The Next Industrial Revolution?” Foreign Affairs, Volume 85, Number 2. Blinder, Alan (2009). “How Many U.S. Jobs Might Be Offshorable,” World Economy, 2009, forthcoming. Cooper, R. (1968). The Economics of Interdependence. New York: McGraw-Hill. Grossman, G. and E. Rossi-Hansberg (2006a). “The Rise of Offshoring: It’s Not Wine for Cloth Anymore,” July 2006. Paper presented at Kansas Fed’s Jackson Hole conference for Central Bankers. Krugman, Paul (1979). "Increasing returns, monopolistic competition, and international trade," Journal of , Elsevier, vol. 9(4), pages 469-479, Krugman, Paul (1980). "Scale Economies, Product Differentiation, and the Pattern of Trade," American Economic Review, vol. 70(5), pages 950-59, December. Krugman, Paul (1991), “Increasing Returns and Economic Geography”, Journal of Political Economy 99, 483-499. http://economistsview.typepad.com/economistsview/2009/06/reinterpreting -the-blinder-numbers-in-the-light-of-new-trade-theory.html

219 NBER Reporter. International Finance and Macroeconomics Jeffrey A. Frankel*

Program Report The Global Financial Crisis: A Selective Review of Recent Research in the International Finance and Macroeconomics Program [The following Program Report appeared in the 2009 Number 2 issue of the NBER Reporter.] In recent months, many members of the NBER?s International Finance and Macroeconomics (IFM) program have turned their attention to the financial crisis that erupted in the United States in 2007 and spread to the global economy in 2008 and 2009. Since my last program review, in 2004, IFM program members have produced nearly one hundred working papers per year on a wide variety of topics. It would be impossible to summarize that enormous body of work in just a few pages. Instead of trying to touch on all of the topics studied by IFM researchers, this survey presents a focused summary of research from the past year that is relevant to the global financial crisis. All of the working papers in the IFM program can be found on the NBER?s publications webpage using the ?working papers by program? feature. Origins of the U.S. Financial Crisis Markus K. Brunnermeier(1) ; Douglas W. Diamond and Raghuram Rajan(2) ; and John B. Taylor have offered useful overviews of the origins and progress of the crisis. (3) One view is that the bubble-like conditions that set the stage for the sub-prime mortgage crisis of 2007 were created by low U.S. interest rates during 2003-6 -- whether because of easy monetary policy by the Fed, a savings glut among foreigners, or under- perceptions of risk by investors in general. The resulting ?search for yield? during this period sent waves of money into alternative assets, including high-interest foreign currencies(4), commodities(5), and especially housing(6). Various analytical tools, ranging from Dynamic Stochastic General Equilibrium models to Irving Fisher?s debt deflation theory, have been brought to bear on the crisis that erupted in 2007.(7) Hui Tong and Shang-Jin Wei develop a methodology to study whether and how a financial-sector crisis can spill over to the real economy and apply it to the case of the subprime mortgage crisis. (8) Kimie Harada and Takatoshi Ito look back at the experience of Japan at the end of the 1990s to shed light on whether the motivation for bank mergers was gains in efficiency or exploitation of too-big-to-fail bailouts. (9) Consequences for the Real Economy

Robert J. Barro and Jos頕rs?udy the relationship between sharp declines in stock market values and economic activity using a sample of 25 nations for the period since

220 World War I. They conclude that conditional on a non-wartime stock market decline of more than 25 percent, which the United States experienced in 2008 and early 2009, the probability of a 10 percent decline in real economic activity is 20 percent, and the probability of a 25 percent decline in real activity is 3 percent. (10) In a series of influential papers, Carmen Reinhart and Kenneth S. Rogoff have studied the historical record of countries experiencing severe financial crises. They report that real housing price declines average 35 percent stretched out over six years from peak to trough, while equity price collapses average 55 percent over a downturn of about three and a half years. The unemployment rate rises by an average of 7 percentage points over the down phase of the cycle and output falls by an average of over 9 percent. The real value of government debt tends to explode, rising an average 86 percent, because of lost tax revenues.(11) Reinhart and Rogoff also find that the historical patterns of banking crises in middle-to-low-income countries have been similar to those in rich countries.(12) Spread of the Crisis throughout the Global Banking System Initially it was hoped that the rest of the world, or at least newly robust emerging markets, would be ?decoupled? from the crisis in the Anglo-American economies. (13) But in 2008 the crisis spread worldwide, in part via the banking system. Nicola Cetorelli and Linda S. Goldberg study the globalization of U.S. banks and the international propagation of domestic liquidity shocks to lending by affiliated banks abroad. (14) An analysis of market-judged creditworthiness of banks by Barry Eichengreen, Ashoka Mody, Milan Nedeljkovic, and Lucio Sarno shows that international interdependence rose from the outbreak of the Subprime Crisis in 2007 through the rescue of Bear Stearns, and that it attained a new high with the failure of Lehman Brothers in the Fall of 2008.(15) What Determines Which Countries Are Worst Hit by the Crisis? What policies can countries adopt ahead of time to make themselves less vulnerable to crises? Ethan Ilzetzki and Carlos Vegh confirm the longstanding view that fiscal policy in developing countries tends to be procyclical, thereby exacerbating macroeconomic swings.(16) Much research shows the danger of incurring liabilities that are denominated in foreign currency. (17) Some emerging market countries learned the currency mismatch lesson after the crises of 1994-2002, but some others in Central and Eastern Europe borrowed in foreign currency during the subsequent cycle. (18) A short time ago, it appeared that many countries, especially Asians and oil exporters, were holding a puzzlingly high level of reserves. (19) But Joshua Aizenman concludes that now the global liquidity crisis has illustrated that foreign exchange reserves provide important self insurance. (20) Reserve accumulation is a way of saving windfall gains in export revenue for a rainy day. Sovereign wealth funds also can play this role.(21) Similarly, Maurice Obstfeld, Jay Shambaugh, and Alan M. Taylor conclude that countries that built up large precautionary holdings of reserves after the East Asia crisis of the late 1990s were less likely to experience large depreciations in the ?Panic of 2008.?(22) Swap lines also can substitute for reserves to some extent, particularly in the case of those emerging market countries lucky enough to have secured contingent lines of credit from the Federal Reserve in 2008.(23) Re-examining Financial Liberalization The long-term trend worldwide has been away from the traditional ?home bias? in portfolio investment,(24) and toward financial integration and diversification. (25) Even India, for example, has opened its capital account. (26)

221 The severity of the current crisis, however, just like the emerging market crises of the 1990s, has raised the question of whether modern liberalized financial markets are more of a curse than a blessing.(27) Sometimes the doubts are phrased as a challenge to the ?Washington consensus? in favor of free markets generally. (28) Carmen and Vincent Reinhart find that global factors, such as U.S. interest rates, have been a driver of the global capital flow cycle since 1960, and that capital inflow booms are no blessing for either advanced or emerging market economies.(29) Enrique Mendoza and Marco Terrones explore how credit booms lead to rising asset prices, and in the case of emerging markets are often preceded by capital inflows and followed by financial crises.(30) Sebastian Edwards finds that external crises have been more costly in Latin America than in the rest of the world. (31) Cross-country regressions by Eswar Prasad and Rajan suggest little connection from foreign capital inflows to more rapid economic growth for developing countries and emerging markets. (32) Some research still finds that financial liberalization improves standard measures of economic performance. Indrit Hoxha, Sebnem Kalemli-Ozcan, and Dietrich Vollrath are a recent example of research in this spirit.(33) In a series of papers, Peter B. Henry has documented the effects of a country opening its stock market to foreign investors.(34) In theory, financial markets should allow efficient risk-sharing. Indeed, Sebnem Kalemli-Ozcan, Elias Papaioannou, and Jos頌uis Peydr nd that financial integration leads to a lower degree of business cycle synchronization. (35) Andrew K. Rose and Mark Spiegel find that proximity to major international financial centers seems to reduce business cycle volatility. (36) But many find that theoretical predictions of risk-sharing benefits are not supported by the data.(37) Conditions under which Capital Inflows are Beneficial A recurrent theme in research on financial integration is that the aggregate size of capital inflows is not as important as the conditions under which they take place. M. Ayhan Kose, Prasad, and Terrones provide a comprehensive analysis of the relationship between financial openness and total factor productivity (TFP) growth. They find strong evidence that inflows of FDI and portfolio equity boost a country?s TFP growth, but that external debt is negatively correlated with TFP growth. (38) Obstfeld argues that, for capital globalization to be beneficial, countries need reforms that curtail the power of entrenched economic interests. (39) Edwards?s results indicate that relaxing capital controls increases the likelihood of experiencing a sudden stop, in particular, if it comes ahead of other reforms.(40) Other recent papers confirm that financial liberalization is good for economic performance if countries have reached a certain level of development, particularly with respect to institutions and the rule of law. Kose, Prasad, and Ashley Taylor find that the benefits from financial openness increasingly dominate the drawbacks once certain identifiable threshold conditions in measures of financial depth and institutional quality are satisfied.(41) Similarly, Aizenman, Menzie D. Chinn, and Hiro Ito find that greater financial openness with a high level of financial development can reduce or increase output volatility, depending on whether the level of financial development is high or low. (42) Do U.S. Current Account Deficits Reflect Unsustainably Low National Saving, or a Comparative Advantage in Supplying High-Quality Assets?

222 If local banks and other financial intermediaries cannot effectively convert savings into high-return investment without the benefit of institutions that support investor rights and the rule of law, then countries lacking those conditions might put their funds into countries that have them. Traditionally, the United States has been presumed to have these institutions ? corporate governance, securities markets, accounting standards, rating agencies ? and developing countries have been presumed to lack them. This then would account for the puzzle of ?capital flowing uphill? from poor countries to rich. (43) Jiandong Ju and Wei find that financial capital tends to flow from economies with low- quality institutions to those with high-quality institutions. (44) The purported superiority of U.S. financial institutions and assets also has provided one line of argument for those who believe that the chronic U.S. current account deficits are fully sustainable. Among those who argue that the United States has been appropriately exploiting its comparative advantage in supplying high-quality assets to the rest of the world are Kristin Forbes;(45) Ricardo J. Caballero, Emmanuel Farhi, and Pierre-Olivier Gourinchas;(46) and Mendoza, Vincenzo Quadrini, and Jose-Victor Rios-Rull. (47) Recurrent upward revaluations in the dollar price of U.S. overseas assets in effect have financed a substantial fraction of recent U.S. deficits. (48) Some believe that the valuation effects are not an unsustainable coincidence, but rather a component of the sustainable returns that the United States enjoys as an ?exorbitant privilege,? as world banker(49) or as supplier of the premier international reserve currency.(50) Stephanie Curcuru, Charles Thomas, and Frank Warnock, offer counterarguments ? based on detailed knowledge of the balance of payments statistics -- to the idea that large and persistent current account deficits are easily financed as an exorbitant privilege that the United States can take for granted. (51) Also on the opposite side from the sustainability view are those who have been arguing for some years that, because large trade and current account deficits of the United States cannot continue indefinitely, the dollar eventually will fall, as private investors and governments become unwilling to accept the risk of increasing amounts of dollars in their portfolios. Prominent examples include Obstfeld and Rogoff(52) and Martin Feldstein. (53) Some even suggest that the dollar?s role as dominant reserve currency eventually could be lost. (54) The eruption of the financial crisis in the United States in mid-2007 has not helped to resolve the conflict between the view that the U.S. current account deficit reflects an unsustainably low rate of national saving and the view that it is a manifestation of the superior quality of assets that the United States is able to offer the world. On the one hand, recent revelations about the myriad shortcomings of U.S. financial institutions seem to argue against the latter view. On the other hand, still in the ?sustainable? camp, Caballero, Farhi, and Gourinchas now argue that the persistent global imbalances and the subprime crisis both stem from a global environment where sound and liquid financial assets are in scarce supply. (55) Caballero and Arvind Krishnamurthy argue that precisely because the assets that the United States has sold to foreigners are its riskless ones (Treasury bills), in accordance with its comparative advantage, Americans have been left holding the "toxic waste," and that this is what has led to the most severe financial crisis since the Great Depression. (56) Michael Dooley, David Folkerts-Landau, and Peter M. Garber point out that the surprising strength of international demand for U.S. dollars in 2008 undercuts the view that the current crisis is the long-predicted day of reckoning for an unsustainable current

223 account. (57) They proclaim that the current account imbalance did not cause the crisis, in the context of their theory that the Chinese authorities deliberately and sustainably continue to buy dollars to keep their currency undervalued as part of an export-led development strategy. (58) Some see the U.S. current account deficit, capital inflows, and low interest rates, and even the crisis itself, as having originated in a ?global savings glut,? (59) stemming largely from China. (60) Even if this view were right, it would leave open the question as to how long the global imbalances are sustainable.(61)

* Frankel directs the NBER's Program on International Finance and Macroeconomics and is the James W. Harpel Professor of Capital Formation and Growth at Harvard's Kennedy School of Government 1.?Deciphering the Liquidity and Credit Crunch 2007-08,? NBER Working Paper No. 14612, December 2008. 2. ?The Credit Crisis: Conjectures about Causes and Remedies,? NBER Working Paper No. 14739, February 2009; and ?Fear of Fire Sales and the Credit Freeze,? NBER Working Paper No. 14925, April 2009. 3. ?The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong,? NBER Working Paper No. 14631, January 2009. Also, J. B. Taylor and J. C. Williams, ?A Black Swan in the Money Market,? NBER Working Paper No. 13943, April 2008. 4. This is the famous ?carry trade,? in which an investor goes short in low-interest-rate currencies and goes long in high-interest-rate currencies: M. Pojarliev and R.M. Levich, ?Trades of the Living Dead: Style Differences, Style Persistence and Performance of Currency Fund Managers,? NBER Working Paper No. 14355, September 2008; A. Craig Burnside, M.S. Eichenbaum, I. Kleshchelski, and S. Rebelo, ?Do Peso Problems Explain the Returns to the Carry Trade?? NBER Working Paper No. 14054, June 2008; M.K. Brunnermeier, S. Nagel, and L.H. Pedersen, ?Carry Trades and Currency Crashes,? NBER Working Paper No. 14473, November 2008; H. Lustig, N. Roussanov,and A. Verdelhan , ?Common Risk Factors in Currency Markets,? NBER Working Paper No. 14082, June 2008. 5. J.A. Frankel , ?The Effect of Monetary Policy on Real Commodity Prices,? in Asset Prices and Monetary Policy, John Y. Campbell, ed., U.Chicago Press, 2008 6. J. Aizenman and Y. Jinjarak, ?Current Account Patterns and National Real Estate Markets,? NBER Working Paper No. 13921, April 2008, finds a strong positive association between current account deficits and the real increase in real estate prices. Also, W. H. Buiter ?Housing Wealth Isn?t Wealth,? NBER Working Paper No. 14204, July 2008. 7. E. G. Mendoza, ?Sudden Stops, Financial Crises and Leverage: A Fisherian Deflation of Tobin?s Q,? NBER Working Paper No. 14444, October 2008. 8. NBER Working Paper No. 14205, July 2008. 9.?Did Mergers Help Japanese Mega-Banks Avoid Failure? Analysis of the Distance to Default of Banks,? NBER Working Paper No. 14518, December 2008. 10. ?Stock-Market Crashes and Depressions,? NBER Working Paper No. 14760, February 2009. 11. ?The Aftermath of Financial Crises,? NBER Working Paper No. 14656, January 2009. 12. In ?Banking Crises: An Equal Opportunity Menace,? NBER No. 14587, December 2008. The crises considered stretch back to the Napoleonic Wars. 13. M.A. Kose, C. Otrok, and E.S. Prasad, ?Global Business Cycles: Convergence or Decoupling?? NBER Working Paper No. 14292, October 2008.

224 14.?Banking Globalization, Monetary Transmission, and the Lending Channel,? NBER Working Paper No. 14101, June 2008. 15. ?How the Subprime Crisis Went Global: Evidence from Bank Credit Default Swap Spreads,? NBER Working Paper No. 14904, April 2009. 16. ?Procyclical Fiscal Policy in Developing Countries: Truth or Fiction?? NBER Working Paper No. 14191, July 2008. 17. For example, G. A. Calvo, A. Izquierdo, and L. Mej ?Systemic Sudden Stops: The Relevance of Balance-Sheet Effects and Financial Integration,? NBER Working Paper No. 14026, May 2008. 18. The mistake was repeated by Hungary; it could be interpreted as a failed ?convergence play? among central European countries considered to be on the path to joining the euro and thus another instance of the carry trade. Poland has done somewhat better: B. Eichengreen and K. Steiner, ?Is Poland at Risk of a Boom-and-Bust Cycle in the Run-Up to Euro Adoption?? NBER Working Paper No. 14438, October 2008. 19. For example, D. Rodrik, ?The Social Cost of Foreign Exchange Reserves,? NBER Working Paper No. 11952, January 2006; and M. Obstfeld, J.C. Shambaugh, and A.M. Taylor, ?Financial Stability, the Trilemma, and International Reserves,? NBER Working Paper No. 14217, August 2008. 20. ?On the Paradox of Prudential Regulations in the Globalized Economy: International Reserves and the Crisis ? A Reassessment,? NBER Working Paper No. 14779, March 2009. ?The deleveraging triggered by the crisis implies that countries that hoarded reserves have been reaping the benefits.? 21. J. Aizenman and R. Glick , ?Sovereign Wealth Funds: Stylized Facts about their Determinants and Governance,? NBER Working Paper No. 14562, December 2008. 22. ?Financial Instability, Reserves, and Central Bank Swap Lines in the Panic of 2008,? NBER Working Paper No. 14826, March 2009. 23. J. Aizenman and G. K. Pasricha, ?Selective Swap Arrangements and the Global Financial Crisis: Analysis and Interpretation,? NBER Working Paper No. 14821, March 2009. 24. H. Hau and H. Rey, ?Home Bias at the Fund Level,? NBER Working Paper No. 14172, July 2008; and P. Benigno and S. Nistic젓International Portfolio Allocation under Model Uncertainty,? NBER Working Paper No. 14734, February 2009; E. van Wincoop and F.E.Warnock, ?Is Home Bias in Assets Related to Home Bias in Goods?? NBER Working Paper No. 12728, December 2006. 25. H.Hau and H. Rey, ?Global Portfolio Rebalancing Under the Microscope,? NBER Working Paper No. 14165, July 2008. 26. E.S. Prasad, ?Some New Perspectives on India's Approach to Capital Account Liberalization,? NBER Working Paper No. 14658, January 2009. 27. G.L. Kaminsky, ?Crises and Sudden Stops: Evidence from International Bond and Syndicated-Loan Markets,? NBER Working Paper No. 14249, August 2008. A variety of country experiences were considered in Capital Controls and Capital Flows in Emerging Economies: Policies, Practices and Consequences, edited by Sebastian Edwards (University of Chicago Press, 2007). 28. A. Estevadeordal and A.M Taylor, ?Is the Washington Consensus Dead? Growth, Openness, and the Great Liberalization, 1970s-2000s,? NBER Working Paper No. 14264, August 2008.

225 29. ?Capital Flow Bonanzas: An Encompassing View of the Past and Present,? NBER Working Paper No. 14321, September 2008. In NBER International Seminar on Macroeconomics: 2008 (University of Chicago Press). 30. ?An Anatomy of Credit Booms: Evidence from Macro Aggregates and Micro Data,? NBER Working Paper No. 14049, May 2008. 31. NBER Working Paper No. 14034, May 2008. 32.?A Pragmatic Approach to Capital Account Liberalization,? NBER Working Paper No. 14051, June 2008?? 33. ?How big are the Gains from International Financial Integration?? NBER Working Paper No. 14636, January 2009. Also F.S. Mishkin, NBER Working Paper No. 13948, April 2008. 34. For example, P.B.Henry and D.Sasson, ?Capital Account Liberalization, Real Wages, and Productivity,? NBER Working Paper No. 13880, March 2008. 35. NBER Working Paper No.14887, April 2009. 36. ?International Financial Remoteness and Macroeconomic Volatility,? NBER Working Paper No. 14336, September 2008. 37. For example, M.B. Devereux, G. W. Smith, and J. Yetman ?Consumption and Real Exchange Rates in Professional Forecasts,? NBER Working Paper No. 14795, March 2009. 38. ?Does Openness to International Financial Flows Raise Productivity Growth?? NBER Working Paper No. 14558, December 2008 39. ?International Finance and Growth in Developing Countries: What Have We Learned,? NBER Working Paper No. 14691, February 2009. 40. ?Sequencing of Reforms Financial Globalization, and Macroeconomic Vulnerability,? NBER Working Paper No. 14384, October 2008. 41. ?Threshold Conditions in the Process of International Financial Integration,? NBER Working Paper No. 14916, April 2009. 42. ?Assessing the Emerging Global Financial Architecture: Measuring the Trilemma?s Configurations over Time,? NBER Working Paper No. 14533, December 2008. Also G. Bekaert, C.R. Harvey, and C. Lundblad, ?Financial Openness and Productivity,? NBER Working Paper No. 14843, April 2009. 43. For example, A. Chari, W. Chen, and K.M.E.Dominguez examine the recent upsurge in acquisitions of U.S. firms, by companies located in emerging markets in ?Foreign Ownership and Firm Performance: Emerging-Market Acquisitions in the United States, NBER Working Paper No. 14786, March 2009. 44. ?When Is Quality of Financial System a Source of Comparative Advantage?? NBER Working Paper No. 13984, May 2008. 45. ?Why Do Foreigners Invest in the United States?? NBER Working Paper No. 13908, April 2008. 46. "An Equilibrium Model of ?Global Imbalances? and Low Interest Rates," NBER Working Papers 11996, 2006; American Economic Review, 98(1), pp. 358-93, March 2008: ?Intermediation rents?pay for the trade deficits.? 47. ?Financial Integration, Financial Deepness and Global Imbalances,? NBER Working Paper No. 12909, February 2007; and "On the Welfare Implications of Financial Globalization without Financial Development," NBER Working Paper No. 13412, September 2007.

226 48. P. Lane and G. M. Feretti, ?A Global Perspective on External Positions,? NBER Working Paper No. 11589, September 2005, in G7 Current Account Imbalances: Sustainability and Adjustment, R.H.Clarida ed., University of Chicago Press, 2007, pp. 67-10; and M.B. Devereux and A. Sutherland, ?Valuation Effects and the Dynamics of Net External Assets,? NBER Working Paper No. 14794, March 2009. 49. P. Gourinchas and H. Rey, "From World Banker to World Venture Capitalist: U.S. External Adjustment and the Exorbitant Privilege,? in G7 Current Account Imbalances: Sustainability and Adjustment, pp. 11-66. 50. M. Canzoneri, R.E. Cumby, B. Diba, and D. Lopez-Salido, ?The Macroeconomic Implications of a Key Currency,? NBER Working Paper No. 14242, August 2008. 51. ?Current Account Sustainability and Relative Reliability,? NBER Working Paper No. 14295, September 2008. In NBER International Seminar on Macroeconomics 2008, University of Chicago Press. 52. ?The Unsustainable US Current Account Position Revisited,? NBER Working Paper No. 10869, November 2004. 53. ?Resolving the Global Imbalance: The Dollar and the U.S. Saving Rate,? NBER Working Paper No. 13952, April 2008. Feldstein identified the root problem as low U.S. saving rates, associated with the housing boom and mortgage refinancing with equity withdrawal. 54. M.D. Chinn and J.A. Frankel, ?The Euro May Over the Next 15 Years Surpass the Dollar as Leading International Currency,? NBER Working Paper No. 13909, April 2008? much as pound sterling had to cede its premier currency status to the dollar after World War I: B. Eichengreen and M. Flandreau , ?The Rise and Fall of the Dollar, or When Did the Dollar Replace Sterling as the Leading International Currency?? No. 14154, July 2008. 55. Financial Crash, Commodity Prices and Global Imbalances,? NBER Working Paper No. 14521, December 2008. 56. ?Global Imbalances and Financial Fragility,? NBER Working Paper No. 14688, January 2009. 57. ?Bretton Woods II Still Defines the International Monetary System,? NBER Working Paper No. 14731 February 2009. 58. Yin-Wong Cheung, Menzie Chinn, and Eiji Fujii evaluate the claim, made by American politicians, that the Chinese yuan is undervalued in ?Pitfalls in Measuring Exchange Rate Misalignment: The Yuan and Other Currencies,? NBER Working Paper No. 14168, July 2008. Also see, ?China?s Current Account and Exchange Rate,? NBER Working Paper No. 14673, January 2009, to be published in China?s Growing Role in World Trade, R.C. Feenstra and S.J-.Wei, editors. I test whether/how China has altered its dollar peg over the last four years in ?New Estimation of China's Exchange Rate Regime,? NBER Working Paper No. 14700, February 2009, forthcoming in Pacific Economic Review, 2009. 59. H. Choi, N. Mark, and D. Sul, ?Endogenous Discounting, the World Saving Glut and the U.S. Current Account,? NBER Working Paper No. 13571, and Journal of International Economics, vol. 75(1), May 2008. 60. Marcos Chamon and Eswar Prasad analyze the high Chinese saving rates in ?Why are Saving Rates of Urban Households in China Rising?? NBER Working Paper No. 14546, December 2008. 61. Joshua Aizenman and Yothin Jinjarak project a large drop in China? s current account surplus over the next six years in ?The US as the ?Demander of Last Resort? and its Implications on China's Current Account,? NBER Working Paper No. 14453, October 2008. http://www.nber.org/reporter/2009number2/index.html

227 The Supply Side of Housing Markets NBER Reporter: Research Summary

2009 Number 2

The Supply Side of Housing Markets Joseph Gyourko*

For a long time there has been an imbalance in what we know about housing markets ? we understand much more about housing demand than housing supply. This has been driven in part by policy interests, although data availability also has played a role. Fortunately, this knowledge gap has begun to narrow in recent years, allowing for a much better understanding of housing markets in general. Given the importance of housing in the economy, and the recent dramatic swings in home prices, better insights into the residential market are very helpful, both to policymakers and to households. Economists understand that supply, not just demand, is critical to understanding housing markets. High prices always reflect the intersection of strong demand and limited supply. If demand in a market is weak, then prices cannot be high, no matter what the supply. And, if supply is unrestricted, then prices cannot be much higher than production costs, no matter what the demand. In practice, the strong negative correlation between housing permits and the level of house prices across markets makes clear that supply-side conditions matter. 1 The highest price markets tend to have the least permitting. If demand alone differed across markets, then we would expect to see abundant new construction in the costly markets. We do not, and the most intense new construction occurs in lower priced markets, indicating that supply conditions vary across markets. In particular, supply appears to be restricted in many high price metropolitan areas.2 Prices have escalated relative to production costs in various markets over time, with the temporal and spatial patterns roughly as follows: In 1970, there was no metropolitan area (including New York City and San Francisco) in the United States in which average house prices exceeded fundamental production costs by more than 20 percent. Fundamental production costs are defined as the sum of the physical costs of construction for a basic, modest quality home, plus a 20 percent land share, plus a 17 percent gross profit margin on structure and land costs for the builder (which is typical over the cycle). By the 1980 census, mean house prices had become much higher than production costs in the major metropolitan areas along the coast of California. A similar phenomenon occurred during the 1980s in many east coast markets running from Washington, D.C. to Boston. The 1990s saw the expansion of this pattern to a very few interior markets, such as Austin and Denver. Even so, average house prices are still quite close to fundamental production costs in most metropolitan areas. Local Regulation and the ?Zoning Tax? Local building regulations and zoning codes could explain at least part of this pattern. Essentially, local regulation acts as a ?zoning tax? -- raising the price of housing above

228 what it would be in the absence of supply restrictions. 3 The research approach to gauging the size of the zoning tax has been to estimate the marginal cost of producing a home and then compare that cost with the actual market value of the house. More specifically, standard neoclassical economics indicates that the price that households are willing to pay for an extra square foot of lot size (the intensive margin) should equal the price of land underlying existing homes (the extensive margin). If this were not the case, and homeowners did not value the land on their plots very much, then they could subdivide and sell off part of their plot to someone else. Our calculations suggest that effective zoning tax rates are quite high in many coastal markets, sometimes reaching over 50 percent, because actual market prices far exceed the hedonic estimates of the value of an extra square foot of land.4 However, the same analysis indicates that in most markets the zoning tax is minimal, which is consistent with elastic housing supplies in many interior markets. If new supply is forthcoming in sufficient magnitude to readily satisfy new demand, then local regulation does not really bind, and prices cannot be influenced much by whatever rules are on the books. While the qualitative nature of those results probably accords with the priors of most economists, it turns out to be very difficult to precisely measure the impact of local regulation on prices. For one thing, the increasing complexity of the local regulatory environment makes accurate measurement difficult. Another key constraint is that accurate comparison requires knowledge of land prices. More specifically, one needs to be able to compare the ?free market? price of land with existing values. The problem is that there are virtually no observed trades of residential land parcels. 5 There are various estimation strategies to deal with this latter issue, but another option is to study a market in which no additional land is required to produce an extra housing unit. Edward Glaeser, Raven Saks, and I did just that in our analysis of the condominium market in Manhattan. 6 For single family homes, new production necessarily includes costs associated with acquiring and preparing the land on which the marginal home sits. In the case of multifamily structures, land and other site preparation costs often do not increase much, if at all, with small increases in the size of the building. The marginal cost of building up is accurately measured by the physical construction costs of an extra floor, because no new land is needed to add another floor of condominium units. In our study of the Manhattan market, Glaeser, Saks, and I documented very large gaps between the market price of condominiums and the marginal cost of producing another floor of such units. Over the roughly two decade period for which we had data (from 1984-2002), unit prices were roughly twice fundamental production costs, indicating a zoning tax rate of about 50 percent for that market. Whether any given regulatory tax can be justified on efficiency grounds is a tough question to answer. In urban economics, a distinguished literature on zoning, which emphasizes the need for land use controls to internalize the social costs of new development, strongly suggests that the optimal tax rate is positive. However, in our analysis of Manhattan, Glaeser, Saks, and I conclude that there is no set of negative externalities (whether aesthetic, congestion, or fiscal related) that could come close to justifying the 50 percent zoning tax in that market. Manhattan is among the easier markets to analyze in this respect because it is not credible (in my opinion, anyway) for its residents to claim that adding a few more housing units will destroy the unique, bucolic nature of the island. That claim might be true in a low-density suburb with a two-acre minimum lot size restriction, where the utility loss to existing residents could

229 be very high. This is not to say that any claim of high costs from new development should be believed at face value -- only that it is difficult in some settings to rigorously apply standard cost-benefit techniques to the problem. Housing Supply and the Nature of Urban Growth More broadly, theory and the data indicate that the supply side of housing markets is mediating both urban growth and decline. Whether housing supply is elastic or inelastic plays a huge role in defining what urban success looks like. 7 If supply is elastic, then strong demand shows up in growing populations amid much home building. This is the story of the rise of the Sunbelt. However, latent demand is strong in many large coastal markets such as Boston, New York, and San Francisco, even though population growth is relatively low, and very few net new housing units are built in these areas. In this version of urban success, growing demand gets reflected in high land prices. This may have important social and economic implications that clearly are worthy of further study by economists. The urban agglomerations along our coasts are thought to be the most productive in the nation. Effectively restricting entry into these areas by not allowing much housing production necessarily pushes growth to other markets that may not be as productive. 8 To the extent that binding local land use controls raise house prices, financial constraints also facilitate more spatial sorting along income lines. This already is evident across communities within metropolitan areas. Chris Mayer, Todd Sinai, and I have suggested that it is occurring across metropolitan areas, with some becoming ?superstars? that can have higher long-run average appreciation rates as long as supply is sufficiently restricted and the nation keeps generating enough rich people with some taste for these superstar markets.9 Restrictive supply also helps define the nature of urban decline. Edward Glaeser and I show that the durable nature of housing, combined with the fact that the supply schedule is inelastic when demand falls below fundamental production costs, largely explains the fact that urban decline is so long and steady in nature. 10 The negative demand shocks experienced by markets such as Detroit lead to very low house prices that help hold people. The durability of housing makes population loss a very slow process. Our work also suggests that cheap housing is relatively more attractive to the poor, which helps to account for the high poverty concentrations in declining markets. Housing Supply and Housing Bubbles Understanding the supply side of housing markets also is helpful in making sense of housing bubbles. According to the model of housing bubbles proposed in a recent paper with Glaeser and Albert Saiz, bubbles are more difficult to start and sustain in less constrained markets with elastic housing supplies. 11 In the major house price run-up of the 1980s, high real price appreciation only occurred in markets with inelastic supply. One of the unique features of the most recent boom is that enormous price growth occurred in elastic markets, such as Phoenix and Las Vegas, which produced increasingly larger amounts of housing during the price run-up. The best indicator of a bubble I know of is a wide and growing gap between house prices and fundamental production costs in a market with elastic supply. The data also show that before the recent bubble, mean prices in these elastically supplied markets almost always were very close to production costs. Hence, we should expect prices to fall to the level of production costs in these particular markets. The state of demand, not supply, will largely determine which happens to prices in the most inelastically supplied markets. Directions for Future Research

230 While much has been learned about housing supply in recent years, much remains to be done. Data collection involving measurement of the local regulatory environment should be at the top of the ?to do? list. Glaeser and a group of Harvard students have amassed a wealth of information on zoning and land use controls over time for much of the Greater Boston area.12 This type of detailed description of the local environment is incredibly time consuming, and will be hard to replicate, but it would be very useful to have similar pictures of other markets. Anita Summers, Albert Saiz, and I took a different path in creating the Wharton Residential Land Use Regulation Index. 13 This involved a national data collection effort. The benefit of our data is that they cover over 2,000 communities across all major metropolitan areas. The cost is that valuable detail on the local environment had to be sacrificed to generate the much larger number of observations. We are re-surveying our communities now, so that research on changes over time soon will be possible. Better estimates of local supply elasticities also are needed. Supply heterogeneity clearly is important, so we need to carefully measure its variation. 14 Next, it is important that research fully integrate heterogeneous supply into a well-specified general equilibrium model of housing market dynamics. There are efforts being made here, but much more remains to be done if we are to truly understand housing market changes, which are dynamic in nature. 15 Finally, we need to understand better why constraints on supply develop in some markets, but not in others. There is interesting work on the political economy of this issue , but again, much remains to be done.

* Gyourko is a Research Associate in the NBER?s Program on Public Economics and the Martin Bucksbaum Professor of Real Estate and Finance at the Wharton School, University of Pennsylvania. His profile appears later in this issue 1. See Figure 2-11 in E. L. Glaeser and J. Gyourko, Rethinking Federal Housing Policy, The AEI Press, Washington, DC (2008). 2. For more detail on the time pattern of house prices relative to production costs see E. L. Glaeser, J. Gyourko, and R. Saks, ?Why Have House Prices Gone Up?? American Economic Review, Vol. 95, No. 2 (May 2005a), pp. 329-33, and ?Why Is Manhattan So Expensive? Regulation and the Rise in House Prices?, Journal of Law & Economics, Vol. 48, No. 2 (October 2005b), pp. 331-70. 3. This was the term that Glaeser and I used in our research, but it should be interpreted as applying to any local land use restriction, not just those related to zoning. See E. L. Glaeser and J. Gyourko, ?The Impact of Zoning on Housing Affordability?, Economic Policy Review, Federal Reserve Bank of New York, Vol. 9, No. 2 (June 2003), pp. 21-39. 4. For a more detailed discussion of how to implement this type of analysis, see E. L. Glaeser and J. Gyourko, ?The Impact of Zoning on Housing Affordability.? 5. For one exception to this, see the data on land values in the New York City market in A. Haughwout, J. Orr, and D. Bedoll, ?The Price of Land in the New York Metropolitan Area,? Current Issues in Economics and Finance, April/May 2008, Federal Reserve Bank of New York. 6. E. L. Glaeser, J. Gyourko, and R. Saks, ?Why Is Manhattan So Expensive?? 7. E. L. Glaeser, J. Gyourko, and R. Saks, ?Urban Growth and Housing Supply,? Journal of Economic Geography, Vol. 6, No. 1 (January 2006), pp. 71-89.

231 8. Glaeser and Tobio (2008) argue that the rise of the Southern Sunbelt markets largely is the result of allowing plentiful, cheap housing, not because of a better amenity set or fundamentally higher productivity. See E. L. Glaeser and K. Tobio, ?The Rise of the Sunbelt,? Southern Economic Journal, Vol. 74, No. 3 (2008), pp. 610-43. 9. J. Gyourko, C. Mayer, and T. Sinai, ?Superstar Cities,? NBER Working Paper No. 12355, revised July 2006. 10. E. L. Glaeser and J. Gyourko, "Urban Decline and Durable Housing," Journal of Political Economy, Vol. 113(2) (2005), pp. 345-75. 11. E. L. Glaeser, J. Gyourko, and A. Saiz, ?Housing Supply and Housing Bubbles?, Journal of Urban Economics, Vol. 64, No. 2 (2008), pp. 693-729. 12. E. L. Glaeser and B. Ward, ?The Causes and Consequences of Land Use Regulation: Evidence from Greater Boston?, Journal of Urban Economics, Vol. 65, No. 3 (2009), pp. 265-78. 13. J. Gyourko, A. Summers, and A. Saiz, ?A New Measure of the Local Regulatory Environment for Housing Markets?, Urban Studies, Vol. 45, No. 3 (2008), pp. 693- 729. 14. E. L. Glaeser and J. Gyourko, ?Housing Dynamics,? NBER Working Paper No. 12787, December 2006, and S. V. Nieuwerburgh and P.-O. Weill, ?Why Has House Price Dispersion Gone Up?? NBER Working Paper No. 12538, September 2006. 15. F. Ortalo-Magne and A. Prat, ?The Political Economy of Housing Supply,? Sticerd Working Paper TE/2007/512, June 2007.

232

TRIBUNA: ECONOMÍA GLOBAL - coyuntura nacional ÁNGEL LABORDA ¿Cambio de rumbo en la política fiscal? ÁNGEL LABORDA 21/06/2009 Siguiendo el calendario marcado en el proceso de elaboración de los presupuestos públicos en España, el Consejo de Ministros del pasado día 12 dio el pistoletazo de salida para los presupuestos de 2010. En dicho Consejo se aprobó la cifra de gasto total del Estado, que luego habrá de distribuirse por capítulos, secciones o programas en el proyecto que el Gobierno presentará a finales de septiembre a las Cortes. También se aprobó el documento de situación cíclica de la economía, que contempla unas proyecciones de los principales agregados macroeconómicos hasta 2012 y que sirve de base para marcar los objetivos de déficit de los diversos niveles de administraciones públicas. Aunque este escenario económico tenga por finalidad guiar la orientación de la política fiscal, en realidad su interés desborda este objetivo, pues el Gobierno presenta a los agentes económicos sus previsiones de comportamiento de la economía española a medio plazo, lo cual es una información esencial en estos momentos. En los gráficos adjuntos se muestran algunas de estas previsiones y se comparan con las de los dos últimos Programas de Estabilidad enviados a Bruselas en diciembre de 2007 y enero de 2009. Como hemos tenido que hacer todos los analistas desde que comenzó esta crisis, el Gobierno vuelve a revisar a la baja el crecimiento del PIB respecto a las cifras presentadas en enero. Ahora se espera una caída del 3,6% para este año y del 0,3% para 2010. No será hasta 2012 cuando la economía española se acerque a esa tasa del 3% que se considera su velocidad de crucero de largo plazo. Aunque para muchos todavía estas previsiones puedan ser algo optimistas, este nuevo cuadro es un ejercicio de realismo respecto a ese discurso de que la crisis pasaría enseguida y que ya en 2010 la economía crecería a tasas cercanas al 3%. No parecen, sin embargo, muy realistas las previsiones de la tasa de paro, pues para que en 2010 no supere el 19% de la población activa y disminuya en los dos años siguientes sería necesario, entre otros factores, que se reduzca la población activa, y esto, a su vez, requeriría un flujo inmigratorio neto negativo. También resulta algo sorprendente la previsión de aumento del deflactor (precios) del PIB, cercana a cero en 2009, 2010 y 2011, y ligeramente superior al 1% en 2012. Probablemente el Gobierno quiere indicar que va siendo hora de dar la vuelta al proceso de pérdida de competitividad que hemos vivido desde que nos integramos en el euro. Pero si esto es así, el Gobierno debería decir a los trabajadores que sus salarios no deberían subir más de un 1% por año; a los empresarios, que sus márgenes unitarios deben estancarse, y a sí mismo, que sus ingresos pueden seguir cayendo en 2010 y crecer muy poco en los dos años siguientes. En este escenario, el Gobierno se plantea como objetivo reducir el déficit del conjunto de las administraciones públicas desde el 9,5% del PIB que estima para este año hasta el 8,4% en 2010, el 5,2% en 2011 y el 3% en 2012. Y para empezar desde ya y demostrar que va en serio, el Consejo de Ministros aprobó un aumento de los impuestos sobre el tabaco y los hidrocarburos (2.300 millones al año) y reducir el presupuesto de gastos del

233 Estado para 2010 un 4,5%. Veremos si esta reducción es real o un simple apaño contable, pero de momento quiero interpretarlo como un cambio de rumbo en la política fiscal respecto a ese discurso que también oíamos hasta ahora de que no importa el déficit, sino salir de la recesión. Claro que importa el déficit, pues se ha escapado de las manos y empieza a originar un tumor de muy mala pinta que puede causar problemas serios a nuestra economía a medio plazo. Ambas medidas me parecen correctas, aunque bastante insuficientes para lograr reducir el déficit al 8,4% del PIB el próximo año. A medio plazo, el objetivo de llevar el déficit al 3% en 2012 es poco realista. Una proyección moderada del gasto público hasta 2012 en el escenario macro que prevé el Gobierno (bajo el supuesto de que no se toman medidas contundentes de recorte), lleva a que éste aumente dos o tres puntos porcentuales (pp) del PIB. Si el déficit debe reducirse 6,5 pp del PIB, ello implica que los impuestos deberían aumentar unos 9 pp. Es para ponerse a temblar. No creo que se llegue a tanto, pero subidas de impuestos, las habrá.

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TRIBUNA: ECONOMÍA GLOBAL RAFAEL DOMÉNECH ¿Un problema potencial? RAFAEL DOMÉNECH 21/06/2009 Una vez acabada la caída libre en la que se encontraban las economías occidentales a finales de 2008 y principios de 2009, ahora el interés se está desplazando a la duración de los efectos de la crisis, sobre la que caben dos escenarios posibles. El primero de ellos es que la crisis no afecta al crecimiento potencial de nuestras economías, por lo que todos sus efectos serían transitorios o cíclicos. De acuerdo con este escenario, la crisis daría lugar a un output gap (la diferencia porcentual entre PIB y su nivel tendencial) negativo muy grande, por lo que el riesgo de deflación a corto plazo podría ser relevante. El segundo escenario posible es que el crecimiento potencial se va a resentir significativamente durante un buen número de años, de manera que la crisis tendría efectos bastante duraderos. Puesto que el nivel tendencial del PIB crecería a una tasa menor, el output gap seguiría siendo negativo, pero mucho menor que en el primer escenario, por lo que el riesgo de deflación también sería más reducido. ¿Cuál de estos dos escenarios es el más verosímil? Una forma bastante rigurosa y didáctica de contestar a esta pregunta es teniendo en cuenta la relación tecnológica entre el PIB y sus factores productivos. De forma muy simplificada, la tasa de crecimiento del PIB depende del crecimiento del capital físico y del trabajo, y del crecimiento de la productividad total de estos dos factores. Aunque el crecimiento potencial de la productividad total de los factores puede incluso aumentar (con las crisis suelen desaparecer las empresas y empleos más ineficientes), seguramente no compensará la caída de la relación capital/producto (como consecuencia del proceso de desapalancamiento de muchas empresas), ni tampoco el aumento del desempleo estructural (como consecuencia de que los reajustes sectoriales en el empleo pueden llevar bastantes años). Por tanto, el escenario más probable es que el crecimiento potencial de la mayoría de las economías occidentales se resienta durante varios años. Sin embargo, dada la magnitud de la crisis, esta disminución del crecimiento potencial no será de la cuantía suficiente como para impedir que el output gap sobrepase el mínimo de las últimas décadas. A pesar de la disminución del crecimiento potencial, en la mayor parte de economías, no es previsible que el PIB crezca por encima de esta tasa hasta final de 2010 o principios de 2011, momento en el que el output gap alcanzará su nivel mínimo, y la tasa de desempleo, su máximo. Que éste sea el escenario previsible no significa que tenga que ser inexorable. De hecho, habría que hacer lo posible para que no se cumplieran estas previsiones. Y para ello, la mejor estrategia es llevar a cabo políticas económicas adecuadas y, con el deseable respaldo de la mayor parte de los agentes sociales, sacar adelante cuanto antes las reformas estructurales necesarias para aumentar el crecimiento y reducir el desempleo. La disminución del crecimiento potencial no impedirá que el output gap alcance el mínimo de las últimas décadas.

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TRIBUNA: ECONOMÍA GLOBAL KENNETH ROGOFF Hay que reequilibrar las relaciones EU-China KENNETH ROGOFF 21/06/2009 A medida que la economía mundial se estabiliza, existe el riesgo creciente de que EE UU y China regresen a los patrones económicos previos a la crisis, lo que supondría un riesgo para ellos y para el resto del mundo. A pesar de la retórica de los funcionarios chinos sobre la necesidad de una nueva moneda mundial que reemplace al dólar y los coqueteos de los legisladores estadounidenses con las cláusulas Buy American (que atemorizan a todos, no sólo a los chinos), nadie querrá hacer olas en un barco que está por naufragar. Así pues, China sigue teniendo un superávit comercial gigantesco y EE UU sigue gastando y pidiendo préstamos. No hay duda de que la estabilidad a corto plazo parece muy atractiva en estos momentos. No obstante, si las relaciones comerciales y de deuda entre China y EE UU simplemente se reanudan a partir de donde se quedaron, ¿qué evitará que vuelva a darse la misma dinámica insostenible que acabamos de presenciar? Después de todo, los enormes préstamos solicitados por EE UU en el extranjero fueron claramente un factor clave que contribuyó a crear el reciente caos financiero, mientras que la excesiva dependencia de China del crecimiento impulsado por las exportaciones la ha hecho muy vulnerable a una caída brusca de la demanda global. Los gigantescos estímulos fiscales en ambos países han servido para evitar temporalmente más daños, pero ¿dónde están los cambios que se necesitan? En estos momentos ¿no sería mejor aceptar más ajustes mediante un crecimiento poscrisis más lento que tendernos una trampa que nos llevaría a una crisis mayor? Es cierto que tanto la Administración estadounidense como el liderazgo chino han hecho algunas propuestas inteligentes de cambio. Pero ¿son sinceras sus intenciones? El secretario del Tesoro estadounidense, Timothy Geithner, ha sugerido un replanteamiento profundo del sistema financiero, y los líderes chinos están empezando a tomar medidas para mejorar la red de seguridad social del país. Estas medidas deberían contribuir en gran medida a que las balanzas comerciales de EE UU y China se sitúen en niveles más sostenibles. Una mayor reglamentación financiera en EE UU significa que los consumidores no podrán pedir préstamos con tanta facilidad y endeudarse excesivamente con hipotecas y tarjetas de crédito. Por otra parte, los consumidores chinos podrían empezar a gastas más de sus ingresos si pudieran preocuparse un poco menos por tener que ahorrar para la atención de la salud, la educación de sus hijos y sus jubilaciones. No obstante, hay razones para preocuparse. Ahora que el mundo parece estar saliendo de su horrible crisis financiera, es parte de la naturaleza humana caer en la complacencia, y la política interna sobre las relaciones comerciales y financieras EE UU-China está muy arraigada. Da miedo pensar en las lecciones que el sector financiero estadounidense extraerá si tras el rescate multibillonario sólo hay reformas superficiales e ineficaces. Y ¿prevalecerán acaso los intereses exportadores de la costa china en las decisiones de política de tipos de cambio a expensas de los consumidores pobres del interior del país?

236 Otro motivo de inquietud es que la recuperación global todavía es frágil. Los líderes estadounidenses y chinos han combatido la crisis no sólo con estímulos fiscales enormes, sino también con una profunda intervención en los mercados crediticios. Esa extraordinaria generosidad fiscal, a costa de los contribuyentes, no puede continuar indefinidamente. El presidente del Banco Mundial, Robert Zoellick, ha advertido, con razón, que este enorme estímulo fiscal temporal es una "inyección de azúcar" que a final de cuentas pasará sin que haya reformas profundas. Como he sostenido anteriormente, el resultado final de los rescates financieros y la expansión fiscal será casi seguramente un aumento de los intereses y de los impuestos y, muy posiblemente, inflación. Para bien o para mal, quizá no sea posible retroceder en el tiempo. Parece que finalmente los consumidores estadounidenses, cuya glotonería contribuyó a alimentar el crecimiento en todo el mundo durante más de una década, se pondrán a dieta. Además de las condiciones más estrictas para los préstamos, la caída de los precios de las casas y las tasas elevadas de desempleo seguirán limitando el gasto de los consumidores estadounidenses. Francamente, unas tasas más altas de ahorro personal en EE UU no serían algo malo. Seguramente ayudarían a reducir el riesgo de que se repitiera pronto la crisis financiera. Los candidatos obvios para sustituirlos serían los consumidores de China y otros países asiáticos, cuyas economías combinadas son más que iguales a la de EE UU. Pero ¿están dispuestos los Gobiernos asiáticos a abandonar su paradigma mercantilista? Fuera de Japón, los encargados del diseño de políticas en Asia ciertamente no parecen estar dispuestos a apreciar el tipo de cambio. Desde el principio de esta década, al menos unos cuantos economistas (entre ellos, yo) habían advertido que era necesario controlar los desequilibrios comerciales y de cuenta corriente a nivel mundial para reducir la posibilidad de una crisis financiera grave. EE UU y China no son los únicos responsables de esos desequilibrios, pero su relación ciertamente está en el centro de ellos. Antes de la crisis hubo mucha palabrería, incluyendo reuniones de alto nivel organizadas por el Fondo Monetario Internacional, pero muy poca acción. Ahora, los riesgos se han desbordado a todo el mundo. Esperemos que esta vez haya más que palabras. Si, por el contrario, los encargados de las políticas en EE UU y China ceden a la tentación de volver a los desequilibrios anteriores a la crisis, las raíces de la próxima crecerán como el bambú. Y ésas no serían buenas noticias para EE UU, para China ni para nadie más. http://www.elpais.com/articulo/economia/Hay/reequilibrar/relaciones/EU- China/elpepueconeg/20090621elpnegeco_2/Tes

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REPORTAJE: ECONOMÍA GLOBAL Asalto al reinado del dólar Cada vez más voces piden una nueva moneda mundial de reserva

SANDRO POZZI 21/06/2009 Estrenándose al frente del Departamento del Tesoro, a principios de año, Timothy Geithner hizo un comentario durante una conferencia en Nueva York que costó un serio disgusto al dólar. Su novatada fue decir que estaba abierto a la idea del gobernador del Banco de China, Zhou Xiaochuan, de avanzar hacia una nueva moneda "supersoberana" similar a la cesta de divisas que maneja el Fondo Monetario Internacional (FMI). El desplome de la divisa estadounidense en los mercados fue inmediato. Geithner matizó después sus palabras y, recurriendo al manual del buen secretario del Tesoro, dejó claro que EE UU apuesta por un dólar fuerte. Pero sin quererlo, alimentó un debate que desde hace años cuestiona al billete verde como moneda de referencia y germen de una futura unión monetaria global. Cuando habla Zhou, todos les escuchan, también en Washington. La idea del jefe del banco central chino es simple en el concepto. Llevarla a la práctica será otra cosa. Se trata de crear una divisa desvinculada de una nación que sea estable a largo plazo. El modelo que plantea es similar a los Derechos Especiales de Giro (DEG) manejados por el Fondo Monetario Internacional (FMI), una cesta de divisas importantes que se utiliza como referencia en el comercio y las finanzas internacionales. La iniciativa cuenta con adeptos, como Rusia, que considera que en la nueva realidad económica hace aún más necesario que existan más monedas de reserva. Las masivas inyecciones de dinero público efectuadas por EE UU para sostener su economía añaden más leña al fuego. China es el principal acreedor de Washington, con cerca de un billón de dólares de deuda estadounidense. Y al igual que Japón y Rusia, está reduciendo el volumen de bonos estadounidenses para, en su lugar, hacerse con deuda emitida por el FMI. Una moneda de reserva, por definición, es la divisa aceptada en todo el mundo para el comercio internacional. Ésa es la visión convencional, por la que sólo podría haber una moneda dominante. Antes de la Segunda Guerra Mundial fue la libra británica. Y desde entonces, el dólar. Pero Jeffrey Frankel, de la Universidad de Harvard, y Menzie Chinn, de la Universidad de Wisconsin, creen que el euro podría llegar a ser un claro contendiente del dólar en 2015. Lo que está por ver es que la divisa única europea pueda ser la moneda dominante. Morgan Stanley explica que reemplazar al dólar es sumamente complejo. Se necesitaría antes que nada que el país o la región de origen de la nueva moneda superase económicamente a EE UU. Atendiendo a ese requisito, el euro podría ser el más claro rival. A no ser que China forjara con otros países asiáticos una unión económica y monetaria mayor que EE UU. Una de las razones por las que el dólar es la divisa líder es porque se apoya aún de alguna manera en las enormes reservas de oro de EE UU. Y la liquidez también es clave para lograr ese status, lo que hace difícil pensar que los DEG puedan funcionar, como señalan

238 los analistas de Alpha Bank. Por eso la alternativa que plantea Barry Eichengreen, de la Universidad de Berkeley, es que ese dominio sea compartido. Los economistas discuten desde hace décadas sobre la debilidad de un sistema basado en una sola moneda de reserva. El modelo actual, dice el economista Joseph Stiglitz, es "insostenible". Y reemplazarlo por uno dominado por el dólar y el euro, o por el dólar, el euro y el yen será aún peor, según el premio Nobel. Por eso, el comité especial que él preside en Naciones Unidas propone implantar una nueva versión de la cesta que maneja el FMI. Si la historia es un referente para anticipar lo que está por venir, la libra dejó de ser la moneda de referencia cuando Reino Unido pasó de ser un país acreedor a deudor. EE UU está hoy en una situación similar. Su adicción al petróleo importado, sumado al colosal déficit público (9% del PIB de media entre 2009 y 2011) y a su abultada deuda (75% del PIB para 2010) son problemas muy serios para justificar la supremacía de su divisa. Nouriel Roubini, profesor de la Universidad de Nueva York, advierte de que antes de lo que se piensa, el billete verde se verá retado por otras divisas. Su apuesta: una cesta de divisas asiática basada en el renminbi chino. Roubini dice que el Siglo XXI será el de China o Asia, aunque reconoce que el dólar no perderá de un día para otro su soberanía y que estos países que alzan ahora la voz no tendrán otra opción que seguir acumulando dólares durante algún tiempo. Que el dólar sea la principal moneda de reserva ayuda a proteger a Washington de pagar más por el dinero que toma prestado. Pero hay una dificultad. Cada vez hay más países que no quieren acumular activos en dólares. "Con el paso del tiempo se reducirá la complacencia de los acreedores de EE UU por financiar y comprar reservas", anticipa Roubini. Los expertos en divisas de HSBC creen, precisamente, que todo este debate se apoya en gran parte en la preocupación de China y de otros países sobre "el potencial riesgo inflacionista de que la Reserva Federal esté imprimiendo dinero". La pregunta que surge, por tanto, es si EE UU será capaz de prevenir que su moneda pierda el status de divisa de reserva después de seis décadas. "Debería cometer un error colosal para renunciar al liderazgo del dólar", según Morgan Stanley. Pero lo cierto es que Washington no se cierra en banda a la idea de usar más la cesta de divisas creada por el FMI, que es utilizada desde hace cuatro décadas exclusivamente por los gobiernos miembros del organismo y por otras instituciones internacionales. Stiglitz admite que los DEG no están exentos de problemas y que se necesitan nuevas reglas para que puedan funcionar. Aún así, cree posible que el nuevo sistema pudiera funcionar en el plazo de un año. No todos lo ven tan simple. "Éste es el inicio de un diálogo", señalan desde Global Investors. Y recuerdan que si países como China, Brasil o India quieren seguir exportando a EE UU no tendrán más remedio que tener dólares en sus reservas. "Lo que sí veremos es menos énfasis en el billete verde, con los bancos centrales alrededor del mundo sumando más euros, yenes y yuanes a sus activos en dólares", remachan los expertos de Riedel Research. Por todo esto, desde Jina Ventures dicen que no hay motivos para preocuparse por el liderazgo del dólar. Pero eso no quita, subrayan, que EE UU deba actuar de manera fiscalmente responsable para dar la sensación de que cuida su moneda.

239 El BRIC avisa Brasil, Rusia, India y China, las grandes economías emergentes agrupadas en el grupo BRIC, no quieren poner todos los huevos en una misma cesta. Representan el 15% del PIB mundial y manejan el 42% de las reservas mundiales en dólares. Por eso, esta semana, reunidos en Ekaterimburgo (Rusia) hablaron de cómo evitar el dólar en sus transacciones utilizando en su lugar sus respectivas monedas, en lo que podría ser el primer paso en un cambio de la arquitectura del sistema de reservas. Los analistas de Seygem Asset Managemet creen que estos países "necesitan una estrategia para diversificar" sus reservas "de una forma ordenada". "Está bien que hablen, porque tienen mucho en común", apuntan desde Riedel Research. Pero el presidente ruso, Dmitri Medvédev, mira más lejos. Opina que la creación de un sistema de pagos supranacional reforzará al conjunto del sistema. El Kremlin, al igual que el Gobierno chino, insiste en que quiere afrontar el debate con cautela, sin causar trastornos. "Nadie quiere arruinar el dólar", remachó Arkady Dvorkovich, asesor económico del presidente. Ambos Gobiernos son conscientes de que su retórica puede acabar minando sus inversiones. Y como dijo Alexei Kudrin, responsable de finanzas ruso, para llevarlo a la práctica se requiere una mayor integración de las políticas económicas. Para los expertos de Foreign Exchange Analytics, es evidente que el grupo BRIC desea desempeñar un papel más relevante en la escena global y que quiere aprovechar la crisis financiera para elevar su influencia. Pero advierten de que otra cosa muy distinta es que exista una cohesión para ofrecer una alternativa viable que les permita romper vínculos con el dólar. - http://www.elpais.com/articulo/economia/Asalto/reinado/dolar/elpepueconeg/20090621el pnegeco_1/Tes

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TRIBUNA: Laboratorio de ideas JAVIER SANTISO España, cantera de talento Por JAVIER SANTISO

JAVIER SANTISO 21/06/2009 España está en recesión. La fiesta se acabó, y con el apagón económico abunda ahora el pesimismo. Reconstruir una estrategia de crecimiento y de inserción internacional requerirá movilizar los talentos del país. Y éstos abundan, tanto fuera como dentro de España. En el exterior hay muchos empresarios y altos funcionarios españoles reconocidos por su profesionalismo. En el ámbito de los organismos y foros internacionales, si bien España consiguió in extremis entrar en el G-20, varios españoles están hoy día en puestos clave para el rediseño de las finanzas internacionales. Uno de ellos es José Viñals, ex subgobernador del Banco de España, nombrado en abril pasado consejero financiero y director de Asuntos Monetarios y Mercados de Capitales del Fondo Monetario Internacional (FMI). Este doctor en Economía por la universidad de Harvard, que también se desempeñó como profesor en la igual de prestigiosa universidad de Stanford, se convierte así en uno de los máximos directivos del organismo con sede en Washington. Su antecesor en el puesto es otro español, Jaime Caruana, ex gobernador del Banco de España, nombrado director general del Banco de Pagos Internacionales (BIS, por su sigla en inglés), ubicado en Basilea, el otro gran organismo que estará a cargo de la resolución de la crisis financiera y bancaria actual. Con ambas promociones se destaca, además de la valía profesional de ambos economistas, el papel central desempeñado por el Banco de España, una institución que ha cobrado prestigio internacional en las pasadas décadas. El talento español desborda, sin embargo, ampliamente la esfera de los organismos internacionales. Los arquitectos o chefs ibéricos deslumbran el mundo entero. El reciente nombramiento como secretario de Estado de Economía de Juan Manuel Campa, profesor de la prestigiosa escuela de negocios IESE, doctor por Harvard y con una amplia trayectoria en EE UU, es una muestra de otra cantera importante: la de economistas españoles que se hicieron un hueco en las universidades más influyentes de EE UU o Europa. En muchas multinacionales abundan los ejecutivos ibéricos. Así, por ejemplo, Christian Morales se desempeña hoy como máximo responsable para Europa, África del Norte y Oriente Próximo del fabricante estadounidense de chips Intel. Otro español, Adolfo Hernández, antes al mando de Sun Mycrosystems en España, se hizo cargo a finales de 2008 del mando de la empresa em la misma región, -Europa, Oriente Próximo y África- de la compañía francoamericana Alcatel-Lucent, con sede en París. En la cúpula dirigente de la tabacalera anglosajona Imperial Tobacco, que absorbió la hispano-francesa Altadis, figura Fernando Domínguez. En Facebook, Javier Oliván, becario de la Fundación Rafael del Pino (jamás alabaremos suficientemente la extraordinaria labor desempeñada por las fundaciones privadas españolas), apenas salido de Stanford fue nombrado responsable de la internacionalización de este gigante de Silicon Valley.

241 En Francia también, la ex ministra de Asunto Exteriores Ana Palacio preside desde finales de 2008 el área internacional del Areva, líder nuclear mundial. Otra mujer, Mercedes Erra, de origen catalán, copreside la multinacional de publicidad Euro RSCG Worlwide, grupo propietario de Havas, agencia que tiene como director general a otro español, Fernando Rodés Vilà. Los grupos publicitarios parecen sentar bien a los ejecutivos españoles: el presidente del Grupo Bassat Ogilvy, Enric Pujadas, formado en la escuela de negocios ESADE, ha sido nombrado miembro del Comité Ejecutivo de Ogilvy Europa, África y Oriente Próximo. Luis Cantarell preside todas las actividades del continente americano de la multinacional suiza Nestlé. Es llamativo que esta empresa, verdadera cantera de consejeros delegados y presidentes (los actuales máximos directivos de Unilever y Carrefour proceden de Nestlé), tiene nada menos que otros dos españoles en su Consejo, José López y Francisco Castañer. En el sector de la distribución, la francesa Carrefour nombró a finales de marzo a un español, Ricardo Currás, miembro de su dirección general, sustituyendo a otro español, Javier Campo. Por su parte, Belén Garijo también se incorporó a la dirección general de otra multinacional francesa, el gigante farmacéutico Sanofi Aventis, como máxima responsable de sus operaciones europeas y canadienses. En la cementera suiza Holcim, Javier de Benito preside las actividades para África del Norte y el Océano Índico. En su competidora francesa, Lafarge, Isidoro Miranda preside las actividades cementeras del grupo y es miembro de su comité de dirección. En la también francesa Alstom, Pedro Solé cubre toda Asia emergente, después de haber impulsado las actividades latinoamericanas de este líder mundial. Por su parte, Julio Rodríguez preside desde 2007 las actividades para Europa de otro gigante francés, Schneider Electric. El catalán Jordi Constans entró, con apenas 42 años, en la cúpula directiva de Danone en 2008, algo que también ha hecho otro español, Félix Martín García, formado en Madrid. Algunos altos directivos españoles también consiguieron alzarse a puestos de relevancia global en sus respectivas empresas a partir de las bases españolas, fundamentalmente Madrid y Barcelona. Así, Antonio Oporto se desempeña como vicepresidente regional para España, Portugal e Iberoamérica de toda el área de transporte de Alstom. En la británica British Telecom, otro español, con base en Madrid, José Luis Álvarez, es responsable de todos los mercados emergentes. En la multinacional Arcelor Mittal, Gonzalo Urquijo, desde su base madrileña, forma parte del selecto comité de dirección de este líder mundial del acero. Desde Barcelona, Jesús Acebillo preside todas las actividades relativas a los emergentes de la multinacional suiza Novartis. Por su parte, la multinacional estadounidense Hewlett-Packard ha nombrado este año al español Santiago Cortés, que fue responsable de la filial ibérica, director general para Oriente Medio, Mediterráneo y África. También desde Madrid, Vicente Moreno, presidente de Accenture, gestiona para la multinacional todas las oficinas ubicadas en África. Los ejemplos podrían seguir multiplicándose. No es casual que España tenga un récord de tres escuelas de negocios entre las primeras mundiales, con IESE, ESADE y el Instituto de Empresa. El reconocimiento del talento español tanto en organismos internacionales como en empresas globales también tiene su equivalente en España. La emergencia de multinacionales españolas como Telefónica o Inditex corrobora ese saber hacer. Los pesimistas dirán que éstas son excepciones, que la base industrial española es demasiado estrecha, que España se encerró en el callejón del bajo coste y del ladrillo. La crisis actual apunta al final de un ciclo. En general, las crisis son momentos que provocan parálisis. Pero también pueden ser momentos únicos para dar un nuevo impulso.

242 Las industrias renovables y las biotecnologías -por no hablar de las infraestructuras y la agroalimentación, donde las necesidades mundiales son y serán colosales- son áreas que muestran senderos posibles por donde avanzar. Lo que está claro es que España posee un as, y es su talento y capital humano, tanto dentro como fuera del país. Esperemos que el país sepa movilizar esta cantera y seguir capitalizando el impulso que dio, en apenas dos décadas, una oscura península perdida más allá de los Pirineos, en el extremo sur de Europa, para convertirse en una potencia económica y empresarial http://www.elpais.com/articulo/semana/Espana/cantera/talento/elpepueconeg/20090621el pneglse_9/Tes?print=1

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TRIBUNA: Laboratorio de ideas JOSEPH E. STIGLITZ El socialismo para ricos de Estados Unidos JOSEPH E. STIGLITZ 21/06/2009 Con todo lo que se está hablando sobre los brotes verdes de la recuperación económica, los bancos de Estados Unidos tratan de repeler los intentos de someterlos a regulación. Aunque los políticos hablen de comprometerse a llevar a cabo una reforma regulatoria para evitar que se repita la crisis, éste es un asunto en el que el diablo realmente se oculta en los detalles, y los bancos harán acopio de toda la fuerza que les quede para asegurarse de que tienen margen de sobra para seguir como antes. El viejo sistema funcionaba bien para los bancos (aunque no para sus accionistas), así que ¿por qué iban a querer un cambio? De hecho, los esfuerzos por sacarlos a flote han invertido tan poco tiempo en pensar en la clase de sistema financiero que queremos para después de la crisis que vamos a terminar con un sistema bancario que es menos competitivo y en el que los grandes bancos que eran demasiado grandes para hundirse serán aún más grandes. Desde hace mucho se es consciente de que esos bancos que son demasiado grandes para hundirse son también demasiado grandes para poder controlarlos. Ése es uno de los motivos por los que el rendimiento de varios de ellos ha sido tan desastroso. Cuando se hunden, el Gobierno organiza una reestructuración financiera y les proporciona garantías para los depósitos, con lo que adquiere una participación en su futuro. Las autoridades saben que si esperan demasiado es probable que los bancos zombies o casi zombies -con poco o ningún valor neto, pero a los que se trata como si fueran instituciones viables- "apuesten por la resurrección". Si hacen grandes apuestas y ganan, se largan con la recaudación; si les salen mal, el Gobierno paga la cuenta. Esto no es simplemente una teoría; es una lección que aprendimos, a un alto precio, durante la crisis de las cajas de ahorro de Estados Unidos en los años ochenta. Cuando el cajero automático dice "fondos insuficientes", el Gobierno no quiere que eso signifique que es el banco, y no la cuenta corriente, el que está sin dinero, así que interviene antes de que la caja esté vacía. En una reestructuración económica, lo habitual es que los accionistas se queden sin un duro, y los propietarios de bonos se conviertan en los nuevos accionistas. A veces, el Gobierno se ve obligado a proporcionar fondos adicionales, o tiene que haber un nuevo inversor que esté dispuesto a hacerse cargo del banco que se ha hundido. Sin embargo, la Administración de Obama ha introducido un nuevo concepto: demasiado grande para ser sometido a una reestructuración financiera. El Gobierno sostiene que se desataría el caos si con estos grandes bancos intentáramos jugar según las reglas de juego habituales. Los mercados serían presa del pánico. Así que no sólo no podemos tocar a los propietarios de bonos, sino que ni siquiera podemos tocar a los accionistas (aunque la mayor parte del valor real de las acciones sea un mero reflejo de una apuesta basada en una ayuda financiera del Gobierno). Creo que esa opinión es errónea. Pienso que la Administración de Obama ha sucumbido a la presión política y a los augurios pesimistas de los grandes bancos que explotan el

244 miedo. Como consecuencia, el Gobierno ha confundido rescatar a los banqueros y sus accionistas con rescatar los bancos. La reestructuración da a los bancos la oportunidad de empezar de cero: los nuevos posibles inversores (ya sean propietarios de capital o de instrumentos de deuda) tendrán más confianza, otros bancos estarán más dispuestos a concederles préstamos y ellos estarán más dispuestos a prestar dinero a otros. Los propietarios de bonos se beneficiarán de una reestructuración ordenada, y si el valor de los activos es verdaderamente más alto de lo que cree el mercado (y los analistas externos), al final cosecharán las ganancias. Pero lo que está claro es que los costes actuales y futuros de la estrategia de Obama son muy elevados (y, por el momento, no han alcanzado su limitado objetivo de reactivar el préstamo). El contribuyente ha tenido que apoquinar miles de millones, y ha proporcionado miles de millones más en garantías, facturas que es probable que haya que pagar en el futuro. Reescribir las normas de la economía de mercado (de un modo que ha beneficiado a aquellos que han causado tanto dolor a toda la economía mundial) no sólo es caro desde el punto de vista financiero, sino que es algo peor. La mayoría de los estadounidenses lo consideran terriblemente injusto, especialmente después de haber visto a los bancos desviar los miles de millones destinados a permitirles reactivar el préstamo hacia pagos de primas y dividendos gigantescos. Romper el pacto social es algo que no debería hacerse a la ligera. Pero esta nueva forma de sucedáneo del capitalismo, según la cual las pérdidas se socializan y los beneficios se privatizan, está condenada al fracaso. Los incentivos están distorsionados. No hay disciplina de mercado. Los bancos "demasiado grandes para ser reestructurados" saben que pueden apostar impunemente (y, con la Reserva Federal proporcionando dinero a unos tipos de interés cercanos a cero, hay fondos de sobra para hacerlo). Algunos han llamado a este nuevo régimen económico "socialismo con características estadounidenses". Pero el socialismo se preocupa por los individuos corrientes. En cambio, Estados Unidos ha proporcionado poca ayuda a los millones de estadounidenses que están perdiendo sus hogares. Los trabajadores que se quedan en paro sólo se benefician de ayudas limitadas por desempleo durante 39 semanas, y luego son abandonados a su suerte. Y cuando pierden su empleo, la mayoría de ellos también pierden su seguro médico. Estados Unidos ha ampliado su colchón de seguridad empresarial de una forma que no tiene precedentes, desde los bancos comerciales hasta los de inversión, luego a los seguros y ahora a los automóviles, sin que haya un límite a la vista. En realidad, esto no es socialismo, sino una prolongación de la arraigada asistencia social a las empresas. Los ricos y poderosos acuden al Gobierno para que les ayude siempre que pueden, mientras que los individuos necesitados reciben poca protección social. Tenemos que terminar con los bancos "demasiado grandes para hundirse"; no hay pruebas de que estos gigantes reporten beneficios sociales que estén en consonancia con los costes que han impuesto a otros. Y si no nos deshacemos de ellos, tenemos que limitar estrictamente lo que hacen. No se les puede permitir que hagan lo mismo que han hecho en el pasado: apostar a costa de otros http://www.elpais.com/articulo/semana/socialismo/ricos/Estados/Unidos/elpepueconeg/2 0090621elpneglse_4/Tes

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REPORTAJE: Primer plano Produciendo parados... y precariedad El hundimiento del empleo destapa los problemas estructurales del mercado laboral MANUEL V. GÓMEZ 21/06/2009 España: 1.760.000 parados. La tasa de paro más baja de la democracia: el 7,9%. ¡Menos que Alemania! Hoy suena a utopía, pero hace casi dos años fue verdad. Apenas un par de semanas después echó a andar, a plena luz, la crisis financiera. Era agosto de 2007. Desde entonces, el mercado laboral español sólo ha traído disgustos. Ciento seis medidas anticrisis después, se ha cobrado casi 1,5 millones de puestos de trabajo. El que fuera alumno aventajado en Europa se ha convertido en el patito feo, en una máquina que fabrica más pardos que nadie. Al principio, la caída mantuvo una cadencia lenta. Pero fue in crescendo. Y la debacle llegó en el último trimestre del año pasado y el primero de éste. Los cuatro millones de parados, tantas veces negados por el Gobierno, irrumpieron con fuerza. El paro ya está en el 17,3% o en el 18,1% de la población activa, según sea la fuente el INE o Eurostat [la oficina europea de estadísticas]. España vuelve así a los deshonrosos lugares que tradicionalmente ha ocupado en las estadísticas laborales europeas. Y la comparación hace la situación todavía más insoportable: en Europa, la tasa de paro es del 8,6%, y el 55% de los nuevos parados del continente proceden de España. Así que de la mano del paro galopante y de la lejana convergencia con el continente - evaporada justo antes de conseguirla- se ha abierto, otra vez, el debate sobre una posible reforma laboral (de llevarse a cabo, sería la quinta de la democracia sin contar la promulgación del Estatuto de los Trabajadores): entre sindicatos y empresarios, entre el Gobierno y el Banco de España, y a última hora se han sumado economistas, abogados, catedráticos de derecho laboral y conocedores del mercado de trabajo divididos en dos grupos, aunque no falta entre ellos quien se ha quedado en medio. Necesaria o no -aquí mismo ya comienza la discusión-, la escalada del paro ha puesto sobre la mesa todas las rémoras del mercado laboral español, las que le llevan al histrionismo permanente. A ser una locomotora de la creación de empleo cuando la economía crece y una voraz trituradora cuando llegan las crisis: de la euforia a la depresión sin solución de continuidad. Y dos rémoras destacan sobre el resto y, además, se alimentan entre ellas. La primera le viene dada al mercado laboral. Tiene su raíz en la propia estructura económica española: el gran peso de la construcción, la hostelería y el turismo, sectores que usan mano de obra de poco valor añadido y poca formación tan intensivamente cuando las cosas van bien, como la destruyen cuando todo se tuerce. Algo que se acentuó durante la ahora denostada década dorada de crecimiento, cuando el ladrillo pasó de emplear habitualmente el 9% de los trabajadores al 13%. La otra, una división múltiple y transversal del mercado laboral que genera múltiples nichos estancos, mucha desigualdad y, sobre todo, bastante precariedad: trabajadores fijos y temporales, diferentes condiciones contractuales para españoles y extranjeros, también para hombres y mujeres o para jóvenes y mayores, y, cómo no, entre personal cualificado y no. Y en todas estas dicotomías, la parte más desfavorecida ha salido peor parada. Sólo en el caso de la división entre hombres y mujeres, la parte a priori más

246 fuerte, la masculina, se ha visto más golpeada por la crisis. Algo que se explica por el desplome del ladrillo, sector que ocupa a hombres fundamentalmente. Esos lastres han sido la rendija por la que se ha colado una destrucción de empleo masiva. Basta echar un vistazo a las estadísticas para comprobarlo. En la construcción, por ejemplo, se han destruido 700.000 empleos en el último año. En los últimos meses parece que la intensidad de la caída se ha frenado por el Fondo de Inversión Local para obras municipales puesto en marcha por el Gobierno. Pero persisten las dudas sobre lo que sucederá cuando éste acabe. Por lo que respecta a los trabajadores temporales, su número ha bajado en más de medio millón, según el INE, con lo que la tasa de temporalidad ha caído al 25%, un nivel casi desconocido en España. Pero, claro, la bajada ha llegado por la vía no deseada, la destrucción de empleo. La no renovación del contrato y la eliminación del puesto de trabajo precario son las fórmulas más baratas para ajustar costes en las empresas. Así, construcción y temporalidad han sido las dos causas, las más inmediatas y señaladas desde todas las tribunas. Aunque las conclusiones que se sacan son distintas según la tribuna que se escuche y también las soluciones que se proponen. En abril, un centenar de economistas (entre ellos, el ahora secretario de Estado de Economía y entonces aún profesor de IESE, José Manuel Campa) presentó un texto para reformar el mercado laboral. Sin dejar de reconocer la importancia del cambio del modelo productivo hacia sectores que aporten más valor añadido y mano de obra más formada y productiva, el Grupo de los 100 -como se les conoce casi desde el principio- hace hincapié en el cambio de la norma para solucionar "los principales problemas que provocan un funcionamiento ineficiente del mercado laboral". Javier Andrés, catedrático de análisis económico en la Universidad de Valencia y uno de los firmantes, afirma: "El cambio de modelo productivo no es excusa para frenar la reforma. Es una falacia. El mercado de trabajo forma parte del modelo". Cercanas a las del Banco de España, las propuestas de este grupo incluyen un contrato único indefinido con una indemnización por despido más baja que la actual "para acabar con la dualidad laboral", la eliminación de la tutela judicial en los despidos (salvo en casos de discriminación) o la flexibilización de la negociación colectiva. El objetivo: acabar con un mercado dual que distingue a España del resto de Europa y la penaliza. No le anda lejos la CEOE. Su propuesta de un contrato anticrisis, de 20 días de indemnización por despido (frente a los 45 o los 33 actuales), tiene por finalidad "romper la dualidad del mercado de trabajo", explica el secretario general, José María Lacasa. Ni que decir tiene que a los sindicatos la música y la letra de estas propuestas no les gusta. Ya habían reaccionado contra la patronal cuando propuso ese contrato anticrisis e hicieron lo previsto al recibir la propuesta. "Es miope buscar en la regulación la solución. En España se ha ensayado todo [en referencia a reformas anteriores]. El problema hay que buscarlo en el modelo productivo", aclara Toni Ferrer, para explicar el rápido deterioro del mercado laboral y la alta tasa de temporalidad. Desde CC OO apoyan este argumento y suman otro. "Lo que se plantea es acabar con la tutela judicial, que es acabar con el principal derecho de los trabajadores: la estabilidad laboral, sobre el que se asientan los demás", explica Ramón Górriz. Para los sindicatos, la prioridad se centra en el cambio del modelo productivo. ¿La temporalidad es un problema? Claro, pero se deriva de la propia estructura económica y

247 del abuso de la ley. "Hay que cambiar el patrón de crecimiento, no podemos ser el país del uso intensivo de mano de obra", añade Górriz. También ellos han encontrado, o buscado, el soporte académico a sus tesis. El pasado viernes recibieron un manifiesto, apoyado con las firmas de más de 750 catedráticos y profesores universitarios y profesionales. Sin llegar a la precisión del texto de los 100, este grupo señala como prioridades la protección de los parados (también los primeros) y el cambio hacia una estructura económica que no recurra al "uso intensivo de trabajo precario, mal remunerado y poco cualificado". Un tema que, a priori, no gusta a la patronal. Lacasa afirma, en una clara muestra de liberalismo: "El cambio es fruto de la decisión individual de miles de empresarios". Desde el Consejo Económico y Social (órgano consultivo que agrupa a agentes sociales, económicos y al Gobierno), su presidente, Marcos Peña, recibe el debate con agradecimiento, pero desconfía de que de él vaya a llegar la solución: "No hay que ofrecer la expectativa de que va a haber una respuesta que lo resuelva". Él preferiría no hablar de reforma laboral, pese a que era secretario general de Empleo cuando se llevó a cabo la mayor de ellas, en 1994, sino reformas para el mercado laboral, entre las que destaca a la educación como "la piedra angular". Y añade: "Cuando el epicentro del debate lo ocupa el precio del despido, distrae la atención de lo esencial". Sea como sea, el debate se ha lanzado. Ahora lo difícil es el acuerdo en el diálogo social, lánguido e improductivo durante esta crisis. Y sin él, el Gobierno ya ha advertido que no habrá reforma. No obstante, para reactivarlo, el presidente, a través de la oficina económica de La Moncloa, ha decidido tomar las riendas. Entre tanto, y pese a los buenos datos de mayo, la amenaza de un paro al alza persiste. El mismo Ejecutivo admitió la semana anterior que hasta 2012 no bajará del 17%. ¿Habrá una sexta? Nada levanta más conflictividad social en España que una reforma laboral. De su mano, han llegado las grandes huelgas generales en la etapa democrática. Basta recordar la más famosa y exitosa de todas ellas, la del 14 de diciembre de 1988, que frenó la reforma que pretendía el Gobierno socialista, o la de 2002 contra el Ejecutivo del PP, que también logró su objetivo. Pero no por ello se han quedado en la cuneta. Desde que se promulgó el Estatuto de los Trabajadores ya se han hecho cinco reformas de cierta envergadura. No obstante, sus defectos estructurales (altas tasas de paro y temporalidad) persisten. La primera se produjo en 1984. Su objetivo, como explica el profesor del IESE Sandalio Gómez en un informe sobre reformas laborales en España, era rebajar el alto nivel de paro, entonces en el 21%. Para ello se impulsó la contratación temporal. Diez años después llegó la segunda. Sin consenso. Y eso costó caro. Hubo huelga general. El paro, en plena crisis, estaba en la tasa más alta de la serie histórica (el 24%) y, de nuevo, se trataba de combatirlo. Entre otras, la reforma abrió la puerta a las Empresas de Trabajo Temporal. La tercera llegó ya con el Partido Popular en el poder, en 1997. Arrancaba la recuperación económica. Se trataba de combatir la alta tasa de temporalidad y dio paso a un nuevo modelo de fomento de la contratación indefinida, con una indemnización menor (33 días frente a los 45 tradicionales) por despido improcedente. Las dos últimas llegaron en plena década dorada, en 2001 y en 2006. La última pretendía atacar el recurso constante a la contratación temporal. La tasa de temporalidad cayó, pero el verdadero desplome de esta estadística ha llegado de la mano de la crisis. - http://www.elpais.com/articulo/semana/Produciendo/parados/precariedad/elpepueco/20090621elpneglse_2/ Tes

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REPORTAJE: Primer plano Dos visiones frente a 10 preguntas Dos grupos de expertos responden un cuestionario de EL PAÍS sobre la reforma laboral

NEGOCIOS 21/06/2009 La reforma del mercado laboral español es inaplazable y ayudará al país a salir más rápido de la crisis y a tener un crecimiento más saludable. Así piensan los 100 economistas que en abril pasado hicieron público un manifiesto en el que pidieron que se eliminen los contratos temporales y se cree un contrato único indefinido con indemnizaciones por despido progresivas. Los firmantes propusieron también flexibilizar la negociación colectiva para que los acuerdos entre empresarios y trabajadores en el ámbito de la empresa prevalezcan sobre convenios de ámbito superior. Otros expertos discrepan. El pasado viernes se dio a conocer un nuevo manifiesto, titulado El trabajo, fundamento de un crecimiento económico sostenible, firmado por unos 700 especialistas y apoyado por UGT y CC OO. Sus firmantes sostienen que la reforma laboral no es tan urgente y que los problemas para salir de la crisis están principalmente en el sector financiero. Cualquier ajuste en el mercado laboral, opinan, debe tener como objetivo aumentar la productividad, no abaratar el despido. Representantes de ambas partes responden a continuación a 10 preguntas formuladas por Negocios sobre el modelo futuro del mercado laboral español. -1 ¿Ha tenido algo que ver la estructura del mercado laboral español con el origen de la crisis? G-700. No. El origen de la crisis ha sido financiero, la restricción internacional del crédito es debida a un conjunto de actuaciones que han bordeado, y en algunos casos rebasado, la legalidad, así como a una escasa y deficiente supervisión pública que obedecía a los postulados de un modelo, el neoliberal, que considera que el mercado es capaz de autorregularse. En lo que afecta al caso español, su expansión e intensificación están ligadas a las características de su estructura productiva, con una elevada presencia de actividades inmobiliarias que ya ha generado un alto grado de endeudamiento de las familias, con un sistema financiero que ahora ha de asumir riesgos elevados, no previstos. En España se ha acentuado la crisis por los excesos inmobiliarios que muchas entidades de crédito han alentado y no fueron en su momento atajadas por las autoridades económicas del país. G-100. No en el origen, pero sí en sus mecanismos de transmisión. El origen de la gran recesión actual es un conjunto de perturbaciones financieras inducidas por los desequilibrios globales de ahorro e inversión, que han acabado generando una elevada pérdida de riqueza de familias y empresas, dando lugar a una intensa reducción de la demanda agregada, tanto interna como externa. La crisis incidió sobre la economía española cuando ésta había acumulado una elevada dependencia del endeudamiento exterior y una excesiva concentración en el sector inmobiliario, convirtiéndola en una víctima propiciatoria ante este tipo de perturbaciones financieras. El hecho diferencial de nuestra economía es que se ha desencadenado una destrucción de empleo y un aumento del paro mucho más intensos que en otros países de nuestro entorno, tanto en aquéllos sujetos a estallidos de burbujas inmobiliarias como sin ellas, de la misma manera que convirtió a España en el motor de creación de empleo, si bien de

249 muy escasa calidad, durante la década anterior. Este deficiente comportamiento está íntimamente relacionado con las características del sistema vigente de contratos laborales y a la estructura y a los contenidos de la negociación colectiva. Por otra parte, el origen de la crisis es irrelevante a la hora de valorar: 1. El funcionamiento deficiente del mercado de trabajo español en las últimas décadas en términos de tasa media y volatilidad del desempleo, crecimiento salarial y, sobre todo, desigualdad entre distintos grupos de trabajadores. 2. La necesidad de una reforma laboral para salir de la crisis mejor y más rápidamente y, sobre todo, para contribuir al crecimiento económico en el medio y largo plazo en un contexto de envejecimiento demográfico, cambio técnico progresivo y globalización. 2 ¿Cuál es la razón básica de que el paro aumente mucho más en España, cuando la recesión es de una intensidad similar o menor a la de otros países europeos? G-700. La estructura productiva, fundamentalmente; con un elevado peso de sectores de alta estacionalidad y comportamiento procíclico en materia de empleo. Así ha ocurrido en crisis anteriores (1977-1985 o 1991- 1995); el elevado peso relativo de la actividad de construcción y servicios inmobiliarios explica buena parte de las fuertes oscilaciones cíclicas del empleo, no sólo en el caso español, sino en otros países europeos que sufren ahora elevadas tasas de desempleo (Países Bálticos, Irlanda...). En el último año y medio, más del 50% de la destrucción de empleo registrada en España es atribuible al sector de la construcción; es un sector muy sensible al cambio de ciclo que se había cargado de empleo en la pasada fase de auge, sumando casi el 20% del empleo acumulado en el periodo. Este fuerte descenso del empleo en la construcción explica, en buena medida, cómo la destrucción de empleo se está llevando a cabo a través de la finalización de contratos temporales, a diferencia de lo ocurrido en la crisis anterior, donde el proceso de ascenso del desempleo se inició en el sector industrial y a través de despidos. Por tanto, habría que responsabilizar también a las políticas que han contribuido a apuntalar ese modelo, no sólo por la vía de la incentivación de la demanda, con apoyos múltiples a la compra de viviendas, sino también el lado de la oferta, a través de subvenciones implícitas y explícitas a determinadas formas de contratación, como los contratos temporales acausales. G-100. El comportamiento diferencial de la economía española se explica por la interacción entre una legislación contractual que favorece un uso excesivo de los contratos temporales generadores de empleos de escaso valor añadido y una negociación colectiva excesivamente rígida, que impide que las empresas puedan poner en funcionamiento respuestas a la caída de la demanda que vayan más allá de la destrucción de empleo e, incluso, de la liquidación empresarial. Como es bien conocido, otros países con mecanismos de flexibilidad externa e interna del empleo distintos a la temporalidad no están experimentando aumentos tan considerables de su tasa de paro. A este respecto, no cabe argumentar que la elevada tasa de temporalidad en España se deba a una estructura productiva con un peso desorbitado de sectores con puestos de trabajo de "duración determinada" (construcción, hostelería, turismo, etcétera). En primer lugar, la inestabilidad laboral es mucho mayor que en el resto de la UE para todos los sectores de actividad y también lo es para los trabajadores de casi todas las edades, niveles educativos y ocupaciones. En segundo lugar, existen contratos indefinidos que permiten acomodar la estacionalidad de la demanda en determinados sectores (contrato a tiempo parcial, trabajadores fijos discontinuos) cuyo uso se ha visto gravemente limitado

250 por el recurso excesivo a los contratos temporales, ya que éstos parecen ser la única fuente operativa de flexibilidad que los empresarios perciben tener a su disposición. 3 ¿Es urgente una reforma laboral en estos momentos? G-700. No. Los problemas para salir de la crisis están en el sector financiero, en el flujo de crédito al sector real y en la activación de la demanda. Aunque puede ser conveniente actuar sobre el funcionamiento del mercado laboral para facilitar ajustes en las empresas con el fin de adaptarse a las circunstancias actuales con fórmulas negociadas con los sindicatos, por ejemplo, sobre el uso del tiempo de trabajo. Y, en última instancia, lo adecuado sería avanzar hacia una reforma acorde con el proceso de reestructuración del sistema productivo, teniendo como objetivo esencial de la hipotética reforma el aumento de la productividad laboral y no el abaratamiento de los costes absolutos del trabajo, actuando, entre otras cosas, contra los incentivos a la temporalidad descausalizada, que aún persisten, en línea con lo que se inició en la reforma de 2006. G-100. Indudablemente. Con independencia del origen del desplome de la demanda agregada, la economía española se enfrenta a dos retos fundamentales: la recuperación de la competitividad exterior y el aumento sostenido de la productividad total de los factores (PTF). El primer objetivo es necesario para que, una vez recuperada la demanda externa, las exportaciones puedan proporcionar un primer motor de creación de empleo. El aumento sostenido de la PTF, aparte de ser una vía de ganancias de competitividad en el corto plazo, permite sostener crecimientos elevados del empleo y de los salarios reales en el medio y largo plazo. Las instituciones laborales vigentes pueden suponer una rémora muy importante a la hora de lograr dichos objetivos. La estructura y contenidos actuales de la negociación colectiva impiden una reasignación sectorial eficiente de los recursos y el necesario ajuste de precios relativos. Por otra parte, existen abundantes argumentos teóricos y evidencia empírica para sostener que el uso excesivo de la contratación temporal perjudica un crecimiento sostenido de la PTF, que, recordemos, ha tenido tasas de crecimiento negativas en nuestro país desde mediados de los noventa, justo cuando la revolución de las tecnologías de la información y la comunicación se extendía a nivel global. 4 ¿Es el cambio de modelo productivo hacia sectores de mayor productividad la mejor vía para reducir la precariedad laboral? G-700. Sí, en principio, aunque el aumento de la productividad por sí mismo no tiene por qué significar un aumento de la ocupación estable. Determinados cambios en la regulación laboral pueden ayudar a avanzar en esa dirección o a evitar obstáculos a esa transformación productiva. Es cierto que algunas de las regulaciones actuales, particularmente en lo que se refiere a contratación temporal en combinación con el mecanismo de financiación del subsidio de desempleo, han coadyuvado a asentar un modelo productivo muy intensivo en trabajo, poco cualificado, en tanto que han facilitado un precio relativamente barato para el mismo. Por eso la legislación laboral debe ayudar a conseguir un círculo virtuoso, porque además la calidad del empleo se traduce en última instancia en productividad, cerrando las compuertas para que los sectores de alta productividad utilicen modalidades contractuales en contradicción con ganancias de productividad en el medio o largo plazo. G-100. Obviamente. Empleos más productivos en sectores de mayor valor añadido permiten incrementar las tasas de empleo y los salarios reales. Pero la cuestión relevante

251 no es si es necesario o no un cambio del modelo productivo, sino cómo se consigue dicho cambio. Desgraciadamente, un modelo productivo no se cambia sin reformas de calado, tanto en el mercado laboral como en otros ámbitos, principalmente en un sistema educativo ineficiente y regresivo socialmente. Lo que una economía produce y cómo lo produce es función de su dotación de capital humano y de los mecanismos de gestión de dicho capital. España partía ya hace 25 años con retrasos educativos, formativos y de inversión en I+D+i en las empresas. Pese a los avances alcanzados en términos absolutos, la regulación laboral ha acentuado estos retrasos relativamente a las economías más desarrolladas. Es responsable de la excesiva rotación entre los trabajadores temporales y de la escasa movilidad de aquellos con mayor experiencia profesional. Por ello, desincentiva la adquisición de capital humano, perjudica su gestión, dificulta la reorganización del trabajo dentro de las empresas y condiciona la movilidad profesional. En definitiva, perjudica las acciones necesarias para una asignación eficiente de los recursos humanos ante cambios técnicos y otras perturbaciones económicas. Sin estas reformas, nuestro sistema productivo volverá a pecar de debilidad. 5 ¿Es modificar el coste del despido una medida eficaz para rebajar la tasa de temporalidad? ¿Hay otras? G-700. Si nos preguntan por la propuesta de un único contrato con costes de indemnización creciente, como ha sido, entendemos que "modificar" se refiere a "reducir" (también podría referirse a incrementar, ¿no?), la respuesta es no; en todo caso, lo facilitaría el encarecimiento de la indemnización por finalización de contrato temporal. Posiblemente también vendría bien incrementar más la cotización de los contratos temporales por desempleo, con el fin de trasladar a las empresas que más utilizan este tipo de trabajo el mayor uso que hacen de este sistema de protección con respecto a las empresas que están relativamente menos inmersas en la temporalidad laboral. Sería una forma de desincentivar el uso de los contratos temporales. Al mismo tiempo, estaría bien, como ocurre en la mayoría de los países europeos, volver a un sistema de causalidad en la contratación temporal, lo que exigiría una mayor intensidad en la inspección y una modificación normativa en el sistema de contratación, dejando sólo dos o tres formas de contracto temporales ligados a causas productivas. En definitiva, si se acercan los costes de despido de los contratos indefinidos a los de los temporales, lo que se conseguirá es aumentar la tasa de temporalidad pero con otro nombre. Será un debate exclusivamente nominalista que, en última instancia, no favorecerá a los asalariados y tampoco quebraría los patrones de comportamiento de los empresarios, en lo que a uso de la excesiva rotación del empleo se refiere. G-100. La pregunta no debería ser cómo reducir la temporalidad, sino si tiene sentido la coexistencia de contratos de trabajo con costes de despido diferentes. Los costes de despido deben diseñarse para evitar que las empresas despidan por encima de lo que sería eficiente, provocando un coste excesivo de la protección social que recae finalmente sobre el contribuyente. La temporalidad podría defenderse, en principio, bajo el principio de causalidad, que rige en el sistema español y que ofrece la posibilidad de un puesto de trabajo de duración determinada sea cubierto mediante un contrato temporal. Sin embargo, resulta muy difícil justificar un sistema dual, basado en alta protección para un grupo de trabajadores y precariedad generalizada para otros. En primer lugar, si el coste social e individual provocado por la pérdida de empleo es similar independientemente del tipo de contrato, no hay ninguna justificación para mantener costes de despido diferentes. En segundo lugar, resulta casi imposible identificar en la práctica cuáles son los puestos

252 de trabajo de "duración determinada" que pueden ser cubiertos por contratos temporales y la extensa variedad de contratos temporales que contempla la regulación española sólo complica en extremo esta identificación. Por lo que se refiere a medidas alternativas para reducir la temporalidad, en el pasado se han usado bonificaciones para la contratación indefinida que se han mostrado muy ineficaces pues suponen un coste muy elevado para las arcas del Estado, desvían recursos de otras políticas activas, provocan sustanciales efectos de peso muerto y sustitución y favorecen a las empresas que generan más inestabilidad laboral. La sustitución de las bonificaciones por un impuesto por despido que penalizara a las empresas que utilizasen en exceso la rotación laboral en su gestión de los recursos humanos sería un paso positivo, si bien sólo debería contemplarse dentro de una modificación sustancial del sistema de contratos de trabajo. 6 ¿Qué ventajas o desventajas tiene simplificar los contratos de trabajo en un solo contrato de tipo indefinido, vinculando las indemnizaciones a la antigüedad? G-700. Es una propuesta que se podría calificar al menos con cuatro apellidos: inoportuna, ignorante, malintencionada e inconstitucional. Con la que está cayendo, en términos de destrucción de empleo, no parece muy oportuno introducir un mecanismo que, en el mejor de los casos, aceleraría el ajuste a la baja del empleo. Reducir el coste no coadyuvaría a generar empleo; los procesos de generación de empleo no están ligados al coste de despido, al menos de manera significativa. Ignora que en un sistema productivo como el español, en particular, pero también en otros, existen necesariamente espacios productivos de elevada estacionalidad. Por ello es inevitable mantener algún tipo de contrato temporal, que puede combinarse, dependiendo de las características productivas, con la expansión de los contratos fijos discontinuos. En ambos casos, para evitar la generalización de su uso (que reforzaría un modelo productivo de trabajo intensivo), convendría establecer de manera clara y con control su relación de causalidad. En suma, con esta modalidad contractual se tendería a una rotación al menos similar a la actual, con una ficción de contratos indefinidos, mucho más baratos en términos de coste de despido. La dualidad del mercado laboral se genera por el lado de la demanda (puestos de trabajo temporales), no por el sistema de contratación; lo adecuado es responder a esa dualidad no con contratos que la escondan, sino con fórmulas que la absorban (causalidad del contrato), protegiendo a los trabajadores que accedan a esos puestos. Sería una transformación puramente nominalista. Un solo tipo de contrato indefinido de tales características, para que sustituyera a los temporales causales, tendría que conllevar un coste de despido equivalente o inferior a los que actualmente suponen los temporales; si esto no ocurriera, posiblemente en los sectores con mayor estacionalidad se expandiría el espacio del empleo irregular o sumergido y/o aumentaría la rotación de los trabajadores por diferentes puestos de trabajo. Luego esconde tras de sí, malévolamente, la demanda histórica de las organizaciones empresariales de este país: reducir los costes de despido. Si los costes los reducimos hasta alcanzar las cotas que ahora conllevan los contratos temporales estaríamos generalizando la precariedad laboral y no contemplando incentivos positivos al avance de la productividad, al desincentivar el avance de fórmulas de "flexibilidad interna".

253 Y, por último, la propuesta aludida lleva consigo una propuesta adicional, menos aireada por los medios de comunicación, que supone la eliminación de la tutela judicial para los despidos, lo que contradice la doctrina del Tribunal Constitucional que sienta el principio de la necesidad de establecimiento en la Ley de una causa justificativa para el despido. G-100. La principal ventaja del contrato único es que suprime de raíz la segmentación entre trabajadores indefinidos y temporales, contribuyendo así a incrementar la estabilidad laboral. Los contratos temporales son extremadamente inestables, por las bajas indemnizaciones a su término, pero también porque se utilizan durante periodos de tiempo cortos, con pequeñas tasas de conversión a indefinidos dada la brecha de indemnizaciones y el círculo vicioso que asocia alta precariedad con baja productividad. Un contrato de trabajo indefinido con indemnizaciones crecientes por antigüedad produciría mucha más estabilidad laboral, dando lugar a periodos de empleo mucho más extensos que los que se registran actualmente con los contratos temporales y, por lo tanto, a mayores derechos de protección por desempleo e indemnizaciones por despido, medidas que no tienen por qué ser menores que las actuales. Además, los beneficios de una mayor estabilidad laboral pueden verse incluso reforzados si al mismo tiempo que se introduce este contrato se llevan a cabo otras medidas que aumenten la eficacia de las políticas del mercado de trabajo, tanto en lo que se refiere a prestaciones por desempleo como a las políticas activas, cuya financiación se reforzaría a través del recorte de las ineficaces bonificaciones. 7 ¿Hay que preservar o cambiar el actual régimen de control judicial de los despidos y la distinción entre despidos procedentes e improcedentes? G-700. Respecto al control judicial de los despidos, nos remitimos a lo señalado en la pregunta anterior. Respecto a la segunda, asumimos el control judicial como imprescindible, entre otras cosas porque el despido es un acto de ejercicio de un poder por parte del empresario que debe estar sujeto a reglas. Consideramos, por otro lado, que el despido es necesariamente causal, dada la variedad de situaciones y conductas que pueden llevarla a él, es decir, necesita el empresario justificar su voluntad resolutoria del contrato en una causa justa (es una exigencia que se deriva del artículo 35 de la Constitución). Y a este respecto, conviene no olvidar que la Ley 45/2002 (el decretazo del último Gobierno Aznar), reformando el procedimiento laboral, ha concluido en la práctica en la creación de un despido sin causa. Esto ha significado que casi el 70% de los despidos habidos en el año 2008 en España se hayan llevado a cabo a través de lo establecido en la citada Ley. De facto ha desaparecido la distinción entre despido procedente e improcedente. G-100. El contrato único establecería la misma indemnización por despido por causas objetivas (económicas, tecnológicas, de formación, organizativas) procedentes y por despidos improcedentes, distinguiendo ambos del despido procedente por causas disciplinarias, cuya indemnización sería nula como en el sistema actual. Por tanto, la tutela judicial se centraría en este último caso y en los casos de discriminación. Consideramos por tanto que esta tutela debe permanecer, aunque preservándola para proteger al trabajador en el caso en que el empresario quiera despedir sin coste alegando inexistentes razones disciplinarias. Por reiterar, nuestra reforma NO plantea en absoluto la introducción del despido libre. La razón para igualar los despidos objetivos procedentes con los improcedentes está motivada por el hecho de que en España los

254 despidos que deberían ser objetivos procedentes acaban tramitándose como improcedentes, dado que las empresas prefieren pagar una mayor indemnización (45 días) a enfrentarse con los órganos judiciales (lentos, caros y quizá demasiado proclives a fallar contra las empresas). Igualando ambos tipos de despidos con una indemnización intermedia se reconoce una realidad existente y se mantiene la tutela judicial de los derechos de los trabajadores. 8 Ante una crisis económica tan intensa, ¿habría que ampliar el pago de prestaciones a los desempleados? G-700. En cuanto a los que ahora acceden a la prestación, no necesariamente; se pueden complementar para los casos de alargamiento de la situación de desempleo con otras prestaciones sociales, específicamente diseñadas para evitar las situaciones de exclusión social, caminando hacia la generación del derecho a una renta básica de inserción, vigente en algunas comunidades autónomas y en diferentes países europeos. No obstante, sí cabría revisar la cobertura del subsidio, contemplando su expansión a colectivos hoy no protegidos. En todo caso, es el momento de impulsar políticas de empleabilidad o inserción destinadas a los desempleados, particularmente en los colectivos con mayores dificultades de inserción (parados de larga duración). Sería el momento, también, para separar los mecanismos de financiación del subsidio contributivo del desempleo y del asistencial, pasando ésta a la financiación directa a través del Presupuesto del Estado. Esto podría dar margen para actuar sobre las cotizaciones por desempleo en la fase de recuperación. G-100. A corto plazo, únicamente cabe mejorar el acceso al sistema de protección por desempleo de los trabajadores sin ningún tipo de cobertura, facilitando las condiciones de acceso a los subsidios y otras rentas asistenciales. Las prestaciones contributivas financiadas con las cotizaciones a la Seguridad Social no deben alterarse en estos momentos; ello provocaría un fuerte déficit del sistema. Una vez pasada la crisis, teniendo en cuenta los elevados niveles de endeudamiento de la población española, convendría cambiar el sistema de prestaciones para que el aseguramiento sea mayor en los primeros meses del periodo de desempleo, volviendo progresivamente a las tasas de reposición del sistema actual en los meses finales del periodo de percepción. Los aumentos de financiación que requieran estos cambios pueden proceder del establecimiento del impuesto por despido pagado por las empresas que abusen de la rotación laboral, generando un sistema de financiación más justo al recaer en mayor medida en aquellas que generen más desempleo. Por otra parte, también se podría completar el sistema de protección con cuentas de ahorro individualizadas, similares a las implantadas en el sistema austriaco, a las que el trabajador pueda tener acceso en los momentos desempleo para cubrir sus necesidades de formación. 9 La función de intermediación de los Servicios Públicos de Empleo para ajustar ofertas y demandas de empleo es muy limitada. Y el acceso a la formación de trabajadores y parados, muy escaso. ¿Qué habría que hacer para mejorar el funcionamiento del mercado laboral? G-700. Efectivamente, en este momento se estima que su penetración está sobre un 3% del movimiento laboral registrado en el país. Para mejorar la labor de intermediación habría que, en primer lugar, poner los servicios públicos de empleo al nivel de los países europeos donde muestran mayor penetración, lo que significa aumentar significativamente sus medios técnicos y humanos y desarrollar e impulsar sistemas de gestión integral -itinerarios, formación, etcétera- de la empleabilidad de los demandantes de empleo, separando esto de las funciones de gestión administrativa de los subsidios. No

255 está demostrado en la experiencia europea (ni en la española, en los ámbitos donde operan) que los servicios privados funcionen de modo más eficiente que los públicos, no obstante, cabe la opción de abrir espacios a aquellos en determinados segmentos del mercado, promocionando la complementariedad con el sistema público. G-100. Dado que ni la intermediación, ni la formación ocupacional y continua, ni otras políticas activas, se han mostrado eficaces en momento de bonanza, no cabe esperar que lo sean en este momento de recesión. Requieren de una reorientación, reduciendo el peso de las bonificaciones, centrando sus esfuerzos en mejorar la empleabilidad de determinados colectivos, basándose en principios de evaluación continua y abriéndose en mayor medida a la colaboración con empresas privadas que ayuden a mejorar la gestión y aplicación de las políticas de empleo activas. Éstas deben concentrarse en mayor medida en los trabajadores con menor cualificación, que son los que sufren los periodos más largos de desempleo, a fin de evitar el paro de larga duración. Tanto la provisión de las actividades de inserción y formación como su financiación deben tener en cuenta la situación particular de cada trabajador parado y generar las oportunidades e incentivos para elevar la salida del paro al empleo. A este respecto, debe llevarse a cabo, de forma rutinaria, una evaluación rigurosa de las actividades realizadas en este campo, hoy prácticamente inexistente. 10 ¿Es necesario revisar el sistema de negociación colectiva? G-700. La negociación colectiva ha demostrado a lo largo del tiempo tener una capacidad y una flexibilidad para ajustarse al entorno económico y productivo bastante superior al de la mayoría de los empresarios. Existen resquicios para la reforma, centrados en temas como la estructura de la negociación colectiva, la articulación de los ámbitos de la misma. Dado el tejido empresarial español, con elevada proliferación de pequeñas empresas, y las características del sistema de representación de los trabajadores, la tendencia habría de ser hacia una mayor preeminencia de los convenios de mayor ámbito, que pudieran complementarse, con contenidos adaptativos, a los ámbitos menores; ello dotaría de mayor eficiencia al sistema, como muestran algunos de los modelos centroeuropeos, a la par que evitaría la aparición de espacios laborales no convenidos, como puede estar ocurriendo en estos momentos. En cualquier caso, la reforma del sistema de negociación colectiva es uno de los retos pendientes del diálogo social en nuestro país. G-100. Los aumentos salariales recientes van más allá del puro efecto composición que supone la reducción del empleo de trabajadores con contratos temporales. Muestran claramente la insensibilidad del sistema de negociación, (especialmente los convenios de sector) ante la grave situación económica actual, contribuyendo activamente al intenso proceso de destrucción de empleo. Ello es fruto de una estructura de la negociación colectiva eminentemente de provincial/sectorial, un modelo que consigue una cobertura amplia aunque muy descoordinada, dando lugar al peor de los modelos posibles de negociación colectiva por sus efectos negativos sobre los resultados macroeconómicos. Su configuración a lo largo de los últimos 50 años ha permanecido prácticamente inalterada, dificultando la adaptación de las condiciones de trabajo a las necesidades productivas en las empresas de cada momento y suponiendo un freno a los aumentos de la productividad. Sin cambios en la regulación que sustenta esa falta de avances, no será posible resolver las deficiencias de la negociación colectiva. Con la regulación actual sobre cláusulas de descuelgue, acuerdos como los que han alcanzado algunas grandes empresas para mantener el empleo sólo son posibles bajo condiciones muy restrictivas cuando deberían ser la norma en vez de la excepción

256 Economía Los sindicatos movilizan a 700 expertos contra la rebaja del despido El grupo rechaza que el cambio de normativa laboral sea la solución de la crisis - Toxo: "Es el tiempo de mirar a la política fiscal para su reforma"

MANUEL V. GÓMEZ - Madrid - 20/06/2009 Durante los últimos meses los sindicatos se han sentido "cercados". Así lo afirmaron los secretarios generales de CC OO y UGT, Ignacio Fernández Toxo y Cándido Méndez, respectivamente. "La ofensiva es brutal", afirmó ayer el primero. De la mano del intenso aumento del paro, han llegado propuestas de reforma laboral que demandaban nuevos contratos con un despido más barato. Algo a lo que ellos se oponen radicalmente. Durante los últimos meses los sindicatos se han sentido "cercados". Así lo afirmaron los secretarios generales de CC OO y UGT, Ignacio Fernández Toxo y Cándido Méndez, respectivamente. "La ofensiva es brutal", afirmó ayer el primero. De la mano del intenso aumento del paro, han llegado propuestas de reforma laboral que demandaban nuevos contratos con un despido más barato. Algo a lo que ellos se oponen radicalmente. Procedían de la patronal, del Banco de España y del mundo académico. La última propuesta en este sentido llegó del banco central, de nuevo, esta misma semana. Ayer, en cambio, los sindicatos recibieron un manifiesto en apoyo de sus tesis firmado por más de 700 catedráticos y profesores universitarios y profesionales (economistas, abogados, psicólogos y sociólogos) conocedores del mercado laboral. El texto, titulado El trabajo, fundamento de un crecimiento económico sostenible, reclama, a grandes rasgos, que las medidas que se adopten para revertir la grave situación del empleo en la actualidad no arranquen por el mundo del trabajo, "no ha sido la causa de la crisis". Esta última frase ha sido el argumento con el que los sindicatos han replicado a las propuestas de reforma laboral aparecidas. Las iniciativas para que se hagan cambios en la normativa laboral han ido apareciendo a medida que el aumento del paro ha puesto de relieve los problemas estructurales de que adolece el mercado laboral. Entre sindicatos y empresarios hay coincidencia a la hora de señalar los problemas, sobre todo, en culpar a la alta tasa de temporalidad que ha permitido una rápida destrucción de empleo. En cambio, hay diferencias casi irreconciliables en las causas de la enfermedad y en la medicina a aplicar. Y eso en buena medida, veta cualquier intento de reforma laboral, pues el Gobierno, para dar un paso en este sentido, exige que haya acuerdo entre empresarios y sindicatos. El punto de partida, para los expertos que presentaron ayer su manifiesto, es frenar la restricción del crédito, extender la protección a los parados y dar los pasos necesarios para un nuevo modelo productivo, que no demande "trabajo precario, mal remunerado y poco cualificado". No es un manifiesto contra nada ni contra nadie, afirmó Carlos Berzosa, firmante y rector de la Universidad Complutense de Madrid, en el acto de presentación celebrado ayer en el paraninfo de la universidad que dirige. Pero lo cierto es que tanto el texto como algunas de las intervenciones estaban llenas de críticas solapadas a las propuestas de reforma del mercado laboral que han aparecido en los últimos meses. Los dardos se dirigían, especialmente, contra la propuesta firmada por el Grupo de los 100, un conjunto

257 de economistas movilizados por la Fundación de Estudios de Economía Aplicada (entre ellos el actual secretario de Estado de Economía, José Manuel Campa), que presentó una iniciativa que entre otras medidas propone un contrato único con un despido más barato que el actual o la unificación de las causas de despido. "El eje no debía ser una reforma en torno al mercado laboral. Me parece una solución pobre", expuso en su intervención Enrique Viaña, catedrático de Economía. "Para los economistas de salón, no existe otra solución que los contratos", añadió el también catedrático, en este caso de Sociología, Juan José del Castillo. Además de ellos, entre los firmantes aparecen los catedráticos Santos Ruesga, Jesús Cruz Villalón o el antiguo secretario general de Empleo con Jesús Caldera, Valeriano Gómez. En su discurso, Toxo también atacó las propuestas del Grupo de los 100. Para él, "la reforma laboral no es para abaratar el despido", sino para acabar con las garantías que conlleva la unificación de las causas del despido, y a la larga "transferir las rentas del trabajo a las rentas del capital". Toxo admitió que hay una "segmentación múltiple" del mercado laboral español, pero subrayó que procede del modelo productivo. Además, reclamó cambios en los impuestos. "Es el tiempo de mirar a la política fiscal para su reforma", afirmó. Para Méndez, los firmantes del manifiesto presentado ayer "han roto el cerco del pensamiento único". El secretario general de UGT subrayó la oportunidad de reaccionar con contenidos y propuestas para evitar caer en viejos y dolorosos errores para los trabajadores". Otra de las aportaciones al debate sobre la reforma laboral, llegó ayer desde el Banco Central Europeo. El miembro del Comité de Dirección José Manuel González-Páramo habló en Oviedo de su necesidad "para que germinen los brotes verdes". http://www.elpais.com/articulo/economia/sindicatos/movilizan/700/expertos/rebaja/despi do/elpepueco/20090620elpepieco_1/Tes

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Vender viviendas, cada vez más caro Las comunidades ignoran la caída del precio de los pisos al cobrar impuestos

LUIS DONCEL - Madrid - 21/06/2009 El portal www.idealista.com ofrece un piso en la calle Dimas, en pleno centro de Madrid, de 90 metros cuadrados por 210.000 euros. Pero, según los cálculos del Gobierno regional, esa vivienda vale muchísimo más. Exactamente, 344.520 euros. Y este sobreprecio que estima la comunidad autónoma le va a salir muy caro al dueño. Porque en el hipotético caso de que encontrara comprador, no sólo tendría que rebajar sus expectativas y adaptar sus precios a estos tiempos de reventón del ladrillo, sino que además se verá obligado a soportar un gravamen mucho más alto de lo que en teoría le corresponde. Gracias al impuesto de transmisiones patrimoniales, cada comunidad autónoma se queda con el 7% del importe de la compraventa de un inmueble. Cada administración regional utiliza sus propios métodos para evitar que los propietarios declaren que la operación se ha cerrado por una cantidad inferior a la real. El problema es que este mecanismo antifraude funcionaba en la época del boom, cuando los precios no dejaban de crecer y las ventas se cerraban por cantidades cada vez más altas. Pero ahora las regiones no se están dando la prisa necesaria para adecuar sus cálculos a la nueva -y deprimida- realidad del ladrillo. Así, volviendo al ejemplo del piso madrileño en la calle Dimas, el Gobierno regional estima que debe ingresar unos 24.000 euros. Pero si el 7% se aplicara sobre los 210.000 euros teóricos a los que se cerrará la venta, las arcas de la comunidad se deberían conformar con 14.700 euros. Es decir, la falta de diligencia de la administración regional le cuesta al propietario del piso en cuestión más de 9.000 euros. Y eso suponiendo que la operación no se firme al final a un precio inferior, lo más habitual en estos tiempos en los que el comprador es el que dispone de más poder para negociar. Cuando la administración regional detecte que el contribuyente ha ingresado una cantidad inferior a la que esperaba hará una liquidación complementaria exigiendo la diferencia. Los casos en que el sobreprecio es mayor afectan a aquellos que están dispuestos a rebajar más el precio de sus propiedades para venderlas. Así, los que más se adaptan a la nueva coyuntura son los más perjudicados. "Nos encontramos con gente que vende por debajo de mercado y que tiene que pagar impuestos en función del valor que las comunidades han estimado del inmueble. Es profundamente injusto, cuando no inconstitucional porque viola el principio de la proporción en la carga tributaria", aseguran fuentes de los notarios. Y lo peor de todo es que la injusticia de esta carga se irá agravando a medida que los precios caigan más y las comunidades no reflejen en sus valoraciones estos descensos. Fuentes de la Consejería de Economía de Madrid señalan que siguen muy de cerca lo que ocurre en la calle para adaptar sus valoraciones una vez al año, y que incluso lo hacen por debajo de los precios del mercado. Lo actualizaron por última vez el pasado mes de diciembre. "Es cierto que hemos recibido alguna queja, pero muy pocas; no significativas", señalan fuentes de la consejería.

259 Luis del Amo, director del Registro de Economistas Asesores Fiscales, explica que cada comunidad autónoma utiliza sus propios métodos para calcular las valoraciones: Madrid lo individualiza para cada inmueble, otras usan el valor catastral multiplicado por un coeficiente y otras, la tasación que se incluyó en el préstamo hipotecario. "Las quejas están llegando de varias comunidades. El afectado puede recurrir a una tasación pericial contradictoria para pagar el impuesto sólo por el dinero que efectivamente ha recibido. Pero el que se acoja a esta alternativa también asume riesgos, porque si pierde tendrá que pagar las costas del perito", señala Del Amo. La solución a este problema, según fuentes notariales, es que las comunidades no sean perezosas y estén atentas a las bajadas de precios para actualizar las valoraciones. Pero que esto ocurra es especialmente dudoso en estos tiempos de crisis en los que la recaudación de las administraciones se ha desplomado.

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CRÓNICA: ECONOMÍA GLOBAL CARTA DEL CORRESPONSAL / Lisboa El AVE paga los platos rotos 21/06/2009 Portugal está en año de elecciones y ya empiezan a sentirse los efectos cuando el partido apenas está en los primeros minutos. La crisis económica, lógico, ocupa un lugar estelar en el recurso argumental de los políticos. El Partido Social Demócrata (PSD), líder de la oposición conservadora, decidió desde el primer momento atacar al Gobierno por el flanco del gasto, concretamente en las obras públicas. No son tiempos de más carreteras, nuevos aeropuertos o de trenes de alta velocidad, insiste el PSD, que habla de despilfarro. El Gobierno socialista que dirige José Sócrates, ni caso. Hasta el 7 de junio. Las cosas han cambiado desde la derrota estrepitosa del Partido Socialista (PS) en las elecciones europeas y la victoria, mucho menos espectacular, pero victoria al fin, del PSD. Ya se sabe que unas elecciones al Parlamento Europeo poco tienen que ver con unas legislativas, en las que se decide el Gobierno de la nación, y que no deberían extrapolarse los resultados de una para cantar victorias futuras que no se han producido. Pero lo cierto es que el 7 de junio fue un aviso para el PS, que hasta entonces vivía confiado desde su torre de marfil en revalidar su mayoría absoluta en los próximos comicios dentro de tres meses. Tras la derrota se imponía un gesto, un guiño, un giro, por pequeño que fuera. El cambio de rumbo se ha producido precisamente en el proyecto más importante del plan gubernamental de infraestructuras: la red de alta velocidad entre Portugal y España. La niña de los amores de Sócrates. Hagamos un breve repaso. En noviembre de 2003, el primer ministro portugués, José Manuel Durão Barroso, y su homólogo español, José María Aznar, anunciaron en la cumbre bilateral de Figueira da Foz las bases de una red de alta velocidad entre Portugal y España. Barroso, un político de centroderecha, habló de "un designio nacional para las próximas dos décadas". Hace justo un año, su sucesor, José Sócrates, socialista, declaraba solemnemente que su país no podía quedar rezagado, ni renunciar a la modernidad al referirse al AVE. Promesas y buenos propósitos. Los dos Gobiernos hablaban de apuesta estratégica, de cambio de cara en cinco años, del AVE Lisboa-Madrid en 2013... Tras el varapalo electoral del 7 de junio, y ante la euforia de la oposición, el Gobierno ha decidido aplazar hasta la próxima legislatura la firma de los contratos para la construcción del tramo Caia-Poceirão de la línea de alta velocidad entre Lisboa y Madrid. Una decisión aplaudida por el presidente de la República, Aníbal Cavaco Silva, que ha sentado fatal a las empresas implicadas en el concurso de licitación del primer tramo del AVE en Portugal, concretamente los consorcios Mota-Engil y Soares da Costa. Temen que un proceso que lleva mucho tiempo acabe de mala manera. En otras palabras, que el próximo Gobierno pudiera congelar la construcción de la red de alta velocidad para rebajar gastos. El primer ministro lo niega rotundamente. Hacerlo tendría consecuencias poco agradables para Portugal, que podría perder 330 millones de euros de los fondos comunitarios recibidos y debería renegociar otros 955 millones. La papeleta queda para el próximo Gobierno.

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TRIBUNA: POR JAVIER MORENO De cómo arruinar el mundo dos veces La crisis de 1929 y la actual comparten una característica: ambas fueron causadas por los errores de políticos y banqueros centrales. Para salir se necesita liderazgo. Pero la socialdemocracia europea no logra encontrarlo

POR JAVIER MORENO 21/06/2009 Pocos líderes de la socialdemocracia europea, y aun de entre los conservadores del Viejo Continente, discreparán del análisis que Barack Obama ofreció el miércoles pasado en Washington. La crisis que azota el mundo desde el verano de 2007 no es resultado de un fallo del capitalismo en sí, según explicó el presidente norteamericano, sino el producto de una cascada de errores humanos, de oportunidades perdidas y de una cierta cultura de la irresponsabilidad que resulta ahora de todo punto inaceptable. Pero también pocos de entre ellos, por no decir ninguno, aceptarían el corolario que se deriva de sus palabras: que la notable derrota que los socialistas de todo el continente hubieron de encajar en las recientes elecciones al Parlamento Europeo, y que amenaza con su extinción política como alternativa a corto plazo, no es sólo el fruto de su manifiesta impotencia para articular un programa ante la crisis; también, ciertamente, de la percepción de los ciudadanos de que la izquierda asumió durante los años de boom y excesos, en parte por molicie y en parte por conveniencia, el discurso que viene ahora en denunciar Obama. Las palabras del presidente norteamericano enmarcaron la presentación de la mayor reforma del sistema financiero de EE UU desde la Gran Depresión. Y cuando, sin citar a nadie por su nombre, Obama atribuyó las culpas del desastre a personas concretas antes que a entes abstractos o la fatalidad del destino, cuyos vagos perfiles suelen convenir a los gobernantes más desvergonzados con la historia, nadie en Washington dejó de pensar en dos hombres: el anterior presidente, George W. Bush, y el antiguo jefe del banco central, Alan Greenspan. Conviene quizá por tanto recordar ahora que también en 1929 cinco hombres, cuyas decisiones fueron clave entre 1920 y 1933, contribuyeron probablemente más que nadie a arruinar el mundo en aquella ocasión: los banqueros centrales de Estados Unidos (Benjamin Strong), Reino Unido (Montagu Norman), Francia (Émile Moreau) y Alemania (Hjalmar Schacht) a los que hay que sumar el presidente Herbert Hoo-ver, que elevó la inactividad a la categoría de arte en política. Debo esta idea a un libro de reciente aparición en EE UU (Lords of Finance. The bankers that broke the World, de Liaquat Ahamed) cuya tesis central, sin ser estrictamente una novedad, resulta lo suficientemente interesante para merecer cierta atención precisamente este año que tantos paralelismos, atinados o exagerados, está dibujando con 1929. El libro relata con detalle la fe en el dogma del patrón-oro de todos ellos, sus desvaríos sobre el funcionamiento real de la economía (que hoy provocarían hilaridad entre los estudiantes de primer curso de cualquier universidad), su triste falibilidad, que es la del

262 ser humano, y finalmente las terribles consecuencias que sus erradas decisiones infligieron a la mayoría de sus conciudadanos. Más allá de las disquisiciones sobre si la crisis actual es o será igual, menor o mayor que la que asoló el mundo a partir de 1929, creo que ése constituye el principal paralelismo que con seguridad se puede trazar ya entre ambos eventos, y que Obama vino a subrayar el otro día: un grupo reducido de altos cargos y sus políticas ocasionaron y eventualmente agravaron dos cataclismos como los de 1929 y 2007-2008. La mayoría de especialistas coincide ahora, efectivamente, en que el derrumbe de Lehman Brothers en septiembre del año pasado puso durante unas semanas al sistema financiero mundial al borde del colapso. La caída del venerable banco de inversión fue en realidad el último, o fue el penúltimo como se verá luego, de una serie de errores que los responsables políticos y monetarios de Estados Unidos habían comenzado a cometer a partir del año 2000 y que se multiplicaron tras los atentados del 11 de septiembre del año siguiente. Algunos de ellos fueron técnicos, o al menos fueron técnicos para la generalidad de los ciudadanos, como la decisión de situar el precio del dinero a un nivel extraordinariamente bajo durante un periodo extraordinariamente prolongado. Otros, sin embargo, fueron políticos. Y entre ellos destaca la decisión de no mirar a fondo (o no mirar en absoluto) a qué se dedicaban los bancos de inversión. El responsable de la política monetaria durante aquellos años fue Alan Greenspan. El de todo lo demás, George Bush. Naturalmente, Bush nunca decidió qué normas de contabilidad había que aprobar, cuáles derogar o cuáles otras modificar. Bush, como he escrito en un artículo reciente, simplemente encarnó la figura política necesaria, como presidente de la primera potencia mundial, que otorgó legitimidad y discurso a todas aquellas prácticas. Bush, en breve, las bendijo. La mayoría de economistas coincide pues en que las causas del desastre actual se reducen a dos: demasiados años de desregulación interesada de los mercados por parte de los hombres de Bush y especulación alimentada por el crédito barato de Greenspan. Muchos de esos economistas creen, por tanto, que Bush, Greenspan y los neocon, por tomar prestado el título del libro de Ahamed, arruinaron el mundo a finales de 2008. Para mayor escarnio, es probable que cuando acabó su mandato, el presidente Bush no supiese mucha más economía que cuando llegó a la Casa Blanca ocho años antes. Y es muy probable también que cuando llegó a la Casa Blanca ocho antes no supiese nada en absoluto. El último gran error (de momento) de esta desgraciada sucesión de acontecimientos se produjo en las semanas posteriores al derrumbe de Lehman, cuando las vacilaciones, la indecisión y, de nuevo, el desconocimiento profundo de lo que estaba sucediendo llevó a lo que quedaba de la Administración Bush a agravar aún más si cabe la situación, según establece convincentemente otro librito aparecido hace apenas dos meses (Getting off track, de John B. Taylor, Hoover Institution Press). Taylor retrotrae esta incomprensión profunda al momento del primer fogonazo de la crisis en agosto de 2007, lo que provocó que durante más de un año se ensayasen una tras otra recetas perfectamente inútiles que no hicieron más que agravar el estado de los mercados y la economía en general. Otro tanto podría predicarse con similar certidumbre del Banco Central Europeo. ¿Cabe extrañarse pues de que la desconfianza de los ciudadanos de todo el mundo en sus gobernantes haya sufrido un grave retroceso? El último Eurobarómetro muestra un desplome de la confianza en todas las instituciones, especialmente la del Banco Central Europeo, pero también en otras, como la Comisión Europea, lo que demuestra que los ciudadanos esperan de sus gobernantes lo que éstos no han sabido proporcionales desde el estallido de esta crisis: esencialmente, protección frente a la inmensa destrucción de

263 riqueza que ha golpeado a los europeos de todos los niveles sociales y a las terribles consecuencias de una exclusión social creciente que amenaza con diezmar a las clases medias y abocar a la miseria a las más modestas; y esencialmente también, confianza. La socialdemocracia europea necesita por ello repensar con urgencia su tarea y las herramientas con las que culminarla con éxito, so pena de ver el continente arrastrado por una deriva populista que la excluya del mapa político. Siendo general en toda Europa la pérdida de confianza en los Gobiernos, en ningún otro país resulta esta afirmación más evidente que en España, cuyo Ejecutivo ha hecho ciertamente esfuerzos por arruinar la mucha o poca que los españoles pudieran haber tenido en sus capacidades; desde negar durante meses las evidencias de una crisis cuyas consecuencias amenazan con ser devastadoras para la mayoría, hasta el empecinamiento del ministro de Trabajo en desmentir que el paro alcanzaría los cuatro millones de trabajadores quince minutos antes de que se anunciase oficialmente tan triste récord, o los continuos retrasos del plan de salvamento de cajas y bancos, que a fecha de hoy sigue sin estar listo. El resultado está a la vista. El 65% de la población, según una encuesta del CIS de mayo, confía poco o nada de las capacidades de gobernación del presidente del Gobierno, especialmente en el terreno económico. Y pese a ello, los socialistas perdieron las elecciones europeas frente a un partido de cuyo líder desconfía ni más ni menos que el 80% de los ciudadanos, según la misma encuesta. Rajoy y el PP, por cierto, formaron parte con entusiasmo de la avanzadilla ideológica de Bush en todas sus variantes, desde la guerra de Irak hasta la milagrería económica que ahora se ha revelado falsa, sin que hayamos escuchado de momento el menor propósito de enmienda y sin que sus propuestas económicas pasen de meros balbuceos inconsistentes. Entretanto, ninguno de los dos partidos ha sido capaz, ni ha querido tampoco, elevar el debate sobre la crisis por encima del nivel sonrojante en el que está entrando de un tiempo acá la política española, como demuestra que el asunto estrella de la pasada campaña consistiese en averiguar si el presidente puede o no desplazarse a los mítines en un avión oficial. España no se merece la clase política que la gobierna, y harán mal los partidos en ignorar los signos crecientes de hartazgo y de desafección de los ciudadanos en un momento en el que el país se dispone a atravesar uno de los periodos de mayor tensión social de su historia reciente por el aumento del desempleo y el desplome de la actividad económica. De nuevo, es a la izquierda a quién más perjudica esta deriva. Como se ha visto, cinco hombres arruinaron el mundo en 1929. Dos, más un puñado de ideólogos neocon, fueron los responsables principales del desastre en 2008. Así que nada indica que no baste con otros dos para arruinar un país. Y aun uno solo. http://www.elpais.com/articulo/opinion/arruinar/mundo/veces/elpepuopi/20090621elpepi opi_11/Tes

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Opinion

June 19, 2009 OP-ED COLUMNIST Out of the Shadows By Paul Krugman Would the Obama administration’s plan for financial reform do what has to be done? Yes and no. Yes, the plan would plug some big holes in regulation. But as described, it wouldn’t end the skewed incentives that made the current crisis inevitable. Let’s start with the good news. Our current system of financial regulation dates back to a time when everything that functioned as a bank looked like a bank. As long as you regulated big marble buildings with rows of tellers, you pretty much had things nailed down. But today you don’t have to look like a bank to be a bank. As Tim Geithner, the Treasury secretary, put it in a widely cited speech last summer, banking is anything that involves financing “long-term risky and relatively illiquid assets” with “very short-term liabilities.” Cases in point: Bear Stearns and Lehman, both of which financed large investments in risky securities primarily with short-term borrowing. And as Mr. Geithner pointed out, by 2007 more than half of America’s banking, in this sense, was being handled by a “parallel financial system” — others call it “shadow banking” — of largely unregulated institutions. These non-bank banks, he ruefully noted, were “vulnerable to a classic type of run, but without the protections such as deposit insurance that the banking system has in place to reduce such risks.” When Lehman fell, we learned just how vulnerable shadow banking was: a global run on the system brought the world economy to its knees. One thing financial reform must do, then, is bring non-bank banking out of the shadows. The Obama plan does this by giving the Federal Reserve the power to regulate any large financial institution it deems “systemically important” — that is, able to create havoc if it fails — whether or not that institution is a traditional bank. Such institutions would be required to hold relatively large amounts of capital to cover possible losses, relatively large amounts of cash to cover possible demands from creditors, and so on. And the government would have the authority to seize such institutions if they appear insolvent — the kind of power that the Federal Deposit Insurance Corporation already has with regard to traditional banks, but that has been lacking with regard to institutions like Lehman or A.I.G. Good stuff. But what about the broader problem of financial excess? President Obama’s speech outlining the financial plan described the underlying problem very well. Wall Street developed a “culture of irresponsibility,” the president

265 said. Lenders didn’t hold on to their loans, but instead sold them off to be repackaged into securities, which in turn were sold to investors who didn’t understand what they were buying. “Meanwhile,” he said, “executive compensation — unmoored from long- term performance or even reality — rewarded recklessness rather than responsibility.” Unfortunately, the plan as released doesn’t live up to the diagnosis. True, the proposed new Consumer Financial Protection Agency would help control abusive lending. And the proposal that lenders be required to hold on to 5 percent of their loans, rather than selling everything off to be repackaged, would provide some incentive to lend responsibly. But 5 percent isn’t enough to deter much risky lending, given the huge rewards to financial executives who book short-term profits. So what should be done about those rewards? Tellingly, the administration’s executive summary of its proposals highlights “compensation practices” as a key cause of the crisis, but then fails to say anything about addressing those practices. The long-form version says more, but what it says — “Federal regulators should issue standards and guidelines to better align executive compensation practices of financial firms with long-term shareholder value” — is a description of what should happen, rather than a plan to make it happen. Furthermore, the plan says very little of substance about reforming the rating agencies, whose willingness to give a seal of approval to dubious securities played an important role in creating the mess we’re in. In short, Mr. Obama has a clear vision of what went wrong, but aside from regulating shadow banking — no small thing, to be sure — his plan basically punts on the question of how to keep it from happening all over again, pushing the hard decisions off to future regulators. I’m aware of the political realities: getting financial reform through Congress won’t be easy. And even as it stands the Obama plan would be a lot better than nothing. But to live up to its own analysis, the Obama administration needs to come down harder on the rating agencies and, even more important, get much more specific about reforming the way bankers are paid.

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TRIBUNA: Empresas & sectores PAUL KRUGMAN Salir de las sombras PAUL KRUGMAN 21/06/2009 Servirá el plan de reforma financiera de la Administración de Obama para hacer lo que hay que hacer? Sí y no. Sí, el plan taparía algunos grandes agujeros en la regulación. Pero, tal y como lo han descrito, no pondría fin a esos incentivos distorsionados que han hecho que la crisis actual sea inevitable. Empecemos por las buenas noticias. Nuestro sistema actual de regulación financiera data de una época en la que todo lo que funcionaba como un banco parecía un banco. Mientras que uno controlase los grandes edificios de mármol con sus filas de cajeros, uno tenía las cosas bastante bien atadas. Pero hoy no hay que parecer un banco para ser un banco. Como lo ha expresado Tim Geithner, el secretario del Tesoro, en un discurso citado infinidad de veces que dio el verano pasado, la banca es cualquier cosa que conlleve la financiación de "activos a largo plazo, de riesgo y hasta cierto punto sin liquidez" con "responsabilidades a muy corto plazo". Dos buenos ejemplos: Bear Stearns y Lehman, que financiaron grandes inversiones en valores de alto riesgo, principalmente con préstamos a corto plazo. Y como Geithner señalaba, en 2007 más de la mitad de la banca estadounidense, en este sentido, estaba en manos de un "sistema financiero paralelo" -otros lo llaman "banca en la sombra"- de instituciones que en gran medida no estaban reguladas. Como señalaba con tristeza, estos bancos que no son bancos eran "vulnerables a las típicas retiradas masivas de depósitos, pero sin las protecciones, como los seguros de depósitos, que el sistema bancario tiene establecidas para reducir esos riesgos". Cuando Lehman cayó, nos dimos cuenta de lo vulnerable que era la banca en la sombra: una retirada generalizada de depósitos del sistema hizo que la economía mundial mordiese el polvo. Por eso, una de las cosas que la reforma financiera tiene que hacer es sacar de la sombra a los bancos que no son bancos. El plan de Obama lo hace al otorgarle a la Reserva Federal el poder de regular cualquier gran institución financiera que juzgue "importante para el sistema" (es decir, capaz de causar estragos con su hundimiento), independientemente de que esa institución sea o no un banco tradicional. A esas instituciones se les exigiría que reservasen cantidades relativamente grandes de capital para cubrir posibles pérdidas, cantidades relativamente grandes de efectivo para cubrir posibles demandas de los acreedores, y así sucesivamente. Y el Gobierno tendría autoridad para hacerse cargo de esas instituciones si diesen la impresión de ser insolventes; la clase de poder que la Corporación de Seguros del Depósito Federal ya tiene sobre los bancos tradicionales, pero que faltaba para instituciones como Lehman o A.I.G. Buena idea. ¿Pero qué pasa con el problema más general de los excesos financieros? El discurso del presidente Obama en el que se esbozaba el plan financiero describía muy bien el problema. Wall Street ha desarrollado una "cultura de la irresponsabilidad", decía

267 el presidente. Los prestamistas no se guardaban sus préstamos sino que, en vez de eso, los vendían baratos para que se reconvirtiesen en valores que, a su vez, eran vendidos a inversores que no comprendían lo que estaban comprando. "Mientras tanto", decía, "la compensación ejecutiva -sintiéndose libre de las ataduras del rendimiento a largo plazo o incluso de la realidad- recompensaba la imprudencia más que la responsabilidad". Desgraciadamente, el plan, de la forma en que se ha publicado, no es consecuente con el diagnóstico. Es verdad que el nuevo Organismo de Protección Financiera al Consumidor propuesto ayudaría a controlar los préstamos abusivos. Y la propuesta de que a los prestamistas se les exija quedarse con el 5% de sus préstamos, en vez de venderlo todo para su reconversión, supondría cierto incentivo para prestar de forma responsable. Pero el 5% no es suficiente para disuadir de gran parte de los préstamos de riesgo, dadas las enormes recompensas que reciben los ejecutivos financieros que ingresan beneficios a corto plazo. Así que ¿qué debe hacerse con esas recompensas? De manera certera, el resumen ejecutivo que la Administración hace de sus propuestas destaca las "prácticas retributivas" como motivo clave de la crisis, pero luego no es capaz de aportar nada sobre la forma de enfrentarse a esas prácticas. La versión larga dice más cosas, pero lo que dice -"los reguladores federales deben ofrecer normas y directrices para que las prácticas de compensación a los ejecutivos de las empresas financieras estén más en consonancia con el valor a largo plazo para el accionista"- es una descripción de lo que debería pasar, más que un plan para hacer que pase. Además, el plan dice muy pocas cosas sustanciales sobre la reforma de los organismos de calificación, cuya disposición a otorgar un sello de aprobación a valores turbios ha desempeñado un importante papel a la hora de organizar el lío en el que estamos. En resumen, Obama tiene una visión clara de lo que ha funcionado mal pero, aparte de regular la banca en la sombra (lo que no es poco, a decir verdad) su plan básicamente le da un puntapié a la pregunta de cómo evitar que todo vuelva a repetirse, y deja las decisiones difíciles para futuros reguladores. Soy consciente de las realidades políticas: conseguir que el Congreso apruebe una reforma financiera no será fácil. E, incluso tal como está, el plan de Obama sería mucho mejor que nada. Pero para ser consecuente con su propio análisis, la Administración de Obama tiene que ser más dura con los organismos de calificación y, lo que es aún más importante, ser mucho más concreta en cuanto a reformar la manera en que se paga a los banqueros. http://www.elpais.com/articulo/empresas/Salir/sombras/elpepueco/20090621elpnegemp_ 4/Tes

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19.06.2009 It is now up to the EP to decide the timetable of Barroso’s renomination

Europe’s leaders gave a political declaration of their support for Jose Manuel Barroso to remain as president of the Commission, but as Jean Quatremer explains, the process is going to be difficult. It is now up to the newly elected European Parliament to set the calendar, and it is possible for this election of the new president to take place after the Irish vote on the Lisbon Treaty, in which case the hurdle for approval would increase from a simple majority (a majority among those present who vote), to an absolute majority (more than half of all deputies, whether present or not). Quatremer has some details about a non published letter Barroso is supposed to have written to lay out his agenda, which sounds like he has no big idea of what he is going to do, or why he wants the job beyond some platitudes. The article quotes Daniela Cohn Bendit as saying that the problem for Merkel and Sarkozy is that they want Barroso, and do not want him. Quatremer makes the point that Barroso wanted to be quickly nominated by the European Council, and the Council has essentially rejected that request. (The bets are that Barroso will still get in, and there may be some dirty deal with the Socialists or the Liberals, but the exercise is no longer quite as straight-forward as it used to be, as he does not have an absolute majority) Cautious, and conditional optimism about the French economy The French statistical office INSEE published this morning the latest forecasts for France, reported in Les Echos (here and here). They forecast the economy to stabilise in the fourth quarter based on the assumption that financial markets normalise and in the absence of all other shocks. Employment is expected to continue to fall, for 2009 the loss is expected to reach 700,000 jobs in the private sector. Consumption growth is still positive (forecasted at +0.7%), though saving rates are about to rise slightly. France seems thus in a much better position than the rest of the euro area, for which GDP is forecasted to contract by 5.6% and consumption by -1.6%.

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Seux on Sarkozy Dominique Seux looks at the political options of Sarkozy, who is to outline his political ambitions in Versaille next Monday. Shall Sarkozy –backed on the success in the European elections – embark on new political projects (as his counsellors suggest) or should he put everything into the combat of the crisis? Seux argues that with an exploding fiscal deficit and another more 500 000 job losses to expect for this year, it would be foolish to slow down reforms as it is the crisis that dictates the reform agenda. Iceland wants to join EU by 2011 FT Deutschland has an article that Iceland will officially apply to become a member of the EU in July, and hopes to enter the union as early as 2011. The paper says that Iceland is trying to speed up the process, but quotes diplomats as saying that this goal was ambitious, or possibly unrealistic, given that entry negotiations, even with a country like Iceland that fulfils most of the EU’s single market rules already, are always more difficult. (In Iceland’s case fisheries is almost certain to be a difficult issue). A third of US prices is declining In a characteristically pointy-headed debate about whether the mean or the median is a better measure of inflation, Mark Thoma has an interesting observation. A third of prices in the consumer price index are now falling, and that number is now up from last year. We are still not in deflation, probably not even close, but this is no doubt a serious statistic. Blanchard on global imbalances Writing in the FT, Olivier Blachard says that the world’s most pressing economic imbalances could be solved if the US and China were to co-ordinate policy – which should involve a rise in domestic spending in China. Blanchard notes that the US private sector had already started to adjust, and in China the introduction of health care reforms were also a first step in the right direction, but China was still clinging on to its export-led growth model. He paints two scenarios: Either the US continues to run deficits to make up for the fall in private sector – which would result in financial instability – or the US would not do this – which would result in a squeeze on global growth. The solution would be a switch in Chinese growth policies, but it is at this point uncertain whether this will happen. Romer on 1937 This is an interesting guest article in the Economist by Christina Romer, chief of President Obama’s Council of Economic Advisers. She takes a look at 1937, when the post-depression recovery was rudely interrupted, and when unemployment rose back to 19%. She says this is a cautionary tale – the result of the US taking back monetary and fiscal accommodation too rapidly. (The remarks are important in the sense that they tell us about the thinking the White House – and probably at the Fed as well. The US will probably make new mistakes, and possibly bigger mistakes as it did in 1937, but it will not be the same mistake.) http://www.eurointelligence.com/article.581+M5bf23fbd0cc.0.html#

270 Housing Special Report June 18, 2009, 5:00PM Where Housing Will Be in 2012 Home prices are likely to fall for the next year, then stabilize, with a rebound in 2012 as the overall economy takes off again By Peter Coy, Mara Der Hovanesian, Christopher Palmeri, Amy S. Choi and Tara Kalwarski Americans have not seen a boring housing market since the last millennium. You know— the average, ordinary kind of market where supply just about matches demand, prices are steady, and real estate ceases to be a topic of daily conversation. Instead, we've had six years of upside craziness followed by three years of downside terror. Now we're in a tug- of-war between those who think we've finally found a bottom and those who are convinced that the overhang of unsold homes is going to push prices considerably lower. By 2012 we may finally get back to blissful boredom. With any luck, three years should be long enough for the U.S. economy to recover and for the nation's housing inventory to shrink to more normal levels. At that point, housing will return to its old ways, with prices governed not by national mood swings and global credit crises but by local issues ranging from zoning to immigration to job growth. Prices? While they're likely to keep falling a while longer under the weight of foreclosures, the market is definitely closer to the bottom than the top. "We expect prices to drop for another year and then stabilize before starting to rise with incomes," says Standard & Poor's (MHP) Chief Economist David Wyss. Moody's Economy.com (MCO) predicts the S&P/Case-Shiller U.S. National Home Price Index, maintained by data specialist Fiserv, will fall about 16% this year before regaining ground. Based on the National Association of Realtors national median home price of $180,000 for the fourth quarter of 2008, that would mean a median of $152,000 at the end of 2009 and then a rebound to $179,000 by the end of 2012. ALL REAL ESTATE IS LOCAL Of course, the national median price is an artificial construct, since there is no such place as National Median, U.S.A. That's why the following pages provide up-close looks at seven markets: Omaha; Seattle; Saratoga Springs, N.Y.; ; Nashville; Austin, Tex.; and Merced, Calif. Each illustrates a different trend that will have a big impact on sales and prices across the U.S. Local job growth is one of the most important factors to study when assessing a market's prospects. Omaha, for example, which has attracted employers such as Yahoo! (YHOO) and Google (GOOG), missed out on the boom but is likewise dodging the bust. With the city adding jobs, the prospects for home prices look good. Detroit, where home prices fell by a third from 2003 through 2008, is likely to suffer even more in coming years as the auto sector continues to shrink. Demographic change, another trend examined here, is equally influential. For instance, Salt Lake City's youthful population is primed for house buying. While the bust left prices in once-bubbly Western markets such as Phoenix and Vegas lower in 2008 than in 2003, Salt Lake prices rose 51% over that period. Other important factors are even more local than those, such as how far a house is from the nearest supermarket. You'll know we're back to an ordinary, boring real estate market when buyers focus less on the intricacies of foreclosures, short sales, and the like and go back to the things that used to matter most: What are the schools like? How quiet is the

271 neighborhood? When am I going to have to replace that roof or cut down that diseased oak? Sellers Mark and Maura Rampolla, who put their house in Oradell, N.J., on the market early this year, are coping with ultra-local issues such as their house being on a fairly busy road. They're also up against the national housing crisis angst. The Rampollas bought their house for $556,000 in 2004. Now they need to sell it because they're moving to the Los Angeles area to set up a West Coast distribution hub for their coconut-water sports-drink company, Zico. They listed the house for $599,000, which would represent a loss after factoring in closing costs and renovations. House hunters didn't even nibble on the property that the Rampollas and their two young daughters have grown to love. In mid-June the couple dropped the price to $559,000. "People say it's a beautiful house, but they're just very nervous right now," says Maura. The Rampollas will probably end up being the first owners to lose money on the Oradell home since it was built in 1925—a phenomenon that's happening across the U.S. The classic American foursquare, with four bedrooms and original chestnut molding, was sold by the Bonavita family to the Riccio family for $47,000 in 1972, the first recorded transaction price. The Riccios made out by selling to the DeSouza family for $285,000 in 1997. The DeSouzas sold just seven years later to the Rampollas for $556,000. "We actually bought the house in a day," laughs Maura. "Mark ran through the house in 10 minutes, I kid you not, because he had to get to a meeting in Queens. ... We had nothing to sell, and we just said: 'Great!' " The good news is that the Rampollas' loss could wind up being some first-time home buyer's gain. From now through 2012, lots of families that couldn't afford to buy when prices went through the roof will be able to get in on the ground floor. Based on today's household incomes and mortgage rates, the National Association of Realtors' Housing Affordability Index is bobbing around the highest level since recordkeeping began in 1970. "To generalize, yeah, it is a good time to buy a house. I don't think there's any urgency because I think it'll still be a great time to buy a house a year from now," says economist Richard DeKaser of Woodley Park Research in Washington. Homebuilders are helping by absorbing their share of the pain. In general, the U.S. needs about 1.5 million new homes a year to accommodate the growing population and the demolition of decayed properties. Builders exceeded that rate during the boom, but now they're building fewer than 500,000 homes per year. Their cutback should reduce the glut of homes and bring the market into better balance by 2012, if not sooner. A STILL-MURKY PICTURE Most important, the economy should be growing briskly again by 2012, according to Moody's Economy.com. In May the firm predicted gross domestic product would shrink 3% this year before growing 1.4% in 2010, 4.7% in 2011, and a robust 5.8% in 2012. It's also looking for home buying and building to return to their pre-bubble paces—no higher and no lower—by 2012. Even if the economy performs as projected, there's still plenty that could go wrong in the housing market. Because conditions have been so unusual, "it's very hard for the model to extrapolate, based on past experiences, what's going to happen this time," says Moody's Economy.com Senior Economist Celia Chen. In a study of global real estate markets, economists Kenneth Rogoff of Harvard University and Carmen Reinhart of the University of Maryland found that home prices fall for an average of six years after a major financial crisis. That would put the U.S. bottom in 2012, or later.

272 Another risk is that potential buyers will stay out of the housing market, no longer trusting in home appreciation to do their saving for them. Writes David Rosenberg, the former Merrill Lynch (BAC) economist who is now chief economist at Toronto-based asset management firm Gluskin Sheff & Associates: "Baby boomers are still in the discovery process on oversized real estate being more of a ball and chain than a viable retirement investment asset." Rosenberg also is concerned that an aging population won't need the kind of big houses erected during the boom. "The high end of the market will be in a bear phase," Rosenberg says in an interview. So much has gone wrong with housing lately that it's easy to imagine worst-case scenarios. But in the more likely case, the market will fall some more, bounce off its lows, then gradually start growing. By 2012, families like the Rampollas may even get a warm, fuzzy feeling about homeownership again. Business Exchange: Read, save, and add content on BW's new Web 2.0 topic network The Global Picture Like the U.S., the global real estate market will continue to struggle amid a weak economy and rising unemployment, according to a recent report by research firm Knight Frank. The worst-performing markets over the past year: Dubai and Singapore, where home prices dropped 32% and 23%, respectively. Israel (up 10.9% over the same period) and the Czech Republic (up 9.9%) saw the biggest spikes. http://www.businessweek.com/magazine/content/09_26/b4137028238311.htm?campaign _id=rss_daily

273 Politics

June 18, 2009 In Poll, Obama Is Seen as Ineffective on the Economy By JEFF ZELENY and DALIA SUSSMAN A substantial majority of Americans say President Obama has not developed a strategy to deal with the budget deficit, according to the latest New York Times/CBS News poll, which also found that support for his plans to overhaul health care, rescue the auto industry and close the prison at Guantánamo Bay, Cuba, falls well below his job approval ratings. A distinct gulf exists between Mr. Obama’s overall standing and how some of his key initiatives are viewed, with fewer than half of Americans saying they approve of how he has handled health care and the effort to save General Motors and Chrysler. A majority of people said his policies have had either no effect yet on improving the economy or had made it worse, underscoring how his political strength still rests on faith in his leadership rather than concrete results. As Mr. Obama finishes his fifth month in office and assumes greater ownership of the problems he inherited, Americans are alarmed by the hundreds of billions of dollars that have been doled out to boost the economy. A majority said the government should instead focus on reducing the federal deficit. But with a job approval rating of 63 percent, Mr. Obama has the backing of Democrats and independents alike, a standing that many presidents would envy and try to use to build support for their policies. His rating has fallen to 23 percent among Republicans, from 44 percent in February, a sign that bridging the partisan divide may remain an unaccomplished goal. The poll was conducted after Mr. Obama completed his fourth international trip as president. He received high marks for his focus abroad, with 59 percent of those polled saying they approve of his approach to foreign policy. And after weeks of criticism from former Vice President Dick Cheney and other Republicans, 57 percent say they approve of how Mr. Obama has dealt with the threat of terrorism. The White House is entering a critical summer with Mr. Obama pledging to push his plans to revamp health care and financial regulation through Congress and Senate hearings scheduled on his first nominee to the Supreme Court. The poll suggested Americans remain patient, even as a strong majority expressed concern that they or someone in their family could lose their jobs in the next year. “My feeling is that Obama is just throwing money at things, but I don’t see anything being specifically targeted,” Lynn Adams, 62, a Republican from Troy, Mich., said in a follow-up interview. “But I’m giving him the benefit of the doubt because he hasn’t been in office long enough.” Judge Sonia Sotomayor, whom Mr. Obama nominated to the Supreme Court three weeks ago, is still widely unknown to the public, the poll found. A majority of people surveyed, 53 percent, said they did not know enough about Judge Sotomayor, who would be the first Hispanic justice, to say whether she should be confirmed. But 74 percent said that it

274 was either very or somewhat important for the Supreme Court to reflect the country’s diversity. Before the Senate votes on her confirmation, 48 percent of people said her positions on issues like abortion and affirmative action were very important to know about. The national telephone poll was conducted Friday through Tuesday with 895 adults, and has a margin of sampling error of plus or minus three percentage points. The poll highlights the political and governing challenges on the horizon for Mr. Obama, including the towering federal budget deficit, which is expected to push the national debt to levels that many economists say could threaten the economy’s long-term vitality. Six in 10 people surveyed said the administration has yet to develop a clear plan for dealing with the deficit, including 65 percent of independents. Mr. Obama, in an interview on Tuesday with CNBC and The New York Times, said the budget deficit was “something that keeps me awake at night.” While Republicans have steadily increased their criticism of Mr. Obama, particularly on the budget deficit, the poll found that the Republican Party is viewed favorably by only 28 percent of those polled, the lowest rating ever in a New York Times/CBS News poll. In contrast, 57 percent said that they had a favorable view of the Democratic Party. The nomination of a Supreme Court justice, as well as the fatal shooting of an abortion doctor in Kansas late last month, injected a fresh dynamic into the national abortion debate. But the poll found essentially no change in the public’s views of abortion in the last two decades, with 36 percent saying it should be generally available, 41 percent saying it should be available but under stricter limits than are now in place and 21 percent saying it should not be permitted. The nomination of Judge Sotomayor also has renewed discussion about affirmative action. Half of those surveyed said they favored programs that make special efforts to help minorities get ahead, a number that rises among nonwhite respondents and women. Far more, 8 in 10, said they favored programs to help low-income Americans get ahead, regardless of gender or ethnicity. The issues of abortion and affirmative action sharply divide voters in each major political party. Among Democrats, 71 percent oppose overturning Roe v. Wade, while Republicans are closely divided. And 67 percent of Democrats support affirmative action programs for minorities, while 60 percent of Republicans oppose them. Beyond these issues, which Mr. Obama has sought to avoid becoming entangled in, he faces a divided public as he works to carry out his executive order to close the prison for terrorism suspects at Guantánamo Bay. The poll found that 8 in 10 expressed worry that detainees released to other countries might be involved in future attacks here. Half of the poll respondents said closing the prison would have no effect on protecting the nation from terror threats, but 3 in 10 said they thought it would make the United States less safe. Many of the detainees being held at the prison have not been charged, and nearly 7 in 10 people surveyed said they would support charging them or releasing them back to the country of their capture. Just 24 percent said the detainees should continue to be held without charge for as long as the government deems necessary. The poll found that a wide majority of those who support closing the prison said their views would not change even if detainees were sent to maximum security prisons in the United States.

275 “It’s a bad symbol for our country: Preach one thing and do something else,” said Roberta Hall, 73, a Democrat from Barboursville, W.Va. “We can transfer them here. We’re good at keeping prisoners. That’s what we do best.” Marjorie Connelly and Marina Stefan contributed reporting.

18.06.2009 A transatlantic divide: While America reforms its regulatory system, Europe waits

Whereas Obama presents his supervisory reforms... It is no surprise that the US is faster in introducing regulatory reform than the Europeans, given their top down political system, but there is one aspect of President Obama’s big reform package which is important, which the European are almost not certain to follow, as it touches on national sensibilities: the regulation of systemically relevant institutions. Under this plan, the Fed takes direct responsibility for the too-large-to-fail institutions, irrespective of their category. They could be banks, or even companies. The FT called it the biggest regulatory revamp since the 1930s, which saw the introduction of the Glass- Steagall reforms. The reforms also include the ability to intervene in the regulation of OTC derivatives markets, but stops short of outright regulation, which would have run into opposition from Congress, which has to approve parts of the plan. The plan has been criticised by some as it concentrates a lot of power in the Fed, as this may raise expectations the Fed might not be able to fulfil. (It certainly would not have not prevented this bubble, as the Fed, Greenspan and Bernanke include, was one of the biggest chearleaders in the past bubble. We like the too-big-to-fail bit, though.) ... the Europeans procrastinate Europe’s regulatory reform programme – the solid but disappointingly unambitious De Larosiere reform – look like to get delay, as the Czech EU presidency has decide to

276 kowtow to the British, who want to postpone the issue of regulatory reform out of existence, FT Deutschland reports. At the last Ecofin, Britain’s finance minister Alastair Darling insisted on a clause in the final declaration, according to which any European regulatory reform must not impact national budgets. (if that is so, how can the Microprudential Authorities realistically be expected to make binding arbitrage among national regulators, as outlined by De Larosiere?) A quote from Mervyn King Mervyn King also gave a sceptical assessment of the state of regulatory and supervisory reforms. As the London Times (hat tip Calculated Risk) reports, King said it is important to prevent too-large-to-fail institutions, or force them to divest, but he said warnings such as these were habitually ignored. “The Bank finds itself in a position rather like that of a church whose congregation attends weddings and burials but ignores the sermons in between.”

Was the IMF bullied into supporting the Latvian exchange rate policy? The FT has an interesting analysis on Latvia – entitled a Lat to worry about – but as Kevin O’Rourke notes in the Irish economy blog, the most interest bit is the following section. “IMF officials have indicated that the organisation was divided over the wisdom of defending the lat’s peg but was finally persuaded by pressure from Riga’s EU partners as well as the Latvian government’s own refusal to contemplate devaluation.” (We heard something like that too. The IMF is very very unhappy with what is happening over there.) Barroso may not have majority in July Jose Manuel Barroso may not have a majority in the European Parliament for a quick July election, FT Deutschland reports, and this may affect the time table for the election. The Socialists, the Greens, and the other left parties have decide not to support him should the EU Council decide to nominate him formally today. The paper say this latest twist will not stop Barroso’s renomination (which is still seen as certain), only delay until September. The left parties want to make some deals, before supporting him. Italy’s economic mess The OECD yesterday forecast an Italian GDP fall by 5.3% this year, almost as bad as Germany’s, followed by only a weak recovery in 2010, in its latest report on Italy, published yesterday, La Repubblica reports. It warns of a rise in unemployment to over 10% next year, the public-sector deficit will hit 10%, while the level of debt will be approaching 120%. The reports also laments the slow progress Italy has made introducing reforms to free up the service sector, and to reform the administration. The OECD was particularly critical of car subsidies to prop up the country’s ailing auto sector, as this would lead to a misallocation of resources. Klau on Obama Thomas Klau has made some interesting observations in his FT Deutschland column, in which he notes that both Merkel and Sarkozy were piqued by Obama’s decision to set his

277 own agenda during his last visit. Klau says Obama expects more of the Europe in terms of international leadership than the Europeans are willing to provide. He is ready for a constructive partnership, but only if the Europeans get their act together. Otherwise, Klau concludes, the US is ready to shift its priorities. He said there are more important people for Obama to deal with than vane European politicians, who are vying for attention. Shiller on house prices Robert Shiller (aka Mark Thoma) has an interesting comment on house prices in his latest Project Syndicate column. “There is a lot of misunderstanding about home prices. Many people all over the world seem to have thought that since we are running out of land in a rapidly growing world economy, the prices of houses and apartments should increase at huge rates.” He says this is wrong. There is no shortage anywhere, and the sobering truth is that the crisis was substantially cause by speculators who misunderstood the factors causing the price increases.

278 Jun 17, 2009 Regulatory Reform in the U.S.: Systemic Regulator and Receivership Back On The Radar Screen o June 17, Comprehensive Plan for Regulatory Reform: : New framework includes the 1) Fed as systemic risk regulator and creation of “council of regulators” 2) requires the originator, sponsor or broker of a securitization to retain a financial interest in its performance ('skin in the game'). Also regulate all financial derivatives for the first time; 3) Consumer Financial Protection Agency for strong investor protection and rules against predatory lending. 4) new resolution mechanism that allows for the orderly resolution of any financial holding company whose failure might threaten the stability of the financial system, including large hedge funds and major insurers such as AIG. 5) lead the effort to improve regulation and supervision around the world. o Specifically: June 16 FT: The Fed will retain day-to-day supervision of the largest bank holding companies – which the Bush administration had proposed taking away – and may become sole regulator. The Fed will also directly supervise non-bank financial companies that reach a size and complexity comparable to these banks. Fed is also likely to be given the final word on bank capital requirements, including a surcharge for the systemically important financial institutions. FDIC will receive new non- bank/holding resolution authority. No federal insurance regulation but a national insurance office within the Treasury to gather information about the industry o FT: Most likely securitizations will be subject to different rating scale.

Main Points of Contention in Congress: o Baker/Wallison: Why expand the powers of an agency that sat idly by as the housing bubble took shape? March 6 Reuters: "Are any of you troubled with giving the Fed so much power?" asked Spencer Bachus, the top Republican on the full House Financial Services committee. o WaPo: second element likely to provoke fierce debate is the establishment of a Consumer Financial Protection Agency with a mandate to increase the availability of financial products in lower-income communities and other underserved areas

Opinions: o George Soros: To avert a repetition, the agents must 1) have “skin in the game” (5% is too little; 10% should be minimum). 2) Securities held by banks should carry a higher risk rating than they do under the Basel Accords. 3) Banks should pay for the implicit guarantee they enjoy by using less leverage and accepting restrictions on how they invest depositors’ money; they should not be allowed to speculate for their own account with other people’s money. 4) The issuance and trading of derivatives ought to be as strictly regulated as stocks. CDS in particular should be outlawed altogether.

279 o Hyun Song Shin; Joseph Mason: Require securitization originators to keep skin in the game is not going to solve anything: The very reason for this banking crisis is that banks actually held on to the economic risk while treating the securitized assets as sold for accounting purposes (see e.g. FAS 140) o Barry Ritholtz: How to solve garbage in, garbage out problem: A default warranty of 3 or 6 months on 30 year mortgages is utterly absurd; Instead, we should mandate a 5 year warranty on 15 year mortgages, and a 7-10 year warranty on 30 years. This way, we align the interest of the underwriter with the securitizer and the ultimate buyer of that structured product. o Elisa Parisi-Capone (RGE Monitor): Goldman Sachs study shows that Basel capital frameworks currently offer capital relief for both securitizations and some re- securitizations--> same economic risk should command same capital requirement. o Paul Volcker: I do not believe hedge funds and private equity need to be so closely supervised and regulated as depository institutions. A presumption of government protection and support for financial institutions outside the [commercial banking] "safety net" should be avoided. Nor by the same token should hedge funds or private- equity funds indirectly benefit from official support by sponsorship or ownership by a banking institution--> Private Equity/ Hedge Fund Consortium Buys IndyMac: White Knights Or Indirect Access To Safety Net? o Rick Bookstaber: Under current arrangements, regulators cannot track the concentration of investors by assets or by strategies, nor can they assess the risks inherent in the huge swaps and derivatives markets. Thus, they cannot map out how a failure in one market might multiply into others. To solve this problem, financial products should be monitored the same way that food and drugs are. Require tags — bar codes if you will — to be attached to financial products so that regulators know what products are being held by each bank and hedge fund. --> see Models To Identify Systemic Financial Risk And Too-Interconnected-To-Fail: Overview Of IMF GFSR Chapters II and III o March 25: Nouriel Roubini: Finally, Geithner and Bernanke (see respective testimonies at AIG hearing on March 24 and plan presentation of March 26) have come to agree about the need for a new insolvency regime for systemically important financial institutions (bank holding companies and non bank financial institutions) in order to avoid another Lehman and expensive ad-hoc bailouts like AIG. A new conservatorship/receivership regime of insolvency could be similar to the one used to manage the orderly takeover of Fannie and Freddie. o March 10: Ben Bernanke (via FTAlphaville): Suggestions for resolving systemic risk include: more supervision for financial institutions deemed ‘too big to fail’, tighter restrictions on the assets in which money market funds can invest, and, perhaps most significantly, modifying the accounting rules which cause pro- cyclicality for bank’s capital positions. o Paul Volcker: More broadly, strict mark-to-market accounting -- entirely appropriate for trading operations and investment banks -- may introduce a degree of volatility in reporting incompatible with the basic and essential business model of banks, which inherently intermediate maturity and credit risks--> Is There an Alternative to MtM Accounting?

280 TWSJ Opinion Journal JUNE 16, 2009 Moral Hazard and the Crisis Volcker: Hedge funds don't need to be regulated like banks. Editor's note: The following is from the keynote address by former Federal Reserve Chairman Paul A. Volcker to a meeting of the International Institute of Finance in Beijing, June 11: Another important common concern is the "too big to fail" syndrome -- the presumption that an institution is so large or so inter-connected with counterparties that its creditors (possibly even shareholders) must be protected. One unfortunate consequence of the massive public assistance provided both banks and nonbanks in dealing with the present crisis is that moral hazard may, I am afraid, become more deeply embedded. We can, and we should, take steps to limit the need and possibility of official "bailouts." One approach would be to set clear policy limits to access to the "official safety net." Deposit insurance and central bank liquidity facilities are properly confined to deposit- taking institutions. It is, after all, those institutions that remain the backbone of the financial system. They provide basic essential services, meeting the needs of households, businesses and other institutions for credit, for a safe and liquid repository for their funds, and for both everyday and complex payment services. Historically, the need for continuity in those functions has provided the rationale for close government supervision and protection. In my view, it is unwarranted that those same institutions, funded in substantial part by taxpayer-protected deposits, be engaged in substantial risk-prone proprietary trading and speculative activities that may also raise questions of virtually unmanageable conflicts of interest. Hedge funds and private-equity funds have an entirely legitimate role to play in providing liquidity and innovation in our capital markets. I do not believe they need to be so closely supervised and regulated as depository institutions. A presumption of government protection and support for financial institutions outside the "safety net" should be avoided. Nor by the same token should hedge funds or private-equity funds indirectly benefit from official support by sponsorship or ownership by a banking institution. The possibility that failure of a large hedge fund or trading organization might present a systemic risk can be reduced by way of speeding timely resolution of troubled nonbanking institutions. Such authority already exists in the United States for insured banking institutions by means of appointing a "conservator" or "receiver" empowered to maintain continuity of services pending a more lasting resolution of a failing institution. There is a growing international consensus that hedge funds and equity funds beyond some de minimus size should at least be required to register, with the implication of limited reporting requirements. There may be a few instances in which such funds become so large as to suggest official capital and leverage requirements would be appropriate. Hedge and private-equity funds are necessarily dependent on banks for credit and operational needs. Encouraged by supervisory and risk-management processes, such funds could be appropriately monitored and controlled through those banking relationships. One other hotly contested matter deserves mention. There isn't much doubt that attempts to enforce strict application of mark-to-market accounting procedures has contributed to

281 confusion, uncertainty and inconsistencies among financial institutions. There is a strong case for reviewing the application of so-called fair value standards to commercial banks, insurance companies and perhaps certain other regulated financial institutions. The problem is not only the difficulty of measuring value in highly disturbed market conditions. More broadly, strict mark-to-market accounting -- entirely appropriate for trading operations and investment banks -- may introduce a degree of volatility in reporting incompatible with the basic and essential business model of banks, which inherently intermediate maturity and credit risks. At the same time, we should demand international consistency and professional judgment in setting accounting standards. Both are today jeopardized. Political bodies in Europe or the United States or any other country are simply not the appropriate venue for reaching well-considered judgments that can be enforced internationally. Instead, we need a bit of patience as the International Accounting Standards Board carefully reviews the application of "fair value" to banks and those other institutions subject to close official scrutiny in reporting. This has been a heavy talk after a splendid dinner in this Great Hall. My excuse is simple, you have a very long, very technical agenda, and I am delighted to be able to get a few words in first. I appreciate your attention. Printed in The Wall Street Journal, page A15 http://online.wsj.com/article/SB124511733241717573.html#

282 COMMENT The three steps to financial reform By George Soros Published: June 16 2009 19:47 | Last updated: June 16 2009 19:47 The Obama administration is expected on Wednesday to propose a reorganisation of the way we regulate financial markets. I am not an advocate of too much regulation. Having gone too far in deregulating – which contributed to the current crisis – we must resist the temptation to go too far in the opposite direction. While markets are imperfect, regulators are even more so. Not only are they human, they are also bureaucratic and subject to political influences, therefore regulations should be kept to a minimum. Three principles should guide reform. First, since markets are bubble-prone, regulators must accept responsibility for preventing bubbles from growing too big. Alan Greenspan, the former chairman of the Federal Reserve, and others have expressly refused that responsibility. If markets cannot recognise bubbles, they argued, neither can regulators. They were right and yet the authorities must accept the assignment, even knowing that they are bound to be wrong. They will, however, have the benefit of feedback from the markets so they can and must continually recalibrate to correct their mistakes. Second, to control asset bubbles it is not enough to control the money supply; we must also control the availability of credit. This cannot be done with monetary tools alone – we must also use credit controls such as margin requirements and minimum capital requirements. Currently these tend to be fixed irrespective of the market’s mood. Part of the authorities’ job is to counteract these moods. Margin and minimum capital requirements should be adjusted to suit market conditions. Regulators should vary the loan-to-value ratio on commercial and residential mortgages for risk-weighting purposes to forestall real estate bubbles. Third, we must reconceptualise the meaning of market risk. The efficient market hypothesis postulates that markets tend towards equilibrium and deviations occur in a random fashion; moreover, markets are supposed to function without any discontinuity in the sequence of prices. Under these conditions market risks can be equated with the risks affecting individual market participants. As long as they manage their risks properly, regulators ought to be happy. But the efficient market hypothesis is unrealistic. Markets are subject to imbalances that individual participants may ignore if they think they can liquidate their positions. Regulators cannot ignore these imbalances. If too many participants are on the same side, positions cannot be liquidated without causing a discontinuity or, worse, a collapse. In that case the authorities may have to come to the rescue. That means that there is systemic risk in the market in addition to the risks most market participants perceived prior to the crisis. The securitisation of mortgages added a new dimension of systemic risk. Financial engineers claimed they were reducing risks through geographic diversification: in fact they were increasing them by creating an agency problem. The agents were more

283 interested in maximising fee income than in protecting the interests of bondholders. That is the verity that was ignored by regulators and market participants alike. To avert a repetition, the agents must have “skin in the game” but the 5 per cent proposed by the administration is more symbolic than substantive. I would consider 10 per cent as the minimum requirement. To allow for possible discontinuities in markets securities held by banks should carry a higher risk rating than they do under the Basel Accords. Banks should pay for the implicit guarantee they enjoy by using less leverage and accepting restrictions on how they invest depositors’ money; they should not be allowed to speculate for their own account with other people’s money. It is probably impractical to separate investment banking from commercial banking as the US did with the Glass-Steagall Act of 1933. But there has to be an internal firewall that separates proprietary trading from commercial banking. Proprietary trading ought to be financed out of a bank’s own capital. If a bank is too big to fail, regulators must go even further to protect its capital from undue risk. They must regulate the compensation packages of proprietary traders so that risks and rewards are properly aligned. This may push proprietary trading out of banks into hedge funds. That is where it properly belongs. Hedge funds and other large investors must also be closely monitored to ensure that they do not build up dangerous imbalances. Finally, I have strong views on the regulation of derivatives. The prevailing opinion is that they ought to be traded on regulated exchanges. That is not enough. The issuance and trading of derivatives ought to be as strictly regulated as stocks. Regulators ought to insist that derivatives be homogenous, standardised and transparent. Custom-made derivatives only serve to improve the profit margin of the financial engineers designing them. In fact, some derivatives ought not to be traded at all. I have in mind credit default swaps. Consider the recent bankruptcy of AbitibiBowater and that of General Motors. In both cases, some bondholders owned CDS and stood to gain more by bankruptcy than by reorganisation. It is like buying life insurance on someone else’s life and owning a licence to kill him. CDS are instruments of destruction that ought to be outlawed. The writer is chairman of Soros Fund Management and author of ‘The Crash of 2008’ (PublicAffairs 2009) http://www.ft.com/cms/s/0/b62b1bd4-5aa3-11de-8c14-00144feabdc0.html

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17.06.2009 IEA warns about further oil price hikes and inflation

In an interview with FT Deutschland, the chief economist of the International Energy Agency, Fatih Birol, said current oil prices of around $70pb would soon lead to inflationary pressures in the world economy, which would prompt central banks to raise their interest rates soon than would otherwise be warranted. He said there was a possibility of a very unfortunate combination of high inflation rates and low growth rates. He said it looks as if the collapse in the oil price last year was only a short break in a rising price trend. He was particularly concerned about supply bottlenecks, which could lead to further price spikes in the future, in the absence of further investment. Hamilton on oil James Hamilton, writing in Vox, says past oil price spikes associated with Middle East conflicts and OPEC embargos were each followed by a global economic recession. This column argues that the onset of the current economic downturn is also partly attributable to a sharp increase in the price of oil. Moreover, the interaction of high oil prices and housing problems contributed to the severity of the downturn. Ordonez calls for labour market reform El Pais leads its economic section with the dispute between Miguel Angel Ordonez, the governor of the Bank of Spain, and the Spanish government, over Ordonez’ repeated calls for a reform of the labour market. Ordonez yesterday repeated his calls that even though the worst falls in GDP may be over, the labour market will be affected for a long time, and may itself contribute to a lackluster recovery. Ordonez wants a single work contract with a much lower level of severance pay. Spain has among the highest severance pay rules in work contracts in the world. Moody’s see funding problems Moody’s said $615bn of debt, held by rating companies, would mature this year, and it is not clear that it could all be rolled over, according to the Financial Times. Moody’s said liquidity was ok, but the trend was deteriorating. While Moody’s is relatively optimistic about the higher rated companies, there is a problem down the lower end, as speculative

285 grade issuers are unable to generate sufficient cash flow.” The consequence would be a significant increase in defaults. German top managers believe in an L-shaped scenario A very interesting poll by Capital Magazine in Germany, as reported by FT Deutschland. Almost two thirds of Germany’s top managers believe the country will not return to the high export levels that prevailed before the crisis, but to much lower long-term growth rates. The poll flatly contradicts the consensus among Germany’s economically illiterate political classes who believe that Germany’s only suffered so much this year because of its strong exports, while Germany will among the first countries to bounce back due to its high competitiveness. The article quotes Bart van Ark, one of Europe’s leading experts on productivity, who said that Germany’s success pre-crisis depended largely on cost- cutting, rather than innovation. In support for European stress tests In Les Echos Augustin Landier and David Thesmar argue that, despite the emergence of some green shoots, the banking crisis is not yet over in Europe. Banks in Eastern Europe are particularly fragile: A 20% currency devaluation would be equivalent to a 20% credit default, or a loss of €300bn to the banking sector in Eastern Europe. The authors call for a European wide stress test, and – like in the US - combined with an obligation to recapitalize. If such an agreement is politically impossible, the minimum would be to freeze dividend payments for those banks whose test results are too weak. EU regulators and supervisory power over remunerations EU Regulators could fine banks that reward staff for excessive risk taking according to a new draft law from the European Commission. Charlie McCreevy is to present the law next week. The Irish Independent has some more details about it. The draft law will need to be adopted by EU governments and the European Parliament to become effective in 2011. It could also include higher capital requirements. Posen to join MPC Adam Posen, deputy director of the Peterson Insitute of International Economics, and well known to Eurointelligence readers through our syndicated column, has been appointed to join the Bank of England’s monetary policy committee, to replace Tim Beasley. The appointment is interesting for two reasons. Unlike other central banks, including the ECB, the UK continues with its tradition to appoint non-nationals to its monetary policy committee, which would be unthinkable in the eurozone. And Posen, an expert on both Germany and Japan, has relevant experience about international financial crises. Here is the Guardian’s news story, and a more personal account by Stephanie Flanders of the BBC. Soros on financial reform Writing in the Financial Times, George Soros calls that financial market reform should rest on three principles. The first is that regulators explicitly take on responsibility for preventing bubbles. Even thought this is not always easy, it is important this regulators abandon the Greenspan view that if market cannot know, how can bureaucrats. Second, central banks should not only control the money supply, but also the availability of credit,

286 which cannot be done with monetary tools alone, but requires regulatory mechanisms such as margin requirements. Third, we must arrive at a new definition of market risk, and replace the efficient market hypothesis with a more robust view. Munchau on Merkel Wolfgang Munchau writes in his FT Deutschland column that Angela Merkel is unbelievably complacent about this crisis, and does not grasp its dynamics even now. If Germany does not fix the banking sector, an attempt her own party is currently undermining by insisting on sweetheart deals for Landesbanken, if Germany does not begin to search for alternatives to its chronic export dependency, and if it does start to think more European, the future will bring low growth and instability. Munchau says Merkel will probably win the elections, as the German electorate is mollycoddled by very high social provisions, but the situation will change dramatically this autumn, as banks are about to tighten their credit policy, and as unemployment approaches 5m.

http://www.eurointelligence.com/article.581+M55c912cdd7d.0.html#

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Blueprint Deepens Federal Role in Markets Plan to Overhaul Financial Regulation Focuses on Consumer Protection, Risk By Binyamin Appelbaum and David Cho Washington Post Staff Writers Wednesday, June 17, 2009 The Obama administration last night detailed a series of proposals to involve the government more deeply in private markets, from helping to steer borrowers into affordable mortgage loans to imposing new limits on the largest financial companies, in a sweeping effort to curb the kinds of reckless risk-taking that sparked the economic crisis. The plan seeks to overhaul the nation's outdated system of financial regulations. Senior officials debated using a bulldozer to clear the way for fundamental reforms but decided instead to build within the shell of the existing system, offering what amounts to an architect's blueprint for modernizing a creaky old building. The White House makes its case for this approach in an 85-page white paper that describes the roots of the crisis. Gaps in regulation allowed companies to make loans many borrowers could not afford. Funding came from new kinds of investments that were poorly understood by regulators. Big firms paid employees massive bonuses, while setting aside little money to absorb potential losses. "While this crisis had many causes, it is clear now that the government could have done more to prevent many of these problems from growing out of control and threatening the stability of our financial system," the white paper says. The plan is built around five key points, according to a briefing last night by senior administration officials and a copy of the white paper obtained by The Washington Post. The proposals would greatly increase the power of the Federal Reserve, creating stronger and more consistent oversight of the largest financial firms. It also asks Congress to authorize the government for the first time to dismantle large firms that fall into trouble, avoiding a chaotic collapse that could disrupt the economy. Federal oversight would be extended to dark corners of the financial markets, imposing new rules on trading in complex derivatives and securities built from mortgage loans. The government would create a new agency to protect consumers of mortgages, credit cards and other financial products. And the administration would increase its coordination with other nations to prevent businesses from migrating to less regulated venues. President Obama is scheduled to announce the full plan today, ending months of political calibration and internal discussion and dropping the details into an already-heated debate on Capitol Hill. Congress is scheduled to hold its first hearings on the proposals tomorrow, and interest groups already are ramping up their campaigns. Congressional leaders say they hope to pass some version of the plan by year's end.

288 "Speed is important," Obama said yesterday in an interview aired by CNBC. "We want to do it right. We want to do it carefully. But we don't want to tilt at windmills. We want to make sure that we're getting the best possible regulatory framework in place so that we're not repeating the mistakes of the past." The administration already has hammered out a number of compromises with key Democrats in Congress, in hopes of creating a proposal that can survive the challenge from competing interests such as hedge funds hoping to avoid regulation and consumer groups seeking even greater protections. But while the proposals sharpen the discussion about reform, they don't end it. "With their proposals today, the administration has moved this critical debate from broad discussion to specific action," said Timothy Ryan of the Securities Industry and Financial Markets Association. The administration's plan leans heavily on the Fed, expanding its role as the regulator of the nation's largest banks such as J.P. Morgan Chase and Goldman Sachs to include other giant financial firms, such as the insurance companies American International Group and MetLife. The agency, which has greater independence from the political process than other regulators, would have broad authority to impose special requirements on those companies, such as mandating that they set aside a larger percentage of their assets against possible losses than smaller firms. Such a requirement could limit large companies' appetite for risk, but also their profit and growth. The plan calls for a council of regulators to consult with the Fed, including the Treasury secretary and the heads of the other financial regulatory agencies: The Securities and Exchange Commission, Commodity Futures Trading Commission, the Federal Housing Finance Agency and the agencies that regulate banks. A primary task of the council would be to recommend which large, globally interconnected firms are too big to fail and should be subject to more rigorous oversight. But the council will not have the authority to oppose decisions made by the central bank. Agencies other than the Fed pressed for the creation of such a council, but its limited role is likely to disappoint them. Prominent Democrats and Republicans in Congress also have signaled that they are reluctant to increase the Fed's powers without imposing stronger limitations. A second element likely to provoke fierce debate is the establishment of a Consumer Financial Protection Agency. The agency would have broad authority to overhaul a tangled mess of federal regulations, such as the various laws that compel lenders to give mortgage borrowers a massive stack of paperwork at closing that includes several calculations of the true cost of the loan itself. "Consumers should have clear disclosure regarding the consequences of their financial decisions," the plan states. The agency also would have the authority to change the way that loans are sold. One idea highlighted by the administration is to require that lenders offer all customers standard "plain vanilla" loans, such as 30-year, fixed-rate mortgages with streamlined pricing. The sale of loans with more complicated terms would be subjected to greater scrutiny by the agency. It could even require that customers who take more complicated loans sign a waiver.

289 And the agency would have a mandate to increase the availability of financial products in lower-income communities and other underserved areas, in part by enforcing the Community Reinvestment Act, which requires banks to make loans everywhere that they collect deposits. To carry out these responsibilities, the agency would be granted the same powers as the regulators charged with keeping banks healthy, including the ability to write rules, conduct examinations, and impose fines and other penalties. Regulatory agencies and industry groups acknowledge failures in recent years. But they say the existing model remains the best way to protect consumers, arguing that the agencies can identify problems more easily because of their close engagement with firms. They also are concerned that a consumer agency could be overly restrictive, limiting access to loans and constraining the development of new types of accounts, loans and other financial services. "This consumer protection agency would be deciding how people get to live as opposed to people getting to decide for themselves," said Kelly King, chief executive of BB&T, a large based in North Carolina. Consumer advocates say the current financial crisis is ample evidence of the need for a new approach. "We've tried it the other way for years, and obviously it didn't work. That's how we got here," said John Taylor of the National Community Reinvestment Coalition. Several ideas have been dropped as the administration picks its battles. The plan will not include a new way of regulating insurance companies at the federal level. The insurance industry, which is regulated at the state level, is deeply divided, and the White House anticipated a distracting fight. The administration instead plans to create an office in the Treasury Department to monitor the insurance industry. Some of the largest insurance companies could still fall under the scrutiny of the Federal Reserve in its new role as a systemic risk regulator. The administration had earlier backed away from a proposal to merge the two agencies that oversee financial markets, and to merge the four agencies that regulate banks. It still will seek to merge the Office of Thrift Supervision and the Office of the Comptroller of the Currency to create a single agency to oversee banks with national charters. It also will propose eliminating the regulatory category for thrifts, traditionally defined as banks that focus on mortgage lending. Steve Adamske, spokesman for the House Financial Services Committee, said committee Chairman Rep. Barney Frank (D-Mass.) plans to launch hearings on the specific proposals next week, and to hold votes on pieces of the legislation as soon as July. "We've been waiting for this for a long time," Adamske said. The Senate is not expected to begin work on the reforms until fall. Staff writers Brady Dennis and Zachary A. Goldfarb contributed to this report. http://www.washingtonpost.com/wp- dyn/content/article/2009/06/16/AR2009061601887.html?wpisrc=newsletter

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With BlackRock's Reach Set to Expand, CEO Defends Money Manager's Stability By Tomoeh Murakami Tse Washington Post Staff Writer Wednesday, June 17, 2009 Two Decades of Growth

BlackRock has grown exponentially since its founding, and it will double its assets under management if its proposed purchase of Barclays Global Investors goes through.

NEW YORK, June 16 -- The acquisition of Barclays Global Investors by BlackRock, which has emerged from the financial crisis as a powerhouse and adviser to the U.S. government, creates a giant overseeing $2.7 trillion in assets, making it by far the largest money manager in the world. To grasp the size of that purchasing power, consider: The Federal Reserve, in its unprecedented effort to rehabilitate the economy, has expanded its balance sheet by $1.2 trillion. The federal government's 2010 budget is $3.6 trillion. The gross domestic product for the United States, the world's largest economy, was $11.7 trillion last year.

291 At a time when "too-big-to-fail" institutions such as AIG and Citigroup have been injected with billions in taxpayer funds, some analysts are raising questions about the scale of the BlackRock enterprise and its ties to the federal government. President Obama is set to propose Wednesday a plan to tighten financial regulation, but largely absent from the debate about regulatory reform has been the role of asset managers, which oversee about $21 trillion of assets globally for institutional investors such as pension funds, hedge funds and university endowments. In an interview Tuesday, BlackRock's chairman and chief executive Larry Fink, who started the firm 21 years ago in a modest New York office, said "$2.7 trillion may sound like a lot of money, but the reality is, most of the added money from BGI is in stock and bond index funds." He disputed the notion that BlackRock could pose a risk to the financial system and the larger economy. For one, he said, "100 percent" of BlackRock's business is managing assets for clients as a fiduciary responsibility, not trading for its bottom line. BlackRock also uses minimal leverage -- $20 billion, or less than 1 percent, of its $2.7 trillion in assets is bought with money lent to clients, Fink said. The use of leverage, or debt, in the pursuit of higher profits amplified losses for financial institutions, including firms that no longer exist such as Bear Stearns. "There's more systemic risk in a hedge fund that has $10 billion in assets that's leveraged 40 to 1 than a BlackRock," he said, adding that every entity with more than $1 billion in assets should be regulated regardless of whether it is public or private. "For every dollar of equity BlackRock has, we have a dollar of assets. That is why it's not a too-big-to-fail issue," Fink said. "What has happened over the past five years, in terms of the tremendous leveraging of certain financial institutions, does not apply to BlackRock. You can't compare the two." Responding to concerns that have been raised by some members of Congress about BlackRock's role in helping the federal government evaluate and manage the rescues of troubled financial institutions, Fink said there was a fire wall between investment management and the part of his firm that performs risk analysis, called BlackRock Solutions. "It so happened that because of the financial crisis, many institutions, public and private, are utilizing that service," Fink said. That business now analyzes risk for $7 trillion of assets and clients include sovereign wealth funds and other governments, he said. Indeed, BlackRock and other asset managers are "not as risky" as a dealer who writes billions of dollars worth of credit-default swaps and whose collapse could spark a chain reaction of failures, said John Coffee, a law professor at Columbia University. But, he added, "If you were giving common advice to $3 trillion worth of funds, you are going to be having an impact that could increase systemic risk. There can be systemic risk if one person or entity is able to make a bet-the-farm-investment decision based on poor investment analysis for an extraordinary large amount of capital." While BlackRock is known as an active manager of fixed-income and other assets, Fink noted that more than $1 trillion of the $1.5 trillion of new assets it will be taking on from Barclay Global Investors is in passively managed stock and bond index funds. "The tendency for increasing concentration and size bothers me. Size also comes with political power," said Simon Johnson, former chief economist at the International Monetary Fund and professor at MIT's business school. "We've all been talking about

292 banks being too big to fail, but other financial institutions could be. I think the next big crisis could come from asset managers." Johnson is co-author of The Hearing blog at washingtonpost.com. The BlackRock-BGI deal, which must be approved by Barclays shareholders, is scheduled to close in the fourth quarter of this year. It is expected to win approval from regulators. The combined firm would be the largest asset manager, followed by State Street, with $1.44 trillion, and Fidelity Investments, with $1.39 trillion, as of the end of last year, according to Pension & Investments magazine. "Those portfolios move up and down with the world -- they are agnostic to the market," Fink said, referring to the index funds. BlackRock "is not a hedge fund," he said. "Our clients award us business on a specific product and strategy, and we have to conform to our clients wishes. All of our clients' money is managed with a specific strategy." Staff researcher Julie Tate contributed to this report. http://www.washingtonpost.com/wp- dyn/content/article/2009/06/16/AR2009061603343.html?wpisrc=newsletter

293 Global Business

June 17, 2009 Stalking A Weaker Wall Street By GRAHAM BOWLEY Wall Street’s great investment houses have never faced a serious foreign challenge in their own backyard. But as tectonic shifts reverberate through the banking industry, their overseas rivals are edging into some of the most lucrative corners of American finance. The Swiss, Germans, British and Japanese are grabbing business from once- swaggering American banks by taking companies public, underwriting new bonds and advising corporations on mergers and acquisitions. And they are hiring more of their rivals’ bankers and traders to continue their winning streak. And while big American banks still tower over global finance, the latest shift, although subtle, is raising some uncomfortable questions, including the big one: Could foreign banks one day do to Wall Street what Japan once did to Detroit? “There is evidence of traction in market share, and you can see that these banks have leapfrogged,” said Fiona Swaffield, an analyst at Execution Ltd., a brokerage firm based in London. “The issue is, how long can this last, and can anyone re-emerge?” For the last decade, the strongest overseas rivals have tried to climb above their American competitors, often with mixed success. Credit Suisse of Switzerland sought to become a universal banking powerhouse with its purchase of the United States investment bank Donaldson, Lufkin & Jenrette in 2000, only to see the merger sour. Deutsche Bank of Germany tried to do the same with a 1998 merger with Bankers Trust, and met with similar troubles. At the same time, foreign banks have become increasingly aggressive in such activities as debt and equity underwriting and mergers and acquisitions. Ten years ago, for instance, only one bank, Credit Suisse, ranked among the top 10 debt underwriters. This year, four foreign banks crowd the field. Similarly, Barclays Capital, Deutsche Bank, Credit Suisse and UBS now list among the top 10 global M.& A. advisers. A decade ago, the only non-United States firm was Dresdner Kleinwort. More recently, overseas banks have hoped to capitalize on the turmoil convulsing the financial industry. The demise of Bear Stearns and Lehman Brothers, two of the oldest names on Wall Street, gave them a rare opportunity to press for advantage. So did messy distractions like Bank of America’s fraught takeover of Merrill Lynch. Meanwhile, many foreign banks have fortified their finances at their regulators’ behest, while avoiding the restrictions and stress tests required of many American rivals. And even as American banks start to return to health, efforts by the Obama administration to rein in the industry are likely to shift the competitive landscape in new ways — a development closely watched by foreign contenders. “What worries me is the competitive edge that non-U.S. banks have vis à vis U.S. banks,” said Eugene A. Ludwig, the comptroller of the currency under President Bill

294 Clinton, who now runs the Promontory Financial Group, a Washington bank consultant group. “Non-U.S. banks generally operate under more coherent regulatory structures than U.S. banks do, which creates imbalances that non-U.S. banks can exploit, especially at a time when their U.S. counterparts are operating under extraordinary constraints.” In the nine months since it snapped up Lehman’s core operations at a bargain- basement price, Barclays Capital, already one of the biggest risk management and financing firms in Europe, has jumped from a minor player to a major firm in the capital markets business. The transaction was a rare chance for Robert E. Diamond Jr., the American president of Barclays, to take on rivals like Morgan Stanley. It brought the British bank business it never had in equities, M.& A. and equity research, while shoring up its debt underwriting and trading business. Since Barclays almost doubled its United States work force overnight by buying the remnants of Lehman, the British bank has jumped to second place in global debt underwriting. It is No. 4 in America, with nearly a tenth of the market, more than Goldman Sachs or Morgan Stanley. This year alone, Barclays advised on $90 billion of mergers and acquisitions on this side of the Atlantic, more than Citigroup and on par with Bank of America, although it still trails the most powerful players, JPMorgan and Goldman Sachs. “We are one of the few Wall Street firms focused on building this year versus consolidating,” said Jerry del Missier, president of Barclays Capital, based in New York. Deutsche Bank, the biggest German bank, has had expansion in the United States “in sight since we bought Bankers Trust in 1998,” said Seth Waugh, chief executive of Deutsche Bank Americas. “We expect to win market share” in mergers and acquisitions, capital markets, trading and , he said. Recently, it has gained lucrative prime brokerage business from hedge funds. And it has made strides in mergers and acquisitions, moving to fifth place globally in the first five months of this year, although it is still in only 11th place in the United States, according to Thomson Reuters. The bank recently added 90 new senior employees to its United States staff of more than 12,000 to broaden operations. Credit Suisse has also wrested prime brokerage business from rivals while stepping up its United States activity in investment-grade corporate debt, earning $20 billion in the first five months, compared with $29 billion for Goldman Sachs. The second-largest Swiss bank gained ground after cutting costs, curbing risky activities and selling billions of dollars in problem assets to cleanse its balance sheet. Brady W. Dougan, the chief executive, said the bank’s decision to refuse Swiss government support had given it strategic flexibility compared with its American competitors, which might remain restrained in how they expand or spend their money overseas. Still, the bank has slipped in at least one field it used to dominate: high-yield capital markets, where it fell to seventh place in the first quarter behind JPMorgan and Bank of America, according to Thomson Reuters. But Mr. Dougan is continuing his push to bolster Credit Suisse’s overall business by aggressively hiring top talent from the investment and divisions of Bank of America Merrill Lynch, Lehman, Citigroup and Goldman Sachs. The bank is also considering a “tactical acquisition” in private banking to siphon even more business from rivals, he added.

295 “Now we have an opportunity to increase, to really, really increase our position,” said Mr. Dougan. Even the Japanese are muscling in on Wall Street’s turf. Nomura has added about 135 people in the United States since October, mainly in its equities division, augmenting its American work force by 10 percent and moving its global business head to New York, in a sign of the potential it sees.

Business

June 17, 2009 Obama Sought to Enlist a Wide Consensus on Finance Rules By STEPHEN LABATON WASHINGTON — President Obama’s plan to reshape financial regulation, which he will unveil on Wednesday, is the product of weeks of meetings among government officials, financial experts, lawmakers, industry executives and lobbyists, many of whom were invited to help the White House draft the proposal. Mr. Obama told reporters on Tuesday that a “lack of oversight” allowed what he called “wild risk-taking.” He said it led to “very dangerous” conditions that imperiled the global economy. But executives from an array of industries caught up in the financial crisis came to Washington over the last several weeks to make their case for how the new regulatory landscape should look. They came from big banks and small ones, insurance companies and stock exchanges, hedge funds and mutual funds, and were joined by officials from consumer groups and big labor — often with conflicting views. Now, lobbyists who lost the initial skirmish inside the administration will head to Congress to try to influence the final product. The plan the president will formally announce on Wednesday would give the Federal Reserve greater supervisory authority over large financial institutions whose problems pose potential risks to the economic system. It would separately expand the reach of the Federal Deposit Insurance Corporation to seize and break up troubled financial institutions. And it would create a council of regulators, led by the Treasury secretary, to fill in regulatory gaps. In doing so, the plan seeks to give Washington the tools to police the shadow system of finance that has grown up outside the government’s purview, and to make it easier for regulators to head off problems at large, troubled institutions or take control of them if they fail. “Unfortunately the growth of the nonbank sector as well as all the complexities and financial instruments outstripped those old regulatory regimes,” Mr. Obama said in an interview on Tuesday with The New York Times and CNBC. Although it would strikingly reorganize the regulatory architecture, the president’s plan results from many compromises with industry executives and lawmakers, and is not as bold as some had hoped.

296 Mr. Obama seemed to acknowledge as much when he posed the question: “Did, you know, any considerations of sort of politics play into it? We want to get this thing passed, and, you know, we think that speed is important. We want to do it right. We want to do it carefully. But we don’t want to tilt at windmills.” At the White House and the Treasury Department in recent weeks, some insurance companies sought a law that would enable them to get a single federal charter instead of multiple state charters. The insurers lost. Consumer groups argued against the banks in favor of a consumer financial protection agency with broad new authority to protect homeowners from unsuitable loans. The consumer groups prevailed. The mutual fund industry successfully argued against a proposal by some banks — which are competitors to mutual funds — to give the Securities and Exchange Commission’s authority over mutual funds to the new consumer agency. Hedge funds and dealers in derivatives sought to minimize the extent to which the government will intrude into their businesses. They partly won; the administration will leave many of the details of that authority to lawmakers and regulators. Savings and loan associations argued unsuccessfully against a proposal by the administration to eliminate federal savings and loan charters, which have been subject to less regulation than bank charters. The administration, which has sought to reduce the corrosive influence of lobbying on policy making, actually encouraged the tussle by inviting executives, academics, former officials and others to the series of meetings overseen by the Treasury secretary, Timothy F. Geithner, and Lawrence H. Summers, the president’s top economic adviser. The meetings were often attended by their top aides: the deputy Treasury secretary, Neal S. Wolin, and Diana Farrell, a deputy director of the National Economic Council at the White House. In the last two weeks alone, the administration has heard from top executives from Goldman Sachs, MetLife, Allstate, JPMorgan Chase, Credit Suisse, Citigroup, Barclays, UBS, Deutsche Bank, Morgan Stanley, Travelers, Prudential and Wells Fargo, among others. Administration officials also discussed the president’s plan with the top lobbyists at major financial trade associations in Washington. The raucous process of overhauling a system that oversees the nation’s most influential and affluent corporate interests is not without precedent. In 1913, the year he signed the law creating the Federal Reserve in response to an earlier market panic, President Woodrow Wilson lamented to a friend about banking reform. “There are almost as many judgments as there are men,” Mr. Wilson said. “To form a single plan and a single intention about it at times seems a task so various and so elusive that it is hard to keep one’s heart from failing.” President Obama’s plan would not consolidate all the banking agencies into one, but it would take some of the existing agencies’ powers to oversee mortgages, credit cards and other kinds of consumer debt and give them to a new regulator, tentatively called the Consumer Financial Protection Agency. The president, however, will ask Congress to merge the Office of Thrift Supervision, the beleaguered agency that missed problems at IndyMac, Washington Mutual and the American International Group, into the Office of the Comptroller of the Currency, a Treasury unit that supervises the largest banks.

297 The plan would impose tighter rules on banks that package and sell securities that are backed by mortgages and other debt. It would require that companies that issue mortgages retain at least 5 percent of them on their books to discourage companies from marketing unsuitable loans. It would also require all advisers of hedge funds and private equity funds to register with the Securities and Exchange Commission and open their books to regulators. And it would impose new conflict of interest rules on the credit rating agencies. The plan is largely the product of extensive conversations between senior administration officials and top Democratic lawmakers — primarily Representative Barney Frank of Massachusetts and Senator Christopher J. Dodd of Connecticut. The two lawmakers head the Congressional committees that will take the first crack at drafting the legislation necessary to make the plan work. John Harwood contributed reporting. http://www.nytimes.com/2009/06/17/business/17regulate.html?th=&emc=th&pagewante d=print

298 Jun 16, 2009 Stress Tests In Europe: ECB Expects Additional US$283 Billion Loan and Securities Losses Among Eurozone Banks Overview: June 16 ECB Financial Stability Review: Taking into account the write- downs on banks’ securities reported by late May 2009 and the banks’ loan loss provisions for 2007 and 2008, the potential future losses of euro area banks, largely concentrated on their loan exposures, could be around $283 billion until the end of 2010 for a total of $649 billion in cumulative loans and securities losses 2007-2010. These potential losses would be cushioned by provisions and retained earnings over the next two years.

o June 16 Scott Bugie S&P’s managing director of financial institutions issues 'report card' (via FT): “Credit losses this year among the largest 50 European banks will get close to doubling from the €128bn [$177bn] figure of last year, with possible trough in Q4 2009." He points to to mounting bad debts on corporate and consumer lending as a dangerous drag on bank profitability for the next two years. He cited Ireland, the UK, Spain and Germany, in that order, as countries where banks would suffer most. Of the 10 lowest-rated European top-50 banks, seven are German, two are Irish and one is Swedish.

o June 12 Bloomberg: European governments have approved $5.3 trillion of aid compared to the $12.8 trillion the U.S. government and the Federal Reserve had spent, lent or committed.

o June 15 WSJ: Deutsche Bank reckons that, of 41 banks it has analyzed, just five would fail the common equity test conducted in the U.S. which required banks, under stressed economic scenarios through 2010, to have Tier 1 common equity to risk- weighted assets of 4% and core Tier 1 capital to risk-weighted assets of 6%. The saving grace for European banks was the U.S. decision to use risk-weighted capital measures for its test. On a total leverage basis, European banks don't compare so well--> see Are Europe's Banks In Worse Shape Than U.S. Banks?

o EU supervisors plan to conduct a stress test of the EU banking system by September in order to quantify the toxic asset overhang and establish if and how much more capital is needed. It is more a highly aggregated stress test rather than by institution as in the U.S. The stress tests will be conducted by national supervisors according to common guidelines and methodology issued by the Committee of European Banking Supervisors (CEBS). A dysfunctional banking system would represent a particular challenge for Europe, whose economies are much more dependent on banks than is that of the US (Pisani-Ferry et al.)

o June 12 Bruegel: A systematic European approach is needed. The respective tests should be based on common macro scenarios, common valuation rules and common stress assumptions. They should be done for all the largest European banks

299 simultaneously and the results should be published for each bank. And there should be centralised oversight of the tests, and aggregation of results. o June 8 IMF: "To make sure the remaining problems in the banking system are addressed, the IMF is backing a coordinated and proactive review of the financial positions and viability of banks. The financial positions of banks need to undergo a comprehensive review to assess capital needs and viability. In addition to identifying impairments, a forward-looking assessment should evaluate the impact of the ongoing recession on capital." o June 9: German finance minister Steinbrueck dismisses need for U.S. style stress tests for single institutions, favors system-wide assessment. o May : EU Commission adopts higher capital requirements and minimum retention in structured products. o Munchau: IMF reports that of the total $4,100bn in expected global writedowns until 2010, the global banking system accounts for $2,800bn. Of that, a little over half – $1,426bn – is sitting in European banks, while US banks account for only $1,050bn. o IMF: In order to achieve a pre-crisis 4% Tangible Common Equity (TCE)/Tangible Common Assets (TCA), capital injections would need to be some $275 billion for U.S. banks, about $375 billion for Euro area banks, about $125 billion for U.K. banks, and about $100 billion for banks in the rest of mature Europe. To achieve this more demanding level of 6% TCE/TCA would require about $500 billion for U.S. banks, about $725 billion for Euro area banks, about $250 billion for U.K. banks, and about $225 billion for the banks in the rest of mature Europe. o Fed Board: Flow of funds data show that 40% of U.S. originated securitizations are held abroad--> about $4.4T out of $10.8T securitizations held abroad, assume $4 T in Europe. Average writedown rate on securitization is 17% as calculated by RGE, so about $680bn writedowns apply for Europe. Assume about half to 75% fall on eurozone banks, or $400 - 500bn. o Goldman Sachs: EMU Domestic loan and securities losses in the eurozone are estimated at 6% of GDP in baseline scenario (in ugly scenario this could double)--> 6% of eurozone GDP in dollars is $730bn (eurozone 2008 GDP=EUR9.3T=$12.2T) .This is exactly in line with the IMF's April 20009 estimate for Eurozone+UK originated losses. o Danske; Fitch: European banks have $1.3T in claims on Central and Eastern European countries. Assuming that 20% of these loans turn bad, EU banks incur about $270bn in CEE-related losses, of which $30bn occur in Sweden (non-eurozone) which leaves writedowns of $240bn. o RGE: Adding all up, expected losses among European banks amount to about $450bn exposure to U.S. securities +$730+ domestic&foreign loan losses+240 CEE=$1.4T. This estimate is in line with the IMF's European bank loss estimate as mentioned in the overview above. o Note: If the domestic loans and securities loss share is assumed to approach the U.S. loss share of around 10-12% as estimated by RGE, then eurozone expected losses add up to about the same dollar value as in U.S., or $1.8T

300 o Sueddeutsche Zeitung (via Harrison/Eurointelligence): German bank supervisor memo leaked to the press shows that the amount of toxic assets on German banks books amount to EUR816bn. Of these, Commerzbank bears EUR101bn including EUR49bn from Dresdner takeover; Landesbank HSH Nordbank bears EUR105bn; WestLB assumes EUR84bn and Landesbank Baden-Wuerttemberg EUR92bn. The situation is better for Deutsche Bank (EUR21bn) as well as Postbank and HVB with EUR5bn each. The worst affected is commercial real estate lender Hypo Real Estate (HRE) that is being seized by the government and which holds EUR268bn of toxic assets on its books. o March 15, NYT: Big foreign banks were also among the main receivers of AIG rescue funds, including Société Générale of France and Deutsche Bank of Germany, which each received nearly $12 billion; Barclays of Britain ($8.5 billion); and UBS of Switzerland ($5 billion). o see further: - The German Banking System: Bank Shareholder Expropriation Bill Clears Parliament - France's Bank Recapitalization Package: Carrots and Sticks - Italian Banks Under Pressure: BPM Is Latest Italian Bank To Seek State Aid - Spanish Banks Alert: Government Takes Over Caja Castilla, First Since 1993 - Greek Banks' Exposure To South East Europe: Will They Weather The Storm? - Ireland Is the First Eurozone Country to Set Up A Swedish-Inspired 'Bad Bank': Will Others Follow Suit? - Moody's Cuts Rating On Austria's Two Biggest Banks: Eastern Woes - Swiss Banks: UBS Not Out Of The Woods Yet - Are Europe's Banks In Worse Shape Than U.S. Banks? http://www.rgemonitor.com/10009/Europe?cluster_id=13750

301 Jun 16, 2009 Spanish Banks: Government Announces EUR99 Billion Rescue Fund Overview: Spain's finance minister said the government is finalizing a EUR 99 billion bank rescue fund Fondo de Reestructuración Ordenada Bancaria (Frob) . The scheme provides for acquiring vote carrying participatory shares in fundamentally viable savings banks. The government would temporarily take over management until the stakes are repaid. June 11 PWC via FT: Bad loan rates for the financial sector as a whole have almost quadrupled in the past year to reach 4.27 per cent of assets. They are expected to double again to 8 per cent by December. June 16: Moody’s downgrades 30 Spanish banks and savings banks.

o June 11 FT: PwC, the accounting firm, said it would be necessary to invest €25bn ($35bn) to €70bn – or 2-6% of gross domestic product – to recapitalize the Spanish financial sector in 2009. Moreover, with some 40,000 branches, Spain is one of the world’s most overbanked countries.

o FT: Astroc, Llanera, Colonial-->heavily indebted business model behind the spectacular rise in Spanish property companies will simply cease to function in the current environment. Spanish banks have lent €292bn ($431bn) to developers, according to Bank of Spain

o Evans-Pritchard August 4: Morgan Stanley estimates "that a non-performing loan ratio of 10- 15% for developers' loans would fully erase earnings in 2009 and would represent between 20-30% of the current tangible capital base of Banco Popular, Sabadell and Banesto.

o June 3,FT: BBVA offers employees five year leave in return for a guaranteed job and 30% pay cut at the end of the five years.

o April 10 Bank of Spain Governor Ordonez: the answer to restoring the flow of credit is neither publicly funded policies to purchase “troubled” (impaired or toxic) assets nor global and indiscriminate bank recapitalisation plans. I am convinced they are of no use for resolving the problem of credit restrictions. The credit-boosting measures best suited to the current situation of the Spanish economy are those aimed at improving the risk profile of both consumer and corporate transactions. This effect may be achieved through different means: e.g. loans subsidised by the Official Credit Institute, credit insurance or the deferral of social contributions.

o March 29: The Spanish government said it will provide as much as 9 billion euros ($12 billion) to Caja Castilla-La Mancha to shore up the regional lender’s finances and protect depositors in the first bank rescue since 1993. Its bad loan ratio climbed to 8% and similar savings institutions are exposed to the same environment.

302 o Jan 28 Alea: Spain’s banks and cajas are negotiating on a one-to-one basis with the Bank of Spain to “fine-tune” their 2008 accounts in order to avoid taking catastrophic write-downs on loans. o February: BNP report: Spanish banking system is highly exposed to construction and property, and property market downswings tend to last. While all credit institutions are exposed, the savings banks (cajas) areparticularly so--> see profile of major banks in report o October 13:Spain passed a law guaranteeing bank debt (inter-bank loans) issued up to the end of the year, which will be valid for five years. The Spanish government also announced that it would not be creating a fund for recapitalising banks, since the country’s institutions are liquid, but it is authorised to do this if it becomes necessary. The government has made 100 billion euro in funding available for the measures.Spain will also increase the guarantee for deposits to 100,000 euros, increasing an existing guarantee fivefold and going beyond a new measure adopted today by the European Union o August 28, Unicredit (via Bloomberg): Since the credit squeeze began a year ago, Spanish institutions raised their monthly borrowing from the ECB by record margins. o BNP: Spanish institutions securitize a considerable part of their loan portfolios. They are the first to be affected by seizure in covered bonds and RMBS market amounting to around €335bn o EIU August, Tett: Spanish banks are currently faring better than U.S. and European peers due to: 1) no off-balance sheet SIVs; 2) countercyclical capital provisioning; 3) access to ECB liquidity facilities. However: bad loans surging fast; internationally oriented banks will fare better. o July 15: Martinsa-Fadesa first publicly traded developer to seek bankruptcy protection after failing to secure a loan that banks had demanded as part of a debt refinancing--> A slump in Spanish home sales, combined with rising borrowing costs, has made it harder for property companies to pay their debts. o Maharg-Bravo (breakingviews): Catch-22: banks can't afford to lend on generous terms but if they don't they could lose even more money--> Association of Spanish Savings banks estimates that overall non-performing loans will triple to 3% by 2009. o Gros: in Spain and Ireland, construction investment has increased to levels (18-20% of GDP) not seen in any other OECD country except Japan--> evidence of large contruction overhang with serious implications for consumption, financial institutions http://www.rgemonitor.com/458?cluster_id=6455

Jun 16, 2009

303 U.S. Housing Starts Rise Sharply from Record Lows in April: More Volatility Ahead? Stabilization in the U.S. housing sector is not yet in sight: inventories and vacancies are still at a record high and continue to put downward pressure on home prices which continue to fall translating into trillions of real wealth losses for the engine of the economy: the U.S. consumer o May 2009: Housing Starts rose by 17.2% m/m to a pace of 532,000 after starts fell 12.8% m/m in April to a record low of 454,000. Starts were down 45.2% y/y in May. Starts of single family units rose by 7.5% m/m in May, while starts in the volatile multifamily segment rose sharply by 77.1% m/m after falling 42.2% in April. Building permits, an indicator of future construction rose 4% m/m to 518,000 indicating that starts might edge upwards in the future. Completions fell 3.3% m/m in April to 811,000 and were down 28.8% y/y in May. o With sales of new homes rising 0.3% m/m in April, unsold new homes currently represent 10.1 months' worth of supply at the current sales rate, down from 10.6 months in March. Sales need to rebound strongly before inventories move towards the long term average of 6.1 months' worth of supply. o April 2009: Construction Spending rose 0.3% m/m in April 2009, but construction spending remains down 10.1% y/y. Housing construction rose in April by 0.6% and is down 34% y/y. Nonresidential spending rose by 0.8%, while government construction fell by 0.6% in April. o High foreclosure rates are depressing home prices and adding to the record levels of inventories that will need to be worked off before starts can pick up. As per the Q1 2009 Delinquency Survey, delinquency rate on one to four family units rose to a record 9.12% of all mortgages in Q12009, the highest since records began in 1972, up from 7.88% in Q42008. Delinquent mortgages and properties under foreclosure together accounted for a record 12.07% of all mortgages (MBA). Foreclosure Filings were reported on 321,480 properties in May. Filings are up 18% y/y in May and were up 24% y/y for Q12009. Foreclosures may hit a record 1.8 million by the first half of the year. (RealtyTrac) o May 2009: The Housing Market Index, an indicator of builder perceptions of current and future home sales rose to 16 in May from 14 in April. Builders' perceptions for current and future sales improved, while the index for buyer traffic remained unchanged. (NAHB) o NAHB builders’ sentiment index rose a single point to 9 in February – virtually unchanged from a record low of 8 in January o CBO: Under an optimistic scenario, starts will return to normal underlying levels by end of 2009; Under cyclical downturn scenario, return to underlying levels doesn't occur until early 2011; Under pessimistic scenario, return to underlying levels occurs in 2H 2012 o Q12009: Toll Brothers cancellation rate (current cancellations to signed contracts) was 37.3% for Q12009 up from 30.25 in Q42008.(Toll Brothers) http://www.rgemonitor.com/80/Housing_Bubble_and_Bust?cluster_id=4245

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Regulatory Revamp Targets Securities at Heart of Crisis Sellers of Mortgage Loans to Share In Losses Under White House Plan By Binyamin Appelbaum Washington Post Staff Writer Tuesday, June 16, 2009 The Obama administration said yesterday that it will seek to overhaul the business of selling investments made from mortgage loans, a marketplace that provided the funding for the housing boom and the tinder for a financial crisis by tying American subdivisions to global markets. The proposal, part of a regulatory blueprint scheduled to be unveiled tomorrow, would give buyers more information while requiring sellers to share in losses. Officials said the combination will encourage responsible lending, create safer investments and renew the flow of funding for mortgages and other loans. Lenders would be required to retain at least 5 percent of the risk of losses on each package of loan pieces, known as an asset-backed security. The employees and contractors who originate loans would be paid gradually, and they could get less if borrowers started to default. The proposal also takes aim at ratings agencies such as Moody's and Standard and Poor's, which investors rely upon to evaluate the quality of asset-backed securities. Those agencies would be required to make clear to investors that the securities are riskier than traditional investments such as corporate bonds. These changes address the market at the heart of the financial crisis, but they make up only a small piece of the administration's blueprint. The plan would give the Federal Reserve new powers to restrict the risks taken by large financial firms. It would create a new authority to dismantle firms that fall into trouble and a separate agency to protect consumers of financial products such as mortgages and credit cards. Many pieces of the proposal would require legislation. Sales of asset-backed securities provided the bulk of funding for mortgages and other consumer lending during the economic boom, as investors spent trillions of dollars buying what was often advertised as a safe, more lucrative alternative to ordinary bonds. The process was lucrative for banks, which could quickly sell loans and use the money for new lending. It was lucrative for Wall Street, which collected fees on each transaction. And it was lucrative for investors, who made outsized profits. But as borrowers began to default on the underlying loans, the value of the securities collapsed, and everything came tumbling down. The administration concluded that securitization encouraged looser lending standards, because companies that sold loans to investors had little reason to care whether borrowers could repay those loans. Furthermore, employees were paid to make loans, but they were

305 not penalized for defaults. And investors could not easily check the excesses because they lacked basic information about the contents of each security. The result? "A serious market failure that fed the housing boom and deepened the housing bust," according to Treasury Department spokesman Andrew Williams. The administration's proposal is not just an attempt to clean up the securitization market. The goal is also to help revive that market, which has seen almost no activity in the last year. That goal was welcomed by industry groups, even as they cautioned that some details needed further examination. "There may be parts of this proposal where the industry disagrees, but we pledge to work closely with the administration and global policymakers on this vital topic," said George Miller, executive director of the American Securitization Forum. The proposal assigns a key role to the Securities and Exchange Commission, which regulates the sale of securities. In addition to requiring increased disclosures about the contents of each security, the agency also would expand its database of corporate bond issues to include asset-backed securities. And the SEC would encourage the adoption of standardized contract language to reduce confusion and allow investors to compare securities more easily. A second component focuses on the credit rating agencies, which have faced criticism for assigning their safest grades to hundreds of securities that ended up losing large portions of their value because they contained mortgage loans that borrowers could not afford. The proposal would require a clear distinction between the ratings assigned to asset- backed securities and other forms of debt such as corporate bonds. The agencies also would be required to disclose more information about their methodology, and about conflicts of interest. Generally, the agencies are paid by the company that issues the security. The final component addresses financial incentives, for instance requiring firms to retain a stake in each security. The plan also would prohibit firms from hedging that risk, meaning that they could not make an offsetting investment. The European Union plans to adopt a similar requirement, an important consideration because firms could easily shift the sale of asset-backed securities to a less restrictive marketplace. But some officials and financial experts still are skeptical about the requirement. They note that lenders often kept a piece of their securitizations during the housing boom, either as a desirable investment or because it could not be sold. This retained risk was a key source of the losses that crippled Citigroup and other banks.

306 Opinion

June 16, 2009 OP-ED COLUMNIST Recession and Revolution By ROSS DOUTHAT Economic fiascos usually have political consequences, and it was only a matter of time before the ripples from the Great Recession produced a crisis in one of the world’s more volatile powers. Luckily for America, it’s happening in Iran. Americans are accustomed to fretting about how theology shapes Iranian politics. But you don’t need to be an expert in Shi’a eschatology to understand how last week’s volatile election gave way to an exercise in self-discrediting thuggery by Iran’s clerical leadership. Worldly forces made the current crisis possible: Stagnating G.D.P., rising joblessness, and runaway inflation. Even if this week’s crackdown somehow strengthens Mahmoud Ahmadinejad’s hand within the ruling clique, the regime as a whole has been severely weakened. The patina of democracy was a useful thing for the ruling mullahs, and riot police can’t make Iran’s economic problems go away. (Iranian statistics put unemployment at 17 percent and the inflation rate at 25 percent; the real numbers may be higher. And chronic mismanagement may even send Iran’s oil revenues — the backbone of its faltering economy — into steep decline.) Their monopoly on violence notwithstanding, the leaders of the Islamic Republic look less like the Nazis of the Middle East, and more like hapless Weimar functionaries watching their country’s finances circle the drain. In 1930s Europe, a economic crisis toppled democratic governments, and swept dictators into power. Liberal societies seemed ineffectual; authoritarianism was the coming thing. The crash of 2008, though, may end up having the opposite effect. Over the last few years, both American alarmists and anti-American triumphalists have emphasized the disruptive power of populist, semi-authoritarian political actors — from Ahmadinejad’s Iran to Vladimir Putin’s Russia to Hugo Chavez’s Venezuela. But these regimes, which depend on petro-dollars for stability at home and influence abroad, may prove far more vulnerable to economic dislocation than their democratic rivals. Amid the wreckage of the Great Depression, intellectuals and policymakers looked to fascist Italy and the Soviet Union for inspiration. But it’s hard to imagine anyone seeing a model in the current crop of authoritarian governments. It’s much easier to imagine them being swept away, if the recession endures, by domestic discontent. Maybe something worse would take their place. Certainly there are authoritarian states — Egypt, Saudi Arabia — where the danger of an Islamist revolution should keep American policymakers awake at night. But as an ideological rival to liberal democracy, Islamism isn’t in the same league with the totalitarianisms of the 1930s. And there aren’t any other likely candidates on the

307 horizon. Indeed, for all the talk about a crisis of global capitalism, what’s most striking about the great financial meltdown is how little radicalism it’s spawned. In the West, especially, there’s been more hysteria about the specter of extremism than actual radical activity. If you listen to certain conservative media personalities, you’d think Obama is channeling Leon Trotsky. If you listen to certain liberal pundits, you’d think that talk radio was fomenting a wave of right-wing violence. But nothing of the sort is happening. Barack Obama is pushing the United States leftward, but his wish list — universal health care, a green industrial policy — has been pinned to the Democratic National Committee’s bulletin board since the 1970s. Glenn Beck and Bill O’Reilly do not, in fact, command an army of gun-toting vigilantes, the crimes of a few lunatics notwithstanding. And in Europe, despite the angst over a few penny-ante racists getting themselves elected to the E.U. Parliament, the crisis’s major beneficiaries have been the cautious, incrementalist parties of the center-right. In Iran, students are protesting for democracy and shouting for Obama. In the West, meanwhile, nobody’s talking about adopting Putinist economic nationalism, or renovating the financial sector using the tenets of the Islamic banking system, or imitating Hugo Chavez’s “Bolivarian Socialism.” (You’ll sometimes hear admiring comments about China’s recent economic management — but never their one-party dictatorship.) Our current global economic crisis was created by Western-style democratic capitalism. But it hasn’t turned into a crisis for democracy and capitalism, because nobody has a plausible alternative. The appeal of authoritarianism, once upon a time, was based on the hope that it might deliver growth, prosperity, and happiness more efficiently than its liberal rivals. But nobody thinks that anymore — not in Washington or London or Tokyo or Berlin, and not, on the evidence of this week’s events, in the Islamic Republic of Iran. Which is why, if the West is fortunate, the current crisis could reverse the pattern of the Great Depression - by demonstrating the resilience of a global democratic order, and the weakness of its challengers. http://www.nytimes.com/2009/06/16/opinion/16douthat.html?th&emc=th

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16.06.2009 ECB gloomy about banking sector

The ECB’s latest stability review is gloomy about European banks, but not quite as gloomy as the IMF’s recent global financial stability report. The ECB says additional losses due to the recession would be $283bn. It said the risk to the financial sector remain high. The FT quotes Lucas Papademos as talking about a negative interplay between the financial sector and the economy, but he stopped short of calling for national stress testing. The IMF’s estimate in April was much higher, based partly on technical differences, and on different assumption about loan performance. The main risks identified by the ECB are a renewed loss of confidence in the banks; balance sheet trouble for insurers; larger-than-expected fall in US house prices; and an even stronger recession. For the full report, see here.

Moody’s downgrades 30 Spanish banks This is bad news for Spain, and it is the headline of El Pais’ economic section this morning. Moody’s downgrades 30 Spanish banks, and issues warnings for Santander and BBVA, and it could have been worse, had it not been for the Spanish government guarantees to the banking sector. The real concern to Moody’s is no longer the bad property loans, which marked the beginning of the crisis, but the deteriorating economy. So it is the feedback loops that Papademos was talking about in the story above. Sarkozy calls for review of financial system In a speech to the International Labour Organisation, Nicolas Sarkozy said the financial system had to be reviewed and reconstructed with the goal to finance entrepreneurs rather than speculators, reports Liberation. Sarkozy said the crisis offers a chance – not to be missed – to review everything including prudential supervision, hedge funds, accounting rules or remuneration rules. He called on the G20 leaders to take their share of responsibility and not to give in to pressure groups. The credit crunch is coming to Germany Frankfurter Allgemeine had an uncharacteristically alarmist editorial on the coming credit crunch. It’s not yet there in the data, but it is going to play out over the next few months,

309 as banks will tighten their credit policies, as the ratings of their customers deteriorate. The falling credit worthiness of their customers is not yet reflected in bank balance sheets, which are likely to take a big hit in the autumn. The paper said this is not only a cyclical problem, but also a structural one, as banks will not return to their before-crisis credit policies. Japan all over We thought for a moment that Germany would at least accomplish consolidation of its Landesbanken, but alas the chances of a Landesbanken consolidation have dwindled markedly, as FT Deutschland reports. The government’s second bad bank law – which applies to the Landesbanken – is now being watered down by influential members of Angela Merkel’s Christian Democrats. The law envisaged that the Landesbanken could dump their toxic assets, at a 10% loss of book value, into a single bad bank, in exchange for consolidation of the entire Landesbanken sector. But both these conditions are in the process of being water down. Bavaria and Baden-Wuerttemberg remain implacably opposed to let go of their Landesbanken. They prefer to privatise them, although no buyer is on the horizon. (So what this means more procrastination, and a longer time for the banking sector to return to normal. This is very similar to what happened in Japan in the 1990s.) German stimulus not getting through Frankfurter Allgemeine has an article that the infrastructure component of Germany’s stimulus plan is not working. Some projects have started here and there, but even the transportation ministry has no clue how much, or how little is currently being spent. The article quotes infrastructure experts as saying that infrastructure is about the most useless target for a stimulus as it takes ages in a country like Germany to get large projects shovel-ready. For an effective stimulus, they say, it would have been better to cut taxes temporarily. Of the two stimulus packages, only a fraction of the money has started to flow from the first package, and nothing yet from the second. (This story confirms what we thought from the outset: that Germany’s stimulus package is headline numbers exercise only. It will not stimulate the economy during the recession, and will probably stimulate the economy during the next upturn, and will thus be highly procyclical) Daniel Cohen on the crisis Writing in Le Monde, Daniel Cohen warns of the dangers of thinking that the crisis is over. He says governments are reacting to the bad press of rising deficits. There is now public action fatigue all around, but this is dangerous because it is not clear at all that an economic recovery is under way. The scenario of a U-shaped recovery is still competing with a “W” – a double-dip recession, and he is particularly concerned about the rise in commodity prices, which reduces the room for manoeuvre for central banks. Setser on the latest global flow data Brad Setser, the best source on the internet on global financial flows, has his first take on the April TIC data from the US treasury. He makes three points. The first is that this was a weak report. In other words demand for US paper from the rest of the world has been very weak – which will accelerate current account adjustment in the US. The second is that official investors are moving towards slightly longer-dated government securities. And third, the data are saying that China’s has reduced its holdings of US Treasuries

310 (though Setser says he does not believe it, judging by past data revisions). Chinn on the latest global flow data Menzie Chinn makes six points about recent trends in global flows: 1. Known dollar reserves as a share of world reserves appear to be falling. 2. Total dollar reserves have likely not declined as precipitously. 3. Even with the decline in the dollar share, it is probably not as low as it was during the early 1990's. 4. The dollar share is (mechanically) linked to the dollar's value. 5. Known dollar reserves at end-2008 are less than predicted by a historical correlation. 6. But this differential is infinitesimal compared to the "unallocated" share of total reserves.

So the conclusion from this analysis is: There is a secular trend towards a decline in the dollar share of global reserves, but it is not very strong – for now. Credit Card companies are getting desperate This is from the NYT, hat tip Calculated Risk. ... Mr. McClelland’s credit card company was calling yet again, wondering when it could expect the next installment on his delinquent account. He proposed paying half of his $5,486 balance and calling the matter even. It’s a deal, the account representative immediately said, not even bothering to check with a supervisor. As they confront unprecedented numbers of troubled customers, credit card companies are increasingly doing something they have historically scorned: settling delinquent accounts for substantially less than the amount owed.

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Moody's recorta el rating de 25 bancos españoles La agencia de calificación Moody's ha rebajado el rating de la deuda senior y de los depósitos de 25 bancos españoles. El anuncio se produce un mes después de que la firma situara en perspectiva negativa a 36 entidades españolas. Todos los iconos apuntan a servicios web externos y ajenos a ELPAIS.es que facilitan la gestión personal o comunitaria de la información. Estos servicios permiten al usuario, por ejemplo, clasificar, compartir, valorar, comentar o conservar los contenidos que encuentra en Internet. CincoDías.com \ Agencias - Madrid - 15/06/2009 La agencia de calificación crediticia Moody's anunció en mayo que ponía bajo revisión para una posible rebaja las calificaciones crediticias de un total de 36 entidades financieras españolas. La agencia de calificación crediticia Moody's anunció el lunes una rebaja en la calificación crediticia de la deuda de 25 entidades españolas (18 de ellas en un escalón y siete en dos) como consecuencia de un deterioro en la calidad de los activos. Los entidades que han sido rebajadas en estas calificaciones de Moodys son Banca March, Banco de Valencia, Banesto, Banco Pastor, Banco Guipuzcoano, Popular, Banco Sabadell, Bankinter, Caixa Cataluña, Caixa de Manresa, Caixa de Terrasa, Caixa Galicia, Caja Rioja, Caja Duero, Caja Cantabria, Bancaja, Caixanova, Caja Vital, CAM y Caja de Burgos. También figuran Caja de Ahorros de Avila, Caja Madrid, Caja Segovia, La Caixa, Ibercaja, Caja España, Caja Insular de Ahorros de Canarias, Caja Laboral, Cajamar y Unicaja. "La creciente presión que enfrentan muchos bancos españoles ante un fuerte deterioro de la calidad de los activos queda reflejada en sus ratings de fortaleza financiera, un tercio de los cuales han bajado hasta D- o incluso más abajo", dijo en una nota Maria Cabanyes, vicepresidente senior de la agencia. "La suave reducción del rating de estos bancos refleja nuestra expectativa de que la ayuda del Gobierno llegará a estas instituciones si dicho respaldo fuera necesario" (a través del fondo de ayuda a la banca que prepara el Ejecutivo, señala el informe. Respecto a la fortaleza financiera, la agencia de medición de riesgos ha señalado que se ha rebajado por "la velocidad y la profundidad del deterioro de la economía española y de su impacto en los balances bancarios". Moody's ha explicado también que las ayudas de capital que podría proporcionar el Estado español a través del fondo de reestructuración y ordenación bancaria (FROB) contribuirían a mejorar la fortaleza financiera de muchas entidades. La lista de entidades a las que ha reducido su fortaleza financiera es: Banca March;

312 Banco de Valencia; Banesto; Banco Guipuzcoano; Banco Pastor; Banco Popular; Banco Sabadell; Bankinter; Caixa Catalunya; Caixa Manresa; Caixa Terrasa; Caixa Galicia; Caja Rioja; Caja Duero, y Caja Cantabria. Además, figuran Bancaja; Caixanova; Caja Vital; CAM; Caja Burgos; Caja Ávila; Caja Madrid; Caja Segovia; Ibercaja; La Caixa; Caja España; Caja Canarias; Caja Laboral Popular; Cajamar y Unicaja La decisión de rebajar la calificación de la deuda subordinada y de las participaciones preferentes se basa en los mismo motivos que los aducidos para acordar el recorte de la deuda a largo plazo y de la fortaleza financiera. La decisión adoptada hoy por Moody's se produce después de que el pasado 19 de mayo acordara revisar, para su posible rebaja, la calificación crediticia de la deuda a largo plazo de 35 entidades financieras españolas. En un contexto de clara recesión económica, la agencia señala que "salvo que se tomen medidas de apoyo de terceras partes - los propietarios o, probablemente, el gobierno- los colchones de capital de algunos bancos se verán pronto afectados por impagos de activos o necesidades de provisiones". La agencia destacó que los bancos que mantienen ratings de fortaleza financiera en "C" o por encima - entre ellos BBVA o Santander, con "B" y Bankinter con "C")- serán resistentes incluso en un escenario de estrés.

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June 16, 2009 Credit Issuers Slashing Card Balances By DAVID STREITFELD The banks were bailed out last fall, the automobile companies last winter. For Edward McClelland, a writer in Chicago, deliverance finally arrived a few days ago.

Mr. McClelland’s credit card company was calling yet again, wondering when it could expect the next installment on his delinquent account. He proposed paying half of his $5,486 balance and calling the matter even. It’s a deal, the account representative immediately said, not even bothering to check with a supervisor. As they confront unprecedented numbers of troubled customers, credit card companies are increasingly doing something they have historically scorned: settling delinquent accounts for substantially less than the amount owed. The practice started last fall as the economy worsened. But in recent months, with unemployment topping 9 percent and more people having trouble paying their bills, experts say this approach has risen drastically.

They say many credit card issuers have revised internal guidelines to give front-line employees the power to cut deals with consumers. The workers do not even have to wait for customers to call and ask for a break. “Now it’s the card company calling you and saying, ‘Let’s talk turkey,’ ” said David Robertson, publisher of the credit industry journal The Nilson Report. Only a few creditors are willing to confirm the practice. Bank of America and American Express say they decide on a case-by-case basis whether to accept less than the full balance. Other card companies refuse to discuss the subject, but their trade group, the American Bankers Association, acknowledges that settlements are becoming more common. The shift comes as the financial services industry finds itself losing some of its legendary power. A credit card reform bill that makes it harder to raise rates on existing balances and prevents certain automatic fees flew through Congress and was signed by President Obama in late May. Borrowers still have a crushing amount of debt to deal with, however. Revolving credit, a close approximation of credit card debt, totaled $939.6 billion in March. The Federal Reserve reported that 6.5 percent of credit card debt was at least

314 30 days past due in the first quarter, the highest percentage since it began tracking the number in 1991. The amount being written off was also at peak levels. After a balance has been delinquent for six months, regulations require the card company to reduce the value of the debt on its books to zero. If a borrower has not paid by this point, chances are he never will. “The creditors would rather have a piece of something now instead of absolutely nothing down the road,” said Adam K. Levin, the founder of the consumer education Web site Credit.com. Banks and credit card companies are discussing new programs that would, for the first time, allow credit counselors to invoke reductions of principal as a routine part of their strategy, said Jeffrey S. Tenenbaum, a lawyer for many counseling agencies. In the past, counselors could persuade card issuers to adjust interest rates and modify late fees, but the balance was untouchable. An example of how quickly the card companies are shifting their approach is in the behavior of HSBC, a major issuer, toward Mr. McClelland. He was paying fitfully on his card, which was canceled for delinquency. In April, HSBC offered him full settlement at 20 percent off. He declined. A few weeks later, it agreed to let him pay half. Traditionally, the creditors could play tough with any accounts that became delinquent because the cardholders had assets. The creditors could sue or place a lien on a cardholder’s house. As the recession grinds on, though, many cardholders have less to lose. Mr. McClelland, 42, is a renter. Since he is self-employed, he has no wages to garnish. But he did not want to feel like a deadbeat. “Having this over and done with was appealing,” he said. He raised the agreed-upon $2,743 and sent it off electronically last week. He has spared himself the prospect of years of collection calls. HSBC said it did not comment on individual cardholders and would not discuss its policy toward settlements. “Every customer situation is unique,” said a spokeswoman, Cindy Savio. The card companies, perhaps understandably, do not want to promote the idea that settlements have become merely a matter of asking nicely. The creditors also point out that a delinquency, like a foreclosure, destroys a credit record. And there can be a Catch-22: those with the fewest assets are the likeliest to receive a settlement offer, but they are also the least able to come up with the cash for that final negotiated payment. Some creditors, though, are helpfully letting people stretch this out over months. Still, a line has been crossed, credit experts say. “Even in the early stages of delinquency, settlements can be dramatic,” said Carmine Dorio, a longtime industry executive who ran collection departments for Citibank, Bank of America and Washington Mutual. During the boom, nonpayers were treated more harshly because, paradoxically, their debt was more valuable. Collection agencies were eager to buy bundles of old debt

315 from the card companies for as much as 15 cents on the dollar. In a healthy economy, even the hopelessly indebted can pay something. In this recession, where collection agencies have little hope of collecting from the unemployed, that business model is suffering. Experts say 5 cents on the dollar is now the most a card company can hope to get for its past-due accounts. Another factor undermining the card companies is the rise of debt settlement firms. These are profit-making companies that charge fees, nearly always in advance, to bargain with creditors on a consumer’s behalf. Settlement companies are under fire from regulators, who say they promise much and deliver little. But their ubiquitous ads, which make a settlement seem not only easy but also a moral victory over shamelessly gouging card companies, have done much to spread the idea. Although there are few independent statistics on the settlement industry, there is no doubt that some generous deals are being done. Consider Bedros Alikcioglu, a gas station owner in Newport Beach, Calif. He owed $112,000 on four cards and was paying $3,000 a month in interest and late fees. “It was so hard to earn that money, and paying it to nowhere didn’t make sense anymore,” said Mr. Alikcioglu, 75. He signed up with a debt settlement company named Hope Financial, which negotiated deals with his creditors to settle for about 35 percent of his balance. Hope Financial is charging Mr. Alikcioglu about 12 percent of his original debt. “I did not want to leave the legacy of bankruptcy,” Mr. Alikcioglu said. “I am now at peace.”

316 16.06.2009 Nobody is prepared for a double-dip recession By: Wolfgang Munchau Last week, the green shoots shrivelled. In South Korea, China and Germany, exports were declining once again. In the US, the Federal Reserve’s Beige Book said “economic conditions remained weak or deteriorated further during the period from mid-April through May”. The March signs of revival turned out to be little more than a technical inventory correction, with no change in the underlying trend. The world economy is still contracting, though perhaps not quite as fast as at the start of the year. As an analysis by economists Barry Eichengreen and Kevin O’Rourke* shows, global industrial output is still on the same trajectory as it was during 1930. The only question is whether we can avoid 1931 and 1932. The answer is yes, but on conditions that seem increasingly implausible if we extrapolate current policies. We can avoid calamity if monetary and fiscal policies remain supportive throughout the duration of this crisis, if we fix the banking system and if we impose regulations to constrain a resurgent financial sector. We also have to be lucky to avoid another round of market turbulence in the near future. In other words ... the answer may well be no. Central banks and governments therefore risk moving too swiftly out of a recession-mode strategy. When Axel Weber, president of the Bundesbank, publicly talks at this time about how to communicate a rise in interest rates, it tells me that the danger of a premature exit, at least in Europe, is clear and present. Fiscal policy exit strategies were at the top of the Group of Eight finance ministers’ agenda on Saturday, with the Europeans in greater haste than others. Nobody is solving the toxic asset and recapitalisation problems of the banks. Financial regulation does not seem to be extending much beyond populist pseudo-measures on tax havens. Plus there is still financial meltdown potential in the system. Latvia, for example, is a ticking time bomb. So at this point, I see the chances as roughly even between a global slump and a return to quasi-stagnation. What is so galling about this scenario is that it is avoidable. The central banks took the right decisions. But the political reaction has been near-catastrophic almost everywhere. Instead of solving the problems to generate a recovery, the political strategies have consisted of waiting for a recovery to solve the problem. The Europeans are relying on the Americans to generate growth. The Americans are relying on the Chinese, who in turn are waiting for the rest of the world. Even if the US were to generate some growth, as is likely after this summer, it would not benefit global exporters; China may be one of the fastest growing economies in the world, but it is only about half as large as the eurozone in dollar terms. And as Brad Setser** has pointed out in his blog, there is absolutely no evidence that China

317 contributes to a global recovery. While Chinese investments are up by more than 30 per cent from last year alone, imports are down 25 per cent. All this hype about decoupling and China pulling the world out of recession is baloney. The data tell us that China’s exports and imports are both falling, and that imports are falling faster. As everybody expects the others to move first, nobody ends up moving. In the meantime, the problems grow worse. US house prices, which are down by a little over 30 per cent from their peak, still have some way to fall. Until the US housing market hits rock bottom, perhaps sometime in 2010, there is no chance of a recovery in the securitisation market, without which there may not be sufficient credit growth. As the recession continues, the number of personal and corporate insolvencies will rise, which in turn will aggravate the problems of the banking sector. I am not surprised that the Bundesbank’s Mr Weber resists the publication of stress tests for the banking system. It would show that the German banking system was insolvent – and that bad and potentially bad assets were equivalent to about one-third of gross domestic product. The only potentially good news in the past three months has been the receding threat of a currency crisis in central and eastern Europe. But I am not even sure that this is for real. The persistent refusal by eurozone policymakers to concede fast-track euro accession for central and eastern member states could yet prove destabilising. Last week, the ECB had to provide €3bn in euro liquidity to Sweden’s Riksbank, in the absence of which Sweden may have experienced its second banking meltdown in less than two decades. The inevitable collapse of Latvia will have ripple effects on the Baltic region and may cause panic among investors in other central and east European countries. This is why last week’s news about the withering green shoots is so important. It tells us that the non-strategy of waiting until things get better is not working. The March signs of life reinforced complacency. Optimism will get us out of this crisis only if it is founded in reality. Last week showed us that this is not the case. *A tale of Two Depressions, www.voxeu.org **blogs.cfr.org/setser http://www.ft.com/servicestools/help/copyright©

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Opinion

June 15, 2009 OP-ED COLUMNIST Stay the Course By PAUL KRUGMAN The debate over economic policy has taken a predictable yet ominous turn: the crisis seems to be easing, and a chorus of critics is already demanding that the Federal Reserve and the Obama administration abandon their rescue efforts. For those who know their history, it’s déjà vu all over again — literally. For this is the third time in history that a major economy has found itself in a liquidity trap, a situation in which interest-rate cuts, the conventional way to perk up the economy, have reached their limit. When this happens, unconventional measures are the only way to fight recession. Yet such unconventional measures make the conventionally minded uncomfortable, and they keep pushing for a return to normalcy. In previous liquidity-trap episodes, policy makers gave in to these pressures far too soon, plunging the economy back into crisis. And if the critics have their way, we’ll do the same thing this time. The first example of policy in a liquidity trap comes from the 1930s. The U.S. economy grew rapidly from 1933 to 1937, helped along by New Deal policies. America, however, remained well short of full employment. Yet policy makers stopped worrying about depression and started worrying about inflation. The Federal Reserve tightened monetary policy, while F.D.R. tried to balance the federal budget. Sure enough, the economy slumped again, and full recovery had to wait for World War II. The second example is Japan in the 1990s. After slumping early in the decade, Japan experienced a partial recovery, with the economy growing almost 3 percent in 1996. Policy makers responded by shifting their focus to the budget deficit, raising taxes and cutting spending. Japan proceeded to slide back into recession. And here we go again. On one side, the inflation worriers are harassing the Fed. The latest example: Arthur Laffer, he of the curve, warns that the Fed’s policies will cause devastating inflation. He recommends, among other things, possibly raising banks’ reserve requirements, which happens to be exactly what the Fed did in 1936 and 1937 — a move that none other than Milton Friedman condemned as helping to strangle economic recovery. Meanwhile, there are demands from several directions that President Obama’s fiscal stimulus plan be canceled.

319 Some, especially in Europe, argue that stimulus isn’t needed, because the economy is already turning around. Others claim that government borrowing is driving up interest rates, and that this will derail recovery. And Republicans, providing a bit of comic relief, are saying that the stimulus has failed, because the enabling legislation was passed four months ago — wow, four whole months! — yet unemployment is still rising. This suggests an interesting comparison with the economic record of Ronald Reagan, whose 1981 tax cut was followed by no less than 16 months of rising unemployment. O.K., time for some reality checks. First of all, while stock markets have been celebrating the economy’s “green shoots,” the fact is that unemployment is very high and still rising. That is, we’re not even experiencing the kind of growth that led to the big mistakes of 1937 and 1997. It’s way too soon to declare victory. What about the claim that the Fed is risking inflation? It isn’t. Mr. Laffer seems panicked by a rapid rise in the monetary base, the sum of currency in circulation and the reserves of banks. But a rising monetary base isn’t inflationary when you’re in a liquidity trap. America’s monetary base doubled between 1929 and 1939; prices fell 19 percent. Japan’s monetary base rose 85 percent between 1997 and 2003; deflation continued apace. Well then, what about all that government borrowing? All it’s doing is offsetting a plunge in private borrowing — total borrowing is down, not up. Indeed, if the government weren’t running a big deficit right now, the economy would probably be well on its way to a full-fledged depression. Oh, and investors’ growing confidence that we’ll manage to avoid a full-fledged depression — not the pressure of government borrowing — explains the recent rise in long-term interest rates. These rates, by the way, are still low by historical standards. They’re just not as low as they were at the peak of the panic, earlier this year. To sum up: A few months ago the U.S. economy was in danger of falling into depression. Aggressive monetary policy and deficit spending have, for the time being, averted that danger. And suddenly critics are demanding that we call the whole thing off, and revert to business as usual. Those demands should be ignored. It’s much too soon to give up on policies that have, at most, pulled us a few inches back from the edge of the abyss. PAUL KRUGMAN, Stay the Course, 15/junio/2009, http://www.nytimes.com/2009/06/15/opinion/15krugman.html?th&emc=th

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June 14, 2009, 5:23 am Stimulus history lesson Republicans are pronouncing Obama’s stimulus a failure: “Today’s announcement is an acknowledgement that the Democrats’ trillion-dollar stimulus is not working, and the American people know it,” House Minority Leader John Boehner said in a statement. “When they passed this spending plan, Democrats said it would immediately create jobs, yet nearly four months later unemployment has continued to climb and none of their rosy predictions have come true.” Just sayin’: June 15, 2009, 1:04 pm Shleifer, Vishny, Minsky (wonkish) I’m on a continuing quest to develop a tractable model of Minsky moments. Why? you may ask. Why not go with verbal intuition? Well, I’m enough of a conventional economist to think that there’s no substitute for a model with dotted i’s and crossed t’s; it’s not THE TRUTH, but it really does help clarify your thinking. So here’s where I am right now. There is a class of models — Shleifer and Vishny is my main inspiration, although other models, like Kiyotaki and Moore, are in the same spirit — in which you can get something like a Minsky moment. The story goes something like this (this isn’t quite how Shleifer-Vishny does it, but not too different): There are three kinds of investors: ordinary investors who buy when the price is low and sell when it’s high; noise traders, who buy and sell randomly*; and highly leveraged informed investors (HLIs), who try to buy low and sell high with other peoples’ money. On average, the HLIs should earn a high rate of return. However, Shleifer-Vishny assume that there are two periods before the goodness of investments is revealed to all — and in period 2 even good investments can look bad thanks to selling by those noise traders. And if the noise traders drive the price down sufficiently, HLIs can face margin calls, forcing them to liquidate and push prices even lower. This is more or less the Minsky moment. But how do we make Minsky moments endogenous? Think about playing this game repeatedly, with the number of HLIs varying based on past performance. If there are very few HLIs, expected returns are high and the probability of a Minsky moment (and its severity if it happens) are low; this will tend to bring more HLIs into the picture, until the system is highly vulnerable. A bad draw on noise traders, and there’s an asset price plunge that hits the HLIs very hard. People decide that leverage is a bad thing, and for a while those who do go into leverage do very well. And the cycle begins again. It’s crude. But I think it does get the nonlinearity Brad DeLong was looking for (though I’d better work up the actual algebra to make sure!).

321 *In his new book The Myth of the Rational Market Justin Fox traces the lineage of the noise-trade assumption to an unpublished paper by Larry Summers that began, THERE ARE IDIOTS.

June 16, 2009, 1:15 pm Is skin in the game the answer? According to the Washington Post, one part of the soon-to-be-announced financial regulatory reform will be a requirement that lenders keep some “skin in the game”: Lenders would be required to retain at least 5 percent of the risk of losses on each package of loan pieces, known as an asset-backed security. … The administration concluded that securitization encouraged looser lending standards, because companies that sold loans to investors had little reason to care whether borrowers could repay those loans. Furthermore, employees were paid to make loans, but they were not penalized for defaults. And investors could not easily check the excesses because they lacked basic information about the contents of each security. The result? “A serious market failure that fed the housing boom and deepened the housing bust,” according to Treasury Department spokesman Andrew Williams. The administration’s proposal is not just an attempt to clean up the securitization market. The goal is also to help revive that market, which has seen almost no activity in the last year. Is that going to do the trick? I’d be more convinced if I hadn’t read my colleague Hyun Song Shin’s piece earlier this year, which declares: The old view, now discredited, emphasised the positive role played by securitisation in dispersing credit risk, thereby enhancing the resilience of the financial system to defaults by borrowers. But having disposed of this old conventional wisdom, the fashion now is to replace it with a new one that emphasises the chain of unscrupulous operators who passed on bad loans to the greater fool next in the chain. We could dub this new fashionable view the “hot potato” hypothesis. The idea is attractively simple and blames a convenient villain, so it has appeared in countless speeches given by central bankers and politicians on the causes of the subprime crisis. But the new conventional wisdom is just as flawed as the old one. Shin argues that financial firms actually used securitization to take on more risk, not to sell it to unknowing clients. This suggests that forcing firms to hold on to some of the securitized debt won’t make much if any difference.

322 June 16, 2009, 8:22 am The return of liquidationism One discouraging feature of the current economic crisis is the way many economists and economic commentators — apparently ignorant of what went on over the last 75 years or so of macroeconomic debate — have been reinventing old fallacies, imagining that they were coming up with profound insights. I’ve written about how Fama, Cochrane, and others have reinvented the “Treasury view”. Now John Tamny has reinvented liquidationism. By the way, thanks to Google Books it’s easy to sample Schumpeter’s thoughts on the Great Depression in the original. It’s really really bad: … our story provides a presumption against remedial measures which work through money and credit. For the trouble is fundamentally not with money and credit …

323 credit bubble bulletin No Conundrum, Again by Doug Noland June 12, 2009 Ten-year Treasury yields traded briefly above 4.0% this week for the first time since last October. Benchmark MBS yields jumped as high as 5.12%, up from 3.94% as recently as May 20th. Long-bond yields reached the highest (4.76%) since October 2007. Despite a near zero Fed funds rate and about $25bn of weekly MBS purchases by the Federal Reserve, yields have surprised the marketplace on the upside. Those of the bullish persuasion are content to see rising yields as confirmation of economic recovery. Others are referring to another “Conundrum.” It is worth noting that 10-year Treasury yields are about 20 bps higher than their German counterparts today, after trading near 20 bps lower only a month ago. When the Greenspan Fed finally nudged up the funds rate from 1% to 1.25% at the end of June 2004, MBS yields were trading at about 5.5%. By the end of 2005 - after Fed funds had been hiked 325 bps to 4.50% - benchmark MBS yields had only increased 30 bps to 5.80%. Mortgage and housing Bubbles continued to gain strong momentum. Greenspan began referring to the low bond yield “Conundrum” – the phenomena where market yields were failing to respond to so-called Federal Reserve “tightening.” The new “Bernanke Conundrum” is a problematic rise in market yields in the face of ultra-low Fed funds and massive quantitative ease (including MBS purchases). I never bought into Greenspan’s Conundrum, nor do I see any current mystery with regard to U.S. market yields. During the period 2004 through 2007, Credit Bubble excess played a fundamental role in distorting the demand for U.S. securities, especially Treasuries and agencies (debt and MBS). Back then I titled a CBB “No Conundrum.” In particular, massive speculative leveraging of mortgage-related securities during the boom created excess market demand and artificially low yields throughout the mortgage finance arena. Extremely loose financial conditions were self-reinforcing, as cheap and readily available mortgage Credit inflated home prices and (temporarily) deflated Credit costs. Market distortion-induced excess returns incited a fateful flood of speculative finance into the mortgage sector. At the same time, Credit Bubble-induced dollar outflows (massive Current Account deficits coupled with heightened flows seeking profits from dollar weakness) inundated foreign central banks (notably China’s), creating artificial foreign demand for U.S. Treasuries and agency securities. In short, the Fed's post-tech Bubble reflation had spurred unwieldy Bubbles throughout the U.S. securities and asset markets – Bubbles the Fed refused to tackle. The Credit Bubble created incredibly distorted supply and demand dynamics for both mortgage securities and Treasuries. At the same time, Bubble-related price and financial profit distortions fostered demand for (“money-like”) U.S. debt securities. This process eased the burden of recycling massive U.S. global outflows back to dollar instruments. The “private” Credit system was expanding uncontrollably, while Fed rate tinkering provided no restraint. Today, with the Wall Street/mortgage finance

324 Bubble having burst, our challenge is to carefully analyze dynamics in an effort to gauge the emergence of new supply/demand and price relationships. Until proven otherwise, I will view the recent backup in U.S. market yields as indicating the emergence of important new global market dynamics. For much of the past year, the dollar benefited from various facets of a short-covering rally. This dollar strength reinforced the perception of U.S. Treasury and agency securities as premier global safe haven assets. Global financial crisis buoyed the dollar, albeit temporarily. U.S. market yields collapsed, bolstering the view in Washington and throughout the markets that U.S. policymakers retained virtually unlimited flexibility. The belief in a renewed King Dollar, in combination with what appeared powerful global deflationary forces, had most convinced that inflation risk had been taken completely out of the equation. But after trading to almost 90 in early March, the dollar index again dropped back below 80. The combination of double-digit (as % of GDP) U.S. federal deficits, massive Federal Reserve “quantitative ease,” and renewed dollar weakness granted virtually unlimited flexibility to policymakers around the globe. China, the U.S. and Europe were on the forefront of unprecedented synchronized global monetary and fiscal stimulus. Government finance Bubble and global reflation dynamics quickly emerged. Global reflation has the markets reexamining early held views. For one, the dollar has become much less appealing, both as a safe haven vehicle and as a longer-term store of value. To be sure, the U.S. is these days a fiscal blackhole. Moreover, global reflation is typically more constructive for the “emerging” and “commodity” economies. And the greater the flows from the “Core” (U.S.) to the “Periphery” the more incentive there is to diversify out of the devaluing dollar. The greater the relative outperformance of non-dollar asset-classes - the greater the self-reinforcing speculative flows available to fuel global reflation. Meanwhile, the combination of a weaker dollar and the emerging global reflationary scenario dramatically alter the prospective U.S. inflationary backdrop. Crude prices have more than doubled from February lows. The rejuvenated dollar from a few months back appeared to assure great leeway to the Bernanke Fed. The expectation was that the Fed essentially had unlimited capacity to employ “quantitative easing.” This bolstered the market’s generally sanguine view of the yield impact from the Treasury’s massive funding requirements. Especially with the announcement of huge ongoing MBS purchases, the view solidified that the Fed would essentially peg long-term market yields - as it does short-term borrowing rates. And, importantly, the perception that the Fed could set artificially low long- term interest rates – hence Treasury funding costs – worked to bolster a more optimistic reading of the U.S. fiscal position (not to mention the U.S. household balance sheet). Yet a much more uncertain world is emerging. Global reflation and international markets are – as inflation and market dynamics tend to do - taking on a life of their own. And just as Credit Bubble dynamics overwhelmed Greenspan rate tinkering back in 2004/05, there are now strong countervailing market forces working against the efficacy of Bernanke helicopter money. If global reflation takes hold simultaneous with a weakening dollar, inflation could easily emerge as a major threat here in the U.S. And if global markets begin determining longer-term U.S. Treasury and MBS yields – as opposed to the Bernanke Fed manipulating them artificially low – the U.S. recovery outlook becomes greatly more clouded.

325 During the 2005 “Conundrum,” market dynamics fed the U.S. Bubble, as artificially low rates boosted household borrowings, asset prices and consumption. Increasingly, it appears the new “Conundrum” is putting upward pressure on market yields. Such a scenario holds the potential to stop the mortgage refinancing boom in its tracks, while delaying a meaningful recovery in housing markets and household consumption. It is fundamental to my analysis that the unfolding reflation will be altogether different than previous ones. On a global basis - and contrary to the consensus view - I expect the U.S. economy to under-perform. Already, a scenario is unfolding where reflation hurts the U.S. consumer through higher energy and import costs, rising borrowing costs, and a greater tax burden. And in contrast to more recent inflations, U.S. securities will be anything but the focal point of global reflation dynamics. I expect global markets to increasingly determine U.S. market yields, with resulting higher borrowing costs and less liquidity generally stymieing recovery in our asset markets. The consensus view would scoff at my thesis of global markets disciplining our policymakers. Many assume that the Fed would respond to rising yields by increasing its purchases of MBS and Treasuries. But monetization would become greatly more problematic in the event of a market turn against our currency. And our foreign creditors have been signaling monetization angst. The really problematic scenario unfolds when market yields spike higher, the Fed monetizes, dollar selling intensifies, and the world questions our capacity to service our federal and mortgage debts. An economy can only inflate Credit, devalue its currency, flood the world with its debt obligations – all working to disburse financial and economic power out to the world – until at some point power dynamics reach a tipping point. There is No Conundrum, Again…

http://www.prudentbear.com/index.php/creditbubblebulletinview?art_id=10240

326 Counter-Cyclical or Counterproductive? by Doug Noland June 05, 2009 My old “analytical nemesis”, Paul McCulley, is out with a long piece this week, “The Shadow Banking System and Hyman Minsky’s Economic Journey.” He begins by stating the rather obvious: “creative financing played a massive role in propelling the global financial system to hazy new heights…” Mr. McCulley then asks a most pertinent question: “How did financing get so creative?” His somewhat insightful article is deeply flawed in that it fails to provide a valid answer. First and foremost, our Credit system ran amok because our “activist” central bank for years pegged and, over time, increasingly manipulated the cost of finance. The Fed essentially guaranteed liquid and continuous markets to an increasingly deregulated and unrestrained marketplace, while repeatedly moving aggressively to bail out the leveraged speculators. The Greenspan Federal Reserve championed “contemporary finance”, in the process creating astounding profit opportunities for those structuring, distributing and leveraging sophisticated Wall Street financial instruments. Dr. Bernanke promised to be there with helicopter money as needed. The Fed, congress, and various Administrations championed financial deregulation – as financial operators salivated. And it certainly didn’t hurt that spurring mortgage borrowing and home ownership became a national priority, as the rapidly expanding government-sponsored enterprises transformed the liquidity and marketability of mortgage securities. Unfettered private Credit expansion created its own loose financial conditions, leaving Fed rate tinkering ineffectual for tightening Credit conditions and Federal Reserve doctrine unwilling to address mounting Credit and asset Bubbles. To be sure, the Wall Street finance/mortgage finance Bubble propagated out of the massive post-tech Bubble inflationary effort. The so-called “shadow banking system” was only one rather conspicuous facet of a historic – and ongoing - experiment in government monetary management. Mr. McCulley writes: “No, I’m not a socialist.” Ok. Over the years, I’ve referred to McCulley and his ilk as “inflationists.” An inflationist may not begin his trek as a socialist, but it’s the nature of such an endeavor to pretty much end up in that territory by the end of the day. Of course, the inflationists today are calling for more extreme and intrusive reflationary measures than those employed in previous crises and deflationary scares. It is now, apparently, necessary for the “full faith and Credit of the sovereign’s balance sheet” to stand behind our entire impaired private sector Credit system. At this fragile stage of the inflationary boom, the inflationists have no qualms “betting the ranch.” Long-time readers know that I, like Mr. McCulley, am a huge admirer of Hyman Minsky. I have over the years deeply embedded Minskian analysis into my analytical framework in an effort to better comprehend the extraordinary financial and economic landscape. Others, including McCulley, have repeatedly invoked Minsky as part of their ideological rationalizations for bailouts and inflationism. And I today find great irony in Mr. McCulley’s piece: After touching upon Minsky’s preeminent analysis with respect to the nature of financial instability and “Ponzi Finance,” McCulley dogmatically prescribes unprecedented government intervention as the elixir to help restore system stability. It’s a flawed analytical framework that comes to a perilous recommendation. If

327 Hyman Minsky were with us, he would surely share a similar view that Washington has trapped itself in a most dangerous “Ponzi Finance” dynamic. We’re witnessing the same analytical errors today that were made in the post-tech Bubble analysis: the willingness to inflate an even greater Bubble for the cause of mitigating the pain from the so-called deflationary risks associated with a bursting of THE Bubble. And with each reflation comes a heightened governmental role in both the markets and real economy – to the point where Washington is essentially backstopping the financial and economic systems. I used to find it rather perplexing that our nation’s largest bond fund managers were among inflationism’s most vocal proponents. I was naïve; it now seems all so obvious. Of course, market operators prefer to have the Fed and Washington there reliably backstopping the markets. An activist central bank pegging interest rates and manipulating the cost (hence, the flow) of finance creates wonderful opportunities for the savviest traders playing the money game most adeptly. The expansion of Bubbles creates great opportunities and then, for the enlightened, the bursting of these Bubbles provides only greater profits. Mr. McCulley is fond of blaming the “shadow banking system” for our acute financial and economic fragility. Yet the responsibility lies more generally with a deeply flawed monetary policy regime – a regime hopelessly locked in interest- rate manipulation and inflationism. To this day I find it perplexing that leading “free market” proponents have been so happy to have the Federal Reserve setting and manipulating the cost of finance throughout the real economy. By now, it should be crystal clear that such a regime cultivates a financial apparatus that systematically misprices risk, over-expands Credit, fosters over- leveraging, emboldens speculation, and massively misallocates and misdirects both financial and real resources throughout. After awhile, so much of the financial apparatus is focused primarily on seeking central bank-induced financial profits. Economic profits and real economy price signals become further marginalized. And with each bursting Bubble and resulting reflation, the government’s role in the system’s pricing mechanism becomes more ingrained, intrusive and destabilizing. The Bubbles change, while the price distortions and imbalances become deeply embedded in the underlying economic structure. I see no reason to back away from the view that the fundamental dilemma today lies not so much in finance but with our deeply impaired economic structure. This structure is a manifestation of years of mispriced finance, Credit and speculative excess, and resource misallocation. From this perspective, it should be obvious that greater Fed-induced market price distortions and Treasury/Fed-induced Credit expansion will only exacerbate structural impairment and delay readjustment. If I had to point to a significant weakness in Minsky’s work, it would be the lack of analytical attention paid to the underlying economic structure (and why it is imperative to incorporate Austrian analysis into our analytical frameworks!). The inflationists today believe that massive (“counter-cyclical”) government market and economic intervention will help the system revive and repair itself. I see current policies as simply a desperate attempt to perpetuate unsustainable financial and economic structures. And system impairment will not have run its course until some semblance of a market-based cost of finance emerges to more effectively allocate financial and real resources throughout the economy. The wholesale socialization of risk may be “counter cyclical” but it is also terribly counterproductive.

328 After the 9/11 catastrophe, I expressed the view that - if our government was compelled to stimulate - it would be preferable to run temporary fiscal deficits instead of manipulating interest rates and the financial markets. Yet the manipulation of the quantity and cost of Credit is much easier for policymakers to implement, and the results (heightened liquidity, risk-taking, and inflating asset prices) can be rather immediate and heartening. Meanwhile, the associated costs are not evident let alone quantifiable. Yet such interventions – and resulting changes in the quantity and flow of finance - seductively take on a life of their own as they breed excesses, future crises and the inevitable call for only greater interventions and inflations. Mr. McCulley concludes with the insight – and I’m paraphrasing here - that deregulated and innovative finance precludes the elimination of “Minsky Moments:” McCulley believes “it’s a matter of having the good sense to have in place a counter-cyclical regulatory policy to help modulate human nature.” I would strongly counter that it is absolutely imperative to have the good sense not to perpetuate Bubbles and inflate episodes of “Ponzi Finance” to the point where they risk systemic collapse. Bankrupting the entire country is a completely unacceptable outcome. At some point the inflationists should accept the reality that they are a big part of the problem – and not the solution. Is that what the bond market is beginning to tell us? http://www.prudentbear.com/index.php/creditbubblebulletinview?art_id=10238 The Core to Periphery Dynamic by Doug Noland May 29, 2009 This week provided ample confirmation for the global reflation thesis. The dollar index dropped another 0.9%. Gold surged $22 to $979. Crude oil jumped $4.67 to a six-month high, posting the largest one-month percentage gain since 1999 (according to Bloomberg). The Goldman Sachs Commodities index rallied 5.5% to an almost 7-month high (up 27% y-t-d). Emerging markets remain on fire. And the Baltic Dry Index rose gain today, increasing its streak of consecutive gains to 19. Leading the “bric” sweepstakes, Russia's RTS equities index jumped 7.3% this week, while India’s Sensex rose 5.3%. Russian stocks are now up 72% y-t-d, followed by India’s 52%, China’s 45%, and Brazil’s 42%. Elsewhere, stocks in Taiwan are up 50%, South Korea 24%, Argentina 47%, and Hungary 22%. The “commodity” currencies led the charge again this week. The South African rand gained 4.1%, the New Zealand dollar 3.3%, the Brazilian real 3.0%, the Australian dollar 2.4%, and the Canadian dollar 2.7%. It was quite a week in U.S. interest rate markets. Ten-year Treasury yields jumped 29 basis points during the shortened week’s first two trading sessions (to 3.74%), before backing off to end the week up only 2 bps to 3.47%. The mortgage marketplace turned rather tumultuous, with benchmark Fannie MBS yields spiking 55 bps from last Friday’s close before ending the week 19 bps higher at 4.33%. Some interest-rate hedging markets seemed in disarray, with the dollar swaps market demonstrating price discontinuity. After closing last week at 14.4 bps, the 10-year dollar swap spread traded as high as 38.25 before ending the week at 19.50. Importantly, at least for the week, mortgage-related market tumult didn’t broaden to other risk markets. Corporate Credit spreads were mostly narrower on the week, even as the company debt issuance boom ran unabated. The junk bond market enjoyed another week

329 of strong fund inflows more than matched by huge issuance. It is also worth noting the resilience of the “emerging” debt markets. Brazilian benchmark dollar bond yields were down 14 bps to 5.86%. Mexican dollar bond yields fell 14 bps to 5.74%. Brazil’s Credit default swap (CDS) prices declined to the lowest level since early October (197 bps, down from the October high of 600 bps). It is no longer the case that when the Treasury market catches a cold others get really sick. At this point, the markets’ sanguine attitude toward dollar and Treasury/MBS weakness is understandable. From a global perspective, a weaker dollar bolsters the inflationary bias that had prior to the Credit meltdown been driving robust economic performance throughout the energy and commodities-based economies. Dollar devaluation also works to reinforce already heady financial flows to “emerging” markets and non-dollar assets more generally. There are facets of inflation that seductively salve recovery. The dramatic loosening of financial conditions globally is supporting an improvement in economic conditions. The optimists are looking for Asia and the developing world to lead a global recovery, and a sinking dollar on a short-term basis would seem to support such a scenario. Our weak currency also empowers the Global Government Finance Bubble. Amazingly, most countries today have unprecedented flexibility to issue debt without fear of negative market reaction or a run against their currencies. I again want to emphasize the dramatic change in circumstances that is increasingly in view throughout global markets and economies. During the nineties – and stretching through the “King Dollar” period earlier this decade – there was an overarching inflationary bias that worked to direct flows TO the “Core” (the U.S. Credit system and securities markets). Whether it was a crisis that initially erupted in Mexico, SE Asia, Russia, Argentine or Brazil, the immediate market response was an abrupt reversal of financial flows from the developing countries to U.S. dollar securities. While there was an ongoing acceleration in speculative flows meandering about the globe in search of big returns, the first sign of trouble would incite a panic straight to the dollar.

The “Core” absolutely dominated the system, providing our policymakers (especially the Fed) extraordinary latitude. The Periphery to Core bias fostered financial crises, along with general Periphery financial and economic instability. This dynamic worked to keep global inflationary pressures in check. Or, better said, the nature of the inflationary flow of finance kept inflation pressures directed to U.S. dollar securities markets - as opposed to energy, commodities and more traditional inflation. The global financial and economic backdrop has changed profoundly. Today, there exists a powerful inflationary bias working to direct flows away from the Core out to the Periphery. This dynamic helps to explain the dramatic change in the cost and availability of finance for the developed world over the past several years – the virtually unlimited cheap finance that funded historic booms in China and Asia. Granted, this flow was abruptly interrupted by last year’s global Credit crisis. It is, however, my view that the dynamic of powerful Core to Periphery flows has resumed. Moreover, it is the nature of this type of dynamic that if such a trend recovers it will likely resume stronger-than-ever (think tech stock post-LTCM reflation or mortgages post-tech Bubble reflation). This analysis is supported by the Periphery’s recent dramatic economic and market outperformance relative to the Core. So, is this bullish or bearish? Well, I believe The Core to Periphery Dynamic is supportive of a more rapid than expected global economic recovery. I definitely expect

330 global inflation to surprise on the upside. Adherents to the global deflationary spiral thesis may be left wondering what the heck happened. The backdrop seems to be set for surprising revival in energy and commodities markets. And I would not be surprised if the global equities rally has some legs. Yet I view The Core to Periphery Dynamic as profoundly bearish for the U.S. At its core, this historic redirection of global flows and inflationary pressures is the consequence of a breakdown in the dollar standard. Failed policies, a resulting deeply impaired economic structure, and massive ongoing devaluation have ended the dollar’s reign as the globe’s premier reserve currency and perceived stable store of value. There is today no sound currency to replace the dollar, so the global financial system operates rudderless and with great uncertainties. It is more certain, however, that the great benefits commanded to our economy and markets over the decades from governing the world’s reserve currency are drawing to an end. Our policymakers still believe they can inflate Credit and manipulate interest rates - and not have to pay a price for it. But the new global reality may be that currency markets protest massive U.S. fiscal deficits and activist monetary policy, while global markets come to dictate U.S. market yields. Over the past two weeks we have seen the dollar and U.S. Treasuries/MBS come under significant pressure. Is this the beginning of global markets disciplining Washington? A robust Core to Periphery Dynamic and the re-emergence of dollar vulnerability are a potent combination. U.S. markets to this point remain sanguine with the prospect of an expanding Federal Reserve balance sheet rectifying any spike in interest rates. But currency markets are no doubt increasingly fixated on our propensity to monetize current and prospective stimulus. At some point, increasingly unwieldy flows out of our currency may force the Fed’s hand. The scenario where the Fed is forced to choose between loose monetary policy and currency crisis sits out there as a potential big negative surprise for U.S. markets. http://www.prudentbear.com/index.php/creditbubblebulletinview?art_id=10234

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15.06.2009 German finance minister scared about inflation

The FT reports from Rome about the G8 finance ministers meeting, which agreed nothing of substance, but which demonstrated clearly how far apart the leading industrialised nations are at present. Germany’s finance minister Peer Steinbruck “was the most emphatic about the need to address inflationary pressures”. Giulio Tremonti is scared about speculators in the commodity markets. The ministers spent a considerable time discussing exit strategies as they are now convinced the crisis is now large over, with the exceptions of Tim Geithner and Alastair Darling, who said that nobody is talking about exiting right now. (Well, this is unfortunately not entirely true). EU to increase IMF funds At the EU summit this week, a decision is likely to provide additional funds for the IMF, FT Deutschland reports, which has already obtained a copy of the summit declaration. In the current version of the text, it says this is in addition to the €75bn already pledged by the EU at the G20 summit. The article says the unexpected increase in IMF funds suggest that governments expect more countries to get into financial difficulties. The papers talks about large credits to the Baltic Republics, but also to Poland. The summit text also explicitly rules out any additional stimulus packages. France increases stimulus expenditures for 2010 In a letter to his ministries, the French prime minister indicated what he expects expenditures of each ministry in 2010 to be. These letters are part of the budget process and are derived the multiannual budget plan. Les Echos has the details with overall expenditures are to raise by 1.2% in line with inflation; stimulus measures (some 1000 programmes involved) receive extra money of €3.5bn (instead of €1.6bn ) while some savings come from pensions and cuts in the defense budget. Government debt is expected to approach 80% of GDP. Meanwhile, the increase of the pension age (currently 60 years) might become subject of the second half of Sarkozy’s presidency, reports Les Echos. The Social security funds reached a record deficit of €20bn, and are expected to rise to €30bn next year. Greece public debt at 111.8% Greece’s public debt rose by an unprecedented 20bn in the first quarter of the year, with public debt reaching staggering 282bn or 111.8% of GDP, reports Kathemerini. A

332 breakdown shows that most debt repayment is due in the long term: Around 24bn in 12- month treasury bills, while medium-term debt – for between one to five years – accounts for 92.7bn. Some 123bn are up for repayment in more than five years. Munchau on green shoots Wolfgang Munchau says in his FT column that the green shoots are shrivelling. The latest output and export data show that after the short-lived improvement in March, things were going downhill again in April and May, and that the strategy by government to wait until things get better is not working. That is true in particular of the financial sector, which needs a recovery to improve, but which itself prevents a recovery through its own ill health. The Europeans are waiting for the Americans, to generate growth, the American are waiting for the China, who are waiting for the rest of the world. This policy is simply not working. Setser on China Brad Setser has more on why China is not adding to global demand. He made some back of the envelopment calculations that suggest that China’s domestic demand for domestically produced goods must have expanding by some 30%, given the fall in imports. “China’s stimulus clearly has yet to spillover into world demand for manufactured goods in a major way. That is too bad. After several years when global demand helped spur Chinese growth (as net exports contributed a significant contribution to growth), this would be a good time for China to return the favor.” Gros on current account imbalances Daniel Gros has an intriguing comment in Vox this morning, in which he asks the questions how could current account imbalances provoke the biggest financial crisis in living history. He says one has to take into account the way current account deficits are financed and how flow imbalances accumulated into large stock disequilibria. It explains the securitisation leading to the crisis as the product of a maturity mismatch between foreign savers seeking short-term assets and excess supply of long-term US mortgage debt. Persaud on bank capital Also writing in Vox, Avinash Persaud says there is a strong consensus that banks had insufficient reserves set aside for a rainy day and that they should be required to hold more capital. He says we should differentiate institutions less by what they are called and more by how they are funded. Encouraging individual risks to flow to those who can absorb them would make the system safer and introduce new players with risk capacities. Dullien on Germany’s balance budget rule Sebastian Dullien, writing in Eurozone Watch, has a good analysis of Germany’s constitutional balanced-budget amendment, which he says is going to be very difficult to undo given the changing political circumstances. What we should expect therefore is for one generation of politicians to try to meet those absurd targets (while other EU countries are not), before this whole thing will be undone in some distant future. He also points out that despite a Grand Coalition, the resolution only passed by a necessary margin of ten votes – it required a two-thirds majority – and as the big parties get smaller, such majorities will become less likely in the future.

333 Why Germany’s exporters are going suffer An interesting comment by Holger Goerg in FT Deutschland, who argued that exports do not simply switch on and off before and after crises, but there are structural components that could lead to a loss of an export market to become permanent. The idea is that exporters pay sunk costs to build up a sales infrastructure abroad. If they were to leave the market, they will have to repay the same costs on reentering. This is why the crisis is particularly serious for Germany, as many small and medium sized companies are currently being driven out of export markets.

15.06.2009 That Healthy Decoupling By: Angel Ubide

The concept of decoupling became one of the casualties of the post-Lehman global economy. Until then, there were heated debates about whether the rest of the world would be able to cope with the slowdown in the United States – and the evidence was clearly in favor of it, as the US started it slowdown in 2005 while the global economy accelerated during 2005-2007. After the Lehman’s bankruptcy global activity came to a sudden stop, hitting some innocent bystanders, such as Japan and some emerging markets, with one of the largest economic contractions ever recorded. Decoupling, thus, was a myth. Not so fast. The concept of decoupling is only valid when there is an idiosyncratic shock – such as the slowdown in the US housing market that created a localized economic downturn in the US. At that point, this shock can indirectly affect other economies via trade or financial markets; if these economies are able to offset the negative impact of the shock with their countercyclical policies, then there is decoupling. Otherwise, there is not. If, however, the shock is global – such as the massive increase in global risk aversion that followed Lehman’s bankruptcy – then there is no possible decoupling: all countries are hit at the same time, and affected depending on the structure of their economies. The shock is global, there is no transmission across countries or the

334 possibility of offsetting it. With this in mind, the existence of decoupling depends critically on the ability of countries to offset the imported shock with countercyclical economic policies. And there is the key element of this crisis. Back in 1997-98, emerging markets were not able to implement countercyclical policies; they were in fact forced to adopt procyclical policies, such as sharp interest rate increases to control their collapsing exchange rates, which aggravated their woes. Their policies could not decouple. In 2007-08, however, emerging markets have been able to apply countercyclical policies thanks to the massive improvement in their policy frameworks over the last decade. For all the criticism of the Washington Consensus, all those countries that have followed it and applied rigorous fiscal discipline, liberalized internal markets and adopted credible and independent monetary policies have been able to slash interest rates drastically and, at least, allow fiscal automatic stabilizers to work. Capital inflows have continued, and their currencies are appreciating again. And as a result of this discipline over the years most emerging markets are recovering much faster than expected and will likely exit this crisis with a set of macroeconomic fundamentals much sounder than those of the G7. The message is very clear: well done, emerging markets, for ensuring with your past discipline that your policies can decouple. This decoupling is also very healthy for the global economy. It allows emerging markets to exert some much needed discipline over the G7. In fact, the lack of decoupling over the last decade allowed for the accumulation of unchecked excesses that, combined with regulation too focused on market discipline, resulted in the boom and bust that we have witnessed. It is very healthy that emerging markets are publicly casting doubts over the soundness of the policy settings in some G7 countries and the outlook for their currencies, because this may be the only way for these G7 countries to achieve the needed domestic political consensus to implement the required reforms. The euro area created the Stability and Growth Pact, and the Lisbon Agenda, to replace the lack of market discipline in individual countries generated by the creation of the euro. The G20 process, and the policy decoupling of emerging markets, is providing some additional discipline to the G7 countries. For the first time in many decades, the world will have to deal with several leading economies that will be competing in a more equal footing. The euro is a reality, Japan has exited its lost decade, despite the recent economic shock, and emerging markets have mostly emerged. The abnormality of the unique position of the US as the only economic locomotive has mostly ended with this crisis. This will allow the US to focus on solving its domestic problems with less concern that the needed restructuring will unduly drag global growth, and hopefully deliver a more balanced global economy. This will also imply that countries that don’t rise to the occasion will run the risk of lagging behind for a long time. The different approach to plant closures across the Atlantic in the restructuring process of the auto industry is a very clear signal that some European countries have not yet realized the competitive threat they are facing. Decoupling, that myth, is happening, is healthy, and badly needed. http://www.eurointelligence.com/article.581+M53900efe78c.0.html#

335 vox Research-based policy analysis and commentary from leading economists Global imbalances and the accumulation of risk

Daniel Gros (Director of the Centre for European Policy Studies, Brussels) 11 June 2009 Why should the existence of current account “imbalances” provoke the biggest financial crisis in living history? This column says one has to take into account the way current account deficits are financed and how flow imbalances accumulated into large stock disequilibria. It explains the securitisation leading to the crisis as the product of a maturity mismatch between foreign savers seeking short-term assets and excess supply of long-term US mortgage deb It is often argued that a key factor behind the current financial crisis has been the large US current account deficit. However, the raison d’être of a financial system is dealing with imbalances (between savers and investors). Hence the question is why should the existence of current account “imbalances”, even if they persist for some time, provoke the biggest financial crisis in living history? The answer must come from the huge, structural build up of a mismatch between asset supply and demand that arose from what are commonly called “global imbalances”. As is well known, the current account deficit of the US arose from an unsustainable increase in consumption (and residential construction). This excess of domestic spending was financed mainly through an increase in the mortgage debt of US households. One key characteristic of mortgages is that they are long-term (often for 30 years). The consumption spree of US households thus led to a large additional supply of long- term (private) assets. However, this supply of longer-term assets was not matched by a corresponding demand for this type of assets. The excess savings from China (and other emerging economies and oil producers) were mostly intermediated by their central bank, which accumulated huge foreign exchange reserves. These reserves were (and still are) almost exclusively invested in short- to medium-term, safe (i.e. government) and liquid securities (mostly in the US).1 There was thus a need for maturity (and risk) transformation on a very large scale to meet a persistent excess demand for safe and liquid assets. Figure 1 shows the relevant data. There is a close correlation between the US current account deficit and reserve accumulation, but it is not perfect since the US deficit had already been very large some time before the ‘search for yield’ started. But before 2003 reserve accumulation had been much lower than the US deficit (which had thus been financed largely by private capital transfers). By contrast, after this date reserve accumulation increased relative to the (increasing) US deficit until, by 2006, reserve accumulation actually surpassed by far the US deficit. There is thus certainly a link between the US current account deficit and the build up of the crisis, but this not as straightforward as sometimes believed.

336 Part of the build up of reserves went also into Euros. IMF data suggest that this part was relatively minor (20-30 %), but it might still have had an impact on government debt in the euro area, contributing to lower interest rates and a compression of yield differentials in Europe as well. Securitisation started in the euro area around this date, although it never acquired the same scale as in the US. Figure 1. Reserve accumulation by emerging economies and the US current account deficit (USD billion)

Source: IMF, World Economic Outlook database April 2009, ”Change in reserves” Another way to look at the same phenomenon is to note that the increased demand for US government debt by emerging economy central banks led to lower yields, thus forcing those savers in the OECD countries which would normally have held government assets to frantically “search for returns”. But this was a search for yield on safe (and liquid) assets. The AAA tranches on securitised US mortgages (and other debt) seemed to provide the safety plus a “yield pick up” without any risk, at least in the sense that the securities were rated AAA. As long as US house prices kept on increasing and unemployment remained low, actual delinquencies remained low and there seemed to be no reason for market participants to question the high ratings of these securities, even though the incentive for the ratings agencies to provide favourable ratings were well known. AAA-rated residential mortgage-backed securities thus provided an important source of liquidity by their widespread use as collateral. From flows to stocks Most analysis of global imbalances has focused on the size of the flows, namely the current account deficit of the US relative to US GDP or world savings. Accordingly, most concerns about global imbalances emphasised the magnitude of the exchange rate adjustment that would be required to rebalance US spending and absorption. However, this aspect turned out not to have been crucial. Instead the severity of the present crisis is due to the unprecedented magnitude of the cumulated imbalances in the stocks of

337 assets and liabilities. The magnitudes of the imbalances between asset supply and demand that cumulated over time are gigantic. Over the period 2000-07, the cumulated US current account deficit amounted to almost $5 thousand billion and US household debt increased by almost $7 thousand billion, of which approximately $5 thousand billion was in the form of mortgages. Meanwhile the foreign exchange reserves of emerging markets increased by about $4 thousand billion (of which the Chinese central bank accounted for about a third). The financial system thus had to transform thousands of billions of dollars of US household mortgages into the type of assets in excess demand from those investors who had been crowded out of the government debt market due to the reserve accumulation by emerging market central banks. In doing so, it took an enormous macro risk (Brender and Pisani 2009). The key technology that permitted the transformation of US mortgages into safe liquid assets was securitisation. Until 2007, it was widely believed that securitisation should lead to a better distribution of risk since the “originate to distribute model – in its pure form – implies a full risk transfer to the buyers of the various forms of asset-backed securities (ABS) and residential mortgage-backed securities (RMBS). However, in the context of global imbalances this could not have happened on a large scale since the massive buying of US government paper by emerging market central banks had displaced other investors whose preference previously had been for safe, short-term, liquid assets. ABS, especially RMBS do not, a priori, have these qualities. A piece of a pool of mortgages represents a longer-term asset; it is only as safe as the underlying mortgages and is only liquid if there is a demand for this specific asset. Government paper of a given maturity is highly substitutable, whereas every asset-backed security constitutes a special case and thus by its nature much less liquid. Ultimately an RMBS more closely resembles an equity investment in a regional mortgage lender than a government bond. The excess demand for short-term, safe, liquid assets created by emerging economies’ accumulation of reserves could not have been satisfied by the securitisation of US mortgages (and consumer credit) without massive credit and liquidity “enhancements” by the banking system. A clean securitisation with full risk transfer to the investor was thus not possible from a general equilibrium point of view. How residential mortgage-backed securities were made safe, short-term, and liquid? The exact way in which this was achieved varies enormously from case to case, but the general rules of the game were the following: Safe As already mentioned above, the appearance of safety was created by the slicing of tranches coupled with high (AAA) ratings for the most senior tranches (in reality most often about 85% of the total as experience suggested that a total loss of over 15% was extremely unlikely to occur). This service was provided by the ratings agencies for which it represented a major source of income.2

Short- to medium-term Banks or shadow banking institutions like special investment vehicles used RMBS (and similar assets) as collateral to borrow more funds, e.g. by issuing asset-backed

338 commercial paper, which is short-term and thus the kind of assets that were in excess demand. Issuance of asset-backed commercial paper, which started surging around 2003 (around the same time as reserve accumulation by emerging economies also increased, as shown in Figure 1), constitutes a classic maturity transformation, which was very profitable (given the absence of capital requirements) as long as central banks kept short- term interest rates low and promised (as did the Federal Reserve) to increase them only at a “measured pace”.

Liquid Asset-backed commercial paper was already more liquid than the assets with which it was backed. However, such programs were usually possible only if a bank provided a back-up line of credit. Only the banking system could provide the back the stop liquidity that was required by the ultimate investors. All these elements were necessary to recycle excess emerging market savings to dis- saving US households. Banks had to provide the maturity transformation and the credit enhancement that later proved so costly to them. This transformation required, of course, a huge increase in the balance sheet of the banking (and shadow banking) system and thus a huge increase in leverage.3 This increase in leverage, in turn, acted as a powerful amplifier once risk returned. Conclusions When one looks at the risk that persistent global current account imbalances may create for finance stability, one has to take into account the way that current account deficits are financed and how flow imbalances accumulate into large stock disequilibria. Looking forward, this analysis implies that the current (smaller but still sizeable) US current account deficit should not lead to similar asset supply and demand mismatches since US households are now starting to save and it is the US government which is running the deficit, thus supplying exactly the kind of assets needed by emerging economy central banks. References Brender, Anton and Florence Pisani (2009) “Globalised finance and its collapse” Dexia, Brussels. Steil, Benn (2009) “Lessons of the Financial Crisis”, Council on Foreign Relations, Centre for Geoeconomic Studies, Special Report No. 45, March.

1 Brender and Pisani (2009) reports that about onethird of all foreign exchange reserves are in the form of bank deposits. Little is known about the maturity composition of the remainder, most of which is invested in interest-bearing securities. The scarce available data on the composition of USD foreign exchange reserves that can be gleaned from the US Treasury International Capital data suggests that over half of foreign official holdings of US securities had a maturity of less than three years. 2 Benn Steil (2009) shows that the correlation between profits of the major ratings agencies and the number of securitised assets rated by them is almost perfect. 3 An increase in capital commensurate with the risk taken by the financial sector would of course have limited the damage, but it would probably have made this transformation too expensive. http://www.voxeu.org/index.php?q=node/3655

339 Eurozone Watch Monitoring economics and economic governance of the euro area June 14, 2009 The Economic Consequences of the Grand Coalition in Germany by Sebastian Dullien Last week, the Grand Coalition made sure that their legacy in Germany's economic policy stance will be far beyond the next election on September 27, 2008. After the Bundestag had already voted to amend the constitution and to include a sweeping ban on public borrowing a couple weeks ago, the Bundesrat (the part of parliament which represents the Länder) now also voted for including a more strict ban on public borrowing into the constitution. Prior to this change, the German constitution had a simple rule: Outside times of "economic disequilibrium", the government was not allowed to borrow more than it was spending on investment. From now on, the rules are much strikter. According to the new rule in the constitution, the German federal level will only be allowed to have a structural deficit of 0.35 percent of GDP from 2016 onwards. The German Länder will not be allowed any structural deficit from 2020 onwards. Only in cases of "desasters outside the control of the government", a deviation from this rule is allowed. (See for a previous critique http://www.euro-area.org/blog/?p=190) This means that the German constitution now forces a very harsh austerity stance one Germany for the coming years. Most recent forecasts include a structural budget deficit for 2010 of 4 to 5 percent of GDP. If the government wants to bring this down into the range of constitutionality before the end of the transition period, it would have to start rebalancing its budget very soon. As most of this structural deficit is now at the federal level and has thus to be all but eliminated by 2016, one can expect an extremely tight fiscal policy over the coming years. In order to reach this target, a consolidation effort of almost 0.8 percent of GDP is needed each year from 2011 onwards. Should there be more need for stimulus in 2009 and 2010 than forecast so far, the necessary consolidation effort will grow accordingly. While the constitutional rule might well prove to cause a lot of problems at the technical level of operating it (as it uses a HP-filter like procedure to estimate structural deficits which tend to be revised very strongly several years into the past), it is very likely that German politicians will try to stick to it before they change it again. Moreover, changing this rule again will prove very hard: Even the grand coalition only got about 10 more votes in the Bundestag than it needed to change the constitution (such a change needs a two-third-majority both in the Bundestag and Bundesrat). In times of normal-sized coalitions, it will prove much harder to mobilize such a majority. Moreover, if the grand coalition continues after September 27 and the Social Democrats will lose as much as the polls predict, even the grand coalition will not be able to change the rules back again. For the rest of EMU this means that after the crisis, Germany will consolidate its budget much earlier and much quicker than the rest of Europe. Consequently, domestic demand

340 will remain weak in Germany. Thus, in the (hopefully) coming recovery, not much of a growth impulse can be expected from EMU's largest economy. http://www.euro-area.org/blog/?p=221

COLUMNISTS Optimism is not enough for a global recovery By Wolfgang Münchau Published: June 14 2009 19:04 | Last updated: June 14 2009 19:04 Last week, the green shoots shrivelled. In South Korea, China and Germany, exports were declining once again. In the US, the Federal Reserve’s Beige Book said “economic conditions remained weak or deteriorated further during the period from mid-April through May”. The March signs of revival turned out to be little more than a technical inventory correction, with no change in the underlying trend. The world economy is still contracting, though perhaps not quite as fast as at the start of the year. As an analysis by economists Barry Eichengreen and Kevin O’Rourke* shows, global industrial output is still on the same trajectory as it was during 1930. The only question is whether we can avoid 1931 and 1932. The answer is yes, but on conditions that seem increasingly implausible if we extrapolate current policies. We can avoid calamity if monetary and fiscal policies remain supportive throughout the duration of this crisis, if we fix the banking system and if we impose regulations to constrain a resurgent financial sector. We also have to be lucky to avoid another round of market turbulence in the near future. In other words ... the answer may well be no. Central banks and governments therefore risk moving too swiftly out of a recession-mode strategy. When Axel Weber, president of the Bundesbank, publicly talks at this time about how to communicate a rise in interest rates, it tells me that the danger of a premature exit, at least in Europe, is clear and present. Fiscal policy exit strategies were at the top of the Group of Eight finance ministers’ agenda on Saturday, with the Europeans in greater haste than others. Nobody is solving the toxic asset and recapitalisation problems of the banks. Financial regulation does not seem to be extending much beyond populist pseudo-measures on tax havens. Plus there is still financial meltdown potential in the system. Latvia, for example, is a ticking time bomb. So at this point, I see the chances as roughly even between a global slump and a return to quasi-stagnation. What is so galling about this scenario is that it is avoidable. The central banks took the right decisions. But the political reaction has been near-catastrophic almost everywhere. Instead of solving the problems to generate a recovery, the political strategies have consisted of waiting for a recovery to solve the problem. The Europeans are relying on the Americans to generate growth. The Americans are relying on the Chinese, who in turn are waiting for the rest of the world.

341 Even if the US were to generate some growth, as is likely after this summer, it would not benefit global exporters; China may be one of the fastest growing economies in the world, but it is only about half as large as the eurozone in dollar terms. And as Brad Setser** has pointed out in his blog, there is absolutely no evidence that China contributes to a global recovery. While Chinese investments are up by more than 30 per cent from last year alone, imports are down 25 per cent. All this hype about decoupling and China pulling the world out of recession is baloney. The data tell us that China’s exports and imports are both falling, and that imports are falling faster. As everybody expects the others to move first, nobody ends up moving. In the meantime, the problems grow worse. US house prices, which are down by a little over 30 per cent from their peak, still have some way to fall. Until the US housing market hits rock bottom, perhaps sometime in 2010, there is no chance of a recovery in the securitisation market, without which there may not be sufficient credit growth. As the recession continues, the number of personal and corporate insolvencies will rise, which in turn will aggravate the problems of the banking sector. I am not surprised that the Bundesbank’s Mr Weber resists the publication of stress tests for the banking system. It would show that the German banking system was insolvent – and that bad and potentially bad assets were equivalent to about one-third of gross domestic product. The only potentially good news in the past three months has been the receding threat of a currency crisis in central and eastern Europe. But I am not even sure that this is for real. The persistent refusal by eurozone policymakers to concede fast-track euro accession for central and eastern member states could yet prove destabilising. Last week, the ECB had to provide €3bn in euro liquidity to Sweden’s Riksbank, in the absence of which Sweden may have experienced its second banking meltdown in less than two decades. The inevitable collapse of Latvia will have ripple effects on the Baltic region and may cause panic among investors in other central and east European countries. This is why last week’s news about the withering green shoots is so important. It tells us that the non-strategy of waiting until things get better is not working. The March signs of life reinforced complacency. Optimism will get us out of this crisis only if it is founded in reality. Last week showed us that this is not the case. *A tale of Two Depressions, www.voxeu.org **blogs.cfr.org/setser http://www.ft.com/cms/s/0/04e578a6-58fa-11de-80b3-00144feabdc0.html

342 Business

June 15, 2009 Insurance Giant A.I.G. Takes Ex-Chief to Court By MARY WILLIAMS WALSH The latest act in the drama of the American International Group opens Monday when the ailing insurance giant takes its former chief executive to court, accusing him of plundering a trust that it says was set up to pay top performers. A.I.G. contends Maurice R. Greenberg, 84, who ran the company for decades, unlawfully took $4.3 billion in stock in 2005, the year he was forced out as chief executive. Mr. Greenberg and his lawyers say that those A.I.G. shares — owned by Starr International, a privately held company, of which he is chairman — were not held in a trust at all. As Starr’s chairman, they say, Mr. Greenberg had the authority to sell the shares and invest the proceeds in new offshore insurance businesses and in a new charitable arm. The government bailout of A.I.G. occurred after the main events in the case, which revolve around the intricacies of trust and securities law. But the trial may delve into the broader questions of who is responsible for A.I.G’s near collapse and whether, as chief executive of A.I.G., Mr. Greenberg was more preoccupied with financial maneuvers than with fostering sound risk management. For his part, he has accused the government of destroying a company that he nurtured. Though Mr. Greenberg sold the $4.3 billion block of stock in 2005, long before the price crashed, he kept much of his personal fortune in A.I.G. shares. When the government stepped in last fall, taking a 79.9 percent stake in the company, Mr. Greenberg and other shareholders were essentially wiped out. The dispute over the Starr International stock sale began with a complaint filed by Mr. Greenberg that A.I.G. was holding an art collection that belonged to Starr. A.I.G. countersued, denying Mr. Greenberg’s accusations and saying he had promised to pay its employees hundreds of millions of dollars and needed to make good. Compensation is a touchy subject at A.I.G. The company came under attack in March when it paid a round of bonuses granted before the bailout. Congressmen said that no company on federal life support had any business paying such extensive bonuses. Furthermore, A.I.G.’s bonus structure in previous years was said to have encouraged excessive risk-taking. Most of the recipients of the recent bonuses repaid the money, and several resigned. On Thursday, one day after the Treasury appointed a new executive compensation czar, A.I.G. said it would use any money recovered in the case to repay its government debts. Initially, though, it said that it would use the proceeds to create a new bonus program for executives. After the jury selection in United States District Court in Manhattan, the opening arguments for Mr. Greenberg will be made by David Boies, the former federal prosecutor who tangled with Microsoft during the Clinton administration, and who represented Al Gore during the contested presidential election of 2000.

343 A.I.G. will be represented by Theodore V. Wells Jr., a white-collar criminal defense lawyer whose clients have included I. Lewis Libby Jr., known as Scooter, the former chief of staff to the former vice president; and the one-time junk-bond financier, Michael R. Milken. Mr. Wells also has represented Mr. Greenberg’s old nemesis, Eliot Spitzer, the former governor of New York, after Mr. Spitzer was found to have been involved with a prostitution ring. Many of the events leading up to Monday’s trial took place in 2005. Mr. Spitzer, then New York State attorney general, was investigating A.I.G. for possible involvement in a bid-rigging conspiracy concerning several companies, including the insurance broker, Marsh & McLennan, which was led by Jeffrey Greenberg, the son of the A.I.G. chief. That inquiry came after accusations by the Securities and Exchange Commission that A.I.G. had been selling insurance-like products intended to help its clients manipulate earnings. In March 2005, after an outside auditor told the A.I.G. board it could not vouch for the company’s numbers, the board ousted Mr. Greenberg, who remained chairman of Starr International, a private company that paid compensation to A.I.G. executives and had a charitable arm. Starr was established in its present form four decades ago, when the modern-day A.I.G. was formed from a network of mostly offshore insurance companies assembled by Mr. Greenberg’s mentor, Cornelius Vander Starr. It is exceedingly rare for one company to pay another’s compensation, and Mr. Greenberg has said that tax considerations would make it impossible to duplicate Starr’s structure today. A.I.G. contends that the company was a “compensation trust,” fulfilling the wishes of Mr. Starr, who died in 1968; Mr. Greenberg was the executor of his will. A.I.G. says Mr. Greenberg breached this trust when he sold the A.I.G. shares. But Mr. Greenberg is expected to argue that the only trust that existed was Starr International’s charitable arm, which is also its sole shareholder. http://www.nytimes.com/2009/06/15/business/15aig.html?th&emc=th

344

Mises As We Knew Him Mises Daily by Friedrich A. Hayek | Posted on 6/15/2009 12:00:00 AM [This "Introduction" by F.A. Hayek was written for the German-language edition of Mises's Notes and Recollections (Erinnerungen von Ludwig von Mises [Stuttgart: Gustav Fischer, 1978]). It was translated into English by Hans-Hermann Hoppe and published in the Austrian Economics Newsletter (Fall 1988): 1–3. It now appears in Memoirs by Ludwig von Mises.]

Although without a doubt one of the most important economists of his generation, in a certain sense Ludwig von Mises remained an outsider in the academic world until the end of his unusually long scholarly career — certainly within the German-speaking world — but also during the last third of his life, when in the United States he raised a larger circle of students. Before this, his strong immediate influence had essentially been restricted to his Viennese Privatseminar, whose members for the most part only became attracted to him once they had completed their original studies. If it would not have unduly delayed the publication of these memoirs, found among his papers, I would have welcomed the opportunity of analyzing the reasons for this curious neglect of one of the most original thinkers of our time in the field of economics and social philosophy. But, in part, the fragmentary autobiography he left provides in itself the answer. The reasons why he never acquired a chair at a German-speaking university during the 1920s or before 1933, while numerous and often indisputably highly unimportant persons did, were certainly personal. His appointment would have been beneficial for every university. Yet the instinctive feeling of the professors that he would not quite fit into their circle was not entirely wrong. Even though his subject-knowledge surpassed that of most occupants of professorial chairs, he was nonetheless never a real specialist. When, in the realm of the social sciences, I look for similar figures in the history of thought, I do not find them among the professors, not even in Adam Smith; instead, he must be compared to thinkers like

345 Voltaire or Montesquieu, Tocqueville and John Stuart Mill. This is an impression that has by no means been reached only in retrospect. But when more than fifty years ago I tried to explain Mises's position in pretty much the same words to Wesley Claire Mitchell in New York, I only encountered — perhaps understandably — a politely ironic skepticism. "Mises must be compared to thinkers like Voltaire or Montesquieu, Tocqueville and John Stuart Mill." Essential to his work is a global interpretation of social development. In contrast to the few comparable contemporaries such as Max Weber, with whom he was connected by a rare mutual respect, in this Mises had the advantage of a genuine knowledge of economic theory. The following memoirs say much more about his development, position, and views than I know or could tell. I can only attempt here to supplement or confirm information regarding the ten years of his time in Vienna (1921–1931) during which I was closely associated with him. I came to him rather characteristically not as a student, but as a fresh doctor of law and a civil servant, subordinate to him, at one of those special institutions that had been created to execute the provisions of the peace treaty of St. Germain. The letter of recommendation by my university teacher Friedrich von Wieser, who described me as a highly promising young economist, was met by Mises with a smile and the remark that he had never seen me in his lectures.

However, when he found my interest confirmed and my knowledge satisfactory, he helped me in every regard and contributed much to make my lengthier visit to the United States possible (before the time of the Rockefeller fellowship) to which I owe a great deal. But although I saw him during the first years daily in an official capacity, I had no idea that he was preparing his great book, Socialism, which upon its publication in 1922 influenced me decisively. Only after I returned from America in the summer of 1924 was I admitted to that circle, which had been in existence for some time, and through which Mises's scholarly work in Vienna mainly exerted its influence. This "Mises Seminar," as we all called the biweekly nightly discussions in his office, is described in detail in his memoirs. Mises though does not mention the hardly less important regular continuations of the official discussions that lasted long into the night at a Viennese coffeehouse. As he correctly describes, these were not instructional meetings, but discussions presided over by an older friend whose views were by no means shared by all members. Strictly speaking, only Fritz Machlup was originally Mises's student. As regards the others, of the regular members, only Richard Strigl, Gottfried Haberler, Oskar Morgenstern, Lene Lieser, and Martha Stefanie Braun were specialists in economics. Ewald Schams and Leo Schönfeld, who belonged to the same highly gifted but early deceased intermediate generation as Richard Strigl, were, to my knowledge,

346 never regular participants in the Mises Seminar. But sociologists like Alfred Schütz, philosophers like Felix Kaufmann, and historians like Friedrich Engel-Janosi were equally active in the discussions, which frequently dealt with the problems of the methods of the social sciences, but rarely with special problems of economic theory (except those of the subjective theory of value). Questions of economic policy, however, were discussed often, and always from the perspective of the influence of different social philosophies upon it. All this seemed to be the rare mental distraction of a man, who, during the day, was fully occupied with urgent political and economic problems, and who was better informed about daily politics, modern history, and general ideological developments than most others. What he was working on, even I, who officially saw him almost daily during those years, did not know; he never spoke about it. We could even less imagine when he would actually write his works. I knew only from his secretary that from time to time he had a manuscript typed from his distinctively clear handwriting. But many of his works only existed in handwriting until publication, and an important article was considered lost for a long time, until it finally resurfaced among the papers of a journal editor. No one knew anything regarding his private work methods until his marriage. He did not speak about his literary activity until he had completed a work. Though he knew that I was most willing to occasionally help him, he only asked me once to look up a quote for his work and this was after I mentioned that I wanted to consult a work on the canonists in the library. He never had, at least in Vienna, a scholarly assistant. "A Jewish intellectual who justified capitalism appeared to most as some sort of monstrosity, something unnatural…" The problems with which he concerned himself were mostly problems for which he considered the prevailing opinion false. The reader of the following book might gain the impression that he was prejudiced against the German social sciences as such. This was definitely not the case, even though in the course of time he developed a certain understandable irritation. But he valued the great early German theoreticians like Thünen, Hermann, Mangoldt or Gossen more highly than most of his colleagues, and knew them better. Also, among his contemporaries he valued a few similarly isolated figures such as Dietzel, Pohle, Adolf Weber and Passow, as well as the sociologist Leopold von Wiese and, above all, Max Weber. With Weber a close scholarly relationship had been formed during Weber's short teaching activity in Vienna, in the spring of 1918, which could have meant a great deal if Weber had not died so soon. But in general, there can be no doubt that he had nothing but contempt for the majority of the professors who, occupying the chairs of the German universities, pretended to teach theoretical economics. Mises does not exaggerate in his description of the teachings of economics as espoused by the historical school. Just how far the level of theoretical thinking in Germany had sunk is indicated by the fact that it needed the simplifications and coarseness of the — herein certainly meritorious — Swede Gustav Cassel in order to again find an audience for theory in Germany. Notwithstanding his exquisite politeness in society and his generally great self-control (he could also occasionally explode), Mises was not the man to successfully hide his contempt. This drove him to increased isolation among professional economists generally as well as among those Viennese circles with which he had scholarly and professional contacts. He became estranged from his cohorts and fellow students when he turned away from the

347 advancing ideas of social policy. Twenty-five years later I could still feel the emotion and anger his seemingly sudden break had caused — when he had turned away from the dominating ideals of the academic youth of the first few years of the century — when his fellow student F.X. Weiss (the editor of the shorter writings of Böhm-Bawerk) told me about the event with unconcealed indignation, obviously in order to prevent me from a similar betrayal of "social" values and an all-too-great sympathy for an "outlived" liberalism. If Carl Menger had not aged relatively early and Böhm-Bawerk had not died so young, Mises probably would have found support among them. But the only survivor of the older Austrian School was my revered teacher Friedrich von Wieser, and he was more a Fabian — proud, as he believed, to have provided a scientific justification for progressive income taxation with his development of the theory of marginal utility. "The problems with which he concerned himself were mostly problems for which he considered the prevailing opinion false." Mises's return to classical liberalism was not only a reaction to a dominating trend. He completely lacked the adaptability of his brilliant seminar fellow Josef Schumpeter, who always quickly accommodated current intellectual fashions, as well as Schumpeter's joy in "épater le bourgeois" [shocking the middle classes]. In fact, it appeared to me as if these two most important representatives of the third generation of leading Austrian economists (one can hardly consider Schumpeter a member of the "Austrian School" in the narrower sense despite all mutual intellectual respect) each got on the other's nerves. In today's world, Mises and his students are regarded as the representatives of the Austrian School, and justifiably so, although he only represents one of the branches into which Menger's theories had already been divided by his students, and the close personal friendship between Eugen von Böhm-Bawerk and Friedrich von Wieser. I only admit this with some hesitation, because I expected much of the tradition of Wieser, which his successor Hans Mayer attempted to advance. But these expectations have not yet become fulfilled, even though those stimuli may perhaps still prove more fruitful than they have been so far. Today's active "Austrian School," almost exclusively in the United States, is at base a Misesian school that goes back to Böhm-Bawerk, while the man in whom Wieser had set such great hopes and who had succeeded him in his chair never really fulfilled the promise. Because he never occupied a regular chair in his field in the German-speaking world, and had to devote most of his time to other-than-scholarly activities until his late fifties, Mises remained an outsider in academia. Other reasons contributed to isolating him in his position in public life and as a representative of a great social-philosophical project.

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A Jewish intellectual who advocated socialist ideas had his respected place in the Vienna of the first third of this century, a place that was accorded to him as a matter of course. Likewise, the Jewish banker or businessman who (bad enough!) defended capitalism had his rights. But a Jewish intellectual who justified capitalism appeared to most as some sort of monstrosity, something unnatural, which could not be categorized and with which one did not know how to deal. His undisputed subject-knowledge was impressive, and one could not avoid consulting him in critical economic situations, but rarely was his advice understood and followed. Mostly he was regarded as somewhat of an eccentric whose "old-fashioned" ideas were impracticable "today." That he himself had constructed, in long years of hard work, his own social philosophy was only known by very few and perhaps could not be understood by distant observers until 1940, when in his Nationalökonomie he presented for the first time his system of ideas in its entirety. But by this time he could no longer reach readers in Germany and Austria. Apart from the small circle of young theoreticians who met at his office, and some highly gifted friends in the business world who were similarly concerned about the future and who are mentioned in the following, he only encountered genuine understanding among occasional foreign visitors like the Frankfurt banker Albert Hahn, whose work in monetary theory he smiled at, however, as a vain sin of youth. Yet he did not always make it easy for them. The arguments by which he supported his unpopular views were not always completely conclusive, even though some reflection could have shown that he was right. But when he was convinced of his conclusions and had presented them in clear and plain language — a gift that he possessed to a high degree — he believed that this would also have to convince others and only prejudice and stubbornness prevented them from understanding. For too long he had lacked the opportunity of discussing problems with intellectual equals who shared his basic moral convictions in order to see how even small differences in one's implicit assumptions can lead to different results. This manifested itself in a certain impatience that was easily suspected of being an unwillingness to understand, whereas an honest misunderstanding of his arguments was the case. I must admit that I myself often initially did not think his arguments to be completely convincing and only slowly learned that he was mostly right and that, after some reflection, a justification could be found that he had not made explicit. And today, considering the kind of battle that he had to lead, I also understand that he was driven to certain exaggerations, like that of the a priori character of economic theory, where I could not follow him.

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For Mises's friends of his later years, after his marriage and the success of his American activity had softened him, the sharp outbursts in the following memoirs, written at the time of his greatest bitterness and hopelessness, might come as a shock. But the Mises who speaks from the following pages is without question the Mises we knew from the Vienna of the twenties; of course without the tactful reservation that he invariably displayed in oral expression; but the honest and open expression of what he felt and thought. To a certain extent this may explain his neglect, even though it does not excuse it. We, who knew him better, were at times outraged, of course, that he did not get a chair, yet we were not really surprised. He had too much to criticize about the representatives of the profession into which he was seeking entrance to appear acceptable to them. And he fought against an intellectual wave which is now subsiding, not least because of his efforts, but which was much too powerful then for one individual to successfully resist. That they had one of the great thinkers of our time in their midst, the Viennese have never understood. F.A. Hayek (1899–1992) was a founding board member of the Mises Institute. He shared the 1974 Nobel Prize in Economics with ideological rival Gunnar Myrdal "for their pioneering work in the theory of money and economic fluctuations and for their penetrating analysis of the interdependence of economic, social and institutional phenomena." See his article archives. Comment on the blog. This "Introduction" by F.A. Hayek was written for the German-language edition of Mises's Notes and Recollections (Erinnerungen von Ludwig von Mises [Stuttgart: Gustav Fischer, 1978]). It was translated into English by Hans-Hermann Hoppe and published in the Austrian Economics Newsletter (Fall 1988): 1–3. It also appears in the Fortunes of Liberalism: The Collected Works of F.A. Hayek (Chicago: University of Chicago Press, 1992), pp. 153–59. http://mises.org/story/3511#

350 Press Release

Release Date: June 12, 2009 For immediate release The Federal Reserve notes the Financial Accounting Standards Board's publication today of Statements of Financial Accounting Standards No. 166 and 167 (FAS 166 and 167), which will have a material effect on banking organizations' accounting for off-balance sheet vehicles. These statements, which become effective in 2010, address weaknesses in accounting and disclosure standards for off-balance sheet vehicles. The new standards amend Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (FAS 140), and FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities (FIN 46(R)). The Federal Reserve is reviewing regulatory capital requirements associated with the adoption of the new accounting standards. In conducting this review, the Federal Reserve is considering a broad range of factors including the maintenance of prudent capital levels, the record of recent bank experiences with off-balance sheet vehicles, and the results of the recent Supervisory Capital Assessment Program (SCAP). As part of the SCAP, participating banking organizations' capital adequacy was assessed using assumptions consistent with standards ultimately included in FAS 166 and FAS 167. Banking organizations should take into account in their internal capital planning processes the full impact of FAS 166 and 167 and assess whether additional capital may be necessary to support the risks associated with vehicles affected by the new accounting standards. 2009 Banking and Consumer Regulatory Policy

351

12.06.2009 The monster returns

The economic forecasts are getting more pessimistic. The ECB yesterday released a relatively sceptical assessment for the next 18 months, Frankfurter Allgemeine reports. There will be no recovery in the euro area this year, not even stabilisation. In the second half this year, the recession will continue at reduced speed. The economy will stabilise during the first half of 2010, and then start to grow again. With this forecast, the ECB has shot down the green shoots theory. Germany’s Institute for International Economics in Kiel revised its own growth forecast for Germany this year downward yet again – to minus 6% - and expect quasi stagnation for 2010, but this assumes no more banking stress (which again is a very optimistic premise). Notably, the institute, which has a monetarist tradition, criticises the ECB for being too cautious in its monetary policy. It should cut interest rates to 0.5%, and undertake more quantitative easing. No formal decision on Barroso at summit Angela Merkel and Nicholas Sarkozy hsave agreed to support Jose Manuel Barroso for another term, but there will be no formal decision at next week’s summit, only a political decision. FT Deutschland cites two reasons. The first is that both Germany and France want to secure greater commitments from Barroso in respects of his agenda and his appointments, as both countries seek specific portfolios through which they can undermine the single market; secondly, there is still a remote possibility of a veto by the European parliament if the decision is taking too fast, and without negotiations. (We think Barroso is certain to get another term, but he will be even weaker than before). Britain blames Germany, Spain for its own difficulties The blame game gets into the next phase. Britain’s finance minister Alastair Darling told the FT in an interview that Britain’s difficult economic situation was aggravated by the failure of other European countries’ failure to clean up their banking mess. The article claimed that Mr Darling did not cite any names, but an unnamed UK Treasury official was at hand to say that Mr Darling was referring to Germany, Sweden and Spain. Darling

352 said these countries were turning a blind eye to the problem, and failed to follow Britain’s lead in indentifying toxic assets and recapitalising institutions.

Lagarde on stress tests and structural deficits Ahead of the G8 finance minister meeting Christine Lagarde gave an interview to Les Echos in which she reiterated that there will be no further stimulus packages and that France will reduce its structural deficit by ambitious public sector reforms rather than through taxes. Lagarde also came out in favour of publication of stress tests, coordinated at the European level. Green shots watch In Greece, residential housing construction activity is expected to recover in the second half of next year, supported by an environment of low interest rates and a moderate decline in prices, writes Kathemerini. Housing prices in Greece are proving “remarkably” more resilient than in other European Union countries with average annual price growth remained marginally positive until the fourth quarter of 2008. Only the construction sector workforce is expected to decline markedly. What on earth is happening in China? China is probably the biggest puzzle of all the advanced nations. Brad Setser wonders how can it be that a country raises investment demand by 30%, yet its imports shrink by 25%, since credit-driven investment booms usually lead to higher imports? The free fall in China’s economy is over, but there is no recovery in Chinese demand for world product, nor is their a recovery in China’s exports to the world. More optimistic on China, as ever, is Jim O’Neill from Goldman Sachs, who thinks that China is decoupling from the world economy, and lead us out of the doldrums, according to a report in the Financial Times. (We think that Setser is right, and O’Neill is wrong. There is no evidence that China is decoupling. Something is going on we do not understand, but it is not a recovery. It that had happened, we would be seeing an increase in Chinese imports). James Hamilton on a CDS scam This is a really funny story – though as often not necessarily for the people affected by it. We have known for a while that people “overinsured” in the credit default swaps markets – that they bought more default insurance than the underlying bonds were worth. Now in the US, a bond insurer used a blatant case of overinsurance to his own advantage. He bought up all the underlying securities in order not having to pay a multiple in compensation out to the insured – who had all bet on a default. James Hamilton of Econbrowser narrates the story, which he dug up in the Wall Street Journal. The case for immediate euroisation Marcin Piatkowski and Krzysztof Rybinski make the case for immediate euroisation in the CEE countries, as a crisis prevention measure. They argue that the volatility in the region is not due to economic policy mistakes, but repatriation of global money. They say euroisation would not only provide stability, but would also strengthen the euro area itself, and would prevent the rise of a euro curtain.

353 Econbrowser Analysis of current economic conditions and policy

« How Important Is China to World Growth? | Main | Do you see what I see? » June 11, 2009 How to lose on a sure-fire bet There was a wonderful story in today's WSJ about how some big banks managed to lose some of their hard-earned TARP money. Let me begin with a little background. A credit default swap is sometimes described as an insurance contract written against the possibility of default of a particular underlying asset. If I buy a CDS and the specified asset defaults, I get to collect money from whoever sold me the contract. If I also have a long position in the asset in question, I might consider buying a CDS written against that asset as an insurance or hedge against the possibility that the asset loses its value. But I don't actually have to own the asset in question in order to buy a CDS from somebody else. I might want to buy a CDS as a partial hedge against some other asset I hold with which the specified security could be correlated. Or maybe I just feel like making a bet with somebody I think is dumber than I am. The fun and games begin when multiple contracts get written on a single credit event and the notional value of outstanding contracts on that event-- the total amount of money that is promised to be paid to the buyers of those CDS in the event of a default on the underlying asset-- becomes larger than the par value of the underlying asset itself. Then it would clearly pay the party who sold those contracts to buy the underlying asset itself at par, relieve the original debtors of their burdensome obligations, and be out only $X (the underlying event) rather than some multiple of $X (all the contracts written on the event). And so the WSJ recounts the tale of a security based on $29 million (par) worth of subprime loans in California, half of which were already delinquent or in default. Betting that the loans weren't worth $29 million sounds like easy money, and the smart guys were willing to pay 80 to 90 cents for each dollar of CDS insurance. It appears from the WSJ account as if little Amherst Holdings of Austin, Texas was happy to sell the big guys like J.P. Morgan Chase, Royal Bank of Scotland, and Bank of America something like $130 million notional CDS on a $27 million credit event, used the proceeds to buy off and make good the underlying subprime loans, and pocketed $70 million or so for their troubles. The big guys, on the other hand, paid perhaps a hundred million and got back zip. Said big guys, naturally, are screaming bloody murder, trying to bring in the lawyers to show that Amherst wasn't playing by the rules of the game. For my money, the first rule we need would be a law, not a rule, that notional not exceed actual. Barring that, here's another rule I trust: a fool and his money are soon parted.

354 Opinion

June 12, 2009 OP-ED COLUMNIST The Big Hate By PAUL KRUGMAN Back in April, there was a huge fuss over an internal report by the Department of Homeland Security warning that current conditions resemble those in the early 1990s — a time marked by an upsurge of right-wing extremism that culminated in the Oklahoma City bombing. Conservatives were outraged. The chairman of the Republican National Committee denounced the report as an attempt to “segment out conservatives in this country who have a different philosophy or view from this administration” and label them as terrorists. But with the murder of Dr. George Tiller by an anti-abortion fanatic, closely followed by a shooting by a white supremacist at the United States Holocaust Memorial Museum, the analysis looks prescient. There is, however, one important thing that the D.H.S. report didn’t say: Today, as in the early years of the Clinton administration but to an even greater extent, right-wing extremism is being systematically fed by the conservative media and political establishment. Now, for the most part, the likes of Fox News and the R.N.C. haven’t directly incited violence, despite Bill O’Reilly’s declarations that “some” called Dr. Tiller “Tiller the Baby Killer,” that he had “blood on his hands,” and that he was a “guy operating a death mill.” But they have gone out of their way to provide a platform for conspiracy theories and apocalyptic rhetoric, just as they did the last time a Democrat held the White House. And at this point, whatever dividing line there was between mainstream conservatism and the black-helicopter crowd seems to have been virtually erased. Exhibit A for the mainstreaming of right-wing extremism is Fox News’s new star, Glenn Beck. Here we have a network where, like it or not, millions of Americans get their news — and it gives daily airtime to a commentator who, among other things, warned viewers that the Federal Emergency Management Agency might be building concentration camps as part of the Obama administration’s “totalitarian” agenda (although he eventually conceded that nothing of the kind was happening). But let’s not neglect the print news media. In the Bush years, The Washington Times became an important media player because it was widely regarded as the Bush administration’s house organ. Earlier this week, the newspaper saw fit to run an opinion piece declaring that President Obama “not only identifies with Muslims, but actually may still be one himself,” and that in any case he has “aligned himself” with the radical Muslim Brotherhood.

355 And then there’s Rush Limbaugh. His rants today aren’t very different from his rants in 1993. But he occupies a different position in the scheme of things. Remember, during the Bush years Mr. Limbaugh became very much a political insider. Indeed, according to a recent Gallup survey, 10 percent of Republicans now consider him the “main person who speaks for the Republican Party today,” putting him in a three-way tie with Dick Cheney and Newt Gingrich. So when Mr. Limbaugh peddles conspiracy theories — suggesting, for example, that fears over swine flu were being hyped “to get people to respond to government orders” — that’s a case of the conservative media establishment joining hands with the lunatic fringe. It’s not surprising, then, that politicians are doing the same thing. The R.N.C. says that “the Democratic Party is dedicated to restructuring American society along socialist ideals.” And when Jon Voight, the actor, told the audience at a Republican fund-raiser this week that the president is a “false prophet” and that “we and we alone are the right frame of mind to free this nation from this Obama oppression,” Mitch McConnell, the Senate minority leader, thanked him, saying that he “really enjoyed” the remarks. Credit where credit is due. Some figures in the conservative media have refused to go along with the big hate — people like Fox’s Shepard Smith and Catherine Herridge, who debunked the attacks on that Homeland Security report two months ago. But this doesn’t change the broad picture, which is that supposedly respectable news organizations and political figures are giving aid and comfort to dangerous extremism. What will the consequences be? Nobody knows, of course, although the analysts at Homeland Security fretted that things may turn out even worse than in the 1990s — that thanks, in part, to the election of an African-American president, “the threat posed by lone wolves and small terrorist cells is more pronounced than in past years.” And that’s a threat to take seriously. Yes, the worst terrorist attack in our history was perpetrated by a foreign conspiracy. But the second worst, the Oklahoma City bombing, was perpetrated by an all-American lunatic. Politicians and media organizations wind up such people at their, and our, peril. http://www.nytimes.com/2009/06/12/opinion/12krugman.html?th&emc=th

356 June 10, 2009, 12:34 pm

Night they reread Minsky. Third Robbins lecture here. June 9, 2009, 12:22 pm A British bounce? Weird politics here in London, with Gordon Brown desperately unpopular even (or maybe especially) among those who surely share his general ideological outlook. http://www.markit.com/assets/en/docs/commentary/markit- economics/june%2009/UK_allsectorPMI_09_06_03.pdf And yet … British economic policies in this crisis have been more aggressive than those of the rest of Europe — and the fall in the pound has given Britain a serious competitive boost. And all of that seems to be having an effect. The chart above shows diffusion indexes for the five big European economies, from Markit. Britain is above 50 (barely), which means actual expansion, as opposed to things getting worse more slowly. It’s not far-fetched to imagine that Britain will soon be experiencing at least a modest recovery, even as its neighbors languish. Yet that possibility doesn’t seem to factor into any of the political discussion.

357 BUSINESS

June 12, 2009 U.S. Recovery Could Outstrip Europe’s Pace By NELSON D. SCHWARTZ PARIS — There was more evidence Thursday that the United States economy might be stabilizing, if not rebounding, even as economic reports in Europe remained gloomy. The American news — showing slight growth in retail sales and a dip in first-time jobless claims, as well as rising stocks — was not enough to end the disagreement between bulls and bears over how soon the economy would improve. But the apparent divergence of fortunes between America and Europe highlighted the different approaches to solving the financial crisis, and why some economists say the more aggressive American strategy may be working better, at least for now. It is a debate that is likely to be one of the issues dominating discussions when finance ministers from the eight largest economies meet in Italy this weekend. Some private economists are even predicting that the American economy will resume growth in the fourth quarter, while Europe’s economy is expected to remain in recession well into 2010, after contracting an estimated 4.2 percent this year compared with an expected 2.8 percent decline in the United States. “The shock originated in the U.S., but Europe is paying a higher price,” said Jean Pisani- Ferry, a former top financial adviser to the French government who is now director of Bruegel, a research center in Brussels. Almost from the beginning of the crisis, the United States and Europe chose largely different paths to aiding their economies. The most stark was Washington’s willingness to commit hundreds of billions of dollars to stimulus spending — in addition to moving aggressively to shore up banks and keep credit flowing — versus Europe’s worry that similar spending would increase inflation in the future. Just as the policies pursued during the Great Depression have been dissected ever since by economists, the fate of the United States and Europe as the two regions emerge from the global crisis will be analyzed for decades to come. The lessons will not only guide policy makers in future crises, but also could redefine the debate over how much state intervention in the economy is appropriate. “History is one big laboratory experiment that only gets run once,” said Niall Ferguson, an economic historian at Harvard who has been one of the loudest critics of the White House’s spending initiatives. The argument behind the American approach — staggering stimulus spending — is that the economy must be prevented from falling into a self-perpetuating downward spiral, and that increasing the deficit to do that is prudent. One crucial concern about America’s increased deficit spending — that it would lead investors to demand higher interest rates on United States debt, making it far more expensive to borrow and slowing the economy — has been allayed, for now. An auction

358 on Thursday of $11 billion in 30-year Treasury bonds found enthusiastic buyers, helping to push the Standard & Poor’s 500-stock index to a seven-month high. But it is impossible to know how much the apparent, if nascent, stabilization of the American economy comes from the stimulus spending and how much from moves like propping up the banking and credit systems, especially because much of the stimulus money has yet to make it to the economy. “I think America is further ahead in terms of fixing problems with the banks,” said Mr. Pisani-Ferry, “and countries like Germany have been hurt tremendously by the decline in world trade.” Figures released this week showed that German exports plunged 28.7 percent in April from a year earlier, the steepest drop since the government began keeping records in 1950. Still, some experts say that Europe’s approach could pay off over the longer run. There remains a significant risk that deficit spending in the United States could lead to inflation in the long run. Concern over the deficit has already led to a sharp rise in interest rates in the last month. A continued rise could threaten any American recovery. And while its growth is expected to be muted for years, Europe will not be burdened by as much debt as the United States, having avoided big stimulus spending. Moreover, many American financial institutions remain larded with bad loans. And some of the banks the government recently allowed to leave the Troubled Asset Relief Program could need additional government help if the economy worsened instead of rebounding. Underscoring the risk that hopes for a quick turnaround anywhere may be premature, the World Bank said Thursday that it expected the global economy to shrink by nearly 3 percent in 2009, far deeper than the 1.7 percent contraction it predicted just over two months ago. And both Europe and the United States face the specter of rapidly rising unemployment, even if a rebound is beginning. The Organization for Economic Cooperation and Development estimates that from 2007 to 2010, developed economies will have shed some 25 million jobs. The unemployment rate in both the euro zone and the United States is expected to rise above 10 percent next year. “That pace of increase has never been experienced in the postwar period,” said Jonathan Coppel, a senior economist at the Organization for Economic Cooperation and Development. “This is going to create a headwind.” When the Treasury secretary, Timothy F. Geithner, first met with other finance ministers representing the 20 largest economies in March, he urged his European counterparts to increase stimulus spending. But in Italy, Mr. Geithner will press them to replicate the stress tests applied to American banks. During a conference call with reporters Thursday, Robert B. Zoellick, the president of the World Bank, reiterated the need for such tests. “A stimulus without getting the credit markets working again is like a sugar high,” Mr. Zoellick said. “I would put a higher focus on getting credit markets working again, getting banks recapitalized and cleaning up bad debts.” http://www.nytimes.com/2009/06/12/business/economy/12euro.html?_r=1&th=&emc=th &pagewanted=print

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Executives Unruffled by Proposed Compensation Rules By Tomoeh Murakami Tse Washington Post Staff Writer Friday, June 12, 2009 NEW YORK, June 11 -- Corporate executives breathed a sigh of relief Thursday after examining the fine print on broad new executive compensation rules and proposals put forth by the Obama administration. While the White House's new so-called special master for compensation, prominent Washington lawyer Kenneth R. Feinberg, has been given unprecedented powers to set pay at seven of the most troubled firms, the plan that was laid out Wednesday largely maintains the status quo for compensation practices at all other publicly traded companies, including hundreds that are receiving taxpayer assistance. In addition, the administration got rid of a previously announced $500,000 salary cap at financial firms that in the future take the kind of exceptional assistance that firms such as Citigroup and Bank of America have received. "Our people kind of thought it was a non-event," one executive of a large bank said. "There's nothing in there that's radical. It's not like the horrible and unethical action from Congress where they were putting artificial caps on pay or trying to steal back bonuses. . . . I don't think there are worries about it on Wall Street." Still, the rules include some measures that activist shareholders have pursued for years. For example, all companies receiving taxpayer assistance will be prohibited from paying executives' state and federal taxes related to perks and golden parachutes. The unexpected ban on the controversial and widespread practice, known as tax gross-ups, was applauded even by pay watch groups who criticized the administration's broader approach to compensation. "They're still allowing a lot of loopholes, but it was nice to see," said Sarah Anderson, a director at the Institute for Policy Studies in Washington. Tax gross-ups "was always one of the most obnoxious perks. At least these guys will have to pay taxes like the rest of us." The rules come as the administration tries to address the public uproar that erupted earlier this year over Wall Street firms that paid out billions of dollars in bonuses despite receiving billions in government aid. On Wednesday, Treasury Secretary Timothy F. Geithner proposed two pieces of legislation aimed at increasing oversight of executive pay packages. The administration also released much-anticipated guidelines that clarified strict executive compensation rules passed by Congress in February as part of the 1,073-page stimulus bill. The actions by the administration on Wednesday make clear its discomfort in mandating what the private sector can pay its employees. Instead, the administration, believing that the financial crisis was partly fueled by poor compensation practices, is seeking to put in place rules that would discourage risk-taking and incentives that would link pay to long-

360 term performance, Gene Sperling, counselor to Geithner, said in congressional testimony yesterday. "The administration certainly saw a linkage between the formulation of executive compensation and how that promoted excessive risk in the financial sector -- they were focused on that," said one person who attended a 75-minute meeting with top regulators and pay experts at the Treasury Department on Wednesday where Geithner discussed broad principles that would guide the administration in regulating pay. "The focus was really on a light touch approach," the person added, speaking on condition of anonymity because the discussions are ongoing. "Nobody said the government needs to regulate with a heavy hand, like caps or micromanagement, but that investors needed more tools to increase disclosure and director accountability." The most controversial provision in the Dodd amendments, as the compensation restrictions in the stimulus bill are known, is the limit on bonuses to a third of overall pay for the most highly compensated employees. That is still in place for the roughly 350 financial institutions receiving funds from the Troubled Assets Relief Program. But the guidelines issued Wednesday for the most part resolved a major source of concern for financial firms that had lobbied fiercely for a favorable interpretation of the Dodd amendments. Treasury clarified the language so that commissions paid to employees for investment management services to clients did not fall under the definition of bonuses. Executives had complained that limiting bonuses, which make up the bulk of annual pay for Wall Street employees, would cause their best traders to flee to foreign rivals and hedge funds. Top traders can take home seven-figure pay packages that exceed those of senior executives. "They addressed a lot of the concerns we had," said one industry source. "It doesn't hit the top traders we were worried about." Referring to Feinberg, this person added, "The special master will look at their pay structure. So they may not be able to keep it if he decides you're taking risky bets and driving the company to the ground." http://www.washingtonpost.com/wp- dyn/content/article/2009/06/11/AR2009061103860.html?wpisrc=newsletter

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Spending Stimulus Money Takes Money Funds Allocated to Federal Bureaucracy as It Gears Up to Oversee Programs By Alec MacGillis, Washington Post Staff Writer Friday, June 12, 2009 Spending $787 billion not only takes time, it turns out, it also costs money -- and that's good news for Washington. To send out $14 billion in supplemental checks to most Social Security recipients, the federal economic stimulus package passed in February included $70 million to cover administrative costs -- much of it overtime for workers handling the checks and queries over the phone. The Health Resources and Services Administration has hired 134 people to oversee $2.5 billion in spending and has spent $326,000 on new workstations at its Rockville offices. The 50-person agency -- with a budget of $84 million -- created to audit the spending just spent $204,000 to outfit its offices in downtown Washington. And the Transportation Department plans to hire two people at its headquarters to help estimate the number of jobs being created by transportation infrastructure spending. This is despite job estimates that will be provided by the states. With the national unemployment rate rising last month to 9.4 percent, a growing criticism is that the stimulus package is not having the desired effect of creating jobs, a perception President Obama and Vice President Biden addressed this week with a vow to accelerate the spending. One reason the full weight of the money has not been felt faster across the country, though, may be that a bureaucracy takes time -- and money -- to gear up in the capital. At one level, even spending on administrative overhead meets the most basic purpose of the package: to get money into the economy. But of the areas that most need a boost, greater Washington is pretty much at the bottom of the list. While unemployment rises elsewhere, it has declined in the region for the past two months, to 5.6 percent, the lowest of any major metro area. Washington is getting a big benefit as it is -- the stimulus package includes billions to erect and refurbish federal buildings, most notably $448 million for a new complex for the Homeland Security Department. But the legislation's effect on the bureaucracy probably will be the biggest boon. The region has already added 9,000 government jobs compared with a year ago. "We are better off than almost anywhere else," said John McClain, an economist at George Mason University. "And in federal employee jobs, we have a growth that we haven't seen in a while." Rep. Eric Cantor (Va.), the second-ranking House Republican, said the money trapped in the bureaucracy is another sign of how ill-conceived the package was: "Anytime you go use the government as the funnel through which spending goes, you're going to have waste." Sen. Tom Coburn (R-Okla.) struck a similar note. "Growing the government won't put people back to work," he said. "Federal agencies should be spending less time shopping for furniture and more time thinking about how to create the right environment for economic growth."

362 But Obama administration officials say the money is being spent precisely to prevent the kind of waste and abuse that critics say is inevitable. They note that it was Congress that set aside $350 million for oversight, money that is now being spent by the new Recovery Accountability and Transparency Board and by the Government Accountability Office, which has dozens of newly hired auditors who are fanning out nationwide to scrutinize spending that is barely underway. "The president has charged the men and women of the government to implement the Recovery Act with haste but also with strong attention to detail," said Tom Gavin, a spokesman for the Office of Management and Budget. Gavin also noted that some of the spending for agencies here helps businesses elsewhere -- a contract for Social Security leaflets went to a Dallas firm, for example, and the one for outfitting the health agency's offices went to a Michigan company. At the Health Resources and Services Administration, spokesman Nicholas Papas said the 134 new employees are needed to oversee the $2 billion in stimulus grants for the country's 1,100 community health clinics and $500 million for doctors and nurses working in underserved areas. The new hires are on a contract or term basis because most of the stimulus spending is supposed to be done in two years, he said. "You want to have oversight, and that takes people and resources to do efficiently," Papas said. "If we're understaffed and there's a lack of oversight, the American people would rightly be upset about that." Mark Lassiter, a spokesman for the Social Security Administration, said the agency needs the $37 million in the stimulus package for the personnel costs of sending out checks because it is barely able to carry its current workload. About $5 million went toward checking the list of recipients against lists of veterans and railroad retirees also qualifying for checks, to avoid double payment. The Transportation Department needed to hire two experts to study job-creation estimates because it lacked the manpower to do the work itself, spokeswoman Sasha Johnson said. "Remember, these people are dealing with the recovery money on top of what they do every day," she said. "We wanted an extra set of hands to look at this." The emphasis on accountability also helps explain the relatively slow pace of the stimulus spending. The White House says $135 billion has been "obligated," or fully approved to be spent, but many programs are still in the early stages of planning and reviewing applications, so eager are officials to spend every dollar right. The Housing and Urban Development Department, for instance, is still holding conferences at hotels nationwide -- at a cost of $348,483 for nine events -- to brief local officials on the application rules for a new $1.5 billion homelessness-prevention program. On Monday, Biden presented plans for a ramp-up of stimulus spending, but the administration had always envisioned an acceleration about now, and the plans included no specific way to goad faster spending. Obama praised the plans, then stressed again the accountability theme that is arguably slowing the process and leaving so much of the money in Washington. "We're going to . . . operate in a transparent fashion so that taxpayers know this money is not being wasted on a bunch of boondoggles," Obama said. "I think that sometimes good news comes in what you don't hear about, and you haven't heard a bunch of scandals -- knock on wood -- so far." http://www.washingtonpost.com/wp- dyn/content/article/2009/06/11/AR2009061102877_pf.html

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Spike in Interest Rates Could Choke Recovery Low Rates Had Sparked Consumer Spending By Neil Irwin Washington Post Staff Writer Friday, June 12, 2009 Rising long-term interest rates are making it more expensive for home buyers, corporations and the U.S. government to borrow money, threatening to further stifle an already weak economy. In just the past two weeks, the rate on a 30-year, fixed-rate mortgage has risen to 5.6 percent from 4.9 percent, ending a boom in refinancing and working against a budding recovery in the housing market. Rates on corporate borrowing have also risen, making it more expensive for companies to expand. And the government has been forced to pay more to finance its deficit. Since the beginning of the year, historically low mortgage rates have had a twin benefit for the economy: They have allowed homeowners to refinance about $1.5 trillion worth of mortgages, thus lowering monthly payments and leaving people with more money to spend on goods and services. Low rates have also created greater incentive for people to buy homes, despite continuing troubles in the housing market. The abrupt rise in rates has removed that key stimulant for the economy. The rise has many causes, some of which reflect good news. As investors have grown more confident about the future, for example, they have become more inclined to put money in risky investments, such as the stock market, rather than lending it to the U.S. government and to government-backed mortgage companies. But other causes give more reason for worry. Investors around the world are increasingly fearful that Congress and the Obama administration will be unwilling to bring taxes and spending in line in the years ahead. That makes the U.S. government appear to be a riskier borrower, leading those who lend to it to demand higher interest payments. The Federal Reserve now finds itself in a box. It could try to lower rates by buying government debt. It has already said it would buy $1.5 trillion in U.S. Treasuries and mortgage-related securities this year to try to stimulate growth. But doing so would likely only deepen fears that the Fed will print money to fund government deficits in the future. That possibility -- while rejected by Fed officials and many mainstream economists -- means that expanding purchases might not have the intended effect of lowering rates. It could even drive them up further. Rates remain very low by historical levels. But the yield on 10-year Treasury bonds has risen to almost 4 percent this week from 3.1 percent on March 14. (It edged down yesterday to 3.9 percent.) A wide range of other rates are essentially moving in tandem with that rate, including mortgages. That shift has far-reaching implications.

364 "Households really have no capacity to afford higher rates at this point," said Scott Anderson, a senior economist at Wells Fargo. "It affects the cost of any long-term borrowing a consumer or business might do, whether it's auto loans, mortgages or business credit." The number of refinance transactions has dropped 62 percent since early April, according to a survey by the Mortgage Bankers Association. Amber Sutton, a District resident, was among those poised to benefit from low mortgage rates. For weeks, she had been considering refinancing her mortgage. By reducing her rate from 5.5 percent to well under 5 percent, she would have been able to reduce her monthly payment by about $200 -- money that would have been available to plow into expanding her business, dog day-care Dogtopia in Woodbridge. "I would have put the savings toward opening a new location in one or two years," Sutton said. Now, with rates higher, refinancing wouldn't offer her any savings. "Borrowers who were approved but didn't lock their rate are just walking away," said Christopher Cruise, a senior loan officer at GotEHomeLoans in Bethesda. "They could have saved a few hundred dollars a month at last month's rates, but it makes no sense for them to refinance now." Even with the benefits provided by refinancing to homeowners, consumer spending has remained soft. In May, retail sales rose 0.5 percent, the Commerce Department said yesterday. But that number was inflated by a sharp rise in gasoline prices that inflated sales at gas stations. So far, home-purchase activity has been relatively stable, according to a range of indicators. But if the higher mortgage rates persist, it could put a damper on a fragile housing market. Home sales have stabilized in the past few months, though at a very low level, spurred in part by lower rates. "The increase so far has not really been enough to choke off home buying," said Jay Brinkmann, chief economist at the Mortgage Bankers Association. He added, though, that "higher rates might lead them to pay a lower price or look for a smaller home." Fed leaders have generally viewed the rise in government borrowing rates as benign, reflecting money flooding away from the safe haven of Treasury bonds and into riskier investments. That, in the view of Fed officials, creates a self-correcting mechanism. If rates rise so much as to choke off economic growth, the resulting weakness in the economy will drive rates back down again. They are more concerned about widespread discussion of the idea that the Fed will buy up Treasury bonds far into the future in a manner that generates high inflation. Lawmakers and television commentators alike have broached that possibility, called "monetizing the debt" with increasing frequency in recent weeks. "The Federal Reserve will not monetize the debt," Fed Chairman Ben S. Bernanke said at a congressional hearing last week. Fed leaders take some solace from the fact that inflation expectations remain low. Nonetheless, the mere existence of that chatter could make the Fed less inclined to ramp up its asset purchases at its next rate-setting meeting scheduled for June 23 and 24. Staff writer Ylan Q. Mui contributed to this report. http://www.washingtonpost.com/wp- dyn/content/article/2009/06/11/AR2009061104297_pf.html

365 Press Release

Release Date: June 10, 2009 For release at noon EDT The Federal Reserve on Wednesday issued the first of an ongoing series of monthly reports providing considerable new information on its credit and liquidity programs. The report, entitled Federal Reserve Credit and Liquidity Programs and the Balance Sheet, makes public a wide range of data concerning borrowing patterns and collateral. "The Federal Reserve strongly believes in transparency as a fundamental principle of central banking in a democracy. This new report, together with other steps taken as a result of a comprehensive review of our disclosure practices led by Vice Chairman Kohn, significantly enhances the information Federal Reserve is releasing and should help the public and the Congress better judge how we are carrying out our responsibilities for stabilizing the financial system and the economy," said Board Chairman Ben S. Bernanke. "We will continue to look for opportunities to broaden the scope of information and analysis we provide." For many of the Federal Reserve's credit and liquidity programs, the new information in the report includes the number of borrowers and borrowing amounts by type of institution, collateral by type and credit rating, and data on the concentration of borrowing. The report also includes information on liquidity swap usage by country, quarterly income for important classes of Federal Reserve assets, and asset distribution and other information on the limited liability companies created to avert the disorderly failures of Bear Stearns and American International Group. In addition, the report summarizes and discusses recent developments across a number of programs. Each report will be available on the Federal Reserve Board's public website approximately two weeks after the end of the month at www.federalreserve.gov/monetarypolicy/bst.htm. The new report is part of the Federal Reserve's continuing effort to enhance the transparency of its credit and liquidity programs and is consistent with the amendment to the recent budget resolution sponsored by Sen. Christopher Dodd, chairman of the Senate Committee on Banking, Housing and Urban Affairs, and Sen. Richard Shelby, the ranking member. Separate from the report, the Federal Reserve Bank of New York recently made available the investment management agreements related to its financial stability and liquidity activities. They are posted on its public website at www.newyorkfed.org/aboutthefed/vendor_information.html. June 2009 Report (928 KB PDF)

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Goals Shift For Reform Of Financial Regulation Anticipating Resistance, Obama Changes Tack By David Cho, Binyamin Appelbaum and Zachary A. Goldfarb Washington Post Staff Writers Wednesday, June 10, 2009 The Obama administration is pulling back from some of its most ambitious ideas for overhauling the financial system, after determining that the consolidation of power under fewer federal agencies would face grave opposition by lawmakers and regulators, sources familiar with the discussions said. Although the unveiling of the plan is a week away, several central elements have already been pummeled in public by lawmakers, wary of the concentration of authority in few hands, and in private by some economists and financial executives consulted by senior officials. The administration had originally sought to eliminate turf wars among agencies and gaps in their oversight, for instance by centralizing the power to oversee banks in one body and combining the two agencies that police financial markets. Those proposals have fallen by the wayside, the sources said. Instead the administration increasingly is focused on adding new layers of regulation on top of old. Officials are planning to empower the Federal Reserve with new powers to manage risk across the financial markets, but are considering setting up a council of regulators to keep the central bank in check. The plan's evolution reflects the administration's revised judgment that some changes, while desirable, do not get at the causes of the financial crisis, while other elements, such as the elimination of entire agencies, would be rejected on Capitol Hill. What remains, however, would still be the most sweeping overhaul of financial regulation since the Great Depression. The administration's proposal reflects its wide range of consultations, which may improve the chances that significant reforms will pass Congress. But as a result, the plan increasingly diverges in key respects from what senior administration officials say is the ideal approach to improving financial regulation. The plan now taking form would include the creation of a council to work with the Fed to coordinate oversight of the financial system, according to testimony by Treasury Secretary Timothy F. Geithner at congressional hearing yesterday. The scaling back of the administration's plan was reported in yesterday's Wall Street Journal. New details emerged yesterday. The proposal for a council is a response to concerns on Capitol Hill that the Fed would otherwise have too much power. But it remains unclear how it would interact with the central bank and whether the new body would be an effective check on the Fed's power.

367 Rep. Barney Frank (D-Mass.), House Financial Services Committee chairman, said that the council would be responsible for identifying unregulated firms and financial markets and assigning jurisdiction over them to a regulator. The body, according to Federal Deposit Insurance Corp. Chairman Sheila C. Bair, would "get us all working together." She added that it would create a system of "checks and balances" and that such a collection of regulators with the authority to oversee systemic risk "is going to be an entity that's got a lot of power." The administration has also moved away from a plan favored by experts to create a single agency to oversee the banking industry. Under the current system, financial firms can choose among four regulators, some of whom receive funding from the companies. This arrangement has spurred agencies to compete for firms' business, sometimes by offering more lenient regulation. To address this problem, the administration plans to propose a merger of two agencies, the Office of Thrift Supervision and the Office of the Comptroller of the Currency. Frank said he also wants the government to remove the incentive for interagency competition by finding alternative financing for the regulators and by preventing firms from picking their regulator. The Fed and the FDIC would continue to oversee some banks. Under the plan, the Securities and Exchange Commission and Commodity Futures Trading Commission would remain separate, though administration officials have raised concerns in internal discussions that the United States is one of few, if any, countries without a unified regulator for financial markets. Other countries have also expressed concern about regulatory gaps between U.S. agencies. Geithner decided against proposing the merger after concluding that the existing structure had not contributed to the financial crisis, a source said. If the administration had pressed ahead with a merger, it would have confronted daunting jurisdictional issues on Capitol Hill, where the SEC is overseen by the House Financial Services Committee and Senate Banking Committee, and the House and Senate Agriculture committees oversee the CFTC. Geithner also is expected to detail the administration's plans for regulating compensation at financial firms. Treasury and SEC officials have discussed requiring companies to disclose compensation not just for senior executives but for the most highly paid employees. The SEC also is planning to propose requiring companies to disclose more information about board meetings to discuss compensation, and details about the types of performance incentives offered to employees. The Treasury and SEC plan to make an announcement about the issue today, officials said. Geithner offered a preview in testimony before Congress yesterday. "The SEC has some important responsibilities and obligations" in this area, Geithner said yesterday. He said the agency may seek "additional tools and authorities." As envisioned earlier, the administration still plans to propose that the government be empowered to dissolve non-bank financial firms that fall into trouble and that a new commission be set up to protect consumers of financial products. Christopher J. Dodd (D-Conn.), chairman of the Senate Banking Committee, said he had urged the administration to approach reform through the question of how best to protect consumers, an approach he described as "bottom up." But Dodd said he was reserving judgment on whether a new commission was the most effective way.

368 Administration officials are also taking steps to coordinate regulatory reforms with their counterparts in Europe and Canada in hope of keeping problematic activities from migrating to countries with more lenient regulatory regimes. Geithner, speaking ahead of his departure for meetings Friday and Saturday with Group of Eight finance ministers in Lecce, Italy, dismissed the notion that the United States may be moving slower or with less ambition than its European counterparts, saying financial leaders would seek consensus. The administration began to craft its reform proposals in February, asking a range of people to describe what had gone wrong. From the outset, President Obama scheduled meetings with congressional leaders, including Dodd and Frank, to solicit opinions. Dodd said he and his staff have been in touch with the administration about regulatory reform on an almost daily basis. Officials also met with former heads of regulatory agencies, academics and industry executives. Engaging Congress and compromising at an early stage has emerged as a hallmark of the administration's approach on major legislative issues, including the stimulus package and the federal budget. But officials are unlikely to avert conflict on key elements. House Republican leaders, meanwhile, are trying to develop a consensus within their ranks on a rival proposal for regulatory reform. A draft of the plan provided to The Post argues for curtailing the Fed's power and creating a single federal bank regulator. Staff writers Anthony Faiola, Brady Dennis and Neil Irwin contributed to this report. http://www.washingtonpost.com/wp- dyn/content/article/2009/06/09/AR2009060903604.html?wpisrc=newsletter

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Economy

June 10, 2009 Michigan Works to Remake Itself Without King Auto By BILL VLASIC and NICK BUNKLEY DETROIT — The former General Motors Centerpoint truck plant in Pontiac, Mich., is another empty building that served for years as a reminder of the declining fortunes of American automakers. But the day after G.M. filed for bankruptcy, it was bustling with activity. Ed Montgomery, the Obama administration’s director of recovery for auto communities and workers, was touring the building with camera crews in tow. Amid all the grim auto news, it was as good a photo op as he could have hoped for — the building was the future home of the Motown Motion Picture Studio. The state, with the help of incentives, lured 25 film crews to Michigan last year to shoot movies like “The Day the Earth Stood Still” and “Gran Torino,” from Clint Eastwood, and officials are hopeful about a new growth industry. “I’m very optimistic about the project,” said Mr. Montgomery, adding that the studio could create 3,000 new jobs. “That’s an excellent start.” But any promising starts in Michigan are overshadowed by the brutal reality of the state’s economic plight. Just across the street from the building Mr. Montgomery was touring, workers at a huge G.M. truck plant learned the day before that their factory would be closing, one of seven more Michigan plants the automaker plans to shut down. G.M. has promised to use its tour through bankruptcy to become a more nimble and competitive company, but Michigan faces an even tougher task in reinventing itself. For all the talk of California’s economic woes, the distress in Michigan is greater. About 800,000 jobs have been lost in the state — about one in every six — since 2000, and its unemployment rate has reached 12.7 percent, higher than any other state. The fallout has been even worse in heavily populated southeastern Michigan. Manufacturing jobs in the seven-county region that includes Detroit have fallen 51 percent since the beginning of the decade, and auto-related positions have fallen 65 percent. The economic crisis has been so severe that Michigan, with a $1.4 billion budget shortfall, is closing eight prisons to save money. It is also canceling more than 130 road and bridge repair projects because the state cannot come up with enough money to get matching federal funds. “Movie studio jobs are going to be measured in the hundreds,” said Don Grimes, an economic forecaster at the University of Michigan. “It’s nowhere near the replacement numbers for what’s going on.”

370 On a broader level, the troubles of the auto industry are having a profound impact on the overall United States economy. The industry — with Michigan as its center — now accounts for only 1.5 percent of the nation’s economic output, down from 3 percent in 2007 and 5 percent at its peak in the 1950s. The automakers have historically played a big part in ending recessions. Car companies, in the past, would increase production and add workers to satisfy pent-up consumer demand after a downturn. But now, the industry’s troubles may be prolonging the misery. “If not for the problems in the auto industry, this recession would have been much milder,” said Ben Herzon, an economist at Macroeconomic Advisors, in St. Louis. In Michigan, the state’s leaders are hoping to build on what’s left of the once-mighty Big Three automakers, and attract new jobs tied to the alternative-fuel vehicles of the future. The state has authorized tax credits to support a new battery manufacturing plant for G.M., and similar assistance for three other proposed battery projects. The jobs created will number in the hundreds at first, but state officials are hopeful that Michigan will be at the center of battery development nationwide. Still, battery production has a long way to go to match the jobs being lost. On Monday, G.M. opened a new battery lab at its Warren, Mich., technical center that will be used by an existing team of about 1,000 engineers. On the same day, the company said it would cut an additional 400 union jobs by shutting down medium-duty truck production in Flint. Michigan is also pursuing wind-power technology, solar-panel manufacturing, even production of railroad cars — any viable industry that might be interested in hiring the thousands of engineers who used to work in the auto industry. “This community still has a lot of things going for it,” said Senator Carl Levin, Democrat of Michigan. “This is the heart of the automotive research capital of the world, and there’s a strong structure to build on.” The bankruptcies of G.M. and Chrysler have, if nothing else, kept both of the automakers alive for the foreseeable future. The state has thus avoided its worst nightmare — that G.M.’s headquarters in Detroit and Chrysler’s sprawling technical center in Auburn Hills would be added to the list of vacant buildings along the Interstate 75 automotive corridor. The research and development campuses at the Detroit automakers, as well as new operations occupied by Toyota and Hyundai, are the foundation for growth in new technologies like lithium-ion batteries. But those operations cannot replace the tens of thousands of manufacturing jobs that G.M., Ford, Chrysler and their suppliers have shed in recent years. White-collar positions have also steadily decreased at all the automakers and their suppliers. In response, Gov. Jennifer Granholm started a retraining program in 2007 — “No Worker Left Behind” — to provide up to two years of free tuition to unemployed workers. So far, more than 60,000 people have signed up. Providing education for laid-off workers is a priority for Governor Granholm, who joined Mr. Montgomery last week on his tour of the Pontiac movie studio. “We are not interested in looking in the rearview mirror,” she said. “We need to be able to play both offense and defense.”

371 Retraining is essential to broaden the skills of factory workers and others in the hardest- hit segments of the economy. “The recession is just crushing industries that tend to employ people with less education — construction, manufacturing, retail stores,” said Mr. Grimes. Classrooms at community colleges across the state are jammed with former auto industry employees trying to prepare themselves for a new career. Greg Cortis, 36, had been a contract worker at G.M.’s huge technical center in Warren, Mich., for three years before he was laid off in October. He is taking courses in carpentry, electrical work and other construction skills in Oakland Community College’s facilities management program. Leaving the auto industry behind, after a total of 15 years in the business, was difficult, he said, but a fact of life in today’s Michigan. “You’ve got to work,” said Mr. Cortis. “I don’t want to be on a two- or three-year unemployment extension.” Louis Uchitelle contributed reporting from New York. http://www.nytimes.com/2009/06/10/business/economy/10michigan.html?th&emc=th

The human side of the global recession http://projects.nytimes.com/living-with-less

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Economy

June 10, 2009 10 Large Banks Allowed to Exit U.S. Aid Program By ERIC DASH The Obama administration marked with little fanfare a major milestone in its bank rescue effort — its decision on Tuesday to let 10 big banks repay federal aid that had sustained them through the worst of the crisis — as policy makers and industry executives focused on the challenges still before them. “This is not a sign that our troubles are over,” President Obama said. “Far from it.” While the announcement had been expected for weeks, the official word put the administration’s imprimatur on a corps of big banks considered healthy enough to extricate themselves from Washington’s grip. The bank holding companies, among them American Express, Goldman Sachs, JPMorgan Chase and Morgan Stanley, plan to return a combined $68.3 billion. That represents more than a quarter of the federal bailout money that the nation’s banks have received since last October, when many feared that failures might cascade through the industry.

But the decision to allow the banks to exit the Troubled Asset Relief Program, or TARP, also ushered in a new, and potentially risky, phase of the banking crisis. Letting the lenders out now — earlier than many had envisioned, and without the industry reforms some consider necessary to prevent future crises — raises many sobering questions for policy makers, bankers and taxpayers.

373 The program was aimed at purchasing assets and equity from banks to strengthen them and encourage them to expand lending during a tightening credit squeeze. But after banks return the TARP money, the administration will forfeit much of its leverage over them. With that loss goes a rare opportunity to overhaul the industry. The administration’s ability to push institutions to purge themselves quickly of bad assets and do more to help hard-pressed homeowners will be diminished. Of even deeper concern is the running trouble inside the banking industry. Despite tentative signs of revival, many banks remain fragile. Four of the nation’s five largest lenders, including Citigroup and Bank of America, were not allowed to return their bailout funds. Some analysts worry that financial institutions that repay bailout money now may turn to Washington again if the economy worsens and losses overwhelm banks. One of the most vexing problems of the credit crisis — how to rid banks of their troubled mortgage investments — remains unresolved. The banks are eager to escape TARP and the restrictions that come with it, particularly the limits on how much they can pay their 25 most highly compensated workers. (Even so, the Obama administration plans to propose guidelines on executive compensation for the broader industry as early as Wednesday.) Yet even banks that return taxpayers’ money will remain dependent on other forms of government aid. Among them are enhanced deposit insurance, incentive payments to modify home mortgages and federal guarantees on bonds that banks sell to raise capital. “They may need the government’s money to get through this storm,” Christopher Whalen, a managing partner at Institutional Risk Analytics, said of the banks. “If the banks have to come back and ask for more money in a few months, I don’t think the response from Washington will be too kind.”

Taxpayers — many of whom probably never imagined that banks would return their bailout money so soon, if ever —stand to make several billion dollars from their investment in the 10 banks. So far, the Treasury has collected about $1.8 billion in interest payments. It also might reap as much as $4.6 billion as the banks seek to expunge other government investments, known as warrants. The first round of repayments will free up billions of dollars that the administration can then funnel to other troubled banks and companies without having to return to Congress for more money. But homeowners and consumers are unlikely to benefit if banks repay their TARP funds en masse. Banks are giving back money that might otherwise be used to make loans. The announcement on Tuesday underscored the stark dividing line across the banking industry. On one side are big banks now considered healthy enough to forgo their TARP money. On the other side are those considered too weak to go without it. Still, some of those weaker banks may be allowed to repay the money soon.

374 Mr. Obama, in remarks on Tuesday in the East Room of the White House, stopped short of declaring the crisis over. And the president, who has been harshly critical of multimillion-dollar bonuses for Wall Street executives, had a message for the banks that were returning the money. “I also want to say: the return of these funds does not provide forgiveness for past excesses or permission for future misdeeds,” he said. The Treasury did not name the banks, but the institutions quickly acknowledged the decision in a barrage of press releases on Tuesday morning. Morgan Stanley was among the first out with the news. American Express, Bank of New York Mellon, the BB& T Corporation, Capital One Financial, JP Morgan Chase, Northern Trust, the State Street Corporation and U.S. Bancorp soon followed. Goldman Sachs, which had pressed hard to repay the money, waited nearly two hours before issuing its release. None of the banks’ executives crowed publicly, but some of their employees celebrated Tuesday night. At an outdoor cafe on Stone Street, near Goldman’s headquarters in Lower Manhattan, Goldman employees toasted their freedom. “This one’s on me,” one called out from his table. “Yeah, as long as it’s not on the government,” a colleague replied. Nearby, at Ulysses pub, two Bank of New York Mellon employees nursed beers and predicted their lives — and pay — would improve, even if the broader economy did not. Rick Waddell, the chief executive of Northern Trust, acknowledged that many banks were still under pressure. “The environment remains challenging,” Mr. Waddell said in a memorandum. But he said it was in the best interest of “shareholders clients, partners and taxpayers to return this capital.” Even Henry M. Paulson Jr., who, as Treasury secretary, summoned banking executives to Washington last fall to press the TARP money on them, said in a statement on Tuesday that he did not see a quick end to the industry’s problems. “The recovery of our financial system is under way, but the road ahead is not short,” Mr. Paulson said. Still, some of his former staff members planned to celebrate. Before leaving the Treasury in January, the staff members joked that they would hold a reunion when the first dollar of the big banks’ TARP money was repaid. That day will most likely come next week, when the actual payments are expected to be made. “I guess we have to organize something — a quick run to the local bar for a drink,” said Michele Davis, the former assistant Treasury secretary for public affairs. Louise Story contributed reporting. ERIC DASH 10 Large Banks Allowed to Exit U.S. Aid Program June 10, 2009http://www.nytimes.com/2009/06/10/business/economy/10tarp.html?_r=1&th&emc=th

375

Miércoles 10/06/2009 8:00 RGE Monitor's Newsletter

Is Eastern Europe on the Brink of an Asia-Style Crisis? The collapse of the Thai baht in July 1997 helped spark the Asian financial crisis. Could events in Latvia spawn a similar contagion? Eyes are focused on this small Baltic economy, amid growing talk of a devaluation, due to the potential for spillover effects into its fellow Baltics, Sweden and the broader Eastern European region. Strong trade and financial linkages, not to mention similar macroeconomic vulnerabilities, mean a Latvian crisis would almost surely have knock-on effects on neighboring Estonia and Lithuania, as detailed in this RGE EconoMonitor post in early May. A Latvian crisis would also have negative spillover effects into Sweden via Swedish banks’ heavy exposure to the Baltic trio. The wildcard is how a Latvian crisis would affect the greater Central and Eastern European (CEE) region. Direct trade and financial linkages between Latvia and CEE economies, outside of the Baltics, are limited. Nevertheless, many of these countries – particularly Bulgaria and Romania – share similar macroeconomic vulnerabilities with Latvia, meaning a crisis there could ‘wake up’ investors to the potential for crises in the rest of the region. What’s the Matter with Latvia? Once an investor darling, Latvia’s booming, double-digit growth earlier this decade was accompanied by massive imbalances - a current-account deficit approaching 25% of GDP (among the world’s widest) and an external debt load that peaked at over 140% of GDP. T he correction in these imbalances would have been challenging under any circumstances, but the global financial crisis and consequent drying up of capital inflows have raised the likelihood of a full-blown balance of payments crisis. Latvia’s currency, the Lat (LVL), is pegged to the euro within a ±1% fluctuation band, and such pegs do not tend to survive harsh economic adjustments like that now underway. In countries with flexible exchange rates, domestic demand does not have to bear the full brunt of correction in external imbalances as currency depreciation can shoulder some of the burden. Latvia’s economy is currently on life support. Although agreement was reached in December on a € 7.5 billion (US$ 10.4 billion) IMF and EU-led rescue package, the government is now forecasting an 18% contraction in growth in 2009 , making it one of the world’s fastest shrinking economies. The immediate focus is on whether Latvia will receive the € 1.7 billion (US$ 2.4 billion) installment of its loan package due in late June. The key stumbling block is Latvia’s ability to meet the 5% of GDP budget deficit limit laid out in the loan terms. The problem is not that Latvia’s government has been spending recklessly. Rather, the issue is that the drop-off in Latvian growth has been so precipitous, far beyond that envisioned when the loan agreement was signed just six months ago, that extreme fiscal belt-tightening is now required to meet the loan terms. A 5% GDP contraction was assumed in the original agreement, as compared to the 18% now forecast.

376 Latvia has been going to agonizing extremes to make the June payout happen, dramatically slashing public sector salaries. More spending cuts are in the works. As Prime Minister Dombrovskis has pointed out, these belt-tightening measures will likely trigger an even deeper recession. Even with the cuts, Latvia’s budget deficit is still expected to come in above the limit, and it remains unclear whether the IMF and European Commission are willing to relax the loan conditions. As RGE Monitor warned in early May: if Latvia does not receive the latest tranche of its IMF-led loan, the country will likely be facing a double whammy of default and devaluation. Signs suggest that even with the June payout, Latvia may not avert devaluation. On June 3, the government failed to find any takers for the LVL 50 mm (US$ 101 mm) in bonds it was hoping to sell. While government officials still speak out adamantly against devaluation, many commentators now see devaluation as inevitable. A former prime minister has called for a 30% devaluation, and Bengt Dennis – a former Swedish centr al banker who now advises Latvia – recently said devaluation is unavoidable. At the same time, Latvia’s central bank has been burning through its foreign reserves in its efforts to maintain the currency peg. From a peak of around US$ 6.6 billion in mid-2008, foreign reserves had plunged to US$ 4.1 billion at the end of May. Why Hasn’t Latvia Already Devalued? A key part of Latvia’s motivation in keeping its peg was its desire to adopt the euro early next decade. That euro adoption goal, however, increasingly looks like wishful thinking given the current economic woes. Some have argued that Latvia is clinging to its currency peg to avoid mass defaults, due to the high level of foreign currency- denominated lending there (around 90% of total loans). However, as RGE Monitor argued in December , mass defaults will occur, regardless of whether Latvia devalues or adjusts via internal deflation. The key difference is that devaluation will likely lead to a more rapid wave of defaults over a shorter period of time, which could magnify stress on the banking system. Potential for Contagion Among the numerous reasons the IMF’s senior representative for Central Europe and the Baltics, Christoph Rosenberg, gave in January for supporting Latvia in its desire to maintain the peg was the idea that a devaluation in Latvia would have far-reaching effects beyond this small Baltic country. “[D]evaluation in Latvia would have severe regional contagion effects, especially given the fragile global funding environment. The spillovers could well go beyond pressures on countries with fixed exchange rate in the Baltics and South-East Europe. For example, market confidence in foreign banks invested in the Baltics and similar countries would likely be affected, with implications for their ability to access wholesale financing.” Estonia and Lithuania Strong trade and financial linkages, not to mention similar macroeconomic vulnerabilities, mean a Latvian crisis would almost surely spread to Estonia and Lithuania's economies. Latvia’s fellow Baltics are its top trading partners. Meanwhile, the same Swedish banks that dominate Latvia’s banking sy stem also dominate those in Estonia and Lithuania, providing another channel for contagion. Latvia is the weakest link of the three, having built up the largest imbalances. Nevertheless, the other two Baltics also experienced booming growth earlier this decade, along with double-digit current-account deficits, and all three are in the midst of severe recessions. Most

377 importantly, Estonia and Lithuania also have currency pegs to the euro, and Latvia’s struggles are raising questions about the sustainability of their fixed exchange rates.

Sweden While Sweden is not looking at a full-blown crisis, its strong financial linkages with the Baltics could dramatically cut in to the Nordic country’s growth prospects. Swedish banks have issued loans to Baltic borrowers equivalent to over 20% of Sweden’s GDP. According to Danske Bank, the loans could cost Sweden a total of anywhere from 2% to 6% of its GDP over several years, depending on how many Baltic borrowers default. Fitch Ratings recently used a number of stress test scenarios to examine Swedish banks’ ability to absorb losses in the Baltics and according to the results, Swedbank - one of Sweden’s largest banks - could be particularly affected. Nevertheless, Danske said in late May that all Swedish banks operating in the Baltics should remain solvent in a devaluation scenario. Some analysts have speculated that it may not be long before the Swedish state has to step in with direct financial assistance to help its banking sector. Central and Eastern Europe (CEE) The broader CEE region has minimal trade and financial linkages with the Baltics. So the key channel of contagion between the Baltics and the broader CEE region would be via the ‘wake up channel’ – meaning a crisis in Latvia could serve as a wake-up call to investors, alerting them to similar vulnerabilities elsewhere. So far, the evidence suggests the rest of the CEE will not go unscathed if Latvia devalues, despite their limited linkages. For example, the recent sell-off in the Polish zloty and Hungarian forint was largely attributed to concerns over potential spillover effects from a Latvian crisis. CEE countries are not a homogenous bloc. Bulgaria and Romania, in particular, share a similar boom-bust trajectory to that being played out in the Baltics. External imbalances in these five countries rivaled, and in some cases exceeded, the build-up of imbalances in pre-crisis Asia. For example, current account deficits in Southeast Asia from 1995-97 fell within the 3.0-8.5% of GDP range, whi le those in Romania, Bulgaria and the three Baltics were well over 10% of GDP in 2008. Like the Baltics, Bulgaria operates a fixed exchange rate system and a key concern is whether a Latvian crisis would shake confidence in Bulgaria’s currency board.

Romania and Hungary may have flexible exchange rates, but like Latvia, they have needed IMF-led rescue packages. If Latvia descends into crisis, it would highlight the fact that a rescue package, in and of itself, is not sufficient to avert economic meltdown.

Other countries in the region – Czech Republic, Poland, Slovakia – also built up imbalances in recent years and are in the midst of their own sharp slowdowns. Nevertheless, their imbalances never reached the same proportion as those in the Baltics and Balkans. Overall, their economies are in stronger positions to weather any contagion. Slovakia successfully entered the Eurozone earlier this year, while Poland qualified for a US$ 20.5 billion flexible credit line (FCL) from the IMF. An FCL is a precauti onary facility, available only to countries with very strong fundamentals, which can be drawn upon at any time and without meeting any specific conditions. Such a facility should help provide Poland with a bulwark against contagion.

378 Latvia’s woes are turning into a cautionary tale for other CEE countries vigorously pursuing euro adoption and could force a reassessment of the benefits. EU newcomers that have not yet adopted the euro are expected to participate in ERM II, a required currency stability test of at least two years for EMU hopefuls in which currencies are required to trade against the euro in a limited fluctuation band. A devaluation would force Latvia to start the challenging ERM II process anew.

Could a Latvian crisis affect the Eurozone? If a balance-of-payments crisis occurs in the Baltics and it spills over into other Eastern European economies (please note that this is a big ‘if’), then the Eur ozone could be affected. The Eurozone’s exposure results from Western European banks’ heavy exposure to Eastern Europe, via subsidiaries, where they hold 60-90% market share (as a % of assets), depending on the country. Given the CEE’s strong financial linkages with Western Europe, the health of Eastern Europe’s economies and its banks could potentially afflict Western European banks, as detailed in this recent RGE EconoMonitor post.

Jun 9, 2009 EM Equities: Does the Bear Rally have Bull Legs?

Overview: After having reached a bottom in Oct 2008, emerging markets stocks have gained 69% to the beginning of June as risk appetite improved, core markets volatility (VIX) subsided, commodity prices rebounded and emerging markets fundamentals remained relatively well in comparison to past episodes of crisis. Moreover, EM countries policy response to the crisis has been relatively aggressive, planting the seeds for a positive domestic demand story. But downside risks remain due to bleak corporate earnings outlook, worries over the real economy and revival of global risk aversion.So far this year, EM equity markets have jumped 38% while global equities have increased 7%. Outlook:

o June 2nd: The surge in emerging-market equities may last another six months (until the end of 2009) as faster economic growth in developing countries prompts investors to keep shifting out of lower-yielding assets. Emerging-market stocks may keep on gaining as investors shift some of the $3.8 trillion in money-funds into equities (Lui and Patterson).

o May 26th: If the US economy surprises on the upside, Chinese economy surprises on the downside, or the financials lead global sectors, developed markets will outperform emerging markets equities. (Bank of America Merrill Lynch)

379 o May 27th: A pause/pullback in this historic rally in global and Latin America equities of the past 2½ months would be healthy; it would likely bring much new money into the markets and we would use such a sell-off to add beta. (Citigroup) o May 18th: Emerging-market stocks may gain an average of 20 percent this year as they rebound faster and stronger than their peers in developed countries, according to Black Rock Inc. The global economy has probably seen its worst in the past two quarters, with developing nations already starting to emerge from the recession. (Bloomberg) o April 21st: The bulls say that this is just the beginning of a sustainable recovery in global risk appetite, supported by signs that Chinese demand is growing again and hopes that the U.S. economy is not free falling anymore. The bears say that, although the medium-term outlook for emerging markets is appealing, the prospect of a slow and painful global economic recovery will translate into bouts of selling pressure. (Reuters) o April 21st: There are still significant downside risks and it will be important to differentiate between emerging markets. Asia remains best positioned and CEE and CIS are the most vulnerable. (Danske) o April 16th: Emerging-market stocks will surge a further 39 percent this year as government spending and interest-rate cuts from China to the U.S. revive demand for developing nations’ exports, according to JPMorgan Chase & Co. (Bloomberg) Regional Performance: Asia (ex-Japan): Asian equities have outperformed mature markets in 2009 thanks to FII inflows amid diminishing risk-aversion and some signs of green shoots. Markets have gained 39% YTD as of first week of June (70% since October 2008) with India and China as the best performers, and Pakistan and Malaysia as the worst performers. Markets have recovered 48% of the losses incurred in 2008 (peak to through, down 59%). Latin America: Latin American equities market has outperformed the other emerging markets regional indexes by rising 46% YTD to the first week of June (83% since it hit bottom in October 2008), with strong performances in Brazil (up 60.5% YTD) and Chile (up 45% YTD). The laggards are Argentina (up 6.2% YTD) and Mexico (up 15% YTD). Overall, LatAm equities market have recovered 37% of the 2008 crash (peak to trough, down 68%). Eastern Europe, Middle East and Africa (EMEA): EMEA equities market have gone up 30% YTD to the first week of June and 62% since it reached bottom in March 2009. In May 2009 alone, equity markets rallied in tandem, with Qatar’s benchmark DSM index in the lead with a 24.6% gain (NCB Capital). Reuters found that Central and Eastern Europe lagged behind the general trend in the current stock market rallies ( (via Sofia Echo). EMEA stock markets have recovered 31% of the sharp correction induced by the global crisis (peak to through, down 66%) Recent EM market Dynamics: o June 8th: Emerging-market stocks dropped the most in two weeks as Credit Suisse Group AG advised selling Taiwan shares and speculation the Federal Reserve may raise interest rates curbed demand for higher-yielding assets. The MSCI Emerging Markets Index fell 1.9 percent to 772.25, the steepest drop since May 21. The 22- country benchmark has lost 3.7 percent in the past five days following a record three-

380 month rally that pushed the index to the highest level relative to earnings since December 2007. (Bloomberg) o June 3rd: Reuters found that Central and Eastern Europe lagged behind the general trend in the current stock market rallies. Despite rebounding by 30-40% over the past three months to June, CEE bourses still generated rather small turnover and rallies were patchy (via Sofia Echo) o June 3rd: Sub-Saharan African markets have been among the worst performing markets in 2009 struck by domestic conditions of high government borrowing and commercial banks’ exposure to margin lending. South Africa the best performing market in the region has risen by a mere quarter. Sub Saharan Africa is experiencing a slump in private and aid inflows since the onset of the global slowdown which is a prime factor behind the underperformance of its equities.(FT) o June 3rd: In late October, EM equities hit a bottom and started to rise. Since then, the FTSE emerging markets index has outperformed the developed markets index by 48.8 per cent (FT). o April 30th: With risk premiums on emerging market assets edging lower and with some investors coming back in March and April, the mood at the Emerging Markets Trade Association's spring forum was mostly upbeat. Emerging-market asset managers from some large Wall Street firms agreed on April 30th that the worst may be behind us. But while the tone was slightly more bullish, global risk aversion is causing them to favor short, liquid names. Analysts were also at odds over how corporate bonds will fair compared with sovereign issues. (Dow Jones) o April 27th: Emerging-market equities, bonds and currencies dropped on concern the outbreak of swine flu from Mexico to New Zealand will reduce tourism revenue and delay the global economy’s recovery. The MSCI Emerging Markets Index retreated 2.6 percent to 631.19 in New York, the steepest decline since April 8. The extra yield investors demand to own developing- nation bonds instead of U.S. Treasuries rose the most in a week, while 21 of 23 emerging-market currencies weakened against the dollar. (Bloomberg) o April 22nd: Short sellers are increasing bets against developing-nation stocks by the most since March 2007, a signal the biggest rally in 16 years may fizzle as profits plunge. Short interest in the iShares MSCI Emerging Markets Index fund, which tracks equities in 23 developing nations, climbed 51 percent in March, the biggest jump in two years, according to New York Stock Exchange data. (Bloomberg)

381 Ni funcionarios ni precarios Entre la temporalidad y el empleo fijo, cien economistas proponen una tercera vía para flexibilizar el trabajo - El coste del despido no es lo único que hay que revisar ARIADNA TRILLAS - Barcelona - 09/06/2009

El mercado laboral español es el más flexible de Europa. Y también el más rígido. Por eso, quien más, quien menos, corrobora que el español es un mercado laboral enfermo. Cuando ha reinado la bonanza económica, ha sido capaz de generar a todo gas más de

382 siete millones de puestos de trabajo en una década, la mayoría en sectores de baja productividad como la construcción. El mercado laboral español es el más flexible de Europa. Y también el más rígido. Sí, a la vez. Por eso, quien más, quien menos, corrobora que el español es un mercado laboral enfermo. Diagnóstico: esquizofrenia. Cuando ha reinado la bonanza económica, ha sido capaz de generar a todo gas más de siete millones de puestos de trabajo en una década, la mayoría en sectores de baja productividad como la construcción. Pero en las fases recesivas, demuestra ser un globo fácil de pinchar, un bluf. De golpe, en un año, se ha evaporado más de un millón de empleos. En mayo hubo alivio, pero el listón de los cinco millones de parados sigue a la vista. Gobierno, empresarios y sindicatos desean que, de esta ruina económica, el mercado laboral salga, si no completamente curado, sí al menos un poco más sano. El problema radica en que se pongan de acuerdo sobre la medicina a tomar. El objetivo del Ejecutivo es la cuadratura del círculo, una tercera vía que no entierre derechos sociales y que bendigan todas las partes. El manifiesto a favor de un contrato único (indefinido y con un coste de despido creciente con la antigüedad), respaldado por un centenar de economistas, se propone como esa tercera vía, aunque la iniciativa ha suscitado rotundo rechazo sindical y ya se ha gestado su correspondiente contramanifiesto. El Gobierno se muestra abierto a la iniciativa, pero la condiciona a que suscite acuerdo entre las partes. Y no es el caso. "Sólo se hará aquello que acuerden los agentes sociales. Y está claro que desde posiciones extremas será difícil alcanzar un pacto", enfatiza la secretaria general de Empleo, Maravillas Rojo, que declina pronunciarse en concreto sobre un manifiesto del que es firmante el nuevo secretario de Estado de Economía, el profesor de IESE José Manuel Campa. "Toda propuesta necesita tener en cuenta lo que ya existe, debe refundirse, integrarse", añade Rojo, en alusión a las distintas tipologías de indemnizaciones vigentes ya en caso de ruptura de contrato y hasta 40 clases de bonificaciones que hay para incentivar la contratación. Un ejemplo de algo que ya existe y que la secretaria de Empleo "vería bien ampliar" a más trabajadores: el contrato de fomento del empleo indefinido que, desde 1997, se ha ido introduciendo para varios colectivos -los de mayores de 45 años, los jóvenes de hasta 30 años, los parados que lleven seis meses sin empleo, todos los discapacitados, las mujeres contratadas en sectores copados por hombres o los contratos que pasen de temporales a fijos-. Este contrato, reforzado a raíz de la reforma laboral de 2006, y del que se firmaron 236.380 en 2008, tiene de gancho para el empresario un coste de despido de 33 días por año trabajado, con tope de 24 mensualidades, en lugar de los 45 días en caso de despido objetivo improcedente, con tope de 42 mensualidades. "Una posible vía de solución sería extender esta modalidad de contratación indefinida (con 33 días de indemnización por despido y 24 mensualidades) al colectivo que en 2006 quedó fuera: hombres trabajadores entre 30 y 45 años de edad. ¿Por qué no? En 2006 hubo una vía de acuerdo que podría ampliarse", comenta Rojo, quien no aclara si eso va a ser una propuesta formal del Gobierno a las partes. En todo caso, el Ejecutivo asegura querer combatir la esquizofrenia, la "dualidad" del mercado laboral español. El alud de bonificaciones para la contratación indefinida a partir de 2006 ha ayudado a incorporar al mercado laboral a algunos colectivos "pero no está bastando para crear nuevo empleo", admite el Gobierno. Recapitulemos. ¿Por qué afirman los sindicatos que el mercado laboral español es el más flexible? Cada mañana, casi un tercio de los ciudadanos que van al tajo penden de un empleo tan frágil como la choza de paja del cuento de Los tres cerditos, que, al primer

383 soplido de crisis, se derrumba. Con el deterioro económico, la primera grasa que se quitan las empresas con problemas sobrevenidos de sobrepeso es la del empleo temporal, porque de esos contratos con fecha de caducidad es posible prescindir a cambio de muy poco dinero (ocho días por año trabajado); a veces, el coste es cero. Los temporales lo tienen difícil para alquilar un piso, no digamos para obtener un crédito. Carecen de estabilidad laboral y los empresarios no se sienten incentivados a invertir en formarles. ¿Por qué proclaman entonces los empresarios que el español es el mercado laboral más rígido? Cuestión de analizar qué ocurre con los restantes dos tercios de los trabajadores con nómina. Por seguir con el cuento de los cerditos, su casa está construida a prueba de enérgicos soplidos, a prueba de recesión. No es que, pase lo que pase, el empresario esté obligado a quedarse con la plantilla. "En la práctica, en España existe ya el despido libre, lo que ocurre es que es caro", resume José Antonio Sagardoy, presidente del despacho especializado en Derecho Laboral Sagardoy Abogados. Romper un contrato indefinido sale más costoso en España que en la mayoría de países vecinos: son 45 días por año trabajado, con un tope de 42 mensualidades, a menos que se trate de despidos procedentes, en que la indemnización es de 20 días. Y jugar con requerir de más o menos manos en función de los vaivenes de la cambiante demanda se complica para las empresas, a lo que se suman los corsés de los que a veces peca la negociación colectiva. Sagardoy realizó hace un tiempo un estudio comparado sobre el coste del despido improcedente de un trabajador que llevara 10 años en la misma empresa, con una remuneración anual de 24.000 euros. La indemnización en España sería de 36.031 euros, frente a los 5.917 euros de Dinamarca, los 6.443,5 euros de Irlanda. Holanda, donde el resultado no sería tan distinto (35.505 euros) introdujo el año pasado una rebaja del coste del despido a 15 días por año trabajado para los menores de 40 años, explica el profesor de economía holandés Marcel Jansen, que enseña en la Universidad Carlos III y que es uno de los promotores del manifiesto por el contrato único que ha acabado de caldear el debate sobre la reforma laboral. Fuentes de la negociación aseguran que, "para el Gobierno, no está archivado". Los sindicatos dicen no. "Esta propuesta busca perpetuar la precariedad y detrás de ellas se esconde la pretensión de que España no puede salir de la crisis sin abaratar el despido. Si todos reconocen que el origen del problema no es laboral, una reforma sería un remedio que no produciría los efectos deseados", replica Toni Ferrer, secretario de Acción Sindical de UGT, para quien "hablar de rigidez laboral cuando pueden destruirse de un plumazo más de un millón de empleos es un chiste". "En el mercado de trabajo español hay flexibilidad, pero es una flexibilidad muy mal repartida, insolidaria e injusta, porque recae sólo sobre los temporales. ¡Nunca vamos a cambiar de modelo productivo si no contamos con unas relaciones laborales estables!", enfatiza Jansen, molesto por el hecho de que el debate público sobre su propuesta se limite a lo que cuesta el despido. "No buscamos abaratar el despido, sino distribuir de forma más equitativa la situación y dar más flexibilidad al mercado laboral sin quitar derechos". Los sindicatos afirman lo contrario. "Éstos no tienen el monopolio de hablar del mercado laboral y no parece importarles mucho la situación de los temporales", espeta otro de los firmantes, Javier Díaz Giménez, profesor de IESE, quien enfatiza que, de los 19 millones de trabajadores, 11 millones son contratos "indefinidos extraprotegidos, casi blindados", frente a siete millones "en precario, muchos de ellos autónomos formales". El manifiesto propone una única modalidad de contrato indefinido (hoy existen 17) para todos los nuevos contratos (no los vigentes). Pero el tope máximo para el aumento -

384 progresivo- de las indemnizaciones en caso de rescisión se pide que quede por debajo de los 45 días. Propone incentivar la búsqueda de empleo graduando la prestación por paro de forma que sea mayor al principio y vaya menguando después. Durante lo peor de la crisis, propone alargar la protección de los parados. También sugiere abrir al sector privado las políticas activas para ayudar a recolocar a un desempleado, en competencia con el Inem, como en Dinamarca o los Países Bajos. O superar la negociación colectiva allí donde las empresas se pongan de acuerdo con sus trabajadores. "Toda la argumentación de una reforma laboral no puede basarse sólo en una comparativa sobre el coste del despido en Europa. No puede pasarse por alto toda la cultura de diálogo social de nuestro país", reflexiona el catedrático de Derecho del Trabajo Salvador del Rey, socio del área laboral, además, del bufete Cuatrecasas. Aun así, Del Rey considera "realistas" las propuestas que buscan "aproximar las indemnizaciones por despido entre el casi nada y el casi todo". Este catedrático coincide con el diagnóstico de los economistas, pero expresa algunas dudas de que un contrato único sea la respuesta adecuada "a un mercado cada vez más diversificado, que no requiere respuestas parciales, sino un enfoque global". Recuerda que existe un tipo de temporalidad vinculada a la precariedad. Pero también otra ligada a actividades estacionales como el turismo y la hostelería. Los pro-manifiesto replican que el contrato único puede ser a tiempo parcial para esos casos, que puede ser un contrato X por horas a la semana o al año. El aspecto más polémico de la propuestas es éste: el contrato unificaría las causas del despido. "Sólo se mantendría la tutela judicial para los despidos por razones de discriminación en la empresa. Entonces, la ley ampararía al trabajador. Creemos que la improcedencia siempre viene de algún tipo de discriminación. Si la empresa tiene dificultades para sobrevivir, ¿de veras es improcedente recortar la plantilla?", apunta desde la Universidad Autónoma de Barcelona (UAB) el economista Jordi Caballé. Ramón Górriz, secretario confederal de Acción Sindical de CC OO, se echa las manos a la cabeza. "Si se aplica, no habría distinción entre despido procedente e improcedente. ¿No ve que se busca un despido sin causa ni control judicial?", pregunta, tras subrayar, como Ferrer, que lo que hace falta es mayor protección social y un nuevo modelo productivo en el que las empresas tengan más flexibilidad interna. La CEOE, que ha propuesto un contrato indefinido con dos años de empleo temporal previo e indemnizaciones de 20 días por año trabajado, declinó participar en el reportaje. Sí remite al último discurso de su presidente, Gerardo Díaz Ferrán, en la Fundación Antares. Allí dijo que "debemos superar el exceso de temporalidad". Dio algunas ideas sobre el cómo: "Puede hacerse por la vía de alguna de las modalidades contractuales propuesta desde ámbitos académicos o empresariales". http://www.elpais.com/articulo/sociedad/funcionarios/precarios/elpepisoc/20090609elpep isoc_1/Tes?print=1

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Last Updated: June 8, 2009 16:26 EDT

Nobel Winner Krugman Sees U.S. Recession Ending Soon (Update1) By Courtney Schlisserman

June 8 (Bloomberg) -- The U.S. economy probably will emerge from the recession by September, Nobel Prize-winning economist Paul Krugman said. “I would not be surprised if the official end of the U.S. recession ends up being, in retrospect, dated sometime this summer,” he said in a lecture today at the London School of Economics. “Things seem to be getting worse more slowly. There’s some reason to think that we’re stabilizing.” U.S. stocks erased an earlier decline after Krugman made his comments. The Standard & Poor’s 500 Stock Index was little changed at 939.14 at 4:07 p.m. in New York after slumping as much as 1.5 percent earlier, and the Dow Jones Industrial Average gained 1.36 points to 8,764.49. Krugman, a Princeton University economist, has warned recently that the U.S. government hasn’t done enough to help the country’s economy recover. Last month, at a conference in Abu Dhabi, he said the fiscal stimulus is “only enough to mitigate the slump, not induce recovery.” The National Bureau of Economic Research, based in Cambridge, Massachusetts, is the official arbiter of U.S. recessions and expansions. Last week, Robert Hall, the head of the NBER’s business-cycle-dating committee, said it’s “way too early” to say the contraction is over. The U.S. has been in a recession since December 2007, and the NBER may take months to decide when a trough has been reached. Recent reports have shown an easing of declines in industrial production and other measures that the group reviews when determining whether the economy is in a recession. Unemployment to Rise

386 Even with a recovery, “almost surely unemployment will keep rising for a long time and there’s a lot of reason to think that the world economy is going to stay depressed for an extended period,” Krugman said. The unemployment rate jumped to 9.4 percent in May, the highest since 1983, partly reflecting more people joining the labor force to look for work. The U.S. Federal Reserve’s efforts to stabilize markets -- measures that have swelled the central bank’s balance sheet -- have helped, Krugman said. “A lot of the spreads in the markets have come down” and “the acute financial stuff seems to have come to a halt,” he said. Fed officials lowered the benchmark interest rate to a target range of zero to 0.25 percent in December and have switched to using credit programs and outright purchases of Treasuries, mortgage-backed securities and housing agency debt as the main tools of monetary policy. $2.31 Trillion The balance sheet’s size peaked at $2.31 trillion in December. It has fluctuated around $2.1 trillion over the past two months. The Fed’s swollen balance sheet is “a little alarming. In the long run you really don’t want the central banks to be so involved in the business of lending,” Krugman said. “But it’s arguably necessary” even if there are questions about “where does it stop?” To contact the reporters on this story: Courtney Schlisserman in Washington at [email protected] Last Updated: June 8, 2009 16:26 http://www.lse.ac.uk/collections/LSEPublicLecturesAndEvents/live/LSELive.htm

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Banks May Need New Stress Tests, Panel Says By Amit R. Paley Washington Post Staff Writer Tuesday, June 9, 2009 The federal government should repeat its stress tests of the nation's largest banks if its assumptions about the severity of the economic downturn prove too rosy, according to a congressional oversight report to be released today. The Congressional Oversight Panel, which oversees the $700 billion government bailout of the financial industry, generally praised the bank evaluations, which assessed the firms' financial health, and lauded regulators for using a reasonable model to conduct the tests. But the panel, headed by Harvard Law School professor Elizabeth Warren, noted that the stress tests assumed an average unemployment rate of 8.9 percent this year under the worst-case scenario. The unemployment rate for last month, however, climbed to 9.4 percent, meaning the assumptions by regulators might have been too optimistic. Federal Reserve Chairman Ben S. Bernanke, whose agency conducted the stress tests, has previously defended the rigor of those evaluations against criticism from economists and other skeptics, who questioned the underlying assumptions. While the oversight panel praised the Fed for releasing an unprecedented amount of information about banks, the report criticized the regulators who performed the tests for not releasing enough information about how the evaluations were conducted, saying the lack of transparency raised "serious concerns" and left "unanswered questions." "Without this information, it is not possible for anyone to replicate the tests to determine how robust they are or to vary the assumptions to see whether different projections might yield very different results," the report says. "It may fail to capture substantial risks further out on the horizon." Stress tests of the nation's largest 19 banks, released last month, concluded that 10 of them needed to raise a combined $75 billion in common equity to withstand an even more severe financial crisis. That figure was much lower than many analysts had expected, buoying confidence in the banking industry. The 154-page report called for the banks to be subject to further stress tests as long as they continue to hold large amounts of toxic assets on their books. The panel also said that regulators should retain the power to conduct stress tests even beyond that time, and that banks should be required to run internal evaluations between federal tests and share the results with regulators. While the panel painted the stress tests as a useful exercise, the report urged that they should be used cautiously.

388 "While no one should gainsay the potentially positive results of the tests," the report said, "it would be equally unwise to think that those results reflect a diagnosis of all of the potential weaknesses or create a necessarily sufficient buffer against future reverses for the banking system." http://www.washingtonpost.com/wp- dyn/content/article/2009/06/08/AR2009060803944.html?wpisrc=newsletter

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09.06.2009 Hang on in there, Gordon – We really need you until January

Gordon Brown survived the dismal European elections, but the FT reports that Labour Party rebels still hope to oust Mr Brown by the autumn, which would jeopardise the Lisbon Treaty. The Independent newspaper has a poll to suggest that Alan Johnson, the popular home secretary and a potential Labour successor to Mr Brown, would be able to deny the Conservatives an overall majority, while Mr Brown might destroy the Labour party if he continue to cling to power. FT Deutschland has an article saying that EU politicians are genuinely concerned about the situation in Britain, and quotes the SPD’s European spokesman as saying that the decision to call a referendum on the Lisbon Treaty would invariably lead to that country’s exit. Philip Stephens says there is a possibility that Cameron might get in this year, in which he will hold a referendum on the Lisbon Treaty, which the UK electorate is almost certain to reject. This would produce a huge crisis in the EU, and might even trigger the beginning of the end of the UK’s membership. In his column he concludes that even Cameron might not want to go that far, and might prefer to be elected after the Lisbon Treaty takes effect. Sarkozy’s remaining challenge Nicolas Sarkozy takes the EP election results as support for himself and his government and announces the next series of reforms. In response to the election victory of the Greens the government is quick to put judicial reforms and climate change on top of the agenda. With the defeat of the Socialists and Francois Bayrou he is confortable at home. Arnaud Leparmentier argues that Sarkozy’s main challenges are at the European level. Angela Merkel if reelected, is likely to continue her strategy of deficit reduction, hardly compatible with Sarkozy’s vision. A crisis cannot be excluded. Turkey concerned about its EU future The Turkish newspaper Hürriyet reports this morning that Turkey will face a mighty challenge after the drift to the centre-right in the European elections. The paper analysts

390 as pointing that the election result is not a response to future Turkish membership but a response to the crisis, but nevertheless the paper’s correspondent concludes that Turkey’s path towards is going to be harder than it would have otherwise. FT Deutschland also has a story on this, quoting Elmar Brok from the EPP as saying that EU enlargement should stop with Croatia. S&P cuts rating for Ireland Standard & Poor's cut its rating for Irish long-term debt to ‘AA’, its lowest level in 14 years, blaming massive losses at Anglo Irish Bank and the likely cost of rescuing the nation's other banks, reports the Irish Independent. S&P expects that the economy won’t return to last year’s level of growth for another five years at least and that debt, meanwhile, could balloon from 45% last year to more than 100% of GDP. The news raised the yield spread against German bunds by 3bp and pushed the euro to a two week low against the dollar. Green shoots interrupted As Brad Setser points out, Korea is the first country to report trade data, which makes a useful but imperfect guide for world trade, as Korea is among the world’s largest exporters. After a recovery in April, exports fell again in May, though not much, though the year-on-year decline is 28%. Taiwan did not as well as in April, and a slight improvement in May, but yoy it’s still down 31%. These data suggest is that the speed of the decline has slowed down, but these data are disappointing. Does the rise in yields slow down the recovery? As the 10-year US Treasury yield heads towards 4%, the FT is wondering whether this complicate the economic recovery. Some commentators quoted in the article say that there is a danger of a negative feedback loop between higher yield and a slower recovery, while others point out that the scenario of a sharp recession followed by a shallow recover is not consistent with high inflation. Protest votes in the Baltics Le Monde has an article on the Baltic states and their desperate battles to counteract rumours of devaluations against the euro despite their economies contracting with double digit rates. In good times, the prospect of EU adhesion had set off an extraordinary growth in credits denominated in euros. As the economic crisis is unfolding, Baltic states took drastic cost cutting measures to defend their peg. Estonia is now in the middle of a political crisis because it refuses to cut further, in Latvia the government only survives with the help of the international community. In last Sunday’s European elections, protest votes propelled extremists from the region into the European Parliament. See also Simon Johnson on disturbing parallels between Latvia and Iceland. How to save Latvia – and sink Sweden The FT is quoting from a rather devious research paper which points towards a way out Latvia’s crisis. Convert the consumer debt – in euros – into Lats, and then devalue the currency by 40%. The damage would be born entirely by the Swedish banks, which have lent them the money. The articles goes on to say that the Swedish banks will lose one way or the other, but at least this way, Latvia is going to survive.

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09.06.2009 Why Germany's export model will no longer work after the crisis By: Wolfgang Munchau

Let me attempt, perhaps foolhardily, to map out a scenario of how the global economic crisis could evolve in continental Europe. Even if we assume a recovery elsewhere, Europe’s economy may be stuck at low growth for some time. To understand why, it is perhaps best to look at sectoral balances for households, companies and the public sector. The current account can be expressed as the difference between national savings and investments. Of the world’s 10 largest economies, the US, the UK and Spain used to run the largest current account deficits before the crisis. The US household sector has been shifting from a negative savings rate before the crisis to a positive rate of 4 per cent of disposable income now. The US corporate sector used to have a large negative savings rate, but this has almost disappeared. So far, the increase in net savings in the US private sector has been balanced by increased borrowing from the US government. I am making three assumptions: the first is that the return to a positive US household savings rate is permanent – even under a scenario of a strong economic recovery. US households will take time to repair their balance sheets after the housing and credit disaster. Second, I also expect US companies not to return to the high level of borrowings that prevailed before the crisis. Third, I expect the US government to reduce its deficit after 2010. The recent rise in long-term bond yields should serve as a reminder that deficits cannot go on rising forever. Taking all three factors together, the US will shift from a strongly negative current account balance towards neutrality, perhaps even a small surplus for a short period. I expect similar shifts in the UK and Spain at different magnitudes. Among countries with large current account surpluses, the three biggest are China, Japan and Germany. I am focusing on Germany here. The German household sector will maintain its high savings rate. The German government increased its deficit during the crisis, but is now looking for a quick fiscal exit strategy. The Bundestag has recently voted through a constitutional balanced-budget clause, which requires cuts in the deficit almost right away. Japan will probably maintain its larger fiscal deficit for longer, but if we take Germany, China and Japan together, we will not see a sufficient and sustained

392 fiscal expansion to compensate for the sectoral shifts elsewhere. Global current account surpluses and deficits add up to zero. So if everybody is saving more, who will be dissaving? It will have to be the corporate sector in the countries with large net exports. So if the US, the UK and Spain are heading for a more balanced current account in the future, so will the surplus countries. The current account balance can also be expressed as the sum of the trade balance, net earnings on foreign assets, and unilateral financial transfers. In several countries, including the US and Germany, the gap between exports and imports serves as a good proxy for the current account. A fall in the trade deficit in the US, UK and Spain implies a fall in the combined trade surplus elsewhere. And as some of the shifts in the US and the UK are likely to be structural, this will have long-term effects on others. In particular, it means the export model on which Germany, China and Japan rely, could suffer a cardiac arrest. What about the argument that a large part of German exports goes to the rest of the eurozone? This is true, but there are imbalances within the eurozone too. Spain has been running a current account deficit of close to 10 per cent of gross domestic product. As that comes down, so will Germany’s equally unsustainable intra-eurozone surplus. Through what mechanism will this export-sector meltdown come about? My guess is that in Europe it will happen through a violent increase in the euro’s exchange rate against the US dollar, and possibly the pound and other free-floating currencies. Exchange rate devaluation would greatly help the US and others to reduce their current account deficits, but it will impair the economic recovery in countries with large trade surpluses and free-floating exchange rates. Last week’s remarks by Angela Merkel, who criticised the Federal Reserve and other central banks for running inflationary policies, sharpened investor perceptions of transatlantic policy divergence and decoupling. Many investors are now starting to bet on a strong appreciation of the euro – the last thing Ms Merkel wants. Neither Germany nor Japan is politically equipped to deal with an exchange rate shock. China may continue to manage its exchange rate, but the Europeans are much less likely to intervene in foreign exchange markets. For the time being, the governments of the classic export nations cling on to their export-based economic model, the model they know best. Their only strategy, if you call it that, is to hope for a miraculous bail-out from the US consumer – which is not going to happen this time. If my predictions prove correct, Germany will be down and out for a long time with a huge and still unresolved banking crisis, an overshooting exchange rate and lower net exports, presided over by politicians who panic about domestic inflation. This will not end well.

Wolfgang Munchau Why Germany's export model will no longer work after the crisis09.06.2009http://www.eurointelligence.com/article.581+M5ad4656d7d8.0.html#

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Press Release

Release Date: June 8, 2009 For immediate release The 10 banking organizations required by the Supervisory Capital Assessment Program to bolster their capital buffers have all submitted capital plans that, if implemented, would provide sufficient capital to meet the required buffer under the assessment's more-adverse scenario. As supervisors, we will be working with the institutions to ensure their plans are implemented quickly and effectively. Supervisors also continue to work with all regulated financial institutions to review the quality of their corporate-governance, risk-management and capital-planning processes. http://www.federalreserve.gov/newsevents/press/bcreg/20090608b.htm

394 vox Research-based policy analysis and commentary from leading economists A Tale of Two Depressions

Barry Eichengreen Kevin H. O’Rourke 4 June 2009

This is an update of the authors' 6 April 2009 column comparing today's global crisis to the Great Depression. World industrial production, trade, and stock markets are diving faster now than during 1929-30. Fortunately, the policy response to date is much better. The update shows that trade and stock markets have shown some improvement without reversing the overall conclusion -- today's crisis is at least as bad as the Great Depression. Editor’s note: The 6 April 2009 Vox column by Barry Eichengreen and Kevin O’Rourke shattered all Vox readership records, with 30,000 views in less than 48 hours and over 100,000 within the week. The authors will update the charts as new data emerges; this updated column is the first, presenting monthly data up to April 2009. (The updates and much more will eventually appear in a paper the authors are writing a paper for Economic Policy.) New findings: • World industrial production continues to track closely the 1930s fall, with no clear signs of ‘green shoots’. • World stock markets have rebounded a bit since March, and world trade has stabilised, but these are still following paths far below the ones they followed in the Great Depression. • There are new charts for individual nations’ industrial output. The big-4 EU nations divide north-south; today’s German and British industrial output are closely tracking their rate of fall in the 1930s, while Italy and France are doing much worse. • The North Americans (US & Canada) continue to see their industrial output fall approximately in line with what happened in the 1929 crisis, with no clear signs of a turn around. • Japan’s industrial output in February was 25 percentage points lower than at the equivalent stage in the Great Depression. There was however a sharp rebound in March. The facts for Chile, Belgium, Czechoslovakia, Poland and Sweden are displayed below; note the rebound in Eastern Europe. Updated Figure 1. World Industrial Output, Now vs Then (updated)

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Updated Figure 2. World Stock Markets, Now vs Then (updated)

Updated Figure 3. The Volume of World Trade, Now vs Then (updated)

Updated Figure 4. Central Bank Discount Rates, Now vs Then (7 country average)

396 New Figure 5. Industrial output, four big Europeans, then and now

New Figure 6. Industrial output, four Non-Europeans, then and now.

397 New Figure 7: Industrial output, four small Europeans, then and now.

Start of original column (published 6 April 2009) The parallels between the Great Depression of the 1930s and our current Great Recession have been widely remarked upon. Paul Krugman has compared the fall in US industrial production from its mid-1929 and late-2007 peaks, showing that it has been milder this time. On this basis he refers to the current situation, with characteristic black humour, as only “half a Great Depression.” The “Four Bad Bears” graph comparing the Dow in 1929-30 and S&P 500 in 2008-9 has similarly had wide circulation (Short 2009). It shows the US stock market since late 2007 falling just about as fast as in 1929-30. Comparing the Great Depression to now for the world, not just the US This and most other commentary contrasting the two episodes compares America then and now. This, however, is a misleading picture. The Great Depression was a global phenomenon. Even if it originated, in some sense, in the US, it was transmitted internationally by trade flows, capital flows and commodity prices. That said, different countries were affected differently. The US is not representative of their experiences. Our Great Recession is every bit as global, earlier hopes for decoupling in Asia and Europe notwithstanding. Increasingly there is awareness that events have taken an even uglier turn outside the US, with even larger falls in manufacturing production, exports and equity prices.

398 In fact, when we look globally, as in Figure 1, the decline in industrial production in the last nine months has been at least as severe as in the nine months following the 1929 peak. (All graphs in this column track behaviour after the peaks in world industrial production, which occurred in June 1929 and April 2008.) Here, then, is a first illustration of how the global picture provides a very different and, indeed, more disturbing perspective than the US case considered by Krugman, which as noted earlier shows a smaller decline in manufacturing production now than then. Figure 1. World Industrial Output, Now vs Then

Source: Eichengreen and O’Rourke (2009) and IMF. Similarly, while the fall in US stock market has tracked 1929, global stock markets are falling even faster now than in the Great Depression (Figure 2). Again this is contrary to the impression left by those who, basing their comparison on the US market alone, suggest that the current crash is no more serious than that of 1929-30. Figure 2. World Stock Markets, Now vs Then

399 Source: Global Financial Database. Another area where we are “surpassing” our forbearers is in destroying trade. World trade is falling much faster now than in 1929-30 (Figure 3). This is highly alarming given the prominence attached in the historical literature to trade destruction as a factor compounding the Great Depression. Figure 3. The Volume of World Trade, Now vs Then

Sources: League of Nations Monthly Bulletin of Statistics, http://www.cpb.nl/eng/research/sector2/data/trademonitor.html It’s a Depression alright To sum up, globally we are tracking or doing even worse than the Great Depression, whether the metric is industrial production, exports or equity valuations. Focusing on the US causes one to minimise this alarming fact. The “Great Recession” label may turn out to be too optimistic. This is a Depression-sized event. That said, we are only one year into the current crisis, whereas after 1929 the world economy continued to shrink for three successive years. What matters now is that policy makers arrest the decline. We therefore turn to the policy response. Figure 4. Central Bank Discount Rates, Now vs Then (7 country average)

400

Source: Bernanke and Mihov (2000); Bank of England, ECB, Bank of Japan, St. Louis Fed, National Bank of Poland, Sveriges Riksbank. Policy responses: Then and now Figure 4 shows a GDP-weighted average of central bank discount rates for 7 countries. As can be seen, in both crises there was a lag of five or six months before discount rates responded to the passing of the peak, although in the present crisis rates have been cut more rapidly and from a lower level. There is more at work here than simply the difference between George Harrison and Ben Bernanke. The central bank response has differed globally. Figure 5 shows money supply for a GDP-weighted average of 19 countries accounting for more than half of world GDP in 2004. Clearly, monetary expansion was more rapid in the run-up to the 2008 crisis than during 1925-29, which is a reminder that the stage- setting events were not the same in the two cases. Moreover, the global money supply continued to grow rapidly in 2008, unlike in 1929 when it levelled off and then underwent a catastrophic decline. Figure 5. Money Supplies, 19 Countries, Now vs Then

401

Source: Bordo et al. (2001), IMF International Financial Statistics, OECD Monthly Economic Indicators. Figure 6 is the analogous picture for fiscal policy, in this case for 24 countries. The interwar measure is the fiscal surplus as a percentage of GDP. The current data include the IMF’s World Economic Outlook Update forecasts for 2009 and 2010. As can be seen, fiscal deficits expanded after 1929 but only modestly. Clearly, willingness to run deficits today is considerably greater. Conclusion To summarise: the world is currently undergoing an economic shock every bit as big as the Great Depression shock of 1929-30. Looking just at the US leads one to overlook how alarming the current situation is even in comparison with 1929-30. The good news, of course, is that the policy response is very different. The question now is whether that policy response will work. For the answer, stay tuned for our next column. Figure 6. Government Budget Surpluses, Now vs Then

402 Source: Bordo et al. (2001), IMF World Economic Outlook, January 2009. References Eichengreen, B. and K.H. O’Rourke. 2009. “A Tale of Two Depressions.” In progress. Bernanke, B.S. 2000. Bernanke, B.S. and I. Mihov. 2000. “Deflation and Monetary Contraction in the Great Depression: An Analysis by Simple Ratios.” In B.S. Bernanke, Essays on the Great Depression. Princeton: Princeton University Press. Bordo, M.D., B. Eichengreen, D. Klingebiel and M.S. Martinez-Peria. 2001. “Is the Crisis Problem Growing More Severe?” Economic Policy32: 51-82. Paul Krugman, “The Great Recession versus the Great Depression,” Conscience of a Liberal (20 March 2009). Doug Short, “Four Bad Bears,” DShort: Financial Lifecycle Planning” (20 March 2009). http://www.voxeu.org/index.php?q=node/3421

403

06/02/2009 03:11 PM EU SPLIT OVER LESSONS OF CRISIS

UK, Ireland Resist Push for More Financial Regulation By Hans-Jürgen Schlamp The European Union is split over how best to apply the lessons of the global downturn to the regulation of financial markets. Countries like Germany want tighter controls on risky deals and exotic securities, but the UK, Ireland and parts of Eastern Europe are fighting for free markets. Peer Steinbrück's face always darkens when he is asked how much more taxpayers' money he will need to bail out the banks. "I don't know," says the German finance minister. "I won't know until after the fact." And when he is asked how he feels, late in the evening after a cabinet meeting in Berlin or a meeting of European Union finance ministers in Brussels, Steinbrück sometimes grumbles in response: "Lousy!"

AFP Stockbrokers in London: The UK is resisting a bid for more EU regulation of financial markets. Europe's finance ministers are not in an enviable position these days. Washington is constantly putting pressure on them to inject additional billions into the economy. Meanwhile Brussels threatens to take them to court for incurring too much government debt. And in times of so much uncertainty, they are also expected to provide answers to the big questions on everyone's mind: How can we jump-start the economy without completely destroying government budgets? Can banks be relieved of their toxic assets without unloading all the risk onto the shoulders of taxpayers? In addition, the 27 EU finance ministers have been given a special task to complete for their respective leaders. At their last meeting in March, the heads of state and government of the EU countries charged the European Commission in Brussels and their finance ministers with investigating new regulatory options. At their next summit in June, "the European Council will take first decisions (sic) to strengthen EU financial sector regulation and supervision," as it is phrased in Brussels bureaucratese. The G-20 summit of the world's leading heads of state and government also vowed to proceed in the same direction. But what happens to the summit visions when attempts are made to put the lofty ideas into practice?

404 There has admittedly been some progress. The European Commission has made some preliminary proposals and the parliament has passed a law under which the amount that one bank can lend to another will be limited in future to 25 percent of the bank's own capital. And banks will be required to retain at least 5 percent of any high-risk securities that they sell. But that was the extent of it, at least for the time being. Moreover, it is highly unlikely that further concrete measures will follow the politicians' bold announcements. There is a crack running straight through the EU, says Werner Langen, a member of the European Parliament for Germany's conservative Christian Democratic Union. Sources close to the EU's finance ministers have expressed similar sentiments, saying that the traditional, continental core of Europe is once more facing off against the British, the Irish and some of the organization's new Eastern European members. London and Dublin, in particular, are blocking anything that could create problems in their respective financial industries. This is understandable, given the fact that Great Britain and Ireland have very few other future-proof industrial sectors. But this path is immensely dangerous for Europe. "We have absolutely no risk management today," says David Wright, deputy director general of the European Commission. According to Wright, there were no warning signals before the financial meltdown because "the necessary mechanisms simply do not exist." Wright believes that it is high time for change. Almost everyone agrees, at least in theory. Even Britain's Prime Minister Gordon Brown had come out clearly in favor of "a strong step in the direction of regulation" at the meeting of EU leaders, a satisfied Chancellor Angela Merkel said after the March summit. "Complex products like banking derivatives which were supposed to disperse risk around the world have instead spread contagion," Brown said in a speech at the European Parliament in Strasbourg in March, where he called for the creation of "global standards" to respond to "global problems." But in expressing these sentiments, Brown apparently neglected to inform his own ministers, undersecretaries and officials of his change of course. They continue to block the creation of substantial regulations for financial institutions at the negotiations in Brussels. 'More Holes than a Swiss Cheese' All the same, the majority of EU members seem determined to reestablish, as far as possible, political control over markets that have become widely deregulated. Specifically, they want: • stricter equity capital regulations for banks, the goal being to prevent excessively risky transactions; • a registration requirement for large hedge funds which would also cover their debt-financed leveraged transactions; • guidelines for salaries and bonus payments in the financial industry, which would be tied to long-term corporate results; • a licensing requirement for rating agencies, which would no longer be allowed to provide consulting services to the same customers they rate; • Europe-wide control of financial market players and common regulatory requirements.

405 For some, these proposals are much too far-reaching, while for others they do not go far enough. Poul Nyrup Rasmussen, president of the Party of European Socialists, is critical of the Commission's draft law and describes it as having "more holes than a Swiss cheese." Martin Schulz, chairman of the Socialist group in the European Parliament, wants to see a "greater unbundling" of executive compensation and bank profits. A simple "recommendation" on the regulation of executive compensation is worthless, says Christian Democratic European Parliament member Klaus-Heiner Lehne. What is needed, according to Lehne, is a real law or -- in EU jargon -- guideline. A similar recommendation, says Lehne, has been in place since 2004, but "only one member state has observed it." Christine Lagarde, France's conservative finance minister, also believes that the proposals are "not enough," and she even sees dangerous gaps. For instance, she says, Brussels wants to allow investment funds which are certified in other regions of the world to be sold in the EU without further examination. Lagarde fears that such funds could prove to be a "Trojan horse" for intruders from tax havens and would "open the door to funds from the Cayman Islands." The British, in particular, take a completely different view of things. On Feb. 22, during a preparatory meeting in Berlin ahead of the G-20 summit, the British negotiator warned his counterparts against excessively extensive regulatory plans. "We should be careful that we do not create problems for the future," he said. The defenders of Britain's investment funds are indeed making sure that the gentlemen in London's City will not be asked to endure too much regulation. They threaten that if regulation becomes too strict, they will move to other markets in Asia or the United States. Meanwhile the British press has been drumming up support for the industry. Even Stuart Fraser, the head of the Policy and Resources Committee of the City of London, warns that tighter EU regulation "would drive the whole industry overseas." Antonio Borges, chairman of the Hedge Fund Standards Board, told the Daily Telegraph that the proposed regulations are "a blatant attack on the UK and US financial systems by Continental countries that neither have a tradition of alternative investments nor a proper understanding of them." Such views are applauded in Europe's new east, where many politicians identify ideologically with the British-Irish position, even though they have no banking centers of their own to protect. Some believe that unregulated growth is more useful in economic terms than the German-style security-focused model. Many of them came of age in communist planned economies and later studied the free market approach at US universities. The resistance coming from both the west and the east has already produced results. For one, a powerful European regulatory authority is unlikely to emerge in the future; regulation will remain in the hands of national authorities. The only remaining bone of contention will probably be the extent to which national regulators should cooperate with each other, and under which rules they should assess risk and, if necessary, intervene in the market. Germany's central bank, the Bundesbank, also supported London's rejection of the idea of an EU-wide authority -- partly in an effort to protect its own turf. "Only the leaders themselves" can now ensure that the June summit will yield more than just "insubstantial chapter headings," says one of the summit's Brussels organizers, noting that French President Nicolas Sarkozy would secretly like to present himself as a "great regulator." German Chancellor Angela Merkel, in the midst of an election campaign, will

406 hardly be willing to stand on the sidelines, says the Brussels official, and Gordon Brown has gone too far in his rhetoric to be able to block everything. Many experts doubt whether all of this will be enough to make sure the right lessons for the future are drawn from the crisis. "We have no understanding at all of the macroeconomic effect of microeconomic processes in these markets," says Carsten Pillath, the general director of the General Secretariat of the Council of the European Union. "A market regulator needs tried-and-tested models in order to evaluate what is happening there. But such models don't exist." Before coming to the EU, Pillath worked in the Finance Ministry and Chancellery in Berlin. The lessons learned from past debacles "did not make us immune to the current crisis," he says. And the next crisis, which will presumably take a completely different course again? "We will enter that," he says, "with the same lack of knowledge." Translated from the German by Christopher Sultan

URL: http://www.spiegel.de/international/europe/0,1518,628123,00.html

407 Thursday, February 12, 2009 Irving Fisher's Debt Deflation Theory and Its Relevance Today

I'm sure readers have noticed that talking about the global economic downturn as a depression is suddenly respectable. A mere three months, use of that term would have gotten one branded as a alarmist (even Nouriel Roubini, who has a taste for drama, often used the code of "L shaped recession").

As a result, economists and commentators are re-examining the Great Depression, particularly since some doubt that the officialdom has drawn the correct lessons from it.

One respected economist from that era whose work is often praised but seldom followed is Irving Fisher. In a VoxEU article, Enrique Mendoza argues in favor of Fisher's debt deflation theory, and explains its policy implications. Fisher is appealing because he sees the unwinding of excessive leverage as the driving force of a depression, while most other theories see it as an outcome.

From VoxEU: Hire Irving Fisher! Enrique G. Mendoza 12 February 2009 This column rehabilitates Irving Fisher’s debt-deflation theory to explain the current crisis. It suggests that fiscal stimulus will do little to prevent the crisis from becoming a protracted slump because the problem lies in finance. A cure will require reversing deflation and restarting the credit system.

“…in the great booms and depressions, each of the above named factors (over production, underconsumption, over capacity, price dislocation, over confidence, over investment, over saving etc.) has played a subordinate role as compared with two dominant factors, namely, over indebtedness to start with and deflation following soon after;… where any of the other factors do become conspicuous, they are often merely effects or symptoms of these two.” (Irving Fisher, 1933, p. 341) Economists read the literature about the Great Depression with deep intellectual curiosity and savour in particular the still ongoing debate about its causes and remedies. Keynesians argue that price and wage rigidities and a failure of aggregate demand were the main culprits for the biggest economic catastrophe recorded in modern history. Monetarists posit that the main culprit was a terrible mistake on the part of the monetary authority, because it allowed the supply of money to contract. The new generation of Neoclassical economists argue that serious policy mistakes on the “real side” of the economy, such as the deployment of major trade barriers, turned a cyclical downturn into the Great Depression, and that issues of price rigidities, demand failures, credit, or monetary policy are at best of second-order importance. In a seminal 1933 article, Mr. Irving Fisher offered a very different and innovative view. He focused on the meltdown of financial markets, the devastating effects of a downward

408 spiral connecting the deflation of assets and goods prices, the process of deleveraging by households and firms, and contraction of economic activity. Until about eighteen months ago, this was just one more of many unsettled economic questions that academic economists love to dwell on, largely because we don’t have a lot of data on Great Depressions to test our theories and because intellectual arrogance prevented us from taking seriously 1990s meltdowns in emerging markets and the Nordic countries as harbingers of what could happen to the US. Today, as we go through the catastrophic process of Fisher’s debt-deflation mechanism, there is no doubt that Fisher was right and the rest are just stories. If anything, we are left wishing prices were rigid! But declaring a winner in the Great Depression debate is unimportant. The critical issue is to use the diagnosis that Fisher offered in his article – and what we have learned about debt deflations since then – to guide policy making. In this climate of hiring gurus for an ever-growing number of “top” economist posts in the US government, I would be very happy if we could just hire Irving Fisher! Three lessons from Irving Fisher Here are the lessons I learned after reading Fisher’s piece again and reflecting on our current dilemmas from its perspective. Lesson 1: Fiscal stimulus is a band-aid. We need – now and for the next two years – massive government spending to support the unemployed and prevent the implosion of state and local governments. Beyond that, spending will not stimulate anything, and it has nothing to do with the causes of the crisis or with putting an end to it. It is the strong pain killer that the economy needs for the infection that afflicts it, but it is just a pain killer, not a cure. Well-crafted tax adjustments can be useful, but only if targeted to address the deflationary pressures and/or the fragility of the financial system (see Lesson 2). By the same token, trade protection and other similarly “brilliant” ideas floating around need to be opposed. They will do nothing to attack the causes of the crisis, and they could make the recession deeper and more protracted. Lesson 2: Deflation must be halted and reversed, and the credit system restarted. Today, as in the early 1930s, these two parts of the puzzle are tightly interrelated, as Fisher explained. Deflation will not stop if the collapse of the credit system is not contained, and the collapse of the credit system will not stop until the deflation of asset and goods prices is controlled. A trillion dollars of fiscal stimulus today will not avoid catastrophe if the financial stabilisation fails. Conversely, the sooner a credible, comprehensive, and effective financial stabilisation plan is implemented, the lower the actual cost of “true” fiscal support needed for the social safety net. Being realistic, however, even if we had this ideal situation in place tomorrow, a major recession – unlike anything most Americans alive today have ever seen – is unavoidable. Catastrophe is here and we will not escape it. But even the 18-to-24-months catastrophe we are in is not the worst outcome. The worst outcome would be a full repeat of the Great Depression. The worst of the Great Depression was not so much the initial economic collapse, as dramatic as that was, but its persistence for several years. This is what we still have time to avoid and where our energy should be invested. The political spin about pushing for reforms and bailouts to “avert disaster” needs to be corrected, so that everyone’s expectations are not biased towards thinking that a trillion dollars of fiscal stimulus means back to business as usual. The emergency is real and present, but not to escape catastrophe. All the numbers we have about employment, production, world trade, the financial system, etc. show that we are already in a catastrophe. The emergency is to

409 avoid the persistence of the stagnation that occurred during the Depression. The emergency is to prevent most of the next decade from looking like 2008. Lesson 3: Prevention. We got into this mess because financial development advanced way ahead of not only regulators and government officials, but the actors in financial markets themselves, including the geniuses who created the innovative financial products that we have now come to know (and fear) by their acronyms – CDOs, MBSs, CMOs, and the greatest villain of all, CDSs! Preventing the next debacle, however, requires careful thinking. Imposing regulations and controls that would return the financial system to its 1960s structure would be a major mistake. The challenge is to identify where things went very wrong and plug the deep holes that exist while preserving the enormous potential that the securitisation of financial assets has for enhancing efficiency and standards of living worldwide. A starting point is to recognise that government made two huge mistakes in (a) directing regulators to ignore products like CDSs, by pretending that simply by an act of law they could be declared not to be standard securities or a form of gambling (both of which they were!), and (b) instituting and enlarging the implicit government guarantee backing the fast expansion of mortgage giants Fannie Mae and Freddie Mac. Had the wisdom of people like Mrs. Brooksley Born prevailed in the late 1990s, the CDS market would have been at least supervised, if not regulated. This alone would have saved us enormous pain today, because the jump from the mid-billions problem that sub-prime mortgages were to the mid-trillions debacle we are suffering occurred largely due to the casino-like setup in which AIG and other financial companies conducted the CDS business. So I end with the lesson that the master himself gave to conclude his article: “Finally, I would emphasise the important corollary, of the debt-deflation theory, that great depressions are curable and preventable through reflation and stabilisation.” (Fisher, 1933, p. 350) References Irving Fisher, “The Debt-Deflation Theory of Great Depressions,”, Econometrica 1933

Economists read the literature about the Great Depression with deep intellectual curiosity and savour in particular the still ongoing debate about its causes and remedies. Keynesians argue that price and wage rigidities and a failure of aggregate demand were the main culprits for the biggest economic catastrophe recorded in modern history. Monetarists posit that the main culprit was a terrible mistake on the part of the monetary authority, because it allowed the supply of money to contract. The new generation of Neoclassical economists argue that serious policy mistakes on the “real side” of the economy, such as the deployment of major trade barriers, turned a cyclical downturn into the Great Depression, and that issues of price rigidities, demand failures, credit, or monetary policy are at best of second-order importance.

In a seminal 1933 article, Mr. Irving Fisher offered a very different and innovative view. He focused on the meltdown of financial markets, the devastating effects of a downward spiral connecting the deflation of assets and goods prices, the process of deleveraging by households and firms, and contraction of economic activity.

Until about eighteen months ago, this was just one more of many unsettled economic questions that academic economists love to dwell on, largely because we don’t have a

410 lot of data on Great Depressions to test our theories and because intellectual arrogance prevented us from taking seriously 1990s meltdowns in emerging markets and the Nordic countries as harbingers of what could happen to the US. Today, as we go through the catastrophic process of Fisher’s debt-deflation mechanism, there is no doubt that Fisher was right and the rest are just stories. If anything, we are left wishing prices were rigid! But declaring a winner in the Great Depression debate is unimportant. The critical issue is to use the diagnosis that Fisher offered in his article – and what we have learned about debt deflations since then – to guide policy making. In this climate of hiring gurus for an ever-growing number of “top” economist posts in the US government, I would be very happy if we could just hire Irving Fisher!

Here are the lessons I learned after reading Fisher’s piece again and reflecting on our current dilemmas from its perspective. Lesson 1: Fiscal stimulus is a band-aid. We need – now and for the next two years – massive government spending to support the unemployed and prevent the implosion of state and local governments. Beyond that, spending will not stimulate anything, and it has nothing to do with the causes of the crisis or with putting an end to it. It is the strong pain killer that the economy needs for the infection that afflicts it, but it is just a pain killer, not a cure. Well-crafted tax adjustments can be useful, but only if targeted to address the deflationary pressures and/or the fragility of the financial system (see Lesson 2). By the same token, trade protection and other similarly “brilliant” ideas floating around need to be opposed. They will do nothing to attack the causes of the crisis, and they could make the recession deeper and more protracted.

Lesson 2: Deflation must be halted and reversed, and the credit system restarted. Today, as in the early 1930s, these two parts of the puzzle are tightly interrelated, as Fisher explained. Deflation will not stop if the collapse of the credit system is not contained, and the collapse of the credit system will not stop until the deflation of asset and goods prices is controlled. A trillion dollars of fiscal stimulus today will not avoid catastrophe if the financial stabilisation fails. Conversely, the sooner a credible, comprehensive, and effective financial stabilisation plan is implemented, the lower the actual cost of “true” fiscal support needed for the social safety net.

Being realistic, however, even if we had this ideal situation in place tomorrow, a major recession – unlike anything most Americans alive today have ever seen – is unavoidable. Catastrophe is here and we will not escape it. But even the 18-to-24- months catastrophe we are in is not the worst outcome. The worst outcome would be a full repeat of the Great Depression. The worst of the Great Depression was not so much the initial economic collapse, as dramatic as that was, but its persistence for several years. This is what we still have time to avoid and where our energy should be invested. The political spin about pushing for reforms and bailouts to “avert disaster” needs to be corrected, so that everyone’s expectations are not biased towards thinking that a trillion dollars of fiscal stimulus means back to business as usual. The emergency is real and present, but not to escape catastrophe. All the numbers we have about employment, production, world trade, the financial system, etc. show that we are already in a catastrophe. The emergency is to avoid the persistence of the stagnation that occurred during the Depression. The emergency is to prevent most of the next decade from looking like 2008.

411 Lesson 3: Prevention. We got into this mess because financial development advanced way ahead of not only regulators and government officials, but the actors in financial markets themselves, including the geniuses who created the innovative financial products that we have now come to know (and fear) by their acronyms – CDOs, MBSs, CMOs, and the greatest villain of all, CDSs!

Preventing the next debacle, however, requires careful thinking. Imposing regulations and controls that would return the financial system to its 1960s structure would be a major mistake. The challenge is to identify where things went very wrong and plug the deep holes that exist while preserving the enormous potential that the securitisation of financial assets has for enhancing efficiency and standards of living worldwide. A starting point is to recognise that government made two huge mistakes in (a) directing regulators to ignore products like CDSs, by pretending that simply by an act of law they could be declared not to be standard securities or a form of gambling (both of which they were!), and (b) instituting and enlarging the implicit government guarantee backing the fast expansion of mortgage giants Fannie Mae and Freddie Mac. Had the wisdom of people like Mrs. Brooksley Born prevailed in the late 1990s, the CDS market would have been at least supervised, if not regulated. This alone would have saved us enormous pain today, because the jump from the mid-billions problem that sub-prime mortgages were to the mid-trillions debacle we are suffering occurred largely due to the casino-like setup in which AIG and other financial companies conducted the CDS business.

So I end with the lesson that the master himself gave to conclude his article:

“Finally, I would emphasise the important corollary, of the debt-deflation theory, that great depressions are curable and preventable through reflation and stabilisation.” http://www.nakedcapitalism.com/2009/02/irving-fishers-debt-deflation-theory.html

Irving Fisher, “The Debt-Deflation Theory of Great Depressions”, Econometrica, 1, Octubre, 1933, pp. 337-57: http://fraser.stlouisfed.org/docs/meltzer/fisdeb33.pdf

412

Irving Fisher Out of Keynes's shadow Feb 12th 2009 | WASHINGTON, DC From The Economist print edition Today’s crisis has given new relevance to the ideas of another great economist of the Depression era

Sue Vago SHORTLY after he was elected president, Barack Obama sounded a warning: “We are facing an economic crisis of historic proportions…We now risk falling into a deflationary spiral that could increase our massive debt even further.” The address evoked not just the horror of the Depression, but one of the era’s most important thinkers: Irving Fisher. Though once America’s most famous economist, Fisher is now almost forgotten by the public. If he is remembered, it is usually for perhaps the worst stockmarket call in history. In October 1929 he declared that stocks had reached a “permanently high plateau”. Today it is John Maynard Keynes, his British contemporary, who is cited, debated and followed. Yet Fisher laid the foundation for much of modern monetary economics; Keynes called Fisher the “great-grandparent” of his own theories on how monetary forces influenced the real economy. (They first met in London in 1912 and reportedly got along well.) As parallels to the 1930s multiply, Fisher is relevant again. As it was then, the United States is now awash in debt. No matter that it is mostly “inside” or “internal” debt—owed by Americans to other Americans. As the underlying collateral declines in value and incomes shrink, the real burden of debt rises. Debts go bad, weakening banks, forcing asset sales and driving prices down further. Fisher showed how such a spiral could turn mere busts into depressions. In 1933 he wrote:

413 Over investment and over speculation are often important; but they would have far less serious results were they not conducted with borrowed money. The very effort of individuals to lessen their burden of debts increases it, because of the mass effect of the stampede to liquidate…the more debtors pay, the more they owe. The more the economic boat tips, the more it tends to tip.

Though they seldom invoke Fisher, policymakers in America are applying his ideas. In academia Ben Bernanke, now the chairman of the Federal Reserve, sought to formalise Fisher’s debt-deflation theory. His research has shaped his response to this crisis. He decided to bail out Bear Stearns in March 2008 partly so that a sudden liquidation of the investment bank’s positions did not trigger a cycle of falling asset prices and default. Indeed, some say the Fed has learnt Fisher too well: from 2001 to 2004, to contain the deflationary shock waves of the tech-stock collapse, it kept interest rates low and thus helped to inflate a new bubble, in property. Were Fisher alive today, “he would tell us we have to avoid deflation, and to worry about all that inside debt,” says Robert Dimand, an economist at Brock University in Canada, who has studied Fisher in depth. “The ideal thing is to avoid these situations. Unfortunately, we are in one.” Fisher was born in 1867 and earned his PhD from Yale in 1891. In 1898 he nearly died of tuberculosis, an experience that turned him into a lifelong crusader for diet, fresh air, Prohibition and public health. For a while he also promoted eugenics. His causes, both healthy and repugnant, combined with a lack of humour and high self-regard, did not make him popular. In 1894, on a trip to Switzerland, he saw, in water cascading into mountain pools, a way to “define precisely the relationships among wealth, capital, interest and income,” Robert Loring Allen, a biographer of Fisher, wrote. “The flowing water, moving into the pool at a certain volume per unit of time, was income. The pool, a given volume of water at a particular moment, became capital.” Over the next 30 years he established many of the central concepts of . In 1911, in “The Purchasing Power of Money”, Fisher formalised the quantity theory of money, which holds that the supply of money times its velocity—the rate at which a dollar circulates through the market—is equal to output multiplied by the price level.

414 Perhaps more important, he explained how changing velocity and prices could cause real interest rates to deviate from nominal ones. In this way, monetary forces could produce booms and busts, although they had no long-run effect on output. Furthermore, Fisher held that the dollar’s value should be maintained relative not to gold but to a basket of commodities, making him the spiritual father of all modern central banks that target price stability. During the 1920s Fisher became rich from the invention and sale of a card-index system. He used the money to buy stocks on margin, and by 1929 was worth $10m. He was also a prominent financial guru. Alas, two weeks after he saw the “plateau” the stockmarket crashed. To his cost, Fisher remained optimistic as the Depression wore on. He lost his fortune and his home and lived out his life on the generosity of his sister-in-law and Yale. But his work continued. He was prominent among the 1,028 economists who in vain petitioned Herbert Hoover to veto the infamous Smoot-Hawley tariff of 1930. And he developed his debt-deflation theory. In 1933 in Econometrica, published by the Econometric Society, which he co-founded, he described debt deflation as a sequence of distress-selling, falling asset prices, rising real interest rates, more distress-selling, falling velocity, declining net worth, rising bankruptcies, bank runs, curtailment of credit, dumping of assets by banks, growing distrust and hoarding. Chart 1 is his: it shows how deflation increased the burden of debt.

Fisher was adamant that ending deflation required abandoning the gold standard, and repeatedly implored Franklin Roosevelt to do so. (Keynes was of similar mind.) Roosevelt devalued the dollar soon after becoming president in 1933. The devaluation and a bank holiday marked the bottom of the Depression, though true recovery was still far off. But Fisher had at best a slight influence on Roosevelt’s decision. His reputation had fallen so far that even fellow academics ignored him. Contemporary critics did poke a hole in his debt-deflation hypothesis: rising real debt makes debtors worse off but creditors better off, so the net effect should be nil. Mr Bernanke plugged this in the 1980s. “Collateral facilitates credit extension,” he said in June 2007, just before the crisis began in earnest. “However, in the 1930s, declining output and falling prices (which increased real debt burdens) led to widespread financial distress among borrowers, lessening their capacity to pledge collateral…Borrowers’ cash flows and liquidity were also impaired, which likewise increased the risks to lenders.” Mr Bernanke and Mark Gertler of New York University dubbed this “the financial accelerator”.

415 The downward spiral can start even when inflation remains positive—for example, when it drops unexpectedly. Consider a borrower who expects inflation of 2% and takes out a loan with a 5% interest rate. If instead inflation falls to 1%, the real interest rate rises from 3% to 4%, increasing the burden of repayment. Asset deflation can do much the same thing. If house prices are expected to rise by 10% a year, a buyer willingly borrows the whole purchase price, because his home will soon be worth more than the loan. A lender is happy to make the loan for the same reason. But if prices fall by 10% instead, the house will soon be worth less than the loan. Both homeowner and lender face a greater risk of bankruptcy.

Today, debt in America excluding that of financial institutions and the federal government is about 190% of GDP, the highest since the 1930s, according to the Bank Credit Analyst, a financial-research journal (see chart 2). There are important differences between then and now. Debt was lower at the start of the Depression, at 164% of GDP. Mortgage debt was modest relative to home values, and prices were not notably bloated: they fell by 24% between 1929 and 1933, says Edward Pinto, a consultant, so were roughly flat in real terms. Debt burdens shot up because of deflation and shrinking output; nominal GDP fell by 46% between 1929 and 1933. Debt burdens are high today mostly because so much was borrowed in the recent past. This began as a logical response to declining real interest rates, low inflation, rising asset prices and less frequent recessions, all of which made leverage less dangerous. But rising leverage eventually bred easy credit and overvalued homes. Even without recession, falling home prices would have impaired enough mortgage debt to destabilise the financial system (see chart 3). Recession makes those dynamics more virulent; deflation could do similar damage. Broad price indices fell in late 2008. Granted, that was caused in part by a one-off fall in petrol costs; but America’s core inflation rate, which excludes food and energy, has fallen from 2.5% in September to 1.8%. Goldman Sachs sees it falling to 0.25% in the next two years. That is low enough to mean falling wages for many households and falling prices for many firms. More widespread and deeper deflation would mean that property prices would have to fall even further to restore equilibrium with household incomes, creating another round of delinquencies, defaults and foreclosures. What is the solution? Fisher wrote that it was “always economically possible to stop or prevent such a depression simply by reflating the price level up to the average level at which outstanding debts were contracted.” Alas, reflation is not so simple. Although

416 stabilising nominal home prices would help short-circuit the debt-deflation dynamics now under way, any effort to maintain them at unrealistically high levels (where they still are in many cities) is likely to fail. Higher inflation could help bring down real home prices while allowing nominal home prices to stabilise, and reduce real debt burdens. But creating inflation is easier said than done: it requires boosting aggregate demand enough to consume existing economic slack, through either monetary or fiscal policy.

Though the Fed does not expect deflation, last month it did say that “inflation could persist for a time below” optimal levels. It is mulling a formal inflation target which, by encouraging people to expect positive inflation, would make deflation less likely. But its practical tools for preventing deflation are limited. In December its short-term interest- rate target in effect hit zero. The Taylor rule, a popular rule of thumb, suggests it should be six percentage points below. The Fed is now trying to push down long-term interest rates by buying mortgage-backed and perhaps Treasury securities. With conventional monetary ammunition spent, fiscal policy has become more important. In 2002 Mr Bernanke argued the government could ultimately always generate inflation by having the Fed finance large increases in government spending directly, by purchasing Treasury debt. Martin Barnes of the Bank Credit Analyst thinks this highly unlikely: “You’d have capital flight out of the dollar. The only way it works is if every country is doing it, or with capital controls.” Fisher died in 1947, a year after Keynes, and remains in his shadow. Mr Dimand notes that Fisher never pulled the many strands of his thought together into a grand synthesis as Keynes did in “The General Theory of Employment, Interest and Money”. More important, Keynes’s advocacy of aggressive fiscal policy overcame the limitations of Fisher’s purely monetary remedies for the Depression. Yet Fisher’s insights remain vital. They have filtered, perhaps unconsciously, into the thinking of today’s policymakers. On February 8th Lawrence Summers, Mr Obama’s principal economic adviser, called for the rapid passage of a fiscal stimulus “to contain what is a very damaging and potentially deflationary spiral.” His advice bridges Fisher and Keynes.

417

The Hicks-Hansen IS-LM Model

Roy Harrod (1937), James Meade (1937) and Oskar Lange (1938) had attempted to express the main relationships of Keynes's theory as equations in order to elucidate the interrelationships between the theory of effective demand and the theory of liquidity preference. In a similar effort, John Hicks, in his famous 1937 Econometrica article, "Mr Keynes and the Classics: A suggested interpretation", drew two curves, "SI-LL" to illustrate these relationships. These curves have since become famously known as the IS- LM model and were popularized by a now-converted Alvin Hansen (1949, 1953). The IS-LM model has remained one of the most formidable pieces of pedagogic machinery and, as far as back-of-the-envelope diagrammatic reasoning is concerned, one of the most efficient ever devised in economics. It is not, however, without substantial problems, both as an internally consistent model or as a representation of Keynes's theory. The crucial feature of the Keynesian system Hicks and Hansen concentrated on when formulating the simple IS-LM is the interaction between the real and monetary markets. From the real market, one extracts the level of income (Y) and from the money market, one obtains the interest rate (r). These variables, in turn, affect elements in the other market - in the simplest version, income affects money demand and interest affects investment. This interaction clearly violates the "classical dichotomy" and, as we shall see, it also does not support the neutrality of money. Financial-real interaction is the core of the IS-LM version of Keynes's theory - therefore, Hicks (1937) concluded with perfect Walrasian instincts, it is necessary to solve for the money and real markets simultaneously. However, many Keynesians, such as Pasinetti (1974), have argued that Keynes's system should be thought of "block recursively" or "sequentially" and thus should not be solved simultaneously. Specifically, it can be argued that the Keynesian system ought to be seen as a sequence of alternating "asset market" and "goods market" decisions - the interest rate being first determined by a portfolio decision in the financial markets and only thereafter determining investment, output and employment in the real market which then feeds back into another portfolio decision, etc. This criticism is noteworthy because the portfolio (LM) decision is made in the context of a stock constraint whereas the real market decisions (IS) is made in a flow constraint. Furthermore, as Richard Kahn (1984) and Joan Robinson (1973, 1978, 1979) emphasized later, the simultaneous equation method of the IS-LM, by eliminating sequential time, also eliminates the time-dependent concepts which they saw as fundamental to Keynes's theory - such as uncertainty, expectations, speculation and animal spirits. As John Hicks (1980, 1988) himself notes in his recantation, these different time references for IS and LM makes the simultaneous IS- LM model incongruous (see also Leijonhufvud, 1968, 1983; Davidson, 1992).

418 The following construction of the IS-LM ignores these problems and is built on the original Hicks-Hansen presentations. The best place to begin is perhaps the very familiar income-expenditure diagram - the "Keynesian cross" - which Paul Samuelson (1948), Abba Lerner (1951) and Alvin Hansen (1953) made popular. Let total planned expenditures - i.e. "aggregate demand" - be: Yd = C + I + G where C is planned consumption, I is planned investment and G is planned government spending (and we are ignoring the foreign sector). If there is goods-market equilibrium, then aggregate demand must equal aggregate supply: Yd = Y where Y is income (or output or aggregate supply). Now, income is either consumed, saved or taxed away, thus we can decompose Y into: Y = C + S + T where the terms follow their traditional definitions (S is savings, T is taxes). Consequently, at equilibrium C + I + G = C + S + T or, simply, assuming a balanced government budget (so G = T), then the equilibrium condition Yd = Y can be written equivalently as: I = S thus planned investment equals planned savings. The equilibrium level of output is potentially any level up to the full employment level. Which level of output actually happens to be the equilibrium depends entirely upon aggregate demand - hence aggregate demand is the primary determinant of the equilibrium level of output. This is indisputably the central message of Keynes's theory: given any level of aggregate demand, producers will try to meet that demand and thus aggregate output will rise or fall to equate the given aggregate demand.

Figure 1 - The Keynesian Cross of Income-Expenditure

419 The computation of the equilibrium output level is actually a quite simple result of the Kahn-Keynes "multiplier". Letting consumption be a linear function of current income:

C = C0 + cY where c is the marginal propensity to consume (MPC) so 0 < c < 1, and C0 is autonomous consumption. Assuming, in turn, that investment demand and government spending are exogenous, (i.e. I = I0 and G = G0), then aggregate demand becomes: d Y = C0 + cY + I0 + G0 which is shown in Figure 1 as the aggregate demand function, Yd. Note that the slope of this curve is the marginal propensity to consume (c) and because 0 < c < 1, the aggregate demand function Yd is flatter than the 45° line. The vertical intercept is merely the

collection of autonomous terms, A0 = [C0 + I0 + G0]. Obviously, in equilibrium, it must be that Y = Yd. Thus, solving for equilibrium output, Y*:

Y* = [C0 + I0 + G0]/(1-c) so the equilibrium level of output is some multiple of the autonomous terms (C0 + I0 + G0), where the term 1/(1-c) is the Kahn-Keynes "multiplier". The equilibrium level of output, Y*, is shown in Figure 1 as the point where the aggregate demand function intersects the 45° line. The basic reasoning behind the Kahn-Keynes multiplier is the idea that expenditure (by people, firms or government) will generate income for somebody and that subsequently some of this income will be consumed and thus generate more expenditure which will in turn generate more income and thus more expenditure, etc. Thus, if autonomous expenditure is C0+I0+G0, then this will be someone's income; thus consumption increases by c(C0+I0+G0), which, in turn, is also an increase in someone's income and thus consumption increases again by c(c(C0+I0+G0), and so on through successive rounds. Thus, the total income generated by an initial autonomous level of expenditure C0+I0+G0 will be: 2 3 Y* = (C0+I0+G0) + c(C0+I0+G0) + c (C0+I0+G0) + c (C0+I0+G0) + ... However, this geometric progression is not eternal: this is a convergent series because the marginal propensity to consume is a fraction. In other words, note that as 0 < c < 1, then this is equal to 2 3 Y* = [C0+I0+G0](1 + c + c + c + ....) = (1/(1-c))[C0+I0+G0] as the sum of an infinite geometric progression (1 + c + c2 + c3 + ....) is merely 1/(1-c) (which is greater than 1). Thus, the initial autonomous expenditures [C0+I0+G0] have generated [C0+I0+G0]/(1-c) of income in the economy as a whole after the multiplier works itself out. Naturally, there is also a disequilibrium dynamic underlying the system implied the Kahn-Keynes "multiplier" process. Specifically, the dynamic of the multiplier argues that output responds to excess demand for goods: dY/dt = ¦ (Yd - Y) where ¦ ¢ > 0, so output increases if there is excess demand for goods (Yd > Y or I > S) and output decreases if there is excess supply of goods (Yd < Y or I < S). This is very

420 different from the Neoclassical macromodel which argued that it was interest rates that cleared the goods market. Now, we noted earlier, following Lerner (1938, 1939, 1944), that actual savings always equals actual investment, thus we must remind ourselves that the I and S denoted here refer only to planned levels of investment and savings. To see why, assume that output is at a position to the left of Y* in Figure 1, such as Y1. At this point, output Y1 is given, thus, by extension, S is fixed. However, obviously, at this point, aggregate demand exceeds aggregate supply, Yd > Y (equivalent to I > S). How can Lerner be correct? Easily. Note that as there is excess demand for goods thus there must be unplanned depletion of firms' inventories - which implies, in turn, that there is unplanned disinvestment. This unplanned disinvestment is the difference between planned d investment and planned savings - i.e. the interval at Y1 between the two curves, Y and the 45° line. Thus, although planned investment exceeds planned savings, actual investment (planned investment minus unplanned disinvestment) is equal to actual savings. The multiplier dynamic, then, proposes that as firms see their inventories deplete unexpectedly, they take this as a signal of excess demand for their goods and consequently increase production - thereby raising output back up to Y*. We can see the same thing for the other side: suppose actual output is to the right of Y*, d for instance, at Y2 in Figure 1. In this case, Y < Y or planned I is less than planned S - or, quite simply, there is unplanned inventory investment as excess goods supply accumulate on inventory shelves. Firms take this as a signal to cut back output - and therefore Y is reduced to Y*. Thus, the Keynesian multiplier dynamic implies that output (Y) does all the adjusting in response to disequilibrium in the goods markets. [Alternatively, the interim difference between aggregate demand and supply can be regarded as representing unplanned or forced savings and dissavings rather than unplanned inventory decumulation and accumulation respectively. Such a characterization, reminiscent of the earlier Wicksellian literature (e.g. Hayek, 1931), would imply that it is consumers expenditure plans, and not necessarily those of firms, which are contradicted in disequilbrium. The resulting multiplier dynamic would not be affected by such an interpretation, although it may seem less natural.] We have noted that we can determine the equilibrium level of output, Y* once we know what the marginal propensity to consume (c) is and what the autonomous terms C0, I0 and G0 are. However, this is a heavily stripped version of the model and these terms ought to be a bit more detailed. For instance, consumption can be defined as:

C = C0 + c(Y - TX) where C0 is autonomous consumption, c is the marginal propensity to consume out of current disposable income, where disposable income is defined as actual income Y minus taxes, TX, which in turn, can be defined as TX = TX0 - TR0 + tY where TX0 are autonomous taxes (e.g. excise taxes), TR0 are net government transfer payments (e.g. unemployment benefits) and t (where 0 < t < 1) is the marginal tax rate so that tY reflects income taxes. In this case, consumption becomes:

C = C0 + c((1-t)Y - TX0 + TR0) which is a bit richer than our earlier expression for the consumption function. The more interesting change in the model is in the description of the investment demand function. Specifically, assume that investment is a negative function of interest rates, r, so that investment demand becomes:

421 I = I0 + I(r)

where Ir < 0 and I0 is autonomous investment. Note that, written thus, investment is a negative function of only one interest rate - this is already a Hicksian modification of the original story. Continuing to assume that G = G0 is completely autonomous, total planned expenditures are now: d Y = C0 + c((1-t)Y - TX0 + TR0) + I0 + I(r) + G0 Thus, in equilibrium, Y = Yd and thus solving for equilibrium output Y*:

Y* = [C0 + c(TR0 - TX0) + I0 + G0 + I(r)]/(1-c(1-t))

or letting A0 denote all the autonomous terms, i.e. A0 = [C0 + c(TR0 - TX0) + I0 + G0 + I(r)], which will be the intercept of our Yd curve, then it follows that:

Y* = A0/(1-c(1-t)) where 1/(1-c(1-t)) is the new multiplier. Of course, 0 < (1-c(1-t)) < 1 thus the aggregate demand function has still a flatter slope than the 45° line, thus there will be an intersection which will yield us equilibrium Y*. We could have made this richer by adding a foreign sector and thereby including autonomous export/import terms and a marginal propensity to import into the multiplier term, but the lesson we believe is clear at this point: whatever we wish to include in the set of autonomous terms or into the multiplier in order to increase "realism", there is an equilibrium level of output Y* that is determinate and a multiplier dynamic that ensures that it is stable. The most important result of this exercise is that Y* corresponds to an equilibrium output level, where I = S, but which may or may not imply full employment. Y* is just one of a continuum of possible output levels. In Figure 1, full employment is noted by YF which is definitely higher than Y* but, contrary to the Neoclassical model, there are no inherent mechanisms to drive the equilibrium level of output to the full employment level. The economy will therefore be sustained at an "underemployment equilibrium".

Furthermore, note that any changes in any of the autonomous terms (e.g. C0, TX0, TR0, I0, d I(r), G0) will lead to a change in A0 and consequently a change in the intercept of the Y line - and consequently the resulting equilibrium level of output, Y*. It is thus easy to visualize that fiscal policy variables, such as government spending (G0), autonomous taxes (TX0), government transfers (TR0) or (via a slightly different channel) the income tax rate (t) will affect the equilibrium level of output, Y*. Thus, equilibrium is policy- effective: government can, by means of increasing spending and transfers or reducing taxes, increase the equilibrium level of output Y*. Thus, Keynesian propositions about the government using expenditure and tax policy to assist the economy by pushing equilibrium output Y* to the full employment level YF - part of what Abba Lerner (1943, 1944) called "functional finance" - are obvious here. Naturally, government fiscal policy variables are not the only things included in the intercept A0: autonomous consumption (C0) and investment terms (I0, I(r)) also affect the equilibrium level of output. Keynes was particularly interested in investment - "that flighty bird" - and how it helped determine the equilibrium level of output and how that could be changed. Specifically, note that investment is a function of the interest rate, r - thus our model is not exactly "closed" because we have said nothing about how the interest rate, r, is determined. Now, the relationship between interest and investment is via the "marginal efficiency of investment" or MEI - as Lerner (1944) appropriately

422 rebaptized it. Essentially, we can think of the MEI curve as downward-sloping: as investment increases, the marginal efficiency of investment collapses. Firms, Keynes proposed, will invest until the MEI is equal to a given rate of interest. Thus, the lower the rate of interest, the greater the amount of investment and vice-versa, thus I(r) is such that dI/dr < 0. Thus, we can begin to set out Hicks's "IS" curve - the equilibrium locus which captures the relationship between interest rate and output. As interest rate rises, I(r) falls and consequently so does Yd - thus, the equilibrium level of output, Y* declines. Thus, as we see in the Figure 3, the IS curve is downward sloping: high r is related with low equilibrium output Y* while low r is related with high Y*. This is an equilibrium locus and not a curve - any point on the curve represent goods market equilibrium, where aggregate demand equals aggregate supply. Points off the curve represent disequilibrium points. For instance, at a given r, we obtain a particular Y* so that if output is actually greater than Y* (Y > Y*) the multiplier dynamic implies that it must fall towards the locus. Similarly, if Y < Y* at a given r, then output must rise towards Y* and thus towards the locus. Thus, points to the left of the IS curve represent points where there is "excess demand" for goods whereas points to the right of the IS curve situations of "excess supply" of goods. The horizontal directional arrows shown in Figure 3 summarize the multiplier dynamic.

We can immediately see that a rise in government spending (G), a rise in transfers (TR0), a decline in taxes (TX0, t), an increase in autonomous investment (I0) or an increase in autonomous consumption (C0) or the propensity to consume (c) all lead to a rightward shift in the IS curve. The opposite cases imply a leftward shift. Now, given:

Y* = [C0 + c(TR0 - TX0) + I0 + G0 + I(r)]/(1-c(1-t)) then by totally differentiation with respect to r and Y, we can note that

dr/dY = (1-c(1-t))/Ir denotes the slope of the IS curve. Thus the lower the income sensitivity of expenditure (the lower the marginal propensity to consume and the higher the income tax rate) and the lower the interest sensitivity of investment, then the steeper the IS curve. Conversely, a high income sensitivity (i.e. a high multiplier) and a high interest sensitivity of investment imply a flatter IS curve. However, we have still to determine the rate of interest - this is where Keynes's theory of liquidity preference comes in. As he writes: "The rate of interest at any time, being the reward for parting with liquidity, is a measure of the unwillingness of those who possess money to part with their liquid control over it. The rate of interest is not the "price" which brings into equilibrium the demand for resources to invest with the readiness to abstain from present consumption. It is the "price" which equilibrates the desire to hold wealth in the form of cash with the available quantity of cash" (Keynes, 1936: p.167) What this means is that people possess a portfolio of assets for which they try to find the "right" liquidity mix. For simplicity, it is assumed to contain only two assets: money (which yields nothing but is highly liquid) and "bonds" (which yield interest but are illiquid). If the rate of interest were zero, nobody would hold bonds in their portfolios - for the liquidity provided by the money would be far superior. However, in order to

423 convince people to "part from liquidity", bonds offer a rate of interest. The greater the rate of interest, the greater the enticement to move away from money and hold bonds instead. Although the issue of expected and actual rates of interest (and a multiplicity of these) is an issue that was papered over by Hicks (1937), the gist of the story can be captured by recognizing that money demand can be written: Md = L(r, Y)

where Lr < 0 and LY > 0, thus as interest rate rises, the demand for money falls (as people prefer to buy interest-bearing bonds) while as output rises people demand more money (as people need money to conduct more transactions). The dependence of money demand on income is a crucial relation - originally mentioned but suppressed by Keynes, and then resurrected by Hicks and Hansen. In contrast, the supply of money is written as: Ms = M/p where M is the nominal money supply which is regarded as exogenously determined and the price level, p, for the moment will be left unexplained. For money market equilibrium, then Md = Ms, or: L(r, Y) = M/p The money market equilibrium is shown in Figure 2.

Figure 2 - Money Market with Liquidity Preference Obviously, the interest rate brings the money market into equilibrium, but how is that possible? We learn in regular microeconomics that the market for apples is cleared by the price of apples - how then is the market for money cleared by the price on another good, i.e. bonds? To understand this, let us note that Keynes implied was the existence of a portfolio stock constraint, which can heuristically be set out as follows: (Md - Ms) + (Bd - Bs) = 0 where the total demand for wealth is Md + Bd and the total supply of wealth is Ms + Ms. By assuming Walras's Law for stocks, a crucial assumption, then this equation will hold true at all times. Now, Keynes claimed that the rate of interest is determined by the supply and demand for bonds. But if interest rate clears the bond market (so Bd = Bs) then we see that necessarily Md = Ms, the money market clears - thus we can also say (as Keynes did repeatedly) that interest rates are determined by the supply and demand for

424 money. In view of the Walras's Law stock constraint, bond market equilibrium and money market equilibrium are, indeed, one and the same thing. If interest rates are too high so that bond demand exceeds bond supply (Bd > Bs), we can see that, via this stock constraint, this translates necessarily into Md < Ms, i.e. an excess supply of money. We can see how this is depicted in Figure 2 when we consider r1 > r*. The portfolio dynamics are simple supply-and-demand logic: if there is excess demand for bonds, then the price of bonds will rise, which means that the rate of interest on bonds will fall - thus r1 declines towards r*. Similarly, the opposite case is also true: when interest is below r* (at, say, r2), then bond supply exceeds bond demand by regular logic - but then, by the stock constraint, this implies that there must be excess demand for money. The dynamics also apply: when there is excess bond supply, then the price of bonds falls and thus the interest rate on bonds rises - so we move from r2 back up to r*. Thus, all this is captured in the money-market diagram alone. Thus, by recognizing this Walras' Law relationship implied by the portfolio allocation of wealth, we can claim that interest rate on bonds is determined in the money market, even though the details of the story are told in the bond market. For more thoughts on this matter, see our review of Keynes's General Theory. Now, recall that Md = L(r, Y), thus money demand is also a function of output, Y. When output rises, the money demand curve will thus rise and therefore the equilibrium level of interest rates, r*, will also rise. Consequently, following Hicks (1937), we can derive an "LM" curve as the equilibrium locus which relates output levels to equilibrium levels of interest. As we see in Figure 3, this is a positive relationship, thus the LM is upward sloping. Keep in mind the important fact that LM represents money market equilibrium, thus M/p = L(r, Y) anywhere along the LM curve. Any point off the LM curve will denote a money-market disequilibrium. Specifically, at a given rate of output, if r is too high, then by the dynamics proposed earlier apply: if r > r*, then there is excess money supply and r declines; whereas if r < r*, then there is excess money demand and r increases. Thus, all points above the LM curve denote situations of excess money supply whereas all points below the LM curve are situations of excess money demand. Thus, the vertical directional arrows in Figure 3 denote the dynamics implied by the financial markets. It is obvious that the LM shifts on the basis of many parameters. An increase in the nominal money supply M, a decrease in prices p, a decrease in the bond supply Bs, an decrease in money demand Md or an increase in bond demand, Bd, all lead to a rightward shift in the LM curve. The opposite of any of these leads to a leftward shift in the LM. Totally differentiating the equilibrium locus:

d(M/p) = Lrdr + LYdY so as d(M/p) = 0, then, the slope of the LM curve is:

dr/dY = -LY/Lr

where LY is the income sensitivity of money demand and Lr is the interest sensitivity of money demand. Thus, if LY is high and Lr is low, we get a steep LM curve. If LY is low and Lr high, then we get a very flat LM curve. What Hicks (1937) called the "liquidity trap" assumes an extreme case of the latter.

425

Figure 3 - Hicks-Hansen IS-LM Model In Figure 3, we superimpose the IS and LM curves to generate the IS-LM diagram. Immediately we can notice that the only point in the diagram where both goods markets and money markets are in equilibrium is at point E, where r = r* and Y = Y*. This is the equilibrium level of output and interest where both goods and money markets clear. By examining the directional arrows implied by the goods market multiplier and the money market financial dynamics, we can notice immediately that equilibrium E is stable as all trajectories tend towards it sooner or later (the IS curve, of course, is nothing but the isokine for dY/dt = 0 and the LM curve being the isokine for dr/dt = 0 - thus the dynamics are easy to derive). It might be worthwhile reminding ourselves what the disequilibrium quadrants (denoted in Figure 3 by I-IV) imply: Quadrant I: excess supply of goods, excess demand for money Quadrant II: excess demand for goods, excess demand for money Quadrant III: excess demand for goods, excess supply of money Quadrant IV: excess supply of goods, excess supply of money Immediately we can begin seeing some implied problems. As Hicks (1980) later carefully noted, one cannot really superimpose a stock equilibrium over a flow equilibrium because their time references are different. To see this, we must realize that any point on the LM curve implies a stock equilibrium - thus, by definition, the demand for wealth equals the supply of wealth. But recall that planned savings translate into additional demand for wealth while planned investment translate into additional supply of wealth. Consequently, how is it ever logically possible, then, to be on the LM curve but not on the IS curve? In other words, by imposing stock constraint at all times, it can never be that the flow constraint is in disequilibrium - thus planned I = S at all times as well. Other familiar problems re-emerge here: does not Keynes's theory of liquidity preference hinge on at least two interest rates, the future expected rate and the current rate? Where are these? These are just a few of the many difficulties implied by an IS-LM depiction of the Keynesian model. However, as a pedagogic, back-of-the-envelope device, IS-LM is supremely efficient. We can see this mechanically. Increases in autonomous effective demand variables (C0, I0, G0, TR0, -TX0 etc.) all lead to rightward-shifts in the IS curve

426 and consequently a new equilibrium at a higher level of output and interest. Increases in money supply, falls in the general price level, lower money demand, etc. all lead to a rightward shift in the LM curve and thus a higher level of output and lower level of interest. Notice also that the relative efficacy of fiscal policy (via IS) and monetary policy (via LM) depend crucially on the slopes of the IS and LM curves - and thus on the presumed interest and income sensitivities of money demand, investment, consumption and other expenditure categories. A relatively steep LM curve and flat IS curve imply that monetary policy is highly effective whereas the converse case of a relatively flat LM curve and steep IS cure imply that fiscal policy is highly effective. The manifold stories which can be told via the Hicks-Hansen IS-LM diagram almost permits one to overlook the logical and theoretical difficulties that underlie it. However, as is evident in the work of many prominent Keynesian economists - such as Abba Lerner (1944, 1951, 1952), Tibor Scitovsky (1940), Sidney Weintraub (1958, 1959, 1961, 1965) and Paul Davidson (1972, 1994) - who never used this apparatus, the IS-LM model is neither the only, nor the most faithful, nor the most coherent tool in which to express Keynes's General Theory - but it might very well be the simplest.

http://homepage.newschool.edu/het//essays/keynes/hickshansen.htm

427 Modelo IS-LM De Wikipedia, la enciclopedia libre El modelo IS-LM, (también llamado de Hicks-Hansen), está inspirado en las ideas de John Maynard Keynes pero además sintetiza sus ideas con las de los modelos neoclásicos en la tradición de Alfred Marshall. Fue elaborado inicialmente por John Hicks en 1937 y desarrollado y popularizado posteriormente por Alvin Hansen. Las curvas IS-LM permanecen como el ejemplo supremo de la pedagogía de la teoría económica de los tiempos de dominio del pensamiento keynesiano. A pesar de ello, el modelo fue cuestionado desde el primer momento por muchos keynesianos tanto por falta de consistencia interna como por no representar realmente el pensamiento de Keynes. Este modelo muestra la interacción entre los mercados reales (curva IS) y monetarios (curva LM). El mercado real determina el nivel de renta mientras que el mercado monetario determina el tipo de interés. Ambos mercados interactúan y se influyen mutuamente ya que el nivel de renta determinará la demanda de dinero (y por tanto el precio del dinero o tipo de interés) y el tipo de interés influirá en la demanda de inversión (y por tanto en la renta y la producción real). Por tanto en este modelo se niega la neutralidad del dinero y se requiere que el equilibrio se produzca simultáneamente en ambos mercados.

Gráfica del modelo. La curva IS se desplaza a la derecha, bien por una política fiscal de incremento del gasto o de transferencias, o bien por una disminución de la tasa de impuestos. El equilibrio se encuentra por tanto en Y2 e i2. Demanda agregada Artículo principal: Demanda agregada Cada punto de la curva IS representa las distintas combinaciones entre el ingreso y la tasa de interés que hacen que la oferta agregada y la demanda agregada en el mercado de producto se igualen. Es decir, la curva IS muestra los pares de niveles de ingreso y tasas de interés para los cuales el mercado de bienes se encuentra en equilibrio. Tiene pendiente negativa porque, como la inversión depende inversamente del tipo de interés, una disminución del tipo de interés hace aumentar la inversión, lo que conlleva un aumento de la producción. La curva IS se deduce de la demanda agregada (DA) y la recta de 45 grados. En el punto en el que se cruzan ambas, el mercado de bienes se encuentra en equilibrio. La DA representa la cantidad de bienes y servicios que los habitantes, las empresas, las entidades públicas y demás, desean y pueden consumir del país para un nivel determinado de

428 precio. La curva de demanda agregada tiene pendiente positiva: si suben los precios la gente querrá comprar menos y si bajan querrá comprar más.

Curva de demanda agregada. El punto donde se cruza con la DA con la recta de 45 grados, es el punto de equilibrio en el mercado de bienes. A partir de esta serie de puntos de equilibro, se obtiene la IS. La Demanda Agregada se iguala a la Y (producción): DA = Y f(C) + f(I) + G = Y Donde f(C) es la función de consumo: C + c·YD. La YD es renta disponible: Y (renta) - t·y (impuestos) + TR (transferencias). Donde f(I) es la función de inversión: I - b·i. La b es la sensibilidad de la demanda de inversión al tipo de interés (i). Donde G es el gasto público. La expresión final seria así: DA = C + c·TR + I + G - b·i + c·Y - c·t·y El componente autónomo de la DA seria A, que es igual a: C + c·TR + I + G. La ordenada por tanto estaria formada por la A y por el -b·i. La pendiente de la DA seria esta: c·(1-t)·Y La expresión final reducida seria así: DA = A - b·i + c·(1-t)·Y Curva de la IS Para obtener la curva de la IS, suponemos que el tipo de interés aumenta por causas exógenas. Al aumentar la i aumenta el componente b·i, como este tiene signo negativo, la DA se desplazará paralelamente hacia abajo, con la misma pendiente que antes (pues esta no varía). Si se desplaza hacia abajo, obtenemos un nivel de Y inferior, y una DA menor también. Realizariamos una gráfica justo debajo de la de Demanda Agregada, y veriamos que la IS con un tipo de interés mayor, tiene un nivel de renta inferior. Se trazaria la curva y obtendriamos la IS con pendiente negativa. La expresión de la IS se obtiene de la DA. Despejariamos de la ecuación el tipo de interés, y obtendriamos:

429 Expresión de la IS

Donde: • i = Tipo de interés. • A = Componente autónomo de la DA, es decir C + c·TR + I + G. • b = Sensibilidad de la demanda de inversión al tipo de interés. • a = Alfa. Es el multiplicador, y esta formado por la ecuación siguiente: 1/(1-c(1-t)). • Y = Renta o nivel de producción.

Curva IS. Curva de la LM Curva LM. La LM se obtiene a partir del equilibrio en el mercado de dinero, que es en conjunto el equilibrio en el mercado de activos. La LM muestra las combinaciones de renta y tipo de interés en los que la demanda de dinero en términos reales es igual a la oferta de dinero. La oferta nominal de dinero es controlada por los bancos centrales de cada país y en este modelo se considera como una constante (Ms). Como en el modelo IS-LM el nivel de precios también es constante, la oferta monetaria real será Ms/p. La demanda de dinero se expresa de la siguiente forma: MD = k·Y - h·i. Donde k es la sensibilidad de la demanda de dinero al nivel de renta, y h es la sensibilidad de la demanda de dinero al tipo de interés.

Si despejamos el tipo de interés, la función quedaría así: Finalmente, como la Ms viene determinada por el banco central, es una variable exógena, será constante y se representará gráficamente como una recta vertical. En el punto donde se cruza esta recta con la curva de demanda de dinero, expresada anteriormente, habrá equilibrio en dicho mercado.

430 A partir de estos puntos de equilibrio, se obtendría la curva LM. Que se expresa de la siguiente forma:

Expresión de la LM

Donde: • M = Cantidad de dinero en el mercado. • p = Nivel de precios. • h = Sensibilidad de la demanda de dinero al tipo de interés. • k = Sensibilidad de la demanda de dinero al nivel de renta. • Y = Renta o nivel de producción.

Equilibrio final [editar] El equilibrio final del modelo se obtiene cuando se iguala la IS (equilibrio en el mercado de bienes) con la LM (equilibrio en el mercado de dinero). Se pueden aplicar distintas políticas para desplazar la IS o la LM. Para desplazar la IS se usan políticas fiscales, que pueden ser expansivas (con el objetivo de aumentar el nivel de renta o producción, es decir la Y) o restrictivas (con el objetivo de disminuir el nivel de renta o producción). Para la IS las políticas a aplicar son las fiscales, y para la LM son las políticas monetarias.

Obtenido de "http://es.wikipedia.org/wiki/Modelo_IS-LM"

431 Michael Burda & Charles Wyplosz, Macroeconomics 4th Edition OUP 2005

WebAppendix 10: The Mundell-Fleming Model http://www.oup.com/uk/orc/bin/9780199264964/01student/webappendix/wa10.pdf (IS-LM Model of the open economy)

This appendix builds up the IS-LM model, formalizing step by step the reasoning in the text. All the relationships are written in linear form, which allows for easy manipulation.

1. Aggregate Demand and the Goods Market Consumption expenditures is given in equation (10.2) of the textbook by the function: C(Ω,Y −T) When wealth is constant, its linearized version is:

(A10.1) C = a0+a1Ω + b(Y – T) = a + b(Y – T),

where the coefficient a = a0+a1Ω includes the effect of wealth and the coefficient b is called the marginal propensity to consume, since it captures the effect of an increase in real GDP (dY), on consumption spending, (dC). It is assumed that b ≤ 1. The investment function is presented in (10.3) as I (i, q) . Departing a little bit from the text, we recognize that Tobin’s q is related to (current and future) economic conditions and allow it to be a positively related to GDP. This is consistent with the discussion of the accelerator in Section 6.3,3. It addition, Tobin’s q depends negatively on interest rates (as discussed in Section 6.3.4). The result is: (A10.2) I = c + dY – ei All the coefficients c, d and e are assumed to be positive, and this is always the case below as well. Finally, we note that exports are X = x0 + x1Y* - x2σ and imports are Z = z0 + z1Y + z2σ Replacing absorption A with GDP Y, as in the text. We can then derive the primary current account function as:

(A10.3) PCA = f – gY +g*Y* – hσ where f = x0 – z0, g = z1, g* = x1, and h = x2 + z2. Desired demand is DD = C + I + G + PCA, so we can write: (A10.4) DD = A + (b+ d – g )Y – ei + g*Y* – hσ where A = a + c + f + G – bT collects all the constant terms and the component of fiscal policy, and is treated as exogenous. The assumption that its schedule is upward-sloping but flatter than the 45o line requires that 0 < b + d – g < 1. Goods market equilibrium occurs when Y = DD (point A in Fig. 10.3), which can be solved as:

432 (A10.5) (A10.5) shows how equilibrium output depends on the domestic interest rate i, foreign GDP Y* and the real exchange rate σ. The coefficient K = 1/(1 –(b + d – g)) is the Keynesian multiplier. The assumption that b + d – g < 1 guarantees that it is positive and larger than 1. You can check that the steeper is the DD demand curve, i.e. the closer to 1 is (b + d – g) the larger is the multiplier. (At the limit, 2 when b + d – g approaches 1, the multiplier becomes infinite). The empirical evidence is that the multiplier is not much larger than 1 for European economies, which means here that b + d – g is close to zero.

2. The IS Curve The assumption that actual output is never very far from equilibrium output means that we can now consider (A10.5) as the equation of the IS curve. It is drawn as i a function of Y, which can be found from (A10.5):

(A10.5’) This shows that the slope of the IS curve is negative and that the curve shifts up (and to the right) when Y* increases and when the real exchange rate σ depreciates. Question: hat happens when wealth Ω or some other exogenous component of A increases?) Also note that the absolute value of the slope of the IS curve is:

This shows that the IS curve is steeper when: - b (the marginal propensity to consume), d (the sensitivity of investment expenditures to GDP) and e (the interest rate sensitivity of investment) are small - g (the marginal propensity to import) is large. Economic interpretation: a given increase in the interest rate Δi reduces demand, which in equilibrium reduces output Y (the Keynesian assumption). The less Y has to fall, the steeper is the IS curve. So: - the less sensitive is demand to the interest rate, i.e. the smaller is e, the less Y needs to fall to restore goods market equilibrium, so the steeper is the IS curve - the less sensitive are C and I to income Y, the less Y needs to change to have the required effect on demand. The logic comes from the 45º graph: to meet the fall in demand, output (goods supply) Y must decline, but this in turn cuts into demand via C and I, hence a need for a further reduction in Y. This is another way of stating the multiplier effect. The smaller are b and d, the smaller this second round effect. - the same logic applies to coefficient g, which represents a demand leakage.

2 To see why, assume that d = g = 0; then b =1 means that any increased in GDP is entirely plugged back into spending, hence more GDP, hence more consumption, in an unending process. If b < 0, some income is saved and does not come back as additional spending, so the effect gradually dies down. The reasoning extends when d > 0, so some of the additional income is spent in the form of investmenet, and when g > 0, so some income leaks out abroad as it is spent on imports. This is related to the leakage story in Section 10.2.3).

433 3. The Money Market and the LM Curve We write the demand for real money as: (A10.6) L (y, i) = αY - βi where α and β are positive coefficients. In practice, α is close to 1 and β is close to 0.1. The equation of the LM curve is: M/P = αY-β i Recall that in Chapter 10, the price level P is assumed to be constant (Keynesian assumption). As the LM curve is drawn, its equation can be written:

(A10.7) We conclude that the slope of the LM curve is α/β. You may also note that it intersects the i- axis (the vertical axis) with an implausibly negative value for the interest rate: i = −M /(βP). This should serve as a warning about the inherent limitations of a linearized macro- model.[No: es una función discontínua: con i = 0, o algo por encima de cero, la sensibilidad de la demanda de liquidez respecto al tipo de interés, β, se hace infinita, α/β = 0 y la recta LM es horizontal] Thus, the LM curve is steeper: - the greater is α (the sensitivity of money demand to income) - the smaller is β (the sensitivity of money demand to the interest rate) Economic interpretation: an increase in output Y raises the demand for money. When the real supply is given and cannot increase, money market equilibrium can only be restored if the interest rate rises and discourages the excess demand. The slope is lower, the smaller the increase in the interest rate necessary to eliminate the excess demand associated with a given increase ΔY in output. So: - a small α means that the demand for money does not increase very much, requiring a small increase in i. - a large β means that a small increase in i has a strong effect on the demand for money, and is sufficient to cut the demand. Macroeconomic Equilibrium The closed-economy version is found by solving (A10.5) and (A10.7) for Y and i. This gives:

(A10.8)

(A10.9)

The Mundell-Fleming model amounts to imposing i = i*, which is done in the next sections.

434 4. Output and Interest Rate Determination under Fixed Exchange Rates Under fixed exchange rates, when we impose the financial integration condition i = i*, we look at (A10.9) and ask: what must change there to make sure that this expression is equal to i*? The answer is that it is the real money stock M/P that must adjust and, since the price level is assumed constant, it is the nominal money supply that will do the work. In the text, we explain how this happens (exchange market interventions to keep the exchange rate fixed) and we conclude that the LM curve shifts to meet the IS and BP curves. In mathematical terms, the endogenous LM response involves nothing more than rewriting (A10.7)

(A10.7.fixed) i.e., given Y, M/P adjusts to ensure i = i* and M = P(αY – βi). Using the decomposition (10.12) between foreign exchange reserves F and domestic credit DC, we see that reserves are determined as F = P(αY – βi) – DC. Output is determined by the IS curve (A10.5), simply noting that i = i*: (A10.5.fixed) Y = K(A− ei *+g *Y *−hσ ) Where the real exchange rate σ = SP/P* remains constant as the nominal rate S and the domestic and price levels P and P*, respectively, are constant. This expression allows us to see the effects – discussed in the text – of changes in the exogenous variables i* and Y* as well as the nominal exchange rate S, which affects the real exchange rate proportionately. Throughout one should remember that M is not exogenous, as long as the central bank is committed to fixing the nominal exchange rate.

5. Output and Interest Rate Determination under Flexible Exchange Rates Under the flexible exchange rate regime, the interest rate parity still requires i = i*, but the money supply M is exogenous and the nominal exchange rate S adjusts. This is because the central bank expressly refrains from intervening on the foreign exchange market. Looking now at (A10.9) we see that with i* and M exogenous, the real exchange rate σ is endogenous and must adjust. This explains why the IS curve shifts to meet the LM and BP curves. Which value of σ delivers the desired shift of IS curve? It is found by rearranging (A10.9) with i = i*:

(A10.9.flexible) We can use this expression in (A10.5) to obtain output, the other endogenous variable. In fact it is easier to simply use the money market equilibrium condition to find:

(A10.5.flexible) We see that Y is determined by the money market equilibrium condition and interest parity (the intersection of the LM and BP schedules), the IS curve is a “residual”, in which σ adjusts

435 passively to ensure goods market equilibrium. Box A10.1 summarizes these results in a compact way. Equation (A10.9.flexible) shows formally the effects on output and the real exchange rate of changes in the exogenous variables M, i* and Y* as discussed in the text. As for the nominal exchange rate, since P and P* are assumed to be constant, it is given by simply adjusting (A10.9.flexible) by foreign and domestic price levels:

Box A10.1. Exogenous? Endogenous? What Determines What Under fixed exchange rates, the money supply is endogenous and the (nominal and real) exchange rate is endogenous. The opposite holds under flexible exchange rate. This explains how we use the three basic equations IS, LM and BP to find three endogenous variables Y, i and either σ or M. Note that BP – the interest rate parity conditions – always sets i = i*, so we are left with two equations and two endogenous variables. Under fixed exchange rates, the central bank exogenously sets S and therefore σ, M is determined by the LM equation and Y by the IS equation. Under flexible exchange rates, the central bank sets M, Y is set by the LM equation and σ by the IS equation. This is summarized in the following table.

436 Business

October 27, 1991 Three Whiz Kid Economists of the 90's, Pragmatists All By SYLVIA NASAR Economists make youth a prerequisite for winning one of the profession's top honors, the John Bates Clark Medal. "We tend to think that everything important is done early," said Paul Samuelson, who won the first Clark Medal, in 1947 at the age of 32, and like five others went on to garner a Nobel Memorial Prize in Economic Science. Most economists already know who this year's Clark Medal winner is -- indeed, committee members at the American Economics Association, which makes the award, have sent him congratulatory notes -- although medal traditions preclude a formal announcement until January. He is Paul R. Krugman of the Massachusetts Institute of Technology, an expert on international economics. The favorite for the next biennial award is Lawrence H. Summers a Harvard professor who is currently in Washington serving as chief economist at the World Bank and was once an adviser to Presidential candidate Michael Dukakis. A third overachiever who might have been in the Clark Medal race, Harvard's Jeffrey D. Sachs, effectively took himself out of the running by deciding that saving the economies of Latin America and Eastern Europe was more important than churning out scholarly articles, another requisite for the Clark. All three can claim remarkable accomplishments and influence far beyond the walls of academia. All reflect the ways in which economics is changing, in style as well as substance. All are part of a countervailing current that contrasts with the highly abstract, Olympian, laissez-faire brand of economics that dominated the nation's universities in the 1970's and early 80's. They are also likely to be around for a while. The graybeard of this group, Paul Krugman, has just turned 38. Mr. Krugman, an elegant theorist, has re-written the book on global trade and finance, a field better known for received wisdom than lively innovation. He did so by inventing a theory, based on imperfections in the way markets function, that helps to explain why countries exchange similar goods, why protectionism can sometimes lead to lasting advantages and why a system positioned between completely fixed and freely floating monetary exchange rates can work. "Paul is to international economics what I.B.M. is to computers," said one admirer. Then there is Mr. Summers, 36, dubbed by one Clark selection committee member "a phenomenon," the rare economist who is equally at home in the ivory tower of pure theory and the down-and-dirty world of policy. Instead of turning a single subject on its head, Mr. Summers has cut a swath through half-a-dozen disciplines with clever, mostly

437 contrarian contributions, like his finding that making it too cheap and easy to trade securities can be bad for the economy. His colleague Jeffrey Sachs, also 36, is a virtuoso of still another stripe. Since the mid- 80's, Mr. Sachs has made transformation of populist or socialist economies like Bolivia, Poland and, more recently, the Soviet Union his personal crusade. For this he won the prestigious Seidman political economy prize, an annual award whose past winners include Nobel laureates Gunnar Myrdal, Robert Solow and James Buchanan. But despite several important articles on 1970's stagflation and 1980's third world debt, Mr. Sachs probably has not produced enough pure scholarship to be a serious Clark contender. Nobody makes as big a splash as these three without provoking criticism. Some economists simply think that there are other, equally gifted, economists who are getting far less attention. "Summers is advising Lithuania. Taylor, a really good conservative economist, is advising the United States," said Robert E. Lucas Jr., chairman of the University of Chicago economics department, referring to John Taylor, until recenly a member of President Bush's Council of Economic Advisors. "That's about the right division of labor between those two guys." Some finance experts dismiss Mr. Summers's enthusiasm for taxing stock trades, saying such a policy has few benefits and many costs. Free traders resent the fact that Mr. Krugman's arguments have lent intellectual respectability to old-fashioned protectionism. Liberals often blame Mr. Sachs's economic shock therapy in countries like Bolivia and Poland for causing mass unemployment. "If the Bolivian Government decided to wipe out the tin miners, they could have done it without Jeff Sachs," said Lance Taylor, an economist at M.I.T. Today's young superstars have much more in common with one another than with the superstars of a decade ago, many of whom are high-wire mathematical geniuses and laissez-faire theorists at the universities of Chicago and . The previous generation tended to be proponents of rational expectations, a theory that holds that Washington's efforts to boost economic growth through fiscal or monetary policy are doomed to failure. By contrast, the three young Cambridge, Mass., economists are on terra firma. "Each one is someone who thinks economics is to be used in analyzing real-world problems and finding solutions." said Stanley Fischer, an economist at M.I.T. The three share a strong desire to make models fit facts. Mr. Summers's articles are brimming with data. Even Mr. Krugman's work, the most academic of the three, fits this reality-checking mode. Mr. Krugman proposed his new trade theory, for example, after observing that most global trade didn't fit conventional models. "I discovered a lot of contrary evidence that had accumulated in search of a theory," he said. "One of my principals ever since has been 'Listen to the people outside the mainstream.' " Such fact-grubbing is complemented with a passion for history. "It's a data bank to draw on," Mr. Sachs said. His insistence that debt relief for countries like Bolivia and Poland made sense was partly based on the fact that in the past creditors have never insisted that essentially bankrupt nations repay their loans in full. To varying degrees, the three see more scope for activist government intervention than do the Chicago and Minnesota economists. Partly for that reason, they are sometimes called neo-Keynesians, influenced by the British economist John Maynard Keynes, the patron saint of those who believe in economic intervention.

438 Mr. Krugman allows that some very limited industrial policy might be justified. Mr. Summers sees scope for government meddling with corporate taxes to stimulate investment. And Mr. Sachs contends that aid and active engagement by the West are critical to helping reform-minded governments overseas survive. It would be a mistake, however, to view the three economists as younger incarnations of John Kenneth Galbraith, who thinks that markets often don't work, or even the liberal 1960's Keynesians like Paul Samuelson at Harvard or James Tobin at Yale. "Larry's generation re-emphasized the importance of markets and the failures of government," said Anita Arrow Summers, Mr. Summers's mother, an economist who recently retired from the Wharton Business School at the University of Pennsylvania. What was Mr. Krugman's reaction upon hearing that he had won the Clark Medal and that his nomination letters compared his scholarly articles to Japanese haiku, Emily Dickinson's poems and Henri Matisse's drawings? Ninety seconds of elation followed by hours of depression, he said. "I was concerned about my creative juices. I wondered whether I could keep it up." Few people share Mr. Krugman's anxiety on that score. Even at unlikly moments, Mr. Krugman ideas flow. His ideas on the role of historical accident in shaping economic geography was sparked by a board game based on the evolution of the American economy that his wife, Robin Bergman, gave him. The standard view when he came on the scene was that countries traded because they have different, more or less naturally endowed resources and tastes, that free trade was almost always ideal and that fixed exchange-rate systems were fatally flawed. Mr. Krugman demonstrated that technology and the dominance of many industries by a few firms explained most trade between similarly endowed nations. He showed that countries could benefit by pursuing strategic trade policies, like import protection and export subsidies. As dissatisfaction with floating exchange rates grew in the 80's and governments took steps -- like the European Monetary System -- to reduce currency fluctuations, Mr. Krugman proved that currency target zones were inherently stable. An only child, Mr. Krugman grew up mostly on Long Island. His mother describes him as a dreamy boy who loved history and played for hours with toy soldiers. "Paul staged the battle of Gettysburg and then he loved to lecture us about it," she recalled. Mr. Krugman got interested in economics at Yale, earned his doctorate at M.I.T. and eventually wound up on the M.I.T. faculty. Ms. Bergman, his wife, is a painter turned clothing designer and knitter. "Our working styles are very similar," she said. "We work in our heads a lot. We're not overly impressed with technique. We're more interested in a unifying theme." Jeffrey Sachs has preached the virtues of free markets to Bolivian union militants, the new leaders of the Russian Republic and, yes, even the Pope. While most of his colleagues were vacationing on Cape Cod last summer, Mr. Sachs was shuttling between Mongolia, which is privatizing the national herd of 24 million yaks; Slovenia, whose newly independent government is trying create a capitalist economy with close ties to Western Europe, and Poland, where the economic reforms of the Solidarity government face a critical electoral test today.

439 More and more of his attention in recent weeks has focused on helping the Russian government devise a plan to revive its economy. And from time to time, he looks in on Argentina and other Latin debtor nations. "These societies are at a fundamental crossroads with one fork leading to political and economic chaos and the other way leading them back to being a prosperous part of the world economy," said Mr. Sachs. "That's very captivating." When possible, his wife, Sonia Ehrlich, a Harvard-educated pediatrician who describes herself as "a happily married single parent," and his two children, Adam, 6, and Lisa, 9, tag along. The last Sachs family trip took them to Athens, Budapest and Warsaw. The Sachs philosophy rests on a set of interconnected convictions. One is that, contrary to populist dogma, workers and entrepreneurs, not government, create prosperity. "Economists, spoiled by a bastardization of Keynes, often talk as if all you had to do is turn a dial marked 'economic growth,' " said Mr. Sachs. Another conviction is that government's job is to create a framework for growth, namely stable prices, a convertible currency, private ownership and legally enforceable private contracts. A third Sachs idea, the one that originally attracted wide attention, is that debt forgiveness for struggling third world debtors is not only just and necessary but ultimately in the best interests of the creditors. Being an outspoken advocate for underdogs is part of the Sachs family tradition. A Democrat, his father is a prominent labor lawyer from Detroit who has argued several cases before the Supreme Court. But some bemoan Mr. Sachs's decision not to become a cloistered researcher. "He was clearly capable of doing pretty important work, but I don't think he did it," said Robert Barro, another Harvard colleague. "It's a major loss." Mr. Sachs's reaction is characteristically impatient. "I do not believe in the life cycle model that says an economist ought to be isolated and insulated until age 60. I know I get better at this having confronted real problems." He adds: "With my views on what's important in economics, getting the Seidman prize was delicious." A purposeful pursuit of objectives was evident long before Larry Summers set foot in Washington. A favorite story of his mother is about her son at about age 10 when she sent him off to a tennis tournament with a casual, "Have fun, Larry." Young Summers reappeared at the the door. "Fun? Fun? It's 90 degrees and you think I'm going for fun?" "O.K., Larry, O.K.," she said. "Go win." Said James Poterba, a colleague at Harvard and one of Mr. Summers's many co-authors, "Larry has always had a clear idea of what he wants to do and how. He finds a unique, clear image of what he wants to say, how he wants to argue, what the supporting data and modeling will have to look like." Mr. Summers came to economics from a remarkable family. Two of his uncles are Nobel laureates and both of his parents, lively and articulate, are also economists. Mr. Summers was offered a full professorship at Harvard before he had even finished his doctoral dissertation. To the surprise of his liberal parents, he followed Martin Feldstein to Washington for a year when the latter became President Reagan's chief economic adviser.

440 He and his wife, Victoria, are the parents of 13-month-old twins, Ruth and Pamela. Mrs. Summers, an attorney and professor, is one of his many co-authors. Indeed, Mr. Summers has produced an unusual number of eye-catching papers. Although he has weighed in on everything from the effect of welfare programs on poverty to the role of machinery investment in economic growth, his main work has focused on unemployment, the taxation of capital and, recently, the behavior of the stock market. And like Mr. Krugman, Mr. Summers won attention by taking aim at conventional wisdom. "I always preferred to not be 100 percent certain of a world view," Mr. Summers said, "but relate to what's happening instead." In the late 70's, when conventional wisdom said that unemployment wasn't a problem because most jobless spells only lasted a few weeks, Mr. Summers showed that while most episodes were indeed short, there existed a hard core of the unemployed that experienced many such short spells. "Larry's biggest impact is that he has showed by example that you can be a superstar doing applied economics," said Andrei Schleifer, a Harvard colleague. "Larry is probably the most influential teacher in economics since Bob Solow." Added Mr. Barro of Harvard, "You don't exactly see a home run, but when you add it all up you have a strong body of work. It's pretty clear that the favorite for the next Clark Medal is Larry." Photos: Larry Summers: "Relate to what's happening." ; Paul Krugman: Trusting "people outside the mainstream." (Alison Shaw for The New York Times); Jeff Sachs: History is "a data bank to draw on." ; Paul R. Krugman; Jeffrey D. Sachs; Lawrence H. Summers Chart: "To the Winners: Honor," lists recipients of the John Bates Clark Medal, their birthdates and the years that six of those winners later won the Nobel Prize (Source: The Ameircan Economic Review) SYLVIA NASAR Three Whiz Kid Economists of the 90's, Pragmatists All October 27, 199 http://www.nytimes.com/1991/10/27/business/three-whiz-kid-economists-of-the-90-s- pragmatists-all.html?pagewanted=1

441

John R. Hicks The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 1972 Prize Lecture Lecture to the memory of Alfred Nobel, April 27, 1973

The Mainspring of Economic Growth In my Theory of Wages, first published in 1932, there is a chapter (VI) entitled "Distribution and Economic Progress". It was the first to be written of the theoretical chapters in that book; so it is in a sense the first of my contributions to economic theory. I do not think much of it now; I think that I have learned a good deal since I wrote it. It has nevertheless had a considerable progeny. Work that is based upon it, or on other constructions of the same character, continues to appear; so it is far from being dead. Yet I myself have moved away. It may be useful to take this opportunity of explaining how this has happened. It is not inappropriate to do so, since in doing so I shall describe what seems to me to be an important part of the work I have done, in all the time from 1932 to the present.1 It was characteristic of that approach, from which I began, that it treated the Social Product as being made by two Factors of Production, Labour and Capital; the services of Labour and the services of Capital contributing to the Product in much the same way. An increase in the amount of either Factor that was applied would increase the Product, other things being equal. With given amounts of Factors applied, there would be just so much Product; so (again other things being equal) there would be a Production Function (as it later came to be called) representing Quantity of Product as a Function of Quantities of Factors applied. The return, per unit, to each Factor was equal to its Marginal Product, which diminished as the amount applied of that Factor increased, the amount of the other remaining constant. It followed at once that an increase in the quantity applied of one Factor (that of the other remaining unchanged) would increase the absolute share of the Product going to the other Factor; but since the absolute share of the increasing Factor might be either increased or diminished (according as its Marginal Productivity curve was elastic or inelastic) the distribution of the Product between the Factors (relative shares) might be shifted either way. Which way it went would depend upon the "shape" of the Production Function, a "shape" which could be represented, as I showed, by what I called the "elasticity of substitution". It was not supposed that the Production Function would remain unchanged over time; it would be shifted by the discovery of new techniques of producing - that is to say, by invention. Inventions, so Wicksell appeared to have shown (and I followed him), would not be adopted unless they raised the Social Product; but the shifts in the Production Function, due to invention, might be "neutral", as far as distribution between the Factors was concerned, or might be biased either way. It seemed to me that rises in wages (rises, that is, in the share of the Product going to Labour per unit of Labour) would encourage the adoption of inventions which economised in Labour and so were biased against Labour; but whether such "induced inventions" were to be regarded as shifts in the

442 Production Function, or as substitutions within an unchanged Production Function, was left rather obscure. The theory, which I have been outlining, has been decidedly influential; but almost every element in it has been a target for criticism. Some of the criticism (such as those directed against the Marginal Productivity theory as such) can, I still believe, be rebutted, or partially rebutted;2 but there is one that remains which I now feel to be decisive. In the Production Function, "Product", "Labour" and "Capital" are quantities; but it is necessary, if they are to be quantified, that there should be some means of reducing their obvious heterogeneity to some kind of uniformity. For none of the three is the reduction a simple matter; it cannot be solved, even in the case of Labour, by counting heads or by counting manhours. The crucial problem, however, is that of capital.3 Capital, here, must mean physical capital goods; it is an aggregate of physical goods which we have to represent by a single quantity. As is now well known (but was not so well known in 1932) there are just two cases in which this can be done without error - without any error, that is, for it is not denied that if either case is approached, without being actually reached, the error may be tolerable. One is the obvious case in which all components change proportionately; the other - which I myself may claim to have clarified in 1939 - is that in which the price-ratios between the goods, or their marginal rates of substitution, remain constant.4 In the former case the complex is representable by a number of physical "bundles"; in the latter there is aggregation in value terms. It is clearly impossible, in the case of the capital stock, to claim that the first of these conditions, in practical application, can be even approximately satisfied. For it is normal experience, in a progressive economy, that its capital, at the end of a period, contains different kinds of goods from those contained at the beginning. New items are introduced, and old items discarded. Only in a theoretical construct - a steady state - can proportions remain unchanged over time; and we can hardly make much use of that property, even for the comparison of steady states, since proportions in one steady state will usually be different from those in another. There is little hope for a way out in that direction. The other, at first sight, looks more appealing. Here however there is a more subtle objection, associated in particular with the work of Joan Robinson.5 If capital increases relatively to labour, other things being equal (so the Production Function theory appears to tell us) the marginal product of capital must fall, so the rate of return on capital must fall. But a fall in the rate of return on capital carries with it a fall in the rate of (real) interest, as a result of which the capitalised values of different goods (goods of different durability, for instance) must change disproportionately. So the marginal rates of substitution between them cannot be kept constant. The constant-price condition cannot be maintained; it involves a contradiction. This does not mean that it is wrong for statisticians to value capital goods at constant prices - their prices, or costs of production, at some base date. Any practical measure of National, or Social Capital must I think be of this character. But a technological relation between Capital and Product, with Capital thus arbitrarily valued, carries no conviction; there is no reason why it should exist.6

All I have said so far is by way of preface. I have, on the whole, left it to others (since my early days) to live in the world of production functions and elasticities of substitution,

443 between Factors globally defined. What I mainly want to talk about is a side of my work which has gradually developed over the years, and which, I now feel, is more promising. It also goes back to that same Theory of Wages. I have so far been discussing Chapter VI; but there are other chapters (IX-X) where will be found the beginnings of quite a different theory. These are curious chapters; their reception, when the book appeared, was much less favourable than that then accorded to Chapter VI. This was partly because the tradition in which I was working in IX-X - the tradition of Böhm-Bawerk and Wicksell - was much less familiar to English readers than that of Pigou, on whom I was drawing in VI; but mostly because of a head-on collision between what I was saying and the "New Economics" which even then, three years before the General Theory, was already beginning to be the Economics of Keynes. When I wrote the Theory of Wages, I was completely innocent of these ideas; I had scarcely a notion of what was going on at Cambridge, or for that matter in Sweden. But hardly had my book left my hands when I began to move in that direction myself. I stumbled upon something which, if not quite the same as Keynes's Liquidity Preference, has a close relation to it. And even before the General Theory appeared in 1936, I had begun to draw some of the consequences.7 There is much of my work which follows from that; I have no time to describe it here. I must keep firmly to the story of those chapters in the Wages book, and what follows from them. The first result of the new point of view, when I reached it in 1933-35, was to make me deeply ashamed of what in those chapters I had written. I realised (too late) how inappropriate it was. It had nothing to do with the state of the world at the time when I was writing. I had diagnosed a disease, but it was not the right disease. The unemployment of 1932 was of quite a different character from what I had supposed. It is nevertheless not useless to analyse a disease, even if it is not the disease which at the moment is important. The time may come when one's work is more to the point. In my case, I think, it has come. The principal ground on which my chapters were attacked, in the thirties, concerned my initial assumption - that Trade Unions, or Government wage-fixers, can raise real wages. This, by Keynes and his followers, was in those days most resolutely denied. Trade Unions, they said, are concerned with money wages, not real wages. It is true that a rise in the money wages of a particular group will raise their real wages relatively to those of others; but a general rise in money wages, in a closed system, will simply result in a rise in prices in the same proportion, thus leaving real wages where they were. This of course implies that there is an elastic money supply. If the money supply is not increased proportionately, the rate of interest will rise; as a result of the rise in interest there will be a fall in the demand for labour. The cause of the unemployment is then identified as the inelasticity of the money supply. It is fairly obvious, in these days, that this Keynesian argument is not so strong as it at first appeared. Directed, as it was of course at first intended to be directed, against the use of wage-cuts as a means of stimulating employment in depression, it retains its force. But it is much less strong on the other tack. Though Trade Unions operate on money wages, it is surely in real wages that they are really interested. If a rise in money wages just leads to a rise in prices, they feel themselves cheated; so they return to demand another round of rises in money wages. Thus we get the cost-inflation, with which (during the last twenty and especially ten years) we have become so familiar. It could not occur without an elastic money supply;

444 so why not put constraints on the money supply, and so check, or at least impede, the inflation? There are bound to be monetarists who will argue that way, and governments, in desperation, are bound to give some attention to them. Is the resulting unemployment then due to the monetary constraint, or to the wage-push which led to the monetary constraint being imposed? One can look at the matter either way, but it can well be argued that the latter way is the more fundamental. So my 1932 analysis has come, at last, to some sort of contemporary relevance; but there is another kind of relevance, of which I had no suspicion when I wrote, but which has been there all the time. This is not a matter of analysing a disease; it is concerned with the normal growth, the healthy growth, of an economy. In healthy growth real wages should be rising. What are the consequences of that rise in real wages? My 1932 analysis was concerned with rises in wages off the normal path; but the rises that are on the normal path should have similar effects, though they will not include the causation of unemployment. Rather similar methods should be usable for their analysis; it should deepen our understanding of the growth process in general. This is the aspect in which I have lately been mainly interested. I will try to sketch some of the results I seem to have been reaching. This will be the subject of the rest of this lecture.

I have talked all this time about those chapters IX-X of the Wages book, without specifying what they contain. Much of what they contain is detail, now irrelevant. There is just one thing that matters. A rise in real wages, however caused, tends in itself to diminish the real rate of profit. This has two effects which work, in a sense, in opposite directions. One is to encourage the substitution of what are usually more capital-intensive methods; the other, because of the transfer of income from profits to wages, is to diminish saving. Far more is now known about both of these effects than I knew in 1932; but the distinction still holds. I will try to re-state it in a more modern form. The first thing on which to insist is that it is quite unnecessary, because we use terms like "capital-intensive" and "rate of profit", to trouble ourselves about the valuation of the capital stock as a whole (as we appeared to have to do on the production function method). What matters is not the average rate of profit on the whole capital stock (which cannot be determined without such valuation); what matters is the rate of profit on new investment. When the new investment is undertaken, that profit is no more than an expected profit, and what is realised may not be the same as what is expected. It seems reasonable, however, if we are concerned with healthy growth, to suppose that there is some broad concordance between what is expected and what is realised. Most ventures come out more or less right. No more than that is required. It cannot be profitable (in this sense) to make machines unless the use of the machines is also profitable; so, to assess the profitability of investment, we should look right forward to the production of final product. In any production plan, so considered, labour is input and final product is output; so a rise in wages, in terms of final product, must diminish the rate of profit on the plan, in terms of final product. To this rule there is I believe no exception. It holds for any plan that could be viable at the rate of wages in question.8 So for any plan (with inputs and outputs expressed in quantity terms) there is a particular relation between (real) wage-rate and (real) profit-rate, which can be drawn out as a downward-sloping curve - what I now like to call the "efficiency curve" of the plan.

445 Next (though only provisionally) let us make the conventional assumption that "technology" is given; that there are just so many production plans, in the above sense, from which choice can be made. Each such plan will have an efficiency curve. Make the "capitalist" assumption (I am not here concerned with the question of its justification) that the plan which is actually chosen for new investment is that which gives the highest return at the current rate of wages. It could be that the choice was unaffected by the level of wages; but it makes more sense to suppose that as wages change, different plans (or techniques) will come to be the most profitable. There will then be substitution along a "spectrum of techniques" as wages rise. It is not the case (as used to be supposed) that there is any single physical index by which we can distinguish those techniques which lie "further down" the spectrum from those which lie "higher up". There is no such index which can be employed without exception. I could already show (in 1939) that the "Period of Production" that was used for this purpose by Böhm-Bawerk and Hayek will not in general serve.9 But what is in substance the same argument can be used against any physical index, such as capital-labour ratio (when capital, by some device, is physically defined).10 Yet we should not allow these refinements to obscure the fact that techniques which lie further down the spectrum (so that they require for their profitable adoption a low rate of profit, or interest) will usually be such as to involve higher preparatory costs, such as construction costs, as a means of economising in running costs of production. We do not usually go astray if we think of such techniques as being in that simple sense more capital-intensive. I shall later return to this substitution effect; for the moment I turn to the other, which is more troublesome. In Theory of Wages (as was natural at the date when it was written) I took the traditional view that more saving meant more capital accumulation, and that capital accumulation was favourable to rising wages. But in Keynes's system of thought, which was so soon to be sprung upon me, the effect of saving seemed to go the other way round. The trouble was not (as might easily be supposed) that Keynes's theory was monetary, while my "classical" theory was non-monetary. One can construct a "barter" system, in which money plays no essential part, but which can still behave in the manner that Keynes identified. (It is not, incidentally, such an unrealistic construction; the world, in 1970-1, produced quite a good imitation of a Keynesian slump in real terms.) It has taken some time for this to be clarified - since Keynes himself, by unfortunate definitions which made saying and investment always equal, obscured the significance of a part of what he was saying. If we make the distinction (which already in 1936 was familiar in Sweden) between desired and realised saving and investment, the issue becomes much clearer. In the desired sense there can be an excess of saving over investment, even in a barter economy; it will take the form of an undesired accumulation, an accumulation of surplus stocks. If there is an excess of investment over saving, in the desired sense, stocks will fall below normal, below what is desired; or surplus orders will pile up, orders which cannot be satisfied without abnormal delay. Such an excess, either way, may be regarded as a sign of disequilibrium - a disequilibrium which is perfectly possible, even in a barter economy.11 Saving-investment equilibrium, so defined, does not imply the Full Employment of Labour; for that also to be attained, further conditions are necessary. One of the conditions is that relative prices should be right. It is unnecessary, here, to discuss the vexed question whether it will always be possible, in a barter system with sufficiently

446 flexible prices, to maintain both full employment and saving-investment equilibrium automatically. (I am myself convinced that it is not necessarily possible, but that is by the way.) What is important, for my present purpose, is that saving-investment equilibrium and full employment are different. One can suppose that there is saving-investment equilibrium, maintained continuously; and yet there can be unemployment, if the ratio of prices to wages is inappropriate. That is what I ought to have said in Theory of Wages. So interpreted, the Keynesian view and the "classical" view fit together. It has taken a long time to clear this up. In the central part of my Contribution to the Theory of the Trade Cycle (1950) I used what I have later called a fixprice model.12 I introduced an equilibrium path - a saving-investment equilibrium path - and a full employment path which lay above it. I was interested only in departures from equilibrium; so the only function attributed to the full employment path was to act as a Ceiling, which imposed a constraint upon the disequlibria which could occur. I did not ask why the equilibrium path should lie below the Ceiling. Indeed, I said much too little about each. I just drew them as straight lines - which is a simple way of saying nothing about them! The natural way of finding out more about them is to consider the possibility of maintaining both saving-investment equilibrium and full employment. Suppose that both conditions have to be fulfilled; what will be the consequences? Real wages, it is clear by now, will have to be flexible; can they be kept flexing always upwards? If they can, it may be that the simultaneous satisfaction of both conditions can be maintained without friction (this does not mean that it must be attained); if they cannot, if there must be fluctuations in real wages when both conditions are satisfied, there will surely be greater difficulties. To learn more about the double-equilibrium path (as we may call it) seems thus to be the next thing required. It has been widely appreciated that it is the next thing required. Many (though by no means all) of the "growth models" that have been developed on all hands during the last twenty years can be considered as answers, or attempted answers, to the question just put. Some of them, especially those labelled "neo-classical", use the production function scheme I began by describing. I am myself untempted by that procedure, essentially for the reason given. It may nevertheless be agreed that the problem is a "classical" problem; since we are putting disequilibrium behind us, what we have learned from Keynes is for the moment irrelevant. It is to the classics that we must go for help. We shall find it, in my view, not in the "neo-classics" but in the British Classical Economists, especially in John Stuart Mill. When Mill "abandoned the Wage Fund" he must have forgotten what he had said about it. (It is not surprising, in view of all the other things he had been doing, if by 1868 his recollection of his earlier work had become a little rusty.) In terms of the double equilibrium path, what is said in his Principles is substantially right. The wage-bill (the real wage-bill) is just the difference between final product and what is taken out of that product for other purposes. What is taken out will include not only "consumption out of profits" but also the consumption of public bodies (as Adam Smith, when he was on this track, had been well aware). So long as the increment in this Take-out does not exceed the increment in final product, the real wage-bill must increase when final production increases. It must do so, along the double equilibrium path.13

We can at last begin to see how the substitution effect and the saving effect fit together. It is essential to hold fast to the behaviour of final output. This is the chain of causation:

447 from investment to final output, from final output to wages, from wages to the rate of profit on new investment, and thence back on investment itself. There is much to be said on each of these steps. I cannot go into detail, but must confine myself to giving a general impression.14 Let us start from the making of an invention, which we had better think of as a major invention, so that the technique of production which it makes possible is much more profitable than any used before.15 It needs to be embodied in new equipment in order that it should be used; so without new investment it cannot be applied. But even if the invention had not been made there would have been some new investment; so the immediate result of the invention is that the technique which is embodied in new investment is changed. The rest of the economy proceeds more or less as before, using old techniques; they are now obsolescent, but they cannot be changed overnight. The new processes will not produce final product at once; there must be a delay before the new equipment comes into production. During that delay, all final product comes from old processes; so (in double equilibrium) the old processes must continue in full production if final product is not to fall. Except by a fall in final product, no additional resources can be transferred to new investment; so it is just the resources which would have been employed in new investment, if the invention had not occurred, which can be transferred to the making of the new "machines". It is by no means certain that final product will be increased even when the new equipment comes into production. For it may well be that the increased profitability of the new machines is simply a matter of reduction in running cost. They have no larger capacity than the machines they replace; it simply costs less to run them. There is then no rise in final output when the new machines come into production. What does happen is that resources are released; but if double equilibrium is to be maintained, they must still be employed. They may be employed in squeezing additional output out of old processes; or they may be employed in making new machines. In the former case, there will at that stage be a rise in final output; and even in the latter case, though there is again no increase in output while the extra machines are being made, there will in the end be an increase in final output. So it is true (as Wicksell supposed) that a profitable invention will always lead to an increase in final output; but it is perfectly possible that the increase may be long deferred. Unless the rise in final output is absorbed by an increase in Take-out, or has to be spread over too large an increase in the supply of labour, rising final output (when it comes) will mean a rising rate of real wages. (This is where substitution will come in.) But suppose for the moment that there is no substitution and no further invention. Investment continues on the same pattern as was established after the first invention occurred. Gradually, as old machines are replaced, the part of the capital stock which has become obsolescent will diminish; more and more will be of a "modern" type. During all that time final product will be expanding, and wages rising. As wages rise, the rate of profit will decline, from the exceptional level reached just after the original invention, towards something more "normal". It will decline, though not before the modernisation has been completed, to the level which is appropriate to a steady state under the new technique; for the level of wages which is established in that steady state is the highest that can be achieved (except by diminishing Take-out) so long as there is no substitution and no new invention. We need not rely, to establish this conclusion, on the "classical" view that a declining rate of profit will diminish the incentive to save.16 Whatever be the nature of saving

448 propensities, an approximation to a steady state is likely to occur, if there is no further technical change. It will be a different steady state, with a different distribution of income, according as saving propensities take one form or another. But it will always be a steady state; and in that state wages will always be higher and profit lower than they were on the way to it. Now we can bring in substitution. If there is substitution along a spectrum of techniques - new techniques which would previously not have been profitable becoming profitable because of the rise in wages - the fall in profits will be slowed up. The effect of the substitution (in most cases at least) will be in the direction of adopting more capital- intensive techniques. These will probably, at their adoption, slow up the rise in final product; and that probably means that they will slow up the rise in the rate of real wages. (Since they are directed towards economising in labour, it is not surprising that they should slow up the rise in wages.) But - and this is vital - the result of the substitution will be to set the economy "aiming" at a steady state with a higher final product per unit of labour, and therefore (with any reasonable behaviour of take-out) a higher level of wages. There are several ways of establishing this essential proposition;17 the simplest, perhaps, is just to observe that in the steady state, when the system is fully adjusted to the new technique, every worker will have more "capital" to help him when the method of production is more capital-intensive.

What I have just been giving is no more than an exercise; it does no more than distinguish one causal sequence which in actual experience will be crossed and mixed up with many others. It does nevertheless appear that this sequence may be rather fundamental. The mainspring of economic progress, it suggests, is invention; invention that works through the rate of profit. Each invention gives an Impulse, as we may call it; but the Impulse of any single invention is not inexhaustible. The exhaustion is marked by falling profit; but the cause of the exhaustion (on the Full Employment, or double equilibrium path) is scarcity of labour. In saying this we are keeping, in substance, quite close to Mill. In Mill the "declining rate of profit" is due to scarcity of land; but there is no reason in principle why the operative scarcity should not be any natural scarcity. Mill's view that the operative scarcity was land scarcity can only be regarded as empirical; it looked like being right at the time when he was writing, but over the whole time since then it does not look like being right. The ultimate scarcity must be that of labour or of land (or both); formally, it must be scarcity of some non-augmentable factor of production. There are of course many other scarcities which will arise in the working - out of the Impulse; but scarcities that can be overcome by investment will not reduce the rate of profit on new investment in general. They will shift the point in the productive process where the investment is to be made, but that is all. It is only the irremovable scarcities which will ultimately compress the rate of profit. Once we recognise that substitution, on the spectrum of techniques, is just one way of overcoming the scarcities that arise out of the Impulse, many things fit into place. If there is no technical change, following on the original invention, other than that which is directly implied by the invention, the Impulse which it gives will soon be exhausted. Scarce factors will then get the full gain which accrues to them from the original invention, but no more. But if there is substitution, directed towards economising in those same scarce factors, the ultimate gain to them will be greater, and may well be far

449 greater. There may still be a question of how the gain is distributed between them. Taken together, however, they must gain in the end from the deferment of exhaustion. It is of little importance, from this point of view, whether the substitutions are supposed to take place along an unchanged "technology frontier", or whether they themselves partake of the nature of invention. The "technology frontier", useful as it has been in the formation of the theory, and still (perhaps) indispensable in the first stages of presentation, is in the end a piece of scaffolding, that we can take down. The puzzles about "induced invention" then give no trouble. We have just to define them as technical changes, the possibility of which is newly discovered in the working - out of the Impulse, and which are such that it would not be profitable to make them until the scarcities by which they are "induced" have developed. They thus appear as secondary inventions, "children" of the original invention, its "economic children"; for we may surely allow it to have other "children'' - technical children, "learning by doing" in a most extended sense - as well. The economies of scale, on which one school of economists lays such great stress, may well be introduced in much the same place. The great inventions will give great and long-lasting Impulses, because they have many "children", of all these kinds. It will clearly be difficult, in relation to contemporary experience, to draw a firm line between the primary invention and its "children", when the latter are so broadly defined. Where the distinction is drawn is bound to be a matter of judgement, or of taste. In relation to earlier ages, where claimants to primary status are less thick upon the ground, the distinction may be easier.18 One can certainly detect, in the nineteenth century, one major invention that gives a recognisable, and separable, Impulse - the railway. The Railway Age was an Impulse, the working - out of which is clearly visible, since there seem to have been at least a couple of decades in which no Impulse of comparable magnitude followed. Many economists (including sometimes Keynes) thought the Depression of the nineteen-thirties to be a Pause of similar character. That could be, but it does not have to be, since the Disequilibrium of the thirties can well be explained in other ways. It is impossible to tell its story without laying great stress upon the monetary aspect, which I have been disregarding; it may well be that it is right to tell the whole of its story in those terms. Yet there may be something more. It would be a great help if we knew, better than we do, if there was something more; for it would help us to understand the innovative process, as it works in this century, and so to know, better than we do, how far we can count upon steadiness in the flow of innovation. The study of past Impulses, with the aid of a better classification, might well throw much light upon this vitally important matter. I return, in conclusion, to the Theory of Wages problem - the consequence of maintaining a level of real wages which is higher than that which is appropriate for double equilibrium. After what has been said, we need not conceive of this problem in a static manner. The equilibrium wage-level may be allowed to be rising, but the actual wage- level is kept, all the time, somewhat above it. That this is a realistic problem cannot nowadays be denied; for the means that are available for the enforcement of such a wage- level are far more extensive than they were in the past. Granted this kind of a wage policy, what happens? There seem to be two main cases. It is possible, in the first place, that the higher wage might be matched by a lower take-out. A lower take-out would raise the (real) wage-level that was consistent with double equilibrium; so the lower take-out should permit of the higher wage being attained without unemployment. So far, so good; it should however be

450 noticed that if the course of the wage-level is established arbitrarily, fluctuations in take- out will probably be necessary in order to keep that arbitrary wage-level consistent with double equilibrium. The matter cannot be settled in this way once and for all. Secondly, suppose that the higher wage-level is not matched by lower takeout. I do not think it can be doubted that this also is a practical problem. For when we remember how much of the consumable product of modern economies is "taken out" for social purposes, the demand for which comes from much the same source as the demand for higher wages, we must surely recognise that the alleviation which can come from lower take-out is likely to be limited. Say then that all that can be done in this direction has been done. Say also that saving-investment equilibrium is to be preserved. (It will not be easy to preserve it, but most of what is to be said under that head is well known; I need not enlarge upon it here.) What, under these conditions, will be the course of the economy? The higher wage, as we have seen, will affect the techniques that are chosen for new investment; we may take it that they will, on the whole, be more capital-intensive than they would otherwise have been, at corresponding dates. Such techniques will in the end raise final output, per unit of labour employed, more than it would have been raised by less capital-intensive investment. But, all along, the volume of investment (in saving- investment equilibrium) will be lower than it would have been otherwise. Thus, although the economy is "aiming" at a steady state in which final consumable output, per unit of labour employed, is higher, employment along the path to that state (and - in principle - even in that final state) will be lower than it would have been. This, I now believe, is what I was trying to say in Theory of Wages; as will be seen, it is subject to many qualifications of which, when I wrote, I had no idea. But in substance the main point stands. That it is possible for a "developing" country, by choice of techniques that are too capital- intensive, to expand employment in its "modern" sector less rapidly than it might have done, is nowadays familiar. What I am saying is little more than an application of that same principle.

1. As seems suitable in this place, I shall confine this account to the evolution of my own ideas, without much attention to what I have learned from others. How much I have learned from others - especially, perhaps, from Roy Harrod, Joan Robinson and Nicholas Kaldor - will nevertheless, I hope, be apparent. 2. As I have explained in the Commentary attached to the second (1962) edition of Theory of Wages, especially pp. 333-41. 3. Crucial in the sense that it has been the major theme of controversy among economists. I accept that the aggregation problems, on the side of Product, are hardly less pressing. 4. Value and Capital (1939), p. 33 and passim. 5. The Production Function and the Theory of Capital (Review of Economic Studies 1954); and later writings. 6. I have stated my present views on the Production Function at greater length in Capital and Growth (1965) pp. 293-305; and in Capital and Time (1973) pp. 177- 84. 7. A Suggestion for Simplifying the Theory of Money (Economica 1935, reprinted in my Critical Essays in Monetary Theory, 1967). I have told the story of my "conversion" in Recollections and Documents (Economica, February 1973).

451 8. Capital and Time (1973) ch. 2. 9. Value and Capital ch. 17. 10. This is the principal point which the "re-switching" controversy is about. For further detail, see Capital and Time, ch. 4. 11. The disequilibrium which in a closed economy is revealed by physical stocks is in an open economy mainly revealed by foreign exchange - the balance of payments. For foreign exchange, in a modern national economy, is the easiest stock to run down, or pile up. 12. See especially Chapter 8 of the book. Also Capital and Growth (1965) chapters 7-l 1. 13. On Mill, see Capital and Time, pp. 58-62. 14. There is a much fuller discussion in Capital and Time, chs 9-10. 15. In the case of an open economy, the opening of a new market for an export, or potential export, will have a similar effect. 16. Nor even upon the sophisticated re-statement of the "classical" view that is due to Cassel (Nature and Necessity of Interest). 17. My own preferred way is that which is set out in Capital and Time ch. 10. 18. These ideas were not fully formed when I wrote A Theory of Economic History (1969), but I was working towards them. From Nobel Lectures, Economics 1969-1980, Editor Assar Lindbeck, World Scientific Publishing Co., Singapore, 1992 http://nobelprize.org/cgi- bin/print?from=%2Fnobel_prizes%2Feconomics%2Flaureates%2F1972%2Fhicks-lecture.html

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