The state of the labour market in the US and the Fed

New York Times had this painful article about how job openings for workers are shrinking. It made me do a chart of job openings/pool of unemployed workers in the US. The ratio was 0.16. There is only one job opening per six unemployed worker.  I wonder if the Federal Reserve acknowledges its role in bringing about this state of affairs. I do not recall any mea culpa from the current Federal Reserve Chairman. This great article in Washington Post adds another ‘feather’ to the Federal Reserve’s cap. The Federal Reserve simply chose not to regulate mortgage lenders even after they were acquired by banks.

I wonder what would happen to all the cheering that the Fed chairman gets for supposedly rescuing the US economy (and the world economy) from the brink if the asset price bubble that has been re-ignited bursts next year with disastrous consequences? Bubbles? Some readers might scoff at the notion as many stock indices and commodity prices are below their previous peaks. That is a flawed basis. A bubble in asset prices is a deviation from fundamentally derived prices – movement in price that cannot reasonably be attributed to fundamentals that normally determine those prices. If the global crisis and de-leveraging have re-calibrated those fundamentals (earnings in the case of companies or demand in the case of commodities) to lower levels, then the level of asset prices at which a ‘bubble’ definition is triggered would consequently be lower as well. A bubble is not defined by the level of stock prices but by its relationship to its fundamental determinants.

On a separate topic, when one reads an article like this, one has to wonder what the authors were trying to achieve. Within a few inches of the header, the journalists acknowledge the difficulty of justifying their header:

The extent of the write-ups is difficult to predict because of banks’ complex balance sheets and uneven use of accounting rules, but some experts believe the rallying credit markets could pave the way for billions of dollars in accounting gains.

It is not only the use of accounting rules that make a judgement difficult. We do not know the value at which banks are carrying these assets in their books. Most of the banks moved these securities from ‘Held for Trading’ to ‘Held for maturity’ and marked them at par. Second, the rally in high-yielding assets including that of bank debt actually forces banks to write up the value of debt issued, thus having to give up the gains they booked when the value of the debt they issued fell. That is indeed a strange accounting rule but enough has been written on that one.

So, without adequate and detailed investigation (not an easy task), it is hard to assign a value to the amount of gains banks would make with the rise in the value of ‘toxic’ assets

G-20 and related straws (mostly) from the FT barn

While FT reports that Presidents Hu and Medvedev both warned on the impact of the crisis on the world and on the rising fiscal cost of it in general terms, it is good to focus on specific developments in both countries. Bloomberg has this news on Russia and this is Wall Street Journal’s piece on one of China’s asset management companies (AMC) extending deadline to redeem a bond by a small matter of another ten years.  See this too.

These bonds were issued in 1999 when AMCs were set up to buy up bad loans from Chinese banks. The article says that they had managed to recover only 20% of the loans! Now, imagine what would be the recovery rate on all the bad loans that might arise from the recent loan binge, if China enters a era of lower growth.

Even as this blog post in FT links to the remarks of Spencer Dale of the Bank of England (Chief Economist?) warning of bubble consequences of central banks’ asset purchases, it also says that

The leaders are also set to agree on delay pulling back from their stimulus packages until recovery is secured

There is an interesting discussion over at Real Economics on ‘Economist.com’ on whether central banks should prop (asset bubbles) and pop, not prop but pop, neither prop nor pop, etc. I have posted a comment too under ‘jeevatma’. The comments by a ‘central bank staffer’ cited from Bradford de Long’s is extremely good. Do not miss that.

I think the policymakers’ intent or statements are one thing but the action is going to be the key. My guess, at this stage, is that withdrawal of stimulus  – monetary and fiscal – would be delayed. This would become evident in 2010 and that would set the stage for the next round of action in bond market and currency markets. But, I think this is the story for 2010.

While the FT says sniping among leaders marred the spirit of co-operation, one should be more understanding of that in the context of the laudable decision to put G-20 at the centre of global economic summitteering. It has got its sceptics but there has to be  a beginning. That has been made. These remarks are to be kept in mind, however:

In a world of proliferating G-groups, the one to watch is that nicknamed “G2” between the US and China.

Many in Pittsburgh have remarked upon the size and sophistication of China’s delegation compared to any other participant barring the US.

“If you want to find out what the world is going to do then take the US position and take China’s position and draw a line somewhere in the middle,” said David Rothkopf a former senior official in the Clinton administration. “As regards the G20, it would have been more efficient to kick Canada and Italy out of the G8 and invite China and India to replace them. But intergovernmental co-operation always adds, it never subtracts.”

Interesting that the FT says that it has seen the official final communiqué and that it would call up on

surplus countries – China, Germany, Japan and oil exporters – urged to raise domestic demand and deficit countries asked to reduce budget and trade deficits once the world has secured a recovery.

Evidently, they have not seen this thoughtful piece by Gideon Rachman. If the elections on 27th September in Germany throw a surprise (i.e., Left parties doing better), then it would set the cat among pigeons in the global capital markets.

This report filed in India’s Business Standard makes for amusing reading. It makes it sound as though India drove the G-20 agenda! Of course, it can be seen here and here too. So, it appears that the Indian Government got the media to sing in one voice.

Interestingly, came across this link in Bruegel (European think-tank) to a conference held in New Delhi recently on the International Co-operation in times of global crisis with views from G-20 countries. Looks like some rich pickings are there. Have not gone through them yet.

Paul Volcker’s scepticism

On the flight back from Zurich to Singapore, I caught up with Paul Volcker’s statement to the Banking Services Committee of the U.S. Congress (House of Representatives).  The full statement is here. He raises some uncomfortable questions:

However well justified in terms of dealing with the extreme threats to the financial system in the midst of crisis, the emergency actions of the Federal Reserve, the Treasury, and ultimately the Congress to protect the viability of particular institutions – their bond holders and to some extent even their stockholders – have inevitably left an indelible mark on attitudes and behavior patterns of market participants.
Will not the pattern of protection for the largest banks and their holding companies tend to encourage greater risk-taking, including active participation in volatile capital markets, especially when compensation practices so greatly reward short-term success?
Are community or regional banks to be deemed “too small to save”, raising questions of competitive viability?
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Does not the extension of support to non-banks, and even to affiliates of commercial firms, undercut the banking/commerce divide, ultimately weakening the commercial banking system?
Will not investors in money market mutual funds find reassurance in the fact that when push came to shove, the Treasury with an extreme interpretation of its authority, took action to preserve those funds ability to meet their declared commitment to pay their investors at par upon demand?

However well justified in terms of dealing with the extreme threats to the financial system in the midst of crisis, the emergency actions of the Federal Reserve, the Treasury, and ultimately the Congress to protect the viability of particular institutions – their bond holders and to some extent even their stockholders – have inevitably left an indelible mark on attitudes and behavior patterns of market participants.

Will not the pattern of protection for the largest banks and their holding companies tend to encourage greater risk-taking, including active participation in volatile capital markets, especially when compensation practices so greatly reward short-term success?

Are community or regional banks to be deemed “too small to save”, raising questions of competitive viability?

Does not the extension of support to non-banks, and even to affiliates of commercial firms, undercut the banking/commerce divide, ultimately weakening the commercial banking system?

Will not investors in money market mutual funds find reassurance in the fact that when push came to shove, the Treasury with an extreme interpretation of its authority, took action to preserve those funds ability to meet their declared commitment to pay their investors at par upon demand?

His comments on commercial banks undertaking risk y activities while enjoying Federal Safety Net are spot-on:

As a general matter, I would exclude from commercial banking institutions, which are potential beneficiaries of official (i.e., taxpayer) financial support, certain risky activities entirely suitable for our capital markets.

The point is not only the substantial risks inherent in capital market activities. There are deep-seated, almost unmanageable, conflicts of interest with normal banking relationships – individuals, businesses, investment management clients seeking credit, underwriting and unbiased advisory services. I also think we have learned enough about the challenges and distractions for management posed by the risks and complexities of highly diversified activities.

I do not know if Mr. Volcker would have approved of this letter but I am sure he would have relished reading it as I did.

I do support his support to  the Administration’s proposal to vest all regulatory powers within Federal Reserve, the institution, even if some market participants have legitimate doubts about the philosophical leanings of certain individuals who have led the institution and are still at the helm.

The reason is that  I do believe that regulators’ information on the state of the banking system should inform monetary policy and vice-versa. It is more efficiently feasible only if both responsibilities reside in one agency.

But, both functions should be assigned equal seriousness in terms of calibre, staffing, scope of mandate and autonomy of mandate. Further, both monetary policy-makers and regulators should be asked to specifically spell out (if not to the public) as to how they exploited the synergies of information they come across and diagnosis that they arrived at.

This framework would only enhance the credibility of both the regulatory process and monetary policy-making process. Suffice to say that the Federal Reserve is not there yet but that is no reason to propose a solution that does not address but compounds the problem. So, the great central banker is right on this one.

U.S. Flow of funds and other stuff

On Thursday, the U.S. Federal Reserve released its quarterly flow of funds data. Quite a few trumpeted the USD2 trillion recovery in household networth forgetting that it is still about 11 trillion below the peak. More interesting is the outright contraction in household and business debt levels. Of course, business debt has just come down in the second quarter whereas household debt has been falling for the last four quarters. Never in the last (nearly) six decades has household debt contracted.

Business debt did towards the turn of the 1990s.  Business debt contraction has happened despite record bond issuance this year. Total Corporate Debt raised in the U.S. this year until last Friday exceeds the total raised in the boom year of 2007. But, bond issuance is not feasible for SMEs. So, a real cleavage is developing in the American society, I guess. Plus, when government borrowing crowds out private sector borrowing by such a long distance, it is hard to see animal spirits returning to the underlying economy.  The stock market level is a marvel, really.

FT Alphaville has two posts with excerpts from David Rosenberg (now with Gluskin Sheff in Canada and formerly with Merrill Lynch in the US as their North America Chief Economist) on the levitation of the US stock market (that applies to most stock markets and other so-called risky assets, actually). The facts cited (compiled by him) are hard-hitting. Investors beware.

Separately, this post in defence of Barclays’ Protium Deal left me shaking my head. Is it a private sector solution when you move things from your right hand to your left hand? The question is at what price and why now, if the recovery is for real?

On the 17th September, C. Rammanohar Reddy had an interesting Op-Ed. on the approach of the Government of India to World Bank for a a loan to recapitalise public sector banks. He has concluded that it would come with conditionalities for financial sector liberalisation.  Perhaps, perhaps not. It is good to sound the bugle. The government needs to be transparent. In my view, the chances of that happening are low. Conditionalities on IMF/World Bank loans have come down these days.  Of course, I have to admit that I found myself shaking my head at the uncritical references to financial liberalisation in this IMF working paper. Habits die hard.

Second, the Government of India does not have the resources to do so, with its huge deficit. Tapping into central bank reserves is not the answer. The government has to borrow from the central bank.

However, terming Raghuram Rajan committee recommendations ‘market fundamentalist’ is a bit rich. He is not a fundamentalist although he would believe, like most other people, that on balance well-functioning, well-regulated and competitive markets do a better job than governments in creating prosperity. Any one who has read his book, ‘Saving capitalism from capitalists’ would not call him a fundamentalist.

Good friend Sushant had sent me the IE interview of Dr. Y. V. Reddy on the first anniversary of the collapse of Lehman Brothers. I, for one, do not hold the Federal Reserve or the U.S. government guilty of having erred on that. It is easy to be wise in hindsight on these matters. Some, of course, see a conspiracy to aid Goldman Sachs’s competitive position. We have no proof except conjectures – somewhat reasonable – but still conjectures.

In any case, I think Dr. Reddy correctly notes that “if Lehman did not occur, some other thing would have happened. Lehman was a symptom of a disease”.

What is interesting is that the preface to the interview refers to Dr. Reddy as the man who was hailed as having saved India from the full impact of the financial crisis because of the policies he followed.  But, one week ago, Shekhar Gupta had a gratuitous dig at the RBI while commenting on Indo-China relations.  SG was treading on slippery slope (to put it gently) when he compared China’s fiscal policy and aggressive (reckless?) bank lending responses to the crisis to what he termed as the ‘guarding the bureaucratic turf’ response of the Indian central bank.

I am not sure if he had a chat with P. Vaidyanathan Iyer before he wrote that paragraph. He may have a valid case against the control mindset at the RBI on other areas. But, forestalling the financial crisis was clearly a success story. RBI does have some lessons to teach other central banks and, finally, it is way too soon to write the final judgement on either the efficacy or the sustainability of China’s crisis response. For starters, he can read these remarks by the chairman of the China Banking Regulatory Commission.

As Op-eds. go, I found this one by Kishore Mahbubani, dean of the LKY School of Public Policy in Singapore, rather interesting, particuarly for its  last paragraph.

No comments required

Gilian Tett’s piece (h.t Christopher Wood of CLSA) in FT on the new vehicle that Barclays is setting up makes for very interesting reading. She uses the right word to describe this: Chutzpah!

I would check out this programme from Channel 4, ‘Middle Class and Jobless’. They do a good job of investigating the true state of the labour market in the UK. They follow a few individuals over 3 months to see if they land up with a sustainable, decently paid, full-time job. At the end of 3 months, the score was zero.

Similarly, BBC 2’s ‘Love of Money‘ is interesting. I watched Episode 2. Gordon Brown brags about his ‘light-touch’ regulation in 2006. But, in 2008 or 2009, when interviewed for the programme, he talks of the need for regulation. I am not sure why there was no cross-examination. Merwyn King’s remarks on the response of media and society even if the central bank tries to lean against the wind with verbal warning and admonitions was a thoughtful one. It appears that we are genetically programmed to boom-bust cycles, then.

Interesting omission was Bernanke while Bush was hauled over the ropes through the reference to the founder of Ameriquest, an aggressive mortgage lender whose founder turned a Republican Party donor and was later appointed ambassador to the Netherlands.

Recent data and comments

The press release that the Swiss National Bank put out today after announcing their interest rate decision makes for interesting reading. A hint of optimism is laced with lots of caveats. This one sentence caught my eye:

In addition, the US has acted as a locomotive driving global economic growth because of its strong demand for imported goods. However, should US consumers step up the process of debt reduction, the country might no longer be in a position to maintain this role, particularly since there is no other source of domestic demand that could fill it.

Former Chief Economist of the BIS, William White, has written an interesting article in FT. He is one of the very few who had a global systemic overview and saw what was coming. All the BIS annual reports and working papers that he authored or co-authored warned of the cataclysm that followed. He is still at it. The German magazine, Der Spiegel, did a good piece on him recently.

The FT article says that some forest fires should be allowed to burn as it would prevent the growth of underground and also future major conflagrations.  In other words, central bankers should allow for some long-term structural adjustments to take place instead of dousing each and every fire with liquidity. 

This is in line with the views expressed in another article, written by one James Rickards in Washington Post in October 2008 when he talked of how ski operators would set off mini-avalanches to forestall a big one.

William White has written a piece for the Federal Reserve Bank of Dallas in which he answers the question of whether central bankers should lean or clean. I have not read it yet. You can find it here.

In the meantime, it just struck me that the September Purchasing Managers’s index of the New York region showed inventories contracting still. Today, we received the older Philadelphia Federal Reserve Manufacturing diffusion index.  New orders dropped, inventories took a big dive and yet employment is shrinking faster than in August. Yet, the headline number showed a big jump!  The expected business activity in six months dropped back to levels last seen in May. The stock market is up again and again and again.

Oh, well.