Captured and jailed for ever

The objections of the French Central Bank governor Christian Noyer to the European Financial Transactions Tax is shocking, sad and comical – all at once. France is better off seeking competitive gains elsewhere and not in and through Finance.

Howard Davies, first and former Chairman of the UK Financial Services Authority (FSA) notes in a piece for ‘Project Syndicate’ that

too big to fail” is another area in which the initial post-crisis enthusiasm for global solutions has failed. The unfortunate result is an uneven playing field, with incentives for banks to relocate operations, whether geographically or in terms of legal entities. That is not the outcome that the G-20 – or anyone else – sought back in 2009. [Link]

Good heart no more?

I had modified Charles Goodhart’s name in the blog post subject header. I could not understand his defence of ‘Help to buy’ policy of the UK. He says it would trigger a supply response. Now, that can be said of any measure that boosts demand. Supply will respond, if profitable enough. The question is whether the economy is better off directing resources to housing or something else? How about tweaking the zoning restrictions and see if demand and supply find their own equilibrium instead of government stoking housing demand.

5% owner’s equity means LTV of 95% regardless of whether it comes from the government or the bank. I cannot understand why they harp on the bank’s LTV ratio being below 90. With London home prices about 7 times that of the rest of England, cannot see much value in keeping LTV north of 60% for London.

The final thing that beats me is when they say that this policy will help the government keep track of the housing bubble? Is the demand for housing going to come only from this policy? In fact, the whole point of the criticism is that this policy is not needed at all when London home prices have barely moved after the crisis of 2008 compared to markets elsewhere. The nominal interest rate is at 0.5% and real rates are massively negative already. So, housing did not need a government helping hand and demand exists outside of the ‘Help to Buy’ scheme. How can government keep track of it?

If a government wants to keep track of the housing bubble, is this the most efficient way of going about it? Real estate transactions, housing loans and home price data would suffice.

If this logic were true, can we extend the logic to monitoring stock market bubbles? The government can start a scheme to lend money people to buy shares and thus it can monitor if a bubble is being formed in the stock market.

Strange. Very strange.


There have been some interesting and rather useful exchanges on this blog on the issue of the survival of the single currency in Europe. Well, with EURUSD on its way to 1.40, we do not know if the survival question is better posed to Americans on their currency. Of course, a strong Euro may be a problem for the Eurozone. But, then, there are lags and lags and we do not know when and if there would be a day of reckoning for the Eurozone or the single currency. In any case, that is what we discussed in this post. Thoughts stirred by the comments by Anindya Mitra also led to this sequel article by Yours Truly in MINT.

While searching for articles by Luigi Zingales in, I came across a very thoughtful piece by Michael Bordo and Harold James on the Eurozone. The piece is titled, ‘The European Crisis in the context of historical trilemmas’ and it makes several interesting observations:

(1) The classic trilemma of monetary policy – fixed exchange rates, free capital flows and independent monetary policy – is extended into other areas with ‘independent monetary policy’ replaced by ‘financial stability’, ‘national policy indepenence’ and ‘democratisation’.

(2) The Eurozone worked quite well as a disciplining mechanism before it entered into effect, but much less well afterwards.

(3) When the democratic/popular backlash occurs, it takes the form of rejection of international/cross-border political commitment mechanism. Voters are surprisingly discerning. Opinion poll data shows a major increase in hostility to the EU in peripheral countries, but with no corresponding unpopularity of the common currency. Hostility to the EU is also evident in parliamentary elections results in Greece and Italy.

(4) The trilemmas are worse in the recent context because of the absence of an escape clause. In the absence of an exchange-rate option, there is a need for greater debt reduction, but that raises a politically awkward question of the distribution of losses between the private and the public sector.

This short paper by Michael Bordo and Harold James is worth reading and reflecting upon.

China Rating and Rebalancing

On the day FitchRatings (majority French owned) downgraded the outlook on US rating, it had also released a statement on China’s single A rating and how it was contingent on rebalancing occurring. There was also a small research note attached to that press release. Both were useful. The media ignored that, (un)surprisingly.

In fact, the sense one got that if the US AAA rating was undeserved (“The U.S. is the most heavily indebted ‘AAA’ rated sovereign, with a gross debt ratio equivalent to double that of the ‘AAA’ median.”- Fitchratings), then China’s single A rating too was rather undeserved and based on the arguments that Fitch had put out and on the basis of the evidence of the last two months (credit spigots opened up), there were both necessary and sufficient grounds to downgrade China or at least put its rating on a negative outlook already.

You can find Fitch press release here. It contains the link to the underlying report that has the analysis.

Inefficient selection

Mr. Luis Miranda pays a tribute to Eugene Fama in an op.ed for MINT. In his natural desire to sign the praises of the winner of the ‘Bank of Sweden’ prize for economics in 2013, he eschews conceptual rigour.

A market crash does repudiate efficient markets theory because, among other things, efficient markets postulate that financial markets (and hence asset prices) discount all relevant (publicly available) information instantaneously.

A crash is a ‘catch-up’ on the part of the market with information unless that information was really ‘news’ to the market.  Therefore, a crash reveals that financial markets (and investors) have not been linearly and continuously discounting relevant information. In other words, asset prices had decoupled from information. That is what a crash proves. Hence, one of the tenets of market efficiency is disproved by market crashes.

The presence of active fund managers,the search for and the willingness to pay for alpha repudiate conclusively market efficiency theory.

Like all theories in social sciences, it was at best a point of departure to analyse the real world. At worst, it was a comprehensive misrepresentation of reality. 

In recent years, Prof. Fama has rallied behind the calls (by Prof. Anat Admati) for banks to beef up their equity capital. He has signed at least one open letter to regulators to dismiss bank claims against having higher equity capital. So, I am prepared to ‘overlook’ his work on financial market efficiency. 

(p.s: Did not know until I went through this interview of Robert Shiller with the Washington Post newspaper that Janet Yellen and Prof. George Akerlof were couples. John Kay seems to mirror my thoughts on the bizarre logic behind the Nobel Committee’s selection of economists and their underlying philosophies).

Bubble vs. Bust

Well, the header of this particular blog post is misleading. The UK did not really have a housing bust. Yet, the Conservative government has come up with a housing bubble to boost economic activity. It is underwriting mortgages and is stumping up cash. Several articles have appeared recently against this. I present you links to them. Some of them may be behind a subscription firewall.

For a good understanding of the UK housing market, read the Martin Wolf article.

The head of Lloyd’s Bank has issued a warning. Coming from an industry member, it is tempered. But, the mere fact that an industry head felt compelled to voice it indicates the enormity of the risks that this scheme carries.

The best of the lot is the article by a FT journalist who moved back to London recently and is planning to move out again, because of the absurd levels of neurotic activity in London.

The UK credit boom – in less than five years after the previous credit boom and bust – is not just confined to the housing market.  UK consumers have taken to credit in a big way (again) to finance new car purchases. Car makers have turned to the UK because of sluggish conditions in continental Europe.

One of the underlying assumptions of the Chicago School of market economics (and, by extension, financial market efficiency) is the rational economic agent who weighs up all benefits and costs and discounts them correctly with an appropriate risk-adjusted discounted rate and uses sufficiently long horizons to estimate benefits and costs of his/her actions (or inaction). Such rational economic agents are supposed to counteract stupid and short-term policy decisions of governments. QED.


US debt crisis

I had not posted anything on this matter because there is far too much out there already. Newt Gingrich wrote something interesting in FT. Basically, he argued that why the Presidential elections of 2012 did not settle the debate on Obamacare. Some readers have exposed the fallacy of his claims on this matter, however. Clearly, I am no expert on Obamacare and its pros and cons. Hence, I am not going into it.

Societies cannot and should not abandon their less privileged to market forces completely. Yes, there is a need for carrots and sticks for individuals to take responsibility for their actions and consequences. But, as with most things in public policy, it is an art and not science and certainly there is no one size that would fit all.  It is about experimentation and being open to new ideas and facts as they emerge.

In any case, if Republicans are really serious about balancing America’s books (American deficits had actually exploded only under Republican Presidents), there are several other areas to focus on first.

My ‘superficial’ view is that, in the light of the massive build-up in measures of inequality in the US, it is both unwise and socially dangerous and divisive to focus on social welfare programmes as the areas of scrutiny in budget expenditure.

Regardless of how and when the debt ceiling issue is settled and the US government shutdown is lifted, this episode cannot have enhanced the image of America in any way. That point is well brought out by three FT journalists – Gideon Rachman, Edward Luce and Richard McGregor.

A word of caution: these three articles might be behind subscription firewalls.