You can ‘bank’ on them – sequel

You cannot make this up. It is hard to believe but it is true. The industry is in distress. Many banks could have died. They gutted themselves and the economy in the process. Nearly so, in some countries and actually so in others. In Britain, banks are thrown a lifeline and there is a cost to the lifeline. A bank manipulates the charge on that lifeline so that it pays less! This is what Lloyd’s Bank did!! Some chutzpah!!! Read about it here.

I am really wondering – lest some think I am throwing mud – how this is thought of, approved (or executed without approval?) and reported? Or, does it go completely unreported and untraced? Hard to believe. What is really going on in the people’s minds who come up with such brilliant ideas? To bite the hand that feeds them and revives them from death? That must be an extraordinary moral fibre, so to speak.

Today, I received links to two blog posts from a person who knows a thing or two about banks and their conduct. The Posner blog post was embedded in the NY Times blog post. But, it is worth highlighting the Posner blog post separately as the sender did. You can read them here and here.

This news-item in FT on the New York Fed pressing banks hard on ethics has a line that says it all:

Fed officials were surprised that some of that reported behaviour occurred after the 2008 crisis, leading them to believe bankers had not curbed their poor conduct.

Included in the article is the link to another article that notes New York Fed’s displeasure at Deutsche Bank’s regulatory filings [Link]

There is another article that carries a pithy comment from the Head of the ‘Financial Conduct Authority’ in the UK:

Martin Wheatley, the head of the Financial Conduct Authority, said the sector’s capacity to “constantly surprise with bad conduct” was alarming, ………..[Link]

Banks were sending letters to clients who were in arrears on fake letter-heads of law firms.

Rajasthan CM gets it right

Now, let me confess that I have not studied the matter in detail besides reading some newspaper articles. But, this statement by the Chief Ministe of Rajasthan caught my eye.

“I believe if you look at reforms in this (labour) sector, it doesn’t go towards hurting labour; it goes towards improving the habitat for employment and that I think this is very, very important,” she said. [Link]

It is not only important to do the right thing but should also appear to do the right thing. She was correct to quickly dispel any impression that it is a pro-business reform. In fact, on most occasions, being pro-business and being a ‘reformer’ are inconsistent. Being ‘pro-market’ and ‘pro-reform’ are consistent. Market consists of buyers and sellers. Usually, whether it is a common good or luxury good, buyers are many and sellers are few (relatively). Therefore, the playing field is not level. These ‘few’ sellers are naturally bigger individually and collectively (in many cases) than that of the many buyers.

Therefore, any policy that is pro-business has to be weighed carefully for the impact it causes on the ‘many’ and for its optics.

Making the labour market flexible – easier entry and exit for labour – is good for greater entry. After all, the objective of any elected democratic  government has to be more employment and not more firing!

In fact, I recall Prof. Ha-Joon Chang writing in his book (’23 things they do not teach you about capitalism’) that unemployment benefits (with appropriate carrots and stick for active employment search and retraining) are the equivalent of bankruptcy protection for businesses. They make employees become less insecure and increase labour mobility. It affords them an opportunity for a fresh start if, for reasons beyond their control, they lose their jobs. It makes eminent sense.

Many so-called reformers would welcome bankruptcy laws but would frown at unemployment benefits as a drain on the State exchequer!

So, getting the reform discourse and communication right is as important as getting the reforms right.

[Although this Op.Ed deserves to be blogged on separately, read how businesses are ‘anti-market’ in the US context].

Good show, India

India’s decision to accept arbitration settlement on the sharing of sea-waters in the Bay of Bengal with Bangladesh deserves fulsome praise for its optics and timing, even if one does not understand the relative merits of the settlement.

This comes with many potential benefits. It is a solid demo. of India’s emphasis on  good neighbourliness. It shows Pakistan what it can gain, if only it stopped engaging and encouraging militants to hurt India. It shows up China in rather poor light, especially in the light of all that has been happening in Vietnam offshore and in Philippines-China disputes. India accepts an arbitration settlement whereas China refused to even consider arbitration proceedings legitimate. Further, while India’s ‘intransigence‘ in WTO is being attacked (wrongly, unfairly and unreasonably), this one shows that India can be flexible.
I only hope that India gained many other ‘quid pro quo’ – on infiltration, terrorism base, etc.  Overall, I think there is much to commend in this development.
Good show, India.

Panagariya endorses

Prof. Arvind Panagariya has picked up the information posted here in this blog about the paragraphs in the budget documents presented by Mr. Jaitley that praise the UPA government for fiscal prudence and fiscal corrective measures!

Yet more clues to the bureaucrats running the show appear in fiscal policy strategy documents, which extol rather than censure UPA’s fiscal management. While complimenting UPA for fiscal consolidation, the documents neglect to focus on its role in promoting unbridled and irresponsible expansion of expenditure schemes.

His full article is as hard-hitting as it should be and it is well worth a read.

Bretton Woods Re-visit

This year is the 70th anniversary of the Bretton Woods Conference held in 1944 that ushered in a fixed exchange rate regime, blending the good elements of the Gold Standard and the flexibility needed for policymakers to avoid something like the Great Depression of the 1930s. It was a well designed system. It ended because America did not wish to disinflate in the 1970s to restore competitiveness. It took the easier way out of running deficits and getting them financed from overseas. Towards that end, it pressed for global financial liberalisation with consequences that are playing out even today and will do so for the foreseeable future.

Why did America let the Bretton Woods collapse? A benign explanation is that America was always scarred by the memories of the Great Depression. It would never disinflate lest it became another Depression. Another expalnation – I like this one better – is provided by Varoufakis:

In 1971 US policy makers made an audacious strategic decision: faced with the rising twin deficits that were building up in the late 1960s (the budget deficit of the US government and the trade deficit of the American economy), Washington decided to turn a blind eye to them. Rather than imposing stringent austerity, whose effect would be to shrink both the twin US deficits and America’s capacity to project hegemonic power around the world, they allowed the deficits to rise….

…. But for Wall Street to act as a “magnet” of other people’s capital returns, it had to be unshackled from the US government’s stringent, 1960s-style regulations. Once finance was unshackled, greed had a field day. Wall Street’s greed and the laxity of regulation by the US government are usually taken as “givens,” as sociopolitical processes somewhat exogenous to the dynamics of US capitalism. They are explained, if at all, along the lines of pop sociology or “cultural studies.” In sharp contrast, my argument is that the laxity of regulation, the so-called “revolving doors,” as well as the increasing greed of Wall Street personnel, were all byproducts of a remarkable phenomenon: the emergence of the first global hegemon whose strength grew in proportion to its deficits. These deficits had to be financed by a constant influx of foreign capital into Wall Street, which required authorities to turn a blind eye to Wall Street’s shenanigans.

Source: Vicious Disequilibrium, Yanis Varoufakis, April 2014.

Be that as it may, there was a splendid look-back at that conference in Bretton Woods from the Indian angle by Niranjan Rajadhyaksha in MINT. It was brilliantly timed for the course I am teaching at IIM, Bangalore for II year students in the PGP programme. I had just finished lectures on Global Monetary Regimes.

Then, there is another one that looks at the possibility (somewhat hopefully) that China might peg its currency to Gold as the Bretton Woods did for the US dollar. For now, I am sceptical. But, well worth a read for it too nicely summarises the post-Bretton Woods years.

Real and pseudo crises

The distinction made by Schwartz ( 1986) between real and pseudo financial crises and its extension by Bordo, Mizrach and Schwartz ( 1995) to systemic risk has resonance for the recent crisis events. Schwartz argued that a real financial crisis involves a scramble for high powered money by the public fearful for the safety of their bank deposits, ie a banking panic or a threat to the payments system. Pseudo crises encompass “ a decline in asset prices of equity stocks, real estate, commodities;depreciation of the exchange value of a national currency;financial distress of a large non-financial firm, a large municipality, a financial industry, or sovereign debtors…” Schwartz ( 1986 page 12). In the case of a real crisis, the monetary authority should act as a lender of last resort and provide whatever liquidity is required to allay the public’s fears. In the case of a pseudo crisis there is no need for action.

In this framework , the recent events of a collapse in the US housing market and its consequences for wealth holders directly or indirectly exposed by derivatives represents a pseudo crisis which should not be the object of central bank intervention. However the spillovers of the subprime crisis into the interbank loan market and the freezing up of liquidity to the banking system in Europe and America did pose the threat of a real financial crisis and should have been dealt with by following the strictures of Thornton ( 1802) and Bagehot (1873) to lend freely but at a penalty rate. Bagehot placed primary emphasis on the Bank of England lending without hesitation on the basis of collateral that would be sound in the absence of a crisis. The penalty rate was to prevent moral hazard.

The actions of the ECB of flooding the money market with liquidity and the Fed of following similar actions and also reducing the discount rate by 50 basis points in August 2007 suggests that they heeded the first part of Bagehot’s lesson to lend freely on the basis of proffered collateral but not quite on the second part of lending at a penalty rate.

Finally we speculate on whether the recent financial crisis could have been avoided if the Fed had not provided as much liquidity as it did from 2001 to 2004. After Y2K when no financial crisis occurred, it promptly withdrew the massive infusion of liquidity it had provided. By contrast thereafter,it foresaw a series of shocks to the economy that might lead to financial crisis, eg the tech bust of 2001 and 9/11. In each case it injected liquidity, but when no financial crisis occurred , it permitted the additional funds it had provided to remain in the money market. In addition, it overreacted to the threat of deflation in 2003-2004 which may have been of the good ( productivity driven) variety rather than of the bad ( recessionary) variety ( Bordo and Filardo 2005).

Source: ‘The Crisis of 2007 :The Same Old Story, Only the Players Have Changed’ (Michael D. Bordo) – remarks prepared for the Federal Reserve Bank of Chicago and International Monetary Fund conference; Globalization and Systemic Risk. Chicago, Illinois September 28, 2007

A half-truth

There is an interesting interview of Alan Greenspan in CBS MarketWatch. Here is the link. This is what he says about the dotcom bubble:

The Fed tried in 1994 to defuse a bubble with monetary policy alone. We called it a boom back then. The terminology has changed, but the phenomenon is the same. We increased the federal funds rate by 300 basis points, and we did indeed stop the nascent stock-market bubble expansion in its tracks. But after we stopped patting ourselves on the back for creating a successful soft landing, it became clear that we hadn’t snuffed the bubble out at all. I have always assumed that the ability of the economy to withstand the 300-basis-point tightening revised the market’s view of the sustainability of the boom and increased the equilibrium level of the Dow Jones Industrial Average. The dot-com boom resumed.

It is an interesting observation. He might be partially right. But, he is also omitting to tell us that the bubble resumed not because the market’s view of the sustainability of the boom changed after withstanding 300 basis points but that he fanned it by becoming a cheerleader for the boom. He hastily made amends after wondering about irrational exuberance in 1996. He cut rates thrice in 1995 and raised them only once in 1997.  Market sentiment and his sentiment (waxing eloquent on once-in-a-lifetime productivity boost) reinforced each other. The boom became a bubble and then a bust. The veteran central banker is somewhat economical with truth.