Paper Profits

The concept of bank capital

“Not yet, Bank of America,” says the Fed, “but the rest of you guys go right ahead. Yes, even you, Citi.

Thus the second round of stress tests came to an end with the conclusion that key players in the banking system are sufficiently well-capitalized that they can be allowed once again to pay dividends to shareholders.

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Global Crisis, Global Reform

Capital Flows, Cross-border Banking, Shadow Banking, and the Dollar

Inspired by the recent yen kerfuffle, in which the G7 central banks intervened to take the opposite side of the speculators’ trade that was driving up the yen, let’s try to connect some dots on the way to drawing a picture of the monetary side of financial globalization.

First big dot, global imbalances. The big story is of course the Chinese trade surplus, and its counterpart the US trade deficit. For our purposes, more important is the mirror image of these trade imbalances in capital flows, meaning foreign asset accumulation in China and foreign borrowing in the US.

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Navigating the Turning Point

From MIT to IMF

By the evidence of the recent IMF conference, there is apparently now consensus that the global financial crisis has killed--“shattered” (David Romer), “destroyed” (Stiglitz)--pre-crisis academic economic orthodoxy. But that orthodoxy had many dimensions, and there is no consensus on where repair efforts are most immediately necessary.

Instead, we see a division of labor emerging in which everyone focuses on that one dimension where they feel themselves to have some special expertise. In such a situation, an overall map may be helpful for making sense of the reconstruction effort as a whole. Read more

IMF Calls for New Economic Thinking

Or Does It?

History will record that the IMF’s conference last week (March 7-8), titled ”Macro and Growth Policies in the Wake of the Crisis”, marked a turning point in mainstream economic debate within academia, probably only one turning point in the crooked road that lies ahead, but nonetheless a significant moment.

Olivier Blanchard, Director of Research at the IMF, struck the significant note in the opening minutes of the first session (2:50 in Session 1). According to him (and I paraphrase), before the crisis, mainstream economic thinking had converged on a beautiful construction in terms of monetary policy, namely “inflation targeting”. We had convinced ourselves that it was enough to focus our attention on one target (inflation), and one instrument (the policy interest rate) to achieve that target.

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Shadow Banks and Narrow Banks

A Money View

One enduring lesson of the crisis is the truth of the old saw “banking is as banking does.” It has never made much intellectual sense to confine attention to a particular class of regulated entities that are called banks, or to track the movements of their assets and liabilities while ignoring the assets and liabilities of entities doing functionally identical business.

If policymakers did so at one time, it was for practical reasons—they were responsible for the things called banks, and had some control over them as well. Non-banks, even if they were functionally identical to banks, were someone else’s problem, and a tough problem too since there were no very evident points of control.

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The Illusion of Control

Exit Strategies and the New Normal

Now comes the ECB testing the water for a possible rate rise, and at the same time the Fed testing the water for a possible stand pat.  The interesting thing is that both justify their policy with exactly the same argument—they are both trying to influence long run inflation expectations. 

The ECB wants to raise rates in order to send the message that it is prepared to be tough on inflation.  Rising commodity prices are seen as a harbinger of future inflation, so it is important to send a contrasting policy message now, as a harbinger of a different future.

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The Inherent Instability of Credit

What kind of “Minsky Moment”?

Ralph Hawtrey, the British economist whose textbook Currency and Credit was the standard for an earlier generation, saw financial instability as the abiding tendency of credit markets, and the attempt to tame that instability as the abiding task of central bankers.  His hope was that attentive discount rate policy could stem divergence, either upward or downward, before it built up strength and became unstoppable. Lender-of-last-resort responsibility brought with it an interest in avoiding the last resort.

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Brave New World

Financial Globalization and the Nation State

Today’s Financial Times articles: Swiss central bank discord provides a warning bell (Feb 24), Sovereigns turn to pre-crisis financial wizardry (Feb 24)

On facing pages in the print version of the FT, the reader is invited to consider the encounter of the modern state with the modern market. On the left hand page the story is about the central bank, on the right hand page the story is about the Treasury, and on both pages the story is about the continuing reverberations of the Global Financial Crisis and the changing role of both central banks and Treasuries as a consequence of financial globalization. Read more

A Money View of Global Imbalances

Who’s afraid of finance?

Today’s Financial Times article: “Bernanke says foreign investors fuelled crisis” (Feb 19, 2011).

The latest evidence is that Bernanke is moving in a money view direction, but he is not there yet. He is not yet moving from his “global savings glut” interpretation of the origins of the crisis, but he is adding a global portfolio dollar demand dimension to it. In a money view, we reason from the opposite direction.

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AIG on the Potomac

The Future of Government Mortgage Finance Support

Today’s Financial Times articles: White House seeks wind down of Fannie and Freddie (Feb 11, 2011), Debate on Fannie and Freddie’s fate looms (Feb 11, 2011)

The stockholders of AIG were wiped out because that company sold insurance on mortgage-backed securities that fell in value. Not only did it price its insurance too cheaply, but it also neglected to allocate capital reserves to the contracts that it wrote.

More or less the same was true of Fannie and Freddie, but without the associated capital resources of a global insurance conglomerate. The ultimate stockholder of Fannie and Freddie, so it turned out, was the U.S. Treasury, and hence the U.S. taxpayer. Read more