Sunday, 14 September 2014

The Co-Op story: a tale of two banks

Over at Pieria, I've posted the text and some of the images from the presentation I gave at the UK Society of Co-operatives conference on September 7th 2014 at the University of Essex. It's the full story of the decline and fall of the Co-Op Bank. Well, not just the Co-Op Bank.....we often forget that there were two banks involved in the Co-Op disaster. One of them was a mutual, but perhaps not the one that you might expect.

The post can be found here.

Monday, 8 September 2014

United Queendom

Oh, this is fun. Bob Denham of EconFilms has turned the economics of Scottish independence (and, let's be honest, the politics too) into what he describes as a "romantic comedy". Cue Rachmaninoff, please...

The mini-series ‘United Queendom’ tells the story of a gay couple on the verge of separation. The couple argue over oils (for the bath), who controls the credit card, membership of ‘The Club’ and whether they should aspire to be like their neighbour, the Scandinavian Model.

With 10 days to go to the referendum and polls showing it will go to the wire, the series is an attempt to get more people engaged in the debate – particularly those who can’t vote but are affected, such as people in the rest of the UK.

Here's what Bob has to say about it:
‘The more people can relate to the debate, the better – and nowhere is that more true than on the economics of a possible break up.’  
He adds:
‘This series is universal. I want everyone in the world to be able to watch and take part.'
I should add that this is not the first time Bob has lampooned a Very Serious Subject. His last online comedy: 'A Very European Break Up' on the European debt crisis has received over 300,000 views and featured in national and international press in countries such as Germany, Greece, the Netherlands and Spain.

The trailer for 'United Queendom' can be found here:

If you'd rather jump in at the deep end, the whole mini-series is here

Enjoy. (I did...)

Thursday, 4 September 2014

Don't pin all your hopes on SME asset-backed securities

Here's a neat chart from JP Morgan (h/t @debtnerd)

(larger version here)

What it says, essentially, is that although the total amount of Euro SME loans currently in issue looks sizeable, by the time you have removed all the loans that would be ineligible for securitisation and purchase by the ECB for one reason or another, there is not much left. Securitising and purchasing 10.3bn Euros worth of SME loans is not going to make a great deal of difference to the distressed periphery.

So the idea must be that the presence of the ECB in the SME ABS market would spur loan issuance. To make a significant difference to credit conditions in the periphery and repair the broken monetary policy transmission mechanism, that loan issuance would have to be simply huge and concentrated in periphery countries. There are several problems with this, to my mind.

Firstly,it makes a huge assumption about the scale of potential demand for credit in the periphery from creditworthy SMEs. Is discouraged demand really that huge - or is there actually a problem with the creditworthiness of potential borrowers, because of the widespread destruction of physical and human capital in the periphery? Distressed corporate loans in the periphery are far higher than in the core. That's why spreads are so high. Why would an SME ABS programme improve the creditworthiness of borrowers?

If the underlying problem is borrower creditworthiness, then it is difficult to see how the SME ABS programme could generate the huge additional loan issuance required to kickstart growth, even with ECB purchases. Unless.....we saw in the US that demand for ABS could encourage lenders with no "skin in the game" to reduce lending standards and even indulge in outright fraud to increase the volume of loans for securitisation. Although the ECB says it is planning to limit purchases to the highest quality SME loans, how would it ensure that this was the case in practice, especially if there turned out to be not very many high-quality SME borrowers in the periphery? I'm sure Blackrock, which is advising the ECB on the design of this scheme, won't have forgotten about the problems in the US - but is it familiar enough with the very different European marketplace to avoid creating opportunities for fraud and sharp practice?

It's also worth remembering that mortgage-backed securities in the US were first created by the GSEs (the first was issued by Ginnie Mae) and were originally designed to be packages of prime mortgages only. Including subprime in the mix was a later development intended to raise returns on junior tranches. If the Eurozone's SME ABS are to be tranched, presumably the ECB would only buy senior tranches - in which wouldn't there potentially be a similar temptation to include poorer-quality loans in the mix to improve the returns to private sector investors?

And what about the regulators? The Eurozone does not have full banking union: supervision particularly of smaller lenders remains at national level. One of the problems in the US was the fragmentation of the regulatory infrastructure - and a fragmented regulatory infrastructure is exactly what there is in the Eurozone, too. National regulators could be under pressure to cut corners from governments anxious to kickstart growth, and from lenders and securitisers anxious to prove they are doing their bit (and improving profitability). Tight regulations are useless if the institutions are too weak or too captive to enforce them. The flawed institutional design of the Eurozone is itself a serious risk to this programme.

So as far as I can see, the SME ABS programme is either going to be too small to make much difference, or is likely to encounter serious problems with loan quality at some point, putting the ECB's balance sheet at risk. I'm particularly worried by the way in which SME ABS purchases by the ECB is being promoted in some quarters as the primary means of "fixing" the periphery (though Draghi himself does not make this mistake). If only we can get credit flowing to periphery SMEs, the thinking goes, all our troubles will be over. This is simply not true. SME ABS purchases cannot substitute for flawed institutions and inadequate fiscal and monetary support. And even more importantly, they cannot compensate for a lack of creditworthy borrowers.

Central support for hard-pressed SMEs in the periphery would probably help to repair those economies. But the ABS issuance and purchase programme alone will not be enough. In the absence of other measures, reliance on such a programme would simply create moral hazard for lenders, securitisers and regulators.

Without German support, QE in the Eurozone remains a distant dream

Q. What further monetary easing measures do I expect the ECB to announce?

A. Maybe a few basis points off interest rates.

Q. Will they announce QE?

A. No.

Q. Why not?

A. Because the ECB needs the Germans to co-operate, and at the moment they aren't co-operating.

There's a fuller explanation at Forbes here.

And the deeper story behind Draghi's Jackson Hole speech at Pieria here.


Wednesday, 3 September 2014

Draghi's Jackson Hole speech has been misunderstood.

At Pieria, I dissect what Draghi actually said at Jackson Hole on 22nd August, and conclude that he has not called for short-term monetary and fiscal stimulus to kickstart growth, as some have argued:
"Some analysts have claimed that this speech was Draghi's “Abenomics” moment. Nouriel Roubini argues that Draghi has outlined a similar “three arrows” approach:
  • structural reforms in periphery countries
  • fiscal easing focused on investment and on demand stimulus in the core
  • quantitative and credit easing
But Roubini, like others, ignores the context of this speech. It is not fundamentally about restoring growth in the short term. Nor is it about the balance of monetary and fiscal policy, or about the responsibilities of core versus periphery. In fact it is not about short-run economic policy at all. It is about unemployment."
Specifically, it's about cyclical unemployment becoming structural, and the prospect of permanently elevated unemployment, a lower participation rate and lower trend growth. A whole generation thrown on the scrap heap.....

Draghi's proposals for addressing this are radical. Read more here.

Monday, 1 September 2014

Fiscal pessimism

At Pieria, I discuss the inadequacy of monetary policy and the implications of the Fiscal Theory of the Price Level for the conduct of government policy. There needs to be a greater role for fiscal policy, and an end to the fear of debt and inflation that is preventing governments from taking the actions required to restore growth. But this means reversing the prevailing direction of economic thought for the last 30 years:
"In the present situation - what Sims calls “fiscal pessimism” - FTPL predicts disinflation. Fiscal pessimism means that people look with horror at rising government debt burdens and future fiscal commitments such as those arising from an ageing population, and think “how on earth are we going to afford this”? They expect much higher taxes in the future and/or serious cuts to spending programmes. If this is also combined with very low interest rates, so they make little or nothing on their growing holdings of government debt, they feel poorer even though their nominal wealth is actually increasing. They may therefore cut discretionary spending and increase precautionary saving in compensation, causing a disinflationary trend....
"It is all very well observing that hope seems to have departed and people appear to have resigned themselves to a depressing, and depressed, future. But why are people so pessimistic? What – or who - has convinced people that government debt levels are unsustainable and there is significant pain to come? In a word, economists."
Read the whole post here.

This is the second of several posts at Pieria covering topics discussed at the recent Lindau Meeting for Economic Sciences. The first post can be found here

Sunday, 31 August 2014

Fear the fear

"Debt isn't always bad, fearing inflation is stupid and governments should spend far more, suggest top economists", reads a headline in the Guardian. Reporting on proceedings at the Lindau Economics Meeting last week, Philip Inman highlights Christopher Sims's lecture "Inflation, Fear of Inflation and Public Debt", in which Sims argues that fear of both inflation and government debt is driving the developed world into a never-ending slump. As Inman explains, the timing and location of this speech are particularly telling:
Sims was well aware he was speaking in a Germany that fears inflation much as the villagers in the Asterix comic books fear the sky falling on their heads. Without naming Angela Merkel, he said anyone who feels threatened by inflation is stupid.

But actually it is worse than that. Fear of inflation is not just stupid, it is dangerous. And the Germans above all should understand this.

Popular mythology in Germany has it that the Weimar hyperinflation of 1922-23 led directly to the rise of Hitler. This is not true. The Nazi party was formed soon after the end of the First World War, but it struggled to achieve electoral success throughout the 1920s. In the German election of 1928, the Nazi party only managed to win 12 seats in the Reichstag. Four years later, in 1932, it was by far the largest party, winning 230 seats with 37% of the vote. What changed during that time?

Here is an excerpt from a speech given by German Chancellor Heinrich Brüning in 1931, at the height of the Great Depression in Europe (my emphasis):

"I will do my utmost to prevent any inflationary measure of any kind, not only in the spirit of justice, not only to protect the weak, but also because it is my opinion that the honest balance of the German economy has to be recreated, in spite of all bitterness, and that any attempt and any request for inflationary measures only can have the goal in mind to foil this process of establishing a clear balance, to pull another veil over the mistakes over the past. Successes in foreign policy can be achieved all the faster, if we are able to present to the world an honest and clear balance of the German finances and the German economy, for everybody to study.

This is the strongest and most efficient weapon the Reich government had, and to forget this weapon was the task of this administration in its first year. Because of it, public opinion all over the world, without exceptions, now takes a completely different point of view when it comes to the reparations, when compared to years past. Domestically it has to be similarly. Many social and professional tensions would have not become that acute, the political right-wing radicalism would not have gained that much strength, if certain healing processes would have been begun earlier, if the surgeon's knife would have cut earlier and more radically in the private as well as public economy.

Brüning used the memory of the earlier Weimar hyperinflation, together with popular hatred of war reparations, to justify extreme austerity measures. And because the scars left by that hyperinflation are so very painful, he got away with it. When the Reichstag threw out his austerity budget, it was imposed by presidential decree. Among other things, sickness benefits and pensions were cut, unemployment insurance was reduced and workers were required to pay higher contributions. There was also a brutal internal devaluation caused by deliberately tight monetary policy: during the two years of Brüning's chancellorship wages, salaries, rents and prices fell by 20%. The result was similar to the Hoover/Mellon liquidationism in the US: it made what was already a deep recession triggered by a financial crisis far, far worse. By 1932 unemployment was nearly 30%, RGDP was falling by 8% per annum and everyone had had enough. Hitler won the 1932 general election with a landslide. The rest, as they say, is history.

It was fear of inflation, fear of debt and fear of extremism that enabled the Nazi party to come to power.

Related reading:

Germany's hyperinflation-phobia - The Economist

The Greater Depression - Brad Delong (ProSyn)