Opinion

James Saft

Living through de-globalization: James Saft

Oct 23, 2012 04:00 UTC

Oct 23 (Reuters) – What was that you were saying about
globalization being inexorable?

A quick look at a series of under-appreciated recent stories
- a Sino-Japanese territorial spat’s real economic consequences
and a drop in both global trade and cross-border lending – shows
a world becoming less tightly integrated and a lot more
economically unpredictable.

The idea that the world will continue to become more
economically integrated, with an ever more complex global supply
chain and increasingly international corporations and banks,
lies at the heart of most mainstream economic thinking.

On this reading the undoubted power of globalization to
create more trade, wealth and profit – albeit unevenly
distributed – means that, over time governments and peoples will
come to exert less influence over their national economies,
giving up some power in exchange for higher growth.

That may continue to be true over the long term, but the
short term is looking quite a bit bumpier.

Japan posted some truly awful trade figures on Monday,
revealing a fall of 10.3 percent in exports in the year to
September. At root was a massive fall in exports to China,
driven in large part by tensions over a group of disputed
islands which sparked anti-Japanese protests in China, attacks
on businesses thought to be Japanese and even on cars made by
Japanese companies.

Japanese exports to China fell by 14.1 percent, accelerating
a fall of 9.9 percent in August. While Japanese imports of
Chinese goods increased by 3.8 percent, exports of cars to China
fell 45 percent and motorcycles 31 percent. Chinese tourist
traffic to Japan also fell, according to the Bank of Japan,
doubtless for the same reason.

As the dispute only caught fire on Sept. 11 when Japan moved
to nationalize the islands, known as Senkaku in Japanese and
Diaoyu in Chinese, the October data will be even worse.

To be sure, the poor data is in part about weakness in the
economy of China, which, islands aside, is still wanting less
industrial equipment, but it is also a salient reminder of the
fragility of the preconditions for increasing economic
integration.

And it’s not just Asia. The global economy may be in the
midst of a rare outright decline in trade, driven by weakness in
the euro zone and elsewhere, but abetted in subtle ways by
changing post-crisis attitudes about risk, income and wealth.
Global trade contracted for the second month in a row in July,
according to the CPB Netherlands Bureau of Policy Analysis, and
decreased in five of the first seven months of the year.

Coming so quickly on the huge 12 percent decline in global
trade in 2009, this is a sign both of the poor health of the
global economy, with troubles from Europe radiating outwards,
but also of a growing tendency for governments to try to cut
their risks from sovereign credit problems elsewhere.

LOAN DATA KEY

There are perhaps two key lessons about banking that
national policy-makers and regulators have learned in the past
five years, and both are arguably creating conditions less
friendly to global financing and global trade.

First, it is easy for a country to be brought low by its
banking system, even if the bad loans were made mostly overseas.
See Iceland for an example of how a swollen banking system
created state liabilities larger than the electorate was willing
to bear.

Second, even if your banks are lending to highly rated
borrowers, like, oh, say, Italy or France, if that sovereign
becomes distressed so may your banking system.

While it is impossible to see clearly from outside, the data
indicates that banks in general, likely pushed by their
regulators, are becoming less friendly to overseas finance,
including trade finance. This is giving national authorities
more control over their banking systems, a key form of
de-globalization, but is crimping trade and integration at the
same time.

New data from the Bank for International Settlements showed
a sharp contraction in cross-border lending in the second
quarter, which fell by 1.9 percent, driven in part by banks
seeking to get out of loans to borrowers in troubled euro zone
countries. Global interbank lending fell even more sharply, by
$609 billion, or 3 percent, in what was the fifth-biggest
quarterly contraction on record.

You can make a case that when, or rather if, the euro zone
gets its institutional house in order interbank and cross-border
lending will resume its upward march, driving and enabling
further globalization as it does.

That may be true but it will be a long time before bank
regulators, much less bank risk managers, take as relaxed a view
of lending overseas, even if it is loans made to a foreign
branch of the same bank.

Black Monday and the Greenspan put: James Saft

Oct 19, 2012 19:11 UTC

By James Saft

(Reuters) – The big milestone this week is not the 25th anniversary of the Black Monday crash but falls a day later when we mark the far darker advent of the Greenspan put.

The Greenspan put, the now long-established policy of easing and appeasing when markets go cold, arguably created the world in which we live – one of low growth, bubbles and, every once in a while, huge busts.

On Monday, October 19, 1987, the U.S. stock market crashed, along with falls in Asia and Europe, culminating in a 22 percent tumble in the Dow.

The exact causes are still in dispute, but currency tensions played a role, as did proposed legislation to take away some of the tax advantages of high-yield merger financings.

Margin calls, as ever, exacerbated falls, as did a then-new phenomenon, the program trade, which helped to drive volumes to then stratospheric levels and gave rise to a feeling that the machines had taken over.

Into the breach stepped Alan Greenspan, just months into an 18-year tenure as chairman of the Federal Reserve. Early the following Tuesday, the Fed came out with a statement, one which will seem very familiar to those who participated in the other crashes, panics and simple malaises which have been the defining financial feature of the past 25 years:

“The Federal Reserve, consistent with its responsibilities as the nation’s central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system.”

The Fed followed up by using open market operations to drive interest rates down to just below 7 percent, a fall of more than 50 basis points on the day. (At the time the Fed didn’t announce interest rate changes, it simply went into the market and transacted them into being.)

The response, like a kid given its first sugary soda, was electric, with a strong rally winning back a small portion of the earlier losses. The Fed kept at it in the coming months, operating quite publicly, and often giving trading desks advance notice, and repeatedly taking overnight interest rates lower.

These actions helped to deaden some of the negative effects of the crash, but helped to set a pattern which leads to where we are today: in a world with fewer and fewer accurate price signals.

PRICE SIGNAL MASKING

One easing campaign does not make an appeasement, so Greenspan over the coming decades kept at it, stepping in time and again when markets grew fretful.

In what came to be known as the “irrational exuberance” speech in 1996, Greenspan made plain, by statement and by omission, that his was to be an asymmetric policy, one which meets tumbles by putting out a safety net but which doesn’t seek to stem bubbles when they are brewing.

“How do we know when irrational exuberance had unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?” he said in his speech at the American Enterprise Institute.

“We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs and price stability.”

But whenever Greenspan was actually confronted with a bust, he recognized that it did threaten to impair growth and price stability. That fact was obvious from 1987: if you will cut to ease a panic, of course you will do it again.

Greenspan cut rates sharply following the Russian default and the Long Term Capital Management crisis in 1998, and again in 2001 when the Internet bubble popped.

The problem with this policy, which Bernanke has largely pursued, is that it is a trap for those who make policy and a reaction-numbing drug for those who are affected by it.

The real impact, for investors and for the economy, is to substantially lessen and obscure the price signals that the economy and markets should normally generate.

Crashes, while destructive, tell us things, like, in the case of the housing crash, to stop lending people money they had no hope of paying back to buy houses they could not afford.

Or take a current example: U.S. Treasuries, some of which virtually guarantee that the buyer will lose purchasing power over time. Is the price telling us that growth and inflation will fail to appear? Or simply that the Fed, with about a tenth of the outstanding stock of Treasuries on its books, is an 800-pound gorilla?

An economy without feedback from price signals is like a body which can’t feel pain, the little things bother you less but the big things may very well kill you.

(At the time of publication, James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft )

(Editing by Chelsea Emery)

Helicopters’ faint whirring heard in UK: James Saft

Oct 17, 2012 20:14 UTC

Oct 17 (Reuters) – It is one thing when commentators burble
on about the possibility of outright central bank financing of
deficits, it is quite another when a viable candidate to lead
the Bank of England is reported to be thinking along these
lines.

Reported of course is different from said, but a speech last
week by Adair Turner, outgoing head of Britain’s Financial
Services Authority and a candidate to be the next governor of
the BOE, may serve as a warning or a promise, depending on your
view of money printing.

Turner, after ticking off the already extensive list of
support the BOE has given to the Treasury and economy, held out
the promise of more:

“We need to be ready if these measures prove insufficient,
to consider further policy innovations, and further integration
of different aspects of policy – to overcome the powerful
economic headwinds created by deleveraging across the developed
world economies.”

Nothing but a hint there, but shortly thereafter two
respected journalists, Robert Peston of the BBC and Simon
Jenkins of The Guardian, reported that Turner believes that the
BOE should simply forgive some bonds issued by Britain which it
owns.r-bank-of-england

Given the opportunity to back away from the suggestion over
the weekend at the IMF meeting in Japan, Turner hung the idea on
Peston, who referred to the idea as “helicopter money,” an image
borrowed from a 2002 speech by Federal Reserve Chairman Ben
Bernanke.

“The whole point of my speech on unconventional policies was
to provide a justification of what we have done over the last
three months in terms of unconventional policies,” Turner said.

“I pointed out there were other things we can do. As for the
specific idea of cancelling gilts or permanent monetization, I
have to say that was reported by my good friend Robert Peston,
but that was Robert’s idea, not my idea.”

That is not saying “never” or “I am not currently
considering that.”

While that could simply be a canny would-be central banker
keeping his options open, his approach stands in marked contrast
to that of Bernanke, who went out of his way recently to combat
fears that the U.S. central bank was monetizing or planned to do
so.

“Monetizing the debt means using money creation as a
permanent source of financing for government spending,” Bernanke
said, going on to stress that his support of the economy would
taper or reverse when the bank sold Treasuries or allowed them
to mature.

INEXORABLE

My guess is that, regardless of who leads the BOE, this
represents an advance in what feels to be an inevitable slide.
Once introduced, especially under current circumstances, the
conversion of large-scale secondary market purchases of
government debt by central banks to outright monetization has an
inexorable feeling to it. Firstly, monetization is hard to
resist in a situation of extremis. If a government fails to be
able to finance itself at what it considers an acceptable price
it is hard to see the central bank making things worse by
selling alongside panicking investors. Far more likely is that
the central bank plays the role of its own government’s lender
of last resort.

Secondly, once we accept the rationale that conventional
monetary policy is no longer effective and therefore
quantitative easing is justified, it is simply another logical
step to buy and destroy debt, rather than buy and hold. Given
that the BOE owns UK bonds equal to about 25 percent of all debt
stock and yet conditions are still, if not deflationary, pretty
dire, the argument seems to apply as well now to monetization as
it recently has to temporary QE. Allowing bonds to mature,
effectively tightening policy, makes no sense within this
argument, if you accept it.

Bernanke’s preferred definition of monetization, that it is
“permanent,” is canny but hard to swallow. First, nothing is
permanent, especially a government printing money; nature and
markets will bring it to an end even if the central bank will
not. As well, permanent hangs on the intention of the bank,
which is harder to credit than its actions.

The somewhat terrifying prospect however is that, like
conventional monetary policy, perhaps QE and its ugly cousin
monetization really don’t work in the current circumstances, at
least as practiced. It is not as if the evidence, based on the
experience in Japan over decades and more recently in Britain
and the U.S., is all that supportive.

This leaves behind the rump risk, which is inflation, or
rather inflation fed by panic. It will not be easy to get
everyone else, who after all still own 75 percent of UK bonds
and 90 percent of Treasuries, to simply stand still while the
central bank monetizes.

EU deserves Nobel for literature: James Saft

Oct 16, 2012 04:03 UTC

(James Saft is a Reuters columnist. The opinions expressed are his own)

By James Saft

(Reuters) – Rather than peace, or even, at a stretch, economics, perhaps the European Union should get a Nobel Prize in literature, as it is a work of imagination, creation, and, at least for a time, the suspension of disbelief.

This is not necessarily a criticism.

The Nobel Committee awarded the EU this year’s peace prize, citing what it said was the evolution from being “a continent of war to a continent of peace.”

That can’t be gainsaid, but what is also remarkable is the way in which, as we witnessed the knitting together of the euro area, rational people, investors who prided themselves on only acting in their own cold self-interest, failed to appreciate the underlying structural absurdities.

We bought it, we believed the story; and for the best explanation for how and why we must turn to Samuel Taylor Coleridge, who in 1817 described how an author can coax the reader into the “willing suspension of disbelief for a moment” by imbuing romantic characters and unlikely events with what he called “a semblance of truth.”

How else do we account for all of those pension fund managers and investors who bet on narrowing interest rate differentials between Greece, Spain, Italy and Germany, despite easy to obtain and real indications that the players had both the ways and means to play one another for fools. And moreover, that the EU itself had no adequate protection against this. “Ode to Joy” was definitely playing in the background when they made those allocations.

How do you credit the unworkable halfway house of a common currency without common taxation and fiscal policy? How do you have a common central bank which is expressly forbidden from playing any central bank’s ultimate trump card: financing its government? How do you support a system in which banks rely on governments, governments on the central bank but the central bank, which is unelected, can neither fully support nor sanction its clients?

To do this participants had to, in essence, close their eyes and buy into a pleasant fiction, one which may have had peace as a byproduct but which was in no way grounded in economics, even if you define economics broadly as a very social science.

Big people were going to do big, important and good things and there was more money to be made going along for the ride than nitpicking.

HARD ROAD

This tells us a lot about the psychology of financial markets, which can build confidence on confidence with little foundation. It tells us a lot less about the future of the euro area.

The EU, and with it the euro, is a fundamentally romantic notion and enterprise, and as such it is extremely difficult to judge what will happen from, as it were, outside the marriage.

Just consider, as we head towards this week’s EU summit, all of the huge uncertainty over what will be reformed, by whom, and even which countries will participate.

Greece, rapidly running out of money, will probably be unable to agree by the summit yet another package of measures with its sponsors at the EU, ECB and IMF. Germany and France are preparing to do battle yet again over austerity. Movement may happen towards a needed central framework of bank supervision, overseen by the ECB, but the workability of that is seriously undermined by the fact that ultimately banks are guaranteed by governments and ultimately, failing fiscal unity, governments can still pursue divergent policies.

This is only underscored by the somewhat embarrassing modesty of the proposal for a federal euro zone budget, which would only be used as a cushion and which is already opposed by Finland.

All of this is to say that the euro project faces huge and complex difficulties getting from where it is to some place where its continued existence in current form is not in serious question. None of this is to say that won’t happen: as a romantic, and worthy, exercise it is less subject to the normal distribution of probabilities.

What is worrying though is Coleridge’s use of the phrase “for a moment” to modify “willing suspension of disbelief.” When I covered the European bond market in the run-up to and after the advent of the euro the structural problems which are now so plain were the obsession of a minority. The rest went along with the narrative. Now that the illusion is punctured it will be much harder to get the majority to play along.

That may not be a full explanation of why the EU deserved the peace prize, but it is definitely why it got it.

(At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on)

Are small investors really that bad?

Oct 4, 2012 19:59 UTC

(James Saft is a Reuters columnist. The opinions expressed are his own)

By James Saft

(Reuters) – It has always been a tenet of faith in markets that individual investors are the financial equivalent of shark chum, forever bamboozled by news flow and buying high and selling low.

A close reading of the data reveals that things might not actually be all that bad.

If so, we might just have to revise our views, not just of individual investors but also of the role and contribution of financial advisers.

The classic view is that small investors are far too prone to being overwhelmed by news flow, selling out after plunges and buying after stocks or markets surge. This is known as the “behavior gap,” that margin between a market-neutral outcome and what we actually achieve in our fumbling.

Much of the intellectual underpinning for this view comes from the annual Quantitative Analysis of Investor Behavior report by analysis firm DALBAR, which attempts to measure the effects of investor decisions to buy, sell or hold mutual funds. here

A dollar cost-averaging investor, for example someone saving for retirement through regular systematic investment, would see huge differences in their returns depending on when in their savings the market had good or bad years.

If someone saves $1,000 a year and the market doubles in the first year but remains flat over the next nine, their dollar-weighted return would be 1.7 pct annually, against a market rate of 7.2 percent. Conversely, if the market is flat for nine years and then doubles in the tenth, they will handily beat the market, with a dollar-weighted return of 12.3 percent vs the same 7.2 percent for the market.

Interestingly, the average equity fund investor, for all her supposed foibles, actually managed to outperform systematic investors over the past 20 years, according to the study.

WHAT’S AN ADVISER FOR?

Given that we are at the end of a decade of lousy returns which was preceded by a decade of good returns, it is no wonder then that individual investors look to have lagged the markets, but this may have little to do with stupid behavior and everything to do with issues outside their control.

This is all a bit of a head-slapper for me. I’ve always believed that individuals make lemming-like decisions which open up opportunity for professionals.

If this is less true than we’ve assumed, then we need to have a look at where advisers actually create value for their clients. Believe me, I take as jaundiced a view of the average person’s ability to manage their own investment affairs as anyone, and yet one plank of that argument seems to be crumbling beneath my feet.

I haven’t got a lot of faith in the average investment adviser’s ability to pick stocks or even to allocate among asset classes – I simply don’t subscribe, for the majority of people, to the belief that trying to beat the market is fruitful.

Instead, I think advisers can really add value by changing behaviors among their clients, by educating them, frankly, to the risks and rewards so that their clients make better provision for the future.

It may be that hosing down investors when they are hell-bent on buying or selling isn’t really that much of a value generator. That doesn’t, however, mean that there aren’t client patterns of behavior which could profitably be changed.

Undersaving, based on an overly optimistic view of either future earnings or future investment returns, is one area, but advisers who are brutally honest about this have always risked losing their clients to other firms selling pipe dreams.

One other possibility worth considering is that the aggregate numbers on market timing are not that bad but that they contain huge numbers of people who are taking on far too much risk by moving in and out in size too often. Clearly those people would benefit from a nice, calm adviser.

In the end, though, we may just have to give the average market plunger a bit more respect than they’ve been getting – they may be as bad as we thought, but we can’t quite prove it.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by Walden Siew)

The monetization game: James Saft

Oct 3, 2012 20:33 UTC

(James Saft is a Reuters columnist. The opinions expressed are his own)

By James Saft

(Reuters) – The issue isn’t whether the Federal Reserve and European Central Bank are monetizing debt now, it is instead whether their actions make them more likely to later.

For both institutions the game is to get the benefit out of buying up government debt, with all the very considerable benefits that brings in current circumstances, while retaining the market’s faith that when things get too wild they will unwind their purchases.

It isn’t that the Fed, or ECB, is monetizing the debt, but rather that they are putting themselves in a situation where reasonable people might expect that they possibly would later. Not will, but might, but that is a big risk to introduce into events in and of itself.

Fed Chairman Ben Bernanke battled against this view in a speech this week in Indianapolis in which he attempted to dispel doubts about the U.S. central bank’s policies, including the belief that it is monetizing debt – printing money for the government’s use – which will fan inflation.

“Monetizing the debt means using money creation as a permanent source of financing for government spending,” Bernanke said. here

“In contrast, we are acquiring Treasury securities on the open market and only on a temporary basis, with the goal of supporting the economic recovery through lower interest rates. At the appropriate time, the Federal Reserve will gradually sell these securities or let them mature, as needed, to return its balance sheet to a more normal size.”

The key word there is temporary, and the key question is: who says?

The market’s faith that the Fed will control inflation is now based, at least in part, on its pledge to take the right actions to stem inflation if and when it becomes too high. So far, obviously, the Fed retains the confidence of savers and investors, and indeed it is fighting an uphill battle against money which is moving too slowly around the economy due to a general preference to pay down debt.

Consider the Fed’s position if it found itself with its current balance sheet but inflation expectations suddenly become unmoored, an unlikely but possible scenario. Would the Fed really under those circumstances join the market in selling Treasuries, sending interest rates very sharply higher?

Perhaps, but, especially given that it is already a very active and influential participant in the Treasury market, the temptation surely would be to continue to buy Treasuries or to accelerate purchases. There would be all sorts of compelling arguments in favor of continuing to buy debt, and even then under Bernanke’s definition it would not be monetization if his intention was to later sell the debt. It might even be the right thing to do. Other market participants, with very different motivations from the Fed’s, understand this and if they think it likely they will act accordingly.

ECB OUT ON A LIMB

This is not too far from the position the ECB is in with Spanish and other weak euro zone sovereign bond markets. ECB chief Mario Draghi, faced with disintegrating support from investors for doubtful euro debt, made the pledge in late July to do “whatever it takes to preserve the euro.” ECB support is conditional on countries making pledges of reform and change, and agreeing them as part of a bailout package. ECB purchases will also be sterilized, meaning that when the ECB buys a Spanish bond it will sell a Dutch one, or something else in its portfolio, keeping the amount of money stable.

Even so this implicit guarantee has every possibility of eventually turning into an explicit one, according to fund manager Jochen Felsenheimer at Assenagon Credit Management in Munich. Peripheral euro debt has rallied splendidly exactly because the expectation is that the ECB will step in if need be.

But what would the ECB do in an extreme situation? What happens if Greece, Spain, Italy, Portugal and France require aid? You may say that’s not likely, but it is impossible to say that if it does happen the ECB will definitely continue to sterilize its bond purchases.

“Seem from a game theory point of view, the ECB’s announcement only works if things never go that far,” Felsenheimer writes in a note to clients.

“The way in which this approach works can be likened to the policy of deterrence used in the Cold War. As long as nobody winces, nothing happens, If somebody winces, everyone loses.”

It is impossible for the ECB to have it both ways: you can’t pledge unlimited support without reckoning with that support’s implications and risks. Of course it is impossible, and would be foolish, for the Fed or the ECB to publicly discuss this in any way other than how they have, because doing so would only increase the risk of a bad outcome. Again, the disaster doesn’t have to come.

Fed and ECB bond buying may or may not be wise policy, but taking their defense of their policy at face value is definitely unwise for investors.

(At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on)

Promises, lies and the interbank market: James Saft

Oct 2, 2012 04:08 UTC

(James Saft is a Reuters columnist. The opinions expressed are his own)

By James Saft

(Reuters) – Maybe it is time to accept that there is no such thing, really, as a free and independent inter-bank lending market.

That’s because a genuine bank loan market, at least one which would be allowed by regulators and participants to exist, must be founded on some combination of good collateral, which is vanishingly scarce, and faith, which has gone away on a long trip.

Understanding why puts us a bit closer to reckoning with exactly how false and officially supported financing markets are, a realization which manages to be both terrifying and strangely reassuring.

Interbank lending, the lifeblood of financing, is, where it is functioning, increasingly based on doubtful or illiquid collateral swapped among banks which are often acceptable only because they have government backing and access to central bank funding. This is particularly true in the euro area, where the European Central Bank seems to go ever further to support bank liquidity.

Against this background, the proposed reforms of the London Interbank Offered Rate (Libor) take on a kind of bitter irony, even necessary and well-intentioned as they are.

Reuters parent company Thomson Reuters Corp collects information from banks and uses it to calculate Libor rates according to specifications drawn up by lobby group the British Bankers Association, which will no longer be involved.

Britain’s Financial Services Authority will try to salvage Libor, which has been deeply damaged by a rate-fixing scandal, taking responsibility for direct oversight, widening the number of banks which participate and making manipulation of the rate for financial gain a criminal offense.

Libor was manipulated in at least two ways: kept too low by banks which lied about the rate at which they could borrow in order to appear more sound; and jigged this way and that by a couple of basis points by traders seeking to profit privately.

Euribor-EBF, which sets the euro zone version of Libor, is considering similar reforms, but is exploring using actual borrowing rates, rather than a bank’s own estimates of its cost of funding.

The reforms are all well and good, but like most lies, the London Interbank Offered Rate required assistance from all sides – banks, investors and regulators.

Credit, or the lack of it, is a vicious or virtual cycle, depending on your outlook. In pre-crisis days banks raised funds freely and cheaply in the interbank market. The realization that some banks might be, or shortly become, bust froze that market, requiring government and central bank backing and intervention.

COLLATERAL SCARCITY

Nowhere has this intervention been more stark than in the euro zone, where the ECB has taken on increasing amounts of both banking and sovereign risk in its efforts to make up for the failures of securitization and the interbank market.

Now it has always been true that in a system with banking insurance and fiat money, one where the government creates money without holding collateral, banks ultimately are creatures of government, only able to exist with government backing, and subject to rates of borrowing which are dominated by government policy.

The ECB has gone further and further to support its banks, and in a circular way, their weakened sovereign backers, accepting a wider array of collateral, pledges against promises, doing funding for unlimited amounts and longer periods and now even taking collateral in foreign currencies.

Despite all of this, the amount of “good” collateral available in the system has been in short supply, as lenders increasingly insist on higher-quality pledges and as more of it ends up parked with the ECB in exchange for cash.

“There is a difference between scarcity and shortage. Scarcity is a fact and not a problem per se. Allocating scarce resources through prices is the way our economies work. The problem would be a shortage of collateral and/or an impaired price mechanism,” Benoît Cœuré, member of the Executive Board of the ECB, said in a speech on Monday.

He argues that this is not the case, but the facts tend to argue back. There has been a huge growth in non-marketable securities – mostly bank loans – pledged to the ECB in recent years. The other huge growth area of collateral pledged to the ECB has been covered bank bonds, a type of over-collateralized bond accepted by the central bank as part of its long-term refinancings.

This is really the definition of a false market, one held together and dictated largely by fiat from on high, rather than real price discovery at ground level. Libor too, though it may be on a tighter leash, will still at a very real level be dependent and determined by government and still set against a backdrop of manipulation.

That might be better policy, but it is still not a real market.

(Editing by James Dalgleish)

(At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on)

Market whistles merrily as Romney sinks: James Saft

Sep 19, 2012 20:20 UTC

Sept 19 (Reuters) – Mitt Romney’s chances of capturing the
White House dwindle almost daily and financial markets seem not
bothered a bit.

Not only have equity markets been buoyant and government
debt stable but also both markets show every indication of
paying more attention to the fate of Europe and to extraordinary
central bank measures than to the election.

Romney’s chances of defeating President Barack Obama in
November are down to 33 percent, according to wagers placed
through Dublin-based online betting exchange Intrade, down from
44 as recently as Aug. 27. Since then the S&P 500
has gained 4 percent, and stands 10 percent higher than
late-June levels. The interest the U.S. must pay to borrow money
for 10 years has risen to a still historically low
1.78 percent from 1.64 percent in the same period.

The election has developed not necessarily to Romney’s
advantage, to paraphrase Emperor Hirohito at the surrender of
Japan. Romney, famously, told wealthy supporters that 47 percent
of Americans will back Obama regardless, consider themselves
victims and entitled and that “my job is not to worry about
those people,” remarks secretly recorded at a $50,000 per plate
fundraiser at a private equity executive’s Florida mansion.

Given events and given the markets, you have to conclude
that either investors don’t believe the odds or are actually
pretty comfortable, or pretty unsurprised, at the prospect of a
second Obama term.

None of this is to advocate for either candidate’s policies,
and it would be a grave error to assume that rising stock
markets are always a positive indicator of a nation’s health,
financial or otherwise. It is also important to remember that
whichever candidate wins the presidency, his ability to enact
policy will depend in very large part on the disposition of the
House and Senate.

And, of course, it is possible that markets change their
minds about the impact of an Obama victory as the possibility
grows nearer, and as the tranquilizing effect of the Fed’s
latest round of, now open-ended, bond buying, fades.

TAXING, SPENDING AND PRINTING

To the extent that politics are driving markets the main
macro issues would be taxation and spending. And while there are
huge differences in the two candidates’ plans, both sets of
policies may have positive or negative impacts on markets,
depending on your outlook.

Obama is proposing to raise tax on long-term capital gains
to 20 percent from 15 percent, and keep current rates for
couples earning less than $250,000. He would also keep a planned
3.8 percent Medicare tax on long-term capital gains and
dividends, which Romney would eliminate. Romney would keep the
zero and 15 percent rates on some dividend and long-term capital
gains, but eliminate tax on capital gains, dividends and
interest for those with adjusted gross income below $200,000.

Those are all figures which argue for a better stock market
reception for Romney, and the fact that we aren’t seeing the
prospect of these lower taxes slipping away have an effect may
simply mean the market was never counting on them.

Both candidates are proposing fiscal tightening, though
Romney hasn’t released enough detail to allow for a true
side-by-side comparison for next year. Generally it would be
fair to expect deeper cuts, over time, from the Romney camp,
cuts which would, by definition, reduce the amount of cash
flowing into corporate tills.

And there is the threat of the fiscal cliff, over which the
U.S. will plunge, with automatic spending cuts and tax hikes, in
2013 if no agreement is reached. The fiscal cliff would be toxic
for equities, and any electoral result which makes it less
likely will be good news for equities.

The only scenarios which would be bad – no, terrible – for
bonds are a loss of confidence in the U.S. or a recovery, both
of which are remote prospects. If we fiscal cliff-dive, the
ensuing recession will drive yields still lower and, perversely,
even a downgrade of the U.S. may back a short-term rally in
government bonds as investors seek to compensate for increased
risk by selling still riskier things like stocks and corporate
bonds. If we slowly, or quickly, reduce the deficit, growth will
suffer and bond prices rise.

The real underlying force in financial markets isn’t
politics but monetary policy, as the Federal Reserve yet again
pulls out the stops in an effort to breathe life back into the
economy. Conventional wisdom is that the ECB has vastly reduced
tail risk out of Europe, which is a huge boon. Even the Bank of
Japan is once again adding to the global liquidity party,
announcing the latest in an as yet unsuccessful series of bond
purchases.

Column: Banks, bailouts and texting and driving: James Saft

Sep 18, 2012 05:01 UTC

(James Saft is a Reuters columnist. The opinions expressed are his own.)

By James Saft

(Reuters) – The idea that a brush with death will change a lucky escapee’s priorities apparently does not apply to bailed out banks.

While you might be pulled from the smoking wreckage of your car and decide to stop texting while driving, the banks which got government injections of capital during the financial crisis concluded, it would seem, that the problem was that they were not pressing the buttons fast enough.

A new study by the Bank for International Settlements, the so-called central banks’ central bank, shows that not only did the bailed out banks not cut back on risk in their lending into the syndicated loan market after being defibrillated by their governments, they actually increased it relative to the market and banks which did not get rescued. here This is both astounding and totally predictable. Astounding because it was so clear that those risks were not just foolish but destructive. Predictable because of course the banks realized that they had not been just lucky but had been given a special exemption from death which will be very hard to revoke.

The study looked at the behavior in the syndicated loan market of a group of 87 banks from industrial economies, accounting for about half of global banking assets, 40 of which took public capital. The syndicated loan market, in which banks originate and distribute loans, is a key source of company funding and is used to fund mergers, recapitalizations, investment or simply ongoing corporate need.

Predictably, the banks which got bailed out were those taking the biggest risks in the syndicated loan market before the crisis, according to the study, making more leveraged loans with high interest rates, and making loans with longer maturities. Their loan books also got hit with more credit downgrades after the crisis broke.

They were also, according to the study, not being paid enough compensation for the risk before the crisis, not just in absolute terms, which given the debacle is obvious, but even relative to the go-go market in which they were operating.

“During the crisis, rescued banks did not reduce the riskiness of their new syndicated lending compared to their non-rescued peers. In fact, our results suggest that the relative riskiness of their lending increased,” the authors of the study Michael Brei and Blaise Gadanecz wrote.

Banks which did not take government coin cut their participation in the riskier leveraged market by about a quarter and made loans in with an average margin which was 36 basis points less. Bailed out banks, in contrast, upped slightly their share of leveraged lending and were paid higher rates. While they upped pricing to make it better in line with risk, it was by a small enough amount that it was not statistically significant.

POLICY OR SELF-INTEREST

It is possible, of course, that getting banks to continue making silly loans was exactly the intention of the bailouts. After all, global funding markets reached a rate of near shut down, and the knock on impact to the real economy was massive and, much like the lending, indiscriminate. Interestingly, bailed out banks raised loan prices more in their home markets than abroad, so clearly they were not simply doing their patriotic duty having been pulled from the fire.

And of course, the same set of incentives were still broadly in place for bankers, though compensation was limited at some firms which were bailed out. Since capacity was being artificially supported, and since bankers get paid for doing deals rather than not driving their firm out of existence, it is only natural that those at banks with hard proof they would not be allowed to explode would continue lending.

You could argue that the truly toxic combination is too-big-to-fail status and zero interest rates. With rates at virtually nothing at the short end, and not much higher two, three or five years out, large banks can no longer count on the sort of net interest margin which has been their traditional lifeblood.

Today’s market is a big contrast to the late 1980s and early 1990s, when the U.S. banking industry was allowed to heal and recapitalize, helped along by a big differential between where they could borrow for short periods and lend for four or five years.

Loan demand also simply is not all that great, especially in the U.S., though there is a huge supply/demand mismatch in the dicier parts of Europe. This has pushed banks towards using their cheap borrowing privilege and ample liquidity to simply speculate in the kind of propriety activity which proved so expensive and embarrassing for J.P Morgan.

With the Fed pouring on more quantitative easing, and with no real sign that too big to fail will be dealt with effectively, moral hazard and risky banking seem to be more a feature than a bug in the global financial system.

At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com and find more columns atblogs.reuters.com/james-saft)

(James Saft)

Banks, bailouts and texting and driving: James Saft

Sep 18, 2012 05:01 UTC

Sept 17 (Reuters) – The idea that a brush with death will
change a lucky escapee’s priorities apparently does not apply to
bailed out banks.

While you might be pulled from the smoking wreckage of your
car and decide to stop texting while driving, the banks which
got government injections of capital during the financial crisis
concluded, it would seem, that the problem was that they were
not pressing the buttons fast enough.

A new study by the Bank for International Settlements, the
so-called central banks’ central bank, shows that not only did
the bailed out banks not cut back on risk in their lending into
the syndicated loan market after being defibrillated by their
governments, they actually increased it relative to the market
and banks which did not get rescued.This is both astounding and totally predictable. Astounding
because it was so clear that those risks were not just foolish
but destructive. Predictable because of course the banks
realized that they had not been just lucky but had been given a
special exemption from death which will be very hard to revoke.

The study looked at the behavior in the syndicated loan
market of a group of 87 banks from industrial economies,
accounting for about half of global banking assets, 40 of which
took public capital. The syndicated loan market, in which banks
originate and distribute loans, is a key source of company
funding and is used to fund mergers, recapitalizations,
investment or simply ongoing corporate need.

Predictably, the banks which got bailed out were those
taking the biggest risks in the syndicated loan market before
the crisis, according to the study, making more leveraged loans
with high interest rates, and making loans with longer
maturities. Their loan books also got hit with more credit
downgrades after the crisis broke.

They were also, according to the study, not being paid
enough compensation for the risk before the crisis, not just in
absolute terms, which given the debacle is obvious, but even
relative to the go-go market in which they were operating.

“During the crisis, rescued banks did not reduce the
riskiness of their new syndicated lending compared to their
non-rescued peers. In fact, our results suggest that the
relative riskiness of their lending increased,” the authors of
the study Michael Brei and Blaise Gadanecz wrote.

Banks which did not take government coin cut their
participation in the riskier leveraged market by about a quarter
and made loans in with an average margin which was 36 basis
points less. Bailed out banks, in contrast, upped slightly their
share of leveraged lending and were paid higher rates. While
they upped pricing to make it better in line with risk, it was
by a small enough amount that it was not statistically
significant.

POLICY OR SELF-INTEREST

It is possible, of course, that getting banks to continue
making silly loans was exactly the intention of the bailouts.
After all, global funding markets reached a rate of near shut
down, and the knock on impact to the real economy was massive
and, much like the lending, indiscriminate. Interestingly,
bailed out banks raised loan prices more in their home markets
than abroad, so clearly they were not simply doing their
patriotic duty having been pulled from the fire.

And of course, the same set of incentives were still broadly
in place for bankers, though compensation was limited at some
firms which were bailed out. Since capacity was being
artificially supported, and since bankers get paid for doing
deals rather than not driving their firm out of existence, it is
only natural that those at banks with hard proof they would not
be allowed to explode would continue lending.

You could argue that the truly toxic combination is
too-big-to-fail status and zero interest rates. With rates at
virtually nothing at the short end, and not much higher two,
three or five years out, large banks can no longer count on the
sort of net interest margin which has been their traditional
lifeblood.

Today’s market is a big contrast to the late 1980s and early
1990s, when the U.S. banking industry was allowed to heal and
recapitalize, helped along by a big differential between where
they could borrow for short periods and lend for four or five
years.

Loan demand also simply is not all that great, especially in
the U.S., though there is a huge supply/demand mismatch in the
dicier parts of Europe. This has pushed banks towards using
their cheap borrowing privilege and ample liquidity to simply
speculate in the kind of propriety activity which proved so
expensive and embarrassing for J.P Morgan.

With the Fed pouring on more quantitative easing, and with
no real sign that too big to fail will be dealt with
effectively, moral hazard and risky banking seem to be more a
feature than a bug in the global financial system.

At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at jamessaft@jamessaft.com and find more columns at)

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