From The Times
December 18, 2008
The party's over if deflation grips the economy
We explain why falling prices could wreak havoc with your finances
Inflation is tumbling and fears are growing that deflation, where prices actually start falling, may become a feature of the economy next year.
This week the Office for National Statistics reported that the consumer prices index (CPI), a key measure of inflation, fell to 4.1 per cent last month, down from a high of 5.2 per cent in September. Jonathan Loynes, chief European economist at Capital Economics, the consultancy, says: “November's CPI figures are another step along the path that is likely to lead to the first bout of deflation in the UK for almost half a century.”
While falling prices may sound great, deflation is actually considered bad for the economy. When prices fall, consumers defer purchases on the assumption that they will be able to buy the same goods cheaper at a later date. This damages demand which can undermine company profits, trigger unemployment and entrench a destructive economic cycle.
Here we explain what falling prices might also mean for your savings, investments, pension, house price and mortgage - and how to guard against the worst effects.
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Q&A: deflation
Spending power down in 70% of households
Savings
To some extent, deflation is good news for savers because it increases the size of deposits relative to prices, making them more valuable in real terms. However, the downside is that the rates on savings accounts are likely to tumble if deflation takes hold because the Bank of England would reduce the base rate to 0 per cent or close to it. Savings rates are already falling fast. At the start of October, when the base rate was at 5 per cent, you could lock in to accounts paying an impressive 7 per cent. But now, with the base rate at 2 per cent, the most you can earn is about 5.5 per cent.
Returns in Japan, which suffered a decade of deflation, are close to non-existant. Simon Somerville, of Jupiter Asset Management, says: “The most you can earn from a Japanese bank account is about 0.4 per cent, but most pay nothing in interest. It is no wonder that many Japanese savers have abandoned banks and put their cash in safes or under the mattress.”
Savers in the UK may not end up quite so badly off, but only because our banks desperately need to bolster their finances. Some may continue to offer decent rates, as it is one of the easiest ways for them to raise money. So the pitiful state of the UK's banking system could yet offer a silver lining for savers.
Kevin Mountford, of the comparison website moneysupermarket.com, says that the best way for savers to guard against falling returns is to lock in to a long-term fixed-rate account. He says: “The best one-year fixed rate is from Anglo Irish Bank, at 5 per cent, but be quick as such rates could disappear soon. It is probably safe to lock up savings for up to two years, but any longer and there is a risk that the base rate - and savings rates - will start moving higher again. Nationwide is offering a two-year Isa bond paying 4 per cent.”
Pensions
Deflation could wreak havoc with retirement plans, especially if the problem persists for years. As prices fall, so will corporate profits and stock market investments. Given that many individuals and companies rely on shares to fund pension growth, many savers will have their retirement plans cast into doubt. Tumbling share prices have already wiped nearly a quarter off the average personal pension fund in the past year.
Even investors in final-salary plans, which guarantee a pension based on income, could hit the skids. As companies struggle to finance their pensions, the remaining final-salary schemes could close en masse. Even the Government, which backs the biggest final-salary scheme of all for public sector workers, may be forced to take drastic action, perhaps closing it to new entrants.
Tom McPhail, of Hargreaves Lansdown, the independent financial adviser, says that anyone approaching retirement should consider locking into an annuity sooner rather than later. He says: “As long as your pension fund has not been decimated by the recent stock market turmoil now might be a good time to buy a retirement income because annuity rates could well fall over the coming year or so. If you can afford to do so, deferring your state pension could also help. Provided that you are prepared to take the longevity and political risk - by which I mean that you don't think that you will die any time soon and you trust the Government to meet its promises - then you can boost retirement income by 10.4 per cent for every year you defer taking your pension.”
Those who are already retired could be among the few winners. Benefits, including the state pension, are linked to the retail prices index and can't be cut if inflation goes negative. The worst that can happen is that benefits remain unchanged. Many pensioners have fixed incomes, so inflation erodes their spending power. If prices drop, they will be able to buy more with their pensions.
House prices and mortgages
Homeowners are already experiencing deflation, with the average house price having fallen by almost 15 per cent over the past year, according to the Halifax.
Deflation in the wider economy would be a further blow because mortgage debt would increase in real terms, by becoming more expensive relative to prices. Fionnuala Earley, Nationwide's chief economist, explains: “Inflation tends to be good for borrowers, as it shrinks the real size of debt. In inflationary periods, wages also tend to rise, making it easier to meet mortgage payments. If there were deflation, debt would hang around longer and even grow in real terms, as wages would not be increasing and prices in the shops would be falling.”
Sadly, there is little that borrowers can do to mitigate the effects of deflation. Melanie Bien, of Savills Private Finance, the mortgage broker, says: “The first step is to keep up with your repayments. The mortgage should be your priority; everything else should be paid after that. You can also help by reducing your mortgage by overpaying. If you are lucky enough to have a tracker mortgage, you could overpay by the amount you are saving from lower interest rates.”
Most lenders will let you overpay by up to 10 per cent of your mortgage each year without penalty.
Ms Bien adds: “If you have an interest-only deal, it is worth considering switching to a repayment mortgage to ensure that the capital is paid off by the end of the mortgage term. This will mean significantly higher monthly payments, but it will be worth it in the long run. Speak to your lender about switching - it is very straightforward and can usually be arranged over the phone.”
Recent housing market history gives no indication whether residential property would be viewed as an attractive investment during a sustained period of deflation. Mortgages would continue to be available but the miserable experience of overextended borrowers could result in widespread aversion to debt, particularly among members of the younger generation.
At the same time, the lack of any meaningful returns from savings might persuade some people with spare cash to put it into property because bricks and mortar would be a tangible asset in an unfamiliar and insecure environment.
Additional reporting by David Budworth
Japan still licking its wounds
The most recent guide to what deflation might mean for UK investors is to look at what happened in Japan in the 1990s, writes Mark Atherton.
When Japan's property and stock market bubble burst with a vengeance in the early 1990s, the country experienced a prolonged period of deflation.
With consumers reluctant to spend because of falling prices, the economy stagnated, company profits fell and the stock market tumbled. The Nikkei index stood at nearly 39,000 at the start of the 1990s but now stands at a lowly 8,500, even though deflation has been eradicated for the time being.
John Hatherly, of Seven Investment Management, says: “What happened was that everyone started to draw in their horns and conserve their cash, rather than put it into assets that were falling in value. Investors deserted shares and property for safer havens.”
One of these safe havens was government bonds. Mick Gilligan, of Killik & Co, the stockbroker, says: “Investors reckoned, correctly, that the Japanese Government would not go bust and that government bonds were a safe bet, even though the interest they paid was small.”
Corporate bonds, on the other hand, tend not to fare so well in deflationary times because, with profits falling, there is less money to cover the bond interest payments and there is always the possibility of defaults on the payments or a collapse in the value of the bond itself if the company goes bust.
http://www.timesonline.co.uk/tol/money/consumer_affairs/article5366383.ece
Tuesday 23 December 2008
Monday 22 December 2008
'Savers are going to have to step up to the risk plate at some stage'
'Savers are going to have to step up to the risk plate at some stage'
The real prospect that rates will fall to zero is a nightmare scenario for those that rely on savings income to bolster their day-to-day living expenses.
By Paul FarrowLast Updated: 7:31AM GMT 11 Dec 2008
Comments 2 Comment on this article
It is hard to imagine savings rates at nil - but it happened in Japan, where savers had no choice but to deal with the harsh reality of not getting a return on their money.
Take a look at this excerpt from the newswires in July 2006 when the Bank of Japan decided to raise rates for the first time in six years from zero to 0.25pc.
"Mizuho Financial, Japan's second largest bank, said last week it would raise interest rates on six-month time deposits for the first occasion in almost six years. It raised the rate for six months to 0.1pc from 0.02pc and the rate for three month accounts to 0.06pc from 0.02pc from July 10. Smaller Sumitomo Mitsui Financial also raised rates on time deposits on Monday.''
Apathetic savers are already getting a pittance on their cash - many of Halifax's savings accounts pay 0.5pc or less already.
For the proactive saver, as Emma Simon reports on page 1, there are ways to get a return on your money over and above 2pc. But you will have to get your skates on to grab a decent deal.
As one commentator remarked last week, savers are going to have to take on a little more risk if they are to get their just rewards. With rates around 6pc, the decision to hoard cash in savings accounts made perfect sense, but the landscape is changing.
As I mentioned a fortnight ago, corporate bond funds offer a decent yield as do many equity income funds. They are by no means a substitute for cash but, if rates languish at such low levels for too long, savers are going to have little choice but to step up to the risk plate at some stage.
It is a different ball game for borrowers, however. When interest rates reached 15pc in 1990, I was green with envy of my bosses at Coutts. The longest standing managers at the Queen's bank were fortunate to have fixed rate mortgages of just 2pc. A perk if ever there was one.
It seemed inconceivable at the time that I or anyone else could pay a miserly 2pc on a home loan - until this week, that is. True, many borrowers won't be paying anything like 2pc. For starters, around half of mortgages are fixed-rate, while more 10pc of home owners are on their lender's standard variable rates and they range between 4pc and 7pc.
However, some lucky borrowers will be paying less than 1pc. C&G, for instance, was offering a two-year tracker discounting base rate by 1.01pc. One can only assume that these borrowers now paying 0.99pc will pay zilch interest if rates tumble to zero. Many lenders were predictably slow to react, or did react but failed to pass on the full one percentage point cut.
But it made a welcome change to see a lender put its customers first for once. Nationwide decided not enforce its collar on tracker mortgages. A collar allows lenders not to pass on interest rate reductions once base rate falls below a certain level - in Nationwide's case, it was 2.75pc. Mind you, I'm fortunate enough to have a two-year tracker from the building society at 0.03pc above base rate. I'll leave it to you to do the maths.
http://www.telegraph.co.uk/finance/personalfinance/comment/paulfarrow/3690421/Savers-are-going-to-have-to-step-up-to-the-risk-plate-at-some-stage.html
The real prospect that rates will fall to zero is a nightmare scenario for those that rely on savings income to bolster their day-to-day living expenses.
By Paul FarrowLast Updated: 7:31AM GMT 11 Dec 2008
Comments 2 Comment on this article
It is hard to imagine savings rates at nil - but it happened in Japan, where savers had no choice but to deal with the harsh reality of not getting a return on their money.
Take a look at this excerpt from the newswires in July 2006 when the Bank of Japan decided to raise rates for the first time in six years from zero to 0.25pc.
"Mizuho Financial, Japan's second largest bank, said last week it would raise interest rates on six-month time deposits for the first occasion in almost six years. It raised the rate for six months to 0.1pc from 0.02pc and the rate for three month accounts to 0.06pc from 0.02pc from July 10. Smaller Sumitomo Mitsui Financial also raised rates on time deposits on Monday.''
Apathetic savers are already getting a pittance on their cash - many of Halifax's savings accounts pay 0.5pc or less already.
For the proactive saver, as Emma Simon reports on page 1, there are ways to get a return on your money over and above 2pc. But you will have to get your skates on to grab a decent deal.
As one commentator remarked last week, savers are going to have to take on a little more risk if they are to get their just rewards. With rates around 6pc, the decision to hoard cash in savings accounts made perfect sense, but the landscape is changing.
As I mentioned a fortnight ago, corporate bond funds offer a decent yield as do many equity income funds. They are by no means a substitute for cash but, if rates languish at such low levels for too long, savers are going to have little choice but to step up to the risk plate at some stage.
It is a different ball game for borrowers, however. When interest rates reached 15pc in 1990, I was green with envy of my bosses at Coutts. The longest standing managers at the Queen's bank were fortunate to have fixed rate mortgages of just 2pc. A perk if ever there was one.
It seemed inconceivable at the time that I or anyone else could pay a miserly 2pc on a home loan - until this week, that is. True, many borrowers won't be paying anything like 2pc. For starters, around half of mortgages are fixed-rate, while more 10pc of home owners are on their lender's standard variable rates and they range between 4pc and 7pc.
However, some lucky borrowers will be paying less than 1pc. C&G, for instance, was offering a two-year tracker discounting base rate by 1.01pc. One can only assume that these borrowers now paying 0.99pc will pay zilch interest if rates tumble to zero. Many lenders were predictably slow to react, or did react but failed to pass on the full one percentage point cut.
But it made a welcome change to see a lender put its customers first for once. Nationwide decided not enforce its collar on tracker mortgages. A collar allows lenders not to pass on interest rate reductions once base rate falls below a certain level - in Nationwide's case, it was 2.75pc. Mind you, I'm fortunate enough to have a two-year tracker from the building society at 0.03pc above base rate. I'll leave it to you to do the maths.
http://www.telegraph.co.uk/finance/personalfinance/comment/paulfarrow/3690421/Savers-are-going-to-have-to-step-up-to-the-risk-plate-at-some-stage.html
House prices to crash 30 per cent, Barclays chief executive John Varley warns
House prices to crash 30 per cent, Barclays chief executive John Varley warns
House prices will crash a further 15 per cent next year, the boss of high street bank Barclays has admitted.
By Myra Butterworth, Personal Finance Correspondent Last Updated: 8:52AM GMT 15 Dec 2008
John Varley of Barclays Photo: Daniel Jones
In a remarkably candid interview, John Varley, the group chief executive of Barclays, warned that Britain is only mid way through the house price slump - meaning the total fall could be as much as 30 per cent.
He described as "madness" the previous lending policies' of banks, in which 100 per cent mortgages and beyond were approved.
Mr Varley admitted that banks were partly to blame for the current recession, saying it was time they showed "humility" and said "sorry" to customers for their role in the sharp economic downturn.
He said banks needed "to take their share of responsibility".
It is the first time that the chief executive of a major bank has spoken so openly in the current climate about the role lenders have played in the sharp turnaround in home owners' fortunes.
The admission comes on the back of the Government giving banks billions of pounds of financial support following the worst banking crisis since 1929. Barclays did not receive government funding.
Mr Varley's comments, made to Jeff Randall, the Daily Telegraph's editor-at-large and to be shown on Sky News this evening, are a dire warning to families across Britain who have already seen the value of their savings and homes plummet amid the credit crisis. They could dissuade potential buyers from seeking loans or moving home. Jonathan Cornell, of mortgage brokers Hamptons Mortgages, said Mr Varley's comments could aggravate the situation further.
The average home in Britain has already dropped £36,000 in value since August last year, according to the country's biggest lenders Halifax. Its latest figures show the average value is now just £163,605.
A further 15 per cent fall would see the average value of a home crash by an additional £25,000 to less than £140,000 based on these figures.
Mr Varley said: "Our view was that from the top to the bottom, you would see a fall of something like 25 to 30 per cent. I suspect we're about halfway through that at the moment. I mean that slowdown, the negative house price inflation started in 2007, it's accelerated in 2008.
"We're probably about halfway through that period, so in other words we've got another 10 to 15 per cent to fall between now and the end of next year. That would be our assessment."
The house price crash has already left many homeowners in negative equity, where the value of their home is worth less than their mortgage.
In the early 1990s, when house prices fell by 10.6 per cent over a prolonged period, 1.8 million home owners had to stay put or face losing thousands when they sold up.
The borrowers who are most vulnerable are those who bought a home with a loan of at least 100 per cent of the value of their property.
At the height of the property boom, when banks were more willing to lend, loans were available at 125 per cent of the value of a property.
Asked for his reaction to the practice, Mr Varley said: "Looking back on it, madness."
Mortgage experts said that lenders would need to offer a wider range of deals to borrowers before the property market showed any signs of recovery.
Melanie Bien, of mortgage brokers Savills Private Finance, said: "Those hoping that the bottom of the housing market had already been reached will have to wait a bit longer with around another 10 per cent drop in prices in 2009 forecast.
"It will then be a while before prices recover but once the bottom has been reached, potential buyers will once again show an interest in purchasing. All we need then is more choice of product at 90 per cent loan-to-value with better rates than are currently available to help first-time buyers in particular onto the housing ladder."
Home sellers have been forced to lower their asking prices dramatically in the past month to achieve a sale.
Around £5,000 was knocked off the average price of a home in the past month, according to property website Rightmove.
It said the average value of a home in Britain dropped from £222,979 in November to £217,808 this month, a fall of 2.3 per cent. House prices are now 10.2 per cent down from May this year.
The figures are higher than those produced by Halifax as they are based on asking prices rather than completions.
Rightmove forecasts that house prices will fall an extra 10 per cent by the end of next year. However, its survey also suggested that the sale prices actually being achieved by estate agents is already down 25 per cent since May.
http://www.telegraph.co.uk/finance/economics/houseprices/3759542/House-prices-to-crash-30-per-cent-Barclays-chief-executive-John-Varley-warns.html
House prices will crash a further 15 per cent next year, the boss of high street bank Barclays has admitted.
By Myra Butterworth, Personal Finance Correspondent Last Updated: 8:52AM GMT 15 Dec 2008
John Varley of Barclays Photo: Daniel Jones
In a remarkably candid interview, John Varley, the group chief executive of Barclays, warned that Britain is only mid way through the house price slump - meaning the total fall could be as much as 30 per cent.
He described as "madness" the previous lending policies' of banks, in which 100 per cent mortgages and beyond were approved.
Mr Varley admitted that banks were partly to blame for the current recession, saying it was time they showed "humility" and said "sorry" to customers for their role in the sharp economic downturn.
He said banks needed "to take their share of responsibility".
It is the first time that the chief executive of a major bank has spoken so openly in the current climate about the role lenders have played in the sharp turnaround in home owners' fortunes.
The admission comes on the back of the Government giving banks billions of pounds of financial support following the worst banking crisis since 1929. Barclays did not receive government funding.
Mr Varley's comments, made to Jeff Randall, the Daily Telegraph's editor-at-large and to be shown on Sky News this evening, are a dire warning to families across Britain who have already seen the value of their savings and homes plummet amid the credit crisis. They could dissuade potential buyers from seeking loans or moving home. Jonathan Cornell, of mortgage brokers Hamptons Mortgages, said Mr Varley's comments could aggravate the situation further.
The average home in Britain has already dropped £36,000 in value since August last year, according to the country's biggest lenders Halifax. Its latest figures show the average value is now just £163,605.
A further 15 per cent fall would see the average value of a home crash by an additional £25,000 to less than £140,000 based on these figures.
Mr Varley said: "Our view was that from the top to the bottom, you would see a fall of something like 25 to 30 per cent. I suspect we're about halfway through that at the moment. I mean that slowdown, the negative house price inflation started in 2007, it's accelerated in 2008.
"We're probably about halfway through that period, so in other words we've got another 10 to 15 per cent to fall between now and the end of next year. That would be our assessment."
The house price crash has already left many homeowners in negative equity, where the value of their home is worth less than their mortgage.
In the early 1990s, when house prices fell by 10.6 per cent over a prolonged period, 1.8 million home owners had to stay put or face losing thousands when they sold up.
The borrowers who are most vulnerable are those who bought a home with a loan of at least 100 per cent of the value of their property.
At the height of the property boom, when banks were more willing to lend, loans were available at 125 per cent of the value of a property.
Asked for his reaction to the practice, Mr Varley said: "Looking back on it, madness."
Mortgage experts said that lenders would need to offer a wider range of deals to borrowers before the property market showed any signs of recovery.
Melanie Bien, of mortgage brokers Savills Private Finance, said: "Those hoping that the bottom of the housing market had already been reached will have to wait a bit longer with around another 10 per cent drop in prices in 2009 forecast.
"It will then be a while before prices recover but once the bottom has been reached, potential buyers will once again show an interest in purchasing. All we need then is more choice of product at 90 per cent loan-to-value with better rates than are currently available to help first-time buyers in particular onto the housing ladder."
Home sellers have been forced to lower their asking prices dramatically in the past month to achieve a sale.
Around £5,000 was knocked off the average price of a home in the past month, according to property website Rightmove.
It said the average value of a home in Britain dropped from £222,979 in November to £217,808 this month, a fall of 2.3 per cent. House prices are now 10.2 per cent down from May this year.
The figures are higher than those produced by Halifax as they are based on asking prices rather than completions.
Rightmove forecasts that house prices will fall an extra 10 per cent by the end of next year. However, its survey also suggested that the sale prices actually being achieved by estate agents is already down 25 per cent since May.
http://www.telegraph.co.uk/finance/economics/houseprices/3759542/House-prices-to-crash-30-per-cent-Barclays-chief-executive-John-Varley-warns.html
£591 billion wiped off UK property market in 12 months
£591 billion wiped off UK property market in 12 months
Home owners in the UK have seen the equivalent of 85 per cent of their annual salary wiped off their property's value this year, according to valuation experts.
By Sarah Knapton Last Updated: 10:32AM GMT 22 Dec 2008
UK homes have lost more than £591 billion in value during 2008, the equivalent of every single British home dropping £22,083 since January, property website Zoopla found.
The research suggested the value of homes decreased by nearly 10 per cent, leaving 2.1 million homeowners owing more on their mortgages than their homes are currently worth.
It means the average homeowner has spent 85 per cent of their annual salary in 2008 simply offsetting the loss of their property's value.
Alex Chesterman, CEO of Zoopla said: "This year will be remembered as the year that marked the acceleration of the housing market correction.
"Values have been declining every month for the past 18 months and, with further job losses predicted, increased repossessions and the continued decline in the number of people buying and selling properties, the bottom is not yet in sight.
"The reality is that some homeowners will face a very tough decision next year whether to try and ride out further value declines and risk falling into further negative equity or cut their losses and sell before the price drops too far."
Hertfordshire was identified as the hardest hit county in 2008 with the average house price dropping by £31,280 since January, followed by Essex at £29,377 and Middlesex £28,978.
A recent survey by Knight Frank suggested the market for prime London property is in freefall, with prices now 14.1 per cent lower than last year.
In June 1990, at the height of the last slump, the annual fall amounted to just 10.6 per cent. Over the past three months prices in London have fallen by 9.3 per cent, with houses depreciating at a faster rate than flats.
http://www.telegraph.co.uk/finance/economics/houseprices/3899791/591-billion-wiped-off-UK-property-market-in-12-months.html
Home owners in the UK have seen the equivalent of 85 per cent of their annual salary wiped off their property's value this year, according to valuation experts.
By Sarah Knapton Last Updated: 10:32AM GMT 22 Dec 2008
UK homes have lost more than £591 billion in value during 2008, the equivalent of every single British home dropping £22,083 since January, property website Zoopla found.
The research suggested the value of homes decreased by nearly 10 per cent, leaving 2.1 million homeowners owing more on their mortgages than their homes are currently worth.
It means the average homeowner has spent 85 per cent of their annual salary in 2008 simply offsetting the loss of their property's value.
Alex Chesterman, CEO of Zoopla said: "This year will be remembered as the year that marked the acceleration of the housing market correction.
"Values have been declining every month for the past 18 months and, with further job losses predicted, increased repossessions and the continued decline in the number of people buying and selling properties, the bottom is not yet in sight.
"The reality is that some homeowners will face a very tough decision next year whether to try and ride out further value declines and risk falling into further negative equity or cut their losses and sell before the price drops too far."
Hertfordshire was identified as the hardest hit county in 2008 with the average house price dropping by £31,280 since January, followed by Essex at £29,377 and Middlesex £28,978.
A recent survey by Knight Frank suggested the market for prime London property is in freefall, with prices now 14.1 per cent lower than last year.
In June 1990, at the height of the last slump, the annual fall amounted to just 10.6 per cent. Over the past three months prices in London have fallen by 9.3 per cent, with houses depreciating at a faster rate than flats.
http://www.telegraph.co.uk/finance/economics/houseprices/3899791/591-billion-wiped-off-UK-property-market-in-12-months.html
Lehman UK sub-prime book about to go in knock-down sale
Lehman UK sub-prime book about to go in knock-down sale
The administrators to Lehman Brothers in the UK are close to selling a £900m portfolio of sub-prime mortgages, for a price of about 50p in the pound.
By Katherine Griffiths, Financial Services Editor Last Updated: 9:14PM GMT 21 Dec 2008
Lehman was one of the largest players in the high-risk end of the mortgage market in the UK.
PricewaterhouseCoopers, which is handling the administration of Lehman in London, set up an auction for one bundle of sub-prime loans as well as other assets including its Capstone servicing business, which employs 450 people.
Second round bids for the portfolio must be tabled before the end of January. Several private equity groups and vulture funds are understood to be interested, including America's Apollo and Blackstone.
The auction of mortgage assets is one of the largest in recent months. The outcome will have ramifications for the banking sector because, if the price is very low, it could put pressure on other lenders to take further mark downs on the value of their mortgage assets.
The British mortgages have been bundled together with Irish and Portuguese loans by PwC. A second tranche of mortgages originated in Latin America and eastern Europe and worth €2.5bn (£2.3bn) will be put up for auction in the new year.
The PwC partners leading the administration, Tony Lomas, Dan Schwarzmann, Steven Pearson and Mike Jervis, have predicted winding up Lehman will be "more complex" than Enron.
Some hedge funds and other parties have expressed frustration because their money is frozen in Lehman accounts.
http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/3885723/Lehman-UK-sub-prime-book-about-to-go-in-knock-down-sale.html
The administrators to Lehman Brothers in the UK are close to selling a £900m portfolio of sub-prime mortgages, for a price of about 50p in the pound.
By Katherine Griffiths, Financial Services Editor Last Updated: 9:14PM GMT 21 Dec 2008
Lehman was one of the largest players in the high-risk end of the mortgage market in the UK.
PricewaterhouseCoopers, which is handling the administration of Lehman in London, set up an auction for one bundle of sub-prime loans as well as other assets including its Capstone servicing business, which employs 450 people.
Second round bids for the portfolio must be tabled before the end of January. Several private equity groups and vulture funds are understood to be interested, including America's Apollo and Blackstone.
The auction of mortgage assets is one of the largest in recent months. The outcome will have ramifications for the banking sector because, if the price is very low, it could put pressure on other lenders to take further mark downs on the value of their mortgage assets.
The British mortgages have been bundled together with Irish and Portuguese loans by PwC. A second tranche of mortgages originated in Latin America and eastern Europe and worth €2.5bn (£2.3bn) will be put up for auction in the new year.
The PwC partners leading the administration, Tony Lomas, Dan Schwarzmann, Steven Pearson and Mike Jervis, have predicted winding up Lehman will be "more complex" than Enron.
Some hedge funds and other parties have expressed frustration because their money is frozen in Lehman accounts.
http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/3885723/Lehman-UK-sub-prime-book-about-to-go-in-knock-down-sale.html
Protectionist dominoes are beginning to tumble across the world
Protectionist dominoes are beginning to tumble across the world
The riots have begun. Civil protest is breaking out in cities across Russia, China, and beyond.
By Ambrose Evans-PritchardLast Updated: 10:30AM GMT 22 Dec 2008
Comments 61 Comment on this article
Greece has been in turmoil for 11 days. The mood seems to have turned "pre-insurrectionary" in parts of Athens - to borrow from the Marxist handbook.
This is a foretaste of what the world may face as the "crisis of capitalism" - another Marxist phase making a comeback - starts to turn two hundred million lives upside down.
We are advancing to the political stage of this global train wreck. Regimes are being tested. Those relying on perma-boom to mask a lack of democratic or ancestral legitimacy may try to gain time by the usual methods: trade barriers, sabre-rattling, and barbed wire.
Dominique Strauss-Kahn, the head of the International Monetary Fund, is worried enough to ditch a half-century of IMF orthodoxy, calling for a fiscal boost worth 2pc of world GDP to "prevent global depression".
"If we are not able to do that, then social unrest may happen in many countries, including advanced economies. We are facing an unprecedented decline in output. All around the planet, the people have reacted with feelings going from surprise to anger, and from anger to fear," he said.
Russia has begun to shut down trade as it adjusts to the shock of Urals oil below $40 a barrel. It has imposed import tariffs of 30pc on cars, 15pc on farm kit, and 95pc on poultry (above quota levels). "It is possible during the financial crisis to support domestic producers by raising customs duties," said Premier Vladimir Putin.
Russia is not alone. India and Vietnam have imposed steel tariffs. Indonesia is resorting to special "licences" to choke off imports.
The Kremlin is alarmed by a 13pc fall in industrial output over the last five months. There have been street protests in Moscow, St Petersburg, Kaliningrad, Vladivostok and Barnaul. Police crushed "Dissent Marchers" holding copies of Russia's constitution above their heads in Moscow's Triumfalnaya Square.
"Russia has not seen anything like these nationwide protests before," said Boris Kagarlitsky from Moscow's Globalization Institute.
The Duma is widening the treason law to catch most forms of political dissent, and unwelcome forms of journalism. Jury trials for state crimes are to be abolished.
Yevgeny Kiseloyov at the Moscow Times said it feels eerily like December 1 1934 when Stalin unveiled his "Enemies of the People" law, kicking off the Great Terror.
The omens are not good in China either. Taxis are being bugged by state police. The great unknown is how Beijing will respond as its state-directed export strategy hits a brick wall, leaving exposed a vast eyesore of concrete and excess plant.
Exports fell 2.2pc in November. Toy, textile, footwear, and furniture plants are being closed across Guangdong, now the riot hub of South China. Some 40m Chinese workers are expected to lose their jobs. Party officials have warned of "mass-scale social turmoil".
The Politburo is giving mixed signals. We don't yet know how much of the country's plan to boost domestic demand through a $586bn stimulus package is real, and how much is a wish-list sent to party bosses in the hinterland without funding.
Shortly after President Hu Jintao said China is "losing competitive edge in the world market", we saw a move towards export subsidies for the steel industry and a dip in the yuan peg - even though China already has the world's biggest reserves ($2 trillion) and the biggest trade surplus ($40bn a month).
So is the Communist Party mulling a 1930s "beggar-thy-neighbour" strategy of devaluation to export its way out of trouble? Such raw mercantilism can only draw a sharp retort from Washington and Brussels in this climate.
"During a global slowdown, you can't have countries trying to take advantage of others by manipulating their currencies," said Frank Vargo from the US National Association of Manufacturers.
It is a view shared entirely by President-elect Barack Obama. "China must change its currency practices. Because it pegs its currency at an artificially low rate, China is running massive current account surpluses. This is not good for American firms and workers, not good for the world," he said in October. The new intake of radical Democrats on Capitol Hill will hold him to it.
There has been much talk lately of America's Smoot-Hawley Tariff Act, which set off the protectionist dominoes in 1930. It is usually invoked by free traders to make the wrong point. The relevant message of Smoot-Hawley is that America was then the big exporter, playing the China role. By resorting to tariffs, it set off retaliation, and was the biggest victim of its own folly.
Britain and the Dominions retreated into Imperial Preference. Other countries joined. This became the "growth bloc" of the 1930s, free from the deflation constraints of the Gold Standard. High tariffs stopped the stimulus leaking out.
It was a successful strategy - given the awful alternatives - and was the key reason why Britain's economy contracted by just 5pc during the Depression, against 15pc for France, and 30pc for the US.
Could we see such a closed "growth bloc" emerging now, this time led by the US, entailing a massive rupture of world's trading system? Perhaps.
This crisis has already brought us a monetary revolution as interest rates approach zero across the G10. It may overturn the "New World Order" as well, unless we move with great care in grim months ahead. This is where events turn dangerous.
The last great era of globalisation peaked just before 1914. You know the rest of the story.
http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/3870089/Protectionist-dominoes-are-beginning-to-tumble-across-the-world.html
The riots have begun. Civil protest is breaking out in cities across Russia, China, and beyond.
By Ambrose Evans-PritchardLast Updated: 10:30AM GMT 22 Dec 2008
Comments 61 Comment on this article
Greece has been in turmoil for 11 days. The mood seems to have turned "pre-insurrectionary" in parts of Athens - to borrow from the Marxist handbook.
This is a foretaste of what the world may face as the "crisis of capitalism" - another Marxist phase making a comeback - starts to turn two hundred million lives upside down.
We are advancing to the political stage of this global train wreck. Regimes are being tested. Those relying on perma-boom to mask a lack of democratic or ancestral legitimacy may try to gain time by the usual methods: trade barriers, sabre-rattling, and barbed wire.
Dominique Strauss-Kahn, the head of the International Monetary Fund, is worried enough to ditch a half-century of IMF orthodoxy, calling for a fiscal boost worth 2pc of world GDP to "prevent global depression".
"If we are not able to do that, then social unrest may happen in many countries, including advanced economies. We are facing an unprecedented decline in output. All around the planet, the people have reacted with feelings going from surprise to anger, and from anger to fear," he said.
Russia has begun to shut down trade as it adjusts to the shock of Urals oil below $40 a barrel. It has imposed import tariffs of 30pc on cars, 15pc on farm kit, and 95pc on poultry (above quota levels). "It is possible during the financial crisis to support domestic producers by raising customs duties," said Premier Vladimir Putin.
Russia is not alone. India and Vietnam have imposed steel tariffs. Indonesia is resorting to special "licences" to choke off imports.
The Kremlin is alarmed by a 13pc fall in industrial output over the last five months. There have been street protests in Moscow, St Petersburg, Kaliningrad, Vladivostok and Barnaul. Police crushed "Dissent Marchers" holding copies of Russia's constitution above their heads in Moscow's Triumfalnaya Square.
"Russia has not seen anything like these nationwide protests before," said Boris Kagarlitsky from Moscow's Globalization Institute.
The Duma is widening the treason law to catch most forms of political dissent, and unwelcome forms of journalism. Jury trials for state crimes are to be abolished.
Yevgeny Kiseloyov at the Moscow Times said it feels eerily like December 1 1934 when Stalin unveiled his "Enemies of the People" law, kicking off the Great Terror.
The omens are not good in China either. Taxis are being bugged by state police. The great unknown is how Beijing will respond as its state-directed export strategy hits a brick wall, leaving exposed a vast eyesore of concrete and excess plant.
Exports fell 2.2pc in November. Toy, textile, footwear, and furniture plants are being closed across Guangdong, now the riot hub of South China. Some 40m Chinese workers are expected to lose their jobs. Party officials have warned of "mass-scale social turmoil".
The Politburo is giving mixed signals. We don't yet know how much of the country's plan to boost domestic demand through a $586bn stimulus package is real, and how much is a wish-list sent to party bosses in the hinterland without funding.
Shortly after President Hu Jintao said China is "losing competitive edge in the world market", we saw a move towards export subsidies for the steel industry and a dip in the yuan peg - even though China already has the world's biggest reserves ($2 trillion) and the biggest trade surplus ($40bn a month).
So is the Communist Party mulling a 1930s "beggar-thy-neighbour" strategy of devaluation to export its way out of trouble? Such raw mercantilism can only draw a sharp retort from Washington and Brussels in this climate.
"During a global slowdown, you can't have countries trying to take advantage of others by manipulating their currencies," said Frank Vargo from the US National Association of Manufacturers.
It is a view shared entirely by President-elect Barack Obama. "China must change its currency practices. Because it pegs its currency at an artificially low rate, China is running massive current account surpluses. This is not good for American firms and workers, not good for the world," he said in October. The new intake of radical Democrats on Capitol Hill will hold him to it.
There has been much talk lately of America's Smoot-Hawley Tariff Act, which set off the protectionist dominoes in 1930. It is usually invoked by free traders to make the wrong point. The relevant message of Smoot-Hawley is that America was then the big exporter, playing the China role. By resorting to tariffs, it set off retaliation, and was the biggest victim of its own folly.
Britain and the Dominions retreated into Imperial Preference. Other countries joined. This became the "growth bloc" of the 1930s, free from the deflation constraints of the Gold Standard. High tariffs stopped the stimulus leaking out.
It was a successful strategy - given the awful alternatives - and was the key reason why Britain's economy contracted by just 5pc during the Depression, against 15pc for France, and 30pc for the US.
Could we see such a closed "growth bloc" emerging now, this time led by the US, entailing a massive rupture of world's trading system? Perhaps.
This crisis has already brought us a monetary revolution as interest rates approach zero across the G10. It may overturn the "New World Order" as well, unless we move with great care in grim months ahead. This is where events turn dangerous.
The last great era of globalisation peaked just before 1914. You know the rest of the story.
http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/3870089/Protectionist-dominoes-are-beginning-to-tumble-across-the-world.html
How to Steer Clear of Shady Advisers
How to Steer Clear of Shady Advisers
By MARY PILON
Bernard Madoff's alleged Ponzi scheme took a devastating toll on scores of victims. But any investor can draw important lessons from the tale of the disappearing $50 billion. Here's a guide to protecting yourself when you choose a financial adviser.
Be wary of guaranteed returns.
Mr. Madoff allegedly wooed many investors by promising consistent returns regardless of market activity. Also be wary about promises of speedy returns. If something sounds too good to be true, it most likely is.
Reputation and referrals aren't enough.
Mr. Madoff was a former Nasdaq Stock Market chairman and fixture on Wall Street -- it's understandable that people felt comfortable with him managing their money. Many investors are happy if they just have an adviser a friend recommends.
But don't make a decision based on the good things you hear.
Check credentials and verify certification with the Financial Industry Regulatory Authority (Finra), which issues licenses for financial advisers.
You should seek out other information, too.
The U.S. Securities and Exchange Commission (sec.gov) lets you search Investment Adviser Public Disclosure forms online, which give information about advisers' business affiliations and any disciplinary actions. Finra also has background information on approximately 660,000 currently registered brokers and 5,100 currently registered securities firms. The information on both the SEC and Finra sites are available at no cost to the public.
Demand transparency.
It's your money, so you have a right to know where it's being invested. Ask lots of questions about your allocation and your money manager's past performance. And set aside time to read through your brokerage statement -- most firms send one a month -- and make sure you're clear on everything documented in it.
Make sure you get a statement from your adviser's firm, not your adviser.
There are claims that Mr. Madoff cooked his books. A firm is less likely to do that, since it's accountable to more parties. Likewise, you should be wary about writing checks directly to your adviser. They should go to a registered investment company.
Get it in writing.
Make sure that both your investments and their explanations are spelled out in writing, for future reference. While you're at it, read the fine print -- and be extremely suspicious if there's no fine print to read.
If you've been a victim of fraud or are suspicious, report it. The SEC has a tip and complaint form on its Web site, sec.gov/complaint.shtml.
Write to Mary Pilon at mary.pilon@wsj.com
http://online.wsj.com/article/SB122981065261124223.html
By MARY PILON
Bernard Madoff's alleged Ponzi scheme took a devastating toll on scores of victims. But any investor can draw important lessons from the tale of the disappearing $50 billion. Here's a guide to protecting yourself when you choose a financial adviser.
Be wary of guaranteed returns.
Mr. Madoff allegedly wooed many investors by promising consistent returns regardless of market activity. Also be wary about promises of speedy returns. If something sounds too good to be true, it most likely is.
Reputation and referrals aren't enough.
Mr. Madoff was a former Nasdaq Stock Market chairman and fixture on Wall Street -- it's understandable that people felt comfortable with him managing their money. Many investors are happy if they just have an adviser a friend recommends.
But don't make a decision based on the good things you hear.
Check credentials and verify certification with the Financial Industry Regulatory Authority (Finra), which issues licenses for financial advisers.
You should seek out other information, too.
The U.S. Securities and Exchange Commission (sec.gov) lets you search Investment Adviser Public Disclosure forms online, which give information about advisers' business affiliations and any disciplinary actions. Finra also has background information on approximately 660,000 currently registered brokers and 5,100 currently registered securities firms. The information on both the SEC and Finra sites are available at no cost to the public.
Demand transparency.
It's your money, so you have a right to know where it's being invested. Ask lots of questions about your allocation and your money manager's past performance. And set aside time to read through your brokerage statement -- most firms send one a month -- and make sure you're clear on everything documented in it.
Make sure you get a statement from your adviser's firm, not your adviser.
There are claims that Mr. Madoff cooked his books. A firm is less likely to do that, since it's accountable to more parties. Likewise, you should be wary about writing checks directly to your adviser. They should go to a registered investment company.
Get it in writing.
Make sure that both your investments and their explanations are spelled out in writing, for future reference. While you're at it, read the fine print -- and be extremely suspicious if there's no fine print to read.
If you've been a victim of fraud or are suspicious, report it. The SEC has a tip and complaint form on its Web site, sec.gov/complaint.shtml.
Write to Mary Pilon at mary.pilon@wsj.com
http://online.wsj.com/article/SB122981065261124223.html
Sunday 21 December 2008
Why the Bank of England must fight the economic Blitz in a battle for Britain
From The Times
December 8, 2008
Why the Bank of England must fight the economic Blitz in a battle for Britain
Gary Duncan: Economic view
It is the 64-trillion-dollar question. As a fearful nation battens down the hatches, the question that everyone wants an answer to is: just how bad is this recession going to get?
After the Bank of England’s latest dose of economic “shock and awe” with last week’s landmark cut in interest rates to 2 per cent, a level last seen in 1951, a colleague asked me why so much commentary on the new recession harks back to Britain’s last one, in the early Nineties. Having closely tracked the misfortunes of business in that episode, his point was that this downturn already feels much worse.
You can see the point. As dire news piles up, it really does seem like the economy is going into freefall. And that feeling matters, as it saps sentiment and drains away confidence. None of us can be certain how fast, or how far, the economy will slide. So, in trying to weigh the true scale of the danger, it is worth peering back at the lessons of history. Sadly, there are plenty of recessions to ponder.
About 20 recessions in Britain since the mid-19th century and at least 255 across 17 developed economies since 1870 are examined in recent papers by Paul Ormerod, highlighted in research by David Owen, of Dresdner Kleinwort. The findings offer a little comfort – although mainly of the cold variety.
First, the good news. Most recessions have tended to be relatively short and afflicted economies have been able to bounce back quickly. Only 33 of the 255 recessions lasted more than two years and, while nine were calamitous, with GDP dropping by more than 30 per cent, three of those related to the First World War and six to the Second World War. The conclusion is that, with the exception of the two world wars and the Great Depression, developed economies have generally revived fairly rapidly from recessions.
That, though, is where the reassurance ends. Tellingly, wars aside, episodes of recession in Britain since the Seventies have been much more severe than in the 19th and early 20th centuries. Crucially, Professor Ormerod finds that the deeper and longer a recession is, the more feeble the recovery then is. As Mr Owen observes, this takes us straight back to the role of confidence. The faster and more viciously recession tightens its grip, the more confidence evaporates and the more elusive recovery becomes as what John Maynard Keynes called the economy’s “animal spirits” are killed off.
It is just this peril that, more and more clearly, confronts Britain. The new recession has taken hold with brutal speed and severity and the immediate, acute danger is that it will, indeed, prove to be markedly worse than that of the early Nineties. That is why the only thing wrong with last week’s drastic interest rate cut was that it was not drastic enough.
The Bank itself admits that “the downturn has gathered pace”, with “a weaker outlook for activity in the near-term”. It is worth remembering that it was already forecasting that the economy would shrink next year by 1.3 per cent or more – more or less matching the 1.4 per cent slump suffered in 1991, at the nadir of the last recession.
There are at least two powerful factors that leave us at grave risk of enduring something still harsher and which threaten to mean that the economy’s slump accelerates still farther.
The first is the global nature of this downturn, with all the leading Western economies now in a synchronised slump. This is bound to aggravate the toll from recession, with no big economy left immune and able to act as a locomotive to pull the others out of the mire. As Mr Owen notes, global trade is close to collapsing.
The second factor is the pivotal role of the banks, the bogeymen of this crisis, and their continuing failure to play their proper role in the economy and provide a steady flow of lending to businesses and households.
While the banks’ behaviour in curbing lending to safeguard their own financial strength is individually rational, it is collectively crazy and will mean a far deeper and more painful recession unless it is quickly reversed. Certainly, interest rate cuts will help to limit the toll from recession, but, as Philip Shaw, of Investec, observed last week, there is no point in having very cheap money if nobody will lend it to you. While the banks insist that they are keeping up the flow of lending, the data tells a different story.
Taken together, these aspects of the present crisis make Professor Ormerod’s conclusions compelling. The swifter, more radical and more aggressive the action taken now by the Bank and the Treasury to nip recession in the bud, the more the danger will diminish, the smaller the eventual toll will be and the bigger the chances of an eventual, potent return to growth.
The Bank has already taken two giant leaps with the successive 1.5 and 1 percentage point cuts in interest rates over the past four weeks. It can no longer be accused of timidity. Another step will take it into uncharted territory and rates to a level not seen seen in the Bank’s 316-year history. It should take this step soon and make it another big one.
Yet it must be bolder still and steel itself quickly to follow the US Federal Reserve in deploying more unorthodox weapons from the armoury of monetary policy, such as large-scale direct lending to the banks, the buying-up of credit products and other forms of so-called “quantitative easing”. It is vital that it acts now to jump-start stalled activity and to get the lifeblood of bank lending flowing once more.
The historical parallels remain resonant. The last time that rates were cut to 2 per cent was in 1939, a month after the outbreak of the Second World War. Now, as then, the country confronts an economic Blitz. It is time for the Bank to wage a battle for Britain.
December 8, 2008
Why the Bank of England must fight the economic Blitz in a battle for Britain
Gary Duncan: Economic view
It is the 64-trillion-dollar question. As a fearful nation battens down the hatches, the question that everyone wants an answer to is: just how bad is this recession going to get?
After the Bank of England’s latest dose of economic “shock and awe” with last week’s landmark cut in interest rates to 2 per cent, a level last seen in 1951, a colleague asked me why so much commentary on the new recession harks back to Britain’s last one, in the early Nineties. Having closely tracked the misfortunes of business in that episode, his point was that this downturn already feels much worse.
You can see the point. As dire news piles up, it really does seem like the economy is going into freefall. And that feeling matters, as it saps sentiment and drains away confidence. None of us can be certain how fast, or how far, the economy will slide. So, in trying to weigh the true scale of the danger, it is worth peering back at the lessons of history. Sadly, there are plenty of recessions to ponder.
About 20 recessions in Britain since the mid-19th century and at least 255 across 17 developed economies since 1870 are examined in recent papers by Paul Ormerod, highlighted in research by David Owen, of Dresdner Kleinwort. The findings offer a little comfort – although mainly of the cold variety.
First, the good news. Most recessions have tended to be relatively short and afflicted economies have been able to bounce back quickly. Only 33 of the 255 recessions lasted more than two years and, while nine were calamitous, with GDP dropping by more than 30 per cent, three of those related to the First World War and six to the Second World War. The conclusion is that, with the exception of the two world wars and the Great Depression, developed economies have generally revived fairly rapidly from recessions.
That, though, is where the reassurance ends. Tellingly, wars aside, episodes of recession in Britain since the Seventies have been much more severe than in the 19th and early 20th centuries. Crucially, Professor Ormerod finds that the deeper and longer a recession is, the more feeble the recovery then is. As Mr Owen observes, this takes us straight back to the role of confidence. The faster and more viciously recession tightens its grip, the more confidence evaporates and the more elusive recovery becomes as what John Maynard Keynes called the economy’s “animal spirits” are killed off.
It is just this peril that, more and more clearly, confronts Britain. The new recession has taken hold with brutal speed and severity and the immediate, acute danger is that it will, indeed, prove to be markedly worse than that of the early Nineties. That is why the only thing wrong with last week’s drastic interest rate cut was that it was not drastic enough.
The Bank itself admits that “the downturn has gathered pace”, with “a weaker outlook for activity in the near-term”. It is worth remembering that it was already forecasting that the economy would shrink next year by 1.3 per cent or more – more or less matching the 1.4 per cent slump suffered in 1991, at the nadir of the last recession.
There are at least two powerful factors that leave us at grave risk of enduring something still harsher and which threaten to mean that the economy’s slump accelerates still farther.
The first is the global nature of this downturn, with all the leading Western economies now in a synchronised slump. This is bound to aggravate the toll from recession, with no big economy left immune and able to act as a locomotive to pull the others out of the mire. As Mr Owen notes, global trade is close to collapsing.
The second factor is the pivotal role of the banks, the bogeymen of this crisis, and their continuing failure to play their proper role in the economy and provide a steady flow of lending to businesses and households.
While the banks’ behaviour in curbing lending to safeguard their own financial strength is individually rational, it is collectively crazy and will mean a far deeper and more painful recession unless it is quickly reversed. Certainly, interest rate cuts will help to limit the toll from recession, but, as Philip Shaw, of Investec, observed last week, there is no point in having very cheap money if nobody will lend it to you. While the banks insist that they are keeping up the flow of lending, the data tells a different story.
Taken together, these aspects of the present crisis make Professor Ormerod’s conclusions compelling. The swifter, more radical and more aggressive the action taken now by the Bank and the Treasury to nip recession in the bud, the more the danger will diminish, the smaller the eventual toll will be and the bigger the chances of an eventual, potent return to growth.
The Bank has already taken two giant leaps with the successive 1.5 and 1 percentage point cuts in interest rates over the past four weeks. It can no longer be accused of timidity. Another step will take it into uncharted territory and rates to a level not seen seen in the Bank’s 316-year history. It should take this step soon and make it another big one.
Yet it must be bolder still and steel itself quickly to follow the US Federal Reserve in deploying more unorthodox weapons from the armoury of monetary policy, such as large-scale direct lending to the banks, the buying-up of credit products and other forms of so-called “quantitative easing”. It is vital that it acts now to jump-start stalled activity and to get the lifeblood of bank lending flowing once more.
The historical parallels remain resonant. The last time that rates were cut to 2 per cent was in 1939, a month after the outbreak of the Second World War. Now, as then, the country confronts an economic Blitz. It is time for the Bank to wage a battle for Britain.
What hope for investment recovery in 2009?
From The Times
December 11, 2008
What hope for investment recovery in 2009?
We ask the experts for their predictions as beleaguered investors say good riddance to 2008
Mark Atherton
Most people cannot wait to see the end of 2008. Whether you were a saver, a stock market investor or a property owner, the past 12 months has delivered some nasty shocks to the system.
The FTSE 100 index of leading UK shares is down 32 per cent this year and the US stock market has fallen by 34 per cent. Emerging markets such as Russia and China, once the darlings of UK investors, have fared even worse.
Even traditional safe havens, such as bricks and mortar, have proved no defence against this year's chill financial winds. UK house prices are down 17 per cent while commercial property has fallen by about 20 per cent.
One piece of good news is that the situation has grown so bad that experts are not expecting it to deteriorate much in 2009. Here are their predictions of what is in store.
Related Links
A good ten-year bet
Q&A: New Star crisis
The UK stock market
With the UK economy now in recession, most experts are forecasting that shares will struggle to make headway in early 2009. But the green shoots of recovery could begin to show in the latter part of the year as the market starts to expect an improvement in the economy. UBS, the Swiss bank, reckons that the FTSE 100 could recover to 5,800 from its current level of about 4,300. Among the sectors it favours are food retailers, health equipment and household goods. Its preferred stocks include Tesco, Smith & Nephew and Next.
Brewin Dolphin, the stockbroker, also forecasts a recovery, albeit a more modest one. Mike Lenhoff, Brewin's chief strategist, says: “There will be more bad news, but the market is already discounting a great deal of it, so shares are now looking cheap. Governments are making huge efforts to respond to the impact of the credit crunch and next year we should start to see them take effect.”
Brewin Dolphin is looking for good performance from sectors such as general retailing and media stocks. Among the shares it likes are Marks & Spencer and Reed Elsevier.
Global stock markets
The general consensus is that the US, which led the world into recession, will also lead the world out of the downturn, triggering a recovery in the US stock market. Max King, strategist at Investec Asset Management, says: “The US trade deficit is falling and household debt is lower than in the UK. The ability of the US economy to bounce back should never be underestimated.”
Meanwhile, Morgan Stanley, the US investment bank, thinks that emerging markets as a whole could rise by more than 60 per cent in the next 12 months. This reflects the expectation that the economies of the industrial world will shrink by 0.9 per cent, while those of the developing world will rise by 4.3 per cent.
For those wishing to invest through funds, Rob Harley, of Bestinvest, the independent financial adviser (IFA), suggests Aberdeen Emerging Markets and Legg Mason US Smaller Companies.
Bonds
Many experts reckon that a lot of bonds are attractively priced after the recent heavy falls. These price falls mean that bonds are also on comparatively high yields, which is good news for investors seeking income. Darius McDermott, of Chelsea Financial Services, another IFA, says: “Falling interest rates and falling inflation will be good for bonds and are likely to send prices higher. It is possible that investors could benefit from a high yield and a rise in the capital value of their investments.”
Among the bond funds that Mr McDermott favours are M&G Optimal Income, which yields 6.5 per cent, and the Henderson Strategic Bond fund, yielding 7.5 per cent.
Alternative investments
Mick Gilligan, a partner at Killik & Co, the stockbroker, says that popular investments such as fine wines and vintage cars have fallen off the radar as prices have fallen.
Among more widely traded alternative investments, Mr Gilligan thinks that gold could have a strong run, especially when investors realise the enormity of the debt burden in the developed economies. He also thinks that oil, which was trading at about $40 a barrel recently, should be considerably higher this time next year.
Meanwhile, experts say that private equity funds, which rely heavily on borrowing, could struggle.
Commercial property
Bill Siegle, of Cluttons, the chartered surveyor, reckons that commercial property prices are likely to continue falling as we enter 2009. As the recession bites, more tenants, including some household names, are likely to default on rental payments.
“There is still a bit further to go before we hit the bottom, though this is likely to happen sometime next year,” Mr Siegle says.The areas that he thinks will prove most profitable when the market recovers are retail warehouses and some industrial parks.
Savers face a bleak 12 months
Prudent savers are finding it harder to obtain a decent return after the Bank of England cut the base rate to its lowest level for 57 years. And with economists predicting that the base rate could drop as low as 0 per cent next year, the prospect for savers is looking increasingly bleak, writes Lauren Thompson.
The rates on savings accounts have fallen fast as the base rate has dropped by three percentage points in the past three months to only 2 per cent. Michelle Slade, of Moneyfacts.co.uk, the financial website, says: “The 7 per cent deals that were available in October seem like a distant memory. The best accounts now pay about 5 per cent - and these will probably not be around for long.”
Capital Economics, the research consultancy, expects the base rate to fall to 1 per cent in the first quarter of next year. It thinks that it could drop to 0 per cent by the end of the year. The experience of Japan, where interest rates have been near zero for years, provides a worrying indication of what that could mean for savers.
Simon Somerville, of Jupiter Asset Management, says: “The most that you can earn from a Japanese bank account is 0.4 per cent, but most pay no interest. Many Japanese have abandoned banks and put their savings in safes or under the mattress.”
There are still some good deals available in the UK. Leeds Building Society is offering 5 per cent on its Fixed Rate Postal Access Bond until May. Those hoping to lock in for three years can get 4.75 per cent with Cheshire Building Society's Three-Year Fixed Rate Bond.
Some of the highest returns are from foreign banks, such as ICICI, the Indian-owned bank, which offers 4.75 per cent for 12 months on its HiSAVE Fixed Rate bond. Even though the bank is foreign owned, deposits of up to £50,000 are guaranteed by the Financial Services Compensation Scheme.
http://www.timesonline.co.uk/tol/money/investment/article5326730.ece
December 11, 2008
What hope for investment recovery in 2009?
We ask the experts for their predictions as beleaguered investors say good riddance to 2008
Mark Atherton
Most people cannot wait to see the end of 2008. Whether you were a saver, a stock market investor or a property owner, the past 12 months has delivered some nasty shocks to the system.
The FTSE 100 index of leading UK shares is down 32 per cent this year and the US stock market has fallen by 34 per cent. Emerging markets such as Russia and China, once the darlings of UK investors, have fared even worse.
Even traditional safe havens, such as bricks and mortar, have proved no defence against this year's chill financial winds. UK house prices are down 17 per cent while commercial property has fallen by about 20 per cent.
One piece of good news is that the situation has grown so bad that experts are not expecting it to deteriorate much in 2009. Here are their predictions of what is in store.
Related Links
A good ten-year bet
Q&A: New Star crisis
The UK stock market
With the UK economy now in recession, most experts are forecasting that shares will struggle to make headway in early 2009. But the green shoots of recovery could begin to show in the latter part of the year as the market starts to expect an improvement in the economy. UBS, the Swiss bank, reckons that the FTSE 100 could recover to 5,800 from its current level of about 4,300. Among the sectors it favours are food retailers, health equipment and household goods. Its preferred stocks include Tesco, Smith & Nephew and Next.
Brewin Dolphin, the stockbroker, also forecasts a recovery, albeit a more modest one. Mike Lenhoff, Brewin's chief strategist, says: “There will be more bad news, but the market is already discounting a great deal of it, so shares are now looking cheap. Governments are making huge efforts to respond to the impact of the credit crunch and next year we should start to see them take effect.”
Brewin Dolphin is looking for good performance from sectors such as general retailing and media stocks. Among the shares it likes are Marks & Spencer and Reed Elsevier.
Global stock markets
The general consensus is that the US, which led the world into recession, will also lead the world out of the downturn, triggering a recovery in the US stock market. Max King, strategist at Investec Asset Management, says: “The US trade deficit is falling and household debt is lower than in the UK. The ability of the US economy to bounce back should never be underestimated.”
Meanwhile, Morgan Stanley, the US investment bank, thinks that emerging markets as a whole could rise by more than 60 per cent in the next 12 months. This reflects the expectation that the economies of the industrial world will shrink by 0.9 per cent, while those of the developing world will rise by 4.3 per cent.
For those wishing to invest through funds, Rob Harley, of Bestinvest, the independent financial adviser (IFA), suggests Aberdeen Emerging Markets and Legg Mason US Smaller Companies.
Bonds
Many experts reckon that a lot of bonds are attractively priced after the recent heavy falls. These price falls mean that bonds are also on comparatively high yields, which is good news for investors seeking income. Darius McDermott, of Chelsea Financial Services, another IFA, says: “Falling interest rates and falling inflation will be good for bonds and are likely to send prices higher. It is possible that investors could benefit from a high yield and a rise in the capital value of their investments.”
Among the bond funds that Mr McDermott favours are M&G Optimal Income, which yields 6.5 per cent, and the Henderson Strategic Bond fund, yielding 7.5 per cent.
Alternative investments
Mick Gilligan, a partner at Killik & Co, the stockbroker, says that popular investments such as fine wines and vintage cars have fallen off the radar as prices have fallen.
Among more widely traded alternative investments, Mr Gilligan thinks that gold could have a strong run, especially when investors realise the enormity of the debt burden in the developed economies. He also thinks that oil, which was trading at about $40 a barrel recently, should be considerably higher this time next year.
Meanwhile, experts say that private equity funds, which rely heavily on borrowing, could struggle.
Commercial property
Bill Siegle, of Cluttons, the chartered surveyor, reckons that commercial property prices are likely to continue falling as we enter 2009. As the recession bites, more tenants, including some household names, are likely to default on rental payments.
“There is still a bit further to go before we hit the bottom, though this is likely to happen sometime next year,” Mr Siegle says.The areas that he thinks will prove most profitable when the market recovers are retail warehouses and some industrial parks.
Savers face a bleak 12 months
Prudent savers are finding it harder to obtain a decent return after the Bank of England cut the base rate to its lowest level for 57 years. And with economists predicting that the base rate could drop as low as 0 per cent next year, the prospect for savers is looking increasingly bleak, writes Lauren Thompson.
The rates on savings accounts have fallen fast as the base rate has dropped by three percentage points in the past three months to only 2 per cent. Michelle Slade, of Moneyfacts.co.uk, the financial website, says: “The 7 per cent deals that were available in October seem like a distant memory. The best accounts now pay about 5 per cent - and these will probably not be around for long.”
Capital Economics, the research consultancy, expects the base rate to fall to 1 per cent in the first quarter of next year. It thinks that it could drop to 0 per cent by the end of the year. The experience of Japan, where interest rates have been near zero for years, provides a worrying indication of what that could mean for savers.
Simon Somerville, of Jupiter Asset Management, says: “The most that you can earn from a Japanese bank account is 0.4 per cent, but most pay no interest. Many Japanese have abandoned banks and put their savings in safes or under the mattress.”
There are still some good deals available in the UK. Leeds Building Society is offering 5 per cent on its Fixed Rate Postal Access Bond until May. Those hoping to lock in for three years can get 4.75 per cent with Cheshire Building Society's Three-Year Fixed Rate Bond.
Some of the highest returns are from foreign banks, such as ICICI, the Indian-owned bank, which offers 4.75 per cent for 12 months on its HiSAVE Fixed Rate bond. Even though the bank is foreign owned, deposits of up to £50,000 are guaranteed by the Financial Services Compensation Scheme.
http://www.timesonline.co.uk/tol/money/investment/article5326730.ece
Call for a new Bretton Woods conference in order to design a new global financial system
It takes two
Bilateral talks between China and the US are the most likely way of solving the global financial crisis and reforming the IMF
Comments (8)
Harold James
guardian.co.uk, Friday 5 December 2008 14.30 GMT
The chaotic and costly international response to the world's current financial disorder has prompted Nicolas Sarkozy, Gordon Brown and German president Horst Köhler, a former head of the International Monetary Fund, to call for a new Bretton Woods conference in order to design a new global financial system. But such a demand depends on a clear understanding of what a new agreement might provide.
It is easy to see the appeal of scrapping today's global financial architecture, because there is obviously much that is broken. The existing institutions were looking increasingly irrelevant in normal times, and ineffective in times of crisis. Although the IMF delivered some gloomily accurate figures about the likely cost of the US housing fiasco, it played almost no role in addressing the current crisis. This was the first international financial crisis since the Bretton Woods conference of 1944 in which the Fund stood on the sidelines.
The major international actor, instead, has been the G7, a grouping dominated by medium-sized European states in which Asia's dynamic emerging economies – the current source of global savings – have no representation.
The Bretton Woods conference succeeded not because it assembled every state, or because the participants engaged in an extensive pow-wow. John Maynard Keynes, an architect of Bretton Woods, believed that the true lesson of the failures of the Depression-era 1930s lay precisely in the character of the large and chaotic 1933 London world economic conference. Keynes concluded that a really workable plan could be devised only at the insistence of "a single power or like-minded group of powers."
Keynes was basically right, but he should have added that it helps when one power can negotiate with one other power. In the past, the most effective financial diplomacy occurred bilaterally, between two powerful states that stood for different approaches to the international economy.
This was true of the preparations for the Bretton Woods meeting. Although there were 44 participating countries, only two really mattered, the UK and, above all, the US. The agreement was shaped by Anglo-American dialogue, with occasional mediation from France and Canada.
Bilateral talks subsequently remained the key to every major success of large-scale financial diplomacy. In the early 1970s, when the fixed exchange-rate regime came to an end, the IMF seemed to have outlived its function. Its articles of agreement were renegotiated by the US, which was looking for more flexibility, and France, which wanted something of the solidity and predictability of the old gold standard.
Later in the 1970s, European monetary relations were hopeless when France, Germany, and Britain tried to talk about them, but were straightened out when only France and Germany took part. In the mid-1980s, when wild exchange-rate swings produced calls for new trade protection measures, the US and Japan found a solution that involved exchange-rate stabilization.
So, what form should such bilateralism take today?
In terms of countries, the obvious new pair comprises the US, the world's largest debtor, and China, its greatest saver. In terms of themes, the conference would have to solve a new type of problem: how states should deal with the large flows of capital that over the past four decades have been mediated by the private sector.
Two alternative models seemed to work until 2008. On one side was the American model, with a variety of regulated banks, lightly regulated investment banks, and largely unregulated hedge funds managing the capital flows. On the other side was the Chinese solution, with increasingly costly reserve management giving way to activist sovereign wealth funds looking for strategic participation in investments abroad.
Both approaches were flawed – and liable to produce political controversy. The American model failed because banks proved to be highly vulnerable to panic once it became clear that sophisticated new financial instruments had formed a haystack spiked with sharp, dangerous, and indigestible losses. And, inevitably, today's big bailouts have been followed by a politically fraught discussion of which banks were rescued, and whose political interests were served. Already, there is a ferocious debate about the influence of Goldman Sachs on the US Treasury. Likewise, the very large European bailouts (totaling as much as 20% of GDP in Germany) have produced controversies about the distribution of costs.
Meanwhile, the Chinese solution gave rise to nationalist fears that sovereign wealth funds might be abused to seize strategically vital businesses or whole sectors of an economy.
The original inspiration behind the creation of the IMF was that a largely automatic and rule-governed body would be a less politicised way of stabilizing markets and expectations. That remains true today: managing temporary stakes in banks in need of recapitalisation, on behalf of large providers of capital (such as the Asian surplus countries), would put a neutral, depoliticised buffer between states and private-sector institutions.
The IMF was originally conceived in 1944 in a world without major private capital flows, one in which states undertook almost all international transactions. Extending its mission to include some private-sector rescues would recognize the preponderant role that markets now play. At the same time, the involvement of a rule-bound international agency would minimise the political poison associated with bank recapitalisations and currency interventions.
In cooperation with Project Syndicate, 2008.
http://www.guardian.co.uk/commentisfree/brettonwoods
http://www.guardian.co.uk/commentisfree/2008/dec/05/global-economy-us-china-imf
Bilateral talks between China and the US are the most likely way of solving the global financial crisis and reforming the IMF
Comments (8)
Harold James
guardian.co.uk, Friday 5 December 2008 14.30 GMT
The chaotic and costly international response to the world's current financial disorder has prompted Nicolas Sarkozy, Gordon Brown and German president Horst Köhler, a former head of the International Monetary Fund, to call for a new Bretton Woods conference in order to design a new global financial system. But such a demand depends on a clear understanding of what a new agreement might provide.
It is easy to see the appeal of scrapping today's global financial architecture, because there is obviously much that is broken. The existing institutions were looking increasingly irrelevant in normal times, and ineffective in times of crisis. Although the IMF delivered some gloomily accurate figures about the likely cost of the US housing fiasco, it played almost no role in addressing the current crisis. This was the first international financial crisis since the Bretton Woods conference of 1944 in which the Fund stood on the sidelines.
The major international actor, instead, has been the G7, a grouping dominated by medium-sized European states in which Asia's dynamic emerging economies – the current source of global savings – have no representation.
The Bretton Woods conference succeeded not because it assembled every state, or because the participants engaged in an extensive pow-wow. John Maynard Keynes, an architect of Bretton Woods, believed that the true lesson of the failures of the Depression-era 1930s lay precisely in the character of the large and chaotic 1933 London world economic conference. Keynes concluded that a really workable plan could be devised only at the insistence of "a single power or like-minded group of powers."
Keynes was basically right, but he should have added that it helps when one power can negotiate with one other power. In the past, the most effective financial diplomacy occurred bilaterally, between two powerful states that stood for different approaches to the international economy.
This was true of the preparations for the Bretton Woods meeting. Although there were 44 participating countries, only two really mattered, the UK and, above all, the US. The agreement was shaped by Anglo-American dialogue, with occasional mediation from France and Canada.
Bilateral talks subsequently remained the key to every major success of large-scale financial diplomacy. In the early 1970s, when the fixed exchange-rate regime came to an end, the IMF seemed to have outlived its function. Its articles of agreement were renegotiated by the US, which was looking for more flexibility, and France, which wanted something of the solidity and predictability of the old gold standard.
Later in the 1970s, European monetary relations were hopeless when France, Germany, and Britain tried to talk about them, but were straightened out when only France and Germany took part. In the mid-1980s, when wild exchange-rate swings produced calls for new trade protection measures, the US and Japan found a solution that involved exchange-rate stabilization.
So, what form should such bilateralism take today?
In terms of countries, the obvious new pair comprises the US, the world's largest debtor, and China, its greatest saver. In terms of themes, the conference would have to solve a new type of problem: how states should deal with the large flows of capital that over the past four decades have been mediated by the private sector.
Two alternative models seemed to work until 2008. On one side was the American model, with a variety of regulated banks, lightly regulated investment banks, and largely unregulated hedge funds managing the capital flows. On the other side was the Chinese solution, with increasingly costly reserve management giving way to activist sovereign wealth funds looking for strategic participation in investments abroad.
Both approaches were flawed – and liable to produce political controversy. The American model failed because banks proved to be highly vulnerable to panic once it became clear that sophisticated new financial instruments had formed a haystack spiked with sharp, dangerous, and indigestible losses. And, inevitably, today's big bailouts have been followed by a politically fraught discussion of which banks were rescued, and whose political interests were served. Already, there is a ferocious debate about the influence of Goldman Sachs on the US Treasury. Likewise, the very large European bailouts (totaling as much as 20% of GDP in Germany) have produced controversies about the distribution of costs.
Meanwhile, the Chinese solution gave rise to nationalist fears that sovereign wealth funds might be abused to seize strategically vital businesses or whole sectors of an economy.
The original inspiration behind the creation of the IMF was that a largely automatic and rule-governed body would be a less politicised way of stabilizing markets and expectations. That remains true today: managing temporary stakes in banks in need of recapitalisation, on behalf of large providers of capital (such as the Asian surplus countries), would put a neutral, depoliticised buffer between states and private-sector institutions.
The IMF was originally conceived in 1944 in a world without major private capital flows, one in which states undertook almost all international transactions. Extending its mission to include some private-sector rescues would recognize the preponderant role that markets now play. At the same time, the involvement of a rule-bound international agency would minimise the political poison associated with bank recapitalisations and currency interventions.
In cooperation with Project Syndicate, 2008.
http://www.guardian.co.uk/commentisfree/brettonwoods
http://www.guardian.co.uk/commentisfree/2008/dec/05/global-economy-us-china-imf
**Desperate times: how the Fed plans to save the world
Economic policy
Desperate times: how the Fed plans to save the world
Larry Elliott, economics editor
The Guardian, Thursday 18 December 2008
The unusual measures unveiled this week by the Federal reserve chairman, Ben Bernanke, promise to usher in an era of free money unprecedented in the history of financial markets. They include tools designed to lower long-term interest rates and boost growth in the world's biggest economy. Here we look at what the measures are, what they mean for you, and what will happen if they don't work.
Why has the Fed been forced to take such drastic steps?
After 18 months in which they have cut interest rates sharply, nationalised leading banks and provided tax rebates for consumers, US policymakers are now desperate to halt America's slide into a deep and painful recession. For historical reasons, fear of a slump runs as deep in the US as does fear of inflation in Germany, but all the conventional policy tools have so far failed. Non-farm jobs fell by more than 500,000 in November, the biggest drop since the mid-1970s, and the housing market is in freefall. Ben Bernanke is a former academic who specialised in the lessons of the Great Depression, one of which is that policymakers have to act fast and decisively to prevent a deflationary spiral setting in.
So what is the Fed proposing?
There are various forms of interest rates. Policy, or short-term, rates are set by central banks and affect the cost of money to the financial system. In the UK, the policy, or bank rate, is 2%. In the US, after Tuesday's cut, the Fed has set a target range of 0% to 0.25% - an all-time low. In normal circumstances, ultra-low policy rates make it easier for banks to lend money to their business and personal customers but these are not normal circumstances. The supply of credit has dried up as banks repair the damage to their balance sheets caused by losses on their ill-judged investments during the boom. Real borrowing rates for households and firms have fallen but not nearly so rapidly as have policy rates. The Fed's actions this week are aimed at cutting real borrowing costs.
How does it do this?
The Federal Reserve has already bought up mortgage-backed securities and the debts of Fannie Mae and Freddie Mac, the two giant state-owned mortgage finance companies. This week it said this programme would be stepped up and perhaps extended to purchases of longer-term treasury securities. Buying treasury bonds, the remedy proposed by Keynes in the 1930s and taken up by Franklin Roosevelt, is a radical step and as yet only being "evaluated" by the US central bank. But its aim is to drive down the long-term interest rates, normally set by buying and selling in the financial markets, through large-scale purchases of bonds. The interest rate - or yield - on bonds goes down as the price goes up, and buying bonds makes them more attractive by reducing the supply. Bringing down the interest rate on long-term bonds also brings down all other long-term interest rates, on fixed-rate mortgages, for example. It also gives the banks more money to lend because they exchange their bonds for money from the central bank.
So what's the drawback?
This process, known as quantitative easing, involves a huge expansion of the central bank's balance sheet so it can buy the bonds. It is not "printing money" since it no extra banknotes are churned out, but it gives the commercial banks more capital to lend on to their customers. To be effective, the central bank has to reassure financial markets that it will hold down long-term interest rates for as long as it takes to get credit markets working again. This means expanding the money supply, with the risk of re-igniting inflation once growth picks up. Bond markets are traditionally terrified by inflation and if investors start to believe that the central bank has lost control, a bond market bubble could potentially turn into a bond market bust.
What happens if it doesn't work?
In those circumstances, the next step will be wholesale use of fiscal policy. Keynes said in his General Theory that there might be cases when spirits in the private sector were so low that there would be no desire to borrow at any level of short-term or long-term interest rates. The state would then try to boost activity itself, either by public works or tax cuts. President-elect Barack Obama's plan for a fiscal boost worth 4% of GDP is an acceptance that quantitative easing might not be enough.
Anything else?
The economist Milton Friedman once said it would be theoretically possible for policymakers to end a depression by dumping wads of cash on the populace below from helicopters. This was cited by Bernanke in a paper in 2002, winning him the nickname Helicopter Ben. Other "unconventional" suggestions include providing consumers with time-limited spending vouchers that would force them to spend, or even making people pay banks for holding their money.
What does it mean for the UK?
The Bank of England and the Treasury are looking at whether quantitative easing would be possible in the UK. The upside would be that mortgage rates, overdrafts and business finance costs would fall if long-term interest rates declined. The downside would be if the markets became alarmed at the risks to inflation, turning the recent run on the pound into a full-blown sterling crisis. The pound does not have the dollar's reserve currency status so the UK is more vulnerable than the US.
Is there an alternative?
The other option is to do what the Austrian school of economists suggest: wait for the crisis to blow itself out. What is needed, they argue, is not shoring up a failed system but a period of creative destruction that will lay the foundations for stronger long-term growth. Politicians, who have elections to fight, find the do-nothing option somewhat unattractive.
Related
5 Dec 2008
American economy is in freefall
5 Dec 2008
Harold James: A new Bretton Woods hinges on negotiations between today's economic superpowers
15 Nov 2008
The G20: Who is there and how desperate are they?
16 Oct 2008
Joseph Stiglitz: Paulson tries again
http://www.guardian.co.uk/business/2008/dec/18/federal-reserve-measures-ben-bernnake
Desperate times: how the Fed plans to save the world
Larry Elliott, economics editor
The Guardian, Thursday 18 December 2008
The unusual measures unveiled this week by the Federal reserve chairman, Ben Bernanke, promise to usher in an era of free money unprecedented in the history of financial markets. They include tools designed to lower long-term interest rates and boost growth in the world's biggest economy. Here we look at what the measures are, what they mean for you, and what will happen if they don't work.
Why has the Fed been forced to take such drastic steps?
After 18 months in which they have cut interest rates sharply, nationalised leading banks and provided tax rebates for consumers, US policymakers are now desperate to halt America's slide into a deep and painful recession. For historical reasons, fear of a slump runs as deep in the US as does fear of inflation in Germany, but all the conventional policy tools have so far failed. Non-farm jobs fell by more than 500,000 in November, the biggest drop since the mid-1970s, and the housing market is in freefall. Ben Bernanke is a former academic who specialised in the lessons of the Great Depression, one of which is that policymakers have to act fast and decisively to prevent a deflationary spiral setting in.
So what is the Fed proposing?
There are various forms of interest rates. Policy, or short-term, rates are set by central banks and affect the cost of money to the financial system. In the UK, the policy, or bank rate, is 2%. In the US, after Tuesday's cut, the Fed has set a target range of 0% to 0.25% - an all-time low. In normal circumstances, ultra-low policy rates make it easier for banks to lend money to their business and personal customers but these are not normal circumstances. The supply of credit has dried up as banks repair the damage to their balance sheets caused by losses on their ill-judged investments during the boom. Real borrowing rates for households and firms have fallen but not nearly so rapidly as have policy rates. The Fed's actions this week are aimed at cutting real borrowing costs.
How does it do this?
The Federal Reserve has already bought up mortgage-backed securities and the debts of Fannie Mae and Freddie Mac, the two giant state-owned mortgage finance companies. This week it said this programme would be stepped up and perhaps extended to purchases of longer-term treasury securities. Buying treasury bonds, the remedy proposed by Keynes in the 1930s and taken up by Franklin Roosevelt, is a radical step and as yet only being "evaluated" by the US central bank. But its aim is to drive down the long-term interest rates, normally set by buying and selling in the financial markets, through large-scale purchases of bonds. The interest rate - or yield - on bonds goes down as the price goes up, and buying bonds makes them more attractive by reducing the supply. Bringing down the interest rate on long-term bonds also brings down all other long-term interest rates, on fixed-rate mortgages, for example. It also gives the banks more money to lend because they exchange their bonds for money from the central bank.
So what's the drawback?
This process, known as quantitative easing, involves a huge expansion of the central bank's balance sheet so it can buy the bonds. It is not "printing money" since it no extra banknotes are churned out, but it gives the commercial banks more capital to lend on to their customers. To be effective, the central bank has to reassure financial markets that it will hold down long-term interest rates for as long as it takes to get credit markets working again. This means expanding the money supply, with the risk of re-igniting inflation once growth picks up. Bond markets are traditionally terrified by inflation and if investors start to believe that the central bank has lost control, a bond market bubble could potentially turn into a bond market bust.
What happens if it doesn't work?
In those circumstances, the next step will be wholesale use of fiscal policy. Keynes said in his General Theory that there might be cases when spirits in the private sector were so low that there would be no desire to borrow at any level of short-term or long-term interest rates. The state would then try to boost activity itself, either by public works or tax cuts. President-elect Barack Obama's plan for a fiscal boost worth 4% of GDP is an acceptance that quantitative easing might not be enough.
Anything else?
The economist Milton Friedman once said it would be theoretically possible for policymakers to end a depression by dumping wads of cash on the populace below from helicopters. This was cited by Bernanke in a paper in 2002, winning him the nickname Helicopter Ben. Other "unconventional" suggestions include providing consumers with time-limited spending vouchers that would force them to spend, or even making people pay banks for holding their money.
What does it mean for the UK?
The Bank of England and the Treasury are looking at whether quantitative easing would be possible in the UK. The upside would be that mortgage rates, overdrafts and business finance costs would fall if long-term interest rates declined. The downside would be if the markets became alarmed at the risks to inflation, turning the recent run on the pound into a full-blown sterling crisis. The pound does not have the dollar's reserve currency status so the UK is more vulnerable than the US.
Is there an alternative?
The other option is to do what the Austrian school of economists suggest: wait for the crisis to blow itself out. What is needed, they argue, is not shoring up a failed system but a period of creative destruction that will lay the foundations for stronger long-term growth. Politicians, who have elections to fight, find the do-nothing option somewhat unattractive.
Related
5 Dec 2008
American economy is in freefall
5 Dec 2008
Harold James: A new Bretton Woods hinges on negotiations between today's economic superpowers
15 Nov 2008
The G20: Who is there and how desperate are they?
16 Oct 2008
Joseph Stiglitz: Paulson tries again
http://www.guardian.co.uk/business/2008/dec/18/federal-reserve-measures-ben-bernnake
Savers seeking solution to financial crisis buy gold
There's gold in them thar' shops: the rush is on
Richard Wray
The Guardian, Thursday 2 October 2008
Tucked away beside the ornate entrance of the Savoy hotel in London are the discreet premises of ATS Bullion. Over the last few days staff there have witnessed an unprecedented phenomenon: queues.
The customers are wary savers looking to build their own solution to the global financial crisis and the parlous state of the banking system. They are buying gold.
"There has been enormous demand," said Sandra Conway, managing director at ATS, one of the UK's leading gold coin and bar merchants. "There are very few sellers of physical gold and we have actually had queues of people today."
The world's makers of gold bars and gold coins are running flat out to try to keep up with this surge in demand, but stocks are dwindling, especially of Krugerrands.
Named after Paul Kruger, who led the Boer resistance to the British at the turn of the 19th century, the coins were first minted in South Africa in 1967. Although it was illegal to import them into the UK during the 1970s and 1980s because of apartheid, they have become one of the most widely circulated gold coins in the world. But the £547 coins are becoming more scarce as investors snap them up.
As a result, the Rand Refinery is now operating seven days a week, as is the Austrian mint, which produces the popular Vienna Philharmonic coin.
The US Mint, responsible for ensuring an adequate supply of American coinage since 1792, has been forced to halt sales of its American Buffalo solid 24 carat gold coin because it was running out of supplies. It is also limiting the availability of its 22 carat American Eagle alternative.
Canny investors had also noticed that both one ounce coins cost less than an ounce of gold on the open market at the time, making them incredibly tempting to anyone looking to make a quick return. Having broken through the $1,000 barrier earlier in the year, the gold price has retreated slightly and is now trading at around $880 an ounce. The 2007 American Eagle one ounce coin, however, was going for $789.95 while the 2006 Buffalo coin cost $800 - offering the potential for an instant return of $80-$90.
http://www.guardian.co.uk/business/2008/oct/02/banking.economics
Richard Wray
The Guardian, Thursday 2 October 2008
Tucked away beside the ornate entrance of the Savoy hotel in London are the discreet premises of ATS Bullion. Over the last few days staff there have witnessed an unprecedented phenomenon: queues.
The customers are wary savers looking to build their own solution to the global financial crisis and the parlous state of the banking system. They are buying gold.
"There has been enormous demand," said Sandra Conway, managing director at ATS, one of the UK's leading gold coin and bar merchants. "There are very few sellers of physical gold and we have actually had queues of people today."
The world's makers of gold bars and gold coins are running flat out to try to keep up with this surge in demand, but stocks are dwindling, especially of Krugerrands.
Named after Paul Kruger, who led the Boer resistance to the British at the turn of the 19th century, the coins were first minted in South Africa in 1967. Although it was illegal to import them into the UK during the 1970s and 1980s because of apartheid, they have become one of the most widely circulated gold coins in the world. But the £547 coins are becoming more scarce as investors snap them up.
As a result, the Rand Refinery is now operating seven days a week, as is the Austrian mint, which produces the popular Vienna Philharmonic coin.
The US Mint, responsible for ensuring an adequate supply of American coinage since 1792, has been forced to halt sales of its American Buffalo solid 24 carat gold coin because it was running out of supplies. It is also limiting the availability of its 22 carat American Eagle alternative.
Canny investors had also noticed that both one ounce coins cost less than an ounce of gold on the open market at the time, making them incredibly tempting to anyone looking to make a quick return. Having broken through the $1,000 barrier earlier in the year, the gold price has retreated slightly and is now trading at around $880 an ounce. The 2007 American Eagle one ounce coin, however, was going for $789.95 while the 2006 Buffalo coin cost $800 - offering the potential for an instant return of $80-$90.
http://www.guardian.co.uk/business/2008/oct/02/banking.economics
Helicopter money - a short guide
Helicopter money - a short guide
Ashley Seager
The Guardian, Thursday 18 December 2008
The idea of dropping money from a helicopter sounds great, particularly if you are lucky enough to be standing under one. But surely it would only happen in a banana republic or some weird work of fiction? Well, maybe.
The term "helicopter money" is on everyone's lips thanks to Ben Bernanke, the head of the US central bank, the Federal Reserve. Dubbed "Helicopter Ben" by his critics, he has been associated with the idea since he gave a speech in 1992 quoting legendary economist Milton Friedman as proposing it in extremis should deflation - or continually falling prices - ever grip a modern economy.
There are now fears that exactly that might be about to happen. On Tuesday night the Fed slashed interest rates to nearly zero in a bid to breathe some life into the collapsing US economy. The Bank of England looks about to do the same thing here. But both central banks are worried that cutting rates to zero may not on its own stop the rot so they are considering radical next steps to pump money into the economy to get people and businesses spending again.
The plan is known as "quantitative easing" which in layman's language means increasing the quantity of money in the economy rather than lowering its price by cutting interest rates. At first instance this will involve buying up government bonds, known as gilts, from individuals and pension funds, for an attractive price. As bonds are a form of saving, if you swap them for cash people are more likely to spend it.
If that doesn't work the government could simply give cash handouts. Poor pensioners or working people would be the priority, as they can be relied on to spend it. You can even issue time-limited spending vouchers for shops. You don't, in reality, need helicopters to do that, but it's a nice image.
http://www.guardian.co.uk/business/2008/dec/18/useconomy-economics
Ashley Seager
The Guardian, Thursday 18 December 2008
The idea of dropping money from a helicopter sounds great, particularly if you are lucky enough to be standing under one. But surely it would only happen in a banana republic or some weird work of fiction? Well, maybe.
The term "helicopter money" is on everyone's lips thanks to Ben Bernanke, the head of the US central bank, the Federal Reserve. Dubbed "Helicopter Ben" by his critics, he has been associated with the idea since he gave a speech in 1992 quoting legendary economist Milton Friedman as proposing it in extremis should deflation - or continually falling prices - ever grip a modern economy.
There are now fears that exactly that might be about to happen. On Tuesday night the Fed slashed interest rates to nearly zero in a bid to breathe some life into the collapsing US economy. The Bank of England looks about to do the same thing here. But both central banks are worried that cutting rates to zero may not on its own stop the rot so they are considering radical next steps to pump money into the economy to get people and businesses spending again.
The plan is known as "quantitative easing" which in layman's language means increasing the quantity of money in the economy rather than lowering its price by cutting interest rates. At first instance this will involve buying up government bonds, known as gilts, from individuals and pension funds, for an attractive price. As bonds are a form of saving, if you swap them for cash people are more likely to spend it.
If that doesn't work the government could simply give cash handouts. Poor pensioners or working people would be the priority, as they can be relied on to spend it. You can even issue time-limited spending vouchers for shops. You don't, in reality, need helicopters to do that, but it's a nice image.
http://www.guardian.co.uk/business/2008/dec/18/useconomy-economics
Financial Services Industry: How things can have gone so wrong
Op-Ed Columnist
The Madoff Economy
By PAUL KRUGMAN
Published: December 19, 2008
The revelation that Bernard Madoff — brilliant investor (or so almost everyone thought), philanthropist, pillar of the community — was a phony has shocked the world, and understandably so. The scale of his alleged $50 billion Ponzi scheme is hard to comprehend.
Yet surely I’m not the only person to ask the obvious question: How different, really, is Mr. Madoff’s tale from the story of the investment industry as a whole?
The financial services industry has claimed an ever-growing share of the nation’s income over the past generation, making the people who run the industry incredibly rich. Yet, at this point, it looks as if much of the industry has been destroying value, not creating it. And it’s not just a matter of money: the vast riches achieved by those who managed other people’s money have had a corrupting effect on our society as a whole.
Let’s start with those paychecks. Last year, the average salary of employees in “securities, commodity contracts, and investments” was more than four times the average salary in the rest of the economy. Earning a million dollars was nothing special, and even incomes of $20 million or more were fairly common. The incomes of the richest Americans have exploded over the past generation, even as wages of ordinary workers have stagnated; high pay on Wall Street was a major cause of that divergence.
But surely those financial superstars must have been earning their millions, right? No, not necessarily. The pay system on Wall Street lavishly rewards the appearance of profit, even if that appearance later turns out to have been an illusion.
Consider the hypothetical example of a money manager who leverages up his clients’ money with lots of debt, then invests the bulked-up total in high-yielding but risky assets, such as dubious mortgage-backed securities. For a while — say, as long as a housing bubble continues to inflate — he (it’s almost always a he) will make big profits and receive big bonuses. Then, when the bubble bursts and his investments turn into toxic waste, his investors will lose big — but he’ll keep those bonuses.
O.K., maybe my example wasn’t hypothetical after all.
So, how different is what Wall Street in general did from the Madoff affair? Well, Mr. Madoff allegedly skipped a few steps, simply stealing his clients’ money rather than collecting big fees while exposing investors to risks they didn’t understand. And while Mr. Madoff was apparently a self-conscious fraud, many people on Wall Street believed their own hype. Still, the end result was the same (except for the house arrest): the money managers got rich; the investors saw their money disappear.
We’re talking about a lot of money here. In recent years the finance sector accounted for 8 percent of America’s G.D.P., up from less than 5 percent a generation earlier. If that extra 3 percent was money for nothing — and it probably was — we’re talking about $400 billion a year in waste, fraud and abuse.
But the costs of America’s Ponzi era surely went beyond the direct waste of dollars and cents.
At the crudest level, Wall Street’s ill-gotten gains corrupted and continue to corrupt politics, in a nicely bipartisan way. From Bush administration officials like Christopher Cox, chairman of the Securities and Exchange Commission, who looked the other way as evidence of financial fraud mounted, to Democrats who still haven’t closed the outrageous tax loophole that benefits executives at hedge funds and private equity firms (hello, Senator Schumer), politicians have walked when money talked.
Meanwhile, how much has our nation’s future been damaged by the magnetic pull of quick personal wealth, which for years has drawn many of our best and brightest young people into investment banking, at the expense of science, public service and just about everything else?
Most of all, the vast riches being earned — or maybe that should be “earned” — in our bloated financial industry undermined our sense of reality and degraded our judgment.
Think of the way almost everyone important missed the warning signs of an impending crisis. How was that possible? How, for example, could Alan Greenspan have declared, just a few years ago, that “the financial system as a whole has become more resilient” — thanks to derivatives, no less? The answer, I believe, is that there’s an innate tendency on the part of even the elite to idolize men who are making a lot of money, and assume that they know what they’re doing.
After all, that’s why so many people trusted Mr. Madoff.
Now, as we survey the wreckage and try to understand how things can have gone so wrong, so fast, the answer is actually quite simple: What we’re looking at now are the consequences of a world gone Madoff.
http://www.nytimes.com/2008/12/19/opinion/19krugman.html?em
The Madoff Economy
By PAUL KRUGMAN
Published: December 19, 2008
The revelation that Bernard Madoff — brilliant investor (or so almost everyone thought), philanthropist, pillar of the community — was a phony has shocked the world, and understandably so. The scale of his alleged $50 billion Ponzi scheme is hard to comprehend.
Yet surely I’m not the only person to ask the obvious question: How different, really, is Mr. Madoff’s tale from the story of the investment industry as a whole?
The financial services industry has claimed an ever-growing share of the nation’s income over the past generation, making the people who run the industry incredibly rich. Yet, at this point, it looks as if much of the industry has been destroying value, not creating it. And it’s not just a matter of money: the vast riches achieved by those who managed other people’s money have had a corrupting effect on our society as a whole.
Let’s start with those paychecks. Last year, the average salary of employees in “securities, commodity contracts, and investments” was more than four times the average salary in the rest of the economy. Earning a million dollars was nothing special, and even incomes of $20 million or more were fairly common. The incomes of the richest Americans have exploded over the past generation, even as wages of ordinary workers have stagnated; high pay on Wall Street was a major cause of that divergence.
But surely those financial superstars must have been earning their millions, right? No, not necessarily. The pay system on Wall Street lavishly rewards the appearance of profit, even if that appearance later turns out to have been an illusion.
Consider the hypothetical example of a money manager who leverages up his clients’ money with lots of debt, then invests the bulked-up total in high-yielding but risky assets, such as dubious mortgage-backed securities. For a while — say, as long as a housing bubble continues to inflate — he (it’s almost always a he) will make big profits and receive big bonuses. Then, when the bubble bursts and his investments turn into toxic waste, his investors will lose big — but he’ll keep those bonuses.
O.K., maybe my example wasn’t hypothetical after all.
So, how different is what Wall Street in general did from the Madoff affair? Well, Mr. Madoff allegedly skipped a few steps, simply stealing his clients’ money rather than collecting big fees while exposing investors to risks they didn’t understand. And while Mr. Madoff was apparently a self-conscious fraud, many people on Wall Street believed their own hype. Still, the end result was the same (except for the house arrest): the money managers got rich; the investors saw their money disappear.
We’re talking about a lot of money here. In recent years the finance sector accounted for 8 percent of America’s G.D.P., up from less than 5 percent a generation earlier. If that extra 3 percent was money for nothing — and it probably was — we’re talking about $400 billion a year in waste, fraud and abuse.
But the costs of America’s Ponzi era surely went beyond the direct waste of dollars and cents.
At the crudest level, Wall Street’s ill-gotten gains corrupted and continue to corrupt politics, in a nicely bipartisan way. From Bush administration officials like Christopher Cox, chairman of the Securities and Exchange Commission, who looked the other way as evidence of financial fraud mounted, to Democrats who still haven’t closed the outrageous tax loophole that benefits executives at hedge funds and private equity firms (hello, Senator Schumer), politicians have walked when money talked.
Meanwhile, how much has our nation’s future been damaged by the magnetic pull of quick personal wealth, which for years has drawn many of our best and brightest young people into investment banking, at the expense of science, public service and just about everything else?
Most of all, the vast riches being earned — or maybe that should be “earned” — in our bloated financial industry undermined our sense of reality and degraded our judgment.
Think of the way almost everyone important missed the warning signs of an impending crisis. How was that possible? How, for example, could Alan Greenspan have declared, just a few years ago, that “the financial system as a whole has become more resilient” — thanks to derivatives, no less? The answer, I believe, is that there’s an innate tendency on the part of even the elite to idolize men who are making a lot of money, and assume that they know what they’re doing.
After all, that’s why so many people trusted Mr. Madoff.
Now, as we survey the wreckage and try to understand how things can have gone so wrong, so fast, the answer is actually quite simple: What we’re looking at now are the consequences of a world gone Madoff.
http://www.nytimes.com/2008/12/19/opinion/19krugman.html?em
The Reckoning: On Wall Street, Bonuses, Not Profits, Were Real
Harvard Endowment Fund had fallen 22 percent
Harvard Endowment Managers Made $26.8 Million
By GERALDINE FABRIKANT
Published: December 19, 2008
The Harvard Management Company, which handles the university’s endowment, said on Friday that the compensation for five of its top managers and its former chief executive was $26.8 million for the fiscal year ended June 30.
The amount included $921,000 for the former chief executive, Mohamed El-Erian, who left in the middle of the fiscal year and returned to the Pacific Investment Management Company. The value of the endowment at the end of fiscal 2008 was $36.9 billion.
The highest paid of the six men was Stephen Blyth, managing director for international fixed income, who received $6.4 million.
Marc Seidner, managing director for domestic fixed income, received $6.3 million; Stanley Zuzic, senior vice president for domestic equities, got $4.9 million; Steven Alperin, managing director for emerging market equities, $4.4 million; and Andrew Wiltshire, managing director for natural resources, $3.9 million.
In past years, the compensation of the endowment’s managers prompted controversy because some academicians and alumni viewed it as excessive in the context of an academic institution.
In the wake of the controversy, Jack Meyer, the chief executive, left in 2005 to form his own hedge fund.
In 2003, the top group of managers earned $107.5 million. A year later, the figure was $78.4 million. In 2005, the board of the management company cut it to $56.8 million.
Since then, Harvard Management’s board has put in place mechanisms to limit the total annual compensation. Internal managers are compensated in a package that includes a bonus calculated on the value added in excess of specific market index benchmarks. Last year, the endowment posted an 8.6 percent return.
After Mr. El-Erian’s departure, Robert S. Kaplan, a professor of management at Harvard Business School, served as chief executive without compensation. Since July, the endowment has been run by Jane L. Mendillo, who formerly ran the Wellesley endowment.
Recently, Harvard announced that the value of the endowment had fallen 22 percent as of the end of October and that it could decline 30 percent by the end of the 2009 fiscal year.
Many schools have taken the unusual step of putting out interim numbers in part to provide some guidance about necessary belt-tightening measures.
http://www.nytimes.com/2008/12/20/business/20harvard.html?ref=business
By GERALDINE FABRIKANT
Published: December 19, 2008
The Harvard Management Company, which handles the university’s endowment, said on Friday that the compensation for five of its top managers and its former chief executive was $26.8 million for the fiscal year ended June 30.
The amount included $921,000 for the former chief executive, Mohamed El-Erian, who left in the middle of the fiscal year and returned to the Pacific Investment Management Company. The value of the endowment at the end of fiscal 2008 was $36.9 billion.
The highest paid of the six men was Stephen Blyth, managing director for international fixed income, who received $6.4 million.
Marc Seidner, managing director for domestic fixed income, received $6.3 million; Stanley Zuzic, senior vice president for domestic equities, got $4.9 million; Steven Alperin, managing director for emerging market equities, $4.4 million; and Andrew Wiltshire, managing director for natural resources, $3.9 million.
In past years, the compensation of the endowment’s managers prompted controversy because some academicians and alumni viewed it as excessive in the context of an academic institution.
In the wake of the controversy, Jack Meyer, the chief executive, left in 2005 to form his own hedge fund.
In 2003, the top group of managers earned $107.5 million. A year later, the figure was $78.4 million. In 2005, the board of the management company cut it to $56.8 million.
Since then, Harvard Management’s board has put in place mechanisms to limit the total annual compensation. Internal managers are compensated in a package that includes a bonus calculated on the value added in excess of specific market index benchmarks. Last year, the endowment posted an 8.6 percent return.
After Mr. El-Erian’s departure, Robert S. Kaplan, a professor of management at Harvard Business School, served as chief executive without compensation. Since July, the endowment has been run by Jane L. Mendillo, who formerly ran the Wellesley endowment.
Recently, Harvard announced that the value of the endowment had fallen 22 percent as of the end of October and that it could decline 30 percent by the end of the 2009 fiscal year.
Many schools have taken the unusual step of putting out interim numbers in part to provide some guidance about necessary belt-tightening measures.
http://www.nytimes.com/2008/12/20/business/20harvard.html?ref=business
Foreign Investors Trade Safe for Safest
Foreign Investors Trade Safe for Safest
('Despite U.S. backing, bonds issued by Fannie Mae and Freddie Mac have skeptics.')
By FLOYD NORRIS
Published: December 19, 2008
AS foreign investors pour cash into United States securities, particularly short-term Treasury bills, they are pulling it out of the higher-yielding bonds issued by the government supported-entities Fannie Mae and Freddie Mac.
Foreign purchases of government securities
The moves appear to indicate that even after the government bailout of the two agencies, there is some lingering doubt that the government would actually stand behind their debts if their situation grew much worse.
The Treasury Department reported this week that in October, overseas investors and governments were net sellers of $50 billion of agency securities, even though they yield significantly more than comparable Treasuries, which the investors bought at a record rate.
Over the summer, prices of agency securities fell as the financial crisis grew worse and some investors began to doubt whether the “implicit” government guarantee behind the agencies could be trusted. In July and August, foreigners were net sellers of $64 billion of such securities, an outflow unlike any previously seen.
That flight was one reason the government stepped in on Sept. 7 to effectively nationalize the agencies, although shares remain publicly traded. At first investors seemed reassured, but the confidence has now waned.
Despite the nationalization, the government has stopped short of putting its full faith and credit behind the bonds. The new data is the first indication that may have mattered to many overseas investors.
The accompanying chart at the top shows the monthly flows this year of foreign cash into Treasury securities and agency securities. More foreign money came into Treasuries in October — almost $91 billion — than in any previous month.
Most of the money — $56 billion in October — has gone into Treasury bills rather than into longer-dated bonds and notes. That flow helped to push down interest rates on bills to historically low levels, sometimes even a bit below zero, as investors sought complete safety.
Until the housing market began to show significant weakness in 2007, foreign flows into agency securities were running at almost $300 billion a year, and the flow stayed strong until the summer scare.
The other chart shows that over the 12 months through October, foreigners put just $65 billion into Fannie Mae and Freddie Mac, the lowest for any such period since 1998. Unless there was a revival of overseas interest in those securities in November and December, 2008 could become the first year to see net sales, at least since the data became available in the early 1990s.
Until the late 1990s there was relatively little overseas investment in agency securities. But as the Clinton-era budget surpluses reduced the supply of available Treasuries, foreign investors discovered these investments, which seemed to be close substitutes. Even after large budget deficits resumed early this decade, the overseas demand for agencies continued to grow until questions about their solvency began to be heard.
Now, virtually all the foreign money is going into Treasuries — at a rate of more than half a trillion dollars a year.
Floyd Norris comments on finance and economics in his blog at nytimes.com/norris.
http://www.nytimes.com/2008/12/20/business/worldbusiness/20charts.html?ref=business
('Despite U.S. backing, bonds issued by Fannie Mae and Freddie Mac have skeptics.')
By FLOYD NORRIS
Published: December 19, 2008
AS foreign investors pour cash into United States securities, particularly short-term Treasury bills, they are pulling it out of the higher-yielding bonds issued by the government supported-entities Fannie Mae and Freddie Mac.
Foreign purchases of government securitiesThe moves appear to indicate that even after the government bailout of the two agencies, there is some lingering doubt that the government would actually stand behind their debts if their situation grew much worse.
The Treasury Department reported this week that in October, overseas investors and governments were net sellers of $50 billion of agency securities, even though they yield significantly more than comparable Treasuries, which the investors bought at a record rate.
Over the summer, prices of agency securities fell as the financial crisis grew worse and some investors began to doubt whether the “implicit” government guarantee behind the agencies could be trusted. In July and August, foreigners were net sellers of $64 billion of such securities, an outflow unlike any previously seen.
That flight was one reason the government stepped in on Sept. 7 to effectively nationalize the agencies, although shares remain publicly traded. At first investors seemed reassured, but the confidence has now waned.
Despite the nationalization, the government has stopped short of putting its full faith and credit behind the bonds. The new data is the first indication that may have mattered to many overseas investors.
The accompanying chart at the top shows the monthly flows this year of foreign cash into Treasury securities and agency securities. More foreign money came into Treasuries in October — almost $91 billion — than in any previous month.
Most of the money — $56 billion in October — has gone into Treasury bills rather than into longer-dated bonds and notes. That flow helped to push down interest rates on bills to historically low levels, sometimes even a bit below zero, as investors sought complete safety.
Until the housing market began to show significant weakness in 2007, foreign flows into agency securities were running at almost $300 billion a year, and the flow stayed strong until the summer scare.
The other chart shows that over the 12 months through October, foreigners put just $65 billion into Fannie Mae and Freddie Mac, the lowest for any such period since 1998. Unless there was a revival of overseas interest in those securities in November and December, 2008 could become the first year to see net sales, at least since the data became available in the early 1990s.
Until the late 1990s there was relatively little overseas investment in agency securities. But as the Clinton-era budget surpluses reduced the supply of available Treasuries, foreign investors discovered these investments, which seemed to be close substitutes. Even after large budget deficits resumed early this decade, the overseas demand for agencies continued to grow until questions about their solvency began to be heard.
Now, virtually all the foreign money is going into Treasuries — at a rate of more than half a trillion dollars a year.
Floyd Norris comments on finance and economics in his blog at nytimes.com/norris.
http://www.nytimes.com/2008/12/20/business/worldbusiness/20charts.html?ref=business
Saturday 20 December 2008
Dollar roars back as global debts are called in
Dollar roars back as global debts are called in
For six years the world has been borrowing dollars to bet on property, oil, metals, emerging markets, and every bubble in every corner of the globe.
By Ambrose Evans-Pritchard Last Updated: 3:48PM BST 23 Oct 2008
The strong rebound in the dollar has surprised some analysts
This has been the dollar "carry trade", conducted on a huge scale with high leverage. Now the process has reversed abruptly as debt deflation - or "deleveraging" - engulfs world markets. The dollars must be repaid.
Hence a wild scramble for Greenbacks which has shaken the global currency system and shattered assumptions about the way the world works. The unwinding drama reached a crescendo yesterday as the euro fell to $1.28, down from $1.61 in July. The slide in the Brazilian real, the South African rand, the Indian rupee, and the Korean won, among others, has been stunning.
Stephen Jen, currency chief at Morgan Stanley, said US mutual funds, pension funds, and life insurers invested a big chunk of their $22 trillion (£13.5 trillion) of assets overseas to earn a higher yield during the boom. They are now in hot retreat as the emerging market story unravels. "There is a complete rethink going on. People are bringing their money back home," he said.
Hedge funds are 75pc dollar-based, regardless of where they come from. Many are now having to repatriate their dollars as margin calls, client withdrawls, and the need to slash risk forces them to cut leverage. The hedge fund industry had assets of $1.9 trillion at the peak of the bubble.
Data collected by the Bank for International Settlements shows that European and UK banks have five times as much exposure to emerging markets as US and Japans banks, with surprisingly big bets in Latin America and emerging Asia - where they rely on dollar funding rather than euros.
The fear is that deflating booms in these frontier economies will have an 'asymettric' effect on the currency markets, setting off another round of frantic dollar buying. "It is not impossible that the euro could collapse completely against the dollar, going back to 2001 levels," said Mr Jen.
He said the "composite" dollar-zone including China, the Gulf oil states, and other countries locked into the US currency system, will together have a current account surplus next year. The de-facto euro bloc of the core euro-zone and Eastern Europe is moving into substantial deficit. This creates a subtle bias in support of the dollar.
Of course, much of the currency shift this year is a natural swing as the crisis rotates from the US to Europe and beyond. The dollar was pummelled in the early phase of the crunch when economists still thought Europe, Japan, China and the rest of the world would decouple, powering ahead under their own steam. The Federal Reserve's dramatic rate cuts were seen then as a reason to dump the dollar.
The decoupling myth has now died. The euro-zone and Japan appear to have fallen into recession before the US itself, led by a precipitous fall in German manufacturing.
The ultra-hawkish stance of the European Central Bank - which raised rates in July - is now viewed as a weakness. Foreign exchange markets are no longer chasing the highest interest yield: they are instead punishing those where the authorities are slowest to respond to the downturn.
A hard-hitting report by Citigroup this week said the ECB had unwisely ignored screaming signals from the bond markets earlier this year for a rate cut. "The ECB did not listen. Not only did they no reduce rates as they should have but they increased them in one of the biggest policy mistakes of 2008," it said.
The spectacular dollar rebound has geostrategic implications. Heady talk earlier this year that dollar hegemeny was coming to an end - or indeed that the US was losing its status as a financial superpower - now seems very wide of the mark.
http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/3242927/Dollar-roars-back-as-global-debts-are-called-in.html
For six years the world has been borrowing dollars to bet on property, oil, metals, emerging markets, and every bubble in every corner of the globe.
By Ambrose Evans-Pritchard Last Updated: 3:48PM BST 23 Oct 2008
The strong rebound in the dollar has surprised some analysts
This has been the dollar "carry trade", conducted on a huge scale with high leverage. Now the process has reversed abruptly as debt deflation - or "deleveraging" - engulfs world markets. The dollars must be repaid.
Hence a wild scramble for Greenbacks which has shaken the global currency system and shattered assumptions about the way the world works. The unwinding drama reached a crescendo yesterday as the euro fell to $1.28, down from $1.61 in July. The slide in the Brazilian real, the South African rand, the Indian rupee, and the Korean won, among others, has been stunning.
Stephen Jen, currency chief at Morgan Stanley, said US mutual funds, pension funds, and life insurers invested a big chunk of their $22 trillion (£13.5 trillion) of assets overseas to earn a higher yield during the boom. They are now in hot retreat as the emerging market story unravels. "There is a complete rethink going on. People are bringing their money back home," he said.
Hedge funds are 75pc dollar-based, regardless of where they come from. Many are now having to repatriate their dollars as margin calls, client withdrawls, and the need to slash risk forces them to cut leverage. The hedge fund industry had assets of $1.9 trillion at the peak of the bubble.
Data collected by the Bank for International Settlements shows that European and UK banks have five times as much exposure to emerging markets as US and Japans banks, with surprisingly big bets in Latin America and emerging Asia - where they rely on dollar funding rather than euros.
The fear is that deflating booms in these frontier economies will have an 'asymettric' effect on the currency markets, setting off another round of frantic dollar buying. "It is not impossible that the euro could collapse completely against the dollar, going back to 2001 levels," said Mr Jen.
He said the "composite" dollar-zone including China, the Gulf oil states, and other countries locked into the US currency system, will together have a current account surplus next year. The de-facto euro bloc of the core euro-zone and Eastern Europe is moving into substantial deficit. This creates a subtle bias in support of the dollar.
Of course, much of the currency shift this year is a natural swing as the crisis rotates from the US to Europe and beyond. The dollar was pummelled in the early phase of the crunch when economists still thought Europe, Japan, China and the rest of the world would decouple, powering ahead under their own steam. The Federal Reserve's dramatic rate cuts were seen then as a reason to dump the dollar.
The decoupling myth has now died. The euro-zone and Japan appear to have fallen into recession before the US itself, led by a precipitous fall in German manufacturing.
The ultra-hawkish stance of the European Central Bank - which raised rates in July - is now viewed as a weakness. Foreign exchange markets are no longer chasing the highest interest yield: they are instead punishing those where the authorities are slowest to respond to the downturn.
A hard-hitting report by Citigroup this week said the ECB had unwisely ignored screaming signals from the bond markets earlier this year for a rate cut. "The ECB did not listen. Not only did they no reduce rates as they should have but they increased them in one of the biggest policy mistakes of 2008," it said.
The spectacular dollar rebound has geostrategic implications. Heady talk earlier this year that dollar hegemeny was coming to an end - or indeed that the US was losing its status as a financial superpower - now seems very wide of the mark.
http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/3242927/Dollar-roars-back-as-global-debts-are-called-in.html
ZIRP: Welcome to the world of sub-zero returns
ZIRP: Welcome to the world of sub-zero returns
Zero is a hard number to understand. In multiplication, it turns other values to nought. In division, it turns them to infinity. In finance, it turns the world upside down. No wonder investors are dizzy.
By Edward Hadas, breakingviews.comLast Updated: 12:50PM GMT 18 Dec 2008
The US is repeating a Japanese experiment with a zero in one of the most important variables in financial markets: the official overnight interest rate. This "Zirp" (zero interest rate policy) is combined with a nearly infinite quantity of government borrowing. The US government is expected to stimulate the economy - well into what looks like a bad recession - with as much as $850bn of new debt.
Meanwhile, the recession is inspiring a flight to safety. That means buying government bonds. The 2.2pc yield on the 10-year US Treasury could approach zero if the Federal Reserve follows up on hints that it will start buying Treasuries itself. So bond prices could move higher. But in the currency market, mega-debts and mini-yields are harmful, which is why the dollar has fallen back from Y98 to Y88 in a month.
The combination of falling yields and falling currency is illogical for a country that depends heavily on foreign capital. But in the Zirp world, many things don't quite stack up. The US isn't the only country that offers this investment conundrum. Take the UK, which is similarly indebted, and similarly borrowing more. The country is heading quickly towards Zirp, with the overnight rate of 2pc likely to be cut in half in January. The 10-year gilt yields a low 3.2pc. And the pound has tumbled as fast as the dollar, from E1.18 to E1.08 in a month.
The move towards Zirp is widespread. Japan never really left, and the eurozone is gradually getting there. The thinking is that free money will keep the credit system from freezing up, while higher government deficits should keep demand from collapsing.
But the policies aren't obviously working. The best that can be said so far is that the world could be in even worse shape without them. As no plausible alternatives are on offer, investors should expect more Zirp.
And that points to many sub-zero returns.
http://www.telegraph.co.uk/finance/breakingviewscom/3832292/ZIRP-Welcome-to-the-world-of-sub-zero-returns.html
Comment: ZIRP = Zero reward to creditors
Zero is a hard number to understand. In multiplication, it turns other values to nought. In division, it turns them to infinity. In finance, it turns the world upside down. No wonder investors are dizzy.
By Edward Hadas, breakingviews.comLast Updated: 12:50PM GMT 18 Dec 2008
The US is repeating a Japanese experiment with a zero in one of the most important variables in financial markets: the official overnight interest rate. This "Zirp" (zero interest rate policy) is combined with a nearly infinite quantity of government borrowing. The US government is expected to stimulate the economy - well into what looks like a bad recession - with as much as $850bn of new debt.
Meanwhile, the recession is inspiring a flight to safety. That means buying government bonds. The 2.2pc yield on the 10-year US Treasury could approach zero if the Federal Reserve follows up on hints that it will start buying Treasuries itself. So bond prices could move higher. But in the currency market, mega-debts and mini-yields are harmful, which is why the dollar has fallen back from Y98 to Y88 in a month.
The combination of falling yields and falling currency is illogical for a country that depends heavily on foreign capital. But in the Zirp world, many things don't quite stack up. The US isn't the only country that offers this investment conundrum. Take the UK, which is similarly indebted, and similarly borrowing more. The country is heading quickly towards Zirp, with the overnight rate of 2pc likely to be cut in half in January. The 10-year gilt yields a low 3.2pc. And the pound has tumbled as fast as the dollar, from E1.18 to E1.08 in a month.
The move towards Zirp is widespread. Japan never really left, and the eurozone is gradually getting there. The thinking is that free money will keep the credit system from freezing up, while higher government deficits should keep demand from collapsing.
But the policies aren't obviously working. The best that can be said so far is that the world could be in even worse shape without them. As no plausible alternatives are on offer, investors should expect more Zirp.
And that points to many sub-zero returns.
http://www.telegraph.co.uk/finance/breakingviewscom/3832292/ZIRP-Welcome-to-the-world-of-sub-zero-returns.html
Comment: ZIRP = Zero reward to creditors
**Debt deflation is tightening its grip over the entire global system.
Deflation virus is moving the policy test beyond the 1930s extremes
Debt deflation is tightening its grip over the entire global system. Interest rates are creeping towards zero in Japan, America, and now across most of Europe.
By Ambrose Evans-Pritchard, International Business EditorLast Updated: 5:50AM GMT 09 Dec 2008
Comments 187 Comment on this article
China will not lift us out - they are the most vulnerable of all Photo: AP
We are beyond the extremes of the 1930s. The frontiers of monetary policy are being pushed to limits that may now test viability of paper currencies and modern central banking.
You cannot drop below zero. So what next if the credit markets refuse to thaw? Yes, Japan visited and survived this policy Hell during its lost decade, but that was a local affair in an otherwise booming global economy. It tells us nothing.
This time we are all going down together. There is no deus ex machina to lift us out. Certainly not China, which is the most vulnerable of all.
As the risk grows, officials at the highest level of the British Government have begun to circulate a six-year-old speech by Ben Bernanke – at the time of its writing, a garrulous kid governor at the US Federal Reserve. Entitled Deflation: Making Sure It Doesn’t Happen Here, it is the manual of guerrilla tactics for defeating slumps by monetary means.
“The US government has a technology, called a printing press, that allows it to produce as many US dollars as it wishes at essentially no cost,” he said.
Critics had great fun with this when Bernanke later became Fed chief. But the speech is best seen as a thought experiment by a Princeton professor thinking aloud during the deflation mini-scare of 2002.
His point was that central banks never run out of ammunition. They have an inexhaustible arsenal. The world’s fate now hangs on whether he was right (which is probable), or wrong (which is possible).
As a scholar of the Great Depression, Bernanke does not think that sliding prices can safely be allowed to run their course. “Sustained deflation can be highly destructive to a modern economy,” he said.
Once the killer virus becomes lodged in the system, it leads to a self-reinforcing debt trap – the real burden of mortgages rises, year after year, house prices falling, year after year. The noose tightens until you choke. Subtly, it shifts wealth from workers to bondholders. It is reactionary poison. Ultimately, it leads to civic revolt. Democracies do not tolerate such social upheaval for long. They change the rules.
Bernanke’s central claim is that the big guns of monetary policy were never properly deployed during the Depression, or during the early years of Japan’s bust, so no wonder the slumps dragged on.
The Fed can create money out of thin air and mop up assets on the open market, like a sovereign sugar daddy. “Sufficient injections of money will ultimately always reverse a deflation.”
Bernanke said the Fed can “expand the menu of assets that it buys”. US Treasury bonds top the list, but it can equally purchase mortgage securities from US agencies such as Fannie, Freddie and Ginnie, or company bonds, or commercial paper. Any asset will do.
The Fed can acquire houses, stocks, or a herd of Texas Longhorn cattle if it wants. It can even scatter $100 bills from helicopters. (Actually, Japan is about to do this with shopping coupons).
All the Fed needs is emergency powers under Article 13 (3) of its code. This “unusual and exigent circumstances” clause was indeed invoked – very quietly – in March to save the US investment bank Bear Stearns.
There has been no looking back since. Last week the Fed began printing money to buy mortgage debt directly. The aim is to drive down the long-term interest rates used for most US home loans. The Bernanke speech is being put into practice, almost to the letter.
No doubt, such reflation a l’outrance can “work”, but what is the exit strategy? The policy leaves behind a liquidity lake. The risk is that this will flood the system once the credit pipes are unblocked. The economy could flip abruptly from deflation to hyper-inflation.
Nobel Laureate Robert Mundell warned last week that America faces disaster unless the Bernanke policy is reversed immediately. This is a minority view, but one held by a disturbingly large number of theorists. History will judge.
Most central bankers suffer from a déformation professionnelle. Those shaped by the 1970s are haunted by ghosts of libertine excess. Those like Bernanke who were shaped by the 1930s live with their Depression poltergeists.
His original claim to fame was work on the “credit channel” causes of slumps. Bank failures can snowball out of control as the “financial accelerator” kicks in. The cardinal error of the 1930s was to let lending contract.
This is why he went nuclear in January, ramming through the most dramatic rates cuts in Fed history. Events have borne him out.
A case can be made that Bernanke’s pre-emptive blitz has greatly reduced the likelihood of a catastrophe. It was no mean feat given that he had to face down a simmering revolt earlier this year from the Fed’s regional banks.
The sooner the Bank of England tears up its rule books and prepares to follow the script in Bernanke’s manual, the more chance we too have of avoiding a crash landing.
Monetary stimulus is a better option than fiscal sprees that leave us saddled with public debt – the path that nearly wrecked Japan.
Yes, I backed the Brown stimulus package – with a clothes-peg over my nose – but only as a one-off emergency. Public spending should be a last resort, as Keynes always argued.
Of course, Bernanke should not be let off the hook too lightly. Let us not forget that he was deeply complicit in creating the disaster we now face. He was cheerleader of Alan Greenspan’s easy-money stupidities from 2003-2006. He egged on debt debauchery.
It was he who provided the theoretical underpinnings of the Greenspan doctrine that one could safely ignore housing and stock bubbles because the Fed could simply “clean up afterwards”. Not so simply, it turns out.
As Bernanke said in his 2002 speech: “the best way to get out of trouble is not to get into it in the first place”. Too late now.
http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/3629806/Deflation-virus-is-moving-the-policy-test-beyond-the-1930s-extremes.html
Debt deflation is tightening its grip over the entire global system. Interest rates are creeping towards zero in Japan, America, and now across most of Europe.
By Ambrose Evans-Pritchard, International Business EditorLast Updated: 5:50AM GMT 09 Dec 2008
Comments 187 Comment on this article
China will not lift us out - they are the most vulnerable of all Photo: AP
We are beyond the extremes of the 1930s. The frontiers of monetary policy are being pushed to limits that may now test viability of paper currencies and modern central banking.
You cannot drop below zero. So what next if the credit markets refuse to thaw? Yes, Japan visited and survived this policy Hell during its lost decade, but that was a local affair in an otherwise booming global economy. It tells us nothing.
This time we are all going down together. There is no deus ex machina to lift us out. Certainly not China, which is the most vulnerable of all.
As the risk grows, officials at the highest level of the British Government have begun to circulate a six-year-old speech by Ben Bernanke – at the time of its writing, a garrulous kid governor at the US Federal Reserve. Entitled Deflation: Making Sure It Doesn’t Happen Here, it is the manual of guerrilla tactics for defeating slumps by monetary means.
“The US government has a technology, called a printing press, that allows it to produce as many US dollars as it wishes at essentially no cost,” he said.
Critics had great fun with this when Bernanke later became Fed chief. But the speech is best seen as a thought experiment by a Princeton professor thinking aloud during the deflation mini-scare of 2002.
His point was that central banks never run out of ammunition. They have an inexhaustible arsenal. The world’s fate now hangs on whether he was right (which is probable), or wrong (which is possible).
As a scholar of the Great Depression, Bernanke does not think that sliding prices can safely be allowed to run their course. “Sustained deflation can be highly destructive to a modern economy,” he said.
Once the killer virus becomes lodged in the system, it leads to a self-reinforcing debt trap – the real burden of mortgages rises, year after year, house prices falling, year after year. The noose tightens until you choke. Subtly, it shifts wealth from workers to bondholders. It is reactionary poison. Ultimately, it leads to civic revolt. Democracies do not tolerate such social upheaval for long. They change the rules.
Bernanke’s central claim is that the big guns of monetary policy were never properly deployed during the Depression, or during the early years of Japan’s bust, so no wonder the slumps dragged on.
The Fed can create money out of thin air and mop up assets on the open market, like a sovereign sugar daddy. “Sufficient injections of money will ultimately always reverse a deflation.”
Bernanke said the Fed can “expand the menu of assets that it buys”. US Treasury bonds top the list, but it can equally purchase mortgage securities from US agencies such as Fannie, Freddie and Ginnie, or company bonds, or commercial paper. Any asset will do.
The Fed can acquire houses, stocks, or a herd of Texas Longhorn cattle if it wants. It can even scatter $100 bills from helicopters. (Actually, Japan is about to do this with shopping coupons).
All the Fed needs is emergency powers under Article 13 (3) of its code. This “unusual and exigent circumstances” clause was indeed invoked – very quietly – in March to save the US investment bank Bear Stearns.
There has been no looking back since. Last week the Fed began printing money to buy mortgage debt directly. The aim is to drive down the long-term interest rates used for most US home loans. The Bernanke speech is being put into practice, almost to the letter.
No doubt, such reflation a l’outrance can “work”, but what is the exit strategy? The policy leaves behind a liquidity lake. The risk is that this will flood the system once the credit pipes are unblocked. The economy could flip abruptly from deflation to hyper-inflation.
Nobel Laureate Robert Mundell warned last week that America faces disaster unless the Bernanke policy is reversed immediately. This is a minority view, but one held by a disturbingly large number of theorists. History will judge.
Most central bankers suffer from a déformation professionnelle. Those shaped by the 1970s are haunted by ghosts of libertine excess. Those like Bernanke who were shaped by the 1930s live with their Depression poltergeists.
His original claim to fame was work on the “credit channel” causes of slumps. Bank failures can snowball out of control as the “financial accelerator” kicks in. The cardinal error of the 1930s was to let lending contract.
This is why he went nuclear in January, ramming through the most dramatic rates cuts in Fed history. Events have borne him out.
A case can be made that Bernanke’s pre-emptive blitz has greatly reduced the likelihood of a catastrophe. It was no mean feat given that he had to face down a simmering revolt earlier this year from the Fed’s regional banks.
The sooner the Bank of England tears up its rule books and prepares to follow the script in Bernanke’s manual, the more chance we too have of avoiding a crash landing.
Monetary stimulus is a better option than fiscal sprees that leave us saddled with public debt – the path that nearly wrecked Japan.
Yes, I backed the Brown stimulus package – with a clothes-peg over my nose – but only as a one-off emergency. Public spending should be a last resort, as Keynes always argued.
Of course, Bernanke should not be let off the hook too lightly. Let us not forget that he was deeply complicit in creating the disaster we now face. He was cheerleader of Alan Greenspan’s easy-money stupidities from 2003-2006. He egged on debt debauchery.
It was he who provided the theoretical underpinnings of the Greenspan doctrine that one could safely ignore housing and stock bubbles because the Fed could simply “clean up afterwards”. Not so simply, it turns out.
As Bernanke said in his 2002 speech: “the best way to get out of trouble is not to get into it in the first place”. Too late now.
http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/3629806/Deflation-virus-is-moving-the-policy-test-beyond-the-1930s-extremes.html
Federal Reserve battles debt and deflation
Federal Reserve is damned either way as it battles debt and deflation
We know what causes a recession to metastasize into a slump. Irving Fisher, the paramount US economist of the inter-war years, wrote the text in 1933: "Debt-Deflation Theory of Great Depressions".
By Ambrose Evans-PritchardLast Updated: 6:34PM GMT 18 Dec 2008
Comments 66 Comment on this article
"Such a disaster is somewhat like the capsizing of a ship which, under ordinary conditions is always near stable equilibrium but which, after being tipped beyond a certain angle, has no longer this tendency to return to equilibrium, but a tendency to depart further from it," he said.
Today we call this "Gladwell's tipping point". Once it goes, you can't get back up. This is why the Federal Reserve has resorted to emergency measures that seem mad at first sight.
It has not only cut rates to near zero for the first time in US history, it is also conjuring $2 trillion of stimulus out of thin air. This is Quantitative Easing, or just plain 'QE' in our brave new world.
The key is the toxic mix of high debt and deflation. An economy can handle one at a time, but not both.
The reason why it "departs further" from equilibrium is more or less understood. The burden of debt increases as prices fall, creating self-feeding spiral. This is what Fisher called the "swelling dollar" effect. Real debt costs rose by 40pc from 1929 to early 1933 by his count. Debtors suffocated to death.
Brian Reading from Lombard Street Research has revived this neglected thesis and come up with some disturbing figures. US household debt is now $13.9 trillion, down just 1pc from its peak last year. Meanwhile household wealth has fallen 14pc as property crashes, a loss of $6.67 trillion. The debt-to-wealth ratio is rocketing.
Clearly the US is already in the grip of debt-deflation. "The obvious conclusion is that the Fed should print money to purchase private sector assets so as to drive up their price," he said.
Fed chief Ben Bernanke does not need prompting. He made his name as a Princeton professor studying the "credit channel" causes of depressions. Now fate has put him in charge of the channel.
Under his guidance, the Fed has this week pledged to "employ all available tools" to stave off deflation - and damn the torpedoes. It will purchase "large quantities of agency debt and mortgage-backed securities." It will evaluate "the potential benefits of purchasing longer-term Treasury securities," i.e, printing money to pay the Pentagon.
Put bluntly, the Fed is deliberately stoking inflation. At some point it will succeed. Then the risk flips quickly to spiralling inflation as the elastic snaps back. There will be a second point of danger.
By late 2009, if not before, the bond vigilantes may start to fret about the liquidity lake. They will worry that the Fed may have to start feeding its holdings of debt back onto the market. The Fed's balance sheet has already risen from $800bn in September to $2.2 trillion this month. It will be $3 trillion by early next year.
"The bond markets could go into free fall," said Marc Ostwald from Monument Securities.
"The Fed went into this all guns blazing just as the Neo-cons went into Iraq thinking it was a great idea to get rid of Saddam, without planning an exit strategy. As soon as we get the first uptick in inflation, the markets are going to turn and say this is what we feared would happen all along. Then what?" he said.
New Star's Simon Ward said all three measures of the US broad money supply are flashing recovery. M2 has risen at annual rate of 17pc over three months.
"It has all changed since the Fed began buying commercial paper in October. If the money supply is booming at 20pc in six months, inflation will become a concern. Given that public debt ratios are already on an explosive path, we risk a debt trap," he said.
For now, the bond markets are quiet. Futures contracts are pricing five years of deflation in the US. Yields on 10-year US Treasuries have halved since early November to 2.09pc, the lowest since the Fed's data began. Three-month dollar LIBOR has plummeted to 1.53pc.
It is the same pattern across the world. 10-year yields have fallen to 1.27pc in Japan, 3pc in Germany, 3.2pc in Britain, and 3.49pc in France.
The bond markets seem to be betting that emergency action by central banks will take a very long time to work, if it works at all. By cutting to zero, the Fed has come close to shutting down the US 'repo' market that plays a crucial role in providing liquidity. It has caused havoc to the $3.5 trillion money markets - as the Bank of Japan, burned by experienced, had warned. It has become even harder for banks to raise money. Some argue that extreme monetary policy is already doing more harm than good.
Mr Bernanke is known for his "helicopter speech" in November 2002, when he nonchalantly talked of the Fed's "printing press" and said it was the easiest thing in the world to "reverse deflation."
Less known is his joint-paper in 2004 - "Monetary Policy Alternatives at the zero-bound". By then doubts were creeping in. He admitted to "considerable uncertainty" as to whether extreme tools will actually work. Liquidity could fail to gain traction.
Put another way, the Fed is flying by the seat of its pants. It should never have let debt grow to such grotesque levels in the first place.
http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/3834108/Federal-Reserve-is-damned-either-way-as-it-battles-debt-and-deflation.html
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