Moral Hazard

Central banks would still act as lenders of last resort.
But they would no longer be forced to lend against virtually any asset, since that very possibility must create moral hazard.
Lord Mervyn King, former governor of the Bank of England. His book is called The End of Alchemy.
Martin Wolf, FT 31 May 2016

Next time there's a crisis, the big banks should be allowed to fail, Lynn
If they don’t pay for their mistakes, then there is no incentive not to keep repeating them.
Rolf Englund blog 9 Febr 2016

I den mån banker ska ha hjälp ska också ägandet gå över till staten.
Annars lär sig ingen något
Johan Norberg 29 mars 2009

"I'm a market-oriented guy, but not when I'm faced with the prospect of a global meltdown,"
President George W. Bush, 14 Nov 2008
Full text

Insättningsgarantin
Det är bra med ökad trygghet för spararna, bara man inte slutar att ha koll på sin bank för det.
Marja Lång, presschef på Riksgälden, DN Ekonomi pappersupplagan 7/10 2010

13 miljarder dollar - 86 miljarder kronor
US bank JP Morgan Chase has agreed to a record $13bn settlement with US authorities
for misleading investors during the housing crisis.
BBC, 20 November 2013

Banks will always blow themselves up, regulator warns
Policymakers will simply have to learn how to deal with banks that blow themselves up because it may be impossible to stop them
Telegraph 13 Nov 2012

Michael Cohrs, a former Goldman Sachs banker who now sits on the Financial Policy Committee, said regulators may be trying too hard to “re-fight the last war” and that “allowing financial companies to blow themselves up, and then try and deal with the fall-out, may be – whether we like it or not – the reality of where we end up”.

U.S. regulators directed five of the country's biggest banks, including Bank of America and Goldman Sachs,
to develop plans for staving off collapse if they faced serious problems,
emphasizing that the banks could not count on government help.
CNBC 10 August 2012

Otmar Issing added that weaker banks in the euro zone should be allowed to fail. Several European governments, such as the U.K. and the Netherlands, have been forced to bailout banks, increasing sovereign debt burdens.

“The medicine still has to be solving problems where they were caused, in the banking industry, restructuring banks, and also cleaning the mess in banks. This can for some time be kept through the crisis for some time through measures from outside, but in the end, Europe is overbanked and weak banks have to disappear,” Issing said.

Moral Hazard
Is it time to put the Great Recession behind us?
Should we just chalk it up to such simplified explanations as
“animal spirits ran amok” and “these things happen occasionally”
Or should we try to get to the bottom of what happened, with a goal of
holding the right people legally and financially accountable?
William D. Cohan, Bloomberg, Oct 22, 2012

The path we ultimately take will reveal to us and the world much about who we are as a people and what ethics, values and morality we stand for.
It will also have serious lasting implications if we hope to avoid a rerun of what happened over the last five years.

William D. Cohan is the author of the recently released "Money and Power: How Goldman Sachs Came to Rule the World" and the New York Times bestsellers "House of Cards" and "The Last Tycoons."

Germany's Left Party is not often associated with neo-liberalism
Sahra Wagenknecht, the deputy floor leader for the Left Party in the Bundestag, joined the East German communist party SED in 1989 just a few months before the fall of the Berlin Wall.
Such a euro-zone-wide partial default, of course, would result in the bankruptcies of several European banks and insurance companies due to the amount of European sovereign bonds they carry on their balance sheets.
"The financial industry has seriously underestimated the risks associated with sovereign bonds,"
Der Spiegel 27 July 2012

Capitalism works – and works far better than any other system – because the discipline of the marketplace keeps greed, folly and incompetence in check.
When this is lacking, when businesses are considered too big, too important, or too interconnected to fail,
this crucial discipline disappears, and disaster is almost inevitable.
Nigel Lawson, Financial Times 5 February 2012

Populister som ylar om att bankerna borde stå sitt kast
har inte funderat över hur ett Europa skulle se ut där finansmarknaden har gått under
DN-ledare 9 oktober 2011

Where the FT disagrees, is in Ms Lagarde’s willingness to allow taxpayers to act as unpaid lifeguards for the financial system
– rescuing the banks if private investors will not.
FT Editorial 29 August 2011

This shifting of risk from bondholders was a bad idea in Ireland and generalising it across the eurozone will not improve it.

It would be better to fill capital holes by mandatory debt to equity swaps that put unsecured bondholders where they belong – behind both taxpayers and depositors.

September 29, 2008 was the day the government guaranteed all bank creditors,
Everything that has happened in Ireland since then, especially its daily recurring banking crisis,
has been a consequence of that fateful decision.
FT Lex February 22 2011

Sammanlagt sitter banker i EU på cirka 30 procent av alla europeiska statspapper.
I flera länder är siffran högre. I det finansiellt skakiga Spanien ägs över 50 procent av statens skuld av banker, framförallt landets egna.
I de nya kapitalreglerna för banker, Basel III på finansfikonspråk, som är tänkta att tämja bankernas spekulation, klassas alla statspapper som helt riskfria. Att låna ut till en stat anses så säkert att det inte kräver någon kapitalbuffert alls, något som gett bankerna skäl att köpa på sig ännu fler obligationer.
Andreas Cervenka, SvD 28 augusti 2011

Storbanker har vant sig vid att ständigt få hjälp av staten och dess hantlangare centralbankerna varje gång det krisar. Detta beskydd sker både genom direkta garantier, som tillexempel att skydda spararnas pengar vid konkurs, och mer underförstådda löften om att staten kommer att göra allt som krävs för att rädda banksystemet om det går snett.
Med denna grundtrygghet i ryggen har bankerna under många år kunnat ta allt större risker och därmed tjäna mer pengar.

The size of the subsidy taxpayers provide to big banks,
through their (our) implicit promise to banks that they won't be allowed to fail
Robert Peston BBC 12 April 2011

For me the most interesting part of the interim report of the Independent Commission on Banking is Annex three (right at the back of the book) on "cost-benefit analysis of financial stability reforms".

Among other things, this looks at the size of the subsidy taxpayers provide to big banks, through their (our) implicit promise to banks that they won't be allowed to fail.

And for the avoidance of doubt, this promise was real: at the height of the banking crisis at the turn of the year between 2008 and 2009, aggregate support in the UK for banks via loans, guarantees and investment provided and underwritten by taxpayers was around £1.2 trillion - and it is probably still a bit over £500bn.

The nightmare of taking on ‘too big to fail’
The objective of regulation is not to prevent bank failures.
Governments cannot prevent them – though they can bail out failed banks
John Kay, FT April 12 2011

There are a couple of things to say about Britain’s banks
They still pose a serious threat to the nation’s long-term stability and prosperity.
They rely for their profits – and for the huge bonuses paid to senior staff – on the fact that taxpayers are underwriting the risks.
Thus public subsidy is turned into private profit
Philip Stephens, FT, April 11, 2011

The eurozone is pressing ahead with the same approach it has followed ever since the collapse of Lehmans
When in doubt, sign another blank cheque to private creditors, and try not to think about the money, or the moral hazard.
Stephanie Flanders, the BBC's economics editor, 22 November 2010

Riksdagen sade på onsdagen för första gången nej till ett EU-förslag med hänvisning till närhetsprincipen
Beslutet gällde två förslag från EU-kommissionen om att alla EU-länder ska bli skyldiga att låna ut pengar till andra medlemsländer som inte klarar av insättningsgaranti och investerarskydd.
Sydsvenskan 7 oktober 2010

Finansutskottets utlåtande 2009/10:FiU43
Finansutskottets invändning gäller den del av kommissionens förslag som handlar om att införa en skyldighet för medlemsländernas ersättningssystem att låna ut medel till andra medlemsstaters ersättningssystem som själva inte klarar sina åtaganden.

Att i EU-rätten införa bestämmelser om en obligatorisk kreditmekanism mellan nationella system, som en sista utväg för att klara av tillfälliga finansieringsbehov, är enligt finansutskottets uppfattning inte förenligt med subsidiaritetsprincipen.

Övriga delar av kommissionens förslag strider enligt utskottet inte mot subsidiaritetsprincipen.

Nassim Nicholas Taleb, renowned derivatives trader, university professor and author of "The Black Swan," warned
of the growing risk the nation has taken on as a result of poor decisions by the Fed and policymakers, including
trillions of dollars in taxpayer money funneled into bailouts of private industry.
"This transformation from private debt ... to public debt" is "bad" from a risk standpoint and "immoral"
Shahien Nasiripour Huffington Post 30/9 2010

The /Obama/ administration’s critics come from every point on the political spectrum but they agree about this:
the banks pushed the country into a crisis, got bailed out and walked away scot-free.
Bank profits are surging. The new financial rules, so voters think, have been shaped by the industry to spare it inconvenience.
The only difference is that lending is suppressed while the banks recuperate – keeping the rest of the economy in the recession that the banks made in the first place.
Clive Crook, FT September 12 2010

A recent paper by Samuel Hanson, Anil Kashyap and Jeremy Stein underlines a crucial point: to be any use, the regulatory minimum capital ratio in good times must substantially exceed the market-imposed standard in bad times

Whenever a big bank becomes insolvent, the Chancellor is faced with a stark choice.
Either you can bail the bank out with taxpayers’ money, his officials will tell him, or tomorrow there will be mayhem in the markets followed by economic collapse.
With the gun placed firmly against his head, the Chancellor will always opt for the apparent lesser of the two evils, and order a bail-out.
Jeremy Warner, Daily Telegraph 15 Jun 2011

That’s what Alistair Darling did, first with Northern Rock, and then later with Royal Bank of Scotland and HBOS. There were any number of more generalised bail-outs of the banking system in between, in the form of government-sponsored liquidity support.

"One of the most catastrophic political decision taken in post-war Europe"
The collapse of Lehman Brothers was without a doubt the single most symbolic moment of the financial crisis.
But for Europe it was on Tuesday, 30 September 2008, when the Irish prime minister gave a blanket guarantee for the entire banking sector.
Wolfgang Münchau, Eurointelligence 7/10 2010

His decision bounded the other eurozone leaders into following suit. The rest is history.

I would go as far as to classify the decision as one of the most catastrophic political decision taken in post-war Europe. This not so much because of the decision itself – it was necessary to stop the rot at the time – but because of a lack of action to embed the decision into a strategy to solve the problems of the banking sector – lack of capitalisation, abundance of toxic assets, poor management, and of course, excessive size.

The fundamental error committed by Europeans governments at the beginning of the crisis was the failure to shrink the banking system, and to force the bondholders to share the cost of the rescue operations. Last week, the Irish government took only the minimalist step to participate the holders of subordinated debt. My explanation is that the banks must have succeeded in scaring the politicians into believing that forced bond-to-equity conversions would signify the end of civilisation as we know it.

Halting the financial doomsday machine
The combination of state insurance (which protects creditors)
with limited liability (which protects shareholders) creates a financial doomsday machine.
Martin Wolf, FT April 21 2010

A year later, the evidence is in: Depression 2.0 has indeed been avoided.
No, I haven’t yet bought that second home. In fact, I actually sold my only one, at a good level, as I was no longer using it, preferring to live in a little rental house on the water where I have my 32-foot fishing boat, named the Moral Hazard, and my 18-foot electric Duffy boat, named the Minsky Moment. Yes, I am sorta non-normal.
Paul McCulley April 2010

Watching Chuck Prince and Robert Rubin, the former Citigroup chairmen, giving evidence today on the bank’s losses in “super-senior” sub-prime mortgage securities, was not reassuring for anyone seeking lessons from the 2008 financial crisis.
In summary, they told the Financial Crisis Inquiry Commission in Washington that the risk management and management structures at Citigroup were state-of-the-art, that regulators were keeping a close eye on the business, and that the board was functioning correctly.
John Gapper FT blog April 8, 2010

The doomsday cycle
Over the last 30 years, the US financial system has grown to proportions threatening the global economic order.
This column suggests a ‘doomsday cycle’ has infiltrated the economic system and could lead to disaster after the next financial crisis.
Peter Boone, Simon Johnson, 22 February 2010
Very Important Aritcle

The City and Wall Street, the last bastions of Marxist workers’ control
Why did financiers think they could get away with rewarding themselves so lavishly?
The answer lies in Tito’s Yugoslavia
Anatole Kaletsky The Times January 14, 2010

Economists propose one obvious solution: bank boards and regulators should also link executive pay to the performance of bank debt, measured either by bond prices or the cost of insuring bank bonds against default using credit default swaps.
That, they argue, would provide both a capitalist incentive and one to keep banks stable – and, better still, without Big Government control.
Gillian Tett, FT June 15 2010

Hamid Mehran, a senior economist at the New York Fed, has been brainstorming the issue with colleagues and academic economists. Mr Mehran and others have concluded that one of the biggest problems with the fat cat financiers is that their pay is linked to share prices.

Executive Compensation and Risk Taking; by Hamid Mehran, Patrick Bolton and Joel Shapiro;
paper presented at Columbia University

The gap between short-term interest rates and long-term bond yields is extraordinarily high. That allows banks, in particular, to borrow at low rates from the central banks and invest the proceeds in government debt;
the same trick was used to rebuild bank profits in the early 1990s.
The Economist print Jan 7th 2010

The banks are currently making lots of money, not only because the taxpayer bailed them out in the first place,
but because they are now borrowing at very low rates, subsidised by the government, while lending at relatively high rates.
Tracy Corrigan, 16 July 2009

Riksbankens erbjudande att låna ut 100 miljarder kronor till de svenska storbankerna mottogs med stort intresse
Räntan fastställdes räntan till 0,45 procent
Leif Petersen 2009-07-14

In contemporary banks, leverage of 30 to one is normal.
Higher leverage is not rare.
Reform of regulation has to start by altering incentives
Banks central activity is creating and trading assets of uncertain value, while their liabilities are, as we have been reminded, guaranteed by the state.
This is a licence to gamble with taxpayers’ money. The mystery is that crises erupt so rarely.
Martin Wolf, Financial Times, June 23 2009

The place to start is with the core of modern capitalism: the limited liability, joint-stock company. Big commercial banks were among the most important products of the limited liability revolution. But banks are special sorts of businesses: for them, debt is more than a means of doing business; it is their business. Thus, limited liability is likely to have an exceptionally big impact on their behaviour.

Lucian Bebchuk and Holger Spamann of the Harvard Law School make the big point in an excellent recent paper. Its focus is on the incentives affecting management. These are hugely important. Still more important, however, is why a limited liability bank, run in the interests of shareholders, is so risky.

In a highly leveraged limited liability business, shareholders will rationally take excessive risks, since they enjoy all the upside but their downside is capped: they cannot lose more than their equity stake, however much the bank loses.

Creditors have little interest in the quality of a bank’s assets or in its strategy. They appear to have lent to a bank.
In reality, they have lent to the state.

The Financial Services Authority (FSA) was in denial about the scale of the banking crisis right
up to the week of the historic multi-billion-pound bailout in October, 2008
Daily Telegraph 7/3 2011

Just days before the rescue, FSA officials, under chief executive Hector Sants, believed the most the banking system would require in emergency equity was £20bn and insisted that their problems were to do with a lack of liquidity rather than low levels of loss-bearing capital.
In fact by the time the crisis was over, the total equity raised by the banking sector came to around £100bn.

Former Chancellor Alistair Darling said there could now be grounds to set up a new inquiry into RBS’s fall. “I would have no objection to an inquiry now. It would be extremely useful to have a thorough understanding of what went wrong,” he said.
Mr Darling’s intervention will increase the pressure for a full public investigation into the collapse of RBS and the wider failure of regulators to spot the problems early.
The FSA declined to comment.

The destruction of wealth - that of investors, including more-or-less anyone saving for a pension - has been savage, running to tens of billions of pounds in each case.
But for RBS, the Financial Services Authority as watchdog has already ruled - just before Christmas - that there was no wrongdoing.
Robert Peston, BBC, 4 January 2011

The calamitous takeover of the rump of ABN in 2007, which did for RBS, was the consequence of misjudgements by the banks' directors that were appalling but within the rules. Or at least that is what the FSA has concluded.

You'll recall that Barclays was bidding in a competition with the consortium led by RBS to buy ABN. To the great good fortune of Barclays and its owners, Barclays lost the bidding war.

But it would certainly be instructive to have a sense of why Barclays' directors were - like RBS's - apparently so desperate to overpay for a bank, ABN, that turned out to be something more poisonous than the curate's egg.

Between the beginning of 2008 and the end of 2009, the losses on loans made by Lloyds and HBOS combined were £39bn
- of which the vast bulk was contributed by HBOS (which became a part of Lloyds two years ago).
Robert Peston, BBC, 4 January 2011

Now, much of what went wrong at HBOS was old-fashioned lethal exuberance about lending to property developers. It's not dissimilar to the madness that infected and harmed all of Ireland's major banks.

Bank of England provided almost 62 billion pounds (USD 102.9 billion) in emergency loans
to Royal Bank of Scotland and HBOS at the height of the credit crisis last year.
The money was repaid in full by January this year
A spokesman for the prime minister said it was "a powerful reminder" of how the banking system had nearly collapsed.
CNBC and BBC 24 Nov 2009

At the end of last year, total assets of the British-based banking system were $11,188bn or 5.5 times gross domestic product.
In acting as insurer of last resort to the British-based banking system, it is taking on huge risks on behalf of taxpayers.
If this turned out to be a global depression, with huge losses for British-based banks, fiscal solvency might even come into question.
Martin Wolf, Financial Times March 5 2009

Royal Bank of Scotland alone accounted for 45 per cent of this latter increase.
At the end of last year, RBS had the largest assets of any British bank, at 166 per cent of GDP.
These asset positions are enormous. It should be noted, however, that they include gross derivatives positions (which is not the case under US accounting).
Net derivatives exposures were far smaller.

RBS was a small Scottish bank that wanted to be big. It succeeded.
Yet, today, the market capitalisation of RBS is a mere £9bn.
Even this is only because the Treasury has not wiped out private shareholders.
The bank is in effect nationalised. Taxpayers bear the cost of guaranteeing this fruit of megalomania.
I must confess an interest: I am a depositor at RBS. As such, I am grateful.

Implicitly, the UK government is guaranteeing the liabilities of the swollen UK banks.
Explicitly, it seems likely to guarantee at least £600bn of toxic assets of RBS and Lloyds under its “asset protection scheme”.

I am no populist.
Yet when I think of the sums earned by those responsible for dumping this mess on to the UK taxpayer, even my blood boils.

The statement that systemic breakdowns are surprisingly rare
in the free-wheeling Anglo-Saxon model is false.
Martin Wolf February 9, 2009

I en marknadsekonomi ska staten inte hålla banker under armarna.
De som har tagit alltför stora risker och sedan drabbas av förluster får stå sitt kast.
Men det finns lägen där denna princip inte går att följa.
Johan Schück, DN 2008-09-28

Det beror på systemrisken, alltså att det uppstår en dominoeffekt där en stor bank faller och drar med sig alla andra, Hela betalningssystemet riskerar då att slås ut. Där tycks USA nu befinna sig. Förtroendet mellan bankerna har nått ett lågvattenmärke, där livsviktiga samhällsfunktioner knappt fungerar.

Hans Tson Söderström och Nils Lundgren:
Riksbanken frångick sin tidigare strategi att försvara kronan genom räntehöjningar för att i stället övergå till direkta interventioner på valutamarknaden.
Detta strategibyte gav privata aktörer som litat på Riksbankens utfästelser om fast kronkurs möjlighet att gå ur sina valutalån, men öppnade samtidigt möjlighet för utländska och inhemska spekulanter att ta position mot kronan.
Ur kapitlet: Hur mycket kostade kronförsvaret 1992? i
Vad hände med Sveriges ekonomi? SOU 1999:150, av Torsten Svereniussid 275 ff.

Question: what happens if you lose vast amounts of other people's money?
Answer: you get a big gift from the federal government — but the president says some very harsh things about you before forking over the cash.
Paul Krugman, New York Times, February 1, 2009

So banks need more capital. In normal times, banks raise capital by selling stock to private investors, who receive a share in the bank's ownership in return. You might think, then, that if banks currently can't or won't raise enough capital from private investors, the government should do what a private investor would: provide capital in return for partial ownership.

But bank stocks are worth so little these days — Citigroup and Bank of America have a combined market value of only $52 billion — that the ownership wouldn't be partial: pumping in enough taxpayer money to make the banks sound would, in effect, turn them into publicly owned enterprises.

Regeringen föreslår åtgärder för att stärka bankernas kapitalbas och därmed öka utlåningen
"För att förbättra möjligheterna för svenska företag att få krediter vill regeringen möjliggöra för bankerna att stärka sin kapitalbas genom statliga kapitaltillskott."
PRESSMEDDELANDE, 3 februari 2009, Finansdepartementet

The vision thing
Her Majesty’s question ("If these things were so large, how come everyone missed them?")
Chris Giles, FT, November 25 2008

The statement that systemic breakdowns are surprisingly rare
in the free-wheeling Anglo-Saxon model is false.
Martin Wolf February 9, 2009

As John Maynard Keynes is alleged to have said: “When the facts change, I change my mind. What do you do, sir?”
It took me a while – arguably, too long – to realise the full dangers.
Maybe it was errors at the US Treasury, particularly the decision to let Lehman fail, that triggered today’s panic.
Martin Wolf, FT, October 7 2008

John McCain: (not Naomi Klein)
"Wall Street has betrayed us.
They've broken the social contract between capitalism and the average citizen"
John McCain, September 16, 2008

The end of American capitalism as we knew it
There is a long-standing argument that "there is no real case for private ownership of deposit-taking banking institutions
Willem Buiter, Financial Times September 17, 2008

A lifelong libertarian, Alan Greenspan does not ordinarily advocate giving the government more power.
But he does so in a new epilogue to the paperback edition of his memoir,
parts of which were made available to The Economist.
The Economist print edition Aug 7th 2008

Mr Greenspan says a high-level panel of American financial officials should be given broad power to seize any financial institution whose failure threatens the entire economy, bail out its creditors and close it down. “We need laws that specify and limit the conditions for bail-outs” and do so transparently with taxpayers’ money, “rather than circuitously through the central bank, as was done during the blow-up of Bear Stearns,” he writes in “The Age of Turbulence”. (Penguin is to release the paperback on September 9th.)

We are all Keynesians again
As the crunch grinds past its first anniversary, central banks’ credibility is still at risk
The Economist print Aug 7th 2008

Ben S. Bernanke and Henry Paulson are under pressure to embrace the big-government policies of America in the 1930s, or Sweden in the 1990s, to contain the conflagration engulfing the U.S. housing and financial markets.
Among the ideas: Using taxpayer money to shore up the capital of loss-ridden Fannie Mae and Freddie Mac
Bloomberg 21/7 2008

Video
Paulson: Banking system is safe
The Treasury Secretary tells CNN's Wolf Blitzer that 99% of the banks in the U.S. have enough capital to meet their needs.
July 21, 2008

Behovet av ett starkare regelverk för hantering av banker i kris
I många fall tycker jag ärligt talat inte att våra nuvarande ordningar för att hantera svaga banker räcker till.
Riksbankschef Stefan Ingves 2008-05-19

One way of measuring how perilously close the U.S. financial system came to melting down in mid-March 2008
is to look at how low the rate on one-month Treasury bills fell at the depths of the crisis.
That number is 12 basis points. 0.12%.
Michael Lewitt, at John Mauldin, 2008-03-31

Misslyckat försök göra en pudel
The world’s leading banks – represented by the Institute of International Finance – concurred with a conclusion long ago reached by the rest of the world:
they screwed up, the credit crisis is largely their fault, and everybody else is suffering for their errors.
The admission may not be enough to prevent a dangerous backlash.
Financial Times editorial April 11 2008

Lagförslaget om en stabilitetsfond uppbyggd av avgifter från bankerna
Risken är överhängande att den blir en perfekt grogrund för nästa finansbubbla.
Nicklas Storåkers, verkställande direktör för Avanza Bank, DN Debatt 29/10 2008

Fannie, Freddie and You
This implicit guarantee means that profits are privatized but losses are socialized. If Fannie and Freddie do well, their stockholders reap the benefits, but if things go badly, Washington picks up the tab.
PAUL KRUGMAN, NYT July 14, 2008

Mr. Volcker argued against a further extension of this /Bear Stearns/ implicit Fed guarantee to hedge funds or private-equity groups, whose failure pose little risk to the system as a whole.
Right about now wouldn't be the worst time for such a hedge-fund blowup, if only to show that the Fed will let it fail.
Wall Street Journal 9/4 2008

Many today are complaining about Alan Greenspan’s monetary stewardship - “serial bubble-blower” is the most polite phrase that I have heard.
But would the world economy really be better off today under an alternative monetary policy that kept unemployment in America at an average rate of 7% rather than 5%?
Would it really be better off today if some $300 billion per year of US demand for the manufactures of Europe, Asia, and Latin America had simply gone missing?
Brad DeLong April 05, 2008

Ett smaklöst aprilskämt?
Morgan Stanley: nedskrivningarna inom banksektorn kommer att uppgå till
4.485 miljarder kronor under 2008.
Bloomberg/Direkt/DI 2008-04-01

För dem som har haft en övertro på marknadens självreglerande krafter
är förstås den internationella kreditkrisen en allvarlig missräkning.
Marknaden har till exempel inte själv kunnat hantera de risker man skapat genom att paketera om bolån till värdepapper som sålts vidare.
Men det är en illusion att tro att en långt gången frihet inte måste paras med tuff tillsyn från offentliga myndigheter.
Signerat, Ragnar Roos DNs ledarsida, 30/3 2008

Government sponsored enterprises
Capital infusions to date fall far short of prospective losses. Without new capital, the financial sector will operate with too much risk and leverage or will put the economy at risk by restricting the flow of credit.
Lawrence Summers, FT March 31, 2008

Without help from the Fed, Bear's shareholders might well have received nothing at all,
and yet the state is stuck at the back of the queue—guaranteeing a $29 billion slug of Bear's worst assets.
The Economist print, March 27th 2008

What do you do when risk and reward are skewed? When Bear's shareholders gain at the taxpayer's expense? Or when the other investment bankers and their shareholders take on that extra bit of risk, knowing that they keep all the gains, but that the state will shoulder some of the losses?

Bear Stearns' bailout has echoes of 1907 panic
In my opinion, the private credit markets have forfeited their privileged right to operate relatively autonomously because of
incompetence, excessive greed, and in minor instances, fraudulent activities.
Bill Gross, April 2008

Home price declines of 20% are in fact much more of a shock to the American economy than the popping of the Internet bubble and NASDAQ 5000, because the amount of homeowner leverage is so much greater. A 20% negative adjustment not only wipes out all ownership equity for millions of Americans, it turns their homes "upside down"

I’ve had a famous picture of J.P. Morgan on my office wall for 25 years. Even now, the old man seems to be staring at my back and taunting me with his famous quote written just below his vest with pocket watch in full view: "Lending is not based primarily on money or property. No sir, the first thing is character." For 20 of these 25 years I thought this idea was a relic of an outdated era. How could you judge the character of a CDO or an asset-backed security? Far better to lend on well collateralised property, I reasoned. But then it became increasingly apparent that credit, when issued against the collateral of assets, had a capacity to multiply itself without restraint. The Shadow sanctioned and blessed increasing leverage under the assumption that "property" (houses) could only go up in value. "Character" had no place in such a modern-day financed-based economy. Liar loans, fraudulent appraisals, or even just the origination and resale of mortgage loans and asset-backed securities themselves proved that character was out, and property securitisation was in.

Sommaren 1991 hälsade jag på min gamle gode vän Sven Rydenfelt. Vi talade om fastighetskrisen som då startat på allvar, och den tanklösa överbelåningen.
- Ja, det är ju märkligt att människor inte tänker på vad som hände 1907, sa Rydenfelt.
Nils-Eric Sandberg, DN 18/10 1996

For the past 25 years or so the financial authorities and institutions they regulate have been guided by market fundamentalism:
All the innovations – risk management, trading techniques, the alphabet soup of derivatives and synthetic financial instruments – were based on that belief.
The innovations remained unregulated because authorities believe markets are self-correcting.
George Soros FT 2/4 2008

Market participants cannot base their decisions on knowledge, or what economists call rational expectations. There is a two-way, reflexive interaction between the participants’ biased views and misconceptions and the real state of affairs. Instead of random deviations, reflexivity may give rise to initially self-reinforcing but eventually self-defeating boom-bust sequences or bubbles.

The authorities ought to prepare for the next shoes to drop. I shall mention only two.

There is an esoteric financial instrument called credit default swaps. The notional amount of CDS contracts outstanding is roughly $45,000bn. To put it into perspective, that is about equal to half the total US household wealth and about five times the national debt.

The other issue is rising foreclosures. About 40 per cent of the 6m subprime loans outstanding will default in the next two years.

“I’m not predicting the collapse of the financial system.”
“This is not a normal crisis,” - “It is the end of an era.”
the “era of superleverage,”
George Soros, Davos, New York Times, January 24, 2008

The shadow banking system of hedge funds and CDOs, CLOs, PIPES, etc.
Bill Gross 1/10 2007

Two weeks ago, the world financial system hung by a thread
as a battle raged among corporate leaders, government officials, portfolio managers and independent traders to control its destiny.
Half wanted to pull it down and spill the globe into economic Armageddon for personal profit, while the other half fought to stave them off.
Jon Markman, CNBC 27/3 2008

It will be months before we understand exactly how the good guys won; for now, we know only that the Federal Reserve Board staged a stunning coup d'etat in Washington last week, fulfilling its goal of stability at any cost.

Backed by allies in the Treasury Department, the bank regulator brazenly tossed aside decades of precedent and law and forced the reckless directors of Bear Stearns into a shotgun marriage with JPMorgan Chase that appears to have prevented disaster.

The ECB chief reiterated that the bank remains "inflexibly attached" to its goal of maintaining price stability.
"If we had reduced interest rates, the moral hazard is that we would have been asking citizens to bail out the banks."
EU Observer 26/3 2008

Jim Grant of Grant's Interest Rate Observer on Bloomberg
"What manner of incompetence - both at the public policy level and at the so-called financial professional level - led to this mess?"
And the people who are paying are the savers, among others.
March 26, 2008

The Financial Services Authority, the City watchdog, has admitted to a catalogue of errors in its handling of the Northern Rock crisis,
which saw the first run on a British bank in more than a century.
Daily Telegraph 26/03/2008

The proposed bail-out of Fannie Mae and Freddie Mac entails the socialisation of risk
– with all the long-term adverse implications for moral hazard –
from an administration supposedly committed to free-market principles.
Joseph Stiglitz, Financial Times July 24 2008

Lessons from the collapse of Bear Stearns
In March 2008, Bear had tangible equity capital of about $11bn supporting total assets of $395bn – a leverage ratio of 36.
FT, John Cassidy March 14 2010

John Cassidy is a staff writer at The New Yorker and the author of ‘How Markets Fail’

Two years ago on Sunday, Treasury Secretary Hank Paulson called up Alan Schwartz, the chief executive of Bear Stearns, and told him the jig was up. “Alan, you’re in the government’s hands now,” he said. “Bankruptcy is the only other option.” Thus began the epic stage of the credit crunch and 24 months on, many costly lessons have been learned.

In March 2008, Bear had tangible equity capital of about $11bn supporting total assets of $395bn – a leverage ratio of 36. For several years, this reckless financing enabled the company to achieve a profit margin of about a third and a return on equity of 20 per cent; when the market turned, it left Bear bereft of capital and willing creditors. During the ensuing months, the same story was to be played out at scores of other banks and non-banks.

Big banks are like nuclear power stations. They provide valuable services, such as channeling capital from savers to entrepreneurs. Occasionally, they blow up, causing damage to the rest of the economy and necessitating spending vast sums of taxpayers’ money on clean-up operations.

Statistical models are like bikinis: what they reveal is suggestive, but what they conceal is vital

Bagehot and Keynes were both right. During a financial crisis, the role of the central bank is to lend money where nobody else will. During an economic slump, the government has to boost demand. In applying these truths, authorities from Washington to Frankfurt to Beijing prevented the Great Recession from turning into another Great Depression.

If you let Bear Stearns fail you can have a run on the entire banking system.
But there are ways to manage Bear or Fannie and Freddie in a fairer way.
If public money is to be put at stake, first all the shareholders of these companies have to be wiped out. Management has to be wiped out, and the creditors of Bear should have taken a hit.
Why did the Fed buy $29 billion of the most toxic securities, and essentially bail out JPMorgan Chase?

The rescue of Bear Stearns was a paradigm-changing event.
Paul Krugman, NYT March 31, 2008

Traditional, deposit-taking banks have been regulated since the 1930s, because the experience of the Great Depression showed how bank failures can threaten the whole economy. Supposedly, however, “non-depository” institutions like Bear didn’t have to be regulated, because “market discipline” would ensure that they were run responsibly.

When push came to shove, however, the Federal Reserve didn’t dare let market discipline run its course. Instead, it rushed to Bear’s rescue, risking billions of taxpayer dollars, because it feared that the collapse of a major financial institution would endanger the financial system as a whole.

And if financial players like Bear are going to receive the kind of rescue previously limited to deposit-taking banks, the implication seems obvious: they should be regulated like banks, too.

The Paulson plan would leave Lehman Bros., Goldman Sachs, Bear Stearns and others of the nonbank financial world unregulated but give them the same right to tap the Fed for cash.
Jim Jubak 4/4 2008

Fed bailout of Bear Stearns
Remember Friday March 14 2008
it was the day the dream of global free-market capitalism died.
Martin Wolf, Financial Times, March 26 2008

For three decades we have moved towards market-driven financial systems. By its decision to rescue Bear Stearns, the Federal Reserve, the institution responsible for monetary policy in the US, chief protagonist of free-market capitalism, declared this era over.

It showed in deeds its agreement with the remark by Joseph Ackermann, chief executive of Deutsche Bank, that "I no longer believe in the market's self-healing power".

Mine is not a judgment on whether the Fed was right to rescue Bear Stearns from bankruptcy. I do not know whether the risks justified the decisions not only to act as lender of last resort to an investment bank but to take credit risk on the Fed’s books. But the officials involved are serious people. They must have had reasons for their decisions.

Mine is more a judgment on the implications of the Fed’s decision. Put simply, Bear Stearns was deemed too systemically important to fail

Systemically important institutions must pay for any official protection they receive. Their ability to enjoy the upside on the risks they run, while shifting parts of the downside on to society at large, must be restricted.

This is not just a matter of simple justice (although it is that, too). It is also a matter of efficiency. An unregulated, but subsidised, casino will not allocate resources well.

Ben Bernanke, Fed chairman, famously understated, described much of the subprime mortgage lending of recent years as “neither responsible nor prudent” in a speech whose details make one’s hair stand on end.
Fostering Sustainable Homeownership, March 14 2008
www.federalreserve.gov/newsevents/speech/bernanke20080314a.htm

I dagsläget har Fed inte mycket att välja på. Alltför stora värden står på spel.
Men att ständigt skyndsamt agera räddare i nöden, när marknadens aktörer misskött sig
eller blåst upp bubblor som spricker, leder också fel. Det är ingen bra uppfostringsmetod
- det är lika illa som att vara curlingförälder.
Det skapar grogrund för aktörerna att ta större risker än vad de annars skulle göra.
Till slut kan riskbeteendet ha blivit så stört att inte ens "storpappa" Ben Bernanke kan reda upp saken.
Vems är det direkta felet till att kreditmarknaden krisar?
DN huvudledare 17/3 2008

Början till eländet var den osunda utlåningen till mindre bemedlade amerikaners husköp.

Sverige kan också behöva skärpa reglerna. Riksbankchefen Stefan Ingves påpekade i förra veckan att Sverige inte har ett fullgott regelverk för att hantera finansinstitut som krisar.
Åtgärderna i samband med bankkrisen i början av 1990-talet var bara tillfälliga, som till exempel den statliga bankgarantin.
Nu är tid att stärka skyddsnäten.

Why this crisis is still far from finished
Mohamed El-Erian, Financial Times April 24 2008

The writer is co-chief executive and co-chief investment officer of Pimco.
His book, ‘When Markets Collide: Investment Strategies for the Age of Global Economic Change’,
will be published by McGraw Hill in June

The optimistic view is based on two distinct elements.
First, that the deleveraging process is reaching its natural end as valuations stabilise and institutions come clean about their losses and raise capital;
second, that a series of previously unthinkable policy responses have been effective in restoring liquidity to the financial system.

During the next few months there will be a reversal in the direction of causality:
the unusual adverse contamination by the financial sector of the real economy is now morphing into the more common phenomenon of
recessionary forces threatening to undermine the financial system.

US consumers ability to sustain spending is already challenged by the declining availability of credit, a negative wealth effect triggered by declining house values, and a lower standard of living as the result of higher energy and food prices and a depreciating dollar.

Fed is again forced to carry the bulk of the burden of the US policy response, it will find itself in the unpleasant and undesirable situation of potentially undermining its inflation-fighting credibility in order to prevent an already bad situation from becoming even worse.

It is déjà vu for those who remember previous emerging market crises:
imploding balance sheets, a bank run, disorderly falls in the currency
Yet there is a huge difference: this is happening in the US
Mohamed El-Erian, FT March 18 2008

The writer is co-chief executive officer and co-chief investment officer of Pimco.
His book, When Worlds Collide:
Investment Strategies for the Age of Global Economic Change,
is scheduled to be published in July by McGraw Hill

Policymakers now face the unpleasant reality of having to cross at least one of two lines in the sand:
... Breaching either line involves long-term damage to the US economy – most notably through moral hazard.

In intervening to stabilise the system as a whole, the authorities end up protecting certain people and institutions from the consequences of their ill-advised actions, thereby undermining the discipline that is crucial to market efficiency.

Central bankers now operate in a world where monetary policy influences only a small part of the fluctuations in overall liquidity in the economy. Mohamed El-Erian, FT January 16 2008

Fed's $200 billion loan scheme won't work
The giveaway strategy -- creating a huge pool of cash to loan to securities dealers, with risky mortgage-backed debt as collateral -- is little but stalling for time.
Bill Fleckenstein, 17/3 2008

I realize the Fed was created to provide a liquidity backstop in times of emergency... The reality that's eluded Fed "experts" is simple: Credits in much of the financial system are simply no good. And creating liquidity and stalling for time won't make those credits good.

Any time that a central bank steps in to rescue a financial institution, it had better have a good defence to those who argue that it is interfering wrongly in markets and promoting moral hazard.
The case against the Fed doing so was put by Gretchen Morgenson in the Sunday New York Times:

No, a wave of house repossessions will not necessarily teach the virtue of living within one’s means,
when the government is around to force lenders to stay their hands,
and create moral hazard on a huge scale
Irwin Stelzer The Sunday Times April 12, 2009

No, imprudent lending will not bring a bank to the end of its rope, so long as the government provides more for survival – and to tie management’s hands.
No, falling car sales will not necessarily force one or more car companies into bankruptcy, as they would in a market free of the long arm of a government beholden to trade unions.
No, a weaker currency will not necessarily buoy exports and reduce imports, not when governments can erect barriers to trade.
And no, a wave of house repossessions will not necessarily teach the virtue of living within one’s means, when the government is around to force lenders to stay their hands, and create moral hazard on a huge scale.

Problems here at home are likely to be exacerbated by an acceleration of Europe’s recession,
now that France and Germany have refused to stimulate their economies, and Britain is more or less broke.
One analyst told me he expects the EU economy to fall off the cliff by the end of the year.

Ben Bernanke in dilemma over bank bail-out
Irwin Stelzer, Sunday Times March 16, 2008

The $200 billion of mortgages Bernanke will be taking on are a drop in the ocean that is the $11 trillion mortgage market. And he has only another $400 billion in Treasurynotes to play with - if he is willing to have these mortgages make up his entire stock of assets.

The credit world is aligning itself into political factions
On one side are the trader-fundamentalists.
As far as they are concerned, the only way to deal with the excesses of the credit markets is to take the write-offs
Opposed to them are the would-be managers of systemic risk.
They believe that the aggressive application of the mark-to-market rule would result in another Great Depression, only bigger.
John Dizard, Financial Times March 4 2008

The credit world is aligning itself into political factions, divided over the right approach to untangling the present mess.
On one side are the trader-fundamentalists, with one hand on the Bloomberg keyboard, the other hand on a dog-eared copy of Atlas Shrugged .

They believe in the literal interpretation of scripture, which in this case means that an asset is only worth what the bid side says it is. As far as they are concerned, the only way to deal with the excesses of the credit markets is to take the write-offs and start over, having accepted the revealed truth of what bankruptcy sale buyers are willing to pay.

Opposed to them are the would-be managers of systemic risk.
They believe that the aggressive application of the mark-to-market rule would result in another Great Depression, only bigger. Their Qum is Washington DC, where the differences between the Republicans and the Democrats are small relative to their agreement that a deep recession, let alone a depression, must be avoided at all costs.
You could call them Keynesians, except that Keynes was strongly opposed to currency debasement.
(Strangely, they still publicly proclaim adherence to a "strong dollar policy", even at $1.50 to the euro.
What would a "weak dollar policy" be?)

The financial system is a subsidiary of the state.
A creditworthy government can and will mount a rescue.
That is both the advantage – and the drawback – of contemporary financial capitalism.
Martin Wolf, Financial Times February 26 2008
Highly recommended

Stage I is to provide liquidity to the banking system at high interest rates. We passed out of Stage I at the end of last year.
Stage II is forgetting about punishing feckless financiers. We are now in Stage II.
Now Alan Blinder says that it is time to move on to Stage III: nationalization.
Brad DeLong's Weblog February 24, 2008

A confidential proposal that Bank of America circulated to members of Congress this month provides a stunning glimpse of how quickly the industry has reversed its laissez-faire disdain for second-guessing by the government — now that it is in trouble.
The proposal warns that up to $739 billion in mortgages are at “moderate to high risk” of defaulting over the next five years and that millions of families could lose their homes.
To prevent that, Bank of America suggested creating a Federal Homeowner Preservation Corporation that would buy up billions of dollars in troubled mortgages at a deep discount, forgive debt above the current market value of the homes and use federal loan guarantees to refinance the borrowers at lower rates.
Mish February 23 2008

Ingrid Matthäus-Maier, a member of the center-left Social Democratic Party (SPD) and the CEO of the state-owned KfW banking group
As the head of KfW, Matthäus-Maier is a major shareholder in IKB the bank the German government is to bail out to the tune of 1 billion euros.
Spiegel On-line February 20, 2008

Ingrid Matthäus-Maier, a member of the center-left Social Democratic Party (SPD) and the CEO of the state-owned KfW banking group, is undoubtedly in one of Germany's highest earnings brackets. Although her annual salary of €418,000 ($614,000) is substantially lower than that of her counterpart at Deutsche Bank, Josef Ackermann, who earns a tidy €13 million a year, she does earn more than twice the salary of German Chancellor Angela Merkel, who has to make do with a mere €200,000.

As the head of KfW, Matthäus-Maier is a major shareholder in IKB, the Düsseldorf-based bank that is on the brink of bankruptcy and is only being kept afloat by a series of government bailouts running into the billions (more...).

That the latest government rescue package will allow IKB Deutsche Industriebank
shareholders to walk away with money in their pockets is a disgrace,
and an incitement to imprudent lending at other banks.
Financial Times editorial 15/2 2008

If the latest €1.5bn rescue goes ahead, IKB will have had around €7.7bn in outside support, and that may not be the end.
All this for a bank with only €1.4bn in shareholders’ equity.

Sverige har föresatt sig att genomföra stålbadet i skuldfällan. Det betyder att Nordbankens stabilitet i finansmarknadens ögon inte kan eller får ifrågasättas.
Annars skulle en akut valutakris kunna vara omedelbart förestående. Det har sannolikt varit ett av skälen för regeringens beslut att betala 2 000 miljoner kr för värdelösa aktier.
Det är ett av alla stötande inslag i finanskrisen; att låta aktieägare som Skandia, Nordbankens aktiefonder, Lundbergs, Nobel Industrier och Trygg-Hansa komma undan med blotta förskräckelsen.
Runt om i världen kommer ögonbryn att höjas.
Att rädda inte bara insättare utan även aktieägare har inte tidigare gjorts någonstans.
Rolf Englund: SvD Näringsliv, 1992-05-13

Nobody wants to see a repeat of the 1930s when bank failures ushered in the Depression.
However, the bargain that was made in the 1930s has been broken.
If commercial banks were to be protected, they should not be allowed to gamble in the securities markets.
The Economist print, Jan 31st 2008

Two points shine out about the financial system over the past three decades:
its ability to generate crises, and the mismatch between public risk and private reward.
Martin Wolf, FT February 5 2008
Highly Recommended

The goal seems to be to avoid a 2008 recession at all costs.
The adjustment of private consumption to sustainable levels is necessary, but is likely to have a negative influence
Ricardo Hausmann, Financial Times January 31 2008

The writer is the director of Harvard University’s Center for International Development

Consumption has been above sustainable levels and needs to adjust down, whatever view one has about the responsibility of adults over their financial decisions.

The same voices that supported tough macroeconomic policies to deal with the excesses of spending and borrowing in east Asia, Russia and Latin America are today pushing for a significant relaxation in the US to deal with the so-called subprime crisis

An efficient adjustment to the US over-consumption imbalance (and Chinese under-consumption) in a way that does not hurt longer-term growth should be based on compensating for the decline of US consumption with an increase in domestic investment and in consumption abroad. It should not be based on giving the US consumer more rope with which to hang himself.

A combination of massive fiscal and monetary easing may reignite US consumer spending. But it is likely to reinflating bubbles in the markets for housing and financial assets.
The fundamental imbalance would remain. It would doom the world to repeat today’s financial mess, but in a still more extreme form
Financial Times editorial 29/1 2008

The US cannot drive the world economy for ever.
Better that the surplus countries increase their demand now.

If something cannot go on for ever it will stop.
U.S. Trade Deficit: Causes, Magnitude and Consequenses
Rolf Englund, May 2001

Protectionist dominoes are beginning to tumble across the world
The riots have begun.
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".
Ambrose Evans-Pritchard, 20 Dec 2008

The world financial system is teetering on the "brink of systemic meltdown",
the head of the International Monetary Fund (IMF)Dominique Strauss-Kahn has warned
BBC 12 October 2008

Dominique Strauss-Kahn said rich nations had so far failed to restore confidence, but he endorsed a new action plan by the G7 group.

Late on Friday, US Treasury Secretary Henry Paulson said the US planned to invest directly in banks for the first since the 1930s, following a similar UK programme of partial bank nationalisation.

A systemic crisis demands systemic solutions
Dominique Strauss-Kahn, Managing director of IMF, FT September 22 2008

These are exceptional times. Exceptional for what has happened to financial markets and for what has not happened, at least not yet, to the broader economy – the onset of a severe recession. Perhaps it was the absence of the latter that lulled too many into viewing the bursting of the housing bubble merely as a correction, the defaults in US subprime mortgages just as misfortune and the failure of important financial institutions as collateral damage.

Six months ago, when the International Monetary Fund estimated more than $1,000bn (€691bn, £546bn) in financial sector losses and predicted a sharp slowdown in the global economy, we were criticised for being too pessimistic. But with much of the losses yet to be realised, and with the financial crisis now acute, it has become clear that nothing short of a systemic solution – comprehensive in tackling the immediate fallout and comprehensive in addressing the root causes – will permit the broader economy, in the US and globally, to function with any semblance of normality.

The intensifying credit crunch is so severe that
lower interest rates alone will not be enough
Dominique Strauss-Kahn, managing director of the International Monetary Fund.
Reported by Chris Giles and Gillian Tett, FT January 27 2008

In a dramatic volte face for an international body that as recently as the autumn called for “continued fiscal consolidation” in the US, Dominique Strauss-Kahn, the new IMF head, gave a green light for the proposed US fiscal stimulus package and called for other countries to follow suit. “I don’t think we would get rid of the crisis with just monetary tools,” he said, adding “a new fiscal policy is probably today an accurate way to answer the crisis”.

Mr Strauss-Kahn’s words rip apart a long-standing global consensus that fiscal retrenchment in the US and Japan is needed to help reduce huge trade imbalances.

Mr Strauss-Kahn’s dramatic change in stance amazed Larry Summers, the former US Treasury secretary. He is known for saying that the IMF stands for “It’s Mostly Fiscal” because the organisation has to be tough with countries’ budgetary laxity.
“This is the first time in 25 years that the IMF managing director has called for an increase in fiscal deficits and I regard this as a recognition of the gravity of the situation that we face,” said Mr Summers.

The issue here is not whether there is going to be a recession in the world or individual countries,
but what governments and central banks could do about it.
There are many problems about policies to maintain activity, but lack of policy instruments is not one of them.
Samuel Brittan

In times of panic, grown-ups keep their nerve.
In a financial crisis, central banks must be the grown-ups.
Martin Wolf, January 24 2008

This week, however, the board of the US Federal Reserve seemed to panic by implementing an extraordinary 0.75 percentage point cut in its interest rates prior to its next scheduled meeting. The move was apparently in response to a falling (though still more than fully valued) stock market.

Similarities between the UK and US do exist:
these countries have shared huge upward moves in house prices,
easy access to credit,
large current account deficits (with the UK’s recently even bigger than that of the US, in relation to gross domestic product),
upward pressure on inflation,
banking sectors strongly affected by the credit squeeze; and, in recent days,
stock market volatility.

The extraordinary divergences seen as recently as last December between three-month interbank lending rates and the Bank’s intervention rate have also disappeared.

Finally, any given decline in the pound is likely to impart a stronger stimulus to the UK’s relatively open economy and generate more upward pressure on inflation than an equivalent fall in the US dollar

The trigger for the Fed action was the move on Friday by Fitch
to strip the US monoline insurer AMBAC of its `AAA’ rating,
Why does it matter?
Because they have guaranteed a large part of that $2.4 trillion bond market.
The best we can hope to do is right the ship slowly, and turn a blind eye to moral hazard for now.
Ambrose Evans-Pritchard

Capitalism involves booms and busts.
There is a phenomenon known as the business cycle that loosely revolves around those booms and busts.
Bill Fleckenstein

Carnegie Mellon economist Allan Meltzer, who is finishing the second volume of his history of the Federal Reserve,
warns that Bernanke is risking a disastrous replay of the 1970s
CNN

Most estimates put the eventual tally for defaults by America’s subprime borrowers at $200 billion-300 billion, The Economist

Up to 110 bn dollar in loans will be made available to world money markets by central banks
Analysts say the unprecedented move is a sign of the severity of the problems.
BBC 13/12 2007
Portal

US Treasury Secretary Hank Paulson can be forgiven for pushing through a rescue plan last week
that amounts to a flagrant abuse of contract law and capitalist principles.
Would free marketeers rather see the whole edifice of capitalism burned to the ground to make their point?
Ambrose Evans-Pritchard, Daily Telegraph, 10/12/2007

The US government’s attempt to stem the growing housing crisis involves
arbitrary judgments, rewards for reckless behaviour and variations of contracts.
But it is justified by the extreme circumstances.
FT Editorial, December 7 2007

I think the really interesting question to be asked to which extent central banks have contributed to, or even caused, this crisis.
This is not about Mr Greenspan, or a single monetary policy decision at a particular time, or whether US interest rates were raised too late in the last cycle.
This question relates to the longer-term impact of monetary policy during the age of global disinflation,
which started in the early 1990s, and which has just ended.
The ECB, the Fed, and the Credit Crisis, Wolfgang Münchau. 07.11.2007

The public sector subsidises the banks risk-taking. It does so because banks provide a utility.
What the banks give in return, however, is gung-ho speculation.
Martin Wolf, FT November 27 2007

“The reasons why the massive liquidity injections and policy rate cuts by central banks have miserably failed are clear,”
“We are facing a credit/insolvency problem in addition to a liquidity crunch and central banks’ monetary policy is impotent in dealing with credit problems.”

NOURIEL ROUBINI, November 26th, 2007

Financial companies' losses due to the US sub-prime crisis could be as much as $400bn
Goldman's chief economist Jan Hatzius predicts leveraged investors may have to reduce their lending by $2 trillion as a result.
"The macroeconomic consequences could be quite dramatic,"
Mr Hatzius said.
BBC 16/11 2007

It is only halfway through November but I think we can already declare the winner of the 2007 Quote of the Year competition. It is Chuck Prince, the former chairman and chief executive of Citigroup.
As Mr Prince departs, however, it should be noted that his statement was not, as history will record it, idiotic.
His offence was not that he misunderstood or misstated how banks have operated over the past few years but that he blurted out the truth rather too openly.
Note that he did not say “if” the music stops but “when”.
John Gapper, FT November 14 2007

Let us call a spade a spade.
The blame for the vulnerability of Northern Rock lies with its management
Would it not be better to let mismanaged institutions go under, while protecting small depositors effectively?
Answer: yes, it would.
Martin Wolf, Financial Times November 15 2007

The Moral Hazard of Subprime Risk
An unholy alliance between the real estate, mortgage lending and securities industries and the Washington political and regulatory elite has brought the US economy, the dollar and millions of Americans to the verge of a serious financial calamity.
The Institutional Risk Analyst, November 12, 2007

The mounting financial crisis emanating from the collapse of the market for complex structured assets also illustrates the huge damage done to the US economy by a financial culture which lacks accountability. The banksters and their political patrons on Capitol Hill profit enormously during boom times, but when the wheels fall off the wagon, the Masters of the Universe scurry back to Washington looking for a public bailout.

Consider how little accountability is demanded today from managers of the largest banks. In 17th Century Britain, the owners of banks had unlimited liability for their institutions. There was no deposit insurance, no central banks or overnight funds market. To own and operate a bank meant you put your entire net worth on the line. Likewise in the US, before the liberal financial reforms of the 1930s, shareholders of banks had double liability, meaning that for every dollar in bank stock owned, an investor had to be prepared to invest another dollar upon call if the bank's capital were impaired. Banks were forced to put a premium on asset quality and liquidity because to do otherwise meant failure for the institution and personal financial ruin for the owners.

Today bankers privatize the profits and socialize the losses, to paraphrase Jim Grant.

In place of personal responsibility, we now have a financial culture that feeds on moral hazard.

World stock markets are braced for further turmoil, amid reports that a US Treasury plan to stabilise troubled credit markets may have stalled.
The $75bn scheme, designed to buy debt of questionable value to avoid panic selling, has been thrown into doubt by problems at Citigroup
BBC 2007-11-07

Two things stand out about the credit crisis cascading through Wall Street:
It is both totally shocking and utterly predictable.
Shocking, because a pack of the highest-paid executives on the planet, lauded as the best minds in business and backed by cadres of math whizzes and computer geeks, managed to lose tens of billions of dollars on exotic instruments built on the shaky foundation of subprime mortgages.
A Fortune special report, November 12 2007

Predictable because whether it's junk bonds or tech stocks or emerging-market debt, Wall Street always rides a wave until it crashes. As the fees roll in, one firm after another abandons itself to the lure of easy money, then hands back, in a sudden, unforeseen spasm, a big chunk of the profits it booked in good times.

What we saw this summer is something we've seen before and will undoubtedly see again. The sell-off was predictable and avoidable.
Some people were apparently shocked to learn that gambling was occurring at Rick's Cabaret.
Speech by Michael E. Lewitt, made at the The Bank Credit Analyst Conference
Mauldin's Outside The Box 2007-11-05

The US subprime lending fiasco and its repercussions on Northern Rock have brought back questions about the banking system
- questions such as “What is a bank?” and “What is money?”
Samuel Brittan, FT October 25 2007

We are reminded of the 1929 crash.
Countless studies have blamed the monetary authorities for having stood by as the world economy slid into the Great Depression.
Charles Wyplosz, Eurointelligence 23.09.2007

Public interventions are a bad thing, unless there is a well-identified market failure. Since early August, we have witnessed a massive market failure due to acute information asymmetry.

Each financial institution knows, or should know, its situation, not just on but also off its balance sheet. There are reasons to believe that this is not fully the case, but let’s overlook this first failure. What each financial institution does not know, and should not know, is what is on the books of the other financial institutions with which it trades daily. The old result, which goes under the colourful name of lemon’s markets, is that, suspecting the worst, no financial institution wants to lend to the others.

The first argument is that there are no innocent bystanders. All financial institutions are guilty of excessive risk taking. Their customers too are to be blamed for having continued to do business with reckless banks. The first argument is uncomfortably close to a value judgment. Who can decide what is ex ante excessive risk taking? Did the bank supervisors issue warnings? If they did not, which we do not know yet, the risks are found ex post to have been excessive.

A second argument will accept that the first one does not hold water, but would, reminds us that risk-takers must face the consequences of their actions when they do not pan out as expected. If they do not, they will be even more reckless the next time around. True, but the question here is one of timing. Should the punishment be imposed now or later? Imposing it now implies accepting all the consequences of an interbank market meltdown. These consequences are too frightful to contemplate.

Finally, comes Bagehot and the recommendation that emergency lending be carried out at penalty rates. The ECB is lending at the normal rate and the Fed even lowered the discount rate, seriously contradicting the Bagehot principle.

In the end, not providing the liquidity amounts to taking an excessive risk, that of punishing millions of citizens if a credit squeeze were to create a serious recession.

We are reminded of the 1929 crash. Countless studies have blamed the monetary authorities for having stood by as the world economy slid into the Great Depression.
Back then, many voices argued that the markets should clean themselves and that excessive risk takers should face the consequences.

Beware moral hazard fundamentalists
The world has at least as much to fear from a moral hazard fundamentalism
that precludes actions that would enhance confidence and stability
as it does from moral hazard itself.
Lawrence Summers, Financial Times September 24 2007

The term “moral hazard” originally comes from the area of insurance. It refers to the prospect that insurance will distort behaviour, for example when holders of fire insurance take less precaution with respect to avoiding fire or when holders of health insurance use more healthcare than they would if they were not insured.

In the financial arena the spectre of moral hazard is invoked to oppose policies that reduce the losses of financial institutions that have made bad decisions. In particular, it is used to caution against creating an expectation that there will be future “bail-outs”.

Moral hazard forms the basis for criticism of a wide range of measures including, among others;
large International Monetary Fund loans to countries experiencing financial panics;
public sector actions to facilitate co-ordination of creditors, as in the famous 1998 case of the New York Fed and Long Term Capital Management;
lender of last resort activities by central banks through their discount window;
aggressive cuts in interest rates following collapses in asset prices;
and the extension of government guarantees or quasi-guarantees to liabilities of financial institutions, as in deposit insurance or the US government’s support for the credit of mortgage lenders Fannie Mae and Freddie Mac.

Financial institutions can fail because they become insolvent, as misguided lending or borrowing causes their liabilities to exceed their assets. But solvent institutions can also fail because of illiquidity simply because creditors rush to withdraw their funds and assets cannot be liquidated fast enough. In this latter case the availability of external support averts needless panic and contagion.

For an opposite view, see:
Carnegie Mellon economist Allan Meltzer, who is finishing the second volume of his history of the Federal Reserve,
warns that Bernanke is risking a disastrous replay of the 1970s
CNN

When Markets Are Too Big to Fail
We support expanding Fannie Mae and Freddie Mac, but...
New York Times editorial 22/9 2007

We support expanding Fannie Mae and Freddie Mac and don’t have a problem with carefully regulating their activities. What is unacceptable is that neither Mr. Bernanke nor Mr. Paulson has called for new rules to constrain excessive risk-taking in the financial markets — activities like creating and selling securities backed by utterly reckless loans — even though those risks have greatly contributed to the markets’ instability and have repeatedly required government intervention.

The worthy goal of the Fed’s recent interventions — including this week’s half a percentage point interest rate cut — is to prevent disruptions in the financial markets from harming the broader economy. But they come with considerable risk. The rate cut, for instance, could backfire, unleashing inflation for reasons not entirely within the Fed’s control.

When it comes to Fannie Mae and Freddie Mac, the presumed government backing is called an “implicit guarantee.” On Wall Street, it has many names — ex-post insurance, a Greenspan put, or now, a Bernanke put. Whatever you call it, its existence demands that markets be subject to adequate rules and oversight.

The term "sea change" has come to mean a profound transformation ever since Will Shakespeare used it in The Tempest.
I think this week we witnessed a true sea change in central bank policy, on both sides of the Atlantic.
John Mauldin's Weekly E-Letter, 21/9 2007

At Jackson Hole on August 31, Bernanke addressing the problem of moral hazard faced by Central Banks, Bernanke noted:
"It is not the responsibility of the Federal Reserve -- nor would it be appropriate -- to protect lenders and investors from the consequences of their financial decisions." He did acknowledge that if the system as a whole was at risk, then a central bank would have to act even in spite of the moral hazard issue.

But the point is that inflation is merely tending down. It is not below 2%, and year over year comparisons in the fourth quarter suggest that headline inflation of closer to 3% is quite possible.

CPI does not measure home prices. It measures something called owner's equivalent rent. And even as house prices rose by 93% in real terms (per Bob Shiller) in the last decade run-up, rent in real terms did not go up all that much, so the cost of a new home was not reflected in the CPI.

Given that the Fed has two mandates, stable prices and full employment, is the Fed abandoning its inflation mandate? Is Bernanke, who argued in academia for explicit inflation targeting, no longer worried about inflation? Is he willing to accept the possibility of 3% inflation? Is inflation getting ready to come back, a la the 1970s? Isn't that what the rise of gold is telling us?
And aren't TIPS suggesting the same since the rate cut (a long term 2.64% inflation)?

"One objection to an easing of monetary policy following the collapse of an asset bubble is that it might lead market participants to believe that the central bank will always act to prop up asset prices, a belief that can make a bubble more likely. The central bank can mitigate such an interpretation, however, if it publicly emphasizes that its monetary policy is not directed at stabilizing any particular asset price but is rather focused on achieving price stability and maximum sustainable employment. Making sure that a house-price collapse does not do serious harm to the aggregate economy in no way eliminates sharp declines in house prices and so does not provide insurance against such declines. The same reasoning holds true for stock prices. Indeed, we have seen substantial declines in housing and other asset prices in many countries even when monetary policy has been eased substantially."

Should central banks take account of asset prices? This was until recently one of the most hotly debated subjects in monetary economics.
As of this week, the issue has been effectively settled. Everybody now believes, or rather acts as if, they should.
Eurointelligence, 19/9 2007

The two central banks that have been the loudest proponents of a policy to ignore asset prices, the Fed and the Bank of England, have both made spectacular U-Turns with a few days. They have both irgnored the bubble when it was inflating, but they now care deeply about it when it is deflating.

This was not the way it was supposed to be, but it happened for reasons that are largely outside the control of the central banks.

The real tragedy of Mervyn King, the governor of the Bank of England, is that he really believed in the position that central banks should focus on inflation only, and provide only limited assistance to the financial sector, perhaps only to maintain the basic financial architecture, but never to bail out defaulting banks.
But back in the real world, there are governments that need to be re-elected, and governments in general do not allow banks to fail. Central banks may be independent these days, but they are part of the body collectively known as government. Central bank independence is extremely limited, even in the euro area, and is mostly confined to monetary policy decisions.

Why, after weeks of refusing to intervene in the money markets,
after declaring again and again that such action would cause moral hazard, and
after the run at Northern Rock appeared to be stabilised, has the Bank of England done a U-turn?
"Of course central banks must avert moral hazard, but in a crisis they need to be helpful"
Financial Times editorial 20/9 2007

Its decision to inject funds into the three-month market, against a wider range of collateral, raises the suspicion that the Bank has been overruled by the Treasury.

Since the credit squeeze began the Bank has insisted that it will only intervene in the overnight market and will only lend against the collateral of AAA government and agency bonds. It has held to that position for two reasons.

First, the Bank has argued that to offer longer-term liquidity would be to bail out those banks that have not financed themselves prudently, and so encourage them to be equally careless in future.

The Bank of England’s principle – a determination to avoid moral hazard – was right. But its forced capitulation suggests that taking so pure and so aloof an intellectual position was unwise. Of course central banks must avert moral hazard, but in a crisis they need to be helpful.

Bank of England Governor Mervyn King has hit back at criticism that he caved into political pressure over the Northern Rock crisis and blamed legislation for preventing the central bank handling it in the way he wanted.

A less risky way to protect savers
Charles Goodhart, Financial Times September 20 2007

The country and the government have been stunned by scenes of the queues of depositors trying to withdraw money from Northern Rock, an archetypal “run” on a bank.
Our present partial deposit insurance scheme did little, or nothing, to prevent that, although it was not meant or designed for that purpose.
So the cry goes out for 100 per cent deposit insurance up to a much larger ceiling, along American lines.

But once that is in place, any management – either risk-loving or just plain crooked – can raise as much money from depositors as it likes by just offering a slightly higher deposit rate.
Think Bank of Credit and Commerce International; remember the Savings and Loan crisis.

We need to think long and hard before rushing down such an unpropitious (i.e. unfavorable)route. There are better alternatives. Let me offer one.

Central banks face a liquidity trap
Central banks have always drawn a line between illiquidity and insolvency.
Raghuram Rajan, Financial Times, September 7 2007

The writer is professor of finance at the Graduate School of Business at the University of Chicago

Illiquidity is often viewed as something temporary, an aberration where central bank intervention is permissible.
Insolvency, on the other hand, is viewed as something fundamental and abominable and thus to be discouraged.
Central bank intervention to restore liquidity to an illiquid market would simply bring prices back to fundamentals.

Intervening to bail out insolvent firms would, however, encourage irresponsible behaviour and should be resisted. At least, so the catechism goes.

So what should a central bank do in a time of market turmoil? It should clearly lend freely against unimpeachable securities and also maintain a liquid market in such securities. Anything more is problematic.

Central banks should not rescue fools
Martin Wolf, Financial Times, August 29 2007

Sometimes a picture is worth a thousand words. The one last Wednesday showing Christopher Dodd, chairman of the US senate’s banking committee, flanked by Hank Paulson, Treasury secretary, and Ben Bernanke, governor of the Federal Reserve, was such a picture.
This showed Mr Bernanke as a performer in a political circus.

Mr Dodd even announced Mr Bernanke’s policies: the latter had, said Mr Dodd, told him he would use “all the tools” at his disposal to contain market turmoil and prevent it from damaging the economy. The Fed has its orders: save Main Street and rescue Wall Street.

Policymakers must distinguish two objectives:
the first is macroeconomic stability;
the second is a sound financial system.

he Federal Reserve failed to do this when it issued statements, on prospects for the economy and on emergency lending, on August 17. This unavoidably – and undesirably – confused the two goals.

This brings one to the second objective: ensuring the functioning of the financial system.
The question is how to help the system without encouraging even more bad behaviour.

The most recent game is a particularly creative one. This time the geniuses seem to have created a “lemons crisis”, after the celebrated paper by the Nobel laureate George Akerlof*.

Consider the market in used cars. Suppose buyers cannot tell the difference between good cars and bad ones (lemons). They will then offer only an average price for cars. Sellers will withdraw any good cars from the market. This may continue until the market disappears entirely.

What is driving this is “asymmetric information”: buyers believe sellers know more about the quality of what they are selling than they themselves do. This seems to be precisely what has now happened to trading in certain classes of security.

Yet the difficulty is not a lack of general liquidity. Central banks have provided it freely. Some would argue that, in the case of the Fed, with its half a percentage point cut in the discount rate, provision has been too cheap and, in the case of the European Central Bank, provision has been too free.

This then is a crisis in the market for financial lemons. So what should the authorities do about that? My answer is “nothing”.

Burned children fear the fire. If some of the biggest and most powerful institutions in the world have been playing with fire, they need to feel the burns.