Sovereign Risk and Asset and Liability Management—Conceptual Issues. By Udaibir S. Das, Yinqiu Lu, Michael G. Papaioannou, and Iva Petrova
IMF Working Paper 12/241
Oct 2012
http://www.imf.org/external/pubs/cat/longres.aspx?sk=40037.0
Summary: Country practices towards managing financial risks on a sovereign balance sheet continue to evolve. Each crisis period, and its legacy on sovereign balance sheets, reaffirms the need for strengthening financial risk management. This paper discusses some salient features embedded in in the current generation of sovereign asset and liability management (SALM) approaches, including objectives, definitions of relevant assets and liabilities, and methodologies used in obtaining optimal SALM outcomes. These elements are used in developing an analytical SALM framework which could become an operational instrument in formulating asset management and debtor liability management strategies at the sovereign level. From a portfolio perspective, the SALM approach could help detect direct and derived sovereign risk exposures. It allows analyzing the financial characteristics of the balance sheet, identifying sources of costs and risks, and quantifying the correlations among these sources of risk. The paper also outlines institutional requirements in implementing an SALM framework and seeks to lay the ground for further policy and analytical work on this topic.
Excerpts:
The financial crises of the last thirty years have amply demonstrated that unattended public and private sector risks can be at crises’ origins. Sovereigns are susceptible to various risks and uncertainties relating to their financial assets and liabilities, depending on the country’s level of economic and financial development. Typically, emerging market sovereigns face increased market exposure of their net foreign asset and debt portfolios, especially as they expand access to domestic and international capital markets. Many frontier market sovereigns are exposed to risks arising from terms-of-trade shocks and changes in debt refinancing terms, and tend to be more vulnerable to exogenous shocks than other countries.
Advanced markets face market risk exposure as well, particularly those that rely on capital market access and are systemically important issuers of public debt. In addition, they face other financial risks associated with an aging population, structural issues that need reform ( health and pension), and contingent liabilities arising from systemically important financial or corporate firms, and or potentially weak financial sectors and/or subnational entities. These risks, if realized, could cause a significant fiscal and financial drain and a consequent fall in the country’s domestic absorption and potential output.
To help identify and manage effectively the key financial exposures, a sovereign asset and liability management (SALM) framework, based on the balance-sheet approach, can be employed. This framework can also be used to inform the macroeconomic and financial stability policy design. SALM focuses on managing and containing the financial risk exposure of the public sector as a whole, so as to preserve a sound balance sheet needed to support a sustainable policy path and economic growth. The SALM approach entails monitoring and quantifying the impact of movements in exchange rates, interest rates, inflation, and commodity prices on sovereign assets and liabilities and identifying other debt-related vulnerabilities (Rosenberg et al., 2005) in a coordinated if not an integrated way (Figure 1).
The SALM approach can also be utilized to facilitate a country’s long-term macroeconomic and developmental objectives such as economic diversification, broadening of the export market, or reducing the dependence on key import products. Further, the SALM approach can help identify long-term fiscal challenges, such as unfunded social security liabilities, implying a future claim on resources (Traa and Carare, 2007). In this context, the SALM framework forms an integral part of an overall macroeconomic management strategy (e.g., Au-Yeung et al., 2006, Bolder, 2002, CREF South Africa, 1995, Danmarks Nationalbank, 2000, Grimes, 2001, Horman, 2002).
For commodity-exporting countries, the SALM approach can highlight the potential asset management challenges that stem from a medium-term fiscal strategy (Leigh and Olters, 2006). For example, high commodity prices lead to higher revenues, concurrently strengthening their (unadjusted) fiscal positions. However, commodity depletion leads to lower future revenues, which could be mitigated with appropriate asset management to ensure that future fiscal expenditures are sustainable.
From a portfolio perspective, the SALM approach could help detect sovereign risk exposures. It allows analyzing the financial characteristics of the balance sheet, identifying sources of costs and risks, and quantifying the correlations among these sources ((Claessens, 2005; Lu, Papaioannou, and Petrova, 2007; Zacho, 2006). If the match of financial characteristics of the assets and liabilities is only partial, risk management could focus on the unmatched portions, i.e., net financial positions. In a short- to medium-term perspective, a financial risk management strategy could then be developed to reduce exposures. For example, if the net position results in a liability exposure, appropriate strategies should be developed to manage the risks associated with such exposure.
The application of the SALM framework could be constrained by a number of policy and institutional factors. Monetary policy objectives have an impact on SALM strategies, by affecting either market—interest rate and exchange rate—risk management or directly the size of the balance sheet. Fiscal policy objectives that aim at limiting annual debt service costs may put constraints on the duration and currency composition of public debt, since high shares of short-term debt are perceived to lead to greater volatility of service costs.
The structure of international and domestic capital markets also shapes the SALM implementation. Some developing countries cannot issue domestic debt because of illiquid and/or shallow domestic debt capital markets and a lack of a reliable local investor base. Their attempts to issue domestic-currency external debt have also not been well-received in international markets owing, in part, to their vulnerability to shocks, restrictions on foreign investors to buy local-currency debt (e.g., on type of instruments, minimum holding period), poor transparency, and/or a lack of interest rate and exchange rate hedging instruments.
In addition, some have argued that combining the management of sovereign assets and liabilities under one framework may not be optimal.5 Cassard and Folkerts-Landau (2000) points out a potential conflict of interest between monetary policy and debt management if a central bank assumes an operational role or actively participates in debt markets. For example, the central bank may be reluctant to increase the interest rates in the face of growing inflation concerns for fear of raising debt rollover costs. Also, the central bank’s intervention policy may be in conflict with its daily task of managing the liquidity of the foreign currency debt.
While risk management approaches for sovereigns may differ from those for the private sector (see Box 1), this paper discusses the salient features embedded in countries’ approaches to SALM, including main objectives, definitions of relevant assets and liabilities, and methodologies used in obtaining optimal debt and asset outcomes. These considerations are typically taken into account when developing an analytical SALM framework, which may evolve into an operational instrument for formulating asset and debt/liability management strategies. Also, the paper outlines common institutional requirements and constraints in implementing an SALM framework, and, based on select country experiences with the SALM approach, draws some stylized lessons and general policy guidelines on adopting an SALM approach.
Friday, October 5, 2012
Thursday, October 4, 2012
Macrofinancial Stress Testing - Principles and Practices - IMF Policy Paper
Macrofinancial Stress Testing - Principles and Practices
IMF Policy Paper
Oct 2012
http://www.imf.org/external/pp/longres.aspx?id=4702
Summary: The recent financial crisis drew unprecedented attention to the stress testing of financial institutions. On one hand, stress tests were criticized for having missed many of the vulnerabilities that led to the crisis. On the other, after the onset of the crisis, they were given a new role as crisis management tools to guide bank recapitalization and help restore confidence. This spurred an intense debate on the models, underlying assumptions, and uses of stress tests. Current stress testing practices, however, are not based on a systematic and comprehensive set of principles but have emerged from trial-and-error and often reflect constraints in human, technical, and data capabilities.
Macrofinancial Stress Testing - Principles and Practices—Background Material
IMF Policy Paper
Oct 2012
http://www.imf.org/external/pp/longres.aspx?id=4703
Summary: Staff conducted a survey of stress testing practices among selected national central banks and supervisory authorities. The online survey was undertaken in November 2011 as part of the preparatory work for the paper on ?Macrofinancial Stress Testing: Principles and Practices. The survey focused on stress testing for banks, which is more widespread and better established—and practices are therefore easier to compare across countries—but also included questions on stress testing for nonbank financial institutions.
IMF Policy Paper
Oct 2012
http://www.imf.org/external/pp/longres.aspx?id=4702
Summary: The recent financial crisis drew unprecedented attention to the stress testing of financial institutions. On one hand, stress tests were criticized for having missed many of the vulnerabilities that led to the crisis. On the other, after the onset of the crisis, they were given a new role as crisis management tools to guide bank recapitalization and help restore confidence. This spurred an intense debate on the models, underlying assumptions, and uses of stress tests. Current stress testing practices, however, are not based on a systematic and comprehensive set of principles but have emerged from trial-and-error and often reflect constraints in human, technical, and data capabilities.
Macrofinancial Stress Testing - Principles and Practices—Background Material
IMF Policy Paper
Oct 2012
http://www.imf.org/external/pp/longres.aspx?id=4703
Summary: Staff conducted a survey of stress testing practices among selected national central banks and supervisory authorities. The online survey was undertaken in November 2011 as part of the preparatory work for the paper on ?Macrofinancial Stress Testing: Principles and Practices. The survey focused on stress testing for banks, which is more widespread and better established—and practices are therefore easier to compare across countries—but also included questions on stress testing for nonbank financial institutions.
Tuesday, October 2, 2012
Banking and Trading. By Arnoud W.A. Boot and Lev Ratnovski
Banking and Trading. By Arnoud W.A. Boot and Lev Ratnovski
IMF Working Paper No. 12/238
Oct 2012
http://www.imfbookstore.org/IMFORG/9781475511215
Summary: We study the effects of a bank's engagement in trading. Traditional banking is relationship-based: not scalable, long-term oriented, with high implicit capital, and low risk (thanks to the law of large numbers). Trading is transactions-based: scalable, shortterm, capital constrained, and with the ability to generate risk from concentrated positions. When a bank engages in trading, it can use its ‘spare’ capital to profitablity expand the scale of trading. However, there are two inefficiencies. A bank may allocate too much capital to trading ex-post, compromising the incentives to build relationships ex-ante. And a bank may use trading for risk-shifting. Financial development augments the scalability of trading, which initially benefits conglomeration, but beyond some point inefficiencies dominate. The deepending of the financial markets in recent decades leads trading in banks to become increasingly risky, so that problems in managing and regulating trading in banks will persist for the foreseeable future. The analysis has implications for capital regulation, subsidiarization, and scope and scale restrictions in banking.
Excerpts
We study the effects of a bank’s engagement in trading. We use the term “banking” to describe business with repeated, long-term clients (also called relationship banking), and “trading” for operations that do not rely on repeated interactions. This definition of trading thus includes not just taking positions for a bank’s own account — proprietary trading — but also other short-term activities that do not rely on private and soft information, e.g. originating and selling standardized loans. Both commercial and investment banks over the last decade have increasingly engaged in short-term trading. We need to understand the rationale for that, and the challenges that it poses.
Such challenges clearly exist. They are perhaps most vivid in Europe, where some large universal banks seem to have over-allocated resources to trading prior to the crisis, with consequent losses affecting their stability (e.g., UBS, see UBS, 2008; an earlier example is the failure of the Barings Bank due to trading in Singapore in 1995). In the United States, the development of universal banks was until recently restricted by the Glass-Steagall Act. Yet there are many examples of a shift of institutions into shortterm activities, with similar negative consequences. Since early 1980-s, many New York investment banks have turned the focus from traditional underwriting to short-term market-making and proprietary investments; these have often backfired during the crisis (Bear Stearns, Lehman Brothers, Merrill Lynch). Also, in 2000-s, commercial banks have used their franchise to expand into short-term activities, such as wholesale loan origination and funding (Washington Mutual, Wachovia), exposing themselves to risk. And post-Glass-Steagall, there is evidence of trading being a drain on commercial bank activities in newly created universal banks, such as Bank of America-Merrill Lynch. A 2012 loss related to the market activities in JP Morgan is another example. The banks’ short-term activities, especially proprietary trading, have received significant regulatory attention: the Volcker Rule in the Dodd-Frank Act in the U.S., and the Report of the Independent Commission on Banking (the so-called Vickers report) in the UK.
The interaction between banking and trading is a novel topic. The existing literature on universal banks focuses primarily on the interaction between lending and underwriting. Such interaction is relatively well-understood, and also was not at the forefront during the recent crisis. Our paper downplays the distinction between lending and underwriting: for us both could possibly represent examples of long-term, relationshipbased banking. We contrast them to short-term, individual transactions-based activities. We see a shift of relative emphasis towards such “trading” as one of the major developments in the financial sector (for sure prior to the crisis).
The focus on trading as a possibly detrimental activity in banks, and its difference from underwriting in this regard, is supported by emerging empirical evidence. Brunnermeier et al. (2012) show that trading can lead to a persistent loss of bank income following a negative shock. In contrast, underwriting, while more volatile than commercial banking, is not associated with persistent losses of profitability.
The key to our analysis is the observation that the relationship business is usually profitable and hence generates implicit capital, yet is not readily scalable. The trading activity on the other hand can be capital constrained and benefit from the spare capital available in the bank. Accordingly, relationship banks might expand into trading in order to use ‘spare’ capital. This funding (liability-side) synergy is akin to the assertions of practitioners that one can “take advantage of the balance sheet of the bank”.
Opening up banking to trading, however, creates frictions. We highlight two of them. One friction is time inconsistency in the allocation of capital between the longterm relationship banking business and the short-term trading activity. Banks may be tempted to shift too much resources to trading in a way that undermines the relationship franchise. Another friction is risk-shifting: the incentives to use trading to boost risk and benefit shareholders as residual claimants. As a result of these two factors, a bank can overexpose itself to trading, compared to what is socially optimal, or ex ante optimal for its shareholders.
Both problems become more acute when financial markets are deeper, allowing larger trading positions. This increases the misallocation of capital and enables the gambles of scale necessary for risk-shifting. The problems also become more acute when bank returns are lower. Both factors have been in play in the last 10-20 years. Consequently, the costs of trading in banks may have started to outweight its benefits. These frictions are likely to persist for the foreseeable future, so a regulatory response might be necessary.
Full text: http://www.imf.org/external/pubs/cat/longres.aspx?sk=40031.0
IMF Working Paper No. 12/238
Oct 2012
http://www.imfbookstore.org/IMFORG/9781475511215
Summary: We study the effects of a bank's engagement in trading. Traditional banking is relationship-based: not scalable, long-term oriented, with high implicit capital, and low risk (thanks to the law of large numbers). Trading is transactions-based: scalable, shortterm, capital constrained, and with the ability to generate risk from concentrated positions. When a bank engages in trading, it can use its ‘spare’ capital to profitablity expand the scale of trading. However, there are two inefficiencies. A bank may allocate too much capital to trading ex-post, compromising the incentives to build relationships ex-ante. And a bank may use trading for risk-shifting. Financial development augments the scalability of trading, which initially benefits conglomeration, but beyond some point inefficiencies dominate. The deepending of the financial markets in recent decades leads trading in banks to become increasingly risky, so that problems in managing and regulating trading in banks will persist for the foreseeable future. The analysis has implications for capital regulation, subsidiarization, and scope and scale restrictions in banking.
Excerpts
We study the effects of a bank’s engagement in trading. We use the term “banking” to describe business with repeated, long-term clients (also called relationship banking), and “trading” for operations that do not rely on repeated interactions. This definition of trading thus includes not just taking positions for a bank’s own account — proprietary trading — but also other short-term activities that do not rely on private and soft information, e.g. originating and selling standardized loans. Both commercial and investment banks over the last decade have increasingly engaged in short-term trading. We need to understand the rationale for that, and the challenges that it poses.
Such challenges clearly exist. They are perhaps most vivid in Europe, where some large universal banks seem to have over-allocated resources to trading prior to the crisis, with consequent losses affecting their stability (e.g., UBS, see UBS, 2008; an earlier example is the failure of the Barings Bank due to trading in Singapore in 1995). In the United States, the development of universal banks was until recently restricted by the Glass-Steagall Act. Yet there are many examples of a shift of institutions into shortterm activities, with similar negative consequences. Since early 1980-s, many New York investment banks have turned the focus from traditional underwriting to short-term market-making and proprietary investments; these have often backfired during the crisis (Bear Stearns, Lehman Brothers, Merrill Lynch). Also, in 2000-s, commercial banks have used their franchise to expand into short-term activities, such as wholesale loan origination and funding (Washington Mutual, Wachovia), exposing themselves to risk. And post-Glass-Steagall, there is evidence of trading being a drain on commercial bank activities in newly created universal banks, such as Bank of America-Merrill Lynch. A 2012 loss related to the market activities in JP Morgan is another example. The banks’ short-term activities, especially proprietary trading, have received significant regulatory attention: the Volcker Rule in the Dodd-Frank Act in the U.S., and the Report of the Independent Commission on Banking (the so-called Vickers report) in the UK.
The interaction between banking and trading is a novel topic. The existing literature on universal banks focuses primarily on the interaction between lending and underwriting. Such interaction is relatively well-understood, and also was not at the forefront during the recent crisis. Our paper downplays the distinction between lending and underwriting: for us both could possibly represent examples of long-term, relationshipbased banking. We contrast them to short-term, individual transactions-based activities. We see a shift of relative emphasis towards such “trading” as one of the major developments in the financial sector (for sure prior to the crisis).
The focus on trading as a possibly detrimental activity in banks, and its difference from underwriting in this regard, is supported by emerging empirical evidence. Brunnermeier et al. (2012) show that trading can lead to a persistent loss of bank income following a negative shock. In contrast, underwriting, while more volatile than commercial banking, is not associated with persistent losses of profitability.
The key to our analysis is the observation that the relationship business is usually profitable and hence generates implicit capital, yet is not readily scalable. The trading activity on the other hand can be capital constrained and benefit from the spare capital available in the bank. Accordingly, relationship banks might expand into trading in order to use ‘spare’ capital. This funding (liability-side) synergy is akin to the assertions of practitioners that one can “take advantage of the balance sheet of the bank”.
Opening up banking to trading, however, creates frictions. We highlight two of them. One friction is time inconsistency in the allocation of capital between the longterm relationship banking business and the short-term trading activity. Banks may be tempted to shift too much resources to trading in a way that undermines the relationship franchise. Another friction is risk-shifting: the incentives to use trading to boost risk and benefit shareholders as residual claimants. As a result of these two factors, a bank can overexpose itself to trading, compared to what is socially optimal, or ex ante optimal for its shareholders.
Both problems become more acute when financial markets are deeper, allowing larger trading positions. This increases the misallocation of capital and enables the gambles of scale necessary for risk-shifting. The problems also become more acute when bank returns are lower. Both factors have been in play in the last 10-20 years. Consequently, the costs of trading in banks may have started to outweight its benefits. These frictions are likely to persist for the foreseeable future, so a regulatory response might be necessary.
Full text: http://www.imf.org/external/pubs/cat/longres.aspx?sk=40031.0
Friday, September 28, 2012
Current economic policies: pro and con
Today’s Economic Data. By Alan Krueger
The White House, September 27, 2012 11:57 AM EDT
http://www.whitehouse.gov/blog/2012/09/27/today-s-economic-data
More than the usual amount of economic statistics were released this morning. As a whole, today’s economic news shows that while we are still fighting back from the worst economic crisis since the Great Depression, we are making progress. We lost more than 8 million jobs and GDP contracted by almost 5 percent as a result of the Great Recession. We have more work to do, but incorporating today’s preliminary benchmark revision to the employment figures released by the Bureau of Labor Statistics with their earlier data indicates that the economy has added nearly 5.1 million private sector jobs, on net, over the past 30 months. BLS announced that total employment likely grew by 386,000 more jobs than previously announced during the 12 months from March 2011 to March 2012, and by 453,000 more private sector jobs in that same time period. In the past decade, the absolute difference between the preliminary and final benchmark revision has averaged 37,000 jobs.
We also saw revised data released today showing that real GDP grew in the second quarter of 2012 by 1.3 percent at an annual rate. Real GDP growth in the second quarter was revised down due, in part, to a downward revision to agriculture inventories as a result of the devastating drought our nation faced this summer. The Obama Administration continues to take all available steps to mitigate the impacts of the drought, and has called on Congress to pass a farm bill that would spur growth and provide rural Americans with the certainty they deserve. We also learned today that the advance report of durable goods orders declined in August, largely as a result of a decline in orders for transportation equipment. Excluding the volatile transportation category, durable goods orders fell by 1.6 percent.
Today’s news shows that we must do more to strengthen our economy and promote job creation. Over a year ago, President Obama proposed the American Jobs Act – a plan that independent economists have said would create up to 2 million jobs. The President will continue to push policies that will continue this progress we have made, including incentives to strengthen the American manufacturing industry, investments in our nation’s infrastructure, and the extension of the tax cuts for 98 percent of Americans and 97 percent of small businesses.
While we are still rebuilding our economy and working to recover from the worst crisis since the Great Depression, we are making progress and the last thing we should do is return to the economic policies that failed us in the past. The revisions announced in today’s reports are a reminder that economic data are subject to large revisions. As a whole the pattern of revisions suggest that the recession that began at the end of 2007 was deeper than initially reported, and the jobs recovery over the last 2.5 years has been a bit stronger than initially reported, although much work remains to be done to return to full employment.
-----------------------------------------------------
As Good As It Gets? WSJ Editorial
Growth of 1.7% isn't what Team Obama promised four years ago.The Wall Street Journal, September 28, 2012, page A16
http://online.wsj.com/article/SB10000872396390444813104578016873186217796.html
Excerpts:
Bob Schieffer: "The fact is, unemployment is up. It is higher than when [President Obama] came to office, the economy is still in the dump. Some people say that is reason enough to make a change."
Bill Clinton: "It is if you believe that we could have been fully healed in four years. I don't know a single serious economist who believes that as much damage as we had could have been healed."
CBS's "Face the Nation," September 23, 2012
---
[Growth Gap: http://si.wsj.net/public/resources/images/ED-AP847A_1obam_D_20120927170003.jpg]
Well, let's see. We can think of several serious people who said we could heal the economy in four years. There's Joe Biden, Nancy Pelosi, Harry Reid, Christina Romer, Jared Bernstein, Mark Zandi, and, most importantly, President Obama himself.
Mr. Obama told Americans in 2009 that if he did not turn around the economy in three years his Presidency would be "a one-term proposition." Joe Biden said three years ago that the $830 billion economic stimulus was working beyond his "wildest dreams" and he famously promised several months after the Obama stimulus was enacted that Americans would enjoy a "summer of recovery." That was more than three years ago.
In early 2009 soon-to-be White House economists Ms. Romer and Mr. Bernstein promised Congress that the stimulus would hold the unemployment rate below 7% and that by now it would be 5.6%. Instead the rate is 8.1%. The latest Census Bureau report says there are nearly seven million fewer full-time, year-round workers today than in 2007. The labor participation rate is the lowest since 1981.
So it has gone with nearly every prediction the President has made about where the economy would be today. Mr. Obama promised that the deficit would be cut in half in four years, but the fiscal 2012 deficit (estimated to be above $1 trillion) will be twice the 2008 deficit ($458 billion).
Mr. Obama said that his health-care plan would "cut the cost of a typical family's premium by up to $2,500 a year," but premiums for employer-sponsored family coverage have gone up $2,370 since 2009, according to the Kaiser Family Foundation.
He said that the linchpin for a growing economy would be renewable energy investment, and he promised to "create five million new jobs in solar, wind, geothermal" energy. Mr. Obama did invest some $9 billion in green energy, but his job estimate was off by at least a factor of 10 and today many solar and wind industry firms are fighting bankruptcy. The growth in domestic U.S. energy production that he now takes credit for has come almost entirely from the fossil fuels his Administration has done so much to obstruct.
There's nothing unusual about candidates making grandiose promises that don't come true. And it's a White House tradition to blame one's predecessor when things don't get better. (Usually these Presidents end up one-termers.)
The bad faith wasn't then. It's now. Mr. Obama really believed that government spending would unleash a robust recovery in employment and housing—an "economy built to last." Now that this hasn't happened and with the Congressional Budget Office predicting a possible recession for 2013, Team Obama claims these woeful results were the best that could have been expected.
The problem with this line is that every President who has inherited a recession in modern times has done better. (See nearby table.) Under Mr. Obama, measured on the basis of jobs, GDP growth and incomes, this has been by far the meekest recovery from the past 10 recessions.
When George W. Bush was elected, he inherited a mild recession from Mr. Clinton amid the bursting of the dot-com bubble, some $7 trillion of wealth eviscerated. Nine months later came the 9/11 terrorist attacks. Yet by 2003 the economy was growing by more than 3% and eight million jobs were created over the next four years.
The Administration and its acolytes claim that the nature of the 2008 financial collapse was different from past recessions, and that it can take up to a decade to restore growth after such a financial crisis. Economist Michael Bordo [http://online.wsj.com/article/SB10000872396390444506004577613122591922992.html] rebuts that claim with historical economic evidence nearby.
In reality, the biggest difference between this recovery and others hasn't been the nature of the crisis, but the nature of the policy prescriptions. Mr. Obama's chief anti-recession idea was a near trillion-dollar leap of faith in the Keynesian "multiplier" effect of government spending. It was the same approach that didn't work in the 1930s, didn't work in the 1970s, didn't work in 2008, and didn't work in such other nations as Japan. It didn't work again in 2009.
Ronald Reagan also inherited an economy loaded with problems. The stock market had been flat for 12 years, inflation rates neared 14%, and mortgage rates almost 20%. The recession he endured in 1981-82 to cure inflation sent unemployment to 10.8%, higher than Mr. Obama's peak of 10%. But the business and jobs recovery by early 1983 was rapid and lasted seven years.
Reagan used tax-rate cuts, disinflationary monetary policy and deregulation to reignite growth—more or less the opposite of the Obama policy mix. Liberals tried to explain the Reagan boom that they said would never happen by arguing that there was nothing unusual about the growth spurt after such a deep recession. So why didn't that happen this time?
When campaigning to be President in 1960, John F. Kennedy denounced slow growth under Eisenhower and Nixon and said "We can do bettah." Growth was 7.2% in 1959 and 2.5% in 1960. Since the recession ended under Mr. Obama, growth has been 2.4% in 2010, 1.8% in 2011 and, after Thursday's downward revision for the second quarter, 1.7% in 2012.
[...]
The White House, September 27, 2012 11:57 AM EDT
http://www.whitehouse.gov/blog/2012/09/27/today-s-economic-data
More than the usual amount of economic statistics were released this morning. As a whole, today’s economic news shows that while we are still fighting back from the worst economic crisis since the Great Depression, we are making progress. We lost more than 8 million jobs and GDP contracted by almost 5 percent as a result of the Great Recession. We have more work to do, but incorporating today’s preliminary benchmark revision to the employment figures released by the Bureau of Labor Statistics with their earlier data indicates that the economy has added nearly 5.1 million private sector jobs, on net, over the past 30 months. BLS announced that total employment likely grew by 386,000 more jobs than previously announced during the 12 months from March 2011 to March 2012, and by 453,000 more private sector jobs in that same time period. In the past decade, the absolute difference between the preliminary and final benchmark revision has averaged 37,000 jobs.
We also saw revised data released today showing that real GDP grew in the second quarter of 2012 by 1.3 percent at an annual rate. Real GDP growth in the second quarter was revised down due, in part, to a downward revision to agriculture inventories as a result of the devastating drought our nation faced this summer. The Obama Administration continues to take all available steps to mitigate the impacts of the drought, and has called on Congress to pass a farm bill that would spur growth and provide rural Americans with the certainty they deserve. We also learned today that the advance report of durable goods orders declined in August, largely as a result of a decline in orders for transportation equipment. Excluding the volatile transportation category, durable goods orders fell by 1.6 percent.
Today’s news shows that we must do more to strengthen our economy and promote job creation. Over a year ago, President Obama proposed the American Jobs Act – a plan that independent economists have said would create up to 2 million jobs. The President will continue to push policies that will continue this progress we have made, including incentives to strengthen the American manufacturing industry, investments in our nation’s infrastructure, and the extension of the tax cuts for 98 percent of Americans and 97 percent of small businesses.
While we are still rebuilding our economy and working to recover from the worst crisis since the Great Depression, we are making progress and the last thing we should do is return to the economic policies that failed us in the past. The revisions announced in today’s reports are a reminder that economic data are subject to large revisions. As a whole the pattern of revisions suggest that the recession that began at the end of 2007 was deeper than initially reported, and the jobs recovery over the last 2.5 years has been a bit stronger than initially reported, although much work remains to be done to return to full employment.
-----------------------------------------------------
As Good As It Gets? WSJ Editorial
Growth of 1.7% isn't what Team Obama promised four years ago.The Wall Street Journal, September 28, 2012, page A16
http://online.wsj.com/article/SB10000872396390444813104578016873186217796.html
Excerpts:
Bob Schieffer: "The fact is, unemployment is up. It is higher than when [President Obama] came to office, the economy is still in the dump. Some people say that is reason enough to make a change."
Bill Clinton: "It is if you believe that we could have been fully healed in four years. I don't know a single serious economist who believes that as much damage as we had could have been healed."
CBS's "Face the Nation," September 23, 2012
---
[Growth Gap: http://si.wsj.net/public/resources/images/ED-AP847A_1obam_D_20120927170003.jpg]
Well, let's see. We can think of several serious people who said we could heal the economy in four years. There's Joe Biden, Nancy Pelosi, Harry Reid, Christina Romer, Jared Bernstein, Mark Zandi, and, most importantly, President Obama himself.
Mr. Obama told Americans in 2009 that if he did not turn around the economy in three years his Presidency would be "a one-term proposition." Joe Biden said three years ago that the $830 billion economic stimulus was working beyond his "wildest dreams" and he famously promised several months after the Obama stimulus was enacted that Americans would enjoy a "summer of recovery." That was more than three years ago.
In early 2009 soon-to-be White House economists Ms. Romer and Mr. Bernstein promised Congress that the stimulus would hold the unemployment rate below 7% and that by now it would be 5.6%. Instead the rate is 8.1%. The latest Census Bureau report says there are nearly seven million fewer full-time, year-round workers today than in 2007. The labor participation rate is the lowest since 1981.
So it has gone with nearly every prediction the President has made about where the economy would be today. Mr. Obama promised that the deficit would be cut in half in four years, but the fiscal 2012 deficit (estimated to be above $1 trillion) will be twice the 2008 deficit ($458 billion).
Mr. Obama said that his health-care plan would "cut the cost of a typical family's premium by up to $2,500 a year," but premiums for employer-sponsored family coverage have gone up $2,370 since 2009, according to the Kaiser Family Foundation.
He said that the linchpin for a growing economy would be renewable energy investment, and he promised to "create five million new jobs in solar, wind, geothermal" energy. Mr. Obama did invest some $9 billion in green energy, but his job estimate was off by at least a factor of 10 and today many solar and wind industry firms are fighting bankruptcy. The growth in domestic U.S. energy production that he now takes credit for has come almost entirely from the fossil fuels his Administration has done so much to obstruct.
There's nothing unusual about candidates making grandiose promises that don't come true. And it's a White House tradition to blame one's predecessor when things don't get better. (Usually these Presidents end up one-termers.)
The bad faith wasn't then. It's now. Mr. Obama really believed that government spending would unleash a robust recovery in employment and housing—an "economy built to last." Now that this hasn't happened and with the Congressional Budget Office predicting a possible recession for 2013, Team Obama claims these woeful results were the best that could have been expected.
The problem with this line is that every President who has inherited a recession in modern times has done better. (See nearby table.) Under Mr. Obama, measured on the basis of jobs, GDP growth and incomes, this has been by far the meekest recovery from the past 10 recessions.
When George W. Bush was elected, he inherited a mild recession from Mr. Clinton amid the bursting of the dot-com bubble, some $7 trillion of wealth eviscerated. Nine months later came the 9/11 terrorist attacks. Yet by 2003 the economy was growing by more than 3% and eight million jobs were created over the next four years.
The Administration and its acolytes claim that the nature of the 2008 financial collapse was different from past recessions, and that it can take up to a decade to restore growth after such a financial crisis. Economist Michael Bordo [http://online.wsj.com/article/SB10000872396390444506004577613122591922992.html] rebuts that claim with historical economic evidence nearby.
In reality, the biggest difference between this recovery and others hasn't been the nature of the crisis, but the nature of the policy prescriptions. Mr. Obama's chief anti-recession idea was a near trillion-dollar leap of faith in the Keynesian "multiplier" effect of government spending. It was the same approach that didn't work in the 1930s, didn't work in the 1970s, didn't work in 2008, and didn't work in such other nations as Japan. It didn't work again in 2009.
Ronald Reagan also inherited an economy loaded with problems. The stock market had been flat for 12 years, inflation rates neared 14%, and mortgage rates almost 20%. The recession he endured in 1981-82 to cure inflation sent unemployment to 10.8%, higher than Mr. Obama's peak of 10%. But the business and jobs recovery by early 1983 was rapid and lasted seven years.
Reagan used tax-rate cuts, disinflationary monetary policy and deregulation to reignite growth—more or less the opposite of the Obama policy mix. Liberals tried to explain the Reagan boom that they said would never happen by arguing that there was nothing unusual about the growth spurt after such a deep recession. So why didn't that happen this time?
When campaigning to be President in 1960, John F. Kennedy denounced slow growth under Eisenhower and Nixon and said "We can do bettah." Growth was 7.2% in 1959 and 2.5% in 1960. Since the recession ended under Mr. Obama, growth has been 2.4% in 2010, 1.8% in 2011 and, after Thursday's downward revision for the second quarter, 1.7% in 2012.
[...]
Sheila Bair: 'Insolvent Institutions Should Be Closed'
Sheila Bair: 'Insolvent Institutions Should Be Closed.' By Robert L Pollock
Political Diary
Wall Street Journal, September 27, 2012, 12:28 p.m. ET
http://online.wsj.com/article/SB10000872396390443328404578022363414879722.html
If you were one of the people scratching your forehead in 2008 as the federal government bailed out Bear Stearns, let Lehman Brothers fail, and then showered hundreds of billions of dollars on the banking system to avert the alleged threat of a "systemic" collapse, you were hardly alone. In fact Sheila Bair, then head of the Federal Deposit Insurance Corporation, shared many of your concerns.
Ms. Bair stopped by the Journal Wednesday as part of a tour to promote her new book on the financial crisis. The headline revelations: She was very skeptical about why the likes of Citibank were deemed worthy of moving heaven and earth to save, and she also doesn't quite understand what Tim Geithner and Hank Paulson were talking about when they used the phrase "systemically important" institutions.
Of Mr. Geithner and Citi, Ms. Bair said you just have to "look at his phone logs" to see the outsized concern he had with preserving the financial giant. He was talking with Citi CEO Vikram Pandit a lot, she says. You got the impression "he was going to stand behind Citi management no matter what . . .. He viewed me as a threat with my desire to impose losses on bondholders."
So what would Ms. Bair have done? "At least make them clean up their balance sheet," instead of just throwing money at them. "If our system is so fragile that a blatantly mismanaged, poorly run bank can't be subject to some market discipline because the whole system is gonna come down, let's just socialize everything."
"It was a joke" what happened, Ms. Bair continued. Now "they're a zombie bank," like so many Japanese financial institutions.
So does Ms. Bair think the concept of systemic risk makes any sense at all? "I think it's a really, really overused word. It's never backed with analysis. It's just 'You gotta do this because it's the system.' I think if you're throwing government money around" you better have a good explanation why letting an institution fail through the normal FDIC process would be a problem.
Ms. Bair's radical alternative to panicked and inconsistent decision making in Washington? "The insolvent institutions should be closed."
"The original sin was with Bear Stearns . . .. I've never seen a good analysis why Bearn Stearns was systemic," she says. But after Bear was bailed out in early 2008, the much bigger Lehman Brothers expected a bailout, too. When it didn't get one, the crisis of fall 2008 began in earnest. "There were so many missteps leading up to this that created market uncertainty."
Political Diary
Wall Street Journal, September 27, 2012, 12:28 p.m. ET
http://online.wsj.com/article/SB10000872396390443328404578022363414879722.html
If you were one of the people scratching your forehead in 2008 as the federal government bailed out Bear Stearns, let Lehman Brothers fail, and then showered hundreds of billions of dollars on the banking system to avert the alleged threat of a "systemic" collapse, you were hardly alone. In fact Sheila Bair, then head of the Federal Deposit Insurance Corporation, shared many of your concerns.
Ms. Bair stopped by the Journal Wednesday as part of a tour to promote her new book on the financial crisis. The headline revelations: She was very skeptical about why the likes of Citibank were deemed worthy of moving heaven and earth to save, and she also doesn't quite understand what Tim Geithner and Hank Paulson were talking about when they used the phrase "systemically important" institutions.
Of Mr. Geithner and Citi, Ms. Bair said you just have to "look at his phone logs" to see the outsized concern he had with preserving the financial giant. He was talking with Citi CEO Vikram Pandit a lot, she says. You got the impression "he was going to stand behind Citi management no matter what . . .. He viewed me as a threat with my desire to impose losses on bondholders."
So what would Ms. Bair have done? "At least make them clean up their balance sheet," instead of just throwing money at them. "If our system is so fragile that a blatantly mismanaged, poorly run bank can't be subject to some market discipline because the whole system is gonna come down, let's just socialize everything."
"It was a joke" what happened, Ms. Bair continued. Now "they're a zombie bank," like so many Japanese financial institutions.
So does Ms. Bair think the concept of systemic risk makes any sense at all? "I think it's a really, really overused word. It's never backed with analysis. It's just 'You gotta do this because it's the system.' I think if you're throwing government money around" you better have a good explanation why letting an institution fail through the normal FDIC process would be a problem.
Ms. Bair's radical alternative to panicked and inconsistent decision making in Washington? "The insolvent institutions should be closed."
"The original sin was with Bear Stearns . . .. I've never seen a good analysis why Bearn Stearns was systemic," she says. But after Bear was bailed out in early 2008, the much bigger Lehman Brothers expected a bailout, too. When it didn't get one, the crisis of fall 2008 began in earnest. "There were so many missteps leading up to this that created market uncertainty."
Wednesday, September 26, 2012
Assessing the Cost of Financial Regulation
Assessing the Cost of Financial Regulation. By Douglas Elliott, Suzanne Salloy, and André Oliveira Santos
IMF Working Paper No. 12/233
http://www.imfbookstore.org/IMFORG/9781475510836
Summary: This study assesses the overall impact on credit of the financial regulatory reforms in Europe, Japan, and the United States. Long-term cost estimates are provided for Basel III capital and liquidity requirements, derivatives reforms, and higher taxes and fees. Overall, average lending rates in the base case would rise by 18 bps in Europe, 8 bps in Japan, and 28 bps in the United States. These results are similar to the official BIS assessments of Basel III and an OECD analysis, but lower as a result of including expense cuts and reductions in the returns required by investors. As a result, they are markedly lower than those of the IIF.
Executive Summary:
Reforming the regulation of financial institutions and markets is critically important and should provide large benefits to society. The recent financial crisis underlined the huge economic costs produced by recessions associated with severe financial crises. However, adding safety margins in the financial system comes at a price. Most notably, the substantially stronger capital and liquidity requirements created under the new Basel III accord have economic costs during the good years, analogous to insurance payments.
There is serious disagreement about how much the additional safety margins will cost. The Institute of International Finance (IIF), a group sponsored by the financial industry, estimated the proposed reforms will reduce economic output in the advanced economies by approximately 3 percent during 2011–15. Official estimates suggest a much smaller drag.
Finding an intellectually sound consensus on the costs of reform is critical. If the true price is too high, reforms must be reassessed to improve the cost-benefit ratio. But, if reforms are economically sound, they should be pursued to increase safety and reduce the uncertainty about rules that creates inefficiencies and makes long-term planning difficult.
This study assesses the overall impact on credit of the global financial regulatory initiatives in, Europe, Japan, and the United States. It focuses on the long-term outcomes, rather than transitional costs, and does not attempt to measure the economic benefits of reforms. Academic theory is combined with empirical analyses from industry and official sources, plus financial disclosures by the major financial firms, to reach specific cost estimates. The analysis here does not address the significant adjustments triggered by the financial and Eurozone crises and the potential transitional effects of adjusting to the new regulations.
The study focuses principally on the effects of regulatory changes on banks and their lending. This is for three reasons: banks dominate finance; the reforms are heavily focused on them; and it is harder to estimate the effects on other parts of the system, such as capital markets. Loans, in particular, are a major part of overall credit provision and there is substantially greater data available on lending activities. Where possible, the study also looks at the effects of new regulations on securities holdings by banks and on securities markets.
Measuring the cost of financial reform requires careful consideration of the baselines for comparisons. They should incorporate the higher safety margins that would have been demanded by markets, customers, and managements after the financial crisis, even in the absence of new regulation. Some studies take the approach of assuming all the increases in safety margins are due to regulatory changes, exaggerating the cost of reforms.
A simple model is used to estimate the increase in lending rates required to accommodate the various reforms. The model assumes credit providers need to charge for the combination of: the cost of allocated capital; the cost of other funding; credit losses; administrative costs, and certain miscellaneous factors. The study establishes initial values for these key variables, determines how they would change under regulatory reform, and evaluates the changes in credit pricing and other variables needed to rebalance the equation. Cost estimates are provided for capital and liquidity requirements, derivatives reforms, and the effects of higher taxes and fees. These categories were chosen after a detailed qualitative assessment of the relative impact of different reforms on credit costs.
Securitization reform was initially chosen as well, but proved impossible to quantify. Finally, an overall, integrated cost estimate is developed. This involves examining the interactions between these categories and including the effects of mitigating actions likely to be taken by the financial institutions as a result of the reforms in totality. This includes, for example, the room for expense cuts to counteract the need for price increases, to the extent that such cuts were not already included in stand-alone impact estimates.
Lending rates in the base case rise by 18 bps in Europe, 8 bps in Japan, and 28 bps in the United States, in the long run. There is considerable uncertainty about the true cost levels, but a sensitivity analysis shows reasonable changes in assumptions do not alter the conclusions dramatically. The results are broadly in line with previous studies from the official sector, partially because similar methodologies are employed. This paper finds similar first-order effects to the official BIS assessments of Basel III (BCBS (2010) and MAG (2010)) and the analysis at the OECD by Slovik and Cournède (2010). The cost estimates here are, however, markedly lower than those of the IIF.
Three extensions of the methodologies from the official studies, though, lead to substantially lower net costs. The base case shows increases in lending rates of roughly a third to a half of those found in the BIS and OECD studies, despite important commonalities in the core modeling approaches with these studies. First, the baselines chosen here assume a greater hike in safety margins due to market forces, and therefore less of a regulatory effect, than the OECD and IIF studies. (The BIS studies do not reach firm conclusions on the additional capital needs). Industry actions through end-2010 suggest that market forces alone would have produced reactions similar to what was witnessed to that point, even if no regulatory changes were contemplated.
Second, this paper assumes that banks will also react by reducing costs and taking certain other measures that have little effect on credit prices and availability, in addition to the actions assumed in the other studies. The official studies do not do so and the IIF study assumes a fairly low level of change. This accounts for 13 bps of cost reduction in Europe, 10 bps in Japan, and 20 bps in the United States. Third, this paper assumes that equity investors will reduce their required rate of return on bank equity as a result of the safety improvements. Debt investors are assumed to follow suit, although to a much lesser extent. The official studies assume no benefit from investor reactions, for conservatism, and the IIF assumes the benefits, although real, will arise over a longer time-frame than is covered by their projections.
There are important limitations to the analysis presented here. Transition costs are not examined, a number of regulatory reforms are not modeled, judgment has been required in making many of the estimates, the overall modeling approach is relatively simple, and regulatory implementation is assumed to be appropriate, therefore not adding unnecessary costs. Despite these limitations, the results appear to be a balanced, albeit rough, assessment of the likely effects on credit. Further research would be useful to translate the credit impacts into effects on economic output.
Again, all of the analysis is based on the long-run outcome, not taking account of a transition being made in today’s troubled circumstances. To the extent that bank capital or liquidity is difficult or very expensive to raise during the transition period—as they are currently in Europe, a reduction in credit supply would be expected and any increase in lending rates would be magnified, perhaps substantially. Deleveraging is clearly occurring at European banks under today’s conditions in response to financial market, economic, regulatory, and political factors. It is impossible to tell whether any appreciable portion of this reaction is due to anticipation of the Basel III rules. Regardless of the transitional effects, it will be possible, over time, for banks to find the necessary capital and liquidity to provide credit, as long as the pricing is appropriate. Capital and liquidity will flow to banks from other sectors if the price of credit rises more than is justified by the fundamental underlying factors.
The relatively small effects found here strongly suggest that the benefits would indeed outweigh the costs of regulatory reforms in the long run. Banks have a great ability to adapt over time to the reforms without radical actions harming the wider economy.
Full text: http://www.imf.org/external/pubs/cat/longres.aspx?sk=40021.0
IMF Working Paper No. 12/233
http://www.imfbookstore.org/IMFORG/9781475510836
Summary: This study assesses the overall impact on credit of the financial regulatory reforms in Europe, Japan, and the United States. Long-term cost estimates are provided for Basel III capital and liquidity requirements, derivatives reforms, and higher taxes and fees. Overall, average lending rates in the base case would rise by 18 bps in Europe, 8 bps in Japan, and 28 bps in the United States. These results are similar to the official BIS assessments of Basel III and an OECD analysis, but lower as a result of including expense cuts and reductions in the returns required by investors. As a result, they are markedly lower than those of the IIF.
Executive Summary:
Reforming the regulation of financial institutions and markets is critically important and should provide large benefits to society. The recent financial crisis underlined the huge economic costs produced by recessions associated with severe financial crises. However, adding safety margins in the financial system comes at a price. Most notably, the substantially stronger capital and liquidity requirements created under the new Basel III accord have economic costs during the good years, analogous to insurance payments.
There is serious disagreement about how much the additional safety margins will cost. The Institute of International Finance (IIF), a group sponsored by the financial industry, estimated the proposed reforms will reduce economic output in the advanced economies by approximately 3 percent during 2011–15. Official estimates suggest a much smaller drag.
Finding an intellectually sound consensus on the costs of reform is critical. If the true price is too high, reforms must be reassessed to improve the cost-benefit ratio. But, if reforms are economically sound, they should be pursued to increase safety and reduce the uncertainty about rules that creates inefficiencies and makes long-term planning difficult.
This study assesses the overall impact on credit of the global financial regulatory initiatives in, Europe, Japan, and the United States. It focuses on the long-term outcomes, rather than transitional costs, and does not attempt to measure the economic benefits of reforms. Academic theory is combined with empirical analyses from industry and official sources, plus financial disclosures by the major financial firms, to reach specific cost estimates. The analysis here does not address the significant adjustments triggered by the financial and Eurozone crises and the potential transitional effects of adjusting to the new regulations.
The study focuses principally on the effects of regulatory changes on banks and their lending. This is for three reasons: banks dominate finance; the reforms are heavily focused on them; and it is harder to estimate the effects on other parts of the system, such as capital markets. Loans, in particular, are a major part of overall credit provision and there is substantially greater data available on lending activities. Where possible, the study also looks at the effects of new regulations on securities holdings by banks and on securities markets.
Measuring the cost of financial reform requires careful consideration of the baselines for comparisons. They should incorporate the higher safety margins that would have been demanded by markets, customers, and managements after the financial crisis, even in the absence of new regulation. Some studies take the approach of assuming all the increases in safety margins are due to regulatory changes, exaggerating the cost of reforms.
A simple model is used to estimate the increase in lending rates required to accommodate the various reforms. The model assumes credit providers need to charge for the combination of: the cost of allocated capital; the cost of other funding; credit losses; administrative costs, and certain miscellaneous factors. The study establishes initial values for these key variables, determines how they would change under regulatory reform, and evaluates the changes in credit pricing and other variables needed to rebalance the equation. Cost estimates are provided for capital and liquidity requirements, derivatives reforms, and the effects of higher taxes and fees. These categories were chosen after a detailed qualitative assessment of the relative impact of different reforms on credit costs.
Securitization reform was initially chosen as well, but proved impossible to quantify. Finally, an overall, integrated cost estimate is developed. This involves examining the interactions between these categories and including the effects of mitigating actions likely to be taken by the financial institutions as a result of the reforms in totality. This includes, for example, the room for expense cuts to counteract the need for price increases, to the extent that such cuts were not already included in stand-alone impact estimates.
Lending rates in the base case rise by 18 bps in Europe, 8 bps in Japan, and 28 bps in the United States, in the long run. There is considerable uncertainty about the true cost levels, but a sensitivity analysis shows reasonable changes in assumptions do not alter the conclusions dramatically. The results are broadly in line with previous studies from the official sector, partially because similar methodologies are employed. This paper finds similar first-order effects to the official BIS assessments of Basel III (BCBS (2010) and MAG (2010)) and the analysis at the OECD by Slovik and Cournède (2010). The cost estimates here are, however, markedly lower than those of the IIF.
Three extensions of the methodologies from the official studies, though, lead to substantially lower net costs. The base case shows increases in lending rates of roughly a third to a half of those found in the BIS and OECD studies, despite important commonalities in the core modeling approaches with these studies. First, the baselines chosen here assume a greater hike in safety margins due to market forces, and therefore less of a regulatory effect, than the OECD and IIF studies. (The BIS studies do not reach firm conclusions on the additional capital needs). Industry actions through end-2010 suggest that market forces alone would have produced reactions similar to what was witnessed to that point, even if no regulatory changes were contemplated.
Second, this paper assumes that banks will also react by reducing costs and taking certain other measures that have little effect on credit prices and availability, in addition to the actions assumed in the other studies. The official studies do not do so and the IIF study assumes a fairly low level of change. This accounts for 13 bps of cost reduction in Europe, 10 bps in Japan, and 20 bps in the United States. Third, this paper assumes that equity investors will reduce their required rate of return on bank equity as a result of the safety improvements. Debt investors are assumed to follow suit, although to a much lesser extent. The official studies assume no benefit from investor reactions, for conservatism, and the IIF assumes the benefits, although real, will arise over a longer time-frame than is covered by their projections.
There are important limitations to the analysis presented here. Transition costs are not examined, a number of regulatory reforms are not modeled, judgment has been required in making many of the estimates, the overall modeling approach is relatively simple, and regulatory implementation is assumed to be appropriate, therefore not adding unnecessary costs. Despite these limitations, the results appear to be a balanced, albeit rough, assessment of the likely effects on credit. Further research would be useful to translate the credit impacts into effects on economic output.
Again, all of the analysis is based on the long-run outcome, not taking account of a transition being made in today’s troubled circumstances. To the extent that bank capital or liquidity is difficult or very expensive to raise during the transition period—as they are currently in Europe, a reduction in credit supply would be expected and any increase in lending rates would be magnified, perhaps substantially. Deleveraging is clearly occurring at European banks under today’s conditions in response to financial market, economic, regulatory, and political factors. It is impossible to tell whether any appreciable portion of this reaction is due to anticipation of the Basel III rules. Regardless of the transitional effects, it will be possible, over time, for banks to find the necessary capital and liquidity to provide credit, as long as the pricing is appropriate. Capital and liquidity will flow to banks from other sectors if the price of credit rises more than is justified by the fundamental underlying factors.
The relatively small effects found here strongly suggest that the benefits would indeed outweigh the costs of regulatory reforms in the long run. Banks have a great ability to adapt over time to the reforms without radical actions harming the wider economy.
Full text: http://www.imf.org/external/pubs/cat/longres.aspx?sk=40021.0
Dodd-Frank's 'Orderly Liquidation' Is Out of Order. By Scott Pruitt and Alan Wilson
Dodd-Frank's 'Orderly Liquidation' Is Out of Order. By Scott Pruitt and Alan Wilson
South Carolina, Oklahoma and Michigan join a federal lawsuit to uphold property rights and checks and balances.The Wall Street Journal, September 25, 2012, 7:14 p.m. ET
http://online.wsj.com/article/SB10000872396390444180004578016953529778498.html?mod=WSJ_Opinion_LEFTTopOpinion
'The tendency of the law must always be to narrow the field of uncertainty." Justice Oliver Wendell Holmes wrote that more than a century ago, but the sentiment runs all the way to our nation's roots. Under our Constitution, the rule of law provides the certainty and transparency necessary to protect individual liberty and support economic growth.
But the 2010 federal financial-reform law known as Dodd-Frank continues to undermine economic growth and the rule of law by injecting immense uncertainty into our economy. As law professor David Skeel demonstrated recently in these pages, the law's Title II gives the Treasury secretary and the Federal Deposit Insurance Corp. unprecedented authority to "liquidate" financial companies. This grants immense power to a handful of unelected federal bureaucrats, empowering them to pick winners and losers among a liquidated company's investors. This arrangement destroys rights long protected by bankruptcy law.
For that reason and others, the attorneys general of South Carolina, Oklahoma and Michigan last week joined a federal lawsuit challenging Dodd-Frank's unconstitutional "orderly liquidation" provisions. Dodd-Frank's elimination of investors' rights directly harms our states because state pension funds are partly invested in financial companies. We must raise these constitutional objections now because once a company is liquidated, it will be too late.
Title II eliminates all meaningful judicial review and due process. Once the Treasury secretary orders the liquidation of a financial company, the company has only 24 hours to convince a federal court to overturn that order. Unless the court somehow manages to decide the entire case in the company's favor before the clock expires, the government wins by default and can begin to liquidate the company even as appeals are pending. Dodd-Frank further limits the authority of the courts by prohibiting them from reviewing whether the Treasury secretary's decision was constitutional, or whether the liquidation is actually necessary to protect financial stability.
The Treasury secretary's largely unaccountable decisions in these cases will put investments at risk, and creditors won't know until it is too late. Dodd-Frank prohibits the company from disclosing the liquidation threat before the district court decides the case. Once the liquidation goes forward, the creditors' only recourse will be to plead their case before the FDIC, with minimal judicial review—meaning that creditors' recoveries are "likely to be close to zero," as bankruptcy scholars Douglas Baird and Edward Morrison have put it.
Even more disturbing is the possibility that a company might agree to be "liquidated" and rebuilt under a new banner—like "New Chrysler" replacing "Old Chrysler"—leaving its creditors no right to block the reorganization. Instead, creditors not favored by federal bureaucrats will have little choice but to accept the deal offered to them by the government in a black-box process.
When the federal government replaced "Old Chrysler" with "New Chrysler" in 2009, it told one set of Chrysler's creditors (Indiana's state pension funds) to swallow $6 million in losses. Indiana attempted to defend its employees' pensions in court, but the government shuttered "Old Chrysler" before the Supreme Court could hear Indiana State Police Pension Trust v. Chrysler. Our states face the same threat because they have invested in the debt of financial companies that can be liquidated under Dodd-Frank.
We have taken an oath to uphold the rule of law and defend the Constitution. We are determined to uphold that oath, including defending the Constitution against the overarching power of the federal government.
Our lawsuit attempts to defend the very heart of our Constitution's structure: By committing such broad power to federal bureaucrats and nullifying critical checks and balances, Dodd-Frank's "orderly liquidation" authority violates the Constitution's separation of powers, the Fifth Amendment's guarantee of due process, and the guarantee of "uniform" bankruptcy laws.
The president and Congress can easily repair these constitutional violations by amending Dodd-Frank, restoring the rights long protected by federal bankruptcy law and reaffirming the Constitution's checks and balances. Until then, we will vigorously defend the rule of law through this litigation. The hard-earned pension contributions and tax payments of our citizens deserve nothing less.
Mr. Pruitt is attorney general of Oklahoma. Mr. Wilson is attorney general of South Carolina.
South Carolina, Oklahoma and Michigan join a federal lawsuit to uphold property rights and checks and balances.The Wall Street Journal, September 25, 2012, 7:14 p.m. ET
http://online.wsj.com/article/SB10000872396390444180004578016953529778498.html?mod=WSJ_Opinion_LEFTTopOpinion
'The tendency of the law must always be to narrow the field of uncertainty." Justice Oliver Wendell Holmes wrote that more than a century ago, but the sentiment runs all the way to our nation's roots. Under our Constitution, the rule of law provides the certainty and transparency necessary to protect individual liberty and support economic growth.
But the 2010 federal financial-reform law known as Dodd-Frank continues to undermine economic growth and the rule of law by injecting immense uncertainty into our economy. As law professor David Skeel demonstrated recently in these pages, the law's Title II gives the Treasury secretary and the Federal Deposit Insurance Corp. unprecedented authority to "liquidate" financial companies. This grants immense power to a handful of unelected federal bureaucrats, empowering them to pick winners and losers among a liquidated company's investors. This arrangement destroys rights long protected by bankruptcy law.
For that reason and others, the attorneys general of South Carolina, Oklahoma and Michigan last week joined a federal lawsuit challenging Dodd-Frank's unconstitutional "orderly liquidation" provisions. Dodd-Frank's elimination of investors' rights directly harms our states because state pension funds are partly invested in financial companies. We must raise these constitutional objections now because once a company is liquidated, it will be too late.
Title II eliminates all meaningful judicial review and due process. Once the Treasury secretary orders the liquidation of a financial company, the company has only 24 hours to convince a federal court to overturn that order. Unless the court somehow manages to decide the entire case in the company's favor before the clock expires, the government wins by default and can begin to liquidate the company even as appeals are pending. Dodd-Frank further limits the authority of the courts by prohibiting them from reviewing whether the Treasury secretary's decision was constitutional, or whether the liquidation is actually necessary to protect financial stability.
The Treasury secretary's largely unaccountable decisions in these cases will put investments at risk, and creditors won't know until it is too late. Dodd-Frank prohibits the company from disclosing the liquidation threat before the district court decides the case. Once the liquidation goes forward, the creditors' only recourse will be to plead their case before the FDIC, with minimal judicial review—meaning that creditors' recoveries are "likely to be close to zero," as bankruptcy scholars Douglas Baird and Edward Morrison have put it.
Even more disturbing is the possibility that a company might agree to be "liquidated" and rebuilt under a new banner—like "New Chrysler" replacing "Old Chrysler"—leaving its creditors no right to block the reorganization. Instead, creditors not favored by federal bureaucrats will have little choice but to accept the deal offered to them by the government in a black-box process.
When the federal government replaced "Old Chrysler" with "New Chrysler" in 2009, it told one set of Chrysler's creditors (Indiana's state pension funds) to swallow $6 million in losses. Indiana attempted to defend its employees' pensions in court, but the government shuttered "Old Chrysler" before the Supreme Court could hear Indiana State Police Pension Trust v. Chrysler. Our states face the same threat because they have invested in the debt of financial companies that can be liquidated under Dodd-Frank.
We have taken an oath to uphold the rule of law and defend the Constitution. We are determined to uphold that oath, including defending the Constitution against the overarching power of the federal government.
Our lawsuit attempts to defend the very heart of our Constitution's structure: By committing such broad power to federal bureaucrats and nullifying critical checks and balances, Dodd-Frank's "orderly liquidation" authority violates the Constitution's separation of powers, the Fifth Amendment's guarantee of due process, and the guarantee of "uniform" bankruptcy laws.
The president and Congress can easily repair these constitutional violations by amending Dodd-Frank, restoring the rights long protected by federal bankruptcy law and reaffirming the Constitution's checks and balances. Until then, we will vigorously defend the rule of law through this litigation. The hard-earned pension contributions and tax payments of our citizens deserve nothing less.
Mr. Pruitt is attorney general of Oklahoma. Mr. Wilson is attorney general of South Carolina.
Monday, September 24, 2012
Benchmarking Financial Systems with a New Database - by Martin Cihak, Asli Demirgüç-Kunt, and Erik Feyen
Benchmarking Financial Systems with a New Database
By Martin Cihak, co-authors: Asli Demirgüç-Kunt, Erik Feyen
Mon, Sep 24, 2012 4:23pm
How do financial systems around the world stack up? Which one has the highest number of bank accounts per capita? Where in the world do we find the lowest interest rate spreads, and where are they the highest? Which country has the most active stock market? Has competition among banks increased or decreased in recent years? Are financial institutions and financial markets in developed economies more or less stable than those in developing ones? Answers to these and many other interesting questions can be found in the Global Financial Development Database, accompanying the 2013 Global Financial Development Report. Both the database and the report were published earlier this month.
The Global Financial Development Database is the most comprehensive publicly available dataset on financial development. It contains over 70 financial system indicators for more than 200 economies on an annual basis from 1960 to 2010. All these indicators are categorized in four broad categories: (a) size of financial institutions and markets (financial depth), (b) degree to which individuals can and do use financial services (access), (c) efficiency of financial intermediaries and markets in intermediating resources and facilitating financial transactions (efficiency), and (d) stability of financial institutions and markets (stability). The selection of these indicators, their detailed definitions and links between the empirical data and the conceptual literature on financial development are discussed in an underlying working paper.
Considerable effort was involved in collecting, cleaning and checking this unique database, which builds upon and improves upon several existing data sources. One of the earlier efforts in this area was the Database on Financial Development and Structure, introduced in Beck, Demirgüç-Kunt, and Levine (2000), and subsequently updated several times. The Global Financial Development Database extends, updates and recalculates these country-by-country indicators, many of which are based on underlying data for individual institutions and markets. (For completeness, the Database on Financial Development and Structure has now been updated again, to be consistent with the more comprehensive Global Financial Development Database.)
In addition to the large electronic file with the Global Financial Development Database, there is also a smaller, pocket version of the dataset, published as the Little Data Book on Financial Development. The booklet shows a subset of indicators for the four categories of financial system characteristics (depth, access, efficiency, and stability) explored in the main database. The data are shown for individual countries as well as for country groups.
Complete text: http://blogs.worldbank.org/allaboutfinance/benchmarking-financial-systems-with-a-new-database
By Martin Cihak, co-authors: Asli Demirgüç-Kunt, Erik Feyen
Mon, Sep 24, 2012 4:23pm
How do financial systems around the world stack up? Which one has the highest number of bank accounts per capita? Where in the world do we find the lowest interest rate spreads, and where are they the highest? Which country has the most active stock market? Has competition among banks increased or decreased in recent years? Are financial institutions and financial markets in developed economies more or less stable than those in developing ones? Answers to these and many other interesting questions can be found in the Global Financial Development Database, accompanying the 2013 Global Financial Development Report. Both the database and the report were published earlier this month.
The Global Financial Development Database is the most comprehensive publicly available dataset on financial development. It contains over 70 financial system indicators for more than 200 economies on an annual basis from 1960 to 2010. All these indicators are categorized in four broad categories: (a) size of financial institutions and markets (financial depth), (b) degree to which individuals can and do use financial services (access), (c) efficiency of financial intermediaries and markets in intermediating resources and facilitating financial transactions (efficiency), and (d) stability of financial institutions and markets (stability). The selection of these indicators, their detailed definitions and links between the empirical data and the conceptual literature on financial development are discussed in an underlying working paper.
Considerable effort was involved in collecting, cleaning and checking this unique database, which builds upon and improves upon several existing data sources. One of the earlier efforts in this area was the Database on Financial Development and Structure, introduced in Beck, Demirgüç-Kunt, and Levine (2000), and subsequently updated several times. The Global Financial Development Database extends, updates and recalculates these country-by-country indicators, many of which are based on underlying data for individual institutions and markets. (For completeness, the Database on Financial Development and Structure has now been updated again, to be consistent with the more comprehensive Global Financial Development Database.)
In addition to the large electronic file with the Global Financial Development Database, there is also a smaller, pocket version of the dataset, published as the Little Data Book on Financial Development. The booklet shows a subset of indicators for the four categories of financial system characteristics (depth, access, efficiency, and stability) explored in the main database. The data are shown for individual countries as well as for country groups.
Complete text: http://blogs.worldbank.org/allaboutfinance/benchmarking-financial-systems-with-a-new-database
Wednesday, September 19, 2012
New Report Aims to Improve the Science Behind Regulatory Decision-Making
New Report Aims to Improve the Science Behind Regulatory Decision-Making
http://www.americanchemistry.com/Media/PressReleasesTranscripts/ACC-news-releases/New-Report-Aims-to-Improve-the-Science-Behind-Regulatory-Decision-Making.html
WASHINGTON, D.C. (September 18, 2012) – Scientists and policy experts from industry, government, and nonprofit sectors reached consensus on ways to improve the rigor and transparency of regulatory decision-making in a report being released today. The Research Integrity Roundtable, a cross-sector working group convened and facilitated by The Keystone Center, an independent public policy organization, is releasing the new report to improve the scientific analysis and independent expert reviews which underpin many important regulatory decisions. The report, Model Practices and Procedures for Improving the Use of Science in Regulatory Decision-Making, builds on the work of the Bipartisan Policy Center (BPC) in its 2009 report Science for Policy Project: Improving the Use of Science in Regulatory Policy.
"Americans need to have confidence in a U.S. regulatory system that encourages rational, science-based decision-making," said Mike Walls, Vice President of Regulatory and Technical Affairs for the American Chemistry Council (ACC), one of the sponsors of the Keystone Roundtable. "For this report, a broad spectrum of stakeholders came together to identify and help resolve some of the more troubling inconsistencies and roadblocks at the intersection of science and regulatory policy."
Controversies surrounding a regulatory decision often arise over the composition and transparency of scientific advisory panels and the scientific analysis used to support such decisions. The Roundtable's report is the product of 18 months of deliberations among experts from advocacy groups, professional associations and industry, as well as liaisons from several key Federal agencies. The report centers on two main public policy challenges that lead to controversy in the regulatory process: appointments of scientific experts, and the conduct of systematic scientific reviews.
The Roundtable's recommendations aim to improve the selection process for scientists on federal advisory panels and the scientific analysis used to draw conclusions that inform policy. The report seeks to maximize transparency and objectivity at every step in the regulatory decision-making process by informing the formation of scientific advisory committees and use of systematic reviews. The Roundtable's report offers specific recommendations for improving expert panel selection by better addressing potential conflicts of interest and bias. In addition, the report recommends ways to improve systematic reviews of scientific studies by outlining a step-by-step process, and by calling for clearer criteria to determine the relevance and credibility of studies.
"Conflicted experts and poor scientific assessments threaten the scientific integrity of agency decision making as well as the public's faith in agencies to protect their health and safety," said Francesca Grifo, Senior Scientist and Science Policy Fellow for the Union of Concerned Scientists. "Given the abundance of inflamed partisan dialogue around regulatory issues, it was refreshing to be a part of a rational and respectful roundtable. If adopted by agencies, the changes recommended in the report have the potential to reduce the ability of narrow interests to weaken regulations' power to protect the public good."
The Keystone Center and members of the Research Integrity Roundtable welcome additional conversations and dialogue on the matters explored in and recommendations presented in this report.
For more information, access the Roundtable's website at: www.Keystone.org/researchintegrity.
Friday, September 14, 2012
A European Deposit Insurance and Resolution Fund: An Update
A European Deposit Insurance and Resolution Fund: An Update. By Dirk Schoenmaker, Duisenberg School of Finance; VU University Amsterdam, and Daniel Gros, Centre for European Policy Studies, Brussels; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
Duisenberg School of Finance Policy Paper Series No. 26
September 12, 2012
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2052886
Abstract:
Cross-border banking is currently not stable in Europe. Cross-border banks need a European safety net. Moreover, a truly integrated European-level banking system may help to break the diabolical loop between the solvency of the domestic banking system and the fiscal standing of the national sovereign.
This policy paper first sketches the building blocks of a Banking Union. Importantly, a new European Deposit Insurance and Resolution Authority (EDIRA) should start simultaneously with the ECB assuming supervisory powers. A combination of European supervision and local resolution cannot work because it is not ‘incentive compatible’. Next, this paper proposes a transition period to gradually phase in the European deposit insurance coverage. Finally, we calculate that a European Deposit Insurance Fund would amount to about €30-50 billion for the 75 euro area banks that were subject to the EBA stress tests. This Fund could be created over a period of time through risk-based deposit insurance premiums levied on these banks. Once up and running, the Fund would then turn into a European Deposit Insurance and Resolution Fund to also deal with the resolution of one or more of these European banks.
Keywords: financial stability, banking, deposit insurance, resolution
JEL Classification: F36, F42, F51, G28
Duisenberg School of Finance Policy Paper Series No. 26
September 12, 2012
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2052886
Abstract:
Cross-border banking is currently not stable in Europe. Cross-border banks need a European safety net. Moreover, a truly integrated European-level banking system may help to break the diabolical loop between the solvency of the domestic banking system and the fiscal standing of the national sovereign.
This policy paper first sketches the building blocks of a Banking Union. Importantly, a new European Deposit Insurance and Resolution Authority (EDIRA) should start simultaneously with the ECB assuming supervisory powers. A combination of European supervision and local resolution cannot work because it is not ‘incentive compatible’. Next, this paper proposes a transition period to gradually phase in the European deposit insurance coverage. Finally, we calculate that a European Deposit Insurance Fund would amount to about €30-50 billion for the 75 euro area banks that were subject to the EBA stress tests. This Fund could be created over a period of time through risk-based deposit insurance premiums levied on these banks. Once up and running, the Fund would then turn into a European Deposit Insurance and Resolution Fund to also deal with the resolution of one or more of these European banks.
Keywords: financial stability, banking, deposit insurance, resolution
JEL Classification: F36, F42, F51, G28
Thursday, September 13, 2012
The Rough Road to Progress Against Alzheimer's Disease
The Rough Road to Progress Against Alzheimer's Disease
PhRMA
Sep 13, 2012
http://www.innovation.org/index.cfm/NewsCenter/Newsletters?NID=205
Two high-profile Alzheimer’s drug development failures were announced in recent weeks shining a spotlight on the challenges and frustrations inherent in Alzheimer’s research. Alzheimer’s disease is among the most devastating and costly illnesses we face and the need for new treatments will only become more acute as our population ages.
Understanding a disease and developing medicines to treat it is always a herculean task but Alzheimer’s brings particular challenges and long odds. A new report from the Pharmaceutical Research and Manufacturers of America (PhRMA), "Researching Alzheimer’s Medicines: Setbacks and Stepping Stones", examines the complexities of researching and treating Alzheimer’s and drug development success rates in recent years.
Since 1998, there have been 101 unsuccessful attempts to develop drugs to treat Alzheimer’s—or as some call them “failures,” according to the new analysis. In that time three new medicines have been approved to treat the symptoms of Alzheimer’s disease; however, for every research project that succeeded, 34 failed to yield a new medicine.
These “failures” may appear to be dead ends – a waste of time and resources – but to researchers they are both an inevitable and necessary part of making progress. These setbacks often contribute to eventual success by helping guide and redirect research on potential new drugs. In fact, the recent unsuccessful trials have provided a wealth of new information which researchers are now sifting through to inform their ongoing research.
Alzheimer’s disease is the sixth leading cause of death in the United States today, with 5.4 million people currently affected.[i] By 2050, the number of Americans with the disease is projected to reach 13.5 million at a cost of over $1.1 trillion unless new treatments to prevent, arrest or cure the disease are found.[ii] According to the Alzheimer’s Association a new medicine that delays the onset of the disease could change that trajectory and save $447 billion a year by 2050.
According to another new report, researchers are currently working on nearly 100 medicines in development for Alzheimer’s and other dementias. Although research is not a straight, predictable path, with continued dedication, we will make a difference for every person at risk of suffering from this terrible, debilitating disease.
[i]Alzheimer's Association, “Factsheet,” (March 2012), http://www.alz.org/documents_custom/2012_facts_figures_fact_sheet.pdf
[ii]Alzheimer's Association, 2012 Alzheimer's Disease Facts and Figures, Alzheimer's and Dementia, Volume 8, Issue 2
PhRMA
Sep 13, 2012
http://www.innovation.org/index.cfm/NewsCenter/Newsletters?NID=205
Two high-profile Alzheimer’s drug development failures were announced in recent weeks shining a spotlight on the challenges and frustrations inherent in Alzheimer’s research. Alzheimer’s disease is among the most devastating and costly illnesses we face and the need for new treatments will only become more acute as our population ages.
Understanding a disease and developing medicines to treat it is always a herculean task but Alzheimer’s brings particular challenges and long odds. A new report from the Pharmaceutical Research and Manufacturers of America (PhRMA), "Researching Alzheimer’s Medicines: Setbacks and Stepping Stones", examines the complexities of researching and treating Alzheimer’s and drug development success rates in recent years.
Since 1998, there have been 101 unsuccessful attempts to develop drugs to treat Alzheimer’s—or as some call them “failures,” according to the new analysis. In that time three new medicines have been approved to treat the symptoms of Alzheimer’s disease; however, for every research project that succeeded, 34 failed to yield a new medicine.
These “failures” may appear to be dead ends – a waste of time and resources – but to researchers they are both an inevitable and necessary part of making progress. These setbacks often contribute to eventual success by helping guide and redirect research on potential new drugs. In fact, the recent unsuccessful trials have provided a wealth of new information which researchers are now sifting through to inform their ongoing research.
Alzheimer’s disease is the sixth leading cause of death in the United States today, with 5.4 million people currently affected.[i] By 2050, the number of Americans with the disease is projected to reach 13.5 million at a cost of over $1.1 trillion unless new treatments to prevent, arrest or cure the disease are found.[ii] According to the Alzheimer’s Association a new medicine that delays the onset of the disease could change that trajectory and save $447 billion a year by 2050.
According to another new report, researchers are currently working on nearly 100 medicines in development for Alzheimer’s and other dementias. Although research is not a straight, predictable path, with continued dedication, we will make a difference for every person at risk of suffering from this terrible, debilitating disease.
[i]Alzheimer's Association, “Factsheet,” (March 2012), http://www.alz.org/documents_custom/2012_facts_figures_fact_sheet.pdf
[ii]Alzheimer's Association, 2012 Alzheimer's Disease Facts and Figures, Alzheimer's and Dementia, Volume 8, Issue 2
Wednesday, September 12, 2012
China's Solyndra Economy. By Patrick Chovanec
China's Solyndra Economy. By Patrick Chovanec
Government subsidies to green energy and high-speed rail have led to mounting losses and costly bailouts. This is not a road the U.S. should travel.WSJ, September 11, 2012, 7:21 p.m. ET
http://online.wsj.com/article/SB10000872396390443686004577634220147568022.html
On Aug. 3, the owner of Chengxing Solar Company leapt from the sixth floor of his office building in Jinhua, China. Li Fei killed himself after his company was unable to repay a $3 million bank loan it had guaranteed for another Chinese solar company that defaulted. One local financial newspaper called Li's suicide "a sign of the imminent collapse facing the Chinese photovoltaic industry" due to overcapacity and mounting debts.
President Barack Obama has held up China's investments in green energy and high-speed rail as examples of the kind of state-led industrial policy that America should be emulating. The real lesson is precisely the opposite. State subsidies have spawned dozens of Chinese Solyndras that are now on the verge of collapse.
Unveiled in 2010, Beijing's 12th Five-Year Plan identified solar and wind power and electric automobiles as "strategic emerging industries" that would receive substantial state support. Investors piled into the favored sectors, confident the government's backing would guarantee success. Barely two years later, all three industries are in dire straits.
This summer, the NYSE-listed LDK Solar, the world's second largest polysilicon solar wafer producer, defaulted on $95 billion owed to over 20 suppliers. The company lost $589 million in the fourth quarter of 2011 and another $185 million in the first quarter of 2012, and has shed nearly 10,000 jobs. The government in LDK's home province of Jiangxi scrambled to pledge $315 million in public bailout funds, terrified that any further defaults could pull down hundreds of local companies.
Chinese solar companies blame many of their woes on the antidumping tariffs recently imposed by the U.S. and Europe. The real problem, however, is rampant overinvestment driven largely by subsidies. Since 2010, the price of polysilicon wafers used to make solar cells has dropped 73%, according to Maxim Group, while the price of solar cells has fallen 68% and the price of solar modules 57%. At these prices, even low-cost Chinese producers are finding it impossible to break even.
Wind power is seeing similar overcapacity. China's top wind turbine manufacturers, Goldwind and Sinovel, saw their earnings plummet by 83% and 96% respectively in the first half of 2012, year-on-year. Domestic wind farm operators Huaneng and Datang saw profits plunge 63% and 76%, respectively, due to low capacity utilization. China's national electricity regulator, SERC, reported that 53% of the wind power generated in Inner Mongolia province in the first half of this year was wasted. One analyst told China Securities Journal that "40-50% of wind power projects are left idle," with many not even connected to the grid.
A few years ago, Shenzhen-based BYD (short for "Build Your Dreams") was a media darling that brought in Warren Buffett as an investor. It was going to make China the dominant player in electric automobiles. Despite gorging on green energy subsidies, BYD sold barely 8,000 hybrids and 400 fully electric cars last year, while hemorrhaging cash on an ill-fated solar venture. Company profits for the first half of 2012 plunged 94% year-on-year.
China's high-speed rail ambitions put the Ministry of Railways so deeply in debt that by the end of last year it was forced to halt all construction and ask Beijing for a $126 billion bailout. Central authorities agreed to give it $31.5 billion to pay its state-owned suppliers and avoid an outright default, and had to issue a blanket guarantee on its bonds to help it raise more. While a handful of high-traffic lines, such as the Shanghai-Beijing route, have some prospect of breaking even, Prof. Zhao Jian of Beijing Jiaotong University compared the rest of the network to "a 160-story luxury hotel where only 11 stories are used and the occupancy rate of those floors is below 50%."
China's Railway Ministry racked up $1.4 billion in losses for the first six months of this year, and an internal audit has uncovered dangerous defects due to lax construction on 12 new lines, which will have to be repaired at the cost of billions more. Minister Liu Zhijun, the architect of China's high-speed rail system, was fired in February 2011 and will soon be prosecuted on corruption charges that reportedly include embezzling some $120 million. One of his lieutenants, the deputy chief engineer, is alleged to have funneled $2.8 billion into an offshore bank account.
Many in Washington have developed a serious case of China-envy, seeing it as an exemplar of how to run an economy. In fact, Beijing's mandarins are no better at picking winners, and just as prone to blow money on boondoggles, as their Beltway counterparts.
In his State of the Union address earlier this year, President Obama declared, "I will not cede the wind or solar or battery industry to China . . . because we refuse to make the same commitment here." Given what's really happening in China, he may want to think again.
Mr. Chovanec is an associate professor of practice at Tsinghua University's School of Economics and Management in Beijing, China.
Government subsidies to green energy and high-speed rail have led to mounting losses and costly bailouts. This is not a road the U.S. should travel.WSJ, September 11, 2012, 7:21 p.m. ET
http://online.wsj.com/article/SB10000872396390443686004577634220147568022.html
On Aug. 3, the owner of Chengxing Solar Company leapt from the sixth floor of his office building in Jinhua, China. Li Fei killed himself after his company was unable to repay a $3 million bank loan it had guaranteed for another Chinese solar company that defaulted. One local financial newspaper called Li's suicide "a sign of the imminent collapse facing the Chinese photovoltaic industry" due to overcapacity and mounting debts.
President Barack Obama has held up China's investments in green energy and high-speed rail as examples of the kind of state-led industrial policy that America should be emulating. The real lesson is precisely the opposite. State subsidies have spawned dozens of Chinese Solyndras that are now on the verge of collapse.
Unveiled in 2010, Beijing's 12th Five-Year Plan identified solar and wind power and electric automobiles as "strategic emerging industries" that would receive substantial state support. Investors piled into the favored sectors, confident the government's backing would guarantee success. Barely two years later, all three industries are in dire straits.
This summer, the NYSE-listed LDK Solar, the world's second largest polysilicon solar wafer producer, defaulted on $95 billion owed to over 20 suppliers. The company lost $589 million in the fourth quarter of 2011 and another $185 million in the first quarter of 2012, and has shed nearly 10,000 jobs. The government in LDK's home province of Jiangxi scrambled to pledge $315 million in public bailout funds, terrified that any further defaults could pull down hundreds of local companies.
Chinese solar companies blame many of their woes on the antidumping tariffs recently imposed by the U.S. and Europe. The real problem, however, is rampant overinvestment driven largely by subsidies. Since 2010, the price of polysilicon wafers used to make solar cells has dropped 73%, according to Maxim Group, while the price of solar cells has fallen 68% and the price of solar modules 57%. At these prices, even low-cost Chinese producers are finding it impossible to break even.
Wind power is seeing similar overcapacity. China's top wind turbine manufacturers, Goldwind and Sinovel, saw their earnings plummet by 83% and 96% respectively in the first half of 2012, year-on-year. Domestic wind farm operators Huaneng and Datang saw profits plunge 63% and 76%, respectively, due to low capacity utilization. China's national electricity regulator, SERC, reported that 53% of the wind power generated in Inner Mongolia province in the first half of this year was wasted. One analyst told China Securities Journal that "40-50% of wind power projects are left idle," with many not even connected to the grid.
A few years ago, Shenzhen-based BYD (short for "Build Your Dreams") was a media darling that brought in Warren Buffett as an investor. It was going to make China the dominant player in electric automobiles. Despite gorging on green energy subsidies, BYD sold barely 8,000 hybrids and 400 fully electric cars last year, while hemorrhaging cash on an ill-fated solar venture. Company profits for the first half of 2012 plunged 94% year-on-year.
China's high-speed rail ambitions put the Ministry of Railways so deeply in debt that by the end of last year it was forced to halt all construction and ask Beijing for a $126 billion bailout. Central authorities agreed to give it $31.5 billion to pay its state-owned suppliers and avoid an outright default, and had to issue a blanket guarantee on its bonds to help it raise more. While a handful of high-traffic lines, such as the Shanghai-Beijing route, have some prospect of breaking even, Prof. Zhao Jian of Beijing Jiaotong University compared the rest of the network to "a 160-story luxury hotel where only 11 stories are used and the occupancy rate of those floors is below 50%."
China's Railway Ministry racked up $1.4 billion in losses for the first six months of this year, and an internal audit has uncovered dangerous defects due to lax construction on 12 new lines, which will have to be repaired at the cost of billions more. Minister Liu Zhijun, the architect of China's high-speed rail system, was fired in February 2011 and will soon be prosecuted on corruption charges that reportedly include embezzling some $120 million. One of his lieutenants, the deputy chief engineer, is alleged to have funneled $2.8 billion into an offshore bank account.
Many in Washington have developed a serious case of China-envy, seeing it as an exemplar of how to run an economy. In fact, Beijing's mandarins are no better at picking winners, and just as prone to blow money on boondoggles, as their Beltway counterparts.
In his State of the Union address earlier this year, President Obama declared, "I will not cede the wind or solar or battery industry to China . . . because we refuse to make the same commitment here." Given what's really happening in China, he may want to think again.
Mr. Chovanec is an associate professor of practice at Tsinghua University's School of Economics and Management in Beijing, China.
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