Saturday, December 24, 2011

Cochrane on European Debt Crisis

John Cochrane on Bloomberg 12/21/2011, "How Bad Ideas Worsen Europe's Debt Meltdown"

我不像 Cochrane 那麼確定市場可以承受的住義大利違約,不過我同意 Cochrane 這篇文章的觀點。

當問題來自於過多的債務,用更多的債來解決只是延後違約的日子,並沒有辦法真正解決原始的問題。ECB 把錢丟給銀行之後如果是建立起防火牆讓他們可以承受希臘等國違約的損失,不致於因為擠兌和缺乏流動性而倒閉,那麼這種作法是可行的,他們也同時必須準備好讓該違約的國家違約。如果這些銀行拿錢來買義大利的公債(目前的 10 年公債 YTM 又接近 7% 了,跟 ECB 貸款的利差有 6%),在大家「假設」義大利不會倒的情況下,這根本是套利。由於最近這筆貸款的抵押品標準很低,所以 ECB 幾乎是鼓勵這種作法。據說在這 489.19 bn 歐元的貸款裡,義大利銀行借的超過 100 bn 歐元,這些錢會去哪裡想也知道。

基於同樣的原理,我贊成 Fed 將利率維持在目前的低水準,不看到明顯通貨膨脹跡象不要輕易調高,但是 QE3 最好還是算了。QE2 的效果已經不彰,實在很難保證 QE3 會有什麼不同的結果。Fed 的資產負債表已經過度肥大,再這樣下去會無法收場。Bernanke 從 Great Depression 學到了教訓,不重蹈在這種時候緊縮貨幣政策的覆轍,但是接下來的收場應該在他的研究範圍之外了。也許下一任 Fed Chair 應該要讓 Paul Volcker 回鍋?

11 comments:

Ben said...

A quick note on what I recently read about certain new Italian debt posted to ECB under LTRO. Apparently Italian banks borrowed $40 billion from themselves, had the loans guaranteed by the Italian government, and then pledged the loans to ECB as collateral under LTRO. Don't have all the facts relating to this issue, and not 100% certain about the accuracy of this info. But could this be why Italian bonds are yielding over 7% again? Or perhaps it is just thin holiday trading volume at work?

And a tweet from Bill Gross of PIMCO a few days ago:

"What does #LTRO stand for? 1. A shell game; 2. Cash for trash; 3. Three-card “monti;” or 4. All of the above."

And the correct answer, IMHO, is 4) All of the Above.

Ben said...

Not sure if you have read this recent Op-Ed in WSJ. The author echos many of my concerns regarding Central Banking actions in the last 20+ years. Have we Americans, as a nation, become too spoiled and too afraid to fail?

Spitznegal was a student(?) of Nassim Taleb, I believe.

-----------------------------------

Christmas Trees and the Logic of Growth

The ubiquitous greenery of the season has me thinking conifers and stock market crashes. There is much to be learned from the coned evergreen trees that form vast forests across the Northern Hemisphere. As the oldest trees on the planet, the mighty conifers have survived threats of catastrophic extinction since the time of the hungry herbivorous dinosaurs.

The conifer's secret to longevity lies in a paradox: Their conquest has been largely the result of episodes of massive forest destruction. When virtually all else is gone, conifers show their strength and prowess as nature's opportunists. How? They have adapted to evade competitors by out-surviving them and then occupying their real estate after catastrophic fires.

First, the conifer takes root where no one else will go (think cold, short growing seasons and rocky, nutrient-poor soil). Here, they find the time, space and much-needed sunlight to thrive early on and build their defenses (such as height, canopy and thick bark). When fire hits, those hardy few conifers that survive can throw their seeds onto newly cleared, sunlit and nutrient-released space. For them, fire is not foe but friend. In fact, the seed-loaded cones of many conifers open only in extreme heat.

This is nature's model: overgrowth, followed by destruction of the overgrowth, and then the subsequent new growth of the healthiest and most robust, which ultimately leaves the forest and the entire ecosystem better off than they were before.

Pondering these trees, it is not too much of a stretch to consider the financial forests of our own making, where excess credit and malinvestment thrive for a time, only to be destroyed—and then the releasing of capital into markets where competition has been wiped out. The Austrian school economists understood this well, basing a whole theory around this investment cycle.

After the purge, great investment opportunities are created, from which prolific periods of growth emanate—provided that sufficient capital remains to reinvest into the fertile and now-open landscape.

Suppressing fire, creating the illusion of fire protection, leads to the wrong kind of growth, which then invites greater destruction. About 100 years ago, the U.S. Forest Service took a zero-tolerance approach to forest fires, stamping them out at the first blaze. Fast forward to 1988 when a massive wildfire at Yellowstone National Park wiped out more than 30 times the acreage of any previously recorded fire.

What obviously occurred was that the most fire-susceptible plants had been given repeated reprieves (bailouts, in a sense), and they naturally accumulated, along with the old, deadwood of the forests. This made for a highly flammable fuel load because when fires are suppressed the density of foliage is raised, particularly the most fire-prone foliage. The way this foliage connects the grid of the forest, as it were, has come to be known as the "Yellowstone Effect."

A far better way to prevent massively destructive fires is by letting the fires burn. Human intervention in nature's cycles by suppressing fires destroys the system's natural homeostatic forces.

To be continued below......

Ben said...

Continued from above.....


Strangely parallel to the Yellowstone catastrophe was the start of the federal government's other fire-suppression policy with the 1984 Continental Illinois "too big to fail" bank bailout. This was followed by Alan Greenspan's pronouncement immediately after the 1987 stock market crash that the Federal Reserve stood by with "readiness to serve as a source of liquidity to support the economy and financial system," which heralded the birth of the "Greenspan put." The Fed would no longer tolerate fires of any size.

From a forestry point of view, the lessons were learned. In 1995, the Federal Wildland Fire Management Policy stated, "Science has changed the way we think about wildland fire and the way we manage it. Wildland fire, as a critical natural process, must be reintroduced into the ecosystem."

Herein are pearls of great wisdom for central bankers today. Central banks are creating a tinderbox by keeping alive many very bad investments, fertilizing them with everything from artificially low interest rates to preferential liquidity to outright securities purchases. As these institutions and instruments overrun the financial landscape, they hamper the economic ecosystem and perpetuate the environment of low growth and high unemployment in which we currently find ourselves.

Seeing periodic, naturally occurring catastrophes as part of the growth cycle requires thinking more than one step ahead, not only longer term but, more specifically, intertemporally. This is perhaps an insurmountable cognitive challenge, both to investors and central bankers in today's news-flash world. When contemplating the forest, we may intuitively understand nature's logic of growth. Yet when we look at the seeds of destruction we have sown through current monetary policy, it is clear we are lost in the trees.

Mr. Spitznagel is the founder and chief investment officer of the hedge fund Universa Investments L.P., based in Santa Monica, Calif.

CCLu said...

Thanks, Ben,

This is a very interesting analogy. I haven't read it.

It reminds me an old philosophy question my former roommate asked me back in our Ph.D. student days. I don't recall the details well, it's something like this:

"A group of sailors sail a boat from port to port. They replace a part of the boat in each stop. Think of this boat like a Lego boat so you can replace anything you like. After a few years over the seas and numerous ports, they come back to where they started, only none of boat parts is original. Can we say the boat comes back? (my answer was yes) Suppose they do not only change the boat part but also a few sailors in each port. When they reach the original port, none of the original sailors is on board. Is this still the boat that left the same port a few years ago or it is a totally different thing? (I was not so sure about this)"

If we let AIG, Morgan Stanley, Goldman Sachs, Citigroup, Wachovia all fail in 2008, Merrill Lynch would go with them because BoA might stop the merger to protect itself. Only God knows if JPMorgan, Bank of America and Wells Fargo can still survive. We give all bankers a good lesson, but the whole financial system might be also wiped out. Eventually a new financial system will arise because the modern economy and old alike cannot work without one. How bad will it be before the new system re-established? I hope it does not cost the whole civilization, otherwise that healthy economy might has nothing to do with the one we live in.

I know it is a healthier way to let the forest burn, but that does not mean we give up all our control over the matter. Does that give the government a reason to intervene in some way?

I always think Bernanke, Paulson and Geithner took some bold actions in 2008. Maybe they were just as timid as I am. Doing nothing back then should be a bolder action.

CCLu said...

On another note, those Italian bankers and politicians should all burn in hell. They are as bad as Greeks, but they are also not far behind.

Ben said...

I guess we will never know what would have happened in 2008 if the government had not intervened aggressively. All investment banks probably would have failed, including Morgan Stanley and Goldman Sachs. Commercial banks are somewhat different because of FDIC insurance protecting depositors. The banking system most likely would have been effectively nationalized, at least on a temporary basis. Sheila Bair, The former FDIC Chairwoman, gave an exit interview to NYT on her account of the 2008 crisis. It is an interesting read from an insider who didn't see things the Bernake-Geitner-Paulson way.

http://www.nytimes.com/2011/07/10/magazine/sheila-bairs-exit-interview.html?pagewanted=all

Your philosophical question is interesting. Since I am a pragmatist, my answer would have been "who cares if the same boat and/or the same crew came back, as long as the mission was accomplished." And yes, I am a heartless selfish SOB:))

I spend most of my time thinking about what's going to happen next. Historical lessons are critical, but only in the context of their predictive power. And history, as you are fully aware, doesn't paint a bright a picture.

Below is a paragraph from a recent interview with Jeffery Gundlach of Doubleline Capital:

"The 2008 problem was a private economy problem and businesses – the business owners – do try, and are incentivised by laws and penalties, to tell the truth when they have earnings calls every quarter. The difference here is it is not company-based. This is a government-based problem and a public economy, public sector problem and the issue that’s so problematic is that the politicians won’t tell you the truth."

How do you say "we are screwed" in Italian?

(Full Disclosure: I invest in funds managed by Doubleline)

CCLu said...

To Ben,

Yeah, that boat thing is my verbose way to say "we can have a healthier economy if we let the banks fail, but will we be in that healthy economy?"

It's not a good idea to sacrifice the future for now, I'm also not sacrifice now to an extreme for the future.

The problem for government intervene is it does not usually represent the best interest of people. Potential conflict of interests aside, sometimes people are just not smart enough to see through things. AIG was bailed out because it was considered as a liquidity problem, it turns out not. I doubt if Paulson and company would do things differently because the economy probably can not handle the AIG bankruptcy after Lehman just filed in the morning. However, they might do things in a different way. When it is obvious that the government needs to say the N word, GS, MS and others should take a haircut for those CDS AIG wrote to ease the backlash from the Capitol Hill. I think that has a potential to be a game changer.

楊大寶 said...

To Ben:

I'm guessing the analogy of Forrest Service applies to Fed. However, I believe Fed deserve the least blame when comparing to other parties.

For example, had Glass-Steagall Act never been broken, we won't to see the disaster of hubris meets financial flexibility. All of the sudden, prestigious investment banks are no longer satisfied doing just corporate finance, they also want to do expand on broker-dealers, securitizations, financial engineering, quantitative trading and private-banking. Couple with the ability to leverage, you have a massive disaster.

Instead of Fed, I guess investment banks, greedy employees, docile investors and incompetent directors deserve much more blame. Basically IB shareholders receive very little after management&employees collect a huge share of profit. If shareholders have any guts they would have step up and elect competent and knowledgeable directors, instead of management's friends. Board of directors absolutely failed in terms of corporate oversight.

Also the regulatory parties, particularly SEC should deserve reprimand as well. SEC absolutely failed spotting fraud and misconducts in the first place. It is suing misconducts...after crisis happened. Officers lacked financial expertise and many of them can't wait to leave SEC and work in private sector, hoping the SEC experience gets them higher-paying jobs. Opportunistic law enforcers =
mediocre work.

Lastly, the rating agencies are quite responsible as well. It's already an oligopoly industry, with high barrier of entry, massive margin, but still failed to deliver quality work. Very disappointing.

Overall, with so many dysfunctional market participants, it is very unfair to assign blame on the Fed. Even with tighter monetary supply, I doubt it will make shareholder more active, directors more responsive, workers less greedy, SEC& rating agencies more competent.

Ben said...

To CCLu,

I see your points now. That philosophical question was way too deep for my simple mind.

We need to resolve the TBTF issue sooner rather than later, but I am afraid that nothing is going to happen till after the election, unless we have another major financial crisis before then.

The funny thing is that the bond market is behaving as if we were already in an recession, but the stock market is trading business as usual. We will find out soon enough which market is right.

To Mr. Yang,

I believe the Yellowstone analogy applied to all government branches including the executive office, the congress, SEC, justice department, treasury, FED(technically FED is a private corporation but that's just a nomenclature), etc. I agree 100% that there are plenty of blames to go around in regard to the 2008 financial crisis. But, at the end of the day, it was just old fashion greed that inflated the housing bubble, as it had happened countless times before in human history. What made the 2008 crisis different was that it almost brought down the entire world financial system. This was not supposed to happen, especially after Bernake delivered his Great Moderation speech back in 2004.

http://www.federalreserve.gov/boarddocs/speeches/2004/20040220/default.htm

I am not in the business of assigning blames. I can't change the past, and I have little to no power to change the future. All I know is that the financial machine is broken and requires a serious overhaul, but all that the politicians and "technocrats" can do now are to make a few minor adjustments, say an "Hail Mary" and hope things would work out at the end. Perhaps miracles indeed do happen and we will all be fine again in a couple of years, but would you bet your entire financial system on it? Not me.

As for the rating agencies, they certainly played an important supporting role in the 2008 crisis. But I have little sympathy for the professional fund managers who bought securities simply because they were AAA rated. These guys deserved to lose their shirt. As for the retail investors, I feel their pain but don't really know what can be done to remedy the situation...it is, unfortunately, the ugly side of capitalism.

CCLu said...

To 楊大寶

What we are discussing here is mostly about the strategy moving forward, not a blaming game.

Yes, we did talk about the past, but it is also about what we can learn from the past events.

I was looking for a figure on this blog for a new post last night(it'
s not done yet), and I found some old posts of mine are seriously flawed, or naive if given some slack. I don't claim to be the smartest guy in the room, so these mistakes are expected. Smarter guys can also make mistakes too. I remember Bernanke once said it is not Fed's job to contain asset bubbles. I doubt he would say the same thing right now. If he still thinks so, he will think otherwise a few years later. I didn't believe the debt problem would be like a runaway horse as it is now, how wrong I was.

We've all learned something from the past few years that a lot of economists cannot learn in their whole life time. This is why I started writing this blog and semi-abandoned my old baseball blog. The financial world is much more interesting than it was in the past. It may not be so interesting for investors, but it certainly is for researchers.

BTW, Glass-Steagall Act was too out of date. It was necessary to get rid of it. When those British and even Germany banks are throwing their weights around in the international financial markets, we can't blame the politicians teamed up with bankers to make banks bigger. This is the reason I don't like "Inside Job", it hides some important facts behind the footage of real interviews. It was necessary to get rid of Glass-Steagall Act. The problem is we didn't learn what we need to regulate and how to regulate them fast enough. There were discussion about regulating derivatives, but the proposals were immature and not political savvy enough to get supports from the financial industry. All those unfortunate events added up to where we are.

It is human nature to be greedy. We read on newspapers that there are selfless people helping others without any return. That is true, but it also rare otherwise they won't make it to newspapers. We need to understand the world better. That is, we need to learn the derivatives better, we need to understand how people use these derivatives better, and we need to grasp human nature better.

The financial overhaul we are expecting to happen needs to learn from the past, so we have to study those bombs blowing up on our faces. It doesn't really matter "who" did things wrong. If it is not Alan Greenspan, it would be another Fed Chair. In a parallel world without Dick Fuld it would have another version of Fuld or Lehman Brothers in it.

楊大寶 said...

To CC,

I just dislike the fact many people(not Ben) just take cheap shots on Fed. I mean where is the love? In my opinion, Fed took bold and gutsy actions to do what it needs to do, they have my full respect.

I need to learn more on Glass-Steagall Act. But I really think the root of the financial crisis is because investment banks get too big.

I personally respect some investment bankers. There are some boutique bankers really focus on client relationship and have their back, and offer unbiased opinion on M&A/reorganization/restructuring.

Unfortunately when banks gets bigger, they want to have it all. They want to securitize products, leverage and build up financial inventory, buying the products it design, it just gets too much. I have observed many kids from my school got into investment banks. Kids work in these banks are driven by fat bonus, which leads risk-seeking behavior. They don't care about the clients, they do excel and powerpoint all day, trying to get deals. It is just a bad combination to have these greedy kids and investment banks that have a lot of financial power. Absolute power corrupts absolutely, just like how Absolut Vodka makes you absolutely screwed up.

Indeed we all make mistakes, but your mistakes do not hurt anyone. Whereas when bankers made mistakes, these mistakes magnified and harm innocent bystanders.

I believe we should make the banks smaller, maybe not bring back Glass-Steagall but something that can reduce the systematic risk.