Home » 2008 (Page 18)
Yearly Archives: 2008
Panic, Fear and Financial Crisis
full text is here:
The financial panic we have been living through has much in common with the great banking panics of the past: rumours of foundering financial giants, concerns about counterparties, the shepherding of cash and flight to the highest quality and most liquid credit instruments, the dumping of riskier assets regardless of price, international contagion and, above all, a heightened sense of the fragility of a weakened financial system. Yet this panic will pass, just like its predecessors.
Bank panics always have the same origin. “Every genuine business panic springs from the same root, which is rank speculation,” wrote one Victorian commentator. Thomas Tooke, the early 19th century merchant and author, ascribed the British crisis of 1793 to “a great and undue extension of the system of credit and paper circulation”. A year earlier, Thomas Jefferson, observing the first financial collapse in the independent United States, noted that “our paper bubble has burst”.
Bank panics invariably reveal the poor quality of lending that accompanied the preceding boom. Walter Bagehot, the greatest of 19th-century writers on finance, was aghast at the stupidity of the directors of the discount house Overend Gurney, whose failure in 1866 was the cause of the last run on a British bank before the ignominious demise of Northern Rock. “They ruined a firm almost inconceivably good by business so inexplicably bad that it could hardly be much worse if they had of set purpose tried to make it bad,” wrote Bagehot.
The behavioural characteristics of the panic are the obverse of those of the boom. Excessive confidence is replaced by extreme fearfulness and a nervous distrust takes the place of blind trust. During the panic, the buying frenzy of the boom gives way to panicky disposals.
Loss aversion becomes extreme during the panic. “The passion of fear,” declared The Times on the day of Overend’s collapse, “is even more powerful than that of hope. There are men who can resist the seductions of promised profits and high premiums, but when depositors think a stoppage is imminent each rushes to secure his deposit in time, caring little for the consequences. Not long ago men trusted everybody; it would seem now that they trust nobody. A great machinery is thrown out of gear.”
The machinery is thrown out of gear by the failure of what economists would call a systemically important financial institution, such as the Ayr Bank in June 1772, Pole Thornton & Co in December 1825, Overend Gurney in May 1866 (which The Times called “the greatest instrument of credit in the Kingdom”), Jay Cooke & Co in September 1873 and the downfall of the Bank of the United States in December 1930. Likewise, the bankruptcy filing of Lehman Brothers on September 15 triggered our current panic.
The main consequence of the panic is a wild scramble for liquidity. Money becomes scarce. This was even more pronounced when currencies were convertible into gold: in every panic, there was too little of the precious metal to go round. Interest rates rose and the securities prices collapsed. “The best mortgages cannot be converted into money without a sacrifice of 20 per cent, and undoubted business paper is selling in Wall Street at a discount of 3 per cent a month,” wrote the New Yorker Philip Hone during the panic of November 1837. Call money rates reached 100 per cent in October 1907.
Every panic is marked by a sense that the financial system is close to complete collapse. Never were such feelings more marked than during the panic that started in London in December 1825. “If the difficulties which existed in the money market had continued only eight-and-forty hours longer …” William Huskisson, the president of the Board of Trade, told the House of Commons, he sincerely believed “that the effect would have been to put a stop to all dealing between man and man, except by way of barter.” Or, as a director of the Bank of England put it during the midst of the crisis: “We must ask not who is gone, but who stands?”
Yet even in 1825 the authorities belatedly succeeded in quelling the panic in that incident by borrowing money from France and distributing a stash of old banknotes found in the vaults of the Old Lady. In the 20th century, the end of the panic tended to coincide with decisive government intervention: Roosevelt’s bank holiday of March 1933, the launching of the Bank of England’s “lifeboat” in December 1974 and the nationalisation of Japan’s Long-Term Credit Bank in October 1998, which was accompanied by a $500bn capital injection into the stricken banking system.
There is good cause for concern. Our modern credit system is more complex, more interconnected and more leveraged than in earlier times. On the other hand, the measures taken by the authorities to allay the crisis are far more extensive than on earlier occasions. Witness the wild scramble by governments around the world to guarantee bank debts, provide loans against dubious securities and inject capital into stricken financial firms.
It is important not to exaggerate the dangers. Dr Johnson dismissed the “general distrust and timidity” on display in 1772 as “little more than a panick terrour from which when they recover, many will wonder why they were frighted”. The current panic will pass as others have done beforehand. This does not mean the aftermath will be pleasant for the wider economy. Emergency measures may allay the panic but they cannot correct the credit excesses that are the root cause of the crisis.
The writer is a member of GMO’s Asset Allocation team
The Great Iceland Meltdown
Who knew? Who knew that Iceland was just a hedge fund with glaciers? Who knew?
If you’re looking for a single example of how the globalization of finance helped get us into this mess and how it will help get us out, you need look no further than British newspapers last week and their front-page articles about the number of British citizens, municipalities and universities — including Cambridge — that are in a tizzy today because they had savings parked in Icelandic banks, through online banking services like Icesave.co.uk.
…
When I went to the Icesave Web site to see what it was all about, the headline read: “Simple, transparent and consistently high-rate online savings accounts from Icesave.” But then, underneath in blue letters, I found the following note appended: “We are not currently processing any deposits or any withdrawal requests through our Icesave Internet accounts. We apologize for any inconvenience this may cause our customers.”
Any “inconvenience?” When you can’t withdraw savings from an online bank in Iceland, that is more than an inconvenience! That’s a reason for total panic.
……
In a flat world, money can easily seek out the highest returns, and when word got around about Iceland, deposits poured in from Britain — some $1.8 billion. Unfortunately, though, when global credit markets closed up, and the krona fell, “the Icelandic banks were unable to finance their debts, many of which were denominated in foreign currencies,” The Times reported. When depositors rushed to get their money out, the Icelandic banking system had too little reserves to cover withdrawals, so all three banks melted down and were nationalized.
It turns out that more than 120 British municipal governments, as well as universities, hospitals and charities had deposits stranded in blocked Icelandic bank accounts. Cambridge alone had about $20 million, while 15 British police forces — from towns like Kent, Surrey, Sussex and Lancashire — had roughly $170 million frozen in Iceland, The Telegraph reported. Even the bobbies were banking in Iceland!
…
Globalization giveth — it was this democratization of finance that helped to power the global growth that lifted so many in India, China and Brazil out of poverty in recent decades. Globalization now taketh away — it was this democratization of finance that enabled the U.S. to infect the rest of the world with its toxic mortgages. And now, we have to hope, that globalization will saveth.
Global Imbalances and the Future of China’s SWFs
China‘s foreign exchange reserves has been piling up fast and furious, now close to $2 trillion. To relieve the huge pressure for China‘s policy makers to seek higher return, and/or to diversify their portfolio holdings, Chinese government should eventually relax the foreign exchange controls, allowing free currency conversion and floating of its exchange rate.
The roots of huge foreign exchange reserves buildup goes back to China‘s rigid exchange rate regime. By ditching the fixed/managed exchange rate system and realizing free currency conversion, trade surplus will be held by Chinese enterprises and individuals. Instead of putting all money into government’s hands and let government agencies, like CIC, do the investment for us (potentially losing our money), individuals and firms should make their own decisions by investing through more sophisticated private institutions. Chinese central bank should only maintain a small amount of foreign exchange reserves, say below $500 billion, to fend off potential currency attacks in future time of crisis. The need for CIC to invest globally will gradually die out and private institutional managers, such as mutual funds or asset management firms, domestic or foreign, will become the dominant force in China. CIC most likely will evolve into one of the many big players in the field, the equivalent of PIMCO, for example.
I hope we are heading toward this direction, and it’s healthier than relying government to manage our money.
Land reform in China
China lets farmers trade land use rights
China has approved reform to enable 730m peasant farmers to trade their land use rights more freely and provide greater legal protection for existing landholders.
The Communist party will “construct a healthy market for the transfer of land contract rights . . . based on the principles of legality, free will and adequate compensation for the peasants,” wrote Chen Xiwen, director of the office of the central leading group on rural work, in a party magazine published on Thursday.
The first land use rights exchange was set up on Monday in the western city of Chengdu to allow farmers to sell or rent out the rights to use their land.
Qin Shikui, head of the state-owned Chengdu United Assets and Equity Exchange, which opened the exchange, said: “The peasants are very excited about this platform being set up. We have had lots of phone calls and people coming to our offices to find out more about the rules and hoping to transfer their land.”
Land has been owned by the state or by rural “collectives” since the the communist revolution in 1949 and cannot be bought or sold by individuals. Under current laws, peasant farmers have mostly been given 30-year land use contracts that allow them to farm plots allocated by local party officials but make it very difficult to sell those contracts or use their land as collateral for loans.
The decision to loosen the constraints on transfers of land use rights and allow exchange markets for trading land titles was made last weekend behind closed doors at a plenary session of the party’s central committee.
Before the meeting, senior officials, including Hu Jintao, the president, had hinted strongly that there would be a breakthrough on rural land reform but a communiqué issued on Sunday at the end of the meeting made only passing mention to perfecting the “land management system”.
Some observers said the omission signalled serious disagreement among China’s top rulers over how far the reform should go towards de facto privatisation of rural land.
Many policymakers have argued that allowing rural citizens to sell their land freely would result in a return to the pre-revolution days of feudal landlords and create a flood of landless poor into the cities.
Mr Chen’s article emphasised the delicate balance the party is trying to strike between its ideological roots and raising productivity in the countryside by encouraging concentration of land in larger, more efficient farms.
“We cannot change the collective ownership status of the land,” Mr Chen said. “We cannot change the land-use designation [from arable to commercial, residential or industrial] and we cannot damage the peasants’ land use contract rights.”
Hot Money into China Drops Sharply
BEIJING — Capital flows into China have slowed sharply and even reversed in recent months, according to official data that reflect how the financial crisis has disheartened investors and disrupted banks in this fast-growing nation.
The inflow shift is part of the dramatic turnaround in China's economic situation in the past few months. Earlier this year, China's currency was surging against the dollar, helping to draw tens of billions of investor dollars into the country. Policy makers fretted about whether the speculative inflows were large enough to destabilize the financial system.
Now, the Chinese currency, the yuan, has barely budged against the dollar for two months, leading many investors to unwind bets on its continued appreciation. The property market and export sector, key drivers of recent growth, seem to be deteriorating rapidly. Investors have noticed.
On Tuesday, China's central bank published figures showing its foreign-exchanges reserves — the world's largest — rising to $1.906 trillion at the end of September from $1.809 trillion at the end of June. But the pace of increases has slowed and the new funds seem to trail what trade and corporate investment are bringing into the country.
"I think it's pretty certain that we are seeing an outflow of capital at this stage," said Glenn Maguire, Asia economist for Société Générale in Hong Kong. However, he said, "what we are seeing is an unwinding of the hot money flows that occurred earlier in the year, rather than outright capital flight."
![[china's foreign exchange reserves]](https://s.wsj.net/public/resources/images/NA-AT169_RESERV_NS_20081014190015.gif)
The new figures suggest China saw very limited, if any, inflows of speculative capital — sometimes called "hot money" — in July and August. And analysts estimate that anywhere from $10 billion to $25 billion left the country in September, just as the financial crisis intensified.
China's banks remain flush with cash even amid the strains affecting other nations' financial systems. Few signs exist of a credit crunch. China's large trade surpluses — which hit a monthly record of $29.37 billion in September — continue to push large quantities of dollars into the financial system.
Officials say they are sanguine. "The impact of this crisis on China is limited and controllable. We are confident we can maintain the stability of China's financial markets." Chinese Premier Wen Jiabao said Tuesday in a telephone conversation with U.K. Prime Minister Gordon Brown, according to a statement by China's foreign ministry.
Part of the slowdown in reserve accumulation is likely due to the recent rally of the dollar. Since China's reserves are reported in dollars, the value of its nondollar holdings has been shrinking. But currency moves don't explain all of the changes, and there were unusual strains in China's markets in September.
"This outflow likely reflected foreign financial institutions attempting to repatriate capital and hoard dollar liquidity in the midst of the credit crisis," said Logan Wright of Stone & McCarthy Research Associates in Beijing.
Even if it has slowed, the continued increase in China's foreign-exchange reserves is welcome news for the U.S. at the moment. It indicates Chinese demand remains for the Treasury debt that is being used to finance efforts to rescue the financial system. While there has been grumbling within China about the low returns on that investment, many observers don't expect the reserves to be switched away from the U.S. on a large scale.
"China is losing a bit of money investing in U.S. Treasurys, given the dollar is depreciating in a long-term trend," Erh-fei Liu, Merrill Lynch's China chairman, said in Beijing. The alternative is worse, he said: "If China stops buying Treasurys, the U.S. will stop importing from China, and that'll hurt China demand and that'll be a loss-loss situation for both countries."
Bernanke on government actions
Krugman wins Nobel prize in economics
Mr. Krugman, born in 1953, and a professor at Princeton University in New Jersey and a columnist for The New York Times, formulated a new theory to answer questions about free trade, the Royal Swedish Academy of Sciences said.
"What are the effects of free trade and globalization? What are the driving forces behind worldwide urbanization? Paul Krugman has formulated a new theory to answer these questions," the academy said in its citation. "He has thereby integrated the previously disparate research fields of international trade and economic geography," it said.
Mr. Krugman was the lone winner of the 10 million kronor ($1.4 million) award, the latest in a string of American researchers to be honored. In 2007, Americans Leonid Hurwicz, Eric S. Maskin and Roger B. Myerson won the prize for laying the foundations of mechanism design theory.
Krugman: Last chance to avoid "Great Depression"
and his Bloomberg interview on the urgency of action this weekend to avoid disaster.
Quote: "The only thing people want to buy is treasury bills and a bottle of water…"