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Mark Carney and Ben Bernanke's Modest Proposals

by ARGeezer Mon Oct 28th, 2013 at 01:09:51 AM EST

The UK at the heart of a renewed globalisation

Mark Carney, Governor of the Bank of England gave a speech linked above at an event to celebrate the 125th anniversary of the Financial Times, London, 24 October 2013. Perry Mehrling posted that speech and a Bloomberg article (see below) about the Federal Reserve's proposal on his Money and Banking discussion forum, asking for discussion. My response is below:

   It seems like both the Fed and the BoE are planing to significantly increase capital reserves well ahead of current Basel III deadlines. This will put pressure on the EMU banks and on European national central banks that have been resisting such increases, as they are far below even the current US and UK reserve requirements. Paris and Berlin will likely complain, with some justification, that they have different systems and should not be held to the same requirements. What will Spain, Greece, Portugal, Italy and Ireland do and how can they comply? The periphery has trouble complying with the current requirements and the ECB is hamstrung by Germany when it comes to helping them and is not a true central bank to begin with. Nor is there a real EMU wide fiscal authority.

    Mark Carney of the BoE made by far the most significant and revealing claims. In effect, he proposes to make the BoE the dealer of last resort for banks and market makers operating in the UK, very much like what Perry Mehrling has proposed and described, in this case with unlimited support in British pounds and significant standing swap agreements with other foreign central banks for other major currencies, including soon the Chinese Renminbi. To me the clear implication is that such backstop would be provided to UK domiciled branches of foreign banks, perhaps via the BoE discount window, but it is hard enough to parse Fed statements, let alone BoE statements.

    To me the revealing part consisted of the following:

    "And in times of actual or prospective stressed conditions we stand ready to provide cheap, plentiful money through more frequent auctions."

    "Cheap, plentiful money" seems a large step beyond Bagehot's "Lend freely at a high rate against good collateral." It sounds like in times of stress there will be QE for the world. Of course the current overnight rate from the BoE is 0.5%, so the "cheap" money commitment seems more like forward guidance. To me this indicates that the BoE are still flummoxed at their inability to increase economic activity through the monetary policies available to the central bank, and, of course, they are saddled with the gratuitous 'austerity' program of the current Tory/LibDem Coalition. Given the dependence of the British economy on the financial sector the prospect of the global economy slipping into deflation must surely terrify the BoE, if not George Osborne. David Cameron might not know enough to be terrified.

    It will be interesting to see how the proposed policy for resolving failed international banks will develop. That has to be the most difficult part of all.  The other shoe to drop will be how the implicit extension of regulation by the BoE to non-Bank market makers unfolds. Will this require action by Parliament and will such action be forthcoming?

Criticisms and additional thoughts are appreciated.

Fed Liquidity Proposal Seen Trading Safety for Costlier Credit   Bloomberg

A proposal to make U.S. banks maintain 30-day war chests in case of a credit crisis is certain to add to borrowing costs, said a former leader of the global group that conceived of the standard. Stefan Walter, who was secretary general of the Basel Committee on Banking Supervision when it approved an initial version of yesterday's Federal Reserve proposal, said U.S. regulators have continued their tough interpretations of Basel III rules.

"The proposed rule would, for the first time in the United States, put in place a quantitative liquidity requirement that would foster a more resilient and safer financial system," Fed Chairman Ben Bernanke said before the vote.

"Nothing is free," said Walter, now a principal at Ernst & Young LLP, in an interview. "Buying more resilience in normal and good times means that liquidity will be priced-in more than before, and that will have a certain degree of impact on the cost of credit. That's the obvious trade-off."

I am of the impression that the Fed can impose its new rule after the 90 day period for comments. I don't know about the degree of freedom of the BoE. The Fed has already raised the capital reserve requirements for the largest banks to 6% as of June, 2013 and this goes quite a ways further. It will be interesting to see the response of Germany, France and the ECB.

From the Bloomberg article:

"This move by the U.S. highlights the different emphasis on either side of the Atlantic about the best way to underpin financial stability," Richard Reid, a research fellow for finance and regulation at the University of Dundee in Scotland, said in an e-mail. "It serves as a reminder that there are limits to regulatory convergence given the underlying differences in financial structure and economic circumstances."

I have to wonder if Carney's audience laughed as I did at comments in the second and third paragraphs of his speech. On the second page more serious issues arise:
Partly as a consequence, the size of the UK's financial sector relative to its economy has increased dramatically. When the FT was in its infancy, the assets of UK banks amounted to around 40% of GDP. By the end of last year, that ratio had risen tenfold.

As we have recently been painfully reminded, a specialisation in financial services carries risks as well as rewards. And those risks will grow, unless we put global banks and markets on a sounder footing. Suppose, for example, that UK-owned banks' share of global banking activity remains the same and that financial deepening in foreign economies increases in line with historical norms. By 2050, UK banks' assets could exceed nine times GDP, and that is to say nothing of the potentially rapid growth of foreign banking and shadow banking based in London.

An island that tries to finance the world? My concern for the British people is that the British financial sector could suffer a collapse similar to that of Iceland or Cyprus in worst case circumstances.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Mon Oct 28th, 2013 at 01:26:49 AM EST
Bank of England's Mark Carney places a bet on big finance  FT  Martin Wolf

Wolf notes that Carney's bank is a new BoE but asks if it is a sensible one. And he questions the new liquidity rules, while noting that "a central bank can, in theory, create money in its own currency without limit. But he worries that, if it does so too generously, the banks will generate more maturity transformation, and this will making the banks and the economy more prone to panic. (Maturity transformation is borrowing short and lending long, which banks have been doing for well over a century. The problem comes when the Central Bank raises the rate, which it should only do very carefully in a crisis.) He notes that Bagehot thought BoE lending at a penalty rate would curb the danger, but worries that the lower the penalties, the more important the new regulations on liquidity management become. And they are unproven.

Wolf argues that scepticism is in order. Ringfencing of retail banking becomes even more important with this approach. I agree. Wolf is disturbed by continued reliance on risk weighted capital and finds a leverage ratio of 30 to one excessive. I agree. Wolf calls for far more equity. Again I agree.

Mr Carney's response is that the ability to "resolve" banks, by converting debt into equity, would solve the problem. I would note that it would have helped had the Fed and FDIC been able to do more of this in '08 and '09. Wolf notes that, while resolution might take taxpayers off the hook, it would not take the economy off the hook. After such a conversion in a crisis banks' ability to expand is limited and he believes that is what matters. But I would ask is that worse than the current system of zombie banks - even if they are healthy looking zombies? (How does one assess the health of a zombie and which witchdoctor do you trust?)

One of the problems of which I have complained is that at a comparable time after the Crash of '29 almost all bad debt had been written off. This time, due to our better understanding of the processes, we have been able to avoid writing off the bad debt. But this is what remains a depressant on the economy and makes the banks zombies, IMO.

The big danger is that the new regulations will be applied with the same 'light touch' as were the old regulations, while the scope of bank activity will be greatly expanded. But this might not happen until and unless the zombies are well and truly staked. So until then perhaps we should learn to appreciate the depressing effects of zombies! And when they are staked - watch out!

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Oct 29th, 2013 at 10:30:17 PM EST

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