April 20 2009 2: Too Much Babylon

Ben Shahn Tenement Yard October 1935
Interior of tenant farmer home. Little Rock, Arkansas

Ilargi: So, buying any financials stocks tomorrow?

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Ilargi: The picture above made me think of the unforgettable Mr. Jacob Miller, here from the movie Rockers with his band Inner Circle. Dread-out.




Jacob Miller - TENEMENT YARD


Right-o !
Hear dem say .......ah ah ah!
Dreadlocks can’t live in a........tenement

Dreadlocks can’t live in a tenement yard
Dreadlocks can’t live in a tenement yard
Too much su-su su-su su-su, too much watchie watchie you
Too much su-su su-su su-su, too much watchie what you are
(repeat)

Dreadlocks can’t live in privacy
Anything him do, old nigga see
Too much watchie watchie watchie, too much su-su su-su su
Too much watchie watchie watchie, too much su-su su-su su

Dreadlocks can’t smoke him pipe in peace
Too much informers and too much fears
Too much watchie watchie watchie, too much su-su su-su su
Too much watchie watchie watchie, too much su-su su-su su

Dreadlocks can’t live in a tenement yard
Dreadlocks can’t live in a tenement yard
Can’t penetrate in a tenement yard
Can’t penetrate in a tenement yard

Dreadlocks can’t live in a tenement yard
Dreadlocks can’t live in a tenement yard
Too much su-su su-su su-su, too much watchie watch you
Too much su-su su-su su-su, too much watchie what you are

Dreadlocks can’t penetrate the red man
All him a do is sell Jah Jah land
Too much watchie watchie watchie, too much su-su su-su
Can’t penetrate in a tenement yard
Can’t penetrate in a tenement yard

Dreadlocks can’t lick him pipe in peace
Too much informers and too much beast
Too much watchie watchie watchie, too much su-su su-su su
Too much watchie watchie watchie, too much su-su su-su

Can’t I-ditate in a tenement yard
Can’t I-ditate in a tenement yard

Dreadlocks can’t lick him pipe in peace
Too much Babylon and too much laws
Too much....
Too much informer.....

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Banks Face $400 Billion More in Losses, JPMorgan Says

Banks are likely to realize about $400 billion more in losses on soured assets, requiring further injections of government capital, JPMorgan Chase & Co. said. Banks will need to set aside about $215 billion more in reserves against their holdings of $2.1 trillion of U.S. home loans that haven’t been packaged into securities, mortgage-bond analysts led by Matthew Jozoff in New York wrote in a report dated April 17. A surge in defaults on subprime mortgages that began in 2006 escalated a U.S. housing slump, leading to a global economic downturn. Banks worldwide have taken writedowns and losses of $920 billion so far, compared with $900 billion of capital raised, the analysts wrote.

“Given the amount of losses still to come, we believe the system will need more government capital,” the analysts wrote. “Healthier institutions may not need more and may try to raise capital from the private sector.” As of the fourth quarter, banks had set aside $85 billion in reserves for residential loans on their books under accounting rules that require allowances only for losses expected to be “realized in the next year or so,” according to the report. Losses from securities portfolios will slow because “they have already gone through large writedowns,” the analysts wrote. Losses worldwide at banks and others from toxic U.S. assets may reach $2.2 trillion, the International Monetary Fund said in a report Jan. 28, more than the $1.4 trillion it predicted in October. World growth will be 0.5 percent this year, the weakest postwar pace, the IMF said in a separate report that day.

The U.S. has pumped capital into banks through the $700 billion Troubled Asset Relief Program; the Treasury Department estimated last month that $134.5 billion of the TARP hadn’t yet been spent or committed. Obama administration officials signaled yesterday there may be no need to request more financial-rescue funds from Congress as several banks plan to return taxpayer money and others are pushed to tap private markets first. The remarks indicate the administration isn’t girding for a battle with lawmakers who have warned that a popular outcry against aiding Wall Street means approval of an expansion of the TARP would be a challenge.

White House chief of staff Rahm Emanuel said in an interview on ABC’s “This Week” program that while he hadn’t seen results of so-called stress tests on the 19 biggest banks, he believed “we won’t” have to get more money. Lawrence Summers, the National Economic Council director, said on NBC’S “Meet the Press” that “the first resort for more capital is going to the private markets,” by issuing new equity or swapping some liabilities into stock that dilutes other stakeholders. The stress tests are scheduled for release May 4, with the Federal Reserve and other regulators aiming to publish the methodology behind the assessments on April 24.

The exams aim to ensure that the 19 companies, including Citigroup Inc., Bank of America Corp., GMAC LLC and MetLife Inc., have enough capital to weather a deeper economic downturn. Since April 9, banks including New York-based Citigroup, Charlotte, North Carolina-based Bank of America, San Francisco- based Wells Fargo & Co. and New York-based JPMorgan have reported better-than-expected profits during the first quarter. Pretax, pre-provision earnings of an estimated $200 billion at the largest banks over the next two years will lessen their capital needs, according to the JPMorgan report.

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Big banks have a big credit problem

Banks are socking away funds for future loan losses at a record clip. But at the sickliest institutions, problem loans are rising even faster. On Monday, Bank of America became the latest big bank to report a stronger-than-expected quarterly profit, posting net income of $4.2 billion, or 44 cents a share. Analysts had expected a profit of just 4 cents a share. Like its rivals Citigroup, JPMorgan Chase and Wells Fargo, Charlotte-based BofA pointed to strong fixed-income trading results and a big rise in earnings from its mortgage business.

BofA managed to post the big profit even as it set aside more than $6 billion to cover future loan losses. The bank's loan loss reserve now stands at $30 billion -- double its year-ago level. BofA expects more borrowers will fall behind on payments or default on their loans as job losses deepen and the economy struggles through its worst recession in decades. "We understand that we continue to face extremely difficult challenges primarily from deteriorating credit quality driven by weakness in the economy and growing unemployment," CEO Ken Lewis said in a statement Monday morning.

Yet as much money as BofA is putting away, both it and Citi -- the two big banks that have received multiple infusions of federal aid over the past year -- are reporting sharp rises in problem loans, particularly on their big credit card portfolios. BofA posted a $1.8 billion loss in its global cards business in the latest quarter. These high credit costs could weigh on the banks' earnings for many quarters -- and perhaps even affect the regulatory stress tests whose results are due to be revealed in coming weeks. While BofA has doubled its loan loss reserve, nonperforming assets -- loans that are no longer producing income as borrowers fall behind on payments -- have more than tripled, reflecting the weakening economy and the acquisition of troubled Countrywide and Merrill Lynch.

As a result, BofA's loan loss reserve now covers just 121% of its nonperforming loans -- down from 203% a year ago. That means the bank has a thinning cushion just as the industry braces for rising losses on commercial and industrial loans, as well as continuing declines in residential real estate. Another bank with a thin cushion is Citi, which reported an unexpected $1.6 billion first-quarter profit Friday even as credit costs doubled from a year ago. Though Citi's loan loss reserve has jumped 78% from a year earlier, nonperforming assets have more than doubled over the same span. As a result, Citi's loan-loss coverage ratio has slipped to 121%, from 177% a year earlier.

In contrast, the stronger big banks -- JPMorgan, which posted a $2.1 billion first-quarter profit last Thursday, and Wells Fargo, which said earlier this month it expects to make $3 billion in the quarter -- have healthier coverage ratios, thanks to extensive reserve building. At JPMorgan, for instance, nonperforming assets have jumped to $11 billion from $4 billion in the span of a year. But the bank has been bulking up its reserves at a similar pace. As a result, JPMorgan's loss reserves at the end of the first quarter amounted to 241% of nonperforming assets -- double the coverage at Citi and BofA, although down from 271% a year ago. And Wells Fargo's reserve ratios have risen significantly over the past year, in large measure due to a $37 billion writedown of bad loans associated with its Dec. 31 acquisition of Charlotte-based lender Wachovia.

Wells' reserves were 255% of nonperforming assets at the end of the first quarter, according to estimates by analysts at Fox-Pitt Kelton, up from 134% a year earlier. (The bank has yet to report its full results for the first quarter.) While coverage ratios are far from the only indicator of a bank's health heading into a prolonged period of economic distress, they are likely to be one factor in the stress tests being conducted by federal regulators. The Federal Reserve and Treasury are expected to begin informing the 19 big banks taking the tests of their results in coming weeks. Those that with lower scores are expected to be forced to raise capital, though the terms and the timing aren't clear. Concerns about the health of the banking sector helped to send shares of most big banks down in midday trading Monday. Still, even BofA -- the biggest loser Monday with a 15% decline -- has experienced a stunning rally since the sector hit its recent low in early March. At their lows Monday, BofA shares had tripled off their March 6 floor.  

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Big Bank Profits Are Bogus! Massive Public Deception!
by Martin Weiss

A big bank CEO on a mission to deceive the public doesn’t have to tell outright lies. He can con people just as easily by using “perfectly legal” tricks, shams, and accounting ruses.

First, I’ll give you the big-picture facts. Then, I’ll show you how big U.S. banks are painting lipstick on some of the fattest pigs ever raised.

Six of America’s Largest Banks at Risk of Failure

As we have written here so often … as we documented in our recent white paper … as we showed in our presentation to the National Press Club … and as we explained again with new data in our follow-up press conference, the nation’s banking troubles are many times more severe than the authorities are admitting.

First, look at the megabanks: The authorities SAY that all of the 14 largest banks have earned a “passing” grade in their just-completed “stress tests.” But just six months ago, the authorities swore that, without a massive injection of taxpayer funds, those same banks would suffer a fatal meltdown.

Was the bad-debt disease magically cured? Did the economy miraculously turn around? Not quite. In fact, we have overwhelming evidence that the condition of the nation’s banks has deteriorated massively since then.

How can our trusted authorities be so blatantly deceptive and still keep their jobs? Perhaps you should ask Fed Chairman Ben Bernanke. Not long ago, for example, he declared that the total losses from the debt crisis would not exceed $100 billion, while conveying the hope that most of those losses could be soon written off. Also around that time, the International Monetary Fund (IMF) estimated the losses would be $1 trillion, with only a small percentage written off.

The IMF’s latest estimate: $4 trillion in losses, with only one-third of those written off so far. Bernanke’s error factor: He was 4,000 percent off the mark, in a world where 50 percent errors can be lethal.

Meanwhile, based on fourth quarter Fed data, we find that, among the nation’s megabanks, six are at risk of failure in our opinion (seven if you count Wachovia and Wells Fargo as separate institutions).

• JPMorgan Chase is the nation’s largest, with $1.7 trillion in assets in its primary banking unit. It’s massively exposed to defaults by its trading partners in derivatives — to the tune of 382 percent (almost four times) its risk-based capital. Plus, since it holds HALF of ALL the derivatives in the U.S. banking industry, JPMorgan is at ground zero in the debt crisis.

• Citibank is the nation’s third largest, with assets of $1.2 trillion in its main banking unit. Its total credit exposure to derivatives is a bit lower than Morgan’s, at 278 percent, but still extremely high. Plus, it has other troubles, especially the surging default rates in its sprawling global portfolio of credit cards and other consumer loans. (More on these in a moment.)
  
• Wells Fargo and Wachovia now make up the nation’s fourth largest bank with combined assets of $1.17 trillion. But in the fourth quarter, they still reported separately, which is illuminating: Even without Wachovia’s troubled assets, TheStreet.com Ratings has downgraded Wells Fargo to a D+. Wachovia, meanwhile, got a D. This tells you that Wells Fargo wasn’t exactly the best merger partner, unless you believe in some bizarre math wherein adding two negatives somehow gives you a positive result.
  
• SunTrust, with $185 billion in assets, is getting hit hard by the collapse in the commercial real estate. Its Financial Strength Rating is D+.
  
• HSBC Bank USA has massive credit exposure to derivatives that’s even greater than Morgan’s: 550 percent of risk-based capital. We’re not looking at its larger foreign operations. But the U.S. numbers are ugly enough, meriting a rating of D+.
  
• Goldman Sachs, which reported for the first time as a commercial bank in the fourth quarter, seems to be taking the biggest risks of all in derivatives. Its total credit exposure is 1,056 percent of capital. Bottom line: It debuts as a bank with a rating of D, on par with Wachovia.

Regional banks: Banking regulators have been largely mute regarding major regional banks. But several are also at risk of failure, including Compass Bank (Alabama), Fifth Third (Michigan), Huntington (Ohio), and E*Trade Bank (Virginia). Primary reason: Massive losses in commercial real estate loans.

Smaller banks: On its “Problem List,” the FDIC reports only 252 institutions with assets of $159 billion. In contrast, our list of at-risk institutions includes 1,816 banks and thrifts with $4.67 trillion in assets. That’s seven times the number of institutions and 29 times more assets at risk than the FDIC admits.

What Explains the Huge Gap Between Official Declarations and Our Analysis?

We all use essentially the same data. And conceptually, the analytical approach is also similar.

The primary difference is that the regulators have an agenda: Instead of protecting the people from bank failures, they’re trying harder than ever to protect failed banks from the people. Specifically …

• They have forever hidden the names of the banks on the FDIC’s “Problem List,” making it almost impossible for average consumers to get prior warnings of troubles.
  
• They have never disclosed their own official ratings of the banks — the CAMELS ratings — making it difficult for the public to find safe institutions they can trust.
  
• They have religiously underestimated — or understated — the depth and breadth of the debt crisis.
  
• And as I explained a moment ago, they have rigged their recent stress tests to give passing grades to all of the nation’s 14 largest banks, sending the false signal that even the most dangerous among them are somehow “safe.”

Legal Cover-Ups, Flim-Flam and Sham In the Big Bank’s “Glowing”First-Quarter Earnings Reports

Wall Street is aglow with the latest “better-than-expected” earnings reports by major banks. But take one look below the surface, and you’ll see three of the most egregious accounting gimmicks in recent history.

Gimmick #1. Toxic asset cover-up. In their infinite wisdom, global banking regulators have now agreed to let banks cover up their toxic assets by booking them at fluffy-high values, bearing little resemblance to actual market prices. Like magic, the bad assets are suddenly worth more, as hundreds of billions in losses are defined away.

Gimmick #2. Reserve flim-flam. Every quarter, banks are required to estimate their losses and decide how much to set aside in loss reserves. If they deliberately guess too much in one quarter and too little in the next, they can shove all their bad earnings into earlier P&Ls and make future P&Ls look rosy by comparison.

Gimmick #3. The great debt sham. Consider this scenario: A financially distressed real estate developer owes the bank $4 million. His revenues have plunged. He’s lost a fortune in his properties. And he’s on the brink of bankruptcy.

Therefore, in the secondary market, traders recognize that loans like his are worth, say, only half their face value, or about $2 million. So far, a very common situation, right?

But now imagine this: He walks into the bank one morning and claims that he really owes only $2 million. Why? Because, in theory, he says, he could buy back his own loan for that price, thereby reducing his debt in half.

In practice, of course, that’s a pipedream. If he actually had the cash to buy back his own loans on the market, then he wouldn’t be financially distressed in the first place. And if he weren’t financially distressed, his loans wouldn’t be selling on the market for half price.

The reality is that he can’t buy back his own debt and never will. And even if he could someday, he will still be on the hook for the full $4 million unless and until he files for bankruptcy and the bankruptcy judge decides otherwise.

That’s why the government would never let real estate developers — or hardly anyone else, for that matter — mark down the debts on their books and still stay in business. But guess what? The government lets banks do precisely that!

It’s the ultimate double standard: The banks get away with inflating their toxic assets. But at the same time, they’re allowed to mark to market their own debts, which happen to be trading at huge discounts on the open market precisely because of their toxic assets.

Accountants call it a “credit value adjustment.” I call it cheating.

Finding all of this hard to believe? Then consider …

How Citigroup Mobilized ALL THREE of These Gimmicks to Create One of the Greatest Accounting Shams of All Time in Its First-Quarter Earnings Report

I’m outraged. But I’m glad to see that someone besides us is speaking out:

• Meredith Whitney, one of the few no-nonsense analysts in the industry, says that the banks’ latest reports are, in essence, “a great whitewash.”
  
• Jack T. Ciesielski, publisher of an accounting advisory service, calls it “junk income.”
  
• And Saturday’s New York Times, picking up from their research, lays out precisely how Citigroup has transformed a massive loss into what appears to be a fat profit …

First, Citigroup deployed the Toxic Asset Cover-Up. By inflating the value of the bad assets on its books, it was able to beef up its after-tax profits by $413 million.

Second, Citigroup used the Reserve Flim-Flam gimmick: By (a) shoving most of its bad-debt losses into last year’s fourth quarter and (b) greatly understating its likely losses in the first quarter, the bank legally rigged its books to look like it had made major improvements. Even assuming no further deterioration in its loan portfolio, I estimate this gimmick alone bloated profits by at least another $1 billion.

Third, Citigroup went all out with the Great Debt Sham, marking down its own debt and creating an additional $2.7 billion in purely bogus profits from this maneuver alone.

So here’s Citigroup’s true math for the first quarter:



And all this despite the fact that Citigroup’s loan portfolios actually deteriorated further in the first quarter. Based on its Q1 2009 Quarterly Financial Data Supplement, we find that:

1. Net credit losses in Citi’s global credit card business surged from $1.67 billion at year-end 2008 to $1.94 billion by March 31. And compared to March 2008, they surged by a whopping 56 percent! (Page 9 of its data supplement.)
   
2. Foretelling future credit card losses, the delinquency rate (90+ days past due) on those credit cards jumped from 2.62 percent at year-end to 3.16 percent on March 31 (page 10).
   
3. Credit losses on consumer banking operations jumped from $3.442 billion on December 31 to $3.786 billion on March 31. And compared to the year-earlier period, they surged 66 percent (page 12).

By almost every measure, Citigroup’s first-quarter numbers are worse than they were just three months earlier and far worse than they were 12 months before.

My forecast: Citigroup’s effort last week to twist this into an “improvement” will go down in history as one of the greatest banking deceptions of all time.

But Citigroup is not the only one. Nearly all other major banks are suffering similar surges in their credit losses and delinquency rates. Nearly all are using at least one of the same gimmicks to bloat their first-quarter profits. And every single one is destined to see massive new losses, driving their shares to new lows and the banking system as a whole into a far more severe crisis.

Bottom line: Rather than the private-public partnership the government has called for to address the nation’s banking woes, we see little more than private-public collusion to hide the truth from the public, paper over the problems and, ultimately, sink the banks into an even deeper hole.

My Recommendations

In my book, The Ultimate Depression Survival Guide, I give you very detailed, step-by-step instructions on what to do immediately. Here’s a quick summary:

Step 1. Get away from risky stocks. Use the recent stock market rally as a selling opportunity — your second chance to get out of danger before it’s too late.

Step 2. Get out of sinking real estate. If there’s a temporary improvement in the market, grab it to sell the properties you’ve been wanting to sell all along.

Step 3. Raise as much cash as you possibly can — not only by selling stocks and real estate, but also by cutting expenses and selling other things you own.

Step 4. Make sure you keep your cash in one of the safe banks on the list we provide on the book’s resource page. Or better yet, follow my instructions on how to buy Treasury bills. They’re safer than any bank, with no limit on the Treasury’s direct guarantee.

Step 5. For assets you cannot sell, buy protection using exchange-traded funds that are designed to go UP when stocks fall. The more the market goes down, the more you make; and those profits can offset any losses you suffer in the stocks or real estate that you cannot sell.

Step 6. Later, get ready for the big bottom in nearly all markets. That’s when you should be able to lock in relatively safe interest rates of 10 percent or more for years to come … buy shares in our country’s best companies for pennies on the dollar … buy a dream home in a great location that’s practically being given away.

The book is now a Wall Street Journal bestseller. You can effectively get as many copies as you want for free, because you earn a $29.95 Weiss Research credit for each one you buy for yourself or others — either for a new service or a renewal. And I am donating 100 percent of my royalties to a national charity — the Campaign to End Child Homelessness.

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America close to the tipping point

Recently released IMF analysis (via Telegraph) indicates that federal debt/GDP ratios in excess of 60 percent tend to become deflationary black holes.

"The impact becomes negative for debt levels that exceed 60pc of GDP," said the Fund.

While no countries were named, this would raise questions about Japan, Germany, France, Italy and ultimately Britain and the US after their bank rescues.

The IMF said the US is at the epicentre of this crisis just as it was in the Depression, setting the two episodes apart from normal downturns. However, the risks are greater this time. "While the credit boom in the 1920s was largely spec­ific to the US, the boom during 2004-2007 was global, with increased leverage and risk-taking in advanced economies and many emerging economies. Levels of integration are now much higher than during the inter-war period, so US financial shocks have a larger impact," it said.

The IMF said the global financial system is still under acute stress, with output tumbling and inflation falling towards zero in key nations. "The risks of debt deflation have increased," it said.

Abrupt halts in capital flows can have "dire consequences" for emerging economies, it said. Eastern Europe has already suffered the effects, with a 17.6pc fall in industrial production in February. The region is highly vulnerable to the credit crunch since it owes more than 50pc of its GDP to Western banks.

The U.S. nominal GDP is about $14 trillion, the gross federal debt is $10 trillion, or 71 percent (the ratio is 46 percent if debt held by the public is used.  (I am not going to go into the issue of which number is “correct,” but the latter is most commonly used.)  Neither of these debt figures, both from fourth quarter 2008, include any of the multifarious bailout commitments.  Just adding a projected $2 trillion fiscal deficit for 2009 to the debt and assuming no growth in GDP takes the ratio using debt held by the public squarely to 60 percent.

Obama’s budget will tip America into a debt-deflationary downward spiral if the IMF is right.  No wonder the American public is slow to warm up to the stimulus plan—and why the public views the banking bailouts as throwing good money after bad.

The American people have a low opinion of government spending and contracting programs.  We read creditable stories about missing billions in Iraq and missing trillions throughout the federal budget.  We have seen how this administration has furthered Wall Street’s class warfare on the American people in its handling of the banking “bailout.”  President Obama looks more and more like a fiscal Manchurian candidate.

So, again, I propose a “middle way”:  let the objective be to take care of the American people, not to achieve some figment of “potential output.”  The Democrats may have good intentions, but they’re listening to the wrong economists, Keynesians who have been out of power for too long and who now are listening to a scribbler of 70 years ago (that they read in their halcyon graduate school days), a Keynes, most of them seem not to realize, who was preaching to an America that was the largest creditor nation in the world, not the greatest debtor.

Let the economists go yell at China, today’s great creditor nation.  China seems to be listening.

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Ilargi: A Bloomberg interview with Joe Stiglitz from a few days ago that is well worth watching and listening to.

Stiglitz: How Not to Fix the Financial System

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(Green) bamboo shoots?

Economists scouring the globe for highs of hope (or at least a slower rate of decline) have found a few green shoots in China. A smaller fall in the March import data. A faster y/y rise in industrial production in March than in February. Signs of life in the housing market. The (undeniably) large increase in bank lending.

I would feel a bit more comfortable, though, if China’s trade data wasn’t tracking the US trade quite so closely. China exports a bit more than the US and imports a bit less, but they are basically comparable in size. And, well, the y/y change in a rolling 3m sum of China’s exports doesn’t look much different that the y/y change in US exports; and the y/y change in China’s imports doesn’t look much different than the y/y change in US imports.

The green shoot from the March import data shows up in the chart – the pace of the y/y decline in China’s imports slowed in March. But the overall story from the trade data is still quite grim. Making judgments on the basis of a single indicator — especially a nominal indicator influenced by price swings - is always risky. But the trade data doesn’t suggest that China’s economy is in robust health.

The simplest explanation for the tight correlation between US and Chinese imports would be a fairly synchronized downturn in both the US and China. That would explain why both countries are importing substantially less – and both are experiencing larger falls in their imports than can be explained by the fall in commodity prices.

Other explanations are obviously possible: About ? of China’s imports are for re-export, so a large share of the fall in China’s imports is a reflection of the fall in China’s exports. And China may import more commodities than the US, and thus falling commodity prices (though there are limits here: the US imports a higher share of its oil than China does) may have a bigger impact on the data.

Both the “import-to-export” and “commodity price” effect would impact China’s imports from the US – but presumably they would have a smaller impact. And, well, if US exports to China are in any way a proxy for Chinese demand, Chinese demand turned down last summer, in July–

The US data ends in February – so it would miss any recent pickup in activity. But it, like the global data, hardly suggests robust Chinese demand growth. A comparison of the y/y change in US exports to China and US imports from China tells a similar story. The fall in US exports to China is actually larger than the fall in US imports from China – and US exports to China turned down before US imports from China headed south. I suspect that the slowdown in US exports to China reflects the broader slowdown in China’s economic growth brought about by the slumping equity market and the slump in private construction – a slowdown that clearly preceded the post-Lehman global crisis.

It is true, as the Economist notes, that US import growth hasn’t been driving Chinese growth for the past couple of years. But that doesn’t mean that exports weren’t driving Chinese growth. US domestic demand started to cool in late 2006 – and that, plus the RMB’s appreciation against the dollar, slowed the growth in US imports from China. Overall Chinese export growth though remained quite robust (see the first chart). China offset slower growth in its exports to the US with more exports to the emerging world – and the RMB’s weakness against the euro propelled strong growth in China’s exports to Europe too. The US, remember, isn’t China’s only market, or even its largest market.

The RMB didn’t depreciate against the dollar over the past six years. It did depreciate against many other currencies. It consequently shouldn’t be a total surprise that the growth in China’s exports to the US lagged China’s overall export growth. Exchange rates do matter.

The Economist continues to assert that exports mattered less to China’s growth than many think.

Maybe.

But the “net exports” unambiguously accounted for between 2 and 3% of China’s growth for most of the past four years. The fall in the imported content of Chinese exports over this period is a big reason for the increase in China’s trade surplus even as China’s commodity imports soared. And recent work by a Li Cui, Chang Shu and Xiaojing Su suggests that fast export growth also spurred a lot of investment. They find, in a paper published by the HKMA, that 10% real export growth produces a 2.5% increase in overall growth – more than can be explained by the direct impact of stronger external demand. During periods when real exports were growing by 20% (or more), their work implies that fast export growth would explain something like 5 percentage points of China’s growth.

Another of the Economist’s arguments – namely that the size of the fiscal stimulus has been unduly discounted — is more persuasive. Consider that a mea culpa, as I have argued that the large size of China’s announced stimulus overstated China’s true stimulus. China’s headline deficit of 3% of GDP just isn’t that impressive, and the swing in the government’s fiscal balance was far less than the announced size of the stimulus.

But it is now pretty clear that the shift in the government’s formal budget wasn’t the only mechanism for providing stimulus to the economy.

China’s banks are state owned. They were liquid, as lending had been curbed to try to keep China’s economy from overheating. And when told to lend more – whether to state firms looking to invest, state firms looking to stockpile commodities or local governments free to spend on ambitious infrastructure projects, they clearly did.

China’s state banks before the current crisis were a bit like the US Agencies before the August subprime crisis. At the peak of the housing boom, the Agencies’ ability to grow their portfolio was constrained (as a result of past accounting irregularities and the like). Their market share was falling. After the subprime crisis curbed private label securitization though, Washington lifted curbs on their activity, and they responded. Similarly, the state banks ability to lend was constrained by lending curbs and a rising reserve requirement at the peak of China’s boom. When the curbs on their lending were lifted, they responded, and in a big way.

The increase in their lending in the first quarter is staggering. The state banks are a far larger part of China’s financial system than the Agencies are in the US, so the expansion of their lending seems to have had a macro impact.

Wang Tao of UBS has produced a graph that shows that the increase in bank lending in the first quarter looks a lot like the increase in late 2002 and 2003. That blowout eventually led to an uptick in inflation, and then to a decision to curb the state banks’ lending growth.* The current blowout looks bigger.

As a result, y/y investment growth in China in q1 was around 30%. That is huge. It presumably reflects a huge rise in public not private investment.

It likely will have a future fiscal cost. The likely losses on these loans probably can be thought of an additional form of fiscal stimulus.

And if Cao Jianhai of the Chinese Academy of Social Science is right, China retains a lot of underlying vulnerabilities, not the least that home prices are over ten times urban income, and thus there is underlying downward pressure on property prices.

But a surge in lending that keeps Chinese demand up until the world recovers isn’t the worst outcome either. The world needs demand – and a lot of public investment, even money-losing investment, in China is one way to generate the needed demand.

China’s 2009 outlook then shapes up as a race between falling private investment (and shrinking exports) and rising public investment, with the trajectory of private consumption the wildcard. 2010 probably won’t be that different.

Moreover, the internal basis for China’s growth still looks imbalanced. The stimulus to public investment has been far stronger than the stimulus to private consumption. Stephen Green of Standard Chartered has this right; I second his call for another initiative to help boost consumption.

Bottom line: I would be a lot more comfortable saying China had turned the corner if there were stronger signs that China’s imports were starting to pick up, and there were stronger signs that the stimulus was starting to spill over into demand for the rest of the world’s goods.

The blowout in lending growth in 02, 03 and early 04 was accompanied by a strong rise in China’s imports. For now, though, China’s imports are shrinking faster than US imports.

Hopefully, that will change soon. A solid pickup in Chinese import demand would be a real green shoot.

* That decision combined with the decision to allow the RMB to depreciate along with the dollar to produce the big increase in China’s surplus. Until lending was curbed, imports were growing almost as fast as exports, and it was possible that the rise in Chinese inflation would have produced a real appreciation that would offset the real depreciation linked to the dollar’s fall.

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Chrysler Turned Down Government Loan Over Limits on Executive Pay

Top officials at Chrysler Financial turned away a $750 million government loan because executives didn't want to abide by new federal limits on pay, sources familiar with the matter say. The government had been offering the loan earlier this month as part of its efforts to prop up the ailing auto industry, including Chrysler, which is racing to avoid bankruptcy. Chrysler Financial is a vital lender to Chrysler dealerships and customers. In forgoing the loan, Chrysler Financial opted to use more expensive financing from private banks, adding to the burdens of the already fragile automaker and its financing company. Chrysler Financial denied in a statement that its executives had refused to accept new limits on their pay.

The company's decision comes amid a firestorm on Capitol Hill and elsewhere over the lavish pay of executives at companies being aided by government money. The uproar has made companies skittish about taking federal aid and hindered the Obama administration's effort to revive lending by replenishing the coffers of the nation's financial firms. The Treasury Department previously had loaned Chrysler Financial $1.5 billion, when less stringent requirements on executive compensation were in place for recipients of federal bailout money. Since that first loan was announced on January 16, the Obama administration and Congress have toughened the rules. During March, when it seemed that the first loan would run out, the Obama administration began working on a deal to lend the company another $750 million.

Quickly, most of the agreement fell into place. But on April 7, Treasury asked Chrysler Financial to have its top 25 executives sign waivers regarding their compensation, sources said. Those waivers would have barred the executives from suing the Treasury or Chrysler Financial over new pay restrictions. As part of the economic stimulus package, Congress approved new executive compensation limits, and the Treasury is currently working on clarifying what the firms must do to comply with these rules. Within a week, the company responded that some of the executives had refused to give their approval. By last week, Treasury had rescinded the loan offer, the sources said.

Chrysler Financial denied that executives balked at the pay limits and said it had met all the restrictions of its first loan from the government's Troubled Assets Relief Program, or TARP. "Executives have not been presented with any new demands with regard to executive compensation," the company said in a statement. "As a TARP recipient we remain in full compliance with current executive compensation requirements." A senior industry official with knowledge of the matter said Chrysler Financial turned down the new government loan because, with auto sales down in April, there has been even less need for financing, the industry official said. The official said that if sales picked up, Chrysler Financial may seek additional government aid, even if it means agreeing to executive compensation limits.

"If Chrysler Financial needs the cash to support Chrysler, they [the executives] are not going to put the auto company at risk," the senior industry official said. "These guys aren't going to blow up the car company for their personal reasons . . . they've done everything they can to support the automotive company." Chrysler Financial recently announced publicly that it no longer needs additional federal loans. Instead, the company said, it will rely on other sources of financing. "Chrysler Financial has determined that it has adequate private capital funding to cover the short-term needs of our dealers and customers and as such no additional TARP funding is necessary at this time," the company said in its statement.

But by forgoing the government loan, the company must borrow money from a group of private banks, including JP Morgan and Citigroup, sources said. That line of financing had been arranged in August, when the company was on the brink of bankruptcy, according to an industry official. The financing from the private banks comes at a higher borrowing cost for Chrysler Financial, a source said. Chrysler and Chrysler Financial are separate companies. But both are owned largely by Cerberus, the secretive private equity firm. Daimler owns a 20 percent stake in each

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GM to get $5 billion, Chrysler $500 million in Fed aid

General Motors Corp. will get up to $5 billion and Chrysler LLC $500 million in short-term aid, according to a 250-page government report obtained Monday by The Detroit News. The Detroit News reported Friday that GM would get about $5 billion and Chrysler $500 million, citing an Obama administration official, which prompted a denial from the White House. The short-term aid figures are disclosed in the report from the Treasury Department's Inspector General on the $700 billion Troubled Asset Relief Program. The report was obtained from a congressional source late Monday. The report also discloses that the Treasury Department has spent $24.8 billion of its projected $25 billion on its auto program, including $13.4 billion for GM, $4 billion for Chrysler, nearly $6 billion to support GMAC and $1.5 billion to aid Chrysler Financial. The report also says that the Obama administration initially plans to set aside $1.25 billion to pay for a warranty program that will guarantee the warranties of Chrysler or GM vehicles if either automaker files for bankruptcy protection.

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Why Rattner Must Resign As Car Tsar

In one of my previous columns “Steve Rattner Couldn’t Save NY Times, How Will He Save Auto Industry,” I found fault with Rattner and his efforts to take The New York Times private. I believed Rattner’s efforts to take the Times private should have disqualified him from an appointment with the Obama Administration; especially the key post of trying to stabilize the collapsing auto industry. The White House still insists that the Administration fully supports Rattner; that reminds me of Bush proclaiming backing for Don Rumsfeld when it was clear he should have been shown the door as defense seccretary. Here's why Rattner deserves the boot.

An even more egregious form of activity that what I previously covered has become public. Rattner, who has extensive ties to Bill and Hillary Clinton, has been identified in several published news reports as the Quadrangle Fund executive who paid $1.1 million to receive more than $100 million from New York State’s multi-billion dollar pension fund to manage. The manner in which the payments were made leaves no doubt that they were meant for “pay to play”, which is illegal in my opinion. Rattner knew that once Quadrangle had lined up the New York State Retirement Fund as a client, Quadrangle could approach other state pension funds and leverage the New York investments for more money to manage from other public employee pension funds.

In 2003 Rattner, the financial genius, via the Quadrangle Group, had invested $250 million to purchase a company GT Brands Holding which was the parent company of The GoodTimes movie brand. In 2004 at the time of the questioned payoffs David Loglisci was New York State Deputy Comptroller. Henry Morris, who was a registered advisor for Searle & Co., a Connecticut-based broker dealer and investment advisor, was a fund raiser for New York State Comptroller Alan Hevesi. Hevesi in October 2006 resigned after pleading guilty to a felony; he’d used an official chauffer for private errands.  Hevesi was New York State Comptroller at the time these “pay to play” transactions occurred. Loglisci and his brothers also made an independent movie, "Chooch," which is Italian slang for “Jackass.” Loglisci and his brothers needed money to market and distribute the film.

Circa October 2004 Rattner, met with Loglisci, a not common Italian name, about an investment by the New York State Retirement Fund in Quadrangle. Loglisci approved the investment. In December 2004 Morris met with Rattner and solicited a finder fee arrangement. Rattner approved the finder fee arrangement. Quadrangle GP Investors II, L.P. entered into a written agreement to pay Searle 1.1% of any amount invested by the New York State Retirement Fund with Quadrangle Capital Partners II Fund, L.P. (Quadrangle Fund). At this time Loglisci had arranged with one of his brothers to meet with Rattner concerning an investment in the film, "Hooch," that had been produced by Loglisci and his brothers. 

Rattner agreed for GT Brands LLC., a Quadrangle affiliate, for $88,841. After the "Chooch" DVD distribution had been agreed upon, Rattner notified Morris of the distribution agreement and the connection to Loglisci. Three weeks later Loglisci personally notified Rattner that the New York State Retirement Fund had invested $100 million with Quadrangle. Quadrangle paid Searle $1.125 million and Morris received 95% of that amount. It is important to note that Quadrangle GP Investors II, L.P.; Quadrangle Capital Partners II Fund, L.P. (Quadrangle Fund); and, GT Brands LLC were all controlled by Rattner.

Rattner, that investing genius, is definitely no Warren Buffett. GT Brands Holding filed for bankruptcy in 2005, two years after Rattner’s Quadrangle purchased it. Rattner appears to be an egomaniac at heart. The most important question was never asked: How much money did Rattner lose while investing $100 million for the New York State Retirement Fund? My estimate is $30 million; more if he invested in The New York Times. That would be a conflict of interest and a violation of the Securities Exchange Act of 1934. Rattner’s ascension to hedge fund prominence and car tsar in the Obama Administration proves that it is not what you know but whom you know.

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Ilargi: A little but critical article. Forget about infrastructure maintenance. Set your priorities now.

Britain has become brittle society, says think tank

Britain has become a "brittle" society where even the smallest effect on resources risks bringing the country to its knees, a think tank will warn next week. It also calls on local authorities to use online networks like Twitter and Facebook to communicate with and advise members of the public during crises. Demanding lifestyles are now reliant on an "outmoded and archaic" infrastructure that is vulnerable to any kind of shock, whether severe weather conditions, flooding, or international conflict, a Demos report will say.

The study, Resilient Nation, calls on individuals to become more self resilient and prepared for disasters or emergencies and less reliant on the state although it stops short of advising the public "stockpile" reserves. It highlights the chaos caused by recent attacks on the country's infrastructure such as the extensive flooding in 2007 and the heavy snowfall earlier this year, which paralysed London's transport system. Author Charlie Edwards, senior researcher at Demos, says: "We live in a brittle society rather than a broken one.
"Our complex modern social systems, our reliance on them and our inability to protect them are a growing concern for us all." He adds: "A single failure in a network can cascade across systems causing all manner of systems to fail."

The report says over 80 per cent of Britons live in urban areas relying on "dense networks" of public and private sector organisations to provide them with food, water, electricity, communications and transport. But it warns: "For much of the time this lifestyle poses us few challenges but it relies on an infrastructure that is outmoded and archaic, and which increasingly lacks the capacity to support our complicated lives." Around 85 per cent of the UK's critical infrastructure is in private hands, it adds, and the country will become increasingly reliant on imports, from areas of the world that are "less stable".

But the Government is still not learning lessons and the study highlights a case where a regional fire service headquarters was planned for a site on a flood plain and next to a railway line carrying radioactive materials. Mr Edwards calls for the public to be more reliant and plan ahead, such as having appropriate insurance if in a high risk area. His report will also suggest the four "Es" of community resilience of engaging with the public, educating them, empowering them and encouraging them to do more themselves.

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Erin Go Broke

“What,” asked my interlocutor, “is the worst-case outlook for the world economy?” It wasn’t until the next day that I came up with the right answer: America could turn Irish. What’s so bad about that? Well, the Irish government now predicts that this year G.D.P. will fall more than 10 percent from its peak, crossing the line that is sometimes used to distinguish between a recession and a depression. But there’s more to it than that: to satisfy nervous lenders, Ireland is being forced to raise taxes and slash government spending in the face of an economic slump — policies that will further deepen the slump.

And it’s that closing off of policy options that I’m afraid might happen to the rest of us. The slogan “Erin go bragh,” usually translated as “Ireland forever,” is traditionally used as a declaration of Irish identity. But it could also, I fear, be read as a prediction for the world economy. How did Ireland get into its current bind? By being just like us, only more so. Like its near-namesake Iceland, Ireland jumped with both feet into the brave new world of unsupervised global markets. Last year the Heritage Foundation declared Ireland the third freest economy in the world, behind only Hong Kong and Singapore.

One part of the Irish economy that became especially free was the banking sector, which used its freedom to finance a monstrous housing bubble. Ireland became in effect a cool, snake-free version of coastal Florida. Then the bubble burst. The collapse of construction sent the economy into a tailspin, while plunging home prices left many people owing more than their houses were worth. The result, as in the United States, has been a rising tide of defaults and heavy losses for the banks. And the troubles of the banks are largely responsible for putting the Irish government in a policy straitjacket.

On the eve of the crisis Ireland seemed to be in good shape, fiscally speaking, with a balanced budget and a low level of public debt. But the government’s revenue — which had become strongly dependent on the housing boom — collapsed along with the bubble. Even more important, the Irish government found itself having to take responsibility for the mistakes of private bankers. Last September Ireland moved to shore up confidence in its banks by offering a government guarantee on their liabilities — thereby putting taxpayers on the hook for potential losses of more than twice the country’s G.D.P., equivalent to $30 trillion for the United States.

The combination of deficits and exposure to bank losses raised doubts about Ireland’s long-run solvency, reflected in a rising risk premium on Irish debt and warnings about possible downgrades from ratings agencies. Hence the harsh new policies. Earlier this month the Irish government simultaneously announced a plan to purchase many of the banks’ bad assets — putting taxpayers even further on the hook — while raising taxes and cutting spending, to reassure lenders. Is Ireland’s government doing the right thing? As I read the debate among Irish experts, there’s widespread criticism of the bank plan, with many of the country’s leading economists calling for temporary nationalization instead. (Ireland has already nationalized one major bank.)

The arguments of these Irish economists are very similar to those of a number of American economists, myself included, about how to deal with our own banking mess. But there isn’t much disagreement about the need for fiscal austerity. As far as responding to the recession goes, Ireland appears to be really, truly without options, other than to hope for an export-led recovery if and when the rest of the world bounces back. So what does all this say about those of us who aren’t Irish? For now, the United States isn’t confined by an Irish-type fiscal straitjacket: the financial markets still consider U.S. government debt safer than anything else.

But we can’t assume that this will always be true. Unfortunately, we didn’t save for a rainy day: thanks to tax cuts and the war in Iraq, America came out of the “Bush boom” with a higher ratio of government debt to G.D.P. than it had going in. And if we push that ratio another 30 or 40 points higher — not out of the question if economic policy is mishandled over the next few years — we might start facing our own problems with the bond market. Not to put too fine a point on it, that’s one reason I’m so concerned about the Obama administration’s bank plan. If, as some of us fear, taxpayer funds end up providing windfalls to financial operators instead of fixing what needs to be fixed, we might not have the money to go back and do it right. And the lesson of Ireland is that you really, really don’t want to put yourself in a position where you have to punish your economy in order to save your banks.

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Ilargi: A segment of Max Keiser's interview on Aljazeera. The theme is hunger. There's not much time left to wrestle back control of our food from Monsanto and Goldman Sachs. The whole interview can be found at maxkeiser.com

Collateralized Commodity Obligations

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G8 admits losing battle against hunger

The Group of Eight leading nations called on Monday “for increasing public and private investment” in agriculture, but their communiqué after the first meeting on the subject acknowledged that efforts to tackle hunger were lagging. G8 agriculture ministers, meeting in northern Italy, said that the world was “very far from reaching” the United Nations’ goal of halving by 2015 the world’s proportion of malnourished people, after they reviewed what the called “alarming data” on hunger. Although officials have in private suggested that the so-called Millennium goal target was almost unachievable, this is the first admission of failure by leading countries. The communiqué, first reported by the Financial Times on Sunday, reiterated the G8’s determination to achieve its goal of “defeating hunger”. The United Nations’ Food and Agriculture Organisation told the G8 that the number of chronically hungry people is set to increase by 75-100m this year as result of persistently high food prices and the economic crisis, bringing the number of malnourished well above the one billion mark.

The communiqué outlined general principles such as opposition to trade protectionism, and support for investment in research. It also called for studies of the role of speculation and whether global stocks of grain could help to mitigate price volatility. But it lacked fresh proposals to tackle hunger. “Agriculture and food security are at the core of the international agenda,” the ministers said at the end of their three-day meeting, reflecting a consensus to reverse what officials called 25 years of decline. Hailing what he called ”a strong declaration of support for the critically important task of promoting food security,” Tom Vilsack, US secretary of agriculture, said: ”Supporting food security is not only our moral obligation... it is our responsibility. We took an important step toward building a consensus around issues affecting access, availability, and utilization of food among vulnerable populations.”

Delegates said that a summit of G8 leaders, due later this year in La Maddalena, could take further steps on food security and provide funding. But charities and some UN officials characterised the meeting as a lost opportunity to resolve the problem. Juergen Voegele, director of agriculture at the World Bank in Washington, said it shared the “impatience” to resolve the food crisis, but added that it was a good political sign that the G8 for the first time was discussing the problem. The gathering was prompted by last year’s spike in the price of agricultural commodities, from wheat to rice, which triggered riots in more than 30 countries, from Bangladesh to Haiti. The G8 ministers, who were joined by representatives of developing nations such as China, India, and key exporters of agricultural commodities, including Brazil and Argentina, acknowledged that the food situation has not improved markedly following last year’s crisis.

While agricultural commodities prices had fallen from last year’s record highs, they were “well above previous lows in many countries”. “The depth of the current economic recession means that the number of people who are poor and, consequently, hungry has increase since last year,” the statement said. “Structural factors may affect prices over the medium term, and increased volatility and demand raise important question about food security in the future.” On the thorny issue of a global grains stockpile, the communiqué reflected the lack of agreement postponing any decision to future studies. “We call upon the relevant international institutions to examine whether a system of stockholding could be effective in dealing with humanitarian emergencies or as a means to limit price volatility.” The communiqué also sidelined disagreements over biofuels, simply stating that production “should be increased in a sustainable manner through balances combination of the energy policies needs and agricultural production”. G8 ministers also vowed to reform the FAO, the main UN body dealing with agriculture and food.

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Remembering Eddie George
by WIllem Buiter

The death of Eddie George (Edward George, or Baron George of St. Tudy in the County of Cornwall, former Governor of the Bank of England) on April 19 came as a shock. I knew he had been ill with cancer for a long time, but one is never prepared for the finality of death. This post is not an attempt to assess his place in history, but just a recording of some tales I will remember him for. Eddie had been Governor of the Bank of England for just under four years when the Bank was made operationally independent for monetary policy in May -June 1997.  He served as Governor for six more years after that.  I got to know him because I was fortunate enough to be chosen by Gordon Brown and his advisers to serve as an external MPC member on the ‘founding’ MPC, which started work in June 1997.

The Governor and Winston Churchill
When I was interviewed for the MPC job on Friday, May 30, 1997 by Ed Balls and Alan Budd, I was told at the end of the interview that two issues still could present obstacles to my appointment.  The first was that I did not have British nationality. The second was a public disagreement with something the Governor (Eddie George) had said. The issue of prior public disagreement was indeed the first thing that came up during the interview. Budd and Balls also said that it did not matter per se, but that they just did not want to be surprised by it. I had publicly disagreed more than once with statements of the Governor, most recently at a Treasury seminar on EMU (the first time I had ever been inside the Treasury). There are various published versions of this around. The easiest place to find it is in “The Economic Case for Monetary Union in the European Union”, the Review of International Economics, Special Supplement, pp. 10-35, 1997. In it I fall all over a passage in a speech by Eddie George from 1995, in which he argues that real economic convergence (convergence of real economic performance and structure) is a prerequisite for successful monetary union. Similar silly and uninformed statements had been uttered widely, among others by Tony Blair. I comment on this as follows (p. 22): The fundamental misunderstanding, reflected in the above quote, of what nominal exchange rate flexibility can deliver prompts the following proposition: Proposition 6. Real convergence or divergence is irrelevant for monetary union.

I then go on for about half a page elaborating just how off the mark any contrary opinion would be. The first issue was a fact that remained a fact until after I had left the MPC in 2000.  I also was the undoubted author of the statement that created the second issue.  I went home thinking: nice to be considered; close but no cigar. I was therefore quite surprised to be called at home the next day (it was a Saturday), to be told that if I wanted the job, I could have it.  I thought about it for 1/4 second and said ‘yes’. The next Monday at 14.30, I met with the Governor in his palatial office at the Bank. All four outside members were announced at that same time (Charles Goodhart and I with immediate effect, DeAnne Julius from September 1, 1997 and Alan Budd on his retirement from the Treasury at the end of the year. The Governor was most gracious. I had decided to wear an Emmanuel College tie to mollify him (Eddie George is a member of Emma, as am I (and indeed Charlie Bean, the current Deputy Governor for Monetary Policy)). Eddie immediately reminded me not only of the article, but also of a lecture I had given (forgotten by me) in which I had said that he knew less economics than Winston Churchill (the statement referred to Churchill’s decision to put the UK back on the gold standard in 1925). Eddie chuckled and said he only mentioned it so that we could get it out of the way and get on with business. I replied that it could hardly be considered insulting to be compared to Winston Churchill. That was the end of the matter.

We continued to have opposite views on the desirability of the UK adopting the euro.  Like many of those who lived through Britain’s entry into the ERM on October 8, 1990 and its inglorious exit on Black Wednesday, 16 September 1992, Eddie viewed the third stage of EMU as another ERM experiment.  He was Deputy Governor at the time of the ERM entry and exit and would have rather swallowed a live whale than go through an ERM trauma again. It is true, regrettably, that the Maastricht convergence criteria include a 2-year stay in ERM2 purgatory, but once that pointless hurdle is cleared, full monetary union is qualitatively different from any fixed-but adjustable peg or target zone regime.  Speculative attacks against a national currency are no longer possible, for the simple reason that there is no longer a national currency separate from the euro. A second reason why I believe Eddie George and I differed on the desirability of full EMU participation for the UK is that he was quite convinced the UK still represented something close to an optimal currency area (OCA).  I viewed and view the UK as a small open economy - a price taker in global markets for goods, services and non-sterling financial instruments, which satisfies none of the traditional (Mundell I) or new (Mundell II) criteria for having an independent currency. Eddie viewed the UK as a small version of the USA.  I viewed it as a somewhat larger version of the Netherlands. We never bridged this gap, but it never became is issue between us, if only because EMU membership was not an issue for the MPC to decide.  During my three years on the MPC,  I made public statements in support of EMU membership only if and when Eddie George or Mervyn King (who was and is even more strongly opposed to EMU membership for the UK than Eddie was) made anti-euro noises in public.

Chair of the MPC
Eddie George was the ideal chairman of the MPC.  He approached the job as the chairman of a collegial board, the first among equals.  He clearly held a unique position.  He chaired the meetings and therefore set the agenda, and had the casting vote in case of a tie.  But it was more than that.  I never called him by his first name while I served on the MPC, but always addressed him as ‘Governor’ or ‘Mr Governor’.  He never asked for that.  It just came naturally. He also never tried to ram his views on the right course of action as regards interest rates down the throats of his MPC colleagues.  Everybody was given the chance to present their views and to question the views of others.  The MPC meetings I attended were among the most ‘disinterested’ and ‘a-political’ discussions of how to achieve the Bank’s mandate, that I have ever attended anywhere - academic in the correct sense of the word: objective, open-minded, disinterested, balanced. Remember that there was no model to imitate or emulate.  We definitely did not want the Fed model, with its dominant Chairman who could and did deny his colleagues on the Federal Reserve Board access to the Federal Reserve Board staff and other resources if they took a line the Chairman disagreed with. Under Ben Bernanke (a much more collegial personality than his two predecessors), the sharp edges of Chairmanial autocracy have been smoothed and rounded off and the ‘presidential’ excesses of the Volcker and Greenspan era appear to have become a thing of the past.

The ECB did not get going until a year and a half after the creation of the MPC, but it too did not present an attractive model.  The very fact that the head of the institution is called ‘President’ suggests a non-collegial form of decision making and management, both within the 6-member Executive Board and within the monetary policy making body, the Governing Council. The current President, Jean-Claude Trichet certainly views himself as the primus, but not inter pares.   The ECB’s hierarchical, Presidential and non-collegial Board and Governing Council, with its decision-making by consensus (a mechanism par excellence for encouraging groupthink and for being systematically behind the curve), is also as different as possible from the model developed under Eddie George. In the final pre-rate decision policy discussion, the Governor would aways get the ball rolling by asking the senior executive MPC member for monetary policy to lead off.  When I was there this was Mervyn King, first as Chief Economist and then as Deputy Governor for Monetary Policy.  After Mervyn, the Governor let all other members of the MPC say their bit, supposedly randomising the order in which members spoke - I don’t have a sample large enough to test the randomness of the ordering.

The Governor aways spoke last.  This has two advantages.  First, if you really want a free and frank discussion, it is likely to be helpful if you don’t know the preferences of the chair. Second, if you believe that the chair should not be put in the minority, it permits the chair to adjust his tune to blend with that of the majority view.  The likely majority view is bound to have emerged by the time it is the chair’s turn to speak. Eddie George was on the winning side in a number of 5 to 4 votes, but he never voted with the minority.  Whether this is because his true preferences always put him in the majority camp (he was a man of the extreme centre) or whether this was because he feared that being put in the minority would undermine the authority of the chair, both at home and abroad, is unclear. Early in the life of the first MPC, Eddie asked me one-on-one what I thought about the Governor voting with the minority, and he indicated that a discussion of the full MPC about the issue might be in order.  I assume he had the same conversation with the other MPC members.  The full MPC discussion never took place while I was there.  Mervyn King has taken the model of individual accountability and majority decision-making one step further, and has voted with the minority on two occasions. I agree with Mervyn’s stance on this issue.  I don’t even believe that the Governor’s authority would be damaged if he voted repeatedly with the minority.  What would hurt the Governor’s authority would be a pattern of repeatedly voting for the wrong policy.

Defending the Bank
Eddie George worked for the Bank of England for 41 years - his entire career.  He loved the institution, its history and traditions, and would turn ferociously on those whom he believed to be damaging it.  During my three years on the MPC, I was involved in just one serious conflict that had Eddie George in the opposite camp.  This was the conflict created by the insistence of the four external MPC members (DeAnne Julius, Sushil Wadhwani, Charles Goodhart and myself) that there needed to be dedicated independent research support for the external MPC members.  It became a serious issue in September 1998. This was part of the external MPC members’ ‘Not the Federal Reserve Board’ drive.  The power of the Chairman of the Federal Reserve Board is derived in no small part from the fact that the FOMC members that have access to independent resources to back up their views (the Presidents of the 12 regional Federal Reserve Banks) have limited status and legitimacy (except for the President of the New York Fed, who at least has status). The six other members of the Board of Governors of the Federal Reserve system have legitimacy (confirmation by the Senate) but have to ask the Chairman for the key to the bathroom and can be frozen out of access to Federal Reserve Board staff and other resources at the (dis)pleasure of the Chairman.  Again, this ludicrous state of affairs appears to be much improved since the arrival of Ben Bernanke as Chairman.  It was, however, the prevailing reality when I served on the MPC. Eddie George considered our request for independent, dedicated resources for the external MPC members a vote of no confidence in himself and the institution.  He felt the external members were accusing him of not being in good faith as regards access to the Bank’s resources.  And he felt strongly we were dividing and even balkanising his Bank.

Eddie George had a short fuse and a perceived attack on the integrity of his Bank was more than enough to light that fuse.  I received a spectacular one-on-one dressing down from him on the issue.  Voices were raised and tempers lost.  Both of us felt that issues of principle were involved. To me it was clear that the policy-related research priorities of the external members of the MPC, when they did not coincide with those of the executive members of the MPC, were invariably put at the end of the queue.  We needed our own dedicated research support if the external members were to do the job they were mandated to do.  It wasn’t a lot of fun.  I had similar unpleasant one-on-one shouting matches on the issue with both David Clementi (Deputy Governor) and with Mervyn King. The external MPC members won on this issue after the internal conflict leaked into the public domain.  Each external member was given the support of one Masters-degree level and one Ph.D.-level researcher.  With eight professional economists at the disposal of the external MPC members (plus the good secretarial and administrative support we had always enjoyed), the resources necessary for a proper discharge of the duties of the external members were, at last, in place. The at times bitter disagreement about independent, dedicated resources for the external MPC members did not, incredible as it may seem, interfere with the dispassionate discussion of the issues relevant to the interest rate decisions of the MPC.  Somehow, everyone involved left their egos at the threshold of the room where the monetary policy decision of the month was about to be made.  That, I think, is in no small part due to Eddie George’s chairmanship, his love of the Bank and his ability to take the long view and see the big picture despite his short fuse.

Genuine warmth and willingness to be bothered
Eddie George had a remarkable generosity of spirit and a willingness to make an effort for people without any expectation of a return, other than the satisfaction of doing the right, or rather the kind, thing.  At some point during my term, my in-laws were visiting from the USA.  I mentioned the visit and the fact that my father-in-law had been a banker for much of his professional life to Eddie - without intending to drop any handkerchiefs. Immediately Eddie suggested that my in-laws come to the Bank, both to meet with him and to be shown the gold (including the legendary gold recovered from the Nazis) in the vaults of the Bank.  It really made the day for my in-laws. Another example.  The wedding reception for Anne Sibert and myself was held in the museum of the Bank of England.  Both Eddie George and Vanessa, his wife, came to that reception.  One of Anne’s junior colleagues at Birkbeck College was absolutely dying to be introduced to Eddie.   Much against my instincts, I played intermediary.  Instead of being at least mildly annoyed, Eddie went straight to the young man and talked to him in his most avuncular mode.  Again a good deed not likely to be requited in this life. Eddie liked people and liked talking to people, and there was genuine warmth in his interactions.  His willingness to talk to people extended to journalists.  This caused concern and even mild panic attacks in the press office, as Eddie would, in not infrequent unguarded moments, proffer views that reflected the truth as he saw it rather than as the rest of the policy establishment would like it to be. The combination of a sensitive issue and a young ingenue journalist was considered especially high-risk as regards the likelihood of clarity instead of tact in the Governor’s statements.

How would Eddie George have handled the financial crisis?
One of the great unanswered questions of the current crisis in the UK is whether with Eddie George as Governor the actions of the Bank of England would have been very different from those of the Bank under Mervyn King. It is clear that, unlike Mervyn King and other MPC members with academic backgrounds like myself, Eddie George understood the importance and fragility of both funding liquidity and market liquidity.  To me, liquidity was stuff from the Radcliffe Report (1959), and stuff that mattered for developing countries and emerging markets.  The notion that the majority of border-crossing banks in the north-Atlantic area could face funding liquidity problems and that a large number of key wholesale financial markets could become disfunctional at the same time did not occur to me before it actually happened. Nor did it occur to the Bank of England. Learning took place, but it was not monotonic.  As late as the summer of 2008, the Bank was making a mess of things by announcing the closure for new business by October 21, 2008 of the Special Liquidity Scheme it had created on 21 April 2008. It is unlikely that Eddie George would have made that mistake.  However, any Governor of the Bank of England would have had to live with the fact that regulatory and supervisory responsibilities had been stripped from the Bank of England when it became operationally independent for monetary policy in June 1997.  Eddie George strongly opposed this decision.  Any Governor would have had to work with the disfunctional Tripartite Arrangement for financial stability between the UK Treasury, the Bank of England and the FSA - the brain child of Gordon Brown and his advisers.  Any Governor would have had to cope with a deposit insurance scheme that did not work and with the complete absence of a Special Resolution Regime for dealing with near-insolvent banks.

We must also remember that the advantages of endowing the central bank with supervisory responsibilities for the banking system (and for other systemically important financial institutions and markets) - a better flow of information - must be weighted against the near-certainty of regulatory capture of the supervisor/regulator by the financial sector.  We have seen this in the US, where the Fed, and even more the SEC, have internalised the interests, world-view and fears of Wall Street to such a degree that it has been impossible to take the tough measures required to clean and restructure banks’ balance sheets,  (re)capitalise banks and restructure their managements and boards to the extent necessary to restore financial intermediation to the point that a sustained economic recovery is possible. When there has to be a choice between better institution-specific information and a material risk of capture, cognitive or other, of the central bank by the captains of finance, ignorance may be the lesser of two evils. But one would have liked to have Eddie George’s wisdom and judgement to draw on during the unprecedented crisis that has swept all before it since August 2007.  He was a man who inspired confidence and trust - the moniker ‘Steady Eddie’, while not terribly orginal, was not inaccurate.  I am fortunate to have known the man.  I will miss him.

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