STARTING in July of 2007, and continuing into August and beyond, I wrote a series of articles under the theme that greed was not good, referring to Ponzi finance, both locally and in the global financial system. Whilst history does not repeat, it often rhymes, and there are some straws in the wind that should tell the intelligent observer of where things are trending, as they were in 2007.
Earlier this week, on Bloomberg’s Charlie Rose, Treasury Secretary Timothy Geithner suggested that rather than the expected hundreds of billions of losses from the financial crisis, the US government’s TARP investments in the banks had already produced a profit of over $19.5 billion, expected to increase to $22 billion, and described criticism as “urban myths”. This “profit” is however nothing more than a sleight of hand, as the Federal Reserve has provided trillions of liquidity support to the US megabanks as part of an enormous expansion of its balance sheet that has included acquiring hundreds of billions in “toxic” assets that will never trade at full value again. The only question remains when and how these losses will be realised, or will they forever remain off balance sheet as part of the assets of the only US institution that can literally print money.
At the very least, the US equivalent of our minister of finance is being misleading, and the fact that he is now questioning the intelligence of his critics suggests a whiff of desperation. His admittedly very difficult situation lies at the very heart of the potential conflict between transparency and confidence, a situation that has been faced countless times through history by those responsible for a nation’s financial affairs. However, there is actually no such conflict if you have done the right thing, and are willing to put the good of the nation above political advantage, which we will address further below.
The second straw in the wind was European Central Bank (ECB) President Mario Draghi committing himself to do whatever it takes to protect the Euro, widely seen as a commitment to “print money” if necessary, ignoring whatever institutional constraints the European Central Bank had previously regarded as limiting its actions. Bond yields of Spanish and Italian bond markets, which had convincingly gone through the seven per cent barrier on their ten year benchmarks, dipped sharply on the news, as it suggested that at minimum the ECB would resume buying of these countries sovereign debt. Nevertheless, unless it is assumed that Draghi just wanted to ensure himself and his colleagues a quiet August on the Italian Riviera, one should assume that the ECB sees something bad in the future that requires it to cross the Rubicon into full fledged quantitative easing (very roughly meaning printing money), following the path already taken by its Japanese, UK, and US brothers.
The biggest straw in the wind ironically was not from a central banker, but from Sandy Weill, former CEO and Chairman of Citigroup, where he had led the rise of the global megabanks. Indeed, he was the first beneficiary of the abolition in 1998 of the Glass Steagall rule, separating retail from investment banking, that had been in existence since the great Depression. He created Citigroup as the world’s largest financial supermarket at the time through a merger with his insurance group Travellers. The retired Weill announced on financial channel CNBC that he now thought that retail and investment banking should be separated, arguing that what heretofore might have been regarded as the summit of achievement of his long career was effectively a mistake, and implying that the big megabanks should be broken up. That this did not occur in 2009 was one of the critical mistakes of the Obama administration, and a major reason behind Treasury Secretary Geithner’s discomfort.
What all this means is that the ice age of the global deleveraging process still has a long way to go, and to use a biblical analogy, we may be less than half way through the seven thin years. In the US, the global megabanks are even bigger than before the crisis, having swallowed up some of their competitors, and the massive global derivatives market is as big as ever. Whilst there has been a sharp reduction in the size of the so called shadow banking system, and in the US and UK at least, bank capital ratios have been raised, many of the global stress points remain. In Europe, debt stressed sovereigns are in any case not in a position to credibly bail out their own banks, which in the case of Spain, for example, are sitting on a mountain of bad real estate loans.
Most importantly, the global economy appears to be turning down simultaneously, with the UK and Europe already in technical recession, a number of economic indices suggesting the US may be at a turning point (for example the sharp fall in the University of Michigan’s index of US consumer confidence), and the famous BRICS (Brazil, Russia, India and China) all slowing sharply. China particularly bears watching, as although, like Brazil, it has the capacity to lower its policy interest rate sharply, unlike the major developed countries which are already at zero, it also suffers from the now worldwide disease of unproductive debt with an even less transparent banking system than in the US, where derivative exposures make some of the large US banks effectively “black boxes”. Europe is probably worse, as their banking system remains very highly leveraged, the eventual size of their bad loan exposure is still completely unknown, all combined with the country coordination problem in responding to crises now so vividly on display by the European Union.
All of this suggests that it would be extremely unwise of our local policymakers to believe we are in a situation of business as usual. If we wait too long, the IMF may have other calls on their attention and resources. It is entirely possible that before the “ice age” deflationary piece of the great recession ends (no doubt to be followed by the “fire” of money printing), US ten year treasures break below 0.8 per cent and the long “30 year” bond will be less than 1.5 per cent, or just under half of where they are now, depending on the state of the US and world economies. The release of the Jamaica Chamber of Commerce’s Business and Consumer confidence indices next week Tuesday, prepared by the same Professor Curtin responsible for the University of Michigan’s release in the US, should give us a good insight into the current and future state of Jamaica’s economy. At the local policy maker level, it looks like we will need both a plan B and a plan C.