Apr 16th 2009
From The Economist print edition
Financial crises can drag on because efficient remedies are politically unpalatable

The Curse of Politics,   Comment by Stephan Olajide

It is indeed appropriate to discuss the political process that seems to mangle all logic and sensibility nowadays. However, we have to go further than the Economist, as this is not merely an issue when a crisis hits and everybody scrambles for the exits. Everyone speaks of a crisis of confidence in our system when it really is a crisis of confidence in our political process that has failed us. In its ultimate analysis it is our political process, in which we have entrusted our lives and our taxes that has to take ultimate responsibility for the crisis we are facing.

How, for example is it possible that the Fed Chairman is left unquestioned for two decades on his proclamation of efficient and self-regulating markets?
How does a regulator allow an all- pervasive application of new theories and models in the system’s core, the financial industry without test-ground and thorough understanding?
How is it possible that politicians get away with paying lip-service to free and unfettered markets and completely neglect their responsibility as the manager and guardian of the system that was entrusted to their care?
How is the Fed Chairman allowed to guarantee the system (the infamous “Greenspan Put”) without a huge backlash from those who have learnt from history?
How has inflation come to be defined as the Core CPI?
How is it possible that politicians around the world were bombarded by warnings of many bright minds about the repercussions of the kind of system they are running without ever acting on any of it?

Yes, politics is the land of compromise amidst vastly differing views but some things are still governed by the laws of logic and sensible management.

Would you allow new theories to blanket and take over your system without testing, without questioning, without regulation and without oversight?
Would you proclaim the system’s efficiency while empirical data negates it?
Would you deregulate and feel happy about no regulation at all?

Would you not find it odd to have to guarantee a system that is supposed to be stable and efficient in itself?
As to our definition of inflation as the CPI, the consumer price index; Inflation is clearly the creation of credit, the increase of money in the system and not some hand-picked niche manifestation of it. The system of Bretton Woods, with its key characteristic being the U.S. dollar reserve currency, has been in force for more than 60 years and its dynamics are well known and discussed. The warning signs of the increasing imbalances brought about by this global system were well observed. Since the fall of the Goldstandard, we have run the longest global fiat money system that allowed (almost) unhindered credit expansion that was supercharged by Modern Finance and Reaganomics gone wrong and monetary policies that lack academic foundation.

Is this the leadership we deserve? Or is it the system that creates these more than mediocre results? Fact is that when reasonable, intelligent people congregate in Washington, the results have become too costly for society. The crisis moment merely highlights how broken our political process really is.

Current policy action in Washington and around the world does not recognise the extent of degeneration of our system, in particular our financial system and runs the risk of bankrupting the US dollar our global currency system. As a nasty side effect policies continue to expand the inequalities built during the boom years.

William Black is uncovering some of the ugliest distortions in our financial system. It is quite clear that power and financial leverage create much opportunity to take more than seems appropriate and Black is right, no-one was looking.

I also agree with Black on having to reinstate Glass-Steagall and a proper regulation of derivative instruments.

However, William Black focuses mostly on the sub-prime example and the question he doesn’t address is why they got away with it. Wasn’t the market supposed to find out and punish unsound businesses and practices? Of course partly to blame is regulation itself but as I show in “Eye of the Storm” the demand side was entirely blinded by their institutional structures and risk management tools and gobbled up all that garbage. Regulation would not have been able to avoid Ninja loans (it would have to be the kind of regulations that the GOP is right to rail about) but since the market mechanism was broken, the market itself didn’t realise what it was doing (that is where we have to regulate, at the root).

Thus, the point of fraud is a very accurate description of what went on in subprime at the very end. However, ultimately the description is incomplete

Regarding Black’s emphasis on a system wide cover-up, it certainly sounds like a conspiracy theory. While I doubt grand scale conspiracies very much it has to be said that it is interesting to see that the same methods and policies continue to be applied by the very people that were responsible for the crisis while reasonable voices were shoved to the sidelines and still to a large degree are not consulted. Most of those experts would suggest quite different policies. I am personally disappointed by the plans Obama is presenting with a seasoned veterans John Volcker and Larry Summers on board.

Maybe something happens to people when they go to Washington, some sort of electromagnetic alterations of their brain circuits. An astonishing example of this is Alan Greenspan who changed his entire belief system when he ascended the Chairmanship of the FED in 1987. The Alan back in 1967 would have turned in his grave. The Alan Greenspan in 1967 analysed the mistakes made before the great Depression in a manner that would have flunked the Alan at the FED. The Alan in 1967 would completely disagree with what he did once in office and he would disagree with much of what Ben Bernanke says and does.

Black is of course right when he points to the Japanese experience as a very real path following current policies. And of course he is right when he points to the unbelievable conflicts of interests that are created by the very people in charge of bailing out their own businesses. The Bush administration was certainly immune to any decency and honesty. I have no reason to believe that the same would happen under an Obama Presidency. However, to date, his administration does certainly treat the financial sector with silk gloves. I would guess that is a result of insecurity about the inner workings of finance and a fear that everything would melt down. A fear however, that is unfounded.

First posted Feb 17, 2009

This question was subject of an article in the Swiss Daily “Tagesanzeiger” , February 12, 2009
For those who don’t read German. In essence the article is talking about an exposure of Swiss banks to eastern European Residential mortgages in the amount of USD 200 billion, that may bankrupt the country.
The situation is in fact much worse than that. Here is an excerpt from “Eye of the Storm” that sums up the situation for Swiss financials.
…, consider Switzerland, a rock-solid country with a GDP of $400 billion, a positive budget, and a public debt of $200 billion, none of it foreign. Switzerland has a very strong economy and a great variety of businesses, small and large, with global size and reach despite their miniature launching pad. We’re talking about Nestle (one of the largest consumer goods brands in the world), Novartis and Roche (the chemical giants), ABB (the global capital equipment giant)—not to mention numerous specialized niche businesses, particularly in mechanics and electro-mechanics. The country, with one of the most efficient public services and a truly world-class infrastructure, is at the forefront in environmental technologies. And let us not forget finance, with UBS and Credit Suisse among the largest global banks. Swiss Re is Munich Re’s main global rival in reinsurance, and Zurich Insurance is one of the largest global financial services companies. It is a splendid, rich, rock-solid economy that punches far above its weight-class on a global level. But now it could be crushed by the punch that is about to land.
At the end of 2006 the assets of the two largest banks in Switzerland alone by far outstripped the size of its host economy. Together they combined an equity base of $80 billion, with outstanding commercial banking loans of $460 billion (mostly domestic commercial banking assets) and other managed assets (mostly foreign leveraged engagements) on their book of $2.8 trillion. Moreover, both banks advised clients for assets in the amount of $4 trillion. In total, Credit Suisse and UBS have managed and influenced assets in the amount of $7.25 trillion, almost 15 times the size of Switzerland’s GDP. Should 20% of noncommercial business go bad and have to be written off (i.e. 20% of $3.25 trillion) by the Swiss government, taxpayers would have to foot a bill of approximately $650 billion for the rescue of these two banks alone. Together with the outstanding debt of $200 billion, total Swiss debt would rise to $850 billion (not counting revenue shortfalls during the crisis)—almost twice its GDP. In a global recession where tax revenues ($150 billion in 2007) are sinking, this would easily turn an $8 billion surplus into an unsustainable deficit. Debt service would increase the bill by $40 billion at a conservative interest rate of 5%. Together with falling tax revenues, the budget deficit could easily explode to $60 billion or more, or 15% of GDP.
It is clear that this and even tamer scenarios would raise the specter of a debt spiral in Switzerland. Think: Switzerland, a country that looks rock solid, with a currency that is still a beacon of stability and safety, could be torn to shreds by a necessary monetization of debt. Yet government and central bankers still seem relatively unconcerned and are grudgingly supporting the two giant banks.

«Der Schweiz droht der Bankrott»
Interview: Claudio Habicht; Aktualisiert am 17.02.2009
Schweizer Banken haben Milliardenkredite nach Osteuropa vergeben – nun können die Kunden die Gelder nicht zurückzahlen. Der Schweiz drohe das Schicksal Islands, sagt Wirtschaftsexperte Artur P. Schmidt.
«Die Schweiz könnte vielleicht gezwungen sein, den Euro zu übernehmen»: Artur P. Schmidt.
Nationalbank sieht keine Gefahr
Laut Nationalbank (SNB) sind in Zentral- und Osteuropa Frankenkredite in der Höhe von 75 Milliarden im Umlauf. Die Nationalbank glaubt nicht, dass die Frankenkredite in Osteuropa einen Einfluss auf die Stabilität der Schweizer Währung haben. Sie stützt sich dabei auf zwei Studien: Diese kommen zum Schluss, dass die Risiken im Zusammenhang mit Frankenkrediten im Ausland kleiner sind als befürchtet.
Die Kredite seien in Haushalten und Firmen konzentriert, die entweder eine hohe Risikofähigkeit besässen oder Einkünfte in fremder Währung aufwiesen. Die Schweizer Banken sind laut SNB im Detailgeschäft mit Krediten in Osteuropa kaum aktiv. Die Frankenkredite werden durch lokale Banken vergeben.
In Ländern wie Polen, Ungarn und Kroatien ist der Franken zur wichtigen Fremdwährung geworden. Tausende Haushalte und Kleinfirmen nahmen ihre Kredite wegen tieferen Zinsen in Franken auf, und nicht in den Landeswährungen Zloty, Forint oder Kuna. In Ungarn sind 31 Prozent aller Kredite in der Schweizer Währung ausgestellt, bei den privaten Haushaltskrediten sind es fast 60 Prozent.
Kreditnehmer in Nöten
Nun hat die Finanzkrise die Ära der günstigen Kredite beendet: Die Ostwährungen sacken ab. Ende September musste man für 100 polnische Zloty noch 46 Franken bezahlen, heute sind es 30 Franken. Das heisst: Immer mehr Kreditnehmer kriegen Probleme mit den Zinsen und bei der Abzahlung. Die Frage ist also, wie sich das auf den Schweizer Finanzplatz auswirkt. Einer, der für die Schweiz schwarz sieht, ist der Wirtschaftsexperte Artur P. Schmidt*: Er glaubt, dass die Schweizer Währung wegen der Frankenkredite in Osteuropa in Gefahr ist.
In Polen, Ungarn und Kroatien ist der Schweizer Franken zur wichtigen Fremdwährung geworden – sozusagen zum Dollar Osteuropas. Tausende Haushalte und Unternehmen haben Franken-Kredite aufgenommen. Warum?
Das rasante Wachstum in vielen Ländern Osteuropas wurde durch Kredite in Schweizer Franken angekurbelt. Schweizerische Banken und Offshore-Institute haben den dortigen Banken Franken geliehen, die diese an ihre Kunden weitergaben. Die Kredite waren attraktiv, weil die Kreditnehmer viel tiefere Zinsen zahlen mussten als bei Krediten in der jeweiligen Landeswährung.
Nun ist dieses System ins Wanken gekommen.
Ja, das System hat nur so lange funktioniert, wie die Wechselkurse zwischen Franken und diesen Währungen einigermassen stabil waren. Das ist aber zurzeit nicht mehr der Fall: So haben der ungarische Forint und der polnische Zloty in den letzten Wochen gegenüber dem Franken über ein Drittel an Wert verloren. Wegen der Abwertungen der Landeswährungen haben sich die Schulden gegenüber der Schweiz um mehr als einen Drittel gesteigert. Viele der osteuropäischen Länder haben ernste Zahlungsschwierigkeiten und stehen quasi vor dem Staatsbankrott.
Was bedeutet das für die Schweiz?
Es ist anzunehmen, dass ein beträchtlicher Teil der insgesamt 200 Milliarden Dollar Osteuropa-Kredite in Schweizer Franken ausgestellt wurden. Gemäss einem Bericht der Bank für Internationalen Zahlungsausgleich sind weltweit Franken-Kredite im Gegenwert von rund 675 Milliarden Dollar im Umlauf – davon wurden etwa 150 Milliarden direkt von der Schweiz, 80 Milliarden von Grossbritannien sowie rund 430 Milliarden Dollar über Offshore-Finanzzentren vergeben. Wieviele dieser Kredite faul sind, ist nicht bekannt. Doch schon wenn die Ausfallrate 20 Prozent beträgt, würden die Banken viel Geld verlieren.
Muss nun der Bund eingreifen?
Wenn die Banken einen massiven Abschreibungsbedarf durch solche Kredite haben, muss ab einer bestimmten Grössenordnung der Staat eingreifen. Dies geschieht bereits durch die Schweizerische Nationalbank: In Polen hat sie der dortigen Zentralbank mehrere Milliarden Franken zur Verfügung gestellt, damit polnische Banken die Kredite decken können. Zugleich hat die schweizerische Nationalbank bereits bei der Europäischen Zentralbank angefragt, ob ihr diese im Notfall Geld ausleihen könnte. Dies ist ein klares Warnzeichen, dass der schweizerische Franken in Bälde unter einen enormen Abwertungsdruck geraten könnte.
Waren die Schweizer Banken zu unvorsichtig bei der Kreditvergabe in Osteuropa?
Ja, in der Tat. Viele Banker wollten zu viel verdienen und haben dabei die Risiken vernachlässigt. Schuld ist auch die Nationalbank, die nicht eingegriffen hat. Zudem haben die Aufsichtsbehörde und die Politiker völlig versagt.
Was muss die Schweiz nun tun?
Nun müssen die möglichen Verluste durch diese Kredite auf den Tisch; vor allem müssen alle möglichen osteuropäischen Risiken lückenlos offengelegt werden. Zusammen mit den Kreditausfällen von UBS und Credit Suisse könnte der gesamte Abschreibungsbedarf für die Schweiz die Grössenordnung des Schweizer Bruttosozialprodukt übersteigen.
Das heisst?
Der Schweiz droht wie Island der mögliche Staatsbankrott. Eine Folge davon wäre, dass die schweizerische Währung massiv an Wert verlieren könnte, möglicherweise sogar crasht. Eine andere wäre, dass die Schweiz in ihrer Kreditfähigkeit massiv zurückgestuft würde. Das wäre ein Trauma für das Land: Die Schweiz galt immer als Hort der Stabilität. Der Franken könnte zu einer instabilen Weichwährung werden. Dann würde die Schweiz vielleicht gezwungen sein, den Franken aufzugeben und den Euro zu übernehmen.
*Artur P. Schmidt ist promovierter Wirtschaftskybernetiker und Herausgeber der Finanzportale www.wallstreetcockpit.com sowie www.bankingcockpit.com. Er hat elf Bücher verfasst, sein aktuellstes Buch «Unter Bankstern» ist im EWK-Verlag erschienen. Schmidt schreibt zudem Fachartikel und Kolumnen für die Nachrichtenportale moneycab.com und telepolis.de. (Tagesanzeiger.ch/Newsnetz)
Erstellt: 12.02.2009, 13:22 Uhr

Comment to the McCulley Plan: Global Quantitative Easing

Madness it is. Here is the largest manager of bonds globally advocating the all-out liquefaction of the system. His main argument, demand is missing and demand must be created, no matter what.
Never once does he mention when and how all this liquidity shall be mopped up again. The theoretical concept remains that when growth picks up, the Fed will take liquidity out of the system. Nothing but a strong recovery would allow it to do that and given the facts of this crisis that is a very brave assumption to make. Equally, Paul and others still implicitly assumes that most debt accumulated is sound and was invested by system, with a process that has reached the pinnacle of efficiency. That assumption is even braver than the first one.
Why is no one calling Paul on this?
He is right in saying that the government is the only institution that can counteract the retrenching of the private sector during the downturn. That activity however, should stay within its financial capabilities and expertise. The extent of quantitative easing necessary to sort out today’s mess is likely to destroy the present system.
You can read the details in “Eye of the Storm”, chapters 6, 8, 20 and 21 should be of particular help with the subject.