Changes in China

Michael Pettis on the 17th Chinese National Peoples' Congress

If either of Bo (Xilai - current trade minister) or Zhou (Xiaochuan - Governor of the Peoples' Bank of China) are promoted onto the Standing Committee, I think we may end up seeing smarter and more preemptive activity in dealing with China’s monetary imbalance. If inflation figures for September and October stay above 5% or even accelerate I think we may see an acceleration of RMB appreciation even earlier than expected. This is all speculation, but like a lot of people in China I will be following the NPC rumor mill very closely.

Before the invention of Northern Rock

Tuesday 27 September 1664 (Pepys' Diary):

"Piggot came to see me, and desire my going down to Brampton Court, where for Piggot’s sake, for whom it is necessary, I should go, I would be glad to go, and will, contrary to my purpose, endeavour it, but having now almost 1000l., if not above, in my house, I know not what to do with it, and that will trouble my mind to leave in the house, and I not at home."

This is about £100,000 in today's money according to this site.

FSA slams the stable door shut

FSA launches scrutiny of bank liquidity - FT

LIBOR

Gillian Tett provides a good overview of LIBOR and some of the questions that have been raised recently about its use. Quotes no longer appear firm and the largest banks seek other forms of liquidity. The main quesion is whether this will continue when current conditions stabilise.

Liquidity

Fed Governor Kevin Warsh discusses liquidity and its relationship to confidence.

Northern Rock

The FT looks at the problems that remain at Northern Rock.

The biggest hurdle facing any potential bidder is the cost of Northern Rock’s balance sheet. At the end of June, the bank’s balance sheet stood at £113.5bn, about £80bn of which was funded through the capital markets. Not all of this is due immediately: Northern Rock has almost £46bn tied up in mortgage-backed securities, which should be unaffected by the bank’s travails.

Even so, any institution looking to take over Northern Rock would still have to be highly confident that it could raise more than £30bn in financing in the short term. In the current environment, even some of the world’s largest banks consider this a stretch.

But raising the necessary financing would only be the first step. The cost of borrowing is also crucial. According to analysts at Citigroup, Northern Rock’s assets generate a return of slightly more than 6 per cent. That is less than the current cost of borrowing in the three-month interbank markets. In other words, any institution that took on Northern Rock’s balance sheet and financed it through the short-term money markets would currently be making a loss.

There are further complications. The immediate panic among customers has abated, but savers are likely to remain wary of Northern Rock for some time. This means the deposit base, which has already fallen by £3bn, is likely to shrink further. Northern Rock has also revealed investments in debt securities, including structured investment vehicles and collateralised debt obligations, which will have to be written down.

The Guardian raises some questions by the shareholders for those in charge.

He emphasised the board was "well aware" of its responsibility to its many shareholders, "including tens of thousands of small shareholders", and its largest shareholder, the charitable Northern Rock Foundation, to which it gives 5% of pre-tax profits to support good causes.

However, the bank has yet to explain why it refrained from informing the stock market of a deterioration in its finances in the middle of August. The governor of the Bank of England, Mervyn King, told the Treasury select committee last week that he was alerted to an impending crisis on August 14.

The shareholder group said it wanted to know why an announcement was delayed until the rescue package was finalised on September 14.

a

The group and the individual

NYT looks at the evolution of behaviour that supports group cohesion. Those societies that had strong group ties (either through religion or other norms) probably had better chance of survival than those that did not. However, there is an argument that suggests that indivudlalism now is more condusive to innovation.

Reintermediation

The Global Liquidity Blog points to a couple of references to the reintermediation that is expandinng banks' balance sheets. This is helping to encourage the demand for liquidity and could also lead to a desire to increase capital.

Bank Run 2

The BBC on the Northern Rock depositors trying to withdraw funds.

"The Chancellor says 'don't panic' but that's what the captain on the Titanic said, and that went down"

SIVs

Excellent overview by Mark Thoma of the role of SIVs in the current liquidity crisis.

TIC data

Just a note to remember that the TIC data do not fully represent UK financial flow.

From Brad Setser

Some of the flows from Europe are pretty easy to explain. Most of the UK’s purchases of Treasuries, for example, seem to be bought by institutions that are either acting for the world’s central bank or doing a roaring business buying US treasuries when the US market is open and selling those Treasuries to China (and others) when their markets are open. Every year the survey revises the UK’s holdings of Treasuries down by something like $100b, and revises the holdings of China and others up. Much the same process likely happens with Agencies, though in that market, Russia could be almost as important as China.

The demand for money

The FT looks at the difficulties in the money market as banks hoard cash and scramble for additional liquidity. This puts another perspective on the debate conducted by William Polley about the optimal amount of cash to hold.

The demand for liquidity is not constant and the cost of iliquidity can increase dramatically at times.

Financing the US deficit

The FT reports on the increased appetite for US acquisitions amongst Asian entities. This should help to mitigate the slide in the US unit that Barry Eichengreen talks about today.

Limits to arbitrage

Good to look again at Schliefer and Vishney, The Limits of Arbitrage and Keynes' "Markets can remain irrational longer than you can remain solvent",
The context?

Brad DeLong with the coverage of John Meriwether's LTCM call for more money.

More on barriers to bottom fishing from Felix Salmon.

The operation of the UK money market

The FT has a good overview of the operation of the UK money market and its interaction with the central bank amidst a story about a 'misunderstanding' between Barclays and HSBC.

The Marshall Plan

Naill Ferguson on Greg Behrman's 'The Most Noble Adventure'.

The total aid package was equivalent to less than three per cent of the recipient countries’ combined national income, and it represented less than a fifth of their gross investment.

To gauge the true importance of the Marshall Plan, it is crucial to get a sense of the amounts involved. Behrman writes, “From June 1947 to its termination at the end of 1951, the Marshall Plan provided approximately $13 billion to finance the recovery . . . of Western Europe.” This was less than half the Europeans’ initial request and four billion dollars less than President Truman’s initial proposal to Congress, but it was still serious money. Behrman computes that, in today’s dollars, “that sum equals roughly $100 billion, and as a comparable share of U.S. Gross National Product it would be in excess of $500 billion.” That’s actually an understatement. In fact, the total amount disbursed under the Marshall Plan was equivalent to roughly 5.4 per cent of U.S. gross national product in the year of Marshall’s speech, or 1.1 per cent spread over the whole period of the program, which, technically, dated from April, 1948, when the Foreign Assistance Act was passed, to June, 1952, when the last payment was made. A Marshall Plan announced today would therefore be worth closer to seven hundred and forty billion dollars. If there had been a Marshall Plan between 2003 and 2007, it would have cost five hundred and fifty billion. By comparison, actual foreign economic aid under the Bush Administration between 2001 and 2006 totalled less than one hundred and fifty billion, an average of less than 0.2 per cent of G.D.P.

Financial Engineering

Brad Stetser with an overview of the comments on financial engineering. This emphasises the uncertainty and the lack of liquidity that is affecting the market. It also highlights the importance of the Fed change to provide confidence that some funds, without access to the discount window, can use banks to push illiquid collateral through to the Fed in exchange for cash.

Bank run

The bank run from "Its a Wonderful Life".



Thanks to Paul Krugman for the reminder.

The discount window

The FT has a story about how the Fed accompanied the cut in the discount rate with a reassurance to financial institutions that, other than the penalty rate, it would not discriminate against institutions that used the window. This certainly seems to be a change from the traditional position that would, it was suggested, mean additional scrutiny of banks that were frequent visitors to the window.

Squeezing the regulatory balloon

Charles Wyplosz has a nice overview on the way that risk has been pushed out of the banking system into other sectors of the financial system. The problem is not so large, particularly in relation to the overall size of the system, but it is not clear where the risk now lies.