May 20, 2012 6:30 pm
.
Desperate times call for desperate ECB measures
.
Jacek Rostowski




At that time Poland (which then occupied the European Union presidency) together with Italy and Spain, insisted that the creation of an effective firewall against the eurozone sovereign debt crisis spreading from country to country, must precede the imposition of capital buffers.



We cannot afford to make the same mistake again. This time a properly functioning firewall must be in place to prevent contagion well before Greece leaves the euro.



Considerable progress has already been made by the EU to ensure that, if the eurozone manages over the next few years to overcome its present problems, dangerously high debt levels will never again be allowed to threaten its integrity. Of particular importance in this regard are the six legal acts relating to fiscal policy that were agreed under the Polish presidency in September. But the “ifrequired is pretty big.



Of course, the best solution to the immediate crisis would be for Greek voters to choose a government next month that would honour its obligations to undergo structural reform and fiscal consolidation. If this happened, Greece could remain in the eurozone.




But to be brutally frank, such a positive outcome to the Greek elections is unlikely unless the probable catastrophic costs for the rest of the eurozone of a Greek exit are credibly eliminated. Greece’s gross domestic product has fallen by about 20 per cent since 2008 and knowing the possible consequences for the rest of Europe of its default, we should not be surprised if many Greek voters decide to call what they perceive as the eurozone’s bluff.



There is only one institution that can provide the firewall that Europe needs in the time we have before the Greek elections, and that is the ECB. It should immediately announce that in the event of a Greek exit from the eurozone it will stand ready to buy unlimited amounts of the sovereign bonds of countries remaining in the euro for a limited period of timesay a year or 18 months.




It is a moot point whether this is against the provisions of the EU treaties and the ECB statute. Jean-Claude Trichet, the former ECB chief, argued when he launched large scale intervention of this kind in August of last year, that when conditions prevent normal monetary policy instruments from operating, the ECB has the right – under its monetary policy mandate – to remedy such conditions. This is also the Polish government’s view.




But even if one believed that such action was normally against the treaties, Poland holds that it is justified in the case of a member state leaving the eurozone, simply because such an event is so unforeseen by the treaties.




Last autumn, Poland proposed that the mandate of the ECB should be clarified in the fiscal pact, so that there should be no doubt that the central bank could intervene in sovereign bond markets if it considered that the integrity of the monetary union was threatened by contagion. Such a decision would, of course, be made entirely independently by the Bank.


.
Unfortunately, the UK’s unwillingness to join the fiscal pact made it an intergovernmental treaty, and thus unable to affect EU treaties. This meant our proposal fell by the wayside.






Today, we are generally in a worse position than six months ago. But in one respect we are better placed. We need the ECB’s readiness to intervene massively in sovereign bond markets only in the case of a country actually leaving the euro. This is an extremely well defined event. Therefore, such intervention would not cause moral hazard, which is – understandably – the main fear of both Germany and the ECB.




After all, no country will leave the eurozone and bring economic catastrophe upon itself so other countries would benefit from the ECB’s intervention. Moreover, by reducing the consequences of an exit for those remaining in the eurozone, and thus increasing the credibility and probability of exit for the persistently wayward, the ECB would actually increase fiscal discipline in the monetary union also in the medium term, and thus reduce moral hazard.



.
The writer is Poland’s finance minister


.
Copyright The Financial Times Limited 2012.


U.S. Economy: Why The Looming Fiscal Cliff Matters

May 20, 2012

Eric Parnell




Worries about a potential slowdown in the U.S. economy are being compounded by the threat of the U.S. economy careening off of a fiscal cliff at the end of the year. Supposing the economy begins to reverse course to the downside in the coming months, how much of an additional drain if any will a reduction in fiscal support place on the U.S. economy and the stock market (SPY).



First, it is worthwhile to examine the specifics of the cliff that so many are now concerned about. Basically, at the end of 2012, a variety government spending programs and tax cuts are set to expire.



According to the Wall Street Journal, this includes roughly $100 billion in government spending cuts along with over $400 billion in tax increases on consumers and businesses. Thus, the cliff represents a total dollar amount equaling 3.5% of GDP. In an economy that is still struggling to achieve sustainable growth over three years since the outbreak of the financial crisis, draining half a trillion dollars out of the system represents a critical drag on future growth.



It is worthwhile to explore in more detail the potential implications of the pending fiscal cliff. To accomplish this objective, it is worthwhile to revisit GDP as measured by the Expenditure Approach, which is the sum of the following four components.



C : Consumer Spending

I : Business Spending

G : Government Spending

X-M : Net Exports (Exports minus Imports)



Prior to the financial crisis, U.S. nominal GDP peaked at $14.416 trillion during 2008 Q2. This included the following composition:


C : $10.127 trillion

I : $2.165 trillion

G : $2.870 trillion

X-M : -$746 billion



By 2009 Q2, the economy bottomed with a total U.S. nominal GDP of $13.854 trillion. This represented a -3.9% nominal contraction in the U.S. economy and included the following composition:


C : $9.782 trillion

I : $1.494 trillion

G : $2.917 trillion

X-M : -$338 billion



Thus, The U.S. economy suffered a -$561 billion decline in nominal GDP due to a -$345 billion drop in Consumer Spending and an even more dramatic -$672 billion decline in Business Spending. This was offset, however, by a +$47 billion increase in Government Spending and a dramatic +$408 billion improvement in Net Exports, as the U.S. stopped importing twice as much as we lost in export demand from overseas customers. In short, the increase in Government Spending and a sharp decline in the trade deficit helped keep the decline in GDP from becoming far worse than what it was at the time.



Let us now fast forward to today. In 2012 Q1, the U.S. economy reached a new nominal peak of $15.462 trillion based on the following composition:


C : $11.015 trillion

I : $2.045 trillion

G : $3.024 trillion

X-M : -$621 billion



We have seen the following developments since the previous nominal peak in the U.S. economy nearly four years ago. Consumer Spending has increased by +$888 billion from the previous peak, but Business Spending is still lower by -$120 billion (and this is on a nominal basis). Government Spending is higher by +$154 billion, and the economy is still holding on to a Net Export improvement of +$124 billion, as the U.S. has added more Exports than it has added in Imports over this time period.


So what are the key takeaways from this information as we look ahead for the U.S. economy. First, although corporations remain as profitable as ever on a net margin basis and balance sheets are generally healthy, Business Spending remains restrained and appears likely to be sensitive to the threat of a slowdown or any new crisis phases in the coming months. Consumer Spending has gained solidly from its previous peak, but would likely come under the most pressure in the event of another economic slowdown with many household balance sheets still fairly stretched.



Thus, the onus would likely once again fall on Government Spending and Net Exports to help offset the decline in Consumer Spending and Business Spending. But with a fiscal cliff looming at the end of the year, not only is the "G" component of GDP not likely to be positive, it has the potential to add on the negative side to the tune of as much as -$100 billion.


.
Moreover, the tax cut expirations would only compound the weakness in the "C" and "I" components. And even if an agreement is reached before the end of the year and the fiscal cliff is postponed into the future, it is unlikely that we will see any meaningful positive numbers on the Government Spending side. At best, it will likely be essentially flat barring some new fiscal program.



As for Net Exports, the notion that the U.S. economy is in relatively better shape at this stage of the crisis will likely serve as a negative as it relates to the trade balance. With many Asian economies also slowing and the situation in Europe descending into crisis, the U.S. can hardly count on export demand from overseas sustaining itself ahead of import demand into the U.S. As a result, a decline in Net Exports would be more likely this time around instead of a sharp improvement.



Bringing this all together, whereas we had two positives in Expenditure Approach to U.S. GDP to help offset two major negatives during the 2008-2009 episode, we are facing a situation in 2012 where all four components of U.S. GDP may turn decidedly negative at around the same time. Such an outcome would not bode well for a U.S. economy that is still trying to find the confidence to return to its feet from the previous recession several years ago.



For these reasons, it will remain worthwhile to monitor the fiscal debate closely in the months ahead including the dialog as we enter the height of the Presidential election season, as it will go a long way in determining exactly how much strain the U.S. economy may be facing in the coming quarters.


May 20, 2012 6:30 pm

The only way to stop a eurozone bank run





If you want to know what will drive the eurozone to destruction, my advice would be to follow the money, and ignore the real economy.


I am exaggerating, of course, but only a little.
The distortions in competitiveness between eurozone member states are important, but in the short run, I would ignore them for three reasons.



First, the competitiveness gap is not as big as some of the estimates suggest. I am especially wary of analysis that shows a divergence of unit labour costs, or other national price indices, since 1999 when the euro was introduced. Germany entered the eurozone with an overvalued exchange rate, which has exaggerated the extent of the subsequent adjustment made by Germany compared with others.



Second, the imbalances between surplus and deficit countries have got smaller, and will continue to do so, albeit very slowly. While I, too, believe that the European Central Bank’s inflation target is too low, further reductions in imbalances are possible as long as Germany produces above average inflation.


.
Third, a lack of competitiveness may imply misery, but does not necessarily trigger a break-up. I can see only one mechanism that could force a collapse of the eurozone: a generalised bank run in several countries. A sovereign state would normally have instruments to handle the danger efficiently, before and after: through a deposit insurance, restrictions on bank withdrawals, and central bank emergency liquidity procedures. But the eurozone is not a state.



The best way to think about bank runs is the 1983 model by Douglas Diamond and Philip Dybvig, US professors of finance, who found that a bank run is one of several rational outcomes of a demand deposit contract between a saver and a bank. The bank lends long. Savers can withdraw at short notice. If a group of savers withdraws, a bank can normally handle this with ease, but if withdrawals exceed a certain threshold, the dynamics of a self-fulfilling bank run set in.


.
The important point of this model is that a bank run can be perfectly rational. One is reminded of the statement by Sir Mervyn King, governor of the Bank of England, who once said that it may not be rational to start a bank run, but it is rational to participate in one.



In this spirit, it is perfectly rational for Greek and Spanish savers to take their money out of the banks. If, in addition, there is speculation that Greece might leave the eurozone, then it is rational that Greek savers take their money out of the country.


.
Should Greece leave the eurozone, it will almost certainly have to impose capital controls and deposit freezes. Since the cost of transferring a savings account from Athens to Frankfurt is negligible, such action constitutes cheap insurance against a potentially catastrophic event.



I would go as far as to say that it would be economically irrational for savers to keep their money in Greece under the present circumstances.



Then there is Spain. A Spanish saver in Bankia is confronted with the following questions: Does the balance sheet give a true and fair depiction of the risks? Is the Spanish government’s deposit insurance credible? Is Bankia safe now that it is partly nationalised?

.

My answers to these questions would be “no”, “no” and “no”. In the absence of a European backstop, Spain has a similar problem to that of Ireland. The Spanish state is too weak to provide sufficient guarantees to the banking system. The refusal by Bankia’s auditors to sign off on the accounts has raised suspicions about accounting practices, which are probably not confined to Bankia. In Spain, there is not so much an immediate risk of a eurozone exit – the risk is with the banks themselves.


.
Spanish press reports suggested that last week Spanish savers withdrew about €1bn in deposits in Bankialess than 1 per cent of the deposit base. This is not a bank run. But it may be the beginning of one. And as Sir Mervyn said, it may then be rational to take part.



What makes bank runs so lethal in the eurozone is the legal framework. The most important rights conferred by the EU to its citizens are the four fundamental freedoms – of movement of labour, goods, services, and capital. 


.
Article 66 of the Treaty on the Functioning of the European Union says the freedom of capital movement can be suspended but only in relation to third countries. The article can be invoked to stop Greek outflows to Switzerland, but not to Germany, at least not legally. That is one of the reasons why a eurozone exit cannot be legally accomplished inside the EU.



The only policy that can credibly counter the threat of a self-reinforcing bank run in the eurozone would be a eurozone-wide deposit insurance and bank resolution regime – at eurozone level. In other words, you have to take the banksall the banksout of the control of their home country.



Such a scheme would, of course, not solve all of the eurozone’s problems. But it would halt the dynamics that could actually soon destroy it.


.
Copyright The Financial Times Limited 2012



The anatomy of the eurozone bank run

May 20, 2012 4:21 pm

by Gavyn Davies




A bank run is now happening within the eurozone. So far it has been relatively slow and prolonged, but it is a run nonetheless. And last week, it showed signs of accelerating sharply, in a way which demands an urgent response from policy-makers.



.

The fear of bank runs is deeply ingrained in all economists who know anything about the genesis of the Great Depression in the United States in the early 1930s. Then, the failure of the Bank of United States in December 1930 led to multiple bank runs across the country. Bank failures in the following two years wiped out personal savings and greatly exacerbated the collapse of demand in the economy.




The classic account of the crisis, by Milton Friedman and Anna Schwartz, concluded that the collapse was largely the fault of the Federal Reserve, which failed to provide enough liquidity to keep the banks functioning and thus end the panic. After the crash, the establishment of the Federal Deposit Insurance Corporation was intended to ensure that deposit holders never again had to live in fear that their savings would be in jeopardy. What are the lessons for the eurozone?



.

The risk of bank runs is an inevitable feature of any banking system which takes short term deposits from lenders, and then makes longer term loans to borrowers. This “maturity transformation” is arguably the key function of a bank, but it brings with it the risk that depositors will ask for their money in large numbers at a time when the bank does not have the liquid resources to meet these demands.



.

This can cause a rational stampede to withdraw money, since depositors who wait until late in the day can lose all of their money. The pioneering work of Diamond and Dybvig in 1983 showed that banking systems are characterised by multiple equilibria. They demonstrated that it is possible for the system to shift without much warning from a good, stable equilibrium to a situation in which it is rational for deposit holders to demand their money immediately.



.

In some ways, the withdrawal of deposits from banks in the periphery of the eurozone is simply a slow motion version of a rational bank run in the Diamond/Dybvig tradition. For example, deposits in Greek banks have fallen by about a third since the beginning of 2010. Deposits in Irish and more recently Spanish banks have also been falling.


.
Depositors have been shifting their money to “saferbanking systems, notably those in Germany. The extent of these declines and other financing difficulties for the banks is illustrated by the rise of Target 2 imbalances contained within the ECB’s balance sheet, which reflect the mechanism through which these cross-border flows have been financed:

.




.


The standard central bank response to this problem is to provide enough liquidity to solvent banks to ensure that deposit holders are always able to withdraw their money, in which case the panic is eventually supposed to subside. The ECB has done this to the full extent required; in this respect it is not possible to criticise the ECB for failing to fulfill the role of lender of last resort to the entire system. Yet the continuing drain on deposits has not been halted.








The reason for this, of course, is the fact that the eurozone is not a single nation state, even though it does have a single central bank. This has two consequences. First, the underlying fear of depositors in the periphery is not simply, or even mainly, one of bank failure. Instead, they probably fear the devaluation of their deposits relative to those in core economies if the euro should break up.






Therefore, the run is being caused by concerns about exchange rate risk, not necessarily by the fear of bank failure as such. This makes it much more complicated to deal with, since it is very difficult to offer guarantees against future exchange rate losses to today’s depositors. Germany would not want to stand behind such guarantees to Greek and Spanish citizens in the event of a euro break-up.








Second, the bank run is greatly increasing the scale of potential transfers between nation states which until recently have been disguised within the ECB balance sheet. As deposits are withdrawn from Greek banks, the ECB replaces these deposits with liquidity operations. If these are standard repo operations, such as those undertaken in the LTROs in December and February, then the ECB is directly assuming risks which the Greek private deposit holder is no longer willing to hold. If the liquidity is injected via Emergency Lending Assistance, then the Bank of Greece is theoretically assuming the risk, rather than the ECB as a whole. But in the event of a euro break-up, these losses would ultimately fall on the ECB itself.




The problem is that this potentially exposes the ECB to much bigger losses than anything which has been contemplated so far by the core economies.
.




.
Up to now, the ECB has been willing to inject liquidity to cover the financing needs of the periphery banks as the inter-bank market has dried up. If instead, they have to contemplate providing semi-permanent funds to cover large further withdrawals of bank deposits, the size and timescale of the injection becomes extraordinarily large.



As the table (from David Mackie of J.P. Morgan) shows, the outstanding bank deposits of the periphery are many times larger than the current exposures of the ECB and core governments to the periphery. It seems inconceivable that core countries like Germany will be willing to expose themselves to these risks if the deposit flight continues.



.
Mario Monti apparently took a plan to the G8 summit to offer jointly-funded guarantees on bank deposits to apply across the entire eurozone. This would certainly help, but whether it would be sufficient to eliminate fears of exchange rate losses if the euro were to disintegrate is another matter. To fix that problem, belief in the integrity of the euro as a single currency needs to be restored. The bank run could bring matters to a head.


May 18, 2012 7:29 pm
.
Banking: Back to the wall
.
By Tom Braithwaite .
.
JPMorgan Chase’s $2bn loss has tarnished the reputation of chief executive Jamie Dimon

 .
Chairman and CEO of JPMorgan Chase Jamie Dimon listens to his introduction before a keynote address©Reuters



Standing bolt upright and with his trademark direct manner, the banker needlessly introduced himself. Mr Chairman,” he respectfully addressed Ben Bernanke of the US Federal Reserve. “Jamie Dimon, JPMorgan Chase.”



.

The chief executive of one of Wall Street’s grandest institutions – the descendant of the fabled House of Morgan” – then rattled off a list of recent financial regulations, followed by a change in tone: “Has anyone bothered to study the cumulative effect of all these things?” With a wry smile, Mr Bernanke, who, like everyone else, addressed him as “Jamie”, acknowledged that, no, nobody had.




That moment of confrontation at a conference last year showed something of the star appeal of Mr Dimon, something of his uncompromising nature in arguing that some regulations are crimping credit and something, his critics say, of his hubris.




.Now, Mr Dimon has found himself the unwelcome focal point of a story that is the talk of Wall Street and the City. London-based traders in JPMorgan’s chief investment office one of them dubbed “the London whale” – made disastrous derivatives trades, which have wiped more than $20bn from the market capitalisation of a bank famed for its risk controls, its “fortress balance sheet” and its chief executive’s obsession with detail.



.

The losses have engulfed one of the big beasts of banking, someone who commanded almost rock-star status. But any sense of schadenfreude is tempered by the realisation of the possible wider consequences of the case for the rest of the industry. “We’re screwed,” was the immediate response of one competitor. While some may have resented his bravura, rivals needed Mr Dimon. The 56-year-old, who took up boxing in early middle age, was the industry’s prizefighter one of the few survivors of the 2008 crisis – who still had the credibility to take on politicians and regulators as they finalise rules that are likely to curb Wall Street’s profits.




Now there are fears in the industry that policy makers will use the trading losses as a reason to tighten the screws. The outsized trading of the CIO, which invests deposits the bank takes but does not lend, has prompted questions over whether Mr Dimon has been circumventing the spirit of the regulation he has been so keen to shape.



.

For Mr Dimon himself the losses have posed a question of his credibilityfuelled in part by his initial handling of the affair. On April 13 he bluntly dismissed news reports about the big trading positions held by the CIO as “a complete tempest in a teapot”. Less than four weeks later, he was forced to reveal that the unit’sterrible, stupid, egregiouserrors had caused $2bn losses.





This jars with his image as the self-assured, charming and, at times, disarmingly frank Wall Street veteran who had successfully steered JPMorgan through the crisis, avoiding the losses that had crippled his rivals.



.

For some in Washington, though, his star had already dimmed. “The Jamie I first met was not the arrogant Jamie that he has become,” says a senior congressional aide. Mr Dimon, he says, “morphed into some combination of Goldman Sachs and Ken Lewis” – the former chief executive of Bank of America – “gratuitously full of himself, unnecessarily angry”.



.

However, in a series of interviews of top executives, a handful of whom are likely successors when Mr Dimon does step down, there is unwavering hostility towards the idea that these losses could force his departure.Ludicrous,” says one. “Crazy,” says another.



.


People will throw rocks at the boat,” says Mike Cavanagh, head of treasury and securities services, who was appointed by Mr Dimon to lead an internal probe into the losses. “It doesn’t change the work we have to do.”



.

Regulators, who are working to understand what actually happened, will be pressing to know how it was that the chief executive could not have known about the losses when he dismissed the CIO’s trading positions as insignificant during a conference call with investors.



.

A woman who lives in a large house in New Jersey, with a tennis court, swimming pool defended by tall oaks, white pillars and – more recentlysecurity guards, may have the answer.




Ina Drew, who resigned as head of the CIO this week, has not replied to requests for comment. However, senior executives blame her for not getting to grips with her wayward trading unit and not passing bad news up the chain quickly enough.



.

Four executives are adamant Mr Dimon did not deliberately misrepresent the bank’s exposure on a first-quarter earnings call on April 13. “As the guy who signs the books and records of this place for the last six years I know how seriously he takes what we tell the market,” says Mr Cavanagh. “He had senior people saying we’ve got the all clear.”



.

The executives agree that it was only after the first-quarter earnings, with losses becoming larger and more sustained that it became obvious the CIO’s estimate of the size of the problems was not credible.


.
Losses that had occurred had been explained in a variety of ways and those losses continued to mount and they picked up pace,” says one, who adds the company was then justified in waiting until its next big regulatory filing on May 10. “There was no obligation that when losses get to ‘x’ we say something. This wasn’t putting the company in harm’s way.”



.

With a balance sheet of $2.3tn and capital levels among the best in the business, it seems unlikely to prove a serious financial blow – though hedge funds believe the bank’s losses are growing as they bet against its position.






Still people close to the bank are surprised that a man with such a grasp of detail could miss the warning signs. A renowned cost-cutter, Mr Dimon recently expressed alarm that fancy potato chips in clear cellophane tied with a ribbon were available in the JPMorgan dining room. His colleague Frank Bisignano launched an investigation, triumphantly reporting back that the chips were cheaper than alternatives bought from local stores.



.

Mr Dimon still prowls the corridors with a sheet of paper in his pocket – an “owe melist of people who need to provide a report. “I used to have nightmares that my name would be on the list,” says one former employee.



.

The fear he can inspire gives a hint of his pugnacious temperament. It was on being fired from Citigroup in the late 1990s that he took up boxing. At Citi he helped Sandy Weill build the world’s biggest financial services group in a series of mergers. It was a strategy he was to repeat at Chicago-based Bank One, where he embarked on his own acquisition campaign that led to today’s JPMorgan Chase.



.

But the executives who surround him today are adamant that he fosters, not batters, talent. “There’s a particularly deep team here up on 48,” says Jimmy Lee, a veteran investment banker, whose office is next to Mr Dimon’s on the 48th floor of 270 Park Avenue, the bank’s headquarters. “The team is crazy deep. Pulled Mike [Cavanagh] off the bench to run this. How many people have a guy like Mike available?”



.

The loyalty from senior executives, whom Mr Dimon has kept dangling with his imprecise thoughts on retirement, can be matched by his loyalty to them. Some insiders say that can be damaging and that he delayed too long in accepting the resignation of Ms Drew, a 30-year bank veteran.



Others question whether as a charismatic, headstrong leader, he has enough people to stand up to himparticularly after removing rivals such as Bill Winters, co-head of the investment bank, two years ago.




One of Dimon’s great weaknesses is that he has not created any succession plan – he has kicked out anyone who really might challenge him,” said one person who knows him.



.

His executives insist they do say “no” to him. Mr Lee argues that Mr Dimon may seem an outsized presence in a world of lower-key peers, but not compared with historical forebears or contemporaries in other sectors.


.
Look in our industry at different times: obviously Pierpont Morgan was a big, larger-than-life leader. If you look at other industries, you get your Larry Ellison and Steve Jobs.”






Mr Lee, who was on Thursday toasting the pricing of Facebook’s initial public offering, on which JPMorgan acted as underwriter, says his boss has been involved in the social networking company’s flotation. “I’ll go into his office and ask him a question and he just immediately locks into my question and is completely zoned in on it, focused on it.”



.

But in Tampa for the bank’s annual meeting with shareholders on Tuesday, Mr Dimon looked tired. His usual rapid-fire delivery accelerated to such a pace that investors present seemed to struggle to make out the words.



.

The meeting was held at the Florida headquarters of TSS, Mr Cavanagh’s business and the unit responsible for the “plumbing” that moves tens of billions of dollars around the world every week. Unusually flat for most of the performance, after little sleep for days, Mr Dimon perked up after the formalities when a junior employee came to shake his hand. “You better not mess up,” Mr Dimon told him with a smile, “then we really would lose billions.”



.


Additional reporting by Gillian Tett, Ajay Makan and Dan McCrum



.
Copyright The Financial Times Limited 2012.