Why the US Federal Reserve should care about finance

A fresh approach to monetary policy should look at markets for signs of overheating

Rana Foroohar





Emerging market stocks, last year’s darlings, are collapsing. Does this mean the bubbles of an artificially inflated market are finally bursting? It is a question worth asking a decade on from 2008. As every Financial Times reader knows, the world’s central bankers were responsible for ensuring that the Great Recession did not become another Great Depression by keeping interest rates low and holding an eye-popping $15tn on their balance sheets.

This led to stock markets reaching all-time peaks, even as it has failed to create any sort of real wage growth. Central banks can create asset bubbles, of course, but they cannot change the wage-suppressing effects of globalisation, technology-driven deflation, and an increasing concentration of corporate power that makes it impossible for workers in rich countries to have any real bargaining power.

I am not faulting the US Federal Reserve, the European Central Bank or any of the other institutions that have run the world’s largest-ever experiment in unconventional monetary policy — although I would argue that, by this point, it is not so unconventional.

Since Alan Greenspan’s era in charge of the Fed, the bias has been to leave rates low and worry about the inevitable asset bubbles later. It is an understandable attitude, particularly given the inability of politicians in the developed world to push through big infrastructure plans, or educational reform, or other things that would actually change things for ordinary people, over the past 10 years.

But it is clear that we have reached the boundaries of what easy money can constructively do.

When 10 per cent of the US population owns 84 per cent of the shares, asset price increases do not create inflation, but inequality.

While Fed chair Jay Powell’s first major speech at Jackson Hole last month made it clear he would not move away from business as usual any time soon, I was most intrigued by a single passage at the very end. It seemed to indicate the Fed knows the current strategy is not really working any more.

“Inflation may no longer be the first or best indicator of a tight labour market,” he said, noting that “in the run-up to the past two recessions, destabilising excesses appeared mainly in financial markets rather than in inflation. Thus, risk management suggests looking beyond inflation for signs of excesses.”

Translation? The Fed chief is admitting that financialisation exists and the markets are now the tail that wags the dog. Central bankers and most economists tend to work with a model that assumes economic downturns create market downturns. But Mr Powell is hinting that the reverse may be true.

This is a big deal. But it is not really a new insight. Far from being a blind follower of “markets know best” efficiency theory, Mr Greenspan himself was well aware that easy monetary policy and stock prices could create bubbles in the market that may have terribly damaging real-world effects (he wrote a paper on the topic in 1959).

Why, then, did Mr Greenspan, and every Fed chief since, allow bubbles to expand and burst rather than getting out in front of them?

The particulars depend on the regime. Despite his sideways references to “irrational exuberance”, Mr Greenspan was a finance-friendly regulator who did not want the music to stop. His successors, Ben Bernanke and Janet Yellen, believed that low interest rates were the only thing standing between the American population and the breadline. Either way, politicians have never made it easy for central bankers to take the punch bowl away.

Does anyone doubt that this mega-bubble will eventually burst? When it does, the results will inevitably ripple through the real economy (academic research shows that most recessions since the second world war followed stock market collapses).

It is possible that the current downturn in emerging market stocks could spread and be the trigger for the economic slowdown that most people believe is coming in the next couple of years. Given this, I would argue we should drop the “wait and see” approach to monetary policy. Ten years after the crisis, and four decades after interest rates began their steady decline, it is time for a fresh approach to monetary policy.

What might this entail? For starters, central bankers should make financial markets a more central part of their models. It is amazing that they are not already front and centre, given the rise of financialisation since the 1980s. Mr Powell admitted that “inflation sends a weaker signal” now than in the past, which makes it important to look elsewhere for signs of overheating.

What metrics might the Fed and other central banks look at? I suggest three. First, the pace of run-up in debt, always the biggest predictor of market trouble. It has been growing more rapidly than gross domestic product for a number of years. The growth of financial assets relative to GDP is also near record levels. Margin debt, ditto.

Or, just take a walk around Brooklyn, where I live. In Bedford-Stuyvesant, a neighbourhood where street shootings are still an issue, a townhouse recently sold for $6.3m. As was the case before 2008, sometimes the best economic indicators are the ones next door.

The price of everything

A scramble to replace LIBOR is under way

Scandal and rickety economics have undermined the benchmark interest rate


SITTING in his office in the Wrigley Building overlooking the Chicago river in 2012, Richard Sandor, who has spent his career inventing financial products, was reading about the scandals surrounding the London Interbank Offered Rate (LIBOR), an array of interest rates set daily by a club of banks in Britain and used to price trillions of dollars’ worth of loans, derivatives and more. “This is stupid,” Mr Sandor recalls saying to a colleague. “Let’s make a bet; LIBOR will lose its pre-eminence.”

Two years later the Federal Reserve reached the same conclusion. It formed a group, the Alternative Rate Reference Committee, which has created a new benchmark dollar interest rate, the Secured Overnight Financing Rate (SOFR). Since April, SOFR has been used for a handful of bond offerings by large institutions including the World Bank, MetLife and Fannie Mae. Central banks in Britain, the euro zone, Japan and Switzerland are also constructing new benchmark rates.

LIBOR is heading for extinction. Its fate was sealed in July 2017 when Andrew Bailey, head of Britain’s Financial Conduct Authority, a regulator, said it would be phased out in 2021. It had been undermined by twin scandals. In the first, a product of the crisis, the rate-setting banks tweaked their quotes, possibly with supervisors’ implicit support, to limit the chances of market panic. In the second traders manipulated the rates subtly, to gild their profits.

The ruckus cost Bob Diamond, the chief executive of Barclays, his job and Tom Hayes, a trader at UBS and Citigroup who was jailed for 11 years, his liberty. Oversight of LIBOR was transferred from the British Bankers Association, a trade body, to British regulators and then to Intercontinental Exchange, an American stock- and derivatives-exchange group. In June Société Générale agreed to pay American authorities $750m to settle a charge of manipulation, adding to a list of seven other big banks. (The French bank also agreed to pay a large sum to settle charges related to a bribery scheme in Libya.)

From fiction to friction

LIBOR also rests on shaky economics. Its roots go back to an informal coalition of London banks in the 1960s. This was formalised into a panel of 20, which submitted daily estimates of their borrowing costs for up to five currencies and seven maturities of up to a year. Yet some quotes are little better than guesses. In July Randal Quarles, the vice-chairman of the Fed in charge of bank supervision, noted that just six or seven transactions a day were used to set one- and three-month dollar LIBOR and an average of one for the 12-month rate, for which on “many days there are no transactions at all”. A few banks have dropped out of the panel; some are staying until 2021 only at the FCA’s request.

On this flimsy foundation a staggering $260trn-worth of financial products, from interest-rate swaps to retail mortgages, are priced, estimates Oliver Wyman, a consulting firm. Dollar LIBOR accounts for by far the biggest chunk, not far short of $200trn; sterling and yen weigh in at $30trn apiece and Swiss francs at $5trn. The chief benchmarks for euros, EURIBOR and EONIA, face an even tighter timetable for reform and replacement than LIBOR. (EONIA does not comply with a recent European Union directive and must go by the end of 2019.)

Creating and then switching to truly market-based alternatives is an almighty task. The Fed’s approach was to tap into the “repo” (repurchase) market. Banks seeking short-term cash sell securities with little credit risk, such as Treasuries, to other banks with a promise to buy them back the next day at a slightly higher price. The difference is in reality the interest rate on an overnight loan. To ensure repayment, they provide collateral. There are $700bn-worth of these transactions daily, which are reported to the Fed through the Depository Trust & Clearing Corporation and the Bank of New York Mellon. After ingesting and processing vast quantities of data to produce a weighted average, the Fed publishes the result, SOFR, at 8am.

Take-up has been slow. So far only seven or eight bonds have been sold using SOFR as a reference price. Doubtless this is partly because of investors’ unfamiliarity with a new product, compounded by the Fed’s inability to explain itself to those who do not understand its jargon. But it may also reflect difficulties with using overnight, near-risk-free rates.

For a start, an overnight rate is exactly that: a term structure has to be constructed for longer maturities, for instance from expected or actual overnight rates. SOFR also reflects the rate on extraordinarily high-quality, essentially risk-free credits, which would default only if America’s government failed. Using it as a benchmark may therefore risk creating a mismatch for the average bank. In a crunch, SOFR may fall as investors run for safe assets, pushing down banks’ revenues from SOFR-linked loans. Yet banks’ own borrowing costs on wholesale markets will increase.

In addition, legal problems loom, and time is short. Contracts continue to be written on LIBOR, of which plenty extend beyond 2021. The Bank of England noted in June that the number of such LIBOR-linked sterling derivatives had risen since the previous year. Many contracts, the bank went on, lack “fallback” clauses setting out which rate applies once LIBOR goes. British regulators wrote to banks on September 19th instructing them to provide by December a summary of their plans for mitigating LIBOR-related risks.

Meanwhile Mr Sandor has developed his own benchmark, which is steadily attracting customers. By 2015 he had convinced a handful of small banks to join his new American Financial Exchange, which now has 99 members and where $1bn-worth of loans are traded daily. From those transactions, a benchmark overnight interest rate for unsecured loans, Ameribor, has been derived.

This month Ameribor was used for the first time in pricing a loan, by ServisFirst Bank of Birmingham, Alabama, to a car dealer in Tennessee. The bank’s chief executive, Tom Broughton, says that it considered SOFR, but because it does not use Treasury repos and its liabilities are not secured, it needs a rate that can accommodate credit risk. Mr Sandor hopes that in two to three years Ameribor will become a benchmark for many of America’s 5,000 regional and community banks and their customers. Whether or not that happens, the era of LIBOR is ending.

Turning Point?

- The "divergence" narrative has gone mainstream, with even the Wall Street Journal running a feature piece documenting the historic disparity between U.S. stocks and the rest of the world.

- There are signs that September marked a turning point beyond which ex-U.S. assets, and EM particularly, should be due for a tactical bounce.

- Here's an in-depth breakdown of the arguments for and against the "convergence" trade complete with a table documenting the history of U.S.-EM divergences.
 

 

You'd be forgiven for pondering whether now is an opportune time to buy the dip in emerging market assets and ex-U.S. assets more generally.

 

Even the Wall Street Journal has picked up on the "divergence" narrative. On Monday, the paper ran a feature story called "U.S. Stocks Widen Lead Over Rest of the World" the point of which is to highlight what I've been documenting for going on two months in these pages and elsewhere.

 

It's been a horrendous year for emerging markets (hereafter "EM"). Have a look:

 

(Barclays)

 

 

While it was initially possible to argue that weakness in developing economy assets was primarily down to the effect idiosyncratic flareups (e.g., Turkey and Argentina) had on sentiment, it's become abundantly clear over the past six or so months that the proximate cause for the malaise is the Fed's tightening cycle.

 

Sure, country-specific risk is at play, but even if you want to suggest that sentiment wouldn't have turned so sour so quickly were it not for the collapse of the Argentine peso and Turkish lira, you run into a chicken-egg problem pretty quickly.

 

That is, was the combination of December's poorly communicated decision to up the inflation target and a couple of equally ill-advised policy rate cuts (in January) just too much for investors when it came to Argentina? And did market participants finally decide that enough is enough when it comes to Turkish President Recep Tayyip Erdogan's autocratic tendencies and unorthodox economic views?

 

Or were Argentina and Turkey simply the wobbliest dominos in an environment where the post-crisis dynamics that drove investors out of the risk curve in search of yield are reversing thanks to Fed tightening? Again, it's a bit of a chicken-egg dilemma.

Whatever the case, what's clear is that Jerome Powell was mistaken when he said the following at an IMF/SNB event back in May:

Monetary stimulus by the Fed and other advanced economies played a relatively limited role in the surge of capital flows to (emerging market economies) in recent years. 

There is good reason to think that the normalization of monetary policy in advanced economies should continue to prove manageable for EMEs. Markets should not be surprised by our actions if the economy evolves in line with expectations.

 

Days after those comments were delivered, I wrote something for this platform called "Jerome Powell May Live To Regret These Statements." Here are some excerpts from that post:

The bottom line is that while there are signs that the EM pain may be short-lived, the problems in Turkey and Argentina aren't going to be resolved any time soon and it seems just as likely as not that the dollar will continue to be underpinned by higher rates in the U.S. and expectations of a more aggressive Fed. 

My contention is that Jerome Powell will live to regret the statements excerpted here at the outset.

 

That was on May 13. Since then, the Turkish lira and the Argentine peso have collapsed and EM equities (EEM) as a group have fallen 11% and nearly 15% at the lows on September 11.

 

In the three months from the publication date on that article and the August highs, the broad dollar (UUP) was up more than 4%.

 

Fast forward to late September and the market was abuzz with talk of the "convergence" trade, something I've detailed both here and on my site at great length. The week before last, that trade worked exceptionally well, depending on how one wanted to express it.

 

At the heart of the convergence narrative is the idea that EM assets will play catch up to their U.S. counterparts through year-end. There are a number of arguments you can make in favor of that view, not the least of which is that the space is just plain old oversold. One might also argue that the scope of the dollar rally and commodities selloff simply isn't comparable to the 2014-2016 episode. That's one argument JPMorgan's Marko Kolanovic makes in his latest note.

 

Here's an excerpt:

Our view in favor of a rotation towards the RoW and EM is based on the premise that the global growth cycle is not over and that stresses in EM are much less severe than those leading into the 2015 crisis. Why is the current situation different? One can look at the scale of two important drivers of EM stress: USD and commodities.  

In 2014-16, the USD rallied ~25%, which should be compared with a ~5% rally in the current episode. Being already near the top of the ~5-year range, there is a low probability the USD can go another 10% or 20% higher (e.g., Trump or the Fed would likely not allow it). Also if one looks at commodity prices, in 2014-16 they declined by ~45% vs. a more modest ~7% decline this year. So by these measures the current stress is five times smaller than what was experienced in the 2014-16 time period. However, we do acknowledge that interest rates are higher in the recent period. We agree that current EM fundamentals are worse than those of DM, but given the recent price action, EM could be the best-performing assets from now to the end of the year, and still be the worst-performing assets for the year.

I'll show you what Marko means. Here's a comparison of the 2014-2016 dollar rally versus the greenback gains since April:

 

 

(Bloomberg)

 

And here's a visualization of Marko's point about weakness in commodities:

 

 

(Bloomberg)

 

 

That comparison suggests the pain in EM is perhaps overdone.

On top of that, EM central bankers have done a fairly admirable job of trying to stay ahead of the game. A series of rate hikes from Turkey, Russia, Indonesia and Argentina suggest policymakers are acutely aware of the risks, but it’s by no means clear they’ll be able to stay out ahead of the storm with a December Fed hike baked in.

 

Consider, for instance, the following chart which shows the Indonesian rupiah plotted with Bank Indonesia's policy rate:

 

 

(Bloomberg)

 

 

That's not a great sign. Indonesia has hiked five times since May to no avail when it comes to shielding the currency.

 

Meanwhile, there's trouble in India. If you aren't up to speed on recent turmoil in the previously buoyant Indian equity market, there's a quick primer here, but suffice to say it's yet another example of a "Fed-induced Tightening Tantrum" (to quote Nomura's Charlie McElligott). Have a look at this:

 

 

(Nomura, Bloomberg)

 

 

Still, September wasn't horrible for EM. In fact, following a truly harrowing first couple of days, developing nation currencies managed to recover and by the end of the month, logged their first monthly gain in six on MSCI's gauge:

 

(Heisenberg)

 

Also, have a look at the following visual which plots the ratio of EM FX volatility to G7 FX volatility against the dollar:

 

 

(Bloomberg)

 

 

That's an important chart. Simply put, it illustrates how critical it is for EM stability that the dollar take a breather for a while.

 

As far as flows go, it's worth noting that last week, EM-dedicated bond funds enjoyed their largest inflow since April:

 

(Barclays, EPFR)

 

 

In short, EM has a bit of an "it's always darkest before the dawn" feel to it right now.

 

But before you go "bargain" hunting, do note that nothing has really changed in terms of the factors that are weighing on the space. That is, the bull thesis seems very tactical rather than fundamental.

 

The Fed's tightening cycle isn't over yet, although it likely will be sometime next year. In the week through Tuesday, the net spec dollar long didn't budge ahead of the FOMC meeting and is still very stretched, suggesting some folks don't see a good reason to bet against the greenback just yet:

 

(Bloomberg)

 

 

As long as the dollar and USD short rates are rising, there will be pressure on risk assets, including and especially EM.

So if you're planning on playing the "convergence" trade, you do want to exercise caution and understand the risks.

 

With that, I'll leave you with a brief excerpt and a great visual from a Goldman note out Sunday that documents the history of U.S.-EM divergences and details how those episodes ultimately played out:

A concrete take-away from the historical playbook is that divergence tends to result in EM rallying (8 of the 10 episodes). Half of these rallies are substantial in length (12 months or longer) and half are relatively short-lived (~4 months). The remaining 2 episodes of divergence resulted in both the S&P 500 and MSCI EM selling-off; in other words, there is no divergence episode that was resolved by S&P 500 immediately catching down to MSCI EM.

Buttonwood

Why Italy’s government bonds are so unstable

If you fret about the euro’s survival, Italian bonds might be the last asset you sell




A SHREWD observer of London’s after-work drinking culture once offered the following bit of mathematical heterodoxy to explain it: “There is no number between two and six.” If you go out with colleagues and stop at two drinks, you will be able to summon the will to go home at a reasonable hour. After a third drink, another will seem like a good idea—and another, and another. You will be on course for a hangover.

A modified version might apply to Italy’s bond market. As long as yields are two-point-something or lower, they are sustainable. At that level, the bonds are safe. Italy’s public finances are stable. As yields rise above 3%, they may become unmoored. The bonds start to look like speculative instruments. The stability of public finances is in question. Yields might plausibly spike to 6% or more.

It is thus a source of anxiety that Italy is on its metaphorical third pint, with yields on ten-year government bonds hovering around the 3% mark. In part this reflects lingering concerns that Italy’s coalition government will table a budget for 2019 that breaks the euro zone’s fiscal rules. More generally, investors are asking themselves what is the right price for Italian risk. The wiser among them admit that they simply do not know. For Italy’s bonds come with a set of implicit options attached that make them tricky to price.

To make sense of Italy’s bond markets, it helps first to make a distinction between safe assets and credit securities. An American Treasury bond is the archetypal safe asset. Yields are largely determined by the interest-rate policy of the Federal Reserve. Bondholders do not worry much about the federal government’s ability to service its debts, which are, after all, in the currency it issues. The typical credit security is a dollar bond issued by a company, such as GM or Apple, or by a country, such as Brazil or Mexico. Its yield will vary with that of a Treasury of the same maturity, with an interest-rate premium, or “spread”, to compensate bondholders for the risk that the borrower might not earn enough dollars to pay its debts.

Neither IPA nor lager

It is hard to draw a line between safe bonds and credit in the euro zone. In contrast with America, there is no unique issuer of the currency. The European Central Bank (ECB), a sort of joint venture, prints the euros. German bunds are treated as the benchmark safe asset, simply because Germany is the zone’s largest economy and has a reputation for thrift.

Which other countries might qualify is a subject of lively bar-room debate. The ECB’s quantitative-easing programme gave the appearance of safety to all euro-zone government bonds, even Italy’s. The ECB in effect covered Italy’s net bond issuance over the past three years, says Lorenzo Codogno, of the London School of Economics. But QE is coming to an end. Other buyers must be found. It is not a coincidence that anxieties about Italy’s public debts, sickly economy and fractious politics have resurfaced.

To make matters worse, Italy’s bonds are not a straightforward credit in the way that, say, Mexico’s dollar bonds are. They come with more implicit options. How should investors, for instance, treat the pledge made in 2012 by Mario Draghi, the ECB’s boss, to do “whatever it takes” to save the euro? When push comes to shove, the ECB might decide that an Italian default would be fatal to the single currency and start buying bonds again. Or it might not. This kind of vague, embedded option is difficult to value. Andrew Balls of PIMCO draws a parallel with the mortgage-backed bonds that were central to the global financial crisis. They once seemed safe. But they became so complex and opaque that they could not be priced.

Bonds are supposed to be simple. Italy’s are not. They are not an investment to buy for your widowed aunt. But some investors do not have the luxury of steering clear. Euro-zone insurers are all but compelled to own sovereign euro bonds and Italy’s market is the largest. The country thus looms large in the bond indices that are a benchmark for many asset managers. If you fret about the euro’s survival, Italian bonds might nonetheless be the last asset you sell. At least you are getting a higher yield in return for the risks. You are paid for your discomfort. That is not true of French bonds, which trade at only a small premium to Germany’s.

Think of the euro-zone bond market as an after-work drinks party. Germany dislikes buying drinks for others, and so has gone home. Italy is on its third trip to the bar. France, which is nursing its first drink, insists that it is leaving soon. But if a fight breaks out, it will get drawn in.

Coping With Venezuelan Migration

By Allison Fedirka

Summary For years there have been stories from Venezuela about food shortages, import cuts and dwindling international reserves. The Venezuelan economy has crumbled before our eyes. President Nicolas Maduro’s downfall has been a question of when, not if. We’re still waiting for the collapse, but Venezuela has finally reached a tipping point. Initially, when the formal market failed, an informal market appeared to fill the void. Where bartering and the black market couldn’t meet basic needs, people would cross into other countries like Colombia to buy what they needed before crossing back. As goods became scarcer and income fell, people stopped coming back. Many opted to go to Colombia, while those with the will and the means frequently opted for faraway places like the United States or southern Europe. In the past year, the informal market has apparently started to fail too. A June 2018 survey by Venezuela’s Consultores 21 found that Venezuelans of every social standing and political persuasion want to leave the country. It found that 54 percent of the upper-middle class and 43 percent from the lower class want to emigrate, as well as 66 percent of Chavistas, 63 percent of supporters of the Democratic Unity Roundtable opposition coalition and 58 percent of other opposition supporters. Even 17 percent of Maduristas, the president’s loyalists, expressed a desire to leave. Leaving is no longer just for the opposition or the wealthy. Venezuelans’ hope for their country’s future is fading too. A strong opposition majority elected to the National Assembly in December 2015, combined with massive protests and rallies throughout 2016, failed to affect real change. Protests still occur, but not of the same magnitude as before. Since 2015, approximately 2.3 million people (7 percent of the population) have emigrated, according to an International Organization for Migration report, and most of those left in the past year. What matters now isn’t what this means for Venezuela – the answer to that question has been obvious for some time – but what it means for the South American countries now trying to cope with Venezuela’s migration crisis. This Deep Dive will identify the countries experiencing the greatest disruption and explain how their governments are responding. It will then examine the broader problems affecting all affected countries – health risks, the job market, the costs of government responses and the political repercussions of mass migration. Finally, it’ll provide an overview of the challenges ahead. Ultimately, we aren’t optimistic about the abilities of these governments to coordinate a response, and though some will fare better on their own than others, every country for itself isn’t a recipe for a stable region in the future.   Regional Impact International Organization for Migration data shows that of the 697,500 Venezuelans who left the country in 2015, 73 percent went to the U.S., Canada or southern Europe (Spain, Italy or Portugal). These were the ideal destinations for people who could afford to get there. But in the past two years, as the situation has reached a breaking point and the profile of those wanting to get out has broadened, the acceptable destinations have gotten much closer – putting South America at the center of the migration crisis. Of the 1.64 million Venezuelans who left the country in 2017, 53 percent stayed in South America. The advantages of South American countries are their proximity, the relatively low cost of travel, their common language (save Brazil), their lower cost of living compared to the U.S. or Europe, and the fact that they have large informal economies, enabling immigrants to jump immediately into work. But the South American countries suddenly facing an influx of Venezuelan migrants were overwhelmed. Over the past few years, the regional rhetoric against the Maduro regime has increased, but little concrete action was taken. Critics feared making things worse inside the country and the dangerous precedent that would come with supporting the removal of another leader in the region. But the flood of Venezuelans into other South American countries is putting a large political and economic strain on those countries that cannot be ignored.   Colombia At the start of Venezuela’s economic downturn, neighboring Colombia was a place for struggling Venezuelans to go to buy goods that were scarce at home. People would cross the border for the day or the weekend into towns like Cucuta and then return home. As the situation worsened, they stopped returning home. Colombia is now the largest destination for Venezuelan migrants and is a transit country along the way to South America’s west coast. The government has started sounding the alarm bells. The problem is the sheer volume of immigrants. Colombia’s director of migration reported that at the end of 2017, the country had more than 550,000 Venezuelans. Just six months later, he said the figure had risen to 870,093, accounting for 1.7 percent of Colombia’s population.   (click to enlarge)   By 2016, the Colombian government was already taking administrative measures such as a wildly unsuccessful border mobility card system to track the movement of Venezuelans. By 2017, Bogota had installed new border control checkpoints and introduced a Special Permit of Permanence, or PEP system, to help normalize the legal status of Venezuelans entering the country. Once they have legal status, Venezuelan migrants can work and access social services. In July, about 381,700 had some type of legal status. Just before leaving office in August, President Juan Manuel Santos signed a decree to normalize an additional 442,000 Venezuelans and bring them into the PEP system. Though Colombia is coping, the foreign minister made it clear that his country can’t take the lead on a migration crisis and that Colombia would seek help from the international community.   Brazil Brazil is a melting pot of immigrants, but even it was unprepared for the recent flood of Venezuelans. What started as a trickle into the state of Roraima around 2015 became a deluge in 2017. That year, the number of Venezuelans entering Roraima increased sevenfold to 35,000. From Jan. 1 to June 22, 2018, the Brazilian Federal Police received 16,953 applications for refugee status. Of those, 16,523 – more than 97 percent – were from Venezuelans. This is more than 20 percent higher than the total number of requests from Venezuelans for all of 2017 (13,583). Brazil’s Federal Police estimate that there are now at least 50,000 Venezuelans in Brazil. Half of them are in Roraima’s capital, Boa Vista, where they represent 7.5 percent of the city’s 332,000 inhabitants. (click to enlarge)   In need of a government response, Brazil’s National Council of Immigration issued a resolution in March 2017 that permitted Venezuelans to apply for two-year temporary residency and eliminated migratory fees for people in need. In February 2018, President Michel Temer declared Roraima to be in a state of vulnerability because of immigration and increased the number of border guards to 170. In April, the government implemented its acclimation and relocation program, which provides legal status for Venezuelans in the country as well as medical exams, vaccinations, access to public health care, schooling for children, language courses and job training. In August, the government started trying to limit the entrance of Venezuelans through visa checks and additional military deployments to the border.   Peru Peru, which boasts one of the most stable economies in South America, is an increasingly popular destination among Venezuelans. Many enter in the northwest through Ecuador and stay, while others continue on to Chile. In 2015, there were only 433 requests for refugee status in Peru. In 2016 and 2017, the government received a total of around 34,000 requests. And 2018 is on pace to rocket past those figures – to date, there are an average of 14,000 applications per month. In July 2018, the country’s National Superintendence of Migration reported that there were 368,000 Venezuelans in Peru and that as many as 46,000 had entered the country in 2018 alone. The foreign minister said at the end of August that there were now over 400,000 Venezuelans in the country. The Peruvian government has had to move quickly to catch up with the influx of immigrants. In August 2017, the National Superintendence of Migration announced that it would activate a hotline to organize the issuance of temporary permits of permanence (a program started in January) to Venezuelans who had entered the country. The measure allowed Venezuelans to normalize their legal status, work legally, access social services, get a tax ID number and integrate into the tax system. This proved inadequate, and over the past year officials set up extra facial and fingerprint recognition systems along the border, revamped websites related to immigration services, and set up screening and processing modules throughout Lima, with plans to add 10 more throughout the country. Finally, on Aug. 25, the government said a passport would be required for entry in the hope that it will help stem the flow of immigrants.   Ecuador Located between Peru and Colombia, Ecuador has mostly been used as a transit country. Since 2016, however, there has been a marked increase in Venezuelans living in the country’s central provinces. The National Secretariat of Communication reported that from January through August this year, 641,353 Venezuelans entered Ecuador. Of those, 525,663 left for other South American destinations. In other words, 115,690 – just under 20 percent – remain in Ecuador. (click to enlarge)   Ecuador’s government was not prepared for more Venezuelans to stay in the country. Ecuadorian law provides temporary residence for those who can prove economic solvency and come from a member of the Union of South American Nations, meaning that Venezuelans with the means can automatically stay for two years. The government has now started taking steps to control the flow of Venezuelans. It has organized bus trips to bring Venezuelans from their point of entry down south to Peru. The government also tried changing the law so that Venezuelans would need to show passports to enter – currently, they need only to show national IDs – but that was overruled by a court. Ecuador has not ruled out instituting some type of quota system.   Common Challenges The sudden arrival of hundreds of thousands of desperate people poses unique challenges for each South American country, but some challenges are shared. The health risks that accompany mass migration rank as the most immediate concern among these governments. Basic sanitation is a serious issue. Many of the cities around entry points to these countries were not built to handle an influx of tens of thousands of people. The Ecuadorian and Peruvian governments declared localized states of emergency in areas of high migration to facilitate the allocation and delivery of government resources to these areas. Brazil has been sending extra doctors to Roraima since 2017. A secondary concern is the potential for disease to spread. Earlier this year, there was a measles outbreak in Venezuela. The Pan American Health Organization’s July update for measles said there are now 2,472 confirmed cases, up 45 percent from June, in 11 American countries. Venezuela accounts for 1,613 of the cases, and Brazil ranks second with 677. These two countries also accounted for over 92 percent of the new cases reported. Governments risk backlash from local populations if they are seen as being unresponsive to major health risks in the general populace. There are also potential economic consequences. The biggest concern is labor. Informal labor markets are large in these countries: They serve as major revenue sources for the local population, but they also account for 70 percent of the work that Venezuelans find upon arrival in a new country, according to the International Organization for Migration. Job competition in the informal market is a concern, as is the suppression of wages in formal employment sectors. Many Venezuelan emigrants have university degrees or technical training. Though these concerns exist throughout the region, they are especially pronounced in Peru. Another economic concern for governments is the cost of supporting mass immigration. Even basic operations such as providing security, administrative processing and sanitation measures at border crossings are expensive. Relocation programs, job training and health care for tens of thousands of people is even more so. Brazil still has not fully recovered from its 2015-16 recession, and the government has been struggling for the past two years to reduce spending. Ecuador is in the midst of recovering from low oil prices and transitioning the economy from high levels of government intervention to more open market conditions. And with so few resources to go around, governments must answer tough questions from voters about why so much is being spent on Venezuelans when the native poor populations have so much need for financial sustenance. (click to enlarge)   Finally, there are the domestic political questions, which will vary for each country. Immigration is by nature a divisive issue. In the case of Venezuelan immigration, anti-immigrant sentiment and political instability will start in border locations with high concentrations of immigrants. Venezuelan immigration has had a huge impact on Brazilian politics, made stronger by the fact that there are elections in October. Tensions were already high between Roraima and the federal government. The state believes the federal government has not provided enough assistance. It also resents the fact that the courts denied its request to close the border with Venezuela. And the immigration debate ties into the national debate about the role of the military in society.   Courses of Action  For the affected countries, the solution involves managing the migration flow rather than trying to bring about regime change in Venezuela. In the short term, regime change would have the opposite of the desired effect. It’s a messy affair when governments fall – transition periods are chaotic, and there is always the rebuilding phase. Regime change would motivate people to leave and wait for stability to be restored before returning home. Moreover, are reluctant to use force to depose a leader out of fear that it would set a precedent that could one day turn against them. And the affected countries lack the spare resources and public support for such action anyway. For now, at least, governments will pursue solutions on the domestic level first. Before taking any decisive measures, one major challenge must be overcome: figuring out the size and scope of the migration issue. Massive amounts of data need to be processed to track who enters and exits – often at different locations. In the case of irregular migration, it may take several months to estimate those figures. Many of the national institutions charged with this task were not designed to deal with issues of this magnitude. Peru’s immigration services are still processing temporary permits of permanence from 2017. Colombia and Peru exchanged basic data on registered Venezuelans, only to discover that some individuals were registered in both countries and reaping the benefits from both. All four countries have resorted to executive decrees to expedite the status of migrants, deploy security forces and/or free up other resources related to humanitarian aid. Affected countries met on Tuesday to exchange ideas and assess the problem. They called for countries to find means to continue accepting Venezuelans, but joint statements won’t solve the problem. Each country has very different capacities to absorb new populations. Brazil is a huge country capable of accepting large numbers of people and with a long track record of integrating foreigners. This is not the case for Ecuador, which is about 30 times smaller than Brazil and has one-eighth the population. And the lack of any existing regional framework severely limits the ability to take a regional approach toward addressing Venezuelan migration. The urgency of the situation does not allow for time to be spent crafting such a framework. Most important, each country will put its national interests ahead of regional cooperation. No country in the region can single-handedly absorb all the Venezuelan emigrants, nor is there a country that can foot the bill for supporting programs in neighboring countries. Cooperation will occur where it suits national interests, provided it doesn’t bind countries to specific courses of action. Where it will be easy for the region to find common ground is in the call for international support – ideally from a multilateral group like the United Nations – and aid to help mitigate the effects of the migration wave.