ERNs Rather Than CoCos?

The Economist reports about a proposal by Jeremy Bulow and Paul Klemperer for equity recourse notes (ERNs) that could bolster a bank’s equity after negative shocks. While contingent convertible bonds (CoCos) are converted into equity when bank capital falls below a defined threshold, ERNs would convert when the share price fell below a trigger price. Moreover, the new shares would be valued at the trigger price even if the share price had fallen much lower. Low share prices thus would trigger both a conversion and a partial default.

Olivier Blanchard To Leave IMF

Chris Gilles reports in the FT about Olivier Blanchard’s plans to retire as IMF chief economist. Olivier emphasized the importance of academic research and challenged the Washington consensus. Under his watch, the IMF

  • questioned the benefits of unrestricted capital flows;
  • suggested higher inflation targets;
  • emphasized costs of “austerity.”

As the article points out not all of these initiatives were successful.

Fintech Competition for Banks

In a series of articles, The Economist reports about technology companies that compete with traditional banks in areas ranging from lending to payments and wealth management.

The introductory article refers to AngelList and references reports by Goldman Sachs (The Future of Finance, copy posted here), BCG and Accenture. And it highlights two factors driving the structural change which I have also emphasized in a recent article: Technology and vanishing trust in banks. The other articles cover:

Updates—some more firms in the business:

CreditGate24.

Pressure to Liberalize Services in Germany

Joachim Jahn and Manfred Schäfers report in the FAZ about pressure by the European Commission and the IMF to liberalize personal services in Germany. The IMF expects less regulation/protection of architects, tax advisors and the like to increase services growth. The tax advisors warn that liberalization would create conflicts of interest for the service providers.

Greece’s IMF Loan Rollover

Kerin Hope and Shawn Donnan report in the FT that Greece used IMF special drawing rights to repay the IMF loan.

Members are required to pay a nominal interest rate to the IMF on the gap between their actual SDR holdings and their allocation, making this week’s move by Athens the equivalent of taking out a low-interest loan from the fund to pay off another.

Greece Will Default …

… or so it seems. Kerin Hope reports in the FT that

[t]he Greek parliament has approved a law proposed by the leftwing Syriza-led government overturning civil service reforms by the previous government aimed at streamlining the country’s inefficient public sector.

13’000 civil servants are to be rehired. The “institutions” have not been consulted. The municipal police force will be revived.

Swiss Withholding Tax Refunds Subject to Restrictions

Katharina Fontana reports in the NZZ about a decision by Switzerland’s highest court concerning the refund of withholding tax on dividends to foreign investors. According to the ruling such refunds may be denied if the investors are found to have engaged in financial engineering with the purpose to help clients circumvent the Swiss withholding tax.

Greece vs Eurozone vs IMF

Peter Spiegel reports in the FT that

Greece is so far off course on its $172bn bailout programme that it faces losing vital International Monetary Fund support unless European lenders write off significant amounts of its sovereign debt, the fund has warned Athens’ eurozone creditors.

Update (May 6, 2015)

According to other reports the IMF downplays disagreement among lenders. Peter Spiegel and Stefan Wagstyl report in the FT:

Officials involved in the talks said the IMF was not seeking large-scale debt relief immediately. Instead, it was warning that any concessions to Athens that allowed the government to post lower budget surpluses — the likely trajectory of the current talks — would require debt relief to make up the difference.

And Ht reports in the NZZ: According to an IMF spokesperson

Poul Thomsen, der Chef der Europaabteilung des Fonds, [hat] in jener Sitzung darauf hingewiesen, dass der Bedarf an zusätzlicher Finanzierung und an Schuldenerleichterungen zur Sicherstellung der Schuldentragfähigkeit umso grösser werde, je mehr man in den Verhandlungen von den ursprünglichen, 2012 vereinbarten Massnahmen und Zielen (des zweiten Hilfspakets) abweiche.

… Doch Moscovici betonte am Dienstag, über die Schulden werde man erst nach einer Einigung über das Reformpaket reden können. Es ist ein offenes Geheimnis, dass dannzumal auch über ein drittes Hilfspaket gesprochen werden muss.

Richtig ist laut Verhandlungskreisen, dass der IMF an den Treffen der «Brussels Group» eine besonders harte Haltung gegenüber Athen einnimmt. Er muss seine eigenen Regeln unter anderem bezüglich der Schuldentragfähigkeit einhalten, um weitere Gelder auszahlen zu können. Am anderen Ende des Spektrums der beteiligten Institutionen steht die EU-Kommission, die ein Auseinanderbrechen der Euro-Zone um fast jeden Preis verhindern will. Werde deren Irreversibilität angetastet, komme sofort die Frage auf, wer der Nächste sei, sagte Moscovici.

In the meantime, the Greek government argues that disagreement among “institutions” makes it impossible to find a compromise. Panagis Galiatsatos reports in the NZZ:

… der Internationale Währungsfonds (IMF) bestehe mit Vehemenz auf strukturellen Reformen (Rentenreform, Liberalisierung des Arbeitsmarkts) und mehr Flexibilität bei der Bestimmung der Primärüberschusses, weil er von einem weiteren Schuldenschnitt ausgehe. Im Gegensatz dazu verlange die EU-Kommission, die einen Schuldenschnitt partout nicht wolle, hohe Primärüberschüsse. Das beweise, dass die Gläubiger in keinem Verhandlungsfeld kompromissbereit seien, während die griechische Regierung Kompromissbereitschaft signalisiert habe.

Schools in Sweden

An OECD report proposes measures to slow the decline in the performance of school children in Sweden. They include (pp. 8-9):

… setting clear and high expectations for all students, building on current curriculum goals with a focus on developing core skills and enhancing skills for the 21st century.
…ensure a better disciplinary climate and teaching and learning approaches that respond to diverse student learning needs, including low and high performers.
Improve the access of disadvantaged families to information about schools and support them in making informed choices. In addition, introduce controlled choice schemes that supplement parental choice to ensure a more diverse distribution of students in schools.

Hypo Group Alpe Adria

The “Independent Commission of Inquiry for the Transparent Investigation of the Events Surrounding the Hypo Group Alpe‐Adria” published its report in December 2014. The summary of the abstract:

The events surrounding HGAA are characterised by undesirable developments and mistakes on the level of the Land and of the Federation. The quick expansion of the bank was only possible due to the liability of the Land of Carinthia, without the latter having been able to fulfil the respective obligations. When the crisis became obvious, the responsible decision‐makers refrained from adequately processing the necessary information, from examining the legal framework to a sufficient degree and from proceeding in a strategic way by developing alternative scenarios and making decisions based on those scenarios.

This began with the Land of Carinthia maintaining its liability for the debts of HBInt and HBA in spite of the rapid expansion abroad. The Land was responsible for a bank whose management tried to exploit the business opportunities in South Eastern Europe without being equipped with the necessary risk management systems and control mechanisms. It is not apparent that the auditors, the bank supervision and the Land of Carinthia (Kärntner Landesholding) made sufficient use of the opportunities open to them in order to work towards limiting the risks.

This continued with the decision of the Republic of Austria to purchase all shares of HBInt without sufficiently examining alternative scenarios and implementing them into a negotiating strategy.

And it ended ‐ in relation to the investigation period ‐ with the lack of a strategy for the time after the nationalisation: The State aid proceedings were not conducted with the necessary commitment; the decision on the establishment of a bad bank was delayed based on extraneous motives; the reappraisal of the past became an end in itself.

Against this background, the Land of Carinthia must be blamed for maintaining its liability thereby enabling the bank to expand abroad despite a lack of sufficient control systems. As regards the Federation, it must be held that the nationalisation cannot be referred to as „emergency nationalisation”, because it was – at least as regards its embodiment – not the only alternative. And it cannot be conceded that as the sole owner of HBInt the Republic of Austria took its decisions for the benefit of the bank and of the public.

Ayn Rand‘s “Atlas Shrugged”

Ayn Rand‘s master work about mind, productive man and his liberation. More than a thousand pages long but rarely tiresome (except for John Galt’s radio speech) the novel blends thriller with common economic sense and Rand’s philosophy of objectivism.

The economics makes sense—incentives matter and give rise to a trade-off between efficiency and equity; but it is crude—market failure is neglected. The most interesting element in the incentive problem faced by the government sponsored “looters” and “leeches” is the sanction of the victim.

The philosophy (as summarized at the end of the paperback) is less convincing; it certainly does not follow from the economics. Much more on objectivism on the website of the Ayn Rand Institute.

Debt Supercycle rather than Secular Stagnation

In a Vox column, Ken Rogoff argues that the world economy experiences a “debt supercycle” rather than the onset of secular stagnation in the West.

Rogoff argues that macroeconomic developments since the financial crisis are in line with historical experience, as documented in his book “This Time is Different” (with Carmen Reinhart): A large fall in output followed by a sluggish recovery; deleveraging; protracted higher unemployment; and a strong rise of the government debt quota are typical after a boom and bust of house prices and credit.

According to Rogoff, policy makers should have implemented more heterodox policies including debt write-downs; bank restructurings coupled with recapitalisations; and temporarily higher inflation targets. Rogoff supports the (in his view, orthodox) fiscal policy responses that were adopted but criticizes that many countries tightened prematurely.

Rogoff acknowledges that secular forces shape the macroeconomy, in particular population ageing; the stabilization of the female labor force participation rate; the growth slowdown in Asia; and the slowdown or acceleration (?) of technological progress. But

[t]he debt supercycle model matches up with a couple of hundred years of experience of similar financial crises. The secular stagnation view does not capture the heart attack the global economy experienced; slow-moving demographics do not explain sharp housing price bubbles and collapses.

Rogoff doesn’t accept low interest rates as an argument in favor of the secular stagnation view. Rather than reflecting demand deficiencies, low interest rates (if measured correctly—Rogoff expects a utility based interest rate measure to be higher) could reflect regulation (favoring low-risk borrowers and “knocking out other potential borrowers who might have competed up rates”) and to some extent central bank policies.

Rogoff argues that the global stock market boom poses a problem for the secular stagnation view. He proposes changed perceptions about the likelihood and cost of extreme events (Barro, Weitzman) as factors to explain both low real interest rates and the stock market boom (after an initial asset price collapse during the crisis).

Regarding policy prescriptions to expand public investment in light of the low interest rates, Rogoff notes that

it is highly superficial and dangerous to argue that debt is basically free. To the extent that low interest rates result from fear of tail risks a la Barro-Weitzman, one has to assume that the government is not itself exposed to the kinds of risks the market is worried about, especially if overall economy-wide debt and pension obligations are near or at historic highs already. [Moreover] one has to worry whether higher government debt will perpetuate the political economy of policies that are helping the government finance debt, but making it more difficult for small businesses and the middle class to obtain credit.

Rogoff considers rising inequality to be problematic (and a possible factor for higher savings rates):

Tax policy should be used to address these secular trends, perhaps starting with higher taxes on urban land, which seems to lie at the root of inequality in wealth trends

He concludes that the case for a debt supercycle is stronger than for secular stagnation:

[T]he US appears to be near the tail end of its leverage cycle, Europe is still deleveraging, while China may be nearing the downside of a leverage cycle.

US Purchasing Power

In a Vox column, Bob Hall argues that in the US, “the standard of living stopped growing around 2000. Family purchasing power today is just the same as in that year.” Hall identifies drivers of a “US secular supply stagnation.” In particular, he sees

no sign of a reversal of the decline in labour’s share of total income …

no sign that a burst of productivity growth will make up for the complete stall in productivity growth around the crisis …

no sign suggesting a departure from the decline in labour-force participation.

Syriza’s Left Wing

In the FT, Kerin Hope and Tony Barber portray left-wing members of the Greek Syriza government. These include:

Panayotis Lafazanis, minister for productive recovery, energy and the environment. He is quoted as saying “My way is no memorandum [Syriza’s term for the bailout agreement], no euro”.

Nikos Voutsis, minister for the interior and administrative reconstruction. He has reversed hiring restrictions; performance evaluation; wants to reinstate the municipal police force; and favors softer policing and more lenient treatment of prisoners.

Aristides Baltas, minister of culture and education. He is quoted as saying that education “should not be governed by the principle of excellence . . . it is a warped ambition.” He wants to eliminate restrictions on the duration of undergraduate studies; abolish university entrance exams; ban police from campuses; and grant students decisive powers to elect university officials.

“Bankensektor im Umbruch (Structural Changes in Banking),” FuW, 2015

Finanz und Wirtschaft, April 18, 2015. PDF. Ökonomenstimme, April 20, 2015. HTML.

  • Banks increasingly face competition in bread-and-butter businesses like term deposits, lending and payments.
  • Two trends shape the sector’s changes: Falling trust in banks, both at the political level and by individual clients; and the rise of the internet.
  • Trust has been squandered. But with cheap access to information, it also has lost importance.
  • Asymmetric information in financial markets might become less of a friction. This could turn into an existential threat for banks.
  • When trust is less important and technology more versatile, increasing returns to scale in the provision of financial services might be a thing of the past. And so the universal bank. New regulatory and tax regimes could foster the process of structural change.

Here are some links to background information:

Nevada Shell Companies, Elliott and Argentina

The Economist reports about Nevada shell companies. In its eternal struggle against the Republic of Argentina, Elliott Management is inquiring about several shell companies in the state. They are suspected to own funds that might have been stolen from the Republic. The hedge fund reasons that it is entitled to those funds because they belong to Argentina, and Argentina owes 2 billion dollars to Elliott according to earlier court rulings. Elliott sued in Nevada for information on the shell companies and has been partially successful.