ECB Bank Stress Test

Claudia Aebersold Szalay reports in the NZZ on the findings of the stress test conducted by the ECB. The article contains a map and tables.

The ECB downgraded the quality of bank assets (mostly bad loans) relative to banks’ own estimates. This is reflected in lower estimates of banks’ equity positions. Moreover, the ECB conducted a stress test and considered two scenarios. According to the adverse one, banks’ equity positions would fall by more than 250 billion Euros. Italy, France and Germany would be hit hardest.

Claire Jones and Alice Ross as well as Martin Stabe offer additional insights in the FT, FT. A report in the FAZ. The ECB‘s page with press release and other information.

Teacher Well Being

sda reports in the NZZ about a study on Swiss teachers’ well being that was commissioned by the Swiss National Science Foundation.

A representative survey among 600 teachers in 5th to 9th grade indicates that every fifth teacher always feels stressed and every third teacher suffers from forms of depression at least once per month. The teachers feel strained because of high work load; conflicts with students’ parents; and difficult pupils. Women and part time teachers are more exposed to the risk of burnout.

Other employees in the public sector do not feel similarly stressed. Nevertheless, nine out of ten teachers like their jobs.

Government, Household and Corporate Debt in the Euro Area

The Economist reviews developments on the debt front:

Between 2007 and 2013 the ratio of government debt to GDP in the euro area rose from 66% to 93%. The spike was more dramatic in the periphery (see chart): in Greece the ratio increased to 175% and in Portugal it virtually doubled to 129%.

The figure in the article shows debt quotas in six countries between 2007 and 2013. The article continues:

Despite Italy’s staggering government debt, its households owe less than Germany’s and its non-financial companies not much more. Spain’s private sector has deleveraged substantially over the past few years, as big recapitalisations have left its banks better able to withstand write-downs of bad loans.

One conclusion put forward is that governments will not be able to reduce debt quotas in the foreseeable future to the levels before the financial crisis.

Dangers of Deflation

The Economist worries about deflation, specifically in the Euro area. The central passages are:

Central bankers can no longer set real (that is, inflation-adjusted) interest rates low enough to restore demand. Wages, incomes and tax revenue all stall, undermining the ability of households, businesses and governments to pay their debts—debts which, in real terms, will grow more burdensome under deflation.

… bad deflation results when demand runs chronically below the economy’s capacity to supply goods and services, leaving an output gap. That prompts firms to cut prices and wages; that weakens demand further. Debt aggravates the cycle: as prices and incomes fall, the real value of debts rise, forcing borrowers to cut spending to pay down their debts, which ends up making matters worse.

Bicycling in Copenhagen

People in Copenhagen like to take the bike. During rush hour, the bike lanes are more crowded than the car lanes. Cyclists have developed a code of conduct that appears to be Copenhagen (or Denmark) specific. When stopping or preparing to turn left, they signal their intention to do so and quickly move aside not to block traffic.

Banking Union

Willem Buiter, Ebrahim Rahbari and Antonio Montilla provide a detailed assessment of the need for a Euro Area banking union and the progress towards it, in a Citi Research document. Some excerpts from the abstract:

… a single supervisor, a common resolution mechanism, including a joint recapitalisation back-up, and an effective lender of last resort – is necessary for the euro area (EA) to survive.

The CA’s [comprehensive assessment’s] conclusion will likely boost EA financial conditions in coming months. Even so, we believe the CA should have been more stringent, current backstops are still inadequate, and the CA will not eliminate divergences in financial conditions …

Remaining elements of narrow banking union are also very important — These are the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM). In particular, the SRM and its bail-in provisions should materially reduce the likelihood that an EA sovereign will be dragged into insolvency through tax-payer-funded bank bailouts. Reduced moral hazard will also likely lower the likelihood and severity of future banking crises. And the combination of CA, SSM and SRM are also likely to mean that the ECB will be an effective lender of last resort for EA banks (and sovereigns).

… one key fragility remains: excessive two-way links between national sovereigns and banks. Risk-weighting of sovereign debt and concentration limits on sovereign debt holdings by banks are necessary to break these links.

A single deposit guarantee scheme is not necessary for monetary union and requires a deeper fiscal union than the minimal common backstops required to make monetary union work. It is therefore unlikely in the foreseeable future, in our view. An EA sovereign debt restructuring mechanism (SDRM) may be necessary to handle legacy sovereign debt restructurings and possible future sovereign insolvencies, but beyond the limited mutualised fiscal backstops necessary for banking union and the SDRM, deeper fiscal union is neither necessary for EA survival nor likely, for political reasons, in the foreseeable future.

The report contains many interesting figures, for example on the exposure of banks to their domestic governments; the correlation between sovereign and bank CDS spreads; lending standards; the share of bank loans in banks’ balance sheets etc.

Large Banks Promise not to Terminate Distressed Derivatives Contracts

Philip Stafford and Tracy Alloway report in the FT that under the stewardship of the International Swaps and Derivatives Association, large banks

have agreed to give up their rights to immediately end derivatives contracts with crisis-hit rivals after global regulators pressed for an industry cross-border agreement to stop counterparties terminating deals with troubled institutions.

The agreement covers 90% of the OTC derivatives market. Incentives to live up to it are weak; not amending one’s contracts with counter parties amounts to the dominant strategy in a prisoners’ dilemma situation. Moreover, institutional investors may have fiduciary duties to end their contracts if a counter party defaults so attaining the cooperative equilibrium may not be possible without legal changes.

DN: But if the initiative succeeds, could it undermine the effective seniority status of derivatives?

Ken Rogoff on Martin Wolf’s “The Shifts and the Shocks”

In Prospect Magazine, Ken Rogoff reviews Martin Wolf’s account of the financial and European debt crises as well as his policy conclusions. Along the way, he offers his own views. Some excerpts:

Wolf rightly believes that one needs to look at the entire global economic system to understand what happened.

… he essentially concludes that there will be no long-run financial stability without kicking banks out of the money creation business, leaving it as a government monopoly, much as leading “Chicago Plan” economists first suggested in the 1930s.

Although Wolf makes a coherent case for considering this radical reform [the Chicago plan], he is rather circumspect on just how bad things will be if we don’t do it. For one thing, he seems to agree with Chicago economist Robert Lucas (whom he otherwise sharply critiques) that if the US financial firm Lehman Brothers had not been allowed to fail, the financial crisis would have been far less acute.

But if one really believes this, then why take all the risks of radical change? Anyone advocating a radical fix, as Wolf does, needs to convert the many politicians, financiers, regulators and even academics who conclude that the real lesson of the crisis should be to never let big banks fail. (This is certainly not my position.)

… By mulling whether the crisis could have been mitigated simply through better tactics during the weekend of 13th-14th September 2008, Wolf undermines his own case for radical reform. To be clear, I think that a major financial collapse would have been very difficult to avoid regardless of how Lehman was handled. Thus Wolf is fundamentally right: radical change is needed. Turning to the eurozone, … He is right that Germany bears its share of responsibility. But he emphasises the potential role of German fiscal stimulus far too much, and correspondingly underestimates the importance of regulatory failures, the rigidity of the 2 per cent inflation target and, above all, northern recalcitrance to restructure and write down southern debts.

… The first problem with Wolf’s simple arithmetic is that Europe is not a closed economy, and indeed Germany depends vastly more on exports to China and the US than exports to the periphery.

… If the capital flows to the eurozone periphery had been mainly in the form of direct foreign investment or equity (instead of short-term debt), they would have been far less problematic. … Germany’s biggest mistakes, by far, were in financial regulation that produced instability.

In truth, the southern Mediterranean countries in Europe are a place where there really is secular stagnation … But secular stagnation in the periphery would have been happening with or without the financial crisis … what could Germany have done? … First, it should have acted earlier to take a euro break-up off the table. Second, it should have found a way to restructure periphery debts at lower interest rates and with more time to repay. Third, it should have moved earlier to endorse a looser monetary policy at the European Central Bank (ECB). Fourth, and more for itself, it should have expanded infrastructure investment at home and abroad.

… rather than pouring fiscal stimulus into a German economy that has for some time arguably been overheated, it would have been far better to give periphery countries more help. … The point that periphery countries suffer from debt overhang should be an obvious one by now …

Wolf finds convincing the comparison between Spain and the UK made by the Belgian economist Paul De Grauwe, who argues that Spain would have been in much less trouble if it had had its own currency. True, but misleading. The claim overlooks the fact that, in many ways, Spain has still not completed the transition from being an emerging market to being an advanced economy. … But governance and institutional development can take many generations to unfold. My overwhelming presumption is that these countries would still have had problems containing their debts. … It is ludicrous to think the periphery has a mere liquidity problem. That is why the debts needed to be written down, or more likely stretched out at lower interest rates, which amounts to the same thing.

… So Germany could have done more to alleviate the crisis in the periphery. But the best way was not to increase spending in Germany, but to help increase spending in the periphery. Even the IMF has finally reached this epiphany, arguing that it should have insisted on “bailing in” private creditors in Europe; that is, making lenders take losses. Instead, too much of its lending effectively just helped to pay off private creditors, and did not provide meaningful budget relief.

Anyone worried about austerity in the periphery should have been first and foremost focused on writing down debt. The idea that arguing for such policies, and that worrying about the effects of debt overhang on growth, amounted to favouring “austerity” is simply ludicrous.

… Austerity in the periphery eurozone is an entirely different animal to that seen in the US and UK. The eurozone periphery suffered a classic sudden stop in private lending, and although the “troika” of the IMF, European Commission and the ECB did step in to help, they were too limited in their willingness to write down debt. Facing a sudden withdrawal of financing, periphery countries had to reduce expenditures.

For the US and UK, the decision to expand and then gradually reduce deficits gave policymakers considerable discretion over the exit strategy. For these countries, one can meaningfully speak about the trade-off between stability and stimulus….

Another key pillar in recovering from a financial crisis should be to boost infrastructure investment. Virtually every economist of every stripe agrees with this recommendation. … Administration officials privately expressed concern that infrastructure projects would take too long to get off the ground, and by the time they did, the spending would no longer be needed. My book with Carmen Reinhart, This Time Is Different, suggested that the recession was likely to be around for a long time, and that infrastructure spending would be extremely helpful.

… In fact, the ostensible argument over debt has nothing to do with progressive and conservative differences. It is about the size of government.

… The financial crisis does create an additional and very important argument in favour of fiscal stimulus, and Wolf is absolutely correct to highlight it. When an economy is at the zero bound on interest rates, and the central bank is unable or unwilling to stimulate inflation, fiscal policy is more effective in raising output. … However, the empirical size of the “fiscal multiplier” (how much output rises relative to increased government spending) is widely debated, and the evidence is very thin. … The fact the UK and US both achieved solid growth in the face of fiscal cuts would seem to contradict the view that multipliers are always and everywhere very large.

… Wolf, in line with Krugman, appears to believe that even wasteful government spending would raise welfare, a claim that is at best debatable.

… As for the resulting debt burden not being an issue, it is far from obvious that governments were wrong to worry about the fiscal burden, as debt more than doubled within a very short time. The ability to issue large amounts of debt in response to crises is a valuable option for governments. But if a country’s debt starts to reach a situation that is perceived as risky, the option might not be as available when needed most.

… Wolf now argues that of course we all knew there would eventually be a vigorous recovery in the UK. I can only say this was not obvious from reading either the Financial Times or the New York Times. Again, this is a matter of calibration, and the awful forecasts of those who focused excessively on fiscal policy and nothing else, underscores how difficult real-world policymaking can be.

Longest Non-Stop Flights

According to Wikipedia, the longest regular non-stop passenger flight, from Sydney to Dallas, takes about 16 hours and covers roughly 13800 km. Close competitors are the flights from Johannesburg to Atlanta (roughly 13600 km) and from Abu Dhabi or Dubai to Los Angeles (roughly 13400 km).

For a nice map of the longest non-stop flights, see here.

World War I in 40 Maps

Zack Beauchamp, Timothy B. Lee and Matthew Yglesias provide a fascinating account of World War I in Vox. Short texts accompanying 40 maps cover the central European powers, Russia, the US, the Balkans, Africa, the Ottoman Empire, Palestine, Arabia, Mexico as well as technology and strategy of the campaigns.

Text 23 on “Britain conquering Palestine:”

After the failure of the Gallipoli campaign in 1916, Allied forces regrouped in Egypt and began making plans to take Ottoman-held land in the Levant. This map shows part of that effort, Britain’s successful 1917 campaign in Palestine. The British invasion of Palestine would have long-lasting consequences. On November 2, 1917, British Foreign Secretary Arthur Balfour wrote a letter endorsing “the establishment in Palestine of a national home for the Jewish people.” Balfour cautioned that “nothing shall be done that may prejudice the civil and religious rights of existing non-Jewish communities in Palestine.” In 1922, the League of Nations officially endorsed British administration of Palestine. British policies after World War I helped lay the groundwork for the eventual UN partition of Palestine between Arab and Jewish states — and everything that followed from that.

Text 24 on “Lawrence of Arabia and Britain’s betrayal of Arab allies:”

One of the most remarkable figures of World War I was TE Lawrence, whose exploits in the Middle East were immortalized in the 1962 movie Lawrence of Arabia. Before the war, Lawrence was an archeologist, and he got to know the Middle East during expeditions to the region. When war broke out, the British recruited him to help organize an Arab revolt against the Ottoman empire. His pre-war connections made him particularly effective in this role. He fought alongside the Arabs in a series of battles between 1916 and 1918. At the end of the war in November 1918, Lawrence presented this map to his superiors in Britain, showing proposed borders for a postwar Middle East. The British had promised independence to Arab Allies who participated in the rebellion, and Lawrence attended the 1919 Paris Peace Conference to press for these promises to be kept. Instead, the British and French divided Arab territories under the terms of the Sykes–Picot Agreement (discussed below), which they had secretly negotiated in 1916.

Text 39 on “Sykes-Picot and the breakup of the Ottoman empire:”

World War I also transformed the Middle East. In 1916, French diplomat Francois Georges-Picot and his British counterpart, Sir Mark Sykes, drew up a map dividing the Ottoman Empire’s Middle Eastern territory between British and French zones of control. The agreement permitted British and French authorities to divide up their respective territories however they pleased. This led to the creation of a series of Arab countries — Lebanon, Syria, Iraq, Jordan, and so on — whose borders and political institutions only dimly reflected the Arab world’s ethno-sectarian makeup. Many scholars believe the Sykes-Picot borders were a major factor in the chaotic state of the Middle East in the decades since then.

Conference on “Law and Economics” with Focus Session on “Bank Resolution” at the Study Center Gerzensee

Joint with CEPR, the Study Center Gerzensee organised a conference on law and economics. The program can be viewed here and papers can be downloaded from CEPR’s website. The focus session on bank resolution featured contributions by

  • Patrick Bolton and Jeffrey Gordon (paper)
  • Martin Hellwig (paper, slides)
  • Mathias Dewatripont (slides)
  • Gerard Hertig
  • Wolf-Georg Ringe (paper)
  • Paul Tucker (paper)

In his talk, Jeff Gordon explained how Dodd-Frank extends the FDIC’s resolution technology from the 1930s to “non-banks” that engage in banking business. Dodd-Frank establishes an “Orderly Liquidation Authority” and in title II a “Single Point of Entry” by putting a holding company (topco) into receivership. The objective is to minimise disruption costs for large institutions, to preserve the going-concern value of the company and to avoid collateral damage. Single point of entry also helps resolve cross-border issues. No comparable institutional framework is available in the EU. In the crisis, US authorities implemented ad-hoc alternatives to bankruptcy: Mergers (which require the approval of shareholders and therefore make it hard to wipe out the target’s shareholders) worked for Bear Stearns (JPMorgan Chase, Maiden Lane, Fed) but not for Lehman Brothers (Barclays, Fed) because the UK authorities refused to waive Barclays shareholder approval, fearing fiscal implications. Recapitalisation with third party funds (Fed) in the case of AIG also required shareholder approval and protected creditors and counter-party claims.

Patrick Bolton cautioned that the rules for the topco are still not clear and discussed alternatives to Dodd-Frank in the bankruptcy code. He emphasised the role of qualified financial contracts and debtor-in-possession interventions.

Martin Hellwig argued that the government rescue of Hypo Real Estate reflected the political will to help influential creditors rather than systemic importance. He questioned the viability of single-point-of-entry arrangements in cross-border resolution, pointing to lack of trust among national regulators. He questioned whether internationally active banks can ever be resolved in an efficient manner and asked whether, in that light, they are socially valuable.

Mathias Dewatripont warned that excessive emphasis on bail-in arrangements can undermine financial stability, for example by having the expectation of a small haircut applied to senior debt tranches trigger a run on all senior debt. To avoid such an outcome, he favoured a clearly identified seniority structure with a significant balance-sheet share of “bail-inable” liabilities. He questioned the usefulness of higher capital requirements, arguing that “prompt corrective action” is politically infeasible unless the equity ratio has fallen below a very low value, 2 percent say.

Wolf-Georg Ringe favoured holding-company structures with sufficient “bail-inable” debt.

Paul Tucker discussed potential problems with the holding-company/single-point-of-entry strategy, related to centralised operations (IT). He raised the issue of accountability and the potential lack thereof if companies are resolved by regulators rather than judges, and he wondered whether national regulators can commit to collaborate across borders if need be. He favoured “bail-inable” debt over equity because the former gives incentives to monitor without the incentive to speculate on the upside.

Gerard Hertig warned that regulatory incentives lead to bank mergers rather than resolution, in particular because authorities tend to be more lenient in crisis times. He argued that because of deposit insurance, resolution worked well in Japan until recently.

Patrick Bolton argued that cocos are badly designed as their triggers are too low and they refer to accounting equity. Instead, he favoured reverse convertible bonds that can be converted by the issuer.

Oliver Hart argued that resolution has the advantage over cocos that the management gets replaced.

Many panelists voiced scepticism towards narrow banking proposals. They feared that control over the money supply might turn into control over credit, referring to the discussion in the US during the 1930s.

The Swiss “Vollgeldinitiative”

On June 3, 2014 the Swiss group “Monetäre Modernisierung” (monetary modernisation) started to collect signatures with the aim to force a national referendum on changes to the Swiss constitution. (The group needs to collect 100,000 signatures within an 18 month period in order to succeed.) The referendum would put the “Vollgeldinitiative” (sovereign money initiative) to vote, an initiative that seeks to fundamentally change Switzerland’s monetary system. The group “Monetäre Modernisierung” is part of a broader international movement with partner groups in the UK, the European Union and the US.

According to the proposal, deposit claims vis-a-vis commercial banks would be transformed into claims vis-a-vis the central bank and deposit liabilities of commercial banks would be transformed into liabilities of those banks vis-a-vis the central bank. Within a certain time span, commercial banks would have to repay those liabilities. Moreover, they would be prohibited from ever creating deposits again—that is, all money should be base money. The proposal envisions the Swiss National Bank to bring new base money into circulation by transferring reserves to the treasury, allowing the government to partly finance its expenditures by means of “original seignorage,” or to citizens. The Swiss National Bank could also lend reserves to banks, against interest, to accommodate fluctuations in money demand. (The resulting interest seignorage would add to government revenues as well.) The initiative aims at a complete separation between money and debt; accordingly, base money would be booked as equity in the central bank’s balance sheet rather than debt.

The proposal goes further than Irving Fisher’s 100% money plan and other proposals for full-reserve banking (and narrow banking) where banks are required to keep the full amount of deposited funds in cash/reserves (or very liquid, safe assets). Under the “Vollgeldinitiative,” the amount of deposited funds does not only have to be kept in cash/reserves but deposits are abolished altogether.

Some background information (in German):

  • The text of the proposed constitutional amendment, with explanations.
  • Background paper by one of the intellectual father’s of the initiative, Joseph Huber. He explains that the name “Vollgeld” is the short form of “voll gültiges gesetzliches Zahlungsmittel,” or legally speaking, “unbeschränktes gesetzliches Zahlungsmittel.”

Some quotes from the Q&A section on the technical implementation of the proposed reform (in German):

Die Girokonten der Kunden werden aus der Bankenbilanz herausgelöst und separat als Vollgeldkonten geführt. Die Guthaben auf den Girokonten bleiben eins zu eins bestehen, werden Vollgeld und somit zu gesetzlichen Zahlungsmitteln gleich Münzen und Banknoten. Ab dann ist nur noch die Nationalbank autorisiert Zahlungsmittel zu schöpfen. Dadurch geschieht mit dem unbaren Giralgeld heute das gleiche wie vor hundert Jahren mit den Banknoten. …

Das bisherige Banken-Giralgeld wird von Gesetzes wegen zu Vollgeld umdeklariert. Liesse man es dabei bewenden, kämen die Banken mit einem Schlag in den Besitz von Vollgeld, obwohl sie nicht das (neue) Vollgeld, sondern nur das (alte) Giralgeld geschaffen haben. Deshalb übernimmt die Nationalbank im Moment der Umstellung alle bisherigen Giralgeld-Verbindlichkeiten der Banken und verpflichtet sich damit, den Bankkunden anstelle von Bankengiralgeld Vollgeld auszuzahlen. Diese Auszahlung erfolgt sofort, damit die umlaufende Geldmenge nicht vermindert wird, und sie erfolgt auf Geldkonten ausserhalb der Bankbilanz, also auf Konten, auf die die Bank keinen Zugriff mehr hat. Für die Bankkunden ist diese Umstellung äusserst relevant: Sie sind jetzt im persönlichen Besitz von gesetzlichem Zahlungsmittel in der Höhe der bisherigen Sichtkonten, die vor der Umstellung blosse Geldversprechen auf Konten der Bank, aber kein Geld waren. …

Nach der Vollgeld-Umstellung gibt es nur noch Nationalbank-Geld. Das elektronische Geld ist genauso vollwertiges Geld wie heute Münzen und Banknoten. Das heisst, die Vollgeld-Zahlungsverkehrskonten der Kunden befinden sich dann nicht mehr in der Bilanz der Banken, sondern diese werden von Banken wie heute Wertpapierdepots verwaltet. Das Geld auf dem Konto gehört nur dem Kunden, wie das Bargeld im Tresor, und ist nicht mehr wie heute, eine Forderung an die Bank. So hat auch der Zahlungsverkehr nichts mehr mit Forderungen und Verpflichtungen zwischen den Banken zu tun, weshalb das heute übliche Banken-Clearing unnötig wird. Wenn ein Kunde eine Überweisung an einen Kunden tätigt, wird einfach Vollgeld von einem Konto auf das andere transferiert. Es passiert dann das, was fast alle Menschen heute meinen, was bei einer Überweisung geschieht.
Diese direkte digitale Übertragung von Vollgeld vereinfacht den Zahlungsverkehr, da die bisherige komplizierte Verrechnung von Forderungen und Verbindlichkeiten zwischen den Banken und eventueller Ausgleich mit Nationalbank-Guthaben entfällt. Statt dessen können Überweisungen sofort ausgeführt und gebucht werden, genauso wie heute der Kauf von Aktien und Wertpapieren. Die bisherige Wartezeit von mehreren Tagen, bis das Geld ankommt, entfällt. Nach wenigen Minuten wird man den Geldeingang auf dem Konto sehen können.

I discuss the initiative here.

“Vollgeld, Liquidität und Stabilität (100% Money, Liquidity and Stability),” NZZ, 2014

Neue Zürcher Zeitung, May 12, 2014. PDF. Extended version in Ökonomenstimme, May 13, 2014. HTML.

  • A 100% money regime reduces the risk of credit bubbles, but requires more and better fine-tuning by the central bank.
  • Central banks can already implement higher reserve requirements. If the fact that they don’t reflects policy failure, then the 100% money proposal risks handing more power to one source of the problem.
  • A 100% money regime increases financial stability, at least temporarily, but it forces banks to find new sources of funding and lowers the interest rate for depositors, which is fine.
  • If lender of last resort support by the central bank occurs at too low interest rates then seignorage revenues are privatised and costs socialised under the current regime. Moving to a 100% money regime would help but so would simple Pigouvian taxation.
  • How can a 100% money regime be enforced if market participants end up coordinating to use other securities than deposits as means of payment?
  • More stable deposits in a 100% money regime do not imply a more stable banking system unless other regulation is imposed that completely prevents “maturity transformation.”
  • Aggregate liquidity cannot be created out of nothing, with or without deposit insurance.
  • Societies have to take a stand on whether they want to guarantee broader monetary aggregates than base money. If so, the cost of the guarantee should be privatised. Problems arise if societies pretend not to provide such guarantees but central banks nevertheless feel obliged to step in ex post and market participants are aware of that fact ex ante; bad, self-fulfilling equilibria are the consequence.
  • Commitment on the part of policy makers is key; it requires independent central bankers and regulators.