The politics of public debt - Wolfgang Streek

Just came across this paper by Wolfgang Streek, The Politics of Public Debt, finishing in a palpable sense of rage directed at the Fed:

Does this sound outlandish? Consider the current state of the distributional game in the United States, a country that, unlike Ukraine or China, is still considered a democracy by many. According to Emmanuel Saez, in 2010, the Year Two after the crisis, at a time of high unemployment and record public debt, 93% of all income gains in the US, i.e., almost the entire amount by which the national income increased , went to the top one per cent of the income distribution. What is more, the top 0.01%, about 15,000 households, received more than  a third, 37%, of those income gains (Saez, 2012).31  There is no reason not to call this an asset stripping operation of epic dimensions perpetrated by a tiny minority benefitting, among other things, from the deepest tax cuts in history. Why should the new oligarchs be interested in their countries’ future productive capacities and present democratic stability if, apparently, they can be rich without it, processing back and forth the synthetic money produced for them at no cost by a central bank for which the sky is the limit, at each stage diverting from it hefty fees and unprecedented salaries, bonuses and profits as long as it is forthcoming –  and then leave their country to its remaining devices and withdraw to some privately owned island?

The European Repo Market, the FTT and Moscovici, new Tax Commissioner

The European repo market was last in the news when the Commission issued its FTT proposals last year in February.  France, through the voice of the new Tax Commissioner Pierre Moscovici, then Minister of Finance, immediately questioned the inclusion of the European repo market in the FTT plans:

To include such [repo] transactions will simply pose a major risk to the functioning of the credit market.

Yet it turns out that  the European repo market is European but in name.

Consider the membership of the European Repo Council (ERC), the private lobby that champions the interests of the repo market players in Europe. Of its 75 members in September 2014, 19 sit on the European Repo Committee, the governing board of the ERC.  Eleven of these – five headquartered in the EU - are on the FSB’s 2013 list of Globally Systemically Important Banks (G-SIBs). 

Table 1 Membership of the European Repo Committee, September 2014

Headquarters	G-SIB	Not G-SIB
Eurozone	Societe Generale (Newedge), Deutsche Bank, Unicredit	Caixabank, Bankia, Intesa Sanpaolo, Commerzbank
Europe	UBS, HSBC, Credit Suisse, Barclays
US	JP Morgan, Goldman Sachs, Citigroup
Asia		Nomura, Daiwa

 The ‘European’ repo market captures the systemic footprint of global banks headquartered in Europe and elsewhere. Its growth has been driven by what Haldane called the ‘collective migration’ of bank business models to interconnected, leveraged, high-yield trading activities. 

SFP vs Reverse Repos vs Fed bills

Remember the fuss around the Fed's RRP change of heart earlier this month?

According to the Treasury Borrowing Advisory Committee, the Fed could have chosen a different sterilization approach: it could have issued its own debt instruments or extended the Supplemental Financing Program, a misnomer for  the Treasury playing at central banking (issuing Tbills for sterilization purposes, for which banks pay in reserves that are held by the Treasury at the Fed).

For TBAC, a committee that brings the Treasury in dialogue with powerful market players (zerohedge calls it the Supercommittee that Really runs America), identified several criteria:

To sum up, the criteria can be grouped in:

- liquidity effects (for Tbills)
- institutional constraints (debt ceiling)
- shadow banks' access to Fed (the 'portable' reserve creation)
- theoretical (ideological) concerns with central bank independence.

Missing from that list is displacing the private repo market...

The topsy-turvy world of the Fed's exit strategy: all too familiar to emerging countries

Jon Hilsenrath, of Wall Street Journal, reflects on the details of the Fed's exit:

• The Fed’s primary tool is an interest rate it pays banks for the money they have on deposit with the central bank, known as interest on excess reserves, or IOER. This will be the upper end of the band. This rate is now 0.25% and seems likely to go to 0.5% with the Fed’s first rate increase. The lower end of the band will be interest the Fed pays money market funds and other nonbanks for cash not on deposit at banks (known as the overnight reverse-repo rate, or ON RRP in Fed lingo). This is now 0.05% and seems likely to go to 0.25% with the Fed’s first rate increase. “Most participants anticipated that, at least initially, the IOER rate would be set at the top of the target range for the federal funds rate, and the ON RRP rate would be set at the bottom of the federal funds target range,” the minutes said.

The big winners, he argues, are foreign banks, who earn nice returns from this band: borrowing from money market funds at or around ON RRP, and then placing it with the Fed at the IOER rate. Domestic banks cannot play this game because fees to the Deposit Insurance Corporation eat in the spread.

Two observations:

1. The band -  - the corridor set by the IOER rate and the ON RRP - under QE is functionally different from the band set by the standing facilities under 'normal' interest rate policy. In the latter case, the upper limit is set by the rate at which the central bank lends to commercial banks. Currently, both the upper and the lower ends are rates at which the central bank mops liquidity from the system. Hence foreign banks' behavior. 

Carney's ambitions for shadow banking reform: empty promises?

Shadow banking is back in public light. The FT has just started a series on it. On the pages of the same FT, Mark Carney, Bank of England governor and crucially, chairman of the Financial Stability Board (FSB), recently outlined the reforms that the FSB has introduced to transform shadow banking into governable market-based finance:

1. Curtailing the links between regulated and shadow banking.

2. Regulating the two shadow banking markets: better incentives for safer securitization structures (think ABS initiatives by Bank of England and ECB) and minimum margin requirements (haircuts) for securities financing transactions in repo markets.

3. Improved transparency and monitoring. 

The reader will be tempted to believe that reform of repo markets, six years after the fall of Lehman Brothers and the run on repo it triggered, is progressing smoothly. This is an important front in the macroprudential battle, according to Carney, because:

A new game: spot the most innovative argument against financial reform

Six years after the collapse of Lehman Brothers, those interested in the dynamics of financial regulation can play a new game: spot the most innovative argument against the litany of reforms introduced since the crisis. Traditional ones such as the impact on lending, economic growth, liquidity do not count. Floyd Norris, of the New York Times, does well here: in the US debates over identifying some non-banks as systemically important, 'mutual fund industry says that designating a fund manager as systemically important could raise its costs. Those costs could be passed on to fund investors, who are taxpayers, and so would amount to a taxpayer bailout'.  Taken to its logical conclusion, this argument says forget about systemic risk, macroprudential policies, Basel III, since the taxpayer always pays, now or later. Of course, the mutual fund industry doesnt bother itself with internal consistency of the argument (which taxpayers would pay and how much in a regulation now, smaller crisis late). 

I have come across another innovative narrative: that regulation creates systemic risk. The view was put forward in a recent paper "Collateral is the new cash: the systemic risks of inhibiting collateral fluidity", written by the European Repo Council (ERC), the trade body representing the views of European repo participants, and presented at an ERC seminar on Friday the 16th of May, in London. The paper will also be presented in France, in partnership with Banque de France, that is to announce new ways to help market-driven manufacturing of high-quality collateral through Euro Secured Notes.

Mark-to-market (the politics of)

Digging around for my paper on the political economy of the repo market, I came across a 1999 position paper from theJoint Group of Banking Associations on Financial Instruments, that at the time opposed the international homogenization of mark-to-market accounting, eerily anticipating the fire sales/liquidity spirals of 2008:

Stock and bond prices exhibit considerable randomness or ‘noise’ unrelated to

identifiable economic fundamentals. This includes exaggerated price swings caused

by disproportionate changes in market sentiment and speculative activity. Recent

examples of market movements provide ample evidence of the extent to which markey prices can move, particularly in thin markets, without economic justification.

Reading this, it remined me of the European Commission's notion of  'virtual/excess' liquidity at the core of its rather radical FTT proposals.  Also of the 2013 FTT critique from the private repo lobby:

          Concepts such as [...] ‘virtual liquidity’ have no little or no foundation in academic research, regulatory analysis or market experience.

The side of the fence clearly matters.

Carry-trades into Latin America

With the spectre of the 1980s hunting emerging markets, stronger interconnectedness may mean higher volatility across global financial architectures. Some interesting data capturing cross-border exposures for Chile, Colombia, Mexico, Brazil and Peru (LA5).

 

Debt held by non-residents fell by an average of 30% across LA5 after Lehman, to then double (Colombia) or triple (rest LA5) in volume (here are the carry-trades Paul Tucker talked about ). In an effort to stem currency appreciation, central banks intervened in currency markets, leading to large sterilizations of an average of 20% of GDP across the group between 2010 and 2012. Despite these interventions, exchange rates appreciated by around 30% for Chile and Colombia, 25% for Peru and 10% for Mexico.