"If money isn't loosened up, this sucker could go down" - George W. Bush warned in September 2008

Wednesday, March 17, 2010

Really great links - zero rate bound - naked CDS - lending standards - Roubini - Jean-Cicero Trichet - Haiti

Everyday Economist - zero rate bound - "The zero lower bound represents a key failure of modern macro in that there is little consensus or agreement about the effects of monetary policy in such a circumstance. The issue is of central importance for determining the correct policy prescriptions — both monetary and fiscal. It is my hope that the recent surge in research on the zero lower bound will ultimately reach a consensus. What’s more, I hope that this consensus takes into account that we live in a world with more than two assets and, as a result, that the zero lower bound is nothing more than an intellectual curiosity."

Tony Jackson - FT - derivatives and risk management - "For specimen one, consider corporate pension funds. Trustees of those funds are now able to hedge most of their risks, from inflation to longevity. But the one big risk remaining – for funds in deficit – is bankruptcy by the corporate sponsor. One obvious hedge is to buy protection through credit default swaps (CDS) written on the sponsor’s bonds. But the “naked” purchase of protection, we are told, is an abuse. CDS should be permitted only for those who hold the bonds in question. But in this case, that would defeat the object. The natural course for a fund would be to buy CDS equal to the deficit. But if it had to buy the sponsor’s bonds in equal amounts, default by the sponsor would simply double the deficit through the writedown of those assets. Note, in passing, that one common objection to naked CDS purchase – that it violates the principles of insurance – does not apply here. Under insurance law, a policy is valid only if the policyholder has an insurable interest – that is, would derive harm rather than benefit from the event in question. The harm being insured against here is self-evident.

Specimen two involves the proposed shifting of all derivatives contracts on to exchanges. The risk here is that companies would have to post margin every time the market moved."

David Merkel - lending standards - "One job ago, at a hedge fund that was bearish on financials, we would talk about this all the time. Regulators could have stopped the crisis in the early 2000s had they simply enforced lending standards. The banks would have screamed and ROEs would have gone into the single digits, but the crisis could have been prevented.
But, regulators are to a degree subject to politicians. Politicians, in the absence of any moral compass aside from re-election, are mainly beholden to those that fund their campaigns, when the electorate is without education, or a moral compass as well. Thus, regulations were neutered."

Nouriel Roubini - private vs. public defaults - "Unsustainable private-debt problems must be resolved by defaults, debt reductions, and conversion of debt into equity. If, instead, private debts are excessively socialized, the advanced economies will face a grim future: serious sustainability problems with their public, private, and foreign debt, together with crippled prospects for economic growth."

Jean-Claude Trichet/FT Alphaville - Caesar vs. Cicero - "I started with Tacitus’ example of bold policy action. I would like to end with Cicero’s fides. There was a famous controversy between Julius Caesar and Cicero 80 years before the crisis described by Tacitus. Rome, at that time, was struggling with a debt overhang. Caesar proposed partly to remit the debt. Cicero strongly opposed such action. He argued that debt forgiveness would shake the foundations of the Roman Republic and destroy one of its most important values: fides. Fides is trust, confidence, good faith.

In modern terms, Cicero was hinting at the moral hazard that can – but need not – be created by intervention in a crisis. The ‘lender of last resort’ responsibility of central banks – that Walter Bagehot advocated 1800 years after Cicero and Tacitus – should always be a dual responsibility. It should be crisis management and future crisis prevention at the same time."

Tyler Cowen - One of the best ways to help Haiti - "Pass a law stating that the Foreign Corrupt Practices Act does not apply to dealings in Haiti. As it stands right now, U.S. businesses are unwilling to take on this legal risk and the result is similar to an embargo. You can't do business in Haiti without paying bribes."

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