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

Monday, June 21, 2010

Really great links - Stability - Congressman, Heal Thyself! - Dollar crisis - IMF - Sovereign CDS

Anonymous hedge funder - Financial regulation and stability - "If there's one thing that I wish the regulators understood, it's that the worst blowups are ignited by bad trades that become a consensus stampede. In emerging markets, the crashes always traced back to something everybody considered "the trade of the year." This time, it was the strong and wrong consensus around housing values. The next one may arise from the assumption that developed-markets sovereigns don't default.
        Stability depends on disagreement. A constructive regulatory regime would institutionalize disagreement-by, for example, increased risk-weighting for assets that are heavily owned-and, in automatic fashion, lean against monolithic consensus. Alas, politicians so unanimous in their views about the power of regulation to prevent crisis appear to be caught in a consensus stampede of their own."

Paul Kasriel - Congressman, Heal Thyself! - "On one of this past Sunday’s morning political talk shows, I heard a congressman say that the runaway federal government spending had to stop. Congressman, sir, although the spending continues to increase, the rate of growth in that spending has slowed enormously. In the 12 months ended May 2010, the accumulated spending by the federal government totaled $3.437 trillion, enough to keep the late Senator Dirksen spinning in his grave for near eternity. Although an admittedly high level, this 12-month accumulated total federal spending was only 2.6% higher than the 12-month accumulated total federal spending for May 2009 (see Chart 1). This is quite a deceleration in growth from the 15.3% registered for the 12 months ended 2009 vs. 2008, near the trough of the last recession. Moreover, the 2.6% year-over-year growth in the 12-month accumulated total federal outlays in May 2010 is considerably lower than the 8.4% year-over-year growth in the 12-month accumulated total federal outlays in May 2006. Why do I mention May 2006? Because at that time, the congressman’s political party controlled Congress and the White House. Congressman, heal thyself!"

James Hamilton - Inflation or deflation - "The source of my concern about long-run inflation comes not from the expansion of the Fed's balance sheet, but instead from worries about the ability of the U.S. government to fund its fiscal expenditures and debt-servicing obligations as we get another 5 or 10 years down the current path. Just as many analysts have had trouble seeing how Greece can reasonably be expected over the near term to move to primary surpluses sufficient to meet its growing debt servicing costs, I have similar problems squaring the numbers for the U.S. looking a little farther ahead.
        The way that I would envision these pressures translating into inflation would be a flight from the dollar by international lenders, leading to depreciation of the exchange rate, increase in the dollar price of traded goods, and possible sharp challenges for rolling over U.S. Treasury debt. We've of course been seeing the exact opposite of this over the last few months, as worries in Europe and elsewhere have resulted in a flight to the dollar and the perceived safety of U.S. Treasuries. That appreciation of the dollar has been one factor keeping U.S. inflation down. So any inflation scare is clearly not an incipient development, but instead something we'd possibly face farther down the road."

Mark Copelovitch - IMF - "The domestic financial interests of the IMF's largest shareholders have been a critical determinant of variation in IMF lending policies over the last three decades. As the Fund's largest quota contributors, the "G-5" countries (the US, Germany, Japan, UK, and France) exercise de facto control over IMF lending decisions. At the same time, the G-5 countries are also home to the largest private creditors in global markets, including the world's largest commercial banks. Consequently, G-5 bank exposure heavily influences these governments' preferences over IMF lending policies. In particular, I find that IMF loan size and conditionality vary widely based on the intensity and heterogeneity of G-5 governments' domestic financial ties to a particular borrower country. When private lenders throughout the G-5 countries are highly exposed to a borrower country, G-5 governments collectively have intense preferences and are more likely to approve larger IMF loans with relatively limited conditionality. In contrast, when G-5 private creditors' exposure to a country is smaller or more unevenly distributed, G-5 governments' interests are weaker and less cohesive, and the Fund approves smaller loans with more extensive conditionality."

Deus Ex Macchiato - Sovereign CDS - "This is a classic example of unintended consequences. One element of Basel 3 is a capital charge for the variation of counterparty valuation adjustment – basically the adjustment derivatives traders take to reflect the credit quality of their counterparties. The CVA is largest on uncollateralised swaps: collateral reduces it massively. And which is the most significant class of counterparties who refuse to post collateral? Sovereigns and supranationals. Therefore making banks hedge their CVA better has the effect of forcing them to buy more sovereign CDS, which in turn may increase government borrowing costs. Spread widening isn’t necessarily caused by the evil CDS market speculating on sovereign default; instead it may well be regulatory action that is the cause."

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