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

Tuesday, July 27, 2010

Really great links - Next credit crisis - Choc-finger - Monetary aggregates -

Craig Pirrong - Capital standards and the next crisis - "Enhanced capital requirements are again being touted as a way of preventing the next crisis. But the Basel Rules were a response to a crisis–the Latin American debt crisis–that paved the way for the next one.
        If the incentive system encourages financial institutions to take on tail risks (due, for instance, for implicit government guarantees), those institutions will find the vulnerabilities in the capital requirements through which they can smuggle such risks onto their balance sheets, like hackers identifying and exploiting each new vulnerability in Windows.
        The existence of vulnerabilities is inevitable–no centrally created set of risk prices will be even close to right. Which means that enhanced capital requirements provide a false sense of security.
        The problem is that the ability of the institution that can price risks more accurately–the capital markets–is fatally undermined by the very real prospect of bailouts of institutions that fail. That is the Original Sin, and as long as we remain in that fallen state, a future crisis is almost inevitable, capital requirements or no. Indeed, the main effect of capital requirements as implemented will be to determine exactly what causes the crisis, not the likelihood of its occurrence."

Craig Pirrong - Chocolate Kisses, or the Financial Times in the Tank - "In this case, it appears that Armajaro already had customers for the cocoa delivered to it. See!, the commentor says, there is real demand, real customers. Well, if you know anything about manipulation, you know that the biggest danger is related to burying the corpse of the manipulation: that is, selling the massive deliveries that you take to squeeze the market. A clever fellow bent on manipulating the market pre-arranges the funeral. If the reports about forward sales of old crop cocoa to processors are correct, that was done in this case. So, rather than being exculpatory, such sales are actually evidence of manipulative intent.
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        The other common excuse, again seen in my SA comments, is that the stuff that is delivered will be consumed. Well, duh. It’s not like the guy is going to eat it all himself, or burn it, or build houses out of cocoa beans. It is going to be consumed. But manipulation distorts consumption pattens–the timing and location of consumption. The stuff is consumed, but in the wrong place at the wrong time, and too much of it is shipped around to the wrong places. The fact that the delivered cocoa will eventually be consumed does not imply that the deliveries are efficient.
        All in all, none of the arguments raised in Armajaro’s defense are even remotely exculpatory, and some are actually adverse. A final judgment would require a full forensic and econometric evaluation of prices, pricing relationships, price-quantity relationships, and movements of cocoa. Time permitting I hope to do some of that. But at this juncture, there is sufficient evidence to conclude that there is a colorable case against Armajaro, and that the arguments raised in its defense are risible.
        Taking huge deliveries in a large backwardation is consistent with manipulation. This is especially true when one party takes all the deliveries. Delivery economics are pretty straightforward, and if they work for one party they tend to work for several. One firm taking all of the deliveries is suspect."

J├╝rgen Stark - Member of the Executive Board of the ECB - Analysis of M3 and other monetary aggregates - "Money has been ignored. In the canonical New Keynesian macro-model on which the intellectual foundations of inflation targeting rests, money has been considered a redundant element in the monetary transmission mechanism. At best, money is seen as a useless appendix to the model, serving only to confuse and distract any policy-maker misguided enough to consider it. Now that the financial crisis has exposed the fault lines underlying this model...
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        The timing of this work in 2007 to enhance monetary analysis was most opportune. Having faced excessive money growth for years, we were indeed perceiving severe challenges. The calls we received at the time were to simply ignore them. We did not find reassurance in these calls. We remained uneasy, but we had no idea ex ante how the excesses in money and credit would eventually unwind.
        At the time, we issued warnings about upside risks to inflation. Eventually the imbalances manifested themselves in successive asset price collapses, a systemic banking crisis, a sharp deceleration in money and credit growth, and a precipitous fall in output.
        Despite our humble performance as economists in forecasting this specific sequence of events, no one can credibly claim that what actually materialised was the most likely among a range of possible scenarios. I think it is fair to say that in order to contain risks to price stability – whether to the up or the downside – there was a pressing need to head off these excesses, instead of dealing with them after the fact.
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        Because of the current financial stability issues, we have been applauded for the monetary analysis, but we are again called to limit its scope. Previously we were asked to plug monetary information into an inflation forecast. Now we are being asked to plug it into the emerging framework for macro-prudential analysis. As a by-product, monetary analysis may both help and be helped by the analysis of bank balance sheets for macro-prudential purposes. However, we do not want to limit monetary analysis to this end. We need to maintain a comprehensive view of the transmission of money to the economy and to focus on pursuing price stability, in line with our mandate."

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