October 31, 2008

How Large are IMF Packages Compared to Past Crises?

The IMF has already announced tentative loan agreements with Iceland, Hungary, and Ukraine, and it is working with other countries on a similar direction. The Fund is ready to lend $2.1 billion to Iceland, $15.7 billion to Hungary, and $16.5 billion to Ukraine. These numbers are significant: they represent around 11% of GDP for Iceland and Hungary, and 8% of GDP in the case of Ukraine.

How do these numbers compare with those of similar packages in past crises? As the table below shows, Uruguay received a line of credit of 21% of GDP in the 2002 crisis, and Argentina was offered two packages totalling 8% of GDP in 2000 and 10% of GDP in 2003. Turkey was offered two packages of around 7-8% of GDP each in 1999 and 2002. Most other packages were smaller.


The recent numbers do not include financing given by the World Bank, regional development banks, and other multilaterals. For example, the total package just offered to Hungary totals $25.1 billion from the IMF, the World Bank, and the EU -- or 18% of GDP. In the Asian crisis of 1997-98, if other sources of financing are added (including World Bank and Asian Development Bank money), Indonesia was offered $36.1 billion (17% of GDP), Korea, $58.4 billion (13% of GDP), and Thailand $17.2 billion (12% of GDP).

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Views of the World Bank Chief Economist

World Bank Chief Economist Justin Yifu Lin today discussed the origins of the financial crisis and its impact on developing countries, and proposed several ways to respond.

Speaking to the Korea Development Institute in Seoul, Lin called for a discussion on several ideas for economic policy management. Among them:

  • Governments should consider carefully whether controlling asset price inflation should be added to the mandate of monetary policy authorities. ("If the Fed is not able to keep these bubbles from inflating, it will not be able to achieve its other objectives.")
  • Financial supervision needs to try its best to keep up with financial innovation. ("The techniques and art of supervision must be able to follow financial-sector innovators into new territory where, by definition, innovation will always have a head start.")
  • Responses to global crises must be systematic, comprehensive, decisive, and coordinated. ("Given how globalized financial sectors now are, piecemeal and unilateral responses to financial crisis will run the risk of worsening the ripples of negative reactions across borders without addressing fundamental problems.")
  • Global problems may require global multilateral solutions. (" If indeed the world does find itself in a global recession next year, as we fear is possible, further and more creative multilateral action may be necessary.... [W]e cannot be constrained by the limits of institutional structures and approaches designed for a world before financial globalization."
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More humour...

Recently found on the web:

What's the capital of Iceland?

About £3.50

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Examples of Good Financial Innovation

These days "financial innovation" has a negative connotation. OTC credit-default swaps come to mind. Yet as economists we naturally think most innovation is good. Could the last decade have been in aberration in terms of financial innovation? Or are there some good financial innovations that are now being over-looked?

Steve Waldman, of Interfluidity fame, has the following examples to offer:

  • Exchange-traded funds
  • The growth of venture capital and angel investing
  • The democratization of access to financial information (e.g., Yahoo! finance)
  • The democratization of participation in financial markets (e.g., the growth of Internet and discount brokerages that offer easy access to a wide variety of stocks, bonds, and exchange-traded derivatives, both domestic and international).

Know any others?

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October 30, 2008

How the Financial Landscape Will Change

Roberto Rocha and Costas Stephanou are the main authors of a new paper on The Unfolding Crisis: Implications for Financial Systems and Their Oversight. The paper is now available for consultation and public comment. The paper's main finding: it is going to be a very different financial landscape in the next few years, and beyond. Many governments will have substantial bank ownership stakes; deposit insurance, once it goes up, will stay up beyond the crisis; unbundling distress assets will be significantly more difficult than in previous crises; the role of credit rating agencies will be re-assessed; there will be some appetite to roll back pension reform (especially second pillar).

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October 29, 2008

Currency Depreciation - Reaching the Asian Crisis Levels

The currencies of Malaysia, Philippines, Korea, and Thailand depreciated between 40% and 53% during the Asian crisis (a 6-7 month period between mid-1997 and January 1998). Indonesia's currency was the outlier, with a depreciation of 84% in the 12 months from July 1997 to July 1998.


How do these numbers compare with the current crisis? The worst performer since July 2008 has been Iceland--its currency depreciated 51% in less than 4 months (more than Malaysia, Philippines, and the same as Korea during the Asian crisis). But other currencies also look bad: South Africa depreciated 38% in less than 4 months (not far from Korea in 1997: 40% in 6 months); currencies from Hungary, Brazil, Korea (again), Poland, and Turkey have depreciated more than 30% since July; those of Ukraine, Czech Republic, Colombia, Chile, and Mexico have already depreciated almost 30% in the same time period. The pressure on emerging market currencies has been extremely strong in the last few months, in particular since September. If this trend continues, we are likely to see many more countries, across all regions, reaching levels similar to those observed during the Asian crisis.


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Zimbabwe: The Star Stock Market

While not a focal point of the financial crisis, share price gains of 20,000% per month in Zimbabwe are creating a stir -- at least for people who read the latest S&P Emerging Stock Markets Review without looking carefully at the underlying numbers. Standard & Poor's calculates a set of stock indices for 51 emerging markets and expresses monthly returns in US dollars. With hyperinflation running at 10 quadrillion percent, there's simply no meaningful way to convert Zimbabwean dollar returns into US dollar returns. Yet this is what S&P analysts apparently did. The result: the September issue of the Emerging Stock Markets Review lists five Zimbabwean companies with US dollar market capitalizations exceeding $1 trillion. The country's total market capitalization apparently dwarfs that of the United States. Fortunately, foreign investors are not that welcomed in Zimbabwe so few have probably rushed in.

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Bulgaria and the Financial Crisis

Crisis Talk is soliciting contributions from crisis analysts around the world. The following contribution comes from Georgi Angelov, senior macroeconomics researcher at the Open Society Institute in Sofia, Bulgaria.

Over the past 18 months, Bulgaria's economy has rarely looked better. In fact, it grew a record 7.1% in the first half of 2008--partly thanks to the 10% flat tax rate for corporate and personal incomes introduced in 2007 and 2008, respectively. In addition, in 2007 Bulgaria attracted record high FDI inflow, amounting to more than 20% of GDP (and an upward revision of these data points is expected).

However, since the financial crisis hit Europe in September, signs that the Bulgarian economy will soon be affected have emerged. Bulgaria is a member of the EU, after all. Its financial system is dominated by European banks and its trading partners are almost all within the EU. Bulgaria now faces two main risks: Slower export growth and reduced capital inflows.

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Collapse of Equity Markets - Beyond the Asian Crisis?

During the 1997-98 Asian crisis, the equity markets of the 5 Asian countries at the epicenter fell between 58% (Korea) and 78% (Malaysia). These declines took place in the 12-15 months from mid 1997. Today, 9 countries have already shown such declines in their stock markets -- but in less than 4 months.


Some examples: Iceland, down 85% since August; Russia down 76% since July; Kazakhstan and Ukraine, down 70% since July; and Brazil, Hungary and Peru have fallen over 65% since July. In four months, 9 countries have already fallen more than Korea fell in one year after the Asian crisis (58%). The stock markets in 17 countries (from a subset of 36 countries) have fallen more than 50% since mid 2008. Slovakia has been the best performer in the sample, losing "only" 15% since July. This tells about the magnitude, speed, and extension of the current crisis, reaching countries in all regions. Unfortunately, there are no signs to assume that the worst is over.


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October 28, 2008

The End of Private Pension Funds in Argentina

Argentina’s decision last week to end private pension funds effectively killed the primary institutional investor in its emerging capital market. Confidence in the market has predictably suffered from this measure, the latest in a series of government meddlings.

Argentina created private pension funds (AFJPs) in 1994. People had the option of remaining in the state-sponsored pay-as-you-go system, but most switched to the new privatized option. AFJPs were constrained to invest a large part of their portfolios in Argentine government debt. In the months ahead of the 2001-02 crisis, the government forced AFJPs to take a larger share of government debt to help it address its budget deficit. In early 2002, the government defaulted on its debt and thus on the savings of millions kept at the AFJPs.

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Softening the Impact of the Global Crisis

When a crisis is seen coming, the knee-jerk reaction of governments is to busy themselves with a variety of ill-thought interventions. Doing something, however inadequate, is considered a show of care. Most often, it is best if the government calmly assesses the developments and intervenes as little as possible. Two cases in point. First, the Great Depression was vastly exacerbated by the actions of the then-young Fed, which reduced money supply and thus prolonged the crisis unnecessarily. (Current Fed chairman Ben Bernanke has built his academic reputation writing on this issue.) Second, the IMF followed a similar increase-the-interest-rate-and-shrink-money-supply stance ten years ago in East Asia. The result was a deepened crisis and a stigma associated with any future IMF actions. Malaysia, the only country that openly avoided the IMF's advice, had a better time than its neighbors.

So what can be done to soften the impact of the unfolding global crisis? I suggest four things:

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October 27, 2008

The Baltics: Holding Steady

With Iceland, Hungary and even Russia in jitters, you would think that the Baltics would catch the financial crisis cold any day now. Market experts have been predicted this for months (see story in the latest The Economist). But these are the same experts who missed the magnitude of the unfolding crisis, so no reason to listen. So far, Estonia, Latvia and Lithuania have held remarkably well.

There are some reasons to be worried. Fitch, a rating agency, calculates their gross external financing requirements in 2009 to be 400% of likely year-end, foreign-exchange reserves in Latvia, 350% in Estonia and 250% in Lithuania. These are the highest ratios among new European Union members. Second, the economies are very dependent on exports to the EU, where demand will drop significantly in 2009 and perhaps in 2010. Third, all three countries have currency boards, with pegs to the euro. If foreigners start withdrawing money out of the region, the money supply shrinks, forcing a recession. 

On the positive side, the Baltics have little public debt, and Estonia in fact has a surplus. The countries' energy bill will drop significantly, which would be welcome news for government finances and businesses alike. Also, all three countries have made big reforms to make business easier. Estonia ranks 22, Lithuania 28 and Latvia 29 in the latest Doing Business rankings. This will enable the workers and businesses to be flexible and move to less affected sectors. This lesson may have been learned from their neighbors, the Nordics, during the early 1990s banking crises. Then, the heavily regulated economies of the Nordics suffered a long recession, and only significant job creating reforms brought them back. The Baltics have less need for reforms, in comparison.

In short, the prospects of a Baltic meltdown are exaggerated.

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October 24, 2008

How it all started (a cartoon)

Cartoon_6 "Gee, I'd like to buy a house but I haven't saved any money for a downpayment and I don't  think I can afford the month payments. Can you help me?"

So begins a funny and informative (and, at times, offensive: don't show this to your kids) cartoon that takes you through the origins of the financial crisis. Source? Anonymous. Probably a former investment banker with inside knowledge...

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Crisis response: What can the World Bank do?

If you are a development institution, crises are opportunities to display leadership. Troubled countries look for help and advice, and they naturally come to you (unless they are East Asian and you are the IMF).

What can the World Bank offer in these times of unrest? First, a little money. In previous crises, the World Bank increased lending by up to $20 billion. This time around, it could even be $30 billion. This is still peanuts relative to the $200 billion the IMF is talking about; and certainly relative to the size of the crisis. To make a simple comparison, rich countries so far have announced various packages for their troubled institutions worth about $9 trillion. In the money game, the World Bank will be a team player in packages someone else typically finances.

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Wolfensohn speaks on role of World Bank

Former World Bank Group President James Wolfensohn discusses the role of the Bank Group during this crisis, the potential impact of Africa, as well as China and Russia in this Oct. 21 Financial Times video interview.

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Time to rethink market discipline

What, really, is market discipline, and how much can we rely upon it for prudential purposes? Market discipline is usually defined as the mechanism or process by which market participants monitor and punish excessive risk-taking behavior by financial institutions. It has gained appeal in recent years--given global financial market trends that have limited the ability of supervisors to adequately monitor such institutions--and it has now become part of the supervisory architecture (pillar 3 of Basel II and Solvency II).

Market purists hold market discipline as an article of faith and as a means to criticize "excessive" government regulation. Some commentators have even argued that market discipline should progressively replace, rather than complement, official supervision. In reality, of course, market discipline has less to do with the market per se than with the institutional and legal framework used to address moral hazard and asymmetric information problems that are endemic in the financial system.

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October 23, 2008

Brokers & pigeons

Recently found on the web:

What's the difference between a Lehman broker and a pigeon?
A pigeon can still make a deposit on a Ferrari.

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Bulgaria: What crisis?

Real_gdp_copyNext month Bulgaria will join the ranks of prosperous economies: the first Starbucks coffee shop opens in Sofia. It may fast become a favorite watering hole for the yuppies. Unless the global financial worries curb their enthusiasm for expensive java.

The government seems optimistic. "Bulgaria is in an extremely advantageous position against the backdrop of what is happening in the United States and Europe, and it should avail itself of its position to a maximum degree," says a report from an October 18 meeting of prime minister Stanishev with leading Bulgarian economists. Indeed, Bulgaria has a small budget surplus, and the economy is run well.

Yet, there are reasons to be worried. First, the top five banks are foreign-controlled: Italian UniCredit (14.2% market share in Q1 2008), Greek United Bulgarian Bank (11%), Eurobank (8.1%), Hungarian DSK Bank (12.9%) and Austrian Raiffeisenbank (10.6%). As problems arise in their home countries, as they have in Hungary, one may expect credit to dry up in their Bulgarian subsidiaries. UniCredit is the most exposed Italian bank to the global crisis. Much of its exposure stems from its acquisition in 2005 of the German bank HVB Group, which put UniCredit among the leading lenders in Central and Eastern Europe. On Monday, its CEO said: "In the past we were used to seeing something between 20-30 percent loan growth. Varying from country to country, I think we will now see something like 10-20 percent (of loan growth)." And Greek banks may not be safe either: a week ago the Greek government announced a 28 billion euro plan—equal to 12 percent of Greece's total gross domestic product—to support its banks, to shore up liquidity.

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Spreading around the risk

Who holds the risk in securitization? A nice paper by Markus Brunnermeier (Princeton University) talks about how financial innovation precipitated the current crisis. It's a good read for anyone who is trying to understand why things unravelled as fast as they have.

The main thesis of the paper is that the financial innovation in the last decade or so clouded the view of who holds the risks. The author says (page 9):

The main disadvantage of securitization is that the transfer of credit risk distances the borrowers from the lenders. First, it makes it unclear who holds what risk. In the end, it might very well be that the risk comes back to the issuing bank, even though it thought it had transferred the risk on to, say, a hedge fund. Second, the banks' incentive to carefully approve loan applications, and their incentive to monitor (and even to collect) these loans, is drastically reduced. Since a big part of the risk is now borne by other financial institutions, banks essentially hold the full risk only for some months before it is passed on to others. Put differently, nowadays a bank faces only a "pipeline risk." That is, only risks that are not yet passed on and are still in the bank's pipeline are the bank's concern.

The article is forthcoming in the Journal of Economic Perspectives.

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October 22, 2008

Ways to Tackle Procyclicality in Banking

Ask most bank supervisors and bankers about the causes of the subprime-cum-financial crisis, and their responses are typically the same. Banking problems manifest themselves in a different way every time, and one can debate whether excessive risk-taking behavior by banks is primarily due to misaligned incentives or to irrational exuberance. However, they all confirm that such behavior is conditioned by, and contributes to, the business cycle. It is difficult for banks to follow more prudent policies during an economic upturn, especially in a highly competitive environment. Credit mistakes made during that period only become apparent in the downturn, resulting in the well-known privatization of gains during good times (excess earnings shared among bank shareholders and staff) followed by the partial socialization of losses during bad times (public bailouts).

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