Defaulting banks - where will it stop?

[Jan Klimkowski]

"Spooky" Ambrose Evans-Pritchard forgets to take his meds:

The Bank of England has not run out of ammo yet. It can cut rates to zero if necessary and then escalate to direct infusions of money by purchasing bonds – or indeed by buying a vast range of securities, assets and even houses if necessary. Ultimately it can print money to cover the budget deficit.

As the late Milton Friedman put it, governments can drop bundles of banknotes from helicopters. If they really want to defeat to deflation, they can. Mr Friedman may have overlooked the fact that gunmen can shoot down the helicopter – the Bank of France in October 1931, when it ditched the dollar; perhaps Asian bond investors today? – but that is to quibble.

Professor Spencer says the Bank of England has learned the hard lessons. Without the constraints of the ERM, Gold Standard, or any other fixed exchange system, it retains great freedom of action.

"They are very aware of the deflation risk. They are cutting rates very fast, and if necessary they too will turn to helicopters. But in the end they will keep the wolf from the door," he said.

http://www.telegraph.co.uk/finance/comme...ation.html

However, it appears Gordon Brown is singing from the same delusional hymnsheet to the Usual Suspects at the CFR:

Speaking to the Council on Foreign Relations, a New York-based thinktank, Brown said: "We need to make monetary policy work to better effect. In the US, interest rates have been reduced to 1%. The European area has been slower - rates are 3.25% in the euro area and 3% in the UK. There is scope for a further reduction in interest rates. It is an essential part of what we are doing."

He said lower interest rates needed to be accompanied by tax cuts and spending increases. The government wanted to avoid a financial giveaway being saved rather than spent, as happened to half the 1% of GDP rebate handed to US taxpayers.

http://www.guardian.co.uk/business/2008/...-brown-g20

George Soros must be licking his lips at the prospect of destroying the pound sterling. Again.

[Myra Bronstein]

...

George Soros must be licking his lips at the prospect of destroying the pound sterling. Again.

Jan, I've long been puzzled by George Soros' motives--supporting supposed progressive causes (like Move On) and such. Care to share insights?

[Jan Klimkowski]

Jan, I've long been puzzled by George Soros' motives--supporting supposed progressive causes (like Move On) and such. Care to share insights?

I find Soros a complete enigma.

He has no qualms about being a speculator and destroying national currencies as during his trashing of the pound sterling on Black Wednesday.

He has bankrolled NGOs and the likes of Solidarity in Eastern Europe to the tune of tens of millions of dollars.

His writings on the workings of markets are those of a highly intellectual mystic.

And he does have the persona of a sophisticated European intellectual from the mid-C20th.

I have little clue as to what really motivates him.

[Jan Klimkowski]

Mike "Mish" Shedlock has just skewered the G20's pompous, pious, business as usual, hot air. (Please note the "My comment" in the article is Mish's):

G-20 Summit Blames Buyers of Poison Apples

Hopes were high that the G-20 summit would issue a statement on US dollar hegemony, currency fluctuations, a new world order, a return to a gold standard, or make some other earth shattering statement. I predicted the summit would be a complete waste of time. Let's take a look.

Bloomberg is reporting G-20 Calls for Action on Growth, Regulatory Changes.

In a statement after a five-hour summit in Washington, the Group of 20 urged a "broader policy response" to spur growth, including potential interest-rate cuts and fiscal stimulus.

My Comment: Wonderful. The US is at 1% and Japan at .3% with every other country on a Mad Race To ZIRP. It did not help Japan or the US and it will not help spur growth anywhere else either.

The group set a March 31 deadline for recommendations on tightening accounting standards, strengthening derivatives markets and increasing oversight of hedge funds and debt-rating firms.

My Comment: Gee let's see. We postponed mark to market accounting, did nothing about off balance sheet accounting, and are blaming hedge funds for loose lending practices at banks.

"There was a common understanding that all of us should promote a pro-growth economic policy," U.S. President George W. Bush said. U.K. Prime Minister Gordon Brown said "there is a clear determination on the part of world leaders in every continent to take necessary action to move economies out of this difficult period."

My Comment: The understanding (or rather the misunderstanding) was that the meeting would actually accomplish something other than sing the praises of pro-growth economic policy.

With no clear promise to cut taxes and interest rates together, markets may be disappointed, said Carl Weinberg, chief economist at High Frequency Economics Ltd. in Valhalla, New York. "This isn't a strong action statement on addressing the matters at hand."

Rather than coordinate action, nations should act "as deemed appropriate to domestic conditions," the leaders said in their statement.

My translation: Everyone will continue to do whatever it was they were doing before.

The group pledged not to erect new trade barriers, guaranteed more resources for the International Monetary Fund if needed and promised to meet again before May.

Tumbling stock markets and forecasts for a worldwide recession are intensifying pressure on the G-20 leaders to act, 15 months after the credit crunch began. The IMF predicts advanced economies will together contract next year for the first time since World War II.

My Comment: Another meeting before May? How exciting. Exactly what is another meeting supposed to accomplish other than issue another lame statement praising growth?

The G-20 leaders, representing 90 percent of the world economy, blamed the crisis on investors who "sought higher yields without an adequate appreciation of the risks."

My Comment: Banks and brokerage packages sold poison apples. The G-20 is blaming those who bought poison apples not those who knowingly sold poison apples.

Reaching agreement on what to do was difficult, French President Nicolas Sarkozy said after the meeting. "I'm a friend of the U.S. but it wasn't always easy," he said. "There were misunderstandings to overcome."

My Comment: Exactly what misunderstandings were overcome?

The statement papered over differences by recognizing that regulation is "first and foremost" a national responsibility, while at the same time demanding "intensified international cooperation" to oversee financial firms whose operations and problems cross national borders.

My Comment: "Papered Over" is right and not a single misunderstanding was overcome.

The leaders called for the creation of "supervisory colleges" for bank regulators around the world to better to coordinate oversight and share information about activities and risk-taking of international banks.

My Comment: They are going to create yet another college of useless bureaucrats that will not do a damn thing but receive outrageous pay for sharing information one can easily find on Bloomberg. Any information actually worth sharing will be hidden from public view just as it is now.

Capital standards should be raised, they said, particularly for banks' structured credit and securitization activities.

My Comment: This is a case of saying one thing and doing another as Compelling Banks To Lend At Bazooka Point and the Battle Over Bazooka Point Lending proves.

The leaders directed their finance ministers to work on recommendations for enhancing disclosure by investors and institutions, including hedge funds, of their financial conditions.

My Comment: Meanwhile Paulson and Bernanke are in a battle with Bloomberg because they are failing to disclose to investors exactly what they are doing with taxpayer money.

Debt-rating companies, which blessed many of the products that have since gone into default, should be registered, and oversight of their actions strengthened to ensure they provide unbiased information and avoid conflicts of interest.

My Comment: This is more useless nonsense. Exactly what good would it do to register Moody's, Fitch, and the S&P. The big three were blessed by the SEC and that is what the problem is. It's Time To Break Up The Credit Rating Cartel.

Accounting standards should be harmonized around the world, the group said, and regulators should consider whether current rules properly value securities, particularly complex, illiquid products, during times of stress.

My Comment: This sounds suspiciously like a move away from mark to market accounting to more mark to fantasy accounting.

The leaders said executive compensation should be managed to "avoid excessive risk-taking," while stopping short of calling for any caps.

My Comment: This is clearly another useless statement.

Warning against protectionism as a way to fight recession, the G-20 vowed not to raise any trade barriers for the next year. They also said they will seek ways by the end of the year to conclude the Doha round of trade talks that collapsed in July.

My Comment: Trade talks have collapsed every year for a decade. The US and EU are primarily to blame.

Leaders will meet again before the end of April, most likely in London, when a new American administration is in office.

My Comment: Why bother?

Heads of emerging-market nations said the G-20 should now replace the Group of Eight as the forum for addressing economic issues.

Brazilian President Luiz Inacio Lula da Silva said the G-8 has "become a group of friends" and there's "no sense in making political and economic decisions without the G-20 countries."

What sense is there in adding more to the group? The odds that 20 can agree to something when 8 cannot is zero. With that let's take a look at the top ten accomplishments of the summit.

G-20 Top 10 Accomplishments

* 10: President Bush said "There was a common understanding that all of us should promote a pro-growth economic policy."

* 09: U.K. Prime Minister Gordon Brown said "there is a clear determination on the part of world leaders in every continent to take necessary action to move economies out of this difficult period."

* 08: The group agreed to not cap executive pay.

* 07: The group sang the praises of low interest rates.

* 06: The group will work on recommendations for enhancing disclosure while hinting it would allow the continuation of mark to fantasy accounting.

* 05: The group called for rating agencies to be registered even though rating agencies in the US are already sponsored by the SEC.

* 04: The group called for the creation of "supervisory colleges" who will not do anything thing but receive outrageous pay for sharing information one can easily find on Bloomberg.

* 03: Argentina, Australia, Brazil, China, India, Indonesia, South Korea, Mexico, Saudi Arabia, South Africa, and Turkey complained "the group of friends" otherwise known as the G-8 would not let them in whenever the G-8 got together to party. The above listed countries are saying to the G-8 "please don't throw a party without us."

* 02: The all inclusive group of 20 friends agreed to throw another party in April.

* 01: Drum roll please..... The number one accomplishment of the G20 meeting was to blame hedge funds and the buyers (not sellers) of poison apples for the financial crisis.


Top 5 Things G-20 Ignored

* 05: US Dollar Hegemony.

* 04: Micro-Mismanagement of interest rates by the Fed and Central Bankers.

* 03: Spending run rampant in US authorized by Congress. Same thing in other G-20 countries.

* 02: Of immediate concern is the Collapse of Trade, Letters of Credit, and Baltic Dry Shipping. Please see Yet More Trade Finance Worries (Not for the Fainthearted).

* 01: Fractional Reserve Lending run rampant, leverage, excessive credit creation, and unsound fiat currencies. In other words the G-20 ignored discussing the very cause of the problem we are now facing.


Mike "Mish" Shedlock

http://globaleconomicanalysis.blogspot.c...oison.html

[Jan Klimkowski]

The vultures are circling around the pound sterling:

How likely is a sterling crisis or: is London really Reykjavik-on-Thames?
November 13, 2008
Willem Buiter

With the pound sterling dropping like a stone against most other currencies and credit default swap rates on long-term UK sovereign debt beginning to edge up, this is a good time to revisit a suggestion I made earlier on a number of occasions (e.g. here, here and here), that there is a non-trivial risk of the UK becoming the next Iceland.

The risk of a triple crisis - a banking crisis, a currency crisis and a sovereign debt default crisis - is always there for countries that are afflicted with the inconsistent quartet identified by Anne Sibert and myself in our work on Iceland: (1) a small country with (2) a large internationally exposed banking sector, (3) a currency that is not a global reserve currency and (4) limited fiscal capacity.

The argument is simple. First consider the case where the banking sector is fundamentally solvent, in the sense that its assets, if held to maturity, would cover its liabilities. Iceland’s banks were supposed to have been in that position, although I have seen no verifiable information on the quality of the three formerly internationally active banks. There is no such thing as a safe bank, even if the bank is sound. Without an explicit or implicit government guarantee, there is always the risk of a bank run (a withdrawal of deposits or a refusal to renew maturing credit and to roll over maturing debt) or a sudden market seizure or ’strike’ in the markets for the bank’s assets bringing down a fundamentally sound bank.

To prevent a fundamentally sound bank succumbing to a deposit run or to asset market illiquidity, the central bank has to be able to act as lender of last resort, providing funding liquidity and as market maker of last resort, providing market liquidity to liquidity-constrained banks.

If the country has an internationally active banking and financial sector and if its foreign currency liabilities have a shorter maturity than its foreign currency assets, and especially if these foreign currency assets have become illiquid, the central bank has to be able to act as foreign currency lender of last resort and market maker of last resort if it is to be able to guarantee the survival of the banking sector when faced with a deposit run and/or illiquid markets for its assets.

The central bank of Iceland could be an effective lender of last resort in Icelandic krona, as it can print the stuff in unlimited quantities. It can be a lender of last resort and market maker of last resort in other currencies only to a limited extend - limited by the fact that the Icelandic krona is not a global reserve currency and by the fiscal spare capacity of the Icelandic sovereign.

If Iceland had been a member of the euro area, its central bank would have been part of the Eurosystem - the euro area central bank consisting of the ECB and the (currently 15) national central banks of the euro area member states. The euro is the junior of the two global reserve currencies. First is the US dollar, with around 64 percent of global official foreign exchange reserves held in US dollars. The euro’s share is around 27 percent. After the euro, there is nothing. Sterling’s share of 4.7 percent (at the overly flattering strong sterling exchange rate of late 2007) reflects its minor-league legacy reserve currency status. The Japanese yen and Swiss franc are completely irrelevant as global reserve currencies.

Clearly if a country has a major-league global reserve currency as its national currency, two consequences follow. First, it is likely to be able to borrow abroad using instruments denominated in its own currency rather than in that of the currency of the lender or some other global reserve currency - they are less affected by ‘original sin’ - in the currency-denomination-of-external-debt sense of the expression. Second, it will be possible for both private parties and for official parties like the central bank, to arrange access to foreign exchange (through swaps with other central banks, credit lines etc.) more easily and on better terms than are available to private parties, central banks and other official agents not blessed with a global reserve currency of their own.

As a member of the euro area, it would have been much easier and cheaper for Iceland to defend itself against speculative attacks on its banks - provided the banks and its government were indeed solvent and perceived to be so. With the krona, not only could solvent banks be brought down, even a solvent but illiquid (in foreign exchange) government could be brought down by a sufficiently large speculative attack on the banks, the currency and the public debt.

Of course, even with the euro, the banks could not have been saved by the Icelandic authorities if the banks were fundamentally unsound and if the government did not have the fiscal strength to recapitalise the banks. Under current circumstances, if the government injects capital into a bank to compensate for past and anticipated future losses, it may not achieve a risk-adjusted expected rate of return on this investment equal to its borrowing cost. The difference will have to be recouped through higher future primary surpluses, that is, higher future government budget surpluses excluding interest payments. If there is doubt in the markets about the ability or willingness of current and/or future governments to raise future taxes or cut future spending to generate the required increase in future primary surpluses, the default risk premium on the public debt will rise. We are seeing such increased default risk premia even for the most credit-worthy sovereigns, including the German government, the US government and the UK government. On Friday October 10, 2008, the spreads on 5 year sovereign CDS were 0.456% for the UK, 0.33% for the USA ad 0.265% for Germany, well above their post-war historical averages. On October 28, 2008, Bloomberg wrote:

“Credit-default swaps on [U.S.] Treasuries have risen nearly 40 percent since TARP was signed into law Oct. 3, and are now about the same as Mexican and Thai government debt before the credit markets began to seize up in June 2007.”

By bailing out the banks, and other bits of the financial system, the authorities reduce bank default risk but by increasing sovereign default risk. As long as there is sufficient fiscal spare capacity (the technical, economic and political prerequisites are met for raising future taxes and/or cutting future public spending by a sufficient amount to service the additional public debt and maintain long-run government solvency).

Iceland’s government did not have the fiscal resources to bail out its banks. All three internationally active banks were put into receivership. The domestic bits then were bought by the government out of the receivership. The Icelandic krona collapsed and is no longer internationally convertible: exchange rate restrictions have been imposed. It is an open issue whether Iceland will default on some of its sovereign debt obligations as well.

How and to what degree is this relevant to the UK? Iceland is a tiny country (about 300,000 people - the size of the city of Coventry). The UK has a population of over 61 million. Nevertheless, the UK is a small open economy for economic purposes: it is a price taker in the markets for its imports and exports and in global financial markets. Its share of world GDP in 2007 was 3.3% (at PPP exchange rates - somewhat higher at market exchange rates). Its currency is no longer a serious world reserve currency.

The UK banking sector’s balance sheet is about half the size of the Icelandic banking sector as a share of annual GDP: just under 450% at the end of 2007 as compared to Iceland’s almost 900%. Switzerland, another vulnerable country (small, no currency with global reserve currency status , large banking sector relative to GDP and limited central government fiscal capacity) has a banking sector balance sheet of just over 650% of annual GDP. With UK annual GDP around £1.5 trillion, that gives us a banking sector balance sheet of well over £ 6 trillion.

The first Chart below shows the size of the balance of the UK banking sector. This includes the Bank of England. If we exclude the Bank of England, the latest observation on the balance sheet of the banking sector and a percentage of annual GDP would still be around 420 percent. The deleveraging of the banking sector, visible at the very end of the sample period, has much further to go. The Chart also shows that foreign currency assets and liabilities of the banking sector are very evenly matched - the two lines are almost indistinguishable. Both now are just below 250% of GDP. I don’t have any data on the degree of mismatch by individual currency. Just the aggregate foreign currency exposure is shown.

While there is no net foreign exchange exposure of the banking system in the UK, banks are banks. The foreign currency liabilities of the banking system are therefore likely to have shorter maturities than the foreign currency assets. The foreign currency assets are also likely to be less liquid than the liabilities. I don’t have information on the maturity and liquidity composition of foreign currency assets and liabilities to confirm or refute this presumption. Let me just say that Iceland’s banks were brought down despite an aggregate match between foreign currency assets and foreign liabilities.

Chart 1


Source: Office for National Statistics

Not only are the UK banks rather large relative to the size of the economy, the gross external assets and liabilities of the British economy are also hefty - about the same size relative to UK GDP as the total assets of the banking sector (there is no deep reason for this coincidence). Chart 2 below shows the gross external asset and liability position and the net foreign investment position of the UK. While not in the Iceland league (Iceland had gross foreign assets and liabilities of around 800 percent of annual GDP at the end of 2007) the UK, with gross foreign assets and liabilities of well over 400 percent of annual GDP does look like a highly leveraged entity - like an investment bank or a hedge fund. By contrast, gross external assets and liabilities of the US straddle 100 percent of annual GDP.

Chart 2


Source: Office for National Statistics

Foreign currency illiquidity risk for the UK banks and authorities

Assume for the sake of argument that the UK’s banks are sound. Most of them obviously are not, which is why so many of them have had capital injected into them by the government, and why all of them benefit from explicit government guarantees on new bank debt issuance and implicit government guarantees that the government will come to their assistance should they be at risk of insolvency. With foreign currency assets of longer maturity and less liquid than foreign liabilities, the banks and the country would still be vulnerable to a foreign currency run on the banks (a refusal to renew foreign currency credit) or a seizing up of the markets in which the banks’ foreign currency assets are traded. The Bank of England’s foreign currency reserves are puny and the government’s foreign currency reserves are small - around US$43 billion, pocket change, really.

No doubt the Bank of England would be able to arrange swaps, credit lines or overdraft facilities with the systemically important central banks - the Fed, the ECB and the Bank of Japan. Given sound banks and sound fiscal fundamentals, it should be possible for the UK to defend the banking sector against runs or market strikes. There would, however, be a cost involved - the cost faced by any issuer of a currency that is not a global reserve currency and who therefore either has to insure ex-ante against the possibility of running short of global reserve currencies, or risk getting clobbered on the terms of an emergency currency swap or similar arrangement cobbled together when the enemies are already scaling the ramparts.

This cost of insuring against foreign currency illiquidity risk will make the City of London less competitive as a global financial center than rivals based in global reserve currency jurisdictions. It provides another strong argument for the UK adopting the euro and for the Bank of England becoming part of the Eurosystem as soon as the other EU member states will let it.

The reason the costly handicap of a minor-league currency does not appear to have harmed the UK in the past is the same as the reason why I have not made the argument in the past. Before the current financial crisis, no-one could conceive of a world in which a financial crisis would start in the global financial heartland - Wall Street and the City of London - rather than in some developing country or emerging market, would paralyze most systemically important wholesale financial markets and lead to the government nationalising much of the north Atlantic region’s banking and wider financial system and underwriting or guaranteeing the rest. Well, most of the world now knows that this is the way things can be. If it retains sterling, the City of London will put itself at a competitive disadvantage (for those who remember then-Chancellor Brown’s Five Tests for euro area membership, this means that the fourth of these tests now has been met also).

Sovereign default risk for the UK

Even if the UK had the euro as its currency, its banks would still have been at risk if they were unsound (their assets, even if held to maturity, would not cover their financial obligations). In this case, bank insolvency would result unless the British authorities were both able and willing to bail them out. I assume in what follows that the government is willing to bail out the banks. The evidence thus far supports this.

Northern Rock and (rump) Bradford and Bingley were nationalised. The SLS allows all banks to swap illiquid asset-backed securities for Treasury Bills. For reasons that cannot be understood by ordinary mortals, the Treasury Bills lent/swapped by the SLS don’t count as public debt (something to do with Treasury bills with less than one year remaining maturity not being part of the public debt for some accounting and accountability purposes - don’t ask). The Bank of England is accepting a wider range of private securities as collateral at the discount window and in repos. The state has a 60 percent ownership stake in RBS and roughly 40 percent ownership stakes in HBOS and Lloyds-TSB. The government has made up to £25o billion available to guarantee new issuance of bank debt. The state stands behind the formal £50,000 deposit guarantee for bank retail deposits.

The key question is, can the government meet all these fiscal commitments, whether firm or flaccid, unconditional or contingent and explicit or implicit ? Does it have the resources, now and in the future, to issue the additional debt required to meet the growing volume of up-front obligations it has taken on?

To be solvent, the face value of the government’s net financial obligations has to be no larger than the present discounted value of current and future primary government surpluses (government surpluses excluding net interest and other investment income). The government argues that its net debt position is strong, with a net debt to annual GDP ratio still just below forty percent. That statistic is a prime example of lies, damned lies and government statistics.

The 40 percent excludes such old sins as the debt incurred through the PFI (private finance initiatives). This will be brought into the total soon. It also does not yet include the net debt of Northern Rock and Bradford and Bingley. It also excludes the debt of RBS, where the government owns a majority stake and the debt of Lloyds-TSB and HBOS, where the government has a controlling minority stake. Under normal accounting practices, the debt of all three banks will have to be counted as public debt in the future.

Three large UK banks, HSBC, Barclays and Abbey (Santander) have not yet taken the King’s shilling - they are attempting to meet the capital raising targets they agreed with the government from sources other than the government. All three banks are, however, heavily exposed to emerging markets (Santander mainly in Latin America, HSBC in Asia, the Americas, Europe, the Middle East, and Africa and Barclays in Europe, Africa and Asia). This has been a source of strength until recently, compared to their competitors who were mainly exposed to the USA and Western Europe. However, with all emerging markets now severely affected by the financial crisis (both directly and through trade links with Western Europe and the USA), what was a source of strength is become a further source of weakness. The likelihood that some or all of the banks that have not yet received capital injections from the government will do so in the not too distant future is rising steadily.

It is not at all far-fetched to hold the view that the British government has effectively guaranteed the balance sheets of the entire UK banking sector. Let’s value this conservatively at 400 percent of annual GDP, some £ 6 trillion. The value of this guarantee depends on the likelihood it will be called upon, and on the amount of money the government would have to come up with if the guarantee is called. Both numbers are highly uncertain and any guestimate is bound to be subjective. The expected payments under the guarantee are, in my view, hardly likely to be less than £300 bn (on top of any money already paid out), some 20 percent of annual GDP. It could be much higher. With a recession of unknown depth and duration looming, there is a material risk that the government would have to come up with a multiple of the £300 bn just mentioned.

Of course, the value of the assets acquired by the government as shareholder has to be set against the explicit and implicit liabilities it has taken on. I would like to see a valuation of the equity stakes of the government that does not benefit from the recent scandalous relaxation of fair-value accounting and reporting that was forced upon the IASB. I don’t believe any valuation that relies on managerial discretion. With the regulatory constraints likely to be imposed on banks in the future, and the lower returns associated with banking-as-a-public utility, the government may well be getting rather poor financial returns on its investment in the banks. While that does not mean the government should not have made the capital injections - the systemic externalities associated with the failure of large banks don’t show up in the share price - it does mean that the immediate fiscal burden of the capital injections is likely to be only partially offset by future dividends and (re-)privatisation receipts.

In addition to the debt that has been and will be issued to finance asset purchases by the government, there are the future debt issuance associated with the large cyclical and structural government deficits that will be a feature of the coming recession. If GDP falls peak-to-trough by, say 3.5 percent and recovers only slowly, we could have a seven percent of GDP or higher government deficit for 2009 and 2010. Together with the explicit or implicit fiscal commitments made to safeguard the British banking system, the numbers are likely to spook the markets.

With the true net public debt to GDP ratio probably already well above 100 percent of GDP and rising, and with massive public sector deficits, partly cyclical and partly structural, about to materialise, the markets will question the fiscal-financial sustainability of the government’s programme with increasing vehemence. The CDS spreads on UK public debt will start rising. The notion that, except for currency, there may not be a safe sterling-denominated asset may come as a shock. But the same is true in the US. In 2009, the US government will have to sell (gross) at least $ 2 trillion worth of government debt (the sum of the Federal deficit plus asset purchases plus refinancing of maturing debt). The largest such figure ever in the past was $550 billion. In the US too, the markets will have to learn to do without a US dollar financial instrument that is free of default risk.

The fiscal dire straits the UK government are in limits their capacity to engage in a discretionary fiscal stimulus to boost domestic demand. For it to be meaningful, a debt or money-financed stimulus of at least one percent of GDP and more likely two percent of GDP is called for. But if the market takes fright and believes that the government will not raise future taxes or cut future public spending by the amounts required to safeguard government solvency despite greater current borrowing, it will add higher default risk premia to the longer-dated UK sovereign debt instruments.

Such mistrust in the temporary nature of a fiscal stimulus would not be irrational. After its first term in office, the government have thrown fiscal restraint to the wind and have engaged in a steady increase in public spending as a share of GDP which has been only partly matched by an increase in the tax burden as a share of GDP. Rising debt and deficits and a fondness for fiscal and accounting gimmicks designed to hide the increase in the debt burden have undermined public confidence in the fiscal rectitude of the government. With enough mistrust, the interest rates will rise by enough to crowd out completely the stimulus to private demand provided by the tax cut or public spending increase. Lack of confidence in the government’s fiscal sustainability would also undermine confidence in sterling. In the worst case, we could see a run on the banks, on the public debt and on sterling all at the same time. This is not the most likely outcome yet, in my view. But it is a distinct possibility.

Could the government monetise the deficits instead (i.e. sell gilts to the bank of England)? The Bank would only be willing to buy such debt (either directly or indirectly in the secondary markets) if it was consistent with its interpretation of its price stability mandate. The Bank appears to believe that short rates may have to go down quite a bit further if it is not to undershoot the inflation target by the end of next year. It may also view the monetisation of gilt issuance as consistent with its mandate.

If there is a conflict between the Bank of England and the government, the government could invoke the Treasury’s Reserve Powers. This is a clause in the Bank of England Act that allows the government to take back the power to set rates from the Bank of England, under exceptional and emergency conditions. It has never been invoked.

If the deficits get monetised, there will not be the upward pressure on real interest rates that would result from debt financing. But the markets may fear the long-term inflationary consequences of the monetary financing, especially if it were to be done by the government after invoking the Treasury’s Reserve Powers. So long nominal rates would be likely to rise if monetisation of the government’s deficits were chosen. Monetisation of deficits would also weaken sterling further.

All may still end up well (cyclically adjusted well, that is). But the piling of fiscal commitment on fiscal commitment by the government is not a risk-free option. The British government has limited fiscal spare capacity. Among the larger European countries, the UK government’s exposure, formal or implicit, to its banking sector is by far the highest. Switzerland, Denmark and Sweden are in a similar pickle, with the banking sector solvency gap threatening to become larger than the fiscal spare capacity of the state.

The British government should go easy on the discretionary fiscal stimulus it applies, lest it risk a triple bank, sterling and public debt crisis. Better to first let the Bank of England use the 300 basis points worth of Bank Rate cuts that it still can play with. Even better to combine rate cuts with measures to directly target the disfunctionalities in the interbank market, such as government guarantees for (cross-border) interbank lending.

The UK shares with the United States of America the predicament that unfavourable fiscal circumstances make the wisdom of a significant fiscal stimulus questionable. In the US as in the UK the twin deficits (government and current account) severely constrain the government’s fiscal elbow room. Both countries need all the help they can get from fiscal stimuli abroad, in China, in Germany and in the Gulf. Beggars can’t be choosers.

http://blogs.ft.com/maverecon/2008/11/ho...on-thames/

[Jan Klimkowski]

Senator Inhofe tells an inconvenient truth - Treasury Secretary Paulson lied to the Senate, Congress and the American people.

Hmmm, how do They deal with that? Simple. MSM ignores it

And lil' ole Tulsa World prints the story to its tiny readership:

11/16/2008

Inhofe: Cancel the 'blank check'

WASHINGTON — U.S. Sen. Jim Inhofe said Saturday that Congress was not told the truth about the bailout of the nation's financial system and should take back what is left of the $700 billion "blank check'' it gave the Bush administration.

"It is just outrageous that the American people don't know that Congress doesn't know how much money he (Treasury Secretary Henry Paulson) has given away to anyone,'' the Oklahoma Republican told the Tulsa World.

"It could be to his friends. It could be to anybody else. We don't know. There is no way of knowing.''

Inhofe's comments, unusually pointed even for a senator known for being blunt, come on the heels of Paulson's shift in how he thinks the bailout funds should be spent.

Last week the Treasury secretary announced he was abandoning his plan to free up the nation's credit system by buying up toxic assets from troubled financial institutions. Instead, Paulson wants to take a more direct action on the consumer credit front.

"He was able to get this authority from Congress predicated on what he was going to do, and then he didn't do it,'' Inhofe said.

"So, that's enough reason right there.''

Inhofe recalled earlier comments opposing Paulson's plan because the administration's point man did not have answers for a number of questions. He also recalled questioning the rush to get the bailout passed.

"I have learned a long time ago. When they come up and say this has to be done and has to be done immediately, there is no other way of doing it, you have to sit back and take a deep breath and nine times out of 10 they are not telling the truth,'' he said.

"And this is one of those nine times.''

Inhofe has laid out his legislative plans for this week on the bailout package in a letter to his Senate colleagues.

He wants to freeze what is left of the initial $350 billion — reportedly $60 billion, but Inhofe concedes he does not know for sure.

Then he wants a provision requiring an affirmative vote by Congress before Paulson can get his hands on the second $350 billion of bailout money.

Current law lays out a scenario where President Bush submits a plan on the second half of the funding.

Lawmakers have 15 days to disapprove it, but Inhofe questions that wording.

"Congress abdicated its constitutional responsibility by signing a truly blank check over to the Treasury Secretary,'' he wrote.

"However, the lame duck session of Congress offers us a tremendous opportunity to change course. We should take it.''

In the interview, the senator said his plans can provide "redemption'' for those senators who supported Paulson.

Inhofe's plan appears to be a long shot at this point. Senators originally approved the bailout plan by a 74-25 vote.

He does not know how much support he has among his Republican colleagues, and he concedes Democratic leaders could block it.

Bush also could veto it if it were to make it out of Congress.

Neither Senate Majority Leader Harry Reid's office nor the Treasury Department commented.

Reid, D-Nev., wants to use the upcoming lame duck session to push economic issues such as extending unemployment benefits and aid to the nation's ailing auto industry.

Inhofe opposes both.

"You don't stimulate the economy by giving away more money,'' he said.

In response to concerns expressed by some that allowing even one of the big automakers to fail would be too much of an economic hit for the nation, Inhofe said reality must be accepted.

"If we keep on nursing a broken system, then we can't expect to have a different result come later on,'' he said.

"I just think we have to draw the line someplace, and the time is here.''

http://www.tulsaworld.com/news/article.a...ecri880405

[Jan Klimkowski]

Ticker Forum's Karl Denninger in typically pugnacious, and astute, form:

The Fed claims to be a "private central bank" but in fact that's a lie too - their losses are yours, and their "liquidity" is your tax money. If The Fed wants to be a "private bank" then cut it off from taxpayer subsidy and revoke its right to print money - instead, force it to compete for private capital just like everyone else. (Threaten Bernanke with that and watch his face turn white and underwear brown.)

The entire reason we are in this mess is because banks and other institutions have been lying about their exposure, capital levels and valuations, and we the people have allowed it to go on for more than a decade.

As noted previously both Wachovia and National City were sold for about 1/3rd of their claimed balance sheet value just days before the sale.

Trillions of dollars off-balance-sheet?

Can anyone spell ENRON?

http://market-ticker.org/archives/661-Th...Money.html

Meanwhile, it looks like Bush & Paulson will now not tap Congress for the second half of the $700 billion. Hmmm.

http://www.bloomberg.com/apps/news?pid=2...rNcRqcl94M

Whassup doc? What's really going on?

[Myra Bronstein]

I find Soros a complete enigma.
...

Ok thanks.
I guess we're in synch on him.

[Mark Stapleton]

Mike "Mish" Shedlock has just skewered the G20's pompous, pious, business as usual, hot air. (Please note the "My comment" in the article is Mish's):


http://globaleconomicanalysis.blogspot.c...oison.html

Thanks for keeping us up to speed, Jan.

So the G20 was a waste of time and energy, eh. Here in Oz it will be remembered for the angry tempest which surrounded Aussie PM Kevin Rudd over THAT phone call:

http://www.watoday.com.au/national/rudd-...-5anj.html

[Peter Lemkin]

I just heard an interesting figure. Between the US and other countries bailing-out the bankers/financiers, the ultra-rich have been given an amazing 4 Trillion dollars in the last 8 weeks alone! Put that in perspective along side the few millions regularly denied for a school lunch program; better shools; health care; etc., et al. Digusting is the only word and I can't understand why more aren't enraged at the theft ongoing for decades, and longer. 4 trillion dollars could solve most of the problems of the poor and struggling middle-classes - but that would be 'socialism' in the eyes of the socalledists at the top. They don't mind socialism [as long as it isn't called that] as long as they are the only beneficiaries. Yes, the Fed is as 'federal' as Federal Express. It is a private bank with its straw in our glass....and they've all but sucked it dry.