Greg Ip

Articles by The Economist’s U.S. Economics Editor

Archive for April 2009

The Federal Reserve: The hedge fund of Foggy Bottom

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The original article is linked here.

If you do not adjust for risk, the Fed is making good money for Uncle Sam


THE Federal Reserve does not set out to make bumper profits. But its 2008 annual accounts, released on April 23rd, would turn many a hedge-fund manager green with envy.

Like Wall Street’s finest, the Fed makes money on a spread. Its main source of funds comes from issuing cash, since currency in circulation is, in effect, an interest-free loan by the public to the central bank. The interest it earns on its loans and securities is almost pure profit, or “seigniorage,” most of which it remits to the Treasury.

Last year the central bank reported a whopping $43 billion in operating income. That was more or less the same level as in 2007, but meanwhile short-term interest rates had plummeted, ending the year near zero. That should have clobbered Fed income, as rate cuts did in the early days of the last recovery in 2002-04 (see chart).

But it did not, for two reasons. First, to shore up financial markets the Fed has pumped up its balance-sheet—its total assets were $2.2 trillion on December 31st, more than double their level of a year earlier. Second, it has been trading in low-risk, low-return Treasury debt and buying higher-yielding private debt—discount loans to banks, commercial paper, and mortgage-backed securities, for example.

The Fed has, in effect, been adding both risk and return to its portfolio. So far so good, despite mark-to-market losses on the securities it acquired bailing out Bear Stearns and American International Group. But as hedge-fund managers have learnt of late, you “reach for yield” at your peril. The risk is an occasional hit big enough to wipe out years of profits.


Written by gregip

April 30, 2009 at 3:58 pm

Obama and trade: Low expectations exceeded

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The original story is linked here.

THE president Apr 30th 2009 | WASHINGTON, DC
From The Economist print edition 

Though Barack Obama has shown less protectionism than was feared, he needs to do more to resist it in Congress and to press forward on Doha

THE president has shown signs of shedding the protectionist baggage he brought to the White House. As presidential candidate, Barack Obama wanted to punish China for manipulating its currency to boost exports. On April 15th President Obama’s treasury secretary quietly issued a report that pointedly did not declare China to be a currency manipulator. Read the rest of this entry »

Written by gregip

April 30, 2009 at 3:31 pm

Central banks:The monetary-policy maze

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 The original story is linked here.


Apr 23rd 2009 | WASHINGTON, DC
From The Economist print edition



The simple rules by which central banks lived have crumbled. A messier, more political future awaits

Illustration by Derek Bacon


IN THE world that existed before the financial crisis, central bankers were triumphant. They had defeated inflation and tamed the business cycle. And they had developed a powerful intellectual consensus on how to do their job, summarised recently by David Blanchflower, a member of the Bank of England’s monetary policy committee, as “one tool, one target”. The tool was the short-term interest rate, the target was price stability.

This minimalist formula fitted the laissez-faire temper of the times. A growing array of financial markets could price risk and allocate credit efficiently. Central bankers had merely to calibrate their interest-rate tools and all other markets would automatically adjust. Central banks still cared about financial stability and full employment, but could argue these were best served by stabilising prices—without, if you please, interference from politicians.


The financial crisis has upended all that. Read the rest of this entry »

Tim Geithner: Baptism of fire

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The original story is linked here.
Apr 23rd 2009 | WASHINGTON, DC
From The Economist print edition



America’s treasury secretary is torn between politics and policy



ASKED after giving a speech on April 22nd whether he regretted taking his new job, Tim Geithner, Barack Obama’s treasury secretary, paused for what seemed an eternity. “I…uh…feel deeply privileged,” he replied. His audience erupted in laughter.

Mr Geithner’s first three months have been a baptism of fire. The markets soared last autumn (see chart) when the New York Fed chief’s name surfaced for the job. But within weeks of taking office in January, personal tax problems, a poorly received plan for fixing the financial system and a backlash against his bail-out of AIG, a big insurer, had some in Washington, DC, counting the months to his resignation.


Talk of resignation has died down as markets have recovered amid renewed hope about the economy. The outrage over AIG burned itself out. And Mr Geithner has scored some successes: he has proposed new federal powers to take over failing financial institutions and he led the way for the G20 to boost the International Monetary Fund’s credit by $500 billion to support cash-starved countries.

Even so, Mr Geithner has not yet silenced the sceptics. Read the rest of this entry »

Written by gregip

April 23, 2009 at 9:51 pm

Economics focus: The curse of politics

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The original story is linked here.

Apr 16th 2009
From The Economist print edition

Financial crises can drag on because efficient remedies are politically unpalatable

Illustration by Jac Depczyk

AS THEIR banking crisis approaches Japanese proportions, Americans can take comfort from the fact that their political culture is more capable of finding a solution. Or can they? Today’s anti-banker backlash bears a striking resemblance to the voter outrage that stymied efforts to fix Japan’s banking system in the 1990s. Indeed, an enduring lesson of financial crises is how political constraints interfere with economically efficient solutions.

For example, America’s Treasury and the Federal Reserve began examining options to use public money to buy up illiquid mortgage assets and to inject capital into financial institutions shortly after rescuing Bear Stearns, a failing investment bank, in March 2008. But it was another six months before they acted on those plans. “There was no way we could go to Congress without the American people understanding we faced a crisis,” says Henry Paulson, the treasury secretary at the time.

Sure enough, not until the failure of Lehman Brothers sparked a global panic in September did Mr Paulson and Ben Bernanke, the Fed chairman, ask Congress to authorise an outlay of $700 billion to support the system. Some say Mr Paulson should have tried harder to acquire the funds before the Lehman crisis. Perhaps, but it is doubtful he would have succeeded. “Even at the height of the crisis, [that] proved almost too hard to do,” he notes.

Phillip Swagel, an economist who will join Georgetown University this autumn, writes in a review* of his experience as an aide to Mr Paulson from December 2006 to January 2009 that market participants and academic economists often proposed solutions that glossed over real-world political and legal obstacles. Some academics argued bank creditors should be forced to swap their debt for equity, for example. But Mr Swagel notes that is not legally possible without a change in the bankruptcy code, a tortuous political process. Similarly, to reduce housing foreclosures the Treasury and Congress focused on reducing interest rates for struggling homeowners, even though this would be less effective than subsidising write-downs of mortgage principal. But politicians and voters would have seen that as an unacceptable bail-out of some undeserving homeowners.

Economists have long studied how institutional constraints interfere with efficient economic choices, such as when special interests erect barriers to entry in product markets. Such constraints have received relatively little attention in the burgeoning literature on financial crises. Yet a closer examination shows that many of the same political obstacles crop up from one crisis to the next. Japan’s Ministry of Finance first sought private-sector solutions to its banking crisis so as not to arouse voter anger by using taxpayers’ money. When those solutions failed, the government proposed in 1995 spending a mere ¥685 billion ($7 billion) to take over the problem loans of seven jusen, or mortgage-finance companies. The backlash was intense. Opposition parties called for the finance minister’s resignation and staged a sit-in at parliament. In one poll, 87% of voters disapproved. The measure eventually passed, but the experience was so searing that it discouraged the government from tackling the banks’ much bigger bad loans until 1997.

In spite of these difficulties, some governments do negotiate the political shoals. South Korea is often praised for the speed and forcefulness with which it took over failing banks and bought up bad loans following its financial crisis in 1997-98. But the South Korean government was able to deflect public anger by arguing that it was being forced to take these steps by the IMF, which to this day most Koreans blame for the crisis.

Sweden took over two banks and issued a blanket guarantee of bank liabilities in the early 1990s even though the governing coalition did not have a majority in parliament. Bo Lundgren, the finance minister at the time, says Swedish voters would have rejected the bail-out had it been put to a referendum. But the government first ensured it had the support of the opposition party (from whom it had inherited the crisis) and then obtained authority from parliament for unlimited funds, so it did not have to return for more money later.


This time it’s not different

A blank cheque would greatly suit Barack Obama, who gave warning on April 14th that American banks may “require substantial additional resources”. Mr Obama has pencilled in another $750 billion of potential stabilisation funds in his 2010 budget but unlocking extra money will be extremely tricky. Despite commanding majorities in Congress and high personal-approval ratings, he must overcome solid opposition from voters jaded by revelations of bankers’ excess.

That may well mean violating certain economic principles. Economists generally prefer transparent to hidden subsidies. But Mr Swagel says that the Treasury came to realise that underpricing insurance for bank assets roused less political opposition than overpaying for assets precisely because the insurance is less transparent. The Treasury is also relying on the Fed to finance illiquid assets by printing money because that requires no congressional approval (even if it compromises the Fed’s independence).

The other temptation is to couple assistance for bankers with a hefty dose of punishment to sate the public’s hunger for justice. Sweden sued the boards of the two banks it nationalised. Several executives agreed to repay their “golden-handshake” severances to avoid prosecution. Mr Obama promised that if banks need more aid, “we will hold accountable those responsible.” The risk, of course, is that pandering to voters’ anger only inflames them further, and makes it even harder to put money into the banking system as need arises.

* “The Financial Crisis: An Inside View” by Phillip Swagel, presented at the Brookings Papers on Economic Activity conference, April 2009

Written by gregip

April 16, 2009 at 11:50 pm

The Federal Reserve: Sacred territory

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The original article is linked here.

Apr 8th 2009 | WASHINGTON, DC
From The Economist print edition

The hyperactive Fed finds its cherished independence is on the line

THE Federal Reserve has ventured ever further into the political realm, propping up failing companies, lending to industries other than banks and financing the federal budget through purchases of Treasury bonds. Now the politicians are threatening to respond in kind. Read the rest of this entry »

Written by gregip

April 8, 2009 at 9:56 pm

For once, a positive parallel to the 1930s

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The original blog post is linked here.
IN THE prelude to the G20 meeting, many commenters, including this newspaper, worried of a repeat of the London Conference of 1933. Franklin Roosevelt is often accused of wrecking it with his refusal to return to the gold standard. The resulting disarray, it is said, deepened the Depression.

Yet one could argue that in its failure to return the world to gold, the 1933 conference was a success. Markets greeted Roosevelt’s July bombshell “enthusiastically”, notes economic historian Allan Meltzer. They correctly anticipated “reflation, rising output, and a vigorous policy of domestic expansion.” As Barry Eichengreen has demonstrated, the gold standard was a monetary straitjacket that transmitted deflation between countries; each country’s recovery is highly correlated with when it abandoned gold.

On this front, I see a parallel (though perhaps a tortured one) with the G20’s decision to boost the IMF’s lending resources from $250 billion to $1 trillion. Read the rest of this entry »

Written by gregip

April 6, 2009 at 8:45 pm