The Financial Stability Forum Meets the Bowery Boys

Financial Stability Forum Report to the G7 April 7/08 (PDF)

"...the balance sheets of financial institutions are burdened by assets that have suffered major declines in value and vanishing market liquidity. Participants are reluctant to transact in these instruments, adding to increased financial and macroeconomic uncertainty.

To re-establish confidence in the soundness of markets and financial institutions, national authorities have taken exceptional steps with a view to facilitating adjustment and dampening the impact on the real economy. These have included monetary and fiscal stimulus, central bank liquidity operations, policies to promote asset market liquidity and actions to resolve problems at specific institutions. Financial institutions have taken steps to rebuild capital and liquidity cushions.

Despite these measures, the financial system remains under stress. While national authorities may continue to consider short-term policy responses should conditions warrant it, to restore confidence in the soundness of markets and institutions, it is essential that we take steps now to enhance the resilience of the global system.

To this end, the FSF proposes concrete actions in the following five areas:

• Strengthened prudential oversight of capital, liquidity and risk management.
• Enhancing transparency and valuation.
• Changes in the role and uses of credit ratings.
• Strengthening the authorities’ responsiveness to risks.
• Robust arrangements for dealing with stress in the financial system."


FINANCIAL STABILITY FORUM

Executive Summary

Strengthened prudential oversight of capital, liquidity and risk management

Capital requirements:

Specific proposals will be issued in 2008 to:
• Raise Basel II capital requirements for certain complex structured credit products;
• Introduce additional capital charges for default and event risk in the trading books of banks and securities firms;
• Strengthen the capital treatment of liquidity facilities to off-balance sheet conduits.

Changes will be implemented over time to avoid exacerbating short-term stress.
(Special challenge: banks have been using SIVs extensively to blow off the Basel II requirements as they had been. What good will raising them do? - Jesse)

Liquidity:

Supervisory guidance will be issued by July 2008 for the supervision and management of liquidity risks.
(Yeah it can wait. Its only the heart of the crisis. - Jesse)

Oversight of risk management:

Guidance for supervisory reviews under Basel II will be developed that will:
• Strengthen oversight of banks’ identification and management of firm-wide risks;
• Strengthen oversight of banks’ stress testing practices for risk management and capital planning purposes;
• Require banks to soundly manage and report off-balance sheet exposures;

Supervisors will use Basel II to ensure banks’ risk management, capital buffers and estimates of potential credit losses are appropriately forward looking.
(Here's a teaspoon and a feather-duster, go clean that Augean Stable. - Jesse)

Over-the-counter derivatives:

Authorities will encourage market participants to act promptly to ensure that the settlement, legal and operational infrastructure for over-the-counter derivatives is sound.
This sounds like sending a copy of MISS MANNERS to Al Capone. -Jesse)

Enhancing transparency and valuation

Robust risk disclosures:
• The FSF strongly encourages financial institutions to make robust risk disclosures using the leading disclosure practices summarised in Recommendation III.1 of this report, at the time of their mid-year 2008 reports.
• Further guidance to strengthen disclosure requirements under Pillar 3 of Basel II will be issued by 2009.
(Sixtieth Rule of Ferengi Acquisition: Keep Your Lies Consistent. - Jesse)

Standards for off-balance sheet vehicles and valuations:
Standard setters will take urgent action to:
• Improve and converge financial reporting standards for off-balance sheet vehicles;
• Develop guidance on valuations when markets are no longer active, establishing an expert advisory panel in 2008.

Transparency in structured products:

Market participants and securities regulators will expand the information provided about securitised products and their underlying assets.
(The core of the problem is that the risk management models these jokers have been using have some whoppers of assumptions in them, and are essentially grounded in foo-foo dust. But let's do more of it and it will get better. - Jesse)

Changes in the role and uses of credit ratings

Credit rating agencies should:
• Implement the revised IOSCO Code of Conduct Fundamentals for Credit Rating Agencies to manage conflicts of interest in rating structured products and improve the quality of the rating process;
• Differentiate ratings on structured credit products from those on bonds and expand the information they provide.

Regulators will review the roles given to ratings in regulations and prudential frameworks.


Strengthening the authorities’ responsiveness to risks

• A college of supervisors will be put in place by end-2008 for each of the largest global financial institutions.
(College! Cool! We'll be Animal House. Ben can be Dean Wurmer. Aw, everyone wants to be Bluto. The Board wants to dance wif yo dates. Road Trip!! - Jesse)

Robust arrangements for dealing with stress in the financial system
• Central banks will enhance their operational frameworks and authorities will strengthen their cooperation for dealing with stress.
(Group yoga sessions? - Jesse)

SP 500 WEEKLY Chart - Bear Market Update April 12

The intra-week volatility is significant, and snapback short covering rallies are normal, and not the exception in this market.

Despite the Fed's almost unprecedented interventions, at least since the 1930's, the market trend is still lower. Look at the daily charts linked on the side of this blog to keep an eye on those chart formations.

Be careful with your leverage, and in particular the use of options, especially April stock index and 'popular plays.' With these continuing low volumes heavy trades to one side invite a violent hit from the well-heeled trading desks.

Watch for cross market correlations and inversions and use these as hedges if you wish to be an aggressive trader. This requires significant capital to maintain adequately.

Cash is a position. Contra-dollar 'cash' positions paying decent yields have been some of our most rewarding plays. There are forex ETF's in addition to actual foreign government bonds and high dividend stocks. Forex trading is triple black diamond, for experienced traders only, with the odds heavily against even a talented amateur.

Sometimes NOT trading is a very powerful tool as you wait for the odds to improve in your favor, or your gains to run higher over time in a position. We have positions contra-dollar we've not touched since early 2006.

Hyperinflationary Depression in the US 2010 - John William, Shadow Government Statistics

We don't necessarily agree with John Williams' analysis here. But its not sufficient to merely disagree. One has to listen to the argument, the key points and mechanisms, and then show WHY they might be invalid and where they might be less probable than something else.

John may be right. We have an enormous respect for him. His site is worth looking at, and his arguments are worth a listen. But we think he makes the error of assuming that the trends will be as they are today, and one can just extend them into the future, without limit, and not account for 'step changes' and likely exogenous events. This is an all too common error with model based predictors.

As a thumbnail sketch of our disagreement, we think that deflation and hyperinflation can only occur deterministically with reference to an external standard. With the lapse of the gold standard, there is none. Therefore its more likely to be the end result of policy decision(s).

Before the US lapses into a hyperinflationary depression the G8 will have an enormous incentive to essentially bail the US out by inflating their own currencies in sympathy and allowing the US to essentially and selectively default on its sovereign debt, in order to save the world financial system. In many ways Bear Stearns is a microcosm of the United States Treasury.

Doing nothing increases the probability that there will be a war, a significant world war, which will tend to wipe the slate clean, at least for the victor (if there is one) in terms of debt obligations. Not only is the US too big to fail, its too big a warpower for anyone to be easily able to collect what's owed to them.

That's what we think, but all things being equal, John does have his points in order, and his hypothesis is probable, more so than deflation, which is also a possibility. Volcker said deflation has an extraordinarily slim chance of occurring in the US. We tend to view it as an overt policy decision. Net debtors do not willingly choose deflation; they are compelled to it by some external force or constraint.

The best argument for the deflation alternative is that our monetary system is dependent on bank loans for the expansion of debt, and debt is money. However, we think the Fed is going to give us a lesson in monetizing debt, and there is plenty of it to go around. Common sense is a fine tool, but more detailed knowledge and rigorous thinking is essential.

John Williams is interviewed by Jim Puplava - MP3 Audio download: A Hyperinflationary Depression in the US 2010

Shadow Government Statistics Homepage

An Accounting View of the Financial Credit Crisis

Here's a joke to cheer up GE shareholders on this difficult morning.
(Hat tip to Sean, the Irish gnome in Zurich)

There are two sides to a bank's balance sheet - the left side and the right side.

The problem is that, on the left side, there is nothing right,
and on the right side, there is nothing left!

And some weekend reading for Jeff Immelt.

As a reminder, US financial companies start reporting their quarterly results next week.