Fed Says the Credit Crisis Is Not Over

From The Times
April 14, 2008

US Federal Reserve says that credit crisis is not over yet
Suzy Jagger in Washington

The credit crisis engulfing the banking system on both sides of the Atlantic has further to run, said the vice-chairman of the US Federal Reserve. As the US Treasury Secretary and central bankers gave warning that proposed financial reforms would not prevent a repeat of the biggest shock to the world economy since the Great Depression, Donald Kohn, of the Fed, said of the present trouble: “It is not over yet.”

His gloomy forecast about the duration of the credit crisis, delivered at the annual spring meeting in Washington of the Group of Seven leading economies, came after the International Monetary Fund had estimated that the market turmoil would trigger losses of almost $1 trillion (£507 billion) among banks, hedge funds and pension groups since last summer. Mr Kohn said: “The market is still adjusting. The turmoil has not settled down yet. It is still a very fragile situation.”

Finance ministers from the United States, Britain, Canada, Japan, France, Germany and Italy endorsed a set of wide-ranging financial reforms to address the credit crisis, but they also said that none of the measures would prevent a similar crisis in the future.

Among the ideas being considered are changes to the way that banks reward staff with huge annual bonuses. Officials are concerned that bonuses encourage risk taking and have proposed an alternative remuneration system that would pay out over a longer time period. Henry Paulson, the US Treasury Secretary, said: “No silver bullet exists to prevent the excesses of the past from re-occurring. It took time to build up recent excesses and it will take time to work through the consequences. We must expect more bumps in the road: 2008 will be a more difficult year.”

Mr Kohn said: “All we can do is to try to make the system more resilient. To make the effects more muted, absorbed by liquidity. Enhanced information and transparency will be greater and will, hopefully, make markets and economies more resilient.”

Mr Kohn was speaking as part of the executive team running the Financial Stability Forum, whose recommendations have been endorsed by the G7 group of nations in a bid to strengthen regulation. The G7 wants to force banks to adopt new crisis prevention measures, such as eventually raising the amount of capital that they hold on their books to act as a cash cushion during difficult market conditions. (The banks do everything they can to circumvent this, as in SIVs in response to the Basel II requirements. So what will change? This is a bandaid on an infected wound. - Jesse)

They have also issued more immediate demands for financial institutions to quickly declare their losses from the crisis. They want to make banks increase the level of transparency to shareholders and regulators about the strength of assets on their balance sheets and to urge regulatory bodies to co-operate better and to share information. They also threatened to introduce legislation that would compel credit rating agencies to admit to conflicts of interest when they rate securities. (Oooooh. Everything they do is a conflicted under the current system. - Jesse)

The G7 finance ministers and bankers agreed to implement reforms within a 100-day timetable, which would make banks set out “fully and promptly” losses and exposures to illiquid mortgage-backed securities blamed for the seizure of credit markets.

However, the policymakers were also keen to say that it was unrealistic to expect regulators to devise an early warning system that would identify the start of a financial crisis or a banking institution that was in difficulties. (Bring back Glass-Steagall. Firewall the guaranteed banking system from reckless speculation and conflicts of interest - Jesse)

Timothy Geithner, of the Federal Reserve Bank of New York, said: “If we could figure out a way to have on our desks a screen with the capacity to predict financial crises it would be terrific, but it is very hard to do. What we can do is make the system more resilient.”

(What we need to do is make the system accountable, credible, and honest. Bring back Glass-Steagall and close the loopholes as we saw with the S&L's. The banks spent hundreds of millions of dollars lobbying to repeal it. Firewall the banking system while they try to reform the speculative arenas. Let them steal from each other and not dip into the public's pockets. - Jesse)

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