Here As There

Developed, Emerging & New Paradigms

2009-10-30T12:31:00.000-07:00

Financial market developments in the past decade have highlighted, I believe, the need for "New Monetary and Fiscal Policy Paradigms" in developed economies with developed capital markets. GDP/unemployment and inflation are the two targets guiding monetary policy at the Fed (and other central banks). I have believed, however, for many years that in developed countries with developed capital markets, asset prices are the key drivers of GDP/unemployment and inflation. Central banks in these countries not only need to analyze and understand the exact transmission mechanisms from asset prices to the real economy and inflation, but also they need to develop measurable targets for asset prices (or, perhaps, a target for an "index of asset prices") to guide and set monetary policy concurrent with the GDP and inflation targets that they already have and use for guiding monetary policy. Without such asset price targeting by central banks in developed countries with developed capital markets, monetary policy in these countries will be "counter-effective", in the sense of creating cycles of vast overshooting (as in the US prior to the current recession) and vast undershooting (as in Japan's "lost decade", as noted in your article) the economy's long-run equilibrium of GDP and inflation.

Waters are even muddier when we turn to the effectiveness of fiscal policy in developed countries with developed capital markets. Here, too, we need to analyze the transmission mechanism from fiscal policy to asset prices in order to understand the impact of fiscal policy on GDP/unemployment and inflation. Lack of clear, measurable impacts of the 2008 and 2009 fiscal stimulus programs in the US are stark cases in point.

In developing/emerging economies with un-/under-developed capital markets, the traditional monetary and fiscal policy paradigms are effective in guiding the economy along its long-run equilibrium growth path. China is a case in point. Chile is another, as are other Asian emerging economies which have implemented fiscal stimulus programs and monetary policy easing.

Post Modern Imperialism

2009-06-17T14:21:00.000-07:00

The post-June 12, 2009 election disturbances in Iran have ushered in the age of post-modern imperialism. Pundits are hailing the internet and various social networking websites--Facebook, Twitter, YouTube-- as helping communication among the Iranian demonstrators in face of government shutdown of cell phones and land lines as well as allowing citizen journalism to impart real-time developments to the outside world in face of the Iranian government's crackdown on foreign media.

I view the role of the tweets and facebooks etc in the Iranian post-election movement as ushering in the age of post-modern imperialism. The US Department of State announced yesterday that it explicitly asked Twitter to not shutdown for scheduled maintenance in order "to keep the Iranian tweets coming". There are a number of subtexts in this seemingly simple request: (1) The State Department wants to have access to real time information on developments in Iran (2) The State Department wants information to be transmitted across the various factions within Iran (3) The State Department wants to plant information among various groups in Iran-- for who is to know where any tweet/facebook/video is coming from? (4) The State Department wants to influence the developments in Iran.

It is no surprise to me that the Iranian government today accused Washington of interfering in its internal affairs. President Obama can give lip-service to Iranian self-determination. However, his administration’s use of social networking sites to impact developments in Iran is nothing short of imperialism, the post-modern way.

My Letter to the Editor Re Op-Ed Article: "When Will the Recession Be Over?" published on March 1, 2009

2009-03-01T11:31:00.000-08:00

I find it interesting that of a panel of eleven illustrious academic and financial market economists and CEOs, not one opined that we should not be looking at historical precedents of recessions to make predictions regarding the end of the current one. Fact is that we are now in a "New Recessionary Equilibrium" (NRE) that is defined by the "New Growth Equilibrium" (NGE) we found ourselves in from the late 1990's until the fourth quarter of 2007. The N in NGE and NRE stands for, figuratively, explosive leveraging and explosive deleveraging, respectively. Never in our history of booms and busts have we had the phenomenon of explosive leverage being the main catalyst neither for growth nor, in continuum, explosive deleveraging being the main catalyst for a steep recession. Given this fact, why is the illustrious panel looking at history to predict the end of our NRE? History has explanatory power but, in general and in this instance in particular, it does not have predictive power.

We need to analyze if current asset prices in fact reflect the massive deleveraging that has taken place-- my suspicion is the answer is a "no". If I am right, then we have a period of further declines in asset prices and contraction ahead of us. Any meaningful prediction of an end to this recession will have to analyze the trajectory of asset price bubbles commensurate with the explosion in leverage that started in the late 1990's and correlate that trajectory with asset price declines commensurate with the massive deleveraging that started somewhat benignly in the fourth quarter of 2007 and became precipitous in the third quarter of 2008. Only then can we start having a meaningful discussion of "when will the recession be over?”.

LINK to Above-Referenced Op-Ed Article:
http://www.nytimes.com/2009/03/01/opinion/01endintro.html?ref=opinion

THE STRESS TEST CONUNDRUM

2009-02-26T15:13:00.000-08:00

I am perplexed by a number of issues with the so-called stress tests being carried out at our nation’s largest banks by assets, those with over $100 billion in assets. Regulators have been on airwaves this week claiming that given current market conditions, these banks are healthy—namely they are sufficiently capitalized now. We are told, the stress tests are only to determine whether they will need additional capital if and only if macroeconomic conditions deteriorate further from where we are today— unemployment climbs to above 10% and housing prices decline by another 25%. Furthermore, we are told that the stress tests will be uniform for all the banks; namely regulators will be making their determinations with the same metrics across all the 19 financial institutions undergoing these tests.

Many unanswered questions remain. First, how are regulators marking the banks’ portfolios? Are they using mark-to-market or mark-to-model? Given the parameters for the stress tests that have been revealed to us this week, it is clear that regulators are using mark-to-model. Why is it clear? Because the parameters regulators have told us they will use are assumptions that are inputs into models not markets. Markets do not need inputs—they just need a bid and an ask. The bid and ask may be very wide. The bid/offer spread is a function of liquidity—the wider the spread, the more illiquid is that market. But the bid/offer spread determines where the market is, however illiquid.

Second, given that regulators are using mark-to-model, then what are the models? Are they models developed by regulators that will be applied uniformly across all the banks being stress-tested? Or, are regulators using the internal models of each bank? If the internal models of each bank are being used, then there is clearly no uniform model being applied across all banks. Besides the need for uniformity in modeling techniques across all banks for the stress tests, the data inputs into the models need to also be uniform across all banks. Where is the data for the models coming from? Is the data coming from the banks or from the regulators?

Third, why are regulators using mark-to-model? Why not mark-to-market? Mark-to-model has led to considerable ambiguity among the investor community as to the actual valuation of the banks’ portfolios for all the reasons elucidated above—this incertainty has fed speculators shorting financial stocks. We risk further ambiguity and further speculation in financial stocks (with all-too-real risks of contagion to the broader market as witnessed in the past six months) with regulators continuing the current practice of banks of using mark-to-model to value their portfolios.

The only transparent and uniform valuation mechanism is the market—even one with wide bid/offer spreads. Regulators could begin, as a point of departure, by applying a real stress scenario for market conditions today. Namely, they could start by marking bank assets at today’s bid prices not the ask prices— a practice, as we know, shunned by banks in the current crisis. Then regulators could apply stress scenarios that could transpire in the future if the economy deteriorates. These stress scenarios would be one where bid prices for assets decline further from current levels by say 10%, 25% and 50%. Then regulators can meaningfully measure the impact on banks’ capital under these stress scenarios.

Mark-to-market gives a level of transparency and uniformity not conferred by mark-to-model. One would imagine that, given the havoc caused by the financial sector, our regulators would want to employ the most transparent valuation mechanism and the most “real” stress scenarios to get a handle on the actual capital health of our nation’s largest banks. We can no longer afford to dance around the important issue of adequate bank capitalizations now and under worsening market conditions. The metrics, however, need to be transparent and uniform. And yet they are not. Our regulators are still dancing around these important issues, thereby sowing the seeds for further uncertainties and speculative runs on our financial institutions and the wider markets.

An Alternative to a Taxpayer-Funded Aggregator Bank

2009-01-24T12:24:00.000-08:00

Since we are once again on the brink of impending government purchases of "troubled" or "bad" assets off of bank balance sheets, let's think of potential market solutions as substitutes to using taxpayer money to take these assets off of balance sheets.

The basic premise of segregating troubled/bad assets which underlies ex-Treasury Secretary Paulson’s TARP, Fed Chairman Bernanke's "bad bank", FDIC Chairwoman Bair’s “aggregator bank” is sound and, one that I believe, does not encounter political or intellectual opposition from different spectrums. What encounters opposition is using taxpayer-funded dollars—i.e. the government—to pay for the monetization of these assets.

These troubled/bad assets do not necessarily have to be monetized by taxpayer money. Indeed the current form of monetization via the proposed TARP/aggregator bank could run the risk of imposing even more opacity on the valuation of these assets. The question is how will the government put a price on these assets? What valuation guidelines will the government employ in the purchase of the assets given that there is no "market" so to speak of for these assets? The government assumes that there will be a market in the future for the disposal of these assets. However, the current valuation methodology for a purchase of these assets by taxpayer money is opaque in any version of the various versions of the “aggregator bank” concept.

As an alternative, therefore, let's turn to the markets to determine valuation for these troubled assets. How would this work given that there is no market for these assets? Let's segregate these bad assets into funds. The funds could be structured as unit investment trusts (UITs). The government would be the [co-] sponsor of the UIT. The prospectus of the UIT would list the securities the trust would hold until its maturity and the UIT’s sponsor(s) would have price guidance for the initial offering of shares. The proceeds raised through the initial public offering of the UIT would then be handed over to the banks to purchase the troubled securities from the banks, thereby monetizing these bad assets.

Monetizing banks' troubled assets through UITs would achieve the goals of the aggregator bank of segregating the bad assets without using taxpayer money, with the added benefit of giving transparency to the valuation of these assets. Multiple UITs, each with a [diversified] pool of assets—MBS, CDOs, CMBS, ABS, etc.—can be structured. Structuring of the UITs and demand by UIT investors would determine the pricing of the initial public offering of the UIT and the proceeds received by banks for their troubled assets. This market solution achieves the goals of an aggregator bank in segregating the bad assets and taking them off of bank balance sheets and yet it hinges on private investors and the market to price and monetize these assets, rather than relying on taxpayer money to fund an opaque monetization.

My Letter to the Editor published in the Jan. 10-11, 2009 print edition of Wall Street Journal and on WSJ.com on Jan. 9, 2009

2009-01-11T07:49:00.001-08:00

Click on one of below links:
http://s.wsj.net/article/SB123154899325870031.html
http://www.facebook.com/profile.php?id=628344151&ref=profile

RATE CUTS ARE NOT A PANACEA

2008-01-19T08:29:00.000-08:00

2008 will be a watershed year determining the course of the US economy for years to come. This course will be determined by the policies of the Bush administration and the Fed in addressing the crisis of confidence in balance sheets.

It should be obvious by now to policymakers, Treasury and Fed alike, that the level of Fed Funds Rate-- currently at 4.25% after a 1% reduction starting from the September 18, 2007 Federal Open Market Committee (“FOMC”) meeting-- is not the reason for the credit crunch/tightening that has been worsening since August 2007. The Fed's attempts at injecting permanent liquidity through reductions in Fed Funds Rate and the Discount Rate have not managed to boost interbank lending nor credit extension by banks to corporates and consumers. Furthermore, the Fed's attempt at injecting short-term liquidity through its new Term Auction Facility (“TAF”) program since December 2007-- implemented both independently and in concert with the major global banks-- have also not managed to give the impetus to increased interbank lending. Indeed, in spite of all these liquidity injections, banks are tightening credit to borrowers across the board, to each other as well as to consumers and corporates alike.

Therefore, a policy successful in averting the looming recession would note the fact that a 1% reduction in the benchmark Fed Funds rate has not only not led to liquidity/credit expansion but rather, in reverse, it has led to further liquidity/credit tightening by banks and investors alike. What is behind the 2007/2008 credit crunch is a crisis of confidence in balance sheets. Credit spreads, indicators of the market's perception of credit risk, have widened dramatically. The "high rates" are not the result of a high Fed Funds Rate, rather they are the result of high credit spreads in the AA bank market, which have exploded since August 2007. The nature of the current crisis of confidence is such that it is driven by the fear that investors/lenders have that what they are buying is, across the board, "junk". Also, this crisis of confidence that has created the credit crunch is different from prior ones because it permeates all rungs and layers of financial sector participants-- the sell side, the buy side, individual investors, etc.-- and asset classes.

This credit crunch will not be solved by further reductions in rates. If policymakers do not intervene immediately with a plan to address the crisis of confidence in balance sheets and instead rely only on further rate cuts to solve the credit problem, the credit crunch will deepen and the specter of a looming recession will grow in conjunction with the risk of our economy running high inflation, signs of which have emerged in the latest indicators.

The most important areas that any plan by policymakers targeted at easing the crisis of confidence in balance sheets should address are the following: (a) fuller balance sheet disclosure; (b) valuation guidelines for all financial instruments, (from exotic derivatives to vanilla products alike) carried on balance sheets—including a requirement for multiple independent valuation sources; (c) risk management policy guidelines—including integration of credit and market risk, inclusion of liquidity risk measures, and disclosure of risk management policies; (d) regulation of rating agencies-- aiming specifically at continuous disclosures of rating methodology across all asset classes, and rating agency relationships with banks, investment banks and issuers to ensure the independence of ratings; (e) regulation of monolines—integrating banking and insurance regulations to create new regulations at the federal level targeted only at monolines.

Policies to address the above issues will lead to a transparency that we urgently need to lift us out of the current credit crunch caused by a crisis of confidence in balance sheets. Transparency is of paramount importance for a smoothly functioning financial market. And at the moment, we are far from both transparency and smooth functioning of markets.

Eunice Bet-Mansour

My Email Sent Today to Scott Pelley of "60 Minutes" Regarding his December 2, 2007 Report on Christians in Iraq

2007-12-04T07:52:00.000-08:00

Dear Mr. Pelley,

I am Assyrian and as a concerned Assyrian I watched with interest and anticipation your 60 Minutes report on Sunday, Dec. 2nd, on Christians in Iraq.

I was, however, deeply disappointed by the scope of your report and perplexed as to its objective. First, there is no mention in your report of the ethnic identification of Iraqi Christians as Assyrians/Chaldeans (heretofore, "Assyrian")-- I find this baffling. Second, there is no discussion of the long historical presence of Assyrians in Iraq. Third, there is no discussion of the Assyrian Nestorian church and its patriarchy nor any discussion of the Assyrian Roman Catholic church and its patriarchy. Fourth, your profile of the religious leader of the community in Iraq is that of an English Anglican chaplain without any concurrent profiles of Assyrian priests and monks; only highlighting the efforts of a foreign religious leader while ignoring the efforts of the local Assyrian religious and secular leaders in maintaining this community is a disservice to Iraqi Assyrians. Fifth, there is no discussion of the historical, cultural and political aspects of the presence of Assyrians in Iraq which give an important dimension to the current purge.

I would really appreciate it if you enlighten me as to the purpose of the report. Perhaps then I will understand why your report ignored some of the most critically important aspects of the "story" of Christians in Iraq, highlighted above.

Thanks & regards,
Eunice Bet-Mansour

In Defense of Derivatives

2007-11-26T12:48:00.000-08:00

Derivatives and Risk have become synonymous in the lexicon of Main Street, especially so since August 2007. A number of fallacies have been bandied about. Fallacy 1: Derivatives are the culprits of the current liquidity crisis. Fallacy 2: Derivatives are Risk. Fallacy 3: Derivatives are Wall Street alchemy.
To right fallacies 2 and 3, derivatives are neither “risk” nor are they “Wall Street alchemy”. Derivatives are a technology. The technology of derivatives is ultimately about risk management. Derivatives Technology slices and dices risk into different components and parcels it off to different trading parties, to those who want to take on the specific risk component(s)—i.e. the buyers of risk or investors in risk—which ultimately means that there are those who want to lay off the [same] risk component(s)—i.e. the sellers of risk. Derivatives technology is about the management of risk, the spreading of different components of risk to different parties who want to take it on. How is this risk transferred to market participants? Obviously, like any other market, at “market-clearing” prices. There are bid and offer prices for the specific risk component and the risk is sold/bought at market-clearing prices.
At this point you may be asking who the risk sellers/originators are and who the risk buyers/investors are. Risk originators are the banks, the investment banks, thrift institutions, finance companies, mortgage banks, etc. Risk buyers are the proprietary trading desks of banks and investment banks, hedge funds, insurance companies, pension funds, etc.
A “market for risk”, where different risk components are bought and sold, was then created with the advent of derivatives technology. The spreading of risk(s) throughout the financial system was and is responsible for the growth of this system and the concurrent underlying economies. Indeed, the exponential growth of credit—first in the form of mortgages and then in the form of all types and variants of credit— is one of the by-products of derivatives technology.
So, what is going on now? Why are we seeing the meltdown that started in August? Is Fallacy 1 indeed not a fallacy? Are derivatives indeed the culprits of the current liquidity crisis? If derivatives technology is a risk transfer mechanism responsible for orderly spreading of risk among market participants and, as a result, responsible for the growth of our economies, then why do we have a crisis on our hands?
What has failed us is not derivatives technology. Our current liquidity crisis is the result of lax origination and investment guidelines, lax credit and market risk management and lax rating standards in an era of unprecedented liquidity.
We have been so awash in liquidity in the past several years that returns on assets have compressed to historically low levels as investors chase assets with attractive returns. This in turn led to those who package/sell risk to originate and sell off riskier risk so as to bump up returns to levels that risk buyers seek—an attempt to structure and price risk at then market-clearing prices. The classic forces of demand and supply were in the works as risk originators/sellers went further down the credit spectrum originating assets with higher return [and higher risk] in response to demand by the buyers/investors in risk demanding more attractive yield. Due diligence of these underlying assets was lax by both risk originators/sellers and risk investors/buyers in the quest for higher returns in an era of high liquidity. Enter the rating agencies. Ratings given by rating agencies are important elements in the due diligence carried out by investors. The rating agencies assigned their ratings to new structures and let investors down in their fiduciary responsibility of monitoring the risks of these securities and downgrading them in a timely manner, namely before a market collapse not after.
If rating agencies were lax in rating standards and risk monitoring and if risk originators and risk investors were lax in due diligence, what happened to the credit and market risk management functions at the sellers and the buyers of risk, the ultimate backstops. Credit departments have to approve any transaction that gets on the books with credit/counterparty risk exposure. Furthermore, while credit departments are responsible for portfolio monitoring of credit risk as long as any deal remains on the books, the market risk group is responsible for the daily valuation and daily analysis of the risk of every deal on the books. Wall Street quants assert that derivatives pricing is a science with highly sophisticated mathematical models as underpinning. Having been a quant myself prior to moving over to origination and structuring of derivatives, I would beg to differ. Yes, we do use highly sophisticated mathematical models for pricing derivatives. And, in most cases these models work. These are cases where markets are “normal”, functioning smoothly and thereby “mark-to-model” pricing is equivalent to “mark-to-market” pricing. These models, however, do not work in times of market crises when liquidity dries up—“mark-to-model” pricing diverges widely from “mark-to-market” pricing in a liquidity crisis. And it is in these times that derivatives pricing and risk management becomes an art and not a science as witnessed time and time again, most recently in the past several months and prior to our current crisis in the Long Term Capital Management crisis when liquidity dried up.
Credit and market risk management are an art in both the best of times and the worst of times. Indeed, prudent containment of risk requires the application of the art to the science continually, in good times as well as in bad times, such that when the bad times come, as they surely will, the fallout is not so spectacular as to create a crisis.

Dangers of the Dollar's Freefall

2007-11-12T08:54:00.000-08:00

The US dollar's plunge is ultimately dangerous not only to our economic well-being but also to our currency's standing as the most important global reserve currency. That the freefall is permitted is at best irresponsible.

The dollar is the world's most important reserve currency. With such large erosion in its value, the dollar runs the risk of being dumped by the central banks of the world as they shift their reserve composition towards the euro and dispose of dollars. China's central bank, which has one of the largest reserves in the world, last week announced just such a potentiality. If China and other countries undertake such a measure, the dollar's freefall will only be accelerated and exacerbated.

We are seeing oil prices hovering at near $100 levels. One of the main trendline reasons for this current spike in oil price is the decline in the value of the dollar. Price of oil is denominated in dollars. The lower the dollar goes, the higher goes the price of oil. As oil producers see a decline in the value of their production because of the decline of the dollar-- i.e. their revenues have lower purchasing power-- they drive up the price of oil to compensate for their purchasing power erosion arising from the dollar's decline. This pendulum will continue as long as the dollar falls further. The ultimate impact of high oil prices and low-value dollar on our economy and that of the world's is recessionary.

That our policymakers have allowed this freefall is irresponsible both domestically and internationally. Concerted intervention in foreign exchange markets together with concerted interest rate policy setting by central banks needs to be undertaken to stem and reverse the freefall and prevent global recession.