Post by depletedreasons on Dec 5, 2007 7:50:58 GMT -5
Sowing the seeds of recession
Wednesday, December 5, 2007
Explaining the current international crisis emanating from the US subprime mortgage sector to the Turkish Daily News, Dr Rodrigue Tremblay warns Turkey that it has become stuck between an export-led growth strategy and an overvalued currency, likening the situation to Argentina in the late '90s
TAYLAN BILGIC
ISTANBUL - Turkish Daily News
Explaining the current international turmoil emanating from the U.S. subprime mortgage sector to the Turkish Daily News, Dr. Rodrigue Tremblay warns Turkey that it has become stuck between an export-led growth strategy and an overvalued currency. Tremblay also criticizes the U.S. Federal Reserve, both under the leadership of Alan Greenspan and Bernanke, of implementing erroneous decisions.
The light at the end of the tunnel for international markets remains distant, if not invisible, as the financial turmoil that began with the U.S. subprime mortgage sector continues to take its toll while analysts guess at the ultimate international fallout.
Since August, the fiasco that began with home loans to consumer with troubled credit has wiped billions of dollars from the balance sheets of many of the world's most powerful financial institutions, sending tens of thousands of American citizens into foreclosure, shaking the thrones of chief executive officers and even, triggering the first "bank panic" of the last 160 years in Britain. As the ominous signs of a recession become more evident, world markets crave for liquidity even as central banks continue slashing interest rates, while the specter of inflation looms ahead.
Explaining the reasons behind the turmoil to the Turkish Daily News, Dr. Rodrigue Tremblay, an emeritus professor of international finance at the University of Montreal, says four interrelated factors are responsible for the current crisis. The first is monetary policy, and here Tremblay joins an increasingly vocal chorus that blames Alan Greenspan's Federal Reserve. He also warns Turkey of the future ahead, as it is a country which is "caught with an overvalued currency while pursuing an export-led growth strategy."
"After the dotcom bubble burst in 2001 and brought about the march to November 2001 recession, the Fed aggressively lowered the Federal Funds rate from 6.5 percent to 1 percent in 2004, the lowest it had been since 1958," reminds Tremblay. "It is considered now that this was excessive, and that the Fed should not have lowered the Federal funds rate below 2 percent and that it should have begun to raise it sometime in 2002."
Criticizing Greenspan:
From 2002 to 2004, the Fed pursued a monetary policy that was "too expansionary," says Tremblay. "Greenspan has argued to explain his policies that he was afraid of an onset of deflation, but few economists agree with him. Between 2002 and 2004, the Fed had no need to keep real short term interest rates so negative for so long, especially as the George W. Bush administration was cutting tax rates and increasing military expenditures with its military invasion of Iraq."
The second reason, Tremblay explains, is the housing boom. "Abnormally low interest rates in the U.S. and elsewhere fed a housing boom worlwide which was unsustainable, because it was, partly, based on price speculation," he notes. "Indeed, mortgage rates in the U.S. remained low, even after the Fed started to raise the Federal funds rate from 1 percent in mid-2004 to 5.25 percent in June 2006. This was brought about by Americans borrowing huge amounts abroad. In 2006, the U.S. current account deficit even reached 6 percent of Gross Domestic Product. China, Japan and oil-producing countries were the main buyers of U.S. Treasury bills and bonds."
The third reason is "new banking rules," that are being laid upon the tables, albeit a bit too late. "With ever rising house prices, lending institutions relaxed their lending rules as the housing collateral behind the loans was gaining in value," Tremblay said. "Mortgage banks and other lenders began to accommodate subprime borrowers with dubious credit by extending mortgage loans to home buyers who would not have qualified in other times. Nontraditional home loans were advanced to borrowers who had no documented incomes. Some loans were interest-only loans with down payments of 5 percent or less. Some were adjustable rate loans (ARMs), with low rates for one or two years to be reset later at much higher rates."
Thus, as of 2006, about 25 percent of American mortgages were subprime and close to 20 percent were adjustable rate loans.
Complex instruments:The fourth reason to the crisis is "new financial instruments."
"With the demand for mortgage loans increasing, large banks resorted to some inventive financing of their own in order to economize their capital. They began repackaging loans and slicing them into new types of securities, and in so doing, shifted their lending risk to the buyers of such securities," Tremblay continues. "Thus came into being a new class of securities - often rated AAA by credit agencies - that money market funds, insurance companies, pension funds and other investors could purchase."
These new structured investment vehicles (SIVs) came under various names such as "Collateralized Bond Obligations" (CBOs) or "Collateralized Debt Obligations" (CDOs), terms which today haunt the U.S. mortgage market. "They had the characteristics of unfunded short term asset-based commercial paper (ABCP). It is this ABCP market which is unraveling presently in the United States and elsewhere, and which is at the center of the current financial crisis," states Tremblay.
At its peak in the summer of 2007, the U.S. ABCP market was valued at some $1.170 trillion. It has fallen now to some $900 billion and is still contracting, as banks write down bad debts.
Does all of this have a relation to the savings-and-loans crisis of the early 1980's, with which over 1,000 savings and loan financial institutions failed, and losses were estimated to have totaled around $150 billion. Tremblay observes that the current crisis is "at the very least as bad, if not worse, because it involves the integrity of the entire American banking sector. The extent of the losses this time is not yet fully known, but everybody agrees that it will be very subtantial."
Impact on the street:
The ongoing debate among economists and economy columnists often neglects the situation of the "man on the street" in the United States. But the average American is having to bear the burden, Tremblay says: "Since home ownership is a large portion of the average American's net worth, declining house prices and foreclosures on delinquent mortgage loans are bound to reduce private consumption spending in the coming months through a negative 'wealth effect.' The loss of jobs and incomes in the construction and financial industries is also going to negatively impact consumption spending. Above all, the average American may have to reduce his debt load. Together, mortgage debt and consumer debt account for some 125 percent of disposable income. These are historically high levels."
Another debate is on the response of Fed to the turmoil. "I think the [Ben Bernanke] Fed panicked when it announced a larger than expected half percentage point cut in both the federal funds rate and in the discount rate, and this after having slashed its discount rate by a half point, on August 17," he says. "The purpose was to facilitate distress borrowing by largest U.S. banks and to facilitate the bailout of their affiliates and other operators, such as hedge-funds, caught in the subprime loans crisis."
Bagehot upside-down:
This response reminds Tremblay of Walter Bagehot's advice for aggressive discounting in a situation of financial crisis. But there is a problem here: "Bagehot's rule calls for the central bank to lend copiously in times of critical credit stringency ... but at a high rate of interest. By lending to troubled lenders at reduced preferential rates, the Fed has been acting as their 'government' or their 'insurer", i.e. subsidizing their risky loans operations and innovative finance, while taxing anybody else who holds American dollars. It is not only attempting to make the banks more 'liquid,' but also more 'solvable' and less likely to fail."
In doing so, and especially with its policy of abandoning the dollar in foreign exchange markets, the Fed is sowing the seeds of future inflation, Tremblay observes: "All the new money which has been injected into the financial system will be difficult to retrieve and inflationary pressures should begin to show in a few years, after an expected economic slowdown. The more so that the 54-year average long inflation-disinflation-deflation Kondratieff cycle is about to run its course by 2010-11. A new inflationary phase should begin thereafter."
The U.S. economy accounts for about one quarter of the world economy, thus when it "coughs," the world gets flu. Then, what is likely to happen to emerging markets such as Turkey, which has seen massive foreign capital inflows during the last few years, when it is the U.S. economy which gets the flu?
Danger for Turkey:
The decline in the U.S. dollar and the concomittent appreciation of the euro and other currencies, coupled with the rise of the price of oil, is bound to have a negative impact on [other] economies," Tremblay answers. "The danger for Turkey is to be caught with an overvalued currency while pursuing an export-led growth strategy. Indeed, in the last few years the Turkish lira has risen against the U.S. dollar and even against the euro. This has had beneficial effects in the fight against inflation, but it also could hurt future growth. The most recent example of such a predicament was Argentina, in the late 1990's, which was forced to abandon its peg to the U.S. dollar."
The turmoil, though having had a negative effect on continental Europe, seems to have shaken the U.S. and British economies much more, at least for now. Tremblay says the rush toward irresponsible banking practices was less prevalent in Europe than in the United States, and that the negative impact should be less prevalent in Europe than in the U.S.
Dr. Tremblay thinks an economic slowdown is "unavoidable" in the year ahead, and hopes that "the worst-case scenario will not materialize."
"Nevertheless, I expect a mild U.S. recession in 2008, to be followed by a more severe one in 2010-2011, at the trough of the 10 year cycle," he claims.
Still the U.S. dollar could "rebound" in the months ahead, as today it is "very much oversold." Tremblay notes that on the long run, "we have entered a period where the demand for energy and resources is going to be strong relative to supplies." This should favor the currencies of resource-based economies, such as Canada, Australia and the emerging economies in general.
Meanwhile, the rising oil prices, currently hovering around $90 a barrel, have been the "mirror image of the decline of the U.S. dollar," Tremblay observes. "The oil market is either close to a top, or is factoring in the bombing of Iran and a resulting serious disruption in oil shipping in the gulf of Hormuz."
"If there were to be a conflict between the United States and Iran, oil prices could go much higher, before plummeting down due to a worldwide recession," he claims. "If it turns out that there is no hot conflict with Iran and no disruptions in the supply of oil, the present high prices would logically ratchet down."
www.turkishdailynews.com.tr/article.php?enewsid=90383
Wednesday, December 5, 2007
Explaining the current international crisis emanating from the US subprime mortgage sector to the Turkish Daily News, Dr Rodrigue Tremblay warns Turkey that it has become stuck between an export-led growth strategy and an overvalued currency, likening the situation to Argentina in the late '90s
TAYLAN BILGIC
ISTANBUL - Turkish Daily News
Explaining the current international turmoil emanating from the U.S. subprime mortgage sector to the Turkish Daily News, Dr. Rodrigue Tremblay warns Turkey that it has become stuck between an export-led growth strategy and an overvalued currency. Tremblay also criticizes the U.S. Federal Reserve, both under the leadership of Alan Greenspan and Bernanke, of implementing erroneous decisions.
The light at the end of the tunnel for international markets remains distant, if not invisible, as the financial turmoil that began with the U.S. subprime mortgage sector continues to take its toll while analysts guess at the ultimate international fallout.
Since August, the fiasco that began with home loans to consumer with troubled credit has wiped billions of dollars from the balance sheets of many of the world's most powerful financial institutions, sending tens of thousands of American citizens into foreclosure, shaking the thrones of chief executive officers and even, triggering the first "bank panic" of the last 160 years in Britain. As the ominous signs of a recession become more evident, world markets crave for liquidity even as central banks continue slashing interest rates, while the specter of inflation looms ahead.
Explaining the reasons behind the turmoil to the Turkish Daily News, Dr. Rodrigue Tremblay, an emeritus professor of international finance at the University of Montreal, says four interrelated factors are responsible for the current crisis. The first is monetary policy, and here Tremblay joins an increasingly vocal chorus that blames Alan Greenspan's Federal Reserve. He also warns Turkey of the future ahead, as it is a country which is "caught with an overvalued currency while pursuing an export-led growth strategy."
"After the dotcom bubble burst in 2001 and brought about the march to November 2001 recession, the Fed aggressively lowered the Federal Funds rate from 6.5 percent to 1 percent in 2004, the lowest it had been since 1958," reminds Tremblay. "It is considered now that this was excessive, and that the Fed should not have lowered the Federal funds rate below 2 percent and that it should have begun to raise it sometime in 2002."
Criticizing Greenspan:
From 2002 to 2004, the Fed pursued a monetary policy that was "too expansionary," says Tremblay. "Greenspan has argued to explain his policies that he was afraid of an onset of deflation, but few economists agree with him. Between 2002 and 2004, the Fed had no need to keep real short term interest rates so negative for so long, especially as the George W. Bush administration was cutting tax rates and increasing military expenditures with its military invasion of Iraq."
The second reason, Tremblay explains, is the housing boom. "Abnormally low interest rates in the U.S. and elsewhere fed a housing boom worlwide which was unsustainable, because it was, partly, based on price speculation," he notes. "Indeed, mortgage rates in the U.S. remained low, even after the Fed started to raise the Federal funds rate from 1 percent in mid-2004 to 5.25 percent in June 2006. This was brought about by Americans borrowing huge amounts abroad. In 2006, the U.S. current account deficit even reached 6 percent of Gross Domestic Product. China, Japan and oil-producing countries were the main buyers of U.S. Treasury bills and bonds."
The third reason is "new banking rules," that are being laid upon the tables, albeit a bit too late. "With ever rising house prices, lending institutions relaxed their lending rules as the housing collateral behind the loans was gaining in value," Tremblay said. "Mortgage banks and other lenders began to accommodate subprime borrowers with dubious credit by extending mortgage loans to home buyers who would not have qualified in other times. Nontraditional home loans were advanced to borrowers who had no documented incomes. Some loans were interest-only loans with down payments of 5 percent or less. Some were adjustable rate loans (ARMs), with low rates for one or two years to be reset later at much higher rates."
Thus, as of 2006, about 25 percent of American mortgages were subprime and close to 20 percent were adjustable rate loans.
Complex instruments:The fourth reason to the crisis is "new financial instruments."
"With the demand for mortgage loans increasing, large banks resorted to some inventive financing of their own in order to economize their capital. They began repackaging loans and slicing them into new types of securities, and in so doing, shifted their lending risk to the buyers of such securities," Tremblay continues. "Thus came into being a new class of securities - often rated AAA by credit agencies - that money market funds, insurance companies, pension funds and other investors could purchase."
These new structured investment vehicles (SIVs) came under various names such as "Collateralized Bond Obligations" (CBOs) or "Collateralized Debt Obligations" (CDOs), terms which today haunt the U.S. mortgage market. "They had the characteristics of unfunded short term asset-based commercial paper (ABCP). It is this ABCP market which is unraveling presently in the United States and elsewhere, and which is at the center of the current financial crisis," states Tremblay.
At its peak in the summer of 2007, the U.S. ABCP market was valued at some $1.170 trillion. It has fallen now to some $900 billion and is still contracting, as banks write down bad debts.
Does all of this have a relation to the savings-and-loans crisis of the early 1980's, with which over 1,000 savings and loan financial institutions failed, and losses were estimated to have totaled around $150 billion. Tremblay observes that the current crisis is "at the very least as bad, if not worse, because it involves the integrity of the entire American banking sector. The extent of the losses this time is not yet fully known, but everybody agrees that it will be very subtantial."
Impact on the street:
The ongoing debate among economists and economy columnists often neglects the situation of the "man on the street" in the United States. But the average American is having to bear the burden, Tremblay says: "Since home ownership is a large portion of the average American's net worth, declining house prices and foreclosures on delinquent mortgage loans are bound to reduce private consumption spending in the coming months through a negative 'wealth effect.' The loss of jobs and incomes in the construction and financial industries is also going to negatively impact consumption spending. Above all, the average American may have to reduce his debt load. Together, mortgage debt and consumer debt account for some 125 percent of disposable income. These are historically high levels."
Another debate is on the response of Fed to the turmoil. "I think the [Ben Bernanke] Fed panicked when it announced a larger than expected half percentage point cut in both the federal funds rate and in the discount rate, and this after having slashed its discount rate by a half point, on August 17," he says. "The purpose was to facilitate distress borrowing by largest U.S. banks and to facilitate the bailout of their affiliates and other operators, such as hedge-funds, caught in the subprime loans crisis."
Bagehot upside-down:
This response reminds Tremblay of Walter Bagehot's advice for aggressive discounting in a situation of financial crisis. But there is a problem here: "Bagehot's rule calls for the central bank to lend copiously in times of critical credit stringency ... but at a high rate of interest. By lending to troubled lenders at reduced preferential rates, the Fed has been acting as their 'government' or their 'insurer", i.e. subsidizing their risky loans operations and innovative finance, while taxing anybody else who holds American dollars. It is not only attempting to make the banks more 'liquid,' but also more 'solvable' and less likely to fail."
In doing so, and especially with its policy of abandoning the dollar in foreign exchange markets, the Fed is sowing the seeds of future inflation, Tremblay observes: "All the new money which has been injected into the financial system will be difficult to retrieve and inflationary pressures should begin to show in a few years, after an expected economic slowdown. The more so that the 54-year average long inflation-disinflation-deflation Kondratieff cycle is about to run its course by 2010-11. A new inflationary phase should begin thereafter."
The U.S. economy accounts for about one quarter of the world economy, thus when it "coughs," the world gets flu. Then, what is likely to happen to emerging markets such as Turkey, which has seen massive foreign capital inflows during the last few years, when it is the U.S. economy which gets the flu?
Danger for Turkey:
The decline in the U.S. dollar and the concomittent appreciation of the euro and other currencies, coupled with the rise of the price of oil, is bound to have a negative impact on [other] economies," Tremblay answers. "The danger for Turkey is to be caught with an overvalued currency while pursuing an export-led growth strategy. Indeed, in the last few years the Turkish lira has risen against the U.S. dollar and even against the euro. This has had beneficial effects in the fight against inflation, but it also could hurt future growth. The most recent example of such a predicament was Argentina, in the late 1990's, which was forced to abandon its peg to the U.S. dollar."
The turmoil, though having had a negative effect on continental Europe, seems to have shaken the U.S. and British economies much more, at least for now. Tremblay says the rush toward irresponsible banking practices was less prevalent in Europe than in the United States, and that the negative impact should be less prevalent in Europe than in the U.S.
Dr. Tremblay thinks an economic slowdown is "unavoidable" in the year ahead, and hopes that "the worst-case scenario will not materialize."
"Nevertheless, I expect a mild U.S. recession in 2008, to be followed by a more severe one in 2010-2011, at the trough of the 10 year cycle," he claims.
Still the U.S. dollar could "rebound" in the months ahead, as today it is "very much oversold." Tremblay notes that on the long run, "we have entered a period where the demand for energy and resources is going to be strong relative to supplies." This should favor the currencies of resource-based economies, such as Canada, Australia and the emerging economies in general.
Meanwhile, the rising oil prices, currently hovering around $90 a barrel, have been the "mirror image of the decline of the U.S. dollar," Tremblay observes. "The oil market is either close to a top, or is factoring in the bombing of Iran and a resulting serious disruption in oil shipping in the gulf of Hormuz."
"If there were to be a conflict between the United States and Iran, oil prices could go much higher, before plummeting down due to a worldwide recession," he claims. "If it turns out that there is no hot conflict with Iran and no disruptions in the supply of oil, the present high prices would logically ratchet down."
www.turkishdailynews.com.tr/article.php?enewsid=90383