Isn’t it too late to concern about the financial stability of the US banks?

2013 is going to be a challenging year for the global economy. Set US obligations to reduce the growth of budget deficit during 2013 and 2021 years and termination of the reduced taxes from 2013 may weaken consumption and cause double dip recession in the US with the contingency effect on global economy. Moreover, isn’t it too late to concern about the financial stability of the US banks due to approaching fiscal cliff?

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 which was passed by the US Congress and signed by President Barack Obama on December in 2010 terminates a two year extension of reduced income taxes known as the “Bush tax cut” in 2013. It also terminates extension of several other measures such as unemployment benefits and reduction of social security and medical care taxes. Moreover, according to the approved Budget Control Act of 2011, US was able to increase debt ceiling to $16.4 trillion in exchange for mandatory $1.2 trillion cuts of budget expenditures during the period from 2013 till 2021.

According to the analysis of the Congressional Budget Office – Fiscal Tightening in 2013 and Its Economic Consequences, published on August 22, 2012, a sharp reduction in the federal budget deficit will cause economy to contract but also put federal debt on more sustainable way. If current laws remain unchanged those lead to the tax increase and spending cuts the federal budget deficit will be reduced by $487 billion in 2013 and federal budget deficit will be $ 641 billion in 2013. According to this scenario it is expected that economic growth will contract to -0.5 % in the 4^th quarter of 2013 compared to the 4^th quarter of 2012. In case the lawmakers extend most tax cuts and other forms of tax relief and prevent automatic certain spending reductions, the federal budget deficit may be reduced by $91 billion in 2013 and federal budget deficit is projected to be $1,037 billion in 2013. According to the alternative fiscal scenario, it is expected the economy to growth by 1.7% in the 4^th quarter of 2013 compared to the 4^th quarter of 2012.
 

It is likely that in the anticipation of the worst case scenario and sharp economic contraction in 2013, the Federal Open Market Committee (FOMC) of the US Federal Reserve decided to continue monetary stimulus with third round of large-scale asset purchases. According to the statement of the FOMC meeting released in September 13, 2012 the Committee agreed to purchase additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee also decided to continue through the end of the year its programme to extend the average maturity of its holdings of securities and to maintain its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. It was expected to increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year and put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.

The continued monetary stimulus programme lifted equity markets; however, will capital gains from the equity price increase be substantial to meet investors’ in the US markets expectations related to the increased taxes on capital gains in 2013. Additionally, will the future economic environment promise more business growth opportunities and policies of higher dividends, so that gains from the dividends were substantial to meet investors’ expectations including increased taxes on dividends in 2013? Moreover, the fiscal policy of higher taxes creates more incentives for corporations to fund development through borrowing due to tax shield which leads to more lending opportunities for banks and increased financial risks related to higher leverage of corporations.

Sold gold reserves held in the IMF may realise frozen capital for economic development

The annual meetings of the World Bank Group and the International Monetary Fund hosted in Tokyo, October 9-14, once again engaged high level representatives from financial organizations and academic communities into the economic growth and financial stability issues. The events started with a brief presentation of the World Economic Outlook (WEO) which emphasised threats of high debts and sluggish economic growth mainly due to weaker demands in advanced economies. Similarly, the press briefing on Global Financial Stability Report (GFSR) highlighted actions restoring market confidence through monetary interventions and financial system reforms related to financial buffers, high-quality capital and sufficient liquidity in advanced economies as well as fiscal discipline in Europe, Japan and the United States. So are there particular circumstances those affect the future economic outlook?

Several events during the last and upcoming month have set more challenges and uncertainties regarding the future economic development. Slowing global economic growth and upcoming leadership changes encourage aggressive economic growth strategies and implementation of short term financial stability measures such as monetary easing measures to relieve credit crunch and market pressure. Approaching the US presidential elections in November 6 may change public debt management policies and measures for reduction of fiscal cliff, set new economy growth and employment programmes, and even affect monetary decisions. China’s slowing economic growth and territorial dispute with Japan, which may weaken economic cooperation between Asian countries, also coincide with the date of the 18th Party Congress on November 8, the date of formal unveiling of China’s new leaders and development policies. Moreover, despite of the measures prepared by European leaders to provide necessary financial support, Europe’s peripheral countries faces internal unrest due to exercised austerity measures, high unemployment and weak economic recovery.

Investment in gold products are seen as a save heaven in the environment of high uncertainties. So could growing gold prices create economic distortions? Expectations of investors that gold may rise to $2,000 an ounce could encourage investment in gold and may freeze capital for economic development.

Even the role of the gold has been reduced in the international monetary system, the IMF remains one of the largest official holders of gold in the world. According to the factsheet on Gold in the IMF published on 24 August, 2012, the IMF held 90.5 million ounces (2,814.1 metric tons) of gold at designated depositories at mid-August 2012. The IMF’s total gold holdings are valued on its balance sheet at SDR 3.2 billion (about $4.8 billion) on the basis of historical cost. As of August 17, 2012, the IMF's holdings amounted to $146.1 billion at current market prices. So, sold gold reserves held in the IMF at market prices could realize frozen capital for economic development.

The Eurosystem’s Outright Monetary Transactions – the ECB’s intervention in management of sovereign debt

Mario Draghi, a president of the European Central Bank introduced the technical features of the Eurosystem’s Outright Monetary Transactions in secondary sovereign bond markets during the press conference on the 6^th of September. The ECB’s approved conditions of programmes allow intervening in the financial markets and absorbing high yield sovereign debt securities.  The special programmes could relief borrowing cost of issued sovereign bonds through the ECB’s purchase of securities those are not accepted by investors. Considerations regarding the monetary and fiscal policies interactions intensified during the period of financial instability. However, interventions of central banks in the management of the sovereign debt are still assessed contrary.

According to the “Interactions Between Sovereign Debt Management and Monetary Policy Under Fiscal Dominance and Financial Instability” (No. 3 of OECD Working Papers on Sovereign Borrowing and Public Debt Management), published by Blommestein, H. J. and P. Turner (2012), it is difficult to separate monetary and public debt management as both policies are involved in the sales of sovereign debt to private sector, though in different forms. New issuance of sovereign debt securities or regulation of the supply and demand of sovereign debt affects investment decisions of firms and households, and impacts on macroeconomic development. Moreover, monetary and fiscal policy interactions, mandates, accountability and potential conflicts of policies were reviewed in the ECB’s article “Monetary and Fiscal Policy Interactions in a Monetary Union” published in July’s Monthly Bulletin, 2012. So, the ECB’s decision on the Eurosystem’s Outright Monetary Transactions could not be judged as urgent and reckless.

A necessary condition for Outright Monetary Transactions approved by the Governing Council of the ECB is strict and effective conditionality attached to an appropriate European Financial Stability Facility/European Stability Mechanism (EFSF/ESM) programme. Such programmes can take the form of a full EFSF/ESM macroeconomic adjustment programme or a precautionary programme (Enhanced Conditions Credit Line), provided that they include the possibility of EFSF/ESM primary market purchases. The transactions will be focused on the sovereign bonds with a maturity of between one and three years with no ex ante quantitative limits in the size of the OMTs. The same pari passu treatment will be accepted for private and other creditors regarding the issued bonds by euro area countries and purchased through the OMTs. Moreover, the liquidity created through the OMTs will be fully sterilised and information about the OMTs holdings will be publicly available. It is also expected that the IMF will be involved into the design of the country-specific conditionality as well as the monitoring of such programmes. 

If we assume that according to the borrowing demand and high costs of Italy and Spain, those two countries will enter the OMTs programmes, what are the high quality securities the ECB is going to sell in order to offset increased liquidity?

How stable and liquid is physical gold?

The World Gold Council is an association comprised of 23 members of the world’s leading gold mining companies those represent approximately 60% of global corporate gold production.  The main goal of the organization is to develop gold market by stimulating and sustaining demand for gold.  Historically, gold is used as a hedge against inflation and deteriorating currencies thus, according to the prolonged financial crisis, the World Gold Council suggested that added gold to the high-quality liquidity buffers could bring stability to the banking system. Additionally, due to gold’s characteristics the World Gold Council expressed believe that gold could be included in banks’ reserve asset portfolios and be used as collateral for liquidity financing.  So could gold be acknowledged as a stable and liquid global currency which is equivalent to high-quality capital?

The physical gold may be purchased from mine producers those refine gold according to the London Good Delivery – the internationally acceptable standards and in the global OTC market.  The reference gold prices are fixed in London twice during the day and either the morning (AM) or the afternoon (PM) fixed price is used for pricing long term contracts. According to the international standards, the bars must be at least 995 parts gold of 1000 and weight between 350 and 430 fine ounces. The physical gold is mainly stored at the Federal Reserve Bank of New York and the Bank of England – the largest custodians safeguarding other central banks’ gold reserves. However, investors may choose a broad array of financial products such as Exchange Traded Funds, Futures and Options, Warrants, Gold Mining Stocks, Gold oriented funds and others those provide opportunities without a purchase of physical gold to gain from the movements of gold price.  

According to the Gold Demand Trends, a report for second quarter 2012 which was prepared by the World Gold Council in August 2012, the total amount of the gold purchased by official sector institutions was 157.5 tonnes and accounted for 16% of overall Q2 gold demand. During the first quarter of 2012, official sector purchased 254.2 tonnes of gold which reflects a 25% increase compared to the 203.2 tonnes of gold purchased during the first quarter of 2011. The biggest buyers were the National Bank of Kazakhstan, the central bank of Philippines, the central bank of Russia, the National Bank of Ukraine, the central bank of Turkey and South Korea’s central bank.

Going back to the World Gold Council’s suggestions, the advantage of established gold as banks’ reserve asset is elimination of credit risk; however, market and liquidity risks may be even severe for financial stability.

The main goal of central banks is to maintain price stability. Moreover, deteriorating exchange rates of domestic currencies reflect the worse economic state of the country.  Reduced purchase power of domestic currency forces governments to reconsider economic policy. Debts of governments and corporations are covered by collateral assets and guarantees. So creditors have legal obligations to repay debts. Market value of equity depends on the asset allocation decisions. In all these cases the responsibility is assigned for managing uncertainties and made decisions.

So will the World Gold Council take responsibility to maintain stable gold price and even more will it emerge as a key authority responsible for the stable global financial system?

Value creation should be a priority of stability policy, shoulddn't it?

US Treasury Secretary Timothy Geithner held private talks with German Finance Minister Wolfgang Schaeuble and ECB’s President Mario Draghi this week. The other confidential meeting was carried between ECB’s President Mario Draghi and Bundesbank Chief Jens Weidmann before the ECB’s monetary policy vote on Thursday, 2 August. Last week M. Draghi’s publicly announced to do whatever it takes in order the Spain’s and Italy’s borrowing costs were reduced and euro stability was maintained. However, Germany’s position remained against resuming the ECB’s government bond buying programme and issuing Eurobonds. Broadcasted the US Treasury Secretary’s interview with Bloomberg on Wednesday, 1 August revealed T Geithner’s concerns about market stability and desires to sustain investors’ confidence, though usage of the euro zone's rescue funds is not clear. Does it mean that €500bn funds of European Stability Mechanism could be used to implement reforms not necessary related to the recapitalization of European banks and sovereign bonds purchase programme?

The slowing down global economy growth was captured with different statistics. However, World Trade Organization’s observations may reveal some new aspects of slowing growth. According to the World Trade 2011, Prospects for 2012, WTO’s press release on 12 April 2012, the world trade expended in 2011 by 5.0%, which is a sharp deceleration from the 2010 rebound of 13.8%. Moreover, it was predicted that the growth would slow further to 3.7% in 2012. On World Trade Report 2012 released on 16 July, 2012, WTO focused on new international trade challenges – increased use of non-tariff measures. These measures reflect regulatory standards for manufactured and agricultural goods. So, political concerns about the health, safety, environmental quality and other social aspects may affect international trade even more than tariffs.

Consequently, value creation should be a priority of stability policy, shouldn't it?

Are negative interest rates a signal of excessive liquidity?

International Monetary Fund warned on increased risks to financial stability in the Global Financial Stability Report released on 16 July, 2012. Excessive European sovereign debts and concerns about the quality of banks assets were mentioned as the main threat to financial stability alongside with the uncertainties on the fiscal outlook and federal debt ceiling in the United States. Financial risks are understood as possibility of losing assets. So, shouldn’t quality of assets remain the main focus and concern?

It could be mentioned that prominent features of June and the first part of July involved further easing of global monetary policies. According to the Monetary Policy Meeting held in June 15, Bank of Japan will encourage the uncollateralized overnight call rate at around 0 to 0.1 percent. The US Federal Open Market Committee decided to continue purchasing Treasury securities with remaining maturities of 6 years to 30 years at the current pace and to sell or redeem an equal amount of Treasury securities with remaining maturities of approximately 3 years or less. The news about the expended operational twist by $269 billion through 2012 was announced on 20 June. The key ECB interest rates were cut by 25 basis points to 0.75% on 5 July. Monetary Policy Committee of Bank of England decided to increase size of Asset Purchase Programme by £50 billion to £375 billion on 5 July. The People’s Bank of China decided to cut one year RMB benchmark deposit and loan rates by 0.25 and 0.31 percentage points to 3% and 6% respectively on 6 July.

Similar remarks could be addressed to the quality of decisions in financial sector. Single supervisory mechanism for euro area banks and the concept to recapitalize banks directly through the European Stability Mechanism (ESM) may fail if banks’ business models are dysfunctional and they cannot sustain financial shocks. Banks’ insolvency arose due to inaccurate assets management and failed estimations. So, additional banks capitalization and facilitated access to attractive borrowing costs will hardly improve the assessment of viability of business plans/investment opportunities.

Moreover, could negative interest rates signal that liquidity is enough in the markets? Investors demand for credibility allowed Germany, Denmark, Finland, Belgium and France to borrow at negative interest rates. When investors chose sovereign bonds with negative interest rates they sink their savings. So, maybe liquidity is already enough and the main concern is to employ existing capital efficiently.

Could leaders of highly regulated institutions be easily replaced?

The FSA has announced about the misleading sales of interest rate hedging products to some SMEs on 29 June and confirmed that it reached agreement with Barclays, HSBC, Lloyds and RBS to provide appropriate redress where mis-selling has occurred. Barclays was fined £290m by authorities in the UK and the US following an investigation into the submission of various interbank offered rates. Chairman of Barclays, Marcus Agius resigned on 2 July, Chief Executive Bob Diamond and Chief Operating Officer Jerry del Missier resigned on 3 July. So, is it difficult to replace leaders of highly regulated and self–running business?

According to the FSA sold interest rate protection products involved “caps” those fix the upper limit to the interest rate on a loan and more complex derivatives such as “structured collars” which fixed interest rates within a band but introduced a degree of interest rate speculation. The investigation at Barclays revealed that some interest rates submissions reflected individual traders’ positions instead of the cost of interbank borrowing. However, its LIBOR submissions were relatively higher than in other banks during the credit crisis period which reflected appropriate management of structural risk, the risk that it may not be possible to decrease administered savings rates in line with decreases in money market (LIBOR) rates, resulting in a margin squeeze where lending is LIBOR-based.

So, is it difficult to find candidates those could prevent mistakes in the future, candidates with integrated knowledge of financial products, business operations and risk management expertise and maybe the most important feature – clear understanding of the role of financial institutions in economy?