Brazen Commentary By BIS

The latest commentary by the highly respected Bank of International Settlements:

Overview: global financial crisis spurs unprecedented policy actions Financial stability concerns took centre stage once again over the period between end-August and end-November. In the wake of the mid-September failure of Lehman Brothers, global financial markets seized up and entered a new and deeper state of crisis. As money market funds and other investors were forced to write off their Lehman-related investments, counterparty concerns mounted in the context of large-scale redemption-driven asset sales. The ensuing sell-off affected all but the safest assets and left key parts of the global financial system dysfunctional. With credit and money markets essentially frozen and equity prices plummeting, banks and other financial firms saw their access to funding eroded and their capital base shrink, owing to accumulating mark to market losses. Credit spreads surged to record levels, equity prices saw historic declines and volatilities soared across markets, indicating extreme financial market stress. Government bond yields declined in very volatile conditions, as recession concerns and safe haven flows increasingly outweighed the impact of anticipated increases in fiscal deficits. At the same time, yield curves steepened from the front end, reflecting repeated downward adjustments in policy rates.

Emerging market assets also experienced broad-based price declines, as depressed levels of risk appetite and associated pressures in the industrialised world spilled over into emerging financial markets. With confidence in the continued viability of key parts of the international banking system collapsing, the authorities in several countries embarked on an unprecedented wave of policy initiatives to arrest the plunge in asset prices and contain systemic risks. Market developments over the period under review went through four more or less distinct stages. Stage one, which led into the Lehman bankruptcy in mid-September, was marked by the takeover of two major US housing finance agencies by the authorities in the United States. Stage two encompassed the immediate implications of the Lehman bankruptcy and the wide-spread crisis of confidence it triggered. Stage three, starting in late September, was characterised by fast-paced and increasingly broad policy actions, as responses to the crisis evolved from case by case reactions to a more international, system-wide approach. In the fourth and final stage, from mid-October, pricing patterns were increasingly dominated by recession fears, while markets continued to struggle with the uncertainties surrounding the large number of newly announced policy initiatives.

Lehman Brothers bankruptcy triggers confidence crisis In this environment of tension over the continued viability of Lehman Brothers, financial market developments entered a completely new phase. The spotlight was now being turned on the ability of key financial institutions to maintain solvency in the face of accumulating losses. The trigger for this new and intensified stage of the credit crisis came on Monday 15 September. That day, following failed attempts by the US authorities to broker a takeover by another financial institution over the weekend, Lehman Brothers Holdings Inc filed for bankruptcy protection, one of the biggest credit events in history.

p/s photos: Janet Hsieh Yi Fen

Reassessing Roubini's Predictions

Unfortunately for Roubini, there is no Nobel Prize in Economic for being the best predictor of global financial markets. Nouriel Roubini warns that the worst in markets and economies is yet to come. On October 23^rd, Nouriel predicted the potential shutdown of financial markets. A day later U.S. stock futures suspended trading after declines of more than 6% at opening tripped the circuit breakers. Nonetheless, Nouriel does not expect another Great Depression, but states that policymakers must act quickly and wisely.

Here are the main elements of Nouriel’s outlook:

Tsunami of corporate defaults (I see some defaults in third tier companies not being able to roll over or secure new funding, but I doubt very much this tsunami of corporate defaults will happen as I still see this being largely concentrated in property, lending and banking. Yes, we are already seeing secondary effects on the broader markets but its not as debilitating as Roubini paints it out to be)

2-year U-shaped U.S. recession that threatens to turn into an L-shaped one if policymakers do not regain control of the financial system (Wow, L-shaped, I don't believe I have come across L-shaped recession recovery graphs in my economics textbooks ... if its not in textbooks, it should not exist, right... though the Japanese economy in 1990s looked very L shaped to me)

global re-coupling to the U.S. will advance from non-U.S. markets to non-U.S. real economies – not even the strongest emerging markets such as Brazil and China will escape global re-coupling (Why is Roubini talking of re-coupling, when there was no de-coupling in the first place? Mind you, all BRICs and Asian markets fell earlier and more severe than the US markets. If that's not evidence of markets NEVER ever having decoupled, I don't know what is?)

vicious cycle of deflation in goods markets, labor markets, commodity markets, financial markets, corporate and household earnings, and aggregate demand (Agree to an extent, but not a prolonged period. The basic roubini's thesis is de-leveraging = deflation, not true. De-leveraging has almost been completed, hedge funds are falling like a ton of bricks, the majority of the weak ones have closed shops already. Good thing about hedge funds, when things are bleak, they close shop very quickly... because no more 20% performance kicker, might as well close and lay low for a while, then reopen a new fund later)

de-leveraging to reduce excess debt in municipalities, households and some firms (As above)

U.S. stock markets declining another 20%-30%, bottoming fall 2009 at the earliest, then moving sideways for years post-recession if growth remains anemic as it did in Japan after its 1990s real estate and equities bust (Again being right for the first part of the call does not mean Roubini will get it right again, I think success has gone to his head. The Japanese experience was due to "inaction", banks were very slow to recapitalise, restructure or allowed to fail. Thats why it took them 15 years and growth is still flat. What the Japanese took 15 years to do, the US and European financial markets did it in 3 month. Roubini losing track of events)

U.S. unemployment rise to reach 8-9% (That is probable but not a prolonged phase because at that unemployment rate, the discount rate may very well go to zero, and we know what happens when there is negative real interest rates)

According to Nouriel, USD assets, commodities, U.S. and international equities, housing, and the USD are quite risky right now. Seek safety in cash or cash-like instruments such as T-bills and bonds of safe, large governments. Though he believes the U.S. dollar will retain its reserve currency status for decades, its status will gradually erode.

Given the size of the expected contraction in private aggregate demand (likely to be about $450 billion in 2009 relative to 2008), Nouriel argues that a fiscal stimulus to the order of $300 billion minimum (and possibly as large as $400 billion) will be necessary to partially compensate for the sharp fall in private aggregate demand.

I like Roubini a lot and he was brave enough to call and defend his views way before they came to fruition. But we should not be blinkered as well, I see some blind spots in his current predictions, as he seems almost "one-tracked-minded" on the whole shebang unfolding to the worst of his nightmares. But, what do I know, I am not a professor or an economist.

p/s photos: Im Ji Hye

The Asian Response

• 10 ASEAN nations planning for a crisis fund to tap from if they face severe liquidity crunch due to global financial crisis; Fund can also be used to purchase bad assets, recapitalize troubled financial institutions and private companies; ASEAN+3, ADB, IMF will contribute to the fund while World Bank has contributed $10bn; also include plans for stand-by liquidity facilities
• In spite of limited exposure to US bank losses, risks from external funding crunch, higher borrowing costs, bank panics and deposit withdrawals are growing for banks and corporates in Korea, HK and Taiwan
• Asian central banks had been injecting liquidity into banking system and cutting rates (discount/policy rate) and/or bank reserve requirements to ease liquidity squeeze and spike in short-term rates (swap, overnight, inter-bank rates and spreads) since Sep; Some banned short-selling, guaranteeing deposits, considering fiscal stimulus; following global central bank intervention, these rates have somewhat eased in recent days
  
• Australia: $7.3bn stimulus for pensioners, middle and low-income groups, first-time home buyers; additional stimulus may follow; deposit guarantees; cut overnight cash rate to 6% from 7%, offering 6-mo/1-yr repos; Term Deposit lending facility, expanded types of collateral, loan maturity under bank lending facility as difference b/w inter-bank and overnight indexed swap rate surged; doubled swap agreement with Fed from $10bn to $20bn; banned short selling; to purchase $3.2 bn in residential-backed mortgage securities to help small lenders offer home loans
• Japan: supplementary budget for fiscal stimulus; providing unlimited dollar funds to banks at a fixed rate against pooled collateral until Jan-09 under swap agreement with Fed; eased rates under lending facility, expanded range of bonds under repos, suspended program of selling bank shares; Injecting liquidity amid spike in Yen overnight LIBOR; banks' exposure to Lehman had led to decline in stock prices and short halt in trading on Sep 15
• India: Raised cap and credit cost on external borrowing of firms; cut interest rate 100pbs to 8%; conducting 14 day Repos to help banks provide credit to MFs; allowed banks to lend to MFs against CDs; Allowed Savings bond holders to borrow from banks against govt paper; to infuse capital into commercial banks to raise CAR up to 12%; cut bank reserve ratio thrice in Oct from 9% to 6.5% (first time in 5 yrs); raised FII limit in corporate bonds; raised interest rate on non-resident deposits by 50bps following similar move in Sep; eased limits on banks to raise foreign capital, restrictions on FII equity investment; eased Liquidity Adjustment Facility; continues to sell FX reserves
• HK: to use forex reserves to guarantee bank deposits, set up a fund for banks to access capital; Cut base rate by 150bps to 2% twice in Oct to contain jump in HIBOR; providing additional liquidity to banks via 3-mo repo window, expanded acceptable collateral
• Korea: cut 7-day repo rate 75bps to 4.25% and lowered the base rate 75bps on loans to SMEs amid high commercial paper and loan refinancing costs, household debt; up to $100 bn to guarantee maturing foreign currency debt; to use forex reserves to inject $30 bn liquidity in won-dollar swap market after an initial $10bn; might buy govt bonds from the market to reduce USD shortage; temporary ban on short selling
• Taiwan: Guaranteed bank deposits; Cut discount rate on 10-day loans to 3.25% on Oct 9 (second time in 2 weeks following first cut since 2003), cut reserve ratio (first time in 8 yrs) and ratio for passbook deposits; injecting liquidity into foreign-currency interbank market; lending via repos to insurance companies w/ extended maturity up to 180 days; banned short selling; instructed 4 major funds and state-owned banks to buy shares after stock market fell to 3-yr low on Sep 15
• Indonesia: allowed commercial banks to use central bank debt and govt bonds as secondary reserves; extended FX Swap tenor to 1 month; passage of foreign currency via banks for firms; abolished limit of daily balance position; eased foreign currency min reserve req; Cut bank reserve ratio 1.58bps to 7.5%; exempted banks from mark-to-market rule, eased rules/cap for firms to buy back shares; Suspended trading on Oct 8/9 following 10% slide in stock market; banned short selling for Oct; injected over 3bn via 6-day repo; lowered overnight repo rate, adjusted rate of liquidity facility; might increase infrastructure spending, fiscal stimulus for exporting firms, households
• New Zealand: overnight Cash Rate cut 100bps to 6.5%; introduced opt-in deposit guarantee scheme; accepting (longer term) bank paper in daily market operations, ABSs from local banks for swapping foreign cash into NZ dollars
• China: Chinese banks reluctant to extend loans to foreign banks in the interbank market; reduced 1-yr lending rate (second time in 3 weeks, first since 2002) by 27bp to 6.93% and 10yr deposit rate to 3.87% and cut bank reserve requirements by 50bp to 17%; eliminated stamp duty on stock purchases with plans to buy shares in state-owned banks; to introduce short selling and margin trading to ease pressure on share prices
• Singapore: guaranteed deposits; Injecting liquidity via market operations; prepared to provide further liquidity if necessary and also to individual banks amid spike in 1-mo and 3-mo SIBOR, BEA bank run, CDS also rising; but rates have eased somewhat following central bank measures
• Malaysia: guaranteed deposits; Might inject liquidity, move interest rates if necessary; planning for an economic stabilization stimulus
  
• Pakistan: declining capital inflows/outflows in inter-bank and open market causing currency depreciation; central bank injected $100-200 bn, raised limit on investment bonds and term finance certificates under banks' statutory requirement
• Easing commodity prices, peaking of inflation, growing risks to exports, economic growth might also shift central banks' bias towards monetary easing; Taiwan, Pakistan, Vietnam had earlier intervened in stock market by narrowing trading band, introducing stabilization fund to contain volatility; India, S.Korea, Thailand, Philippines, Indonesian intervening in forex market to contain downward pressure on currency (led by capital outflows, decline in external balances)

Comments: Malaysia and Singapore are still the last to act. Hinting that their fundamentals are more solid than the rest. Safe to say that there is "no attack" on the currency so far. The difference is that Singapore was adamant in defending the strength of the Sing dollar - which could very well bite them in the back as their property side is headed for a substantive fall.

p/s photos: Haruna Yabuki