RGE’s Wednesday Note – The Perils of Name-Calling

This week’s newsletter is excerpted from an analysis by Nouriel Roubini: “The U.S.-China Currency and Trade Collision Course.” Dr. Roubini reflects on recent discussions with Chinese policymakers at the China Development Forum, including his suggested response to the flaring U.S.-China currency rift, as well as in-depth discussion of what might happen if the U.S. brands China a “currency manipulator.” Below is his outline of the problem.

Why Japan Needs a ‘Hatobama’

From The Wall Street Journal

By Ian Bremmer and Nouriel Roubini

Like President Barack Obama, Japan’s new Prime Minister Yukio Hatoyama made lots of extravagant economic and foreign policy promises on the road to victory earlier this year. Mr. Obama has shown flexibility and the willingness to compromise. Will Mr. Hatoyama do the same? If not, Japan will be in for a rough ride in 2010.

Insolvent banks should feel market discipline

From the Financial Times:

Joseph Schumpeter famously argued that the essence of capitalism was creative destruction, by which new economic structures are born from the rubble of older ones. The government stress tests on the 19 largest US banks, the results of which are due be announced on Thursday, could have facilitated this process. The opportunity looks likely to be missed.The tests, which measure how viable banks are under adverse economic conditions, have no “failed” category, even if as many as 10 are reported to need additional capital. But, given that the economic environment already reflects the tests’ worst-case scenario and that recent estimates by the International Monetary Fund of financial sector losses have doubled in six months, the stress test results will not be credibly interpreted as a sign of bank health. 

Instead, market participants will conclude that banks requiring extra capital have, in fact, failed. As a result, these institutions will not be able to raise outside capital and will immediately require government help.

Once again, the question will be how the near-insolvent banks can be kept afloat, to avoid systemic risk. But the question we really should be asking is: why keep insolvent banks afloat? We believe there is no convincing answer; we should instead find ways to manage the systemic risk of bank failures.

We Can’t Subsidize the Banks Forever: Government has to show it can handle major insolvencies

From The Wall Street Journal:

The results of the government’s stress tests on banks, to be released in a few days, will not mark the beginning of the end of the financial crisis. If we are to believe the leaks, the results will show that there might be a few problems at some of the regional banks and Citigroup and Bank of America may need some more capital if things get worse. But the overall message is that the sector is in pretty good shape.

OB-DP568_oj_rou_E_20090504185544.jpgChad Crowe

Concorde’s fate offers a lesson for finance

Published in the Financial Times on April 15 2009

The supersonic Concorde aircraft was considered in the 20th century to be the most sophisticated airliner, flying at twice the speed of sound. Its crash in Paris on July 25 2000 destroyed this confidence. Some blamed the crash on metal fragments from another aircraft; others argued that Concorde was overweight and unbalanced. The accident led to some design modifications but in 2003 Concorde was in effect jettisoned in favour of subsonic aircraft, much slower but easier to maintain.

It is not too much of a stretch to compare the global financial system of the pre-subprime era to Concorde. It was fiercely innovative and grew at a record pace for close to two decades, only to suffer a new type of hard landing without clarity as to whether it was the fault of the system’s pilots or also of those regulating its maintenance.

Geithner Presents a Viable Plan to Dispose of the Toxic Assets…that Does Not Rule Out that Insolvent Banks Should be Taken Over

A similar piece, co-authored with Matthew Richardson, was published at the New York Daily News:

For the economy to be viable, the financial system must be healthy, and for this to occur, the financial system needs to be cleansed of its poorly performing loans and so-called toxic securities backed by loans, such as mortgage backed securities. This way, once creditworthy institutions and individuals come to the market looking for capital to borrow, financial firms will be in a position to lend them the money and more generally able  provide financial services to the economy.

Nationalize the Banks! We’re all Swedes Now

From the Washington Post:

The U.S. banking system is close to being insolvent, and unless we want to become like Japan in the 1990s — or the United States in the 1930s — the only way to save it is nationalization.

As free-market economists teaching at a business school in the heart of the world’s financial capital, we feel downright blasphemous proposing an all-out government takeover of the banking system. But the U.S. financial system has reached such a dangerous tipping point that little choice remains. And while Treasury Secretary Timothy Geithner’s recent plan to save it has many of the right elements, it’s basically too late.

A proposal to prevent wholesale financial failure

From the FT:

The worst financial crisis since the Great Depression has highlighted the risks from the collapse of systemically important financial institutions. Huge bail-outs were undertaken based on a fear that the collapse of such institutions would cause havoc, with collateral damage to the real economy. Examples include Bear Stearns, Fannie, Freddie, AIG, Citi­group, the insurance of money market funds and new US Federal Reserve programmes for banks and broker-dealers. Allowing Lehman Brothers to collapse had such severe systemic effects that the global financial system went into cardiac arrest and is still dealing with the aftermath.

Formula For Fiscal Fitness

The instant he takes office, President Obama’s imme diate priority must be to fix the economy, which is spiraling downward rapidly in the worst financial crisis since the 1930s. The clear answer is a combination of government spending (the “stimulus package”) and financial restructuring – and the latter is the more important.