The Big Picture |
- LIBOR: The World’s Most Dishonest Number
- Kocherlakota’s Dissent
- Kiron Sarkar Weekly Report 9.23.14
- How to Be An Innovator
- Are Stocks Cheap or Pricey?
- 10 Sunday Reads
| LIBOR: The World’s Most Dishonest Number Posted: 24 Mar 2014 03:00 AM PDT
The FDIC has sued 16 of the largest banks in the world plus the British Bankers Association (BBA) alleging that they engaged in fraud and collusion to manipulate the London Inter-bank Offered Rate (LIBOR). BBA called LIBOR "The most important number in the world." LIBOR is actually many numbers that depend on the currency and term (maturity) of the loan. The collusion involved manipulating most of these rates. A vast number of loans and derivatives are priced off of these "numbers." Estimates of the notional dollar amount of deals affected by the collusion range from $300-550 trillion in deals manipulated at any given time. The LIBOR frauds began no later than 2005 and continued through 2011.
The BBA and the banks claimed to the world that LIBOR was simply the prices (interest rates) set by the market for what it cost the world's largest banks to borrow from each other. The banks would report to the BBA those interest rates and, after excluding outliers, the average reported cost to borrow for X days in Y currency would be reported as the LIBOR "number." The system was not regulated. The theory was that the banks self-regulated. LIBOR was the City of London's "crown jewel" and theoclassical economics predicted that the elite banks' self-interest in their reputation and the value they gained from having LIBOR as the global standard would ensure that the banks would report honestly. As my readers know, any discussion of the "banks'" interests is dangerously misleading. The key question is the interests of the banks' officers, particularly those that control the banks. The "unfaithful agent" (bank officer) is the leading threat to the banks. Theoclassical economists assumed away the "agency" problem. The fact that the FDIC "only" sued 16 of the largest banks in the world does not indicate that the other elite banks were run honestly. The other elite banks were not part of the group that set LIBOR so they could not join in the cartel. The LIBOR conspiracy could only succeed and persist if none of 16 elite banks was controlled by honest officers and no regulator acted to end the collusion once they became aware of the collusion (which happened no later than April 16, 2008). We ran a real world test of the ethics of the leaders of 16 of the world's most elite banks. The scorecard according to the U.S. government agency that investigated the matter (the FDIC) reports that each of the leaders failed. Our twin emergencies are financial and ethical. According to the FDIC investigation, the three largest banks in America (including the world's two largest banks), the four largest banks in the U.K, the largest bank in German, the largest bank in Japan (plus one of the handful of surviving "main banks"), the third largest bank in France, the two largest Swiss banks, the second largest bank in Canada, and the second largest bank in the Netherlands conspired together to manipulate LIBOR and not only lied about it but also covered up the cartel and the fraud scheme it used. The 15 surviving banks' total assets were nearly twice as large as the U.S. GDP as of September 30, 2013. Here are the data on the banks sued by the FDIC
^Data for banks that follow U.S. generally accepted accounting principles (GAAP) (yes; that includes Credit Suisse) adjusted to the International Financial Reporting System (IFRS) basis to make data comparable. (The difference is how financial derivative positions are measured.) *I excluded one of the banks the FDIC sued, WestLB AG, because the (infamous) German Landesbank was sold as part of a German bailout during the crisis. It had over $400 billion in total assets before its collapse during the crisis. Ethics Consider the ethical and political implications of what the FDIC investigation has confirmed. The entire barrel of apples is rotten. Every CEO failed the ethical test, and the ethical bar that they failed to surmount was set exceptionally low. That can only happen when a "Gresham's" dynamic has been allowed to persist for years because of the three "de's" (deregulation, desupervision, and de facto decriminalization). Such a dynamic can cause "bad ethics to drive good ethics out of the markets." No one should be able to view the facts the FDIC cites without a sense of horror combined with an urgent commitment to transform the industry that has done so much financial and ethical harm to our nations. The twin emergencies are global. Crony Capitalism and Politics There are two possibilities: the Obama administration knew for six years that the world's largest banks were endemically led by frauds or the administration learned of that fact recently when it learned of the results of the FDIC investigation. The LIBOR scandal became public knowledge with the Wall Street Journal's April 16, 2008 expose, so the Bush administration also knew it was dealing with elite frauds. If the Obama administration has long known that fraud was endemic among the leaders of the world's largest banks, then its policies toward those CEO and the banks they control have been reprehensible and harmful. If the administration has just learned from the FDIC investigation about the true nature of the CEOs that it has refused to hold accountable and allowed to retain and even massively increase their wealth through leading control frauds then we can doubtless expect a series of emergency actions transforming the administration's finance industry policies. The FDIC lawsuit provides a "natural experiment" that allows us to test which of the possibilities was correct. Let's review the bidding. The U.S. government, through the FDIC, has found after a lengthy investigation that the leaders of 16 of the world's largest banks conspired together to form a cartel to manipulate the LIBOR "numbers" and to defraud the public about the scam. This should have led the criminal justice authorities to prosecute large numbers of senior officers of these banks – but none of them have been prosecuted. It obviously poses a grave threat to the "safety and soundness" of the entire financial system. The endemic frauds led by elite CEOs demonstrate such a pervasive failure of integrity and ethics by the leaders of the finance industry that there is a moral crisis of tragic proportions. So here are some questions (along with the usual who, when, where details) I request that the media formally ask the administration:
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| Posted: 24 Mar 2014 02:00 AM PDT Statement on Kocherlakota Vote at March 19, 2014, Meeting of the Federal Open Market Committee
Note* I view the March 19 Federal Open Market Committee (FOMC) statement as an unusually significant one. In that statement, the FOMC adopted new forward guidance about the evolution of its target for the federal funds rate. I see that new guidance as being intended to describe the Committee's decisions for some time to come. I dissented from the new guidance for two reasons. The first reason is that the new guidance weakens the credibility of the Committee's commitment to target 2 percent inflation. The second reason is that the new guidance fosters policy uncertainty and thereby suppresses economic activity. In what follows, I'll elaborate on these reasons, discuss an alternative form of forward guidance, and conclude by strongly endorsing one aspect of the FOMC's new forward guidance. In terms of credibility: the Personal Consumption Expenditure (PCE) inflation rate has drifted downward over the past few years and is currently near 1 percent. The FOMC's new forward guidance does not communicate purposeful steps being taken to facilitate a more rapid increase of inflation back to the 2 percent target.The absence of this kind of communication weakens the credibility of the Committee's inflation target, by suggesting that the Committee views persistently sub-2-percent inflation as an acceptable outcome. In terms of uncertainty: Currently, most labor market metrics imply that the economy is still well short of maximum employment. In its forward guidance, the Committee provides little information about its desired rate of progress toward maximum employment. Indeed, the guidance provides little quantitative information about what would characterize maximum employment. These omissions create uncertainty about the extent to which the Committee is willing to use monetary stimulus to foster faster growth, and this uncertainty is a drag on economic activity. How could the FOMC have done better? I believe that, over the past 15 months, the Committee's forward guidance about the fed funds rate has been highly effective at shaping market expectations. That guidance has relied on an unemployment rate threshold of 6.5 percent and an inflation outlook guardrail of 2.5 percent. Given the effectiveness of this quantitative approach, I would have favored adopting a similar approach going forward. For example, the Committee could have adopted language of the following form: "the Committee anticipates keeping the fed funds rate in its current range at least until the unemployment rate has fallen below 5.5 percent, as long as the one-to-two-year-ahead outlook for PCE inflation remains below 2 1/4 percent, longer-term inflation expectations remain well-anchored, and possible risks to financial stability remain well-contained." This alternative guidance communicates the Committee's willingness to use monetary policy tools to push inflation back up to 2 percent. It reduces macroeconomic uncertainty by being clearer about the kinds of labor market and inflation conditions that are likely to be associated with an increase in the fed funds rate. Finally, it deals with the unlikely possibility of risks to financial stability through an explicit escape clause. There is one key aspect of the Committee's new forward guidance that I strongly endorse. The guidance provides information about the Committee's intentions for the behavior of the fed funds rate once employment and inflation are near mandate-consistent levels. Those intentions are appropriate, and communicating them should help stimulate economic activity by reducing uncertainty about the likely path of the fed funds rate once the Committee's goals are reached. Note* I thank Ron Feldman, David Fettig, Terry Fitzgerald and Sam Schulhofer-Wohl for their comments. | ||||||||||||||||||||||||||||||||||||
| Kiron Sarkar Weekly Report 9.23.14 Posted: 23 Mar 2014 04:30 PM PDT Overview The (unintended, I believe) remark by Mrs Yellen that the FED could raise interest rates 6 months following the end of the tapering programme has had ripple effects worldwide. US bond yields (the 10 year is yielding 2.78%) and the US$ have appreciated, with the Yen and the Euro lower. The weaker Euro (around US$1.38) has certainly come as a relief to the ECB, who had been trying (unsuccessfully) to talk the currency down, though at some stage the ECB will have to act I suspect. Markets also sold off, with emerging markets faring the worst, though the Nikkei closed -1.6% lower on Thursday. However, with low inflation in the US and no signs that it will rise materially in coming months, the market response to a possible earlier rise in rates by the FED looks premature. Generally, the most recent data suggests that the US is doing better than currently thought, which should support US markets, though risks internationally are rising. My real concerns remain with China and Japan and most emerging markets generally. Investors are reducing their investment in China by record amounts, together with emerging markets in general, a trend which I believe will continue. The Chinese authorities did indeed announce plans for a fixed asset programme and are likely to ease lending restrictions in an effort to stimulate growth. However, the speed of their response I suspect reflects their heightened concern about the Chinese economy. Chinese markets did rise on Friday on the news, though I believe that such rallies will be relatively short lived. I have been bearish on China for many years now, but recent data/news has taken a decided turn for the worse. Analysts have reduced their 2014 GDP growth forecasts to around 7.0%, though I believe that the Chinese economy will be hard pressed to achieve these forecasts. Based on recent comments and economic data, it looks as if Abenomics and the BoJ's policy has not delivered as expected. Q2 GDP is likely to come in materially negative. I believe that the Yuan and the Yen will decline, which could result in both countries exporting deflation. Whilst there are some signs that the economies of the EZ have stabilised, growth is at very low levels. The increasing sanctions on Russia have the ability to hurt clearly Russia, but countries such as Germany as well. Furthermore, there is also the possibility of political turmoil as local and EU elections are due over the coming months, with more nationalist parties gaining support – French municipal elections are coming up. I remain cautious of equity markets. The risks, especially from major economies such as China and Japan are rising. As a result, I continue to believe that it is better to sit back and wait. US Industrial production rose by +0.6% in February, mainly due to a pickup of the auto sector. The increase was well above estimates of +0.2%. Factory production rose by +0.8%, the largest rise since August. Inflation remains contained. Consumer prices rose by just +1.1% Y/Y in February. Core prices rose by +1.6% Y/Y. US housing starts came in at an annualised pace of 907k, roughly the same as the upwardly revised rate of 909k in January. More importantly, building permits rose by +7.7%, which suggests an improvement in coming months. However, existing home sales declined by -0.4% to an annual rate of 4.60mn homes in February, the lowest level since mid 2012, though in line with expectations. Weather could well have impacted. Prices were +9.1% higher Y/Y The US current a/c deficit declined by more than forecast to US$81.1bn in Q4 2013. It was the smallest deficit since 1999 and mainly due to an increase of more than US$5bn in income earned from overseas. US weekly jobless claims came in 320K, slightly higher than last weeks 315k, though better than the forecast of 322k. The less volatile 4 week moving average declined to 327k, down from 330.5k. The data is yet more confirmation that the US economy is improving. The Philly Fed index came in at 9.0 M/M, well above the 3.2 expected and the -6.3 in February. Whilst employment and prices paid came in lower than expected, importantly the new orders component rose materially. In addition, capex plans rose to near pre recession highs, as firms indicated that they expected to replace equipment and, in addition, forecast increased sales. Following a stress test, the FED reported that 29 out of 30 banks had enough capital to cope with an economic downturn, with core capital exceeding 5.0% under the stress test assumptions. However, there is a threat that some banks could be restricted from paying dividends. Europe The forward looking German investor confidence index, the ZEW, declined to 46.6, from 55.7 in February and well below the forecast of 52.0. Investors are concerned about the situation in the Ukraine, together with the slowdown of the Chinese economy, the low level of growth in the EZ and the strong Euro. It was the 3rd monthly decline. German exports to a number of emerging markets remains a real threat. The EZ agreed on legislation to create a single agency to deal with problem banks. Once the legislation has been approved by the EU Parliament, it will establish a EZ wide Single Resolution System, together with a E55bn fund to be paid for by banks over a period of time. The E55bn fund will be able to be fully accessed by any EZ country earlier than had previously been the case (down to 8 years from 10 previously) and, in addition, the ability of a country’s finance minister interfering in the process has been curbed somewhat. However, the bottom line is that the complexity of the proposed system could well delay the ability to close down and subsequently reopen banks quickly and until the fund can be accessed fully by any EZ country, the onus remains on the individual country. Whilst better than previous proposals, the current agreement still poses significant risks. UK unemployment declined by 34.6k in February, better than the decline of 25k expected. The unemployment rate remained unchanged at 7.2%. Average earnings increased by +1.4% in January – there are some indications that earnings are picking up. The UK budget was announced on Wednesday. The 2014 growth forecast was revised higher to 2.7%, from 2.4%, in line with expectations. The higher growth rate will reduce the budget deficit, which is forecast to decline to 6.6% in 2014/15, from 6.8% previously. Budget deficits in subsequent years are also forecast to be lower. Employment is forecast to increase. Japan The ex deputy governor of the BoJ suggested that the Central Bank will ease policy further in the next few months. He added that further fiscal stimulus was likely. At present, the BoJ buys the equivalent of around 40% of bonds issued by the government. There have been calls to increase that percentage !!!!! China The Chinese authorities announced that they would spend Yuan 1tr (US$160bn) on redeveloping shantytowns. In addition, they intend to build more transport links and ease some residence registration rules. Furthermore, local governments will be entitled to to issue bonds to help pay for further urbanisation. I suspect the spending is more to help the Chinese economy, which has been slowing at a fast pace. In addition, property prices are slowing rapidly – yet another sign of the weaker economy. A property developer has defaulted. Later in the week, the Chinese authorities confirmed that they would "accelerate preliminary work and construction on key investment projects". In addition, the authorities have announced a trial programme for companies to sell preferred shares, which is thought to help banks meet stricter capital requirements. Whilst these measures will help in the short term, I do not believe that they will be sufficient. The Yuan declined to 6.20 against the US$ on Wednesday, a level which if breached could result in material losses on derivative products taken out by Chinese companies in anticipation of a stronger Yuan – estimated at US$3.5bn by Morgan Stanley. The Yuan continued to decline on Thursday, following Mrs Yellen's comments referred to above. At one point it reached over 6.23 to the US$, the weakest for over 1 year. Chinese markets (the CSI 300) declined to their lowest level in 5 years on Thursday but recovered sharply on Friday on speculation that the government will loosen credit restrictions for property developers and banks. Kiron Sarkar | ||||||||||||||||||||||||||||||||||||
| Posted: 23 Mar 2014 02:00 PM PDT How to be more innovative? Some advice from the experts on how to design your personal innovation roadmap — in three steps.
Slides from a keynote presentation prepared for Queen’s School of Business Innovation Summit, 2014. | ||||||||||||||||||||||||||||||||||||
| Posted: 23 Mar 2014 06:30 AM PDT
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My Sunday Washington Post Business Section column is out. This morning, we look at whether stocks are cheap or expensive. The print version had the full headline Are Stocks Cheap or Not? How to Tell. The conclusion is surprisngly middle of the road. Here’s an excerpt from the column:
Its a good exploration of various metrics. > Source: | ||||||||||||||||||||||||||||||||||||
| Posted: 23 Mar 2014 04:30 AM PDT Grab a cup of coffee and start your Sunday right with these reads:
What’s for brunch?
Roll Over Beethoven | ||||||||||||||||||||||||||||||||||||
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