A better bail out

Interesting article by Barry Ritholz arguing the case to not repeat the mistakes made in the GFC.

www.bloomberg.com/opinion/articles/2020-03-23/coronavirus-u-s-needs-to-do-bailouts-the-right-way-this-time

“Today, we have a new crisis, one with roots in the last rescue plan. In fashioning our response to the 2020 Covid-19 pandemic, we should be careful to avoid the mistakes made in haste then. Consider three broad categories of the last crisis’ errors: 1) inadequate fiscal stimulus; 2) lack of support for the social safety net; and 3) overly generous bailouts terms for banks and other companies. All were unpardonable, but for now let’s focus on the third error.”

We are seeing clear evidence that fiscal support will be available and that government recognises the need to help individuals and small companies get through this crisis. What is up for grabs is the terms on which larger companies (Barry cites the airlines) are supported. His point that the government should make sure it retains a share of the upside seems fair to me. If a company can get a better deal somewhere else then it should take it.

Tony

APRA’s approach to COVID 19

I have been flagging the potential for IFRS 9 to amplify the impact of the COVID 19 pandemic. This announcement from APRA is broader than IFRS 9 but does seem to be responding to this risk. This is obviously a welcome response to the immediate issue but I still believe the design issue with procyclicality needs to be addressed once the crisis is over.

This link takes you to APRA’s announcement

https://www.apra.gov.au/news-and-publications/apra-advises-regulatory-approach-to-covid-19-support

ECB acknowledges the potential for IFRS 9 to amplify procyclicality

This ECB press release lists four initiatives to deal with impact of Covid 19

  • ECB gives banks further flexibility in prudential treatment of loans backed by public support measures 
  • ECB encourages banks to avoid excessive procyclical effects when applying the IFRS 9 international accounting standard 
  • ECB activates capital and operational relief measures announced on March 12, 2020
  • Capital relief amounts to €120 billion and could be used to absorb losses or potentially finance up to €1.8 trillion of lending

This guidance on flexibility is helpful (arguably necessary) but it would have been better if the relationship between loan loss provisioning and capital buffers was more clearly thought through and built into the design of the system before it was subject to its first real test.

Tony

Capital Rules Get Less Stressful – Matt Levine

Nice quote from Matt Levine’s opinion piece on the change in US bank capital requirements

Everything in bank capital is controversial so this is controversial. Usually the controversy is that some people want higher capital requirements and other people want lower capital requirements. Here, pleasantly, part of the controversy is about whether this is a higher or lower capital requirement.

https://www.bloomberg.com/opinion/articles/2020-03-05/capital-rules-get-less-stressful

Banks may be asked to absorb more than their contractual share of the economic fallout of the Coronavirus

We have already seen signs that the Australian banks recognise that they need to absorb some of the fallout from the economic impact of the Coronavirus. This commentator writing out of the UK makes an interesting argument on how much extra cost banks and landlords should volunteer to absorb.

Richard Murphy on tax, accounting and political economy
— Read on www.taxresearch.org.uk/Blog/2020/03/04/banks-and-landlords-have-to-pick-up-the-costs-of-the-epidemic-to-come-if-the-the-economy-is-to-have-a-chance-of-surviving/

I am not saying banks should not do this but two themes to reflect on:

1) This can be seen as part of the price of rebuilding trust with the community

2) it reinforces the cyclicality of the risk that bank shareholders are required to absorb which then speaks to what is a fair “Through the Cycle” ROE for that risk

I have long struggled with the “banks are a simple utility ” argument and this reinforces my belief that you need a higher ROE to compensate for this risk

Tony

Dutch Central Bank is proposing to increase mortgage risk weights for Dutch IRB banks in response to elevated macro prudential risks

The European Banking Authority (EBA) published today an Opinion endorsing the decision by Central Bank of the Netherlands (De Nederlandsche Bank – DNB) to modify capital requirements in order to address an increase in macroprudential risk.

These extracts from the EBA press release give you the main facts

This new measure aims at enhancing the resilience of the Dutch banking sector to a potential severe downturn in the residential real estate market against the background of sustained price increases in real estate over the past few years.

In particular, the DNB notified the EBA of its intention to introduce a new macroprudential measure, which consists of a minimum average risk weight floor at the portfolio level based on the loan-to-value (LTV) ratio of the individual loans. More specially, a 12% risk weight is assigned to the portion of the loan not exceeding 55% of the market value of the property that serves to secure the loan, and a 45% risk weight is assigned to the remaining portion of the loan. If the LTV ratio is lower or equal to 55, then a fixed 12% risk weight is assigned to the loan.

In its Opinion, addressed to the Council, the European Commission and the DNB, the EBA acknowledges, in line with the ESRB recommendation on medium-term vulnerabilities in the residential real estate sector in the Netherlands, the concerns on the build-up of risk in this sector, the large proportion of high-LTV loans, high level of indebtedness in Dutch households and the low risk weights for real estate exposures by Dutch IRB banks. In light of this conclusion, the EBA does not object to the deployment, by the DNB, of its proposed macroprudential measure

Possible pitfalls of a 1-in-X approach to financial stability – Bank Underground

Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed are those of the authors, and are not necessarily those of the Bank of England, or its policy committees. Posting on this blog, Adam Brinley Codd and Andrew Gimber argue that false confidence in people’s ability to calculate probabilities of rare events might end up worsening the crises regulators are trying to prevent.

The post concludes with their personal observations about how best to deal with this meta-uncertainty.

Policymakers could avoid talking about probabilities altogether. Instead of a 1-in-X event, the Bank of England’s Annual Cyclical Scenario is described as a “coherent ‘tail risk’ scenario”.

Policymakers could avoid some of the cognitive biases that afflict people’s thinking about low-probability events, by rephrasing low-probability events in terms of less extreme numbers. A “100-year” flood has a 1% chance of happening in any given year, but anyone who lives into their 70s is more likely than not to see one in their lifetime.

Policymakers could  be vocal about the fact that there are worse outcomes beyond the 1-in-X point of the distribution.

— Read on bankunderground.co.uk/2020/02/06/possible-pitfalls-of-a-1-in-x-approach-to-financial-stability/

We don’t want economic growth

We don’t want economic growth https://stumblingandmumbling.typepad.com/stumbling_and_mumbling/2020/01/we-dont-want-economic-growth.html

I think there is a lot of truth in this blog post

– subject to achieving a reasonable minimum, people do seem to care more about relative position than absolute wealth

– the creative destruction associated with growth is good for the herd but the individuals who lose their jobs and can’t find a place in the new economic order are obviously not so keen on the process

– conventional economic policy advice government receives does not really engage with these questions

Relevant extract from the blog copied below

There are, for my purposes, two things are going on here.

One is that what matters for well-being is not so much absolute income as our income relative (pdf) to our peers: if we are doing better than them, we’re happy and if we are doing worse, we’re miserable. Andrew Clark and Andrew Oswald have found that happiness depends more upon relative (pdf) income than absolute income, whilst Christopher Boyce and colleagues have found that it is a person’s position in the income ranking (pdf) that matters for their well-being, not their absolute income**.

If it is relative income we care about, then stagnation shouldn’t trouble us. We have as much chance of getting ahead of our peers when GDP is flatlining as we do when it is growing.

Also, though, economic growth is associated with some things many of us don’t like – with the creative destruction than runs down some industries and areas. As Banerjee and Duflo show in Good Economics for Hard Times, the economy is “sticky”: people do not or cannot adjust to such disruption. Hence Anand Menon’s heckler’s point: “that’s your bloody GDP. Not ours.” A stagnant economy in which zombie firms preserve jobs and in which we face less threat from foreign competition or new technology is perfectly tolerable for many – and better than the tumultuous, threatening growth of the 80s and 90s.

Book recommendations

Doing book recommendations seems to be very on trend. That said, I am a sucker for the “here are my favourite books” tag so here are some of the books I read this year that I can recommend.

“Scale: The Universal Laws of Life and Death in Organisms, Cities and Companies”, by Geoffrey West

The Value of Everything: Making and Taking in the Global Economy”, by Marianna Mazzucato

“The Economist’s Hour: How the False Prophets of Free Markets Fractured Our Society” by Binyamin Appelbaum

“Scale” identifies some universal scaling laws that apply in and across a range of domains, the nature and origin of these systematic scaling laws, how they are all interrelated, and how they lead to a deep and broad understanding of many aspects of life and ultimately to the challenge of global sustainability. The ways in which companies are subject to similar scaling laws to those observed in biological organisms was especially interesting for me but this is just one of a range of topics covered to draw out intriguing insights.

“The Value of Everything” has a particular view on the role of government that you may, or may not, agree with. However even the skeptics who don’t accept her overall thesis would benefit from the primer the writer offers on the different theories of value that have held sway over the formulation of public policy.

Finally, “The Economist’s Hour”. I am only half way through this book but it offered new insights for me on the role of economists and economic theory in driving some pretty fundamental changes in the society we live in.

Tony