Fed & ECB - A Study In Contrast

This week is jam-packed with events that will keep markets on their toes, but the two to focus on are the testimony to the Joint Economic Committee by Fed Chairman Ben Bernanke on Tuesday and the European Central Bank meeting on Thursday (the bank stress tests will be released on Thursday after the markets close. But given all the leaks, there might not be much left to release come the time.). Bernanke and Trichet will be far more interesting, highlighting the difference in approach to the crisis resolution - and reminding us at the same time of the limitations of central banks.

Bernanke will with no little pride be able to point to some hopeful developments, the slowdown in orders, including export orders, abating in the manufacturing sector - still a weathervane for the broader economy despite the service sector's weight - consumer confidence picking up, even house prices, while still falling, no longer setting record declines. Plus, there have been more signs of healing in the financial markets - risk gauges like Libor/OIS are narrowing - 3-month Libor is headed below 1% - and one Fed facility, at least - the one that supports commercial paper- is seeing less usage (though that's in part a reflection of the lower demand for corporate borrowing due to the recession). Sure, he'll be crossing his fingers behind his back as he speaks, given testing times ahead in the auto industry and the continued worsening in the jobless rate (a 9% unemployment rate for April is not out of the question). He will do his utmost to calm any fears that the Fed is in over its head with its ballooning balance sheet by outlining the exit strategies, the groundwork for which was laid in the March joint statement by the Fed and Treasury. And he will have soothing words for those worried about record debt levels. Demand? No sign it's waning massively, plus never underestimate the power of a determined central bank. Inflation? Conscious of the danger, believes the Fed has it under control. And the administration, he will note, is determined to reduce the deficit in the years ahead.

Two days later, listen to Jean-Claude Trichet, president of the European Central Bank. He will explain why a 1/4 percentage point cut in the euro zone's key rate to 1.0% and the extension of its refi operations from six months to possibly a year are sufficient to lay the groundwork for recovery, even as these measures pale in contrast to the Fed's actions. He has a point: Structurally, the euro zone depends on banks for lending, in contrast to the U.S., which relies heavily on debt markets - so expanding money supply is one key way of ensuring the supply of credit to the economy. Add the automatic stabilizers such as unemployment benefits, welfare payments, healthcare etc, to the special spending packages, and the euro zone and the U.S. are spending similar amounts. And he too can point to success: Euro zone market rates are in many instances lower than dollar rates, even though the Fed's key rate is much lower. But most importantly, expect Trichet to remind his audience of the stifling impact of ever-rising government deficits: consumers, fearful of higher taxes later, don't spend any additional funds, opting to save them instead; interest rates eventually end up having to be higher than desirable to attract investors; economies lack the resources to tackle the big structural issues, such as pension funding, better education, etc.

So, is the ECB free-riding on the coattails of the Fed's massive intervention? Or is the Fed being reckless, and is it the ECB that should be lauded for its adherence to fiscal discipline? It's probably a bit of both, and a lot of the difference in the approach is based on their history - the Fed and the Great Depression; the ECB and Europe's battle with hyperinflation.
But it's also a moot point in many ways. There's only so much central banks can do; they are after all merely guardians of the economy. It's time to remember that the economic challenges the euro zone and the U.S. face require political solutions. From the big exporters to the finance- and real-estate dependent economies - it's time we recognize the integral part the economy plays in society and reclaim our power to set its course.

Enron, Bear Stearns & Treasury's Financial Stability Plan

The government is set to present the heart of its financial stability plan - how to deal with the toxic assets clogging up banks' balance sheets - a stark reminder how little progress has been made in dealing with the root of the financial crisis a year after the Bear Stearns bailout.
There's no harm in thrashing out the pros and cons of this plan yet again. But what is urgently needed - and what we are highly unlikely to get - is a sober debate of the big picture, the plan's framework. Transparency will once again fall by the wayside. The taxpayer will be asked to pay up, without being told what it is that we're taking on all this debt for, let alone being involved in the debate whether this is the best solution.

The arguments against the Financial Stability plan are easy to list and most involve practicalities. Private investors will be reluctant to lend because they fear arbitrary changes to the ground rules by populist lawmakers, no matter how cheap the funds are the government will offer them. Valuing these assets so that banks will be willing to sell them without overpaying for them remains a tricky issue. The mood right now is for solutions that work immediately - yet this plan is nothing if not complex and will take time to implement.

But of far greater importance is an issue that we seem to have lost sight of as the crisis has progressed: the need for transparency. We as taxpayers, whose full faith and credit are on the line, have a right to know what these purchases are that we are funding. The Treasury has a web site www.financialstability.gov. It should post the assets that are going up for sale there, including the prospectuses that the government will send out to investors. And please, spare me the "nobody would understand them, they are so complex" argument. It's irrelevant - all that matters is that anyone who is interested has the option to find out more.
What we can't have is a replay of Maiden Lane I - remember the $30 billion facility set up in June last year to take over Bear assets that JPMorgan's Dimon washed his hands off? It's faded into the mist of the financial crisis, but it's still there - just a bit diminished: at the end of 2008, the $30 billion - of which JPMorgan had put up $1 billion - had shrunk to $26 billion. Yet nobody except the New York Fed, JPMorgan and the portfolio manager Blackrock have any idea what's in that portfolio. What harm could come of making these assets public?

This insistence on obscurity is the biggest problem we face. The taxpayer must be treated as equal partner in the resolution of the financial crisis. Officials have decided that the best way to rescue the banking system and the economy is by reviving the shadow banking system - those obscure markets that allowed lenders to repackage loans and sell them on to third parties. But they have yet to explain how they arrived at this decision; they have yet to involve us, the taxpayers, in their discussions.

Off-balance sheet vehicles were instrumental in allowing banks to circumvent capital rules and take on far more risk than they should have - in a replay of what brought down Enron. They should have been banned in 2002, we are now paying for regulators' inability to act forcefully seven years on (we won't even ask where Congress was all those years. Those Congressmen baying for bonus recipients' blood should take a long, hard look at their own record.) These same regulators have now embarked on a strategy that revives those markets that allowed us to live beyond our means, borrow more than we could afford.

Is that the best plan we can come up with?

Business As Usual Is Not An Option

Ben Bernanke, our unruffled Federal Reserve chairman, was asked today whether spending trillions of dollars is the right answer given that it was overspending that got us into trouble in the first place. And his answer was clear - but also goes to the heart of the widespread unease that many feel right now: We cannot afford not to spend. Without aggressive measures, the downturn will become much worse. We need to get through this crisis, then only can we start talking about being fiscally responsible. For sure, there has to be a plan to address the ballooning budget deficit; but now is not the time to be prudent - and he cited St. Augustine's famous "God let me be moral - only not just right now."


The rub with this though is that St. Augustine knew what he had to achieve, and more importantly, what he had to do to fulfill God's demands. It was more or less in his own hands. But it's far from obvious that any of the world's governments have any coherent notion of how to get to the blessed state of sustainable deficits, both external and internal. We need to rethink the premise of a global economy that is driven chiefly by consumer spending in the largest economy, the U.S. Rebalancing the global economy will require the U.S. to curb consumption and invest more in education, transportation, clean technology and many other areas that have been neglected in the past decades. Japan, China and Germany (numbers 2-4 of the global economy) must wean themselves off the exporting fix - these economies must find a way to stimulate private consumption. None of this will be achieved overnight; the scale of the challenge we are facing is daunting.

Conventional wisdom says that the housing market in the U.S. lies at the root of the current crisis - that is partly true. But a different statement would also be correct: it was the massive global imbalances that created the havoc we are now struggling to contain. The G7's conciliatory tone toward China - rather than the usual yuan bashing - was a first step; but the forum that will prove decisive in outlining the post-crisis economic order should ideally be the G20 - where emerging and developed nations come together - which next gathers in London in early April. It has been mostly a talking shop, a handy place for national grandstanding. But under the new U.S. leadership, it has to be hoped that this will change, because we cannot emerge on the other side of the crisis with the same or similar imbalances in the world economy. We cannot afford business as usual.