Crisis Talk - The World Bank Group

Lagging Indicators

Forecasts have become a favorite pastime of economists of all stripes. Not a week goes by without some eminent organization coming up with an even-darker prediction for growth in 2009 (and lately, 2010). The IMF has been a clear leader in updating its forecasts, doing so every second month since September. Some commercial banks - the same who entirely missed the crisis onset - are now competing for the gloomiest forecast. Why is this happening?

Well, the severity of the crisis is deeper than anyone expected, so some updating is natural. But when does is become clear that forecasters are simply running behind the news? To me, this is clear now. Here is my prediction: we will have another 2-3 rounds of gloomier forecasts, at which points some signs of recovery will show up and the forecasters will start "upgrading." And once upgrades come, there will be an avalanche of those.

To keep your sanity, don't follow forecasts closely. Instead, what can be more useful for policymakers and business people is to use scenarios. Say, a low, middle and high scenario. Then simulate what you would do if the world enters any of these scenarios. This is more fun, and at this point provides more useful information than any single forecast.

Trade Finance in Africa

According to a recent World Bank press release, "Africa is likely to be the worst-hit region by the global financial crisis." This seems to be the height of unfairness, given that African countries had little to do with creating the current global crisis. How then best to mitigate the effects on the region of the world that is expected to be hit the worst?

Among its many pronouncements, the recent G20 summit stressed the importance of supporting trade finance in responding to the crisis. But a recent article in VoxEU.com suggests that trade finance is not really the problem - at least for firms in Sub-Saharan Africa. Researchers contacted SMEs in export-oriented sectors in the region, and this is what they found:

US Economy Shrinks by 6.1% in Q1, 2009

This just in: the GDP numbers for the first quarter are out and they are worse than expected. The economy slowed down by 6.1% year on year. Forecasters had expected a 4.7% drop.
 
Still, commentators are keeping a stiff upper lip and arguing that this is great news as it means that inventories are dwindling and this is necessary for the economy to rebound. Sounds somewhat improbable, but then these are the same commentators that didn't call the crisis a year ago. Don't pay much attention.

Stiglitz on Big Banks

Joe Stiglitz visited the World Bank yesterday and talked about needed changes to fight future crises. One controversial thought that has some merit: break up big banks so they do not pose a "too big to fail" risk.
 
There is anyhow a market-based movement in that direction. The days of the "supermarket bank" are over. It is not obvious what this huge diversification in the last 15 years has brought in the way of benefits. At least there are no studies I am aware of that make this case in a compelling way. More importantly, it is a lot more difficult to regulate and supervise big banks.
 
The question is who has enough power to break up the big guys. Noone in the US. Too cosy of a relationship with the regulators (says Stiglitz). What about Europe? Not clear either. In all likelihood, this idea will go the way of Stiglitz's super-bankruptcy idea: nowhere. Still, good someone is thinking.

Obama’s Trade Policy Test

A special safeguard case against imported tires from China, initiated by the United Steelworkers (USW), was announced this week. Under China's WTO accession agreement, members are permitted special safeguards until 2013. This is the first such case filed under the new administration. The U.S. International Trade Commission has 60 days to rule on the petition and make a recommendation. If it rules in favor, President Obama will have 90 days to decide on a remedy. 

During the previous administration, six special safeguard cases were filed, four went to President Bush, but none were acted on. Bush cited standard free trade principles in declining to act.

Effective Insolvency Regimes: Q&A with Mahesh Uttamchandani

Editor’s Note: Recently, I sat down to have a chat with Mahesh Uttamchandani, Senior Counsel for Insolvency & Creditors' Rights at the World Bank and head of the World Bank's Global Insolvency & Creditors' Rights Initiative. An expert on insolvency regimes, Mr. Uttamchandani kindly answered my questions about the role that effective insolvency regimes can play in helping emerging markets cope with the impact of the financial crisis. (A PDF of this interview is also available.)

Q:

One of the issues that has been raised in the context of the crisis are the estimates for corporate debt in emerging markets – somewhere between $1.25 and $2 trillion is coming due in 2009. Do you see a wave of corporate bankruptcies in 2009? And if so, how prepared are emerging markets to deal with this?

A:

If you look first at the U.S. as an example, going from 2007 to 2008, you see a 2.5 times increase in the number of corporate bankruptcies, which is significant. But what is staggering – if you look at only non-financial firms – you see a 1,000 percent increase in the value of assets that have gone into bankruptcy. What we thought was a financial crisis is now a real-economy crisis, certainly in the United States. That’s got to migrate, and it has certainly migrated to the developing world. So, the implication is you’ll see rising unemployment and a significant drop in productivity as this hits the real sector.

In a lot of countries, particularly in Eastern Europe, the banks couldn’t raise money in the local market sufficiently, so they went to the foreign market and raised foreign currency and passed this foreign exchange risk on to their borrowers. So now you have borrowers who have seen a significant drop in the value of their local currency, which raises their indebtedness overnight. So I think that’s exactly what we’re expecting.

Google Search Terms: A Better Way to Predict Financial Vulnerability Indicators?

Many country-level macro financial indicators such as total bank credit to the private sector are produced with a lag. Sometimes a month, but often longer.

So you can try to predict the current period's credit change by estimating a statistical model that relies on the credit increase and the credit stock of previous periods. One such simple model for Australian monthly private credit is depicted by the red line in the graph below (the actual change is in blue). As you can see, the fit of the red line is "smooth" and not very impressive.

Investor Protections and Economic Growth

A close look at equity prices around the world reveals how much they have been affected by the current financial crunch as well as by credit and market risks. Fluctuations in growth and exchange rate expectations have only enhanced their influence. Financial integration has scaled up the correlation between advanced, emerging, and (to a measurable extent) developing economies’ equity markets over the last dozen weeks, so that equity prices have been moving more closely together. However, financial integration has not been accompanied by a harmonization of investor protections and corporate governance principles.

As the policy response to the economic crisis moves from short-term solutions – corporate bailouts and economic stimulus – to longer-terms fixes like financial market regulatory reform, it becomes increasingly important that policy-makers move beyond finger-pointing. Countries with stronger investor protections tend to grow faster than those with poor protections. A recent paper, using objective measures of investor protections in 170 countries, establishes that the level of investor protection matters for cross-country differences in GDP growth. An improvement in investor protection leads to better risk sharing, which implies a larger demand for capital. This “demand” effect indicates a positive association between investor protection and growth.

Belt Tightening in Eastern Europe

Hungary just adopted measures to reduce government spending and increase taxes. The new measures cut 1.3 billion forint ($5.7 billion) off the budget and increased the VAT from 20 to 25 percent. In addition, the payroll tax on gross wages is reduced by 5%, and pensions and public sector salaries are frozen.
 
"The goal is to save jobs, and protect families and small businesses from the crisis," said the prime minister in announcing the measures.
 
Soon, every East European country will need such measures. Those who are able to cut expenditures may be able to keep their budgets from accumulating big deficits. Otherwise the last decade of growth and increased prosperity will soon be forgotten.

The U.S. as an Emerging Market?

Simon Johnson, a prolific academic writer and former Chief Economist of the IMF, has come out with a relatively negative view on the U.S. financial system, both current and past. According to Simon, the personal interlinkages between the political and financial systems in the U.S. are very similar to those in many, if not most, emerging markets. And the policy approach towards solving the financial crisis has been dominated by attempts to minimize the pain for bankers, rather than for the overall economy. The bank-by-bank approach with generous bail-outs, while avoiding more drastic actions that might risk shareholders’ equity stakes and senior manager bonuses, has not really helped so far. In order to really get out of the slump, Simon recommends more decisive action in the banking sector, including temporary nationalization and clean up of banks, but also the breaking-up of the financial oligarchy with its links to the political system.

Krugman Throws Out the Baby, Bathwater, and Fellow Economists

Nobel prize winner Paul Krugman made a big splash across European newspapers this week, criticizing Europe’s governments for being too timid in their fiscal stimulus. He seems to have forgotten that most countries in Continental Europe already have large automatic stabilizers in the form of social safety nets, automatically driving up government expenditures during times of crisis. And while the Ricardian equivalence certainly does not hold one-to-one, additional government consumption might very well be partly off-set by more private savings, at least in countries like Germany, where even nearly a century after hyperinflation, inflation fears run still high.

Some Recommendations for Dutch Banks

The Dutch banking association recently commissioned a report by an independent committee (including my Tilburg and European Banking Center colleague Sylvester Eijffinger) to draw lessons from the recent financial crisis, which hit the Dutch banking sector quite hard, and formulate recommendations. This committee just released its report. Before you reach for your Dutch-English dictionary, please be assured that the report is actually in English, reflecting the international character of the Dutch academic and financial sectors. 

Some of the recommendations do not surprise, such as better governance structures, remuneration policies that do not award large bonuses if the bank makes losses, and anticyclical capital buffers. Others I find rather difficult to achieve, such as aiming for non-financial targets including customer satisfaction (where Dutch banks have lots of room for improvement, as I can assure you from personal experience). 

Where I am getting really nervous is when too much focus is put on non-owner stakeholders' interests, including employees of banks, or rewarding shareholders who hold on to their shares for at least four years, such as individual shareholders whose shares will probably be voted by someone else through proxy votes. Delinking the ownership structure from the voting structure has rarely fostered efficient banking, as examples from many emerging markets have shown.

The Great Mark-to-Market Debate

The leaders of the Group of 20 (G20) recently called on the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) to improve financial reporting standards for calculating the market value of assets in illiquid markets. The debate over mark-to-market accounting, which is a subset of fair-value accounting, and its role in the financial crisis, made its way to Congress during the first half of March 2009. The concern is that banks will not incur the losses booked per mark-to-market accounting as asset values recover over time from today’s clearance sale prices.

The mark-to-market concept may sound trivial, especially when compared to a $787 billion rescue plan, but getting it right would be a significant step toward addressing the causes of the credit crisis. The main aim is to simplify the complexity of financial reporting and off-balance sheet financing and to make progress towards a single set of high quality global accounting standards. 

In a forthcoming paper in the Journal of Economic Policy Reform, I discuss the costs of mark-to-market valuation within the US 2009 (Bailout) Emergency Economic Stabilization Act (EESA). The paper highlights how mark-to-market valuation standards influenced financial institutions, explains why mark-to-market policy suspension proponents can support EESA, and explains how the FASB and the SEC can count on EESA while assessing the need for mark-to-market valuation policy.

Japan Tries Again

Stung by the label of a lethargic stimulator during the 1990s, Japan is competing with the US for how much money to put out now. The third stimulus package, at 150 billion dollars, is the latest of a series to come (see the BBC story).
 
The new money mostly goes into incentives to buy fuel-efficient cars and consumer electronics. As such, it is a subtle Buy Japanese package. Nothing wrong with that. Similar packages have emerged in nearly every car-producing economy. The plan also provides some extra security for temporary workers.
 
The government plans to finance it with a new issuance of bonds.

Bank Fragility in Spain

A recent article in the Economist points to the Spanish savings banks (cajas de ahorro) as cause for worry. The ownership and governance structure of these financial institutions is somewhat odd, as they are not really owned by anyone, but rather have the form of a private foundation, with a board of trustees that includes representatives of local governments, depositors and clients. 

While originally geographically restricted, many of these cajas are now active throughout Spain. These institutions have been very successful over the past years, growing their market share at the expense of the commercial banks (the largest of which looked for profits beyond Spanish borders, especially in Latin America). A recent paper found these savings banks to be less risk-loving and more stable than commercial banks in Spain. More recently, however, Spain’s savings banks started to tap wholesale funding markets to continue their expansion while commercial banks put on the brakes, which exposed the savings banks to new funding risks.

W

A new betting game has emerged - on what the shape of the eventual recovery will be. So far the candidates have been V, U, L. Enter W - and you thought you got rid of him!
 
A W-shaped recovery looks like this. An initial steep decline is followed by the Fed and the European Central Bank pumping money into the respective economies, and temporarily lifting demand, until it falls again. So for a while it looks like a V, then another prolonged collapse. So in a way it should be a combination of the letters VL. It also has another meaning - a very long recession.

Searching for Bright Spots in Trade

I have been following the decline in trade closely. The numbers for February are a disaster. Trade is down over 30 percent relative to the same month last on average across a wide range of countries (for detailed data, click to read Trade Collapses in the New Year: Update). The only consolation is that February is just slightly worse than January. 

I decided to look for some bright spots, no matter how small. Taking U.S. and Japanese import data at the 6-digit level (more than 5000 products), there are bound to be some. While over 75 percent of categories in both countries declined in February, there are indeed a handful of bright spots in important categories. 

Russian Leaders Join the Global Assets Disclosure Movement

On Monday, Russian President Dmitry Medvedev and Prime Minister Vladimir Putin published their assets and income declarations for 2008. The move was followed by the the Cabinet ministers on Tuesday. Among other officials, the Speaker of the Upper House of the Parliament, Sergey Mironov, published his declaration on April 1.

In a TV interview aired on March 24, Mr. Medvedev made disclosure a moral value. When disclosing, "every person will have to make the decision to honestly show his income and assets or to hide them”, he stated. Using his own example, the president intends to solve the debate on whether the declarations should be published. A debate, which has not been solved legislatively - Russian disclosure laws, including the big anti-corruption package of December 2008, are ambiguous about publication of declarations.

Sachs on the Latest Treasury Plan

Jeffrey Sachs apparently has no shame. In the last few years, he has made a name for himself by asking rich countries to double and triple development aid. Without answering the obvious concern: much of aid seems to be wasted (says Bill Easterly and a host of academic research), so tripling it without any reform of the aid architecture just triples the waste. But these are just details, and they have not prevented Professor Sachs from hooking up with Bono and Angelina Jolie to "raise awareness." A few years back they declared victory, only to find out recently that the total amount of official development aid has actually declined. Oh, well - off to the next big cause.

A Brave IMF

In a supposedly-leaked report, the IMF has said the best strategy for Eastern Europe in fighting the current crisis is to adopt the euro fast (see the FT article). This is an obvious point and one that some Baltic countries and Bulgaria have made for months. To the consternation of the European Central Bank (ECB), which takes the view that proper procedure should be followed and conversion to the euro shouldn't be rushed. It could in fact be delayed.
 
This is a case of bravery on the side of the IMF - and a second big hit for the institution in a week (also see this). And a case of constipated thinking on the part of ECB. The cost of early euro entry is surely a lot smaller for Europe than the eventual cost of bailouts and macro instability that is otherwise likely in Eastern Europe. So why does the ECB push this line (for now)?

Finally, Big Bankruptcy

GM is preparing for bankruptcy (see the CNN story), in case it cannot meet a June 1 deadline to reach concessions with unions and creditors. Finally.
 
US car-makers are about 70% as productive as Japanese ones - even those with plants in the United States. In a real market they would have restructured or exited some time ago. But the Big 3 have much lobbying power, and have used it to stay afloat. GM's luck may have finally run out. Who will benefit? The environment, for one.

G20 Update: Best Protestor of All?

 

(Thanks to Rob Kahn for the pointer.)

The View from Hong Kong (China)

I spent the last couple of days in Hong Kong (China), talking mainly with academics, but also with people closer to the markets. The recession (or is it already a depression?) has hit Hong Kong (China) quite hard, with exports dropping substantially. This has actually resulted in the challenge to find storage space for empty ship containers; well, as many ships idle in the port anyway, empty containers can just be left on the ships. Unemployment has increased, though still in the single digits. There has not been as much of an impact on peoples’ lives as perhaps in the U.S., as the savings rate is quite high and people can live off reserves.

One wonders, however, how long this will hold. Housing prices have already dropped by 20%, but with maximum loan-value ceilings of 70% – imposed by the regulators – this will not lead to immediate distress in the banking sector. The recipe applied so successfully after the East Asian crisis – export yourself out of the crisis – will be much harder to apply, as the target markets are certainly less willing customers this time around, which also makes a quick recovery unlikely. As In Europe, the Lehman insolvency has also left its mark in Hong Kong (China), with bearers of Lehman’s mini-bonds losing their shirt, and consumer complaints of sales techniques rising. Rather than bailing out customers, however, the Hong Kong (China) approach seems to force more transparency in the sales process, including audio-taping sales conversations. Of course, this might just lead to a migration of certain conversations towards bars and coffee shops.

IMF Gets a Deserved Boost

A big outcome of the ongoing G20 meeting is a commitment to triple the amount of money the IMF has for lending (see the BBC story), to $750 billion. This is welcome news. Of all the possible things the G20 leaders could have done, this one would ease the crisis the most.

The G20 has also committed about $250 billion to boost global trade. This one I don't get. Exactly how will this money be used? Perhaps for trade finance. If so, there is no evidence this is a real bottleneck to trade. Or, alternatively, the money could be used to buy products and thus spur demand. But what to buy? This reminds me of one of my first visits to Ukraine. I went to a heavy machinery factory and was shown a huge tank. So huge, in fact, that it couldn't leave the factory - the doors were not large enough. The manager was very proud of it nevertheless.