Crisis Talk - The World Bank Group

The Middle East Gets Down to (Insolvency) Business

Ten Middle Eastern countries have just signed a joint declaration to work on improving their insolvency regimes. Egypt, Jordan, Lebanon, Libya, Oman, West Bank and Gaza, Qatar, Saudi Arabia, Sudan, and United Arab Emirates met in Abu Dhabi earlier in the week and agreed to (excerpt):

ENCOURAGE policy makers, legislators and regulators to acknowledge the benefits of a well-functioning insolvency regime and work towards building and addressing the legal, regulatory and institutional frameworks necessary for sound insolvency regimes in the region;

ENGAGE market practitioners such as accountants, lawyers, insolvency professionals to work with policy makers to build the suitable infrastructure necessary for a sound insolvency regime--including the necessary regulatory architecture of insolvency practitioners;

STRENGTHEN the institutional framework of regulators and judiciary, and enhance their capacities necessary for effective and efficient implementation of insolvency laws;

RECOGNIZE the specific assistance being provided by the World Bank in the form of direct technical assistance to: (1) Improve insolvency legislation; (2) Build frameworks for out of court resolution of insolvency cases; and (3) Increase domestic capacity to effectively regulate insolvency practitioners all of which has the aim of, inter alia, reducing the time and cost associated with insolvency proceedings; and

ESTABLISH a Regional Forum on insolvency and creditor rights which will aim to engage, educate, and inform more stakeholders into the reform process and will serve as a platform for sharing of international and regional best practices on both policy and infrastructure areas on insolvency and creditor rights.

Managing Systemic Crises

On Tuesday the World Bank and IMF held a joint conference on Managing Systemic Crises and Redesigning Financial Systems. Check out presentations from heavyweights in the world of economics, including Luigi Zingales, Andrei Shleifer, and Daron Acemoglu.

It's also worth checking out a presentation by Charles Calomiris in which he discusses why we need macro-prudential regulation as a complement to micro-prudential discipline:

• Because of agency problems, pricing of risk on buy side is not always accurate.
• The combination of monetary policy looseness and agency problems can create incentives to ride a bubble.
• Market discipline is not enough under these circumstances; there needs to also be a belt on top of the suspenders, because of agency problems.

Time for the Tax Experts

A new report from Citigroup Global Markets (subscription required) titled Out of the Frying Pan? Fiscal Vulnerability Takes Centre Stage argues that the global financial crisis has moved into its third stage. First there was a financial vulnerability phase, in which countries with high loan/deposit ratios suffered, and this was followed by (and overlapped with) an external vulnerability phase. In this second phase, countries with high external financing needs suffered the most. Fortunately, they have been buoyed by a combination of an increased supply of finance - in large part through a ramped up IMF - and a decline in demand for external finance through improved current account balances.

The V-shaped Recovery is Out, the Rational Consumer is In

Nouriel Roubini continues his attack on the optimists, informing us that we are past the point of a V-shaped recovery:

...the optimists who in 2009 spoke of a soft landing for the U.S. economy or a mild V-shaped eight-month recession (like the U.S. ones in 1990-91 and 2001) were proved utterly wrong, while those who argued that this would be a longer and more severe U-shaped, 24-month recession were correct. In the U.S., we are already in the 18th month of a U-shaped recession; the V is out of the window.

So forget about the letter "V" and start fixating on the "U" and the "W".

10% Unemployment in the U.S. by Christmas?

So says a just-released Fed report. The drop in economic activity in 2009 could be up to 2%.

That doesn't sound alarming - most of Europe is in deeper trouble. But combined with a recent average growth of 2.5% a year, this means the output gap will be nearly 5%. Hence a longer recovery period. Americans may have also forgotten what double-digit unemployment feels like. And how long it takes to pull out of it.

Supplementing the Leverage Ratio with a Gender Ratio

The idea of a leverage ratio as a useful prudential tool has by now entered the mainstream. (See, for example, this week's Economist: "There is now impressive momentum behind the idea of a leverage ratio, a measure that puts a fixed ceiling on the total amount of assets that a bank can hold relative to its capital.") One less conventional idea could be a gender ratio. In a piece on VoxEU, Anne Sibert argues that the financial crisis was testosterone-fueled:

UK Labour cabinet member Hazel Blears suggests a second reason, commenting that, “Maybe if we had some more women in the boardrooms, we [might] not have seen as much risk-taking behaviour” (Sullivan and Jordan 2009). Indeed, the financial services industry – one in which lap dancing is apparently considered appropriate corporate entertainment (UK Equality and Human Rights Commission) – is overwhelmingly male dominated. Women hold only 17% of the corporate directorships and 2.5% of the CEO positions in the finance and insurance industries in the US (Sullivan and Jordan 2009). In Iceland – home to a particularly spectacular collapse – it is said that there was just one senior woman banker, and that she quit in 2006 (Lewis 2009). If men are especially prone to being insufficiently risk averse and overly confident, then this male dominance may have contributed to the financial crisis.

Czech Exceptionalism

The Czechs have long sought to identify themselves more with the West than the East. It looks like the financial crisis has given a boost to their claims to be exceptional. A new note from J.P. Morgan (subscription required) on the EBRD meetings reports:

The CNB [Czech National Bank] is pleased that foreign investors and the media have started to differentiate between the specifics of the Czech economy and the rest of Central and Eastern Europe. The CNB emphasized that, unlike the rest of the region, the local banking sector is a creditor to foreign banks due to the surplus of deposits over loans. Household FX borrowing is non-existent.

It's interesting to note one of the reasons behind this Czech exceptionalism - they avoided the eastern European equivalent of subprime loans in the United States. No foreign-currency denominated mortgages for the Czechs, unlike their neighbours a little further east. Smart move.

More Successful Bankruptcy Reforms During Crisis Episodes

I may have to take back what I said about crisis episodes not being optimal periods for reform of bankruptcy regimes. Leora Klapper, a senior economist at the World Bank, informs me in a short article on The Use of Bankruptcy in the Resolution of Corporate Distress that:

Importantly, systemic crisis periods are also periods of great opportunity for meaningful reform that would otherwise be stymied by powerful political interests.  Claessens et al. (2002) provide examples of such reforms from [the] East Asian financial crisis, which include the passage of improved bankruptcy laws in South Korea, Thailand and Malaysia, and the formation of specialized bankruptcy courts in Indonesia and Thailand.  Another example of a successful reform comes from Colombian bankruptcy reform introduced in the midst of a major financial crisis in late 1999. Gine and Love (2008) show that the reform significantly improved the efficiency of the bankruptcy process by streamlining reorganization proceedings.

Quantitative Easing: Do Actions Speak Louder than Words?

The IMF provides some cautionary advice on quantitative easing to emerging market policy makers in a recent position note, Coping with the Crisis: Policy Options for Emerging Market Countries:

Quantitative easing (QE): The central bank expands its balance sheet by purchasing assets such as longer maturity government bonds. QE seems less appropriate for EMEs [Emerging Market Economies], where deflationary expectations are unlikely to be present (and even in advanced countries, evidence on its effectiveness is limited). If anything, there is a risk that markets misinterpret QE as a return to inflationary policies—particularly if there is little commercial paper and QE takes the form of purchases of government securities. Therefore, except in extreme situations (e.g., the policy rate is already set to zero), QE should only be attempted by countries with a history of low inflation and macroeconomic stability, with central bank independence and credibility.

I suspect the IMF will have to be a little more vocal on this one if it wants to be heard, though. Actions speak louder than words, and the actions of the U.S. Federal Reserve in buying up $1.2 trillion of government debt and mortgage-related securities could very well be deafening.

Bankruptcy Reform: Better Late than Never

Recently, Simeon pointed out the need for a good bankruptcy regime as part of the crisis response: "No matter how successful fiscal stimulus packages and other crisis response measures might be, there will soon be a flow of corporate bankruptcies." Unfortunately, reforms of this magnitude take time to implement, so governments end up resorting to more interventionist measures (as Simeon points out in his post). New research suggests that it's not impossible to reform in the midst of crisis, though.

Writing in the Finance & PSD Impact newsletter, Xavier Gine and Inessa Love report that Colombia managed to carry out a successful reform of its bankruptcy code in late 1999:

CEPR on Trade Policy in the Crisis

In the wake of the financial crisis, export credit is scarce. While comprehensive data is not available, it stands to reason that, when banks worldwide are shrinking their balance sheets to ensure their own survival, the financial system would be less willing to extend new export credits. Marc Auboin reports a financing gap of around $25 billion, based on the main Wall Street banks, and spreads of 300 to 600 basis points over Libor, contrasted with normal spreads of around 30 basis points (Auboin 2009 and Canuto 2009).

That statement comes from a recent policy paper from the Centre for Economic Policy Research on Trade Policy in a Time of Crisis. The authors recommend subsidies for trade finance to support the export sector in developing countries. One question for the authors: Of course the spreads on trade finance have widened (just like on almost every other kind of finance) - isn't the relevant issue whether the spreads on trade finance have widened more than other spreads?  

Two Views on the Prospects for Recovery in Eastern Europe

The IMF's recent Regional Economic Outlook for Europe has a less than sanguine view of the prospects for recovery in eastern Europe. The report contains a graph (pictured below) that estimates the likelihood of various regions emerging from the crisis, based primarily on the extent of external debt and deficits. Europe is a pretty clear outlier:

Europe Divided

It looks like the IMF will have its work cut out for it in eastern Europe:

The European Central Bank has rejected pleas from central and eastern European states for it to use its firepower to boost euro liquidity in the region’s beleaguered banking system, Emerging Markets can reveal.

Non-eurozone central banks in eastern Europe had aggressively lobbied the ECB in recent months, to accept their local currency-denominated sovereign bonds as eligible securities in ECB refinancing operations with parent banks operating in the region.

But central banks in Poland, Hungary and the Czech Republic – the most vocal of lobbyists on this issue – yesterday received letters from ECB president Jean-Claude Trichet informing them he had rejected their calls, people familiar with the matter said.

Perhaps we should go back to capitalizing "eastern" in "Eastern Europe"? 

In the Alphabet Soup

Speculation abounds as to what letter or symbol best characterizes the shape the crisis is taking. A V -- steep down and equally steep climb back -- is dismissed by most as wishful thinking.  A U -- quick drop, indeterminate period of leveling off, followed by a recovery -- remains a hoped for possibility.  A  W -- down, up, then down and maybe up again -- is a dismal prospect.  The pessimists foresee an L; i.e., down and then stagnation as far as the eye can see. On Wednesday the Financial Post of Canada offered the hook -- a precipitous downward slide, followed by a curve back up, but never getting to the height of the starting point.  Having read all this speculation, herewith my symbolic offering: ?.

The IMF Blows One

Apparently, in the zeal to show just how bad the situation in eastern Europe is, the IMF exaggerated the external financing needs of a few countries "due to typographical errors." See a polite Reuters report on this story. Also see a less-polite Financial Times story.

After the numbers for some countries were challenged by central bankers, analysts and journalists, the IMF revised the data and began publishing new figures for the external debt/reserve ratios of some eastern European countries. The ratio for the Czech Republic was cut from 236 per cent to 89 per cent and Estonia’s was reduced to 132 per cent from 210 per cent. It is understood that the figure for Ukraine is also being cut to 116 per cent from 208 per cent, that Lithuania’s ratio of 425 per cent may also be recalculated and that others may follow.

The IMF said on Wednesday it would verify its numbers and publish correct figures on its website as soon as they were available. “We regret any confusion that may have arisen as a result of our publication of erroneous figures.”

Micronesia Disclosure Bill Vetoed: How to Overcome Concerns about Separation of Powers and Privacy?

We have recently witnessed how the financial crisis has prompted the extension of disclosure requirements for government officials and corporate executives in Russia, China and Hong Kong (China). My prognosis was that more and more disclosure was coming up.
 
However, no wave comes without a retreat. On April 27, the President of Micronesia cited infringement of the separation of powers and of privacy in vetoing the disclosure bill, passed by the country’s Congress a month earlier. The bill required public disclosure of assets, income and business interests by holders of the country’s top political offices, such as the President, Vice-president, members of the Congress, ministers, Chief Justice of the Supreme Court, Public Auditor and members of the board of directors of the Development Bank of Micronesia. The disclosure requirements also covered immediate family members of officials. The administration of disclosure was to be vested with the country’s election authority. 

What Christy Romer Says

If you want to know the latest "party line" on the crisis in the United States, read Christina Romer's testimony from last week. The summary forecast is as follows:

We currently expect that the pace of the overall decline in the economy to moderate sharply over the next several months. This is consistent with the Blue Chip consensus forecast, which shows a rate of decline of GDP of 2.1% in the second quarter. We expect the economy to level out in the second half of the year and then begin to recover. Whether the recovery begins later this year, as most private forecasters predict, or takes a bit longer is hard to know. Because labor market indicators tend to lag changes in output, most likely we will see positive GDP growth before we see increases in employment and declines in the unemployment rate.

Bosnia: The Latest IMF Client

Bosnia just announced a $1.6 billion package from the Fund. Who is next?

Needed Urgently: Good Bankruptcy

As the crisis unfolds, the need for a good bankruptcy regime is starting to dawn on policymakers. No matter how successful fiscal stimulus packages and other crisis response measures might be, there will soon be a flow of corporate bankruptcies. Previous crises show that such bankruptcies lag behind the start of a crisis by a year or two. As demand falls, businesses try to cut expenses, restructure payments, renegotiate with suppliers. Ultimately, many live on. But some fail.

For these, it is useful to have an efficient bankruptcy regime so creditors do not have to write off the whole value of the loan. But bankruptcy is never a popular reform, and governments typically get to it when the courts are already clogged with insolvency cases. By the time a reform is completed, more interventionist options (for example, the use of asset-management companies) are needed.

A recent survey of previous experience in bankruptcy reform suggests a menu of possible reform choices while in crisis. The analysis is to a large extent based on the data from the Doing Business project, and its section on Closing a Business.

Here we present the section on dealing with systemic distress:

Hedging the Fund II: The IMF as Policeman or Social Worker?

This is the second post on views presented at an April conference on “New Ideas in Development After the Financial Crisis,” sponsored by the Center for Global Development and the School of Advanced International Studies. The first post summarized a speech by Dominique Strauss-Kahn, Managing Director of the IMF. Here I deal with other ideas put forward on how the IMF should change and function.

Sebastian Mallaby, Director of the impressively named Center for Geoeconomic Studies at the Council on Foreign Relations, strongly supported the resurgence of the IMF. But what he envisions is IMF 2.0, or perhaps 3.0, considerably altered from its previous state. His take: In reaction to the crises of the late 1990s, and ensuing IMF conditionality, developing countries have accumulated massive U.S. dollar balances to self-insure against the next crisis. The present situation exacerbates the trend. But these reserves failed to provide security either to the holders, or to the United States (or the world economy), not despite but precisely because many of these dollars were parked in U.S. debt instruments. (I assume he means that this promoted the “there is too a free lunch” mentality.) While acknowledging the significance of unfettered greed and regulatory failure, Mr. Mallaby views the existence of the reserves, and the way they were managed (or mis-managed), as contributing greatly to the present meltdown.

Buiter on Emerging Markets

Willem Buiter is among the foremost European monetary economists who is providing commentary on the unfolding crisis. (Charles Goodhart and Martin Hellwig round up the top-3). Here is what Buiter wrote recently on his blog:

The prospects of the emerging markets depend:

• First, on their dependence on external demand
• Second, on their dependence on external finance and,
• Third, on the scope for expansionary domestic demand management and the ability of the authorities to use it intelligently and flexibly.

The Slowing Second Derivative

Larry Summers allegedly was heard saying: "I am happy to see the slowdown in the second derivative." I hope this wasn't at a cocktail party, since the remark would have flown over most people's heads.
 
The point is that some recent data show that although it's still falling, demand for many goods and services in the United States is falling less than earlier in the year. Which can be interpreted as "the worst is over," assuming some sort of a V or U recovery, as opposed to a W or an L recovery (see my previous post on the shape of the recovery).
 
I wouldn't be so optimistic. Perhaps we are seeing a plateau in the crisis. How long it is going to hold is a third-derivative question.

Hedging the Fund

On 04.23.09 I attended the second day of a conference here in Washington on “New Ideas in Development After the Financial Crisis,” jointly presented by the Center for Global Development and the School of Advanced International Studies.  A number of the economic illuminati spoke:  e.g., Dominique Strauss-Kahn, Kemal Dervis, Sebastian Mallaby, Santiago Levy, Jose-Antonio Ocampo, Benno Ndulu, Justin Lin and others. 

In this first of two blog posts, I report on the presentation of the Fund’s Managing Director, dealing both with his views on the crisis and how the IMF has changed - and should further evolve - to deal with it.  The second will recount the views of other presenters on what the crisis means for the international financial institutions in general, and the Fund in particular.

What a difference a crisis makes!  Eighteen months ago the IMF was on the ropes.  A highly critical clientele had repaid the bulk of outstanding loans, resources were dwindling, staff were demoralized and diminishing, and there was not much of a purpose in sight.  Today, said Mr. Strauss-Kahn, the need for and relevance of the IMF was “manifest.”  Why?  Because the crisis has shown that “the links between the financial sector and the real economy are deeper” than had been thought, and that “global financial interactions” were both more prevalent and important than foreseen.  The IMF, with its capacity to quickly help poor countries deal with a sudden loss of crucial capital inflows, and middle and high income countries (e.g., Poland, Iceland, Ukraine) cope with crisis and financial collapse, is very much back in business.  Mr. Strauss-Kahn did his commendable best to deplore the dreadful circumstances leading to the Fund’s revival, but I thought I detected the tiniest hint of satisfaction - the IMF is definitely not going under on his watch.

Where Economic Freedom is Still in Fashion

In the East and South. With the advent of the economic crisis, Western pundits have immediately jumped on the "capitalism is dead" story. Things French are in fashion - and not only French kissing.
 
Yet in Eastern Europe, where I have travelled extensively over the past few months, the opposite is true. Policymakers are even more determined to divest the state from the remaining state-owned enterprises, the remaining subsidies to inefficient sectors. No one is talking about the death of capitalism, and certainly no one is talking about state ownership of banks. According to Arvind Subramanian, the same sentiment is prevalent in India and China.
 
Why is that? First, because only a decade ago Eastern Europe underwent a big "adjustment," and in many countries this was blamed on the corruption and incapacity of state-owned institutions. This changed society in two ways: the average citizen considers herself a freemarketeer in economics issues, and a new class of politicians came about, espousing free markets.