Influential Belgian economist Paul de Grauwe argues in a Vox piece that ECB should be buying Irish and other high-yield eurozone sovereign bonds in the secondary market to correct what he describes as “panic” pricing. I think he’s got a point and it would certainly help stabilize expectations about fiscal prospects here and in those other countries.
It’s certainly no more radical than actions currently being taken by the Fed to stabilize their markets. A promising idea?
A report in this morning’s Sunday Independent flies the kite for a new State Agency to invest equity in private companies. Inevitably, this will remind some of Foir Teoranta, a state agency which was officieally described as a lender-of-last-resort to private companies in the 1970s and 1980s.
Founded in 1972, Foir Teoranta’s stated objective was “to provide reconstruction finance for potentially viable industrial concerns which are unable to raise capital from the normal commercial sources.”
I’m not aware of a systematic analysis of Foir Teo’s effectiveness in that period. Maybe readers can remember more. But my impression is that, on its dissolution in 1991, it was not widely regarded as having been a brilliant success.
So what would make a new company of this type successful? The Indo’s article confirms that it would be well-managed, so that’s all right. But what else? The intended emphasis is said to be on equity, rather than debt (which was Foir’s main instrument). But is that a strength or a weakness in the current climate? How would it complement the European Investment Bank’s EIF, which seems to be in the same territory?
Would it be better to think in terms of a partial credit guarantee scheme instead? After all, if the banks are to receive huge injections of government capital, should one not be thinking of them as a natural source of finance to keep viable firms going? Partial credit guarantee schemes have been the policy instrument of choice for governments wishing to expand credit to small and medium enterprises, and there is an astonishing number of such schemes around the world. However here too there are severe risks; my recent review of these schemes emphasizes the drawbacks and the need for careful scheme design, if damage is to be avoided.
Much of the recent comment on this blog has understandably focused on the specifically Irish angles in saving the banks and getting credit flowing again, getting on top of the government deficit and improving competitiveness. But any progress towards these goals in a purely Irish context will be set at naught if the global economy continues to head south. We thus have a vital interest in the success of the various stimulus packages intended to reverse, or at least reduce, the slide into global recession.
The IMF’s most recent World Economic Outlook update (published January 28th last) presented its third downward revision of its economic forecasts in just four months. It now projects global growth of just ½ per cent in 2009, with advanced economies expected to suffer their deepest recession since World War II. Collectively, advanced economies are expected to contract by 2 per cent in 2009 – the first annual contraction in the post-war period.
Should the NPRF be used for bank recapitalisation?
I have always thought the fund a good idea. It helped increase national saving by reducing measured budget surpluses. (These surpluses would have been difficult to sustain politically.) And I believed it would make pension benefits more secure in the face of a rising tax cost as the population ages. Along with many others, I thought the fund only a good idea if investment decisions were not politicized. That seems almost quaint.
I now think it serves another purpose that I simply did not appreciate. Others were more prescient. It provides a valuable bulwark against the tail risk of a real “run-on-the-country” kind of crisis (that includes both bank and government debt). The risk is nicely captured by Larry Summers in his 2000 Richard Ely lecture on international crises. As he says, in this kind crisis the mode of investment analysis shifts from “economics to hydraulics.” Fundamentals become irrelevant as everyone tries to get their money out before everybody else.
The existence of a large and relatively liquid NPRF makes falling into such a bad equilibrium less likely. I therefore think the Government should be slow to commit a large chunk of the fund to bank recapitalization. My sense is that it would be better to borrow the funds, notwithstanding the recently increased spread. Having a substantial liquid sum on the asset side of the government’s balance is valuable insurance in perilous times.
I’ve written here before about my puzzlement over the widespread international enthusiasm for “bad bank” proposals and I haven’t changed my mind since.
A more attractive proposal, which is getting less attention, is the idea of establishing new banks. It could be argued that this directly addresses the problems being created by the weak capitalization of the international banking system, without the extreme moral hazard problem associated with TARP-style over-paying for bad assets. The financial intermediation function performed by banks is crucial to the efficient functioning of the economy and, for a number of reasons, undercapitalized banks do not perform this function well. Understanding this, the approach of govenments everywhere has been to use taxpayers money to prop up undercapitalized banks. But while banks play a crucial role that doesn’t mean that we necessarily need the current set of banks to perform this role.
Kevin already posted a link to Willem Buiter proposing something like this but the idea is now being given wider prominence. Here for instance is a nice clearly-written piece from today’s Wall Street Journal by Stanford’s Paul Romer. An important benefit of this type of plan, as Romer notes, is that it seems more likely to attract additional private sector equity capital relative to the various plans to attract new investors for existing banks with failed management and murky balance sheets. Indeed, I first read about the idea of new banks in this 2009 predictions piece from celebrity uber-bear bank analyst Meredith Whitney and she was focusing purely on the private sector opportunities. She said: “I think you’ll see more new banks created. We’ve already seen more applications. And it’s a great idea: You start with a clean balance sheet and make loans today with today’s information. Plus, right now you’ve got a yield curve that’s good for lending.”
Skeptics could point out that these new banks will lack the branch network or knowledge capital of existing banks. However, branch networks could be purchased pretty cheaply these days and the newly-minted banks could be attractive places for those bankers with good track records to work. Perhaps the best argument against this idea is the time lags involved in getting new banks set up. But the problems in the international banking system seem likely to be with us for some time so useful long-term solutions may be called for.
No doubt I’m being wide-eyed and innocent here. Perhaps our trusty band of loyal commenters can give me a word to the wise.