Category: Banking Crisis

Krugman and Layard on a manifesto for economic sense

Paul Krugman and Richard Layard put forward a case for a coherent and evidence based approach to the crisis. Essentially they argue that a strategy of focusing on the reduction of public debt levels exclusively in order to regain market confidence makes no sense, and has been falsified empirically. They also argue that structural imbalances shouldn’t prevent the use of discretionary fiscal policy for stabilization purposes when it is available.

This chart of the drop in domestic demand from the recent Nevin Institute quarterly report (page 4) is particularly striking as a motivating factor in discussing Krugman and Layard’s piece.

Final Domestic Demand

Krugman and Layard have a manifesto you can sign up to (I did).

There are lots of things in this piece I agree with, but two big ones are:

1. Placing the blame for the crisis at governments’ feet makes no sense. The crisis didn’t start in the public finances, it began in the private sector(s).
2. The confidence argument and its attendant strategy is completely wrong headed at this juncture, Ireland in particular shouldn’t be held up by anyone as the role model for austerity, either in the 1980s or today.

There are also aspects I don’t see as pertinent to the Irish case.

Krugman and Layard write:

A second argument against expanding demand is that output is in fact constrained on the supply side – by structural imbalances. If this theory were right, however, at least some parts of our economies ought to be at full stretch, and so should some occupations.

But in Ireland, in the IT sector for example, and especially in really high end tech jobs like online video gaming and such, they can’t get people. (Obviously in other sectors like services and construction their argument holds.) There are other examples but I think in a small open economy like Ireland this argument isn’t that important.

The key question from an Irish point of view is: to what extent is the Krugman-Layard prescription possible in a country with so little fiscal room for maneuver? Translating the argument down a bit, if Ireland is somewhere between Greece and Spain in terms of it’s problems, even if Enda Kenny et al bought the Krugman/Layard prescription lock stock and two smoking barrels, given where we are right now, are our options severely limited in any event? I’d welcome your thoughts on this.

Call for papers – conference on bank resolution mechanisms, Spring 2013

Call for Papers

Bank Resolution Mechanisms

A joint academic-practitioner conference with the theme Bank Resolution Mechanisms wil be held in Dublin, Ireland on Thursday May 23rd, 2013, organized by the Financial Mathematics and Computation Cluster (FMCC) at University College, Dublin and the Department of Economics, Finance & Accounting at National University of Ireland Maynooth.

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Depfa Bank collapse and the Irish taxpayer

There seems to be almost unanimous agreement within the Irish media that had the IFSC-based Depfa Bank not been bought by another German bank just before its collapse at the beginning of the financial crisis, the bill would have landed on the Irish taxpayer. Dan O’Brien repeats this view in an article in the Irish Times on Saturday.

I am not sure that the issue is as clearcut as is supposed. Willem Buiter (pages 9-11) suggests that we are in uncharted territory in these matters.

Extension Needed on the Irish Banks Liquidity Target Date

In early 2009, the Irish domestic banks had three critical problems: insolvency, distress, and a liquidity crisis.  Only one of these problems, the liquidity crisis, was solved successfully at an acceptable cost, via ECB liquidity provision.  This massive liquidity provision was one key motivation for the Financial Measures Programme (FMP), which lays out a plan the banks must follow to become liquidity self-financing.  Now, through no fault of the Irish banks but because of the continuing financial crisis, the liquidity target plan in the FMP is looking much too optimistic and needs some adjustment. 

  • 1. The loan-to-deposits target date should be changed from 2013 to (end-of) 2015.
  • 2. The ECB should make clear that their liquidity assistance to Irish banks is for a longer period than originally envisioned.

Without these adjustments, the Irish domestic banks will be incentivised to continue to starve the domestic economy of credit over the next few years.

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Cocos for European Banks

Everyone agrees on the need for big changes to bank resolution mechanisms both in Europe and in the USA. The problems with bank resolution differ in Europe and the USA, and the appropriate solutions differ too. Coco bonds make great sense for the Eurozone but are less appropriate for the USA. European regulators need to think for themselves on cocos, not just ape the muted response of US regulators. Contingent convertible (coco) bank bonds have a trigger point (such as a minimum equity/asset ratio) which when reached immediately forces a conversion of the liability from a debt to an equity claim. So when the bank gets into trouble, junior-grade debt liabilities immediately disappear and are replaced by diluted equity. Coco bank bonds are a very partial solution (at best) to the TBTF bank resolution problem in the USA. For all but the very biggest banks, the harsh and effective resolution system in the USA can close and re-open troubled banks very quickly. This type of super-fast bank resolution will never happen in the fragmented multi-national banking system of the Eurozone. Also, the technical competence of bank oversight in the USA will never be matched across all seventeen countries of the Eurozone, some of whom have long histories of weak and ineffective bank regulation. Cocos can partly substitute for weak regulatory oversight by encouraging greater market discipline emanating from bank bondholders.  Cocos would fit well into the design of a politically-feasible banking union for the Eurozone. 

If the euro survives, some type of contingent convertibility for bank debts in the Eurozone is likely to be part of the new banking system.  Ireland as a small economy in the Eurozone would particularly benefit from a coco feature imposed on bank bonds, and should encourage this regulatory policy innovation.