Mark Sadowski on bank bailouts and repayment

Mark Sadowski left the following comment:

6) Financial Sector Bailout Costs to Government.

The best source for data on this is the IMF Fiscal Monitor. See Table 1.6 on Page 9:

http://www.imf.org/external/pubs/ft/fm/2014/01/pdf/fm1401.pdf

Another source of data is Eurostat:

http://epp.eurostat.ec.europa.eu/portal/page/portal/government_finance_statistics/excessive_deficit/supplementary_tables_financial_turmoil

The following is a list of countries’ financial sector bailout cost as a percent of GDP and the proportion that has been paid back (percent). All data comes from the IMF except for the data for Portugal and Denmark which comes from Eurostat.

Country-Cost-PaidBack
U.S.””””4.5-106.7
Germany-12.5″”15.2
U.K.””-10.3″”20.4
Spain””-7.7″”40.3
Nether.-18.7″”75.9
Belgium””7.5″”42.7
Greece””30.9″”22.0
Portugal-10.7″”-0.7
Denmark””6.0″”41.7
Ireland-40.1″”17.2
Slovenia-12.0″”-0.0
Cyprus””10.9″”-0.0

Note that the cost of the U.S. bailout of the financial sector was far less than Germany, the U.K. or the peripheral members of the Euro Area. Moreover the U.S. bailouts have been paid back with interest, whereas apart from the Netherlands none of the E.U. members have recovered more than half of the cost of bailing out their respective financial sectors. This to me is evidence that the U.S. financial sector has probably fully recovered, whereas the various troubled European financial sectors almost certainly have not.

One last point, and I think this is very important. Note that although the UK financial sector has performed very poorly, recall that in terms of NGDP growth, the UK has outperformed nearly all of the countries in the Euro Area. So a poor performing financial sector is not at all as pivotal as Tony Yates seems to think. So once again I think the causality goes from NGDP to the financial sector and not the other way around.

I’m no expert in this area, so I’d appreciate any comments that might explain the surprising figures, such as the fact that Greek and Spanish banks have repaid more of their bailout costs than German banks.  Did fiscal transfers help the Greek banks?  Also, does this undercut the argument that the US banking crisis was the cause of the global recession? (An argument I always found unpersuasive.)

PS.  Very sorry to hear about Gary Becker.  He was the most brilliant teacher I ever had.  And perhaps the most influential microeconomist of the past 50 years.


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75 Responses to “Mark Sadowski on bank bailouts and repayment”

  1. Gravatar of Jon Jon
    4. May 2014 at 10:52

    Subprime brought down Lehman sure but it was largely European banks that were driving the frenzied buying of US subprime to begin with. This was largely due to regulatory arbitrage in Europe from their obsession with basil II–those European banks were able to hold low to zero capital against the subprime assets by using derivatives contracts with (principally) AIG to insure against loss.

    Meanwhile us thrift supervision kept a simple leverage ratio rule in addition to basil. Thus subprime was largely a nonstory and us bank failures only came later after tight money cratered even prime loans.

    Too many people used the us crisis as a vehicle for advancing their political goals.

  2. Gravatar of ssumner ssumner
    4. May 2014 at 11:01

    Thanks Jon, I completely agree about the US.

    Question about Europe: If they had AIG derivatives as insurance, does that mean US subprime was not the major cause of European banking distress? Or was the insurance only partial?

  3. Gravatar of Kevin Erdmann Kevin Erdmann
    4. May 2014 at 11:02

    I wish the terminology was different. Bank balance sheets are loaded with mortgages, which were doing ok as real estate prices settled down, until 2008, when the Fed totally botched the money supply and caused massive impairments in those assets. Then the Fed loaned banks capital that was paid back, with interest.

    Call GM a bailout. But, for the most part, the Fed’s interaction with the banks seems to me to approximate punching them in the eye, and then handing them a cold steak to hold against it until the swelling stopped. The bailout terminology feeds populist antipathy towards finance, but it’s so entrenched that it’s hard not to use it.

  4. Gravatar of Kevin Erdmann Kevin Erdmann
    4. May 2014 at 11:12

    Jon, interesting. This is what is so infuriating to me about the public love affair with regulations. These problems simply wouldn’t exist if banks had private deposit insurance. These regulatory arbitrage opportunities would be eliminated by market discipline among insurers. TBTF would be a non-issue also, as no private insurer would be willing to take on that much risk.

    But it’s like when Milton Friedman suggested to Phil Donahue in the late 1970’s that we should get rid of interstate trucking regulations, and Donahue reacted as if trucks would suddenly start driving into ditches and bursting into flames.

    The totality of these banking regulations surely is a net cost to society. Is there any time in US history where we look back and say something like, “Aren’t we lucky that we protected ourselves with unit banking?” But, public sentiment is just on a whole other planet with regard to this stuff.

  5. Gravatar of Kevin Erdmann Kevin Erdmann
    4. May 2014 at 11:14

    And, I suppose, GM was more of a taking than a bailout, so even there, the terminology might be off.

  6. Gravatar of Vivian Darkbloom Vivian Darkbloom
    4. May 2014 at 11:19

    I’m not sure why the extent of government bailouts and eventual loan repayments should be the measure of the extent of the banking crisis or the effect that crisis had, if any, in causing the recession.

    More important would be the number of banks that went bankrupt, avoided bankruptcy through acquisition and the loss of market value of the entire sector and the effect this had on lending and consumer confidence. A number of significant US banks would have gone bankrupt or would have needed a government bailout had they not been acquired (voluntarily or through government “nudging”) by other banks:

    http://en.wikipedia.org/wiki/List_of_banks_acquired_or_bankrupted_during_the_Great_Recession

    That’s not to say that the Great Recession was caused by a banking crisis, but the bailout amounts and repayment amounts are at best a very incomplete metric.

    As for the repayment percentage, did other countries force solvent banks to accept government loans as the US Treasury did?

  7. Gravatar of Mark A. Sadowski Mark A. Sadowski
    4. May 2014 at 12:20

    Scott,
    “I’m no expert in this area, so I’d appreciate any comments that might explain the surprising figures, such as the fact that Greek and Spanish banks have repaid more of their bailout costs than German banks. Did fiscal transfers help the Greek banks?”

    This was item six in a list of metrics that I researched out of my desire to understand why Europeans are so obsessed with banking crises when Americans seem to have moved on to other issues.

    The bailout list astonished me as well, as you rarely hear much in the press about the apparently horrible condition of the German financial sector. In fact if you look at the Eurostat data you’ll see that the cost of bailing out German banks peaked at 305 billion euro in 2010, and this is significantly more than the entire financial sector bailout cost of the rest of the Euro Area combined.

    However, I found the following in the NYT for example:

    http://www.nytimes.com/2013/08/10/business/global/in-germany-little-appetite-to-change-troubled-banking-system.html

    August 9, 2013

    In Germany, Little Appetite to Change Troubled Banks
    By JACK EWING

    “FRANKFURT “” One of the most battered banking systems in Europe has a history of mismanagement, corruption and politically connected lending, and it has cost taxpayers hundreds of billions of euros.

    Is it Italy, Spain or perhaps Greece? No. That description is of Germany’s banking sector.

    While the country’s economy is often held up as a model, German banks are among Europe’s most troubled. They required a bailout bigger than the one American banks received, and many are still struggling to recover…”

    In fact this lack of attention seems to be an important factor. The situation is not really being dealt with constructively and instead it is being allowed to fester. It also puts a different spin on why Germany put the brakes on a Euro Area banking union: apparently they don’t want the poor management of their banks to come under closer Euro Area regulatory scrutiny.

    So much for German efficiency.

  8. Gravatar of benjamin cole benjamin cole
    4. May 2014 at 16:36

    The amazing Mark Sadowski.
    Compared to national defense, fixing up banks was pennies to Benjamin Franklins, in terms of costs to US taxpayers. In a sense, it is an unimportant issue—if the central bank can keep NGDP growing.
    I wonder if issues such as unemployment comp, VA “disability” programs, rural subsidies and defense spending are many times bigger drags on real output than whether or not banks get bailed out…..

  9. Gravatar of PeterP PeterP
    4. May 2014 at 16:46

    Wrong premise. The government is the issuer of money – it doesn’t experience “cost” like the rest of us, users of the currency. It doesn’t make sense to cheer the fact that the government got more money back than it out in – sucking money out of the private sector is bad for output, every time. You only cheer surpluses if there is raging inflation, not the case now.

  10. Gravatar of Jon Jon
    4. May 2014 at 17:41

    Scott,

    The AIG derivatives were only ~400B and the bailout of AIG by the Fed largely kept those guarantees in place. http://www.businessweek.com/stories/2008-10-15/how-aigs-credit-loophole-squeezed-europes-banks

    This created pressure on European bank’s capital, but the death blow was probably related to bad bets that Europe was converging.

    http://www.stern.nyu.edu/cons/groups/content/documents/webasset/con_039370.pdf

  11. Gravatar of Major_Freedom Major_Freedom
    4. May 2014 at 18:16

    “One last point, and I think this is very important. Note that although the UK financial sector has performed very poorly, recall that in terms of NGDP growth, the UK has outperformed nearly all of the countries in the Euro Area. So a poor performing financial sector is not at all as pivotal as Tony Yates seems to think. So once again I think the causality goes from NGDP to the financial sector and not the other way around.”

    These figures are consistent with the theory that higher inflation prevents corrections from taking place, which results in “poorly performing” economies.

  12. Gravatar of MichaelM MichaelM
    4. May 2014 at 20:49

    I think the performance of the US banking sector is no real surprise. After all, once the Fed reversed course and started expanding like an overblown balloon the first things it was buying were mortgage backed assets. The Fed has dramatically expanded its balance sheet with assets it bought off of US banks (amongst other customers).

    In other words, the difference between the US and the Eurozone is the monetary authority in the former has been doing its job and the monetary authority in the latter hasn’t.

  13. Gravatar of Ralph Musgrave Ralph Musgrave
    4. May 2014 at 21:49

    Slightly off topic, but there’s a very easy way to eliminate all bank subsidies and sudden bank failures (something that Dodd-Frank, the Basel lot, etc have spectacularly failed to do). It’s to implement full reserve banking.

    Under the latter system, long term loans cannot be funded from liabilities fixed in dollar terms (e.g. retail deposits). I.e. depositors have two options. 1, if they want 100% safety, they lodge money in entities which DO NOT lend on the money in any faintly risky way: i.e. the money is just lodged at the central bank, or possibly invested in short term government debt.

    2. Where people want a significant rate of interest, they invest in mutual funds (which can lend on the money), but investors, not taxpayers carry the risk if silly loans are made. And where silly loans ARE MADE, the lending entity does not collapse: all that happens is that the value of investors’ stake in the entity falls in value (e.g. the mutual fund units fall in value).

    Hey presto: no more sudden bank failures or bank subsidies of any sort.

  14. Gravatar of Major_Freedom Major_Freedom
    5. May 2014 at 00:10

    Ralph:

    That would definitely solve the problem of bank failures caused by “bank runs.”

    In fact, the Fed paying interest on reserves (IOR) is a policy that has the effect of raising the reserve ratio closer to 100%, and yet, tragically, because Sumner’s attention is on “spending”, he wants to eliminate IOR, because he wrongly thinks that bank panics happen because of inadequate “spending”, rather than the other way around.

  15. Gravatar of Ralph Musgrave Ralph Musgrave
    5. May 2014 at 02:07

    Major Freedom,

    I suggest the dramatic rise in reserves is down to QE rather than IOR. I’ve actually no objection to stopping IOR. In fact I favor going even further, that is I favor the system advocated by Milton Friedman in his 1948 paper “A Monetary and Fiscal Framework for Economic Stability”. That involved the government / central bank machine issuing no interest yielding liabilities at all. I.e. the “machine” issues no interest yielding debt: just base money.

    Warren Mosler advocated the same in this Huffington article (2nd last para):

    http://www.huffingtonpost.com/warren-mosler/proposals-for-the-banking_b_432105.html

  16. Gravatar of ssumner ssumner
    5. May 2014 at 04:51

    Kevin, Good points.

    Vivian, Do you know how those other metrics compare between the US and Europe?

    Mark, Thanks for that information about Germany. My impression is that all countries are flawed, it’s just a question of how badly. Germany is good at doing some things and not others. And in some cases (like labor markets) they have sound policies at some points in time and not others.

    Peter, Not sure who you are referring to. Who “cheered” the bailouts?

    Thanks for the info Jon.

    Michael, I agree that monetary policy is the key difference.

    Ralph, I tend to agree that Federally insured deposits should only be invested in risk-free activities (reserves, T-bills, etc.) Unfortunately the banks are too politically powerful.

  17. Gravatar of Ralph Musgrave Ralph Musgrave
    5. May 2014 at 05:02

    Scott,

    Thanks for your support, but you’re giving in before the first shot is fired. Please devote a little space on your blog to making insulting remarks about banks. E.g. J.P.Morgan were recently finded $20bn, making them much the biggest criminal organisation in the US. And Tony Blair works for them which proves they’re a criminal organisation…:-)

  18. Gravatar of TravisV TravisV
    5. May 2014 at 05:36

    It’s a little frustrating to see Warren Buffett praise Tim Geithner’s new book…….

    “Stress Test: Reflections on Financial Crises.”

    “This is Tim Geithner’s forthcoming book. It’s about the crisis, and Buffett says it’s a must-read for anyone in management.”

    http://www.businessinsider.com/gates-munger-buffett-reading-list-2014-5#!INTxT

  19. Gravatar of TravisV TravisV
    5. May 2014 at 05:39

    Huh?!?!?!?!?!?!?!?!?!?!?!

    “EU Expects Recovery to Lower Unemployment Faster”

    “The ongoing economic recovery across Europe should help unemployment fall faster than previously expected, according to a new EU forecast released Monday.”

    http://abcnews.go.com/International/wireStory/eu-expects-recovery-lower-unemployment-faster-23586412

  20. Gravatar of TravisV TravisV
    5. May 2014 at 05:46

    Michael Sankowski attacks Tyler Cowen:

    “You can then honestly try to engage the idea. But that is not what Cowen is doing at all – he’s going out of his way to create a smokescreen of possible ways Piketty could be wrong, going out of his way to link to possible problems with Piketty – every possible problem without much regard for the quality of the critique.

    I really hope this starts to get people thinking about what Tyler Cowen is doing as a blogger, because is certainly isn’t trying to find out the truth and help people understand the world better.”

    http://monetaryrealism.com/tyler-cowen-always-trying-to-obscure-the-issues

  21. Gravatar of Morgan Warstler Morgan Warstler
    5. May 2014 at 06:09

    Tyler responded on twitter… this was his first volley, his positive effort:

    http://www.nytimes.com/2013/07/21/business/wealth-taxes-a-future-battleground.html?_r=0

  22. Gravatar of TravisV TravisV
    5. May 2014 at 07:08

    “China’s Property Bubble Has Already Popped, Nomura Says”

    http://blogs.wsj.com/economics/2014/05/05/chinas-property-bubble-has-officially-popped-report-says/?mod=marketbeat

  23. Gravatar of Doug M Doug M
    5. May 2014 at 07:09

    Regarding Germany, I see this footnote.

    Support includes here the estimated impact on public debt of liabilities transferred to newly created government sector entities (about 11 percent of GDP),
    taking into account operations from the central and subnational governments. As public debt is a gross concept, this neglects the simultaneous increase in
    government assets. With this effect taken into account, the net debt effect up to 2012 amounted to just 1.6 percent of GDP, which was recorded as a deficit.

    I am not sure exactly what this means, but it seems that the accounting is different.

  24. Gravatar of Doug M Doug M
    5. May 2014 at 07:18

    How much of the “German Bailout” comes from Greece? In negotiating the restructuring of Greek debt the German government bought a fair amount of Greek debt from German banks.

    I don’t think that this is considered a loan to the banks, and will never be repaid — at least not by the banks, maybe by Greece.

  25. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. May 2014 at 07:22

    MichaelM,
    “The Fed has dramatically expanded its balance sheet with assets it bought off of US banks (amongst other customers).”

    I have to nitpick with this because there is this perception, I suppose largely because of expanding reserve balances, that QE involves the Fed buying securities from depository institutions, when in fact, in aggregate, all of the securities have been bought from non-banks.

    The following figures all come from the Federal Reserve Flow of Funds (Table L.109).

    The Fed started increasing its holdings of securities in September 2008, although QE1 was not officially announced until November 25. It concluded at the end of March 2010. From 2008Q2 to 2010Q1 depository institutions increased their holdings of Treasuries from $101 billion to $263 billion. They also increased their holdings of Agency Bonds and Agency MBS from $1,426 billion to $1,858 billion.

    QE2 was hinted at by Bernanke at Jackson Hole in August 2010. It only involved the purchase of Treasury securities. It concluded at the end of June 2011. From 2010Q2 to 2011Q2 depository institutions increased their holdings of Treasuries from $261 billion to $270 billion.

    QE3 was hinted at by Bernanke at Jackson Hole in August 2012. It is ongoing. From 2012Q2 to 2013Q4 depository institutions increased their holdings of Treasuries from $295 billion to $305 billion. They incrased their holdings of Agency Bonds and Agency MBS from $1,906 billion to $1,949 billion.

    During each QE depository institutions have increased their holdings of the very same kinds of securities that the Fed has been buying, meaning that in aggregate 100% of the securities have been bought from non-banks. This in turn means that QE has directly increased the amount of currency and deposits held by non-banks, and thus has resulted in the direct increase of the supply of broad money.

  26. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. May 2014 at 07:42

    Ralph Musgrave,
    “Slightly off topic, but there’s a very easy way to eliminate all bank subsidies and sudden bank failures (something that Dodd-Frank, the Basel lot, etc have spectacularly failed to do). It’s to implement full reserve banking.”

    That isn’t off topic at all. In fact if you read my initial comments that led to this post I was specifically responding to a blog post by Tony Yates concerning the Full Reserve banking debate. I have no strong opinions about Full Reserve banking one way or another, but I would like to point out that in the case of the US it addresses a problem that simply has never existed.

    The US financial crisis was dominated by investment banks and other non-depository institutions. Failures by depository institutions were comparatively minor and were almost entirely addressed by the FDIC.

    One of the points of my comment is that the British and other Europeans talk as though their “banking crisis” is a universal problem, when it most certainly is not.

  27. Gravatar of Ralph Musgrave Ralph Musgrave
    5. May 2014 at 09:49

    Mark Sadowski,

    I realize FDIC dealt with the smaller / retail deposit accepting banks. But I suggest there is a broader or more general problem with banks: a problem that afflicts investment banks, shadow banks, in fact the whole lot. Certainly the crisis in the US was to a significant extent a run on shadow banks.

    The problem is that banks’ liabilities tend to be fixed in dollar terms: e.g. a bank typically borrows $X from entity Y for a specific period. In contrast, their assets vary in value, and can fall drastically in value: at which point the bank is technically insolvent, or actually insolvent and does a “Lehman”.

    That problem is solved if banks and all lending entities are simply barred from funding loans from deposits or other liabilities which are fixed in dollar terms: i.e. all such funding must be in the form of shares (or in the case of Laurence Kotlikoff’s version of full reserve, stakes in mutual funds (which do the lending)).

    That change would certainly have a deflationary effect: the cost of loans would rise. But that’s easily countered by standard stimulatory measures. Obviously Keynsians, MMTers and market monetarists disagree on which is the best stimulatory measure, but that’s a separate issue.

    The important point is that those stimulatory measures cost nothing in real terms, plus the net result would be less lending based economic activity and more non-lending based activity. Given the recent big expansion in private debts, that strikes me as a good outcome.

  28. Gravatar of dtoh dtoh
    5. May 2014 at 10:34

    I have been saying this for a long, long time.

    1. Politically TBTF will never go away.

    2. Given 1), the CB needs to flexibly regulate asset/equity ratio by asset class (including maturity, date of origination, etc.)

    This is a simple way to to solve all the problems.

  29. Gravatar of TravisV TravisV
    5. May 2014 at 11:01

    Mark Sadowski and Kevin Erdmann,

    See below from Jeffrey Gundlach and Scott Grannis. Whose housing forecast is better and why?

    http://finance.yahoo.com/news/doublelines-gundlach-recommends-shorting-homebuilders-172256046.html

    “Gundlach recommends shorting homebuilders ETF”

    “Jeffrey Gundlach, chief executive and chief investment officer of DoubleLine Capital, said on Monday that investors should bet against the SPDR S&P Homebuilders ETF because he does not see the expected rebound in single-family housing occurring.

    Gundlach, speaking at the Sohn Investment Conference in New York, said that problems dogging the housing market include expected rises in mortgage rates and the amount of student loan debt carried by young adults, which makes saving for a down payment difficult.

    He also said that if mortgage financiers Fannie Mae and Freddie Mac were wound down by the government, mortgage rates would rise.”

    http://scottgrannis.blogspot.com/2014/02/the-housing-recovery-is-not-at-risk.html

    “The housing recovery is not at risk”

    “there is no reason to think that the current level of housing prices is vulnerable to a decline, even if interest rates rise by several hundred basis points in the next few years. Remember: higher interest rates are the natural by-product of a stronger economy; if rates go up in the next few years it will likely be because the economy is strengthening, real incomes are rising, the population is growing, and the demand for home ownership is rising. Higher interest rates only threaten the economy when they are forced higher by contractionary monetary policy. We are still many years away from such as situation.”

  30. Gravatar of Miami Vice Miami Vice
    5. May 2014 at 11:12

    It does not mean that in aggregate 100% of the bonds were purchased from non banks. “In aggregate” they all could have increased their holdings of agency MBS and treasuries. It would depend on new issues of agency MBS and treasuries.

  31. Gravatar of Lorenzo from Oz Lorenzo from Oz
    5. May 2014 at 12:30

    It also puts a different spin on why Germany put the brakes on a Euro Area banking union: apparently they don’t want the poor management of their banks to come under closer Euro Area regulatory scrutiny.
    The Euro was sold as a Deutschmark for everyone who joins the Eurozone. I am not sure people realised that that translated to “Germany’s monetary and banking policies for everyone”. But, clearly, that is what they got.

  32. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. May 2014 at 12:45

    Scott,
    Off Topic.

    Larry Summers reveals why the U.S. dodged a bullet when he failed to get nominated to run the nation’s monetary policy.

    http://www.washingtonpost.com/opinions/britains-economic-growth-is-not-a-sign-that-austerity-works/2014/05/04/26b345e8-d204-11e3-937f-d3026234b51c_story.html

    May 4, 2014

    Britain’s economic growth is not a sign that austerity works
    By Lawrence Summers

    Larry Summers:
    “…Start with the current situation of the British economy. While growth has been rapid very recently, this is only because of the depth of the hole that Britain dug for itself. Whereas in the United States gross domestic product is well above its pre-crisis peak, in Britain GDP remains below previous peak levels and even further short of levels predicted when austerity policies were implemented. Not surprisingly, given this dismal record, the debt-to-GDP ratio is now nearly 10 percentage points higher than was forecast, and the date when budget balance will be achieved has been pushed years back to the end of the decade…”

    Presumably this is relevant because, unlike the UK, the US has done no fiscal austerity at all. Except that of course such a claim would be ridiculous.

    In my opinion the most objective way of measuring fiscal policy stance is the change in the general government cyclically adjusted balance, particularly the cyclically adjusted primary balance (CAPB). The cyclically adjusted balance takes into account any changes in the general government budget balance due to the business cycle. Thus changes in the cyclically adjusted balance are mostly due to discretionary fiscal policy (tax changes as well as spending changes), and consequently may be taken as a proxy for the degree of fiscal stimulus. The CAPB goes a step further, factoring out changes in net interest on government debt and thus ensuring that practically all of the changes in fiscal balance are discretionary in nature.

    Estimates of the CAPB for the Advanced Nations can be found on the bottom half of Table 2 in the IMF Fiscal Monitor:

    http://www.imf.org/external/pubs/ft/fm/2014/01/pdf/fm1401.pdf

    Between calendar years 2009 (before David Cameron became Prime Minister of the UK) and 2014 the US, the UK and the Euro Area increased their CAPB by 4.0%, 6.8% and 3.5% of potential GDP respectively. So yes, the UK has done more fiscal austerity than the US, but the US has done more than the Euro Area, which is itself no model of real economic growth.

    Moreover, although real GDP (RGDP) growth has been weak in the UK, year on year CPI inflation was consistently above the the 2.0% target from December 2009 through December 2013.

    https://research.stlouisfed.org/fred2/graph/?graph_id=120740&category_id=

    This is in part because the rate of change in aggregate demand (AD), or nominal GDP (NGDP), has been relatively strong.

    (continued)

  33. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. May 2014 at 12:47

    (continued)

    Here is NGDP in the US, the Euro Area and the UK scaled to 100 in 2008Q2:

    https://research.stlouisfed.org/fred2/graph/?graph_id=118595&category_id=

    As can be seen UK NGDP is up 11.9% as of 2013Q4 compared to 15.3% for the US and only 3.7% for the Euro Area.

    So both the US and the UK have had experienced significantly faster AD growth than the Euro Area despite doing more fiscal austerity. This no doubt has something to do with the fact both the US and the UK have done substantial amounts of QE, whereas the Euro Area has done precisely none.

    Larry Summers:
    “…Two additional points about Britain’s growth experience require emphasis. First, the acceleration in growth has less to do with austerity spurring growth than with a slowdown in the pace at which policy became more austere. The pace of fiscal contraction has slowed over the past two years. Slowing fiscal contraction means the decrement to growth caused by fiscal policy becomes more attenuated. Other things equal, this would be expected to produce more favorable growth performance. Ironically, the greater the fiscal multiplier, the greater would be the predicted turnaround when the pace of contraction slowed. So the turnaround in growth over the past 18 months is as much evidence against austerity as for austerity…”

    The UK’s Office of Budgetary Responsibility’s (OBR) estimates of the impacts of fiscal austerity on the level of RGDP can be found in Chart 2.26 on Page 54:

    http://cdn.budgetresponsibility.independent.gov.uk/FER2013.pdf

    If you read the surrounding text you’ll note the graph depicts the varying effects of each type of fiscal policy change, including both spending and revenue, on level RGDP by fiscal year. (Fiscal years in the UK run from April 1, through March 31.) *The estimates in this chart are comprehensive and fully account for the lagged effects*.

    The chart shows that fiscal policy is estimated to have the following effects on level RGDP in percent by fiscal year:

    FY””””-RGDP
    2009-10-(+0.5)
    2010-11-(-0.5)
    2011-12-(-1.2)
    2012-13-(-1.5)
    2013-14-(-1.4)

    Since these are *level* effects we need to convert them to *changes*:

    FY””””-RGDP
    2010-11-(-1.0)
    2011-12-(-0.7)
    2012-13-(-0.3)
    2013-14-(+0.1)

    Now let’s turn to the actual NGDP and RGDP growth and inflation as measured by the GDP implicit price deflator:

    https://research.stlouisfed.org/fred2/graph/?graph_id=176344

    Estimates of 2014Q1 RGDP only just came out and are not reflected in the above link. NGDP and deflator estimates are not yet available for 2014Q1 but both can be estimated from nominal gross value added (GVA) data which was released at the same time as the RGDP data. Here are the resulting growth rates by fiscal year:

    FY””””-NGDP-RGDP-Deflator
    2010-11-4.6-2.0-2.6
    2011-12-3.1-0.8-2.3
    2012-13-1.4-0.3-1.1
    2013-14-4.0-2.3-1.6

    Note that when the OBR estimates that fiscal austerity was most deletorious to economic growth, AD (NGDP) growth was actually at its fastest, and as fiscal austerity was progressively decreased in each of the two subsequent fiscal years, both NGDP and RGDP growth nevertheless decreased. Note also that in the just completed fiscal year RGDP growth was faster than in any of the three previous fiscal years, but since NGDP growth was not as fast as it was in FY 2010-11 this is due more to the fact that inflation has slowed than it is to faster AD growth.

    In other words, the timing of the economic effects of fiscal austerity does not at all match the actual pattern of aggregate demand (AD) growth. Moreover the recent superlative RGDP growth is more due to a subsiding of negative aggregate supply (AS) shocks than it is to outstanding AD growth.

  34. Gravatar of TallDave TallDave
    5. May 2014 at 12:59

    none of the E.U. members have recovered more than half of the cost of bailing out their respective financial sectors.

    How odd. Why is that? PIIGS bonds?

  35. Gravatar of TallDave TallDave
    5. May 2014 at 13:03

    So much for German efficiency.

    Ever since I learned that German corporations are required to seat unions on the board, I’ve been wondering what similar horrors might have taken root in their financial system.

  36. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. May 2014 at 13:22

    TravisV,
    “See below from Jeffrey Gundlach and Scott Grannis. Whose housing forecast is better and why?”

    Scott Grannis. Grannis has a far better understanding of interest rates. (In fact he sound like a Market Monetarist.)

    When stock analysts talk about “interest rate sensitive sectors” they are usually talking about stocks related to discretionary consumer spending or financial sector stocks. Neither of these things is directly related to housing and construction. Moreover the evidence on the correlation durable good sales, particularly automobiles, and interest rates is weak. Similarly the relative profitability of financial sector, which deals in much more than just mortgages, is remarkably insensitive to the yield curve regardless of what many financial analysts may say. I’ve done a thorough Granger causality analysis of the financial sector and banking in particular and the evidence of any relationship is not what is commonly thought.

    But housing and construction is not considered an interest rate sensitive sector even by most stock analysts. Here is a graph of the real 30-year mortgage rate and New Privately-Owned 1-unit Housing Units Under Construction since 1971:

    http://research.stlouisfed.org/fred2/graph/?graph_id=129828&category_id=0

    Why 1-unit construction? Because the correlation between residential investment and 1-unit construction is very strong unlike total contruction. That’s because multi-unit construction is volatile and adds less value. And 1-unit construction is available in monthly frequency unlike residential investment (so it’s also useful for nowcasting).

    In particular note that the correlation between real mortgage rates and construction is significantly positive in the 1970s and from 1987 through 1996. The correlation only reverses in the early 1980s and in much of the 2000s. In particular look at how real mortgage rates and construction have behaved since 2009:

    http://research.stlouisfed.org/fred2/graph/?graph_id=129829&category_id=0

    Real mortgage rates and housing contruction are significantly *positively* correlated.

    But taken as a whole the correlation between real mortgage rates and construction is close to zero. This is because the principle driver of housing construction is not mortgage rates but household income, household wealth and demographics.

  37. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. May 2014 at 13:42

    Miami Vice,
    “It would depend on new issues of agency MBS and treasuries.”

    This is not true. It does not matter at all what has happened to the outstanding amount of such securities.

    If depository institutions as a whole have increased their holdings of such securities during each QE, then the Fed’s net purchases of such securities necessarily have been from some other sector of the economy.

  38. Gravatar of TravisV TravisV
    5. May 2014 at 14:19

    Mark Sadowski,

    Thank you VERY MUCH! Two points:

    (1) Do you expect there to be a strong correlation between U.S. RGDP growth and real long-term interest rates over the next 10 years?

    (2) Gundlach is no dummy. For example, he spotted the key relationships below:

    http://www.businessinsider.com/impact-of-quantitative-easing-on-yields#!I7hc6

    http://gundlachonthemarkets.blogspot.com/2013/09/quantitative-easing-stock-market.html

    Gundlach, a brilliant guy, got so close but couldn’t quite put it all together. Agonizing!

    Just goes to show how counterintuitive macroeconomics is. If a brilliant guy like Gundlach can’t figure it out, it might take a VERY long time for the consensus of macroeconomists to figure it out.

  39. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. May 2014 at 17:07

    TravisV,
    “Do you expect there to be a strong correlation between U.S. RGDP growth and real long-term interest rates over the next 10 years?”

    There are multiple theories about the term structure of interest rates:

    http://en.wikipedia.org/wiki/Yield_curve

    The Liquidity Premium and Preferred Habitat theories are the most widely accepted theories of term structure of interest rates because they explain the major empirical facts about the term structure so well. They also combine the features of both the Expectations Theory and the Segmented Markets Theory by asserting that a long term interest rate will be the sum of a liquidity premium and the average of the short term interest rates that are expected to occur over the life of the bond.

    So, for a given liquidity premium, if long term real interest rates change this means that the average of the sum of expected expected real interest rates have changed. In turn, short term real rates reflect monetary stance and are likely to be low when RGDP has been growing slowly and high when RGDP has been growing fast.

    So theoretically long term real rates should correlate well with the RGDP growth rate.

    And in fact there is a modestly significant correlation (10% level) between real 10-year T-Note yields (adjusted for year on year PCEPI) and RGDP growth over the past 60 years. Furthermore RGDP growth Granger causes real 10-year T-Note yields at the 5% significance level.

  40. Gravatar of TravisV TravisV
    5. May 2014 at 17:40

    Mark Sadowski,

    Thanks! Was Gundlach right about causality when he said that “slight” higher interest rates killed home sales last year?

    Link below:

    http://www.businessinsider.com/sohn-conference-live-blog-2014-5?tru=JdYzI#ixzz30t68RiNg

  41. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. May 2014 at 18:05

    TravisV,
    No, Gundlach is simply wrong about interest rates and housing.

  42. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. May 2014 at 18:08

    Scott,
    Off Topic.

    Somehow I missed this. Jeff Frankel had a followup to his earlier proposal that the ECB buy Treasuries. He proposed that the ECB buy Treasuries directly from the Fed:

    http://content.ksg.harvard.edu/blog/jeff_frankels_weblog/2014/04/16/ecb-qe-via-fx-plan-b/

  43. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. May 2014 at 18:12

    Scott,
    Off Topic.

    Marshall Auerback has been at the brown acid again.

    http://macrobits.pinetreecapital.com/feds-conundrum/

    “It is agreed by all that there are long lags between monetary policy and the inflation rate.”

  44. Gravatar of ssumner ssumner
    5. May 2014 at 18:22

    Ralph, I have nothing against banks, except for their lobbying. My real target is the government–especially the politicians.

    Travis, I find the eurozone unemployment projections to be plausible, but 11.4% in 2015 is still horrible.

    Mark. Agree about Summers. Frankel’s idea (buying T-bonds) is fine, but the idea of buying from the Fed is a bit too cute. It won’t fool anyone.

  45. Gravatar of Kevin Erdmann Kevin Erdmann
    5. May 2014 at 21:34

    TravisV,

    Sorry, I just saw your comment above. I agree with Mark and Grannis, not Gundlach. Coincidentally, I recently posted about this very topic.

    I think home prices could still go up even if 10 year rates move up another couple percent. My fear is that misplaced fears about asset markets will pressure the Fed to cold cock the economy again.

    http://idiosyncraticwhisk.blogspot.com/2014/04/new-home-sales-and-prices.html

  46. Gravatar of Miami Vice Miami Vice
    5. May 2014 at 23:40

    Mark S

    I’m confused. I’m not trying to say this is what happened; only to illustrate a point. If everyone increases their holdings of treasuries (fed, financials, non-financials) who in aggregate did the fed purchase treasuries from? It would be the government, right? Honest question.

  47. Gravatar of Miami Vice Miami Vice
    5. May 2014 at 23:40

    Mark S

    I’m confused. I’m not trying to say this is what happened; only to illustrate a point. If everyone increases their holdings of treasuries (fed, financials, non-financials) who in aggregate did the fed purchase treasuries from? It would be the government, right? Honest question.

  48. Gravatar of Mark A. Sadowski Mark A. Sadowski
    6. May 2014 at 03:16

    Miami Vice,
    “If everyone increases their holdings of treasuries (fed, financials, non-financials) who in aggregate did the fed purchase treasuries from? It would be the government, right?”

    The Fed is part of the government. It would mean the Fed must have purchased them from the Treasury, which is not a depository institution.

  49. Gravatar of dtoh dtoh
    6. May 2014 at 08:50

    Miami, Mark

    “I’m confused. I’m not trying to say this is what happened; only to illustrate a point. If everyone increases their holdings of treasuries (fed, financials, non-financials) who in aggregate did the fed purchase treasuries from? It would be the government, right? Honest question.”

    “The Fed is part of the government. It would mean the Fed must have purchased them from the Treasury, which is not a depository institution.”

    I think you will both find it more conducive to understanding monetary policy to think not in terms of government (Fed + Treasury) and non-government (private banks, firms and indviduals), but rather in terms of banks (Fed + private banks) and non-banks (firms, Treasury and individuals).

  50. Gravatar of don johnson don johnson
    6. May 2014 at 09:03

    Mark S,

    You are of course correct. I reread what you had written. The point I was trying to make was that they were purchased from the treasury. In my haste I realize now I was just repeating what you had already said.

  51. Gravatar of Mark A. Sadowski Mark A. Sadowski
    6. May 2014 at 09:50

    dtoh,
    There is a tendency to refer to the Treasury as the government when in fact it is only part of the government. The Fed is also part of the government. However, in this particular instance consolidating the Fed with anything else would almost surely make matters worse. It is far simpler to view this in terms of three entities: 1) the Fed, 2) depository institutions, and 3) non-banks (everything else).

    The only way that QE could not add to broad money supply is if the Fed purchased securities from depository institutions and depository institutions failed to replace these securities. Such purchases would only have added to reserve balances or to vault cash and not to deposits or to currency held by the public.

    If depository institutions turned around and replaced any of the securities they sold to the Fed by buying more from non-banks, then this is effectively the same as if the Fed had purchased securities from non-banks in the first place, since such purchases would increase the amount of deposits or currency held by the public.

    During each QE depository institutions have increased their holdings of the same kinds of securities that the Fed has bought, meaning that effectively 100% of the securities the Fed has bought have been bought from non-banks. Thus QE has directly increased the supply of broad money.

  52. Gravatar of Mark A. Sadowski Mark A. Sadowski
    6. May 2014 at 09:57

    don johnson,
    I wrote the above comment before I had a chance to read your second one.

    In any case I hope this most recent statement is clearer still.

  53. Gravatar of TravisV TravisV
    6. May 2014 at 10:32

    Question:

    Were the high deficits of the late 1980’s / early 1990’s really a huge concern? Or is it another myth promoted by Bob Rubin and other Very Serious People?

  54. Gravatar of dtoh dtoh
    6. May 2014 at 10:43

    Mark,
    I think we’re saying the same thing.

    If the Fed buys securities from Chase in exchange for deposits at the Fed, this has no more impact on the economy than if the St. Louis Fed were to exchange securities for deposits with Minneapolis Fed.

    Fed OMP that are completely offset by an increase in ER have no impact on the economy.

    The only thing that matters is if the banking sector (Fed or private banks) induces a marginal increase in the exchange of financial assets for real goods and services by the non-banking sector (private or government).

    The non-banking sector increases it’s holdings of deposits and currency only because they intend to increase their spending on real goods and services. (The non-banking sector holds the amount of cash and deposits it needs for transactions. They increase these holdings if they tend to spend more.)

    The non-banking sectors will marginally increase it’s exchange of financial assets for real goods and services if a) the real price of financial assets rises relative to the price of goods and services, and/or b) expected future NGDP increases.

    It doesn’t matter if the Fed deals direct with non-banking sector or whether private banks intermediate the trade, or whether private banks buy assets from the non-banking sector independent of the Fed.

  55. Gravatar of JN JN
    7. May 2014 at 03:55

    Scott, Mark,

    You can’t look at the German banking sector through the same lens as the American one. The structure is completely different.

    I am not sure what those figures include, but several ‘bailouts’ in Germany have taken the shape of second-loss insurances rather than outright recapitalisations.
    To date, most of those insurances have not even been paid out. Moreover, they generate premiums, pretty much like a CDS.

    The German banking sector has its faults, with some corporate governance issues in particular (and slightly low capitalisation, though see below). But it is also relatively stable. Some landesbanks failed during the crisis (because they invested in… US RMBS and CDOs) but they don’t play a major role in financing the economy. Local and interlinked saving banks and cooperative banks (there are around 800 of them) have been very resilient over the past decades, with almost no failure. Infinitely more than tiny US banks.
    The commercial banks don’t play such a major role in the economy as in the US or the UK. Commerzbank failed but DB survived.

    Germans are resisting a banking union because their banks would have to comply with the same criteria as other, riskier, banking systems of southern Europe. The German banking sector has always operated on a thin capital base, with a low risk/low profitability model. German culture isn’t one of over-borrowing and not paying back debt is shameful. Germans don’t walk away from their homes.
    All those crucial differences disappear when one takes a look at all banking systems through the same lens.

  56. Gravatar of ssumner ssumner
    8. May 2014 at 05:44

    JN, Interesting information, and I certainly share the German view that a banking union is a bad idea.

    I’m surprised you said that commercial banks play a smaller role in the economy than in the US. Most of the articles I read suggest exactly the opposite. Are those articles wrong?

    I certainly agree that America’s small bank sector is very dysfunctional.

  57. Gravatar of Mark A. Sadowski Mark A. Sadowski
    8. May 2014 at 11:05

    JN:
    “The commercial banks don’t play such a major role in the economy as in the US or the UK.”

    Scott:
    “I’m surprised you said that commercial banks play a smaller role in the economy than in the US.”

    I also find this claim to be rather dubious.

    See for example this chart on banking sector assets to GDP by country:

    http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2013/05/Global%20bank%20assets%20%25%20of%20GDP.jpg

    Or this chart of individual bank assets to GDP by host country:

    http://www.zerohedge.com/sites/default/files/images/user5/imageroot/madoff/Banks%20As%20%25%20Of%20GDP.jpg

    Although these charts come by way of Zero Hedge, they are accurate.

    According to the ECB Statistical Warehouse, Monetary Financial Institution (MFI) assets were 271% of GDP in Germany in 2013Q4 and 477% of GDP in the UK in 2013Q3. For comparison, the Federal Reserve Flow of Funds shows that depository institution assets were only 92% of US GDP in 2013Q4.

    Even when viewed in terms of share of GDP the banking sector is larger in Germany than it is in the US. According to Eurostat “financial service activities, except insurance and pension funding” (ISIC K64) was 3.2% of GDP in Germany in 2011 and 5.5% of GDP in the UK in 2011. In contrast according to the BEA “credit intermediation and related activities” (NAICS 522) was only 2.7% of US GDP in 2012.

  58. Gravatar of Kevin Erdmann Kevin Erdmann
    8. May 2014 at 11:49

    dtoh:

    I would agree with your comments about ER. But, I think it is interesting that the banks didn’t just exchange assets like treasuries for cash as a result of the QE’s. I would have expected to see this, to a certain extent. But, the cash from QE’s came into the banks as deposits, and the banks generally held onto their other cash-like assets. So, the QE’s did apparently create an increase in deposits, which raises some interesting questions, considering the remainder of your post.

  59. Gravatar of ssumner ssumner
    9. May 2014 at 05:43

    Thanks Mark.

  60. Gravatar of mr mr
    9. May 2014 at 15:44

    I think JN meant Deutsche Bank and Commerzbank, when he referred to commercial banks. And I would also suspect the low US numbers, that arise mainly from different accounting methods and the size of the country’s “clandestine” but equally risky shadow banking sector.

  61. Gravatar of Mark A. Sadowski Mark A. Sadowski
    9. May 2014 at 20:25

    mr,
    “And I would also suspect the low US numbers, that arise mainly from different accounting methods and the size of the country’s “clandestine” but equally risky shadow banking sector.”

    US “shadow banking” consists of MMMFs, GSEs, Agency backed mortgage pools, issuers of ABS, security brokers and dealers, open market paper and overnight repo. If you sum up the assets listed in Federal Reserve flow of funds sheets L.120, L.123, L.124, L.125, L.128 and L.208 that comes to about $15.3 trillion. Add in an estimated $5.5 trillion for the overnight repo market and that brings it to $20.8 trillion or about 122% of GDP.

    http://libertystreeteconomics.newyorkfed.org/2012/06/mapping-and-sizing-the-us-repo-market.html

    So depository institution and shadow banking assets together are about 214% of GDP in the US.

    But Germany also has a sizable shadow banking sector. The Bundesbank’s own estimates put it at about 25% of the size of the MFIs or assets of about 68% of GDP.

    http://www.bundesbank.de/Redaktion/EN/Standardartikel/Press/Contributions/2013_09_16_dombret_sueddeutsche_zeitung.html

    That means that Germany’s MFI and shadow banking assets together are about 339% of GDP which is still over 50% larger than the American “banking” sector.

  62. Gravatar of Skepticlawyer » An awkward wrinkle in Bagehot’s dictum (or Circeronian public policy) Skepticlawyer » An awkward wrinkle in Bagehot’s dictum (or Circeronian public policy)
    9. May 2014 at 22:30

    […] financial institutions insolvent by increasing their liabilities and destroying their assets. As a commenter on Scott Sumner’s blog nicely put it, the US GFC bailouts were as if the Fed punched […]

  63. Gravatar of James in London James in London
    9. May 2014 at 22:30

    Mark: And then there is the difference between US GAAP and IFRS accounting. Derivatives are largely netted off US bank balance sheets, but not off European ones. And then there is the issue of foreign assets. Almost all US bank assets are domestic, large chunks of European bank assets are non-domestic. I think these two elements would significantly shrink German bank assets to its GDP. Remember what Marcus Nunes recently posted about Germany exporting its excess savings, it’s done via German banks.

  64. Gravatar of ssumner ssumner
    10. May 2014 at 09:35

    James, Don’t German firms rely heavily on bank loans, whereas American firms rely more on equity financing?

  65. Gravatar of Mark A. Sadowski Mark A. Sadowski
    10. May 2014 at 10:24

    James in London,
    Financial derivatives are not included at all in the Federal Reserve flow of funds. The ECB flow of funds added financial derivatives to German MFI assets in December 2010 under the “remaining assets” category. As of 2013Q4 German MFI remaining assets were 30% of GDP.

    At the transition in December 2010 German MFI remaining assets went up by about 4.6 fold, so I would estimate MFI financial derivative assets are about 24% of GDP in Germany. Excluding them lowers MFI assets to 247% of GDP. Adding in the shadow banking sector brings banking sector assets to 315% of GDP which is still nearly 50% larger than the US banking sector assets including shadow banking.

    Incidentally, UK MFI financial derivative assets were 155% of GDP so excluding them reduces UK MFI assets to 322% of GDP. And according to a 2012 report on shadow banking by the FSB, the UK’s shadow banking sector held $9 trillion in assets (5.6 trillion pound sterling) in 2011 or an amount equal to 365% of GDP:

    http://www.financialstabilityboard.org/publications/r_121118c.pdf

    Thus UK banking sector assets excluding financial derivatives but including shadow banking assets is equal to nearly 690% of GDP which is over three times larger than US banking sector assets measured the same way.

    Yes, GAAP and IFRS accounting affects the estimated asset amounts held by individual firms. Barth and Prabha delivered a report on this and other issues in 2012:

    https://www.chicagofed.org/digital_assets/others/events/2012/international_conference/barth_111512.pdf

    In particular note Table 1 which starts on Page 6. Assets of US banks as of 2012Q2 are reported according to both GAAP and IFRS standards. Assets of European banks are reported according to IFRS standards. In addition the recorded financial derivative amounts are reported according to GAAP standards for US banks and to IFRS standards for European banks.

    In my opinion the simplest thing to do is to simply subtract out all the financial derivatives, then convert to the local currency and divide by NGDP. The euro was equal to about $1.28, and the pound sterling to about $1.58, in 2012Q2. US NGDP was about $16.160 trillion, German NGDP about 2.662 trillion euro and UK NGDP about 1.542 trillion pounds in 2012Q2.

    Deutsche Bank’s assets without financial derivatives were equal to $1.754 trillion in 2012Q2, or about 1.370 trillion euro, or about 51% of German NGDP. HSBC’s assets without financial derivatives were equal to about $2.296 trillion in 2012Q2, or about 1.453 trillion pounds, or about 94% of UK NGDP. JP Morgan Chase’s assets without financial derivatives were equal to $2.204 trillion in 2012Q2 or about 14% of US NGDP.

    As for foreign assets, that’s not completely true. Figure 12 of Barth and Prabha’s report shows that seven of the largest US banks have significant foreign assets. In particular, about 42% of Citibank’s assets are foreign.

    I agree the ratio of an individual bank’s assets to GDP is likely to be larger for smaller countries than for larger countries. But this still doesn’t explain why the size of the overall banking sectors, no matter how one accounts it, is so much larger relative to GDP in European countries than it is in the US.

  66. Gravatar of James in London James in London
    10. May 2014 at 13:04

    Mark. Very impressive, but … The ratios shown in this article from The Economist are more consensus.
    http://www.economist.com/blogs/graphicdetail/2012/09/global-debt-guide
    The UK is so high because it is a major offshore financial centre. Global banking is what the UK does. So, when you click through you see the financial sector to GDP is very high. New York City would be the same. Luxembourg, Hong Kong, Singapore, Ireland and Jersey alll show similar effects.

    European banks have most of their mortgage markets and large corporations debt on their balance sheets, US banking is almost unique in the world in seeing almost all those assets off the banks’ balance sheets and securitised (mortgages) or just disintermediated (the corporate bond market).

    It’s hard to say whether German corporates are more debt-financed than US ones. International corporates are much alike these days. Siemens vs GE, BMW vs Ford, Deutsche Telekom vs AT&T; AstraZeneca vs Pfizer, Reckitt Benkiser vs J&J, Shell vs EXXON. The US is rather unique though in having a huge, cash rich, global tech sector.

    Deutsche Bank is the only global wholesale bank in Germany, the US has five. I’d expect Deutsche to be a bigger % of German GDP than JPM. Surprisingly, JPM’s balance sheet is as domestic as Wells Fargo. Citi is unique in the US with its international balance sheet footprint.

  67. Gravatar of James in London James in London
    10. May 2014 at 13:04

    Mark. Very impressive, but … The ratios shown in this article from The Economist are more consensus.
    http://www.economist.com/blogs/graphicdetail/2012/09/global-debt-guide
    The UK is so high because it is a major offshore financial centre. Global banking is what the UK does. So, when you click through you see the financial sector to GDP is very high. New York City would be the same. Luxembourg, Hong Kong, Singapore, Ireland and Jersey alll show similar effects.

    European banks have most of their mortgage markets and large corporations debt on their balance sheets, US banking is almost unique in the world in seeing almost all those assets off the banks’ balance sheets and securitised (mortgages) or just disintermediated (the corporate bond market).

    It’s hard to say whether German corporates are more debt-financed than US ones. International corporates are much alike these days. Siemens vs GE, BMW vs Ford, Deutsche Telekom vs AT&T; AstraZeneca vs Pfizer, Reckitt Benkiser vs J&J, Shell vs EXXON. The US is rather unique though in having a huge, cash rich, global tech sector.

    Deutsche Bank is the only global wholesale bank in Germany, the US has five. I’d expect Deutsche to be a bigger % of German GDP than JPM. Surprisingly, JPM’s balance sheet is as domestic as Wells Fargo. Citi is unique in the US with its international balance sheet footprint.

  68. Gravatar of Mark A. Sadowski Mark A. Sadowski
    10. May 2014 at 20:41

    James in London,
    “The ratios shown in this article from The Economist are more consensus…”

    Here’s the diagram to which you are evidently referring:

    http://cdn.static-economist.com/sites/default/files/imagecache/original-size/t4-fin_0.png

    I’ve been talking about assets as a percent of GDP. This diagram depicts *liabilities*, specifically credit market instruments (loans and securities excluding financial derivatives). Conventionally the size of the banking sector is measured by total assets to GDP, market capitalization to GDP or Gross Value Added (GVA) as a percent of GDP, not credit market instrument liabilities as a percent of GDP.

    Yes, there may be a correspondence between assets and credit market liabilities, and in fact what this chart shows is that financial sector credit market liabilities are nearly 200% of GDP in the UK, about 100% of GDP in Germany and 40% of GDP in the US. So even this measure shows a similar ranking.

    Incidentally, despite the fact that The Economist was the source of this diagram, this is *not* a very conventional way of counting these things. The accounting methodology comes from McKinsey and so excludes asset-backed securities and excludes foreign owned debt from the UK figure. For example, the FSA Turner Review does not make any of these adjustments. In my opinion all of these figures severely undercount financial sector credit market instrument liabilities.

    “The UK is so high because it is a major offshore financial centre. Global banking is what the UK does…”

    Then what’s the contradiction? I’m claiming that Germany and the UK have larger banking sectors than the US and you’re telling me that the UK is a major banking center. Generally speaking major centers of banking have large banking sectors.

    “European banks have most of their mortgage markets and large corporations debt on their balance sheets, US banking is almost unique in the world in seeing almost all those assets off the banks’ balance sheets and securitised (mortgages) or just disintermediated (the corporate bond market).”

    According to table L.218 in the US flow of funds, 68.5% of home mortgages are held by GSEs, Agency backed mortgage pools and issuers of ABS (which are all considered to be part of the shadow banking sector) and 27.7% are held by depository institutions. So most, but not all, of US home mortgages are held by shadow banks. But this doesn’t mean the mortgages simply vanished. When I added in the shadow banking sectors I ended up including nearly all of US home mortgages.

    And with respect to corporate securities, yes outstanding German corporate securities are only about 42% of GDP compared to about 69% in the US. But UK corporate securities are about 144% of GDP. German MFI holdings of corporate securities are equal to about 25% of GDP which is relatively large considering the small amount of German corporate securities outstanding. US depository institutions’ holdings of corporate securities are only equal to about 8% of GDP and so are rather small compared to the amount of the US corporate securities outstanding. (US shadow banking’s holdings are only about 2% of GDP.) UK MFI holdings of corporate securities are equal to about 23% of GDP which is proportionately only slightly larger than US depository institution holdings given the large amount of UK’s corporate securities outstanding.

    So the bottom line is corporate securities help explain why the US banking sector is smaller than the German since a larger amount are outstanding and a much smaller proportion are held by banks. But the UK corporate securities market does not perform a similar role.

  69. Gravatar of James in London James in London
    10. May 2014 at 21:47

    Mark.
    “So the bottom line is corporate securities help explain why the US banking sector is smaller than the German since a larger amount are outstanding and a much smaller proportion are held by banks.” I agree.

    The notion of a “UK corporate securities market” is a tricky concept. Half the world issues securities in the UK, half the world banks in the UK. Those securities go to domestic and foreign players in London. The balance sheets of international bank subsidiaries and branches in London are almost as big as the domestic banking system. Charts 1 and 3:
    http://www.bankofengland.co.uk/pra/Documents/publications/policy/2014/branchsupcp4-14.pdf

    The UK punches well above its weight in having Sterling as a reserve currency. And as a corporate HQ for the world. Over 80% of the revenues of the FTSE100 companies are generated overseas. What is a “UK” corporate? What does “domicile” mean for any large corporate these days? So much is merely tax and regulation driven, “real” locale is meaningless, economically.

    I am not sure what we are arguing about with those Economist/McKinsey tables: one man’s liability is another man’s asset.

  70. Gravatar of Mark A. Sadowski Mark A. Sadowski
    11. May 2014 at 05:43

    James,
    “I am not sure what we are arguing about with those Economist/McKinsey tables: one man’s liability is another man’s asset.”

    As I said they’re related, but it depends on the question one is trying to answer. If it is how indebted the financial sector is, then the McKinsey tables are very relevant (although I disagree with their methodology). If the question is how large the banking sector is, then they are somewhat peripheral. There are more direct ways of answering that question, such as assets as a percent of GDP.

    The subject never came up, but as along as it’s fresh on my mind, how large is the US financial derivatives market?

    According to the most recent OCC report its gross positive fair value (how it’s measured in the European flow of funds and by IFRS) is $3.6 trillion or about 21% of GDP (page 8):

    http://www.occ.gov/topics/capital-markets/financial-markets/trading/derivatives/dq413.pdf

    About 97% of financial derivatives (by notional value) are held by the five largest US banks. Netting (GAAP) reduces it to $298 billion.

    Its peak size was in 2008Q4 when it reached $7.1 trillion or about 49% of GDP, but it has substantially shrunk since then, so much so that at about 24% of GDP even the German derivatives market is larger. (And since the British financial derivatives market is 155% of GDP, it is now over seven times larger.)

    That’s why “grossing up” the US banking sector wouldn’t have made any difference.

  71. Gravatar of James in London James in London
    11. May 2014 at 13:05

    I guess the origin of this discussion was whether German or US or UK banking was most safe or risky. None are safe if, in a market-wide liquidity squeeze, the lender of last resort abdicates their responsibility. To be fair the LOLR’s only paused before acting, but that pause was enough to crash the global economy. They paused, partly due to misplaced inflation fears, but partly due to “moral hazard” concerns (especially in the UK).

    The LOLR’s job is much harder if the banks in their jurisdiction have become so large that there is no one big enough to take them over except the state or central bank. The US has approached that level,with the latest round of turbulence. Only Wells outside the big five wholesale banks could do it, and they seem very set in never becoming or owning a bulge bracket investment bank.

  72. Gravatar of James in London James in London
    12. May 2014 at 04:23

    Mark. One other thing, derivatives accounting is a very, very murky world. The real “gross” figure you should start with is the gross notional derivative trades outstanding. They are around $600tn globally, split 40/60 US banks and RoW banks.

    The Positive Replacement Value is an asset, and is the “mark to market” of the gross notional trade. It is usually hedged with a Negative Replacement Value. However, that is only like saying every loan asset has be funded with a deposit liability. The loans do net to the deposits (broadly speaking, there are of course securities as assets and wholesale funding as liabilities). The banks like to use the netted PRVs and NRVs, but that does understate the total assets and leverage. The PRVs and NRVs are only daily marked to market and can and do move, often wildly.

    The PRVs have not reduced much since 2008. In addition, one man’s PRV is not equal to another’s, as the PRVs are often stated after quite a lot of intitial netting. How much is quite murky indeed, the IFRS has battled for fuller disclosure against the headwind of FASB that wants less.

    The trickiness of the work is shown by the error in the Barth/Chicag Fed piece Figure 1 that shows Morgan Stanley with just $78bn of “IFRS” derivatives when it is actually as big as Citi/GS in the space. Henc ethe US has five big wholesale derivative banks, not four.

  73. Gravatar of Mark A. Sadowski Mark A. Sadowski
    12. May 2014 at 08:35

    James,
    Actually the notional value of financial derivatives globally is currently about $710 trillion.

    http://www.bis.org/statistics/dt1920a.pdf

    According to the OCC the notional value of US financial derivatives is about $237 trillion that means the US share of the global financial derivatives market by this measure is 33%.

    However, in terms of gross market value, the $3.6 trillion US share of the $18.7 trillion global financial derivatives market by this measure is only 19%.

    And in terms of gross credit exposure (value after netting) the most recent global numbers I can find are for December 2012 (“OTC Derivatives Market Analysis Year-End 2012′):

    https://www2.isda.org/functional-areas/research/studies/

    They show that the $430 billion US share (via the OCC) of the $3.6 trillion global financial derivatives market by this measure was only 10.7%.

    I would like to tell you the precise notional, gross and net values of financial derivatives held by various European countries but so far as I can tell only the BIS really knows all these figures, and apparently they’re not telling anybody (except for the ISDA).

    However, according to the ECB Statistical Warehouse, the gross market value of UK financial derivatives is 5.5 trillion pounds or $8.9 trillion or about 48% of the global derivatives market by what is perhaps the most commonly accepted measure:

    http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=158.IEAQ.Q.GB.N.V.LE.F34.S1.A1.S.1.N.N.Z

    Note that it increased six-fold between 2007Q1 and 2008Q4 and that it has remained enormous ever since.

  74. Gravatar of James in London James in London
    13. May 2014 at 22:13

    Mark. The whole point of these derivatives is that they work around national boundaries. They provide the grease to the wheels of international finance. Turning one currency into another, one maturity into another, and one variable rate into a fixed rate or vice versa.

    National statistics can’t capture them as they are often cross-currency and cross-border. And different accounting conventions makes them impossible to compare, from one bank to the next and certainly from one country to the next.

    The fact that the vast bulk are OTC means the “market value” is hard to find. There are some central repositories for the trades that record a “value” but that value is not the same as recorded in bottom-up bank accounts.Two counterparties to the same trade are not required to value the contract the same as the contracts are usually part of bundled trades that combine and alter the value of a component part to the owner. The contracts are very often quite long term so also have many assumptions in the valuation on discount rates, future interest rates, inflation rates, volatility etc that mean counter parties can also legitimately disagree on their value, until the contract eventually comes to term – or it can be rolled over.

    All this complexity is what creates systemic risk, and what regulators guaranteeing mere deposits have to worry about.

  75. Gravatar of Floccina Floccina
    19. May 2014 at 13:38

    So once again I think the causality goes from NGDP to the financial sector and not the other way around.

    So does that mean that the Fed Gov. should not have bailed anything out but instead put the pedal to the metal on NGDP by having the Fed buy much more assets much more quickly?

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