Fitch Upgrades Greek Debt Amidst Debt Writedown

Sources:
Bloomberg: Greece has Rating Upgraded by Fitch
Boston Globe: Greek Debt Upgraded, but Outlook Still Grim
Business Day: Fitch Lifts Greece out of Default Territory
Eurostat News Release: Euro Area Government Debt Down to 87.4% of GDP


On Tuesday March 14, credit rating agency Fitch upgraded future Greek bonds from a “restricted default” to a B- rating. Fitch is the first of the major ratings agencies to upgrade Greek debt. The main reason for the improved outlook is the recent debt write-down, or “haircut,” accepted by 83.5% of private investors holding Greek bonds. The haircut will result in private debt holders taking investment losses of more than 70%, which includes both lost interest and principal, and will cut Greece’s debt burden by $159 billion—about one third of Greece’s total debt. Fitch also assigned a “stable outlook” for Greece, meaning it is not expected to change Greece’s rating again in the near future.

The B- rating applies to all future bonds Greece issues. Unfortunately, a B- rating qualifies as junk status, meaning Greek debt is not viewed as a stable investment in the international markets and regulations prevent some institutional investors from purchasing junk bonds. Foreign-law bonds, which are not governed by Greek law and therefore were not forced to agree with the Greek 70% haircut, maintained their C rating based on the uncertainty surrounding their debt write-down settlement scheduled for April 11.

The debt write-down is a positive sign for Greece. First, the haircut was a central aspect in the Eurozone and IMF deal agreeing to provide $226 billion in bailout funds over the next few years. That total includes amounts not yet disbursed from the initial Greek bailout, along with $170 billion in new bailout funds. Second, the write-down significantly decreases Greece’s debt-to-GDP ratio. Currently, the Greek debt-to-GDP ratio stands at approximately 160%, but an IMF report claims that the write-down paves the way for the ratio to fall to 116.5% by 2020 and 88% by 2030. However, that same report notes that the country’s debt-to-GDP ratio could remain as high as 145% in 2020 if Greece is not financially disciplined.

Even amidst the debt upgrade, international debt experts warn that Greece’s recovery is still a long way off, meaning employment and economic growth will be slower than expected. While the debt writedown paves the way for the immediate disbursement of bailout funds, Greece must continue to meet fiscal targets every three months set by international creditors to receive future bailout funds. While the debt haircut greatly decreases Greece’s current obligations and led to a ratings upgrade, the financial future of Greece remains very unclear.

Eurozone’s Bailout Fund Suffers Credit Downgrade

Sources:
FT: S&P Downgrades Eurozone Bail-out Fund
Reuters: Rescue Fund Downgrade Raises Pressure on Euro Zone
WSJ: S&P Cuts Rating on Europe's Bailout Fund
Telegraph: S&P cuts EFSF bail-out fund rating: statement in full

On Monday, the credit rating agency Standard & Poor’s lowered the credit rating of the Eurozone’s bailout fund, the European Financial Stability Facility’s (EFSF), one notch from its top AAA rating to AA+. The downgrade comes, in part, as a result of S&P’s decision on January 13th to lower the AAA ratings of France and Austria—two of the fund’s guarantors—as well as the Eurozone’s inability to adequately contain the region’s debt crisis. The fund still retains its AAA rating from credit agencies Moody’s and Fitch.

The EFSF’s main function is to safeguard financial stability in Europe by providing financial assistance to Eurozone countries. To do so, the EFSF issues bonds or other debt instruments on capital markets to raise the money necessary to lend to struggling Eurozone governments. The fund is backed by guarantees from Eurozone countries and derives its credit rating from the ratings of those countries. To maintain its AAA rating, the EFSF’s bonds could only be guaranteed by AAA rated countries. However, following the lowering of the ratings on France, Austria, and several other countries, the EFSF bonds are no longer fully supported by the guarantees of only AAA rated countries.

The credit downgrade of the EFSF could potentially lead to higher lending costs for countries borrowing from the EFSF. This is because the fund’s lending capacity would now have to be reduced (as there are fewer AAA guarantors) or the remaining AAA countries (such as Germany) would have to agree to increase the amount of their guarantees. However, Germany has already rejected raising its contribution to the fund, leaving the EFSF to attract investors by promising to pay higher premiums (return for the investor, but additional cost for the borrower). Nonetheless, last Tuesday, the EFSF managed to successfully sell its full target amount of €1.5 billion ($1.9 billion) of six-month bills at a yield of 0.2664% compared to a yield of 0.222% when it was rated AAA, signaling that robust demand still exists for ESFS debt.

Lastly, in an effort to increase the bailout fund’s lending capacity and effectively deal with the debt crisis, Eurozone leaders have accelerated the implementation of the European Stability Mechanism (ESM) (which will replace the EFSF as a bailout fund) to July 2012. The ESM differs from the current EFSF fund in that it is funded through paid-in capital provided by Eurozone countries, instead of just guarantees as with the EFSF. Also, the ESM would have a lending capacity of 500 billion euros—much larger than that of the EFSF. Thus, the ESM should offer lower lending costs since investors should be more willing to purchase bonds that are backed by capital rather than guarantees. In any event, the downgrade of the EFSF will make it more costly for troubled economies in the Eurozone to get financial aid and harder for the region to contain the debt crisis.

Standard and Poor’s Changes Rating Criteria – Downgrades 15 Banking Companies

Sources:

NPR: S&P Downgrades Top U.S. Banks' Credit Ratings

Reuters: S&P Cuts Ratings on Big Banks After Criteria Change

S&P: Standard & Poor's Applies its Revised Bank Criteria to 37 of the Largest Rated Banks and Certain Subsidiaries

WSJ: S&P's New Criteria Prompt Downgrades of BofA, Barclays, Citi

Standard & Poor’s (S&P), one of the ‘big three’ New York City-based credit rating agencies (Fitch and Moody’s round out the trio), announced new rating criteria for banks on November 9, 2011. This week, S&P applied the new criteria to 37 of the world’s largest financial institutions, which resulted in the downgrading of 15 major institutions including Goldman Sachs, Bank of America, UBS, JP Morgan Chase, Citigroup, Morgan Stanley, and The Royal Bank of Scotland.

S&P’s new criteria consist of two key steps. First, S&P evaluates a bank’s financial health and ability to withstand severe or extreme economic stress without reliance on external support and assigns each bank a “stand-alone credit profile.” Second, S&P assesses the degree of extraordinary government or institutional support available to a given bank. These two conclusions are then factored into the broader credit rating methodology, which includes complex risk analysis and assumptions and an overall financial evaluation.

By taking into consideration the degree of external support a bank may have available from central banks or due to its association with a parent group, S&P attempts to create a more accurate credit profile by evaluating the bank not only as an independent financial entity, but also as to the position of the bank within the financial industry as a whole. The new criteria appear promising; however, it may also extend the reach of credit rating agencies and prove controversial. The new criteria allow S&P to consider a bank’s position within the broader context of global finance, governmental support, political climate and economic conditions and to reflect that information in the credit rating. The recent bank downgrades are largely a result of the industry’s susceptibility to such factors and increasing reliance on governments and central banks worldwide.

The new criteria were designed to allow the rating agency more flexibility to respond to rapidly changing market conditions and adjust credit ratings accordingly. Prior to implementing the new criteria, S&P detailed its underlying assumptions and methodologies for rating banks in a series of reports on January 6, February 16, November 1, and November 9, 2011. According to the November 9, 2011 report, “the criteria are designed to improve transparency of bank ratings globally.”

SEC's New Rules on Credit Rating Agencies

Sources:
WSJ: SEC Aims to Tighten the Rules on Raters
Bloomberg: SEC Credit-Rating Rules, 401(k) Bill, WTO’s Airbus Aid Ruling: Compliance
SEC: SEC Proposes Rules to Increase Transparency and Improve Integrity of Credit Ratings

On Wednesday, the Securities and Exchange Commission (SEC) proposed more restrictive rules on credit rating agencies (CRAs). CRAs rate the “creditworthiness” of debts as well as financial institutions holding debts. During the financial crisis, CRAs were criticized for contributing to the housing bubble by providing inaccurate and inflated ratings for mortgage-backed securities. Congress, in passing the Dodd-Frank Wall Street Reform and Consumer Protection Act, intended to correct such problems, and the SEC’s new rules would implement relevant provisions of the Act. The SEC’s proposed rules aim to “strengthen the integrity and improve the transparency of credit ratings,” said SEC Chairman Mary L. Schapiro.

Specifically, new rules would require CRAs to disclose more background information explaining their ratings. In the case of ratings on asset-backed securities, CRAs would have to submit any information provided by a third-party firms which conduct a review of the underlying assets. Also, the new rules require CRAs to file an internal control report with the SEC every year. Additionally, the new rules propose measures to prevent conflicts of interest problems. CRAs and issuers of debts have close relationships as most CRAs get fees from issuers and CRAs provide advice for issuers regarding how to receive high ratings. Under the new rules, for example, CRAs are not allowed to issue a rating if their employee who is involved in the sales of a debt also plays a part in assigning a credit rating for the debt. If a CRA violates such rules, the SEC can suspend or revoke the CRA’s registration with the SEC.

Critics say that the new rules still do not require CRAs to provide sufficient information about the ratings. In addition, some point out that the rules would not solve the fundamental problems of an “inherent conflict” that arise from close relationships between CRAs and issuers. As for the internal control report requirement, Kathleen Casey, one of the SEC commissioners, said that small-sized CRAs might find the requirement onerous and the requirement could discourage such CRAs from registering with the SEC, reducing competition.

The new rules will be finalized after the 60-day comment period. Upon a final approval by the SEC commissioners, the rules will apply to the CRAs registered with the SEC. Currently, 10 CRAs including Moody’s Corp. and Standard & Poor’s are registered with the SEC.

What Were the Causes the Financial Crisis?

Sources:
WSJ: Head of Crisis-Panel Says Warning Signs Weren't Heeded
Financial Times: US crisis inquiry points to widespread failures
NPR: The Crisis Reports: A Literary Analysis
PBS: Financial Crisis Commission Divided Over Causes, Culprits Behind Meltdown

The Financial Crisis Inquiry Commission (FCIC), comprised of six Democrat-appointed members and four Republican-appointed members, was established in May 2009 and tasked with investigating the causes of the 2008 financial crisis. Last month it released its final report on the causes of the financial crisis, concluding that the financial crisis was “avoidable.” This report, adopted by six Democratic commissioners, said regulation failures, corporate governance problems, excessive borrowings and “systemic breaches” in ethics all had led to the financial crisis. The chairman of the FCIC, Phil Angelides, emphasized that the crisis was “a result of human action, inaction, and misjudgments.” For example, he said the Federal Reserve missed several opportunities to prevent the financial crisis by not properly regulating practices such as predatory lending and derivatives investment.

However, four Republican commissioners disagreed with the majority’s conclusion and wrote two dissenting reports. Three of the commissioners focused on larger forces such as global credit and housing bubbles, saying that the crisis was not avoidable. “It’s too simple to say in hindsight that if people would have just behaved differently, this crisis wouldn't have happened,” said Keith Hennessey, one of the three Republican commissioners. The dissenters also criticized the majority’s report for listing too many causes—their report focused on ten causes including credit and housing bubbles, “nontraditional mortgages,” “failures in credit-rating and securitization” transforming “bad mortgages into toxic financial assets,” financial institutions taking massive housing risk and holding too little capital, and “financial shock and panic.”

Another dissenting report was prepared by Peter Wallison, a fellow at the American Enterprise Institute. According to his report, the main contributor to the crisis was the government’s housing policy of facilitating housing for low-income earners through the government-sponsored mortgage enterprises, Fannie Mae and Freddie Mac.

The FCIC’s report is the first official report released by the U.S. Government. Mr. Angelides said that the report could be a “guidepost to policymakers and the public,” especially for lawmakers implementing the Dodd-Frank financial reform bill that was passed in July 2010.

Discussion: Among the three reports, which report do you think best explains the causes of the financial crisis? (Full reports are available at http://www.fcic.gov/.)

"Swiss Finish" to New Global Capital Rules

Sources:
Economist: First Mover
Financial Times: Swiss urge capital boost for banks
NYTimes: 2 Swiss Banks Facing Higher Capital Standards
WSJ: UBS, Credit Suisse Face Tough New Capital Rules

Last month, global regulators reached an agreement on new capital rules for banks. Under the new Basel III rules, banks are required to hold core capital of minimum 7 percent of risk-weighted assets. The Basel Committee on Banking Supervision also recommended that the top 30 global banks should hold more capital in addition to the minimum requirement. On October 4th, Switzerland made the first move. The proposals by the Commission of Expert (Commission) require the two "systemically important" banks, Credit Suisse and UBS, to hold 19 percent of risk-weighted assets (10 percent in the form of common equity plus 9 percent of contingent convertible bonds (CoCos)). CoCos are similar to bonds but convert to equity if core capital ratios falls below a predefined level. The Commission, appointed by the government, was comprised of representatives from the central bank, industry, etc. If the Parliament approves the proposals, the two banks must comply with the new rules by 2019.

The proposed rules will "significantly mitigate the too big to fail problem in Switzerland and thus reduce the risk for the Swiss economy," said Philipp M. Hildebrand, Chairman of the Swiss National Bank (SNB) Governing Board. According to the Commission, the total capital requirement of 19 percent makes sense given the size of Credit Suisse and UBS and their potential impact on the economy. The balance sheets of the two banks amount to around six times the nation's gross domestic product. Also, during the financial crisis (from the last quarter of 2007 to the first quarter of 2009), UBS incurred losses of 13 percent of risk-weighted assets.

Both Credit Suisse and UBS confidently say that they can meet the heightened requirement by 2019. However, experts disagree over the practicalities of CoCos. John Cryan, UBS's financial director doubts whether a CoCo market would emerge or whether banks can use it. Only two banks, Lloyds and Rabobank, have used CoCos so far, issuing around $16.4 billion last year. Credit rating agencies have not been willing to rate CoCos. On the other hand, Thomas Jordan, director of the SNB, is confident that investors will buy CoCos. According to the Economist, CoCos can be viewed as "a kind of catastrophe insurance for which a premium is received in return for a small chance of a big loss," and banks will be able to use CoCos. The Commission estimates that if Credit Suisse and UBS use CoCos to raise 9 percent of their risk-weighted assets, the amount would be approximately SFr 72 billion.

Discussion:
1. Jose-Maria Roldan, head of banking regulation for the Bank of Spain, said that CoCos are "brilliant ideas but... preferred shares and subordinated debt also looked great before the crisis and they were totally useless. Why do we think financial innovation will work this time around?” What are the benefits and disadvantages (or risks) when banks use CoCos to raise capital?

2. The Commission heightened the capital requirement, but did not propose to break up the two biggest banks or limit their size or activities (e.g., proprietary trading) Should the Commission have suggested breaking up the two banks or limiting their size or activities in order to address the too-big-to-fail problem?

Is Basel III “Doomsday” for Banks and Economic Growth?

Sources:
Financial Times: Bankers Warn of Basel III hit to GDP
Financial Times: Bankers’ ‘doomsday scenarios’ under fire
Financial Times: Basel Chief hits back at growth curb claim
Financial Times: Digesting the Basel Reforms
Bloomberg Businessweek: Geithner Meeting Barnier on Basel III Presses Banks
Wall St. J.: G-20 is Nearing Accord on New Capital Rules
Bank for International Settlements: History of the Basel Committee and its Membership

The Basel Committee on Banking Supervision (Basel Committee) sets global banking standards, which national regulators then implement. In 1988, the Basel Committee introduced a measure of capital called the Basel Capital Accord (Basel I) requiring a minimum capital of 8%. In 2004, the Basel Committee issued a revised framework, commonly referred to as Basel II, which refined the standardized rules set forth in the Basel I.
Among other things, Basel II lowered capital requirements and allowed the largest and most sophisticated banks to use internal models to calculate risk of their assets in determining the capital charges against them. Basel II is the minimum standard for international banks and many countries have adopted it in some form.

While Basel II sought to improve on Basel I by aligning regulatory capital requirements more closely to banks’ underlying risk, many have criticized it. In the wake of the global financial crisis, criticism of Basel II has not waned, but has actually increased. In fact, many critics such as Charles Goodhart, a former Bank of England policy maker and professor at the London School of Economics, have gone as far as saying “that Basel II failed.” Therefore, regulators are trying to fix Basel II through a financial reform dubbed “Basel III.”

Basel III will still rely on the banks’ risk models, but will call for tighter control of what goes into the calculations. There will be a narrower definition of what counts as capital and higher capital charges against riskier holdings such as derivatives. Basel III may also impose a cap on the amount of assets a bank can have in relation to its equity. Put simply, Basel III would require banks to keep enough money in reserve to insulate them against future crises. Not surprisingly, these proposed changes have not been without criticism.

As you may surmise, the loudest criticism of Basel III comes from the banking industry. Banks are claiming that the increased capital requirements will significantly reduce their profitability. Moreover, the world’s leading banking industry group has warned that economic growth in the eurozone, the U.S., and Japan will be cut by three percentage points between now and 2015 if the proposed changes come into force. Another group warns that this would lead to 9.7 million fewer jobs in those countries. Thus, according to the banking industry, the combined effects of Basel III will have a disastrous effect on the worldwide economic recovery.

Proponents of Basel III believe that these worries are unwarranted. Banks are assuming the “maximum impact of the maximum change with the minimum behavioral change.” Banks’ business models are not static and can be changed to deal with the new regulations. Furthermore, if Basel III is applied with equal force to all banks, there is no reason why banks could not maintain their profitability by passing the costs of increased capital to their customers without adverse impact on business. However, it is not clear that they would necessarily do so.

Due to the differing views regarding the effects of Basel III, the Basel Committee and the Financial Stability Board have given a mandate to the Bank for International Settlements to assess the economic effects of the Basel III reform. The estimates are still in progress, but the study shows that the costs “aren’t huge” and the “improvements to the resilience of the financial system will not permanently affect growth—except for possibly making it higher.” However, even if the reforms do slow economic growth, many proponents believe that it is a price worth paying for a stable financial system worldwide.

Even though the banking industry contends that the effects of Basel III will be disastrous, it is debatable whether Basel III truly is doomsday for banks and economic growth. Indeed, if there are costs, they may be a small price to pay for global financial stability going forward.

Discussion:
1) If Basel III does reduce banks' profitability, how do you think banks will deal with it (pass it on to customers, find a loophole, more innovation, etc.)?
2) Even if Basel III slows economic growth, do you think it is a price worth paying for a stable financial system?

U.S. Could Be Majority Stakeholder in Automaker Bailout

Sources: Wall Street Journal, U.S. Would Hold Majority Stake Under New GM Plan; Financial Times, US to take Majority GM Stake

A new plan to save major U.S. automaker General Motors (“GM”) involves plant closures, job losses, and an aggressive debt-for-equity swap making the U.S. government the majority stakeholder. GM is working to meet a June 1 deadline to produce a viable turnaround plan to get government assistance—or face bankruptcy.

So far, GM has received $15.4 billion in emergency assistance from the U.S. government, and it is seeking $11.6 billion more with the plan. The plan would require the government to hand over half of its debt for equity in GM—in effect, forgiving half of GM’s debt to the government in exchange for a large stake in the company. GM officials have left open the possibility for government representation on the Board of Directors—though the Treasury has not shown any interest in actually running the company, but is more concerned with getting the company to run smoothly for its shareholders and other constituencies. GM’s clear preference is to stay out of bankruptcy—but company officials said that if the debt-for-equity plan fails, it will be forced to seek protection under U.S. bankruptcy laws.

Current GM bondholders have until May 26 to vote on the plan—but some bondholders said there is little incentive to accept the plan because it strongly favors the government and unions, and suggested that it might be more favorable to seek a solution in bankruptcy proceedings. Sources close to a committee representing GM bondholders said that they are close to proposing a counter-offer in the next ten days. They said the payoff to bondholders that GM is offering is less than what GM offered other parties, including unions and taxpayers—and is less attractive than the last plan GM offered bondholders.

If the plan succeeds, GM will cut 13 of 47 plants and 7,000 more jobs by the end of 2010. GM will also close the 83-year-old Pontiac brand and cut its dealership network from 6,200 to 3,600 by the end of 2010.

Questions for Discussion:

What does this mean for other U.S. automakers (like Chrysler) and other major industries in the U.S.? What does this mean for taxpayers? Is the debt-for-equity swap the right approach?

Fed to Remain Creative in Monetary Policy

Source: Financial Times, Fed Study Puts Ideal US Interest Rate at -5%

An internal policy analysis prepared for the Federal Reserve’s last policy meeting indicates that the ideal interest rate for the U.S. economy’s condition should be -5% (yes, that is a minus sign). The conclusion, while unrealistic in actual application, encourages the Fed to continue using unconventional policies to stimulate the economy.

The -5% projection is based on the Taylor Rule, which estimates an appropriate interest rate based on unemployment and inflation. Even though a central bank cannot cut rates below zero, the analysis indicates that the Fed should continue its unconventional policies that stimulate the economy that roughly equate to a -5% interest rate. Separate estimates indicate that the Fed would need to expand its asset purchased by more than the $1,150 billion increase that the Board of Governors approved at the Fed’s last meeting. The Fed is not expected to make any substantial monetary policy changes at its next meeting—especially in light of the fact that the economy is a bit stronger than it was during the last meeting—but is expected to brainstorm potential monetary policy changes at its next meeting. One option is the Canadian approach of setting an explicit timeframe for keeping interest rates at or around 0%, though that approach is subject to debate—some arguing that it is not credible and could be ineffective.

At its last meeting, the Fed purchased long-term treasuries for the first time in decades—and is keeping open the possibility of buying more if economic forecasts go down again. But policymakers will most likely watch how market interventions already underway affect the economy before implementing new policies.

Questions for Discussion:

In light of basic macroeconomic theory, is monetary policy creativity the right approach? Given the tools that the Fed has to control the money supply and the expansion or contraction of the economy, are the Fed’s hands tied if they don’t opt for creative solutions? Or should the Fed follow macroeconomic models and try to affect only one monetary factor at a time?

Is the Cloud Over the Banking Industry Lifting—Or Is This Just the Eye of the Storm?

Sources; NYTimes, Banking Industry Showing Signs of a Recovery; Associated Press, Citi Results Top Street Forecasts, But Shares Fall

Four banks announced positive earnings news this week—Citigroup, JPMorgan Chase, Goldman Sachs, and Wells Fargo—signaling a glimmer of hope for the banking industry’s recovery from a serious financial crisis that left credit markets frozen and left investors holding a handful of near-worthless securities. JPMorgan Chase reported $2.1 billion profit in the first quarter, with revenues up 45% from last year—and Citigroup, while it still reported a loss, reported earnings higher than forecast.

Financial-sector officials say that there are still weaknesses in the system. Millions of homeowners are still defaulting on their mortgages, home-equity loans, and consumers continue to default on credit card payments. The commercial real-estate sector is just starting to feel the blow of the recession—General Growth Properties, one of the nation’s largest mall operators, filed for bankruptcy on Thursday, for one of the largest collapses in history.

Still, banking institutions seem poised to continue down the road to full recovery—and many are eager to get rid of their debt from federal bailouts. One JPMorgan official noted that if the bank wanted to pay back its loan from the federal government tomorrow, it could—“We have the money,” he said. Low interest rates are encouraging many new homeowners to take out mortgages, and commercial and investment banks are acting with cautiously optimism, storing away millions in reserves in order to be ready for the next wave of losses. The overall sense is that until prices stabilize and unemployment peaks, banks will be concerned about losses on their balance sheets.

The Treasury is expected to release “stress test” findings on May 4, detailing which banks will be likely to sustain their earnings and survive the ever-present volatility in the system. The findings are expected to reveal that some banks may need to raise fresh capital—from private investors, but also by converting the preferred shares of stock currently held by the government (exchanged in bailout transactions) to common shares to sell to the public and other investors.

Question for discussion:

Does the banking industry’s positive numbers signal a larger recovery for the rest of the economy? Or do the positive earnings reflect only the effects of the government’s bailout efforts?

Global Trade Falling and Protectionism on the Rise

Sources:
NY Times - Trade Is Falling Fast Across the Globe
Washington Times - Trade Barriers Up, Global Study Says

Global trade is declining at a rapid pace not seen for several decades. Data from 15 of the world's largest exporters indicates their total value of exports in February 2009 was about one-third lower than in Feburary 2008. China, a recent export titan, saw its exports drop by 41 percent during that period. The current fall in global trade volume is more severe than that during the Great Depression era of the 1920s and 1930s.

Not all of the news is bad, however. United States exports, although falling year-over-year by 22 percent, actually rose a small amount between January 2009 and February 2009. It was the first month-over-month increase for U.S. exports since they reached a high of $121 billion in July 2008. And China's large stimulus program appears to have encouraged imports, especially from Australia.

Along with the overall decrease in global trade volume, major economic players have been putting up trade barriers at an increased pace during the global financial crisis. Although the G20 summit participants recently agreed not to resort to protectionist measures during the time of financial crisis, countries such as the U.S., China, Brazil, India, South Korea, and the E.U. bloc have been most active in devising new trade barriers.

The trade barrier study, by Grail Research, noted that non-tariff and non-traditional barriers were the weapon of choice. These barriers are less directly confrontational but also more difficult to track and quantify.


Discussion:
1. What are the benefits of trade barriers to countries during a time of global recession?
2. Will increased global trade be the cause or effect of global economy recovery?

U.S. Farmers Hit by Global Downturn

NY Times - Farm Exports Fall Sharply in Global Recession

AP - Weak Crop Prices End Feast in Farm States

After experiencing a boom year in 2008, United States farmers' earnings will likely be pared significantly in 2009. The U.S. Department of Agriculture has predicted that farm income will fall about 20 percent in 2009, down to $71.2 billion. Farm exports, which make up about 20 percent of total farm production, are forecasted to fall from $117 billion to $96 billion.

U.S. agriculture rode a wave of prosperity in 2008, when agricultural commodities prices peaked, exports increased due to increasing developing country demand, and global conditions such as a drought in Australia increased demand for U.S. products.

Since then, however, U.S. agricultural conditions have become significantly bleaker. The rising value of the dollar has made U.S. exports more expensive and less competitive. The dollar has appreciated against the Euro (from $1.60 to $1.32) and the Pound ($2 to $1.47). Commodities prices have also fallen across the board, most between 40 and 50 percent since their highs in mid-2008.

U.S. agricultural exports have also softened because of decreased global demand due to the global financial crisis. Exports volumes of corn have fallen by 40 percent in recent months, with wheat falling 30 percent.

Not all of the news for U.S. farmers is bad. Farmland and farm building property values are still expected to rise by a small amount in 2009, although by much less than their seven percent increase in value in 2008. And rising requirements for the use of ethanol will give corn growers a buffer against decreasing exports.

Discussion:

1. How do U.S. declining agricultural revenues compare with other industries, such as manufacturing and services? Although their conditions are deteriorating, are U.S. farmers actually in a better position relative to other U.S. economic sectors during the financial crisis?

Alberta Province Projects Deficits on Lower Oil Revenues

Sources:
Globe and Mail (Toronto) - Alberta Tightens Pursestrings Despite Downturn
Bloomberg - Alberta Offers Incentives to Drillers as Revenues Decline
Vancouver Sun - Alta. to Post $4.7B Deficit

The Canadian province of Alberta will face its first deficit in 16 years due to declining oil and natural gas revenues. Alberta, which holds the second-largest reserves of oil in the world behind Saudi Arabia, had been growing rapidly and spending large amounts on infrastructure and resource development. The Alberta government projection puts the deficit at C$4.7 billion, which would be the largest in the province's history.

The red ink is being driven by struggles in the oil industry. Companies' spending on oil extraction--which involves extracting oil from bitumen found in vast deposits of sand--is expected to drop by half, to $10 billion. Overall resource revenues for the province, headlined by oil and natural gas, will fall by C$6.4 billion. Oil prices that are expected to hold at US$55 in the near future are contributing to lack of spending on oil development.

The Alberta government expects to run budget deficits for three years prior to a return to surplus. The government is also expected to offer incentives to encourage oil drilling, contributing as much as C$1.5 billion. Unlike other provinces, however, Alberta will not embark on a stimulus spending campaign to jolt its economy back to life. Instead, the province will impose measures of financial austerity such as a 9.6 percent cut in capital spending.

Although some construction industry and labor leaders warn that Alberta's inaction during the crisis could cost 100,000 jobs, the government predicts a more modest 15,000 loss in jobs. Overall, Alberta's economy will shrink by about two percent in 2009.


Discussion:
1. Given the better-off condition of Canada's economy compared to other large economies, which priority should Canadian leaders be more concerned about: immediate stimuli measures or preventing large deficit spending?

Japan getting aggressive in attempts to stimulate economy

Sources: Tokyo to launch record fiscal stimulus, Financial Times; Japan ready to take lead on aggressive stimulus plan, Financial Times

The Japanese Prime Minister Taro Aso ordered his government to prepare a record $99bn (Y10,000bn) fiscal stimulus package on Monday to help alleviate the global credit crisis. The Japanese government plans to release details of the package on Friday and submit actual legislation to the Diet by late April or early May.  Aso declared that the stimulus should include measures dealing with healthcare and medical services, subsidies to local governments, a new social safety net for non-regular workers, increased use of government financial institutions to ease the credit crunch, and solar energy.

Aso also offered the International Monetary Fund a $100bn line of credit at the G20 Summit, which was described by Dominique Strauss-Kahn, IMF Managing Director, as the “biggest loan in the history of mankind.”  Japan offered an additional $22bn in financial trade assistance for developing economies.

Japan’s economy has suffered along with the rest of the world during the financial crisis. The demand for Japanese exports has fallen in recent months—by almost half in February— and the country’s GDP fell by 3.3 percent quarter-on-quarter at the end of 2008. Additionally, Japan’s industrial output was down 9.4 percent month-on-month and job availability rates are at their lowest since 1974. Japan has been actively attempting to combat the crisis and, in addition to the newly proposed stimulus package, the Japanese government has passed stimulus measures costing a total of Y12,000bn, which amounts to 2 percent of Japan’s GDP.

Questions

(1) What are potential Japanese motivations for offering so much financial aid to the rest of the world?

(2) What impact will the Japanese stimulus measures have on the Japanese economy? On the world economy?

Geithner Open to Possible Ouster of Bank Chiefs

Treasury Chief Says He's Open to Ousting Heads of Frail Banks, New York Times

U.S. Prepared to Oust Bank Chiefs, Financial Times



In an interview Sunday, U.S. Treasury Sec. Timothy Geithner said that the government was open to the idea of removing the chiefs and/or senior management teams of certain U.S. banks. Specifically, Geithner suggested that the government may require the removal of high ranking bank executives and directors as a condition of those banks receiving high levels of government aid or bailout funds.

Geithner offered the possibility of ousting bank executives in response to a question challenging the Obama Administration's choice to fire General Motors CEO Rick Wagoner while leaving bank executives untouched. Sec. Geithner first highlighted the government's (under the previous administration) decisions to change the leadership at AIG, Fannie Mae, and Freddie Mac, long before any discussion of ousting auto executives. He then made clear his--and the Administration's--willingness to remove failing bank executives, suggesting that such removals could be required "not just to protect the taxpayer but to make sure this is the kind of restructuring necessary for [the banks] to emerge stronger."

In addition to opening the door to possible leadership changes at American banks, Sec. Geithner also used his Sunday interview to fervently dispel rumors and suggestions that the Treasury Department was structuring certain banks' bailout agreements in a way that would allow those banks to circumvent some compensation limitations and requirements placed by Congress in the bailout legislation. “Our obligation is to apply the laws that Congress just passed on executive comp[ensation], and we’re going to do that.”

Discussion Questions:
1) Should the government, as part of its bailout packages, have the power to compel the removal of executives in banking, automotive, or any industry?
2) Is the government employing a double standard to the auto and banking industries?

House Passes Weaker Bill as Furor Tempers Over AIG Bonuses

Sources: WSJ, House Passes New, Weaker Bill Curbing Bonuses; NYTimes, Bonus Bill Passes House, to Republicans’ Chagrin

After the U.S. Senate effectively quashed the House of Representative’s severe reaction a few weeks ago to the announcement of AIG, which received over $180 billion of federal bailout funding, paying executives several million in bonuses, the House passed a second, less-severe bill on Wednesday. The new bill prohibits firms who received funds from the Troubled Asset Relief Program (“TARP”) from making payments to executives as part of new or existing compensation packages that are deemed “unreasonable or excessive.” The new bill also allows compensation packages approved before the enactment of TARP to be curtailed.

The bill requires that companies award bonuses and other supplemental payments according to performance-based standards set by federal regulators, including the Treasury Department, the Federal Financial Institutions Examination Council and the TARP Congressional Oversight Panel. The Treasury would have far more discretion in defining “excessive” bonuses than the previous bill allowed for.

Congressional Republicans decry the measure as unwarranted government intervention in the private sector. Some lawmakers expressed concern that the new policy would disrupt efforts to stabilize the financial sector because companies would be more inclined to pay back their bailouts more quickly in order to be able to give their executives competitive compensation packages to retain them. Senate enthusiasm for bonus curtailing has waned as reports indicate that many AIG executives have given back the controversial payments.

Questions for Discussion: Do you think the AIG bonuses are still an issue that policymakers should address? To what extent do politics (i.e., reelection and “political capital”) factor into their decisions to vote for or against this bill? Is it good policy to stand behind, even though most executives have returned their bonuses?

Mired in Recession, But U.S. Consumers a Bit More Positive

Wall Street Journal - Economy Raises Tentative Hopes a Trough is Finally in Sight
USA Today - Poll: Outlook Improving About Economy

U.S. consumer views of the economy have become more optimistic in the past few weeks as several economic indicators have brightened. 29% of respondents in a recent Gallup poll say the economy is improving; that is nearly double the percentage who said that just weeks ago. Nevertheless, nearly two-thirds of respondents felt the economy was getting worse and only 9% would classify the U.S. economy as "good".

Increased consumer optimism has blossomed on the heels of several positive (even if temporary) economic indicators. The Dow Jones Industrial Average rose for the third week in a row and has recouped 20% since it hit bottom a few months ago. Consumer spending increased by a small amount in February, and new housing has stemmed its decline.

The current recession started in December 2007, and Americans' increased optimism comes amid the 17th straight month of recession. Analysts are attempting to predict when the trough of the current downturn will occur, and they recently discovered a bit of good news: in past recessions, unemployment applications reached their peak several months before the trough of the recession. U.S. unemployment applications peaked at 650,000 in mid-March. Although that fact gives reason for optimism, overall U.S. unemployment numbers continue to climb upward. The current indicator of 8.1% is the highest in the past 25 years, and many economists predict it will continue to rise even if the U.S. economy begins growing again.

U.S. consumers continue to exhibit high levels of anxiety about their economic prospects. The personal savings rate was 4.2% in February, whereas the savings rate prior to the recession was near zero. Their anxiety appears justified: average after-tax income fell in February, as it had in several prior months.


Discussion:
1) How much does consumer confidence influence tangible economic and financial recovery?
2) Is the trough in the current recession near, or are the current indicators merely temporary ledges before further falls?

U.S. Dep’t of Treasury Unveils Details of Toxic Asset Plan

Sources: Washington Post, Treasury Unveils Details of Plan to Relieve Banks of Toxic Assets; CNN.com, Dow Jumps Almost 500 Points

Treasury Secretary Timothy Geithner unveiled details of the Obama Administration’s plan to clean up toxic assets in the financial system—the long-awaited and politically risky “Public Private Investment Plan” (PPIP). The announcement sent the stock market skyward on Monday, with the Dow gaining 500 points at its biggest one-day point gain since October 2008.

To get troubled assets off of banks’ books, the government and private investors will invest between $500 billion and $1 trillion in buying real-estate-related loans and securities from banks, using $100 billion from the Troubled Assets Relief Program, the Bush Administration’s program to rescue the nation’s failing institutions. The idea is that once the assets are off their books, banks will resume lending and the credit freeze that has crippled world economies will start to thaw. The government and private investors will hold those assets long-term and will be on the hook should the assets lose value (and stand to gain if those assets appreciate in value).
President Obama said that while the financial system is still very fragile, he believes “we are moving in the right direction.” He also commented that the PPIP will position the Treasury more appropriately to lay regulatory groundwork to prevent another crisis of this magnitude. Geithner admitted that the government is taking a huge risk with this plan but underscored that it is better than the alternatives and that “you can’t solve a financial crisis without the government taking on risk.” Treasury officials are banking on the theory that toxic assets’ values have been driven so low due to excessive fear—and not reasonable beliefs in how the economy will actually perform. The hope is that new purchases of those troubled assets will kick-start the markets to functional normally again.

The PPIP has been carefully crafted to serve three diverse goals: giving private investors plenty of incentive to buy the distressed assets, getting banks to willingly sell these assets and protecting taxpayers from unreasonable risk. Private investors could end up putting only 7% of the purchase price down with government contributions and private lenders (who will receive government guarantees). Private investors could receive up to 50% of potential profits—a stance that Treasury officials say will give government and private investors equal stakes, and more of a “we’re all in this together” feeling about the plan.

Some believe that the Treasury is giving up too much to private investors—that if the plan works, it could be very profitable and the government will not have enough of a stake to get the windfall that taxpayers deserve. Banks are concerned about the program, too—mainly that their troubled assets are worth more than current market prices and that they would be forced to incur losses on those assets if they are forced to sell now.

Questions for Discussion:

Do you think the plan will work? Reflecting on past “radical” government actions whose goals were to bring the U.S. out of recessions and depressions—such as FDR’s nearly socialist programs in the 1930s—do you think this controversial plan will bring calm and stability back to the financial markets?

Commodities Prices Rise as Investors See Inflationary Dollar

Sources:

Bloomberg - Commodities Head for Biggest Weekly Gain in 2 Months on Dollar

LA Times - Commodities Rocket as Dollar Sinks After Fed Moves

Bloomberg - Oil Climbs to Near Four-Month High, Copper Advances on Dollar

Commodities prices rose last week by the most in a several-month span, pushing upward by around seven percent. Investors shifted their money into commodities following news from the U.S. Federal Reserve that it would buy $300 million of government debt and bonds. That news prompted concerns of long-term inflation and and therefore a falling dollar.

Commodities prices had tumbled from their record high in July 2008 as the global financial crisis accelerated. Oil prices, for instance, fell from over $150 a barrel to less than $40 a barrel in the span of a few months. 

However, commodities prices recently rebounded as investors sought a safe haven from the declining value of the dollar. The Euro pushed up to 1.36 against the dollar after the Federal Reserve's most recent plan to purchase debt, which will involve essentially printing more money and diluting the dollar's value.

Oil led the jump in commodities prices, while natural gas, copper, heating oil, and cocoa also registered significant gains. Oil climbed above $50 a barrel after hitting a low of $34 in February. 

The rise in commodities prices also reflects investor optimism that the global financial crisis has hit bottom and should begin to rebound soon, or at least not fall any further.

Discussion:

1. How does the price of commodities affect nations' economies globally? Are primary-product exporting countries with relatively poor populations helped or harmed by increases in commodities prices? 

U.S. Treasury Renews Focus on Purchase of Toxic Assets

Treasury Plans to Provide Loans to Buy Bad Assets, New York Times
Geithner to Unveil Toxic Asset Plan, Financial Times

On Monday, the Obama administration, specifically Treasury Secretary Timothy Geithner, will announce plans to assist U.S. banks in removing toxic assets from their balance sheets. The long-awaited plan, which was originally set to be announced much earlier in President Obama's term, is designed to purchase, either directly or through loans, up to $1 trillion of toxic assets from banks and financial institutions. Economists and industry analysts are widely anticipating the details of the plan, as the estimated $2 trillion dollars in toxic assets, including troubled mortgages and related securities, are still widely believed to be dragging down the financial sector and the U.S. economy generally.

The plan is not expected to provide for the direct government purchase of the toxic assets, but rather will likely involve making heavily subsidized, low interest loans made to institutions who purchase the assets at government-managed auctions. While the Treasury Department, under Sec. Geithner's leadership, will be the primary steering agency of the toxic asset plan, the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) will also play roles in the administration and distribution of the funds.

In addition to the potential economic impact of the new toxic asset purchase plan, it has also become very politically significant to the Obama administration, especially Sec. Geithner. Geithner and the administration have weathered days of criticism regarding the awarding of over $150 million in federal bailout money as bonuses to AIG executives and are seen by many to be depending on a warm reception of the toxic asset plan to reverse their current political fortunes.

Discussion Questions:
1. Should further public funds be invested in private corporations?
2. Is the Obama administration's toxic asset plan a good strategy to spur economic recovery?
3. Will the political impact of the plan be sufficient to alleviate criticism of Sec. Geithner?