Friday, October 31, 2008

Reads of the day

Nice summary from Jeff Frankel of the recent recession indicators. suggests using prices and quantities to measure health of the labor market rather than depend on unemployment. Noting that all the problems with the unemployment rate he is mentioning are exacerbated in Turkey, I'd have to say I'd agree with him. BETAM of Bahcesehir University have done some work on linking unemployment data to growth; I bet they would have been much more successful with a better labor market indicator.

Decoupling of a difficult kind- between the sovereign CDSs. Incidentally, if I didn't mess up my calculations, Italy's probability of default comes out to be 9-10%. Felix Salmon reports that we can see a similar story going on between Russia and Brazil.

David Altig of the Atlanta Fed has a couple of posts on the Fed's recently-established facilities. Part 1 looks at the commercial paper funding facility, whereas part 2 discusses the facilities targeted at money market funds.

Ft Alphaville summarizes a recent BoA reserach note that explains what the effective Fed funds rate has to do with money market funds breaking the buck.

James Hamilton and Menzie Chinn of Econbrowser summarize the latest GDP figures.

One positive aspect of the GDP figures is that we now have all the data to for the Fair model, which I had covered before. Plug the numbers in, and we have a narrow Obama victory.

International Data to Track the Financial Crisis

I've been getting a lot of questions of late on where tho find the different global indicators I've been mentioning in my blogs. Therefore, I decided to create a list of global indicators pertaining to the crisis. This will be a work-in-progress entry, meaning I will update it periodically. It'll probably look messy at first, but I hope to organize it in time.

US Data: Most US data can be found in FRED- Federal Reserve Economic Data; I prefer to access it from the St. Luis Fed web site. In addition, you can use the Statistical Supplement to the Federal Reserve Bulletin, which is a monthly publication putting together data from elsewhere on the Fed's website.

VIX: Called the Wall Street's fear gauge, VIX is implied volatility of S&P500 index options (a more detailed definition is here). You can access VIX futures market prices and volumes here.

Thursday, October 30, 2008

Reads of the day

Tod den Heuschrecken!

Zubin Jelveh goes over a recent paper that shows that not all the blame should go to the low interest rates for the jump in subprime lending. The results of the paper hint that securitization played a role as well. You can watch a video of one of the authors going over the paper.

Early in the week, Jeff Sachs advocated (among other measures) the Fed to extend swap lines to major EM, including Turkey. Yesterday, Brazil, Mexico, Singapore and Korea got exactly that. In the meantime, IMF has come with a new, sans conditions short-term lending facility for EM.

FOMC slashed the Fed funds rate 50bp to 1%, but a simple Taylor rule shows that the policy rate could well go down to zero by mid-2009.

The Financial crisis in perspective: Four quick lessons from Princeton University Press Economics books.

Yves Smith notes that financing difficulties may be obstructing trade. This is a valid explanation of the recent fall in the Baltic Dry Goods Index as well.

Another interesting one from Yves Smith: She argues that the capital plight from EM was exacerbated by prime brokers Goldman and Morgan curtailing lending to hedge funds, as the two faced tougher regulatory standards after becoming banks. I haven't looked for the actual numbers to prove or disprove her point, but the timing definitely fits.

A short history of central banking from Brad DeLong.

WSJ summarizes research on asset price bubbles, at Princeton by Bernanke protegees.

Another credit crunch multiplier: The good old money multiplier- yes, the one you've encountered in Intro. Macro.

If we were living in normal times, the steep yield curve would have meant strong growth in 2009. Here's another post on the yield curve, this one's on the famous Greenspan conundrum. And finally, decomposing the yield curve into interest rate expectations and term premium components yields (no pun intended) that it is interest rate expectations that predict recessions.

How neoclassical economists think about the crises. Their predictions on residential versus nonresidential investment have turned out to be true in the latest US GDP data.

Wednesday, October 29, 2008

deja vu all over

I don't know if it's just me, but the global financial crisis seems to me written "deja vu" all over it.

I will not dwell into the comparisons with Japan's financial crisis and lost decade; there are many excellent articles on that topic. Nor would I like to don the cynical Cynaro costume and bash developed country governments for having lectured to Turkey and other emerging markets that "markets are good, government intervention is bad". What makes me scratch my head and wonder "where I've seen all of this before" is two smaller examples from my own SOE (small open economy), Turkey:

First, as you can see in the excellent posts by Brad Setser and James Hamilton, following Fed's balance sheet has been a favorite pastime for economists. I do not want to do the guy an injustice (and I dare not, knowing he is an accomplished boxer), but Deniz Gokce made a name for himself in the 1990s with his interpretations and explanations of the Central Bank Analytical Balance Sheet. At the time, market participants tried to get a sense on where USDTRY was headed by looking at the balance sheet. In addition, with the Treasury being funded by the CBT, following the balance sheet was an important indicator where the economy is heading. Deniz Gokce the concept in a monetary policy framework in article from early 2007- for a more detailed expose, see his paper for TUSIAD back in 1995.

Second, Iceland's central bank raised interest rates 6% on Tuesday, more than reversing the 3.5% cut of two weeks ago. As an FT article reports, it was rather the IMF that raised interest rates, but the episode nevertheless reminded me of the trajectory of Turkish policy rates in April-June 2006.

Speaking of the 2006 episode, one of the factors that exacerbated the crisis then was the row that ensued on the appointment of a new Central Bank governor. A new paper finds that markets react negatively to irregular governor changes. BTW, the Serdengecti-Yilmaz transition is classified in their dataset as an irregular change...

Tuesday, October 28, 2008

Reads of the day

Quantitative easing on the horizon for the Fed?

BOE Financial Stability Report in pictures.

Nice little piece from the IMF highlighting that not all Eastern European countries are alike.

Not all commercial papers are alike either. Incidentally, the much-discussed Fed Minnesota piece (third entry) was only looking at high quality commercial paper.

IMF paper on high real interest rates in Turkey.

Is the Fed losing control of the Federal Funds rate?

Quote of the day (0n TARP): The thing about being addicted to something - like easy credit - is that generally, the best way off it is not to engorge yourself with more.

Nice summary of the academic literature pertaining to the crisis.

More on the Fed's Balance sheet from James Hamilton.

Interactive graph of the Case Shiller house price index from the New York Times.

Open Economics courses from my alma mater

Rates actually rose rather than fell after the FED started its commercial paper (CP) program. I had been suspecting of a similar effect for the TAF.

Monday, October 27, 2008

USDTRY: From parity to 2:1

Back in my days as a bank Treasury economist, I used to provide forecasts for the important Turkish macro variables to the trading and sales teams. While my forecasts for inflation, current account and the like were usually well-heeded, I can't say the same for my FX (USDTRY) and Tbill (benchmark) forecasts. In early 2008, my seemingly bearish view on USDTRY and the benchmark was sharply in contrast to the traders' (and the market's) bullish view and had become a major source of jokes (along with my losing streak of Besiktas bets- mind you, this was shortly after the losses to Liverpool and Ezikbahce).

In fact, the Treasury's lack of confidence in my asset price forecasts made perfect sense. After all, as a market economist for a little bit over a year, I was still getting acquainted with the workings of markets. Besides, there is theoretical and empirical support that exchange and interest rates cannot be forecasted over short periods of time, and for this reason, I myself wasn't eager to provide forecasts on USDTRY and the benchmark either. Still, I did the best I could, but I just could not get my analysis in line with the bullish view prevalent in the market.

I used time series models, asset pricing models and open economy macro models. I even calculated the equilibrium real exchange in six ways. Whatever I did, TRY always seemed overvalued and USDTRY always seemed poised for an upward move. At the time, the leading sentiment in our Treasury (and in the markets in general) was that USDTRY was heading towards parity, and to counter that I'd jokingly say that it was heading towards 2.

Move forward 8 months, and USDTRY, which had been close to 1.1500 earlier in the year, is now closer to 2:1 than parity. I have to admit that my analytical framework had not captured such worsening of the financial crisis and therefore, most of analyses were spitting out USDTRY in the 1.4000s by year-end. This no way proves that economic analysis is superior to market sentiment; on the contrary, rowing against markets will usually capsize your ship in the short-t0-medium run. But in the long-run, one of two things happen: 1. You die, as Keynes said. 2. If you are not dead, Economics catches up with you. Therefore, I'd still call the move in USDTRY the vindication of Economics against market sentiment.

And worst of all, worse may be yet to come, at least to emerging markets. The Economist asks the trillion-dollar question in its latest issue: What will happen to emerging economies? As much as EM currencies have depreciated, most countries, including Turkey, have not experienced a currency crisis yet. In the current highly uncertain environment, opinion has changed markedly against Turkey, which weathered the storm well early on, in a couple of weeks. The country's well-known vulnerabilities, summarized in the latest issue of the Economist, have turned it to one of the EM perceived to be prone to a crisis. In this vein, Turkish assets, which started the EM shakeover episode as relatively resilient, could see further falls.

With the godfather of currency crises (not Soros, he created one, whereas Krugman invented one, although this fact has been overlooked recently after he got the Nobel Prize for his contributions to trade theory and new economic geography theory ) reporting a likely hard landing in EM in the coming months, we may not be that far off from my USDTRY 2:1 prediction. At least, the parity, as EURUSD is known, is moving towards parity, if this'd be a consolation for market participants. They got the number right, but the currency wrong...

Sunday, October 26, 2008

Reads of the day

Two good articles on credit default swaps: In defense of CDSs and CDSs demystified

The week in pictures from Econompicdata

Marginal Revolution has plotted LIBOR and T-bills data from the Fed going back to the 70s to offer a long-term perspective on the TED spread. The moral: TED has been prone to wild swings in the past as well.

Emerging markets to get their own swap line, from the IMF.

FDIC's failed bank list for the past eight years: I counted 15 for 2008...

The credit-score conundrum: Credit scores rising along with delinquency rates.

BIS international banking statistics for 2Q08 show that the credit contraction is well underway: So much for the four myths discussion going on for the past few days.

BNP Paribas has calculated European banks' exposures to emerging markets. With troubles brewing in EM, will there be another negative feedback loop to Europe? If you want, you can play a bit with Deutche's online emerging markers default probabilities calculator, which calculates the probability of default implied in CDSs with various recovery rate assumptions.

The OFHEO home price index changes its name to the FHFA home price index, but the dismal story behind the index remains.

Saturday, October 25, 2008

A funny thing

happened to me Saturday morning. Unlike Paul Krugman, I did not wake up to find out I had won an award. Instead, when I logged in to my blogspot account to enter my take on Turkey's fiscal policy, I came across this:

To make a long story short, Turkish citizens can make a complaint of an offensive website in their local courts, and if the court decides that the website is indeed insulting Turkey, it can prevent access to the website from all of Turkey by blocking the IP and DNS addresses. Youtube has been inaccessible from Turkey (at least by using normal means) for months, and a couple of videos insulting Ataturk was all it took.

Nope, I did not travel abroad to be able to enter my blog; all I had to do was to access blogger via a VPN. But, my blog (and all of blogspot) is likely to remain inaccessible from Turkey for a long time. I guess that's all I have to say about that, except that maybe I should thank the Turkish legal system for providing some weekend entertainment.

Thursday, October 23, 2008

A bit of humor...

...while a discussion on the extent the CBT should intervene on FX markets is going on.

I was using the term rather liberally here, referring to the actions towards managing liquidity of the last few days as an intervention as well, but even a full-scale intervention would be much better than this.

BTW, correct me if I am wrong, but the guy at the far back looks like Ferhan. I guess the Europe trip was a cover-up:)

HT: Mehmet Batili via DSOFT

Tuesday, October 21, 2008

Reads of the day

Monopoly, the new version

Yet another funding facility from the Fed

Casey Mulligan summarizes the findings of a recent paper that questions four widely-held beliefs about the financial crisis. Felix Salmon responds and the Economist is not too kind, either. Anyway, one of the points they are making, the surprisingly resilient interbank lending, is also highlighted by Rebecca Wilder.

New York Fed has a new toy: A dynamic map of credit card and mortgage delinquencies

So does the FT: The Weathermap of European Economies

More on lending standards from the Big Picture: Not a research paper like the two papers that Odd Numbers discussed, but a simple introduction

Emerging markets crisis roll call from RGE

The Financial Ninja summarizes the crisis with some great (and scary) Fed charts

Summary of some recent academic writings on the crisis

How the lira depreciation looks with respect to some other EM currencies

Monday, October 20, 2008

Reads of the day

My sincere thanks to Zubin Jelveh for going over two recent papers that look at whether subprime lending standards had loosened in the last few years and find seemingly opposite results. In a little over a day after I had lamented at not having the time to read the papers, I find his excellent analysis- I have always found blogging very useful (otherwise, why have a blog), but I am impressed big time now...

I was finding it ironic for some time that USD was moving in the opposite direction of a popular exchange rate model. Rebecca Wilder starts with the same observation and concludes by introducing a new variable to include in exchange rate models.

Hedging against recession risk at prediction markets- no knowledge of finance required...

Why it pays to look inside indices: Sometimes, you get a gain mostly on one or two components of the index, as was the case in the latest US leading indicators index.

Nice, Krugmanesque model from Mark Tahoma on the incentives of households to default on their mortgage payments intentionally.

James Hamilton summarizes the latest US industrial production and Michigan consumer sentiment outturns.

Efficient? Markets Hypothesis

The US government's financial commitment to end the crisis- in a nicely laid-out graphic

Shackleton and the credit crisis (the same guy has also similar explanations of CDOs and CDSs, which can be reached from the same link)

More on Turkish FX liquidity

While I was trying to come up with some novel Turkish banking data for the Financial Econometrics class I am teaching this semester, a friend of mine in retail banking called up to ask where she could find data on syndicated lending to Turkish banks. I thought I could use the data for my class, so I took it to heart to helping my friend. Conversations with a couple of friends who analyze banks revealed that that data is not easily available, but I was halfway in my data-gathering efforts when I saw Erdal Saglam writing in Turkish business daily Referans on the same subject.

Normally, I am as naive as they come, but Erdal Saglam, whose interconnectivity is more than a CDS, and my banker friend on the same topic managed to raise even my eyebrows. So, a call to my friend and a couple of banking analysts confirmed what I suspected: Syndicated and securitized lending is likely to dry up for the rest of the year and in 2009. This, combined with the already hefty payments of banks in 2008 and 2009, means that banks are likely to continue to scramble for liquidity. In fact, I had mentioned in an earlier post that FX liquidity is getting tight in Turkish markets, and the fight for liquidity may have already begun: FX deposit rates have gone up to 7% from 5% in a matter of days.

As much as Erdal Saglam's article is right on target, it turns out that his numbers are not correct. Below are the actual numbers, courtesy of my retail banker friend, which I also confirmed with a couple of banking analysts.

Bank year-month Type Size Currency
Garanti 8-Nov Syndication 700 US$
TEB 8-Nov Syndication 240 EUR
Finansbank 8-Nov Syndication 479 US$
Finansbank 8-Nov Syndication 425 US$
Akbank 8-Dec Syndication 400 US$
Akbank 8-Dec Syndication 550 US$
YKB 8-Dec Syndication 700 US$
Vakifbank 8-Dec Syndication 200 US$
Vakifbank 8-Dec Syndication 375 US$
Alternatifbank 8-Dec Syndication 113 US$
Akbank 9-Jan Syndication 100 US$
Isbank 9-Apr Syndication 900 US$
Garanti 9-May Syndication 600 EUR
Akbank 9-Jun Syndication 500 EUR
Garanti 9-Jul Securitization 175 US$
Sekerbank 9-Jul Syndication 250 US$
Vakifbank 9-Jul Syndication 750 US$
Akbank 9-Aug Syndication 1000 US$
Tekstilbank 9-Aug Syndication 132 US$
YKB 9-Sep Syndication 1000 EUR
Isbank 9-Sep Syndication 485 US$
Isbank 9-Sep Syndication 236 EUR
Vakifbank 9-Dec Syndication 175 US$
Isbank 10-May Securitization 700 US$
Tekstilbank 10-Aug Syndication 25 US$
Tekstilbank 10-Aug Securitization 87.5 EUR
Garanti 11-May Securitization 300 EUR
Isbank 11-Jun Securitization 250 US$
Isbank 11-Nov Securitization 600 US$
Akbank 12-Jun Securitization 550 US$

Sunday, October 19, 2008

Reads of the day

Tyler Cowen gives three main underlying causes of the crisis: Global savings glut, greater willingness to take on risk and weak governance & oversight. Well, actually three and a half: There was also some bad luck involved, as these three combined to create the financial mess we are in.

Some weekend gossip: This time, it's the IMF. Felix Salmon had warned on Srauss-Kahn's lower back problem more than a year ago. Interesting side point: The WSJ article and a blog piece by Felix Salmon were the only articles on the issue I stumbled upon in in the international news sphere, whereas it made headlines in all the major newspapers in Turkey. Do Turks, being the Fund's best customer in the last few years, follow the fund too closely? Or do they just love gossip?

There is anecdotal (chats with bankers) as well as hard (latest CBT actions) that Turkish banks are scrambling for FX liquidity. You can almost hear them screaming: Where is my swap line? Brad Setser goes on to discuss the broader implications of unlimited liquidity.

Mark Tahoma summarizes the argument that has been going on between New Keynesians and neoclassical economists (or at least one neoclassical economist) on using fiscal spending to simulate the economy- would be a very good case study in an Introductory Macro class as some of the main conceptual differences between the two camps are revealed.

One of the interesting results of the predictions markets literature has been confirmed: Manipulation, by letting the wisdom of the crowds take advantage of the manipulator, can actually improve the efficiency of prediction markets- see also my recent post on prediction markets

Leading indicators and consumer sentiment are at all time lows- and not just for the US. I've been wondering whether this shift reflects the recession or is simply a side product of the recent financial turmoil. News n Economics argues convincingly that it is the former.

Nice summary of where we stand on LIBOR from FT Alphaville- also has links to many of the interesting writings of the week on the subject.

Crowding in or crowding out, that's the question- whereas the first article argues that capital injections to banks will enable banks to attract more capital, Casey Mulligan applies Ricardian equivalence to argue for the opposite.

A new working paper, discussed in Odd Numbers argues that lending standards did not decrease in the subprime market after all. But an IMF working paper had reached the opposite conclusion. I wish I had time to go over both and decide for myself...

Fed's response to the crisis, in chronological order.

One of the leading experts on US housing argues against policies aimed at trying to stop house prices falling further.

The week in pictures from Econompicdata

Death of an theorem

CDOs and CDSs explained

To close with a lighter tone: Research of the week, dedicated my buddy Hakan.

Saturday, October 18, 2008

Reads of the day: Special Turkish edition

Turkey becomes non-permanent member of the UN security council

A forthcoming paper in World Development finds that export decisions of Turkish manufacturing firms depend on exporting history, with the recent past weighing much more heavily: It'd be really nice if they dwell on the reasons in future research and distinguish between competing explanations, but you'd need a different database than the one they are using for that. I am also thinking that, after having mentioned Turkish firm-level databases twice in a row, I should write an introduction on what is out there.

Case analysis of the Turkey-US WTO rice dispute

Case study of Turkish automobile and consumer electronics industries (two major exporters)

I just noticed I might have wasted a few months of my life...

I just came across a really interesting paper by Ricardo Hausmann and company on growth diagnostics. They illustrate the problem of identifying binding constraints in an economy with the following example from the animal kingdom (Ricardo is great at coming up with such short stories for motivating his work):

"Suppose you were asking: what is the binding constraint to animals thriving in the Sahara desert? This is not unlike the question of what limits economic growth in a country. However, in the Sahara, it is instructive to note that of those few animals that do thrive in that environment, a very large proportion are camels and a very small proportion are hippopotamus. The fact that the animals most intensive in the use of water, hippopotamus, are scarce while the animals least intensive in the use of water, camels, are thriving suggests that the supply of water may be a binding constraint to the spread of animals in the Sahara.

In general, the idea is that looking at the nature of the most successful parts of the economy can be informative of the constraints that affect others. We would expect to observe that those who are either structurally less intensive in the constrained factor, or at least more able to bypass it, will be doing comparatively well. Conversely, those sectors most intensive in the constraint will be doing relatively poorly."

The idea is that surveys/interviews with firms to identify binding constraints, usually conducted with the relatively more successful companies, can take you in the useful direction because these firms are successful precisely because they have been able to surmount these constraints one way or another. For example, if such firms are reporting that customs is not a binding constraint, it may be that they bribe the officials to get their goods across, while corruption continues to be a major impediment.

At my previous life in Ankara, I spent a few months net working on the Turkey Investment Climate Assessement. In fact, we were using the TOBB database of firms, which covers all the registered enterprises rather than a limited (and therefore biased) databases such as from TUSIAD (for an extreme case of this problem, see McKinsey 2003, which used the largest firms to make inferences on whole sectors). However, by taking our sample from registered firms, we were totally ignoring unregistered firms, i.e. the informal sector (we even had a section on informality in the survey).

What is the solution? The "waste of life" in the subject was a bit of an exaggeration; the Worldbank ICA surveys have definitely been useful, at least for Turkey. But to identify the real bottlenecks in the economy, it could have been identified with the De Soto way, i.e. taking the informal sector into the picture.

Friday, October 17, 2008

Reads of the day

The Black Swan guy is stating the obvious after all (risk managers were really bad)

Brad DeLong goes over how the US tried to tackle the crisis in half a dozen ways for the past one and a half years.

The seen and the unseen of Fed policy (and a bit of Bastiat)

I have my cab driver index of economic indicators, but here is a better one: the mailman index

Estimating the damage in credit stress

Simple hedge fund outflow model

The scariest hour on Wall Street

August TIC data shows that the dollar rally in that month was not supported by inflows

Brad Setser looks at Treasury and agency holdings of foreign central banks (and does some more Fed balance sheet analysis)

Voice of a Hedge Fund

With the great hedge fund unwind underway, I thought it might be a good idea to publish a very recent investor letter of a hedge fund (the letter was written yesterday). I am skipping the boring (and private) parts on the returns of the fund and publishing the commentary on the current markets, with the manager's permission of course...

"...But we should ask ourselves, why is gold not making a stronger comeback? Gold, to many investors, is a safe haven. People demand gold as a hard asset which can protect investor’s diminishing wealth. The euro/dollar parity is showing a -9.92% drop while gold’s decline of -5.12% is less severe. The strengthening dollar contradicts skyrocketing money supplies and people are buying dollars instead of gold to shelter cash during this financial crisis.

We are going through a historic time which I believe and reiterate is the end of the credit era. The U.S. announced its bail-out plan to save the banks with a $700bn budget. European leaders pressed for an overhaul of global financial structures after Asia joined western countries in bailing out banks to avert a financial meltdown and tackle a looming global recession. Developing countries are investing directly into the banking system to insure bank deposits, guarantee certain bank debt and in some cases nationalize banks. I believe companies, mainly small and micro-cap ones, which need short term financing to continue their operations, are going to have a difficult time staying in business. Banks are not willing to lend and the customers they do lend to are being charged higher rates.

The catalyst to this lack of short term lending is Lehman Brothers. When Lehman went bankrupt, most investors, myself included, thought the bank’s failure—like Bear Stearns—was necessary to clean up the financial system. However, the most alarming development to emerge in the aftermath of the Lehman collapse centered on other bank’s money market accounts which held Lehman bonds in their portfolios. When Lehman became insolvent, investors saw an instant decline in the value of their money market accounts. Thus, people got scared and pulled their capital out. Furthermore, on the other side of the scale, banks used the funds from the money market accounts to lend short-term loans or lines of credit to small businesses and other banks. The bankruptcy of Lehman therefore, stopped lending between banks, capitulating the fall of the financial system.

The liquidity the government is pouring into the financial markets will take time to jumpstart the economy. The credit problems are beyond sub prime and will soon reveal the effects of the deterioration in the consumer credit markets. Two thirds of this economy depends on consumer spending which has tapered off considerably in the past six months. This is a very special time for the financial markets. The most important thing for investors to achieve is to preserve capital and steer clear of any unnecessary risk, as the additional systemic risk premium is still hovering in the markets.

The Meadowbrook Beta Neutral Fund is benefiting from its asset allocation model in these unstable and extremely volatile markets. Although we have experienced rough markets in the past and navigated our way through them, we are aware of the current market situation and additional risks like systemic risk, economic risk and political risk. We are confident in our processes and our investment discipline and we see great opportunity amidst this market turmoil. People make irrational decisions in chaotic markets and we are ready to take advantage of that. Once we see the markets stabilize, there will be an opportunity of a lifetime for funds like us with preserved capital and sensible risk management. Thank you for your continued support during this exceptional period.

Afsin Alp
Portfolio Manager"

Thursday, October 16, 2008

Reads of the day

Macro Man summarizes developments of the last couple of days (as I was traveling yesterday, I found it very useful to bring myself up to speed)

News from the US housing market: Mortgage rates surging and house prices likely to decline further, but it don't look that bad when compared to some other countries

Some more good news: Econbrowser summarizes a couple of recent positive developments I had linked in the past few days

While a recent paper forecasts deflation for the US, financial markets are conveying a similar message (you can do the same exercise with TIPS and you get a similar picture)

A nice and short piece on the Lehman CDS payout, which also goes over some general topics of debate surrounding CDSs.

I've been seeing a lot of comparisons of the current US financial meltdown the Japanese 1990s crisis and worries that US is about to enter its lost decade. Here's a good expose of why it won't...

...And while we are in the 1990s, let's have a look at the Swedish bailout with an article from the Economist (1993)

Is the shipping sector about to become one of the casualties of the global slowdown? At least, that's what prices are signaling

A second Q&A from two Chicago economics on the financial meltdown (the first one, which I had linked way back, is here)

Menzie Chinn shows that despite the repeated rate cuts, monetary policy is still not lax, at least if we measure it by looking at its effects on some key interest rates

From Accrued Interest: Some more credit market indicators- here is a repost of an earlier one from Calculated Risk

Wednesday, October 15, 2008

RGE: How Risky is Turkey's Current Account Deficit?

RGE analyst Mary Stokes just published a short piece on Turkey's current account (or rather external financing) vulnerabilities. Other than a couple of minor points such as her statement that "any deficit above 5% starts to ring alarm bells", I don't have major objections to the article, and the the projections she is reporting are in line with the forecasts of local economists I trust. The only point that needs to be added is the resilience of corporate borrowing so far, which, in light of the current financial turmoil, emerges as a conundrum (too much exposure to GreenspanSpeak can be hazardous to your English, such weird words never came to my mind before reading his autobiography a few months ago) . And in fact, with the projections of other parts of the capital account more or less evident, whether this resilience will continue is the million-dollar question. But before answering that question, some quick facts on Turkish corporate borrowing:
  • Corporate borrowing is at around USD 125bn (as of end-June), of which only 20% is short-term. Moreover, at the end of 2007, more than half the debt had a maturity of five years or more. Thus, Turkish corporate sector is unlikely to be exposed to a roll-over problem even if funding dries up.
  • The Central Bank calculates the currency mismatch at USD 70bn (as of end-March), but this does not take into account that the owners of these companies hold significant FX. Fortis economist Haluk Burumcekci and his team calculate the currency mismatch of corporates and individuals at USD 5.9bn as of end-June.
  • Again, CBT reports that foreign borrowing of corporates is extremely concentrated, with around 60% of borrowing in the services sector (40% of which in real sector) and 70% in 250 firms.
Where does all of this leave us? Certain sectors and large corporates could be under risk, but the danger is nowhere near as the media hype a figure of USD 125bn is bringing.

Back to the million-dollar (or 125 billion dollar) question, we could first ask if corporate borrowing in other comparable countries were just as resilient: A casual look at data suggests that Turkish corporate borrowing was indeed more resilient than Eastern European countries with large current account deficits, but there were definitely others such as Brazil with robust corporate borrowing in the first half of 2008. Then, we may postulate that there was some liquidity available in the first three quarters of this year, some of which made its way to corporates in Turkey and other EM. However, it'd be childishly optimistic to expect for the same pattern to hold up in 4Q08 and 2009.

My friends at Istanbul Analytics offer another, really intriguing explanation of the resiliency of corporate borrowing: They argue that "Turkish exports have been underestimated for years, and lots of money has been kept abroad as a result, in forms that are difficult to capture in the International Investment Position surveys. These assets are now being round-tripped to the Turkish economy as loans, to avoid financial taxes and disclosure requirements." Leaving aside the obvious question "why now", I tried to validify their theory by comparing Turkish export data with UN import data country by country (i.e. comparing Turkey's exports to Germany with Germany's imports from Turkey). Simple descriptive statistics reveal that the data are indeed rather different, but I did not continue with the exercise because the differences could just be do statistical errors rather than underestimations. I vaguely remember a reference in the Feenstra Advanced Trade book of a paper undertaking a similar task, so once I come up with an appropriate methodology, I'll come back to this exercise. Until then, the 125 billion dollar question remains unanswered...

Tuesday, October 14, 2008

Reads of the day

Some indicators for tracking the credit crisis (you know how I feel about LIBOR, but I have no problem with the rest)

While most economists critical of the original Paulson plan like recapitalizing banks, there is an important dissenter

My favorite Krugman post

Ice Age applied to bubbles, a la Krugman (my second favorite Krugman post, just reads like one of his brilliantly tractable models)- via Economist's View

Ian Ayres talks about what we still don't know about the subprime crisis and Shiller's The Subprime Solution(s) (see also my review)...

...While in a recent paper, Gary Gorton explains what we know (the best summary I've seen so far)

Speaking of Shiller, a recent WSJ article talks about his Graham P/E measure, named after Great Depression investor Benjamin Graham. Bob Shiller is a great student of economic history and is brilliant at bringing to light such things into light.

Dr. Doom continues to be pessimistic

How one of US Treasury's recently acquired toys can help value mortgage-related assets

Graph of the day: Factors adding to reserves and off balance sheet securities lending program (via The Big Picture)

A new paper shows that countries accumulate reserves as a precaution not for sudden stops but for "sudden flights"

This year's events have suggested that Bernanke may have been right on two important questions on the Great Depression, but Brad DeLong notes that he probably would have preferred to be wrong

Quote du jour (in French to make up for yesterday's zhe deflation)

If I die and am reincarnated, I'd like to come back as the bond market so that I can intimidate everybody...

I'll definitely be following my favorite bond market blog today

Monday, October 13, 2008

Reads of the day

We were warned on the mortgage crisis. Becker and Posner offer their takes on why the warnings were ignored, not just for the mortgage crisis but throughout the financial meltdown.

The role of informational cascades on the road to the financial crisis, a la Shiller

Central Banks announce unlimited liquidity

The credit crisis is spreading to credit cards and auto loans

Policymakers are thinking of easing rules on mark-to-market accounting, but it may not be such a good idea

News from the US Real Street: Retail sales continue to look bleak, but mortgage loans have surged in the last two weeks

Zhe deflation is coming (at least for the US)- sorry for the misspelling, I just watched the original Pink Panther)

Prediction Markets: US elections and Economics Nobel Prize

What do the Nobel Prize in Economics (actually the Riskbank prize in honor of Alfred Nobel), to be announced in a few hours, and US elections have in common? There are active markets for both where anyone can bet on the outcome of each of these events.

Prediction markets, as such markets are known, offer a wide spectrum, from large for-profit exchanges (Betfair and Intrade) to the non-profit (Iowa Electronic Markets). There are even prediction markets where all winnings go to charity (Bet2Give) and where no actual money is used (Hollywood Stock Exchange, NewsFutures). In fact, there is even a Prediction Markets Industry Association now.

Political prediction markets have been with us for quite a while; a recent paper traces the origins of betting on political outcomes to 16th century Italy and notes that betting on US elections was common until WWII. So we are in fact seeing the revival of a quite old trade. As I have been looking at what prediction markets/betting exchanges are predicting for US elections, I've come across an interesting phenomenon; in almost all markets covering elections, I've been seeing the reversal of fortunes in McCain and Obama, with a slight McCain lead in early September now transformed into a huge Obama lead. Of course, political analysts can come up with many reasons on this shift, but let me present an economic view: Yale economist Ray Fair has had an econometric model that predicts the outcome of US elections for more than two decades. You have to read the one of his papers to get all the details (I recommend the 1996 version), but his main insight is that current economic conditions determine the fate of the incumbent party. In my first year studying Economics (with Ray Fair himself), I was really confused by the results of the model after learning that the US economy is affected by business cycles rather than policy decisions in the short-run. Talk about the rational voter... Anyway, Fair allows us to compute our own predictions for the 2008 election using his 2004 equations. It is true that the US outlook for 2008 has really worsened in the past month, with all the forecasters including the IMF adjusting their outlook for the economy sharply downwards. However, to get the numbers currently in prediction markets, we would need a huge contraction in 2008! What is going on? For one thing, prediction markets are merely predicting the odds a candidate will win, not the number of electoral seats or percentage of votes he is expected to win, so direct mapping from prediction markets to the FairModel is not possible although it is possible to extract probabilities from odds. Call it wishful thinking if you want to, but although I am aware that the 30-point jump is difficult to be justified by economic outcomes alone, I feel that at least some of it is due to the the rapidly changing perceptions on the fate of the US economy.

The discussion in the previous paragraph, however, raises a more general question on the reliability of prediction markets. This is the subject of a literature survey piece, into which I do not dare to delve, but my quick skim of the literature did not provide a definite answer: For every paper that shows that prediction markets work, either theoretically or empirically, I was able to find another one that reports they don't. We may decide to heed the old saying that people will put their money where their mouth is and look only at markets where actual money is being exchanged, but there is research that shows that virtual markets fare no worse than actual ones (Disclaimer: Two of the authors are affiliated with NewsFutures, a virtual market and a firm that set us private virtual markets for companies, but anyone questioning the validity of their findings is full of bollocks, sorry Justin, just had to squeeze this in). One can also argue that some prediction markets are suffering from lack of liquidity, but in a recent paper, Paul Tetlock of Columbia University finds that limit orders may cause more liquid markets to be less efficient, i.e. deviate further from outcomes. So where does all this bring us to? My understanding of the literature is "prediction markets definitely reveal some information, but use it at your own risk", at least for now... I'll definitely continue tracking them, but I am unlikely to depend on prediction markets as my sole sources for forecasts.

Coming back to the Nobel Economics prize, what are prediction markers revealing? NYT Economix blog is listing the latest odds from some betting exchanges, whereas Greg Mankiw is reporting the results of the Harvard Nobel Prize Pool. I guess we'll know which market is the most efficient for this particular event soon...

Sunday, October 12, 2008

Reads of the day

A simple bailout proposal/model from Mark Tahoma

Some misconceptions about the Credit Default Swaps markets

The G7 Action Plan to combat financial turmoil: Someone is rightly not very happy...

How to jump-start the interbank market

More doubts on whether LIBOR-based measures are accurate indicators lending strains

The Fed's latest custodial data is showing that central banks are taking shelter in US Treasuries

Shiller: The Subprime Solution

As I mentioned before, books on the financial crisis have started to appear even though markets and the world economy may not have hit rock-bottom yet. Robert Shiller's The Subprime Solution, as its title suggests, does not claim to be a comprehensive guide to the financial meltdown, but an expose of where it all began, i.e. subprime lending. However, it even does not cover all aspects of the subprime meltdown such as the repackaging of the mortgages and the plunge in mortgage-backed securities in the early stages of the financial crisis. The book's span is limited to the surge and subsequent fall in home prices and its effect and subprime borrowers. However, this narrow focus turns out to be the book's major strength, as it allows Shiller delve into topics he has worked for the past 20 years and where his real expertise lies without getting off-track.

In the first part of the book, Shiller traces the roots of the crisis at the housing bubble driven by what he has called before irrational exuberance before offering solutions. While the ideas expressed here will not be new to those familiar with Shiller's previous work, his solutions, classified as short and long-run, are definitely worth a look. Whereas the short-term solutions focus on a bailout to mortgage borrowers, the longer-term solutions, which are the more thought-provoking, are organized around two main themes: Shiller first concentrates on institutions towards a more efficient information infrastructure such as a system for comprehensive financial advice for all (not just the wealthy), a new financial watchdog, default-option financial planning, improved financial disclosure & databases and new economic units of measurement to take into account rising prices and incomes. Then, he goes on to suggest new markets for risk management such as real estate derivatives markets, mortgages adjusting in response to an individual's ability to pay and changing economic conditions, insurance against a fall in her earning potential and home equity insurance.

While his suggestions of new markets, some of which have appeared in his earlier work, are indeed novel, it seemed to me that they would be difficult to implement in the current information infrastructure. For example, while real estate price indices (initiated by Shiller himself) do exist, better data and more educated individuals would be needed for the proposed markets to function properly. In this sense, his suggestions for a more efficient information infrastructure seem to be necessary conditions for his markets for risk management. I believe the book would have benefited more from the explicit exposition of this link between the two types of long-run solutions.

Shiller's unique style of using interesting anecdotes to illustrate his points, in the same vein as his earlier books such as Irrational Exuberance and The New Financial Order: Risk in the 21st Century, keeps the book interesting. Although he is an accomplished economist with many important contributions, anecdotes such as a luncheon with Turkish investors in Ozdere and origins of the term "bailout" enable him to convey his ideas much better than a literature survey would. In fact, such quotes were exactly what Shiller was looking for when I RAed for him during his early research on indexation.

As the World is focused on illiquid interbank markets and more importantly financial meltdown & global recession, Shiller's latest book enabled me to pause and look back to the subprime crisis of 2007 with a book that is both thought-provoking and enjoyable...