Category Archives: Financial Crisis

China just made a key preparation for disaster in its economy

China has given its bond traders the go-ahead to begin trading credit default swaps (CDS), an indication that the government is preparing for more big corporate bankruptcies, Bloomberg reports.

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Credit default swaps allow investors to insure themselves against the default of a given security.

China develops rules for credit default swaps as bankruptcies loom – Business Insider

Is China Building a Road to Ruin? – WSJ

But at what cost? A report by four academics at the University of Oxford’s Saïd Business School has created a stir by arguing that what outside observers often hail as a towering strength of the Chinese system has instead led to colossal waste. All this construction, they say, has produced cost overruns equal to one-third of China’s $28.2 trillion debt pile in 2014, and unless China scales back it is “headed for an infrastructure-led national financial and economic crisis” with global ramifications.

Examining data on 95 road and rail projects, the authors say cost overruns are typically about the same as in democracies, and although China handily wins on speed it comes at the expense of quality, safety and the environment.

Most of the finished routes carry paltry traffic; a few are clogged. Either way, the outcome is grossly inefficient.

Is China Building a Road to Ruin? – WSJ

We are still groping for truth about the financial crisis – FT.com

But post-crisis reforms may have robbed the Federal Reserve of precisely the powers it will need to avert the next Lehman. That, according to a fascinating new book, Connectedness and Contagion, by Hal Scott of Harvard Law School, is because of a final truth we thought we knew — the crisis of 2008 was not what we thought it was.

Mr Scott says correctly that the popular explanation for the crisis was “connectedness” — the domino effect when the failure of one institution leads to failures of others that lent to it or relied on it for funding. Attempts to make banks hold more capital and indulge in fewer risks, and to regulate those that are “systemically important” revolve around attacking connectedness.

But Mr Scott shows that none of the banks that fell or were rescued were important enough to another big institution to cause its failure. Instead, Lehman nearly brought down the financial system through “contagion”, or the fear of connectedness. That led short-term funding markets on which banks relied for funding and which paid company payrolls, to dry up as trust evaporated. Contagion is about basic psychology.

We are still groping for truth about the financial crisis – FT.com

Amazon.com: Connectedness and Contagion

The Dodd–Frank Act of 2010 was intended to reform financial policies in order to prevent another massive crisis such as the financial meltdown of 2008. Dodd–Frank is largely premised on the diagnosis that connectedness was the major problem in that crisis — that is, that financial institutions were overexposed to one another, resulting in a possible chain reaction of failures. In this book, Hal Scott argues that it is not connectedness but contagion that is the most significant element of systemic risk facing the financial system. Contagion is an indiscriminate run by short-term creditors of financial institutions that can render otherwise solvent institutions insolvent. It poses a serious risk because, as Scott explains, our financial system still depends on approximately $7.4 to $8.2 trillion of runnable and uninsured short-term liabilities, 60 percent of which are held by nonbanks. Scott argues that efforts by the Federal Reserve, the FDIC, and the Treasury to stop the contagion that exploded after the bankruptcy of Lehman Brothers lessened the economic damage. And yet Congress, spurred by the public’s aversion to bailouts, has dramatically weakened the power of the government to respond to contagion, including limitations on the Fed’s powers as a lender of last resort. Offering uniquely detailed forensic analyses of the Lehman Brothers and AIG failures, and suggesting alternative regulatory approaches, Scott makes the case that we need to restore and strengthen our weapons for fighting contagion.

Amazon.com: Connectedness and Contagion: Protecting the Financial System from Panics (MIT Press) eBook: Hal S. Scott: Kindle Store

5 Ways the Global Economy Could Slide into Another Great Depression | The National Interest

Forget the sub-prime crisis: another global depression could see millions thrown out of work, thousands of bankruptcies and severe losses in trade and financial markets that could bring the world economy to its knees.

Think it won’t happen? Here are five ways the world could enter another Great Depression: Hard Brexit, US protectionism, China slump, European implosion and emerging market debt.

5 Ways the Global Economy Could Slide into Another Great Depression | The National Interest

An Italian financial crisis poses huge threat to global economy – AEI

… Italy today checks practically every box for the making of a full-blown economic and political crisis within the next year or two.

For a start, since adopting the euro in 1999, the Italian economy has amply demonstrated that it is incapable of maintaining international competitiveness or generating meaningful economic growth. Worse yet, since 2008, the Italian economy has experienced a triple-dip recession that has left the country’s gross domestic product (GDP) at around 6 percent below its 2008 pre-crisis peak and its unemployment rate at over 11 percent.

Not surprisingly, years of economic recession have blown a massive hole in the Italian banking system’s balance sheet. It is estimated that Italian banks now have around 360 billion euros in nonperforming loans, which amounts to a staggering 18 percent of their loan portfolio. If that were not bad enough, the Italian banks also hold unhealthily large amounts of Italian government debt, which now totals more than 10 percent of their overall assets.

An Italian financial crisis poses huge threat to global economy – AEI

Deutsche CEO: Negative rates have ‘fatal consequences’

While intended to spur growth by directing money away from safe-haven investments, negative rates instead have spurred higher savings rates and economic unease among Europeans — essentially the opposite of their intended purpose. Japanese government debt up to 10 years in duration also carries negative yields.

Cryan said the ECB deserved praise for rescuing the economy during the financial crisis, but it has gone too far.

Deutsche CEO: Negative rates have ‘fatal consequences’

People must save even more money because they aren’t earning anything at the bank. Also, insurance companies are in trouble because they can’t earn much either. Negative interest rates will eventually cause a crisis.

Savers hit by negative rates are starting to store their cash in safes: S&P

“In Japan, we have got anecdotes that safes are actually being purchased for the storage of cash, much more so, because in Japan, there is a high propensity of the net households having a greater degree of savings and so instead of putting it in a bank deposit, they are keeping it under the mattress or basically in a safe,” Andrew Paranthoiene, director at S&P Global Ratings, told CNBC in London on Friday.

Media reports suggest sales of mini-vaults to Japanese consumers have risen since the Bank of Japan introduced negative rates earlier this year.

Commerzbank and Munich Re in Germany have also considered stashing physical cash, according to media reports.

Savers hit by negative rates are starting to store their cash in safes: S&P

Global interest rates lowest in 5,000 years – SmartCompany

Yes, you read that headline right and, no, it’s not a typo!

Global interest rates are now, rather stupendously, at their lowest level in 5,000 years.

Bank of America Merrill Lynch came to this conclusion as it compiled some very impressive research for the latest edition of its Longest Pictures report, which included more than 100 charts tracking such things as ownership of financial assets, returns, volatility and valuation since 3,000 BC.

Global interest rates lowest in 5,000 years – SmartCompany

The extremely low interest rates should tell you that something is seriously wrong with the world today. And what is wrong today is likely to get worse before it gets better.

Why negative interest rates are mad, bad – and dangerous

The biggest problem with negative rates, though, is that the policy is so weird and unnerving that it could actively discourage the very private-sector investment we need to get the big western economies back on track. Bemused by negative rates, many business bosses will be spooked completely if we venture even further down the monetary rabbit hole, and use so-called ‘helicopter money’ — with the authorities putting new money directly into every citizen’s bank account. Yet, incredibly, such measures are on the cards.

‘It would be so nice if something made sense for a change,’ says Alice, in Lewis Carroll’s classic. She could have been talking about 21st-century central banking.

Why negative interest rates are mad, bad – and dangerous

Student Loans And The Coming Financial Crisis – Forbes

Two points here, one relating to colleges, the other to the broader economy. First, there is overwhelming evidence that the main beneficiaries of the student loan programs are not students, but rather university bureaucrats, professors, and others who have captured the loan money via higher tuition fees that are then dispersed within the university community. While the programs have expanded college enrollment somewhat from what would exist otherwise, that has simply added to the massive underemployment problem – college graduates doing jobs requiring few skills. We are sending kids to colleges in massive numbers to enrich some adults (college administrators and senior professors), only to be consigned to a future with big debt burdens. The solution isn’t ending the burden through de facto forgiveness of loans, but rather to stop the loan programs in the first place. Reverse our overinvestment in higher education.  In terms of financing students, it is time to initiate Income Share Agreements (students selling equity, not debt, in themselves), or at the very least force colleges to have skin in the game where loans are made.

Student Loans And The Coming Financial Crisis – Forbes

As China prepares to host the G20 economic summit, fears for its own economy grow

Oppressive heat and humidity in my part of the country finally broke this week in a giant storm that, despite its destructive power, came as a relief. In some ways, the global economy feels as if it’s waiting, too.

Climbing stock markets notwithstanding, many have recognized an ominous feeling of escalating pressure that may need a crisis to bring things back into balance. Some commentators, including billionaire investor George Soros, have hinted that China is ready for a storm.

“I think there’s an eerie resemblance of what’s happening in China to what happened here leading up to the financial crisis, 2007-2008,” Soros said during an Asia Society event in New York earlier this year. “It’s similarly fuelled by credit growth and an eventually unsustainable expansion of credit.”

Waiting for a China crisis to reset the global economy: Don Pittis – Business – CBC News

America’s Brewing Debt Crisis | Foreign Affairs

Both criticisms distract from the real problem with the act, which is that it left some key problems unaddressed. In dealing with reckless lending and excess leverage, it misses one of the most important causes of the crisis: “runnable liabilities,” or short-term debt that the govern­ment does not insure. The U.S. financial sector holds trillions of dollars of such debt, including uninsured bank deposits and the short-term liabilities of other financial institutions, such as overnight loans. What makes this kind of debt so dangerous is that during a crisis, short-term lenders, unlike long-term ones, can demand their money back imme­diately, leaving borrowers unable to pay all their creditors quickly. The financial sector stops lending money, credit dries up for consumers and businesses, and the economy grinds to a halt. This is what happened in 2007 and 2008, when massive runs on short-term debt spread panic throughout the financial sector and helped trigger the Great Recession.

America’s Brewing Debt Crisis | Foreign Affairs

A year after the crisis was declared over, Greece is still spiralling down | Business | The Guardian

Against a backdrop of monumental debt – €320bn, or 180% of GDP, the accumulation of decades of profligacy – fatalism is fast replacing pessimism on the streets. “Our country is doomed,” sighs Savvas Tzironis, summing up the mood. “Everything goes from bad to worse.”

Close to half a million Greeks are believed to have migrated since the crisis begun, thanks to the searing effect of persistent unemployment (at just under 24%, the highest in Europe) and an economy that has shed more than a third of its total output over the past six years. The nation has been assigned some €326bn in bailout loans since May 2010 – the biggest rescue programme in global financial history. Yet the fear that it is locked in an economic death spiral was given further credence last week when Eurobank analysts announced that consumption and exports had also fallen, by 6.4% and 7.2%, in the second quarter of the year.

A year after the crisis was declared over, Greece is still spiralling down | Business | The Guardian