Will central banks buy real estate? Adopting Belarus standard.
Few years ago I had dinner with deputy governor of the central bank of Belarus (for those who do not now where it is, it is an Eastern neighbor of Poland, and it belongs to a club of communist countries with North Korea and Cuba). He had a permission to leave Belarus for three days and delayed return could put him to jail or at least cost him a job. Anyway, he told me the the central bank operated several sovhozes (collective farms) as the Belarus lunatic leader Lukaszenka wanted state owned enterprises to take care of those farms, so central bank has several of those.
I am reading in today’s Financial Times that Western world biggest central banks are contemplating adopting Belarus standard. They want to move into real estate. To be precise they may start mass purchases of mortgage-backed securities. Hey, this is different than owning a sovhoz, you may say. In the collateralized world there is hardly any difference, you simply hold a more diversified portfolio and you care less abut risk, sometimes you are even risk careless. So in practice buying MBS paper is no different that owning few collective farms by the central bank of Belarus.
I stick to my view presented in the previous post. Central banks should focus on safeguarding stable prices, which is at risk now, globally, and governments should manage the crisis. What we need is not increasing global money supply by half a trillion dollars, we need a well-targeted action to address the problem of confidence crisis. If bank A starts lending money to bank B only if bank A has enough liquid assets (read my lips – government paper) then swap MBS for govies. Becasue – as FT argues – prices of some MBS imply unrealistic default rates (way too high) , then governments could make a lot of money. This would be relative change (asset swap), while purchases by central bank could lead to further increase of global money supply. Central banks should be reminded about existing research which shows that on the global level acceleration of money supply will lead to higher inflation, from already elevated levels.
My advice, governments should do massive assets swaps with troubled investment banks, insurance companies and mortgage houses. Central banks should manage inflation risks.
7 responses to "Will central banks buy real estate? Adopting Belarus standard."
I’m with you on this one. Central banks should stabilize the economic by keeping the prices stable, regulating interests, decreasing unemployment in order to increase production and by many other notoriously known ‘pratiques’ to help the real estate market – I’ve chosen this point of view like I’m working as a realtor in Toronto. Now, as you ’see my view’ what do you guys think? Will central banks buy real estate?
Sir, I am not economist, so appologize for lack of understanding. What is the difference b/w the US Fed taking in MBS and giving back Treasuries in the form of a loan, and the US Treasury buying MBS and giving back cash or Treasuries? The Fed has $750B or so of Treas available to swap, and can effect long term loans, thereby cushioning price realization to the downside over long time horizon. Is either approach inflationary? Is one activity “sterilized” and the other not? Thank you. I find your views and information very thought provoking and insightful.
I am expecting that markets will remain very nervous and that few more bankruptcies are in the pipeline (after all the estimated USD600bn in subprime losses are yet to see the daylight). So it is very likely that central banks will do more, or much more, including purchases of MBS or accepting them as collateral.
When central banks buy assets, they issue cash, or credit the commercial banks account at the central bank with the appropriate amount. This in turn boosts money supply. Swapping treasuries for MBS only changes relative asset structure, commercial banks have more treasuries, central bank has more MBS. No extra cash is created.
Central banks around the world conduct monetary policy but also act as asset managers (CHina with 1.6bn of reserves, I did manage with my team US$50bn portfolio in Polish central bank). Any decision taken in the future should be seen as “asset management” one, and not as part of monetary policy implementation. This way central banks would avoid dangerous “moral hazard” risk going forward. And I believe that in the long-run public sector asset management decisions should be the government responsibility (eg. SWFs). Central banks can act as excellent asset manages only in exceptional circumstances (think of Norges bank managing Norway’s revenues from oil and gas) or Government of Singapore Investment Corporation / Temasek. GIC delivered average 9.5% annual return over the past 25 years. We need more governments (including US one) to learn from Norway or from Singapore how to manage assets in a sound manner, and we do not need central banks to adopt Belarus standard. If is very easy to implement, simply higher few smart guys managing university endowments, they did excellent job in the past and they focus on long-term returns.
I received this comment from Witold Grostal by email:
Mr Governor, I read your text with interest. Your texts are always thought provoking, so let me share some remarks.
Firstly, government bonds are govt’s liabilities and not its assets, so how can a govt swap T-bonds with a commercial bank. To the best of my knowledge govt does not hold any T-bonds. It’s the central bank that holds domestic T-bonds, but only as a collateral for a loan to a commercial bank or holds them temporarily as a consequence of a repo transaction, which means that these T-bonds have been already swapped for cash (or more broadly speaking base money). Plus central bank holds foreign T-bonds as FX reserves, but I assume they weren’t meant to be part of the swap proposal.
Besides, does it make a great difference for the society as a whole whether it is the central bank or a govt that purchases outright worthless MBS? (let’s assume for a moment they are worthless) In either case it is ultimately the taxpayer that will carry the burden, either by higher taxes (when the govt has to write off the worthless MBS from its balance sheet) or by an inflation tax (when the CB has issued money against a worthless MBS). The distribution of the cost across the society may be slightly different, but the aggregate effect is pretty much the same. There was quite an interesting text by Martin Wolf in FT on Apr 1st on that (“The prudent will have to pay for the profligate”).
Secondly, if it’s such a good business to buy now cheap MBS – as the quoted FT view and the “State as grand speculator” view implies – why don’t Saudi Arabian SWFs or other investors buy them? The above presented line of argument is based upon a notion that markets are not efficient, i.e. they don’t properly valuate assets. Saying so in times of asset prices tumbling is cheap – maybe prices’ dramatic decline is a powerful proof of markets efficiency, i.e. markets self-correction mechanism. However painful price corrections may be, it’s doubtful that they can be prevented by any govt or central bank intervention. It’s hard to prove that govts are better in valuating assets. Why? Well, ex ante no one knows what an asset will be worth in the future, but zillion profit-seeking investors are probably better positioned to guess their fair value than any team of Nobel-prized govt clerks.
Thirdly, I cannot understand why the govt should manage country’s foreign reserves. Firstly, FX reserves’ primary objective is not to make profit on it, but to guarantee the exchangeability and stability of a currency. The return on FX reserves is only a byproduct of holding them (which does not mean profit should not be maximized). If FX reserves where accumulated only for the sake of return that would mean we believe that the public sector can manage assets better than the private sector (let’s put aside cases like Norway where a government extracts a national nonrenewable treasury such as oil and should probably transform it into a financial asset and keep it for some time for the sake of public consumption smoothing – I’ll get back to it later on). You know better than me, that it is the socially planned economy that lost the race with a market economy and not the other way round.
Now, economic literature and history proves that central bank independence from the govt and parliament is a sine qua non condition for the central bank to maintain stable value of a currency. Don’t you think that all the factors that make a govt a poor currency issuer make it at the same time a poor asset and reserves manager. Not because govt clerks are less intelligent people, but because of different incentives. As an illustrative example one could easily think of the discussions some years back in Poland about using part of the revaluation provision (booked at the NBP) to finance govt spending. Leaving managing reserves to the govt would entail creating a risk that the govt would ultimately spend part or all its FX reserves on “socially desirable purposes”. Would it be welfare enhancing for the society? I solemnly doubt it. First I don’t believe govt is a good public spender, second it would most probably lead to inflation outbreak and a
significant currency depreciation (which is ultimately the same thing), thus depriving private agents of part of their wealth. Taking into account all this it’s not hard to be quite skeptical of govt’s superiority to an independent central bank in managing reserves. Hiring “smart guys managing university endowments” is no solution here, as even with these guys it would be high govt officials that would probably take decisions on strategic asset allocation, so a ‘lack of independence argument’ is still valid.
To complement the view, next to thinking about Singapore or Norway, look at some African or Caucasus countries. A national treasury (oil, gold, diamonds – you name it) and the govt management of it was a source of political tensions, if not civil war. Needless to say, giving such assets to a central bank would not probably change much in those countries, but it illustrates a more general point: public sector should in general keep out of managing assets, except the truly public ones (e.g. infrastructure) or FX reserves (which are a necessity for an exchangeable and stable currency).
Sorry for being so long, but provocative claims need broad responses
)
Thank you for your comment, it is probably better so write few shorter ones, as there may be some technical issues with long comments.
Now the merits. You are right to say that proposed “asset swap” is not a typical asset swap. It means allowing troubled bank paying for government treasuries at tenders with MBS rather than with cash. I think it is a much more transparent solution than using central bank as intermediary, because public debt goes up immediately and you see the fiscal cost of saving the banking sector.
You raise the issue how the state assets should be managed and you seem to suggest that it should be given to the private sector to manage. I agree, but the vision of the country and strategic priorities have to be set by the state. This is precisely waht Norway is doing, the set the SAA and the run many private sector mandates to manage assets in specific markets. SImilar set up is in Hong Kong or in Singapore, GIC. Now Chinese CIC is adopting similar style. You can set up state owned institution, pay very well, hire best talent and serve your country well. The problem is that in Poland (and many other countries that have socialist past) it is next to impossible today. Excellent trader, that generates systematically higher returns than the market should probably be paid around million dollars per year (75% of that should be in a form of performance related bonus). Now imagine how such proposal would be treated by media or by politicians. Governor of the central bank of Norway once said in public that he is proud that his best trader makes much more than him. We have a long way before we arrive at such level of civic society that you can see in Nordic countries.
I wrote a paper with Urszula Sowa (global reserves management) where we show that earning a bit more on vast foreign reserves may lead to higher potential output, sometimes this improvement is very significant.
Reply from Witold Grostal received by email:
Mr Governor, thanks for a prompt reply. Let me respond to your answer. The result of your proposed swap would be an increase of govt liabilities (equal to the amount of T-bonds given to the commercial bank) and an increase in assets of the govt (equal to the amount of the swapped MBS). This operation has either to be rolled-over or when the maturity of the T-bond expires (1) the MBS is either swapped back or (2) is sold in the market (some money is regained by the govt) or (3) is completely written off from the govt balance sheet (if it’s worthless). In effect, it does not increase the public debt, until it’s (2) sold or (3) written off. I agree that it’s probably more transparent than just giving cash to the stricken banks by the central bank, but the aggregate effect on a broad public sector balance sheet is similar (as both govt and central bank are parts of the public sector).
Secondly, you suggest that “the vision of the country and strategic priorities have to be set by the state”. I completely agree. I would even add that it should be a “democratic state”, as Chinese govt also sets ambitious priorities, but I doubt they fully recognize and represent the preferences of the Chinese people. But setting priorities does not mean it is the state that should realize them. Example: top priority of most countries, including Poland, should be: reaching per capita income comparable to – let’s say Norway, US, Hong Kong. Way to do it: create a market economy with sound and reliable legal system, easily enforceable property rights etc. and not state-owned companies producing everything according to three-year plans. Let’s come back to your “blackout” post. If Poland and other countries desperately need increasing their energy production capacities it should be their state’s priority (not least for the sake of low
inflation – esp. in the future when Poland has to comply with the Maastricht price stability criterion). But an energy priority doesn’t imply a govt should run powerplants or energy providers. Private sector does this job much more efficiently. Ms Thatcher was one of the first politicians bold enough to express it both verbally and in action.
You say “You can set up state owned institution, pay very well, hire best talent and serve your country well.” You’re an optimist. Well, imagine a company. The CEO knows next to nothing about the business the company operates in, the senior staff has little experience in the field and the board has a poor track record in management. Possible in private sector? Yes, but rare. What about public sector – far too common to be optimistic. Not only, in post communist countries. In my view, hiring the most talented people, paying them very well in the public sector is equally probable as a central bank effectively running sovhozs
Your today’s post on “China SWFs go shopping” is an illustrative example of the Belarussian-type policy. Why on earth should the Chinese govt purchase stakes in French oil companies or Australian banks? To make profit? OK, but why should Chinese govt decide on the allocation of so much of Chinese savings. Should it not be the Chinese people who should decide what they want to invest their savings in? Take care. W
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