G20 leaders met in Pittsburgh on 24-25 September and released a communique about the path forward. It is long and covers a very broad range of issues from financial stability to climate change and to development strategies. The key message is that G20 become the top official decision-making body and the global governance scheme should reflect the 21^st century power structure, not the past, although the pace of rebalancing – quota and vote in the IMF – remains slow and uncertain.

With respect to financial stability leaders voiced a need to increase capital in financial institutions, create powerful international supervision networks to control large transnational financial institutions, create better and tougher regulation (unified across major financial centers) and control bankers compensation, to reduce excessive risk. It is also welcome that simple leverage ratio will be imposed to reduce taking excessive leverage (asset to capital) that reached 60 !!! in some large financial institutions.

We will see how implementation proceeds, as it did not come unnoticed that US leader was verbally committed to free trade and WTO agenda and at the same time levied additional duties on Chinese tires. It is not forgotten, that IMF has impressive agenda for fighting global imbalances agreed among five powerful members of the G20 in 2006, and just few months later not only abandoned the agenda, but moved fast in the opposite direction (e.g. regarding US fiscal imbalance).

So far so good, but I think that G20 leaders “forgot” about one crucial issue, that will backfire in the next few years. One of the key reasons of the present financial crisis is huge complexity of financial derivatives, which creat rsik that nobody fully understands, including creators of this risk (large banks) and including regulators. We should also remember, that prime factor leading to creation of financial derivatives is REGULATION (to avoid paying taxes, to optimize between jurisdictions, etc.)> In my view the current policy direction is towards MORE REGULATION and towards MORE COMPLEX REGULATION. For example tough regulation on bankers’ pay will immediately result in new, more complex pay structure, that will aim at maintaining income levels (which are outrageous indeed). Therefore what is lacking in the G20 policy direction is a drive towards SIMPLICITY in financial markets.

Gdy byłem wiceprezesem NBP mialem bardzo wielu gości zagranicznych. Ale jedna wizyta zrobila na mnie szczególnie duże wrażenie. To był gość ze Szwecji, który za niecały rok miał zostać członkiem Zarządu banku centralnego Szwecji (Riksbank-u), który jednocześnie pełni funkcję Rady Polityki Pieniężnej. Otóż ten ekonomista, pomimo że był świetnie wykształcony, miał za zadanie odwiedzić szereg banków centralnych na całym świecie, zrozumieć jak prowadzą politykę pieniężną, poznać środowisko bankierów centralnych. Dzięki temu był świetnie przygotowany do pełnienia funkcji bankiera centralnego w momencie obejmowania funcji wicepezesa zarządu (w Riksbanku każdy członek zarządu jest automatycznie wiceprezesem).

A jak to wygląda w Polsce. Po pierwsze, nie dość że wymienia się naraz cała Rada, co jest niedobre dla ciągłości procesu decyzyjnego i zaburza “pamięć instytucjonalną”. Po drugie, w takiej sytuacji, wyboru członków RPP powinno się dokonać co najmniej pół roku wcześniej, żeby mogli odbyć szereg dyskusji z ustępującą Radą, poznać pracowników NBP, odbyć szereg podróży do innych banków centralnych (w tym szczególnie ECB) w celu zbudowania kapitału relacji.

A tymczasem mamy polskie piekiełko. Do końca kadencji Rady drugiej kadencji zostało 4-5 miesięcy, a proces wyboru nowych jeszcze nie ruszył, co więcej dowiadujemy się z mediów, że jest kłótnia o to czy PSL mianuje 2 czy 1 członka RPP trzeciej kadencji.

Proszę porównać jakość decyzji w sprawie RPP w Szwecji i w Polsce, podobnie jest w innych obszarach sektora publicznego. Napiszcie proszę co zrobić, żeby w Polsce można było podejmować decyzje takiej jakości jak w Szwecji. Przecież to nie jest w końcu takie trudne.

Raport o stabilności sektora finansowego opracowany przez Departament Systemu Finansowego NBP jest bardzo ciekawy. Oczywiście najciekawsze są symulacje sytuacji finansowej banków w różnych scenariuszach rozwoju sytuacji gospodarczej. Poniżej krótkie podsumowanie wyników:

- jeżeli rozwój sytuacji gospodarczej będzie taki jak w projekcji NBP z czerwca 2009, bezrobocie w końcu 2010 roku wzrośnie do ponad 13 procent, co będzie oznaczało, że odsetek gospodarstw domowych z ujemnym buforem dochodowym (dochód gospodarstwa minus minimalne koszty utrzymania minus koszt spłaty kredytów)  wzrośnie z 8.7 procent w 2007 roku do 10.7 procent w 2010 roku, gdyby gospodarstwa nie otrzymywały zasiłku dla bezrobotnych ten odsetek wyniósłby 13.2 procent. Trudno ocenić czy to dużo, tym bardziej że jest rządowy program wspierający nowych bezrobotnych w spłacie kredytów mieszkaniowych. Niemniej można ocenić, że rozpoczęty w ostatnich miesiącach proces pogarszania się jakości kredytów konsumpcyjnych może w świetle wyników tych symulacji przybrać na sile i że może pojawić się nowy problem społeczny – ubóstwa pułapki zadłużenia.

Na stronach 68-72 raportu są przedstawione wyniki stress-testów dla banków. Jeżeli 5 procent terminowo spłacanych kredytów stałoby się kredytami nieregularnymi, wówczas banki o udziale około 30 procent w aktywach sektora bankowego miałoby według stanu na kwiecień 2009 współczynniki wypłacalności poniżej wymaganych 8 procent i wymagałoby dokapitalizowania. Według danych z sierpnia 2008 roku taki sam szok powodował, że banki o udziale tylko 18 procent w aktywach sektora miałyby problem ze współczynnikiem wypłacalności.

My article “There is no free zombie lunch ” has been published by opendemocracy.net. It argues that Obama plan is deeply flawed. I invite both humans and zombies to comment.

Carmen Reinhart and Kenneth Rogoff wrote one more paper comparing the past crises with the current one. This time they focus on what happends to the real economy after the crisis. Here is what they found, it is consistent with IMF research presented in October issue of WEO.

“First, asset market collapses are deep and prolonged. Real housing price declines average 35 percent stretched out over six years, while equity price collapses average 55 percent over a downturn of about three and a half years. Second, the aftermath of banking crises is associated with profound declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls (from peak to trough) an average of over 9 percent, although the duration of the downturn, averaging roughly two years, is considerably shorter than for employment. Third, the real value of government debt tends to explode, rising an average of 86 percent in the major post–World War II episodes, amid collapsing tax revenues.”

Depressed? Here is a link to some fun reading.

Just released ISM PMI index fell to 32.4%, lowest since 1980, values below 50 indicate that economy is contracting. There are also two even more worrisome bits of data: new orders index fell to 22.7% (13th consecutive month of decline) which is the lowest readig on record for this index going back to 1948! The ISM Pirces index fell to 18%, the lowest reading for the index since 1949, which indicates possibility of deflation.

In Poland just relased PMI published by RBS/Markit fell to 38.3%, employment, output and new orders posted sharp declines, largest in many years. Also prices dropped despite signifant weakening of the zloty, which indicates that price pressures are receding very fast. I suggested that MPC cut interest rate by 175bp in December to 4%, the did only 75 bp (more than markets expected anyway). Both foreign and domestic data suggest that they should cut by 100 bp in January, but MPC is a prisoner of the gradual approach and is likely to split into two 50s. As I wrote in December I see no value in delaying rate cuts when big credit crunch is coming to town, orders are falling off the cliff and price pressures are yesterday’s story.

Have you read the recent text in the Economist by once claimed the best central banker in the world, a maestro, Alan Greenspan. Here is a quote that got me thinking outside the box about how to use accounting to solve the current crisis.

“Government credit has in effect acted as counterparty to a large segment of the financial intermediary system. But for reasons that go beyond the scope of this note, I strongly believe that the use of government credit must be temporary. What, then, will be the source of the new private capital that allows sovereign lending to be withdrawn? Eventually, the most credible source is a partial restoration of the $30 trillion of global stockmarket value wiped out this year, which would enable banks to raise the needed equity. Markets are being suppressed by a degree of fear not experienced since the early 20th century (1907 and 1932 come to mind). Human nature being what it is, we can count on a market reversal, hopefully, within six months to a year.

Though capital gains cannot finance physical investment, they can replenish balance-sheets. This can best be seen in the context of the consolidated balance-sheet of the world economy. All debt and derivative claims are offset in global accounting consolidation, but capital is not. This leaves the market value of the world’s real physical and intellectual assets reflected as capital [my bolding]. Obviously, higher global stock prices will enlarge the pool of equity that can facilitate the recapitalisation of financial institutions. Lower stock prices can impede the process. A higher level of equity, of course, makes it easier to issue debt.”

Olivier Blanchard, IMF chief economist had an interview with Le Monde. If you do not read French don’t worry, below are few quotes taken from Google live translation from French to English? By the way, is translation a dying business, Google seems to be doing a decent job.

“The coming months will be very bad. It is imperative to stem this loss of confidence, revive and, if necessary, replace private demand, if we want to prevent the recession from turning into Great Depression.  Of course, under normal circumstances, we recommended that Europe to reduce those deficits.  But we are not normal times. [...]. The principle of these measures has indeed been accepted by all countries from the G20 meeting in Washington and the European summit in the Elysee that took place in mid-October.  Unfortunately, they are being implemented too slowly. The behavior of U.S. authorities lacked consistency and clarity. In Europe, the balance sheets of banks are still partly fictitious and the purchase of assets relates to negligible amounts. The result is that banks continue to liquidate their positions. They repatriate in considerable capital they had invested abroad. . It is estimated that their claims on emerging countries reached 4000 billion dollars [2872milliards euros]. Billions of dollars have left the country in recent months. [...] We need governments and central banks clearly indicate they are ready to do everything to avoid another Great Depression.  For the moment, a fiscal expansion of 2% seems sufficient.  But, if circumstances so require, States must be prepared to do more, 3% or more if necessary. We must think about now, because it is not easy to spend effectively such masses of money!”

Olivier last comment is particularly relevant. The wall of public money involved in fighting crisis topped 12 trillion US dollars (including quaranties), which is equivalent to 15% of the world GDP.  Are we using these funds wisely or as we just found that US banks that received state aid did not know where these funds went, as they were not booked properly. If we don’t do it right, the Madoff 50 billion fraud will be a peanut comparing to 12 trillion state bailout using tax payers funds.

Financial Times article reports on British FSA idea to force banks to hold 6-10% of assets in government bonds. Becasue bank hold today some 5% of assets in government bonds, it would imply a shift of GBP87 to GBP353bn from credit risk assets to government securities. One question and one observation immediately arise:

• question: what will be the impact of regulatory selling of credit spread assets on already very depressed market?
• observation: many economists have raised a question about credit standing of governments that adopted huge bailout plans, UK and USA in particular. There was a doubt whether Asian and Gulf investors will continue to fund these huge borrwing needs into 2009 or 2010. Now regulators seem to have found a perpetuum mobile. We inject state owned capital into ailing financial intitutions raised by … selling government bonds to these institutions. I need to do some math to see the net result, but it feels that corporate lending may be squeezed further, a very unwelcome outcome these days. Any thoughts?

Banking sector has expanded at a rapid pace, there are different sets of rules around the world inviting regulatory arbitrage (e.g. concentrated hedge funds locations), there is a need to discuss New Bretton Woods deal. This is a brief summary of a seminar that took place ….

…. in 1992 in Rand Institute.

Participants (including professors Aliber, McKinnon, Meltzer, and top Rand institution staff) already in 1992 noted that IMF has no real powers, that G7 process is inefficient, that GATT process ends its useful life, and called for action, especially in the unregulated banking sector. Here we are, fifteen years later facing “financial holocaust” of the Western finance. How come we did nothing, Rand paper documents that bright economists, influential ones did see the problem, and the saw it early enough.

At the time Rand journal seminar concluded that no new institution was needed and that it was enough to provide political enforcement mechanisms at the country level. But today we face financial nuclear explosion, WTO failure, countries’ failure (EU member Hungary, and rich country Iceland). So what are people recommending today, ahead of 15 November meeting between Nicolas “Che Guevara” Sarkozy (I gave him the nickname for ridiculous attempts to reverse globalization) and G.W. Bush, the worst US president on record. See Barry Eichengreen article , which recommends modest steps:

• remove regulatory argitrage
• create countercyclical regilatory measures
• increase capital requremenst

These are all good suggestions. I somehow feel that the word “modest step” does not fit today’s landscape. We badly need a bold step. Earlier, when Obama was still debating Hilary Clinton I wrote on this blog that he will become the next president, which now seems almost certain, and that it may deliver a political earthquake, a global one. So we should not hope for any new deal coming out of the meeting of the 20th century leaders. We need global change of political leadership, we need young generation, in their 30s and 40s to take over. Only when old pricks are replaced by new, young global elite, capable of sharing common vision we will have a chance to get a new deal. As Jim Rogers, cofounder of Quantum fund with George Soros said last year, in 1807 smart people moved to London, in 1907 smart people moved to New York, in 2007 smart people move to Asia. The new deal initiated by president Obama should be finalized in Beijing.