Bloomberg writes on the difference between writedown and credit loss:

Investment banks and the investment-banking units of financial conglomerates mark their assets to market values, whether they’re loans, securities or collateralized debt obligations, and label that a “writedown” when values decline. Commercial banks take charge-offs on loans that have defaulted and increase reserves for loans they expect to go bad, which they label “credit losses.” Commercial banks can have writedowns on holdings of bonds or CDOs as well.

• European banks whose losses are smaller than $1 billion each are in this group: ING Groep, Allied Irish Banks, Bradford & Bingley, Aareal Bank, Deutsche Postbank, Lloyds TSB Group, Standard Chartered, Northern Rock, HBOS, Dexia, WestLB, Commerzbank, NordLB, Rabobank, HVB Group, Sachsen LB, Intesa Sanpaolo.
• Asian banks with writedowns smaller than $1 billion: Mitsubishi UFJ, Shinsei, Sumitomo Trust, Aozora Bank, DBS Group, Australia & New Zealand Banking Group, Abu Dhabi Commercial, Bank Hapoalim, Arab Banking Corp., Fubon Financial, Industrial & Commercial Bank of China, Citic International, BOC Hong Kong, Bank of East Asia.
• Canadian banks included in this group: Bank of Montreal, National Bank of Canada, Bank of Nova Scotia, Royal Bank of Canada.

• AIBD – Association of International Bond Dealers, now ICMA.
• BIS – Bank for International Settlements
• EBR – European Bank for Reconstruction and Development
• ECB – European Central Bank
• EIB – European Investment Bank
• ECSDA – European Central Securities Depositories Association
• IASB – International Accounting Standards Board
• IASC – International Accounting Standards Committee
• ICMA – International Capital Market Association
• IMF – International Monetary Fund
• ISSA – International Securities Services Association

More can be found here

(This skepticism edges on the border of radicalism, for instance when he assaults the environmentalist movement and compares them to communism and nazism, without understanding the political economy governing global environmental regimes.)

In his article, he calls for a return to the Gold Standard. The standard argument against a return to the Gold Standard is that the volume of gold does not grow fast enough as the volume of money that is needed for the economy to grow. To fix that problem, Reisman proposes to set the price of Gold held at the reserve at about 12.700 US-Dollars and then assign this gold to the banks holding deposit accounts and other type of highly liquid assets.

Unfortunately, he does not discuss one prominent problem with the Gold Standards: most of the US-Dollar-Reserves are not held by commercial banks inside the USA, but by Central Banks outside the USA. Would the Fed really hand over their gold (even if it stays in their vault) to the Chinese Central Bank, for instance?

Reisman also discusses the vicious circles of highly-leveraged financial markets and how deflation can spread through an economic system. What is particular interesting are how the losses occured from loans in subprime mortgage market can have a more detrimental effect on the economy as whole (his full argument is present in the CMAP, click on the picture).

First, from bond-insurers to credit-rating-agencies to banks:

[B]anks’ capital now hinge[s] on the survival of bond insurers striving to insure more than two trillion dollars of outstanding bonds on the basis of capital of their own of roughly ten billion dollars. Collapse of the bond insurers would mean that credit-rating firms [...] reduce the ratings of all the bond issues [...] deprived of insurance coverage. [...] [L]ower credit ratings would make them ineligible for purchase by numerous investors, such as many pension funds. [If these] bonds were owned by banks, the value of the banks’ assets would be correspondingly reduced [...]

Secondly, from banks to prime-mortgage-lenders:

As the result of losses sustained in subprime mortgages, banks and other lenders could no longer provide funds as readily for the purchase of prime mortgages. The resulting few percent drop in the value of prime mortgages has served to wipe out the entire capital of prime mortgage lenders whose capital was so highly leveraged that it constituted an even smaller percentage of the value of their assets than the few percent drop in the price of those assets.

Thirdly, from the prime-mortgage-lending market to government-sponsored lending market:

The liquidation of the assets of such lenders, which consisted mainly of prime mortgages, has meant a further fall in the price of prime mortgages, to the point where the credit even of the government-sponsored mortgage lenders Fannie Mae and Freddie Mac has come into question. [...] The Federal Reserve’s rescue of Bear Stearns can be understood in part in the light of its desire to avoid further declines in the assets and capital of Fannie Mae and Freddie Mac, which would have resulted if Bear had had to sell off its holdings of mortgages.

Fourthly, from banks to the business needing credit:

The decline in the assets and capital of banks [...] reduce[s] the ability of banks to lend money to borrowers to whom they would otherwise normally lend. The effects of such credit contraction [...] be seen in the growing difficulty even of sound firms to obtain financing required for expansion.

Fifthly, from the banks credit contraction to a multiple credit contract because of minimum capital requirements:

[R]eductions in the capital of banks can result in multiple contractions of credit. [...] [B]anks are normally required to possess capital equal to five percent of their outstanding loans and investments. [...] [R]eductions in banks’ capital below the five percent level have the potential to result in contractions of credit twenty times as large, in efforts to reestablish the five percent ratio.

Sixthly, from multiple credit contraction to reduction of money supply

Credit contraction by banks [is 9reducing the outstanding volume of checking deposits in the economic system and [...] the quantity of money in the economic system. [...] If those banks do not then make equivalent new loans, accompanied by the creation of equivalent fresh checking deposits for new borrowers, the amount of the checking deposits used to repay the loans simply disappears.

Seventhly, from money supply to business earnings to business spending to wages to private consumption:

Such contraction of credit and money operates to reduce the amount of spending in the economic system. Money no longer spent is business sales revenues no longer earned. A drop in business sales revenues, in turn, causes a drop in spending by the firms that would have earned those sales revenues. This further drop in spending reduces both the sales revenues of other firms, namely, those that would have supplied the firms in question, and wage payments to workers, as employees are laid off in the face of declining sales. And, of course, as wage payments fall, so too does the spending of wage earners for consumers’ goods.

Eightly, from decreased spending of businesses and consumers to banks:

As the sales revenues of business firms decline, so too do their profits and their ability to repay debts, including debts to banks. The resulting further declines in the value of bank assets further reduce the capitals of banks, causing more credit contraction, further reductions in the quantity of money and volume of spending, and still more reductions in the asset values and capitals of banks, on and on in a self-reinforcing vicious circle.

The message is clear: a small loss in a small share of the market can result in a contraction of the whole economy through various feedback loops.

The G-7 meetings are ‘potentially’ the most important in the world. This is the gathering of Finance/Treasury Ministers and Central Bankers of historically the seven most economically powerful nations.

There is a big gap, however, between potential and reality when it comes to fixing the problems in financial systems. Central bankers will not permit it.

[...]

With people who run the Bank of Italy, the Bank of Canada and the US Treasury today having close ties to Goldman Sachs, there is not a snowball’s chance in Bahamas that the endemic conflict of interest issue in financial services, which is the heart and soul of the problem, will ever be addressed.

So the pabulum fed to the public from the G-7 is an insult to our intelligence. Unless and until these most powerful governments take control of their treasuries from central bankers, their capital markets will continue to sink into an abyss where bankers will suck dry the wealth and the dreams of the People until they rebel.

Unfortunately, he does not go more into the argument of the diverging interests between Central Bankers and Finance Ministers. Finance Ministers in the history of the G7 have always tried to bring the Central Banks at the same table, and with the Financial Stability Forum even the regulators sit at that table.

There are two explanations for that:

1. Finance Ministers don’t understand the often technical questions related to financial regulation.
2. Finance Ministers don’t want to be involved in the sometimes uncomfortable dealings of monetary policy and need ’scapegoats’ to blame for unpopular decisions like deflation.

The truth, as always, is in the middle. Most finance ministers know quite well the technical and legal details of financial regulation, although there are exceptions. Nevertheless, supervisory agencies and central banks often have a more direct access to markets than the political bodies, thus they are more informed and maybe more sensitive to what is happening in the markets. That is why the Bank for International Settlements as Bank for Central Banks still plays such an important role in the Financial Architecture .

Good financial regulation needs to have an ear at the market, otherwise it will be ignored by market participants. The conflict of interest is not really between finance ministers and central bankers, but between good intentions and bad outcomes.

Bill Cara has a point though, as Central Banks are often more inclined to listen to large commercial banks than to other participants in the markets. Would the US Fed bail out a monoline insurer? Maybe not, but certainly an investment bank.

In addition to that, it is quite convenient for Finance Ministers not to be responsible for Monetary Policy or Financial Regulation. It allows some rather uncomfortable decisions to be made by “neutral” bodies.

The April 11 statement was “not very different” from the importance of the 1985 Plaza Accord.

The Plaza Accord reached by the G7 in 1985 refers to a joint intervention in the Currency Markets against the stark appreciation of the US-Dollar in the 1980s. If the comparison is right, then Finance Ministers and Central Bank Governors have agreed to intervene into the currency markets to stabilize the value of the dollar.

Log nominal value of US dollar against other major currencies. NBER defined recession dates shaded gray. Source: Federal Reserve Board via FRED II via Econonbrowser.

Menzie Chinn at Econbrowser discusses the article and is skeptic about the capability of G7 finance ministers to intervene in foreign exchange markets:

• Policymakers, especially finance ministers, have limited means to affect exchange rates directly. [...]
• The evidence that sterilized intervention works is actually more mixed than is commonly allowed. [...]
• When effects of intervention have been identified, they typically (although not always) seem to be of a short term nature. [...]

Prof. Chinn goes on to quote from Owen Humpage’s “Government Intervention in the Foreign Exchange Market” (2003):

Sterilized intervention affords monetary policy makers a means of occasionally pushing an exchange rate in a desired direction. The alternative level then serves as a new starting point for a random walk process compatible with existing fundamentals.

Prof. Chinn then argues that while monetary policy makers cannot change the underlying market fundamentals, their signal to intervene in currency markets can be credible if also the fiscal policies are adjusted.

He predicts that the exchange rate intervention is not immiment, but will occur sooner or later:

If the Fed perceives that the dollar has dropped far enough to keep the U.S. economy out of a deep recession, and the ECB perceives the euro has risen enough to adversely impact euro area economic activity at a time of a pronounced slowdown (see here), then “the stars will be aligned” for a change in the path of (monetary) fundamentals, and hence the value of the dollar.

It is strange that both the Bloomington article and the Econbrowser-blog-post focus so much on exchange rates because Christine Lagard does make some interesting comments in the interview given to Bloomberg Television.

She points out to a special calendar: a 100-day-action-plan (with one of the instruments being a call for disclosure of the losses by banks) and a 300-day-action plan. The measures suggested in the FSF-Report are however not as clearly structured in a 100- and 300-days-action-plan.

Interestingly as well, she sees the changes of International Accounting Standards to be the most crucial one:

Bloomington: Is there a specific change, a specific part of that plan that will make the most immediate difference?

Lagarde: I think the demand that we are putting on the International Accounting Supervisory Board [probably the IASB] is going to be the most critical one. Because what we are saying is actually that the accounting principles that apply at the moment – the marked-to-market is fine, we are not questioning that at all – but we’re simply saying that in the absence of market [liquidity] then clearly additional tools need to be used, indices and various other mechanisms that we want the IASB to actually recommend. And that is important because it will help banks in particular, financial institutions in general, to actually to put a value on something which could not be valued so far.

To make another prediction: the micro-economic changes agreed upon by the G7 Finance Ministers will have a much bigger impact on this crisis as the exchange interventions that the interested public mind seems to crave for.

To assess the impact of the report on the global financial architecture and the responses to the credit crisis in the financial markets, it is worthwhile recalling the original demands of the G7.

In essence, the FSF was asked to look at the underlying causes of the credit crisis (which it did) and make proposals for tackling the problem. Quite clearly the FSF concentrated mostly on the micro-economic implications of Financial Regulation and not so much on more macro-economic developments, such as global interest rates, exchange rate movements or the role of new actors like Sovereign Wealth Funds as (de-)stabilizing force in the Financial Markets.

The general message of the report cam be summarized as follows: Blame the banks, blame the credit rating agencies, blame national supervisors! There is very little blame directed at the political level, the central banks or the international bodies coordinating supervision.

This however was expected, given that G7 wanted the conduct of business by the banks (especially the business of off-balance-sheets-vehicles which speculate heavily in structured products) and the credit rating agencies (which are involved in analysing and rating structured products, but also in giving advice on how to set-up structured products) to be at the heart of the global regulatory response.

The FSF reponse shows a tricky balance when it comes to the global framework for Banking Regulation. On the one hand, the FSF wants to increase the scope of Basel II and encourage more countries to adopt the framework, on the other hand Basel II has some deficiencies which have worsened this crisis, that a reform Basel II will undergo a scrutinous review.

The report addresses the fields where Basel-II will undergo a review:

• Increased minimum capital requirements for capital requirements for complex structured credit products (such as Colleratlized Debt Obligations of asset-backed securities) when they are in the balance sheets of financial institutions, especially taking into account liquidity risk when the secondary market for these products evaporates.
• Increased minimum capital requirements for the so-called off-balance-sheets vehicles.
• Less reliance on the ratings of credit-rating agencies when assessing the liquidity risks of securities and less reliance on the ratings of monoline-insurers in Basel II.

The main task of reforming Basel-II will reside in the BCBS, but it seems that other organisations such as IOSCO and IAIS will provide guidance. Furthermore, the FSF will provide guidance for the national regulators to improve their supervision and enforcement of the Basel-II-rules and ensuring that the financial institutions have adequate risks management models.

The enforcement of the national supervisors is also crucial when disclosing losses, which the FSF has enphasized in quite drastic words. The FSF has put out the mid-year reports as a condition for the banks to disclose their losses for two reasons:

• firstly, it wants to overcome the prisoner-dilemma of banks which are faced with the problem that a joint disclosure of losses in the long-term leads to increased trust in the interbank-lending-markets, but in the short-run represents a punishment by the markets when share prices drop.
• secondly, disclosing the losses will be a precondition for a bail-out through lower interest rates by the central banks which the financial institutions could use to recapitalize themselves.

Interestingly, also the IAASB is called upon for to improve the auditing standards, despite the fact that at least in the public mind, incorrect auditing was not the big problem of the credit crisis. The IASB is also called upon to update International Accounting Standards, especially for structured products. Finally, markets are urged to implement better settlement standards for OTC-derivates. All three events point to the problem that underlying causes of the credit crisis is really market information.

The heavy attack on the Credit Rating Agencies follows the market information perspective, but seems to be politically motivated. The internal code of conduct of Credit Rating Agencies does minimize conflict of interests and the IOSCO-2004-Code for CRAs (which is called for an update by 2009) is too vague and general as to really provide some substantial guidance.

Most likely there will be regulation calling for internal firewalls between the departments dealing with the consultancy for structured products, and the analysts rating structured products. As the FSF indicates, there will also be regulation that the CRAs have to introduce differentiated rating schemes for structured products.

Yet it is not clear that all of these measures will help to tackle the fundamental problem of the global financial market, which is an often incoherent and overlapping financial architecture regulating financial markets.

For large financial conglomerates, the regulatory landscape is very complex. The FSF proposes to introduce “Colleges of Supervisors” from the main jurisdictions. This is an interesting idea, especially because such “Colleges of Supervisors” are also going to be introduced for Cross-Border Financial Institutions.

It is also to be welcomned that the international bodies are encouraged to develop more closer cooperation, especially the IMF and the FSF are moving closer again. Whether this is motivated by the idea of strengthening the role of the IMF or linking macro-ecnomic and micro-economic aspects of Financial Stability, can only be speculated.

In any case, there is no central, singular, international, supervisory authority and given the complexity of the problem, it is unlikely that such an authority will emerge any time soon. But until then, the reform of the financial architecture will be patchwork – and the FSF Report is a good example of this principle.

• Institution: Institute of International Finance
• Abbreviation: IIF
• Type: Private
• Founded: 1983
• Members Total: 350 members headquartered in more than 60 countries. Mostly commercial banks, but membership is also open to Securities firms, Fund managers. Law firms, Multinational companies, Stock exchanges, Trading companies, Central banks, Advisory firms, or Rating agencies, Multilateral agencies, or National agencies.
• Membership in: none
• Membership of: World Bank
• Description: The Institute of International Finance was created in 1983 in response to the international debt crisis. Members include most of the world’s largest commercial banks and investment banks, as well as a growing number of insurance companies and investment management firms.
• Working Group: Steering Committee on Regulatory Capital, Steering Committee on International Insurance Regulation, Steering Committee on Effective Regulation, Group of Trustees, Committee on Market Best Practices
• Outreach: Does not apply
• Reporting to: Does not apply
• Website: www.iif.com
• Highest Organ: Board of Directors
• Chair: Josef Ackermann
• Seat: Washington, DC
• Function: Lobbying body of the multinational banks
• Standards: Principles for Stable Capital Flows and Fair Debt Restructuring in Emerging Markets