Global Economic Snapshot

There is so much fear wrapped up in this financial crisis that government leaders are willing to support anything, even if this means the bailout bill was concocted mostly between Henry Paulson and his former colleagues as Goldman Sachs.

It is true that action is needed to contain the financial crisis. Many of the most gifted economists--Paul Krugman, Lawrence Summers, and Joseph Stiglitz, for instance-are now in favor of a bailout. Stiglitz, a Nobel Laureate, is the pioneer of "moral hazard" theory, so it's hard to argue that this group doesn't understand the dangers of public largesse.

The Federal Deposit Insurance Corporation (FDIC) insures bank deposits up to $100,000 per individual per bank. But, in the second quarter of 2008, only 63% of bank deposits were insured leaving $2,574bn in uninsured deposits in US banks. As faith in the financial system slides, some fear that a failure to put in place a larger guarantee on deposits could result in a run on banks. The revised bailout bill the Senate is voting on tonight includes a measure to temporarily increase insurance on deposits from $100,000 to $250,000.

Snapshot asks, if the new bailout package fails, will depositors lose more confidence and pull their uninsured deposits?

FDIC - Quarterly Banking Profile Q2 2008
Bloomberg - FDIC Seeks Authority to Raise Deposit Insurance Limit
IMF - Deposit Insurance and Crisis Management
Roubini - Roubini Sees `Silent' Run on Banks

A group of 166 economists from around the country wrote a letter protesting the $700bn bailout plan. They say it is unfair to help risk-taking financial firms and not mortgage holders, unclear on what terms toxic assets will transfer from private institutions to the state, and that the bailout will damage the long run health of the financial system.

The letter offers no explicit alternatives, but implies that a better plan would have more support for mortgage holders, clearly define the contracts between the Treasury and private firms, and not abandon the free market principles that anchor the U.S. financial system.

Snapshot asks, what would their vision for the bailout plan look like?

Financial institutions across the United States are scrambling for cash as the bankruptcy of Lehman Brothers, the acquisition of Merrill Lynch by Bank of America, and AIG's troubled balance sheet spread fears of systemic risk. The overnight lending rate controlled by the Federal Reserve jumped to nearly 7% from the target rate of 2%, the largest spread in nearly 20 years. The Fed injected $70bn into the market but the Dow Jones Industrial Average ignored the emergency measures and lost 500 points, the largest decline since September 11, 2001.

Snapshot asks, was yesterday's capitulation a new phase of deleveraging in credit markets?

Barron's - The Brave New World of U.S. Finance
Meredith Whitney - Whitney Warns of More Write-Downs

What I said is that they were adequately capitalized. And they were adequately capitalized according to the law on June 30th.
-James Lockhart, Federal Housing Finance Agency Director (September 8, 2008)

This was not the case according to Morgan Stanley, which was pulled in by Treasury Secretary Hank Paulson to analyze the health of Fannie and Freddie in early August.

After the Fannie and Freddie bailout, many law makers will try to create independent oversight over these large Government Sponsored Enterprises (GSEs). But Morgan Stanley reported that a bailout would cost upwards of $50bn, while William Poole estimated it may be as high as $300bn. Furthermore, the bailout will not turn around falling house prices, which are more the result of a massive price correction and not of the price of mortgages.

Exports surged 19% year-on-year in the second quarter of 2008 and helped boost GDP growth to 3.3%. Though many think the US has become more competitive, higher exports actually reflect the higher prices of exported food and mineral fuels. Food and beverages accounted for 8.4% of the total goods exports, but because of the increase in prices during the second quarter they made up a staggering 18% of total export growth. Similarly, industrial products were driven up by the increase in refined fuel products.

Snapshot asks, if the commodity bubble has burst and rising commodity prices are driving GDP, what does that imply for third quarter growth?

UBS - Global Economic Perspectives
Wall Street Journal - U.S. Revises GDP Growth Higher

China's leadership is contemplating a RMB 400bn ($58bn) stimulus package that includes large spending on a backlog of transportation projects like subways and railroads, according to JPMorgan. The Chinese government, unlike that of the United States, understands the benefits that infrastructure investments have on increasing efficiency and stimulating a slowing economy. JPMorgan predicts Chinese leaders will release the stimulus once we see more signs of a weakening economy and commodity prices fall further, which would reduce the input costs for strained Chinese producers. If exporters, which make up 37.5% of GDP, are badly hit and shed jobs, infrastructure investment may even prop up private consumption, which has held up remarkably well despite inflating food prices and a falling stock market.

Snapshot asks, can we learn how to invest in public infrastructure and stimulate a slowing economy from the Chinese government?

Investors are fleeing Russian and Georgian assets due to the recent crisis. Russian foreign exchange reserves fell $16.4 billion in the past week, the largest decrease since the 1998 ruble crisis. Yields on ruble bonds rose 75 to 150 basis points and the business community complained about lack of access to credit. One Russian columnist wrote, "The million-headed hydra of the bourgeoisie has sent a signal: ‘change your course comrades!"

Snapshot asks, did the Russian business community yank the reins of the Russian military?

Newsweek - The Bulls Have Left Moscow
Financial Times - Investors quit Russia after Georgia war
Moscow Times - Reserves Plummet $16.4Bln in a Week
Reuters India - Emerging Markets-Russia, Georgia assets extends losses

High commodity prices masked weak economic fundamentals in many commodity exporting countries. Now the risk of a global slowdown is higher, reducing demand for commodities and hurting export revenues in commodity rich countries. Commodity rich Brazil, Russia, and Australia have been hurt by the falling prices while less demand in India and China also indicates there will be a world recession.

Snapshot asks, are we watching a commodity bubble pop or do falling commodity prices indicate a forthcoming world recession?

BNP Paribas - Market Watch
Financial Times - Falling Brics
BullionVault - Demand Destruction & Central Bankers

Senior executives from the world's largest investment banks recently released a report suggesting new regulations of global credit markets. On Wall Street, there is a widespread loss of faith that the financial system can adequately assess and price risk. The report proposes stringent standards within banks for reporting the value of complex securities on balance sheets and recommends the creation of a market clearinghouse to allow quick exchange and valuation of such investments.

Snapshot asks, are these regulations cosmetic and an attempt to fend of heavy government regulation?

Financial Times - US banks urge sweeping credit market reform
Counterparty Risk Management Policy Group - Official Report