Sunday, September 28, 2008

Should Government bail-out the financial sector

About the $700 bn proposed by the Treasury Secretary Paulson, Mexico had its own financial bail-out in late 90's, it was called FOBAPROA -now IPAB-. In essence, the plan for the U.S. lack considerable differences with mexican's. If Congress concedes the special power to Secretary Paulson, the government would back (probably buying) the "toxic" assets from bank's balance sheet.

So, what are the lessons to be learned from IPAB? First, whether using taxpayer's money to save rich's banks is right or wrong is not worth to discuss. Consider the following argument: if the government bails-out the rich's banks it should do it in order to protect the lower income population from inflation, unemployment and financial unstability. What would happen to low income families' savings if the financial crisis spreads to regional institutions? They would probably be at risk.

Second, as long as the government provides confidence to financial sector's agents a plan could be developed to profit from current dismal. Summers' approach puts it simply in macro words: the plan is not necesarly a downfall for a number of reasons, specially, because the intertemporal sum of income for the government in the medium term can be greater or equal to zero.

Third, financial institutions, just as the FED did with AIG's bail-out, should be charged with a penalty rate for the loans they get.

Fourth, the financial sector must be restablished quickly, with tougher rules, in order to start making profits for the government and pay the loans.

Certainly, even though the sum of revenue for government in a period of time could be positive, an asymetric treatment of taxpayers needs to be addressed. Lets not forget that as interest rates increase, current consumption is more expensive relative to future consumption, thus, current taxpayers are very likely to have a budget much more constrained than future ones -this is probably the exact same effect that eplains why there was a lessening on the government's deficit in the 90's.

Fortunately, governments often can make profits from those companies that bail-out, take for example airlines. Consistently, governments must save either airlines or financial institutions. The latter has some clear characterisctics of being an industry a natural monopoly, Summers mentions Mexico's bail-out in 1995. The financial sector is clearly a very particular one. Calculation of the long term profits made -in a positive scenario- for financial assets bought are, inherently, far more complicated.

It is indeed a weak spot of the $700 bn proposal that, in case of buying toxic assets, is far from clear the value at which they should be bought. Now the government could be pushing up the value of those toxic assets, increasing in the process future taxpayer's burden. Some market mechanism could be, as recently suggested, a reverse auction.

There are, indeed, a lot of voices that prevent from using taxpayers' money for buying private assets, specially toxic ones. Zingale's approach is just as comprehensive as Summers', it privileges the use of current mechanism for bankcrupcies such as Chpater 11. However costless for taxpayers this approach, it takes far more time as stress by Chicago's professor. A positive shock in confidence is a particularly strong policy in current situation, in order to restor confidence.

Now that Congress voted against the bail-out, is hard to tell whether it was an electoral decision or a unbiased one. For certain, the delay in the bail-out package would just make it more important.

Saturday, September 6, 2008

There are no such bubbles: An extension

At the end of Salvador’s post there is a policy transmission channel that left some ends untied. Maybe central banks’ around the world are leading the way answering them.

Assuming that the link between future markets and agricultural commodities is, at most, weak, assume also that the link between future oil prices and agricultural prices is strong. A downward trend of almost every commodity since last month surprised investors dragging down yields in commodities future markets’. Gold is down by 21 percent from January’s price, corn is down 29 percent, oil 26 percent, wheat, and soy are down too.

What has happened? There is an ever growing probability that U.S. GDP will stop growing at some point this year (maybe it already has as the economic growth is to be publish for the 3rd semester) Department of Commerce calculated a 3 percent rate of growth for the second quarter just last august 28th. This among other reasons helped to finish the very slow transition of the FED’s monetary policy stand from loose to neutral (adding more weight on inflation concerns).

The European Central Bank has not languished in its rough stand against inflation over any other threat. A growing number of central banks around the world are more focused on fighting increasing inflation expectations. Banco de Mexico shifted its primary rate three times this year, from 7.5 percent to 7.75 percent on June, then to 8 percent on July and finally to the current 8.25 percent.

There is a great number of voices claiming that restrictive monetary policy will not help to stimulate aggregate demand around the world. Moreover, they preach that economies will sink since there are fundamental factors that cause high prices of agriculture commodities.

Maybe its time to start considering that central banks are, indeed, fighting inflation with restrictive monetary policies. The thing is that they are not doing so through traditional channels. Consider the following argument: as central banks are increasing interest rates and in most cases pushing up sovereign bond yields, this un-coordinated action (think of it as it were coordinated without lost of generality) is bursting the bubble component of high commodity prices.

How is this possible? Just a coordinated action among central banks could burst a global bubble, thus shifting investors' money to sovereign bonds from future markets. So, unwillingly, restrictive world monetary policy is contributing to commodity prices’ slump.

Taking Salvador’s argument. High prices in commodities do not cause grain supply increases because of the nature of technology-lacking agricultural sector in many countries, then, again, how is it possible that corn lost around 29 percent in just 6 weeks? Or that oil had lost almost 26 percent in the same period? A plausible answer is that the “coordinated” monetary policy is bursting global bubbles.

Furthermore, if “coordinated” policy remains, its possible that the next bubble to be born after commodity’s will be stopped. The only loose end thus would be that a stronger dollar, pushed by low growth expectations in Europe and Asian economies, will not temper U.S.’ trade deficit, nor will help to the biggest economy in the world to grow. There are no such bubbles, thanks to restrictive monetary policy.

Friday, September 5, 2008

Gasoline Prices

The welfare assessment that Mexican government implicitly did when it choose not to apply a more aggressive price adjustment on gasoline prices, helping the inflation forecast not to explode is luckily paying back soon. As commodity prices slump, oil has lost around 25% in just six weeks, gasoline prices in Mexico are to converge faster with those in the south border of the U.S.

A closer look to price settings in the last eight months show that Magna Gasoline, the fuel with a greater demand, increased by 4.85%. This rate is considerably lower than the inflation figure for basic goods, which the central bank reported at 6.55% in the same period.

Strictly speaking, there still exists a distortion in relative prices. What should we expect? It is possible to construct a strong case against diminishing distortions effects on prices. It is hard to deny that changes in gasoline prices cause, in a greater proportion, changes in overall prices.

This is equivalent to argue that further increases in gasoline prices will only lead to increases in basic goods’ prices. Why? Taking the recent evidence provided by the fiscal reform of September 07, where the tax burden on gasoline prices was increased, however changes were planned for start in January 08, prices in Mexico jumped in 07’s last quarter.

So, are Mexicans frightened of inflation? Is hard to prove. Yet, it is easier to contrast the slow responses in prices of average businessmen to the introduction of a new tax, the fixed rate entrepreneurial tax, IETU, with the prompt response to a future increase in gasoline prices.

Despite its name, IETU has real and monetary consequences in Mexican’s wealth, even if they are not businessmen. For starters, as any tax in the economy it reduces disposable income whether of firms or individuals. It certainly creates distortions in some prices. This particular tax, for instance, increases the price of future capital relative to current capital boosting physical investment.

A Ricardian equivalence assessment is needed to insure that this distortion exist, however in its short life it has collected revenue under the forecast figure, letting the hypothesis of a bigger investment rate unanswered.

In any case, IETU has not induced firms to raise prices, whereas future gasoline prices did. Government could include in future welfare assessments the long run compared to short run effects of taxes, whether negative or positive. IETU price distortions thus boost Mexican economy, while gasoline negative taxes were unnecessary given the one time response to future gasoline price increases.