Author: db

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Liquidity again

Sam Woods was questioned by the Treasury Committee on Wednesday. Transcript below, starting 16:50.

A few odd things. Woods says there have been defaults and downgrades, but soon after claims that ‘blowouts in bond spreads’ are driven by liquidity. He mentions the Matching Adjustment as the ‘piece of machinery that is operating quietly in the background’, and Baldwin asks whether without it there would be actual insolvencies. Woods first says that there wouldn’t, or he thinks there wouldn’t, then says that without it there would be ‘a major problem’.

Why don’t they just state the accounting numbers as they are, i.e. some firms with no net assets at all, or negative assets, adding that this doesn’t make the firms insolvent, because it’s merely a liquidity effect and the spreads will narrow back again? Why falsify the accounting?

More later, I expect.

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Off to a good start

April 5 2020  (article by Andrew Bailey in the Financial Times)

Bank of England is not doing ‘monetary financing’

… the Monetary Policy Committee voted last month to increase the bank’s bond holdings by £200bn to support the needs of the British people. Some external commentators are linking this move to fears that it that it may be using “monetary financing”, a permanent expansion of the central bank balance sheet with the aim of funding the government.

This type of reserve creation has been linked in other countries to runaway inflation. That is because it could undermine a central bank’s ability to control monetary conditions over the medium term. Using monetary financing would damage credibility on controlling inflation by eroding operational independence. It would also ultimately result in an unsustainable central bank balance sheet and is incompatible with the pursuit of an inflation target by an independent central bank.

But the UK’s institutional safeguards rule out this approach.

April 9 2020

The UK has become the first country to embrace the monetary financing of government to fund the immediate cost of fighting coronavirus, with the Bank of England to directly finance the state’s spending needs on a temporary basis.  The move would allow the government to bypass the bond market until the Covid-19 pandemic subsides even though it will face criticism it is engaged in Zimbabwe-style policy that has led to hyperinflation where it has persisted.

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No area immune

Source Schroders

 

Banks seem to be missing, so perhaps they are immune? (Hint: I think not).

 

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Coronavirus exposes illusion of UK bank capital strength

A great piece here by Jonathan Ford of the FT. For those on the wrong side of the paywall, his case is as follows.

The Bank intervened last week to stop banks paying out dividends, the official reason being the coronavirus panic. But why didn’t the Bank prevent capital distributions earlier, given the much-heralded capital rebuilding exercise? Ford argues that the official measure of capital strength, CET1, may be illusory, given that it is based on ‘risk weighted assets’, a subjective and hence gameable measure of asset value.

A less gameable measure involves comparing equity not with a RWAs, but simply the total unadjusted asset number. Moreover, because accounting measures of book equity are backward-looking and may conceal losses, it makes sense to use the bank’s market capitalisation in their stead — especially when events are moving fast.

He quotes our own Professor Dowd saying that Barclays’ leverage ratio (equity divided by unadjusted asset value) is now just 1.2 per cent.

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Letter from Sam Woods to insurers on distribution of profits

Here.

When UK insurers’ boards are considering any distributions to shareholders or making decisions on variable remuneration, we expect them to pay close attention to the need to protect policyholders and maintain safety and soundness, and in so doing to ensure that their firm can play its full part in supporting the real economy throughout the economic disruption arising from Covid-19.

[…]

In the current situation of high uncertainty, it is therefore critical that insurers manage their financial resources prudently in order both to ensure that they are able to meet the commitments they have made to policyholders in a way that is consistent with the expectations of the Financial Conduct Authority, and to enable them to continue to invest in the economy.

But that is odd though. The whole purpose of the Solvency II regime is to provide the necessary safety and soundness through model-based, PRA-approved capital management. A 100% coverage ratio corresponds to a 1 in 200 probability of default, and to my knowledge, no firm is allowed to operate under the soft limit of 130% capital coverage, which corresponds (by my mathematics) to a probability of lower than 1 in 2,000 years.

So why the worry, Sam?

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Has China really beaten coronavirus?

A disturbing article in the Grunian yesterday challenging the Chinese cases-deaths-recovery statistics suggesting that the virus has been completely eliminated.  Many doubt the numbers are as good as officials have reported, and while the data we have used here comes from John Hopkins University, that is simply a copy of what the Chinese authorities say it is.

Any rational person would doubt these figures,” one internet user wrote in response to an essay posted by a volunteer in Wuhan questioning the statistics.

So the data really reflects 3 things. (1) the biological properties of the virus, i.e. whether it can be transmitted by sneeze droplets, how far and so on. (2) The expectations and fears of the population reacting to data about the epidemic, and (3) control exercised by the authorities over the properties of the data.

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The quickest return to normalcy

An excellent article from Jonathan Kay published last week, echoing the points that Eumaeus has been making for the last month.

The more aggressively that our leaders act to suppress the spread of COVID-19, the more quickly the crisis will pass, and the sooner we will all be able to return to normal daily life. The decisions we make now could mean the difference between a global recession and a historical event on par with The Great Depression.

The good news is that we definitely can suppress COVID-19, even if no cure or effective vaccine emerges. We know this because it already has been done in the most populous country on Earth.

He cites the effectiveness of the Chinese response in slowing the growth of the virus almost (at the time he was writing) to a halt.