WORLD ECONOMY DILEMMA

Reported in the FT: Forecasts in the OECD’s latest Economic Outlook imply that in 6 of its members (the Netherlands, Switzerland, Sweden, Japan, the UK and Ireland) the private sector will this year run a surplus of income over spending greater than 10% ratio to GDP. Another 13 will have private surpluses between 5% and 10%. The latter includes the USA, with 7.3%/GDP. The eurozone private surplus will be 6.7%ratio to GDP and that of the OECD as a whole 7.4%. In the USA, In the eurozone, it is forecast at 5.5%/GDP and in the OECD at 7.3%. Actually this is also a product of private savings rising as the counterpart to public sector higher borrowing, after change in the external account balance.
Moreover, the shift in the private sector balance between 2007 and 2010 is forecast to be 9.7% in USA, and exceed 10%/GDP in no fewer than 8 OECD member countries. It is also forecast to exceed 5%/GDP in another 8. Martin Wolf commenting on this says, "Depression threatened. Note that such huge shifts towards frugality will have occurred, despite the unprecedented monetary loosening. While the latter helped prevent a still-greater collapse in private spending, the huge fiscal deficits, largely the result of automatic stabilisers, have been no less important. If governments had tried to close fiscal deficits, as they attempted to do in the 1930s, we would be in another Great Depression."
Wolf then asks, "So how do we exit? To answer the question, we need to agree on how we entered. A big part of the answer is that a series of bubbles helped keep the world economy driving forward over the past three decades. Behind these, however, lay a credit super-bubble, which burst in 2008. This is why private spending imploded and fiscal deficits exploded."
I explain what he means by the bubbles in terms of credit boom growth later below.
Wolf continues, "Now, after the implosion, we witness the extraordinary rescue efforts. So what happens next? We can identify two alternatives: success and failure.
By “success”, I mean reignition of the credit engine in high-income deficit countries. So private sector spending surges anew, fiscal deficits shrink and the economy appears to being going back to normal, at last. By “failure” I mean that the deleveraging continues, private spending fails to pick up with any real vigour and fiscal deficits remain far bigger, for far longer, than almost anybody now dares to imagine. This would be post-bubble Japan on a far wider scale. Unhappily, the result of what I call success would probably be a still bigger financial crisis in future, while the results of what I call failure would be that the fiscal rope would run out, even though reaching the end might take longer than worrywarts fear. Yet the big point is that either outcome ultimately leads us to a sovereign debt crisis. This, in turn, would surely result in defaults, probably via inflation. In essence, stretched balance sheets threaten mass private sector bankruptcy and a depression, or sovereign bankruptcy and inflation, or some combination of the two. I can envisage two ways by which the world might grow out of its debt overhangs without such a collapse: a surge in private and public investment in the deficit countries or a surge in demand from the emerging countries. Under the former, higher future income would make today’s borrowing sustainable. Under the latter, the savings generated by the deleveraging private sectors of deficit countries would flow naturally into increased investment in emerging countries."
Martin Wolf recognised and repeats here what Lord Turner at the FSA and others, but not all, know that the credit crunch has its origins in extreme world trade imbalances that developed in the past decade, extreme differences between credit boom (CB) growth economies (that he calls deficit countries) and export-led (EL) growth economies (that he calls high-income countries).
In CB economies (USA above all, also UK, Spain, Ireland, Greece etc.) increasingly the trade deficit was financed by banks selling asset backed securities directly and indirectly to the EL economies (Germany, Japan, China etc.). The CBs grew by boosting domestic consumption and housing wealth thereby drawing in more and more net imports, while the ELs grew by exports and by capital investment (especially in China's case).
The world, and within it the EU, was polarised by two growth policy extremes, between CBs with a rampant internal growth impulse and ELs profiting from CBs by remaining heavily baised to external growth impulse; everyone else can be placed in a mixed continuum somewhere in between.
Martin points to the dilemma we face now. This reduces to how to avoid simply returning everything to how it previously was? He suggests we do this by CBs investing more and ELs consuming more. The CBs and ELs have to shift, or even reverse, their stances, essentially to rejoin the rest of the world in a mixed policy of trying to balance external and internal growth.
For die hard monetary policy managers, I'm sorry for them if they find such an explanation with its focus on external account and trade too much like Keynesiansm of the past, unpalatable, deeply unfashionable for their modernist technocratic-monetary taste. Martin ends by saying China must boost its consumption. It tried last year and has taken fright because the credit liberalisation went to boost infrastructure and capital investment further which is it knows and recognises already structurally far to high a % of GDP. The country’s banking regulator has told lenders to cut back on credit, especially non-recourse loans to local governments’ financial arms in an attempt to reduce future bad loans. China remains reluctant to boost wages and give up (not until it knows it absolutely must) its low-wage cost competitiveness. It is hooked on economic good news as its main global brand image, like a cocaine addict, desperately unwilling to look at the truth behind the advertised facts that might necessitate revising its economic size downwards by at least 40%! Yet, even with its large population, how it expects to become genuinely the world's second biggest economy with wages at $6,000 beggars understanding.
China, in pursuit of its healthy aspirations to lead the BRICS and join the OECD country club, should enforce its 40-hour week legislation and encourage its population to aspire to more leisure and a higher quality of life. But, the same is also true of highly developed EL economies, Germany and Japan. They need to do far more to actively examine their own internal barriers to higher consumption and internal job creation.
The CBs are far less averse to changing their growth stance that the ELs with their classic conservatism of why do anything different when I have plenty of money lying in the bank?
We may have to wait for China to experience an almighty asset bubble burst and then for the German-led Euro Area's regular recession bus to arrive in about 2 year's from now.
What will shake Japan out of its tree should not be yet more loss of self-confidence, but a recognition that it is time to take its profits and spend that domestically to give its hard-working people the reward of a decade or so of a good time. Of course, the USA tried in vain saying that to Japan for decades without response, and no doubt that is the model that inspires China.
Wolf points to further implications, "Yet exploiting such opportunities would involve radical rethinking. In countries like the UK and US, there would be high fiscal deficits over an extended period, but also a matching willingness to promote investment. Meanwhile, high-income countries would have to engage urgently with emerging countries, to discuss reforms to global finance aimed at facilitating a sustained net flow of funds from the former to the latter. Unfortunately, nobody is seized of such a radical post-crisis agenda. Most people hope, instead, that the world will go back to being the way it was. It will not and should not. The essential ingredient of a successful exit is, instead, to use the huge surpluses of the private sector to fund higher investment, both public and private, across the world. China alone needs higher consumption. Let us not repeat past errors. Let us not hope that a credit-fuelled consumption binge will save us. Let us invest in the future, instead."

GREEK CRISIS

Leaving aside questions of how big the black market and smuggling is in Greece, or whether it has used several questionable techniques for disguising the country's true GDP/GNP, debt and deficit, or the passionate left/right politics, Greece is being singled out as the comparative example within the EU whereby the other states may feel only relatively virtuous. What did the country's economy really do and what was the cost benefit to it of Euro membership? Greece's Prime Minister warned his country’s debt woes are a ‘European problem’. But he issued a plea for EU help as deeper-pocketed nations led by Germany continued to wrangle over what kind of rescue is appropriate. Spain, Ireland and Portugal are thought to be most vulnerable to a loss of confidence among investors as they grapple with massive debt mountains. Spain is the most worrying case given the size of its economy. Economists at BNP Paribas estimate that bailout costs of Europe’s fiscal crisis could be £280bn, of which nearly £175bn is attributable to Spain. In Greece's case the requirement is only a few tens of €billions.PM Papandreou says, ‘We are a country which cannot alone deal with the speculation. So this has become a European problem, because if we do have a major problem, this could create a contagion for other countries too who are not to blame,' which is putting the matter kindly. There are some domestic policy problems. Germany’s Finance Ministry yesterday says it has no specific plans to help Greece after a magazine claimed eurozone governments may offer £22bn of financial aid. In fact, that much they have already supplied. It is a test for the flexibility and integrity of the Euro Area idea. It is also a domestic political test in a country, and Athens especially, where political protests are a well-honed art form. Greece has a massive shipping sector, biggest port in the Medittaranean, valuable tourism, and reliable agricultural exports, but not enough to balance the external account at a tolerable level. These and other productive industry sectors did not grow their borrowing or were denied loans by the Hellenic banks that were obsessed like banks in UK, USA, Spain, and Ireland with mortgage boom, but also growing their banking networks in Turkey and the Balkans.
In Greece's case, fast growth in home ownership was a new and novel experience, especially exciting for the economy, part of its catch-up with the aggregate average of the EU. Greece has been much transformed for the better by its decade of fast credit-boom growth. It embraced credit-boom, but the external trade deficit rose to 18% ratio to GDP, the highest in the OECD. This would not have been possible without Euro membership that secured it from currency risk, but could not help it to balance its external account better. Yet, for most of the last decade the economy felt very positive.
Doom-monger economists like myself and real banking experts recognised the boom must eventually end and the property bubble would burst - as it did, if later than for UK and USA, and 90% of bank capital, as I predicted in 2006 for 2009-2012 for several banks including the Central Bank, would be nominally wiped out - at least until debt recoveries and economic recovery would restore matters. Warnings and advice to restructure lending by the Bank of Greece in 2006 and 2007 to the commercial banks were ignored. The banks securitised a fifth of their loanbooks, grew their funding gaps, just like banks elsewhere were doing, and thereby financed the trade deficit to worsen, and grew their property lending gloriously, just like Ireland. And like Ireland, while recognising the perilousness of the situation Greece expected the Euro Area economy would take care of them and the Euro Area economy would bounce back. The ECB did not, however, prove as flexible and as resolute as The Bank of England and The Federal Reserve in scaling up to deal directly with the Credit crunch.
The Euro Area's members like Greece and Ireland that had for some years been the fastest growing and much above average contributors to general Euro Area growth might have felt they had the right to special temporary emergency help when the crisis hit them - a false hope. One intersting difference surprisingly between Ireland and Greece is that the problems of Greece not Ireland were able to knock 50 points off the S&P 500!
What Greece like Ireland under-estimated was the implication of their central banks not having access to their own money market facilities, which had been given over to the ECB. This has meant that unlike UK and USA, bank bailouts had to be negotatiated with ECB or paid for by special loans from EU/ECB or paid for on-budget by bond issuance - most painful in Maastricht terms. It is the fact of having to resort to on-budget bond issuance that makes the deficit and debt ratios especially high, but as sanguine realists have commented, this is a small and temporary problem in the wider scheme of EU-wide economic concerns.
The Bank of Greece had before the crisis advised its member banks to lend more to help exporters and reduce the share of their loanbooks dominated by property. This remains urgently important advice. We must hope that the Greek banks take this advice seriously and now act upon it.

G20 AGENDA STALLING - DAVOS NEWS

UK Chancellor Alistair Darling said on Friday UK would not join in any European effort to bail out Greece. This sounds harsh - Darling is no Lord Byron for Greece a la 1820s or no Churchill sending in the british and French fleets in 1916, and BEF in 1941 and the Fleet for some bombardment after WW2, times when Greece was in crisis. Greece should be hlped by other Euro area economies. The UK has much to do given the disproportionately large share of EU financial services in its jurisdiction - additionally perhaps it might get round one day to helping Ireland and being less beligerent with Iceland.
Darling has pledged not to use differences in global financial regulations to promote the City of London. That's nice - in fact some would say he has been doing more than that and making London somewhat less attractive - which to me doesn't matter much either way. Others, however, are not so legalistic. It is part of EU law that no EU state should seek to beggar its neighbours or create competitive advantages for its financial sector. Yet, The Mayor of London and other Conservative figures and supporters are saying the opposite that their priority must be to enhance the ttractiveness and competitive advantages of London. fact is they don't know how to do that and would be foolish to imagine that less regulation would do it. the matter is not so simply defined. Calculating the cost/benefits of regulation is business terms is very hard to do. In repeating my view on Greece, Darling said, when answering questions about a possible EU bail-out of Greece at Davos, that it is a problem as one for the eurozone i.e. the Euro currency states and the ECB, not the wider European Union. (For analysis of Greece see my blog: http://monetaryandfiscal.blogspot.com) “The euro area has primary responsibility for anything that might be happening. We are not involved in that,” he said, reminding all that the UK's 'economics' decision (which I supported for good reasons that are technical not political or cultural) to stay out of the single currency means it is not part of the Euro Grouping that discusses eurozone affairs, adding “It is in the interests of the eurogroup they provide whatever assistance [is required].”
The chancellor also made it clear that Britain’s decision not to follow either the proposed US banking levy or the “Volcker rule” (banning proprietary trading by, and hedge funds within, banks) was not an attempt to steal financial services business to London from New York. He said: “I don’t want someone coming to our country because they are avoiding some legitimate concern somewhere else.” This sounds good and good for Dublin!
The chancellor’s main purpose in Switzerland was to meet with banks and urge the all to hasten reforms of banking and global economic management, issues on which he sees backsliding in the G20 agenda. I defined the G20 agenda into 90 tasks, which others have picked up and now bandy about as what is to be done. But, many of the tasks require a lot of detailed work; they involve major changes to what is traded on or off exchanges, to ratings agencies, and not least building new regulatory oversight bodies and then bring in the rest of the world to be fully in agreement and participative. The macro-economic and macro-financial models to underpin all this are however totally not there, and have not been planned yet and those that are underway are game-theory network risk models for dealing with single bank failures - so we do not yet have any governmental efforts behind trying to understand the credit crunch and recession comprehensively in macro-model or macro-prudential model data terms. This means that many policy objectives cannot be followed with support of deep analysis that is globally competent.Darling said, “The process is presently going through the Basel Committee at a rate I believe is far too slow. We simply don’t have years to sort this problem out. We need to sort it out later this year”. Big models take at least two years! He deplored, according to the FT, the possibility that the main Basel committee recommendations on banking reforms may be delayed from the present timetable of this autumn. “They might slip into 2011 and that would be very, very bad.” Darling was equally concerned that the G20 framework for balanced and sustainable growth, the international action to address global trade imbalances, was also mired in the mud - think of Flanders and The Western front, main Street versus wall Street with attrition all along the line. Referring to both G20 processes, he said: “There needs to be a sense of urgency that frankly has been absent over there in the last few weeks.” I totally agree, but that's not what happens when the Eurocrats and civil servants generally have to do more than juggle competing opinions.
His comments reflect those aired yesterday by Angel Gurria, secretary general of the OECD, who may wonder whether the IMF that is at the heart of the G20 agenda has the firepower for the job and needs OECD in Paris with all its massive brainpower to weigh in too, who said: “I don’t think anything of substance has been done during the crisis to correct global imbalances. It was the crisis itself that reduced imbalances”. If she meant global imbalances in finance she is of course on another planet. She meant global trade imbalances that astute economists know lay at the root cause of the crisis. Trade flows are definitely like scattered jigsaw pieces thrown into disarray. It'll be some time before we see how those pieces fall and that is what is gnawing at the long nails of Forbidden City mandarins in Beijing as they scroll through their beautiful painting of economic statistics. on that no small matter see http://bankingeconomics.blogspot.com/ Time to sell east buy west?

UK NATIONAL INCOME & OUTPUT (GDP)

(source: Simon Ward at Henderson New Star)
UK GDP data exaggerates recession depth. GDP data is subject to major revisions for up to 30 months. UK revisions tend to be upward. A comparison with the last 3 cycle recessions suggest UK official estimate of a recent fall in GDP of 5.7% between Q1 2008 & Q2 2009 will be revised to show a much smaller decline. This view is supported by indicators, such as labour market stats, which, though worsening, is doing so less than expected per official GDP fall.
Bank of England has a "real-time" database of national accounts statistics that, for some series, including GDP, goes back to 1976. Based on recessions in 1974-75, 1979-81 and 1990-91, real GDP (after netting for consumer inflation) fell from peak to trough by 4.6%, 6.5% and 4.3% respectively. In the latest vintage of statistics, the falls are 2.7%, 6.0% and 2.5%. So revisions have cut the GDP drop by 1.9%, 0.5%, & 1.7%. The smallest of the 3 adjustments (1979-81) may be misleading because it coincides with major change to profile of the recession. The originally-estimated 6.5% GDP decline referred to the change between Q2 1979 and 3Q 1981 but recession trough subsequently shifted to Q1 of 1981. The latest statistics show a 4.6% GDP decline over the original recession period. A 6-month shift in start or end of recession estimate is not unusual e.g. the current US recession whose end was announced by Ben benranke today. It was originally thought to have started mid-2008 and then backdated to Winter 2007. UK recession was backdated too to having started in mid 2008 and is expected to end at end this year or early next year.
Paat comparisons indicate, however, that the current estimate of a 5.7% UK GDP decline by the second quarter of 2009 could eventually be revised down by as much as 1.9 percentage points. A simple model for GDP growth based on changes in vacancies and claimant-count unemployment suggests that, and at keast that a substantial downward adjustment is warranted. Tracking GDP rises and falls in the last three cycles suggests an annual decline of 3.7% in the first quarter of 2009 versus a current official estimate of 4.9%.

Toxic debt boon - UK

By Ian Fraser
Published: The Sunday Times
Date: May 10th, 2009
THE UK government should be able to claw back at least of half its forecast budget deficits in 2010-12because of higher-than-expected returns from its ownership of shares in troubled banks and profits from bank bailouts, according to an Edinburgh-based economist.
Robert McDowell, a banking economist and risk-management consultant, said: “The UK and US Treasuries are charging substantial fees and exerting 25-30% haircuts, leaving themselves with more than adequate headroom to generate substantial medium-term profit which, I calculate, will finance both their bank recapitalisations and pay off half of medium term government budget deficits, thus relieving taxpayers of the risk of sharply higher future tax rates.”
The British and American treasuries have been widely slammed for their programmes to purchase or swap billions of pounds of “toxic waste” or “legacy assets” from the banks – including impaired mortgage-backed securities, collateralised debt obligations, credit card bonds and student loans.
However McDowell, who advises banks and sometimes governments and is a contributor to the high-profile www.asymptotix.eu financial risk management blogging site, indicated such criticisms are unjustified.
He believes that, while asset-backed securities (such as RMBS and CMBS) were arguably the cause of the credit crunch, they are also going to play a major part in bringing it to an end.
McDowell has worked out that the government various support schemes for the banking sector – including the special liquidity scheme and the asset protection scheme – will generate a net profit for the UK government of about £185bn, and very possibly more than £200bn, “which is a substantial three-year gain from off-budget financing worth about £900bn currently.”
He said the benefit may all be used as part of the Bank of England’s £150bn quantitative easing scheme authorization for buying in government bonds. This would be the same as paying off a major part of government fiscal borrowing, said McDowell.
He said that if the government is able to book his higher expected profit of £200bn, then it would be able to eradicate some 45% of future budget deficits, on the assumption that these will limb to £175bn in 2009 before falling to £160bn in 2010 and £125bn in 2011.
McDowell added: “Given that long-term interbank funding that UK banks require to finance their funding gaps remains so hard to obtain from private sector sources, we can expect the Bank of England to add several £100bn more to the asset protection scheme during the remainder of this year, which means we can be confident there will be a £200bn three-year gain or more - sufficient to cover half of government budget deficits.”
In his recent budget report Chancellor Alistair Darling said: “Reflecting the principle of transparency, the fiscal forecasts include a provisional estimate for the high end of a range for the net impact of unrealised losses on financial sector interventions, equal to 3½ per cent of GDP.”
The Treasury has forecast the UK’s budget deficit will be 12.4% of GDP in 2009/10, 11.9% in 2010/11 and 9.1% in 2011/12. McDowell said the Chancellor was signaling that about half of the forecast deficit is required to compensate the economy for the banks’ plight and will not need to be spent if the government’s financial sector interventions pay off.
“I know it is hard for taxpayers to understand that their money is not what the government is playing with in its liquidity windows and treasury bills for bank asset swaps,” said McDowell.
“They readily confuse government budget deficits with bank bailouts. The two things are not the same. Government budget deficits are almost entirely fiscal responses merely to recover economic growth, not to recapitalise or restructure the banks directly.”
He said the spate of government bond issuance in recent weeks has been entirely sensible. “There is too much absurd doom-mongering in financial markets,” he added.
An version of this article was published in The Sunday Times under the headline “Toxic debt boon” on May 10th, 2009.

CREDIT RATINGS AGENCIES BET ON GLOOM

McCreevey, the EU DG for Competition is pushing through a law to force the major credit ratings agencies, Moody's, S&P, and Fitch to publish and validate their models and ratings systems. If they want t stay in business they must become more transparant and ensure that the disastrous kinds of absolute failures that Moody's had to confess to in its securitisation ratings models (announcement 16 June 2007) are never repeated. The ratings agencies are under threat from governments and are critically in the gunsights of the G20 agenda. They are also going to be arraigned in class action suits. Their commercial survival is threatened. This fundamental problem going forward is not holding them back from rattling the cages of the markets with threatened downgrades and dire warnings. The latest is corporate bond defaults. I find Moody's forecasts just absurd and irresponsible. The banks are in the firing line along with the corporations if corporate bond defaults rise to the percentages forecast. It is in the power of banks directly, and governments indirectly via fiscal reflation, and sometimes directly e.g. GM, plus shareholding investors and institutional investors especially have yhet to be tapped by non-bank corporations for significant help. Therefore, corporate defaults are something that can be managed, mitigated, assuaged, and we are supposedly in the US and UK within 2-4 quarters of return to positive GDP growth. Therefore, what is the basis of Moody's estimates. It seems they have simple trend line forecasts and are not taking account of risk mitigation factors.
Moody's is rightly being heavily blamed for bug-ridden ratings models applied to securitisation issues that were indifferent to rising defaults.
But insofar as Moody's, S&P and Fitch feel the heat of major blame for the crisis, essentially for applying 'through-the-cycle ratings generally and not advising enough on actual short term risks, and like many forecasters who missed the turning points, they are now erring on the other side by being excessively gloomy, and as ever assessing risks gross oblivious to collateral and risk mitigation actions available to all inolved. As a risk rater, predicting more gloom has an obvious gain of believing that it is harder to be blamed for being doom-laden than for being euphoric, for bearish rather than bullish opinions. The assumption is that everyone currently will be much more forgiving of an overly pessimistic forecast than an overly optimistic one, so best be biased towards 'Roubini' scenarios. Of all the lawsuits in the pipeline against the Ratings Agencies, none are lawsuits for over-estimating defaults. If they keep on like this I for one can forsee precisely such lawsuits. They are not impossible to define.
As per optimistic forecasts, there are few benefits to accuracy; when has a risk manager earned bonus for predicting shock events won't happen that subsequently don't? Coming up with improbabilities (Nassim Taleb's 'Black Swans' building on Plato's white swans and John Stuart Mill's use of black swans as examples of inductive reasoning, or my own alterntive South American Swan theory, of swans that are only black from the neck up!) is above almost everyone's 'pay-grade' even that of CEOs and their Boards. Governments never publicly predict recessions. Everyone fears that gloomy forecasts risk becoming self-fulfilling. Yet, these are precisely the risks that the ratings agencies are now running as a knee-jerk reacion to all the criticism they have received; they are biting back with vengence!
The default rate for speculative grade corporate loans was 4.1% in 2008, which is 71st out of the 89 years of data on this series, below 2001, 1990, and 1970 peaks. The prediction (above) for a 16% default rate in 2010 is a record spike in defaults, higher than any year, including 15.4% in 1933. If Armageddon turns up, you can't blame Moody's for not warning us.
Moody's forecasting model is dubious and simplistic, based on few factors and context-free factors at that, too few observations and embarrassingly incomplete macro-economic models. The data is highly serially correlated, implying the number of observations vastly overstates the range of outcomes, typical monte-carlo.
They operated a new model in 2007 called the Credit Transition Model. This uses recent credit grade transitions, an unemployment forecast, plus yield spreads (currently high, especially when many famous brands are offering 50% higher coupon than bank rate plus LIBOR). Credit risk grade 'buckets' are broad and it takes a lot to transition to lower grades, but this has been eased and there is a wholesale trends of downgrade transitions, and so projecting those forward easily generates an increase in default rates. But, major corporations are split by sector are not highly granular buckets. Therefore it is actually not straightforward to translate PD rates and stress LGDs to produce actual value of defaults. The unemployment rate is going up, but how that correlates with defaults is non-trivial to model and forecast. There are likely to be some finger in the air assumptions here, especially when not part of a complete macro-economic model. Do High Yield spreads correlate with future default rates? If so then we would simply place corporate borrowers into risk grade PD buckets depending on their bond yields and forget eveything else?
Moody's predicted rising corporate defaults in 1998 that did not arrive. In 1990 and 2000, they did not predict the increases in defaults, they merely changed credit ratings as default rates arrived. To the extent default rates are serially correlated, the high yield spreads did not add much information, nothing much to be relied upon. Better would be to go back to basics and Du Pont Ratios.
A bond trading well below par is in trouble, but the hypothesis that aggregate high yield spreads predicts future default rates as based on historical data, is very doubtful. Nonetheless, the new model shows an eerily accurate forecast over the past 15 years (according to the Moody's Credit Transition Model 2007 document there was a successful backtesting: Beware a time series model designed to make forecasts that inevitably has to incorporate past trends and yet be a necessary simplification, hence the back-test is merely the model's slightly simplified way of representing the recent past, not evidence of an ability to forecast the past as it might forecast the future. Moody's Annual Default report 1999 published in January 2000, there was a prediction of future defaults falling in speculative grades to "between 6.0% and 4.5%", but "trending downward over the year", also with "increasing recovery rates". They also noted the US moving away from the 'Asian Crisis' of 1998, and so were oblivious to the next bubble burst and stock market crisis leading into recession. Recessions happen suddenly and aggregating economic forecasts always result in compromise smoothing of the data, on top of which is the problem that GDP data gets revised in hindsight severely for up to 2 years after the data is first published. The fact is that users of Moody's and the other ratings agencies models expect a superior insight based on very detailed annual reports analysis etc. commiserate with what they imagine to be the rigorous analysis of corporate credit ratings based on some models of Du Pont ratios. Instead what we have is a simple-minded model that any analysts could construct in a spreadsheet from readily available information, and very little of that!
So, like those AAA-rated circa 2003-mid-2007 Mortgaged Backed Securities, Moody's is giving the market exactly what it agrees with and wants right now, subjectively, not objectively, more of the same lack of intellectual courage and lack of academic rigour. It is hard to vouch for whether S&P and Fitch deserve to be tarred by the same brush. But, so far that seems a reasonable working assumption?
As Eric Falkenstein says in his seeking Alpha article from which I took much by way of inspiration for the above, "part of being a professional credit executive is knowing the difference between what you can predict and what you can't. Moody's should simply stop forecasting aggregate default rates. They don't add any value here and merely highlight that for anything many people already have an opinion on, Moody's is not a special lens, but rather a mirror." That I broadly agree with from an investor viewpoint. From a concern about banks' balance sheets, aggregate defaults are certyainly worth analysing and modeling and fporecasting, but clearly they require a lot of sectoral disaggregation and to be part of a fully worked out macro-economic model, which Moody's is clearly not resourced for!

G20 COMMUNIQUE

Banks need to take note that they are all citizens' banks and this is the premise why if they have the right to offer public services i.e. banking licenses, in truth they all belong to governments and in a crisis that ownership can be readily exercised totally. Therefore, all banks needs to read and understand the G20 Communique fully. The total Communique is only 9 pages plus 8 pages of annexes.
The main statement states the following:
1. We, the Leaders of the Group of Twenty, met in London on 2 April 2009.
2. We face the greatest challenge to the world economy in modern times; a crisis which has deepened since we last met, which affects the lives of women, men, and children in every country, and which all countries must join together to resolve. A global crisis requires a global solution.
3. We start from the belief that prosperity is indivisible; that growth, to be sustained, has to be shared; and that our global plan for recovery must have at its heart the needs and jobs of hard-working families, not just in developed countries but in emerging markets and the poorest countries of the world too; and must reflect the interests, not just of today’s population, but of future generations too. We believe that the only sure foundation for sustainable globalisation and rising prosperity for all is an open world economy based on market principles, effective regulation, and strong global institutions.
4. We have today therefore pledged to do whatever is necessary to:
restore confidence, growth, and jobs;
- repair the financial system to restore lending;
- strengthen financial regulation to rebuild trust;
- fund and reform our international financial institutions to overcome this crisis and prevent future ones;
- promote global trade and investment and reject protectionism, to underpin prosperity; and
- build an inclusive, green, and sustainable recovery. By acting together to fulfil these pledges we will bring the world economy out of recession and prevent a crisis like this from recurring in the future.
5. The agreements we have reached today, to treble resources available to the IMF to $750 billion, to support a new SDR allocation of $250 billion, to support at least $100 billion of additional lending by the MDBs, to ensure $250 billion of support for trade finance, and to use the additional resources from agreed IMF gold sales for concessional finance for the poorest countries, constitute an additional $1.1 trillion programme of support to restore credit, growth and jobs in the world economy. Together with the measures we have each taken nationally, this constitutes a global plan for recovery on an unprecedented scale.
Restoring growth and jobs
6. We are undertaking an unprecedented and concerted fiscal expansion, which will save or create millions of jobs which would otherwise have been destroyed, and that will, by the end of next year, amount to $5 trillion, raise output by 4 per cent, and accelerate the transition to a green economy. We are committed to deliver the scale of sustained fiscal effort necessary to restore growth.
7. Our central banks have also taken exceptional action. Interest rates have been cut aggressively in most countries, and our central banks have pledged to maintain expansionary policies for as long as needed and to use the full range of monetary policy instruments, including unconventional instruments, consistent with price stability.
8. Our actions to restore growth cannot be effective until we restore domestic lending and international capital flows. We have provided significant and comprehensive support to our banking systems to provide liquidity, recapitalise financial institutions, and address decisively the problem of impaired assets. We are committed to take all necessary actions to restore the normal flow of credit through the financial system and ensure the soundness of systemically important institutions, implementing our policies in line with the agreed G20 framework for restoring lending and repairing the financial sector.
9. Taken together, these actions will constitute the largest fiscal and monetary stimulus and the most comprehensive support programme for the financial sector in modern times. Acting together strengthens the impact and the exceptional policy actions announced so far must be implemented without delay. Today, we have further agreed over $1 trillion of additional resources for the world economy through our international financial institutions and trade finance.
10. Last month the IMF estimated that world growth in real terms would resume and rise to over 2 percent by the end of 2010. We are confident that the actions we have agreed today, and our unshakeable commitment to work together to restore growth and jobs, while preserving long-term fiscal sustainability, will accelerate the return to trend growth. We commit today to taking whatever action is necessary to secure that outcome, and we call on the IMF to assess regularly the actions taken and the global actions required.
11. We are resolved to ensure long-term fiscal sustainability and price stability and will put in place credible exit strategies from the measures that need to be taken now to support the financial sector and restore global demand. We are convinced that by implementing our agreed policies we will limit the longer-term costs to our economies, thereby reducing the scale of the fiscal consolidation necessary over the longer term.
12. We will conduct all our economic policies cooperatively and responsibly with regard to the impact on other countries and will refrain from competitive devaluation of our currencies and promote a stable and well-functioning international monetary system. We will support, now and in the future, to candid, even-handed, and independent IMF surveillance of our economies and financial sectors, of the impact of our policies on others, and of risks facing the global economy.
Strengthening financial supervision and regulation
13. Major failures in the financial sector and in financial regulation and supervision were fundamental causes of the crisis. Confidence will not be restored until we rebuild trust in our financial system. We will take action to build a stronger, more globally consistent, supervisory and regulatory framework for the future financial sector, which will support sustainable global growth and serve the needs of business and citizens.
14. We each agree to ensure our domestic regulatory systems are strong. But we also agree to establish the much greater consistency and systematic cooperation between countries, and the framework of internationally agreed high standards, that a global financial system requires. Strengthened regulation and supervision must promote propriety, integrity and transparency; guard against risk across the financial system; dampen rather than amplify the financial and economic cycle; reduce reliance on inappropriately risky sources of financing; and discourage excessive risk-taking. Regulators and supervisors must protect consumers and investors, support market discipline, avoid adverse impacts on other countries, reduce the scope for regulatory arbitrage, support competition and dynamism, and keep pace with innovation in the marketplace.15. To this end we are implementing the Action Plan agreed at our last meeting, as set out in the attached progress report. We have today also issued a Declaration, Strengthening the Financial System. In particular we agree:
- to establish a new Financial Stability Board (FSB) with a strengthened mandate, as a successor to the Financial Stability Forum (FSF), including all G20 countries, FSF members, Spain, and the European Commission;
- that the FSB should collaborate with the IMF to provide early warning of macroeconomic and financial risks and the actions needed to address them;
- to reshape our regulatory systems so that our authorities are able to identify and take account of macro-prudential risks;
- to extend regulation and oversight to all systemically important financial institutions, instruments and markets. This will include, for the first time, systemically important hedge funds;
- to endorse and implement the FSF’s tough new principles on pay and compensation and to support sustainable compensation schemes and the corporate social responsibility of all firms;
- to take action, once recovery is assured, to improve the quality, quantity, and international consistency of capital in the banking system. In future, regulation must prevent excessive leverage and require buffers of resources to be built up in good times;
- to take action against non-cooperative jurisdictions, including tax havens. We stand ready to deploy sanctions to protect our public finances and financial systems. The era of banking secrecy is over. We note that the OECD has today published a list of countries assessed by the Global Forum against the international standard for exchange of tax information;
- to call on the accounting standard setters to work urgently with supervisors and regulators to improve standards on valuation and provisioning and achieve a single set of high-quality global accounting standards; and
- to extend regulatory oversight and registration to Credit Rating Agencies to ensure they meet the international code of good practice, particularly to prevent unacceptable conflicts of interest.
16. We instruct our Finance Ministers to complete the implementation of these decisions in line with the timetable set out in the Action Plan. We have asked the FSB and the IMF to monitor progress, working with the Financial Action Taskforce and other relevant bodies, and to provide a report to the next meeting of our Finance Ministers in Scotland in November.
Strengthening our global financial institutions
17. Emerging markets and developing countries, which have been the engine of recent world growth, are also now facing challenges which are adding to the current downturn in the global economy. It is imperative for global confidence and economic recovery that capital continues to flow to them. This will require a substantial strengthening of the international financial institutions, particularly the IMF. We have therefore agreed today to make available an additional $850 billion of resources through the global financial institutions to support growth in emerging market and developing countries by helping to finance counter-cyclical spending, bank recapitalisation, infrastructure, trade finance, balance of payments support, debt rollover, and social support. To this end:
- we have agreed to increase the resources available to the IMF through immediate financing from members of $250 billion, subsequently incorporated into an expanded and more flexible New Arrangements to Borrow, increased by up to $500 billion, and to consider market borrowing if necessary; and
- we support a substantial increase in lending of at least $100 billion by the Multilateral Development Banks (MDBs), including to low income countries, and ensure that all MDBs, including have the appropriate capital.
18. It is essential that these resources can be used effectively and flexibly to support growth. We welcome in this respect the progress made by the IMF with its new Flexible Credit Line (FCL) and its reformed lending and conditionality framework which will enable the IMF to ensure that its facilities address effectively the underlying causes of countries’ balance of payments financing needs, particularly the withdrawal of external capital flows to the banking and corporate sectors. We support Mexico’s decision to seek an FCL arrangement. 19. We have agreed to support a general SDR allocation which will inject $250 billion into the world economy and increase global liquidity, and urgent ratification of the Fourth Amendment.
20. In order for our financial institutions to help manage the crisis and prevent future crises we must strengthen their longer term relevance, effectiveness and legitimacy. So alongside the significant increase in resources agreed today we are determined to reform and modernise the international financial institutions to ensure they can assist members and shareholders effectively in the new challenges they face. We will reform their mandates, scope and governance to reflect changes in the world economy and the new challenges of globalisation, and that emerging and developing economies, including the poorest, must have greater voice and representation. This must be accompanied by action to increase the credibility and accountability of the institutions through better strategic oversight and decision making. To this end:
- we commit to implementing the package of IMF quota and voice reforms agreed in April 2008 and call on the IMF to complete the next review of quotas by January 2011;
- we agree that, alongside this, consideration should be given to greater involvement of the Fund’s Governors in providing strategic direction to the IMF and increasing its accountability;
- we commit to implementing the World Bank reforms agreed in October 2008. We look forward to further recommendations, at the next meetings, on voice and representation reforms on an accelerated timescale, to be agreed by the 2010 Spring Meetings;
- we agree that the heads and senior leadership of the international financial institutions should be appointed through an open, transparent, and merit-based selection process; and
- building on the current reviews of the IMF and World Bank we asked the Chairman, working with the G20 Finance Ministers, to consult widely in an inclusive process and report back to the next meeting with proposals for further reforms to improve the responsiveness and adaptability of the IFIs.
21. In addition to reforming our international financial institutions for the new challenges of globalisation we agreed on the desirability of a new global consensus on the key values and principles that will promote sustainable economic activity. We support discussion on such a charter for sustainable economic activity with a view to further discussion at our next meeting. We take note of the work started in other fora in this regard and look forward to further discussion of this charter for sustainable economic activity.
Resisting protectionism and promoting global trade and investment
22. World trade growth has underpinned rising prosperity for half a century. But it is now falling for the first time in 25 years. Falling demand is exacerbated by growing protectionist pressures and a withdrawal of trade credit. Reinvigorating world trade and investment is essential for restoring global growth. We will not repeat the historic mistakes of protectionism of previous eras. To this end:
- we reaffirm the commitment made in Washington: to refrain from raising new barriers to investment or to trade in goods and services, imposing new export restrictions, or implementing World Trade Organisation (WTO) inconsistent measures to stimulate exports. In addition we will rectify promptly any such measures. We extend this pledge to the end of 2010;
- we will minimise any negative impact on trade and investment of our domestic policy actions including fiscal policy and action in support of the financial sector. We will not retreat into financial protectionism, particularly measures that constrain worldwide capital flows, especially to developing countries;
- we will notify promptly the WTO of any such measures and we call on the WTO, together with other international bodies, within their respective mandates, to monitor and report publicly on our adherence to these undertakings on a quarterly basis;
- we will take, at the same time, whatever steps we can to promote and facilitate trade and investment; and
- we will ensure availability of at least $250 billion over the next two years to support trade finance through our export credit and investment agencies and through the MDBs. We also ask our regulators to make use of available flexibility in capital requirements for trade finance.
23. We remain committed to reaching an ambitious and balanced conclusion to the Doha Development Round, which is urgently needed. This could boost the global economy by at least $150 billion per annum. To achieve this we are committed to building on the progress already made, including with regard to modalities.
24. We will give renewed focus and political attention to this critical issue in the coming period and will use our continuing work and all international meetings that are relevant to drive progress.
Ensuring a fair and sustainable recovery for all
25. We are determined not only to restore growth but to lay the foundation for a fair and sustainable world economy. We recognise that the current crisis has a disproportionate impact on the vulnerable in the poorest countries and recognise our collective responsibility to mitigate the social impact of the crisis to minimise long-lasting damage to global potential. To this end:
- we reaffirm our historic commitment to meeting the Millennium Development Goals and to achieving our respective ODA pledges, including commitments on Aid for Trade, debt relief, and the Gleneagles commitments, especially to sub-Saharan Africa;
the actions and decisions we have taken today will provide $50 billion to support social protection, boost trade and safeguard development in low income countries, as part of the significant increase in crisis support for these and other developing countries and emerging markets;
- we are making available resources for social protection for the poorest countries, including through investing in long-term food security and through voluntary bilateral contributions to the World Bank’s Vulnerability Framework, including the Infrastructure Crisis Facility, and the Rapid Social Response Fund;
- we have committed, consistent with the new income model, that additional resources from agreed sales of IMF gold will be used, together with surplus income, to provide $6 billion additional concessional and flexible finance for the poorest countries over the next 2 to 3 years. We call on the IMF to come forward with concrete proposals at the Spring Meetings;
- we have agreed to review the flexibility of the Debt Sustainability Framework and call on the IMF and World Bank to report to the IMFC and Development Committee at the Annual Meetings; and
- we call on the UN, working with other global institutions, to establish an effective mechanism to monitor the impact of the crisis on the poorest and most vulnerable.
26. We recognise the human dimension to the crisis. We commit to support those affected by the crisis by creating employment opportunities and through income support measures. We will build a fair and family-friendly labour market for both women and men. We therefore welcome the reports of the London Jobs Conference and the Rome Social Summit and the key principles they proposed. We will support employment by stimulating growth, investing in education and training, and through active labour market policies, focusing on the most vulnerable. We call upon the ILO, working with other relevant organisations, to assess the actions taken and those required for the future.
27. We agreed to make the best possible use of investment funded by fiscal stimulus programmes towards the goal of building a resilient, sustainable, and green recovery. We will make the transition towards clean, innovative, resource efficient, low carbon technologies and infrastructure. We encourage the MDBs to contribute fully to the achievement of this objective. We will identify and work together on further measures to build sustainable economies.
28. We reaffirm our commitment to address the threat of irreversible climate change, based on the principle of common but differentiated responsibilities, and to reach agreement at the UN Climate Change conference in Copenhagen in December 2009.
Delivering our commitments
29. We have committed ourselves to work together with urgency and determination to translate these words into action. We agreed to meet again before the end of this year to review progress on our commitments.

To download go to:
http://www.londonsummit.gov.uk/resources/en/PDF/final-communique
Annexes:
http://www.londonsummit.gov.uk/resources/en/PDF/annex-ifi
http://www.londonsummit.gov.uk/resources/en/PDF/annex-strengthening-fin-sysm
The annexes add 2 + 6 pages to the main communique of 9 pages. The whole statement is commitment to do things expressed as principles. There is a lot of room for interpretation.