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The developed world tax payers are bailing out the banking system – The US and UK will be the first to reveal a widespread liquidity trap.

Posted by Adrian on April 22, 2008

The Bank of England will be bailing out some larger to medium size banks, similar to the obscene bailout of Bear Stearns by the Federal Reserve and the Fed also adding billions on dollars of mortgage backed securities to their balance sheet. Mervyn King the BoE governor of course utilizes the ‘we are doing this for the public’ argument by taking on mortgage debt and essentially bailing out a bank. The possible bank in question is Royal Bank or Scotland.

Banks are private businesses, they make money and really don’t care about individuals. Which is an obvious aspect to their business model, banks are highly competitive and run a risk management section with no staff in it. They (banks) have made some horrendous miscalculations and errors in the history of the banking industry. A few banks should sink, go out of business, go bankrupt to teach the sector a lesson.

The unfortunate aspect of the central banks of the world, is the ability to play with taxpayers money to prop up a private industry. For an example, a central bank will loan a retail bank at a discounted rate. The monies used to loan, or bail that retail bank out (buying mortgage toxic waste) is from tax payer contribution. The business, which is the retail bank, will then loan you the money at a higher rate, so they can profit. Then you can also mix in the grossly overpaid CEO’s and upper management, even when a bank is failing – as a kind of insult to injury. The customer, or consumer is being fleeced. With central banks taking on risk and moving that risk (junk) to their balance sheets, it is inevitable that extra taxes are needed to shore up capital in central banks. So taxes remain high, or increase, combine that with inflation, deprecating assets (housing, stocks and pretty much everything connected with the assets markets). A terrible situation.

I agree with what Jim Rogers says, when he says that it is ‘socialism for the rich’ (bailing out banks). He is right, it is socialism for the rich when central banks should be there to protect the integrity of money, but instead are used to bail out an institution, that should be made an example of and allowed to go bankrupt.

So we also assume that the central banks of the world can afford to go on these bank rescue missions. This causes the central banks to increase money supply, since they have taken on risk, they have now allowed themselves to be seen in a position to bail out the whole banking sector – which extends beyond mortgage banked securities, there is also credit, car loans and other debt markets.

Recently the Reserve Bank of Australia has bought 320 million (Australian dollars) of MBS’s. This will of course lead to an increase of money supply, I am unsure that an increase in money supply in Australia could be offset by high yielded Australian dollar. Australia is clearly in realm of hyperinflation (hence the cash rate at 7.25%). The purchase could indicate that a smaller Australian bank is in trouble, and the RBA (albeit on a smaller lever – although could increase) is doing what the BoE and Fed have done and continue to do. With deleveraging, declining asset markets and inflation. The RBA may cut rates sooner than later, the bank has lost it’s battle with inflation (interest rate hikes were too late). Hence the talk by economists that interest rates are going to pause or be cut , as the Australian market is heading for a sharp downturn (local banks lending rates continue upward), especially the property market. In that case we could see a dramatic sell off of the AUD, with inflation continuing upward for the economy

The liquidity trap occurs when a central bank bails out a bank and we then have to assume, that these banks will then lend the money out. Not just shore up capital, which is what they are doing. Also, the world (in my opinion) is at the brink of recession (US already in recession, Japan, Singapore and parts of Europe following suit). This would mean that the consumers demand for credit will diminish. Not just from deleveraging, but also from collapsing asset markets like housing. If central banks are beginning to act reckless, just as the retail banks have done, is a liquidity trap going to occur?

Found this pierce written by Professor Paul Krugman, which goes into detail of what a Liquidity Trap means in relation to the Japanese markets of the 90’s. Some mathematical logarithmic equations in there, also an old piece going back to 1998. Nevertheless a good read.

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4 Responses to “The developed world tax payers are bailing out the banking system – The US and UK will be the first to reveal a widespread liquidity trap.”

  1. The Yield Curve of Keynes’ Liquidity Trap

    The liquidity trap is usually defined as a zero lower limit of short-term interest rates.

    However you can define a yield curve of the Liquidity Trap where you have a positive lower limit of long-term interest rates.

    If the Market does not reward the investor for interest rate risk at a given maturity he then prefers liquid assets over long-term assets of that maturity: it is what Keynes’ termed the liquidity preference.

    When a yield curve is steep the Market prefers long-term assets over short-term assets, when the yield curve is inverted the Market prefers short-term assets over long-term assets.

    The normal curve marks Market indifference between short-term and long-term assets.

    The Yield Curve of Keynes’ Liquidity Trap is simply the normal yield curve coming out of 0% for very short term-assets.

    The traditional zero lower limit is simply the short part of the Keynes’ Liquidity Trap Yield Curve.

    My model says that, when long-term rates get to their positive lower limit, banks stop transforming short-term rates into long-term investments of that maturity.

    Then central banks, in order to increase long-term investments, the conduit of money creation, is constrained to lower short-term rates to zero without being able to generate any long-term investments.

    What makes Keynes’ Liquidity Trap so terrible is that it stops the money creation.Because of Greenspan Conundrum it is highly probable that long term rates will reach the longer part of the yield curve of Keynes’ Liquidity Trap before short-term rates fall to zero.

    My model of the yield curve never gave a signal of a systemic collapse during the recent credit crisis: it has always predicted that the Federal Reserve had sufficient room to rescue the market and the economy.<

  2. Adrian said

    Thank you for your informative post regarding the Keynes’ Liquidity Trap.

  3. […] of the country is essentially already in one and Australian banks (that are fragile) could become liquidity traps. So what might occur is the Australia government may send out ’stimulus’ cheques akin […]

  4. Hey not sure if you looked into this but what do you know about the relations between Japan and Africa, or Singapore and Japan? I’ve read this really great article and would like your thoughts and comments.

    Japan Leads the Way in Africa’s Economic Development
    01 Sep 2008

    In the last 15 years, Japan has emerged as the global leader in the development of Africa. By doing so, it has also strengthened its bilateral relations with the continent and has secured economic benefits for both parties.
    A major way Japan has spearheaded the task of invigorating Africa’s economy is through the Tokyo International Conference on African Development (TICAD). The TICAD is a conference in Tokyo held every five years to improve relations between Africa and its development partners. The first TICAD, TICAD I, took place in 1993, and the most recent, TICAD IV, wrapped up at the end of May of 2008. At all four conferences, Japan has reinforced its long-term commitment to promoting peace and economic stability in Africa.
    During TICAD I, Japan took the lead in producing the “Tokyo Declaration on African Development,” a document that aimed to encourage high-level policy dialogue between Africa and its development partners. Japan remained optimistic about Africa’s potential though many other of Africa’s development partners began to lose interest. At the end of TICAD I, several prospects appeared promising, though almost nothing was guaranteed.
    Five years later, TICAD II generated the “Tokyo Agenda for Action,” which was much more action-oriented than the Tokyo Declaration on African Development. This document called for poverty reduction and a push for Africa’s integration into the global economy. TICAD III drew over 1,000 African delegates including the Chairperson of the African Union, Thabo Mbeki. This conference analyzed the achievements of TICAD over the past 10 years and developed future goals for African development.
    TICAD IV took place from May 28-30 2008. Japan’s Prime Minister Yasuo Fukuda met with representatives from 51 African countries, 22 donor nations, and 55 international organizations. In all, more than 3,000 people participated in TICAD IV making it the most heavily attended TICAD of the four. The conference aimed to boost economic growth, ensure human security, and address environmental issues in Africa.
    The conference recognized that the key to Africa’s growth is the development of the continent’s infrastructure. History has proven that improvements in transportation infrastructure attract more private investments. Japan has targeted Africa’s infrastructure as the main area it will develop, pledging $4 billion in Official Development Assistance (ODA) loans by the end of 2012. Increasing ODA loans will encourage Japanese private-sector investment in Africa. Furthermore, Japan will double its grant aid and technical cooperation in the next five years. The Japanese government will also establish a fund at the Japan Bank for International Cooperation that aims to double investment in Africa.
    At the conference, Prime Minister Fukuda also tracked Africa’s economic progress over the past decade. Sub-Saharan Africa’s economy grew at a rate of 5% from 2004-2007 and reached 6% in late 2007. Japan will look to further increase Africa’s economic growth by helping the continent double its rice output to 28 million tons by 2018. Furthermore, Japan will give a significant portion of a $100 million global emergency food assistance package to Africa.
    Africa has long complained that though it contributes very few greenhouse gases, it must still suffer the effects of global warming. Africa only contributes about 3.8% of the world’s greenhouse gas emissions. By taking the lead on climate change initiatives, Japan has indirectly assisted in resolving Africa’s environmental problems. Japan’s “Cool Earth 50,” introduced in 2007, aims to reduce greenhouse gas emissions by 50% by 2050. Japan has also led the way in the creation of the $10 billion Climate Change Fund. In addition, Japan automakers have made a push to produce cleaner, more fuel-efficient cars including many hybrid models.
    In the next five years, Japan will train 100,000 people as health workers who will travel to African countries that suffer from a shortage of health care. Japan has also pledged $560 million to the Global Fund to fight AIDS, Tuberculosis, and Malaria, about $330 million of which will go directly to Africa.
    The TICAD conferences have given Japan tremendous opportunities to strengthen diplomatic and economic ties with Africa. As a resource-rich continent, Africa can offer Japan many precious metals that the country needs for its high-tech industries. Africa is home to 89% of the world’s platinum, 60% of its diamonds, 34% of its chrome, 37% of its zirconium, and 53% of its cobalt. Because the Japan Bank for International Cooperation is providing $490 million to co-sponsor a nickel mining project in Madagascar, Japan’s Sumitomo Corporation will have the right to purchase 30,000 tons of nickel annually. In addition, Japan will begin to import platinum, nickel and cobalt from Botswana.
    With strong bilateral ties with Africa, Japan also has Africa’s support as it seeks a permanent seat on the UN Security Council. The African countries account for 25% of the UN General Assembly. Africa’s support has been crucial to Japan winning the Asian non-permanent Security Council seat in 1996 and the election of Shigeru Oda to the UN International Court of Justice. If it is to secure Africa’s political support and imports of raw materials, it is in Japan’s best interest to continue to assist Africa in its economic development. As long as Japan continues to invest in Africa and solidify ties with it though future TICAD conferences, both parties will continue to gain significant benefits.

    Here’s the other

    Japan, Singapore CRE Investors Brave Liquidity Crunch
    MBA (8/30/2007)

    Large-lot deals and office sector activity spurred Japan and Singapore into a strong first half of the year, as the current global liquidity crisis does not appear to stall real estate investment in Asia.
    Japan and Singapore, with collective investment amount in large-lot deals during the first and second quarters, accounted for more than half of the regional total, and international institutions and real estate investment trusts continued their activity throughout the region, according to research from CB Richard Ellis International.
    Research analysts said investors remained “overwhelmingly positive” toward the Japanese real estate market with nine consecutive quarters of economic expansion and an annualized real growth rate of 3.3 percent during the first quarter the year.
    Indeed, Reuters reported earlier this month that New York-based private investors, The Blackstone Group, will open a real estate office in Tokyo to look for deals in Japan’s property market, and Bloomberg reported Farifield, Conn.-based GE Real Estate could increase its Japanese property holdings by more than 60 percent this year to reach $8.6 billion. GE Real Estate has been in Japan since 1998.
    “Japan has been ready for global investments for a long time. Now, it is coming to fruition and a lot of investment will go to Japan,” said Raymond Mobrez Ph.D, director at http://www.asiaecon.org, Los Angeles, Calif.
    The combined value of the first quarter’s 10 largest investment deals totaled $6.9 billion in U.S. currency, including the acquisition of a portfolio of industrial properties by Tokyo-based Secured Capital Japan and DLJ Real Estate Capital Partners at a price of nearly $1.4 billion.
    Meanwhile, Fitch Ratings, New York, reported that the losses from subprime exposure in certain Japanese banks would be “comfortably absorbed” by a portion of the bank’s annual earnings.
    “None [of the banks] should see its solvency threatened from this factor alone, as the exposures are only a small fraction of the banks’ equity,” Fitch said. “The large Japanese banks have sponsored and provided liquidity commitments to a number of conduits; to fulfill these commitments they may need to raise liquidity in yen and dollars, although these banks are unlikely to encounter difficulties raising the necessary liquidity, given the limited size of these commitments versus their balance sheets [up to 5 percent].”
    “There is more order in the financial infrastructure in Japan than in any other nation in Asia,” Mobrez said.
    CBRE International said Japanese REITs remained dominant players, adding to their portfolios in Tokyo and the rest of Japan. However, with the financial markets pricing a further interest rate increase, the report said that the 10-year Japanese Government Bonds yield increased from a 1.6 percent average in April to a 1.9 percent average in June, shrinking the positive spread of net operating income yields.

    In Singapore, investment transactions totaled more than $15.8 billion in the first half of the year, a 70 percent increase from the previous year, according to CBRE International. Development sites drove acquisitions as private equity groups and foreign funds gained interest in office properties.
    MCP Raffle, a unit of Macquarie Global Property Advisors, purchased Temasek Tower for nearly $660.8 million, making it the most significant office transaction in the first half of the year, CBRE said.
    Average rents for Singapore industrial space also increased in the second quarter, with high-tech space posting its largest gains in five years, according to CBRE. Analysts expect supply constraints in the office market and optimistic business conditions to increase demand and rents.
    The Singaporean banks were the most transparent in Asia, according to Fitch. The overall collateralized debt obligation exposure in the Singaporean banks was at nearly $1.5 billion, which could potentially give rise to losses that would dent annual earnings. However, Fitch said it would not materially weaken the banks’ capital,
    “Singapore has always been an attractive investment hub,” Mobrez said, in reference to Singapore’s financial stability, based on policy and infrastructure. “Financial market discipline is a role model for China to copy from Singapore.”

    Development Bank of Singapore disclosed $850 million of CDO/collateralized loan obligation exposures, including asset-backed securities exposure of $188 million. Not all of the $188 million is subprime-related—some is A-paper or higher—and it amounts to nearly 1.5 percent of DBS Group’s equity.
    Fitch’s data indicated limited exposure to problematic subprime mortgage assets among life insurers and—in a worst-case scenario—losses related to subprime exposures are likely to be within 6 percent of equity even for the more aggressive investors among the life insurance companies.
    Mobrez noted that Asia as a whole requires fiscal discipline from investors rather than overaggressive investment.
    “Financial balance is a key element in Asia. Investors have to look at that,” Mobrez said. “Investors have to walk into Asia with open eyes, rather than the belief that they just have to invest for the sake of investing.”

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