Credit Default Swaps on Trial

The result of credit compulsion was rather paradoxical.

This key difference between the US and (continental) Europe explains the resilience of the US economy to the collapse of its credit boom.

Credit default swaps (CDS) are particularly suspicious instruments.

Ecuador needed to go all the way to a credit event in December 2008 to be able to purchase the bonds at bargain prices.

But the macroeconomic weakness in the US now goes beyond the decreased supply of credit. Falling house prices reduce household wealth and therefore consumer spending.

The Federal Reserve lowered its target federal funds rate to zero before Obama was inaugurated, and initiated many programs to try to revive credit markets, with mixed results (the commercial paper facility has helped, whereas others seem to have gotten off to less sanguine starts).

Lack of robust credit growth will hamper private consumption and investment spending.

Indeed, CDSs are blamed as one of the main causes of the financial crisis.

Indeed, a chain of financial intermediaries now earn fees without bearing the credit risk.

People are skeptical for understandable reasons, and in the case of the credit crisis, angry.

The IMF s creditors consider it a necessary safeguard against increased risks in the Fund s credit portolio.

In this way, the Fed contributed to creating the sub prime crisis. However, in the Fed s defense, low interest rates were needed to maintain the expansion.

In this way, the Fed contributed to creating the sub prime crisis.

Additional wage cuts will not help export oriented companies, which are mired in a credit crunch.

No one knew the real value of credit default swaps and of the various tranches of collateralized debt obligations.

Those economies that are dependent on exports to the US and Europe and that have large current account surpluses (China, most of Asia, and most other emerging markets) will suffer from the G7 recession.

Those with large current account deficits (India, South Africa, and more than 20 economies in East Europe from the Baltics to Turkey) may suffer from the global credit crunch.

The ECB s insistence on voluntary restructuring that is, avoidance of a credit event has placed the two sides at loggerheads.

The ECB s insistence on voluntary restructuring that is, avoidance of a credit event 160 has placed the two sides at loggerheads.

It is also difficult to trace back to the 1980 s the origins of the credit explosion and the proliferation of exotic and poorly understood financial instruments that lay at the heart of the 2007 2008 crisis.

Before the 2008 financial crisis, CDSs were an esoteric product, known only to a restricted number of sophisticated investors and specialized academics.

PRINCETON Currency chaos is back, highlighting demands for a revised international monetary order. The rapid decline of the dollar and the pound, but also of the renminbi now more firmly tied to the dollar than ever is fanning tensions.

PRINCETON Currency chaos is back, highlighting demands for a revised international monetary order.

The Macedonian government has been trying to acquire fresh capital by issuing a Eurobond, a type of credit sold on the European banking market.

Tighter credit rationing will then further hamper the ability of households and firms to borrow, spend, invest, and sustain economic growth.

It may have had something to do with the near total lack of response of long term interest rates to monetary tightening.

Likewise, the third engine, Japan, is running out of fuel after a year of fiscal and monetary stimulus.

At the beginning of the current credit crunch, many historically minded people picked 1907 as the key precedent.

But the comparison is misleading, because 2007 was the peak of a credit bubble that led to a lot of wasteful investment.

Monetary policy alone cannot resolve the consequences of inaction by regulators and supervisors amid the credit excesses of the last few years.

This caused a credit crunch and prolonged deflation in the late 1990 s, as the central government tried to clean up the mess.

Today, however, more than four years into a credit crisis, a conspicuous enigma calls this legacy into question.

It was argued then as now that debt relief depended on Russia implementing (IMF approved) economic reform programs aimed at restoring creditworthiness.

For the time being.

Goodbye. See you tomorrow.

We urgently need to monitor and understand the role of shadow banking and the too big to fail banks in creating the global credit glut.

They became major contributors to the Fund s emergency loan pool (the New Arrangements to Borrow) immediately after the crisis and now provide 15.5 of the NAB s resources.

But, given the huge size of China s credit bubble and the enormous amounts of money needed to recapitalize the banking system, only some of them will be bailed out.

The G 7 action plan aims to restore the flow of credit by securing interbank lending, and coordinated central bank actions have provided unprecedented levels of liquidity to the market.

As in Europe and the US, the worst will be avoided in 2012 only by kicking the can down the road with more monetary, fiscal, and credit stimulus.

While its depth and length cannot be predicted, a continued credit crunch, sovereign debt problems, lack of competitiveness, and fiscal austerity imply a serious downturn.

Strong financial market supervision will also be needed to contain risks stemming from credit booms, asset bubbles, and financial market volatility.

The alternative theory of a global credit glut gained more ground with the release last week of the Financial Stability Board s report on shadow banking.

To lose one international lending institution head is misfortune, to lose two looks like carelessness (my apologies to Oscar Wilde).