It's also wrecking the carry trade. That's when you borrow at low interest rates in one place just to lend at higher rates somewhere else. For a long time, Japan has been a popular place to do this, for two reasons: the longtime recession has kept its interest rates low, and the government's committment to keep the currency cheap in order to subsidize exports has seemed like a shelter against a sharp currency move that would force borrowers to repay the loan in suddenly-more-expensive yen. Now that the yen is rising seemingly uncontrollably, investors are racing to unwind their positions.
The sharp movements in the currency market are somewhat surprising, particularly the euro's decline. Not very long ago, we were asking whether the euro would replace the dollar as the world's reserve currency; not it's the "sick man of Europe", as confidence in banks and businesses has been badly shaken. Europe took on less mortgage risk than the US, but much more emerging markets exposure, which is looking like a very bad bet with commodity prices plunging and credit contracting.
All of this seems like a pretty stinging rejoinder to the notion that the problem is simply a failure of regulatory stringence. The problems have spread across regulatory regimes, currencies, and banking systems; besides Canada, not a single large economy has escaped. Perhaps the problem is Basel II--having a unified standard may have left us more vulnerable. But there's something here deeper and more frightening than a lack of adequate rules.
Update: Tyler Cowen has more on the problems European banks have with emerging market exposure, and adds:
By the way, this is further evidence that the driving force behind the earlier boom was the global savings glut, and sheer giddiness, not the excessively loose monetary policy of Greenspan's Fed. The ECB has pursued a relatively tight monetary policy since its origin. It also will be interesting to see what trouble arises in Spain, since Spanish banking regulation has been considered a model of how to keep these problems under control.
But hardly anyone invests like that--a chunk of money at one point in time and then none afterward. Use dollar-cost (or yen-cost, whatever) averaging, and I'm pretty sure Nikkei investors (at least the typical 401(k) types) have made money.
I don't understand your argument, which seems akin to "the US cannot be experiencing regulatory lapse because the crisis is global."
This argument ignores the following: (1) the US crisis, however caused, can stimulate a global crisis; (2) the lack of regulation in the US does not imply that there might also be a need for global regulation of the flows that exist between countries.
I'm sure there are a few who think this was simply a failure of regulatory stringence ... but it still feels like a straw-man to me.
We had a bubble, and that exhibited itself in both market moves and oversight changes. The same market over-confidence feed real estate bubbles and deregulation.
The unwind has to happen both ways, taking us not to "socialism" but to a better memory of what kind of moderately regulated market economy built our wealth.
The massive European banking problems are symptoms of a lot more than just a global credit contraction; those banks were at least as exposed to excess risk as ours. If the problem were our regulation, we should not see this kind of massive problem abroad--pain, yes, but not widespread failure.
The lower mortgage loan standards which began in the US sparked the housing bubble and made the losses much greater when the bubble burst. But the spread of this crisis feels to me like a classic bank run - people get scared and want to withdraw their money while there's still time; or in this case, they refuse to lend short term and pull their money from hedge funds, again simply to wait out the crisis and avoid risks.
First commercial paper and overnight bank lending dried up, and now hedge funds are being forced to sell their holdings because of redemptions, and people all over the world have just panicked and decided it's safer to stick their money under their mattress. If we think of this as a situation similar to a bank run, it may help us to figure out what can be done to at least reduce these problems in the future. Why has this 'flight to safety' been so much more traumatic than others? Is it because people don't know where 'safety' can be found at the moment?
Perhaps the problem is Basel II--having a unified standard may have left us more vulnerable.
I've been wondering about that, but hadn't seen it stated until now. I'm glad it's come up, because I think it's a valid concern. It's not that the idea of Basel II, mark-to-market, required asset classes, etc. are bad. The problem is that it forced everyone to use the same models, particularly the ones used by the ratings agencies. And since a model is by definition an approximation that is wrong at times, it left us vulnerable to everybody being wrong at once. Perhaps this is why some hedge funds, not tied to the same model, have reportedly been doing better.
It's tough to say what the solution to this is, in light of the Enron experience showing us the danger of letting some companies make up their own models. It may be that there is no government solution . An interesting contrast was given by the head of TIAA-CREF in an NPR interview recently. He basically said that they avoided much of the subprime mortgage securities because their risk management people didn't think the models were accurately pricing the risk, so they weren't worth it.
"If the problem were our regulation, we should not see this kind of massive problem abroad--pain, yes, but not widespread failure."
Surely you can see the logical fallacy.
Why is Canada the only major economy to so far survive the financial crisis without needing major shoring up of its financial institutions?
Perhaps the rest of the world might want to investigate that question more carefully.
In an earlier thread I asked how derivatives like CDSs are regulated ion Europe, Japan and other markets, since the G-L-B "nonregulation" of these assets is often cited as the kind of deregulation that caused the crisis. I firmly believe that the repeal of Glass-Stegall was not a cause of these problems, and probably saved a few banks in the current crisis.
I think that since this deregulation charge is being thrown around, it would be helpful to know what the norm is.
Peter - The Canadian government heavily regulates the big banks, and as a reward it protects them from outside competition. The cost is to the consumer, who puts up with much higher fees for practically every banking service, as well as lower interest rates.
What's happening in Europe isn't just fallout from the U.S. crisis. They were making their own bad loans. The "Economist" for May 17 had a special report on international banking that had an anecdote illustrating this. A cautious Spanish banker went to a conference of European banks and was the only one who wasn't making risky loans. All the other bankers were into "securitization and derivatives." He was thought of as stupid for being cautious. (p. 4).
There's also this article that makes Europe look worse than the U.S:
http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/3260052/Europe-on-the-brink-of-currency-crisis-meltdown.html
I can't speak about Canada, but here in the U.S., credit unions are doing all right because they were cautious. Likewise, those of us who were cautious about personal debt are doing fine.
I don't see which regulations would have helped with this. Lots of people wanted to gamble or else use bad advice. Regulations wouldn't have stopped them. This is a zeitgeist problem and not a regulation problem.
Maybe someone can explain to me how CDS magnified this crisis (which clearly began with bad loans). People have said that CDS tied the bad loans to 'everyone' and that, if they had been 'regulated', we would simply have had a bad loan problem but not a crisis.
How does this fit with the fact that commercial paper and overnight lending also dried up? It seems that banks and others were just generally worried, which can happen with or without a 'regulated' CDS market.
One problem with CDS was that no one knew who held what, making blind panic easier. CDS doesn't increase the total amount of bad loan risk, but it makes it more difficult for people to know who in the end would be stuck with losses from bad loans. But was there total transparency regarding where the subprime mortgages were, except for CDS? If not - if no one knew who actually held all the bad loans to begin with - then having transparency in the CDS market wouldn't have made a significant difference. Or are people just equating CDS with CDO?
Should Japan even consider itself a country focused on exports anymore?
They've blown past the point of being a inexpensive labor country a while ago. They're are a leader in productivity enhancements, but the employees have surely directed the value of those enhancements into their salaries by now.
Some companies, like Toyota, have moved their manufacturing out of Japan to places with cheaper costs (labor, raw materials, transportation, taxes, etc.)
Maybe the rising Yen is simply a reflection of the truth, they are a consumer nation that specializes in product and manufacturing innovations.
I wouldn't be so quick to believe that Canadian banks are solid- the deflation in commodity markets may yet reveal enormous losses there, too.
If the current correction in commodities represents the end of the secular bull market in them, and not just a cyclical correction, then Yancy Ward will probably be right. Some of the commodity-producing parts of Canada have had huge real estate booms. Jim Rogers thinks this is just a cyclical correction though, and that all the pump-priming governments are doing will lead to a wave of inflation and another leg up for commodities when the recession is over.
Dave,
But a cyclical correction can last far longer than your average Alberta bank can remain solvent.
Just because the Nikkei is at a 26-year low doesn't mean they're in significantly worse economic straits than the rest of us......they've had economic problems for years, and they've still got the second largest economny in the world. Let's keep everything in perspective.
Indeed, the Canadian economy will probably tank along with the rest of the world's - after all we're highly globalized.
More to the point, by being heavily regulated our banks won't crash because we took excessive risks and made piles of money. Instead, our banks will crash because everyone else took excessive risks and made piles of money.
At least we get to feel morally superior as we go down... (And Canadians are good at that :-))
I keep wondering how this can be so if Basel II capital adequacy standards are not yet in effect for U.S. banks.
Holdfast is correct. Canadian banks make their money by taxing the serfs. Their oligopolistic profit streams mean that they don't have to take on risk in order to get a return on capital. So they just sat on the sidelines during the whole sub-prime/CDS bonanza, which turned out to be the right decision.
This might in fact be a workable model going forward. Consumers will just have to be told that those big fat fees they are going to pay are a "stability premium." Also, Canadian banks don't lend money to people who don't have jobs or assets, so it'll back to redlining.
"But hardly anyone invests like that--a chunk of money at one point in time and then none afterward. Use dollar-cost (or yen-cost, whatever) averaging, and I'm pretty sure Nikkei investors (at least the typical 401(k) types) have made money."
Actually, you seem to be missing the meaning of "26 year low".
If you'd bought a Nikkei index fund at any point in the last 26 years, you'd be underwater today.
besides Canada, not a single large economy has escaped
Well there is Australia.
But I suppose socially, geopolitically, legally and economically, Australia and Canada are very close matches.
Not climatically though.