Sometimes the “long-term” never comes

| February 2, 2012 | 0 Comments

Traders and other short-term oriented people in finance often use a certain acronym to describe and justify their myopic tendencies: IBGYBG. “I’ll be gone, you’ll be gone”, with the unspoken corollary being, “So why shouldn’t we do this profitable yet risky trade that might blow up somewhere down the line after we’re long gone?”

Now central bankers, regulars and other “responsible”-type folk would never quite put it that way. Still I couldn’t help being struck by the similar way in which they seem to be focusing exclusively on today’s problems with a possible consequence of storing up bigger problems for tomorrow. Consider:

  • The European Union may allow banks to include asset-backed securities in their calculation of their 30 day emergency liquidity buffer. (Source.) The assets used to calculate this liquidity coverage ratio are supposed to be “easy to sell”. As Josh Brown has written, asset correlation and extreme volatility tend to go together. So it’s quite conceivable that these ABS won’t be easy to sell at just such a stressed moment.
  • Also in the EU we have Michel Barnier, Commissioner for Internal Markets and Services, saying that he will delay bail-in rules for banks until the crisis has passed. (Source.) These rules are meant to ensure that when banks get into trouble the holders of their bonds will be among the first to suffer losses. Instead of taxpayers. You know, like capitalism or something. Barnier says that, given the current crisis, the plan should instead be enacted in the “medium to long term”.

But of course Europe’s not the only one engaging in these sort of “pray and delay” strategies. Faced with a U.S. economy that is still very sluggish the Federal Reserve has said that it will continue to keep interest rates extremely low for three more years. Satayjit Das did an excellent takedown in Tuesday’s Financial Times of all of the distortions this creates:

  • labor gets substituted with capital in the production process, i.e. companies with access to cheaper money have more incentive to borrow in order to buy equipment as opposed to hiring workers
  • defined benefit pension funds find the value of their liabilities increasing because these are discounted at a lower rate
  • asset prices get inflated and the “dumb money” flows to bad investments

This is not meant to ignore or minimize the fact that central bankers and regulators are facing a very difficult economic environment, and that the need to make it through another day can justifiably trump longer-term considerations. But it’s easy to forget the extraordinary, unprecedented amount of assistance being lent to the economy, the fact that it’s been going on for 4 years now and the idea that it will likely continue into the foreseeable future. What’s the end-game here? Where will this lead? As the FT’s Gavyn Davies writes:

the recent use of central bank balance sheets has been so unusual and potentially so profound that the underlying economics deserves much more careful examination than it has been receiving lately.

All you have to do is look at this chart from James Bianco posted on the Big Picture earlier this week to see what he means.

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Image credit: CmdrFire on Flickr

 

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Category: Macroeconomics

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