Monday, November 10, 2008

Jaimie Caruana for Fed Chairman!

Inside the Fed, there were running debates resembling academic seminars, with Mr. Bernanke running discussions but often offering few opinions.
—The Wall Street Journal, November 10, 2008

Who is Jaimie Caruana, you ask?

As governor of Spain’s central bank, Mr. Caruana “helped implement dynamic provisioning,” according to the same Wall Street Journal—i.e. this morning’s edition—that also reported on the Bernanke Fed’s predilection for verbal noshing of the academic type.

What is “dynamic provisioning,” you ask?

It is, essentially, a spare fuel tank for banks that siphons off excess cash when an economy is running smoothly, for the day that same economy starts to sputter, as The Wall Street Journal explains:

In 2000, Spain’s central bank introduced a system of so-called dynamic provisioning that forced banks to build up reserves against future, hypothetical losses. At the time, Spanish banks stiffly resisted the regulation, fearing they would lose ground against competitors.

Now the rules are credited with giving Spanish financial institutions with big capital cushions that have helped them ride out the financial turmoil remarkably well, despite the collapse of the country’s housing bubble.

Take a gander at the chart on loan-loss provisions in the Journal story for a look at how Mr. Caruana’s efforts prepared Spain for the inevitable. (Sharp-eyed readers may note that Iceland appeared to be well-reserved at the time.)

Imagine, a political appointee who took the time to think ahead!

That’s why our vote is for Jaime Caruana, for Fed Chairman.

Jeff Matthews
I Am Not Making This Up

© 2008 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews.
Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way: such inquiries will not be responded to. This content is intended solely for the entertainment of the reader, and the author.


Anonymous said...

This is also called "cookie-jar provisioning", which accounting watchdogs view as totally inappropriate because the company salts away earnings that they can then access when times are tough, and the acctg profession has felt that this inaccurately presents the company's current financial picture. Now the situation has changed...

Jeff Matthews said...

Not a bit.

This is forcing bankers to take higher loan loss provisions than they want to, so that when the cycle turns against them (as it always, eventually, does) they don't need the ask the Feds for a bailout.

Nothing at all to do with hiding reserves to smooth earnings.

And, not for nothing, it's worked.


Anonymous said...

jeff, check your e-mail dude!

Anonymous said...

Didn't our beloved SEC a few years back force a Georgia bank (Suntrust ?) to reverse part of their bad debt allowance as it could be used to manage earnings? This also told all the other banks not to bother about increasing their bad debt reserves. (The same SEC that allowed the investment banks to go to thirty times leverage instead of just twenty times).

Jeff Matthews said...

The "Anonymous" who urges me to check our email attempted to post a long comment with one unfortunate attribute: yahoo message board langugage.

"Dude, clean it up" and it will appear.


Anonymous said...

Yes, the SEC did sue SunTrust about their reserving policy and forced them not to do exactly what JM is lauding the Spanish banks for doing. STI was formerly viewed as one of the most conservative banks in the US, with very good reserve policies, but commenter #1 got it right - the SEC frowned upon it. No common sense, that group.

Jeff Matthews said...

"Dude" still doesn't get it.

The problem is not the word "dude." The problem is an analogy you make that is not going to appear in these virtual pages.

If you can't see it, we're not going to explain it further.


Anonymous said...

I think Jaime Caruana works (or used to?) at the IMF. And possibly got the job there while his buddy Rodrigo de Rato (of Spain - of course) was the Managing Director of IMF. I heard they are under investigation in Spain for corruption - is that true?

kostas said...

You can reread the textbook of Mishkin, who is now another of academic governors at the Fed, aside from B. He says and i have seen it in some other authoritative sources, that :

A) A central bank has two basic policy tools at its disposal, one is interest rate, second is the reserve ratio.

B) The first one is normally used. The reserve ratio is a blunt tool, inappropriate to use on a frequent basis.

So, you can see that there is prevailing opinion in the US against dynamical reserve ratios. And i think we are really talking about reserve ratio, not loan loss reserves - somethink that confused another poster.

China uses primarily the reserve ratio as a monetary policy tool. It was very obviously inefficent in dealing with the overheating problem in the past couple of years, but one might argue that in combination with more aggressive rate tightening it would have worked. But then its not clear why rate increases alone would not do the job... Same goes for the US, if Greenspan did not wait to raise rates until late in 2004, when GDP was already growing at nearly 5%, things would not have been like this.

Add to this the coming implementation of Basel II, which basically does away with capital reserve ratio as a primary measure of soundness of the balance sheet, and we are in for a new, prolonged battle over this issues. But perhaps opposition from banks will be simply brushed aside, and restrictions on their activities of all kinds and not just on their capitalization ratios will become the norm.