TUESDAY, JULY 27, 2010


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‘Systemic risk’ and the next bubble CONCEPT GAINS


NEW SCRUTINY


Theory focuses on global financial connections


by Howard Schneider


Americans might be counting on the day when home and re- tirement-fund values start to rise again, but anyone expecting to benefit from a future boom in prices should take note: Eco- nomic policymakers around the world are looking for ways to make sure that doesn’t happen, or at least not with such intensity that it risks the kind of bust that usually follows. In studying how to respond to the recent crisis and create a more stable system, central bankers, international officials and others have been focusing on a concept known as “systemic risk.” That’s the type of falling- domino problem that allowed mortgage defaults in the United States to lock up the global finan- cial system because of the com- plex connections among banks, investment companies, insurers and other firms around the world. The phenomenon is not fully understood. “We sort of know vaguely what systemic risk is and what factors might relate to it. But to argue that it is a well-developed science at this point is overstating the fact,” said Raghuram Rajan, a former International Monetary Fund chief economist and author of “Fault Lines,” which explored the role of U.S. real estate and credit bubbles in the crisis. A recent IMF paper described study of the field as “in its in- fancy.” Still, some central bank- ers and regulators are devising ways to try to control systemic risk, and one of the things they are focusing on is its connection to fast run-ups in the prices of real estate or other investments, or a quick expansion of credit and lending.


When to step in? Before the recent crisis, reg-


ulators assumed that markets with large numbers of people with enough information and the ability to move money freely could assess the risks of different investments and look out for themselves. That thinking guid- ed U.S. policy under then-Federal Reserve Chairman Alan Green- span, creating the conditions that allowed millions of Amer- icans to buy homes and borrow money under loose credit terms. Sometimes consumers profited if they sold property at the right time, but sometimes they be- came saddled, along with their bankers, with unaffordable mort- gages or houses that declined sharply in value. But that approach did not ad-


equately account for systemic risk. Policymakers in the United States and Europe and at organi- zations such as the IMF are dis- cussing how government agen- cies could best step in when mar-


10-YEAR TREASURY UP $0.30 PER $1,000, 2.99% YIELD


CURRENCIES $1 = 86.86 YEN; EURO = $1.299 DIGEST ANTITRUST


The current discussion in- volves some of the basic princi- ples of how markets should work in a post-crisis age. It throws open a range of sensitive ques- tions such as whether the Fed and other central banks should use interest rates or other tools for such actions as restraining home prices that are judged to be rising too fast.


“I think there has been a mas- sive change in the debate,” said Andrew Smithers, founder of the London-based Smithers & Co. economic consultancy. “Simply ignoring asset prices is so de- monstrably silly that it will not carry on either side of the Atlan- tic.”


Although Fed Chairman Ben S. Bernanke and others speak wari- ly about using interest rates or the other “very blunt” tools of the central bank to address problems in specific parts of the economy, he also has said he remains “open-minded” to the idea. Other ideas under discussion include imposing higher capital requirements on banks under certain conditions to slow lend- ing, as well as steps such as forc- ing potential home buyers to make larger down payments — familiar to Asian regulators who have had to cope with rapid in- creases in real estate values.


A new bureaucracy Overheated markets or dan-


NELSON CHING/BLOOMBERG NEWS


Overheated markets for real estate and other assets could face closer scrutiny from regulators. For instance, some analysts say China’s property market has the hallmarks of a bubble.


Setting limits Some suggested measures to


control systemic risk by limiting credit and asset bubbles: Force homeowners and


investors to make larger down payments on property. Pro: Protects banks by ensuring that mortgage holders have more equity, and cools property markets by slowing demand. Con: Prevents some


creditworthy buyers from obtaining loans if they cannot save enough for the down payment. Force banks to set aside more capital during good times.


kets appear to get overheated. It is not easy to tell the differ- ence between a risky “bubble” and a healthy economic expan- sion, and confusing one for the other could mean slower growth and lost opportunities. Yet the cost of the recent crisis in terms of lost production and high unemployment has con- vinced a broad array of officials, regulators and analysts that gov- ernment should do more to “lean against” markets that are thought to be growing too fast, and in the process try to ensure


Pro: Keeps institutions from lending too freely when property markets are overheating, and builds up capital reserves to help banks through downturns. Con: Like any


“counterycyclical” policy, risks limiting otherwise healthy economic growth. Raise interest rates. Pro: Slows lending and


borrowing by increasing the cost. Con: Traditionally, central banks have used interest-rate policy to regulate the overall economy. Using it to focus on problems in specific sectors, such as real estate,might undercut those other aims.


that the United States, Europe and other key areas don’t again surge in an unsustainable way — or crash in the aftermath. “The benefits of successfully


moderating both phases of the credit and asset price cycle are clearly worth pursuing,” the Switzerland-based Bank for International Settlement said in a recent report. The BIS serves as a grouping of the world’s major central banks, including the U.S. Federal Re- serve, and is an influential voice in financial regulation.


gerous levels of credit and bor- rowing are hardly pressing issues in the current climate, in which concern is centered on keeping a shaky recovery on track in the United States and Europe. But the attention given systemic risk is apparent in the new bureauc- racy growing up around it. The legislation signed into law last week by President Obama in- cludes a Financial Stability Over- sight Council, with powers to study and move against possible sources of systemic risk in the United States.


Europe is establishing a Euro- pean Systemic Risk Board; the BIS has set up a Financial Stabil- ity Board to study and make rec- ommendations about the issue; and the IMF has proposed a cen- tral role for itself in monitoring systemic risk on a global scale. In recent papers, both the IMF and the BIS discussed the chance that a wrong policy choice might slow otherwise healthy economic growth. But they also said the depth of the recent downturn showed that central banks and other government agencies need to expand their traditional focus on such issues as inflation and employment, and to be more at- tuned to controlling systemic risk and ensuring general finan- cial stability. Central banks in the developed world have learned how to keep prices stable, but “there was a gaping hole in the system,” which ignored financial stability con- cerns, IMF financial counselor Jose Vinals wrote in a recent es- say. Although he said central banks need to keep inflation as their chief focus on monetary policy, he also called for “more ‘leaning’ in good times and the need for ‘less cleaning’ in bad times once bubbles explode.” schneiderh@washpost.com


E.U. opens two investigations on IBM The European Union opened


two antitrust probes of IBM on Monday, accusing the U.S. tech- nology giant of abusing its domi- nant position in the mainframe computer market. One investiga- tion stems from complaints by IBM competitors T3 and Turbo Hercules, who say that IBM “shuts out providers of emulation technology” by tying its main- frame hardware and software to- gether. The other probe, begun at the E.U. executive’s own initiative, ac-


REGULATORS


The Federal Trade Commission has banned eight individuals and companies from selling mort- gage-relief services, after settling charges that they used false ad- vertising to deceive borrowers facing foreclosure. The FTC said Monday that it has ordered the firms and indi- viduals to return $29.2 million in fees allegedly collected from cli- ents. Some of the individuals charged are unable to pay, how- ever, and the agency said it has agreed to suspend $11.5 million


AUTOMOTIVE


FTC bans 8 from selling mortgage relief in judgments.


Since the housing crisis began,


the FTC has brought 29 cases against those who have falsely promised mortgage relief in ex- change for hefty fees up front. Some of the companies used names that could lead borrowers to think the firms were partici- pating in the Obama administra- tion’s $75 billion mortgage modi- fication effort, known as Making Home Affordable.


— Associated Press


cuses IBM of “discriminatory be- havior toward competing suppli- ers of mainframe maintenance services” and cites IBM’s “re- stricting or delaying access to spare parts” for which it is the only source. Mainframes are powerful computers used by large corporations and govern- ments to store and process crit- ical business information. The opening of an antitrust in-


vestigation does not mean the E.U. has proof of any wrongdoing. — Associated Press


S


A11


M. SPENCER GREEN/ASSOCIATED PRESS Ford unveils a leaner Explorer SUV


Ford’s completely redesigned 2011 Explorer is set to arrive in dealer- ships this winter. The automaker said its sport-utility vehicle would have seating for seven and fuel economy similar to that of a Toyota Camry sedan. Prices have not been announced.


— Associated Press ALSO IN BUSINESS


 FedEx boosts outlook: FedEx on Monday raised its earnings outlook for the quarter and full year, citing a boom in air and truck shipments that is being driven by its international priori- ty service, which ships high-val- ue goods such as computers, iPhones and e-readers. The company, a bellwether for


U.S. economic health, expects to earn between $1.05 and $1.25 per share for its quarter ending Aug. 31, up from 58 cents a share a year ago. The forecast is up from its previous guidance of 85 cents to $1.05 per diluted share. For the fiscal year ending in


May 2011, FedEx expects earn- ings per share of $4.60 to $5.20, up from its earlier guidance of $4.40 to $5 a share.  Citigroup says its iPhone app stored user data: Citigroup said Monday that its iPhone banking program had been saving ac- count information in hidden files on customers’ smartphones and computers, but that an update


Basel panel reaches deal on bank rules


Accord is first step in creating common global standards


by Howard Schneider


A panel of world financial offi- cials has reached “broad agree- ment” on new rules to govern the global banking system but has postponed some key elements for as long as seven years while the impact is studied, the Swit- zerland-based group said Mon- day. The group includes represen-


tatives of the world’s major cen- tral banks, including the Federal Reserve, and the accord marks an important step forward in ef- forts to build a system less sus- ceptible to the sort of shocks that occurred during the recent fi- nancial crisis and more able to weather any downturn. The aim is to create common standards to be applied in all banking centers, and to do so by the time the world’s major na-


tions gather in South Korea in November for their next summit. Monday’s agreement is “a landmark” toward that end, said European Central Bank Presi- dent Jean-Claude Trichet, chair- man of the group of central bankers and regulators who form the Basel Committee on Banking Supervision. The panel has not reached agreement on some of the most important and sensitive issues — notably how much capital banks are going to be asked to hold and the degree to which they will be required to hold it in the form of common equity, considered the best buffer against a downturn. Those issues remain under dis- cussion amid both protest from the banking industry that strict new standards will crimp eco- nomic growth and division be- tween the United States and Eu- rope over how tough new capital standards should be. European banks have traditionally relied less on common equity, while the United States and some Asian nations want banks globally to have enough highly liquid assets


on hand to withstand a shock at least as great as the one experi- enced in the recent crisis. Still, Monday’s announcement represents progress in what has been a complex discussion that attempts to mold regulatory principles that can be applied to banks and banking systems in a broad variety of nations. The committee includes representa- tives from 27 nations, and all but one — Germany, according to news reports from Europe — agreed to the new provisions. The panel agreed, for example, to allow a larger variety of assets to be counted as the highest- quality capital, which will make it easier for some European firms to meet new capital require- ments. It also agreed that large, highly


connected companies — those considered “too big to fail” — be subject to capital surcharges and other provisions so they are bet- ter protected in the event of a downturn.


Some of the group’s more con- troversial ideas — such as forcing some banks to rely more on long-


term sources of funding or ad- here to new limits on lending — remain in the plan but will be im- plemented during a transition period of as long as seven years. In a study of the Basel process, Brookings Institution fellow Douglas Elliott said the trade- offs being negotiated by the pan- el are clear: financial stability vs. more expensive credit, as banks are forced to raise and hold more capital in relation to the loans they make. “Newly toughened capital and


liquidity requirements should make national financial systems — and indeed the global finan- cial system — safer,” Elliott wrote. “Unfortunately, enhanced safety will come at a cost. . . . It is beyond serious dispute that loans and other banking services will become more expensive and harder to obtain.” Monday’s announcement was


“good on both timing and on the maintenance of the basic integri- ty of a globally negotiated, har- monized increase in capital and liquidity requirement,” he said. schneiderh@washpost.com


would delete the data and make the devices stop storing them. “There has been no data


breach,” said spokeswoman Nata- lie Riper in a statement. The pro- gram lets U.S. Citibank custom- ers see their account and credit card balances, pay bills and trans- fer money. The hidden files were logging account numbers and bill payment information, among other data.  Nissan recalls 46,000 Cube hatchbacks: Nissan on Monday filed documents with the Nation- al Highway Traffic Safety Admin- istration recalling 46,000 Cube hatchbacks because of possible problems with fuel spilling dur- ing rear-end crashes. The voluntary recall involves Cubes made between Jan. 30, 2009, and July 30, 2010. The au- tomaker notified dealers last week and will contact owners on Aug. 30. Dealers will be able to at- tach a special protector to pre- vent leaks, Nissan said. — From news services


Post Tech CECILIA KANG Excerpt from voices.washingtonpost.com/posttech ‘Jailbreaking’ the iPhone


Changes in federal copyright laws will allow users of Apple’s iPhone and other smartphones to lawfully download applications that aren’t approved by the phone’s maker or carrier, the Library of Congress said Monday. The practice, known as “jailbreaking,” has been criticized by Apple and other firms, who say their mobile devices can become destabilized when users download unapproved software. Apple would not comment on whether it would sue the Library of Congress’s copyright office over the changes made to the Digital Millennium Copyright Act. Those changes also allow users to take their mobile phones from one carrier to another with the approval of their new service provider. In a statement, Librarian of Congress James H. Billington said copyright laws are evaluated every three years to ensure that they are keeping up with the way consumers use technology. “The purpose of the proceeding is to determine whether current technologies that control access to copyrighted works are diminishing the ability of individuals to use works in lawful, non-infringing ways,” Billington said.


Apple argues that its approval process for iPhone applications has resulted in a better experience for phone users. “As we’ve said before, the vast majority of customers do not jailbreak their iPhones as this can violate the warranty and can cause the iPhone to become unstable and not work reliably,” the company said in a statement. Some groups, such as the Electronic Frontier Foundation, say users of Apple’s popular smartphone want to be able to switch carriers or obtain applications that aren’t in Apple’s iTunes applications store. The EFF filed a request to the Library of Congress for some of the changes. The organization argued that the closed iTunes model didn’t protect copyrights but restricted consumer choice.


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