Today’s published Commons order papers contain a question to be answered by a minister later this week. The Guardian is prevented from identifying the MP who has asked the question, what the question is, which minister might answer it, or where the question is to be found.
The Guardian is also forbidden from telling its readers why the paper is prevented – for the first time in memory – from reporting parliament. Legal obstacles, which cannot be identified, involve proceedings, which cannot be mentioned, on behalf of a client who must remain secret.
It sounds tremendously exciting, doesn’t it?
Anyway, the House of Commons Question Book is publically available. There are thousands of them (questions, that is). There were 2,344 outstanding questions as of Monday 12 October 2009 (see here).
But the question in question, as it were, is apparantly this one, which as I type has been shifted forward to Wednesday 14 October 2009 (I have no idea, but suspect that unanswered questions get shuffled forward as necessary, so it’s best to start at the root Question Book if you’re searching for something):
(292409)
Paul Farrelly (Newcastle-under-Lyme): To ask the Secretary of State for Justice, what assessment he has made of the effectiveness of legislation to protect (a) whistleblowers and (b) press freedom following the injunctions obtained in the High Court by (i) Barclays and Freshfields solicitors on 19 March 2009 on the publication of internal Barclays reports documenting alleged tax avoidance schemes and (ii) Trafigura and Carter Ruck solicitors on 11 September 2009 on the publication of the Minton report on the alleged dumping of toxic waste in the Ivory Coast, commissioned by Trafigura.
I didn’t figure the question out myself. I got it from Alex Massie at The Spectator. Alex also helpfully points us to the Guardian’s reports from Wed 16 September 2009 on Trafigura and their exploits in the Ivory Coast [Main article, supporting article, 8MB pdf of the emails] and highlights the fact that Trafigura is now a trending topic on Twitter.
While I join the general expressions of anger at the gagging of the press over parliamentary proceedings, I also note that this will ultimately serve to help The Guardian’s reputation enormously.
When ordering a latte from a British caff, remember that their unit of measure for barista-applied sugar is much larger than the little packets you get at specialist coffee shops.
The Murdoch Empire ™ has decided to pull the plug on their free newspaper for the going-home-on-the-tube market, The London Paper, after making a pre-tax loss of £12.9 million in the year to June 2008.
That they’re hemorrhaging cash right now is no surprise since advertising expenditure is strongly pro-cyclical — it plummets in a recession and explodes in a boom. To some extent, they’ve been unfortunate that the credit crisis and it’s associated advertising caution has been around for two of their three years and obviously the competition with Associated Newspapers’ London Lite won’t have helped. Nevertheless, I’m not sure that it was ever a viable business model and frankly, even if it were, I’m glad that they’ve folded. Ian Burrell puts it mildly when he says:
For the past three years, the sight of purple-and-mauve jacketed vendors thrusting free newspapers into the hands of office workers as they headed home from work has been a familiar feature in the capital.
“Thrusting” is the correct word to use, but I would prefix it with a few choice adverbs, “obnoxiously” being the most polite. The vendors are seriously rude. They make a deliberate point of blocking traffic and getting in your face. It is genuinely infuriating — I find myself wanting to scream at them — but I know that they’re just doing what they’re told to do.
On their way home from work, nobody cares which of the free papers they read. Since the papers themselves are desperate to get your eyeballs, the ideal economic situation would therefore be for them to pay you to choose them. But that’s impossible on a practical level, so instead they end up forcing a non-monetary cost on everybody by slowing everyone down and annoying the hell out of people.
Since Associated Newspapers still have a 24% stake in the Evening Standard, this will probably mean the end of the afternoon freesheet (I imagine that the Metro in the morning will stick around), but even if it doesn’t, it will almost certainly mean the end of the obnoxious vendors forcing themselves on people. They’ll just stick the London Lite in the same bins that they use for the Metro instead. Presumably those vendors are being paid (minimum wage, I would guess) and so getting rid of them might make it narrowly profitable if there is just one afternoon freesheet.
On Saturday night, just before midnight, Daniela and I were roped into playing a game of cricket on Sunday for a team of ex-pats. Well … “roped” is the wrong word and much too unfair: we signed up with enthusiasm. No, that’s not quite right, either. Dani gets incredibly excited by this sort of random adventure and she signed up with genuine enthusiasm. It was inevitable at that point that I sign up as well (with Australia levelling the Ashes up in Leeds, I did have a patriotic duty to join the fray), but my enthusiasm was buoyed somewhat by the wine and had a slightly greasy patina of apprehension. I hadn’t played a proper game since October 1992 when I was in my high school team and Dani had only played a couple of games of backyard cricket with the dog chasing the ball. Still, we were assured that experience and ability were by no means necessary, so we agreed con gusto.
We only got to bed at 3am on Sunday (it was a big night – a friend was leaving London), but managed to wake in time to gather with the rest of the team in central London at 11:30am, coffee in hand. To the casual eye, my whites may have looked a bit like an old pair of khakis supplemented with a borrowed white polo shirt. Dani, of course, was resplendent in white from top to bottom. The team we played for represents a charity and, it turns out, there are charities that offer transportation services to other charities, so we all piled into the mini-bus more usually used for carrying disabled children to be driven for an hour and a half to the interminable maze otherwise known as the Oxfordshire countryside.
We must have spent 40 minutes twisting and turning and silently swearing at the perpetually manic directions of the lady in the SatNav (“Recalculating. After point four miles, turn left, then turn left.”). I was sitting next to our captain – an Indian chap with an easy grin who was about to submit his Ph.D. He alternated between trying to figure out where we were, pouring scorn on the English badminton team for pulling out of the world championships in India and declaring confidently that, as an Australian, I must be a fantastic fielder who would happily throw himself horizontal to stop a boundary. I mumbled something about a bit of practice in the nets before the match and stared anxiously at the six-foot hedges.
We eventually found the Ipsden Cricket Club [Google Maps]. It’s a beautiful ground that backs onto a (recently harvested) wheat field and has a gigantic ash (?) tree down on the long boundary at the western end. The pavilion even has a piece of the original floorboards of the Long Room at Lord’s. The weather was superb, with barely a cloud and a fair breeze coming from the north west. I guess that the temperature would have been in the mid-twenties (Celsius). There were some Red Kites in the sky and quite a few gliders were out for the day.
A couple of the guys padded up and we took turns bowling in the nets. I somehow managed to keep mine in the general direction of the stumps, managed a few yorkers and even clean bowled one of our batsman once. The captain told me that I would bowl in the match and our friend that had invited us expressed some joy that he wouldn’t have to be bowler number five all on his own. I started to pick up some confidence. It was fun. It was relaxed. I didn’t suck.
The game was to be 35 overs each; we fielded first. The Canadian on our team used to play as a catcher in baseball and became the wicket keeper. Dani alternated between Third man and Long on, while I swapped between Point and Mid-wicket. We had two good bowlers, two pretty-good bowlers, and me and my mate who’d invited us. We did pretty well in the first 10 or 11 overs. We got a couple of wickets and they weren’t scoring too quickly (maybe four per over?). I didn’t fumble my first couple of touches of the ball and Dani was enjoying herself.
Then I missed a ball badly. I froze, didn’t get down to it and had to run swearing after the thing only to watch it dribble over the boundary. Not to worry, it was only one mistake and other people were occasionally missing some too. After a couple more overs I was called up to bowl. I was okay in my first over: clearly nervous and not very good, but not obscenely bad either. My second over, however, was a shambles that in hindsight I’m almost oddly proud of. It was chaotic, occasionally dangerous to the batsman and very, very expensive. I was “rested” after that.
My second over also roughly marked the start of our mini collapse. Without a fifth bowler, our two decent guys had to bowl 11 or 12 overs each (the Ipsden team very kindly waived the rule requiring no more than seven overs per bowler) and they started to get tired. I was fading mentally pretty quickly and I missed four or five balls in what turned into a pretty farcical fielding display. I even managed to have my feet slip out from under me on one occasion. Drinks came out after 21 overs and our captain took the time to observe that we were fielding atrociously.
By that point the batsmen had settled in nicely, though and our fielding was rarely the problem. Boundaries, boundaries, everywhere became the order of the day. Poor Dani had to scramble down the embankment past the boundary to hunt for the ball in the bracken on more than one occasion. I was out at Deep cover point and Deep forward leg by then and under instruction to stay on the boundary (not walk in with the bowler). I may not have had the reflexes for the infield, but dammit, I could run around like a mad hare as sweeper. For the last five overs or so, I switched over to the northern side of the field and played Square leg and Deep cover. I managed to stop the three or four balls that came to me, saving a couple of singles and a boundary, so my fielding ended, if not a high note, then at least having recovered a smidgen of self-confidence. Ipsden managed 3 for 236 after 35 overs, with one chap on 101 not out. It had taken three and a half hours.
Our hosts put on quite a spread for the break. Half a dozen types of sandwiches, some chips (“crisps” to the English) and a bunch of delicious sweet tarts and teacakes filled us up mightily with endless cups of tea. The black labrador of the club president happily wandered between us, soaking up the attention. I reminded Dani how to hold the bat (it’s not a natural position for someone new to the game) and we both earnestly hoped that we wouldn’t need to pad up.
Dani’s and my friend opened the batting along with the captain and it shortly became clear that the race was on. I was surprised. Apparantly last year the Ipsden team had gotten our lot all out for only 60. Dani and I ended up sitting and watching a fine batting display as our batters clipped along to seal the win with two balls and six wickets to spare. One of our lads managed a fantastic century and another 74. The sun had started to set by the end and the wind, still fresh, began to chill a little. Jumpers, cups of tea and the dog to the rescue, we were toasty warm through to the end.
It was the last game for our captain, who on top of the win to remember was presented with a bottle of champagne and a first-edition copy of C.L.R. James’s classic, “Beyond a boundary“, by the regular members of the team. We got back to London about 9:30pm and were home by 10. It was an absolutely cracking day. We really enjoyed ourselves and the team was a great bunch of guys. It was, in many ways, the very best sort of day in England.
Now if only I weren’t so stiff the day after that I can barely walk …
One of my friends disagrees with my thoughts on the MP expenses scandal in Britain. I’m not entirely sure, but I believe that part of our difference of opinion starts at a disagreement over what it really means to be a politician.
So here is my question to the world at large (yes, I recognise that it might be a false dichotomy): Is “politician” a job title just like any other, or is being a politician to have some sort of sacred, noble trust? Is there is something more to the role than simply maximising the returns to your constituents or the country as a whole?
Let me propose a thought experiment (for any American’s in the audience, parliament = congress and MP = representative).
Suppose we change the law so that a) voting for your representative to parliament is mandatory; b) each member of parliament represents exactly the same number of people; and c) in addition to electing a representative to parliament, everybody is permitted to vote directly on any matter brought before that parliament. If you choose to vote directly on an issue, then the weight of your representative’s vote is decreased proportionately. In this way, we would have the possibility of anything between 100% pure direct democracy and standard representative democracy, depending on what people choose.
How many people would choose to vote directly on some issues? How many on every issue? Clearly the answer is that we’d have a distribution. Some people would vote directly on everything, some would do so occasionally and some never at all.
So what do we make of that distribution? I’ll grant that I’m thinking like an economist here, but I think it’s a perfectly normal, mundane choice between trade-offs. Should I pay attention to the debate on fishing regulation or should I do something else? Everybody faces a different combination of available options, preferences over those options, incomes and relative prices between those options, so any range of attention to parliament might emerge.
In that situation, choosing to not vote directly is entirely equivalent to taking your shirts to the dry cleaner or hiring a maid to clean your house once a week. It’s an economic decision like any other, which in turn makes “politician” just another service industry job title like “financial adviser” or “maid”.
[Side note: This scenario is currently my ideal. If I could, I’d have MPs paid per parliamentary vote per person represented, with a negative hit to anybody that introduced a bill to parliament so as to discourage frivolous votes.]
Update (1 June ’09): Put another way, why should a backbench opposition MP, who has only an abstract and indirect power over my life, be subject to more stringent ethical standards than the person performing heart surgery on me, who has direct and absolute power over my life?
It’s both spectacular and petty. The fraction of MPs that truly scammed the system is tiny and the scale of the claims for the most part only seems offensive in a recession. It was started by Cameron as a political stunt, but when Torys were implicated he had to take it nuclear or look terrible. The Speaker was culpable, yes, but he was thrown under the bus by Brown all the same. That The Telegraph got the complete list in a leak is more of a story, to my mind.
What style of Speaker will emerge is an interesting question. If it’s another Labour party member, it will be easy to imagine the role moving somewhat in the direction of the Speakers of the lower houses in Australia (where the role is quite partisan) and the USA (where it is extremely partisan). In a parliamentary democracy (Australia, UK) , that will serve to grant the executive more power over the legislature, which is a Bad Thing ™ in my books, as it reduces the ability of the opposition to contribute to the legislative process in any meaningful way.
I’ve occasionally thought that in the event of Australia becoming a republic, the president’s primary constitutional role might simply be to ensure the fair operation of the judicio-political system. So, for example, the president – or their appointee – might be the official Speaker of the House but would not have a vote (even in the event of a tie) and could not introduce legislation.
Of course, having the monarch appoint an independent Speaker of the Commons in the UK would get MPs’ knickers in a collective knot over the sovereignty of parliament. Another reason to be a republic.
John Hempton has an excellent post on valuing the assets on banks’ balance sheets and whether banks are solvent. He starts with a simple summary of where we are:
We have a lot of pools of bank assets (pools of loans) which have the following properties:
The assets sit on the bank’s balance sheet with a value of 90 – meaning they have either being marked down to 90 (say mark to mythical market or model) or they have 10 in provisions for losses against them.
The same assets when they run off might actually make 75 – meaning if you run them to maturity or default the bank will – discounted at a low rate – recover 75 cents in the dollar on value.
The banks are thus under-reserved on an “held to maturity” basis. Heavily under-reserved.
He then gives another explanation (on top of the putting-Humpty-Dumpty-back-together-again idea I mentioned previously) of why the market price is so far below the value that comes out of standard asset pricing:
Before you go any further you might wonder why it is possible that loans that will recover 75 trade at 50? Well its sort of obvious – in that I said that they recover 75 if the recoveries are discounted at a low rate. If I am going to buy such a loan I probably want 15% per annum return on equity.
The loan initially yielded say 5%. If I buy it at 50 I get a running yield of 10% – but say 15% of the loans are not actually paying that yield – so my running yield is 8.5%. I will get 75-80c on them in the end – and so there is another 25cents to be made – but that will be booked with an average duration of 5 years – so another 5% per year. At 50 cents in the dollar the yield to maturity on those bad assets is about 15% even though the assets are “bought cheap”. That is not enough for a hedge fund to be really interested – though if they could borrow to buy those assets they might be fun. The only problem is that the funding to buy the assets is either unavailable or if available with nasty covenants and a high price. Essentially the 75/50 difference is an artefact of the crisis and the unavailability of funding.
The difference between the yield to maturity value of a loan and its market value is extremely wide. The difference arises because you can’t eaily borrow to fund the loans – and my yield to maturity value is measured using traditional (low) costs of funds and market values loans based on their actual cost of funds (very high because of the crisis).
The rest of Hempton’s piece speaks about various definitions of solvency, whether (US) banks meet each of those definitions and points out the vagaries of the plan recently put forward by Geithner. It’s all well worth reading.
One of the other important bits:
Few banks would meet capital adequacy standards. Given the penalty for even appearing as if there was a chance that you would not meet capital adequacy standards is death (see WaMu and Wachovia) and this is a self-assessed exam, banks can be expected not to tell the truth.
(It was Warren Buffett who first – at least to my hearing – described financial accounts as a self-assessed exam for which the penalty for failure is death. I think he was talking about insurance companies – but the idea is the same. Truth is not expected.)
Okay. First, a correction: There is (of course) a market for CDOs and other such derivatives at the moment. You can sell them if you want. It’s just that the prices that buyers are willing to pay is below what the holders of CDOs are willing to accept.
So, here are a few thoughts on estimating the underlying, or “fair,” value of a CDO:
Method 1. Standard asset pricing considers an asset’s value to be the sum of the present discounted value of all future income that it generates. We discount future income because:
Inflation will mean that the money will be worth less in the future, so in terms of purchasing power, we should discount it when thinking of it in today’s terms.
Even if there were no inflation, if we got the money today we could invest it elsewhere, so we need to discount future income to allow for the (lost) opportunity cost if current investment options generate a higher return than what the asset is giving us.
Even if there were no inflation and no opportunity cost, there is a risk that we won’t receive the future money. This is the big one when it comes to valuing CDOs and the like.
Even if there’s no inflation, no opportunity cost and no risk of not being paid, a positive pure rate of time preference means that we’d still prefer to get our money today.
The discounting due to the risk of non-payment is difficult to quantify because of the opacity of CDOs. The holders of CDOs don’t know exactly which mortgages are at the base of their particular derivative structure and even if they did, they don’t know the household income of each of those borrowers. Originally, they simply trusted the ratings agencies, believing that something labeled “AAA” would miss payment with probability p%, something “AA” with probability q% and so on. Now that the ratings handed out have been shown to be so wildly inappropriate, investors in CDOs are being forced to come up with new numbers. This is where Knightian Uncertainty is coming into effect: Since even the risk is uncertain, we are in the Rumsfeldian realm of unknown unknowns.
Of course we do know some things about the risk of non-payment. It obviously rises as the amount of equity a homeowner has falls and rises especially quickly when they are underwater (a.k.a. have negative equity (a.k.a. they owe more than the property is worth)). It also obviously rises if there have been a lot of people laid off from their jobs recently (remember that the owner of a CDO can’t see exactly who lies at the base of the structure, so they need to think about the probability that whoever it is just lost their job).
The first of those is the point behind this idea from Chris Carroll out of NYU: perhaps the US Fed should simply offer insurance against falls in US house prices.
The second of those will be partially addressed in the future by this policy change announced recently by the Federal Housing Finance Agency:
[E]ffective with mortgage applications taken on or after Jan. 1, 2010, Freddie Mac and Fannie Mae are required to obtain loan-level identifiers for the loan originator, loan origination company, field appraiser and supervisory appraiser … With enactment of the S.A.F.E. Mortgage Licensing Act, identifiers will now be available for each individual loan originator.
“This represents a major industry change. Requiring identifiers allows the Enterprises to identify loan originators and appraisers at the loan-level, and to monitor performance and trends of their loans,” said Lockhart [, director of the FHFA].
It’s only for things bought by Fannie and Freddie and it’s only for future loans, but hopefully this will help eventually.
Method 2. The value of different assets will often necessarily covary. As a absurdly simple example, the values of the AAA-rated and A-rated tranches of a CDO offering must provide upper and lower bounds on the value of the corresponding AA-rated tranche. Statistical estimation techniques might therefore be used to infer an asset’s value. This is the work of quantitative analysts, or “quants.”
Of course, this sort of analysis will suffer as the quality of the inputs falls, so if some CDOs have been valued by looking at other CDOs and none of them are currently trading (or the prices of those trades are different to the true values), then the value of this analysis correspondingly falls.
Method 3. Borrowing from Michael Pomerleano’s comment in rely to Christopher Carroll’s piece, one extreme method of valuing CDOs is to ask at what price a distressed debt (a.k.a. vulture) fund would be willing to buy them at with the intention of merging all the CDOs and other MBSs for a given mortgage pool so that they could then renegotiate the debt with the underlying borrowers (the people who took out the mortgages in the first place). This is, in essense, a job of putting Humpty Dumpty back together again. Gathering all the CDOs and other MBSs for a given pool of mortgage assets will take time. Identifying precisely those mortgage assets will also take time. There will be sizable legal costs. Some holders of the lower-rated CDOs may also refuse to sell if they realise what’s happening, hoping to draw out some rent extraction from the fund. The price that the vulture fund would offer on even the “highly” rated CDOs would therefore be very low in order to ensure that they made a profit.
It would appear that banks and other holders of CDOs and the like are using some combination of methods one and two to value their assets, while the bid-prices being offered by buyers are being set by the logic of something like method three. Presumably then, if we knew the banks’ private valuations, we might regard the difference between them and the market prices as the value of the uncertainty.
There’s a perennial idea of proposing Northern Ireland as a model of how progress might be achieved in the fighting between Israelis and Palestinians. After reading this recent posting by Megan McArdle, one of the difficulties in such an idea becomes plain.
In Northern Ireland, both sides had moral, if not logistical, support from larger powers that were themselves allies. So while the nationalists found it difficult to trust the British government, they would generally trust the US government, who in turn trusted the British government, while the same chain applied in reverse for the loyalists.
By contrast, while Israel receives moral and logistical support from the USA, none of America’s close allies really comes close to giving the Palestinian cause at large, let alone Hamas in particular, the sort of tacit support that America gave the Irish nationalists.
Important: Much of this post is mistaken (i.e. wrong). It’s perfectly possible for America to have an M1 money multiplier of less than one even if they were an entirely closed economy. My apologies. I guess that’s what I get for clicking on “Publish” at one in the morning. A more sensible post should be forthcoming soon. I’m leaving this here, with all its mistakes, for the sake of completeness and so that people can compare it to my proper post whenever I get around to it.
Update: You can (finally) see the improved post here. You’ll probably still want to refer back to this one for the graphs.
At the time of writing, the latest figure (for 17 December 2008) was 0.954. That’s fascinating, because it should be impossible. As far as I can tell, it has been made possible by the wonders of financial globalisation and was triggered by a decision the US Federal Reserve made at the start of October 2008. More importantly, it means that America is paying to recapitalise some banks in other countries and while that will help them in the long run, it might be exacerbating the recessions in those countries in the short run.
Money is a strange thing. One might think it would be easy to define (and hence, to count), but there is substantial disagreement of what qualifies as money and every central bank has their own set of definitions. In America the definitions are (loosely):
M0 (the monetary base) = Physical currency in circulation + reserves held at the Federal Reserve
M1 = Physical currency in circulation + deposit (e.g. checking) accounts at regular banks
M2 = M1 + savings accounts
They aren’t entirely correct (e.g. M1 also includes travelers cheques, M2 also includes time/term deposits, etc.), but they’ll do for the moment [you can see a variety of countries’ definitions on Wikipedia].
The M1 Money Multiplier is the ratio of M1 to M0. That is, M1 / M0.
In the normal course of events, regular banks’ reserves at the central bank are only a small fraction of the deposits they hold. The reason is simple: The central bank doesn’t pay interest on reserves, so they’d much rather invest (i.e. lend) the money elsewhere. As a result, they only keep in reserve the minimum that they’re required to by law.
We therefore often think of M1 as being defined as: M1 = M0 + deposits not held in reserve.
You can hopefully see why it should seem impossible for the M1 money multiplier to fall below 1. M1 / M0 = (M0 + non-reserve deposits) / M0 = 1 + (non-reserve deposits / M0). Since the non-reserve deposits are always positive, the ratio should always be greater than one. So why isn’t it?
Step 1 in understanding why is this press release from the Federal Reserve dated 6 October 2008. Effective from 1 October 2008, the Fed started paying interest on both required and excess reserves that regular banks (what the Fed calls “depository institutions”) held with it. The interest payments for required reserves do not matter here, since banks had to keep that money with the Fed anyway. But by also paying interest on excess reserves, the Fed put a floor under the rate of return that banks demanded from their regular investments (i.e. loans).
The interest rate paid on excess returns has been altered a number of times (see the press releases on 22 Oct, 5 Nov and 16 Dec), but the key point is this: Suppose that the Fed will pay x% on excess reserves. That is a risk-free x% available to banks if they want it, while normal investments all involve some degree of risk. US depository institutions suddenly had a direct incentive to back out of any investment that had a risk-adjusted rate of return less than x% and to put the money into reserve instead, and boy did they jump at the chance. Excess reserves have leapt tremendously:
Excess Reserves of Depository Institutions (USA, Accessed: 7 Jan 2009)
Adjusted Monetary Base (USA, Accessed: 7 Jan 2009)
If we think of M1 as being M1 = M0 + non-reserve deposits, then we would have expected M1 to increase by similar amounts (a little under US$800 billion). In reality, it’s only risen by US$200 billion or so:
M1 Money Stock (USA, Accessed: 7 Jan 2009)
So where have the other US$600 billion come from? Other countries.
Remember that the real definition of M1 is M1 = Physical currency in circulation + deposit accounts. The Federal Reserve, when calculating M1, only looks at deposits in America.
By contrast, the definition of the monetary base is M0 = Physical currency in circulation + reserves held at Federal Reserve. The Fed knows that those reserves came from American depository institutions, but it has no idea where they got it from.
Consider Citibank. It collects deposits from all over the world, but for simplicity, imagine that it only collects them in America and Britain. Citibank-UK will naturally keep a fraction of British deposits in reserve with the Bank of England (the British central bank), but it is free to invest the remainder wherever it likes, including overseas. Since it also has an arm in America that is registered as a depository institution, putting that money in reserve at the Federal Reserve is an option.
That means that, once again, if Citibank-UK can’t get a risk-adjusted rate of return in Britain that is greater than the interest rate the Fed is paying on excess reserves, it will exchange the British pounds for US dollars and put the money in reserve at the Fed. The only difference is that the risk will now involve the possibility of exchange-rate fluctuations.
It’s not just US-based banks with a presence in other countries, though. Any non-American bank that has a branch registered as a depository institution in America (e.g. the British banking giant, HSBC) has the option of changing their money into US dollars and putting them in reserve at the Fed.
So what does all of that mean? I see two implications:
Large non-American banks that have American subsidiaries are enjoying the free money that the Federal Reserve is handing out. By contrast, smaller non-American banks that do not have American subsidiaries are not able to access the Federal Reserve system and so are forced to find other investments.
The US$600+ billion of foreign money currently parked in reserve at the Fed had to come out of the countries of origin, meaning that it is no longer there to stimulate their economies. By starting to pay interest on excess reserves, the US Federal Reserve effectively imposed an interest rate increase on other countries.
